Federal Register, Volume 77 Issue 118 (Tuesday, June 19, 2012)[Federal Register Volume 77, Number 118 (Tuesday, June 19, 2012)]
[Rules and Regulations]
[Pages 36611-36726]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-12746]
[[Page 36611]]
Vol. 77
Tuesday,
No. 118
June 19, 2012
Part II
Commodity Futures Trading Commission
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17 CFR Parts 1, 16, and 38
Core Principles and Other Requirements for Designated Contract Markets;
Final Rule
Federal Register / Vol. 77, No. 118 / Tuesday, June 19, 2012 / Rules
and Regulations
[[Page 36612]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 16, and 38
RIN 3038-AD09
Core Principles and Other Requirements for Designated Contract
Markets
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is adopting new and amended rules, guidance, and acceptable
practices to implement certain statutory provisions enacted by Title
VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act
(``Dodd-Frank Act''). The final rules, guidance and acceptable
practices, which apply to the designation and operation of contract
markets, implement the Dodd-Frank Act's new statutory framework that,
among other things, amends section 5 of the Commodity Exchange Act
(``the Act'' or ``CEA'') concerning designation and operation of
contract markets, and adds a new CEA section 2(h)(8) to mandate the
listing, trading and execution of certain swaps on designated contract
markets (``DCMs'').
DATES: Effective date: The rules will become effective August 20, 2012.
Compliance date: The compliance date for contract markets that have
obtained designation on, or prior to, the date of publication of this
release: Designated contract markets must comply with the rules adopted
in this release (except Sec. 38.151(a)) by October 17, 2012; and must
comply with Sec. 38.151(a) in accordance with the timeline described
in SUPPLEMENTARY INFORMATION.
FOR FURTHER INFORMATION CONTACT: Nancy Markowitz, Deputy Director, 202-
418-5453, [email protected], Nadia Zakir, Special Counsel, 202-418-
5720, [email protected], or Aaron Brodsky, Attorney-Advisor, 202-418-
5349, [email protected], Division of Market Oversight, Commodity
Futures Trading Commission, Three Lafayette Centre, 1155 21st Street
NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Title VII of the Dodd-Frank Act
B. The Dodd-Frank Act Amendments Applicable to Designated
Contract Markets
II. Final Rules
A. Repeal of Designation Criteria
B. Adoption of Rules and Revised Guidance and Acceptable
Practices
C. General Regulations (Subpart A)
1. Sec. 38.1-Scope
2. Sec. 38.2-Exempt Provisions
3. Sec. 38.3--Procedures for Designation
4. Sec. 38.4--Procedures for Listing Products and Implementing
Designated Contract Market Rules
5. Sec. 38.5--Information Relating to Contract Market
Compliance
6. Sec. 38.7--Prohibited Use of Data Collected for Regulatory
Purposes
7. Sec. 38.8--Listing of Swaps on a Designated Contract Market
8. Sec. 38.9--Boards of Trade Operating Both a Designated
Contract Market and a Swap Execution Facility
9. Sec. 38.10--Reporting of Swaps Traded on a Designated
Contract Market
D. Core Principles
1. Subpart B--Designation as Contract Market
2. Subpart C--Compliance With Rules
i. Sec. 38.150--Core Principle 2
ii. Sec. 38.151--Access Requirements
iii. Sec. 38.152--Abusive Trading Practices Prohibited
iv. Sec. 38.153--Capacity to Detect and Investigate Rule
Violations
v. Sec. 38.154--Regulatory Services Provided by a Third Party
vi. Sec. 38.155--Compliance Staff and Resources
vii. Sec. 38.156--Automated Trade Surveillance System
viii. Sec. 38.157--Real-Time Market Monitoring
ix. Sec. 38.158--Investigations and Investigation Reports
x. Sec. 38.159--Ability to Obtain Information
xi. Sec. 38.160--Additional Sources for Compliance
3. Subpart D--Contracts Not Readily Subject to Manipulation
4. Subpart E--Prevention of Market Disruption
i. Sec. 38.251--General Requirements
ii. Sec. 38.252--Additional Requirements for Physical-Delivery
Contracts
iii. Sec. 38.253--Additional Requirements for Cash-Settled
Contracts
iv. Sec. 38.254--Ability to Obtain Information
v. Sec. 38.255--Risk Controls for Trading
vi. Sec. 38.256--Trade Reconstruction
vii. Sec. 38.257--Regulatory Service Provider
viii. Sec. 38.258--Additional Sources for Compliance
5. Subpart F--Position Limitations or Accountability
6. Subpart G--Emergency Authority
7. Subpart H--Availability of General Information
i. Sec. 38.401(a)--General
ii. Sec. 38.401(b)--Accuracy Requirement
iii. Sec. 38.401(c)--Notice of Regulatory Submissions
iv. Sec. 38.401(d)--Rulebook
8. Subpart I--Daily Publication of Trading Information
9. Subpart J--Execution of Transactions
10. Subpart K--Trade Information
i. Sec. 38.551--Audit Trail Required
ii. Sec. 38.552--Elements of an Acceptable Audit Trail Program
iii. Sec. 38.553--Enforcement of Audit Trail Requirements
11. Subpart L--Financial Integrity of Transactions
i. Sec. 38.601--Mandatory Clearing
ii. Sec. 38.602--General Financial Integrity
iii. Sec. 38.603--Protection of Customer Funds
iv. Sec. 38.604--Financial Surveillance
v. Sec. 38.605--Requirements for Financial Surveillance Program
vi. Sec. 38.606--Financial Regulatory Services Provided by a
Third Party
vii. Sec. 38.607--Direct Access
12. Subpart M--Protection of Markets and Market Participants
i. Sec. 38.651--Additional Sources for Compliance
13. Subpart N--Disciplinary Procedures
i. Sec. 38.701--Enforcement Staff
ii. Sec. 38.702--Disciplinary Panels
iii. Sec. 38.703--Review of Investigation Report
iv. Sec. 38.704--Notice of Charges
v. Sec. 38.705--Right to Representation
vi. Sec. 38.706--Answer to Charges
vii. Sec. 38.707--Admission or Failure To Deny Charges
viii. Sec. 38.708--Denial of Charges and Right to Hearing
ix. Sec. 38.709--Settlement Offers
x. Sec. 38.710--Hearings
xi. Sec. 38.711--Decisions
xii. Sec. 38.712--Right To Appeal
xiii. Sec. 38.713--Final Decisions
xiv. Sec. 38.714--Disciplinary Sanctions
xv. Sec. 38.715--Summary Fines
xvi. Sec. 38.716--Emergency Disciplinary Actions
14. Subpart O--Dispute Resolution
15. Subpart P--Governance Fitness Standards
16. Subpart Q--Conflicts of Interest
17. Subpart R--Composition of Governing Boards of Contract
Markets
18. Subpart S--Recordkeeping
i. Sec. 38.951--Additional Sources for Compliance
19. Subpart T--Antitrust Considerations
20. Subpart U--System Safeguards
i. Sec. 38.1051--General Requirements
21. Subpart V--Financial Resources
i. Sec. 38.1100(a)--Core Principle 21, and Sec. 38.1101(a) and
(c)--General Rule and Computation of Financial Resources Requirement
ii. Sec. 38.1101(b)--Types of Financial Resources
iii. Sec. 38.1101(d)--Valuation of Financial Resources
iv. Sec. 38.1101(e)--Liquidity of Financial Resources
v. Sec. 38.1101(f)--Reporting Requirements
22. Subpart W--Diversity of Boards of Directors
23. Subpart X--Securities and Exchange Commission
i. Sec. 38.1200 (Core Principle 23), Sec. 38.1201 (Additional
Sources for Compliance), and Guidance in Appendix B.
III. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Cost Benefit Considerations
IV. Text of Final Rules
I. Background
A. Title VII of the Dodd-Frank Act
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street
[[Page 36613]]
Reform and Consumer Protection Act.\1\ Title VII of the Dodd-Frank Act
\2\ amended the CEA\3\ to establish a comprehensive, new regulatory
framework for swaps and 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; (2) imposing clearing and trade
execution requirements on standardized derivative products; (3)
creating robust 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 Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010) (``Dodd-Frank Act'').
\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. (amended 2010).
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B. The Dodd-Frank Act Amendments Applicable to Designated Contract
Markets
In this final rulemaking, the Commission is establishing the
regulatory obligations that each DCM must meet in order to comply with
section 5 of the CEA, as amended by the Dodd-Frank Act, initially upon
designation and thereafter on an ongoing basis.
Section 735 of the Dodd-Frank Act amended section 5 of the CEA
pertaining to the designation and operation of contract markets, by:
(i) Eliminating the eight criteria that must be met for designation as
a contract market, contained in former section 5(b) of the CEA; (ii)
amending most of the core principles, including incorporating most of
the substantive elements of the former designation criteria, and
requiring that all DCMs demonstrate compliance with each of the core
principles as a condition of obtaining and maintaining designation as a
contract market; and (iii) adding five new core principles, including
Core Principle 13 (Disciplinary Procedures), Core Principle 20 (System
Safeguards), Core Principle 21 (Financial Resources), Core Principle 22
(Diversity of Boards of Directors), and Core Principle 23 (Securities
and Exchange Commission).\4\
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\4\ New Core Principle 13 is verbatim of former Designation
Criterion 6.
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In addition, section 723(a)(3) of the Dodd-Frank Act added section
2(h)(8) of the CEA to require, among other things, that swaps that are
required to be cleared must be executed either on a DCM or on a Swap
Execution Facility (``SEF''),\5\ unless no DCM or SEF makes the swap
``available to trade.'' \6\ Section 5h(a)(1) of the CEA, as amended by
the Dodd-Frank Act, also prohibits any person from operating a facility
for the trading and processing of swaps unless the facility is
registered as a SEF or a DCM. Accordingly, unless otherwise specified
in this release, each of the 23 core principles and the final
implementing regulations, guidance and acceptable practices, apply to
all ``contracts'' listed on a DCM, which will include swaps, futures
and options contracts. The rules adopted in this release also implement
relevant provisions related to the trading and execution of swaps on
DCMs.
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\5\ The Commission proposed rules governing the registration and
operation of SEFs in a separate, rulemaking titled ``Core Principles
and Other Requirements for Swap Execution Facilities.'' 76 FR 1214,
Jan. 7, 2011. The core principles applicable to DCMs pursuant to
section 5 of the Act and the core principles applicable to swap
execution facilities pursuant to section 5h of the Act include, in a
number of instances, similar or identical language. Although the
Commission's interpretation of specific language in section 5 of the
Act may inform its interpretation of similar or identical language
in section 5h of the Act, and vice versa, the Commission may
interpret the core principles applicable to each category of
registered entity in light of that category's unique market
characteristics and regulatory functions and responsibilities.
\6\ See section 723(a) of the Dodd-Frank Act. The Commission
separately proposed rules implementing the ``made available to
trade'' mandate. See 76 FR 77728, Dec. 14, 2011.
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On December 22, 2010, the Commission published proposed regulations
to implement the statutory provisions of the Dodd-Frank Act relevant to
the designation and operation of DCMs (``DCM NPRM''), under part 38 of
the Commission's regulations.\7\
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\7\ 75 FR 80572, Dec. 22, 2010 (``DCM NPRM''). The DCM NPRM also
proposed revisions to related regulations under parts 1 and 16.
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The proposed rulemaking was subject to an initial 60-day comment
period, which closed on February 22, 2011. The comment period was
subsequently reopened on two separate occasions, each time for an
additional 30 days.\8\ The Commission received numerous written
comments from members of the public, and Commission staff participated
in several meetings with market participants, including representatives
of both currently-designated and prospective contract markets.\9\
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\8\ See 76 FR 14825, Mar. 18, 2011; see also 76 FR 25274, May 4,
2011.
\9\ The Commission received comment letters from numerous
parties, including the following: ACM Capital Management; Alice
Corporation; Alternative Investment Management Association; American
Bankers Association and ABA Securities Association; American Gas
Association; Argus Media, Inc. (``Argus''); Better Markets, Inc.
(``Better Markets''); BJ D'Milli; BlackRock, Inc. (``BlackRock'');
Bloomberg; CBOE Futures Exchanges (``CFE''); CME Group Inc.
(``CME'') (CME's comments were submitted on behalf of its four DCMs:
the Chicago Mercantile Exchange, Inc., the Board of Trade of the
City of Chicago, Inc., the New York Mercantile Exchange, Inc., and
the Commodity Exchange, Inc.); Citadel; Committee on Capital Markets
Regulation; Committee on Futures and Derivatives Regulation of the
New York City Bar Association; DC Energy; The Depository Trust &
Clearing Corporation; East Coast Petroleum; ELX Futures, L.P.
(``ELX''); Eris Exchange, LLC (``Eris''); Electric Trade
Association; FIA/FSR/IIB/IRI/ISDA/SIFMA/US Chamber of Commercial
(jointly); Green Exchange LLC (``GreenX''); ICAP;
IntercontinentalExchange, Inc. (``ICE'') (ICE's comments were
submitted on behalf of its four regulated futures exchanges: ICE
Future US, Chicago Climate Futures Exchange, ICE Futures Europe, and
ICE Futures Canada); International Swaps and Derivatives Association
(``ISDA''); Kansas City Board of Trade (``KCBT''); Markit;
MarkitSERV; Minneapolis Grain Exchange, Inc. (``MGEX''); Noble
Energy; NYSE Liffe US LLC (``NYSE Liffe''); Nodal Exchange, LLC
(``Nodal''); Todd Petzel; OneChicago LLC Futures Exchange (``OCX'');
Swaps and Derivatives Market Association; Tradeweb; Trading
Technologies International, Inc. (``Trading Technologies'');
Wholesale Markets Brokers' Association; Working Group of Commercial
Energy Firms (Hunton and Williams); and joint letter from CME, NYSE
Liffe, GreenX, Eris Exchange, CBOE Futures Exchange, KCBT and MGEX
(``CME Joint Comment Letter''). A number of comment letters solely
addressed the implementation phasing for Dodd-Frank rulemakings.
Those comments are outside the scope of this rulemaking and are more
appropriate to the recent rulemaking pertaining to ``Swap
Transaction Compliance and Implementation Schedule: Clearing and
Trade Execution Requirements under section 2(h) of the CEA.'' See 76
FR 58186, Sep. 20, 2011.
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In this notice of final rulemaking, the Commission is adopting many
of the proposed rules, guidance, and acceptable practices. However, as
a result of the written comments received and dialogue with market
participants, the Commission has revised and/or eliminated a number of
regulations that were proposed in the DCM NPRM, and in a number of
instances, has codified guidance and/or acceptable practices in lieu of
the proposed rules.
The Commission also received a number of comments pertaining to the
costs and/or benefits of certain proposed regulations. The Commission
has undertaken an extensive review of the costs and benefits of the
regulations being adopted in this release pursuant to section 15(a) of
the CEA,\10\ as is further discussed in the cost benefit consideration
section of this final rulemaking. As discussed in that section, the
Commission has determined that the final rules appropriately balance
the costs and benefits associated with oversight of DCMs pursuant to
the
[[Page 36614]]
CEA, as amended by the Dodd-Frank Act.
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\10\ 7 U.S.C. 19.
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The Commission is hereby adopting final regulations to implement
section 5 of the CEA, as well as the requirements of sections 2(h)(8)
and 5h(a)(1) of the CEA, as amended by the Dodd-Frank Act, as
applicable to DCMs. The final regulations will eliminate the guidance
on compliance with the designation criteria for DCMs, implement new and
revised regulations for the core principles, and codify certain
requirements and practices that have evolved over the years and are
commonly accepted in the industry.
The final regulations adopted herein will become effective 60 days
after publication in the Federal Register. Contract markets that have
obtained designation prior to or at the time of the publication of this
release must comply with the new and revised rules adopted in this
release, except Sec. 38.151(a), within 60 days of the effective date
of this release; and must comply with Sec. 38.151(a) in accordance
with the timeline described in the discussion of that rule below.
II. Final Rules
A. Repeal of Designation Criteria
Section 735 of the Dodd-Frank Act eliminated the eight DCM
designation criteria in former CEA section 5(b), and largely
incorporated the substance of those criteria into the core principles.
Accordingly, the Commission is eliminating the guidance on compliance
with the designation criteria for DCMs contained in appendix A to part
38.\11\
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\11\ As proposed in the DCM NPRM, appendix A to part 38 will
contain the application form for contract market designation.
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B. Adoption of Rules and Revised Guidance and Acceptable Practices
To implement section 735 of the Dodd-Frank Act, the Commission
proposed a number of new and revised rules, guidance, and acceptable
practices to implement the new and revised core principles. As
described in the DCM NPRM, the Commission evaluated the preexisting
regulatory framework for overseeing DCMs, which consisted largely of
guidance and acceptable practices, in order to update those provisions
and to determine which core principles would benefit from having new or
revised derivative regulations. Based on that review, and in view of
the Dodd-Frank Act's amendments to section 5(d)(1) of the CEA,\12\
which specifically provides the Commission with discretion to
determine, by rule or regulation, the manner in which boards of trade
comply with the core principles, the Commission proposed revised
guidance and acceptable practices for some core principles and, for
several core principles, proposed to codify rules in lieu of guidance
and acceptable practices.\13\
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\12\ Former Core Principle 1 stated, among other things, that
boards of trade ``shall have reasonable discretion in establishing
the manner in which they comply with the core principles.'' This
``reasonable discretion'' provision underpinned the Commission's use
of core principle guidance and acceptable practices. Section 735 of
the Dodd-Frank Act amended this provision to include the proviso
that ``[u]nless otherwise determined by the Commission by rule or
regulation * * *,'' boards of trade shall have reasonable discretion
in establishing the manner in which they comply with the core
principles. See 7 U.S.C. 7(d)(1)(amended 2010).
\13\ Guidance provides DCMs and DCM applicants with contextual
information regarding the core principles, including important
concerns which the Commission believes should be taken into account
in complying with specific core principles. In contrast, the
acceptable practices are more specific than guidance and provide
examples of how DCMs may satisfy particular requirements of the core
principles; they do not, however, establish mandatory means of
compliance. Acceptable practices are intended to assist DCMs by
establishing non-exclusive safe harbors. The safe harbors apply only
to compliance with specific aspects of the core principle, and do
not protect the contract market with respect to charges of
violations of other sections of the CEA or other aspects of the core
principle.
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Summary of Comments
The Commission received a number of comments generally pertaining
to the proposed codification of rules in lieu of guidance and/or
acceptable practices. Several commenters contended that the principles-
based regime has permitted the U.S. futures markets to prosper and keep
pace with rapidly changing technology and market needs, and that a
rules-based regime will stifle growth, innovation, and competition.\14\
Others noted that the futures markets' resilience throughout the
financial crisis is evidence in support of the effectiveness of a
principles-based regime.\15\ Commenters also argued that the
prescriptive nature of the rules will result in increased costs for
DCMs and for the Commission \16\ and that current industry best
practices are subject to change and are only able to evolve through
continuous improvement and innovation, which is only possible under a
flexible regime.\17\ Several commenters provided comments on the
codification of specific rules in lieu of guidance and/or acceptable
practices, which are addressed below, in the discussion of the
respective rules.
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\14\ CME Comment Letter at 3-4 (Feb. 22, 2011); Eris Comment
Letter at 1-2 (Feb. 22, 2011); GreenX Comment Letter at 1 (Feb. 22,
2011); ICE Comment Letter at 3 (Feb. 22, 2011); KCBT Comment Letter
at 1, 9 (Feb. 22, 2011).
\15\ CME Comment Letter at 3 (Feb. 22, 2011); ICE Comment Letter
at 2 (Feb. 22, 2011); KCBT Comment Letter at 9 (Feb. 22, 2011); Eris
Comment Letter at 3 (June 3, 2011).
\16\ CME Comment Letter at 3 (Feb. 22, 2011); GreenX Comment
Letter at 2 (Feb. 2, 2011); MGEX Comment Letter at 2 (Feb. 22,
2011).
\17\ CME Comment Letter at 3 (Feb. 22, 2011); GreenX Comment
Letter at 2, 11 (Feb. 22, 2011).
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Discussion
This final rulemaking largely adopts the framework of rules,
guidance and acceptable practices that was proposed in the DCM NPRM,
with certain substantive revisions to the regulations, as described in
this release. For several core principles, the Commission is
maintaining the rules, guidance and acceptable practices, as proposed,
with appropriate revisions arising from the Commission's consideration
of comments. In several instances, this final rulemaking converts
proposed rules to guidance and/or acceptable practices for various DCM
compliance practices.
In determining whether to codify a compliance practice in the form
of a rule or guidance/acceptable practice, the Commission was guided by
whether the practice consisted of a commonly-accepted industry
practice. Where there is a standard industry practice that the
Commission has determined to be an acceptable compliance practice, the
Commission believes that the promulgation of clear-cut regulations will
provide greater legal certainty and transparency to DCMs in determining
their compliance obligations, and to market participants in determining
their obligations as DCM members, and will facilitate the enforcement
of such provisions. Several of the rules adopted in this notice of
final rulemaking largely codify practices that are commonly accepted in
the industry and are currently being undertaken by most, if not all,
DCMs.
In the context of each individual rule, the Commission also was
guided by comments that provided a basis for greater flexibility or, in
some instances, for greater specificity, in respect to the stated
compliance obligation.
In addition, the Commission's determination to codify certain
compliance practices as rules, rather than as guidance/acceptable
practices, is based on its long experience in regulating DCMs. In
numerous instances, the rules codify practices that have evolved from
the Division of Market Oversight's (``DMO'') recommendations in the
context of Rule Enforcement Reviews (``RERs'').\18\
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\18\ As noted in the DCM NPRM, the RERs are the cornerstone of
the Commission's oversight program, serving as a key tool for
monitoring a DCM's compliance with the core principles, and also as
a primary means for identifying industry trends and DCM best
practices for self-regulation. See DCM NPRM at 80574-75 for a more
detailed discussion of RERs.
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[[Page 36615]]
Some commenters claimed that the Commission's approach was overly
prescriptive and inconsistent with the core principle framework.\19\
While maintaining the core principle framework as part of the Dodd-
Frank Act, Congress revised DCM Core Principle 1 to specifically
provide the Commission with discretion to determine, by rule or
regulation, the manner in which boards of trade are to comply with the
core principles.\20\ Accordingly, in circumstances where a standard
industry practice has developed, the Commission is adopting rules in
order to provide greater legal certainty and transparency to DCMs and
market participants. In other circumstances, the Commission is
maintaining the guidance and acceptable practices framework,
particularly where the Commission experienced that a standard
compliance approach has not evolved within the industry over the years.
In those instances, the final regulations maintain the flexibility for
DCMs to determine the specific manner in which they choose to satisfy
their compliance obligations.
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\19\ See e.g., CME Comment Letters (Feb. 22, 2011, Apr. 18,
2011, Jun. 3, 2011 and Aug. 3, 2011); MGEX Comment Letter (Jun. 3,
2011); GreenX Comment Letter (Feb. 22, 2011).
\20\ 7 U.S.C. 7(d)(1)(amended 2010).
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Several commenters claimed that the codification of additional
rules will increase the Commission's costs of regulating DCMs. The
Commission believes that a regulatory framework consisting of a higher
proportion of rules, in addition to guidance and acceptable practices,
may in fact be less costly to administer, as DCMs will have a clear
understanding of what is required in order to demonstrate compliance
with the core principles. The costs and benefits of this final
rulemaking are described further in the Cost Benefit Consideration
discussion of this release.
C. General Regulations (Subpart A)
The regulations in this final rulemaking are codified in a series
of subparts under part 38. The general regulations consisting of
Sec. Sec. 38.1 through 38.10 \21\ are codified in subpart A, and the
regulations applicable to each of the 23 core principles are codified
in subparts B through X, respectively.\22\
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\21\ The DCM NPRM did not propose any revisions to Sec. 38.6 of
the Commission's regulations.
\22\ Each of these subparts begins with a regulation containing
the language of the core principle.
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1. Sec. 38.1--Scope
The Commission proposed non-substantive revisions to Sec. 38.1
that corrected cross-references to other sections of the Commission's
regulations. Section 38.1 is adopted as proposed.
2. Sec. 38.2--Applicable Provisions
Proposed Sec. 38.2 specified the Commission regulations that are
applicable to DCMs. In addition to revising the heading, the proposed
revisions to Sec. 38.2 updated the list of Commission regulations that
are applicable to DCMs, including the relevant regulations that have
been codified, or are proposed to be codified, upon the Commission's
finalization of the relevant rulemakings that culminated upon enactment
of the Dodd-Frank Act. These included regulations relating to real-time
reporting of swaps and the determination of appropriate block size for
swaps under part 43, requirements for swap data recordkeeping and
reporting under part 45, designation requirements for swap data
repositories under part 49, and position limits under part 150 and/or
part 151, as applicable.
Discussion
The Commission is revising Sec. 38.2 to specify the Commission
regulations from which DCMs will be exempt. The original intent of
Sec. 38.2 was to exempt DCMs from various Commission regulations under
Title 17 that were codified prior to the CFMA. Proposed Sec. 38.2
listed the specific regulations with which DCMs were required to
comply, with the understanding that the DCM was exempt from those not
listed. In this final rulemaking, to add clarity, the Commission is
revising the title of the rule to ``Exempt Provisions'' and is
modifying Sec. 38.2 to reflect the list of regulations from which DCMs
are exempt. Those regulations include: Sec. 1.35(e)-(j), Sec.
1.39(b), Sec. 1.44, Sec. 1.53, Sec. 1.54, Sec. 1.59(b) and (c),
Sec. 1.62, Sec. 1.63(a) and (b) and (d) and(f), Sec. 1.64, Sec.
1.69, part 8, Sec. 100.1, Sec. 155.2, and part 156. While Sec. 38.2
likely will be amended if and when the referenced rules are eliminated
from the regulations or modified, this revised approach will eliminate
the need for the Commission to continually update Sec. 38.2 when new
regulations with which DCMs must comply are codified.
3. Sec. 38.3--Procedures for Designation
Sec. 38.3(a)--Application Procedures
Among the proposed revisions to Sec. 38.3, which contains the
application and designation procedures for DCM applicants, the
Commission proposed to eliminate the 90-day expedited review procedures
for DCM applications, which currently are codified in Sec. 38.3(a)(2).
The proposed modification would result in all DCM applications being
subject to the statutory 180-day review procedures provided under
section 6(a) of the CEA and Sec. 38.3(a)(1) of the Commission's
regulations.\23\
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\23\ 7 U.S.C. 8(a).
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As noted above, the Dodd-Frank Act eliminated the standalone DCM
designation criteria. Accordingly, the Commission proposed re-
designating appendix A to include a new DCM application form (``Form
DCM'') that contains comprehensive instructions and a list of necessary
information and documentation required to initiate a DCM designation
proceeding. All new applicants seeking designation would submit to the
Commission a completed form, including the information required in each
exhibit.\24\
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\24\ Form DCM would also be used by applicants amending a
pending application and existing DCMs applying for an amendment to
their order of designation.
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The DCM NPRM also proposed certain revisions to Sec. 38.3 that
would require DCM applications and certain related DCM filings to be
filed with the Secretary of the Commission in an electronic format, via
the Internet, email, or other means of direct electronic submission as
approved by the Commission.\25\
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\25\ The proposed electronic filing requirements would
specifically apply to DCM applications, reinstatements, requests for
transfer of designations, requests for withdrawal of application for
designation, and vacation of designations. As explained in the DCM
NPRM, the proposed revisions would make the DCM application filing
process consistent with the electronic process used for filing rule
and product submissions under parts 39 and 40 of the Commission's
regulations. See 17 CFR parts 39 and 40. In addition to these
substantive revisions, many of the proposed revisions to Sec. 38.3
were non-substantive and were intended to clarify the rule.
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Summary of Comments
Two commenters discussed the proposed elimination of the 90-day
expedited review process for DCM applications in Sec. 38.3(a)(1).
Nodal expressed support for the proposed elimination of the 90-day
review procedures.\26\ Eris opposed the proposed elimination and
commented, among other things, that Form DCM should result in a
streamlined and standardized review process and that eliminating the
90-day accelerated review process would place new entities at a
competitive disadvantage because it
[[Page 36616]]
would delay their time to market, which is critical for new
entrants.\27\
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\26\ Nodal Comment Letter at 5 (Feb. 22, 2011).
\27\ Eris Comment Letter at 4 (Feb. 22, 2011).
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Discussion
The Commission is adopting proposed Sec. 38.3(a) with one
modification.
As described in the DCM NPRM, the Commission proposed eliminating
the 90-day accelerated review process based on its experience in
processing DCM applications. Specifically, the Commission has found
that in the interest of meeting the expedited approval timeline,
applicants seeking expedited review often filed incomplete or draft
applications without adequate supporting materials. Accordingly, the
90-day review process required the expenditure of significant
Commission resources as well as the applicant's resources, and often
resulted in placing the DCM designation requests on the 180-day review
track. It is the Commission's view that the 180-day review period is a
more reasonable timeframe for the review of designation requests and
will result in more efficient use of the applicant's and the
Commission's resources.
In regards to Eris' specific claim that elimination of the 90-day
accelerated review process would place new entities at a competitive
disadvantage by delaying their time to market, the Commission notes
that eliminating the 90-day review process will not prevent Commission
staff from reviewing and/or rendering a determination on a DCM
application before the 180-day period ends, particularly in instances
where a DCM application is substantially complete, does not raise novel
issues, and/or where a DCM applicant timely provides supplemental or
follow-up responses or documentation necessary for a designation
determination.\28\ Similarly, while the Commission recognizes that Form
DCM will provide the added benefit of a more streamlined and
standardized procedure for submitting and reviewing DCM applications,
such benefits will not necessarily result in an expedited Commission
determination. Rather, the completeness of the application and timely
response to Commission staff's requests will determine the timeframe
within which the Commission reviews a DCM application.
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\28\ Section 6(a) of the Act provides that ``the Commission
shall approve or deny an application for designation or registration
as a contract market * * * within 180 days of the filing of the
application.'' 7 U.S.C. 8(a).
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To account for potential changes in the Commission's prospective
technological capabilities, the Commission is slightly modifying the
proposed text of Sec. 38.3(a) to clarify that a board of trade must
file Form DCM electronically ``in a format and manner specified by the
Secretary of the Commission.''
The Commission is also making several minor non-substantive and
organizational revisions to Form DCM. Additionally, the Commission is
clarifying that the exhibits submitted in connection with Form DCM
should include a description of how the applicant meets the definition
of ``board of trade'' (as defined in section 1a(2) of the CEA).
Applicants must submit all applicable exhibits simultaneous with the
submission of completed Form DCM. Form DCM and all exhibits must be
substantially complete prior to submission.
Sec. 38.3(b)--Reinstatement of Dormant Designation
Proposed Sec. 38.3(b) required that a dormant DCM, prior to
listing or relisting products for trading, must reinstate its
designation under the procedures of paragraphs (a)(1) and (2) of Sec.
38.3. The proposed rule provided that applications for reinstatement of
designation may rely upon previously-submitted materials that pertain
to, and accurately describe, current conditions. The Commission did not
receive any comments on Sec. 38.3(b) and is adopting this provision as
proposed.
Sec. 38.3(c)--Delegation of Authority
Proposed Sec. 38.3(c) delegated authority to the Director of the
Division of Market Oversight (or such other employees as the Director
may designate) to notify an applicant seeking designation in the event
that the application is materially incomplete and that the 180-day
review period is stayed. The Commission did not receive any comments on
Sec. 38.3(c) and is adopting this provision as proposed.
Sec. 38.3(d)--Request for Transfer of Designation
The Commission proposed new Sec. 38.3(d) to formalize the
procedures that a DCM must follow when requesting the transfer of its
DCM designation and positions comprising open interest, in anticipation
of a corporate event (e.g., a merger, corporate reorganization, or
change in corporate domicile) which results in the transfer of all or
substantially all of the DCM's assets to another legal entity. Proposed
Sec. 38.3(d)(2) required a DCM to submit to the Commission a request
for transfer of designation no later than three months prior to the
anticipated corporate change. If a DCM did not know or could not
reasonably have known of the anticipated change three months prior to
the change, it was required to immediately file the request as soon as
it did know of such change. The proposed rule required, that in either
case, the request must include a series of submissions, including,
among other things, the underlying agreement that governs the corporate
change, a narrative description of the corporate change that includes
the reason for the change and its impact on the DCM, a discussion of
the transferee's ability to comply with the CEA and the Commission's
regulations, the governing documents of the transferee, and a list of
contracts, agreements, transactions or swaps for which the DCM requests
transfer of open interest.
Proposed Sec. 38.3(d) also required, as a condition of approval,
that the DCM submit a representation that it is in compliance with the
CEA, including the DCM core principles, and the Commission's
regulations. In addition, the proposed rule required a DCM to submit
various representations by the transferee, including, but not limited
to, a representation that the transferee will assume responsibility for
complying with all applicable provisions of the CEA and the
Commission's regulations and that none of the proposed rule changes
will affect the rights and obligations of any participant to which open
positions are transferred.
Summary of Comments
CME contended that the proposed rule is overly prescriptive because
it applies a ``one-size-fits-all approach'' even though the
circumstances of each transfer are likely to be unique.\29\ While CME
did not oppose the three-month advance notification requirement, it did
oppose what it believed to be the broad scope of the additional
documentation required to be submitted simultaneously with such
notification.\30\ CME stated that the required information is
unnecessary and is likely to result in later notification to the
Commission.\31\ As an alternative, CME recommended that the Commission
tailor the information it requires based on the nature of the requested
transfer.\32\
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\29\ CME Comment Letter at 11 (Feb. 22, 2011).
\30\ Id.
\31\ Id.
\32\ Id.
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CME also contended that if a DCM could not have reasonably known of
an anticipated change three months in advance, then it cannot
``immediately'' file both the request and all of the required
submissions once it does know, because preparing the
[[Page 36617]]
submissions takes time. CME suggested that the rule be amended to
require that the documentation be filed ``promptly'' as soon as the DCM
knows of the change, rather than ``immediately.'' \33\
---------------------------------------------------------------------------
\33\ Id.
---------------------------------------------------------------------------
Discussion
In response to CME's contention that each transfer is likely to be
unique, and its opposition to some of the documentation required by the
rule, the Commission notes that the specific information requirements
contained in the proposed rule are necessary to enable the Commission
to determine that the transfer is in compliance with the CEA. The
required documents, such as the transfer agreement, governing
documents, list of contracts to be transferred, and compliance
representations, are relevant to the Commission's determination of the
DCM's ongoing compliance with the CEA. Such documentation is also
relatively standard in transfer transactions. The Commission
recognizes, however, that there may be some variations in the form of
governance documents or underlying agreements for each transfer.
Accordingly, DCMs may provide the substance of the required information
in the form available to them.
In response to CME's suggestion that the rule be amended to require
that the documentation be filed ``promptly'' as soon as the DCM knows
of the change, rather than ``immediately,'' the Commission notes that
the proposed rule specifically stated that in situations where a DCM
could not have reasonably known of an anticipated change three months
in advance, the DCM must immediately file the request as soon as it
knows of such change, with an explanation as to the timing of the
request. The Commission believes that in the context of this rule, use
of the term ``promptly'' rather than ``immediately'' would not provide
a meaningful distinction, as the rule simply requires DCMs to provide
the documentation as soon as they know of the change.
As described in connection with Sec. 38.3(a), the Commission is
slightly modifying the proposed text to clarify that a DCM must file a
request for transfer of designation electronically ``in a format and
manner specified by the Secretary of the Commission.'' The Commission
is adopting the remainder of the rule as proposed.
Sec. 38.3(e)--Request for Withdrawal of Application for Designation
Proposed Sec. 38.3(e) specified the procedures that a DCM must
follow for withdrawing an application for designation. The Commission
did not receive any comments on this provision. The Commission is
slightly modifying the proposed text to clarify that an applicant must
file a request for withdrawal of application for designation
electronically ``in a format and manner specified by the Secretary of
the Commission.'' The Commission is adopting the remainder of the rule
as proposed.
Sec. 38.3(f)--Request for Vacation of Designation
Proposed Sec. 38.3(f) specified the procedures that a DCM must
follow for vacating its designation. The Commission did not receive any
comments on this provision. The Commission is adopting it as proposed,
with a slight modification to the proposed text to clarify that a DCM
must file a request for vacation of designation electronically ``in a
format and manner specified by the Secretary of the Commission.''
Sec. 38.3(g)--Requirements for Existing Designated Contract Markets
Proposed Sec. 38.3(g) required that each existing DCM provide the
Commission with a signed certification of its compliance with each of
the 23 core principles and the Commission's regulations under part 38,
within 60 days of the effective date of the publication of the final
rules proposed in the DCM NPRM. The failure of any existing DCM to
provide such certification would be grounds for revocation of the DCM's
designation status. The Commission requested comments on whether the 60
day period is sufficient, and if not, what period of time may be more
appropriate, and why.
Summary of Comments
Multiple commenters opposed the proposed 60-day timeframe for
existing DCMs to certify compliance with the core principles and
associated regulations. Commenters suggested several alternative
timeframes, including 90 days,\34\ 120 days,\35\ 180 days,\36\ 12
months,\37\ and 18 months.\38\ KCBT argued that the proposed effective
date is unreasonable and would be burdensome for DCMs, and suggested
that the Commission work with each DCM to create a reasonable
compliance timeframe.\39\
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\34\ Nodal Comment Letter at 4 (Feb. 22, 2011).
\35\ CFE Comment Letter at 6-7 (Feb. 22, 2011).
\36\ GreenX Comment Letter at 21 (Feb. 22, 2011).
\37\ MGEX Comment Letter at 2 (Feb. 22, 2011), and at 1 (June 3,
2011).
\38\ NYSE Liffe Comment Letter at 14 (Feb. 22, 2011).
\39\ KCBT Comment Letter at 2 (Feb. 22, 2011).
---------------------------------------------------------------------------
Commenters stated that a 60-day timeframe would be unreasonable
given the expenditure of resources and detailed analysis required as a
result of significant changes to existing core principles and the
addition of new core principles. GreenX stated that Core Principle 21
(Financial Resources) may require DCMs to obtain new investment or
financing arrangements.\40\ KCBT stated that it will take DCMs time to
convert programs and processes from current acceptable practices to
adherence to what it sees as prescriptive objectives and deadlines.\41\
Nodal, which is currently operating as an exempt commercial market
(``ECM''), stated that 60 days is an unnecessarily harsh timeframe for
an existing business to transform its operations and demand changes
from its support providers.\42\ Finally, NYSE Liffe claimed that even
90 or 120 days would be insufficient because certain proposals, such as
Core Principles 2 (Compliance with Rules), 4 (Prevention of Market
Disruption), and 20 (System Safeguards), will require the
implementation of automated systems that require significant time to
implement coding and conduct testing.\43\ NYSE Liffe further claimed
that the DCM's management and boards will have to review and approve
rule changes before they can be implemented, and that the DCM will also
have to negotiate and execute changes to contracts with third-party
service providers.\44\ CME disagreed with the assertion that the
proposed new regulations simply codify practices that are commonly
accepted in the industry, and argued that the rules will necessitate
strategic, operational, system, and rule changes.\45\ CME claimed that
it would need a minimum of 180 days just to assess the impact of the
new regulations and to identify, design, and plan the projects
necessary to implement them.\46\
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\40\ GreenX Comment Letter at 21 (Feb. 22, 2011).
\41\ KCBT Comment Letter at 2 (Feb. 22, 2011).
\42\ Nodal Comment Letter at 4 (Feb. 22, 2011).
\43\ NYSE Liffe Comment Letter at 14 (Feb. 22, 2011).
\44\ Id.
\45\ CME Comment Letter at 12 (Feb. 22, 2011).
\46\ Id.
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MGEX stated that a ``catch all'' certification is of limited value
given that DCMs spend ``countless hours and dollars'' demonstrating
that they are in compliance with core principles through RERs and
responding to other
[[Page 36618]]
Commission inquiries.\47\ MGEX also questioned whether it can conclude
with any certainty that it is in compliance with the new and revised
core principles and regulations.\48\ MGEX requested that the
certification requirement be stricken, or if the requirement is deemed
necessary, that the process be limited to providing a signed letter
attesting to compliance (and that all application forms and
documentation that are required with a formal application should be
waived for existing DCMs).\49\ MGEX also requested that current DCMs
that are already compliant with the existing core principles should be
grandfathered.\50\
---------------------------------------------------------------------------
\47\ MGEX Comment Letter at 2 (Feb. 22, 2011).
\48\ Id.
\49\ Id.
\50\ MGEX Comment Letter at 1 (June 3, 2011).
---------------------------------------------------------------------------
Nodal stated that the proposed rules do not address how a DCM
applicant that is operating as an ECM pursuant to a grandfathering
order can comply with the DCM requirements, and suggested that the
Commission stagger certain compliance timeframes to accommodate
entities that are operating pursuant to grandfather relief and that may
potentially seek to operate as a DCM.\51\
---------------------------------------------------------------------------
\51\ Nodal Comment Letter at 4 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission acknowledges commenters' concerns regarding the 60-
day time frame for existing DCMs to certify compliance with the core
principles and is eliminating this requirement from the final rules. In
addition, the Commission has determined that existing DCMs may need
additional time to comply with the rules being adopted in this release,
and is therefore allowing DCMs an additional 60 days after the
effective date of this release to comply with all of the new and
revised final rules, except for Sec. 38.151(a), as described in this
release. All DCMs are expected to be in compliance with the final rules
by that date. Albeit, the new and revised core principles, as amended
by the Dodd-Frank Act, took effect on July 16, 2011, and all DCMs were
required to be in compliance with each of the new and revised core
principles as of that date. The Commission further notes that all DCMs
will continue to be subject to compliance reviews by the Commission,
including RERs.
With respect to Nodal's comments regarding the impact of the
effective date of the DCM and SEF rules on ECMs, the Commission issued
orders whereby entities operating as exempt commercial markets pursuant
to section 2(h)(3)-(7) of the CEA, or as exempt boards of trade
pursuant to section 5d of the CEA, could receive grandfather relief to
continue to operate in accordance with those provisions notwithstanding
their deletion from the CEA effective July 15, 2011, by the Dodd-Frank
Act.\52\ The continued operation and compliance timeframes for exempt
boards of trade and exempt commercial markets are addressed by those
orders, and accordingly, are outside the scope of this rulemaking.
---------------------------------------------------------------------------
\52\ See 75 FR 56513, Sept. 16, 2010; see also 76 FR 42508, Jul.
14, 2011.
---------------------------------------------------------------------------
4. Sec. 38.4--Procedures for Listing Products and Implementing
Designated Contract Market Rules
The proposed amendments to Sec. 38.4 were largely intended to
conform the rule to Sec. Sec. 40.3 (Voluntary submission of new
products for Commission review and approval) and 40.5(b) (Voluntary
submission of rules for Commission review and approval).\53\ Those
rules were recently revised in the separate release pertaining to
``Provisions Common to Registered Entities.'' \54\
---------------------------------------------------------------------------
\53\ Section 40.3 was amended to require additional information
to be provided by registered entities submitting new products for
the Commission's review and approval. Section 40.5(b) codified a new
standard for the review of new rules or rule amendments as
established under the Dodd-Frank Act. 75 FR 44776, Jul. 27, 2011.
\54\ Id.
---------------------------------------------------------------------------
Summary of Comments
In comments submitted both in connection with this rulemaking and
with the proposed rulemaking for ``Provisions Common to Registered
Entities,'' \55\ CME stated that the proposed procedures for listing
products would increase the burdens associated with new product
submissions and rule changes and would create new and costly
bureaucratic inefficiencies, competitive disadvantages in the global
marketplace, and impediments to innovation.\56\ CME stated that there
has been no showing that the current streamlined process undermines
market integrity, and that the process in fact has facilitated growth
and innovation.\57\
---------------------------------------------------------------------------
\55\ Id.
\56\ CME Comment Letter at 10, 13 (Feb. 22, 2011).
\57\ Id.
---------------------------------------------------------------------------
CFE stated that a number of the regulations proposed in the DCM
NPRM require DCMs to provide notification and reports to the
Commission, but that the proposed regulations do not specify the manner
in which the required notifications and reports should be submitted to
the Commission.\58\ CFE requested that the Commission designate a
single email address for the submission of all DCM notifications and
reports.\59\
---------------------------------------------------------------------------
\58\ CFE Comment Letter at 7 (Feb. 22, 2011).
\59\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting the rule as proposed. The rule conforms
to revisions to part 40 that were made in a separate rulemaking for
``Provisions Common to Registered Entities.'' \60\ In that rulemaking,
the Commission, among other things, revised and eliminated several
proposed documentation provisions in order to respond to comments that
the submission of documentation in connection with new rules and rule
amendments would be burdensome. The Commission also noted that the
final rules will conserve both Commission and registered entity
resources and will be less burdensome than existing practice. CME's
comments on these provisions were addressed in the part 40 rulemaking,
and are outside the scope of this rulemaking.'' \61\
---------------------------------------------------------------------------
\60\ 75 FR 44776, July 27, 2011.
\61\ Id.
---------------------------------------------------------------------------
In response to CFE's comment, the Commission notes that all filings
submitted pursuant to part 38 should be filed electronically with the
Secretary of the Commission, in a format and manner determined by the
Secretary, at [email protected] and the Division of Market Oversight
5. Sec. 38.5--Information Relating to Contract Market Compliance
Sec. 38.5(a)--Requests for Information; Sec. 38.5(b)--Demonstration of
Compliance; and, Sec. 38.5(d)--Delegation of Authority
The provisions in Sec. 38.5 address requirements for DCMs to
provide information relating to contract market compliance. Proposed
Sec. 38.5(a) required that a DCM must file with the Commission
information related to its business as a DCM, including information
relating to data entry and trade details, upon Commission request.
Proposed Sec. 38.5(b) required that a DCM must file with the
Commission a written demonstration that the DCM is in compliance the
core principles, upon Commission request. Proposed Sec. 38.5(d)
delegates the Commission's authority to seek information as set forth
in paragraph Sec. 38.5(b) to the Director of the Division of Market
Oversight, or such other employees as the Director may designate. As
noted in the DCM NPRM, except for technical revisions, the
aforementioned proposed rules were not substantively modified from
their current versions. The Commission did
[[Page 36619]]
not receive any comments on these rules and adopts them as proposed.
Sec. 38.5(c)--Equity Interest Transfers
Proposed Sec. 38.5(c) required DCMs to file with the Commission a
notice of the transfer of ten percent or more of its equity, no later
than the business day following the date on which the DCM enters into a
firm obligation to transfer the equity interest.\62\ The proposed rule
required that the notification include several submissions, including
any relevant agreements (including preliminary agreements), changes to
relevant corporate documents, a chart outlining any new ownership or
corporate or organizational structure, a brief description of the
purpose and any impact of the equity interest transfer, and a
representation from the DCM that it meets all of the requirements of
section 5(d) of the Act and Commission regulations thereunder. The
proposed rule also required that DCMs notify the Commission of the
consummation of the transaction on the day in which it occurs. Proposed
Sec. 38.5(c)(3) \63\ required that when there is a change in
ownership, the DCM must certify, no later than two business days
following the date on which the change in ownership occurs, that the
DCM meets all of the requirements of section 5(d) of the CEA, as
amended by the Dodd-Frank Act, and the provisions of part 38 of the
Commission's regulations. The proposed rule also required that the DCM
include, as part of its certification, an explanation of whether any
aspects of the DCM's operations will change as a result of the change
in ownership and, if so, that the DCM must provide a description of the
changes.
---------------------------------------------------------------------------
\62\ See generally, DCM NPRM for an explanation of the proposed
10 percent threshold.
\63\ The Commission proposed redesignating Sec. 38.5(d) as
Sec. 38.5(c).
---------------------------------------------------------------------------
Summary of Comments
Two commenters stated that they do not object to the general
notification requirement, but contended that the submissions required
to be simultaneously filed with the initial notification do not lend
themselves to preparation within the 24-hour time frame proposed in the
rules.\64\ NYSE Liffe proposed that a period of ten business days to
provide the additional information would allow more time for the DCM to
provide accurate and meaningful information.\65\ NYSE Liffe also
requested clarification that the requirement to provide ``preliminary
agreements'' only pertains to agreements that have been executed, and
not to drafts that may have been exchanged for purposes of
discussion.\66\
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\64\ CME Comment Letter at 13 (Feb. 22, 2011) (noting that
associated changes to relevant corporate documents are unlikely to
be finalized until closer to the transfer date); NYSE Liffe Comment
Letter at 13 (Feb. 22, 2011) (noting that the information will have
to be collected and formatted).
\65\ NYSE Liffe Comment Letter at 14 (Feb. 22, 2011).
\66\ Id.
---------------------------------------------------------------------------
CME stated that a representation from a DCM that it meets all of
the requirements of section 5(d) of the CEA is more appropriate as a
requirement upon consummation of the equity interest transfer, rather
than with the initial notification.\67\
---------------------------------------------------------------------------
\67\ CME Comment Letter at 13 (Feb. 22, 2011).
---------------------------------------------------------------------------
MGEX stated that as a mutual association with a membership-based
ownership structure, it frequently experiences changes in membership
and ownership.\68\ MGEX stated that notice to the Commission seems
reasonable for single event situations where a new party obtains a ten
percent or more interest at one time, but disagreed with the rationale
for the requirement to recertify again as part of such event.\69\
Instead, MGEX suggested that the Commission should inquire only if
there is a concern over such an event.\70\
---------------------------------------------------------------------------
\68\ MGEX Comment Letter at 2 (Feb. 22, 2011).
\69\ Id. at 3.
\70\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting the proposed rule with certain
revisions.
The Commission is revising the rule to provide that the DCM must
submit to the Commission a notification of each transaction involving
the transfer of ten percent or more of the equity interest in the
designated contract market, and that such notification must be provided
at the earliest possible time but in no event later than ten business
days following the date upon which the designated contract market
enters into a legally binding obligation to transfer the equity
interest.
The Commission acknowledges NYSE Liffe and CME's concerns regarding
the timing of the submission filing requirement and therefore has
extended the time period to up to ten business days for a DCM to file
notification with the Commission upon entering into an agreement to
transfer an equity interest of ten percent or more. While DCMs may take
up to ten business days to submit a notification, the DCM must provide
Commission staff with sufficient time, prior to consummating the equity
interest transfer, to review and consider the implications of the
change in ownership, including whether the change in ownership will
adversely impact the operations of the DCM or the DCM's ability to
comply with the core principles and the Commission's regulations
thereunder. The rule further reminds DCMs that any aspect of an equity
interest transfer described that necessitates the filing of a rule as
defined in part 40 of the Commission regulations must comply with the
rule submission requirements, including timing of filing, of section
5c(c) of the CEA and part 40, and all other applicable Commission
regulations.
In response to CME's comment that the representation from a DCM
that it meets all of the requirements of section 5(d) of the CEA is
more appropriate as a requirement upon consummation of the equity
interest transfer, and NYSE Liffe's comment that the Commission clarify
that ``preliminary agreements'' do not include draft documents, the
Commission is revising the rule to eliminate references to the specific
documents that must be provided with the notification. Rather, the
Commission may upon receiving a notification of the equity interest
transfer, where necessary, request appropriate documentation pursuant
to its authority under Sec. 38.5 of the Commission's regulations. Such
documentation may include: (i) Relevant agreement(s), including any
preliminary agreements (not including draft documents); (ii) associated
changes to relevant corporate documents; (iii) chart outlining any new
ownership or corporate or organizational structure, if available; (iv)
a brief description of the purpose and any impact of the equity
interest transfer; and, (v) a certification, upon consummation of the
equity interest transfer that the designated contract market continues
to meet all of the requirements of section 5(d) of the Act and
Commission regulations adopted thereunder.
The Commission acknowledges MGEX's comment but believes that the
rule is necessary. The Commission must oversee and ensure the continued
compliance of all DCMs with the core principles and the Commission's
regulations. In order to fulfill its oversight obligations, and to
ensure that DCMs maintain compliance with their self-regulatory
obligations, the Commission must undertake an effective due diligence
review of the impact of ownership transfers. Accordingly, the
Commission adopts the proposed rule, with the aforementioned
modifications.
[[Page 36620]]
6. Sec. 38.7--Prohibited Use of Data Collected for Regulatory Purposes
Proposed Sec. 38.7 \71\ prohibited DCMs from using proprietary
data or personal information submitted by any person to the DCM for
regulatory purposes, for business or marketing purposes. In the DCM
NPRM, the Commission noted that nothing in the proposed provision
should be viewed as prohibiting a DCM from sharing such information
with another DCM or SEF for regulatory purposes, where necessary.
---------------------------------------------------------------------------
\71\ The DCM NPRM did not propose any revisions to current Sec.
38.6 (Enforceability), and this provision remains unchanged.
---------------------------------------------------------------------------
Summary of Comments
Several commenters argued that the restriction on the use of
proprietary or personal information is too broad. CME stated that the
proposed rules should distinguish between proprietary and personal
information that is provided to a DCM exclusively for regulatory
purposes and information that is provided to a DCM for both regulatory
and non-regulatory purposes.\72\ CME claimed that a DCM should be
permitted to use the latter type of information for business or
marketing purposes, provided that the DCM has transparent rules and
policies which disclose what information collected by the DCM will be
used exclusively for the furtherance of its self-regulatory obligations
and how such confidential information will be protected.\73\ CME also
contended that a DCM should not be precluded from using proprietary or
personal information that is provided for regulatory purposes for
business or marketing purposes where the market participant has
specifically agreed to such use.\74\ MGEX agreed with the underlying
purpose of the proposed rule but suggested allowing market participants
to opt-out of having their information used for business or marketing
purposes.\75\
---------------------------------------------------------------------------
\72\ CME Comment Letter at 13-14 (Feb. 22, 2011).
\73\ Id.
\74\ Id.
\75\ MGEX Comment Letter at 3 (Feb. 22, 2011).
---------------------------------------------------------------------------
ELX stated that the standard should rest on whether the use and
manner of use of the information violates the reasonable expectation of
confidentiality on the part of the disclosing firm.\76\ For example,
ELX stated that senior officers of the exchange should have access to
such data to understand the markets they are responsible for overseeing
even if they don't have a ``compliance'' moniker in their title.\77\
ELX also stated that an exchange should be able to consolidate
proprietary data in an anonymous fashion to explain its markets without
running afoul of the proposed rule.\78\ ELX also claimed that a DCM
should be able to use its discretion to convey proprietary information
for business or marketing purposes back to employees of the firm that
supplied the data.\79\ For example, ELX stated that a DCM should be
permitted to explain to a trading desk how the activities of its firm
have changed or could be conducted more cost-effectively.\80\
---------------------------------------------------------------------------
\76\ ELX Comment Letter at 3 (Feb. 22, 2011).
\77\ Id.
\78\ Id.
\79\ Id.
\80\ Id.
---------------------------------------------------------------------------
Discussion
The Commission has considered the comments and is amending proposed
Sec. 38.7 to allow DCMs to use proprietary or personal information for
business or marketing purposes if the person from whom they collect or
receive such information clearly consents to the use of its information
in such a manner. In response to CME and ELX's comments, the Commission
notes that a DCM could use information that it receives for both
regulatory and non-regulatory purposes for business or marketing
purposes (or could convey proprietary information back to employees of
the firm that supplied the data) if the source of the information
clearly consents to the use in such a manner. The Commission is also
amending the proposed rule to prohibit a DCM from conditioning access
to its trading facility based upon such consent.
Finally, as stated in the preamble to the proposed rule and
amplified above, the Commission notes that Sec. 38.7 is intended to
protect regulatory information provided by market participants to DCMs
from unauthorized commercial use.\81\ The Commission notes consistent
with the requirements of the final rule, DCMs should have rules to
safeguard regulatory information from misuse. The Commission would
expect such rules, among other things, to restrict access to such
information within the DCM to avoid improper use of such information
for commercial purposes.
---------------------------------------------------------------------------
\81\ See 75 FR 80572, 80577, note 37, Dec. 22, 2010.
---------------------------------------------------------------------------
7. Sec. 38.8--Listing of Swaps on a Designated Contract Market
Proposed Sec. 38.8(a) required a DCM to notify the Commission,
prior to or upon listing its first swap contract, of the manner in
which it will fulfill each of the requirements under the amended CEA
and part 38 with respect to the listing, trading, execution and
reporting of swap transactions.
Proposed Sec. 38.8(b) required a DCM, before it lists swaps, to
request from the Commission a unique, alphanumeric code for the purpose
of identifying the DCM. The rule required a DCM to do so pursuant to
the swap recordkeeping and reporting requirements under then-proposed
part 45 of the Commission's regulations. Proposed Sec. 38.8(b) also
codified the obligations of DCMs to comply with the provisions of part
45, which set forth the recordkeeping and reporting requirements for
DCMs with respect to swaps.\82\
---------------------------------------------------------------------------
\82\ See ``Swap Data Recordkeeping and Reporting Requirements,''
Proposed Rule, 75 FR 76573, Dec. 8, 2010.
---------------------------------------------------------------------------
Summary of Comments
CFE argued that a DCM should be allowed to offer trading in swaps
in the same manner that a SEF is permitted to do so, and that it would
be costly and unnecessary to require a DCM to create a separate SEF in
order to offer trading in swaps instead of just permitting the DCM to
adopt separate rules that permit the trading of swaps on the DCM
consistent with the SEF requirements.\83\ CFE argued that a DCM should
not have to create a separate entity, board, board committees,
membership application and approval process, and rule set in order to
offer trading in swaps in the same manner that a SEF can do when it
already has all of those components in place and can simply add any
required components for SEFs.\84\
---------------------------------------------------------------------------
\83\ CFE Comment Letter at 1 (Feb. 22, 2011).
\84\ Id. at 2.
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ELX stated that the DCM NPRM did not make clear what criteria will
be used to distinguish between a swap contract and a futures contract,
and claimed that this ambiguity will cause uncertainty and redundant
costs for boards of trade that would prefer to follow a DCM model
without having to adopt a parallel set of rules and procedures.\85\ ELX
cited compliance with section 727 of the Dodd-Frank Act and Sec. 38.10
as one area where clarity is needed.\86\
---------------------------------------------------------------------------
\85\ ELX Comment Letter at 4 (Feb. 22, 2011).
\86\ Id. at 5.
---------------------------------------------------------------------------
Discussion
The Commission is adopting the rule as proposed, with one
clarification. CFE's comments take issue with provisions in the Dodd-
Frank Act that are not within the Commission's discretion to revise.
Swaps are permitted to be traded on a SEF or a DCM, pursuant to rules
promulgated for each entity.\87\ Accordingly, swaps
[[Page 36621]]
traded on a DCM must be traded pursuant to DCM rules. As noted in the
Final Exemptive Order issued July 14, 2011,\88\ DCMs may list and trade
swaps after July 16, 2011 without further exemptive relief. In that
Order, the Commission noted that if a DCM intends to trade swaps
pursuant to the rules, processes, and procedures currently regulating
trading on its DCM, the DCM may need to amend or otherwise update its
rules, processes, and procedures in order to address the trading of
swaps.\89\ In response to ELX, the determining factors in
distinguishing between swaps and futures are outside of the scope of
this proceeding. The CEA provided a definition for swaps under section
1a(47), and the Commission published proposed rules and interpretive
guidance to further define the term on May 23, 2011.\90\
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\87\ See CEA section 2(h)(8), 7 U.S.C. 2(h)(8). See also 17 CFR
38.9 (``A board of trade that operates a designated contract market
and that intends to also operate a swap execution facility must
separately register[hellip]and on an ongoing basis, comply with the
core principles under Section 5h of the Act, and the swap execution
facility rules under part 37 of this chapter'').
\88\ 76 FR 42508, Jul. 14, 2011.
\89\ Id. at 42,518, n. 131. On July 27, 2011, DMO staff sent a
notification letter to all existing DCMs stating that if the DCM
intends to list swaps prior to the effective date of the final rules
implementing part 38, it must include with its initial submission of
the terms and conditions of a swap contract (pursuant to section
5c(c) of the CEA, as amended by the Dodd-Frank Act) any amendments
to its rules that are necessary to provide for the trading of swaps,
including a concise explanation and analysis of any systems and
oversight procedures that the DCM proposes to revise in order to
accommodate the trading of swaps. The information requested in the
July 27 letter is separate from the request in proposed section
38.8(a); however, information provided in response to the July 27
letter may support, in part, the requirement under section 38.8(a)
to provide a written demonstration detailing how the DCM is
addressing its self-regulatory obligations with respect to swap
transactions.
\90\ 76 FR 29818, May 23, 2011.
---------------------------------------------------------------------------
The Commission is modifying Sec. 38.8(b), consistent with the
Commission's final Swap Data Recordkeeping and Reporting Requirements
Rule,\91\ to require DCMs to generate and assign a unique swap
identifier at, or as soon as technologically practicable following, the
time of execution of the swap. The unique swap identifier (``USI'')
must have two alphanumeric components. The first component is the
unique alphanumeric code assigned to the DCM by the Commission for the
purpose of identifying the DCM with respect to USI creation. DCMs must
obtain this first alphanumeric component from the Commission prior to
executing any swap on its facility.\92\ The second component is an
alphanumeric code generated and assigned to that swap by the automated
systems of the DCM, which shall be unique to that swap and different
with respect to all such codes generated and assigned by that DCM to
all other swaps. Each DCM must generate and assign a USI at, or as soon
as technologically practicable, following the time of execution of the
swap. The DCM is required to transmit the USI to the SDR, each swap
counterparty, and the registered derivative clearing organization
(``DCO'') (if the swap is cleared). The DCM, similar to all registered
entities and counterparties, is required to use the USI to identify the
swap in ``all recordkeeping and all swap data reporting pursuant to
[part 45].'' This clarification is based upon the final rulemaking that
implements swap data recordkeeping and reporting requirements under
part 45 of the Commission's regulations.\93\
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\91\ 77 FR 2136, Jan. 13, 2012.
\92\ The Commission will establish a formal process by which
DCMs can obtain a USI identifier.
\93\ 77 FR 2136, Jan. 13, 2012.
---------------------------------------------------------------------------
8. Sec. 38.9--Boards of Trade Operating Both a Designated Contract
Market and a Swap Execution Facility
Proposed Sec. 38.9(a) codified the requirement that a board of
trade that operates a DCM and that intends to operate a SEF must
separately register pursuant to the SEF registration requirements and,
on an ongoing basis, must separately comply with the SEF core
principles under section 5h of the CEA, as amended by the Dodd-Frank
Act, and the applicable Commission regulations to be codified under
part 37 of the Commission regulations.\94\
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\94\ See notice of proposed rulemaking pertaining to ``Core
Principles and Other Requirements for Swap Execution Facilities.''
76 FR 1214, Jan. 7, 2011.
---------------------------------------------------------------------------
Proposed Sec. 38.9(b) codified the statutory requirement that any
board of trade that is a DCM and intends to operate as an independent
SEF may use the same electronic trade execution system for listing and
executing swaps, provided that the board of trade makes it clear to
market participants whether the electronic trading of such swaps is
taking place on or through the DCM or the SEF.\95\
---------------------------------------------------------------------------
\95\ Section 5h(c) of the CEA, as amended by the Dodd-Frank Act,
provides:
IDENTIFICATION OF FACILITY USED TO TRADE SWAPS BY CONTRACT
MARKETS.--A board of trade that operates a contract market shall, to
the extent that the board of trade also operates a swap execution
facility and uses the same electronic trade execution system for
listing and executing trades of swaps on or through the contract
market and the swap execution facility, identify whether the
electronic trading of such swaps is taking place on or through the
contract market or the swap execution facility.
---------------------------------------------------------------------------
Summary of Comments
CME requested clarification as to whether the regulation is
intended to create a more substantive obligation on the part of DCMs
and SEFs given that market participants typically interface with
electronic platforms through proprietary or third-party front end
systems that are not controlled by the DCM.\96\
---------------------------------------------------------------------------
\96\ CME Comment Letter at 14 (Feb. 22, 2011).
---------------------------------------------------------------------------
ICE noted that while the proposed rule prescribed how a DCM can
list swaps, it did not describe how the core principles, written for
futures contracts, apply to a DCM listing swaps. ICE requested
clarification that a swap can be executed on a DCM using the same
execution methods as on a SEF, such as a request for quote (``RFQ'')
mechanism.\97\ Finally, ICE stated that, like a SEF, a DCM should be
able to allow the bilateral execution of swaps where there is no
clearing mandate.\98\ ICE claimed that without these clarifications,
there will be a bias away from the trading of swaps on DCMs in favor of
SEFs, and that the rulemaking would frustrate Congress' intention of
also having swaps trade on DCMs.\99\
---------------------------------------------------------------------------
\97\ ICE Comment Letter at 10 (Feb. 22, 2011).
\98\ Id.
\99\ Id.
---------------------------------------------------------------------------
Alice Corporation states that organizations that choose to operate
both a SEF and DCM should be able to meet the requirements of both
entities with a single organization.\100\ Alice Corporation also stated
that it offers the ability to fill a large size order with multiple
contracts on an all-or-nothing basis, as customers with large orders
sometimes wish to execute with a single contracts.\101\ Alice stated
that this design would enable automatic execution of block size trades,
and questioned whether an impartially offered price discount for volume
would be acceptable to the Commission.\102\
---------------------------------------------------------------------------
\100\ Alice Corporation Comment Letter at 3 (May 31, 2011).
\101\ Id.
\102\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting the rule as proposed. In response to
CME's comment, the Commission notes that it would not be sufficient for
a board of trade that operates both a DCM and a SEF to simply have DCM
rules that might identify whether a transaction is being executed on a
DCM or a SEF. Instead, a consolidated DCM/SEF trading screen must
identify whether the execution is occurring on the DCM or the SEF,
irrespective of how proprietary or third-party front end
[[Page 36622]]
systems eventually present that data to market participants. Section
5h(c) of the CEA, as amended by the Dodd-Frank Act, clearly requires
that a board of trade that operates both a DCM and SEF identify to
market participants whether each swap is being executed on the DCM or
the SEF.
With respect to comments requesting clarification that a swap can
be executed on a DCM using execution methods other than a central limit
order book \103\ the Commission notes that swaps executed on a DCM are
subject to all rules and requirements applicable to futures and options
traded on DCMs.\104\ In particular, all swaps traded on a DCM must be
executed through the DCM's trading facility, except as otherwise
expressly permitted by Core Principle 9,\105\ and are subject to the
Commission's rules pertaining to DCMs. Only certain Commission rules,
for example, those relating to the real-time and regulatory reporting
of swaps, will be different for swaps in relation to futures. In
response to ICE's comment that a DCM, like a SEF, should be able to
allow the bilateral execution of swaps where there is no clearing
mandate, the Commission notes that ICE's position is based on the
proposed SEF rules, which are not yet finalized.\106\ Moreover, the
Commission further notes that under the CEA, a DCM must be a board of
trade, which is defined under section 1a(2) of the CEA, 7 U.S.C. 1a(2),
as an organized exchange or other trading facility.\107\ As defined
under the CEA, both an organized exchange,\108\ and other trading
facility \109\ require, among other things, multiple participants to
execute or trade contracts or transactions, by accepting bids or offers
made by other participants that are open to multiple participants in
the facility or system, or through the interaction of multiple bids or
offers within a system with a pre-determined nondiscretionary automated
trade matching and execution algorithm.
---------------------------------------------------------------------------
\103\ ICE Comment Letter at 2-3 (Feb. 22, 2011); Alice
Corporation Comment Letter at 3 (May 31, 2011).
\104\ Section 723 of the Dodd-Frank Act provides that the
execution of swaps subject to the clearing requirement of section
2(h)(1) of the CEA must occur either on a DCM or on a SEF, unless no
DCM or SEF makes the swap available to trade.
\105\ Core Principle 9 provides, in relevant part, that ``[t]he
rules of the board of trade may authorize, for bona fide business
purposes:
(i) Transfer trades or office trades;
(ii) An exchange of--
(I) Futures in connection with a cash commodity transaction;
(II) Futures for cash commodities; or
(III) Futures for swaps; or
(iii) A futures commission merchant, acting as principal or
agent, to enter into or confirm the execution of a contract for the
purchase or sale of a commodity for future delivery if the contract
is reported, recorded, or cleared in accordance with the rules of
the contract market or a derivatives clearing organization. 7 U.S.C.
5(d)(9).
\106\ The Commission further notes that pursuant to Core
Principle 21, all contracts traded on a DCM must be cleared through
a registered DCO, irrespective of the clearing mandate.
\107\ The CEA requires that DCMs must be boards of trade, as
defined under the CEA. See, e.g., 7 U.S.C. 7(a) (stating the a board
of trade may apply for designation as a contract market); see also 7
U.S.C. 7(d) (core principles apply to board of trade).
\108\ As defined in section 1a(37) of the CEA, the term
``organized exchange'' means a trading facility that: (A) Permits
trading: (i) By or on behalf of a person that is not an eligible
contract participant; or (ii) by persons other than on a principal-
to-principal basis; or (B) has adopted (directly or through another
nongovernmental entity) rules that: (i) Govern the conduct of
participants, other than rules that govern the submission of orders
or execution of transactions on the trading facility; and (ii)
include disciplinary sanctions other than the exclusion of
participants from trading.
\109\ As defined in section 1a(51) (A) of the CEA, the term
``trading facility'' means a person or group of persons that
constitutes, maintains, or provides a physical or electronic
facility or system in which multiple participants have the ability
to execute or trade agreements, contracts, or transactions--(i) by
accepting bids or offers made by other participants that are open to
multiple participants in the facility or system; or (ii) through the
interaction of multiple bids or multiple offers within a system with
a pre-determined nondiscretionary automated trade matching and
execution algorithm. See section 1a(51)(B) and (C) for exclusions
and special rules application to trading facility.
---------------------------------------------------------------------------
The Commission has considered Alice Corporation's comments, and
notes that while a board of trade that is a single corporate entity may
operate both a DCM and a SEF, DCMs and SEFs have separate core
principles and requirements, and any entity that operates both must
separately meet the statutory and regulatory requirements of each
facility. In response to Alice Corporation's further comment that
counterparties on a DCM should be able to offer volume-based quotes, it
is unclear whether Alice Corporation's comment is being offered in the
context of acceptable methods of trading on a DCM's central marketplace
or in the context of off-exchange transactions. If the former, the
Commission reiterates that the acceptable methods of trading on a DCM's
central marketplace are specifically determined under the CEA, which
requires at a minimum that DCMs must be ``trading facilities,'' though
even in that context the Commission has accepted trading systems beyond
pure price-and-time algorithms. If Alice Corporation's reference to
volume-based quotes is some sort of off-exchange trading methodology,
the Commission reiterates that its analysis of such a proposal would be
conducted under Core Principle 9. The comment does not offer sufficient
information to analyze the suggestion at this time.
9. Sec. 38.10--Reporting of Swaps Traded on a Designated Contract
Market
Proposed Sec. 38.10 codified the compliance obligations of DCMs
with respect to real-time reporting of swap transactions and swap data
recordkeeping and reporting obligations, as was required under then-
proposed parts 43 \110\ and 45 \111\ of the Commission's regulations,
respectively.
---------------------------------------------------------------------------
\110\ See ``Real Time Public Reporting of Swap Transaction
Data,'' Proposed Rule, 75 FR 76139, Dec. 7, 2010.
\111\ See ``Swap Data Recordkeeping and Reporting
Requirements,'' Proposed Rule, 75 FR 76573, Dec. 8, 2010.
---------------------------------------------------------------------------
Summary of Comments and Discussion
CME referred the Commission to comments it submitted on February 7,
2011 with respect to proposed rulemakings under part 43 (real-time
public reporting of swap transaction data) and part 45 (swap data
recordkeeping and reporting requirements).\112\
---------------------------------------------------------------------------
\112\ CME Comment Letter at 14 (Feb. 22, 2011).
---------------------------------------------------------------------------
Rule 38.10 references the reporting requirements contained under
parts 43 and 45, but does not contain the substantive obligations
associated with the requirements. Accordingly, CME's comments were
considered in connection with the final rulemakings under parts 43 and
45.
The Commission is adopting this provision as proposed, with certain
clarifications to conform the rule to the regulations under parts 43
and 45. Specifically, proposed Sec. 38.10 required that each DCM, with
respect to swaps traded on or through the DCM, report specified swap
data to an SDR. The Commission is modifying Sec. 38.10 to clarify that
DCMs must maintain and report specified swap data for swaps traded ``on
or pursuant'' to the rules of the DCM. The clarification is consistent
with the rulemakings that implement real-time reporting of swap
transaction data and swap data recordkeeping and reporting requirements
under parts 43 and 45 of the Commission's regulations.\113\
---------------------------------------------------------------------------
\113\ 75 FR 76140, Dec. 7, 2010; 75 FR 76574, Dec. 8, 2010.
---------------------------------------------------------------------------
D. Core Principles
As noted above, this release reorganizes part 38 to include
subparts A through X. Each of subparts B through X includes relevant
regulations applicable to the 23 core principles. This final rulemaking
codifies within each subpart the statutory language of the respective
core principle.\114\
---------------------------------------------------------------------------
\114\ As noted in the DCM NPRM, in two instances the language of
the core principle, as codified, was slightly revised to add
references to the CEA where the statutory language simply cited to
the CEA section without citing to the statute. These non-substantive
edits were made to sections 38.100 and 38.1200.
---------------------------------------------------------------------------
[[Page 36623]]
1. Subpart B--Designation as Contract Market
In the DCM NPRM, the Commission proposed to codify the statutory
text of Core Principle 1 in Sec. 38.100.\115\ The Commission is
adopting Sec. 38.100 as proposed.
---------------------------------------------------------------------------
\115\ Section 735 of the Dodd-Frank Act amended Core Principle 1
by adding that compliance with the core principles, and any other
rule or regulation that the Commission may impose under section
8a(5) of the CEA, is a necessary condition to obtain and maintain
designation as a contract market, and by adding the condition that
``unless otherwise determined by the Commission by rule or
regulation,'' DCMs have reasonable discretion in establishing the
manner in which they comply with the core principles. 7 U.S.C.
7(d)(1).
---------------------------------------------------------------------------
2. Subpart C--Compliance With Rules
Section 5(d)(2) of the CEA, as amended by the Dodd-Frank Act,
requires that a DCM establish, monitor, and enforce compliance with its
rules, including rules regarding access requirements and the terms and
conditions of any contract to be traded on the contract market, and
rules prohibiting abusive trade practices.\116\ A DCM must also have
the capacity to detect and investigate potential rule violations and to
sanction any person that violates its rules. In addition, a DCM's rules
must provide it with the ability and authority to perform the
obligations and responsibilities required under Core Principle 2,
including the capacity to carry out such international information
sharing agreements that the Commission may require.
---------------------------------------------------------------------------
\116\ Section 735 of the Dodd-Frank Act amended section 5 of the
CEA to eliminate DCM designation criteria and amends several core
principles, including Core Principle 2. Core Principle 2 was amended
to include language formerly found in Designation Criterion 8--
Ability to Obtain Information, and to specifically require that a
DCM have the ability to detect, investigate, and sanction rule
violations.
---------------------------------------------------------------------------
The Commission proposed several rules implementing amended Core
Principle 2, as further described below.
i. Sec. 38.150--Core Principle 2
Proposed Sec. 38.150 codified the text of section 5(d)(2) of the
CEA.
CME commented that a DCM cannot be expected to carry out
international or other informational sharing agreements to which it is
not a party, and should not be compelled by regulation to enter into
such agreements.\117\ KCBT opposed the requirement that a DCM establish
rules and enter into informational-sharing agreements, particularly
when such agreements contain specific requirements that are unsuitable
to a DCM or conditions with which the DCM is unable to comply.\118\
---------------------------------------------------------------------------
\117\ CME Comment Letter at 15 (Feb. 22, 2011).
\118\ KCBT Comment Letter at 3 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission is adopting Sec. 38.150 as proposed. Section 38.150
simply codifies the statutory language of the core principle. The
Commission, therefore, does not have discretion to amend the
requirements or obligations imposed by the statute.\119\
---------------------------------------------------------------------------
\119\ Section 5(d)(2)(C) of the CEA, as amended by the Dodd-
Frank Act, states that ``[t]he rules of the contract market shall
provide the board of trade with the ability and authority to obtain
any necessary information to perform any function described in this
subsection, including the capacity to carry out such international
information sharing agreements as the Commission may require.'' 7
U.S.C. 7(d)(2).
---------------------------------------------------------------------------
ii. Sec. 38.151--Access Requirements
Sec. 38.151(a)--Jurisdiction
Proposed Sec. 38.151(a) required that prior to granting a member
or market participant access to its markets, the DCM must require the
member or market participant to consent to its jurisdiction.
Summary of Comments
CFE stated that the term ``market participant'' used in the
proposed rule should be limited to non-members of a DCM that have the
ability to enter orders directly into a DCM's trade matching system for
execution, and that the term should not include non-members that do not
have this ability.\120\ CFE further commented that the proposed rule
should not apply to customers whose orders pass through a member's
system before receipt by a DCM because, according to CFE, in that
instance the customer order is being received by the DCM from the
member.\121\ CFE also asserted that customers that submit orders
through a member do not have the privilege of trading on a DCM and thus
the proposed rule should not apply to them.\122\
---------------------------------------------------------------------------
\120\ CFE Comment Letter at 2 (Feb. 22, 2011).
\121\ Id.
\122\ Id.
---------------------------------------------------------------------------
CME recommended that the Commission withdraw the proposed
rule.\123\ It contended that requiring clearing firms to obtain every
customer's consent to the regulatory jurisdiction of each DCM would be
costly.\124\ Moreover, CME commented that even if such consent were
obtained, the proposed rule would be entirely ineffective in achieving
the Commission's desired outcome.\125\ CME explained that if a non-
member who had consented to the exchange's jurisdiction under the
proposed rule committed a rule violation and subsequently elected not
to cooperate in the investigation or disciplinary process, the
exchange's only recourse would be to deny the non-member access and, if
appropriate, refer the matter to the Commission.\126\ CME further
explained that a DCM's enforcement options, and the regulatory
outcomes, do not change based on whether or not there is a record of
the non-member consenting to jurisdiction, but rather depend on whether
the non-member chooses to participate in the DCM's investigative and
disciplinary processes.\127\
---------------------------------------------------------------------------
\123\ CME Comment Letter at 17 (Feb. 22, 2011).
\124\ Id. at 16.
\125\ Id.
\126\ Id.
\127\ Id.
---------------------------------------------------------------------------
ICE contended that the proposed rule should distinguish between
direct-access and intermediated market participants.\128\ Furthermore,
ICE stated that a trader should be specifically subject to the
jurisdiction and the disciplinary process of the DCM only when the
privilege of trading on a DCM is specifically granted by the DCM.\129\
Likewise, KCBT explained that even if a non-member consents to KCBT
jurisdiction, but later fails to abide by such consent, KCBT's only
recourse would be to revoke such participant's market access.\130\
Therefore, KCBT questioned the benefit of implementing the proposed
rule.\131\
---------------------------------------------------------------------------
\128\ ICE Comment Letter at 12-13 (Feb. 22, 2011).
\129\ Id. at 15.
\130\ KCBT Comment Letter at 2 (Feb. 22, 2011).
\131\ Id.
---------------------------------------------------------------------------
NYSE Liffe sought clarification regarding the type of market
participant covered by the proposed rule.\132\ NYSE Liffe requested
that the Commission confirm that, unless NYSE Liffe permits market
participants direct access to its trading platform, it would not
consider a DCM to be ``granting'' market participants access to its
markets, thus necessitating that it require market participants to
consent to the DCM's jurisdiction.\133\
---------------------------------------------------------------------------
\132\ NYSE Liffe Comment Letter at 11 (Feb. 22, 2011).
\133\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting Sec. 38.151(a) as proposed. While
acknowledging the comments described above, the Commission believes
that Sec. 38.151(a) codifies jurisdictional requirements necessary to
effectuate the statutory mandate of Core Principle 2 that a board of
trade ``shall have the capacity to detect, investigate, and apply
appropriate sanctions to any person that violates any rule of the
[[Page 36624]]
contract market.'' In the Commission's view, settled jurisdiction--
established by a DCM prior to granting members and market participants
access to its markets--is necessary to effectively investigate and
sanction persons that violate DCM rules. In particular, a DCM should
not be in the position of asking market participants to voluntarily
submit to jurisdiction and cooperate in investigatory proceedings after
a potential rule violation has been found. Similarly, market
participants should be clear that their trading practices are subject
to the rules of a DCM, including rules that require cooperation in
investigatory and disciplinary processes. For the avoidance of doubt,
the Commission notes that the scope of Sec. 38.151(a) is not limited
to market participants with direct market access, or limited as
otherwise suggested by CFE, ICE and NYSE Liffe. To the contrary,
persons whose trades are intermediated, persons who are customers of
member firms, and persons whose access to the exchange is granted by or
through member firms are within the scope of Sec. 38.151(a).
The Commission notes commenters' suggestion that a DCM's ultimate
recourse against non-members who fail to cooperate in investigations or
disciplinary proceedings is to deny such non-members access to the
exchange and, if appropriate, refer them to the Commission. The
Commission confirms that denial of access and referral to the
Commission are the appropriate steps for a DCM to take when a market
participant fails to cooperate in an investigation or disciplinary
proceedings. The Commission expects that DCMs will in fact follow these
steps. However, the Commission does not agree that this absolves DCMs
from their responsibility to establish jurisdiction over members and
market participants as an initial condition of trading. Finally, the
Commission recognizes that DCMs may need additional time to secure
existing market participants' agreements to jurisdiction. Accordingly,
the Commission is granting DCMs up to 180 days following the applicable
effective date of the rules being adopted in this release to comply
with the requirements of Sec. 38.151(a) with respect to existing
members and market participants. Each DCM may determine for itself how
it will secure such agreements. For example, a DCM could utilize its
clearing firms to secure the agreement. With respect to new members and
market participants, DCMs will be subject to Sec. 38.151(a) on the
effective date of the rules being adopted in this release.
Sec. 38.151(b)--Impartial Access by Members, Market Participants and
Independent Software Vendors
Proposed Sec. 38.151(b) required that a DCM provide its members,
market participants and independent software vendors (``ISVs'') with
impartial access to its markets and services, including: (1) access
criteria that are impartial, transparent, and applied in a non-
discriminatory manner, and (2) comparable fee structures for members,
market participants and ISVs, receiving equal access to, or services
from, the DCM. In regards to the proposed rule's comparable fee
structure requirement, the DCM NPRM preamble discussion of proposed
Sec. 38.151(b) stated that ``[f]ee structures may differ among
categories if such fee structures are reasonably related to the cost of
providing access or services to a particular category.''\134\
---------------------------------------------------------------------------
\134\ See DCM NPRM at 80579. As an example, the preamble further
stated that ``if a certain category required greater information
technology or administrative expenses on the part of the DCM, then a
DCM may recoup those costs in establishing fees for that category or
member or market participant.'' Id.
---------------------------------------------------------------------------
Summary of Comments
Chris Barnard supported this requirement, stating that the only
reason for charging different fee structure would relate to differing
costs of providing access or service to a particular category.\135\ CFE
commented that the Commission's application of the requirement to have
comparable fee structures is too narrow.\136\ CFE stated that it is in
a DCM's best interest to set fees at levels that encourage
participation on the DCM (rather than to exclude participants) because
having greater participation leads to greater contract volume and thus
more transaction revenue for the DCM.\137\ CFE agreed that a DCM should
be able to have fee structures that differ among categories and did not
believe that the only permitted differentiation should be based on
cost.\138\
---------------------------------------------------------------------------
\135\ Barnard Comment Letter at 2 (Feb. 22, 2011).
\136\ CFE Comment Letter at 3 (Feb. 22, 2011).
\137\ Id.
\138\ Id.
---------------------------------------------------------------------------
CME stated that the fee restrictions imposed by the proposed rule
exceed the Commission's authority under the Dodd-Frank Act, and
questioned the basis for the proposed rule.\139\ In particular, CME
argued that the agency lacks authority to set or limit fees charged by
DCMs.\140\
---------------------------------------------------------------------------
\139\ CME Comment Letter at 8-9 (Feb. 22, 2011).
\140\ Id.
---------------------------------------------------------------------------
ELX stated that exchanges must have some flexibility in
implementing fees in order to allow new markets to effectively build a
customer base.\141\ According to ELX, not all customers ``receive the
same commission'' from their FCM, IB or executing broker, and it is
artificial to require exchanges to forego their flexibility in pricing
to build a marketplace.\142\ ELX further stated that competition should
not be rigidly regulated at the exchange level while other regulated
entities doing business with customers are permitted to use competitive
pricing.\143\
---------------------------------------------------------------------------
\141\ ELX Comment Letter at 3 (Feb. 22, 2011).
\142\ Id. at 4.
\143\ Id.
---------------------------------------------------------------------------
ICE noted that the discriminatory conduct prohibited by the
proposed rule would be subject to review by the Commission as an
``access denial'' issue under part 9 of the Commission's
regulations.\144\ Moreover, ICE asserted that in its view, there has
been no pattern of DCMs denying access to their markets that warrants
the proposed rule.\145\ ICE added that the proposed rule should not
require access requirements for traders who do not apply for, and are
not granted access to, the trading platform by the DCM.\146\
---------------------------------------------------------------------------
\144\ ICE Comment Letter at 15 (Feb. 22, 2011).
\145\ Id. at 15.
\146\ Id.
---------------------------------------------------------------------------
KCBT objected to the Commission's mandate of access and fee
equality, stating that the mandate may not take into consideration all
aspects of an exchange's varying fee or access structures, including
beneficial rate structures for high-volume traders or market maker
programs.\147\ Consequently, KCBT urged the Commission to withdraw from
its attempt to impose fee restrictions on DCMs.\148\
---------------------------------------------------------------------------
\147\ KCBT Comment Letter at 3 (Feb. 22, 2011).
\148\ Id.
---------------------------------------------------------------------------
MGEX stated that in general, it is in the best interest of the DCM
to have open and available markets and services.\149\ Therefore, MGEX
argued that the proposed rule is unnecessary and infringes on the
business judgment of the DCM.\150\
---------------------------------------------------------------------------
\149\ MGEX Comment Letter at 3 (Feb. 22, 2011).
\150\ Id.
---------------------------------------------------------------------------
Trading Technologies stated that the Commission should modify its
proposed impartial access rules to require that DCM co-location service
fees be reasonably related to the cost of providing such services.\151\
---------------------------------------------------------------------------
\151\ Trading Technologies Comment Letter at 4 (Jun. 3, 2011).
The Commission recently addressed co-location fees in a separate
proposed rulemaking for ``Co-location/Proximity Hosting Services.''
See notice of proposed rulemaking, 75 FR 33198, Jun. 11, 2010.
---------------------------------------------------------------------------
[[Page 36625]]
Discussion
The Commission is adopting the rule as proposed, with the
modifications and clarifications described below.
The Commission believes that the proposed rule falls within the
Commission's authority under the Dodd-Frank Act. As an initial matter,
Congress, under the Dodd-Frank Act, expressly authorized the Commission
to promulgate rules implementing requirements for DCMs, including
access requirements.\152\ Moreover, the statutory language of Core
Principle 2 expressly requires that DCMs ``establish, monitor and
enforce compliance with the rules of the contract market, including:
(1) Access requirements[.]'' \153\ Though the CEA does not specify that
DCMs provide ``impartial'' access, the Commission believes that a
reasonable reading of the CEA is that it permits rules that would
promote impartial access.
---------------------------------------------------------------------------
\152\ See CEA section 5(d)(1)(A)(ii) (Core Principle 1), 7
U.S.C. 7(d)(1).
\153\ CEA section 5(d)(2)(A)(i) (Core Principle 2), 7 U.S.C.
7(d)(2).
---------------------------------------------------------------------------
The Commission has considered comments that claimed that the rule
is unnecessary, and believes that impartial access rules are necessary
in order to prevent the use of discriminatory access requirements as a
competitive tool against certain participants. In particular, access to
a DCM should be based on the financial and operational soundness of a
participant, not on factors that could bar access and result in
discriminatory access or act as a barrier to entry. Any participant
should be able to demonstrate financial soundness by showing either
that it is a clearing member of a DCO that clears products traded on
that DCM, or that it has clearing arrangements in place with such a
clearing member. Furthermore, granting impartial access to participants
that satisfy a DCM's access requirements will likely enhance the DCM's
liquidity and the overall transparency of the swaps and futures
markets.
In regards to comments pertaining to the proposed rule's treatment
of fees, the Commission believes that commenters have misinterpreted
the proposed requirement for comparable fee structures for categories
of market participants receiving equal access to the DCM. The
requirement in proposed Sec. 38.151(b) neither sets nor limits fees
charged by DCMs. Rather, it states only that the DCM set non-
discriminatory fee classes for those receiving access to the DCM as a
way to implement the requirement of impartial access to DCMs. DCMs may
establish different categories of market participants, but may not
discriminate within a particular category. Accordingly, contrary to
CME's comment claiming that the fee restrictions imposed by the
proposed rule exceed the Commission's authority under the Dodd-Frank
Act, the rule does not set or impose fees on DCMs.
To clarify the DCM NPRM preamble discussion of the proposed rule's
fee requirement, and in response to CFE and KCBT's comment that a DCM
should be able to differentiate among categories by using factors other
than cost, the Commission notes that when a DCM determines its fee
structure, it may consider other factors in addition to the cost of
providing a member, market participant or ISV with access. The proposed
requirement that DCMs have a comparable fee structure for categories of
market participants was not designed to be a rigid requirement that
fails to take into account legitimate business justifications for
offering different fees to different categories of entities seeking
access. The Commission recognizes that DCMs may also consider services
they receive from members, market participants or ISVs (in addition to
costs) when determining their fee structure. Market making is an
example of one type of service that could merit a fee discount.
To address comments submitted in connection with proposed Sec.
38.151(a) pertaining to the uncertainty of the term ``market
participant,'' the Commission is replacing the term ``market
participant'' in proposed Sec. 38.151(b) with the phrase ``persons
with trading privileges.''
The Commission is adopting the remainder of the rule as proposed.
Sec. 38.151(c)--Limitations on Access
Proposed Sec. 38.151(c) required a DCM to establish and
impartially enforce rules governing any decision by the DCM to deny,
suspend, or permanently bar a member's or market participant's access
to the contract market. Any decision by a DCM to deny, suspend, or
permanently bar a member's or market participant's access to the DCM
must be impartial and applied in a non-discriminatory manner.
Summary of Comments
CFE, ICE, and NYSE Liffe commented on the uncertainty of the term
``market participant'' as used in paragraphs (a), (b), and (c) of
proposed Sec. 38.151.\154\
---------------------------------------------------------------------------
\154\ CFE Comment Letter at 2 (Feb. 22, 2011); ICE Comment
Letter at 14 (Feb. 22, 2011); NYSE Liffe Comment Letter at 11 (Feb.
22, 2011).
---------------------------------------------------------------------------
Discussion
To address comments pertaining to the uncertainty of the term
``market participant,'' the Commission is replacing the term ``market
participant'' in proposed Sec. 38.151(c) with the phrase ``persons
with trading privileges.''
iii. Sec. 38.152--Abusive Trading Practices Prohibited
As proposed, Sec. 38.152 required a DCM to prohibit the following
abusive trading practices: front-running, wash trading, pre-arranged
trading, fraudulent trading, money passes, and any other trading
practices that the DCM deems to be abusive. Additionally, a DCM
permitting intermediation would be required to prohibit additional
trading practices, including trading ahead of customer orders, trading
against customer orders, accommodation trading, and improper cross-
trading. The proposal also required a DCM to prohibit any other
manipulative or disruptive trading practices prohibited by the Act or
by the Commission pursuant to regulation.\155\
---------------------------------------------------------------------------
\155\ Section 747 of the Dodd-Frank Act amended section 4c(a) of
the CEA, 7 U.S.C. 6c(a), by adding three disruptive practices which
make it: unlawful for any person to engage in any trading, practice,
or conduct on or subject to the rules of a registered entity that--
(A) Violate bids or offers;
(B) Demonstrates intentional or reckless disregard for the
orderly execution of transactions during the closing period; or
(C) Is, is of the character of, or is commonly known as the
trade as `spoofing' (bidding or offering with the intent to cancel
the bid or offer before execution).
---------------------------------------------------------------------------
Summary of Comments
CME and MGEX stated that the proposed rule is too vague because it
does not specifically define the enumerated prohibited trade
practices.\156\ CME also stated that DCMs should have reasonable
discretion to establish rules appropriate to their markets that are
consistent with the CEA and that satisfy the core principles.\157\ CME
additionally commented that prearranged trading, which is identified in
the proposed rule as a prohibited trade practice, may be permissible at
DCMs that allow for block trading, exchange for related position
transactions, and pre-execution communications, subject to specified
conditions.\158\
---------------------------------------------------------------------------
\156\ CME Comment Letter at 17 (Feb. 22, 2011) (CME also argued
that the proposed regulation was superfluous given that Core
Principle 12 already requires a DCM to establish and enforce rules
to protect markets and market participants from abusive practices);
MGEX Comment Letter at 3 (Feb. 22, 2011).
\157\ CME Comment Letter at 17 (Feb. 22, 2011).
\158\ Id. at 17-18.
---------------------------------------------------------------------------
Chris Barnard commented that the proposed rule refers to the
prohibition of ``any other manipulative or disruptive trading practices
prohibited by the Act
[[Page 36626]]
or by the Commission,'' which is important in order to cover new
disruptive practices as they emerge, including spoofing.\159\ Better
Markets commented that it is unclear whether any of the practices
associated with high frequency trading will be prohibited by the
Commission.\160\ Better Markets recommended that the Commission expand
its list of prohibited trade practices to include exploiting a large
quantity or block trade, price spraying, rebate harvesting, and
layering the market, as all four of those practices involve fraudulent
trading.\161\
---------------------------------------------------------------------------
\159\ Barnard Comment Letter at 3 (May 20, 2011).
\160\ Better Markets Comment Letter at 5 (Feb. 22, 2011).
\161\ Id. at 5-8.
---------------------------------------------------------------------------
Discussion
The Commission is adopting Sec. 38.152 as proposed, subject to the
modification described below.
In response to CME and MGEX's concerns regarding the perceived
vagueness of the enumerated trading practices, the Commission notes
that the definitions of the respective abusive trading practices are
commonly known within the industry. Moreover, the enumerated practices
in the proposed rule are commonly prohibited within the industry and
are typically already prohibited in DCM rulebooks.\162\ Although the
Commission believes, as noted by CME, that a DCM should have reasonable
discretion to establish rules for their markets, the Commission
believes that, at a minimum, a DCM must prohibit the abusive trading
practices identified in the rule. Indeed, in the RERs conducted by
Commission staff to examine DCMs' core principle compliance, Commission
staff has found that it is essential for a DCM to be able to
demonstrate the capacity to detect, investigate, and enforce the
trading violations prohibited under the rule. Consistent with CME's
comments on this issue, the Commission clarifies that in certain
limited circumstances, as provided under the CEA and the Commission
regulations, pre-arranged trading, including block trading and exchange
for related position transactions, are permissible at DCMs.
Accordingly, the Commission is amending proposed Sec. 38.152 to
clarify that a DCM must prohibit pre-arranged trading except as
otherwise permitted in part 38 of this chapter. The Commission confirms
that pre-execution communications are permissible if allowed by a DCM's
rules that have been certified to or approved by the Commission.
---------------------------------------------------------------------------
\162\ See e.g., CME Rule 534 (Wash Trades Prohibited), and MGEX
Rule 743.00 (Accommodation or Wash Trades Forbidden).
---------------------------------------------------------------------------
In response to Chris Barnard's comment about the inclusion of
``spoofing'' as a prohibited trade practice, the Commission notes that
section 747 of the Dodd-Frank Act amended section 4c(a) of the CEA and
includes spoofing as a disruptive trading practice. In the final rule,
DCMs are required to prohibit any other manipulative or disruptive
trading practices prohibited by the Act. Additionally, the Commission
notes that Better Markets' comments regarding Core Principle 2 and high
frequency trading are addressed in the context of Core Principle 4.
iv. Sec. 38.153--Capacity To Detect and Investigate Rule Violations
Proposed Sec. 38.153 required that a DCM have arrangements and
resources for effective rule enforcement.\163\ This included the
authority to collect information and examine books and records of
members and market participants. Additionally, the proposed rule
required a DCM to have, in addition to appropriate resources for trade
practice surveillance programs, appropriate resources to enforce all of
its rules.
---------------------------------------------------------------------------
\163\ As noted in the DCM NPRM, proposed regulation 38.153 was
based on the former application guidance for Core Principle 2.
---------------------------------------------------------------------------
Summary of Comments
CFE requested that the Commission clarify the term ``market
participant.'' \164\ CFE claimed that if the term ``market
participant'' were to be interpreted to apply to all customers and not
just those customers with direct electronic access to the DCM, then the
rule would greatly expand a DCM's regulatory responsibilities over
participants with whom it has no direct relationship or
connection.\165\ CFE further asserted that the rule would greatly
increase costs for the DCM and that it would be very difficult for a
DCM to undertake the same examination responsibilities for customers
that do not have a direct relationship with the DCM that are applicable
to a DCM member.
---------------------------------------------------------------------------
\164\ CFE Comment Letter at 2 (Feb. 2, 2011).
\165\ Id.
---------------------------------------------------------------------------
CME stated that the proposed rule appears to imply that the entire
class of non-member, non-registered market participants will be subject
to the panoply of recordkeeping requirements currently applicable only
to members, registrants, and direct access clients of CME.\166\
Additionally, CME commented that the proposed rule does not detail
which books, records and information the DCM must be able to obtain
from non-member market participants.\167\
---------------------------------------------------------------------------
\166\ CME Comment Letter at 18 (Feb. 22, 2011).
\167\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting this provision as proposed, subject to
the modification described below.
The Commission is cognizant that a broad interpretation of the term
``market participant'' could significantly increase the regulatory
responsibilities for DCMs. As noted above, the use of ``market
participant'' may be interpreted to capture a wider range of persons
than the Commission intended. Therefore, in response to the commenters'
concerns, the Commission is replacing the term ``market participant''
with ``persons under investigation'' in the final rule. Thus, a DCM
must have the authority to collect books and records from its members,
and from any persons under investigation, for effective enforcement of
its rules. The books and records collected by the DCM should encompass
all information and documents that are necessary to detect and
prosecute rule violations.
v. Sec. 38.154--Regulatory Services Provided by a Third Party
As the Commission stated in the DCM NPRM, the CEA ``provides that a
DCM may comply with applicable core principles by delegating relevant
functions to a registered futures association or another registered
entity'' (collectively, a ``regulatory service provider'').\168\
Proposed Sec. 38.154(a) required that a DCM that contracts with a
regulatory service provider ensure that its regulatory service provider
has sufficient capacity and resources to provide timely and effective
regulatory services. The proposed rule also made clear that a DCM
``will at all times remain responsible for the performance of any
regulatory services received, for compliance with the [DCM's]
obligations under the CEA and Commission regulations, and for the
regulatory service provider's performance on its behalf.'' \169\
---------------------------------------------------------------------------
\168\ Id. at 80580.
\169\ 75 FR 80572, 80612, Dec. 22, 2010.
---------------------------------------------------------------------------
Proposed Sec. 38.154(b) required that a DCM maintain adequate
compliance staff to supervise any services performed by a regulatory
service provider. The proposed rule also required that the DCM hold
regular meetings with its regulatory service provider to discuss
current work and other matters of regulatory concern. The DCM must also
conduct periodic reviews of the adequacy and
[[Page 36627]]
effectiveness of services provided on its behalf.
Proposed Sec. 38.154(c) required a DCM that utilizes a regulatory
service provider to retain exclusive authority over certain areas,
including the cancellation of trades, issuance of disciplinary charges
against members or market participants, and denials of access to the
trading platform for disciplinary reasons. While the proposed rule
permitted a DCM to retain exclusive authority in other areas of its
choosing, it required that the decision to open an investigation into a
possible rule violation reside with the regulatory service provider.
Summary of Comments
MGEX, KCBT and CME asserted that the proposed rule was overly
burdensome or unnecessary.\170\ MGEX expressed general opposition to
proposed Sec. 38.154, stating that if a service has been delegated to
another registered entity pursuant to a Commission-approved agreement,
then this ``should be sufficient and no other formal agreement is
necessary.'' \171\ KCBT contended that proposed Sec. 38.154 is overly
burdensome and duplicative, particularly when a DCM contracts with a
regulatory service provider that is also a DCM required to comply with
the same core principles.\172\ KCBT noted that it currently is a party
to a services agreement with another DCM and that it will be costly and
unnecessary to perform periodic reviews and hold regular meetings with
this regulatory service provider.\173\
---------------------------------------------------------------------------
\170\ MGEX Comment Letter at 3 (Feb. 22, 2011); KCBT Comment
Letter at 3 (Feb. 22, 2011); CME Comment Letter at 19 (Feb. 22,
2011).
\171\ MGEX Comment Letter at 3 (Feb. 22, 2011).
\172\ KCBT Comment Letter at 3 (Feb. 22, 2011).
\173\ Id.
---------------------------------------------------------------------------
Similarly, CME contended that the proposed rule was overly
prescriptive and suggested that the rules would better serve as
guidance and acceptable practices.\174\ In particular, CME pointed to
the requirements that a DCM conduct periodic reviews of the services
provided and hold regular meetings with the regulatory service provider
to discuss ongoing investigations, trading patterns, market
participants, and any other matters of regulatory concern.\175\ CME
stated that ``[w]hile it may well be that it is constructive for the
DCM to hold regular meetings with its service provider and `discuss
market participants,' the core principle should stand on its own and
the DCM should have the flexibility to determine how best to
demonstrate compliance with the core principle.'' \176\
---------------------------------------------------------------------------
\174\ CME Comment Letter at 18-19 (Feb. 22, 2011).
\175\ Id.
\176\ CME Comment Letter at 19 (Feb. 22, 2011).
---------------------------------------------------------------------------
CME further objected to the requirement that exclusive authority to
open investigations remain with the regulatory service provider.\177\
While it argued that the regulatory service provider ``should have the
independence to open an investigation at its discretion, [CME] sees no
reason why the DCM cannot also direct the regulatory service provider
to open an investigation.'' \178\ Additionally, CME and KCBT both
objected to the requirement in proposed Sec. 38.154(c) that all
decisions concerning the cancellation of trades remain within the
exclusive authority of the DCM.\179\ CME and KCBT argued that a DCM may
be better served by granting such authority to a regulatory service
provider.\180\
---------------------------------------------------------------------------
\177\ Id.
\178\ Id.
\179\ CME Comment Letter at 19 (Feb. 22, 2011); KCBT Comment
Letter at 3 (Feb. 22, 2011).
\180\ Id.
---------------------------------------------------------------------------
NYSE Liffe expressed support for the idea that a DCM will remain
ultimately responsible for meeting its regulatory obligations even when
it contracts with a regulatory service provider.\181\ However, NYSE
Liffe requested clarification regarding what authority must be
maintained by a DCM when it uses a third-party regulatory service
provider.\182\ NYSE Liffe pointed to the requirement in proposed Sec.
38.154(c) that a DCM must retain ``exclusive authority'' in certain
areas and requested further clarification as to the definition of
``exclusive authority.'' \183\ In particular, NYSE Liffe requested
guidance as to whether a DCM retains ``exclusive authority'' if its
regulatory service provider prepares and presents an investigation
report to a DCM's review panel, or assists DCM staff in presenting the
matter, as long as the ultimate decision to bring a disciplinary action
remains with the DCM's review panel.\184\ Additionally, NYSE Liffe
sought guidance as to whether a regulatory service provider would be
permitted to ``prosecute a disciplinary proceeding * * * so long as the
ultimate decision to impose a penalty on a respondent, including a
possible denial of access to the trading platform, resides with a
hearing panel formed pursuant to the DCM's rules?'' \185\
---------------------------------------------------------------------------
\181\ NYSE Liffe Comment Letter at 9 (Feb. 22, 2011).
\182\ Id.
\183\ Id.
\184\ Id.
\185\ Id. at 10.
---------------------------------------------------------------------------
Discussion
The Commission is adopting Sec. 38.154(a) and (b), as proposed,
and is adopting Sec. 38.154(c) with certain modifications.
In the past, the Commission has described acceptable
``contracting'' and ``delegating'' arrangements for the performance of
core principle functions by third-parties.\186\ The Commission proposed
Sec. 38.154 to clarify its previous guidance on such arrangements. In
particular, the Commission does not draw substantive distinctions
between ``contracting'' and ``delegating'' arrangements as they pertain
to core principle compliance functions. Regardless of the term by which
a DCM may refer to its utilization of a third-party, the Commission
believes that the same regulatory requirements are applicable for
purposes of part 38. For purposes of part 38, the Commission refers to
such arrangements as ``delegation.'' The Commission also notes that
DCMs must remain responsible for carrying out any function delegated to
a third party, and that DCMs must ensure that the services received
will enable the DCM to remain in compliance with the CEA's
requirements. The Commission believes that proposed Sec. 38.154
effectively establishes a system for administering regulatory services
provided to DCMs by third party regulatory service providers. The
Commission is of the view that the rule generally provides an
appropriate balance between flexibility and ensuring that a DCM
properly oversees the actions of its regulatory service provider to
ensure accountability and effective performance.
---------------------------------------------------------------------------
\186\ See 66 FR 42256, 42266, Aug. 10, 2001.
---------------------------------------------------------------------------
The Commission acknowledges comments asserting that the rule is
overly burdensome or unnecessary but believes that a DCM that elects to
use a regulatory service provider must properly supervise the quality
and effectiveness of the regulatory services provided on its behalf.
The Commission believes that proper supervision will require that a DCM
have complete and timely knowledge of relevant work performed by the
DCM's regulatory service provider on its behalf. The Commission also
believes that such knowledge can only be acquired through the periodic
reviews and regular meetings required under proposed Sec. 38.154.
Additionally, the Commission acknowledges CME and KCBT's comments
regarding the cancellation of trades but believes that the potential
economic consequences of trade
[[Page 36628]]
cancellations on a DCM's members and market participants are such that
a DCM should retain exclusive authority over the cancellation of
trades.
The Commission has considered CME's comment regarding the
importance of allowing a DCM to open investigations into possible rule
violations. The Commission believes that a DCM should have the ability
to request that its regulatory service provider conduct an
investigation on a market participant or to conduct such an
investigation on its own. Consequently, the Commission is modifying
Sec. 38.154(c) by removing the requirement that the decision to open
an investigation into possible rule violations reside exclusively with
the regulatory service provider.
Lastly, in response to the request by NYSE Liffe for additional
guidance regarding whether certain regulatory decisions must be
retained by a DCM, the Commission believes that a DCM would retain
``exclusive authority'' under Sec. 38.154(c) if it permits a
regulatory service provider to present, or assist DCM staff to present,
an investigation report or evidence to a disciplinary panel as long as
the decisions to bring a disciplinary action and impose a disciplinary
penalty on a respondent, including the decision to deny access, remains
with the DCM or the DCM's disciplinary bodies.
vi. Sec. 38.155--Compliance Staff and Resources
In proposed Sec. 38.155(a), the Commission required that a DCM
establish and maintain sufficient compliance staff and resources to
conduct a number of enumerated tasks, such as audit trail reviews,
trade practice surveillance, market surveillance, and real time market
monitoring. The proposed rule also required that the DCM have
sufficient compliance staff to address unusual market or trading events
and to conduct and complete any investigations in a timely manner.
In proposed Sec. 38.155(b), the Commission required a DCM to
monitor the size and workload of its compliance staff annually to
ensure that staff and resources are adequate. In the preamble to the
proposed rule, the Commission clarified that it was not proposing that
compliance staff size be determined based on a specific formula.
Rather, the Commission intended ``to leave to the discretion of each
individual DCM to determine the size of the staff it needs to
effectively perform its self-regulatory responsibilities.'' \187\ In
making this determination, the proposed rule also set forth certain
factors that should be considered in determining the appropriate level
of compliance resources and staff.
---------------------------------------------------------------------------
\187\ DCM NPRM at 80580.
---------------------------------------------------------------------------
Summary of Comments
NYSE Liffe noted that in proposed Sec. 38.154(b), ``a DCM that
contracts with a regulatory service provider must still maintain
sufficient compliance staff.'' \188\ NYSE Liffe suggested that Sec.
38.155 take into consideration whether a DCM has contracted with a
regulatory service provider in determining the appropriate level of
compliance staff and resources.\189\ NYSE Liffe also requested that the
Commission ``make clear that a DCM meets its requirement to have
sufficient compliance staff to address unusual market or trading events
where its regulatory services provider has sufficient resources for
addressing these unusual events.'' \190\
---------------------------------------------------------------------------
\188\ NYSE Liffe Comment Letter at 10 (Feb. 22, 2011). See also
DCM NPRM at 80612.
\189\ NYSE Comment Letter at 10 (Feb. 22, 2011).
\190\ Id.
---------------------------------------------------------------------------
Chris Barnard requested that the Commission amend Sec. 38.155 to
require DCMs to have a chief compliance officer ``working within a job
description, structures, rules and procedures that act to maintain its
independence.'' \191\
---------------------------------------------------------------------------
\191\ Barnard Comment Letter at 3 (May 20, 2011).
---------------------------------------------------------------------------
Discussion
The Commission believes that proposed Sec. 38.155 effectively sets
forth the requirement that DCMs must establish and maintain sufficient
compliance staff to enforce compliance with its rules as required under
Core Principle 2, and accordingly, the Commission is adopting Sec.
38.155 as proposed.
The Commission is of the view that having adequate staff to perform
a DCM's compliance and enforcement responsibilities is essential to the
effectiveness of its self-regulatory programs, including market
surveillance, audit trail, trade practice surveillance, and
disciplinary programs. The Commission believes (as noted by NYSE Liffe)
that the staff of a regulatory service provider may be taken into
consideration when determining whether a DCM has sufficient compliance
staff. However, the Commission notes that pursuant to Sec. 38.154(b),
each DCM must still retain sufficient compliance staff to supervise the
quality and effectiveness of any services provided by a regulatory
service provider on its behalf.
The Commission acknowledges Chris Barnard's comment that a DCM
should be required to designate a chief compliance officer but notes
that the Dodd-Frank Act mandates that certain regulated entities, such
as SEFs, swap data repositories, and derivatives clearing
organizations, designate chief compliance officers. There is no
explicit statutory requirement for DCMs. Therefore, the Commission does
not believe it is appropriate to require DCMs to appoint a chief
compliance officer. However, it is current industry practice for DCMs
to designate an individual as chief regulatory officer, and it will be
difficult for a DCM to meet the requirements of Sec. 38.155 without a
chief regulatory officer or similar individual to supervise its
regulatory program, including any services rendered to the DCM by a
regulatory service provider.
vii. Sec. 38.156--Automated Trade Surveillance System
Proposed Sec. 38.156 required a DCM to maintain an automated trade
surveillance system capable of detecting and investigating potential
trade practice violations. The automated trade surveillance would be
required to maintain all data reflecting the details of each order
entered into the trading system, including order modifications and
cancellations, and data reflecting transactions executed on the DCM.
The proposed rule required the automated surveillance system to process
this data on a trade date plus one day basis (``T+1 basis'').
Additionally, according to the rule, the automated trade surveillance
system would be required to provide users with the ability to compute,
retain and compare trading statistics; compute profit and loss; and
reconstruct the sequence of trading activity.
Summary of Comments
CME commented that an exchange does not capture order details,
modifications or cancellations for open-outcry orders in an automated
manner unless such orders are transmitted to the floor via the
exchange's order routing system, or with respect to privately
negotiated transactions.\192\ CME asserted that it has been unable to
design a system that automates the actual investigation of potential
trade practice violations, and that it would not be able to do so
within 60 days of the final rules taking effect.\193\ CME further
argued that it is unclear whether the regulation applies to electronic
trading or open outcry trading.\194\ CME challenged the use of what it
deems as ``broad and ambiguous'' terms to describe
[[Page 36629]]
capabilities that a DCM's automated trade surveillance system is
required to have, including the capability to detect and flag specific
trade execution patterns and anomalies; compute, retain and compare
trading statistics; and compute trade gains, losses, and futures-
equivalent positions.\195\ CME recommended that the Commission
reconsider the requirements of this regulation and consider a more
flexible, core principles-based approach.\196\
---------------------------------------------------------------------------
\192\ CME Comment Letter at 20 (Feb. 22, 2011).
\193\ Id.
\194\ Id.
\195\ Id.
\196\ Id.
---------------------------------------------------------------------------
MGEX agreed with the proposed requirement that a DCM's automated
surveillance system must maintain all trade data and order data on a
T+1 basis, but opposed the proposed requirement that a DCM compute,
retain and compare trading statistics.\197\ MGEX contended that this
information is not a trade data item and requested that this
requirement be removed from the final rule.\198\
---------------------------------------------------------------------------
\197\ MGEX Comment Letter at 4 (Feb. 22, 2011).
\198\ Id.
---------------------------------------------------------------------------
NYSE Liffe commented that it would take significant time to
determine the types of changes to existing automated systems required
to implement the proposed rules, including Sec. 38.156, and
recommended that the Commission provide existing DCMs with at least 18
months from the effective date of the rule to certify compliance with
the final regulations.\199\
---------------------------------------------------------------------------
\199\ NYSE Liffe Comment Letter at 14 (Feb. 22, 2011).
---------------------------------------------------------------------------
Better Markets commented that an automated trade surveillance
system, which records orders, modifications of orders, and
cancellations, must allow for such data to be time-stamped at intervals
consistent with the capabilities of high frequency traders that use the
DCM's systems to transact.\200\
---------------------------------------------------------------------------
\200\ Better Markets Comment Letter at 9 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission is adopting proposed Sec. 38.156, with one
modification.
The requirement that an automated trade surveillance system
maintain all data reflecting the details of each order entered into the
trading system is being moved to Sec. 38.552 (Elements of an
acceptable audit trail program). Specifically, the Commission believes
that Sec. 38.552(b) is the more logical place in the Commission's
rules to address this aspect of a DCM's automated surveillance system
because paragraph (b) specifies the requirements for a DCM's audit
trail program, including a history of all orders and trades.
In response to CME's comment regarding a system that automates the
actual investigation, the Commission notes that CME has misinterpreted
the proposed rule, as Sec. 38.156 applies to a DCM's automated
surveillance system and not to the actual investigation which the
Commission expects would be carried out by a DCM's compliance staff
with the assistance of automated surveillance tools. The Commission
confirms that the speed and timing of capturing information through an
automated trade surveillance system is different for open-outcry than
for electronic trading, as CME stated in its comments; this is
addressed in the discussion concerning Sec. 38.552.
In regards to CME's comment pertaining to the breadth of the rule,
while the Commission acknowledges that computing, retaining, and
comparing trading statistics may not specifically be a trade data item,
the Commission believes that these analytical tools are a necessary
component of an effective trade surveillance system. The Commission
notes that timing concerns raised by NYSE Liffe regarding compliance
with the final rules are addressed above in the Sec. 38.3 discussion.
Additionally, the Commission notes that Better Markets' comments
regarding Core Principle 2 and high frequency trading are addressed in
the context of Core Principle 4.
viii. Sec. 38.157--Real-Time Market Monitoring
Proposed Sec. 38.157 codified existing practices at DCMs for real-
time monitoring of electronic trading, and reflected the growth of
electronic trading in the U.S. futures markets, as well as the
Commission's experience in designating new contract markets since
passage of the CFMA.\201\ Proposed Sec. 38.157 required a DCM to
conduct real-time market monitoring of all trading activity on its
electronic trading platform to ensure orderly trading and identify
market or system anomalies. The proposed rule further required a DCM to
have the authority to cancel trades and adjust trade prices when
necessary, and that any price adjustments or trade cancellations must
be transparent to the market and subject to clear, fair and publicly-
available standards.
---------------------------------------------------------------------------
\201\ See DCM NPRM at 80581.
---------------------------------------------------------------------------
Summary of Comments
In its comments, CME reiterated its belief that the proposed rules
are overly prescriptive.\202\ CME argued that the standards set in the
proposed rule are unreasonably high.\203\ CME pointed to the
requirement that a DCM ``conduct real-time market monitoring of all
trading activity on its electronic trading platform(s) to ensure
orderly trading and identify any market or system anomalies'' and
argued that it is not clear whether any DCM could comply with these
standards.\204\
---------------------------------------------------------------------------
\202\ CME Comment Letter at 20-21 (Feb. 22, 2011).
\203\ Id.
\204\ CME Comment Letter at 20-21 (Feb. 22, 2011) (citing DCM
NPRM at 80613, with emphasis added by CME).
---------------------------------------------------------------------------
Better Markets stated that when conducting real-time market
monitoring, DCMs should have the capability to monitor high frequency
trading.\205\ Better Markets argued that this process should include
``monitoring of orders and cancellations, each time-stamped at
intervals consistent with the capabilities of [high frequency
traders].'' \206\
---------------------------------------------------------------------------
\205\ Better Markets Comment Letter at 9 (Feb. 22, 2011).
\206\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting Sec. 38.157, as proposed, subject to
the modification described below.
In regard to the CME's comment, the Commission believes that Sec.
38.157, as proposed, enables a DCM to effectively monitor its
electronic markets and grants a DCM the flexibility to determine the
best way to conduct real-time market monitoring. The Commission also
believes that the proposed rule correctly mandates that a DCM conduct
real-time market monitoring of all trading activity that occurs on its
electronic trading platform(s) in order to detect disorderly trading
and market or system anomalies, and take appropriate regulatory action.
The Commission recognizes that real-time market monitoring cannot
ensure orderly trading at all times, but it should be able to identify
disorderly trading when it occurs. Therefore, the Commission is
modifying the first sentence of proposed Sec. 38.157 to remove the
requirement to ``ensure orderly trading'' and instead state that ``a
designated contract market must conduct real-time market monitoring of
all trading activity on its electronic trading platform(s) to identify
disorderly trading and any market or system anomalies.'' In response to
Better Markets' comments, the Commission believes that Sec. 38.157 is
sufficient to establish a DCM's obligations with respect to real-time
market monitoring of all trading on a DCM's electronic trading
platform, including high frequency trading. The Commission will
continue to assess the impact of high
[[Page 36630]]
frequency trading on the markets regulated by the Commission.
The Commission believes that Sec. 38.157 effectively establishes a
DCM's obligations with respect to real-time market monitoring of
trading activity on its electronic trading platforms. Accordingly, the
Commission is adopting Sec. 38.157 as modified above.
ix. Sec. 38.158--Investigations and Investigation Reports
Sec. 38.158(a)--Procedures
Proposed paragraph (a) of Sec. 38.158 required that a DCM have
procedures to conduct investigations of possible rule violations. The
proposed rule required that an investigation must be commenced upon
Commission staff's request or upon discovery of information by the DCM
indicating a possible basis for finding that a violation has occurred
or will occur.
Summary of Comments
CME argued that the proposed rule diminishes any discretion on
behalf of DCMs to determine the matters that warrant a formal
investigation, because at the time of discovery or upon receipt of
information, and before a review occurs, there always may be a possible
basis that a violation has occurred or will occur.\207\ CME agreed that
written referrals from the Commission, law enforcement authorities,
other regulatory agencies, or other SROs should result in a formal
investigation in every instance.\208\ However, CME contended that the
DCM should have reasonable discretion to determine how it responds to
complaints and other referrals, including the discretion to follow-up
with a less formal inquiry in certain situations.\209\
---------------------------------------------------------------------------
\207\ CME Comment Letter at 21 (Feb. 22, 2011).
\208\ Id.
\209\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting Sec. 38.158(a) as proposed, subject to
a minor modification. The Commission confirms that in certain
circumstances a DCM should have reasonable discretion regarding whether
or not to open an investigation, as noted by CME. Consequently, the
Commission is revising paragraph (a) of Sec. 38.158 to reflect that an
investigation must be commenced upon receipt of a request from
Commission staff or upon the discovery or receipt of information by the
DCM that indicates a ``reasonable basis'' for finding that a violation
``may have'' occurred or will occur.
Sec. 38.158(b)--Timeliness
Proposed Sec. 38.158(b) required that an investigation be
completed in a timely manner, which is defined in the proposed rule as
12 months after an investigation is opened, absent mitigating factors.
The mitigating factors identified in the proposed rule included the
complexity of the investigation, the number of firms or individuals
involved as potential wrongdoers, the number of potential violations to
be investigated, and the volume of documents and data to be examined by
compliance staff.
Summary of Comments
CME expressed general support for the proposed rule, but
recommended that the list of possible mitigating circumstances also
include the domicile of the subjects and cooperative enforcement
matters with the Commission, since the DCM may not have independent
control over the pace of the investigation.\210\ CME also requested
that the Commission make clear that the time period necessary to
prosecute an investigation once it is referred for enforcement action
is independent of the 12-month period referenced in the
regulation.\211\
---------------------------------------------------------------------------
\210\ Id.
\211\ Id. at 22.
---------------------------------------------------------------------------
Discussion
The Commission is adopting the rule as proposed.
The Commission believes that a 12-month period to complete an
investigation is appropriate and timely. Although the Commission
believes, as noted by CME, that additional mitigating factors could
justifiably contribute to a delay in completing an investigation within
a 12-month period the Commission notes that the factors included in the
proposed rule were not intended to be an exhaustive list of mitigating
circumstances. In the Commission's view, the factors listed in the
proposed rule represent some of the more common examples that could
delay completing an investigation within the 12-month period. The
Commission also confirms that Sec. 38.158 only applies to the
investigation phase of a matter.
Sec. 38.158(c)--Investigation Reports When a Reasonable Basis Exists
for Finding a Violation
Proposed Sec. 38.158(c) sets forth the elements and information
that must be included in an investigation report when there is a
reasonable basis for finding a rule violation, including: (i) The
reason for the investigation; (ii) a summary of the complaint, if any;
(iii) the relevant facts; (iv) compliance staff's analysis and
conclusions; (v) a recommendation as to whether disciplinary action
should be pursued; and (vi) the member or market participant's
disciplinary history.
Summary of Comments
CME commented that rule violations can range from very minor to
egregious and not every rule violation merits formal disciplinary
action.\212\ CME argued that minor transgressions can effectively be
addressed by the issuance of a warning letter by CME compliance staff,
and that the Commission should amend the rule accordingly to account
for this possibility.\213\
---------------------------------------------------------------------------
\212\ Id.
\213\ Id.
---------------------------------------------------------------------------
CME and ICE opposed the requirement that a DCM include a
respondent's disciplinary history in the investigative report that is
submitted to a review panel.\214\ CME commented that a respondent's
disciplinary history is not relevant to the consideration of whether
that respondent has committed a further violation of the DCM's
rules.\215\ However, CME noted that an exception would be where the
prior disciplinary offense is an element of proof for the rule
violations for which compliance staff is asking the review panel to
issue charges, such as a violation of a previously issued ``cease and
desist'' order.\216\ ICE stated that unless the rule violations that
are the subject of the investigative report involve pervasive
recordkeeping violations, only substantive violations in the
respondent's history would be relevant to the review panel's
deliberations.\217\
---------------------------------------------------------------------------
\214\ CME Comment Letter at 21-22 (Feb. 22, 2011); ICE Comment
Letter at 15 (Feb. 22, 2011).
\215\ CME Comment Letter at 35 (Feb. 22, 2011).
\216\ Id.
\217\ ICE Comment Letter at 15 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission is adopting the rule as proposed, subject to one
modification to address the comments from CME and ICE.
The Commission confirms, as CME noted, that ``minor
transgressions'' can be addressed by a DCM's compliance staff with the
issuance of warning letters and this is discussed below in Sec.
38.158(e). However, as further discussed below in Sec. Sec. 38.158(d)
and (e), no more than one warning letter may be issued to the same
person or entity found to have committed the same rule violation within
a rolling 12-month period.
The Commission also agrees with CME and ICE that a respondent's
disciplinary history is not always
[[Page 36631]]
relevant to the consideration of whether a respondent has committed a
further violation of a DCM's rules. As a result, this requirement is
being eliminated from the final rule. The Commission notes, however,
that all disciplinary sanctions, including sanctions imposed pursuant
to an accepted settlement offer, must take into account the
respondent's disciplinary history.
Sec. 38.158(d)--Investigation Reports When No Reasonable Basis Exists
for Finding a Violation
Proposed Sec. 38.158(d) sets forth the elements and information
that must be included in an investigation report when it has been
determined that no reasonable basis exists for finding a rule
violation, including: (i) The reason the investigation was initiated;
(ii) a summary of the complaint, if any; (iii) the relevant facts; and
(iv) compliance staff's analysis and conclusions. The proposed rule
also required that if a DCM's compliance staff recommends that a
warning letter be issued, the investigation report must also include
the potential wrongdoer's disciplinary history.
Summary of Comments
CME recommended that the Commission amend the proposed rule to
account for a DCM's ability to close a case administratively and still
issue a warning letter without disciplinary committee approval, as the
CME Market Regulation Department currently has such authority.\218\
---------------------------------------------------------------------------
\218\ CME Comment Letter at 22 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission is adopting Sec. 38.158(d) as proposed, subject to
one modification.
The Commission is eliminating the provision in paragraph (d) that
discussed the concept of warning letters because the Commission does
not believe that a DCM would need to limit the number of warning
letters that can be issued when a rule violation has not been found.
For example, Commission staff has found in its RERs that some DCMs
issue warning letters as reminders or for educational purposes. The
Commission notes, however, that this modification does not impact the
limitation on the number of warning letters that may be issued--by a
disciplinary panel or by compliance staff--to the same person for the
same violation in a rolling 12-month period when a rule violation is
found to have been committed.
Sec. 38.158(e)--Warning Letters
Proposed Sec. 38.158(e) provided that a DCM may authorize its
compliance staff to issue a warning letter or to recommend that a
disciplinary committee issue a warning letter. The proposed rule also
provided that no more than one warning letter for the same potential
violation may be issued to the same person or entity during a rolling
12-month period.
Summary of Comments
CME and MGEX opposed the requirement that a DCM may only issue one
warning letter to the same person for the same rule violation in a
rolling 12-month period.\219\ CME stated that the rule is unduly
prescriptive and fails to take into consideration important factors
that are relevant to a DCM when evaluating potential sanctions in a
disciplinary matter.\220\ CME stated that the DCM should have
discretion to determine the appropriate sanctions in all cases.\221\
MGEX contended that the requirement will effectively prohibit a DCM
from using warning letters as an educational tool or reminder.\222\
According to MGEX, the proposed rule forces DCMs to adopt summary fines
and prevents them from pursuing minor infractions, which may lead to
additional unintended consequences outside of the purpose of the Dodd-
Frank Act.\223\ MGEX recommended that the Commission remove this
requirement and provide the DCM more flexibility in determining the
proper methodology for enforcing rules, regulations, and
procedures.\224\
---------------------------------------------------------------------------
\219\ CME Comment Letter at 22-23 (Feb. 22, 2011); MGEX Comment
Letter at 4 (Feb. 22, 2011).
\220\ CME Comment Letter at 22 (Feb. 22, 2011).
\221\ Id.
\222\ MGEX Comment Letter at 4 (Feb. 22, 2011).
\223\ Id.
\224\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting Sec. 38.158(e) with certain
modifications, including to convert a portion of the rule to guidance.
The Commission acknowledges the comments from CME and MGEX
concerning the issuance of warning letters but believes that in order
to ensure that warning letters serve as effective deterrents, and to
preserve the value of disciplinary sanctions, the Commission believes
that no more than one warning letter may be issued to the same person
or entity found to have committed the same rule violation within a
rolling 12-month period.\225\ As discussed in the DCM NPRM, while a
warning letter may be appropriate for a first-time violation, the
Commission does not believe that more than one warning letter in a
rolling 12-month period for the same violation is ever
appropriate.\226\ This provision will remain as a rule. A policy of
issuing repeated warning letters, rather than issuing meaningful
sanctions, to members and market participants who repeatedly violate
the same or similar rules denigrates the effectiveness of a DCM's rule
enforcement program.\227\ Furthermore, the section of the proposed rule
governing warning letters is consistent with what Commission staff has
advised DCM applicants in the past and with recommendations made in
prior RERs.\228\
---------------------------------------------------------------------------
\225\ For purposes of this rule, the Commission does not
consider a ``reminder letter'' or such other similar letter to be
any different than a warning letter.
\226\ See DCM NPRM at 80581.
\227\ See id. at 80581.
\228\ See 1998 Rule Enforcement Review of Kansas City Board of
Trade; and Rule Enforcement Review of the Minneapolis Grain Exchange
(Aug. 27, 2009).
---------------------------------------------------------------------------
The Commission notes that the final rule does not include the
reference that a warning letter issued in accordance with this section
is not a penalty or an indication that a finding of a violation has
been made because paragraph (e) only addresses warning letters that are
issued for a finding of a violation. Also, the provision requiring a
copy of a warning letter issued by compliance staff to be included in
the investigation report is being eliminated from the final rule
because the Commission has determined that such a requirement is
unnecessary.
As noted above, the Commission believes that minor transgressions
can be addressed by the issuance of a warning letter by a DCM's
compliance staff. Accordingly, in order to provide a DCM with
flexibility in this regard, the Commission is moving this provision of
the rule to the guidance section of Core Principle 2. The text of the
guidance provides that the rules of a DCM may authorize compliance
staff to issue a warning letter to a person or entity under
investigation or to recommend that a disciplinary panel take such
action.
x. Sec. 38.159--Ability To Obtain Information
Proposed Sec. 38.159 required a DCM to have the ability and
authority to obtain any necessary information to perform any function
required under proposed subpart C (Compliance with rules) of the
Commission's regulations. This would include the capacity to carry out
any international information sharing agreements required by the
[[Page 36632]]
Commission. Proposed Sec. 38.159 also provided ``that information
sharing agreements can be established with other designated contract
markets and swap execution facilities, or the Commission can act in
conjunction with a DCM to carry out such information sharing.'' \229\
---------------------------------------------------------------------------
\229\ DCM NPRM at 80614.
---------------------------------------------------------------------------
Summary of Comments
CME and KCBT stated that a DCM should not be mandated to carry out
international or other informational sharing agreements to which it is
not a party and should not be compelled by Commission regulation to
enter into agreements, particularly when such agreements contain terms
determined by other parties, which conceivably could include terms or
conditions unsuitable to a DCM or conditions that a DCM is unable to
comply with.\230\
---------------------------------------------------------------------------
\230\ CME Comment Letter at 15 (Feb. 22, 2011); KCBT Comment
Letter at 3 (Feb. 22, 2012).
---------------------------------------------------------------------------
Discussion
The Commission is adopting Sec. 38.159 as proposed. In response to
CME and KCBT's comments, Sec. 38.159 clarifies and codifies the Core
Principle 2 requirement that a DCM have the ability and authority to
obtain necessary information to perform its rule enforcement
obligations. The core principle specifically requires that the rules of
the DCM provide it with the ability and authority to perform any
function described in the core principle, including capacity to carry
out such international information sharing agreements, as the
Commission may require. The rule provides that information sharing
agreements can be established with other DCMs or SEFs, or that the
Commission can act in conjunction with a DCM to carry out such
information sharing.\231\ The Commission notes that the language of
Sec. 38.159, including the language to which CME objects, is
substantially similar to the language of Core Principle 2. The
Commission also notes that while the rule requires DCMs to have the
capacity to carry out such information sharing agreements, as is
required by the statute, the rule does not mandate or prescribe the
specific terms of such agreements, and thus, DCMs would have the
ability to collaborate on the terms of such agreements. The Commission
believes that Sec. 38.159 appropriately implements the requirements of
section 5(d)(2)(C) of the CEA and is adopting Sec. 38.159 as proposed.
---------------------------------------------------------------------------
\231\ As noted in the DCM NPRM, this proposed language is
virtually identical to the language found in the guidance for former
Designation Criterion 8.
---------------------------------------------------------------------------
xi. Sec. 38.160--Additional Rules Required
Proposed Sec. 38.160 required a DCM to adopt and enforce any
additional rules that it believes are necessary to comply with the
requirements of this subpart C.
The Commission has determined to codify proposed Sec. 38.160 as
guidance for Core Principle 2 in appendix B, rather than a rule, in
order to provide DCMs with added flexibility in adopting rules that
they believe are necessary to comply with this core principle.
Consistent with this determination, the Commission is replacing
proposed Sec. 38.160 with new Sec. 38.160 (titled ``Additional
sources for compliance'') that simply permits DCMs to rely upon the
guidance in appendix B of this part to demonstrate to the Commission
compliance with Sec. 38.150 of this part.
3. Subpart D--Contracts Not Readily Subject To Manipulation
The Dodd-Frank Act did not revise the statutory text of Core
Principle 3 (Contracts Not Readily Subject to Manipulation). DCMs
historically have complied with the requirements of Core Principle 3
through the guidance provided in Guideline No. 1, which was codified in
former appendix A to part 40, which is now superseded by appendix C
under part 38 of this final rulemaking. In the DCM NPRM, the Commission
proposed to maintain the guidance under former Guideline No. 1 in new
appendix C, but with certain proposed revisions, as the central mode of
compliance for DCMs under Core Principle 3. In addition to the
guidance, the DCM NPRM proposed two rules under Core Principle 3.
Proposed Sec. 38.200 codified the statutory language of Core Principle
3, and proposed Sec. 38.201 referred applicants and DCMs to the
guidance in appendix C to part 38 for purposes of demonstrating to the
Commission their compliance with the requirements of Sec. 38.200.
In the DCM NPRM, the Commission proposed certain revisions to
former Guideline No. 1, including: (1) Codifying the provision in
appendix C of part 38, and eliminating it from part 40; (2) re-titling
the guidance as ``Demonstration of Compliance That a Contract is not
Readily Susceptible to Manipulation;'' and (3) amending and updating
the guidance to expand the provision to include swap transactions.
Proposed appendix C to part 38 was intended to act as a source for
new and existing DCMs to reference for best practices when developing
products to list for trading. The amended guidance provided greater
detail to DCMs regarding the relevant considerations in demonstrating
compliance with Core Principle 3 when designing a contract and
submitting supporting documentation and data to the Commission at the
time the DCM submits: (1) The terms and conditions of a new contract
under Sec. Sec. 40.2 or 40.3, or (2) amendments to terms and
conditions under Sec. Sec. 40.5 or 40.6. Specifically, proposed
appendix C to part 38 provided guidance regarding: (1) The forms of
supporting information a new contract submission should include; (2)
how to estimate deliverable supplies; (3) the contract terms and
conditions that should be specified for physically delivered contracts;
(4) how to demonstrate that a cash-settled contract is reflective of
the underlying cash market, is not readily subject to manipulation or
distortion, and is based on a cash price series that is reliable,
acceptable, publicly available and timely; (5) the contract terms and
conditions that should be specified for cash-settled contracts; (6) the
requirements for options on futures contracts; (7) the terms and
conditions for non-price based futures contracts; and (8) the terms and
conditions for swap contracts.
Estimating Deliverable Supply
Summary of Comments
CME commented on the proposed guidance pertaining to estimating
deliverable supply in paragraph (b)(1)(i)(A) of proposed appendix
C.\232\ CME contended that the proposed definition of deliverable
supply is restrictive and inconsistent with long-standing industry
practice.\233\ Specifically, CME objected to the proposed provision
that states that ``an appropriate estimate of deliverable supply
excludes supplies that are committed to some commercial use.'' \234\
CME stated that DCMs have historically estimated deliverable supplies
by including in their calculations all supplies that are stored in the
delivery territory or that move through the
[[Page 36633]]
delivery territory, including a determination of amounts committed to
commercial use.\235\ CME asserted that the proposed rulemaking does not
identify any problems with continuing to use the current methodology in
these markets, and claimed that if the proposed standard is adopted, it
will impose additional costs on exchanges and market participants,
including requiring exchanges to survey market participants annually
with no defined benefit.\236\
---------------------------------------------------------------------------
\232\ CME Comment Letter at 38 (Feb. 22, 2011). Proposed
paragraph (b)(1)(i)(A) of appendix C provided guidance on how to
estimate the deliverable supply of a commodity that underlies a
futures contract. The estimated deliverable supply should reflect
the amount of that commodity that can reasonably be expected to be
readily available to long traders to take delivery and short traders
to make delivery at the expiration of a futures contract. This
information is used by Commission staff when considering a
contract's terms and conditions in determining whether a contract is
readily susceptible to manipulation. DCM NPRM at 80631.
\233\ CME Comment Letter at 38 (Feb. 22, 2011).
\234\ See proposed paragraph (b)(1)(i)(A), appendix C. DCM NPRM
at 80631.
\235\ CME Comment Letter at 38 (Feb. 22, 2011).
\236\ Id.
---------------------------------------------------------------------------
Moreover, CME argued that the requirement that DCMs submit monthly
deliverable supply estimates ``for at least the most recent five years
for which data sources permit'' to be used by the Commission to review
a DCM's certification or approval request for a new contract or related
rule amendment is onerous for DCMs.\237\ Instead, CME suggested that
the Commission require monthly estimates of deliverable supply for the
most recent three years.\238\
---------------------------------------------------------------------------
\237\ Id.
\238\ Id.
---------------------------------------------------------------------------
Discussion
The Commission acknowledges CME's comments regarding the proposed
guidance for estimating deliverable supply but notes that a DCM has
historically been required to estimate deliverable supplies, which has
required that a DCM consult with market participants on a regular
basis. In that regard, contrary to CME's claim, the proposed guidance
stating that exchanges should survey market participants should not
impose additional costs on exchanges. As noted above, Commission staff
will continue to work with exchange staff to determine how the
deliverable supply for a certain commodity should be estimated.
Moreover, the Commission confirms, as noted by CME, that the term
``commercial use'' may not be appropriate and could cause confusion.
Accordingly, the Commission is eliminating the sentence in proposed
paragraph (b)(1)(i)(A) that references the term ``commercial use,'' and
is replacing it with the term ``long-term agreement.'' Specifically,
the Commission will clarify in paragraph (b)(1)(i)(A) that an estimate
of deliverable supply would not include supply that is committed for
long-term agreements (i.e., the amount of supply that would not be
available to fulfill the delivery obligations arising from current
trading).
The Commission is further clarifying in paragraph (b)(1)(i)(A) of
the guidance that an exchange may include all or a portion of the
supply that is committed for long-term agreements if it can demonstrate
that those supplies are consistently and regularly made available to
the spot market for traders to acquire at prevailing economic values.
Specifically, the Commission is adding language to paragraph
(b)(1)(i)(A) to provide that if the estimated deliverable supply that
is committed for long-term agreements, or a significant portion
thereof, can be demonstrated by the exchange to be consistently and
regularly made available to the spot market for short traders to
acquire at prevailing economic values, then those ``available''
supplies committed for long-term contracts may be included in the
exchange's estimate of deliverable supply for that commodity.\239\
---------------------------------------------------------------------------
\239\ In adding this language, the Commission is responding to
CME's March 28, 2011 comment letter which stated that the Commission
should define what it understands as ``long-term agreement,''
stating that requiring DCMs to consult with market participants to
estimate deliverable supply on a monthly basis would be a
substantial burden.
---------------------------------------------------------------------------
Similarly, in paragraph (b)(1)(i)(C) of the guidance, the
Commission is eliminating the term ``commercial use'' and replacing it
with the term ``committed for long-term agreements.''
The Commission further agrees with CME that three years of monthly
estimates of deliverable supply is sufficient for the Commission to use
to determine whether or not a contract is readily susceptible to
manipulation or distortion. In this regard, the Commission is amending
paragraphs (a)(2), (b)(1)(i)(A), (b)(1)(i)(B), and (b)(1)(i)(C) to
reflect a three year obligation.
Calculation of Price Indices
Summary of Comments
CME commented on the proposed guidance for calculating price
indices in paragraphs (c)(3)(ii) and (g)(ii) of appendix C.\240\ CME
stated that the guidance may not be applicable for some markets where
there may not be eight independent entities in the entire industry, and
that in those situations, the cash settlement survey should include
transactions representing at least 51 percent of the total production
of the commodity in question.\241\
---------------------------------------------------------------------------
\240\ CME Comment Letter at 38-39 (Feb. 22, 2011). Proposed
paragraphs (c)(3)(ii) and (g)(ii) of appendix C addressed
calculation procedures for safeguarding against potential attempts
to artificially influence a cash settlement price for futures
contracts settled by cash settlement. The guidance provided that if
the cash price is determined by a survey of cash market sources, the
survey should include either: (1) at least four independent entities
(if such sources do not take a position); or (2) eight entities (if
such sources trade for their own accounts).
\241\ CME Comment Letter at 38 (Feb. 22, 2011). Proposed
c(3)(ii) and (g)(ii) of appendix C provided that: ``Where a
designated contract market itself generates the cash settlement
price series, the designated contract market should establish
calculation procedures that safeguard against potential attempts to
artificially influence the price. For example, if the cash
settlement price is derived by the designated contract market based
on a survey of cash market sources, the designated contract market
should maintain a list of such entities which all should be
reputable sources with knowledge of the cash market. In addition,
the sample of sources polled should be representative of the cash
market, and the poll should be conducted at a time when trading in
the cash market is active. The cash-settlement survey should include
a minimum of four independent entities if such sources do not take
positions in the commodity (e.g., if the survey list is comprised
exclusively of brokers) or at least eight independent entities if
such sources trade for their own accounts (e.g., if the survey list
is comprised of dealers or merchants).''
---------------------------------------------------------------------------
Argus stated that it is important that the examination of a
referenced index price should recognize the differences in markets and
instrument types, and that the methodologies used to determine an index
price may vary depending on the characteristics of the market in
question.\242\ Accordingly, Argus recommended that any review of the
integrity of a price index should be flexible enough to account for
differences in markets and instrument types.\243\ Argus also requested
that the Commission clarify that the proposed guidance for calculation
of prices is applicable only to DCMs or SEFs, and does not apply to
independent price data providers of price indices.\244\ Argus stated
that as a market data price provider it obtains price data that is
voluntarily provided to it by market participants, and that it has no
means of requiring participants to provide that data.\245\ In that
regard, Argus contended that for less liquid markets, there may only be
a few market participants willing to provide data to Argus to use to
determine a price series for a commodity.\246\ Argus noted that, in
contrast, a DCM or SEF has the ability to use market transactions
traded on its platform, or to survey market participants that trade on
its platform, to determine a cash settlement price.\247\ Thus, Argus
stated that the guidance in paragraph (c)(3)(ii) should not apply to
market data price providers.\248\
---------------------------------------------------------------------------
\242\ Argus Comment Letter at 4 (Feb. 22, 2011).
\243\ Id.
\244\ Id. at 4-6.
\245\ Id.
\246\ Id.
\247\ Id.
\248\ Id.
---------------------------------------------------------------------------
Discussion
In light of the concerns raised in the comments above, the
Commission is
[[Page 36634]]
eliminating the last sentence of paragraphs (c)(3)(ii) and (g)(ii),
which provides that ``[t]he cash-settlement survey should include a
minimum of four independent entities if such sources do not take
positions in the commodity (e.g., if the survey list is comprised
exclusively of brokers) or at least eight independent entities if such
sources trade for their own accounts (e.g., if the survey list is
comprised of dealers or merchants).'' The Commission notes that the
guidance in appendix C to part 38 is not a restrictive list of
acceptable methodologies. The Commission will continue to review a
contract's susceptibility to manipulation on a contract-by-contract
basis, including taking into account the characteristics of the
underlying market with respect to the price methodology used by
independent price data providers.
The Commission is also making several clarifying amendments to
appendix C to part 38. The Commission is amending the guidance in
paragraph (c)(2) pertaining to a DCM's evaluation of the susceptibility
of a cash-settled contract to manipulation. Specifically, the
Commission is adding the phrase ``[i]n a manner that follows the
determination of deliverable supply as noted above in b(1)'' to the
first sentence in paragraph (c)(2). This will clarify that for cash-
settled contracts based on physical commodities, an exchange should
analyze the size and liquidity of the cash market that underlies the
listed contract as it would if the contract were settled through
physical delivery.
The Commission also is amending paragraph (c)(4)(i)(E) regarding
Maximum Price Fluctuations Limits for cash-settled contracts, to
clarify that for broad-based stock index futures contracts, rules
should be adopted to coordinate with New York Stock Exchange (``NYSE'')
declared Circuit Breaker Trading Halts.\249\ However, because there are
proposals for alternative market coordination currently being
considered (other than the Circuit Breaker Trading Halt), the guidance
will be amended to add the proviso ``or other market coordinated
Circuit Breaker mechanism.'' \250\
---------------------------------------------------------------------------
\249\ See discussion of NYSE circuit breakers, available at:
http://usequities.nyx.com/markets/nyse-equities/circuit-breakers.
\250\ See supra discussion of section 38.255.
---------------------------------------------------------------------------
Finally, the Commission is amending paragraph (e)(1), regarding
Security Futures Contracts, to eliminate the sentence that states ``[a]
designated contract market should follow the appropriate guidance
regarding physically delivered security futures products that are
settled through physical delivery or cash settlement.'' The sentence
was included in the guidance and is being eliminated because part 41
Security Futures Products governs trading in those contracts including
the minimum requirements that an underlying security or security index
must have and maintain to be listed for trading on a DCM.
4. Subpart E--Prevention of Market Disruption
The Dodd-Frank Act amended current Core Principle 4 by: (i)
Changing the title of the core principle from ``Monitoring of Trading''
to ``Prevention of Market Disruption;'' and (ii) specifying the methods
and procedures DCMs must employ in discharging their obligations under
Core Principle 4. The amendments to Core Principle 4 emphasize that
DCMs must take an active role not only in monitoring trading activities
within their markets, but in preventing market disruptions. The rules
proposed for this core principle largely codified the relevant
provisions of the existing Application Guidance and Acceptable
Practices for Core Principle 4, as contained in appendix B to part 38,
and included new requirements that clarified and strengthened certain
DCM obligations arising under the amended core principle.
i. Sec. 38.251--General Requirements
Core Principle 4 requires DCMs to conduct real-time monitoring of
trading and have the ability to comprehensively and accurately
reconstruct trading.\251\ Accordingly, these requirements are set forth
in proposed Sec. 38.251. Further, the proposed rule required that
intraday trade monitoring must include the capacity to detect abnormal
price movements, unusual trading volumes, impairments to market
liquidity, and position-limit violations. Proposed Sec. 38.251 also
required that, where the DCM cannot reasonably demonstrate that its
manual processes are effective in detecting and preventing abuses, the
DCM must implement automated trading alerts to detect potential
problems.
---------------------------------------------------------------------------
\251\ 7 U.S.C. 7(d)(4).
---------------------------------------------------------------------------
The Commission invited comment on whether DCMs should be required
to monitor the extent of high frequency trading, and whether automated
trading systems should include the ability to detect and flag high
frequency trading anomalies.
Summary of Comments
Several commenters asserted that their current regulatory systems
do not allow for effective real-time monitoring of position limits. CME
opined that requiring real-time monitoring capabilities across every
instrument for vague terms such as ``abnormal price movements,''
``unusual trading volumes,'' and ``impairments to market liquidity''
does not provide DCMs with sufficient clarity with respect to what
specific capabilities satisfy the standard.\252\ CME specifically
stated that the Commission should clarify and appreciate the unique
aspects of different types of trading venues and distinguish where
requirements are different.\253\ CME also stated that the regulations
should distinguish between trading conducted on an electronic venue and
trading conducted in an open-outcry venue.\254\ MGEX stated that the
automated trading alert requirement of proposed Sec. 38.251 ``seems to
add more burden and cost than potentially providing any real value.''
\255\ KCBT requested that the Commission remove this requirement and
stated that customer reportable positions are received once daily on a
T+1 basis and that it is impractical to require DCMs to monitor for
intraday compliance with position limits.\256\
---------------------------------------------------------------------------
\252\ CME Comment Letter at 24 (Feb. 22, 2011).
\253\ Id.
\254\ Id.
\255\ MGEX Comment Letter at 4 (Feb. 22, 2011). MGEX also stated
that the Commission should adopt a more flexible core principle
approach. See MGEX Comment Letter at 2 (June 3, 2011).
\256\ KCBT Comment Letter at 4 (Feb. 22, 2011).
---------------------------------------------------------------------------
ICE stated that it has previously made the Commission aware of the
difficulties inherent in trying to monitor positions on a real-time
basis, and that the only way to accurately determine whether an
intraday position limit violation has occurred is on the basis of
information available on a T+1 basis.\257\ ICE also requested that the
Commission delete the phrase ``impairments to market liquidity'' from
the rule, arguing that the wording is vague and has ``no foundation''
in the core principle.\258\
---------------------------------------------------------------------------
\257\ ICE Comment Letter at 11 (Feb. 22, 2011).
\258\ Id.
---------------------------------------------------------------------------
With respect to the monitoring of high frequency trading, several
commenters stated that such monitoring would be problematic.\259\ MGEX
and CME raised concerns over the absence of a definition for high
frequency trading, which CME claimed can include many
[[Page 36635]]
different trading strategies.\260\ CME questioned whether the
Commission had unique concerns about high frequency traders, and
further remarked that the Commission has not articulated what purpose
would be served by singling out high frequency trading for special
monitoring.\261\ CME further stated that empirical studies have
consistently demonstrated that high frequency trading fosters tighter
markets, greater liquidity and enhanced market efficiency.\262\
---------------------------------------------------------------------------
\259\ KCBT Comment Letter at 4 (Feb. 22, 2011); MGEX Comment
Letter at 4 (Feb. 22, 2011); CME Comment Letter at 24-25 (Feb. 22,
2011).
\260\ MGEX Comment Letter at 4 (Feb. 22, 2011); CME Comment
Letter at 24-25 (Feb. 22, 2011).
\261\ CME Comment Letter at 25 (Feb. 22, 2011).
\262\ Id.
---------------------------------------------------------------------------
CME stated that ``[a]s a practical matter, however, CME Group, and
we imagine other DCMs, certainly have the capability to monitor the
messaging frequency of participants in their markets and can quickly
and easily identify which participants generate high messaging
traffic.'' \263\ CME also stated that it requires registered users who
predominantly enter orders via an automated trading system to be
identified as automated traders and that their orders are identified in
the audit trail as originating from automated systems.\264\ Finally,
CME noted that its systems were designed to identify anomalies or
transaction patterns that violate their rules or might otherwise be
indicative of some other risk to the orderly functioning of the
markets.\265\
---------------------------------------------------------------------------
\263\ Id.
\264\ Id.
\265\ Id.
---------------------------------------------------------------------------
Better Markets opined that the Dodd-Frank Act provides the
Commission with an opportunity to get ahead of high frequency and
algorithmic trading and that, while hedgers undoubtedly need market
liquidity, high frequency traders generate volume that does not
reliably generate liquidity for market participants.\266\ In addition,
Better Markets commented that many widely used tactics of high
frequency traders are specifically designed to influence pricing
decisions by providing false signals of market price levels and depth,
and, as a result, the Commission must take an expressly restrictive
approach to high frequency trading.\267\
---------------------------------------------------------------------------
\266\ Better Markets Comment Letter at 7 (Jun. 3, 2011).
\267\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting proposed Sec. 38.251, with certain
modifications, including converting portions of the rule to guidance.
The Commission is modifying Sec. 38.251 to eliminate the
obligation to monitor, on an intraday basis, for ``impairments to
market liquidity.'' The Commission is also revising the rule to clarify
what must be included in real-time monitoring as compared to monitoring
of intraday trading that may not need to be done in real time.
Monitoring of market conditions, price movements and trading volumes in
order to detect and attempt to resolve abnormalities must be
accomplished in real time in order to achieve, as much as is possible,
the statute's new emphasis on preventive actions. It is acceptable,
however, to have a program that detects, on a T+1 basis, trading abuses
and position-limit violations that occur intraday.
In addition, the rule is now being supplemented with guidance and
acceptable practices in appendix B to part 38. The Commission believes
that monitoring for market anomalies is a key part of a DCM's ability
to demonstrate its ``capacity and responsibility to prevent
manipulation, price distortion, and disruptions of the delivery or
cash-settlement process,'' as required by the statute. Moreover, given
the number of listed contracts and the volumes of trading on any
particular DCM, the Commission believes that automated trading alerts,
preferably in real time, are the most effective means of detecting
market anomalies. While having an effective automated alerts regime
will be set forth as a method of monitoring in guidance, a DCM will
maintain flexibility in meeting the requirement of the rule by, for
example, demonstrating the effectiveness of an alternate method of
monitoring.
With respect to position-limit monitoring, the DCM NPRM did not
require that such limits necessarily be monitored in real time.
However, DCMs must have the ability to monitor such limits, including
for intraday violations, at a minimum on a T+1 basis. Therefore, the
requirement to monitor for position-limit violations is clarified in
the rule and further described in the guidance and acceptable practices
in appendix B, giving the DCM some flexibility in meeting the
requirement.
As for the Commission's inquiry about requiring additional
monitoring of high-frequency trading, the Commission recognizes that
DCMs should be capable of monitoring for the types of trading that may
be characterized as ``high frequency,'' but has decided not to
implement, in this rulemaking, further rules pertaining to the
monitoring of high frequency trading. The Commission is encouraged that
there are efforts underway, both within and outside the Commission, to
define and develop approaches for better monitoring of high-frequency
and algorithmic trading. This is particularly evident from recent work
done at the behest of the Commission's Technology Advisory Committee
(TAC).\268\ Further, the United Kingdom government's Foresight Project
also commissioned a recently released report on the future of computer
trading in financial markets, which aims to assess the risks and
benefits of automated buying and selling. This project may assist the
Commission's further development of a regulatory framework for high
frequency trading activities.\269\
---------------------------------------------------------------------------
\268\ See, e.g., reports associated with the TAC available at
http://www.cftc.gov/idc/groups/public/@swaps/documents/dfsubmission/tacpresentation030111_ptfs2.pdf.
\269\ See ``The Future of Computer Trading in Financial
Markets'' available at http://www.bis.gov.uk/foresight/our-work/projects/current-projects/computer-trading.
---------------------------------------------------------------------------
ii. Sec. 38.252--Additional Requirements for Physical-Delivery
Contracts
Proposed Sec. 38.252 required, among other things, that for
physical-delivery contracts, DCMs must monitor each contract's terms
and conditions as to whether there is convergence of the futures price
to the cash price of the underlying commodity and must take meaningful
corrective action, including addressing conditions that interfere with
convergence, or if appropriate, change contract terms and conditions,
when lack of convergence impacts the ability to use the markets for
making hedging decisions and for price discovery.
The Commission requested comments on what other factors, in
addition to the delivery mechanism, a DCM should be required to
consider in determining whether convergence is occurring.
Summary of Comments
CME, MGEX and KCBT all opposed what they deemed to be a
prescriptive rule, and noted that most of the requirements in proposed
Sec. 38.252 are currently acceptable practices under appendix B for
the monitoring of trading.\270\ These commenters contended that the
requirements in proposed Sec. 38.252 should remain as acceptable
practices.\271\
---------------------------------------------------------------------------
\270\ CME Comment Letter at 25 (Feb. 22, 2011); MGEX Comment
Letter at 5 (Feb. 22, 2011); KCBT Comment Letter at 4-5 (Feb. 22,
2011).
\271\ Id.
---------------------------------------------------------------------------
ICE also noted that for certain products it is inherently more
difficult to statistically determine convergence of futures to cash
market prices.\272\
---------------------------------------------------------------------------
\272\ ICE Comment Letter at 12 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission is adopting Sec. 38.252, with certain
modifications, including
[[Page 36636]]
converting a portion of the rule to acceptable practices.
The Commission is retaining as a rule the general obligation that
DCMs monitor physical-delivery contracts with respect to their terms
and conditions as they relate to the underlying market and monitor the
adequacy of deliverable supplies to meet futures delivery requirements.
The DCM must also make a good-faith effort to resolve conditions that
threaten reasonable convergence or the adequacy of deliverable
supplies. While the Commission acknowledges ICE's comment that for
certain products it may be more difficult to ascertain convergence
because of the absence of reliable cash prices, the Commission is of
the view that a DCM must monitor the performance of its contracts to
ensure they continue to perform their economic functions.
In order to provide DCMs with additional flexibility in meeting
their monitoring obligations associated with physical-delivery
contracts, the specific elements of such monitoring that were initially
included in the proposed rule are now included in acceptable practices
under appendix B of part 38, rather than in the rule.
iii. Sec. 38.253--Additional Requirements for Cash-Settled Contracts
In addition to requirements that DCMs monitor the pricing and
methodologies for settling cash-settled contracts, proposed Sec.
38.253 required that, where a DCM contract is settled by reference to
the price of a contract or instrument traded in another venue,
including a price or index derived from prices on another exchange, the
DCM must have rules that require the traders on the DCM's market to
provide the DCM with their positions in the reference market as the
traders' contracts approach settlement. In the alternative, Sec.
38.253 provided that the DCM may have an information sharing agreement
with the other venue or designated contract market.
Summary of Comments
Argus commented that it is inappropriate to require DCMs to monitor
the ``availability and pricing of the commodity making up the index to
which the contract will be settled'' where the index price is generated
based upon transactions that are executed off the DCM's market.\273\
---------------------------------------------------------------------------
\273\ Argus Comment Letter at 6 (Feb. 22, 2011).
---------------------------------------------------------------------------
CME disagreed with what it contended was the prescriptive nature of
the proposed rule, and noted that many of the requirements in proposed
Sec. 38.253 are currently acceptable practices for trade
monitoring.\274\ CME suggested that the requirements in Sec. 38.253
remain as acceptable practices.\275\ CME further stated that the
Commission is uniquely situated to add regulatory value to the industry
by reviewing for potential cross-venue rule violations, and noted that
the Commission is the central repository for position information
delivered to it on a daily basis and in a common format, across all
venues.\276\ CME also asserted that the Commission would be imposing an
onerous burden on DCMs and their customers by requiring the reporting
of information that the Commission already receives or will be
receiving.\277\ CME also stated that the alternative proposal, that the
DCM enter into an information-sharing agreement with the other venue,
also will result in additional costs to both entities, and that it may
not be practical or prudent for a DCM to enter into such an agreement
with the other venue.\278\ CME noted that its rules already allow it to
request such information from market participants on an as-needed
basis.\279\
---------------------------------------------------------------------------
\274\ CME Comment Letter at 26 (Feb. 22, 2011).
\275\ Id.
\276\ Id.
\277\ Id.
\278\ Id.
\279\ Id.
---------------------------------------------------------------------------
Nodal stated that DCMs that are a party to an industry agreement
(such as the International Information Sharing Memorandum of
Understanding & Agreement) should satisfy the information sharing
requirement in this rule by virtue of such agreement.\280\
---------------------------------------------------------------------------
\280\ Nodal Comment Letter at 5 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission is codifying proposed Sec. 38.253, with certain
modifications, including to convert a portion of the rule to acceptable
practices. The Commission removed from the rule the requirement that
DCMs monitor the availability and pricing of the commodity making up
the index to which the contract will be settled. Section 38.253(a)
requires that DCMs monitor the pricing of the index to which the
contract is settled, and that DCMs monitor the continued
appropriateness of the index to which the contract is settled and take
steps to resolve conditions, including amending contract terms where
necessary, where there is a threat of manipulation, disruptions, or
distortions. For cash-settled contracts, the Commission believes that a
DCM must have the ability to determine whether a trader in its market
is manipulating the instrument or index to which the DCM contract
settles.
In regards to Sec. 38.253(b), as the CME noted, the Commission
does obtain certain position information in the large-trader reporting
systems for futures and swaps. However, the Commission may not
routinely obtain such position information, including where a DCM
contract settles to the price of a non-U.S. futures contract or a cash
index. Notwithstanding the continued importance of a DCM's obligation
to monitor across other venues in such circumstances, the Commission
believes that the rule need not set forth the specific methods to
accomplish such monitoring. Accordingly, the Commission sets forth the
specific methods of accomplishing the cross-venue monitoring under
acceptable practices. Specifically, the rule requires that the
monitoring of cash-settled contracts must include access to information
on the activities of its traders' in the reference market. The
acceptable practices for this rule provides that a DCM, at a minimum,
gather such information, either directly or through information sharing
agreements, to traders' position and transactions in the reference
market for traders of a significant size in the DCM contract, near the
settlement of the contract.
iv. Sec. 38.254--Ability To Obtain Information
To ensure that DCMs have the ability to properly assess the
potential for price manipulation, price distortions, and the disruption
of the delivery or cash-settlement process, proposed Sec. 38.254
provided that each DCM require that traders in their market keep
records, including records of their activity in the underlying
commodity and related derivative markets and contracts, and make such
records available, upon request, to the designated contract
market.\281\ The proposed rule further required that DCMs with
participants trading through intermediaries must either use a
comprehensive large-trader reporting system or be able to demonstrate
that it can obtain position data from other sources in order to conduct
an effective surveillance program.
---------------------------------------------------------------------------
\281\ The pre-existing acceptable practice for Core Principle 4
provides that DCMs, at a minimum, should have routine access to the
positions and trading of their market participants.
---------------------------------------------------------------------------
Summary of Comments
CME opposed the proposed rule and recommended that the types of
records that the DCM should require traders to keep should be covered
in acceptable
[[Page 36637]]
practices.\282\ KCBT contended that it is unnecessary and burdensome
for a DCM to require traders to keep such records.\283\ Similarly, MGEX
raised concerns about the burden that will be placed on its traders as
a result of the proposed record-keeping obligation, and noted that, for
contracts not traded on the DCM, it is unclear what records a DCM must
tell its trader to keep.\284\
---------------------------------------------------------------------------
\282\ CME Comment Letter at 26 (Feb. 22, 2011).
\283\ KCBT Comment Letter at 5 (Feb. 22, 2011).
\284\ MGEX Comment Letter at 5 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission is adopting Sec. 38.254 as proposed, but is
allowing, as an acceptable practice in appendix B, that DCMs limit the
requirement of Sec. 38.254(b) to those transactions or positions that
are reportable under the DCM's large-trader reporting system or where
the market participant otherwise holds substantial positions.
The Commission has considered the comments, but does not believe
that this rule is unnecessary or that the requirements should instead
be codified as acceptable practices. The Commission notes that a
trader's burden to keep such records is sound commercial practice, and
that a trader of a reportable size is already required, under
Commission's regulations Sec. 18.05 for futures and options and Sec.
20.6 for swaps, to keep records of such activity and to make them
available to the Commission upon request. In addition, the Commission
has found trader records to be an invaluable tool in its surveillance
efforts, and believes that the DCM, as a self-regulatory organization,
should have direct access to such information in order to discharge its
obligations under the DCM core principles, and in particular Core
Principle 4.
v. Sec. 38.255--Risk Controls for Trading
Proposed Sec. 38.255 required DCMs to have in place effective risk
controls including, but not limited to, pauses and/or halts to trading
in the event of extraordinary price movements that may result in
distorted prices or trigger market disruptions. Additionally, the rule
provided that where a DCM's contract is linked to, or a substitute for,
other contracts on the DCM or on other trading venues, including where
a contract is based on the price of an equity security or the level of
an equity index, risk controls should, to the extent possible, be
coordinated with those other contracts or trading venues. In the
preamble of the DCM NPRM, the Commission requested comments on what
types of pauses and halts are necessary and appropriate for particular
market conditions. The preamble of the DCM NPRM also recognized that
pauses and halts comprise only one category of risk controls, and that
additional controls may be necessary to reduce the potential for market
disruptions. The preamble specifically listed several risk controls
that the Commission had in mind, including price collars or bands,
maximum order size limits, stop-loss order protections, kill buttons,
and any others that may be suggested by commenters. The Commission
invited comments on the appropriateness of the listed risk controls,
and posed the following questions: What other DCM risk controls are
appropriate or necessary to reduce the risk of market disruptions?
Which risk controls should be mandated, and how?
Summary of Comments
Several commenters asserted that DCMs should have discretion to
determine the specific risk controls that should be implemented within
their markets.\285\ CME commented that the marketplace would benefit
from some standardization of the types of pre-trade risk controls
employed by DCMs and other trading venues, and expressed support for an
acceptable practice framework that includes pre-trade quantity limits,
price banding, and messaging throttles, but argued that the specific
parameters of such controls should be determined by the DCMs.\286\
---------------------------------------------------------------------------
\285\ CME Comment Letter at 26 (Feb. 22, 2011); KCBT Comment
Letter at 5 (Feb. 22, 2011); ICE Comment Letter at 11-12 (Feb. 22,
2011); CFE Comment Letter at 4 (Feb. 22, 2011); NYSE Liffe Comment
Letter at 11 (Feb. 22, 2011); ELX Comment Letter at 4 (Feb. 22,
2011); MGEX Comment Letter at 5 (Feb. 22, 2011); ICE Comment Letter
at 12 (Feb. 22, 2011); Barnard Comment Letter at 3 (Feb. 22, 2011).
\286\ CME Comment Letter at 27 (Feb. 22, 2011).
---------------------------------------------------------------------------
Various commenters also stated that there are effective ways to
prevent market disruptions other than pauses and halts, and that the
appropriate controls may depend on a number of factors, such as the
product, number of market participants, and the market's liquidity. CME
contended that the Commission should not impose rules that mandate
coordination of such risk controls.\287\ NYSE Liffe argued that a DCM
should be able to take into account other controls, but should not be
required to adopt identical controls.\288\ MGEX stated that forcing
market coordination of trading pauses and halts is unnecessary, and
that if market instability moves from one contract market to another,
the next market should be able to pause or halt trading as it
determines necessary.\289\ ICE stated that a temporary price floor or
ceiling can work better than a pause or halt since trading can continue
uninterrupted, thereby offering the earliest opportunity for price
reversal should the market deem a sudden large move to be an
overreaction or error.\290\ ICE also stated that pauses and halts are
not the only effective way to prevent market disruption, and that by
being prescriptive, the Commission is freezing innovation in preventing
market disruptions.\291\
---------------------------------------------------------------------------
\287\ Id.
\288\ NYSE Liffe Comment Letter at 11 (Feb. 22, 2011).
\289\ MGEX Comment Letter at 5 (Feb. 22, 2011).
\290\ ICE Comment Letter at 12 (Feb. 22, 2011).
\291\ Id.
---------------------------------------------------------------------------
Finally, Better Markets asserted that the proposed rules are
extremely useful, but incomplete.\292\ Better Markets stated that there
should be a ``speed limit'' to serve as a buffer against the potential
for an uncontrolled spiral of disruption fueled by HFTs, and that the
rule should require that bids be kept open for minimum durations and
that positions be held for minimum durations.\293\
---------------------------------------------------------------------------
\292\ Better Markets Comment Letter at 9 (Feb. 22, 2011).
\293\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting proposed Sec. 38.255, with certain
modifications, including converting a portion of the rule to acceptable
practices. As stated in the DCM NPRM, the Commission believes that
pauses and halts are effective risk management tools that must be
implemented by DCMs to facilitate orderly markets. As the Commission
noted in the DCM NPRM, risk controls such as trading pauses and halts,
among other things, can allow time for participants to analyze the
market impact of new information that may have caused a sudden market
move, allow new orders to come into a market that has moved
dramatically, and allow traders to assess and secure their capital
needs in the face of potential margin calls. Automated risk control
mechanisms, including pauses and halts, have proven to be effective and
necessary in preventing market disruptions and, therefore, will remain
as part of the rule.
The Commission notes that the pauses and halts are intended to
apply in the event of extraordinary price movements that may trigger or
propagate systemic disruptions. Accordingly, in response to ICE and
other commenters that question the necessity of pauses and halts over
other forms of risk controls, the Commission notes that a DCM's ability
to pause or halt trading in extraordinary
[[Page 36638]]
circumstances and, importantly, to re-start trading through the
appropriate re-opening procedures, will allow DCMs to mitigate the
propagation of shocks that are of a systemic nature and to facilitate
orderly markets. Furthermore, DCMs must ensure that such pauses and
halts are effective for their specific order-routing and trading
environment and are adapted to the specific types of products traded.
Following the DCM NPRM's publication, the Pre-Trade Functionality
Subcommittee of the CFTC Technology Advisory Committee (``TAC'') issued
a report that recommended the implementation of several trade risk
controls at the exchange level.\294\ The controls recommended in the
Subcommittee report were consistent, in large part, with the trade
controls referenced in the preamble to the DCM NPRM, and which are
being adopted in this final rulemaking.\295\ The TAC accepted the
Subcommittee report, which specifically recommended that exchanges
implement pre-trade limits on order size, price collars around the
current price, intraday position limits (of a type that represent
financial risk to the clearing member), message throttles, and clear
error-trade and order-cancellation policies.\296\ The Subcommittee
report noted that ``[s]ome measure of standardization of pre-trade risk
controls at the exchange level is the cheapest, most effective and most
robust path to addressing the Commission's concern [for preserving
market integrity].'' \297\
---------------------------------------------------------------------------
\294\ ``Recommendations on Pre-Trade practices for Trading
Firms, Clearing Firms and Exchanges involved in Direct Market
Access,'' March 1, 2011, available at http://www.cftc.gov/idc/groups/public/@swaps/documents/dfsubmission/tacpresentation030111_ptfs2.pdf.
\295\ The DCM NPRM specifically mentioned position limits that
must be monitored for intraday violations, daily price limits,
trading pauses, reasonability tests for order price and size, stop
logic functionality, and trade-cancellation policies in the form of
``no-bust'' ranges.
\296\ See ``Pre-Trade Functionality Subcommittee of the CFTC
Technology Advisory Committee report, ``Recommendations on Pre-Trade
Practices for Trading Firms, Clearing Firms, and Exchanges Involved
in Direct Market Access,'' at 4-5 (March 1, 2011), accepted by the
TAC and available at: http://www.cftc.gov/idc/groups/public/@swaps/documents/dfsubmission/tacpresentation030111_ptfs2.pdf.
\297\ Id. at 4.
---------------------------------------------------------------------------
The Commission believes that the implementation of the specific
automated trade risk controls listed in the DCM NPRM is generally
desirable, but also recognizes that such controls should be adapted to
the unique characteristics of the markets to which they apply. Indeed,
any controls should consider the delicate balance between avoiding a
market disruption while not impeding a market's price discovery
function. Controls that unduly restrict a market's ability to respond
to legitimate market events will interfere with price discovery.
Accordingly, consistent with many of the comments on this subject,
the Commission is enumerating specific types of automated risk
controls, in addition to pauses and halts, that may be implemented by
DCMs in the acceptable practices rather than in the rule, in order to
give DCMs greater discretion to select among the enumerated risk
controls, or to create new risk controls that may be more appropriate
or necessary for their markets. DCMs also will have discretion in
determining the parameters for the selected controls. Specifically, the
acceptable practices for Core Principle 4 provide that DCMs should have
appropriate trade risk controls adapted to the unique characteristics
of the markets to which they apply that are designed to prevent market
disruptions without unduly interfering with that market's price
discovery function. The acceptable practices also enumerate several of
the pre-trade controls cited by the Joint CFTC/Securities and Exchange
Commission (``SEC'') Advisory Committee, specifically: Pre-trade limits
on order size, price collars or bands around the current price, message
throttles, and daily price limits.\298\
---------------------------------------------------------------------------
\298\ The DCM NPRM did not specifically address whether DCMs
should require market participants to certify that their electronic
systems were adequately tested before trading on a DCM, nor did it
specifically address pre-trade, post trade or emergency controls and
supervision of electronic systems. The Commission may address
electronic system testing, controls, and supervision-related issues
in a subsequent proceeding.
---------------------------------------------------------------------------
Additionally, in response to commenters' concerns, the Commission
is moving the language in the proposed rule concerning the coordination
of risk controls among other markets or exchanges to the acceptable
practices. Specifically, a DCM with a contract that is linked to, or is
a substitute for, other contracts, either on its market or on other
trading venues, must, to the extent practicable, coordinate its risk
controls with any similar controls placed on those other contracts. If
a contract is based on the price of an equity security or the level of
an equity index, such risk controls must, to the extent practicable, be
coordinated with any similar controls placed on national security
exchanges.
Independent of this rulemaking, the Joint CFTC/SEC Advisory
Committee recommended that the SEC and CFTC require that the pause
rules of the exchanges and FINRA be expanded to cover all but the most
inactively traded and listed equity securities, ETFs, and options and
single stock futures on those securities.\299\
---------------------------------------------------------------------------
\299\ The Joint CFTC-SEC Advisory Committee on Emerging
Regulatory Issues was established a few days after the dramatic
securities market events of May 6, 2010, called by some the ``Flash
Crash.'' The Committee is charged with addressing regulatory issues
of mutual concern to the CFTC and SEC. See ``Recommendations
Regarding Regulatory Responses to the Market Events of May 6,
2010,'' (Feb. 18, 2011) available at http://www.cftc.gov/MarketReports/StaffReportonMay6MarketEvents/index.htm.
---------------------------------------------------------------------------
vi. Sec. 38.256--Trade Reconstruction
The Dodd-Frank Act added language to Core Principle 4 providing
that a DCM must have the ability to comprehensively and accurately
reconstruct all trading on its trading facility. These audit-trail data
and reconstructions must also be made available to the Commission in a
form, manner, and time as determined by the Commission. Proposed Sec.
38.256 codified these requirements.
Summary of Comments
CME argued that audit trial data is extremely detailed and
voluminous and that the DCMs should be given adequate time to prepare
the trading data before it is supplied to the Commission.\300\ CME
suggested that the wording ``in a form, manner, and time as determined
by the Commission'' be replaced with ``such reasonable time as
determined by the Commission.\301\
---------------------------------------------------------------------------
\300\ CME Comment Letter at 27 (Feb. 22, 2011).
\301\ Id.
---------------------------------------------------------------------------
Chris Barnard expressed support for the trade reconstruction
requirement but requested that the rule be clarified to ensure that the
trade reconstruction requirement includes all trading events, including
the entry of bids and offers in the order of their occurrence, as well
as executed trades in order.\302\
---------------------------------------------------------------------------
\302\ Barnard Comment Letter at 2 (May 20, 2011).
---------------------------------------------------------------------------
Discussion
The Commission is clarifying the rule slightly so that the audit
trail data must be available to the Commission ``in a form, manner, and
time that is acceptable to the Commission.'' The revised wording is
consistent with Sec. 38.950(a), which requires that DCMs maintain
records in a form and manner that is acceptable to the Commission.
The Commission believes that the DCM audit-trail requirements
contained in Sec. 38.551 and Sec. 38.552 clarify the DCM's obligation
for reconstruction of trading and are sufficient to meet Mr. Barnard's
concerns.
[[Page 36639]]
vii. Sec. 38.257--Regulatory Service Provider
Proposed Sec. 38.257 provided that a DCM must comply with the
regulations in subpart E through a dedicated regulatory department, or
by delegation of that function to a regulatory service provider over
which the DCM has supervisory authority.
Discussion
The Commission did not receive any comments on the proposed rule,
and is adopting the rule as proposed.
viii. Sec. 38.258--Additional Rules Required
Proposed Sec. 38.258 required a DCM to adopt and enforce any
additional rules that it believed were necessary to comply with the
requirements of subpart E.
Discussion
Though the Commission did not receive any comments on the proposed
rule, the Commission is of the view that the obligations in the
proposed rule are more appropriate in the guidance. Accordingly, the
proposed rule is moved to guidance. Consistent with this determination,
the Commission is replacing proposed Sec. 38.258 with new Sec. 38.258
(titled ``Additional sources for compliance'') that simply permits DCMs
to rely upon the guidance and acceptable practices in appendix B of
this part to demonstrate to the Commission compliance with Core
Principle 4.
5. Subpart F--Position Limitations or Accountability
Core Principle 5 under section 5(d)(5) of the CEA requires that
DCMs adopt for each contract, as is necessary and appropriate, position
limitations or position accountability. The Dodd-Frank Act amended Core
Principle 5 by adding that for any contract that is subject to a
position limitation established by the Commission pursuant to section
4a(a) of the CEA, the DCM shall set the position limitation of the
board of trade at a level not higher than the position limitation
established by the Commission. At the time of the publication of the
DCM NPRM, the federal position limits established by the Commission
were codified in part 150 of the Commission's regulations, and the
Commission had proposed rules to replace part 150 with new requirements
in part 151, consistent with the requirements of the Dodd-Frank Act.
The Commission published the final rules for ``Position Limits for
Futures and Swaps'' on November 18, 2011.\303\ That final rulemaking
requires DCMs to comply with part 150 (Limits on Positions) until such
time that the Commission replaces part 150 with the new part 151
(Limits on Positions).\304\ In that final release, the Commission
requires that exchanges adopt their own position limits for 28 physical
commodity contracts subject to federal limits, and provides acceptable
practices for establishing position limits in other commodity
contracts. The Commission also established alternative acceptable
practices of adopting position accountability rules in lieu of position
limits for non-spot months in those other commodity contracts. Proposed
Sec. 38.301 required that each DCM must comply with the requirements
of part 151 as a condition of its compliance with Core Principle 5.
---------------------------------------------------------------------------
\303\ See ``Position Limits for Futures and Swaps,'' 76 FR
71626, Nov. 18, 2011.
\304\ Id. at 71632.
---------------------------------------------------------------------------
Summary of Comments
CME stated that the proposed position limits in the part 151
rulemaking may affect the price discovery mechanism of the U.S. futures
markets and asked that the Commission give careful consideration to the
comments it submitted in the part 151 rulemaking.\305\
---------------------------------------------------------------------------
\305\ CME Comment Letter at 27 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission is adopting the rule, with one modification. The
rule is being revised to add an additional clause that requires DCMs to
continue to meet the requirements of part 150 of the Commission's
regulations--the current position limit regulations--until such time
that compliance is required under part 151. This clarification will
ensure that DCMs are in compliance with the Commission's regulations
under part 150 in the interim period--until the compliance date for the
new position limits regulations takes effect. CME's comments were more
appropriate to the Position Limit rulemaking proceeding, and they were
addressed in that rulemaking.\306\
---------------------------------------------------------------------------
\306\ 76 FR 71626, Nov. 18, 2011.
---------------------------------------------------------------------------
6. Subpart G--Emergency Authority
The Dodd-Frank Act made minor, non-substantive changes to Core
Principle 6 under section 5(d)(6) of the CEA. In implementing the core
principles, the Commission proposed to retain most of the former
Application Guidance associated with Core Principle 6 (found in
appendix B to part 38 of the Commission's regulations) with some
revisions and additions.
Proposed Sec. 38.350 codified the statutory text of the core
principle. Proposed Sec. 38.351 referred applicants and DCMs to the
guidance and acceptable practices in appendix B to part 38 for purposes
of demonstrating to the Commission their compliance with the
requirements of subpart G. The proposed guidance provided that a DCM
should have the authority to intervene as necessary to maintain fair
and orderly trading and to prevent or address manipulation or
disruptive trading practices, whether the need for intervention arises
exclusively from the DCM's own market or as part of a coordinated,
cross-market intervention. The proposed guidance also provided that the
DCM rules should include procedures and guidelines to avoid conflicts
of interest in accordance with new provisions proposed in Sec. 40.9
and to include alternate lines of communication and approval procedures
in order to be able to address, in real time, emergencies that may
arise. The proposed guidance also clarified that the DCM must have
rules that allow it to take such market actions as may be directed by
the Commission.
The proposed rulemaking also proposed certain acceptable practices,
including that the DCM have: (i) Procedures and guidelines for
decision-making and implementation of emergency intervention in the
market, and (ii) the authority to: Liquidate or transfer open positions
in the market,\307\ suspend or curtail trading in any contract, require
market participants in any contract to meet special margin
requirements, and allow it to take such market actions as the
Commission may direct.
---------------------------------------------------------------------------
\307\ In situations where a swap is traded on more than one
platform, emergency action to liquidate or transfer open interest
must be directed, or agreed to, by the Commission or Commission
staff.
---------------------------------------------------------------------------
Summary of Comments
KCBT contended that liquidation of positions and special margin
requirements are more appropriately addressed in the rules and
procedures relevant to Derivatives Clearing Organizations.\308\ CME
commented that the Commission should revise the proposed guidance to
make clear that DCMs have the flexibility and independence necessary to
address market emergencies.\309\
---------------------------------------------------------------------------
\308\ KCBT Comment Letter at 6 (Feb. 22, 2011); see also 76 FR
69334, Nov. 8, 2011.
\309\ CME Comment Letter at 28 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission adopts proposed Sec. Sec. 38.350 and 38.351,
without modification.
In response to the comments pertaining to the proposed guidance,
the
[[Page 36640]]
Commission is making slight revisions to the guidance to clarify that
DCMs retain the authority to independently respond to emergencies in an
effective and timely manner consistent with the nature of the
emergency, as long as all such actions taken by the DCM are made in
good faith to protect the integrity of the markets.
In response to KCBT's comments, the Commission notes that the
statute requires DCMs, in consultation and cooperation with the
Commission, to adopt rules permitting them to liquidate open positions
and impose special margin requirements under their emergency authority.
7. Subpart H--Availability of General Information
Core Principle 7 requires that DCMs make available to the public
accurate information concerning the contract market's rules and
regulations, contracts and operations. The Dodd-Frank Act amended Core
Principle 7 by adding a provision requiring the board of trade to make
public the rules and specifications describing the operation of the
DCM's electronic matching platform or trade execution facility.\310\
Since passage of the CFMA, the types of information and the various
practices for providing information have become standardized across the
industry as DCMs have adopted practices that comply with the current
guidance and acceptable practices for Core Principle 7. Accordingly,
proposed Sec. 38.401 in subpart H codified these practices. In
addition, the Commission proposed several additional provisions to
ensure that pertinent information is available to the Commission,
market participants and the public, as described below.
---------------------------------------------------------------------------
\310\ This requirement, while new to the text of Core Principle
7, was previously required as part of former Designation Criteria 4.
---------------------------------------------------------------------------
The Commission also proposed to codify the statutory text of the
core principle in Sec. 38.400, and is adopting the rule, as proposed.
i. Sec. 38.401(a)--General
Proposed Sec. 38.401(a) required DCMs to have in place procedures,
arrangements and resources for disclosing to market authorities, market
participants, and the public accurate and relevant information
pertaining to: (i) Contract terms and conditions, (ii) rules and
regulations applicable to the trading mechanism; and (iii) rules and
specifications pertaining to the operation of the electronic matching
platform or trade execution facility. Under the proposed rule, DCMs are
required to ensure that market authorities, market participants, and
the public have available all material information pertaining to new
product listings, new or amended governance, trading and product rules,
or other changes to information previously disclosed by the DCM, within
the time period prescribed in proposed Sec. 38.401(c). Section
38.401(a) of the proposed regulation required that DCMs provide the
required information to market participants and the public by posting
such information on their Web site, as set forth in proposed Sec.
38.401(c).
Discussion
The Commission did not receive comments on the proposed rule, and
is adopting the proposed rule with minor, non-substantive
modifications.\311\
---------------------------------------------------------------------------
\311\ The Commission is revising Sec. 38.401(a) to clarify
several internal references.
---------------------------------------------------------------------------
ii. Sec. 38.401(b)--Accuracy Requirement
Proposed Sec. 38.401(b) required that each DCM have procedures in
place to ensure that any information or communication with the
Commission is accurate and complete, and further that no false or
misleading information is submitted and that no material information is
omitted. Similarly, the proposed rule required that each DCM have
procedures in place to ensure the accuracy and completeness of any
information made available to market participants and the public,
including information that is made available on its Web site.
Summary of Comments
NYSE Liffe expressed concern that the requirement to provide
``accurate and complete'' information in ``any communication'' with the
Commission would chill dialogue between DCMs and Commission staff.\312\
NYSE Liffe argued that in addition to submitting formal filings with
the Commission, DCM staff frequently interact with Commission staff on
a more informal basis, and in some cases DCM staff may speak without
complete information.\313\ NYSE Liffe asserted that a DCM may feel
constrained from directly responding to Commission inquiries or from
reaching out to Commission staff if it is concerned that the
information it provides to the Commission may later prove to be
inaccurate or incomplete.\314\ Accordingly, NYSE Liffe requested
clarification that the proposed rule will only apply to formal filings
made with the Commission.\315\ NYSE Liffe also noted that while it
makes every effort to accurately post information required to be made
public, for several data elements, it must rely on data sent to it by
clearing service providers and member firms.\316\ NYSE Liffe argued
that it would be inappropriate to set a strict liability standard over
aggregated data that part 16 of the Commission's rules requires the DCM
to make public when it does not entirely control the generation of
component parts of that data.\317\
---------------------------------------------------------------------------
\312\ NYSE Liffe Comment Letter at 12 (Feb. 22, 2011).
\313\ Id.
\314\ Id.
\315\ Id.
\316\ Id. at 13.
\317\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting proposed Sec. 38.401(b), with certain
revisions. While DCMs must provide the Commission with accurate and
complete information, the Commission recognizes that the proposed rule
text may raise concerns with DCMs in freely communicating with
Commission staff in certain instances. Accordingly, the Commission is
revising the rule to clarify that a DCM must ``provide information that
it believes, to the best of its knowledge, is accurate and complete,
and must not omit material information'' with respect to any
communication with the Commission, and any information required to be
transmitted or made available to market participants and the public,
including on its Web site or otherwise. The requirements of Sec.
38.401(b) are intended to be, and should be interpreted as being,
consistent with the false reporting provision under section 9(a)(3) of
the CEA, 7 U.S.C. 13. The amended rule accommodates the possibility
that DCMs may not exercise complete control over all of the information
that they receive from third-parties and later make public.
iii. Sec. 38.401(c)--Notice of Regulatory Submissions
The Commission historically has required DCMs to update their
rulebooks upon the effectiveness of a rule amendment, product listing
or rule certification that has been filed with the Commission. While
proposed Sec. 38.401(c) maintained the general requirement for posting
rules in the DCM rulebook upon their effectiveness, the Commission
believed that market participants and the public would benefit from
notifications of proposed rule amendments, product listing (or de-
listings) and rule certifications in advance of their taking
effect.\318\
[[Page 36641]]
Accordingly, proposed Sec. 38.401(c) required each DCM to post on its
Web site all rule filings and submissions that it makes to the
Secretary of the Commission. The proposed rule required that this
information be posted on the DCM's Web site simultaneous with the
filing of such information with the Commission. The DCM NPRM stated
that, where applicable, the DCM Web site should make clear that the
posted submissions are pending before the Commission.\319\ This
requirement was designed to provide market participants with advance
notice of rule amendments and certifications, consistent with the goal
of Core Principle 7 to make pertinent information available to market
participants and the public. This proposed posting requirement was in
addition to the obligation of DCMs to update their rulebooks upon the
effectiveness of a rule submission or certification.
---------------------------------------------------------------------------
\318\ This is especially relevant when the Commission determines
to stay the certification of a DCM submission, as provided by the
Dodd-Frank Act, for a 90-day review period, thereby triggering a
public comment period.
\319\ The DCM NPRM noted, for example, that a DCM's Web site may
contain a separate web page for ``regulatory filings'' or ``rule
certifications'' for posting submissions or certifications
pertaining to new product listings, new rules, rule amendments or
changes to previously-disclosed information. DCM NPRM at 80586.
---------------------------------------------------------------------------
To the extent that a DCM requests confidential treatment of certain
information filed or submitted to the Commission, the proposed rule
required the DCM to post the public portions of the filing or
submission on its Web site.
Summary of Comments
CME and KCBT both contended that the requirement that DCMs post
regulatory submissions on their Web site simultaneously with their
filing with the Commission is duplicative, as the Commission already
posts these submissions on the CFTC Web site.\320\ CME and KCBT further
argued that they use other methods to communicate regulatory changes to
the public, including bulletins, email notifications, and press
releases.\321\ CME requested that if the Commission does choose to
retain this requirement, that a DCM be given a minimum of one business
day to post such filings, rather than having to post ``simultaneously''
with the Commission filing.\322\ CME noted that even a one-day standard
would be a significantly higher standard than the Commission holds
itself to with respect to posting the filings it receives from DCMs
today.\323\
---------------------------------------------------------------------------
\320\ CME Comment Letter 28-29 (Feb. 22, 2011); KCBT Comment
Letter at 6 (Feb. 22, 2011).
\321\ CME Comment Letter at 29 (Feb. 22, 2011); KCBT Comment
Letter at 6 (Feb. 22, 2011).
\322\ CME Comment Letter at 29 (Feb. 22, 2011).
\323\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting the proposed rule, with certain
modifications. The Commission believes it is important for market
participants and the public to have advance notice of rule amendments
and certifications prior to their taking effect, consistent with the
goal of Core Principle 7 to make pertinent information available to
market participants and the public. Where applicable, the DCM Web site
should make clear that the posted submissions have been submitted to
the Commission, but are not yet in effect. For example, a DCM could
post its submissions or information filed with the Commission on a
separate web page that is designated as ``regulatory filings'' or
``proposed rulebook amendments.'' The Commission notes that the
requirement to make information available to the public necessitates
that such information can be accessed by visitors to the Web site
without the need to register, log in, provide a user name or obtain a
password, as is the current practice under Commission regulations.\324\
In response to CME, the Commission notes that it adopted a similar
requirement in the final rulemaking pertaining to Provisions Common to
Registered Entities.\325\ In that final rulemaking, the Commission
codified in Sec. 40.5(a)(6) the requirement that a registered entity
submitting a voluntary rule submission post such submission on its Web
site concurrent with the filing of such submission with the
Commission.\326\ Consistent with Sec. 40.5, the Commission is revising
the posting requirement in the proposed rule from ``simultaneous'' to
``concurrently'' with the filing of the information with the
Commission. The proposed rule is also being revised to clarify that the
posting requirement applies to any information or ``submission''
provided to the Commission.
---------------------------------------------------------------------------
\324\ See former acceptable practices to Core Principle 7. 17
CFR part 38, appendix B (2010).
\325\ See 76 FR 44776, 44794, July 27, 2011.
\326\ Id.
---------------------------------------------------------------------------
iv. Sec. 38.401(d)--Rulebook
Proposed Sec. 38.401(d) codified the pre-existing DCM practices
pertaining to updating DCM rulebooks.\327\ The proposed rule required
that DCMs post and routinely update, their rulebooks, which appear on
their Web sites. The proposed rule required that each DCM update its
rulebook the day that a new product is listed or a new or amended rule
takes effect. The proposed rule further required that DCM Web sites be
readily accessible to the public, and that the information posted
therein be available to visitors to the Web site without requiring
registration, log-in, or user name or password.
---------------------------------------------------------------------------
\327\ As noted above, the requirement to maintain an accurate
and updated rulebook does not relieve DCMs of their obligations
under proposed paragraph (c) to post on their Web sites all rule
filings and submissions submitted to the Commission.
---------------------------------------------------------------------------
Discussion
The Commission did not receive comments regarding this proposed
rule and is adopting the rule as proposed. As noted in the DCM NPRM,
the vast majority of DCMs maintain Web sites that comply with the
requirements in the rule.
8. Subpart I--Daily Publication of Trading Information
Core Principle 8 requires that DCMs make available to the public
accurate information on settlement prices, volume, open interest, and
opening and closing ranges for actively traded contracts on the
contract market. The Dodd-Frank Act did not amend Core Principle 8.
Accordingly, proposed Sec. 38.451 codified the pre-existing acceptable
practices, which largely required that DCMs comply with Sec. 16.01
(Trading volume, open contracts, prices and critical dates) of the
Commission's regulations.
In addition, the Commission proposed certain revisions to Sec.
16.01, consistent with the Dodd-Frank Act amendments to the CEA,
including revisions regarding the information a reporting market must
record and publish on futures, swap, and options contracts on a
commodity.\328\ Specifically, the proposed amendments to part 16
specified the type of information that DCMs or SEFs must publish daily
regarding the swaps contracts traded. The proposed rule required that
DCMs and SEFs publish specified information for each trading day, for
each swap, class of swaps, option on a swap, or class of options on a
swap, as appropriate. For swap contracts that are standard-sized
contracts (i.e., contracts that have a set contract size for all
contracts), the proposed rule required the reporting of volume and open
interest for swaps and options on swaps in terms of number of contracts
traded, similar to how futures contracts currently are reported. For
swap contracts that are non-standard-sized (i.e., contracts whose
contract size can
[[Page 36642]]
vary for each transaction), the proposed rule required that the volume
and open interest be reported in terms of total notional value traded
for that trading day.
---------------------------------------------------------------------------
\328\ The term commodity also includes ``excluded commodities.''
---------------------------------------------------------------------------
The Commission also proposed to amend Sec. 16.01(b) to require
each DCM or SEF to publish for each trading day, by commodity and
contract month or by tenor of the swap, the opening price, high price,
low price and settlement price of the swap or option on swap contract.
The Commission requested comments on end-of-day price reporting for
swaps. Specifically, the Commission requested comments on the following
issues:
For interest rate swaps, because the tenor on an interest
rate swap can be one of thousands of possible periods, what would be an
appropriate manner to display end-of-day prices for each interest rate
swap?
Would certain end-of-day swap price reporting be more
meaningful than others? If so, which methods of price reporting would
be more meaningful and why?
Would certain end-of-day swap price reporting be
misleading? If so, which methods of price reporting would be misleading
and why?
The Commission also proposed to revise Sec. 16.01 to require
reporting markets to report directly to the Commission pursuant to the
requirements of 16.01(d), information pertaining to the total volume of
block trades that are included in the total volume of trading.
Finally, the Commission also proposed to codify the statutory text
of the core principle in Sec. 38.450, and is adopting the rule, as
proposed.
Summary of Comments
Several commenters discussed the revised reporting requirements
that were proposed in Sec. 16.01. Eris stated that DCMs and SEFs
should be held to the same reporting standards for interest rate
swaps.\329\ In particular, Eris commented that a DCM or SEF should
report real-time, intraday prices for par swaps at standard maturities,
publish open interest grouped in maturity buckets based on the
remaining tenor of each instrument, and publish at the end of day the
settlement curve from the clearinghouse as well as the specific
settlement values applied to each cleared swap.\330\ Specifically, Eris
recommended: (1) That daily open interest should be published publicly
in a summary fashion with open interest grouped in maturity buckets
based on the remaining tenor of each instrument, (2) that end of day
pricing should be based upon a market-driven curve where the
clearinghouse's methodology to generate the daily settlement curve, as
well as all of the inputs and components of the settlement curve, are
made transparent to the full trading community, and (3) the
clearinghouse should publish the specific daily settlement values
applied to each cleared swap, without revealing open interest at a
granular level.\331\
---------------------------------------------------------------------------
\329\ Eris Comment Letter at 4 (Feb. 22, 2011).
\330\ Id. at 4-5.
\331\ Id.
---------------------------------------------------------------------------
Better Markets recommended that proposed Sec. 16.01 also require
the daily publication of the number of orders and order cancellations
separately for futures, options and swaps.\332\ According to Better
Markets, that data would indicate the levels of high frequency trading
activity within market segments.\333\
---------------------------------------------------------------------------
\332\ Better Markets Comment Letter at 9 (Feb. 22, 2011).
\333\ Id.
---------------------------------------------------------------------------
CME stated that while it does not object to reporting block trades
that are included in the daily volume of trading, this new requirement
will require it to ascertain what systems changes will be necessary and
how long such changes will take to implement.\334\ CME also stated that
the end of day price reporting of interest rate swaps should be
addressed as a separate initiative outside of the DCM and SEF
rulemakings given the state of change in the swaps markets and how the
market is expected to evolve as a result of regulatory reforms
underway.\335\
---------------------------------------------------------------------------
\334\ CME Comment Letter at 29 (Feb. 22, 2011).
\335\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is codifying Sec. 16.01 as proposed, with a
technical revision to renumber paragraph (a).
The Commission recognizes that the end-of-day reporting for
interest rate swaps by each DCM and SEF may require a more flexible
reporting scheme to take into account the venue in which the interest-
rate swap is cleared. In this respect, the daily settlement curve (the
yield curve for particular interest rate (e.g., LIBOR, TIBOR, Euribor,
etc.)) at each clearinghouse may differ based on the assumptions of the
curve. The Commission has considered the proposed reporting standard
put forth by Eris, however, in light of the novelty of swaps trading on
DCMs, the Commission believes that the more detailed reporting
obligations under Sec. 16.01 are warranted at this time. The
Commission did not receive any objections to the additional reporting
of block trades or to the swaps reporting standards. The Commission
further clarifies that in making information available to the general
public, as required in 16.01(e), DCMs should ensure that such
information can be accessed by visitors to the Web site without the
need to register, log in, provide a user name or obtain a
password.\336\
---------------------------------------------------------------------------
\336\ See e.g., former acceptable practices to Core Principle 7
(imposing similar requirement with respect to rulebooks). 17 CFR
part 38, appendix B (2010).
---------------------------------------------------------------------------
Better Markets' comments pertaining to high frequency trading are
addressed under the general discussion in Core Principle 4 pertaining
to HFTs.
9. Subpart J--Execution of Transactions
The Dodd-Frank Act revised Core Principle 9 to read as follows:
The board of trade shall provide a competitive, open and
efficient market and mechanism for executing transactions that
protects the price discovery process of trading in the centralized
market of the board of trade. * * * The rules of the board of trade
may authorize, for bona fide business purposes:
(a) Transfer trades or office trades;
(b) An exchange of:
(1) Futures in connection with a cash commodity transaction;
(2) Futures for cash commodities; or
(3) Future for swaps; or
(c) A futures commission merchant, acting as principal or agent,
to enter into or confirm the execution of a contract for the
purchase or sale of a commodity for future delivery if the contract
is reported, recorded, or cleared in accordance with the rules of
the contract market or a derivatives clearing organization.\337\
---------------------------------------------------------------------------
\337\ 7 U.S.C. 7(d)(9). The language that provides that off-
exchange transactions are permitted for bona fide business purposes
if authorized by the board of trade's rules was formerly contained
in Designation Criteria 3.
In view of Congress' revisions to Core Principle 9, and the
Commission's own experience over the past decade in overseeing
compliance with former Core Principle 9 \338\ and related regulation
1.38,\339\ the Commission proposed a number of new and revised rules,
guidance and acceptable practices in order to implement the revised
core principle, which requires DCMs to
[[Page 36643]]
provide a competitive, open and efficient market and mechanism for
executing transactions that protects the price discovery process of
trading in the centralized market of the board of trade.
---------------------------------------------------------------------------
\338\ Former Core Principle 9 provided as follows: ``[T]he board
of trade shall provide a competitive, open and efficient market and
mechanism for executing transactions.''
\339\ As described in the DCM NPRM, regulation 1.38 (Execution
of Transactions) of the Commission's regulations requires, among
other things, that all purchases and sales of a commodity for future
delivery or a commodity option on or subject to the rules of a DCM
be executed by open and competitive methods, with certain exceptions
for transactions that are executed noncompetitively pursuant to a
DCM's rules. See DCM NPRM, 75 FR at 80588 (discussing regulation
1.38).
---------------------------------------------------------------------------
Proposed Sec. 38.500 codified the statutory text of Core Principle
9.\340\ Proposed Sec. 38.501 specified the manner in which
transactions on the DCM's centralized market must be executed, and set
forth the requirements applicable to transactions that are executed off
of the DCM's centralized market, and incorporated certain
clarifications pertaining to the allowable types of off-exchange
transactions. Proposed Sec. 38.502 implemented the core principle's
requirement that DCMs provide a market and mechanism for executing
transactions that protects the price discovery process of trading in
its centralized market. The rule proposed a centralized market trading
requirement for all contracts listed on a DCM.
---------------------------------------------------------------------------
\340\ The Commission is finalizing regulation 38.500 in this
release.
---------------------------------------------------------------------------
Proposed Sec. 38.503 set forth revised rules and related guidance
pertaining to block transactions in futures contracts, including the
appropriate size, price and reporting of block trades; proposed Sec.
38.504 set forth rules pertaining to block transactions in swap
contracts. Finally, the DCM NPRM proposed new and revised rules under
Core Principle 9 that clarified other off-exchange transactions,
referred to collectively as ``exchanges of derivatives for related
positions'' and office trades and transfer trades.
Summary of Comments and Discussion
The Commission received a significant number of comments on all
aspects of the proposed rules under Core Principle 9, comprising both
general and specific comments pertaining to the Commission's
interpretation of Core Principle 9 and various other aspects of the
proposed rules.
In particular, commenters raised numerous questions pertaining to
the centralized market trading requirement rule's delisting requirement
for non-compliant contracts and the available alternatives for trading
such contracts.\341\ Commenters also raised questions pertaining to
certain aspects of the proposed rules for block transactions and
exchanges of derivatives for related position transactions.\342\ The
Commission has considered these comments, along with comments
pertaining to other aspects of the proposed rules under Core Principle
9, and believes that additional time is appropriate before finalizing
the proposed rules for Core Principle 9. In particular, the Commission
plans and expects to take up the proposed rules under Core Principle 9
when it considers the final SEF rulemaking. The additional time will
allow the Commission to consider the available alternatives for
contracts that may not comply with the proposed centralized market
trading requirement (including listing contracts on a SEF), as well as
the related implications of the rules for off-exchange transactions,
including block transactions and exchange of derivatives for relates
position transactions (``EDRPs''). At that time, the Commission will
address the comments received in connection with proposed Sec. Sec.
38.501-38.506.
---------------------------------------------------------------------------
\341\ See, e.g., CME Comment Letter at 4-8, 29-30 (Feb. 22,
2011); CME Comment Letter at 2-6 (April 18, 2011); CME Joint Comment
Letter at 2-6 (June 3, 2011); CME Comment Letter (Aug. 3, 2011);
BlackRock Comment Letter at 2-3 (Feb. 22, 2011); ICE Comment Letter
at 3-6 (Feb. 22, 2011); CFE Comment Letter at 4-7 (Feb. 22, 2011);
CFE Comment Letter (June 3, 2011); OCX Comment Letter at 2-5 (Feb.
22, 2011); Eris Comment Letter at 1-3 (Feb. 22, 2011); Eris Comment
Letter at 3 (June 3, 2011); GreenX Comment Letter at 8-11 (Feb. 22,
2011); GreenX Comment Letter at 4 (April 18, 2011); and, GreenX
Comment Letter (June 3, 2011).
\342\ See, e.g., ICE Comment Letter at 7 (Feb. 22, 2011); CME
Comment Letter at 31 (Feb. 22, 2011); ELX Comment Letter at 3 (Feb.
22, 2011); and, KCBT Comment Letter at 6 (Feb. 22, 2011).
---------------------------------------------------------------------------
10. Subpart K--Trade Information
Section 5(d)(10) of the CEA (Core Principle 10), as amended by the
Dodd-Frank Act, requires DCMs to capture, verify, and retain detailed
trade information (i.e., audit trail data) for all transactions in
their markets. The core principle requires DCMs to maintain rules and
procedures that provide for the recording and safe storage of all
identifying trade information in a manner that enables the DCM to
assist in the prevention of customer and market abuses and to provide
evidence of any rule violations. The Dodd-Frank Act did not
substantively revise Core Principle 10, and therefore, the application
guidance and acceptable practices for former Core Principle 10 provided
the basis for the Commission's proposed audit trail regulations in
subpart K.\343\ In addition, the Commission also looked to the issues
that arose in the context of RERs pertaining to Core Principle 10.
---------------------------------------------------------------------------
\343\ The Commission previously expressed the regulatory
requirements of former Core Principle 10 through its application
guidance for that core principle. See 17 CFR part 38, app. B,
Application Guidance and Acceptable Practices for Core Principle 10.
It also provided additional insight regarding the core principle
through detailed acceptable practices that all DCMs could use to
demonstrate compliance with former Core Principle 10. The acceptable
practices explained that ``the goal of an audit trail is to detect
and deter customer and market abuse.'' Id. at (b)(1). It also
outlined the elements of an effective audit trail. Those elements
included original source documents, which help to establish the
accuracy and authenticity of an audit trail. Also included is a
transaction history database and electronic analysis capability,
which allow a DCM to more easily access and review audit trail data
to identify possible trading abuses and rule violations. Finally,
the acceptable practices pointed to a DCM's safe storage capability,
emphasizing that audit trail data must be stored in a manner that
protects it from unauthorized alteration, accidental erasure, or
other loss.
---------------------------------------------------------------------------
The Commission proposed to codify the statutory text of Core
Principle 10 in proposed Sec. 38.550, and is adopting that rule as
proposed.
i. Sec. 38.551--Audit Trail Required
Proposed Sec. 38.551 is based on the application guidance and
acceptable practices for former Core Principle 10.\344\ Proposed Sec.
38.551 established the overarching requirement that a DCM's audit trail
program must help to ensure that the DCM can appropriately monitor and
investigate any potential customer and market abuse. The proposed rule
also provided that the audit trail data captured by a DCM must be
sufficient to reconstruct all transactions within a reasonable period
of time, and to provide evidence of any rule violations that may have
occurred. The proposed rule further provided that audit trails must be
sufficient to track customer orders from the time of receipt through
fill, allocation, or other disposition. Proposed Sec. 38.551 applied
equally to open-outcry and electronic trading.\345\
---------------------------------------------------------------------------
\344\ 17 CFR part 38, app. B, Core Principle 10, Application
Guidance and Acceptable Practices.
\345\ 75 FR 80572, 80617-80618, Dec. 22, 2010.
---------------------------------------------------------------------------
Summary of Comments
Two commenters stated that the proposed rule is too
prescriptive.\346\ CME argued that the proposals were a departure from
a principles-based regulatory regime and would stifle growth and
innovation.\347\ Similarly, MGEX argued that prescriptive rules would
impose additional burdens and costs upon DCMs.\348\
---------------------------------------------------------------------------
\346\ CME Comment Letter at 33-34 (Feb. 22, 2011); and MGEX
Comment Letter at 7 (Feb. 22, 2011).
\347\ CME Comment Letter at 34 (Feb. 22, 2011).
\348\ MGEX Comment Letter at 7 (Feb. 22, 2011).
---------------------------------------------------------------------------
Chris Barnard agreed with the proposed requirement that all DCMs
have the ability to reconstruct all trading.\349\ Mr. Barnard suggested
that the requirement that an exchange be able to reconstruct trading
should include ``all trading events, including the entry of bids and
offers in the order of their occurrence, as well as executed trades * *
*'' in order to permit
[[Page 36644]]
exchanges to fully reconstruct and verify all trading activities.\350\
---------------------------------------------------------------------------
\349\ Barnard Comment Letter at 2 (May 20, 2011).
\350\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting Sec. 38.551 as proposed. While the
Commission acknowledges CME and MGEX's comments, the Commission does
not believe that requiring an exchange to capture and retain all audit
trail data--to ensure that the exchange can reconstruct all
transactions on its markets--places an undue burden on exchanges or
stifles innovation. As noted above, the requirement that DCMs capture
and retain all audit trail data is central to ensuring that the DCM can
appropriately monitor and investigate any potential customer and market
abuse, as required by the core principle. The Commission is not
persuaded that this requirement would unduly burden DCMs, as these
requirements are the same as the responsibilities currently outlined in
the Acceptable Practices and Application Guidance for Core Principle
10. In addition, exchanges are free to decide the manner and the
technology they use to capture and retain audit trail data. The
Commission is not prescribing how this should be done and therefore
does not believe that this requirement will stifle innovation.
The Commission also notes that the text of Sec. 38.551 defines
certain regulatory outcomes that exchanges must achieve, but does not
prescribe a specific means by which exchanges must achieve those
outcomes. Accordingly, the rule is not prescriptive as it permits an
exchange to achieve the required outcome in a number of ways.
Proposed Sec. 38.551 required that a DCM ``must capture and retain
all audit trail data necessary to detect, investigate, and prevent
customer and market abuses.'' \351\ The creation and retention of a
comprehensive audit trail enables exchanges to properly reconstruct any
and all trading events and to conduct a thorough forensic review of all
trade information. The Commission believes that the ability to
reconstruct trading is a fundamental element of a DCM's surveillance
and rule enforcement programs.
---------------------------------------------------------------------------
\351\ DCM NPRM at 80617-18.
---------------------------------------------------------------------------
ii. Sec. 38.552--Elements of an Acceptable Audit Trail Program
Proposed Sec. 38.552 established the four elements of an
acceptable audit trail program. First, proposed Sec. 38.552(a)
required a DCM's audit trail to include original source documents,
defined to include unalterable, sequentially-identified records on
which trade execution information is originally recorded, whether
manually or electronically. Additionally, the proposal required that
customer order records indicate the terms of the order, the account
identifier that relates to the account owner, and the time of the order
entry. Finally, proposed Sec. 38.552(a) required that, for open-outcry
trades, the time of report of order execution also be captured in the
audit trail.
Second, proposed Sec. 38.552(b) required that a DCM's audit trail
program must include a transaction history database. Proposed Sec.
38.552(b) specified the trade information required to be included in a
transaction history database, including a history of all orders and
trades; all data input in the trade matching system for clearing; the
categories of participants for which trades were executed (i.e.,
customer type indicator or ``CTI'' codes); timing and sequencing data
sufficient to reconstruct trading; and identification of each account
to which fills were allocated.
Third, proposed Sec. 38.552(c) required that a DCM's audit trail
program have electronic analysis capability for all data in its
transaction history database, and that such electronic analysis
capability allow the exchange to reconstruct trades in order to
identify possible rule violations.
Finally, proposed Sec. 38.552(d) required that a DCM's audit trail
program include the ability to safely store all audit trail data, and
to retain data in accordance with the recordkeeping requirements of DCM
Core Principle 18 and associated regulations. Safe storage capability
required a DCM to protect its audit trail data from unauthorized
alteration, accidental erasure, or other loss.
Summary of Comments
In addition to submitting general comments asserting that the
proposed rules are overly prescriptive, CME stated that while it
currently maintains a database that includes a history of all orders
and trades for electronic trading, the open outcry trading venue ``does
not support an electronic transaction history database that captures
the history of all orders, including orders that may be cancelled prior
to execution.'' \352\ CME requested that, in the event that open-outcry
orders are not entered into an electronic order routing system, the
Commission clarify the requirements to take into account the
distinctions between electronic and open-outcry trading.\353\
---------------------------------------------------------------------------
\352\ CME Comment Letter at 33 (Feb. 22, 2011).
\353\ Id.
---------------------------------------------------------------------------
Better Markets requested that the Commission consider the impact
that high-frequency traders may have on creation and maintenance of an
exchange's audit trail data.\354\ Specifically, Better Markets
commented that each of the elements of an exchange's audit trail,
including all customer orders, should be ``time-stamped at intervals
consistent with the capabilities of [high-frequency traders] * * *''
\355\
---------------------------------------------------------------------------
\354\ Better Markets Comment Letter at 9 (Feb. 22, 2011).
\355\ Id. at 10.
---------------------------------------------------------------------------
Discussion
The Commission is adopting Sec. 38.552 as proposed, with certain
revisions in response to comments received, and additional
clarifications as explained below.
First, in response to CME's comment that the Commission's audit
trail rules should recognize the distinctions between electronic
trading and open outcry trading, the Commission is revising Sec.
38.552(b) to specify that a transaction history database must include a
history of all trades, whether executed electronically or via open-
outcry. However, order information must be included in the database
only to the extent that such orders are entered into an electronic
trading system. In addition, Sec. 38.552(b) also clarifies that order
data includes modifications and cancellations of such orders. This
reflects a regulatory requirement previously proposed as part of Sec.
38.156, but moved to Sec. 38.552(b) in the final rules. The final
rules further revise Sec. 38.552(b)(2) by replacing the customer type
indicators listed in the proposed rule with the term ``customer type
indicator code.''
The final rules also revise Sec. 38.552(c) to include the
requirement that an exchange's electronic analysis capability must
provide it with the ability to reconstruct trading and identify
possible trading violations.\356\
---------------------------------------------------------------------------
\356\ The text added to regulation 38.552(c) is language
originally proposed in regulation 38.156 and has now been deleted
from regulation 38.156.
---------------------------------------------------------------------------
The Commission acknowledges Better Markets' comments regarding
audit trail data with respect to high-frequency trading. However, the
Commission believes that the audit trail rules adopted herein,
particularly the requirements that an exchange retain and maintain all
data necessary to permit it to reconstruct trading, will help ensure
that information and trades entered into an electronic trading system
by high-frequency traders will be collected and retained as any other
[[Page 36645]]
audit trail data would be collected and retained.
The Commission believes that the four elements set forth in Sec.
38.552 are necessary to ensure that a DCM can capture and retain
sufficient trade-related information, can reconstruct trading promptly,
and has the necessary tools to detect and deter potential customer and
market abuses through its audit trail. Specifically, original source
documents must include all necessary trade information to reconstruct
trading on the DCM. The transaction history database facilitates rapid
access and analysis of all original source documents, thereby aiding
DCMs in monitoring for customer and market abuses, while electronic
analysis capability helps ensure effective use of audit trail data by
requiring appropriate tools to use in conjunction with a DCM's
transaction history database. Safe storage capability enables a DCM to
properly preserve and protect the audit trail data so that it is
readily available for the DCM to use in any future investigation or
inquiry into possible violations of DCM rules.
With the clarifications and revisions discussed above, the
Commission adopts Sec. 38.552 as the elements required of an
acceptable audit trail program.
iii. Sec. 38.553--Enforcement of Audit Trail Requirements
Proposed Sec. 38.553 established the elements of an effective
audit trail enforcement program. The proposed rule was organized in two
parts. First, proposed Sec. 38.553(a) required a DCM to develop an
effective audit trail enforcement program. The proposed rule provided
that an effective enforcement program must, at a minimum, review all
members and market participants annually to verify their compliance
with all applicable audit trail requirements.
Proposed Sec. 38.553(a) was further divided into two paragraphs.
Paragraph (a)(1) set forth minimum review criteria for an electronic
trading audit trail, including annual examinations by DCMs of randomly
selected samples of front-end audit trail data from order routing
systems to ensure the presence and accuracy of required audit trail
data. In addition, paragraph (a)(1) required that exchanges: Review the
processes used by members and market participants to assign and
maintain exchange user identifications; review usage patterns
associated with user identifications; and review account numbers and
CTI codes in trade records to test for accuracy and improper usage.
Paragraph (a)(2) of proposed Sec. 38.553 established minimum review
criteria for open-outcry trading, requiring DCMs to conduct annual
reviews of all members and market participants to verify their
compliance with their trade timing, order ticket, and trading card
requirements.
Second, proposed Sec. 38.553(b) required DCMs to develop programs
to ensure effective enforcement of their audit trail and recordkeeping
requirements. This requirement applied equally to both open-outcry and
electronic trading. Proposed Sec. 38.553(b) required exchanges'
enforcement programs to identify members and market participants that
routinely failed to comply with the requirements of Core Principle 10
and to levy meaningful sanctions when deficiencies were found. Such
sanctions could not include more than one warning letter or other non-
financial penalty for the same violation within a rolling 12 month
period.
Summary of Comments
As noted above with respect to other rules, several commenters
requested clarification of the term ``market participant'' in Sec.
38.553(a) and Sec. 38.553(b), including questioning who qualifies as a
``market participant.'' \357\ Specifically, MGEX and NYSE Liffe
suggested that the term ``market participant'' should be limited to
only those participants who have direct access to the trading
platform.\358\ CME commented that the Commission should limit the
requirement for annual audit trail reviews to the ``clearing firm level
rather than the market participant level'' because conducting an annual
audit trail and recordkeeping review of ``every participant who enters
an order into [a trading system would be] exceptionally onerous, costly
and unproductive.'' \359\ Additionally, MGEX argued that exchanges
should be permitted to conduct annual reviews by testing a sample of
market participants in order to make the annual reviews of audit trail
and recordkeeping requirements ``more efficient, adequate and less
burdensome.'' \360\
---------------------------------------------------------------------------
\357\ CME Comment Letter (Feb. 22, 2011); NYSE Liffe Comment
Letter (Feb. 22, 2011); MGEX Comment Letter (Feb. 22, 2011).
\358\ MGEX Comment Letter at 7 (Feb. 22, 2011); NYSE Liffe
Comment Letter at 12 (Feb. 22, 2011).
\359\ CME Comment Letter at 33(Feb. 22, 2011).
\360\ MGEX Comment Letter at 7 (Feb. 22, 2011).
---------------------------------------------------------------------------
In response to the proposed Sec. 38.553(b)'s requirement for
sufficient sanctions for violations of audit trail and recordkeeping
requirements, MGEX argued that such a requirement is ``arbitrary and
counterproductive.'' \361\ MGEX proposed that the Commission should
simply require exchanges to have an adequate audit trail program,
including adequate enforcement of the audit trail requirements.\362\
MGEX argued that such an approach would allow an exchange to develop
``what works best for their business while meeting intended audit trail
requirements.'' \363\
---------------------------------------------------------------------------
\361\ Id.
\362\ Id.
\363\ Id.
---------------------------------------------------------------------------
Discussion
The Commission adopts proposed Sec. 38.553, with certain
amendments.
The Commission has considered the comments pertaining to this rule
and believes that the term ``market participants,'' as used in
Sec. Sec. 38.553(a) and 38.553(b), requires clarification.
Accordingly, ``market participants'' is amended to instead state
``persons and firms subject to designated contract market recordkeeping
rules'' throughout Sec. 38.553. The Commission recognizes that the
term ``market participants'' may be viewed to capture a wider range of
persons than the Commission intended to subject to the proposed
regulation. Therefore, this amendment to Sec. 38.553 clarifies that
its requirements apply to those individuals and firms that are subject
to DCM recordkeeping rules.
The Commission does not believe that sampling-based reviews of
audit trail and recordkeeping requirements are adequate to reasonably
ensure compliance with audit trail rules. Sections 38.553(a) and
38.553(b) require audit trail enforcement programs that will yield some
certainty with respect to exchanges' accurate and consistent access to
all data necessary to reconstruct all transactions in their markets and
provide evidence of customer and market abuses. Absent reliable audit
trail data, an exchange's ability to detect or investigate customer or
market abuses may be severely diminished.
The Commission does not believe that requiring exchanges to issue
no more than one warning letter for the same violation within a rolling
12-month time period is arbitrary and counterproductive. The proposed
requirement to limit DCMs to no more than one warning letter for the
same violation within a rolling 12-month time period helps ensure that
exchanges levy meaningful fines and sanctions to deter recidivist
behavior. However, the Commission is amending Sec. 38.553(b) to
clarify that its requirements with respect to warning letters only
apply where exchange compliance staff finds an actual rule violation,
rather than just the suspicion of a violation.
[[Page 36646]]
The Commission notes that Sec. 38.553 reflects staff's findings
and recommendations in recent RERs regarding DCMs' audit trail
enforcement programs, including recommendations regarding more frequent
audit trail reviews and larger sanctions for audit trail violations.
The proposed rule also reflects the Commission's directive to DCMs in
recent RERs to develop audit trail programs for electronic trading that
are comparable in rigor and scope to their audit trail programs for
open-outcry trading.\364\ Accordingly, the Commission is adopting Sec.
38.553 with the aforementioned modifications.
---------------------------------------------------------------------------
\364\ See Rule Enforcement Review of the Minneapolis Grain
Exchange (August 27, 2009), and Rule Enforcement Review of ICE
Futures U.S. (Feb. 2, 2010).
---------------------------------------------------------------------------
11. Subpart L--Financial Integrity of Transactions
The Dodd-Frank Act amended the text of Core Principle 11 largely to
incorporate the language from former Designation Criteria 5.\365\
---------------------------------------------------------------------------
\365\ Former Designation Criterion 5 stated that ``the board of
trade shall establish and enforce rules and procedures for ensuring
the financial integrity of transactions entered into by or through
the facilities of the contract market, including the clearance and
settlement of the transactions with a derivatives clearing
organization.'' 17 CFR Part 38, app. A (2010).
---------------------------------------------------------------------------
This core principle requires that a DCM establish and enforce rules
and procedures for ensuring the financial integrity of transactions
entered into, on, or through the facilities of the contract market,
including the clearing and settlement of the transactions with a DCO.
Core Principle 11 also requires that a DCM establish and enforce rules
to ensure: (i) The financial integrity of any futures commission
merchant (``FCM'') and introducing broker (``IB''); and (ii) the
protection of customer funds. Because the substance of this core
principle is unchanged, the Commission interpreted the statutory
provisions in the same manner as they are currently interpreted. The
Commission proposed to codify current practices carried out by the
industry, as well as practices listed in the application guidance for
Core Principle 11 and former Designation Criterion 5. In addition,
based upon its experience, the Commission proposed some new practices
and requirements for DCMs in implementing Core Principle 11.\366\ Among
other rules, the Commission proposed to codify the statutory text of
Core Principle 11 in Sec. 38.600, and is adopting the rule as
proposed.
---------------------------------------------------------------------------
\366\ The Commission received five comment letters that
discussed proposed regulations 38.600 through 38.607. The comments
were received from ICE Comment Letter (Feb. 22, 2011), ELX Comment
Letter (Feb. 22, 2011), MGEX Comment Letter (Feb. 22, 2011), KCBT
Comment Letter (Feb. 22, 2011), and CME Comment Letter (Feb. 22,
2011).
---------------------------------------------------------------------------
i. Sec. 38.601--Mandatory Clearing
Proposed Sec. 38.601 provided that all transactions executed on or
through a DCM, other than transactions in security futures products, be
cleared through a Commission-registered DCO.
Summary of Comments
CME commented that the mandatory clearing requirement should not
apply to swaps traded on a DCM because not all swap contracts will be
required to be cleared, such as foreign exchange swaps and swaps for
end users.\367\ CME further stated that this requirement would put a
DCM at a competitive disadvantage to a SEF without justification, and
recommended that the Commission revise proposed Sec. 38.601 to exclude
swaps from the clearing rule.\368\
---------------------------------------------------------------------------
\367\ CME Comment Letter at 34 (Feb. 22, 2011).
\368\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting the proposed rule, with certain
amendments. The Commission believes that the language of the core
principle specifically imposes a clearing obligation for all
transactions executed on a DCM (as is the current practice) and has
therefore not revised the rule to exclude swaps.\369\
---------------------------------------------------------------------------
\369\ Although the DCM and SEF Financial Integrity Core
Principles are similar, the SEF core principle contains the language
``including the clearance and settlement of the swaps pursuant to
section 2(h)(1).'' Section 5h(f)(7) of the CEA, 7 U.S.C. 7b-2(f)(7),
as added by section 733(f) of the Dodd-Frank Act. The DCM core
principle states ``including the clearance and settlement of the
transactions with a derivatives clearing organization.'' The
Commission reads section 2(h)(1) as a limitation on the clearing
obligation for SEFs, and as a result, proposed regulation 37.701
requires all transactions executed on a SEF to be cleared unless the
transaction is exempted from clearing under section 2(h)(7) of the
CEA or the Commission determines that the clearing requirement under
section 2(h)(1) of the CEA is inapplicable. Since Congress did not
provide for a limitation on the clearing obligation in the DCM core
principle, all transactions executed on or through a DCM must be
cleared through a Commission-registered DCO.
---------------------------------------------------------------------------
However, the Commission has revised the rule to make clear that
transactions in security futures products that are executed on or
through a DCM are also subject to the mandatory clearing requirement.
Such products may be cleared either through a DCO or through a clearing
agency registered pursuant to section 17A of the Securities Exchange
Act of 1934.\370\
---------------------------------------------------------------------------
\370\ 15 U.S.C. 78a et seq. (2010)
---------------------------------------------------------------------------
ii. Sec. 38.602--General Financial Integrity
Proposed Sec. 38.602 provided that DCMs must adopt rules
establishing minimum financial standards for both member FCMs and IBs
and non-intermediated market participants.
Summary of Comments
ICE contended that the Commission has expanded the standard in Core
Principle 11 by requiring DCMs to establish minimum financial standards
for all of their members and non-intermediated market
participants.\371\ ICE further stated that many DCMs eliminated
specific financial standards for their non-FCM members and instead
require that non-FCM member transactions be guaranteed by a clearing
member.\372\ As a result, ICE requested confirmation that a DCM rule
requiring such clearing arrangements to be in place would satisfy
proposed Sec. 38.602.\373\ ICE also requested confirmation that a DCM
rule requiring an FCM to maintain capital in accordance with applicable
Commission regulations would satisfy the DCM's duty to set financial
requirements for its FCM members.\374\
---------------------------------------------------------------------------
\371\ ICE Comment Letter at 12 (Feb. 22, 2011).
\372\ Id. at 13.
\373\ Id.
\374\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting the rule as proposed. In response to
ICE's comments, the Commission confirms that a DCM rule requiring that
transactions by a non-FCM member be guaranteed by a clearing member
will satisfy Sec. 38.602.\375\
---------------------------------------------------------------------------
\375\ The Commission notes that this requirement does not speak
to DCO requirements under, for example, Core Principle D (Risk
Management) for its clearing members.
---------------------------------------------------------------------------
However, a DCM rule requiring an FCM to maintain capital in
accordance with applicable Commission regulations will not, in itself,
satisfy the DCM's duty to set minimum financial standards for its FCM
members. The term ``minimum financial standards'' used in Sec. 38.602
is not intended to cover only capital requirements. Rather, Sec.
38.602 should be read in conjunction with Sec. 38.604, which requires
surveillance by a DCM of financial and related information from each of
its members. The Commission notes that a DCM's duty to set financial
standards for its FCM members involves setting capital requirements,
conducting surveillance of the potential future exposure of each FCM as
compared to its capital, and taking appropriate action in light of the
results of such surveillance.
[[Page 36647]]
iii. Sec. 38.603--Protection of Customer Funds
Proposed Sec. 38.603 provided that DCMs must adopt rules for the
protection of customer funds, including the segregation of customer and
proprietary funds, the custody of customer funds, the investment
standards for customer funds, intermediary default procedures and
related recordkeeping.
Summary of Comments
KCBT stated that because its rules incorporate by reference the
requirements of the CEA, the requirement to implement exchange rules
that mirror Commission regulations is duplicative, unnecessary and
burdensome.\376\ In addition, KCBT noted that its clearing corporation
already has rules in place to address intermediary default
procedures.\377\
---------------------------------------------------------------------------
\376\ KCBT Comment Letter at 7 (Feb. 22, 2011).
\377\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting the rule as proposed. In response to the
comments, the Commission confirms that DCMs must adopt rules as
required under Sec. 38.603. Establishing such rules is important
because it will provide evidence: (i) that each DCM has focused
attention on the specific regulations promulgated under the CEA; and
(ii) that such regulations are appropriately implemented. Section
38.603 does not specify the exact rules to be implemented by each DCM,
but sets forth the substance of what the rules of each DCM must
address.
In response to KCBT's comment that its clearing corporation already
has rules in place to address intermediary default procedures, the
Commission notes that DCO rules protect the DCO, not fellow customers.
Nonetheless, the performance of the functions required by Sec. 38.603
may be allocated between a DCO and DCM pursuant to appropriate written
agreements. Such agreements would have to include an arrangement
between the DCO and DCM that the DCO would undertake the responsibility
to protect the individual customers of the DCM.
iv. Sec. 38.604--Financial Surveillance
Proposed Sec. 38.604 required that a DCM must routinely receive
and promptly review financial and related information from its members,
and conduct ongoing financial surveillance of the risk created by the
positions taken by an FCM's customers. To meet this requirement, the
DCM must have rules pertaining to minimum financial standards of
intermediaries that include, among other things, rules prescribing
minimum capital requirements for member FCMs and IBs.\378\ The DCM must
also have rules pertaining to the protection of customer funds that
must include, among other things, that each DCM must continually survey
the obligations of each FCM created by its customers' positions and, as
appropriate, compare those obligations to the financial resources of
the FCM. If the obligations of a member FCM appear excessive as
compared to the FCM's capital, a DCM should take appropriate action,
including contacting the FCM or the FCM's designated self-regulatory
organization (``DSRO'').
---------------------------------------------------------------------------
\378\ An FCM that is a clearing member will also have additional
obligations to the DCO as a result of its clearing membership.
---------------------------------------------------------------------------
Summary of Comments
KCBT commented that it already reviews on a daily basis the open
positions and percentage of open interest held by each clearing member,
and ``pay/collect information'' based upon open positions and
reportable positions.\379\ KCBT is concerned that the use of the terms
``continually'' and ``excessive'' in the proposed regulation is
vague.\380\ In addition, KCBT noted that the DSRO should continue to
review the obligations of each firm for which it is the DSRO because
the DSRO has access to all customer positions being carried by the FCM
in all markets and thus is in a better position to ensure that the FCM
has sufficient capital for the overall positions being carried by the
FCM.\381\
---------------------------------------------------------------------------
\379\ See KCBT Comment Letter at 7 (Feb. 22, 2011).
\380\ Id.
\381\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting the rule as proposed and notes that the
rule codifies existing industry practice. In response to comments
raised by KCBT, the Commission notes that the term ``continually'' in
the proposed rule requires that a DCM survey the obligations of each
FCM created by the positions of its customers throughout the trading
day, not just based upon end-of-day positions. Financial risk can shift
dramatically throughout the day as a result of the combination of price
move and new trades, making it difficult for a DCM to fulfill its
obligations to establish and enforce rules to ensure: (i) the financial
integrity of FCMs and IBs and (ii) the protection of customer funds
pursuant to Core Principle 11, if such DCM limited its monitoring to
daily. FCMs and IBs could be exposed to excessive risk if they are
taking on risky positions during the day with the expectation that
those risks will be offset prior to the daily review period set by the
DCM. The Commission also notes that an arrangement between a DCO and a
DCM, whereby the DCO is responsible to a DCM for the performance of
certain functions, including the monitoring required pursuant to Sec.
38.604, will continue to be permitted by the Commission.
In response to KCBT's comment regarding the vagueness of the word
``excessive,'' the Commission expects a DCM to exercise professional
judgment in monitoring the risks of its FCMs as compared to their
available capital, and to take follow-up action to inquire into and
address any exceptional situations. This monitoring should occur in
addition to any DSRO review.
v. Sec. 38.605--Requirements for Financial Surveillance Program
Proposed Sec. 38.605 required DCMs, as self-regulatory
organizations (``SROs''), to comply with the standards of amended Sec.
1.52 to ensure the financial integrity of intermediaries by
establishing and carrying out an SRO program for the examination and
financial supervision of intermediaries. Section 1.52, as proposed to
be amended, sets forth the required elements of SRO supervisory
programs and permits one or more SROs to establish, subject to
Commission approval, a joint audit plan to provide for the SRO
supervision of members of more than one SRO. As noted in the DCM NPRM,
proposed amendments to Sec. 1.52 included references to existing
guidance to SROs contained in the Financial and Segregation
Interpretation No. 4-1 (Advisory Interpretation for Self-Regulatory
Organization Surveillance Over Members' Compliance with Minimum
Financial, Segregation, Reporting, and Related Recordkeeping
Requirements), and Addendums A and B to Financial and Segregation
Interpretation No. 4-1, and Financial and Segregation Interpretation
No. 4-2 (Risk-Based Auditing), which guided the practices of members of
the Joint Audit Committee (``JAC'') operating a joint audit plan that
had been approved by the Commission.\382\
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\382\ See 73 FR 52832, Sept. 11, 2008 (requesting comments prior
to the Commission's approval of the most recent Joint Audit
Committee agreement, which approval was granted March 18, 2009). See
also, DCM NPRM, 75 FR at 80596.
---------------------------------------------------------------------------
Discussion
No comments were received pertaining to the proposed rules, and the
Commission is adopting proposed
[[Page 36648]]
Sec. 38.605 and Sec. 1.52 without modification.
The Commission notes that the staff guidance contained in Division
of Trading and Markets Financial and Segregation Interpretations 4-1
and 4-2, and related Addendums A and B to Financial and Segregation
Interpretations 4-1, remains effective. Accordingly, while the revised
Sec. 1.52(b)(4) provides that an SRO's financial surveillance program
must include the onsite examination of each member FCM no less
frequently than once every 18 months, Financial and Segregation
Interpretation No. 4-2 provides that FCMs should generally be subject
to an onsite examination at least once every 9 to 18 months, with
examination cycles exceeding 15 months only for registrants with a
demonstrated history of strong compliance and risk management in order
to provide flexibility for unexpected events or to vary examination
dates.
While Sec. 1.52 now codifies long established staff positions, and
SRO practice, with respect to the manner in which SROs execute their
financial surveillance and supervisory programs with respect to member
intermediaries, the Commission will continue to evaluate options to
further enhance the manner in which intermediaries are supervised and
to strengthen the protection of customer funds.
vi. Sec. 38.606--Financial Regulatory Services Provided by a Third
Party
Proposed Sec. 38.606 provided that DCMs may satisfy their
financial surveillance responsibilities under proposed Sec. Sec.
38.604 and 38.605 by outsourcing such responsibilities to a registered
futures association or other regulated entity, including, for example,
a DCO. Proposed Sec. 38.606 provided that a DCM must ensure that the
regulatory service provider has the capacity and resources to conduct
the necessary financial surveillance and, notwithstanding the use of a
regulatory service provider, the DCM remains responsible for compliance
with its financial surveillance obligations.
Summary of Comments
MGEX commented that the proposed requirements seem reasonable, and
stated that the requirements could be satisfied under the current
delegation and information sharing agreements such as the Commission-
approved JAC Agreement for Services.\383\ MGEX also commented that DCMs
should not be required to audit third party regulatory providers
because that would frustrate the purpose, efficiency, and economic
value of outsourcing to a third party.\384\
---------------------------------------------------------------------------
\383\ MGEX Comment Letter at 8 (Feb. 22, 2011).
\384\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting the proposed rule without modification.
In response to MGEX's comments, the Commission notes that Sec. 38.606
would not be satisfied solely by relying on a DCM's JAC Agreement. The
current JAC Agreement does not cover the type of financial surveillance
specified in Sec. 38.604, nor does it, by its terms, serve as an
outsourcing regulatory services agreement for the type of outsourcing
contemplated under Sec. 38.606. Accordingly, in order to satisfy the
requirements of both Sec. Sec. 38.604 and 38.605, a regulatory
services agreement must specifically include the following: (i) the
regulatory services to be performed, which to satisfy Sec. 38.604 must
include intraday monitoring of FCM obligations and positions; (ii) to
whom and for whom such services are to be provided; and (iii) a
statement or representation that the provider of the services has the
capacity and resources to perform the identified services.
vii. Sec. 38.607--Direct Access
Proposed Sec. 38.607 required a DCM that allows customers direct
access to its contract market to implement certain direct access
controls and procedures in order to provide member FCMs with tools to
manage their financial risk. The proposed rule contemplated that an FCM
would continue to have primary responsibility for overall risk
management, but that the DCM would be required to establish an
automated risk management system permitting an FCM to set appropriate
risk limits for each customer with direct access to the contract
market.
Summary of Comments
CME supports risk controls at both the DCM and DCO levels, and also
at clearing firm and direct access client levels.\385\ CME supports the
discretion that the proposed rules provide a DCM in terms of the
control model for access, and recommended a level of standardization
with respect to the types of DCM pre-trade controls in the form of
acceptable practices.\386\ ELX recommended that the Commission consider
allowing an FCM to bypass use of DCM-provided controls if an FCM has
its own controls that a DCM tests and deems to be sufficient.\387\ MGEX
commented that the Commission should not mandate that a DCM provide the
technology as a prescriptive rule, and further claimed that such tools
are the FCM's responsibility and DCMs should not be required to assume
these responsibilities.\388\
---------------------------------------------------------------------------
\385\ CME Comment Letter at 34 (Feb. 22, 2011).
\386\ Id.
\387\ ELX Comment Letter at 5 (Feb. 22, 2011).
\388\ MGEX Comment Letter at 8 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
After reviewing the comments discussed above, the Commission is
adopting the proposed rule without modification and believes that risk
controls are appropriate at the FCM, DCO and DCM levels. The Commission
notes that it is impossible for an FCM to protect itself without the
aid of the DCM when a customer has direct access to a DCM and thus
completes trades that are the financial responsibility of such
customer's FCM before the FCM's systems have an opportunity to prevent
the execution of such trades. As a result, DCMs allowing customers
direct access to their markets must implement certain controls and
procedures to allow FCMs to manage their risk. As stated in the
proposed rule, these controls would not be required for a DCM that
permits only intermediated transactions and does not permit direct
access.
The responsibility to utilize these controls and procedures remains
with the FCM. Each FCM permitting direct access must use DCM-provided
controls, regardless of the purported efficacy of an FCM's
controls.\389\ This principle is supported by CME's comment letter, the
Commission's Technology Advisory Committee report (the ``DMA
Report''),\390\ and the FIA Report on Market Access Risk Management
[[Page 36649]]
Recommendations (the ``FIA Report'').\391\
---------------------------------------------------------------------------
\389\ The efficacy of these controls also hinge, in part, on the
proper functioning of the electronic systems of DCMs, FCMs and
direct access market participants, and thus, necessitates that such
electronic systems are routinely tested and monitored. Accordingly,
the Commission may address additional electronic system testing and
supervision-related issues in the future.
\390\ See Pre-Trade Functionality Subcommittee of the CFTC
Technology Advisory Committee report, ``Recommendations on Pre-Trade
Practices for Trading Firms, Clearing Firms, and Exchanges Involved
in Direct Market Access'' (March 1, 2011), accepted by the TAC and
available at: http://www.cftc.gov/idc/groups/public/@swaps/documents/dfsubmission/tacpresentation030111_ptfs2.pdf. The DMA
Report recommends specific controls that should be adopted by each
FCM and DCM and notes that ``the exchanges are the point furthest
downstream, so coordination at this level has the greatest leverage
to impact the industry as a whole.'' DMA Report at p. 4. The
controls provided by the DCM serve as the backstop, in the event
that an FCM's controls are insufficient. The DMA Report notes that,
although the recommendations may seem redundant, it ``strongly
believes that an approach of multiple, redundant checks across the
supply chain offers the most robust protection to markets.'' Id. at
p. 5.
\391\ See FIA report on ``Market Access Risk Management
Recommendations'' (April 2010), available at: http://www.futuresindustry.org/downloads/Market_Access-6.pdf. (``FIA
Report'').
---------------------------------------------------------------------------
As discussed in the DCM NPRM, the Technical Committee of the
International Organization of Security Commissions (``IOSCO'')
published a final report on principles for direct electronic access in
August of 2010 (the ``IOSCO DEA Report'') stating that, in an automated
trading environment, the only controls that can effectively enforce
limitations on risk are automated controls.\392\ Further, the IOSCO DEA
Report noted that a market should not permit direct electronic access
unless effective systems and controls are in place to enable risk
management, including automated pre-trade controls enabling
intermediaries to implement appropriate trading limits.\393\ The IOSCO
DEA Report stated that ``[t]here is no convincing rationale for not
using automated credit limit system filters * * * it will be critical
for intermediaries, third party vendors and markets to cooperate in
putting into place appropriate systems and controls.'' \394\ One
example provided in the report was that a market could provide and
operate an automated system (i.e., software and hardware) that would be
used by the intermediary and clearing firm.\395\
---------------------------------------------------------------------------
\392\ IOSCO, Final Report of the IOSCO Technical Committee,
``Principles for Direct Electronic Access to Markets,'' at 20, IOSCO
Doc. FR08/10 (August 12, 2010), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD332.pdf.
\393\ Id.
\394\ Id. at p. 22.
\395\ Id.
---------------------------------------------------------------------------
Further, the FIA's working group, consisting of DCMs, clearing
firms, and trading firms, recommended that pre-trade controls be set at
the exchange level, and that the controls be mandatory to ensure that
there are no latency disadvantages.\396\ In a publication in January
2011, the FIA reported that the majority of exchanges have policies and
tools in place that comply with those recommendations.\397\ The DMA
Report also discussed the latency for an FCM that elects to use a DCM's
controls as compared to an FCM that does not.\398\ This disadvantage is
eliminated if each DCM requires all FCMs to use the DCM-provided
protections.
---------------------------------------------------------------------------
\396\ See e.g., FIA Report.
\397\ See Leslie Sutphen, ``Exchange Survey Finds Wide Range of
Risk Controls in Place'' (January 2011), at 28, available at: http://www.futuresindustry.org/downloads/RC-survey.pdf.
\398\ See DMA Report at p. 4.
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12. Subpart M--Protection of Markets and Market Participants
Core Principle 12, as amended by the Dodd-Frank Act, requires that
DCMs establish and enforce rules to protect markets and market
participants from abusive practices committed by any party, including
abusive practices committed by a party acting as an agent for a
participant, and promote fair and equitable trading on the contract
market.
The Commission proposed to codify the statutory text of the core
principle in Sec. 38.650, and is adopting the rule as proposed.
i. Sec. 38.651--Additional Sources for Compliance
Proposed Sec. 38.651 required that a DCM have and enforce rules
that are designed to promote fair and equitable trading and to protect
the market and market participants from abusive practices including
fraudulent, noncompetitive or unfair actions, committed by any party.
The rule also required that DCMs must have methods and resources
appropriate to the nature of the trading system and the structure of
the market to detect trade practice and market abuses and to discipline
such behavior, in accordance with Core Principles 2 and 4, and the
associated regulations in subparts C and E of this part, respectively.
The proposed rule required that DCMs also must provide a competitive,
open and efficient market and mechanism for executing transactions in
accordance with Core Principle 9 and the associated regulations under
subpart J of this part.
Summary of Comments
Chris Barnard and Better Markets referenced a discussion from the
DCM NPRM preamble that provided that a DCM must establish rules that
require the fair, equitable, and timely provision of information
regarding prices, bids, and offers to market participants.\399\ Mr.
Barnard requested that the Commission amend the wording of proposed
Sec. Sec. 38.650 and 38.651 to include this language and Better
Markets requested that the proposed rules prohibit privileged access to
data feeds, arguing that the practice is disruptive of fair and
equitable trading.\400\
---------------------------------------------------------------------------
\399\ Better Markets Comment Letter at 10 (Feb. 22, 2011) and
Barnard Comment Letter at 4 (May 20, 2011) (citing DCM NPRM at
80597).
\400\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting the rule with a technical modification
to revise the heading of the rule from ``Additional sources for
compliance'' to the more appropriate ``Protection of markets and market
participants.'' All other aspects of the proposed rule will remain
unchanged.
The Commission believes that Mr. Barnard's concerns are adequately
addressed by the rules adopted in this release. As an initial matter,
Sec. 38.650 simply codifies the language of Core Principle 12 and thus
cannot be amended by the Commission. Additionally, the broad
requirement to promote ``fair and equitable trading'' contained in
Sec. Sec. 38.650 and 38.651, as well as the Core Principle 9
requirement to provide a ``competitive, open, and efficient market and
mechanism for executing transactions,'' are sufficient to capture the
obligation to provide fair, equitable, and timely information regarding
prices, bids, and offers. With respect to Better Markets' comment, the
Commission notes that the language from the DCM NPRM cited by Better
Markets was not intended to preclude co-location. Instead, the DCM NPRM
provides that a market should be fair and equitable in its information
distribution, meaning all participants in co-location agreements should
pay the same price for a given level of service and access. This does
not mean that everyone in the market is required to get information at
the same time, but rather that every member of a connection or access
type class must be treated equally in terms of service and cost. The
faster access to price, bid, and offer information afforded by co-
location is no different than the faster access to information afforded
to traders in the pits prior to the markets becoming electronic. The
Commission believes that prohibiting co-location, or requiring that co-
location services be throttled to a point that all participants are
able to consume information or access the matching engine at the same
speed, would not be practical or reasonable. The Commission also notes
that it recently addressed co-location fees in a separate proposed
rulemaking for ``Co-location/Proximity Hosting Services.'' \401\
---------------------------------------------------------------------------
\401\ See, Notice of proposed rulemaking, 75 FR 33198, Jun. 11,
2010.
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13. Subpart N--Disciplinary Procedures
Core Principle 13 is a new core principle, created by section 735
of the Dodd-Frank Act. The core principle incorporates the concepts
from former Designation Criterion 6 (Disciplinary Procedures) and
former DCM Core Principle 2.\402\ The core principle
[[Page 36650]]
specifically requires that DCMs establish and enforce disciplinary
procedures that authorize the DCM to discipline, suspend or expel
market participants and members that violate the DCM's rules, or
delegate the function to third parties.
---------------------------------------------------------------------------
\402\ Compare former CEA section 5(b)(6) and section 5(d)(2)
with CEA section 5(d)(13) as amended by the Dodd-Frank Act. Prior to
the passage of the Dodd-Frank Act, the standards for DCMs'
disciplinary practices were found in Designation Criterion 6 and the
statutory language, guidance, and acceptable practices for former
Core Principle 2. Designation Criterion 6 required that a DCM
establish and enforce disciplinary procedures that authorized it to
discipline, suspend, or expel members or market participants that
violated the rules of the DCM, or similar methods for performing the
same functions, including delegation of the functions to third
parties. Paragraph (a)(2) of the application guidance for former
Core Principle 2 required DCMs to have the ``arrangements,
resources, and authority [necessary] for effective rule
enforcement,'' and the ``authority and ability to discipline and
limit, or suspend the activities of a member or market participant
pursuant to clear and fair standards.'' 17 CFR part 38, app. B,
Application Guidance for Core Principle 2 at (a)(2) (2010). In
addition, paragraph (b)(4) of the former core principle's acceptable
practices required any DCM that wished to take advantage of the
acceptable practice's safe harbor to have ``prompt and effective
disciplinary action for any violation * * * found to have been
committed.'' 17 CFR part 38, app. B, Acceptable Practices for Core
Principle 2 at (b)(4) (2010). Paragraph (b)(4) also referenced part
8 of the Commission's regulations as an example that DCMs could
follow to comply with Core Principle 2. 17 CFR 8.01 et seq. In its
experience, the Commission has found that many DCMs' disciplinary
programs do in fact model the disciplinary structures and processes
in part 8. While the acceptable practices for former Core Principle
2 offered the disciplinary procedures in part 8 as an example of
appropriate disciplinary procedures, DCMs were exempt from part 8
pursuant to regulation 38.2. The disciplinary procedures proposed
herein do not re-subject DCMs to part 8 of the Commission's
regulations, but rather propose new disciplinary procedures for
inclusion in part 38.
---------------------------------------------------------------------------
Summary of Comments
Several commenters submitted letters discussing the disciplinary
procedures contained in subpart N. While the comments were generally
supportive of the Commission's objectives, commenters expressed a
general desire for the Commission to rely on a more principles-based
approach, and argued that the proposed rules were overly prescriptive.
Some commenters also articulated specific concerns regarding several
rules that they believed would adversely impact DCMs.
Discussion
The Commission thoroughly reviewed and considered all comments
received and, where appropriate, made modifications to the proposed
rules, including converting some proposed rules into guidance. These
modifications, explained further below, have resulted in changes to the
numbering of the proposed regulations and in a reduction in the number
of separately-enumerated rules, from 16 proposed rules to 12 final
rules.
The Commission proposed to codify the statutory text of the core
principle in proposed Sec. 38.700, and adopts the rule as proposed.
The Commission is also adding Sec. 38.712 to refer applicants and DCMs
to the guidance in appendix B to part 38.
i. Sec. 38.701--Enforcement Staff
Proposed Sec. 38.701 required that a DCM establish and maintain
sufficient enforcement staff and resources to effectively and promptly
prosecute possible rule violations within the jurisdiction of the
contract market. The proposed rule also required a DCM to monitor the
size and workload of its enforcement staff annually and increase its
resources and staff as appropriate. The Commission recognized that at
some DCMs, compliance staff also serves as enforcement staff. That is,
they both investigate cases and present them before disciplinary
panels. These proposed rules were not intended to prohibit that
practice.
The Commission believes that adequate staff and resources are
essential to the effective performance of a DCM's disciplinary program.
This has repeatedly been reflected in Commission staff's findings and
recommendations in recent RERs, in which DMO staff recommended that
DCMs increase their compliance and/or enforcement staff levels and
monitor the size of their staff and increase the number of staff
appropriately as trading volume increases, new responsibilities are
assigned to staff, or internal reviews demonstrate that work is not
completed in an effective or timely manner.
Proposed Sec. 38.701 also provided that a DCM's enforcement staff
may not include members of the exchange or persons whose interests
conflict with their enforcement duties. Moreover, the proposed rule
prohibited a member of the enforcement staff from operating under the
direction or control of any person or persons with trading privileges
at the contract market. These provisions sought to ensure the
independence of enforcement staff, and help promote disciplinary
procedures that are free of potential conflicts of interest.
Summary of Comments
MGEX noted that, as a combined DCM/DCO, it interprets the rule to
allow staff to serve as enforcement and review staff for both the DCM
and DCO divisions of MGEX, and any other entities that become a
combined DCM/DCO.\403\
---------------------------------------------------------------------------
\403\ MGEX Comment Letter at 8 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission is adopting the rule as proposed. The Commission
believes that adequate staff and resources are essential to the
effective performance of a DCM's disciplinary program. This has
repeatedly been reflected in Commission staff's findings and
recommendations in recent RERs, in which Commission staff recommended
that DCMs increase their compliance and/or enforcement staff levels and
monitor the size of their staff and increase the number of staff
appropriately as trading volume increases, new responsibilities are
assigned to staff, or internal reviews demonstrate that work is not
completed in an effective or timely manner.\404\
---------------------------------------------------------------------------
\404\ See Rule Enforcement Review of the Minneapolis Grain
Exchange (Aug. 27, 2009), Rule Enforcement Review of ICE Futures
U.S. (Feb. 2, 2010), Rule Enforcement Review of the Chicago Board of
Trade and the Chicago Mercantile Exchange (Sep. 13, 2010), and Rule
Enforcement Review of New York Mercantile Exchange and Commodity
Exchange (August 30, 2011) for findings and recommendations
pertaining to the adequate size of DCM compliance and enforcement
staffs.
---------------------------------------------------------------------------
The Commission notes that MGEX's interpretation regarding the
sharing of compliance staff across a combined DCM/DCO is acceptable,
provided that the combined DCM/DCO has sufficient staff to meet the
DCM's regulatory compliance needs in an effective and timely manner. In
addition, with respect to DCM matters, staff must be accountable to the
DCM and its Regulatory Oversight Committee. The Commission also notes,
however, that its a priori acceptance of integrated compliance staff is
limited to the unique circumstances of a fully integrated exchange and
clearing house.
ii. Sec. 38.702--Disciplinary Panels
Proposed Sec. 38.702 required a DCM to establish one or more
Review Panels and one or more hearing panels (together, ``disciplinary
panels'') to fulfill its obligations under this section. The
composition of both panels was required to meet the composition
requirements of proposed Sec. 40.9(c)(3)(ii) \405\ and could not
include
[[Page 36651]]
any members of the DCM's compliance staff, or any person involved in
adjudicating any other stage of the same proceeding. Paragraph (b) of
the proposed rule provided that a Review Panel must be responsible for
determining whether a reasonable basis exists for finding a violation
of contract market rules, and for authorizing the issuance of a notice
of charges against persons alleged to have violated exchange rules. If
a notice of charges is issued, then paragraph (c) of the proposed rule
helped to ensure an impartial hearing by requiring a separate hearing
panel to adjudicate the matter and issue sanctions. While proposed
Sec. 38.702 required DCMs to empanel distinct bodies to issue charges
and to adjudicate charges in a particular matter, the rule permitted
DCMs to determine for themselves whether their review and hearing
panels are separate standing panels or ad hoc bodies whose members are
chosen from a larger ``disciplinary committee'' to serve in one
capacity or the other for a particular disciplinary matter.
---------------------------------------------------------------------------
\405\ Section 40.9(c)(3)(ii), as proposed in the separate
release titled ``Requirements for Derivatives Clearing
Organizations, Designated Contract Markets, and Swap Execution
Facilities Regarding the Mitigation of Conflicts of Interest'',
provided that ``Each Disciplinary Panel shall include at least one
person who would not be disqualified from serving as a Public
Director by regulation 1.3(ccc)(1)(i)-(vi) and (2) of this chapter
(a ``Public Participant''). Such Public Participant shall chair each
Disciplinary Panel. In addition, any registered entity specified in
paragraph (c)(3)(i) of this section shall adopt rules that would, at
a minimum: (A) Further preclude any group or class of participants
from dominating or exercising disproportionate influence on a
Disciplinary Panel and (B) Prohibit any member of a Disciplinary
Panel from participating in deliberations or voting on any matter in
which the member has a financial interest.'' See 75 FR 63732, Oct.
18, 2010.
---------------------------------------------------------------------------
Summary of Comments
A number of commenters opposed the two-panel approach described in
proposed Sec. 38.702. CME stated that the Commission should rely on
core principles, rather than what it sees as a prescriptive approach,
as DCMs may have an established structure or may develop new structures
that clearly satisfy the objective of the core principle, but that may
not precisely comply with the language.\406\ CME illustrated two
practices it believed may be precluded by the text of proposed Sec.
38.702: (1) CME's Market Regulation staff determines whether certain
non-egregious rule violations merit referral to a Review Panel and they
issue warning letters on an administrative basis; and (2) CME's hearing
panel adjudicates a disciplinary case prior to the issuance of charges
pursuant to a supported settlement agreement.\407\
---------------------------------------------------------------------------
\406\ CME Comment Letter at 35 (Feb. 22, 2011).
\407\ Id.
---------------------------------------------------------------------------
ELX contended that the proposed rule would impose the need to
create processes and procedures for certain functions already carried
out by its Compliance Director, who is supervised by the Regulatory
Oversight Committee.\408\ ELX suggested that a DCM should be able to
obtain a waiver from the two-panel requirement if it already has been
designated as a contract market and currently operates under an
alternative structure with respect to disciplinary procedures that have
sufficient controls.\409\
---------------------------------------------------------------------------
\408\ ELX Comment letter at 5 (Feb. 22, 2011).
\409\ Id.
---------------------------------------------------------------------------
MGEX argued that the rule is overly prescriptive, that there is no
reasonable basis for the distinction between the two panels, and that
one panel would maximize resources and streamline the process for all
involved.\410\ MGEX argued that staff is able to differentiate between
the roles, and that the Commission should simply have the right to
inquire if it has a question surrounding disciplinary panels or
processes.\411\
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\410\ MGEX Comment Letter at 9 (Feb. 22, 2011).
\411\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting the proposed rule with certain
modifications to address comments. The Commission considered
commenters' views and believes that the proposed rule can be modified
to address concerns without diminishing the purpose of the proposed
rule. Accordingly, the final rule will require DCMs to have one or more
disciplinary panels, without imposing a specific requirement for DCMs
to maintain a ``review panel'' and a ``hearing panel.'' The final rules
replace specific panel names (i.e. ``review panel'' and ``hearing
panel'') with a generic reference to the ``disciplinary panel''
throughout part 38. However, even under a single-panel approach,
individuals who determine to issue charges in a particular disciplinary
matter may not also adjudicate the matter. The final text of Sec.
38.702 permits flexibility in the structure of DCMs' disciplinary
bodies, but not in the basic prohibition against vesting the same
individuals with the authority to both issue and adjudicate charges in
the same matter. The modifications reflected in the final text of Sec.
38.702, together with the revisions made to the final text of Sec.
38.703, permit DCMs to rely on their senior-most compliance officer
(i.e., a DCM's Chief Regulatory Officer), rather than on a disciplinary
panel, to issue disciplinary charges, as suggested by ELX. However, the
Commission notes that the adjudication of charges must still be
performed by a disciplinary panel. Finally, the composition and
conflicts requirements for disciplinary panels will be adopted with one
modification, by replacing the reference to Sec. 40.9(c)(3)(ii) with a
reference to the more general ``part 40.''
iii. Sec. 38.703--Review of Investigation Report
The introductory paragraph of proposed Sec. 38.703 required a
Review Panel to promptly review an investigation report received
pursuant to proposed Sec. 38.158(c), and to take action on any
investigation report received within 30 days of such receipt. Under
paragraph (a) of the proposed rule, after receipt of the investigation
report, if a Review Panel determined that additional investigation or
evidence was needed, it would be required to promptly direct the
compliance staff to conduct further investigation. In the alternative,
under paragraph (b) of the proposed rule, if a Review Panel determined
that no reasonable basis existed for finding a violation, or that
prosecution was unwarranted, it would be permitted to direct that no
further action be taken, and that a written statement be provided
setting forth the facts and analysis supporting the decision.
Finally, under paragraph (c) of the proposed rule, if a Review
Panel determined that a reasonable basis existed for finding a
violation and adjudication was warranted, it was required to direct
that the person or entity alleged to have committed the violation be
served with a notice of charges.
Summary of Comments
While CME agreed that an investigation report should include the
subject's disciplinary history, CME disagreed with the requirement in
proposed Sec. 38.158 that the disciplinary history be included in the
version of the investigation report sent to the Review Panel.\412\ CME
believed that the disciplinary history should not be considered by the
Review Panel at all when determining whether to issue formal charges,
arguing that a market participant's disciplinary history is not
relevant to the consideration of whether it committed a further
violation of DCM rules.\413\
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\412\ CME Comment Letter at 35 (Feb. 22, 2011).
\413\ Id. While the Commission largely agrees with CME's
comment, the Commission directs interested parties to regulation
38.158 for a further discussion of the required components of
investigation reports.
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Discussion
Consistent with revisions to proposed Sec. 38.702, the Commission
is modifying proposed Sec. 38.703 to provide greater flexibility to
market participants in determining an approach to disciplinary panels.
The Commission is eliminating
[[Page 36652]]
all but paragraph (c) of the proposed rule, and is moving paragraph (c)
to Sec. 38.704 (Notice of charges), which the Commission is
renumbering as Sec. 38.703. The revisions to proposed rules Sec.
38.702 and Sec. 38.703 will provide DCMs with the flexibility to
follow a single-panel approach, provided that a single panel does not
perform the function of issuing and adjudicating the same charges. In
addition, a DCM will have the flexibility to allow its senior-most
regulatory officer, such as its Chief Regulatory Officer, to review an
investigation report and determine whether a notice of charges should
be issued in a particular matter.
iv. Sec. 38.704--Notice of Charges
Proposed Sec. 38.704 described the minimally acceptable contents
of a notice of charges (``notice'') issued by a Review Panel. The rule
required that the notice adequately state the acts, conduct, or
practices in which the respondent is alleged to have engaged; state the
rule, or rules, alleged to have been violated; and prescribe the period
within which a hearing on the charges may be requested. Further, the
proposed rule also required that the notice advise the respondent
charged that he is entitled, upon request, to a hearing on the charges.
Paragraphs (a) and (b) of the proposed rule provided that a DCM may
adopt rules providing that: (1) The failure to request a hearing within
the time prescribed in the notice, except for good cause, may be deemed
a waiver of the right to a hearing; and (2) the failure to answer or
expressly deny a charge may be deemed to be an admission of such
charge.
Discussion
No comments were received regarding proposed Sec. 38.704, and the
Commission is adopting the proposed rule with certain modifications.
Given that paragraphs (a) and (b) of proposed Sec. 38.704 allowed,
but did not require, a DCM to issue rules regarding failures to request
a hearing and expressly answer or deny a charge, the Commission
believes that the language in these paragraphs is better suited as
guidance rather than a rule. The Commission will adopt this language as
guidance in appendix B to part 38.
In addition to the aforementioned revisions, and as described
above, the Commission is moving paragraph (c) of proposed Sec. 38.703
to proposed Sec. 38.704, and is renumbering proposed Sec. 38.704 as
Sec. 38.703.
v. Sec. 38.705--Right to Representation
Proposed Sec. 38.705 required that, upon being served with a
notice of charges, a respondent must have the right to be represented
by counsel or any other representative of his or her choosing in all
succeeding stages of the disciplinary process. Together with proposed
Sec. Sec. 38.704 (requiring an adequate notice of charges to the
respondent), 38.708 (conferring the right to hearing), and 38.710
(hearing procedures), Sec. 38.705 helped ensure basic fairness for
respondents in disciplinary proceedings.
Summary of Comments
CME commented that the language of this rule should be limited to
avoid conflicts in representation and, accordingly, requested that the
rule be revised to clarify that a respondent may not be represented by:
(1) A member of the DCM's disciplinary committees; (2) a member of the
DCM's Board of Directors; (3) an employee of the DCM; and (4) a person
substantially related to the underlying investigation, such as a
material witness or other respondent.\414\
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\414\ CME Comment Letter at 35 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission is adopting the proposed rule with certain
modifications. The Commission acknowledges CME's concern and is
amending the proposed rule to incorporate CME's suggestion to clarify
that a respondent must have the right to be represented by legal
counsel or any other representative of its choosing in all succeeding
stages of the disciplinary process, except any member of the designated
contract market's board of directors or disciplinary panel, any
employee of the designated contract market, or any person substantially
related to the underlying investigations, such as material witness or
respondent. Additionally, as a result of the rule deletions and
modifications discussed above, proposed Sec. 38.705 as modified is
being adopted as Sec. 38.704.
vi. Sec. 38.706--Answer to Charges
Proposed Sec. 38.706 provided that a respondent must be given a
reasonable period of time to file an answer to a charge. In general,
paragraphs (a) through (c) of the proposed rule provided that the rules
of the DCM may require that: (1) The answer must be in writing and
include a statement that the respondent admits, denies or does not have
and is unable to obtain sufficient information to admit or deny each
allegation; (2) failure to file an answer on a timely basis shall be
deemed an admission of all allegations in the notice of charges; and
(3) failure in an answer to deny expressly a charge shall be deemed to
be an admission of such charge.
Discussion
Although no specific comments were received on proposed Sec.
38.706, commenters generally requested greater flexibility to establish
their own disciplinary procedures.\415\ The Commission believes that
proposed Sec. 38.706 is a rule where greater flexibility can
reasonably be accorded. Accordingly, the Commission is maintaining as a
rule the requirement that a respondent must be given a reasonable
period of time to file an answer to a notice of charges, and is
condensing the remainder of the proposed rule by replacing
subparagraphs (a), (b), and (c) with a requirement that any rules
adopted by a DCM governing the requirements and timeliness of a
respondent's answer to charges must be ``fair, equitable, and publicly
available.'' Finally, as a result of the rule deletions and
modifications discussed above, proposed Sec. 38.706 as modified is
being adopted as Sec. 38.705.
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\415\ See generally, CME Comment Letter (Feb. 22, 2011); and
MGEX Comment Letter (Feb. 22, 2011).
---------------------------------------------------------------------------
vii. Sec. 38.707--Admission or Failure To Deny Charges
Proposed Sec. 38.707 provided that, if a respondent admits or
fails to deny any of the violations alleged in a notice of charges,
then a hearing panel may find that the violations admitted or not
denied have in fact been committed. If a DCM adopted a rule concerning
the admission or failure to deny charges, then paragraphs (a) through
(c) of the proposed rule provided that: (1) The hearing panel must
impose a sanction for each violation found to have been committed; (2)
the DCM must promptly notify the respondent in writing of any sanction
to be imposed and advise the respondent that they may request a hearing
on such sanction within the period of time stated in the notice; and
(3) the rules of the DCM may provide that if the respondent fails to
request a hearing within the period of time stated in the notice, then
the respondent will be deemed to have accepted the sanction.
Discussion
Although the Commission did not receive specific comments
pertaining to the proposed rule, the Commission is moving the entire
rule, with certain modifications, to the guidance in appendix B. Given
that proposed Sec. 38.707 allowed, but did not require, a DCM to issue
rules regarding a respondent's admission or failure to
[[Page 36653]]
deny charges, the Commission believes that the proposed rule is better
suited as guidance in appendix B to part 38 rather than a rule. The
Commission believes adopting the proposed rule as guidance, rather than
a rule, will grant DCMs greater flexibility in administering their
obligations, consistent with the general comments seeking the same.
Furthermore, the text that will now be included as guidance is being
modified to reflect the single-panel approach adopted in Sec. 38.702,
replacing specific panel names with a generic reference to the
``disciplinary panel.''
viii. Sec. 38.708--Denial of Charges and Right to Hearing
Proposed Sec. 38.708 provided that in every instance where a
respondent has requested a hearing on a charge that he or she denies,
or on a sanction set by the hearing panel pursuant to proposed Sec.
38.707, the respondent must be given the opportunity for a hearing in
accordance with the requirements of proposed Sec. 38.710. The DCM's
rules were permitted to provide that, except for good cause, the
hearing must be concerned only with those charges denied or sanctions
set by the hearing panel under proposed Sec. 38.707 for which a
hearing has been requested.
Discussion
The Commission did not receive comments pertaining to this rule,
but is adopting the proposed rule with modifications.
The Commission is revising the proposed rule to reflect the single-
panel approach adopted in Sec. 38.702, replacing specific panel names
with a generic reference to the ``disciplinary panel.'' In order to
provide DCMs with greater flexibility in establishing disciplinary
procedures, the Commission also is removing the section of the proposed
rule which was optional--allowing a DCM's rules to provide that, except
for good cause, a hearing must be concerned only with those charges
denied or sanctions set by the panel for which a hearing has been
requested. Finally, as a result of the withdrawal of certain preceding
rules discussed above, proposed Sec. 38.708 as modified is being
adopted as Sec. 38.706.
ix. Sec. 38.709--Settlement Offers
Proposed Sec. 38.709 provided the procedures a DCM must follow if
it permits the use of settlements to resolve disciplinary cases.
Paragraph (a) of the proposed rule stated that the rules of a DCM may
permit a respondent to submit a written offer of settlement any time
after an investigation report is completed. The proposed rule permitted
the disciplinary panel presiding over the matter to accept the offer of
settlement, but prohibited the panel from altering the terms of the
offer unless the respondent agreed. In addition, paragraph (b) of the
proposed rule provided that the rules of the DCM may allow a
disciplinary panel to permit the respondent to accept a sanction
without admitting or denying the rule violations upon which the
sanction is based.
Paragraph (c) of proposed Sec. 38.709 stated that a disciplinary
panel accepting a settlement offer must issue a written decision
specifying the rule violations it has reason to believe were committed,
and any sanction imposed, including any order of restitution where
customer harm has been demonstrated. Importantly, paragraph (c) also
provided that if an offer of settlement is accepted without the
agreement of a DCM's enforcement staff, the decision must carefully
explain the disciplinary panel's acceptance of the settlement. Finally,
paragraph (d) of proposed Sec. 38.709 allowed a respondent to withdraw
his or her offer of settlement at any time before final acceptance by a
disciplinary panel. If an offer is withdrawn after submission, or is
rejected by a disciplinary panel, the respondent must not be deemed to
have made any admissions by reason of the offer of settlement and must
not be otherwise prejudiced by having submitted the offer of
settlement.
Discussion
Although no specific comments were received in regards to this
proposed rule, the Commission is adopting the provisions of the
proposed rule as guidance in appendix B. The Commission believes that
adopting the proposed rule as guidance rather than a rule will grant
DCMs greater flexibility in administering their obligations, consistent
with the general comments seeking the same. Furthermore, the Commission
is revising the guidance text to make it consistent with its
modifications regarding the single-panel approach adopted in Sec.
38.702 and the customer restitution revisions adopted below with
respect to proposed Sec. 38.714.
x. Sec. 38.710--Hearings
Proposed Sec. 38.710 required a DCM to adopt rules that provide
certain minimum requirements for any hearing conducted pursuant to a
notice of charges. In general, sections (a)(1) through (a)(7) of the
proposed rule required the following: (1) A fair hearing; (2) authority
for a respondent to examine evidence relied on by enforcement staff in
presenting the charges contained in the notice of charges; (3) the
DCM's enforcement and compliance staffs must be parties to the hearing
and the enforcement staff must present its case on those charges and
sanctions that are the subject of the hearing; (4) the respondent must
be entitled to appear personally at the hearing, have the authority to
cross-examine persons appearing as witnesses at the hearing, and call
witnesses and present evidence as may be relevant to the charges; (5)
the DCM must require persons within its jurisdiction who are called as
witnesses to participate in the hearing and produce evidence; (6) a
copy of the hearing must be made and become a record of the proceeding
if the respondent has requested a hearing; and (7) the rules of the DCM
may provide that the cost of transcribing the record must be borne by a
respondent who requests a transcript. Additionally, proposed paragraph
(b) specified that the rules of the DCM may provide that a sanction be
summarily imposed upon any person within its jurisdiction whose actions
impede the progress of a hearing.
Summary of Comments
Two commenters requested that the Commission revise proposed Sec.
38.710(a)(2). CFE commented that proposed Sec. 38.710(a)(2) should
limit a respondent's access only to evidence a DCM plans to introduce
at a hearing.\416\ CFE further requested the exclusion of evidence
covered under attorney-client privilege, attorney work product
privilege, or other confidential reports and methodologies, including
the disclosure of the name of a confidential complainant.\417\ CFE also
argued that investigation and examination materials prepared by a DCM
should be protected from disclosure as internal work product unless the
DCM intends to introduce them at the hearing.\418\
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\416\ CFE Comment Letter at 5 (Feb. 22, 2011).
\417\ Id.
\418\ Id.
---------------------------------------------------------------------------
CME similarly argued that proposed Sec. 38.710(a)(2) should be
revised so that a respondent may not access protected attorney work
product, attorney-client communications, and investigative work product
(such as investigation and exception reports).\419\
---------------------------------------------------------------------------
\419\ CME Comment Letter at 36 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission is adopting paragraph (a) of the proposed rule with
certain modifications, and is converting paragraph (b) of the proposed
rule to guidance in appendix B.
[[Page 36654]]
The Commission has considered CFE and CME's comments, and believes
that a DCM should be permitted to withhold certain documents from a
respondent in certain circumstances, and thus, is revising proposed
Sec. 38.710(a)(2) (now Sec. 38.707(a)(2)) accordingly. Because
proposed Sec. 38.710(b) (which provided that the DCMs' rules may
provide that a sanction may be summarily imposed upon any person whose
actions impede the progress of a hearing) was an optional requirement
for DCMs, the Commission is adopting this language as guidance in
appendix B to part 38. Furthermore, the Commission is eliminating
proposed Sec. 38.710(a)(7), an optional rule that in certain cases
allowed for the cost of transcribing the record of the hearing to be
borne by the respondent. The Commission also is revising the rule text
to make it consistent with its modifications regarding the single-panel
approach adopted in Sec. 38.702 and its modifications to proposed
Sec. 38.712 discussed below. Finally, as a result of the withdrawal
and renumbering of the rules discussed above, proposed Sec. 38.710 as
modified is being adopted as Sec. 38.707.
xi. Sec. 38.711--Decisions
Proposed Sec. 38.711 detailed the procedures that a hearing panel
must follow in rendering disciplinary decisions. The proposed rule
required that all decisions include: (1) A notice of charges or a
summary of the charges; (2) the answer, if any, or a summary of the
answer; (3) a summary of the evidence produced at the hearing or, where
appropriate, incorporation by reference in the investigation report;
(4) a statement of findings and conclusions with respect to each
charge, and a careful explanation of the evidentiary and other basis
for such findings and conclusions with respect to each charge; (5) an
indication of each specific rule with which the respondent was found to
have violated; and (6) a declaration of any penalty imposed against the
respondent, including the basis for such sanctions and the effective
date of such sanctions.
Discussion
No comments were received on proposed Sec. 38.711. The Commission
is adopting Sec. 38.711 as proposed with minor modifications to
reflect the single-panel approach adopted in Sec. 38.702, and
replacing specific panel names with a generic reference to the
``disciplinary panel.'' In addition, as a result of the withdrawal and
renumbering of preceding rules discussed above, proposed Sec. 38.711
as modified is being adopted as Sec. 38.708.
xii. Sec. 38.712--Right To Appeal
Proposed Sec. 38.712 provided the procedures that a DCM must
follow in the event that the DCM's rules authorize an appeal of adverse
decisions in all or in certain classes of cases. Notably, the proposed
rule required a DCM that permits appeals by disciplinary respondents to
also permit appeals by its enforcement staff. For DCMs that permit
appeals, the language in paragraphs (a) through (d) of proposed Sec.
38.712 generally required the DCM to: (1) Establish an appellate panel
that is authorized to hear appeals; (2) ensure that the appellate panel
composition is consistent with Sec. 40.9(c)(iv) of the Commission's
regulations and does not include any members of the DCM's compliance
staff, or any person involved in adjudicating any other stage of the
same proceeding; (3) except for good cause shown, conduct the appeal or
review solely on the record before the hearing panel, the written
exceptions filed by the parties, and the oral or written arguments of
the parties; and (4) issue a written decision of the appellate panel
and provide a copy to the respondent promptly following the appeal or
review proceeding.
Discussion
Although no specific comments were received on proposed Sec.
38.712, the Commission is converting the proposed rule to guidance in
appendix B. Given that proposed Sec. 38.712 allowed, but did not
require, a DCM to issue rules regarding a respondent's right to appeal,
the Commission is moving this provision to guidance in appendix B to
part 38. The Commission believes that adopting the proposed rule as
guidance rather than a rule, will grant DCMs greater flexibility in
administering their obligations, consistent with the general comments
seeking the same.
The Commission notes that the reference to Sec. 40.9(c)(iv) in the
proposed rule was a technical error. Instead, proposed Sec. 38.712
should have referenced the composition requirements of an appellate
panel outlined in Sec. 40.9(c)(3)(iii). Accordingly, the Commission is
replacing the reference to Sec. 40.9(c)(iv) with a reference to the
more general ``part 40'' in the guidance text. Furthermore, the
Commission is revising the guidance text to reflect the single-panel
approach now adopted in Sec. 38.702, replacing specific panel names
with a generic reference to the ``disciplinary panel.''
xiii. Sec. 38.713--Final Decisions
Proposed Sec. 38.713 required that each DCM establish rules
setting forth when a decision rendered under this subpart N will become
the final decision of the DCM.
Discussion
No comments were received in regards to the proposed rule, and the
Commission is adopting the proposal without modification. However, as a
result of the renumbering of certain preceding rules discussed above,
proposed Sec. 38.713 is being adopted as Sec. 38.709.
xiv. Sec. 38.714--Disciplinary Sanctions
Proposed Sec. 38.714 required that every disciplinary sanction
imposed by a DCM must be commensurate with the violations committed and
must be clearly sufficient to deter recidivism or similar violations by
other market participants. Additionally, the proposed rule required
that, in the event of demonstrated customer harm, any disciplinary
sanction must include full customer restitution. In evaluating
appropriate sanctions, the proposed rule required the DCM to take into
account a respondent's disciplinary history.\420\
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\420\ Proposed regulation 38.158(c), which was proposed with
respect to Core Principle 2, required that a copy of a member or
market participant's disciplinary history be included in the
compliance staff's investigation report.
---------------------------------------------------------------------------
Summary of Comments
CFE supported the goal articulated in proposed Sec. 38.714, but
argued that in certain situations, the requirement for customer
restitution should not apply where it may not be possible for a DCM to
determine the amount of customer harm, which parties may have been
harmed, and/or how the harm was allocated among potentially aggrieved
parties.\421\ CFE requested that the Commission clarify that the
requirement to include customer restitution in a disciplinary sanction
does not apply to the extent that a DCM is unable to determine with
reasonable certainty what the restitution should be, to whom to provide
restitution, and/or how to allocate restitution.\422\
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\421\ CFE Comment Letter at 6 (Feb. 22, 2011).
\422\ Id.
---------------------------------------------------------------------------
Chris Barnard argued that sanctions should include a public
reprimand and/or be published.\423\
---------------------------------------------------------------------------
\423\ Barnard Comment Letter at 2, 4 (May 20, 2011) (Barnard
stated that under a properly functioning sanctions regime, sanctions
must be: (1) Significantly greater than potential benefits derived
from a breach of rules; (2) targeted at those parties who stand to
gain from a breach of rules, whether natural or legal persons; and
(3) include a public reprimand and/or be published).
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[[Page 36655]]
Discussion
The Commission is adopting the proposed rule with certain
modifications. The Commission has considered CFE's comment, and is
revising the proposed rule so that it does not require customer
restitution if the amount of restitution, or the recipient, cannot be
reasonably determined. Furthermore, the Commission is revising the
proposed rule to clarify that a respondent's disciplinary history
should be taken into account in all sanction determinations, including
sanctions imposed pursuant to an accepted settlement offer. The
Commission also notes that final disciplinary actions taken against
registered persons and entities are recorded in the National Futures
Association's Background Affiliation Status Information Center
(``BASIC'') database, which is available to the public online. Finally,
as a result of the renumbering of preceding rules discussed above, the
Commission is renumbering the proposed rule as Sec. 38.710.
xv. Sec. 38.715--Summary Fines for Violations of Rules Regarding
Timely Submission of Records, Decorum, or Other Similar Activities
Proposed Sec. 38.715 permitted a DCM to adopt a summary fine
schedule for violations of rules relating to timely submission of
accurate records required for clearing or verifying each day's
transactions, decorum, attire, or other similar activities. Under the
proposed rule, a DCM may authorize its compliance staff to summarily
impose minor sanctions against persons within the DCM's jurisdiction
for violating such rules. The proposed rule made clear that a DCM
should issue no more than one warning letter in a rolling 12-month
period for the same violation before sanctions are imposed.
Additionally, the proposed rule specified that a summary fine schedule
must provide for progressively larger fines for recurring violations.
Summary of Comments
CME objected to the restriction of one letter of warning per
rolling 12-month period.\424\
---------------------------------------------------------------------------
\424\ CME Comment Letter at 36 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission is partially adopting the proposed rule, and is
converting the remaining portion of the rule to guidance in appendix B.
The Commission is maintaining as a rule the provision in the
proposed rule that prohibits a DCM from issuing more than one warning
letter per rolling 12-month period for the same violation. Commission
staff has consistently recommended in RERs that DCMs must engage in
progressive discipline in order to deter recidivism.
The Commission is converting the remainder of proposed Sec. 38.715
to guidance in appendix B because the proposed rule allowed, but did
not require, a DCM to adopt a summary fine schedule.
Finally, the proposed rule is being renumbered in its adopted form
from Sec. 38.715 to Sec. 38.711, and is retitled as ``Warning
letters.''
xvi. Sec. 38.716--Emergency Disciplinary Actions
Proposed Sec. 38.716 provided that a DCM may impose a sanction,
including a suspension, or take other summary action against a person
or entity subject to its jurisdiction upon a reasonable belief that
such immediate action is necessary to protect the best interest of the
marketplace. The proposed rule also provided that any emergency action
taken by the DCM must be in accordance with certain procedural
safeguards that protect the respondent, including the right to be
served with notice before the action is taken or otherwise at the
earliest possible opportunity after action has been taken; the right to
be represented by legal counsel in any proceeding subsequent to the
emergency disciplinary action; the right to a hearing as soon as
reasonably practical; and the right to receive a written decision on
the summary action taken by the DCM.
Discussion
No comments were received on proposed Sec. 38.716. Given that
proposed Sec. 38.716 allowed, but did not require, a DCM to adopt
rules regarding emergency disciplinary actions, the Commission is
moving the text of proposed Sec. 38.716 to guidance in appendix B to
part 38.
Due to the renumbering described above, the Commission is also
replacing proposed Sec. 38.712 with new Sec. 38.712 (titled
``Additional sources for compliance'') that simply permits DCMs to rely
upon the guidance in appendix B of this part to demonstrate to the
Commission compliance with the requirements of Sec. 38.700 of this
part.
14. Subpart O--Dispute Resolution
The Dodd-Frank Act re-designated former Core Principle 13 as Core
Principle 14. Aside from renumbering the core principle, the language
of the core principle remained substantively unchanged. The core
principle governs the obligations of DCMs to implement and enforce a
dispute resolution program for their market participants and market
intermediaries.\425\
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\425\ 17 CFR part 38, app. B.
---------------------------------------------------------------------------
In addition to proposing to codify the statutory text of the core
principle in proposed Sec. 38.750, the Commission proposed to maintain
the guidance and acceptable practices.
Discussion
No comments were received on proposed Sec. 38.750, Sec. 38.751,
or the proposed guidance under Core Principle 14. The Commission is
adopting the rules and guidance as proposed.
15. Subpart P--Governance Fitness Standards
Other than to re-designate former Core Principle 14 as Core
Principle 15, the Dodd-Frank Act did not revise the text of this core
principle. Core Principle 15 requires DCMs to establish and enforce
appropriate fitness standards for directors, members of any
disciplinary committee, members of the contract market, and any other
persons with direct access to the facility (including any parties
affiliated with any of the persons described in this core principle).
In the DCM NPRM, the Commission proposed to codify the statutory text
of the core principle in Sec. 38.800. The Commission did not receive
comments pertaining to proposed Sec. 38.800, and is adopting the rule
as proposed.
As noted in the DCM NPRM, the substantive regulations implementing
Core Principle 15 were proposed in a separate rulemaking that also
would implement Core Principles 16 (Conflicts of Interest), 17
(Composition of Governing Boards of Contract Markets) and 22 (Diversity
of Boards of Directors).\426\ Until such time as the Commission may
adopt the substantive rules implementing Core Principle 15, the
Commission is maintaining the current Guidance under part 38 applicable
to Governance Fitness Standards (formerly Core Principle 14).
Accordingly, the existing Guidance from appendix B of Part 38
applicable to Core Principle 15 is being codified under the revised
appendix B adopted in this final rulemaking.\427\ At such time as the
[[Page 36656]]
Commission may adopt the final rules implementing Core Principle 15,
appendix B will be amended accordingly.
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\426\ See ``Governance Requirements for Derivatives Clearing
Organizations, Designated Contract Markets, and Swap Execution
Facilities; Additional Requirements Regarding the Mitigation of
Conflicts of Interest,'' Notice of Proposed Rulemaking, 76 FR 722,
January 6, 2011. CME submitted a comment letter discussing proposed
regulation 38.801 in connection with 76 FR 722.
\427\ The Commission is also adding regulation 38.801 to simply
permit DCMs to continue to rely upon the guidance in appendix B to
demonstrate to the Commission compliance with regulation 38.800.
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CME submitted a comment letter discussing proposed Sec. 38.801 in
connection with the separate proposed rulemaking implementing Core
Principle 15. CME's comments will be considered in connection with that
rulemaking.
16. Subpart Q--Conflicts of Interest
The Dodd-Frank Act re-designated current Core Principle 15
(Conflicts of Interest) as Core Principle 16, and in all other
respects, did not substantively amend the core principle. The
Commission proposed to codify the statutory text of the core principle
in proposed Sec. 38.850, and is codifying the statutory text of Core
Principle 16 in Sec. 38.850 as proposed.
As noted in the DCM NPRM, the substantive regulations implementing
Core Principle 16 were proposed in two separate rulemakings that also
would implement Core Principles 15 (Governance Fitness Standards), 17
(Composition of Governing Boards of Contract Markets) and 22 (Diversity
of Boards of Directors).\428\ Until such time as the Commission may
adopt the substantive rules implementing Core Principle 16, the
Commission is maintaining the current guidance and acceptable practices
under Part 38 applicable to Conflicts of Interest (formerly Core
Principle 15). Accordingly, the existing Guidance and Acceptable
Practices from appendix B of part 38 applicable to Core Principle 16
are being codified in the revised appendix B adopted in this final
rulemaking.\429\ At such time as the Commission may adopt the final
rules implementing Core Principle 16, appendix B will be amended
accordingly.
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\428\ See ``Governance Requirements for Derivatives Clearing
Organizations, Designated Contract Markets, and Swap Execution
Facilities; Additional Requirements Regarding the Mitigation of
Conflicts of Interest,'' Notice of Proposed Rulemaking, 76 FR 722,
January 6, 2011; and ``Requirements for Derivatives Clearing
Organizations, Designated Contract Markets, and Swap Execution
Facilities Regarding the Mitigation of Conflicts of Interest,'' 75
FR 63732, Oct. 18, 2010.
\429\ The Commission is also adding regulation 38.851 to simply
permit DCMs to continue to rely upon the guidance in appendix B to
demonstrate to the Commission compliance with section 38.850.
---------------------------------------------------------------------------
CME submitted a comment letter that referenced comments it
submitted in connection with the separate rulemakings implementing Core
Principle 16. CME's comments will be considered in connection with
those rulemakings.
17. Subpart R--Composition of Governing Boards of Contract Markets
The Dodd-Frank Act re-designated former Core Principle 16
(Composition of Governing Boards of Mutually Owned Contract Markets) as
Core Principle 17, and revised the title of the core principle to
``Composition of Governing Boards of Contract Markets.'' In addition,
while the core principle formerly applied only to mutually owned DCMs,
and required such DCMs to ensure that the composition of their
governing boards included market participants, the amended core
principle was amended to require the governance arrangements of all DCM
to be designed to permit the consideration of the views of market
participants.\430\ The Commission proposed to codify the statutory text
of the core principle in proposed Sec. 38.900, and is adopting the
rule as proposed.
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\430\ 7 U.S.C. 7(d)(17).
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As noted in the DCM NPRM, the substantive regulations implementing
Core Principle 17 were proposed in a separate rulemaking that also
would implement Core Principles 15 (Governance Fitness Standards), 16
(Conflicts of Interest), and 22 (Diversity of Boards of
Directors).\431\ The rules implementing Core Principle 17 will be
adopted in that separate rulemaking.
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\431\ See ``Governance Requirements for Derivatives Clearing
Organizations, Designated Contract Markets, and Swap Execution
Facilities; Additional Requirements Regarding the Mitigation of
Conflicts of Interest,'' Notice of Proposed Rulemaking, 76 FR 722,
January 6, 2011. CME submitted a comment letter discussing proposed
regulation 38.801 in connection with 76 FR 722.
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18. Subpart S--Recordkeeping
Core Principle 18, as amended by section 735 of the Dodd-Frank Act,
requires all DCMs to maintain records of all activities related to
their business as contract markets, in a form and manner acceptable to
the Commission, for at least five years.\432\
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\432\ See section 5(d)(18) of the CEA, 7 U.S.C. 7(d)(18).
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The Commission proposed to codify the statutory text of the core
principle in Sec. 38.950, and is adopting the rule as proposed.
i. Sec. 38.951--Additional Sources for Compliance
Proposed Sec. 38.951 required all DCMs to maintain records,
including trade records and investigatory and disciplinary files, in
accordance with Commission regulation Sec. 1.31, and in accordance
with proposed Commission regulation Sec. 45.1 with respect to swap
transactions.\433\ The proposed rule reiterated DCMs' obligation to
comply with Sec. 1.31(a), which requires that DCM books and records be
readily accessible for the first two years of the minimum five-year
statutory period, and be open to inspection by any representatives of
the Commission or the United States Department of Justice.\434\ Section
1.31(a) also requires DCMs to promptly provide either copies or
original books and records upon request of a Commission
representative.\435\ As noted in the preamble, the proposed rule also
incorporated by reference Sec. 1.31(b)'s description of the acceptable
methods of storing books and records.\436\ Finally, proposed Sec.
38.951 also incorporated by reference the requirements set forth in
Sec. 1.31(c) regarding electronic storage systems, and the
requirements in Sec. 1.31(d) regarding retention of trading cards and
of other trade, order, and financial reports.\437\ Separately, proposed
Sec. 38.951 also required DCMs to comply with the recordkeeping
requirements in Sec. 45.1 with respect to swaps transactions.\438\
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\433\ See DCM NPRM at 80622.
\434\ Id.
\435\ Id.
\436\ Id. at 80601.
\437\ Id. at 80622.
\438\ See proposed regulation 38.951. At the time of the DCM
NPRM, the part 45 rules were proposed. See 75 FR 80622, Dec. 22,
2010. The part 45 rules were recently codified. See 77 FR 2136, Jan.
13, 2012.
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Summary of Comments
MGEX argued that the proposed rule is too prescriptive in requiring
that all records and data must be indexed and duplicated.\439\ MGEX
also commented that the requirement to retain records for ``at least 5
years'' created uncertainty and requested clarification on how long
records must be kept.\440\ MGEX questioned the rationale for obligating
DCMs to keep Commission-required data separate from other data.\441\
Further, MGEX stated that ``DCMs should not be substitute storage
facilities for Commission data, nor should they be required to relocate
and resubmit data that has already been submitted to the Commission.''
\442\ Chris Barnard recommended that records should be required to be
kept indefinitely rather than for at least five years.\443\
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\439\ MGEX Comment Letters at 9 (Feb. 22, 2011) and at 3 (June
3, 2011).
\440\ Id. (requesting a limit on the length of time a DCM should
be required to hold data).
\441\ Id.
\442\ Id.
\443\ Barnard Comment Letter at 4 (Feb. 22, 2011).
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[[Page 36657]]
Discussion
The Commission is adopting the proposed rules under Core Principle
18 with the modification described below.
The Commission acknowledges MGEX's comment but notes that Sec.
38.951 incorporates recordkeeping requirements to which DCMs are
already subject by direct operation of Sec. 1.31. Even if the
Commission were to amend Sec. 38.951 as requested, many of the
concerns expressed by MGEX would remain, including the obligation to
keep certain data separately. In this regard, the Commission notes that
the Acceptable Practices for former Core Principle 17 stated that Sec.
1.31 ``governs recordkeeping requirements under the Act.'' \444\ Upon
adopting Sec. Sec. 38.950 and 38.951, Sec. 1.31 will still govern
significant elements of recordkeeping under the Act. Accordingly, the
Commission is largely adopting Sec. 38.951 as proposed. The Commission
is making one modification to the proposed rule, however, by replacing
the reference to Sec. 45.1 with a reference to the more general ``part
45.''
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\444\ See 17 CFR part 38, app. B, Application Guidance and
Acceptable Practices for Core Principle 17.
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In response to MGEX's request for clarification regarding the
requirement to retain records for ``at least 5 years,'' the Commission
notes that the recordkeeping requirement for swaps is governed by rules
that were recently codified in part 45, which requires DCMs to maintain
all requisite records from the date of the creation of the swap through
the life of the swap and for a period of at least five years from the
final termination of the swap.\445\ With respect to all other records,
DCMs can satisfy their recordkeeping requirement pursuant to Sec.
38.950 by retaining such records for five years, unless the Commission
determines prior to the expiration of the five-year term that the
records must be retained for a longer period of time. The Commission
also notes that the ``at least 5 years'' obligation is required under
statute. Specifically, as noted in the preamble of the proposed rule,
one notable difference between the former Core Principle 18, and the
current amended version, is that while records were previously required
to be maintained ``for a period of 5 years,'' Core Principle 18 now
requires that records must be retained for ``at least 5 years.'' \446\
Accordingly, the proposed rule required a DCM maintain records of all
activities related to its business as a DCM in a form and manner
acceptable to the Commission for at least five years.\447\ Similarly,
in response to Chris Barnard's recommendation that the records be held
indefinitely, the Commission believes that the current statutory
requirement to maintain records for at least 5 years is sufficient at
this time, but notes that it may extend the time period if it
determines that an extended recordkeeping time is necessary.
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\445\ 77 FR 2136, Jan. 13, 2012.
\446\ See preamble to proposed regulation 38.950. 75 FR 80601,
Dec. 22, 2010.
\447\ See proposed regulation 38.950(a). 75 FR 80622, Dec. 22,
2010.
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19. Subpart T--Antitrust Considerations
The Dodd-Frank Act renumbered former Core Principle 18 as Core
Principle 19, and in all other respects, maintained the statutory text
of the core principle. As noted in the DCM NPRM, the Commission
believed that the existing guidance to this Core Principle remained
appropriate. Accordingly, other than to codify the statutory text of
Core Principle 19 into proposed Sec. 38.1000, the Commission did not
propose any amendments to the pre-existing guidance under part 38.
Proposed Sec. 38.1001 referred applicants and DCMs to the guidance
in appendix B to part 38 for purposes of demonstrating to the
Commission their compliance with the requirements of proposed Sec.
38.1000.
Discussion
No comments were received in regards to the proposed rule and
guidance, and the Commission is adopting the rule and guidance as
proposed.
20. Subpart U--System Safeguards
Core Principle 20 is a new core principle created by the Dodd-Frank
Act, and pertains to the establishment of system safeguards by all
DCMs. Core Principle 20 specifically requires DCMs to: (1) Establish
and maintain a program of risk oversight to identify and minimize
sources of operational risk through the development of appropriate
controls and procedures and the development of automated systems that
are reliable, secure, and have adequate scalable capacity; (2)
establish and maintain emergency procedures, backup facilities, and a
plan for disaster recovery that allow for the timely recovery and
resumption of operations and the fulfillment of the responsibilities
and obligations of the DCM; and (3) periodically conduct tests to
verify that backup resources are sufficient to ensure continued order
processing and trade matching, price reporting, market surveillance,
and maintenance of a comprehensive and accurate audit trail. The rules
proposed under subpart U implement these requirements. The Commission
proposed to codify the statutory text of the core principle in proposed
Sec. 38.1050, and adopts the rule as proposed.
i. Sec. 38.1051--General Requirements
The rules proposed under Sec. 38.1051 (a) and (b) would require a
DCM's program of risk analysis and oversight to address six categories
of risk analysis and oversight, including information security;
business continuity-disaster recovery (``BC-DR'') planning and
resources; capacity and performance planning; systems operations;
systems development and quality assurance; and physical security and
environmental controls.
The proposed rule in Sec. 38.1051(c) specifically would require
each DCM to maintain a BC-DR plan and BC-DR resources sufficient to
enable resumption of trading and of all of the responsibilities and
obligations of the DCM during the next business day following any
disruption of its operations, either through sufficient infrastructure
and personnel resources of its own or through sufficient contractual
arrangements with other DCMs or disaster recovery service providers.
The proposed rule also would require each DCM to notify Commission
staff of various system security-related events, including prompt
notice of all electronic trading halts and systems malfunctions in
Sec. 38.1051(e)(1), timely advance notice of all planned changes to
automated systems that may impact the reliability, security, or
adequate scalable capacity of such systems in Sec. 38.1051(f)(1), and
timely advance notice of all planned changes to programs of risk
analysis and oversight in Sec. 38.1051(f)(2). The proposed rule also
required DCMs to provide relevant documents to the Commission in Sec.
38.1051(g) and to conduct regular, periodic, objective testing and
review of its automated systems in Sec. 38.1051(h). Moreover, proposed
Sec. 38.1051(i) would require each DCM, to the extent practicable, to
coordinate its BC-DR plan with those of the members and market
participants upon whom it depends to provide liquidity, to initiate
coordinated testing of such plans, and to take into account in its own
BC-DR plan, the BC-DR plans of relevant telecommunications, power,
water, and other essential service providers.
Summary of Comments
CME commented that recovery time objectives (``RTOs'') in each
catastrophic
[[Page 36658]]
situation should consider the impact on all market participants and
independent technology services providers in the context of determining
a proper RTO.\448\ CME also objected to what it considers to be an
overly broad requirement in Sec. 38.1051(e)(1) to notify Commission
staff promptly of all electronic trading halts and systems
malfunctions.\449\ CME argued that required reporting should be limited
to any material system failures. Further, CME criticized Sec.
38.1051(f)(1), arguing that the mandate that DCMs provide the
Commission with timely advance notice of all planned changes to
automated systems that may impact the reliability, security, or
adequate scalable capacity of such systems is overly burdensome, and
not cost effective.\450\ Additionally, CME argued that the Sec.
38.1051(f)(2) requirement that DCMs provide timely advance notice of
all planned changes to their program of risk analysis and oversight is
too broad and generally unnecessary.\451\ Finally, CME noted that it
does not control, or generally have access to, the details of the
disaster recovery plans of its major vendors.\452\
---------------------------------------------------------------------------
\448\ CME Comment Letter at 36 (Feb. 22, 2011).
\449\ Id. at 37.
\450\ Id.
\451\ Id.
\452\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting the proposed rule, with the
modifications described below. As noted in the DCM NPRM, automated
systems play a central and critical role in today's electronic
financial market environment, and the oversight of core principle
compliance by DCMs with respect to automated systems is an essential
part of effective oversight of both futures and swaps markets. Advanced
computer systems are fundamental to a DCM's ability to meet its
obligations and responsibilities.\453\
---------------------------------------------------------------------------
\453\ See 75 CFR 80572, 80601-80602, Dec., 22, 2010.
---------------------------------------------------------------------------
The Commission has considered CME's comment, and believes that
timely advance notice of all planned changes to address system
malfunctions is not necessary and is revising the rule to provide that
DCMs only need to promptly advise the Commission of all significant
system malfunctions. With respect to planned changes to automated
systems or risk analysis and oversight programs, the revised rule will
require timely advance notification of material changes to automated
systems or risk analysis and oversight programs. Finally, the rule does
not require DCMs to control or have access to the details of the
disaster recovery plans of its major vendors. Rather, the rule suggests
coordination to the extent possible.
21. Subpart V--Financial Resources
New Core Principle 21 requires DCMs to have adequate financial
resources to discharge their responsibilities, and specifically
requires that DCMs maintain financial resources sufficient to cover
operating costs for a period of at least one year, calculated on a
rolling basis.
i. Sec. 38.1100--Core Principle 21, and Sec. 38.1101(a) and (c)
General Rule and Computation of Financial Resources Requirement
Proposed Sec. 38.1100 codifies the statutory text of the core
principle and is being adopted as proposed.
Proposed Sec. 38.1101(a)(1) and (3) required DCMs to maintain
sufficient financial resources to cover operating costs for at least
one year, calculated on a rolling basis, at all times. Proposed Sec.
38.1101(a)(2) would require any entity operating as both a DCM and a
DCO to comply with both the DCM financial resources requirements, and
also the DCO financial resources requirements in Sec. 39.11.\454\
Proposed Sec. 38.1101(c) required a DCM to make a reasonable
calculation of the financial resources it needs to meet the
requirements of proposed Sec. 38.1101(a) at the end of each fiscal
quarter.
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\454\ See 76 FR 69334, Nov. 8, 2011. Commission regulation 39.11
establishes requirements that a DCO will have to meet in order to
comply with DCO Core Principle B (Financial Resources), as amended
by the Dodd-Frank Act. Amended Core Principle B requires a DCO to
possess financial resources that, at a minimum, exceed the total
amount that would enable the DCO to meet its financial obligations
to its clearing members notwithstanding a default by the clearing
member creating the largest financial exposure for the DCO in
extreme but plausible conditions; and enable the DCO to cover its
operating costs for a period of 1 year, as calculated on a rolling
basis.
---------------------------------------------------------------------------
Summary of Comments
OCX requested that the Commission define whether ``operating
costs'' are gross or net.\455\ GreenX recommended that the Commission
expressly state that ``operating costs'' should be determined from a
cash flow statement perspective.\456\
---------------------------------------------------------------------------
\455\ OCX Comment Letter at 5 (Feb. 22, 2011).
\456\ GreenX Comment Letter at 19 (Feb. 22, 2011).
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Chris Barnard recommended that each DCM calculate and regularly
publish its solvency ratio, defined as the DCM's available financial
resources divided by the DCM's financial resources requirement.\457\
Chris Barnard stated that the Commission should be notified when this
ratio falls below 105 percent.\458\
---------------------------------------------------------------------------
\457\ Barnard Comment Letter at 5 (May 20, 2011).
\458\ Id.
---------------------------------------------------------------------------
KCBT stated that the proposed requirements would result in
duplication for entities that operate both a DCM and a DCO, because
proposed Sec. 39.11 imposed similar requirements on DCOs.\459\ KCBT
stated that its DCO was established as its wholly-owned subsidiary
corporation for purposes of limiting liability and that as a
``privately-owned, for-profit corporation, it should be able to
determine its own levels of capital resources and deployment.'' \460\
KCBT referenced this rationale in response to proposed Sec.
38.1101(a)(3), (b), (e), and (f).\461\
---------------------------------------------------------------------------
\459\ KCBT Comment Letter at 8 (Feb. 22, 2011).
\460\ Id.
\461\ Id.
---------------------------------------------------------------------------
Discussion
The Commission is adopting proposed Sec. 38.1101 (a) and (c) with
the modification described below. The Commission notes that
specifically defining ``operating costs'' could result in unintended
restrictions on DCMs. The Commission will maintain the flexibility of
the proposed rule by not further defining ``operating costs'' and
instead permitting each DCM to have reasonable discretion in
determining the methodology it will use to make the calculation. For
these reasons, the Commission also declines to incorporate a solvency
ratio requirement to the final rules.
Finally, the Commission has revised the text of Sec. 38.1101(a)(2)
(redesignated as paragraph (a)(3)) to clarify that a DCM that is also
registered with the Commission as a DCO must demonstrate that it has
sufficient resources to operate the combined entity as both a DCM and
DCO,\462\ and further, that such combined entity need only file single
quarterly financial resources reports in accordance with Sec.
39.11(f). The Commission is not requiring a dually-registered entity to
file two separate reports because the operating resource requirements
for a DCM and DCO are the same, and the combined DCM/DCO is required to
have sufficient financial resources to cover its operating costs as a
combined entity. The DCO financial resource requirements in Sec. 39.11
differ from those in Sec. 38.1101 only insofar as they add a
requirement for default resources, which is applicable only to a
[[Page 36659]]
DCM/DCO acting in its capacity as a DCO.
---------------------------------------------------------------------------
\462\ The Commission anticipates that a corporate entity that
operates more than one registered entity may share certain costs,
and may allocate those costs among the registered entities as
determined by the Commission on a case by case basis.
---------------------------------------------------------------------------
ii. Sec. 38.1101(b)--Types of Financial Resources
Under proposed Sec. 38.1101(b), financial resources available to
DCMs to satisfy the applicable financial requirements would include the
DCM's own capital (assets in excess of liabilities) and any other
financial resource deemed acceptable by the Commission. A DCM would be
able to request an informal interpretation from Commission staff on
whether a particular financial resource would be acceptable.
Summary of Comments
OCX stated that the proposed rule may encourage DCMs to cut
services in order to reduce their operational need for cash.\463\
---------------------------------------------------------------------------
\463\ OCX Comment Letter at 5 (Feb. 22, 2011).
---------------------------------------------------------------------------
Several commenters recommended that the Commission include specific
examples of financial resources that might satisfy the requirement. OCX
inquired whether firm commitments from owners to honor capital calls
would be acceptable under the proposed rule.\464\ CME contended that
the intent of Congress was to construe the terms ``financial
resources'' broadly and include anything of value at the DCM's
disposal, including operating revenues.\465\ CME stated that if
Congress wanted to exclude operating revenues from what would be
considered financial resources, Congress could have incorporated an
``equity concept.'' \466\
---------------------------------------------------------------------------
\464\ Id.
\465\ CME Comment Letter at 37 (Feb. 22, 2011).
\466\ Id.
---------------------------------------------------------------------------
GreenX contended that the Commission should continue to permit
flexibility for DCMs, but also requested that the Commission provide
specific examples of which assets can be included in the calculation of
``financial resources.'' \467\ GreenX requested confirmation that
accounts receivable and other assets that are reasonably expected to
result in payments to the DCM, as well as subordinated loans, are
acceptable financial resources.\468\ GreenX also stated that committed
lines of credit and similar facilities should be considered ``good''
financial resources, and that such interpretation is standard in the
ordinary business world.\469\ GreenX stated that the proposed increase
in the amount of financial resources needed by DCMs, and the
restrictions on the use of debt financing, would impede the ability of
start-ups to become and remain DCMs.\470\
---------------------------------------------------------------------------
\467\ GreenX Comment Letter at 19 (Feb. 22, 2011).
\468\ Id.
\469\ Id. at 18.
\470\ GreenX Comment Letter at 14 (Feb. 22, 2011).
---------------------------------------------------------------------------
GreenX proposed language to replace proposed Sec. 38.1101(a)(3),
(b), and (e) that would provide that a DCM ``be required to maintain
sufficient financial resources to cover its projected operating costs
for a period of at least one year, including unencumbered, liquid
assets equal to at least six months of such projected operating costs,
and that committed lines of credit or various debt instruments may be
included in calculating those financial resources, as long as the DCM
is not incurring indebtedness secured by its assets and counting both
those assets and the indebtedness as part of its financial resources.''
\471\ GreenX further contended that if the Commission is unwilling to
accept this language, the Commission should: (i) clearly specify that
the ``financial resources'' requirement in proposed Sec. 38.1101(a)(3)
is a separate requirement from the liquidity requirement in proposed
Sec. 38.1101(e), and (ii) delete the language in the proposed
liquidity requirement suggesting that proposed Sec. 38.1101(e) is part
of the proposed one year's required operating costs coverage.\472\
Absent revision, GreenX stated that the current proposal could result
in a requirement of up to 18 months of financial resources if a DCM
used a line of credit to satisfy the liquidity requirement.\473\
Moreover, if this provision is not changed, GreenX recommended that the
Commission undertake a cost-benefit analysis of requiring DCMs to
maintain financial resources in excess of one year's operating
costs.\474\ GreenX also stated that the Commission should not adopt a
``one-size-fits-all approach'' to the financial resources requirements
as between DCOs and DCMs, since different circumstances and different
purposes support differential treatment.\475\
---------------------------------------------------------------------------
\471\ Id. at 17.
\472\ Id. GreenX recommended striking the words in proposed
regulation 38.1101(e) ``to meet the requirements of paragraph (a) of
this section'' and ``If any portion of such financial resources is
not sufficiently liquid.''
\473\ Id. at 14-15.
\474\ Id. at 17-18.
\475\ GreenX discussed the significantly different roles played
by DCMs and DCOs (i.e., DCMs do not guarantee or novate trades and
their capital is not at risk in the event of a default) and further
states that the ``Commission should not adopt a one-size-fits-all
approach and should not treat DCOs and DCMs in the same manner where
different circumstances and different purposes support differential
treatment.'' GreenX notes that ``the role of financial resources
(and letters of credit) in the DCM context is to ensure that DCMs
can continue to operate in the ordinary course of business and make
payments as they become due, which does not have the same time
sensitivity that it does in the DCO context.'' See GreenX Comment
Letter at 17 (Feb. 22, 2001).
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Discussion
The Commission is adopting the proposed rule with one modification.
The provision in Sec. 38.1101(b) stating that acceptable financial
resources include a DCM's own capital and ``any other financial
resource deemed acceptable by the Commission'' was meant to capture
other types of resources on a case-by-case basis and provide
flexibility to both DCMs and the Commission. Accordingly, the
Commission notes that a DCM's own capital means its assets minus its
liabilities calculated in accordance with the Generally Accepted
Accounting Principles (``GAAP''). The Commission believes that if a
certain financial resource is deemed to be an asset under GAAP, it is
appropriate for inclusion in the calculation for this rule, and the
rule has been revised accordingly. To the extent a certain financial
resource is not considered an asset under GAAP, but based upon the
facts and circumstances a DCM believes that the particular asset should
be so considered, Commission staff will work with the DCM to determine
whether such resource is acceptable. In response to comments pertaining
to the acceptable forms of financial resources, the Commission may
consider projected revenues as an acceptable financial resource for
established DCMs that can demonstrate a historical record of revenue;
but not for DCM applicants, relatively new DCMs or DCMs with no such
record.
The Commission believes that GreenX misinterprets the relationship
of Sec. 38.1101(a)(3) and Sec. 38.1101(e). The Commission clarifies
that the one-year financial resources requirements in Sec.
38.1101(a)(3) and the six month liquidity requirement in Sec.
38.1101(e) could be met by using the same financial resources. GreenX
is correct that if a sufficient portion of the financial resources used
for the one-year financial resources requirement in Sec. 38.1101(a)(3)
are illiquid, it is possible that an entity could be required to have
18 months of financial resources to meet the requirements of these two
sections. However, the Commission is requiring only one-year of
financial resources, six months of which must be liquid financial
resources. Each DCM may exercise discretion in determining how to meet
this requirement (e.g., six months of liquid financial resources
combined with six months of illiquid ones, 12 months of liquid
financial resources, or 12 months of illiquid financial resources with
a line of credit
[[Page 36660]]
covering six months of financial resources). Indeed, the Commission
notes that most, if not all, DCMs have considerably more financial
resources than the minimum one-year required by this rule. In addition,
if a DCM does not have this liquidity, it is not achieving the goal of
the core principle, as it will be unable to pay its creditors. Further,
the language of the core principle does not limit the resource
requirement to one year, as it specifically states that a DCM's
financial resources are adequate if the value of such resources exceeds
one year of operating costs. Also in response to GreenX, the costs and
benefits associated with all of the rules being adopted in this
release, including Sec. 38.1101, are discussed in the cost benefit
section of the release.
In response to GreenX's comment regarding the financial resources
requirements of DCOs and DCMs, the Commission notes that the financial
resources requirements in Sec. 38.1101, for DCMs, and in Sec. 39.11,
for DCOs, are different. In addition to the requirement to maintain
financial resources sufficient to cover operating costs for one year,
Sec. 39.11 also requires DCOs to possess a certain level of default
resources.\476\ As GreenX correctly notes, DCMs do not guarantee or
novate trades and a ``one-size-fits-all'' approach is not being applied
here.
---------------------------------------------------------------------------
\476\ See 76 FR 69334, Nov. 8, 2011.
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iii. Sec. 38.1101(d)--Valuation of Financial Resources
Proposed Sec. 38.1101(d) required DCMs to calculate the current
market value of each financial resource used to meet their obligations
under these proposed rules, no less frequently than at the end of each
fiscal quarter. The proposed rule required DCMs to perform the
valuation at other times as appropriate. As the Commission noted in the
DCM NPRM, the proposed rule is designed to address the need to update
valuations in circumstances where there may have been material
fluctuations in market value that could impact a DCM's ability to meet
its obligations on a rolling basis as required by proposed Sec.
38.1101(a). The proposed rule requires that when valuing a financial
resource, the DCM reduce the value, as appropriate, to reflect any
market or credit risk specific to that particular resource, i.e., apply
a haircut.\477\ Under the proposed rule, DCMs would be permitted to
exercise discretion in determining the applicable haircuts, although
such haircuts would be subject to Commission review and acceptance.
---------------------------------------------------------------------------
\477\ A ``haircut'' is a deduction taken from the value of an
asset to reserve for potential future adverse price movements in
such asset.
---------------------------------------------------------------------------
Summary of Comments
GreenX recommended an explicit statement that the use of GAAP
principles in calculating the market value of each financial resource
in meeting obligations under the rules would satisfy the requirements
of this subsection, without limiting other potential methods of
complying.\478\
---------------------------------------------------------------------------
\478\ GreenX Comment Letter at 19 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission is adopting the proposed rule without modification.
In response to GreenX's comment, the Commission notes that GAAP does
not include haircuts, but valuation under GAAP does take into account
current market values. The Commission expects each DCM to monitor the
value of its resources to be certain that the calculation of the value
of its assets reflects current market conditions in accordance with
GAAP. A haircut is not intended to be applied in the ordinary course,
but to be used in those unusual market circumstances that require an
accounting intervention. As stated in the DCM NPRM, the Commission will
permit DCMs discretion to, in the first instance, choose an appropriate
haircut methodology. The Commission will evaluate the appropriateness
of such methodology on a case-by-case basis.
iv. Sec. 38.1101(e)--Liquidity of Financial Resources
Proposed Sec. 38.1101(e) required that DCMs maintain unencumbered
liquid financial assets, such as cash or highly liquid securities,
equal to at least six months' operating costs. As noted in the DCM
NPRM, the Commission believes the requirement to have six months' worth
of unencumbered liquid financial assets would give a DCM time to
liquidate the remaining financial assets it needs to continue operating
for the last six months of the required one-year period. A DCM would be
permitted to use a committed line of credit or similar facility to
satisfy the requirement, in the event that the DCM does not have six
months' worth of unencumbered liquid financial assets.
The Commission notes that a DCM may only use a committed line of
credit or similar facility to meet the liquidity requirements set forth
in proposed Sec. 38.1101(e). Accordingly, a committed line of credit
or similar facility is not listed in proposed Sec. 38.1101(b) as a
financial resource available to a DCM to satisfy the requirements of
proposed Sec. 38.1101(a).
Summary of Comments
CME stated that the liquidity measurement is only relevant in the
context of winding-down, and claims that a three month period, rather
than six months, is a more accurate assessment of how long it would
take for a DCM to wind down.\479\
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\479\ CME Comment Letter at 37 (Feb. 22, 2011).
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GreenX requested clarification of the terms ``unencumbered'' and
``committed.'' \480\ GreenX suggested that assets should be considered
unencumbered even if they are ``subject to security interests or
adverse claims, as long as the DCM can use and expend those assets in
the ordinary course without requiring consent of lenders or
claimants.'' \481\ GreenX also requested that the Commission clarify
whether ``committed'' is intended to mean anything other than a line of
credit or similar facility that has been extended pursuant to a legally
binding agreement.\482\ Finally, GreenX recommended that the Commission
expressly state that lines of credit and similar facilities incurred
from banks and other commercial financial institutions on market
standard terms will presumptively qualify as good ``committed lines of
credits and similar facilities'' for purposes of proposed Sec.
38.1101.\483\ GreenX requested that any requirements applicable for
lines of credit be specified in the final regulations.\484\
---------------------------------------------------------------------------
\480\ GreenX Comment Letter at 18 (Feb. 22, 2011).
\481\ Id.
\482\ Id.
\483\ Id.
\484\ Id.
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Discussion
The Commission is adopting the proposed rule without modification.
The Commission believes that a six month period is appropriate for
a wind down period and notes that commenters did not provide any
support for the claim that a wind down would take only three months.
In response to GreenX's request for clarification, the Commission
notes that it is using ``unencumbered'' in the ``normal commercial
sense'' to ``refer to assets that are not subject to a security
interest or other adverse claims.'' \485\ By ``committed line of credit
or similar facility,'' the Commission means a committed, irrevocable
contractual obligation to provide funds on demand with preconditions
limited to the execution of appropriate agreements. In other words, a
facility with a material adverse financial condition restriction would
not be acceptable. The purpose of
[[Page 36661]]
this requirement is for a DCM to have no impediments to accessing its
line of credit at the time it needs liquidity. Further, DCMs are
encouraged to periodically check their line of credit arrangements to
confirm that no operational difficulties are present.
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\485\ Id.
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v. Sec. 38.1101(f)--Reporting Requirements
Proposed Sec. 38.1101(f) required DCMs, at the end of each fiscal
quarter, or at any time upon Commission request, to report to the
Commission: (i) the amount of financial resources necessary to meet the
requirements set forth in the regulation; and (ii) the value of each
financial resource available to meet those requirements. The proposed
rule also required a DCM to provide the Commission with a financial
statement, including the balance sheet, income statement, and statement
of cash flows, of the DCM or of its parent company (if the DCM does not
have an independent financial statement and the parent company's
financial statement is prepared on a consolidated basis).
Under the proposed rule, a DCM was required to provide the
Commission with sufficient documentation explaining the methodology it
used to calculate its financial requirements, and the basis for its
valuation and liquidity determinations. The proposed rule also required
the DCM to provide copies of any agreements establishing or amending a
credit facility, insurance coverage, or any similar arrangement that
evidences or otherwise supports its conclusions. The Commission, in its
sole discretion, would determine the sufficiency of the documentation
provided. According to the proposed rule, the DCM would have 17
business days \486\ from the end of the fiscal quarter to file the
report, unless it requests an extension of time from the Commission.
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\486\ This filing deadline is consistent with the deadline
imposed on FCMs for the filing of monthly financial reports. See 17
CFR regulation 1.10(b).
---------------------------------------------------------------------------
Summary of Comments
Three commenters requested an extended deadline for filing the
financial reports required as a result of the proposed rule. CFE stated
that for DCMs that are public, or have financial statements
consolidated with those of a public company, the filing deadlines
should be the same as those required by the SEC for Forms 10-Q and 10-
K.\487\ CME provided a similar comment stating that the proposed 17 day
filing deadline is not feasible and that instead, the requirement
should be consistent with the SEC's reporting requirements.\488\
Similarly, GreenX stated that it has procedures in place to comply with
the SEC's requirements and that the proposed requirements in this rule
would require new programming and resources.\489\ GreenX recommended
extending the reporting deadline to 30 calendar days, noting that this
is still more burdensome than the requirements imposed by the SEC on
national securities exchanges.\490\ Rather than recommending an
extended deadline, KCBT objected to the proposed quarterly filings and
stated that the annual submissions that it provides to the Commission
should suffice.\491\
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\487\ CFE Comment Letter at 6 (Feb. 22, 2011).
\488\ CME Comment Letter at 38 (Feb. 22, 2011).
\489\ GreenX Comment Letter at 20 (Feb. 22, 2011) (GreenX also
stated that normal year-end adjustments typically require much more
than 17 business days to complete).
\490\ Id.
\491\ KCBT Comment Letter at 8 (Feb. 22. 2011).
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In addition to the comments received regarding the reporting
deadline, two commenters requested clarification as to the
confidentiality of any filings made pursuant to proposed Sec.
38.1101(f).\492\ Further, CME requested clarification that consolidated
financial statements covering multiple DCMs, and DCOs where relevant,
comply with the proposed rule.\493\
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\492\ CFE Comment Letter at 6 (Feb. 22, 2011); CME Comment
Letter at 37-38 (Feb. 22, 2011).
\493\ CME Comment Letter at 37-38 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission is adopting the proposed rule with certain
amendments.
The Commission is persuaded that the proposed 17 business day
filing deadline may be overly burdensome. The SEC requires its
quarterly reports on Form 10-Q to be filed with the SEC 40 calendar
days after the end of the fiscal quarter for accelerated filers and 45
calendar days after the end of the fiscal quarter for all other SEC-
registered entities.\494\ The SEC requires annual reports on Form 10-K
to be filed with the SEC 60 calendar days after the end of the fiscal
year for large accelerated filers, 75 calendar days for other
accelerated filers and 90 calendar days for non-accelerated
filers.\495\ The Commission has extended the 17 business day proposed
filing deadline to 40 calendar days for the required reports for the
first three quarters. This revision to the rule will harmonize the
Commission's financial resource filing requirement with the SEC's
requirements for its Form 10-Q. Similarly, the Commission has extended
the filing deadline for the fourth quarter report to 60 days in order
to harmonize the requirement with the SEC's filing deadline for the
Form 10-K. However, to the extent that a DCM is also registered as a
DCO, the DCM must file its quarterly financial reports in accordance
with the requirement of Sec. 39.11 (which requires that reports be
filed within 17 business days after the end of each fiscal quarter).
The shorter time frame for submission of a dual registrant's quarterly
financial reports is based on the heightened significance of financial
oversight for the clearinghouse, which serves as the central
counterparty for all cleared transactions.
---------------------------------------------------------------------------
\494\ See 17 CFR 249.308a.
\495\ See 17 CFR 249.310.
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The Commission has considered KCBT's comments, but does not believe
that annual submissions are sufficient. The Commission believes that
prudent financial management requires DCMs to prepare and review
financial reports more frequently than annually, and expects that DCMs
currently are reviewing their finances on at least a quarterly basis.
In response to the comments requesting clarification on the
confidentiality of the filings made pursuant to the financial resources
regulations, the Commission does not plan to make such reports public.
However, where such information is, in fact, confidential, the
Commission encourages DCMs to submit a written request for confidential
treatment of such filings under the Freedom of Information Act
(``FOIA''),\496\ pursuant to the procedures established in Sec. 145.9
of the Commission's regulations.\497\ The determination of whether to
disclose or exempt such information in the context of a FOIA proceeding
would be governed by the provisions of part 145, and any other relevant
provision.
---------------------------------------------------------------------------
\496\ 5 U.S.C. 552 et seq. (2010).
\497\ 17 CFR 145.9 (2010).
---------------------------------------------------------------------------
In response to the request for clarification in regard to
consolidated financial statements, the Commission clarifies that
consolidated financial statements would comply with the rule.
Section 38.1101(g) delegates authority to perform certain functions
that are reserved to the Commission under Sec. 38.1101 to the Director
of the Division of Market Oversight.
22. Subpart W--Diversity of Boards of Directors
Core Principle 22 is a new core principle that was added by the
Dodd-Frank Act. The core principle requires that publicly traded DCMs
must endeavor to recruit individuals to serve on their board of
directors from among
[[Page 36662]]
a broad and culturally diverse pool of qualified candidates.
In the DCM NPRM, the Commission proposed to codify the statutory
text of the core principle in proposed Sec. 38.1150, and is adopting
Sec. 38.1150 as proposed.
As noted in the DCM NPRM, the substantive regulations implementing
Core Principle 22 were proposed in a separate rulemaking that also
would implement Core Principles 15 (Governance Fitness Standards), 16
(Conflicts of Interest), and 17 (Composition of Governing Boards of
Contract Markets).\498\ The rules implementing Core Principle 22 will
be adopted in that separate rulemaking.
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\498\ See ``Governance Requirements for Derivatives Clearing
Organizations, Designated Contract Markets, and Swap Execution
Facilities; Additional Requirements Regarding the Mitigation of
Conflicts of Interest,'' Notice of Proposed Rulemaking, 76 FR 722,
January 6, 2011. CME submitted a comment letter discussing proposed
regulation 38.801 in connection with 76 FR 722.
---------------------------------------------------------------------------
CME submitted a comment letter responding to the DCM NPRM that
referenced comments it submitted in connection with that rulemaking.
CME's comments will be considered in connection with that rulemaking.
23. Subpart X--Securities and Exchange Commission
The Dodd-Frank Act added new Core Principle 23, requiring that DCMs
keep any records relating to swaps defined in CEA section 1a(47)(A)(v),
as amended by the Dodd-Frank Act, open to inspection and examination by
the SEC.\499\ Consistent with the text of this core principle, the
Commission proposed guidance under part 38 that provided that each DCM
should have arrangements and resources for collecting and maintaining
accurate records pertaining to any swap agreements defined in section
1a(47)(A)(v) of the amended CEA.
---------------------------------------------------------------------------
\499\ 7 U.S.C. 7; see also section 5(d)(23) of the CEA, as
amended by the Dodd-Frank Act.
---------------------------------------------------------------------------
i. Sec. 38.1200--Core Principle 23, Sec. 38.1201 (Additional Sources
for Compliance), and Guidance in Appendix B
The Commission proposed a combination of rules and guidance to
implement the core principle. Proposed Sec. 38.1200 codified the
statutory text of the core principle. Proposed Sec. 38.1201 referred
applicants and DCMs to the guidance in appendix B to part 38 for
purposes of demonstrating to the Commission their compliance with the
requirements of the core principle. The proposed guidance stated that
DCMs should have arrangements and resources for collecting and
maintaining accurate records pertaining to any swaps agreements defined
in section 1a(47)(A)(v) of the Act.
Summary of Comments
CME requested guidance on what records need to be retained and for
how long they must be retained.\500\
---------------------------------------------------------------------------
\500\ CME Comment Letter at 38 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission is adopting the proposed rules and guidance, with
the modifications described below.
In response to CME's comment, the Commission notes that the
guidance provides that DCMs should retain ``any'' records relevant to
swaps defined under CEA section 1a(47)(a)(v), and that the DCM should
leave such records open to inspection and examination, for a period of
five years. Commission staff consulted with representatives from the
SEC, who confirmed that SEC's relevant recordkeeping requirements
typically extend for a period of five years.\501\ The five year
requirement is also consistent with the recordkeeping requirement under
Core Principle 18 and Sec. 1.31 of the Commission's regulations.
---------------------------------------------------------------------------
\501\ See 76 FR 10982, Feb. 28, 2011, (Proposed regulation
818(b) requires security-based swap execution facilities to keep
books and records ``for a period of not less than five years,'' the
first two years in an easily accessible place). Rule 17a-1(b)
(240.17a-1(b) requires national securities exchanges, among others,
to keep books and records for a period of not less than five years,
the first two years in an easily accessible place, subject to a
destruction and disposition provisions, which allows exchanges to
destroy physical documents pursuant to an effective and approved
plan regarding such destruction and transferring/indexing of such
documents onto some recording medium.).
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III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') \502\ requires federal
agencies, in promulgating rules, to consider the impact of those rules
on small entities. The rules adopted herein will affect designated
contract markets (``DCMs''). The Commission has previously established
certain definitions of ``small entities'' to be used by the Commission
in evaluating the impact of its rules on small entities in accordance
with the RFA.\503\ The Commission previously determined that DCMs are
not small entities for the purpose of the RFA.\504\ The Commission
received no comments on the impact of the rules contained herein on
small entities. Therefore, the Chairman, on behalf of the Commission
and pursuant to 5 U.S.C. 605(b), certifies that the rules will not have
a significant economic impact on a substantial number of small
entities.
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\502\ 5 U.S.C. 601 et seq. (2010).
\503\ 47 FR 18618-21, Apr. 30 1982.
\504\ Id.
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B. Paperwork Reduction Act
This final rulemaking contains information collection requirements.
The Paperwork Reduction Act (``PRA'') \505\ imposes certain
requirements on federal agencies in connection with their conducting or
sponsoring any collection of information as defined by 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. The Commission proposed to amend collection 3038-
0052 to allow for an increase in response hours for the proposed
rulemaking amending part 38, which included the increase in burden
hours that will result from the amendments to rules 1.52 and 16.01 that
are also part of this rulemaking.\506\ Notably, most of the collection
burdens associated with part 38 are covered by a currently approved
collection of information for part 38, or by other existing or pending
collections of information. Thus, only those burdens that are not
covered elsewhere are included in the Commission's proposed amendment.
---------------------------------------------------------------------------
\505\ 44 U.S.C. 3501 et seq.
\506\ See 75 FR 80572, 80603, Dec. 22, 2010 .
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The title of the collection will continue to be ``Part 38--
Designated Contract Markets.'' The Commission submitted the amended
collection to the Office of Management and Budget (``OMB'') for its
review and approval in accordance with 44 U.S.C. 3507(d) and 5 CFR
1320.11. Pursuant to a notice of action from OMB in March 2011,
approval of the amended collection is pending a resubmission of the
proposed information collection that includes a description of the
comments received on the collection and the Commission's responses
thereto, which will be made available by OMB at www.reginfo.gov.
Responses to this collection of information will be mandatory. The
Commission will protect proprietary information gathered according to
the FOIA and 17 CFR part 145, ``Commission Records and Information.''
In addition, section 8(a)(1) of the CEA strictly prohibits the
Commission, unless specifically authorized by the CEA, from making
public ``data and information that would separately disclose the
business transactions or market positions of any person and trade
secrets or names of customers.'' \507\ The Commission is also required
to protect certain information
[[Page 36663]]
contained in a government system of records according to the Privacy
Act of 1974.\508\
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\507\ 7 U.S.C. 12.
\508\ 5 U.S.C. 552a.
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Proposed Collection
In its existing collection of information for part 38, the
Commission estimated 300 hours average response time from each
respondent for the collection of designation and compliance
information.\509\ Based on its experience with administering registered
entities' submission requirements since implementation of the Commodity
Futures Modernization Act of 2000,\510\ the Commission estimated in the
DCM NPRM that the response time for the designation and compliance
collections in the proposed rule would generally increase the
information collection burden by 10 percent. This increase is due to
the introduction of swaps trading on DCMs permitted under section
723(a)(3) of the Dodd-Frank Act and the addition of new core principles
with which DCMs must comply, excepting Core Principle 21 (Financial
Resources), for which a separate burden estimate is discussed below,
and the burdens associated with any information collection requirements
that are being accounted for in other existing or pending collections.
With respect to all but financial resources compliance, the Commission
estimated in the DCM NPRM that it would collect information from 17
respondents.\511\ Accordingly, a 10 percent estimated increase would
result in 30 additional hours per respondent and 510 additional hours
annually for all respondents for designation and compliance.
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\509\ 66 FR 42256, 42268, Aug. 10, 2001.
\510\ Public Law 106-554, 114 Stat. 2763 (2000).
\511\ The number of designated contract markets increased from
13 to 17 since the last amendment to Collection 3038-0052 and from
17 to 18 since the DCM NPRM was published in the Federal Register.
---------------------------------------------------------------------------
With respect to Core Principle 21, the Commission estimated in the
DCM NPRM that each of the 17 anticipated respondents may expend up to
10 hours quarterly for filings required under the proposed regulations,
totaling 40 hours annually for each respondent and 680 hours across all
respondents with respect to compliance with Core Principle 21.
Commission staff estimated that respondents could expend up to an
additional $3,640 annually based on an hourly wage rate of $52 (30
hours + 40 hours x $52) to comply with the proposed rules. This would
result in an aggregated additional cost of $61,880 per annum (17
respondents x $3,640).
Summary of Comments and Discussion
Estimated Burden Hours for Compliance for Part 38 Amendments
The Commission received several comments regarding the estimated
hours of burden for compliance with the proposal to amend part 38.\512\
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\512\ As noted above, the Commission is not finalizing proposed
regulations 38.501--38.506 at this time, and expects and plans to do
so when it considers the final SEF rulemaking, The Commission will
consider all comments related to these provisions at such time.
---------------------------------------------------------------------------
In particular, the Commission confirms that that the new DCM
application form, Form DCM, provides a roadmap of required
documentation, balances the needs of the Commission with the needs of
the marketplace, and should result in a streamlined and standardized
review process, as was noted by Eris.\513\
---------------------------------------------------------------------------
\513\ Eris Comment Letter at 4 (Feb. 22, 2011).
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Other commenters suggested that the 60 days proposed in Sec.
38.3(g) for existing DCMs to certify compliance with the core
principles and the rules implementing them would be unduly
burdensome.\514\ As discussed in the preamble, the Commission is
eliminating this provision from the final rules.
---------------------------------------------------------------------------
\514\ See, e.g., GreenX Comment Letter at 21 (Feb. 22, 2011);
KCBT Comment Letter at 2 (Feb. 22, 2011); Nodal Comment Letter at 4
(Feb. 22, 2011); NYSE Liffe Comment Letter at 14 (Feb. 22, 2011);
CME Comment Letter at 12 (Feb. 22, 2011); and CFE Comment Letter at
7 (Feb. 22, 2011).
---------------------------------------------------------------------------
CME stated that it would be costly to comply with the proposed
Sec. 38.151(a) requirement that clearing firms obtain every customer's
consent to the regulatory jurisdiction of each DCM.\515\ The Commission
believes that Sec. 38.151(a) codifies requirements necessary to
effectuate Core Principle 2's statutory mandate; a DCM must have an
agreement in place prior to granting members and market participants
access to its markets in order to ensure that the DCM has the capacity
to detect, investigate, and apply appropriate sanctions to persons that
violate DCM rules. Any incremental costs associated with this rule are
covered by the 10 percent increase contained in the Commission's
amended information collection.
---------------------------------------------------------------------------
\515\ CME Comment Letter at 16 (Feb. 22, 2011).
---------------------------------------------------------------------------
CME stated that an increased documentation burden associated with
the submission process would greatly increase the cost and timing for
DCMs to list products, without providing any corresponding benefit to
the marketplace.\516\ CME stated that the Commission indicated that the
proposed rules for Provisions Common to Registered Entities will
increase the overall collection burden on registered entities by
approximately 8,300 hours per year.\517\ The referenced burden was
accounted for in the Commission's information collection for the part
40 rules that were adopted in July, 2011, however, and therefore the
burden associated with that collection is not duplicated here.\518\
Notwithstanding this, the Commission believes that any DCM must have an
agreement with its customers such that the customer agrees to cooperate
with the DCM, where necessary, in order for the DCM to perform its
statutory functions.
---------------------------------------------------------------------------
\516\ CME Comment Letter at 10 (Feb. 22, 2011).
\517\ See 75 FR 67282, 67290, Nov. 2, 2010.
\518\ See Collection 3038-0093.
---------------------------------------------------------------------------
Similarly, CME commented on the burdens associated with rules
implementing Core Principles 8 and 18, in particular, the requirement
to separately identify block trading in daily volume reports.\519\ The
burden associated with block trading is accounted for in the
information collection associated with the Commission's Real-Time
Public Reporting of Swap Transaction Data rulemaking.\520\ To avoid
double-counting, no adjustment is being made to the amendment to this
part 38 collection.
---------------------------------------------------------------------------
\519\ CME Comment Letter at 30-31 (Feb. 22, 2011).
\520\ See ``Real Time Public Reporting of Swap Transaction
Data,'' 77 FR 2909, Jan. 20, 2012.
---------------------------------------------------------------------------
In addition, MGEX commented on the rules implementing the general
recordkeeping requirements of Core Principle 18.\521\ Core Principle 18
incorporates by reference Sec. 1.31 of the Commission regulations and
the recordkeeping requirements in the Commission's Swap Data,
Recordkeeping, and Reporting Requirements rulemaking.\522\ The Sec.
1.31 requirements are already covered by the existing information
collection for part 38, with the incremental costs associated with the
introduction of swap trading, if a DCM elects to do so, covered by the
10 percent increase contained in the Commission's amended information
collection. The recordkeeping requirements in the proposed Swap Data,
Recordkeeping, and Reporting Requirements rulemaking are accounted for
in the information collection request that was developed for that
rulemaking. To avoid double-counting, no adjustment is being made to
the amendment to the part 38 information collection in response to the
comment.
---------------------------------------------------------------------------
\521\ MGEX Comment Letter at 9 (Feb. 22, 2011).
\522\ See ``Swap Data Recordkeeping and Reporting
Requirements,'' 77 FR 2136, Jan. 13, 2012.
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With respect to the information collection in rules implementing
Core
[[Page 36664]]
Principle 10, CME and MGEX commented that establishing specific audit
trail requirements would be burdensome, costly, and unnecessary.\523\
DCM compliance with Core Principle 10 should predate the enactment of
the Dodd-Frank Act, however, and the information collections associated
with Core Principle 10 are covered by the Commission's existing part 38
information collection. Any burden increase associated with the
maintenance of additional records resulting from the introduction of
swap trading, if a DCM elects to do so, has been accounted for in the
10 percent increase in designation and compliance costs discussed
above.
---------------------------------------------------------------------------
\523\ CME Comment Letter at 33 (Feb. 22, 2011) and MGEX Comment
Letter at 7 (Feb. 22, 2011).
---------------------------------------------------------------------------
CME submitted a comment regarding the information collection
burdens associated with rules that were proposed to implement new Core
Principle 20, which requires each DCM to maintain a business
continuity-disaster recovery plan and to report system security-related
events and all planned changes to automated systems that may impact the
reliability, security, or scalability of the systems.\524\ In response
to CME's concerns that the rule would require reporting of
insignificant system events, the Commission is adopting final rules
that require reporting only of significant system malfunctions and
advance notification only of material system changes. The resulting
burden reduction eliminates the need to increase the proposed part 38
information collection amendment.
---------------------------------------------------------------------------
\524\ CME Comment Letter at 36-37 (Feb. 22, 2011).
---------------------------------------------------------------------------
Finally, MGEX commented that the hours estimated for designation
and compliance and the additional new annual cost of compliance with
the proposed rules were extremely low, and claimed that due to the vast
number of additional requirements, the total burden is becoming
``unwieldy and excessive.'' \525\ MGEX did not provide any estimate of
what costs would be more accurate for purposes of the part 38
information collection, and thus the Commission could not evaluate
alternative estimates to determine whether they would be more
appropriate than what was proposed, which was based on past Commission
experience with existing collections of information and which accounts
only for those collections of information that are not now or will not
be covered by other collections of information.
---------------------------------------------------------------------------
\525\ MGEX Comment Letter at 9-10 (Feb. 22, 2011).
---------------------------------------------------------------------------
Estimated Burden Hours for Core Principle 21
In addition to the general increase proposed for the existing part
38 collection discussed above, the Dodd-Frank Act established new Core
Principle 21 (Financial Resources) that requires respondents to have
adequate financial, operational and managerial resources.\526\ In order
to demonstrate compliance with Core Principle 21, each respondent will
need to file specific reports with the Commission on a quarterly basis,
which would result in four quarterly responses per respondent per year.
In the proposed rulemaking, the Commission estimated that each
respondent would expend 10 hours to prepare each filing required under
the proposed regulations, and the Commission estimated that it would
receive filings from 17 respondents.
---------------------------------------------------------------------------
\526\ See section 735(b) of the Dodd-Frank Act.
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The Commission received several comments on the proposed financial
resources collection. KCBT stated that the financial resources rules,
as proposed, would result in duplicative reporting for entities that
operate as both a DCM and DCO.\527\ In response to this comment, the
Commission is now finalizing the rules with revisions that clarify that
a DCM that also is registered with the Commission as a DCO is obligated
only to file its financial resources reports under the DCO rules,
though it nonetheless must maintain the financial resources necessary
to satisfy the operating cost requirements of the DCM and the DCO
separately.
---------------------------------------------------------------------------
\527\ KCBT Comment Letter at 7-9 (Feb. 22, 2011).
---------------------------------------------------------------------------
CFE, GreenX, and KCBT requested that the Commission extend the
proposed deadline for filing of financial resources reports from 17
days after the end of each quarter, in particular to accommodate DCMs
that are public companies, or that have financial statements that are
consolidated with those of a public company, so that the filing
requirements would be aligned with the requirements for SEC forms 10-Q
and 10-K, which are longer.\528\ GreenX stated that failing to extend
the time for filing to align with the SEC filing requirements, for
which it and other public companies already have procedures and
controls in place, would result in unnecessary new programming and
staff resources.\529\ KCBT objected to the quarterly filing requirement
and suggested that annual reporting would be sufficient.\530\
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\528\ CFE Comment Letter (Feb. 22, 2011), GreenX Comment Letter
(Feb. 22, 2011), KCBT Comment Letter (Feb. 22, 2011).
\529\ GreenX Comment Letter at 19-20 (Feb. 22, 2011).
\530\ KCBT Comment Letter at 8-9 (Feb. 22, 2011).
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The Commission is not persuaded that an annual reporting
requirement would be sufficient in terms of financial management on the
part of the DCM or regulatory oversight on the part of the Commission.
With respect to regulatory oversight, the adoption of an annual
reporting requirement alone would result in a need for periodic checks
by the Commission on financial resources compliance by DCMs between
annual reports. The multiple unscheduled checks that would be necessary
each year, in the form of calls for a demonstration of compliance by a
DCM, as well as more formal rule enforcement reviews, would burden the
Commission's examination resources. If DCMs are required to report on a
quarterly basis, DCMs may be able to demonstrate risks toward which the
Commission's resources should be directed. Moreover, unscheduled checks
would most likely be more burdensome for DCMs than quarterly reporting.
Thus, the Commission is adopting both quarterly and annual reporting
requirements in these final rules.
However, in response to the comments, the Commission is adopting
final rules that would mitigate the burden that would result from the
adoption of filing deadlines that do not align with SEC filing
requirements. Accordingly, the final rules establish a deadline for the
filing of financial resources reports of 40 calendar days after the end
of the quarter for the first three quarters of a DCM's fiscal year, and
60 calendar days after the end of the DCM's fourth quarter.
Final Burden Estimate
The final rules require each respondent to file information with
the Commission. Information collections are included in several of the
general provisions being adopted in Subpart A, as well as in certain
regulations implementing Core Principles 5, 7, 8, 10, 11, 13, 18, 20,
and 21. The Commission has carefully evaluated the comments discussed
above and determined that the 10 percent general increase by which the
Commission seeks to amend its part 38 collection of information is
appropriate. The 10 percent increase is intended to cover only the
burdens associated with collections of information that are not already
covered in the existing part 38 information collection, or in other
existing collections or collections that are being established with
other rulemakings.
[[Page 36665]]
The 10 percent increase tracks the already approved part 38
information collection, which accounted for the many one-time or
infrequent information collections contained in part 38 over the
assumed life of a DCM. As a general rule, the information collections
in this rulemaking that are not already covered have the same
characteristics: The required filing of one-time certifications and
demonstrations of compliance by existing DCMs; the filing of occasional
exemptive requests; reporting of material events that are expected to
occur infrequently; the expansion of a DCM's existing audit trail
program to cover swap transactions, if the DCM determines to list
swaps; and the one-time or infrequent system changes needed to report
transactions, such as EDRPs, that are not covered in the information
collection requests of other rulemakings.
The changes sought by the commenters that are being adopted would
only marginally reduce the overall information collection burden. Thus
the Commission has determined not to reduce its burden estimates.
Accordingly, the Commission expects that with respect to all but
financial resources compliance, a 10 percent estimated increase would
result in 30 additional hours per respondent and 540 additional hours
annually for all respondents for designation and compliance.
With respect to Core Principle 21, the Commission expects that each
of the 18 anticipated respondents may expend up to 10 hours quarterly
for filings required under the regulations, totaling 40 hours annually
for each respondent and 720 hours across all respondents with respect
to compliance with Core Principle 21.
Aggregate Information Burden
In conclusion, amended collection 3038-0052 will result in
respondents expending up to an additional $3,640 annually based on an
hourly wage rate of $52 (30 hours + 40 hours x $52) to comply with the
proposed rules. This would result in an aggregated additional cost of
$65,520 per annum (18 respondents x $3,640). This final burden estimate
accounts for the 18 respondents that the Commission believes will be
affected by the final rule, rather than the 17 initially proposed.\531\
Otherwise, there is no change from the rule as proposed.
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\531\ The DCM NPRM referenced 17 respondents. The number of
respondents was revised to 18 to include Eris, which was designated
on October 28, 2011.
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C. Cost Benefit Considerations
Background on Designated Contract Markets
Designated contract markets (``DCMs'') were established by the
Commodity Futures Modernization Act of 2000 (``CFMA'') as one of two
forms of Commission-regulated markets for the trading of futures and
options contracts based on an underlying commodity, index, or
instrument. Specifically, the CFMA established, under section 5 of the
CEA, eight designation criteria and 18 core principles governing the
designation and operation of DCMs. To implement the CFMA, the
Commission codified regulations under part 38 consisting largely of
guidance and acceptable practices which were illustrative of the types
of matters an applicant or DCM may address and at times provided a safe
harbor for demonstrating compliance, but did not necessarily mandate
the principle means of compliance.
Section 735 of the Dodd-Frank Act amended section 5 of the CEA by:
(1) Eliminating the eight designation criteria contained in former
section 5(b) of the CEA; (2) revising the existing core principles,
including the incorporation of many of the substantive elements of the
former designation criteria; and (3) adding five new core principles,
thereby requiring applicants and DCMs to comply with a total of 23 core
principles as a condition of obtaining and maintaining designation as a
contract market.
The Dodd-Frank Act also amended Core Principle 1 to provide that in
its discretion, the Commission may determine by rule or regulation the
manner in which DCMs comply with the Core Principles.\532\ Accordingly,
in proposing this rulemaking, the Commission undertook a comprehensive
evaluation of its existing DCM rules, guidance, and acceptable
practices associated with each core principle in order to update those
provisions and determine which core principles would benefit from new
or revised regulations. As described in this notice of final
rulemaking, in addition to codifying new rules for several core
principles, the Commission also is maintaining the guidance and
acceptable practices, with necessary modifications, in many instances.
The Commission believes that the promulgation of bright-line
requirements in those instances where an industry best practice has
developed will better serve the goals of the Dodd-Frank Act, and will
provide the industry and market participants with greater specificity
and regulatory transparency, and will improve the Commission's ability
to effectively enforce its regulations.
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\532\ The Dodd-Frank Act amended Core Principle 1 to clarify
that boards of trade have reasonable discretion in establishing the
manner in which they comply with the core principles, ``[u]nless
otherwise determined by the Commission by rule or regulation.'' 7
U.S.C. 7(d)(1).
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The Commission's Cost Benefit Consideration
Section 15(a) of the CEA requires the Commission to ``consider the
costs and benefits'' of its actions 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.\533\
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\533\ 7 U.S.C. 19(a).
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To further the Commission's consideration of the costs and benefits
imposed by its regulations, the Commission requested in the DCM NPRM
that commenters provide data and any other information or statistics on
which they relied to reach any conclusions regarding the costs and
benefits of the proposed rules.\534\ The Commission received one
comment that provided quantitative information pertaining to the costs
relevant to the Commission's proposed rules for Core Principle 9.\535\
A number of commenters did, however, express the general view that
there would be significant costs associated with implementing and
complying with the proposed rules, with some commenters generally
stating their belief that the costs would outweigh any potential
benefits.\536\ Given the lack of quantitative data provided in the
comments or publicly available, the Commission has provided a
qualitative description of the costs that would be incurred by
DCMs.\537\ In a
[[Page 36666]]
number of instances, the Commission is adopting rules that codify
existing norms and best practices of DCMs (often reflected in existing
guidance and acceptable practices and recommendations made in recent
Rule Enforcement Reviews (``RERs''). In those cases, the existing norms
or best practices serve as the baseline--that is, the point from which
the Commission considers the incremental costs and benefits of the
regulations adopted in this release. In other cases, however, there is
no existing baseline either because the requirements arise under the
new or revised core principles, or because the Commission determined to
revise existing requirements or practices.
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\534\ 75 FR at 80605, Dec. 22, 2010.
\535\ CME Comment Letter (Aug. 3, 2011). As discussed above, the
Commission will consider all comments related to the proposed rules
implementing Core Principle 9 when it finalizes those rules. The
Commission expects and plans to finalize the rules implementing Core
Principle 9 when it finalizes the SEF rulemaking.
\536\ See, e.g., comment letters from CME (Feb. 22, 2011, Apr.
18, 2011, Jun. 3, 2011 and Aug. 3, 2011), MGEX (Feb. 22, 2011 and
Jun. 3, 2011), and GreenX (Feb. 22, 2011).
\537\ Moreover, for each core principle, the first section of
the regulation is a codification of the statutory language of the
core principle as a rule--and accordingly, the Commission did not
consider the costs and benefits of these rules because they do not
reflect the exercise of discretion by the Commission. Where the
Commission includes additional regulations for a core principle, the
Commission considered the costs and benefits.
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To assist the Commission and the public in assessing and
understanding the economic costs and benefits of the final rule, the
Commission has analyzed the costs of those regulations adopted in this
rulemaking that impose additional requirements on DCMs above and beyond
the baseline described above. In most instances, quantification of
costs is not reasonably feasible because costs depend on the size and
structure of DCMs, which vary markedly, or because quantification
required information or data in the possession of the DCMs to which the
Commission does not have access, and which was not provided in response
to the NPRM. The Commission notes that to the extent that the
regulations adopted in this rulemaking result in additional costs,
those costs will be realized by DCMs in order to protect market
participants and the public. In adopting these final regulations, the
Commission attempted to take the least-prescriptive means necessary to
promote the interests of the Dodd-Frank Act without impacting
innovation and flexibility.
The following costs and benefits are organized, for the most part,
by core principle. For each DCM core principle,\538\ the Commission
summarizes the final regulations, describes and responds to comments
discussing the costs and benefits of the proposed regulations, and
considers the costs and benefits of the associated regulations,
followed by a consideration of those costs and benefits in light of the
five factors set out in Sec. 15(a) of the CEA. In addition, the
Commission considers the costs and benefits associated with the
codification of rules in place of guidance and acceptable practices.
The Commission notes that many of its regulations refer to requirements
that are contained in other rulemakings, some of which have been
finalized and others which are still before the Commission. The costs
and benefits of these regulations are discussed in connection with
those other rulemakings.
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\538\ The costs and benefits of Core Principles 15, 16, 17, and
22 are discussed in connection with separate rulemakings for
``Governance Requirements for Derivatives Clearing Organizations,
Designated Contract Markets, and Swap Execution Facilities;
Additional Requirements Regarding the Mitigation of Conflicts of
Interest,'' 76 FR 722, Jan. 6, 2011, and ``Requirements for
Derivatives Clearing Organizations, Designated Contract Markets, and
Swap Execution Facilities Regarding the Mitigation of Conflicts of
Interest,'' 75 FR 63732, Oct. 18, 2010. The substantive regulations
implementing Core Principles 15, 16, 17, and 22 were proposed in
those separate rulemakings. Until such time as the Commission may
adopt the final substantive rules implementing these core
principles, the Commission is maintaining the current guidance and
acceptable practices under part 38 relevant to Core Principles 15
and 16. Accordingly, the existing guidance and acceptable practices
from appendix B to part 38 relevant to these core principles is
being codified in the revised appendix B adopted in this final
rulemaking. This will not result in additional costs because the
Commission is simply codifying existing Guidance and Acceptable
Practices. At such time as the Commission may adopt the final rules
implementing these core principles, appendix B will be amended
accordingly.
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The Commission further notes that certain final rules, including
Sec. Sec. 38.3(b), (c), (e), and (f), 38.5(a) and (b) and 38.256,
38.257, and 38.258 are essentially unchanged from existing rules
applicable to DCMs and are not discussed further in this section, since
they do not impose new costs and benefits as a result of the
Commission's rulemaking.
Finally, the Commission is obligated to estimate the burden of, and
provide supporting statements for, any collections of information it
seeks to establish under considerations contained in the Paperwork
Reduction Act,\539\ and to seek approval of those requirements from the
Office of Management and Budget. Therefore, the estimated burden and
support for the collections of information in this rulemaking, as well
as the consideration of comments thereto, are discussed in the
Paperwork Reduction Act section of this rulemaking as required by that
statute.
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\539\ 44 U.S.C. 3501 et seq.
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(1) Rules in Lieu of Guidance and Acceptable Practices
Appendices A and B to part 38 of the Commission's regulations
provide guidance and acceptable practices for DCMs to comply with the
CFMA DCM core principles and designation criteria. In this release, the
Commission is codifying as rules certain of these obligations of DCMs.
The rules codify certain DCM practices that Commission staff has
historically recommended in RERs as appropriate under the guidance and
acceptable practices, which are already followed by DCMs. In certain
cases, the rules are less prescriptive than the existing guidance and
acceptable practices they replace, and the rules therefore maintain the
flexibility for DCMs to determine many aspects of their compliance
programs.
Summary of Comments
As described in this release, the Commission received a number of
comments opposing the codification of rules in lieu of guidance and
acceptable practices. In response to commenters' concerns, the
Commission is converting some of the proposed rules, in whole or in
part, to guidance or acceptable practices.
CME, GreenX, MGEX, and KCBT expressed concern with the costs
imposed by the conversion of guidance and acceptable practices to
rules, stating that rules are more costly and burdensome to DCMs and
will increase costs to the Commission \540\ and end-users of
derivatives.\541\ CME claimed that there is no public policy benefit to
what it described as ``one-size fits all rules.'' \542\ OCX and CME
questioned the benefit of what they viewed as the prescriptive tone of
the proposed rules.\543\ Commenters also asserted that converting
guidance and acceptable practices to rules may hinder or deter
innovation for DCMs.\544\
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\540\ See CME Comment Letters (Feb. 22, 2011, Apr. 18, 2011,
Jun. 3, 2011 and Aug. 3, 2011); MGEX Comment Letter (Jun. 3, 2011);
GreenX Comment Letter (Feb. 22, 2011); KCBT Comment Letter at 9
(Feb. 22, 2011).
\541\ CME Comment Letter at 3 (Feb. 22, 2011).
\542\ CME Comment Letter at 8 (Feb. 22, 2011).
\543\ OCX Comment Letter at 1-2 (Feb. 22, 2011); CME Comment
Letter at 2-3 (Feb. 22, 2011).
\544\ See e.g., ICE Comment Letter at 1-2 (Feb. 22, 2011), Eris
Comment Letter at 2 (Feb. 22, 2011), CME Comment Letter at 3-4 (Feb.
22, 2011), GreenX Comment Letter at 1 (Feb. 22, 2011).
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Discussion
As explained throughout this release, in several instances the
Commission has converted compliance obligations that were previously
proposed as rules to guidance and acceptable practices (in whole or in
part) in order to accommodate certain comments raised by market
participants. In determining whether to codify a compliance practice in
the form of a rule or guidance and acceptable practices, the Commission
was guided by: (i) The comment letters that provided a basis for
greater flexibility or, in some instances, for greater specificity,
with respect to the stated compliance obligation; (ii) whether the
practice consisted of a widely-accepted industry practice; and
[[Page 36667]]
(iii) whether the proposed rules were of a discretionary nature, and
thus, were more appropriate as guidance and/or acceptable practices. In
other circumstances, the Commission believes that maintaining certain
regulations as rules will better serve market participants and the
public by providing greater transparency and specificity and by
improving the ability of the Commission to effectively enforce its
regulations.
While CME claimed that the codification of rules is more costly to
the Commission,\545\ the Commission does not believe that rules are
necessarily more costly to administer than guidance and acceptable
practices. To the contrary, guidance and acceptable practices may be
more costly to the Commission than rules because of the potential need
to review individual exchange actions that do not meet the provisions
of guidance and acceptable practices to determine if they comply with
the underlying core principle. The Commission also notes that many of
the rules are general in nature, allow for innovation and flexibility,
and are not intended to be ``one size fits all.'' In response to the
comment that rules will be more costly for end-users, the Commission
notes that these regulations apply to DCMs, not to end-users, and are
intended to protect market participants.
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\545\ CME Comment Letter at 2-4 (Feb. 22, 2011).
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Commenters have suggested that as markets evolve or DCMs innovate,
rules may become outdated and may no longer be consistent with evolving
industry practice.\546\ The Commission notes that in such instances,
DCMs could petition the Commission for exemptive orders in order to
implement new methods of compliance or request that the Commission
propose revisions to its rules. The Commission notes that in accordance
with Executive Order 13579, it will periodically review its existing
significant regulations to determine whether any such regulations
should be modified, streamlined, expanded, or repealed so as to make
the agency's regulatory program more effective or less burdensome in
achieving the regulatory objectives.\547\
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\546\ See e.g., CME Comment Letter at 3 (Feb. 22, 2011), Eris
Comment Letter at 3 (Jun. 3, 2011), ICE Comment Letter at 10-11
(Feb. 22, 2011).
\547\ 76 FR 41587, July 14, 2011.
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Commenters also stated that converting guidance and acceptable
practices to rules may hinder or deter innovation for DCMs.\548\ The
Commission notes, in response to comments received, that many of the
rules that commenters interpret as possibly having an effect on
innovation, such as those that relate to technology (including certain
rules under Core Principle 4, Prevention of Market Disruption), have
been moved to guidance and acceptable practices in the final rule in
order to provide DCMs with greater flexibility.
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\548\ See e.g., ICE Comment Letter at 1-2 (Feb. 22, 2011), Eris
Comment Letter at 2 (Feb. 22, 2011), CME Comment Letter at 3 (Feb.
22, 2011), GreenX Comment Letter at 1 (Feb. 22, 2011).
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Costs
Costs to DCMs
As noted above, the rules finalized in this release generally are
designed to codify existing industry practice, and implement new or
revised core principles. However, the Commission is cognizant of the
possibility that less established DCMs may require more significant
modifications to their existing programs to comply with these rules if
they do not currently follow industry practices. Nevertheless, it is
likely less costly for DCMs to demonstrate compliance with rules than
to demonstrate compliance with guidance and acceptable practices, which
may require significantly more communications and exchange of documents
with Commission staff. Accordingly, the primary cost imposed on DCMs as
a result of converting guidance and acceptable practices to rules is
the potential inability of DCMs to choose a different method of
complying with the core principles as DCMs innovate or industry
standards evolve. This cost may be present in each instance throughout
this document where the Commission is replacing guidance or acceptable
practices with rules. However, the Commission has made every attempt to
provide sufficient flexibility to allow DCMs to continue to pursue the
most efficient methods of compliance, within the rules, guidance and
acceptable practice structure adopted in this release.
It also is possible that certain DCMs are currently engaged in
practices that they consider to be in compliance with core principles,
but which do not precisely follow existing guidance or acceptable
practices (perhaps because the DCM considers a somewhat different
method of complying with the core principle to be more efficient given
the nature of the DCM). In such an instance, a DCM would now need to
change those practices to be in full compliance with the rule. The
Commission is not aware of any specific examples of DCMs that consider
themselves to be in compliance with core principles, while not
following the Commission's guidance or acceptable practices. Therefore,
the Commission is unable to quantify the cost associated with this
potential scenario. However, all DCMs should be in compliance with
existing guidance and acceptable practices, and the Commission does not
believe that DCMs employing variant practices can object to the cost of
complying with existing guidance and acceptable practices.
As discussed above, the Commission notes that many of the rules
that could affect innovation, such as those that relate to technology,
have been moved to guidance and acceptable practices in the final rule
in order to provide DCMs with added flexibility. However, even with
guidance and acceptable practices in place of rules, innovation costs
may still exist to a degree since the Commission may need to modify
guidance and acceptable practices as industry practices evolve.
Furthermore, as is the case under current guidance and acceptable
practices, a DCM that devises a new method of complying with a core
principle may incur certain costs to demonstrate such compliance to the
Commission. It is not feasible to quantify these costs since the
Commission has no way to predict how industry practices will evolve or
what rule adjustments will be needed.
Costs to Market Participants and the Public
If converting guidance and acceptable practices to rules hinders or
deters innovation for DCMs, commenters have asserted that DCMs may
decline to innovate to the same extent that they innovate at present,
potentially depriving market participants and the public of important
advancements. However, costs to market participants as a result of
converting some of the guidance and acceptable practices to rules
should be minimal since existing requirements, including guidance and
acceptable practices, would also need to be adjusted as important
advancements occur, and commenters provided no specific examples of how
converting the guidance and acceptable practices to rules would deter
innovation. It is not feasible to quantify these costs since the
Commission has no way to predict how DCMs will innovate or industry
practices will evolve.
Benefits
Benefits to DCMs, Market Participants, and the Public
The codification of rules in lieu of guidance and acceptable
practices provides specificity and transparency to DCMs, market
participants, and the public. It also increases the likelihood of
prompt compliance with the core
[[Page 36668]]
principles because DCMs will have a clear understanding of what is
required in order to demonstrate compliance with the applicable core
principle. In turn, a DCM's ability to achieve prompt compliance with
the rules instills confidence in market participants and the public who
utilize the markets to offset risk and who utilize prices derived from
the price discovery process of trading in centralized DCM markets.
Specific enforceable standards also promote more efficient and
effective enforcement by the Commission.
The costs and benefits of each of the rules, including rules that
replace guidance or acceptable practices, are set out below in the
cost-benefit discussion for the general compliance regulations under
part 38 and for each core principle.
(2) General Compliance Regulations Under Part 38 \549\
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\549\ Proposed regulations 38.1 and 38.2 are not discussed
because they impose no requirements on market participants.
Regulation 38.1 updates internal references within part 38 and
regulation 38.2 specifies the regulations from which DCMs will be
exempt. Proposed regulations 38.3(b), (c), (e), and (f) are
essentially unchanged from existing rules and impose no new costs or
benefits. Additionally, regulation 38.6 is not being revised by this
release.
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Sec. 38.3(a) (Application procedures)
Rule Sec. 38.3 sets forth the application and approval procedures
for new DCM applicants. Rule Sec. 38.3(a) specifies the application
process, including the new requirement that the board of trade file the
DCM Application Form (``Form DCM'') electronically. Rule Sec. 38.3(a)
also eliminates the 90-day expedited approval procedures for DCM
applications. Accordingly, all DCM applications will be reviewed within
the 180-day period governed by procedures specified in CEA section
6(a).\550\
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\550\ 7 U.S.C. 8(a).
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Summary of Comments and Discussion
The Commission did not receive comments on the costs associated
with filling out Form DCM.
Eris contended that eliminating the 90-day accelerated review
process would place new entities at a competitive disadvantage because
it would delay their time to market, which they believe is critical for
new entrants.\551\
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\551\ Eris Comment Letter at 4 (Feb. 22, 2011). Eris was
designated as a contract market on October 28, 2011.
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The Commission has found that, in the interest of meeting the
expedited approval timeline, applicants seeking expedited review often
file incomplete or draft applications without adequate supporting
materials. This has resulted in the expenditure of significant amounts
of staff time reviewing incomplete or draft applications, necessitating
numerous follow-up conversations with applicants, and usually resulting
in the removal of applications from the expedited review timeline.
Additionally, some applications raise new or unique issues that require
additional time for the Commission to review. Notably, since the
passage of the CFMA, eleven DCM applicants have requested expedited
treatment, but, for some of the reasons noted above, only three were
designated within the shortened timeframe.\552\ Moreover, eliminating
the accelerated 90-day review process will not prevent DCMs from coming
to market in an expeditious manner because the rule does not prevent
the Commission from continuing to review applications within a shorter
timeframe if DCM applicants submit substantially complete applications.
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\552\ The three applicants that were designated within the
shortened timeframe included NYSE Liffe, Chicago Climate Futures
Exchange (``CCFE''), and GreenX. The remaining applications that
were not approved during the expedited timeframe included: Inet
Futures Exchange, OneChicago, CBOE Futures Exchange, U.S. Futures
Exchange, ELX Futures, The Trend Exchange, NQLX Futures Exchange,
and Cantor Futures. The Commission notes that while NYSE Liffe,
CCFE, and GreenX became designated within 90 days, they each
submitted multiple draft DCM applications that were processed and
reviewed by Commission staff for significantly longer than 90 days.
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Costs
Form DCM is designed to elicit a demonstration that an applicant
can satisfy each of the DCM core principles. Toward this end, Form DCM
requires submission of information about an applicant's intended
operations. Much of this information has been required of applicants
under previous regulations. Accordingly, the use of Form DCM does not
represent a substantive departure from the Commission's practices over
the past decade. With respect to new core principles, Form DCM captures
information that tracks statutory requirements and applicable
Commission implementing regulations. In fact, by providing greater
specificity and transparency as to what is expected from an applicant
and by reducing the need for Commission staff to request, and the
applicant to provide, supplementary information, Form DCM should reduce
costs for applicants by minimizing the flow of documentation and
discussions between DCM applicants and Commission staff needed for
applicants to submit a complete application.
As noted above, eliminating the 90-day expedited review period is
unlikely to impose additional costs on DCMs or to result in competitive
disadvantage because it does not prevent the Commission from continuing
to review applications within a shorter timeframe if DCM applicants
submit substantially complete applications.
Benefits
The new application form has several benefits for DCM applicants.
The new form is designed to ensure that applicants are in compliance
with the DCM Core Principles--as required by the statute. The form
improves upon existing practice by standardizing the information that a
DCM must provide. The form includes comprehensive instructions that
will guide DCM applicants and specify lists of documents and
information that must be provided as exhibits. The Commission
anticipates that the new application form will streamline the DCM
designation process, both for DCM applicants and the Commission. The
form will provide applicants with greater specificity and transparency
regarding the type of information that is required. The use of the
standardized form is expected to reduce the amount of time Commission
staff will need to review applications, which should enable qualified
DCMs to begin operating sooner. Other than the specific requirements
necessitated by the new and revised core principles, and applicable
regulations, the majority of information required under the new form
consists of information that the Commission historically has required.
With respect to the elimination of the expedited review period, the
Commission determined in the proposal that the 90-day accelerated
review process was inefficient and impracticable. Applicants seeking
expedited review often filed incomplete or draft applications, without
adequate supporting materials, in the interest of meeting the expedited
approval timeline.\553\ This required Commission staff to expend
significant amounts of time reviewing incomplete or draft applications
and usually resulted in removal of the application from the expedited
review timeline. Eliminating the expedited process is consistent with
[[Page 36669]]
the statutory 180-day review period, and should result in a better use
of Commission resources. During the 180-day review period, applicants
will have adequate time to respond to Commission staff requests for
additional information, resulting in a more efficient process for
applicants and for the Commission.\554\
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\553\ For example, while NYSE Liffe, GreenX, and CCFE became
designated 79, 88, and 60 days, respectively, after they submitted
their applications, they each submitted several versions of draft
applications that required numerous follow-up conversations with
Commission staff. While GreenX technically became designated within
88 days, the Commission actually processed GreenX's application in
draft form for nearly a year.
\554\ This rule is consistent with the Commission's elimination
of the 90-day expedited review procedures for derivatives clearing
organization applications under part 39. See ``Derivatives Clearing
Organization General Provisions and Core Principles,'' 76 FR 69334,
69337, Nov. 8, 2011.
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Section 15(a) Factors
1. Protection of market participants and the public. Given the
critical role that DCMs play in the financial markets, a role that now
includes providing a marketplace for the trading of swaps as well as
futures and options, it is essential that the Commission conduct a
comprehensive and thorough review of all DCM applications. Such review
is essential for the protection of market participants and the public
insofar as it serves to limit the performance of DCM functions to only
those entities that have provided adequate demonstration that they are
capable of satisfying the core principles. The new Form DCM and the
elimination of the 90-day application review period will enable the
Commission to more efficiently and accurately determine whether it is
appropriate to designate a DCM applicant as a contract market.
2. Efficiency, competitiveness, and financial integrity. The
Commission expects that the use of Form DCM will promote efficiency,
competitiveness, and financial integrity by requiring at the outset all
information the Commission deems necessary to consider an application
for designation as a contract market. As discussed above, the
Commission's experience with lengthy reviews of draft applications and
other materially incomplete submissions highlights the need for a
streamlined and formalized process. By replacing a series of provisions
under current Sec. 38.3(a) with a streamlined Form DCM, and by
eliminating the 90-day expedited application review period, the
Commission is promoting increased efficiency by providing specific
guidance to applicants and DCMs before they undertake the application
process, and by facilitating the submission of a materially complete
final application. This also will reduce the need for the submission of
supplemental materials and repeated consultation between applicants and
Commission staff. The result will be a more cost effective and
expeditious review and approval of applications. This will benefit
potential and existing DCMs as well as free Commission staff to handle
other regulatory matters.
In addition, the use of Form DCM will make available to the public
the Commission's informational requirements so that all prospective
applicants have a heightened understanding of what is involved in the
preparation and processing of an application. Form DCM will promote
greater transparency in the process and will enhance competition among
DCMs by making it easier for qualified applicants to undertake and
navigate the application process in a timely manner.
Form DCM is designed to address an applicant or a DCM's ability to
comply with the core principles, which form the bedrock of the
Commission's oversight, and which Congress determined are essential to
ensure the financial integrity of transactions and derivatives markets,
generally. In particular, the required information in the Form DCM
(Exhibits I-J--Financial Information and M and T--Compliance) elicit
important information supporting the applicant or DCM's ability to
operate a financially sound DCM and appropriately manage the risks
associated with its role in the financial markets.
3. Price discovery. The Commission does not anticipate that use of
Form DCM or the elimination of the 90-day review period will impact the
price discovery process.
4. Sound risk management policies. The Commission expects that the
use of Form DCM will promote sound risk management practices by
requiring applicants and DCMs to examine their proposed risk management
program through a series of detailed exhibits and submissions. The
submission of exhibits relating to risk management, including exhibits
I-J (Financial Information) and M, O, and T (Compliance) aid Commission
staff's analysis and evaluation of an applicant's ability to comply
with the core principles.
5. Other public interest considerations. The standardization and
streamlining of the DCM application process benefits the public in
terms of more efficient use of Commission resources and more cost-
effective and transparent requirements for applicants and DCMs. DCMs
play a key role in the financial markets, and this role takes on even
greater significance now that swaps may be traded on DCMs. A coherent
and comprehensive approach to DCM designation is needed to ensure that
only qualified applicants will be approved and that they are capable of
satisfying the requirements of the core principles and Commission
regulations.
Sec. 38.3(d) (Request for transfer of designation) and Sec. 38.5
(Information relating to contract market compliance)
Rule Sec. 38.3(d) is a new rule that formalizes the procedures
under which a DCM may request the transfer of its designation to a new
legal entity as a result of a corporate event such as a merger or
corporate reorganization. Rule Sec. 38.5(c) \555\ is a new rule that
requires that the DCM must submit to the Commission a notification of
each transaction involving the transfer of ten percent or more of the
equity interest in the designated contract market, and that such
notification must be provided at the earliest possible time but in no
event later than ten business days following the date upon which the
designated contract market enters into a legally binding obligation to
transfer the equity interest. As described in the preamble, upon
receiving a notification of an equity interest transfer, the Commission
may request, where necessary, additional information and specific
documentation from the DCM pursuant to its authority under Sec. 38.5,
although such documentation is no longer required with the initial
notification. The Commission did not receive any comments discussing
the costs or benefits of proposed Sec. Sec. 38.3(d) or 38.5(c).
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\555\ The provisions in regulation 38.5 regarding requests for
information and demonstrations of compliance (paragraphs (a) and (b)
in the final rules) were largely unchanged after Dodd-Frank and will
not be discussed in this rulemaking because they do not result in
any incremental costs or benefits.
---------------------------------------------------------------------------
Costs
Under Sec. 38.3(d), only DCMs that wish to request the transfer of
their designation will incur the one-time cost associated with filing
the request with the Commission and preparing the underlying documents
and representations that must be included with the request. The
Commission notes that it has historically requested that DCMs file
similar information in the event of a transfer of designation. The
Commission is reducing the burden associated with the proposed
regulations by clarifying that DCMs have the flexibility to determine
the appropriate form of the documents they are required to submit. The
Commission estimates that the submissions and notifications required
under Sec. 38.3(d) will take around two hours to compile at a cost of
approximately $104.
The Commission is also reducing the burden associated with proposed
[[Page 36670]]
Sec. 38.5(c) by eliminating the requirement that DCMs must provide a
series of documents and a representation along with the notification of
an equity interest transfer. DCMs that enter into agreements that could
result in equity interest transfers of 10 percent or more will incur
one-time costs associated with preparing and submitting the required
notification for each event. The Commission estimates that the initial
notification required under Sec. 38.5(c) will take around one hour to
compile at a cost of approximately $52.
Benefits
Section 38.3(d) formalizes the procedures that a DCM must follow
when requesting the transfer of its DCM designation and positions
comprising open interest in anticipation of a corporate event. The
provision requiring three months advance notice of an anticipated
corporate change will provide the Commission with sufficient time to
evaluate the anticipated change and determine the likely impact of the
change on the DCM's governance and obligations, as well as the impact
of the change on the rights and obligations of market participants
holding open positions. The rule will permit the Commission to evaluate
the transferee's ability to comply with the applicable laws and
regulations. The rule also requires DCMs to submit a representation
that they are in compliance with the applicable laws and regulations.
This requirement provides regulatory specificity to DCMs regarding
their obligations.
Section 38.5 provides Commission staff with an opportunity to
determine whether a change in ownership at a DCM resulting from an
equity interest transfer will adversely impact the operations of the
DCM, or the DCM's ability to comply with the Core Principles and the
Commission's regulations. Section 38.5 ensures that DCMs remain mindful
of their self-regulatory responsibilities when negotiating the terms of
significant equity interest transfers.
Section 15(a) Factors (Sec. Sec. 38.3(d) and 38.5(c))
1. Protection of market participants and the public. Given the
critical role that DCMs play in the financial markets, a role that now
includes providing a marketplace for the trading of swaps as well as
futures and options, it is essential that the Commission conduct a
comprehensive and thorough review of all requests for transfer of
designation and notifications of equity interest transfers. Such review
is essential for the protection of market participants and the public
insofar as it serves to limit the performance of DCM functions to only
those entities that have provided adequate demonstration that they are
capable of satisfying the core principles. The new formalized
procedures for transfers of designation and equity interest transfers
will provide the Commission with the opportunity to determine the
impact those transfers are likely to have on a DCM's ability to comply
with the core principles and on the market.
2. Efficiency, competitiveness, and financial integrity. The
Commission expects that the formalized procedures for requesting a
transfer of designation and for notifying the Commission of an equity
interest transfer will promote efficiency, competitiveness, and
financial integrity by providing the Commission with the opportunity to
obtain the information the Commission deems necessary to consider such
requests. The result will be more cost effective review and approval of
requests for transfer of designation and equity interest. This will
benefit DCMs. Financial integrity is also promoted as the transferee's
ability to meet core principles will be examined.
3. Price discovery. The Commission does not anticipate that the
formalized process for requesting a transfer of designation or
notifying the Commission of an equity interest transfer will impact the
price discovery process.
4. Sound risk management policies. The Commission expects that the
formalized processes for transfers of designation and equity interests
will promote sound risk management practices by requiring DCMs to
examine their proposed risk management program through a series of
submissions that aid Commission staff's analysis and evaluation of a
DCM's ability to comply with the core principles.
5. Other public interest considerations. The standardization and
streamlining of the transfer of designation and equity interest
transfer process benefits the public by permitting more efficient use
of Commission resources and more cost-effective requirements for DCMs.
A coherent and comprehensive approach to transfers of designations and
equity interests is needed to ensure that all DCMs continue to satisfy
the requirements of the core principles and Commission regulations.
Sec. 38.3(g) (Requirements for existing designated contract markets)
Proposed rule Sec. 38.3(g) required existing DCMs to certify
compliance with each of the core principles within 60 days of the
effective date of the final rules. In response to comments, the
Commission has eliminated this requirement from the final rules. The
Commission believes that the removal of this provision will decrease
costs for DCMs.
Sec. 38.4 (Procedures for Listing Products)
Section 38.4 conforms the prior regulation to that of new rules in
part 40 of the Commission's regulations.\556\ There are no costs
imposed by the conforming changes beyond those discussed in connection
with that rulemaking.
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\556\ ``Provisions Common to Registered Entities,'' 76 FR 44776,
Jul. 27, 2011.
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Sec. 38.7 (Prohibited use of data collected for regulatory purposes)
Rule Sec. 38.7 is a new rule that prohibits a DCM from using for
business or marketing purposes proprietary or personal information that
it collects from market participants unless the market participant
clearly consents to the use of its information in such a manner.\557\
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\557\ The Commission notes that the requirements of regulation
38.7 are in line with similar rules intended to provide privacy
protections to certain consumer information finalized in a separate
rulemaking implementing regulations under the Fair Credit Reporting
Act. See 76 FR 43879, Jul. 22, 2011.
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Costs
The Commission notes that in response to general comments that did
not discuss costs or benefits, it has amended this provision to allow
DCMs to use this information for business or marketing purposes if the
market participant clearly consents to the use of its information in
such a manner. The costs imposed by this provision are limited to the
cost a DCM might incur in obtaining a market participant's consent to
use its information for the purposes described above. The Commission
does not prescribe the method by which a DCM must obtain such consent
and believes that the burden of doing so would be minimal and would
likely involve sending an email or a letter.
Benefits
This rule protects market participants' information provided to a
DCM for regulatory purposes from being used to advance the commercial
interests of the DCM. The rule eliminates incentives on the part of
DCMs to use market participants' proprietary or personal information
for their own commercial gain. The rule does, however, afford market
participants the flexibility to
[[Page 36671]]
consent to a DCM's use of their personal information for commercial
purposes if they so desire.
Section 15(a) Factors
1. Protection of market participants and the public. This rule
protects market participants and the public by ensuring that
information they provide to DCMs for regulatory purposes it not used
inappropriately to advance the commercial interests of the DCM without
their consent.
2. Efficiency, competitiveness, and financial integrity. This rule
encourages greater participation in the markets by ensuring market
participants that their proprietary and personal information will not
be used by DCMs without their consent. Increased participation by
market participants will foster greater liquidity, tighter spreads, and
more competitive markets. The rule also promotes efficient and
competitive markets by ensuring that DCMs do not use access to their
market participants' data (without their consent) as a source of
competitive advantage.
3. Price discovery. Fostering a competitive environment, as
mentioned above, aids in the compilation of information traded in
markets to further price discovery.
4. Sound risk management practices. The Commission has not
identified any effects that this rule will have on sound risk
management practices.
5. Other public interest considerations. The Commission has not
identified any effects that this rule will have on other public
interest considerations.
Sec. 38.8 (Listing of Swaps on a Designated Contract Market)
Section 38.8(a) provides that a DCM that lists a swap contract for
trading on its contract market for the first time must file with the
Commission a written demonstration detailing how the DCM is addressing
its self-regulatory obligations with respect to swap transactions.
Section 38.8(b) provides that prior to listing swaps for trading on
or through the DCM, each DCM must request an alphanumeric code from the
Commission for purposes of identifying the DCM pursuant to part 45.
Summary of Comments and Discussion
ELX argued that the DCM NPRM did not make clear what criteria will
be used to distinguish between a swap contract and a futures contract
and argued that this ambiguity will cause uncertainty and redundant
costs for boards of trade that would prefer to follow a DCM model
without having to adopt a parallel set of rules and procedures.\558\
---------------------------------------------------------------------------
\558\ ELX Comment Letter at 4 (Feb. 22, 2011).
---------------------------------------------------------------------------
As noted in the Final Exemptive Order issued July 14, 2011,\559\ a
DCM may list and trade swaps after July 16, 2011 under the DCM's rules
related to futures contracts, without further exemptive relief. In the
Order, the Commission noted that if a DCM intends to trade swaps
pursuant to the rules, processes, and procedures currently regulating
trading on its DCM, the DCM may need to amend or otherwise update its
rules, processes, and procedures in order to address the trading of
swaps.\560\
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\559\ 76 FR 42508, Jul. 14, 2011.
\560\ Id. at 42518, n. 131.
---------------------------------------------------------------------------
Costs and Benefits
In order to comply with new Sec. 38.8(a), DCMs listing swaps for
the first time will incur costs associated with filing the required
demonstration detailing how the DCM is addressing its self-regulatory
obligations and fulfilling its statutory and regulatory obligations
with respect to swap transactions. The Commission estimates that this
filing will take two hours to complete at a cost of about $104.
With respect to Sec. 38.8(b), the comments, costs, and benefits of
this provision will be discussed in the rulemaking that implement swap
data recordkeeping and reporting requirements under part 45 of the
Commission's regulations.\561\
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\561\ See 77 FR 2136, Jan. 13, 2012.
---------------------------------------------------------------------------
Sec. 38.9 (Boards of Trade Operating Both a Designated Contract Market
and Swap Execution Facility)
Section 38.9 provides that a board of trade that operates a DCM
also may operate a SEF, provided that the board of trade separately
register as a SEF pursuant to the requirements set forth in part 37.
The rule also requires such boards of trade to comply with the core
principles under section 5h of the Act and the SEF rules under part 37,
on an ongoing basis.
Additionally, the rule codifies the requirement contained in
section 5h(c) of the CEA, which provides that a board of trade that
operates both a DCM and a SEF, and that uses the same electronic trade
execution system for executing and trading swaps that it uses in its
capacity as a DCM, must clearly identify to market participants for
each swap whether the execution or trading is taking place on the DCM
or the SEF. The Commission did not receive any comments on the costs or
benefits of this provision and is adopting the rule as proposed.
Costs and Benefits
The obligations imposed by Sec. 38.9 are codifications of the new
statutory requirement placed on DCMs. The obligations imposed by the
CEA are not within the Commission's discretion to change. However, the
Commission believes there are several benefits to restating the
statutory requirements in the regulations. Codification of statutory
requirements in the regulations will improve the Commission's ability
to enforce the statutory language and will provide market participants
with a more unified regulatory picture and with greater context and
specificity regarding the congressional intent underlying the
regulations.
Sec. 38.10 (Reporting of Swaps Traded on a Designated Contract Market)
Section 38.10 provides that each DCM that trades swaps must report
specified swap data as provided under parts 43 and 45.\562\ This
provision is consistent with the statute's reporting requirements as
reflected in sections 2(a)(13)-(14) and 21(b) of the CEA. The costs and
benefits of these rules are discussed in connection with those
rulemakings.
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\562\ ``Real-Time Public Reporting of Swap Transaction Data,''
77 FR 1182, Jan. 9, 2012; ``Swap Data Recordkeeping and Reporting
Requirements,'' 77 FR 2136, Jan. 13, 2012.
---------------------------------------------------------------------------
(3) Core Principle 2: Compliance With Rules
For the most part, the regulations adopted under Core Principle 2
codify: (1) Language found in the guidance and acceptable practices
issued under former Core Principle 2 and former Designation Criterion
8; (2) existing DCM compliance practices that the Commission believes
constitute best practices; and (3) recommendations made over the past
several years by the Commission in RERs, and which are currently
largely followed. The Commission also incorporated into the rules for
Core Principle 2 certain concepts contained in part 8 of its
regulations--Exchange Procedures for Disciplinary, Summary, and
Membership Denial Actions. Most DCMs' compliance and enforcement
practices relating to Core Principle 2 obligations historically have
been consistent with the rules contained in part 8. The Commission is
also adopting some requirements that are new for DCMs. The costs and
benefits of each of these requirements are discussed below.
[[Page 36672]]
Sec. 38.151(a) (Jurisdiction), Sec. 38.151(b) (Impartial access by
members, persons with trading privileges, and independent software
vendors) and Sec. 38.151(c) (Limitations on access)
Section 38.151(a) requires that prior to granting a member or
market participant access to its markets, the DCM must require the
member or market participant to consent to its jurisdiction. Section
38.151(b)(1) requires a DCM to provide its members, persons with
trading privileges, and independent software vendors (``ISVs'') with
impartial access to its markets and services, including access criteria
that are impartial, transparent, and applied in a non-discriminatory
manner. Section 38.151(b)(2) requires that the DCM provide comparable
fee structures for members, persons with trading privileges, and ISVs
receiving equal access to, or services from, the DCM.
Section 38.151(c) (Limitations on Access) requires a DCM to
establish and impartially enforce rules governing any decision by the
DCM to deny, suspend, or permanently bar a member's or a person with
trading privileges access to the contract market. Accordingly, any
decision by a DCM to deny, suspend, or permanently bar a member's or
person with trading privileges access to the DCM must be impartial and
applied in a non-discriminatory manner. Section 38.151(a) derives from
the statutory language of Core Principle 2. While Sec. Sec. 38.151(b)
and (c) are new rules, they codify existing industry practice and
current Commission requirements.
Summary of Comments
CME stated that it would be costly to comply with the proposed
Sec. 38.151(a) requirement that clearing firms obtain every customer's
consent to the regulatory jurisdiction of each DCM.\563\ KCBT
questioned the benefit of implementing the proposed rule.\564\
---------------------------------------------------------------------------
\563\ CME Comment Letter at 16 (Feb. 22, 2011).
\564\ KCBT Comment Letter at 2 (Feb. 22, 2011).
---------------------------------------------------------------------------
With respect to 38.151(b)(1), MGEX stated that it is generally in
the best interest of the DCM to have open and available markets and
services. Therefore, MGEX argued that the proposed rule was unnecessary
and infringed on the business judgment of the DCM.\565\
---------------------------------------------------------------------------
\565\ MGEX Comment Letter at 3 (Feb. 22, 2011).
---------------------------------------------------------------------------
With respect to 38.151(b)(2), CME argued that the Commission does
not have the authority to set or limit fees charged by DCMs, likening
the requirement for comparable fee structures to an industry-wide fee
cap that has the effect of a tax.\566\
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\566\ CME Comment Letter at 8-9 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission believes that Sec. 38.151(a) codifies
jurisdictional requirements necessary to effectuate Core Principle 2's
statutory mandate that a board of trade ``shall have the capacity to
detect, investigate, and apply appropriate sanctions to any person that
violates any rules of the contract market.'' In the Commission's view,
a DCM must establish jurisdiction prior to granting members and market
participants access to its markets in order to effectively investigate
and sanction persons that violate DCM rules. A DCM should not be in the
position of asking market participants to voluntarily submit to
jurisdiction after a potential rule violation has been found. In
response to CME's comment, the Commission clarifies that each DCM may
determine for itself how it will secure such agreements. For example, a
DCM could utilize its clearing firms to secure the agreement. The
Commission recognizes that DCMs may need additional time to secure
market participants' agreements to jurisdiction. Accordingly, in order
to reduce the burden associated with this rule, the Commission is
granting DCMs up to 180 additional days following the applicable
effective date for existing members and market participants to comply
with the requirements of Sec. 38.151(a).
With respect to Sec. 38.151(b), and as discussed in further detail
in the preamble, the Commission has considered the arguments asserted
by commenters and determined that the rule is necessary in order to
prevent the use of discriminatory access requirements as a competitive
tool against certain participants. The Commission has, however,
listened to commenters' concerns about the costs associated with the
regulation and believes the rules strike an appropriate balance.
Any comment implying that the Commission is attempting to set or
limit fees charged by DCMs is misplaced. The requirement in Sec.
38.151(b)(2) neither sets nor limits fees charged by DCMs. Rather, the
rule states only that the DCM set non-discriminatory fee classes for
those receiving access to the DCM as a way to implement the requirement
of impartial access to DCMs. Accordingly, DCMs may establish different
categories of market participants, but may not discriminate within a
particular category. As the Commission noted in the preamble, when a
DCM determines its fee structure, it may consider other factors in
addition to the cost of providing access. The fee structure was not
designed to be a rigid requirement that fails to take account of
legitimate business justifications for offering different fees to
different categories of entities seeking access. The Commission
recognizes that DCMs may also consider services they receive (in
addition to costs) when determining their fee structure. Accordingly,
the comment suggesting that the Commission does not have authority to
set fees is misplaced as the rule neither sets nor limits fees charged
by DCMs.
Costs
The costs associated with Sec. 38.151(a) derive from the statute
and are likely to be limited to the cost of obtaining customers'
consent to the DCM's jurisdiction. In response to comments received,
the Commission is not mandating the method for obtaining consent; this
may afford cost savings to DCMs. The Commission believes that most DCMs
are generally already in compliance with the requirements of Sec.
38.151(b), which require that DCMs provide comparable fee structures
for members, persons with trading privileges, and ISVs receiving equal
access to, or services from, the DCM. In addition, the Commission
believes that most DCMs currently have rules that comply with the
requirements of Sec. 38.151(c), which states that DCMs must establish
and enforce rules governing any decisions to deny, suspend, or
permanently bar a member's or market participant's access to the
contract market. Accordingly, the Commission believes that the final
rule is unlikely to impose additional costs on DCMs.
Benefits
The requirements of Sec. 38.151(a) ensure that DCMs can
effectively investigate and sanction persons that violate DCM rules, as
required by Core Principle 2. A DCM should not be in the position of
asking market participants to voluntarily submit to jurisdiction after
a potential rule violation has been found. This requirement also
ensures that market participants are clear that their trading practices
are subject to the rules of a DCM.
As noted above, the impartial access requirements of Sec.
38.151(b) prevent DCMs from using discriminatory access fee
requirements as a competitive tool against certain participants. Access
(and decisions to limit access) to a DCM should be based on the
financial and operational soundness of a participant, rather than
discriminatory or other improper motives. Impartial access benefits the
market by ensuring that all participants that meet the requirements are
able to trade on the DCM, thus
[[Page 36673]]
potentially increasing liquidity in the marketplace. The preamble's
discussion that any participant should be able to demonstrate financial
soundness either by showing that it is a clearing member of a DCO that
clears products traded on that DCM or by showing that it has clearing
arrangements in place with such a clearing member specifies that access
will be neutral and non-discriminatory. Granting such impartial access
to participants will likely improve competition within the market by
ensuring access criteria do not inappropriately deter market
participants from participating in the market.
The benefits described above also apply to the requirement that DCM
decisions to deny, suspend, or permanently bar a member or person with
trading privileges' access to the DCM should be impartial and applied
in a non-discriminatory manner.
Section 15(a) Factors
1. Protection of market participants and the public. The final
rules protect market participants by ensuring that DCMs can effectively
investigate and sanction persons that violate DCM rules, and by
ensuring that similarly situated market participants receive similar
access criteria and comparable fee structures, consistent with the
statute. Accordingly, the rules protect market participants from the
potential that DCMs may employ unfair or discriminatory practices in
rendering access determinations. In addition, the rules will provide
market participants with greater specificity regarding DCMs procedures
for denials and suspensions. This will benefit the market by ensuring
that market participants know what behavior will lead to denials and
suspensions and that denials and suspensions are being imposed in a
fair and non-discriminatory manner.
2. Efficiency, competitiveness, and financial integrity. The rules
prevent DCMs from employing discriminatory or preferential criteria in
granting members, persons with trading privileges, and ISVs access to
their market. Accordingly, the rules will likely promote participation
and competition within the marketplace by ensuring access criteria do
not inappropriately deter market participants from participating in the
market. Efficiency is promoted by defining clear rules governing the
denial or suspension of a member's or person with trading privileges
access to the contract market. The final rules may also promote
financial integrity in the derivatives markets because sound, non-
discriminatory access criteria and fee structures are less likely to
deter the financial integrity of members and market participants.
3. Price discovery. As noted above, the rules are likely to
increase competition within the market by optimizing market
participation. Increased participation is likely to enhance the DCM's
liquidity, leading to enhanced price discovery.
4. Sound risk management practices. The Commission has not
identified any effects that this rule will have on sound risk
management practices other than the effects related to the factors
above, especially with respect to financial integrity.
5. Other public interest considerations. The Commission has not
identified any effects that this rule will have on other public
interest considerations.
Sec. 38.152 (Abusive Trading Practices Prohibited)
Section 38.152 requires a DCM to prohibit abusive trading
practices, including front-running, wash trading, fraudulent trading,
and money passes, as well as any other trading practices that the DCM
deems to be abusive. The Commission did not receive any comments
discussing the costs or benefits of this provision.\567\
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\567\ CME commented that the rule is overly prescriptive. CME
Comment Letter at 17-18 (Feb. 22, 2011). The Commission considered
this comment in preparing this release and discusses the costs and
benefits of the codification of rules in lieu of guidance and
acceptable practices in further detail in section C(1) above.
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Costs
DCMs generally already have rules in place that prohibit the
conduct enumerated in the CEA and the final rule. They also have the
systems and staff necessary to detect, investigate, and prosecute
possible rule violations. Accordingly, the Commission believes that the
final rule is unlikely to impose additional costs on most DCMs.
Benefits
The rule ensures that DCMs prohibit the specific trading practices
identified in the rule, as well as any manipulative or disruptive
trading practices prohibited by the CEA or by Commission regulation.
Market participants and the public are likely to have greater
confidence in markets that are protected from abusive trade practices,
and therefore will be more willing to participate in the market, which
may enhance liquidity, competition, and price discovery.
Section 15(a) Factors
1. Protection of market participants and the public. Congress
determined in Core Principle 2 that market participants must be
protected from abusive trade practices. Market participants rely on
properly functioning futures markets in order to hedge risk and must
have confidence in the integrity of the markets in order to actively
participate. Rule 38.152 requires DCMs to prohibit conduct that could
result in harm to market participants, as well as members of the public
who rely on the prices derived from the market. The rule protects
market participants and the public from possible wrongdoing on the part
of firms and commodity professionals with whom they deal.
2. Efficiency, competitiveness and financial integrity of futures
markets. The rule promotes efficiency, competitiveness, and financial
integrity in the DCM market because markets that are protected from
abusive trade practices will likely attract greater market
participation, and increase public confidence in the market, and
thereby will likely increase competition and liquidity.
3. Price discovery. The rule similarly promotes price discovery
because markets protected from the trading abuses prohibited by the
rule are likely to operate more efficiently and more accurately and to
attract greater market participation and competition; such markets
better reflect the forces of supply and demand, leading to greater
price discovery.
4. Sound risk management practices. The Commission has not
identified any effects that this rule will have on sound risk
management practices, other than the effects related to the factors
above.
5. Other public interest considerations. The Commission has not
identified any effects that this rule will have on other public
interest considerations.
Sec. 38.153 (Capacity To Detect and Investigate Rule Violations), Sec.
38.155 (Compliance Staff and Resources), Sec. 38.156 (Automated Trade
Surveillance System), and Sec. 38.157 (Real Time Market Monitoring)
Sec. 38.153 (Capacity To Detect and Investigate Rule Violations)
Section 38.153 requires that a DCM have arrangements and
appropriate resources for the effective enforcement of all of its
rules, including the authority to collect information and examine books
and records of members and persons under investigation, and adequate
resources for trade and surveillance programs. While the proposed rule
required DCMs to have the authority to collect information and
[[Page 36674]]
examine books and records for ``members'' and ``market participants,''
the final rule imposes a lesser burden on DCMs by replacing the term
``market participants'' with ``persons under investigation.''
Summary of Comments and Discussion
CFE requested that the Commission clarify the term ``market
participant,'' arguing that if the term ``market participant'' were to
be interpreted to apply to all customers--and not just those customers
with direct electronic access to the DCM--a DCM's regulatory
responsibilities would greatly expand over participants with whom it
has no direct relationship or connection, greatly increasing costs for
the DCM.\568\
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\568\ CFE Comment Letter at 2 (Feb. 22, 2011).
---------------------------------------------------------------------------
Similarly, CME stated that the proposed rule implied that the
entire class of non-member, non-registered market participants would be
subject to the panoply of recordkeeping requirements currently
applicable only to members, registrants, and direct access clients of
CME.\569\ CME stated that there has been no showing that such a
requirement will further the DCM's ability to effectively carry out its
self-regulatory responsibilities and that it would be imprudent to
impose these costs and burdens on market participants.\570\
---------------------------------------------------------------------------
\569\ CME Comment Letter at 18 (Feb. 22, 2011).
\570\ Id.
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The Commission notes that Core Principle 2 requires a DCM to have,
in addition to appropriate resources for trade practice surveillance
programs, appropriate resources to enforce all of its rules. Further,
the Commission is cognizant that a broad interpretation of the term
``market participant'' could significantly increase the regulatory
responsibilities for DCMs. In response to the commenters' concerns, the
Commission is replacing the term ``market participant'' in the proposed
rule with ``persons under investigation'' in the final rule, which will
reduce the costs of compliance.
Costs
The requirements of this rule are not new for DCMs. Prior to the
Dodd-Frank Act, the Commission expected a DCM to have adequate capacity
and resources for effective rule enforcement.\571\ The existing costs
associated with Sec. 38.153 include the initial and recurring costs
associated with a DCM investing in the resources and staff necessary to
provide effective rule enforcement. A DCM must have sufficient staff
and resources, including the resources to collect information and
examine books and records of members and persons under investigation
and to analyze data to determine whether a rule violation occurred.
Other costs include automated systems to assist the compliance staff in
carrying out self-regulatory responsibilities for the DCM. The
Commission believes that existing DCMs generally already have the
systems necessary for effective rule enforcement. Further, replacing
the term ``market participant'' with ``persons under investigation'' in
the final rule will reduce the costs by narrowing the scope of the
requirement.
---------------------------------------------------------------------------
\571\ Commission staff has recommended these practices through
RERs.
---------------------------------------------------------------------------
Benefits
The rule ensures that a DCM has arrangements and resources for
effective rule enforcement. A DCM can best administer its compliance
and rule enforcement obligations when it has the ability to access and
examine the books and records of its members and persons under
investigation.
Sec. 38.155 (Compliance staff and resources)
Section 38.155 requires that a DCM establish and maintain
sufficient compliance staff and resources to conduct a number of
enumerated tasks, such as audit trail reviews, trade practice
surveillance, market surveillance, real-time market monitoring, and the
ability to address unusual market or trading events and to complete any
investigations in a timely manner. The Commission did not receive any
comments discussing the costs or benefits of this provision.
Costs
The Commission notes that it currently requires DCMs to have
sufficient compliance staff and resources to perform the noted
regulatory functions and that most DCMs have already expended the costs
necessary to comply with the requirements under Sec. 38.155. Any DCM
not currently in compliance with the rule will incur the cost of hiring
and maintaining sufficient staff and resources (e.g. electronic
systems) to conduct effective audit trail reviews, trade practice
surveillance, market surveillance, and real-time market monitoring, to
address unusual market or trading events, and to complete any
investigations in a timely manner. However, this requirement is
consistent with existing practice at many DCMs and reflects staff
recommendations made in RERs from time to time. DCMs will also incur
the cost of the annual monitoring of the size and workload of
compliance staff and resources, which will require oversight time for
compliance staff, management and the regulatory oversight committee.
Any costs associated with Sec. 38.155 will vary depending upon a DCM's
trading volumes, the number of products offered for trading, and the
complexity of conducting surveillance on the particular products
offered by the DCM. In addition, changes in market characteristics such
as volatility, the presence or absence of intermediaries, and the
nature and sophistication of market participants may also impact the
costs associated with Sec. 38.155.
Benefits
This rule ensures that DCMs have adequate compliance staff and
resources to conduct effective audit trail reviews, trade practice
surveillance, market surveillance, and real-time market monitoring in
order to help detect rule violations and abusive trading practices.
DCMs must also have adequate resources necessary to address unusual
market or trading events in order to help stabilize market conditions
if necessary and to complete any investigations in a timely manner. To
this end, the rule promotes market integrity, customer protection, and
the effectiveness of DCMs as self-regulatory organizations.
Sec. 38.156 (Automated trade surveillance system)
Section 38.156 requires a DCM to maintain an automated trade
surveillance system capable of detecting and investigating potential
trade practice violations and able to process this data on a trade date
plus one (``T+1 basis''). The Commission did not receive any comments
discussing the costs or benefits of this provision.\572\
---------------------------------------------------------------------------
\572\ In its comment letter, CME stated this rule is overly
prescriptive. See CME Comment Letter at 20 (Feb. 22, 2011). The
Commission considered this comment in preparing this release and
discusses the costs and benefits of the codification of rules in
lieu of guidance and acceptable practices in further detail in
section C(1) above.
---------------------------------------------------------------------------
Costs
Costs associated with Sec. 38.156 include the costs of developing
and maintaining an automated system capable of conducting trade
practice surveillance, as well as requiring a DCM to have adequate
compliance staff to administer the trade surveillance system. Adequate
staff resources are necessary to administer, maintain, and periodically
upgrade the system. For existing DCMs, the costs associated with Sec.
38.156 should not be new, as the regulation generally reflects current
industry practices and Commission
[[Page 36675]]
requirements. Further, any costs will vary according to the complexity
and analytical power of the trade surveillance system it builds, as
well as the amount of compliance staff necessary to administer,
maintain, and upgrade the system given the DCM's product and
participant profiles. Moreover, the Commission has found, through RERs,
that a DCM's automated surveillance system typically satisfies the
requirements set forth in the final rule (e.g., the ability to compute,
retain, and compare trading statistics). Therefore, the Commission
believes that it will be unnecessary for most DCMs to incur costs to
significantly upgrade their automated surveillance systems to comply
with the final rule.
Benefits
The rule ensures that a DCM has an adequate automated trade
practice surveillance system. These systems play a critical role in
ensuring that a DCM can effectively conduct investigations and detect
and prosecute possible trading abuses, including the abusive trading
practices enumerated in Sec. 38.152. Such systems improve DCM
compliance staff's ability to sort and query voluminous amounts of data
in order to better detect potential rule violations and abusive trading
practices that could harm market participants.
Sec. 38.157 (Real-Time Market Monitoring)
Section 38.157 requires a DCM to conduct real-time market
monitoring of all trading activity on its electronic trading
platform(s) to identify disorderly trading and any market or system
anomalies and to have the authority to cancel trades and adjust trade
prices when necessary.\573\
---------------------------------------------------------------------------
\573\ In its comment letter, CME stated that this rule is overly
prescriptive. CME Comment Letter at 20-21 (Feb. 22, 2011). The
Commission considered this comment in preparing this release and
discusses the costs and benefits of the codification of rules in
lieu of guidance and acceptable practices in further detail in
section C(1) above. The Commission did not receive any other
comments discussing the costs or benefits of this provision.
---------------------------------------------------------------------------
Costs
Costs associated with Sec. 38.157 include the costs of developing
and maintaining electronic systems to facilitate real-time monitoring
of all trading activity on a DCM's electronic trading platform(s). DCMs
will also bear the cost of maintaining sufficient staff to conduct
real-time market monitoring and to administer any interventions in the
market that may be required, including the cancellation of trades,
suspension and resumption of trading, and responses to any disorderly
market conditions requiring human intervention.
The Commission notes, however, that existing DCMs already have
market monitoring capabilities, either directly or through a regulatory
service provider. In addition, existing DCMs also have rules and
procedures in place regarding items such as the cancellation of trades.
As such, many of the costs associated with Sec. 38.157 are likely to
have been previously expended by existing DCMs. The Commission also
notes that the change in the final rule that replaces the requirement
to ``ensure orderly trading'' with a requirement to ``identify
disorderly trading'' will likely reduce the overall burden of the rule.
Moreover, any costs associated with Sec. 38.157 will vary widely
according to a DCM's trading volumes, the number of products offered
for trading, and the complexity of conducting real-time market
monitoring on the particular products offered by the DCM. In addition,
changes in market characteristics such as volatility, the presence or
absence of intermediaries, and the nature and sophistication of market
participants may also impact the costs associated with Sec. 38.157 due
to their correlation to system and staff requirements.
Benefits
The real-time monitoring requirements imposed by the rule will
promote orderly trading and will ensure that DCMs have the capability
to promptly identify and correct market or system anomalies. Prompt
responses to these anomalies will likely mitigate the effects of these
anomalies and may help prevent them from generating systemic risk or
other severe problems. The requirement that any price adjustments or
trade cancellations be transparent to the market and subject to clear,
fair, and publicly-available standards ensures that market participants
are not subject to arbitrary or opaque processes in the event that
their trades are involuntarily cancelled.
Section 15(a) Factors (Sec. 38.153 and Sec. Sec. 38.155-38.157)
1. Protection of market participants and the public. The rules
protect market participants and the public by requiring that a DCM has
the capacity to detect and investigate rule violations, including
adequate compliance staff and resources, automated trade surveillance
and real time monitoring capability. These rules will help ensure fair
and equitable markets that are protected from abusive trading practices
or manipulative market conditions. Under the rules, market users are
protected from possible wrongdoing on the parts of firms and commodity
professionals with whom they deal to access the marketplace. In
addition, the rules are likely to protect the public from the potential
of price distortion.
Additionally, the requirement in Sec. 38.157 that any price
adjustments or trade cancellations are transparent to the market and
subject to clear, fair and publicly-available standards protects market
participants from opaque rules related to price adjustments and trade
cancellations.
2. Efficiency, competitiveness and financial integrity of futures
markets. The requirement that DCMs have the capability to monitor and
detect rule and trade practice violations and market anomalies improves
market efficiency, promotes financial integrity, and helps to ensure
fair and equitable markets by ensuring that violations and market
anomalies are promptly addressed and do not generate systemic risk or
other severe problems. It also helps to ensure that market prices are
not distorted by prohibited activities. The rules also enhance the
competitiveness of the market by increasing participant confidence in
the integrity of the market and by requiring DCMs to maintain and
establish resources for effective rule enforcement through the
collection of relevant information and examination of relevant books
and records.
3. Price discovery. Requiring DCMs to conduct effective monitoring
and surveillance of their markets and to have the capacity to detect
rule violations will help ensure that legitimate trades with
fundamental supply and demand information are accurately portrayed in
market prices. Mitigating rule violations, which deter from the price
discovery process in DCM markets, helps provide confidence in the
prices market participants use to hedge risk and to provide confidence
in the price discovery process.
4. Sound risk management practices. The rules promote sound risk
management practices as they would allow DCMs to better evaluate and be
aware of risks posed by trading practices or member activities.
5. Other public interest considerations. The Commission has not
identified any effects that this rule will have on other public
interest considerations.
Sec. 38.154 (Regulatory Services Provided by a Third Party)
Section 38.154(a) requires that a DCM that contracts with a
registered futures association or another registered entity
(collectively, a ``regulatory service provider'') ensures that its
regulatory
[[Page 36676]]
service provider has sufficient capacity and resources to provide
timely and effective regulatory services.
Section 38.154(b) requires that a DCM maintain adequate compliance
staff to supervise and periodically review any services performed by a
regulatory service provider.
Section 38.154(c) requires a DCM that utilizes a regulatory service
provider to retain exclusive authority over certain decisions. While
the proposed rule permitted a DCM to retain exclusive authority in
other areas of its choosing, it required the decision to open an
investigation into a possible rule violation to reside exclusively with
the regulatory service provider. As discussed in the preamble, this
requirement has been removed from the final rule. These regulations
update and clarify the last general public guidance issued
approximately 10 years ago by the Commission in this area.\574\
---------------------------------------------------------------------------
\574\ See 66 FR 42256, 42266, Aug. 10, 2001.
---------------------------------------------------------------------------
Summary of Comments
MGEX, KCBT, and CME stated that the proposed rule is either overly
burdensome or unnecessary.\575\ MGEX expressed its general opposition
to proposed Sec. 38.154 by stating that if a service has been
delegated to another registered entity pursuant to a Commission-
approved agreement, then this ``should be sufficient and no other
formal agreement is necessary.'' \576\ KCBT contended that proposed
Sec. 38.154 is overly burdensome and duplicative, particularly when a
DCM contracts with a regulatory service provider that is also a DCM
required to comply with the same core principles.\577\ KCBT noted that
it is currently party to a services agreement with another DCM and
argued that it will be costly and unnecessary to perform periodic
reviews and hold regular meetings with this regulatory service
provider.\578\ CME contended that the proposed rule is overly
prescriptive and suggested that the rule would be better served as
guidance and acceptable practices.\579\
---------------------------------------------------------------------------
\575\ MGEX Comment Letter at 3 (Feb. 22, 2011); KCBT Comment
Letter at 3 (Feb. 22, 2011); CME Comment Letter at 18-19 (Feb. 22,
2011).
\576\ MGEX Comment Letter at 3 (Feb. 22, 2011).
\577\ KCBT Comment Letter at 3 (Feb. 22, 2011).
\578\ Id.
\579\ CME Comment Letter at 18-19 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
The Commission has determined that, on the whole, Sec. 38.154
strikes the appropriate balance between flexibility and ensuring that a
DCM properly oversees the actions of its regulatory service provider to
ensure accountability and effective performance. The Commission
believes that it is necessary to require a DCM to conduct periodic
reviews and to hold regular meetings with its regulatory service
provider. A DCM that elects to use a regulatory service provider must
properly supervise the quality and effectiveness of the services
provided on its behalf, and can only do so by acquiring detailed
knowledge during periodic reviews and regular meetings required under
Sec. 38.154.
Costs
The costs associated with Sec. 38.154 will include the cost of
initially determining whether a regulatory service provider has the
capacity and resources necessary to provide timely and effective
regulatory services. An existing DCM replacing a current regulatory
service provider with a new one will have a similar cost. For existing
DCMs with a regulatory service provider, this should not be a new cost
as DCMs are currently required to conduct such due diligence when
entering into an agreement for regulatory services from a third-party
provider, in line with existing industry practices.
The costs associated with Sec. 38.154 will also include the cost
of hiring and maintaining sufficient compliance staff at the exchange
to effectively supervise the quality and effectiveness of the services
provided by a regulatory service provider, including the cost of
holding regular meetings with their regulatory service provider and the
cost of periodic reviews of the adequacy and effectiveness of services
provided. These costs will vary widely depending upon a DCM's trading
volumes, the number of products offered for trading, and the complexity
of conducting surveillance on the particular products offered by the
DCM. Changes in market characteristics such as volatility, the presence
or absence of intermediaries, and the nature and sophistication of
market participants may also impact the costs associated with Sec.
38.154. DCMs will also bear the cost of documenting any instances where
their actions differed from those recommended by their regulatory
service provider. Commenters did not, however, provide any specific
costs to the Commission.
The Commission notes that prior to the Dodd-Frank Act, many of the
requirements under Sec. 38.154 (and many of the associated costs
summarized above), were already required under Commission policy with
respect to compliance with Core Principle 2. Section 38.154
communicates the Commission's expectations with respect to supervision
of third-party regulatory service providers in a more consistent and
explicit manner.
Benefits
The rule ensures that all regulatory service providers have the
capacity to provide the services they contract to perform, and that
DCMs are aware of the quality and outputs of the services provided on
their behalf. Additionally, the rule ensures that all DCMs have the
staff to adequately supervise their regulatory service providers and
that these regulatory service providers effectively perform the
services they are engaged to perform. By requiring that DCMs oversee
the services provided by the regulatory service provider, and thereby
ensuring that the service provider is meeting the expected standards
for compliance, the rule will likely result in cost savings to the DCM,
as the failure of a service provider to adequately fulfill its duties
may result in costs to DCMs for not meeting compliance obligations.
Section 15(a) Factors
1. Protection of market participants and the public. The final rule
promotes the protection of market participants and the public because
it ensures that regulatory service providers that are utilized by DCMs
are properly supervised and have the capacity to perform the services
they are engaged to provide, including conducting market surveillance
for rule violations and performing other market regulatory activities
that protect market participants and the public.
2. Efficiency, competitiveness and financial integrity of futures
markets. Markets that have effective oversight, surveillance, and
monitoring are likely to function more efficiently as rule violations
and market abuses would be detected more quickly. Proper supervision of
a regulatory service provider that provides these functions will ensure
the provider has the ability to perform these activities and will in
turn promote confidence in the market and likely increase competition.
3. Price discovery. The Commission has not identified any effects
that this rule will have on price discovery.
4. Sound risk management practices. The Commission has not
identified any effects that this rule will have on sound risk
management practices, other than those enumerated with regard to the
factors above.
5. Other public interest considerations. Section 38.154 is
particularly important in promoting the public interest as regulatory
service providers that help DCMs comply with their obligations are
effectively standing
[[Page 36677]]
in place of their DCM clients in providing elements of front-line self-
regulation.
Sec. 38.158 (Investigations and Investigation Reports)
Section 38.158(a) requires that a DCM have procedures in place to
conduct investigations of possible rule violations, and requires an
investigation to be commenced upon the request of Commission staff, or
upon the discovery by a DCM of information indicating a reasonable
basis for a finding that a violation may have occurred or will occur.
The final rule reduces the burden imposed by the proposed rule by now
requiring that an investigation must be commenced upon receipt of a
request from Commission staff or upon the discovery or receipt of
information by the DCM that indicates a ``reasonable basis'' for
finding that a violation ``may have'' occurred or will occur. Section
38.158(b) requires that an investigation be completed within 12 months
after an investigation is opened, absent mitigating factors as
specified in the rule. Sections 38.158(c) and (d) set forth the
elements and information that must be included in an investigation
report when there is or is not a reasonable basis for finding a rule
violation. Section 38.158(e) provides that no more than one warning
letter for the same violation may be issued to the same person or
entity during a rolling 12-month period.\580\
---------------------------------------------------------------------------
\580\ In its comment letter, CME stated that this rule is overly
prescriptive. CME Comment Letter at 21-22 (Feb. 22, 2011). The
Commission considered this comment in preparing this release and
discusses the costs and benefits of the codification of rules in
lieu of guidance and acceptable practices in further detail in
section C(1) above. The Commission did not receive any other
comments discussing the costs or benefits of these provisions.
---------------------------------------------------------------------------
Costs
Section 38.158(a) codifies the current practice at DCMs because
every DCM already has investigation procedures, guidelines, and
compliance staff. Therefore, the Commission does not believe the final
rule creates any new resource requirements. Unlike the proposed rule,
which may have imposed certain costs not currently incurred by DCMs,
the final rule limits the situations under which a DCM must conduct an
investigation and keeps the final rule in line with current practices.
Under section 38.158(b), a DCM may have to periodically adjust its
compliance staff resources to ensure that investigations are completed
within the time period specified in the final rule. However, the
Commission notes that this is not a new cost for DCMs. The Commission,
through RERs, has already communicated to DCMs that it expects a DCM to
complete investigations in a timely manner.
Sections 38.158 (c) and (d) require a DCM to have sufficient
compliance staff to conduct investigations and to prepare investigation
reports. The Commission notes that this is not a new cost for DCMs. The
Commission, through RERs, has already communicated to DCMs that it
expects a DCM to have adequate staff to perform these responsibilities.
The Commission has also reduced the cost associated with proposed Sec.
38.158(c) by eliminating the requirement that an investigation report
include the member or market participant's disciplinary history at the
DCM.
Under Sec. 38.158(e), a DCM will be required to maintain
sufficient compliance staff to conduct investigations and to determine
whether a warning letter should be issued for exchange rule violations.
The Commission notes that this is not a new cost for DCMs. The
Commission, through RERs, has already communicated to DCMs that it
expects a DCM to have adequate staff to perform its self-regulatory
responsibilities and to issue warning letters when appropriate.
Benefits
Section 38.158(a) provides that a DCM must establish and maintain
procedures that require its compliance staff to conduct investigations
of possible rule violations. Investigations that examine potential rule
violations help to ensure that rule violations are appropriately
examined and prosecuted.
The Commission has determined that the completion of investigations
in a timely manner, as required by Sec. 38.158(b), increases the
effectiveness of a DCM's rule enforcement program because prompt
resolution of investigations is essential to discouraging further
violations of a DCM's rules and addressing violations before they
escalate. Timely investigations also assist the Commission in
appropriately and quickly removing bad actors from markets. By ensuring
that DCMs are effectively overseeing potential rule violations on a
regular and timely basis, the rule helps DCMs to determine and address
violations before they escalate, and serves as a beneficial deterrent
against misconduct.
The required elements and information that must be included in an
investigation report under Sec. Sec. 38.158 (c) and (d) will assist
disciplinary panels in determining whether there is a reasonable basis
for finding that a violation of exchange rules warrants the issuance of
charges. The investigation reports that must be provided to the
Commission will also assist in reviewing the adequacy of a DCM's trade
practice and disciplinary programs.
Section 38.158(e) will ensure that warning letters serve as
effective deterrents and will protect the public and market
participants against individuals engaging in recidivist activity. A
policy of issuing repeated warning letters rather than issuing
meaningful sanctions to members and market participants who repeatedly
violate the same or similar rules denigrates the effectiveness of a
DCM's rule enforcement program.
Section 15(a) Factors
1. Protection of market participants and the public. The final rule
protects market participants and the public by requiring DCMs to flag
potential rule violations, providing a framework for which an
investigation is conducted, and protecting against individuals who
attempt to engage in violative recidivist activity. By ensuring that
investigations are adequately performed, the rule protects market
participants and the public by ensuring that remedial action is taken
as appropriate. Moreover, timely investigation of rule violations will
help to promote fair and equitable markets free of abusive trading
practices or manipulative market conditions, and will provide market
users assurance that the overseers of the markets in which they trade
have the capacity to effectively investigate wrongdoing.
2. Efficiency, competitiveness and financial integrity of futures
markets. For the reasons noted above, the final rule also promotes
efficiency, competitiveness, and financial integrity in the derivatives
markets by requiring that a DCM have adequate resources to commence an
investigation upon the discovery or receipt of information indicating
that there is a reasonable basis for finding that a violation may have
occurred or will occur, and to conduct this investigation in a timely
manner.
3. Price discovery. The requirement that DCMs conduct
investigations in a timely manner helps to ensure that the market is
protected from disruptive and manipulative practices. This rule will
help protect the price discovery process of markets from these
violations, and thus help provide confidence in the prices market
participants use to hedge risk.
4. Sound risk management practices. The Commission has not
identified any effects that this rule will have on sound risk
management practices other than
[[Page 36678]]
those enumerated with regard to the factors above.
5. Other public interest considerations. The Commission has not
identified any effects that this rule will have on other public
interest considerations.
Sec. 38.159 (Ability To Obtain Information)
Section 38.159 implements the Core Principle 2 requirement that a
DCM have the ability and authority to obtain necessary information to
perform its rule enforcement obligations, including information sharing
agreements. The Commission did not receive any comments discussing the
costs or benefits of this provision.
Costs and Benefits
This rule codifies and implements the requirements of Core
Principle 2 that DCM must have the ability and authority to obtain any
necessary information to perform any required function, including the
capacity to carry out such international information-sharing
agreements, as the Commission may require. To the extent that a DCM
determines it is necessary for it to enter into an information sharing
agreement with other DCMs or SEFs, the rule makes it clear that this is
permitted. In so doing, DCMs may face additional costs. However, these
costs are unlikely to be significant and will only be incurred should a
DCM determine that it is necessary to enter into an information sharing
agreement with another DCM or with a SEF. Additionally, some DCMs are
already parties to such agreements. The Commission is unable to
quantify the cost of entering into such agreements as the costs will
vary depending on several factors, including the nature of the
agreement, the size of the DCM, and whether the DCM is negotiating a
new agreement or signing-on to an existing agreement.
Section 15(a) Factors
1. Protection of market participants and the public. The final rule
protects market participants and the public by providing a mechanism
for which DCMs can obtain necessary information to carry out their
duties. A DCM's ability and authority to obtain information in order to
perform its rule enforcement obligations is imperative in order to
identify rule violations and ensure that remedial action is taken as
appropriate. Moreover, this requirement will help to promote fair and
equitable markets free of abusive trading practices or manipulative
market conditions, and will provide market users assurance that the
overseers of the markets in which they trade have the capacity to
effectively investigate wrongdoing.
2. Efficiency, competitiveness and financial integrity of futures
markets. For the reasons noted above, the final rule also promotes
efficiency, competitiveness, and financial integrity in the derivatives
markets by requiring that a DCM have an adequate means to obtain
information to enforce its rules.
3. Price discovery. The requirement that DCMs have a mechanism to
obtain appropriate information about traders in its markets helps to
ensure that the market is protected from disruptive and manipulative
practices. This rule will help protect the price discovery process of
markets from these violations, and thus help provide confidence in the
prices market participants use to hedge risk.
4. Sound risk management practices. The Commission has not
identified any effects that this rule will have on sound risk
management practices other than those enumerated with regard to the
factors above.
5. Other public interest considerations. The Commission has not
identified any effects that this rule will have on other public
interest considerations.
(4) Core Principle 3: Contracts Not Readily Susceptible to
Manipulation
Sec. 38.201 (Additional Sources for Compliance and Appendix C)
Section 38.201 refers applicants and DCMs to the guidance in
appendix C to part 38 (Demonstration of Compliance That a Contract is
Not Readily Susceptible to Manipulation), for purposes of demonstrating
their compliance with the requirements of Sec. 38.200, which codifies
Core Principle 3. The guidance under appendix C to part 38 amends and
replaces Guideline No. 1 under appendix A to part 40.
Summary of Comments and Discussion
CME commented that the proposed rulemaking did not identify any
problems with continuing to use the current methodology to estimate
deliverable supply, and claimed that if the proposed standard is
adopted, it will impose additional costs on exchanges and market
participants with no defined benefit, including requiring exchanges to
survey market participants annually.\581\ CME also commented on the
provision that DCMs submit monthly deliverable supply estimates,
stating that this requirement is onerous for DCMs and suggesting that
the Commission should only require monthly estimates of deliverable
supply for the most recent three years.\582\
---------------------------------------------------------------------------
\581\ CME Comment Letter at 38 (Feb. 22, 2011).
\582\ CME Comment Letter at 9 (Mar. 28, 2011).
---------------------------------------------------------------------------
The Commission notes that the proposed guidance regarding
estimating deliverable supply is not a departure from existing and
longstanding practice. Estimating deliverable supply has historically
required that a DCM consult with market participants on a regular, if
not monthly, basis. In that regard, the burden of maintaining contacts
with market participants should not be any more or less than it has
been. In response to CME's second comment, the Commission has made
amendments to its proposed appendix C by requiring DCMs to submit
monthly estimates of deliverable supply for the most recent three years
rather than for five years.
Costs
In order to comply with this regulation, DCMs would have to incur
the cost of supplying supporting information and documentation to
justify the contract specifications of a new product or substantial
rule amendment. However, the Commission believes there will likely be
no additional costs attributed to the rule because under existing
practices, DCMs conduct market analysis for new products before
deciding whether or not it makes business sense to list a new product
for trading, including interviewing market participants. Additionally,
DCMs also conduct market analysis before adopting amendments to
existing contract terms and conditions.
Benefits
The guidance outlined in appendix C to part 38 provides a reference
for existing and new regulated markets for information that should be
provided to the Commission for new products and rule amendments based
on best practices developed over the past three decades by the
Commission and other regulators. This guidance will likely reduce the
time and costs that regulated markets will incur in providing the
appropriate information. The guidance also reduces the amount of time
it takes Commission staff to analyze whether a new product or rule
amendment is in compliance with the CEA. Some DCMs regularly provide
the information outlined in appendix C, but others do not include
enough information for Commission staff to determine whether the
contract is in compliance with the CEA. Having all of the supporting
information included in a new product submission or rule amendment
reduces the resources Commission staff must
[[Page 36679]]
expend to request such information from the exchange or to find
independently.
Section 15(a) Factors
1. Protection of market participants and the public. The
information recommended in appendix C for inclusion in the new product
or rule amendment submission provides insight and evidence of the DCM's
research into the underlying cash market of the DCM's product. This
should allow for a timely review by Commission staff of the DCM's
supporting analysis and data to determine whether the contract is not
readily susceptible to manipulation.
2. Efficiency, competitiveness and financial integrity of futures
markets. By providing guidance based on best practices regarding what a
DCM should consider when developing a futures contract or amending the
rules of an existing contract, the contracts listed by DCMs, as a
whole, should be more reflective of the underlying cash market by
promoting efficient pricing through convergence.
3. Price discovery. The guidance provides the information a DCM
should analyze to determine if its contract is designed in such a way
to promote convergence at expiration, and thus promote the price
discovery mechanism of the centralized market.
4. Sound risk management practices. By following the best practices
outlined in the guidance in appendix C, a DCM can minimize the
susceptibility of a contract to manipulation or price distortion while
it is developing the contract terms and conditions for its futures
contract. As a result, the risks to the DCM's clearing house and market
participants would also be minimized.
5. Other public interest considerations. The Commission has not
identified any effects that this rule will have on other public
interest considerations.
(5) Core Principle 4: Prevention of Market Disruption
Sec. 38.251 (General Requirements)
Section 38.251 requires that DCMs collect and evaluate data on
individual traders' market activity on an ongoing basis, monitor and
evaluate general market data, have the ability to conduct real-time
monitoring of trading and comprehensive and accurate trade
reconstructions, and monitor for violations of exchange-set position
limits. Based upon comments, the Commission removed what were perceived
as prescriptive elements from the proposed rule (including a
requirement that DCMs have manual processes or automated alerts
effective in detecting and preventing trading abuses) and included them
in the guidance and acceptable practices in appendix B.
Summary of Comments and Discussion
Several commenters asserted that their current regulatory systems
do not allow for effective real-time monitoring of position limits and
that this regulation would impose additional costs.\583\ Additionally,
MGEX stated that the automated trading alert requirement of proposed
Sec. 38.251 did not provide any real value and only imposed more
burden and cost.\584\
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\583\ CME Comment Letter at 24-25 (Feb. 22, 2011), MGEX Comment
Letter at 4 (Feb. 22, 2011), KCBT Comment Letter at 4 (Feb. 22,
2011), and ICE Comment Letter at 4 (Feb. 22, 2011).
\584\ MGEX Comment Letter at 4 (Feb. 22, 2011).
---------------------------------------------------------------------------
The Commission notes that while Sec. 38.251 requires that DCMs
monitor for intraday position-limit violations it does not require that
position limits necessarily be monitored in real-time. Instead, the
rule requires that DCMs demonstrate the ability to comprehensively and
accurately reconstruct daily trading activity for the purposes of
detecting trading abuses and violations of exchange-set position
limits, including those that may have occurred intraday. The acceptable
practices under appendix B explains that while real-time monitoring is
the most effective method, an acceptable program may monitor for
intraday violations on a T + 1 basis. The flexibility afforded by the
guidance should limit the cost of compliance given that T+1 monitoring
is likely less costly than real-time monitoring.
In order to provide greater specificity to market participants,
reduce costs, and maximize flexibility, the Commission is also
converting the requirement that a DCM have an effective automated
alerts regime to detect trading abuses from a rule to an acceptable
practice so that a DCM will have added flexibility in meeting this
requirement, as the Commission believes that automated trading alerts,
though not necessarily in real time, are the most effective means of
detecting market anomalies. The Commission is also removing provisions
from the proposal dealing with the real-time monitoring of impairments
to market liquidity and clarifying in the guidance and acceptable
practices what must be included in real-time monitoring as compared to
what may not need to be monitored in real-time.
Costs
While some DCMs already have the ability to monitor for intraday
trading abuses and market activity, including position-limit violations
as required in Sec. 38.251, other DCMs may need to hire additional
staff (even if the monitoring is done on a T+1 basis) and may need to
install and maintain new or advanced systems with improved
capabilities. Additional costs will vary based on the number of
products a DCM offers and its trading volumes. However, the Commission
notes that a DCM may be able to reduce the costs associated with this
rule by using a unified monitoring system to jointly satisfy the
requirements of Sec. 38.251 and Sec. 38.157 (Real-time market
monitoring). Notwithstanding any related costs, Sec. 38.251 brings
DCMs into compliance with the statutory language of the Dodd-Frank Act,
which requires that DCMs conduct real-time monitoring of trading
activities and be able to reconstruct trading. The regulation does so
by minimizing costs while abiding by the Dodd-Frank Act.
Benefits
The Dodd-Frank Act amended Core Principle 4 to emphasize that DCMs
must take an active role not only in monitoring trading activities
within their markets, but in preventing market disruptions. Rule 38.251
requires that DCMs have the proper tools to prevent manipulation or
other disruptions. By requiring DCMs to prevent manipulation or other
disruptions, the Commission is able to help ensure that market
participants are able to execute trades at prices that are not subject
to preventable market disruptions. Moreover, to help reduce the cost of
compliance, the Commission is providing DCMs with flexibility in
meeting the rule's requirements as set forth in guidance and acceptable
practices.
Sec. 38.252 (Additional Requirements for Physical-Delivery Contracts)
Section 38.252 requires that DCMs monitor physical-delivery
contracts' terms and conditions as they relate to the underlying
commodity market and to the convergence between the contract price and
the price of the underlying commodity, address conditions that
interfere with convergence, and monitor the supply of the commodity
used to satisfy the delivery requirements.\585\
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\585\ The Commission received comments from CME, MGEX, and KCBT
stating that this rule is overly prescriptive. CME Comment Letter at
25 (Feb. 22, 2011), MGEX Comment Letter at 4-5 (Feb. 22, 2011), KCBT
Comment Letter at 4 (Feb. 22, 2011). The Commission considered these
comments in preparing this release and discusses the costs and
benefits of the codification of rules in lieu of guidance and
acceptable practices in further detail in section C(1) above.
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[[Page 36680]]
Costs and Benefits
The Commission has a long history of monitoring for convergence and
addressing issues of non-convergence.\586\ The Commission notes that
this surveillance requirement is currently in place and that DCMs are
unlikely to incur any additional costs as a result of this codification
of an existing practice. The rules adopted in this release ensure that
market participants are better able to hedge their risk and that price
discovery is enhanced by helping to detect disconnects between futures
and underlying physical market prices. Close monitoring of physical-
delivery contracts helps prevent the manipulation of prices, and the
public benefits from futures prices that reflect actual market
conditions because those prices often form the basis for transactions
taking place in the physical market.
---------------------------------------------------------------------------
\586\ See, e.g., ``Statement of the Agricultural Advisory
Committee,'' October 29, 2009, available at: http://www.cftc.gov/idc/groups/public/@aboutcftc/documents/file/aac102909_bruns.pdf.
---------------------------------------------------------------------------
Sec. 38.253 (Additional Requirements for Cash-Settled Contracts)
Section 38.253 requires that for cash-settled contracts, a DCM must
monitor the pricing of the index to which the contract will be settled
and also monitor the continued appropriateness of the methodology for
deriving the index. If a DCM's contract is settled by reference to the
price of a contract or commodity traded in another venue, the DCM must
have access to information on the activities of its traders in the
reference market.
Summary of Comments and Discussion
CME commented that the Commission is uniquely situated to add
regulatory value to the industry by reviewing for potential cross-venue
rule violations, noting that the Commission is the central repository
for position information delivered to it on a daily basis in a common
format across all venues.\587\ CME asserted that the Commission would
be imposing an onerous burden on DCMs and their customers by requiring
the reporting of information that the Commission already receives or
will be receiving.\588\ CME also stated that the alternative proposal,
that the DCM enter into an information-sharing agreement with the other
venue, also will result in additional costs to both entities, and that
it may not be practical or prudent for a DCM to enter into such an
agreement with the other venue.\589\ CME noted that its rules already
allow it to request such information from market participants on an as-
needed basis.\590\ Argus stated that the cost of monitoring the
``availability and pricing'' of the commodity making up a third-party
index to which a contract is settled would be prohibitive.\591\
---------------------------------------------------------------------------
\587\ CME Comment Letter at 25-26 (Feb. 22, 2011).
\588\ Id. at 26.
\589\ Id.
\590\ Id.
\591\ Argus Comment Letter at 6-7 (Feb. 22, 2011).
---------------------------------------------------------------------------
The Commission believes that a DCM must have the ability to
determine whether a trader in its market is manipulating the instrument
or index to which the DCM contract cash-settles. A DCM must be able to
obtain information on its traders' activities in the underlying
instrument or index. Nonetheless, the Commission believes the rule need
not prescribe the specific methods to accomplish this, for example, by
information-sharing agreements or by placing a reporting burden on
traders who carry a position near contract settlement. Accordingly, the
description of the methods for obtaining these data on traders'
activity in an underlying index or instrument are set forth in the
acceptable practices, rather than included in the rule. Also, the
specific requirement that DCMs monitor the availability and pricing of
the commodity making up the index has been removed from the rule.
Costs
DCMs have, as a part of the contract market designation process,
long been required to perform this type of surveillance on cash-settled
contracts, and thus are unlikely to incur substantial additional costs
on these contracts. DCMs may, however, incur significant additional
costs for collecting information on traders' activities in the
underlying instrument or index. These costs cannot be quantified
because they will vary according to the particular instrument or index.
Moreover, no DCM provided the Commission with any quantification of the
costs of compliance. In consideration of the comment received from CME,
the Commission has attempted to minimize the costs that will be
incurred by giving DCMs some flexibility in determining the size of
positions and the dates for which position data is collected. This will
sharply reduce the costs for DCMs that routinely have few traders that
hold substantial positions near contract expirations.
Benefits
In certain markets, the settlement price is linked to prices
established in another market. Linked markets are becoming more and
more prevalent, and the interconnected nature of these markets may
create incentives for traders to disrupt or manipulate prices in the
reference market in order to influence the prices in the linked market.
Detecting and preventing this sort of manipulation requires information
on traders' activities in the cash-settled contract and in, or related
to, the index to which it is settled. This rule ensures that DCMs have
the information and tools they need to accomplish their statutory duty
to prevent manipulation and disruptions to the cash-settlement process
and enhances the confidence of market participants and the public that
these contracts are free of manipulation.
Sec. 38.254 (Ability To Obtain Information)
Section 38.254 requires DCMs to require that traders in their
markets keep records, including records of their activity in the
underlying commodity and related derivative markets and contracts. If
its market has intermediaries, the DCM must either use a comprehensive
large-trader reporting system or obtain position data from other
sources in order to conduct an effective surveillance program.
Summary of Comments and Discussion
KCBT contended that it is unnecessary and burdensome for a DCM to
require traders to keep such records.\592\ Similarly, MGEX discussed
the burden that the proposed rule would place on its traders as a
result of the proposed record-keeping obligation, and noted that, for
contracts not traded on the DCM, it is unclear what records a DCM must
tell its traders to keep.\593\
---------------------------------------------------------------------------
\592\ KCBT Comment Letter at 5 (Feb. 22, 2011).
\593\ MGEX Comment Letter at 5 (Feb. 22, 2011).
---------------------------------------------------------------------------
The Commission notes that a trader's burden to keep such records is
sound commercial practice, and that a trader of a reportable size is
already required, under Sec. 18.05 of the Commission's regulations, to
keep records of such trades and to make them available to the
Commission upon request. In addition, the Commission has found trader
records to be an invaluable tool in its market surveillance effort, and
believes that the DCM, as an SRO, should have direct access to such
information in order to fulfill its obligations under the DCM core
principles, and in particular, Core Principle 4. The Commission is,
however, providing in appendix B an
[[Page 36681]]
acceptable practice for meeting the requirements of Sec. 38.254(b)
that allows the DCM to limit the duration and scope of the trader's
obligations. For instance, in the acceptable practices, the Commission
permits a DCM to restrict the record-keeping requirement to traders who
are reportable to the DCM in its large-trader reporting system or who
otherwise hold a substantial position. As an acceptable practice, the
reportable level of a trader is at the discretion of the DCM, as long
as the reportable level is consistent with an effective oversight
program.
Costs
A trader's cost to keep such records should be minimal if, as
expected, it is part of their normal business practice. Moreover, the
Commission already imposes a similar requirement on large traders under
its rule 18.05 (Maintenance of books and records). As a result, a
trader's additional cost to provide records to the DCM, and the DCM's
cost to request and process the records, will be low if, based upon the
Commission's experience, such requests are infrequent and targeted to
specific and significant market situations.\594\
---------------------------------------------------------------------------
\594\ CME opposed the rule as proposed and recommended that the
types of records the DCM should require traders to keep should be
covered in acceptable practices. CME Comment Letter at 26 (Feb. 22,
2011).
---------------------------------------------------------------------------
Benefits
This rule ensures that DCMs have sufficient information in order to
assess the potential for price manipulation, price distortions, and the
disruption of the delivery or cash-settlement process as required by
Core Principle 4. Detecting and preventing manipulation requires
information on large traders' positions in the relevant contracts and
their activities in the underlying markets. Access to this information
is vital to an effective surveillance program. Absent this information,
the DCM may fail in its statutory duty to prevent manipulation and
disruptions to the cash-settlement process.
Sec. 38.255 (Risk controls for trading)
Section 38.255 requires that DCMs establish and maintain risk
control mechanisms to prevent or reduce the potential risk of price
distortions and market disruptions, including, but not limited to,
market restrictions that automatically pause or halt trading in market
conditions prescribed by the DCM.\595\ While the rule requires pauses
and halts, the acceptable practices enumerate other additional types of
risk controls that would also be permitted, giving wide discretion to
the DCM to select among the listed controls, to create new ones that
are most appropriate for their markets, and to choose the parameters
for those selected. If equity products are traded on the DCM, then the
acceptable practices for this rule include, to the extent practicable,
coordination of such controls with those placed by national security
exchanges.\596\
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\595\ The Commission received several comments stating that rule
Sec. 38.255 should not be prescriptive. See, e.g., CME Comment
Letter at 26-27 (Feb. 22, 2011), KCBT Comment Letter at 5 (Feb. 22,
2011), ICE Comment Letter at 12 (Feb. 22, 2011), CFE Comment Letter
at 3-4 (Feb. 22, 2011), NYSE Liffe Comment Letter at 11 (Feb. 22,
2011), ELX Comment Letter at 4 (Feb. 22, 2011), and MGEX Comment
Letter at 5-6 (Feb. 22, 2011). The Commission considered these
comments in preparing this release and discusses the costs and
benefits of the codification of rules in lieu of guidance and
acceptable practices in further detail in section C(1) above.
---------------------------------------------------------------------------
Summary of Comments and Discussion
ICE stated that a temporary price floor or ceiling can work better
than a pause or halt since trading can continue uninterrupted, thereby
offering the earliest opportunity for price reversal should the market
deem a sudden large move to be an overreaction or error.\597\ ICE also
stated that pauses and halts are not the only effective way to prevent
market disruption, and that by being prescriptive, the Commission is
freezing innovation in preventing market disruptions.\598\
---------------------------------------------------------------------------
\597\ ICE Comment Letter at 12 (Feb. 22, 2011).
\598\ Id.
---------------------------------------------------------------------------
In response to ICE and other commenters that question the necessity
of pauses and halts over other forms of risk controls, the Commission
notes that pauses and halts to trading have been effective in the past.
The ability of DCMs to pause or halt trading in extraordinary
circumstances and, importantly, to re-start trading through the
appropriate re-opening procedures, will allow DCMs to mitigate the
propagation of shocks that are of a systemic nature and to facilitate
orderly markets. Furthermore, DCMs must ensure that such pauses and
halts are effective for their specific order-routing and trading
environment and are adapted to the specific types of products traded.
With respect to ICE's comment regarding innovation, the Commission
notes that DCMs are not prohibited from implementing additional risk
controls, such as temporary price floors or ceilings as ICE suggests,
or any other appropriate risk control, including those not enumerated
in the acceptable practices.
Costs
Although pauses and halts are not currently required by Commission
regulation, many DCMs already have the types of risk controls that are
required by Sec. 38.255, as well as others that have been moved to
acceptable practices.\599\ There may be certain one-time costs of
programming such controls where they are not already present as well as
on-going costs to maintain and adjust such controls across time. Some
DCMs have pauses and halts only for stock index futures, while
utilizing other risk controls for other contracts. For those DCMs, the
costs of adding pause and halt functionality to the other contracts
should be minimal since much of that technology would already exist.
DCMs that do not currently utilize pauses and halts should be able to
implement them with existing software, so that the cost should be
relatively modest. As noted in the Pre-Trade Functionality Subcommittee
of the CFTC Technology Advisory Committee report, the costs would
largely be borne by the exchanges and would center around intellectual
property, as many exchanges develop, own, and manage their own
technology.\600\ However, the exact costs associated with implementing
risk controls were not described in verifiable detail in the Pre-Trade
Functionality Subcommittee report and can vary greatly from one DCM to
another. Additionally, the costs will depend on which specific risk
controls will be implemented and the trading platform being used by the
DCM. The Commission received no comments indicating that risk controls
cannot be implemented in a cost-effective manner using commercially
available technology.
---------------------------------------------------------------------------
\599\ An FIA working group survey revealed that 66 percent of
exchanges surveyed currently offer pre-trade risk controls at the
exchange levels and that an additional 27 percent of respondents are
planning to add such controls in the future. See http://www.futuresindustry.org/downloads/RC-survey.pdf at 27.
\600\ See ``Recommendations on Pre-Trade Practices for Trading
Firms, Clearing Firms and Exchanges involved in Direct Market
Access,'' Pre-Trade Functionality Subcommittee of the CFTC
Technology Advisory Committee (``TAC Subcommittee
Recommendations''), (March 1, 2011) at 4, available at http://www.cftc.gov/idc/groups/public/@swaps/documents/dfsubmission/tacpresentation030111_ptfs2.pdf. The Commission notes that the
subcommittee report was submitted to the Technology Advisory
Committee and made available for public comment, but no final action
has been taken by the full committee.
---------------------------------------------------------------------------
As further noted in the Pre-Trade Functionality Subcommittee of the
CFTC Technology Advisory Committee report, ``[s]ome measure of
standardization of pre-trade risk controls at the exchange level is the
[[Page 36682]]
cheapest, most effective and most robust path to addressing the
Commission's concern [for preserving market integrity].'' \601\
Congress specifically modified DCM Core Principle 4 to substitute the
title ``prevention of market disruptions'' for the previous title of
``monitoring of trading.'' The new rules on risk controls, which are
designed to prevent market disruptions before they occur, bring the
rules in line with the amended statute.
---------------------------------------------------------------------------
\601\ See TAC Recommendations at 4, available at http://www.cftc.gov/idc/groups/public/@swaps/documents/dfsubmission/tacpresentation030111_ptfs2.pd.
---------------------------------------------------------------------------
Benefits
The Commission anticipates that the benefits of this rule will be
substantial. As noted in the DCM NPRM, risk controls such as automated
trading pauses and halts can, among other things, allow time for
participants to analyze the market impact of new information that may
have caused a sudden market move, allow new orders to come into a
market that has moved dramatically, and allow traders to assess and
secure their capital needs in the face of potential margin calls.\602\
Moreover, the Commission notes that pauses and halts are particularly
intended to apply in the event of extraordinary price movements that
may trigger or propagate systemic disruptions. Accordingly, the
Commission notes that a DCM's ability to pause or halt trading in
certain circumstances and, importantly, to re-start trading through the
appropriate re-opening procedures will allow DCMs to mitigate the
propagation of shocks that are of a systemic nature and to facilitate
orderly markets. For these reasons, the Commission believes that pauses
and halts are the most effective risk management tools to carry out
this purpose and will facilitate orderly markets and prevent systemic
disruptions. While the Commission is requiring pauses and halts in the
rule, the Commission is enumerating other types of automated risk
controls that may be implemented by DCMs in the acceptable practices in
order to give DCMs greater discretion to select among the enumerated
risk controls or to create new risk controls. The Commission believes
that this combination of rules and acceptable practices will facilitate
orderly markets and mitigate systemic disruptions while maintaining a
flexible environment that facilitates innovation.
---------------------------------------------------------------------------
\602\ 75 FR 80572, 80584, Dec. 22, 2010.
---------------------------------------------------------------------------
Sec. 38.256 (Trade Reconstruction), Sec. 38.257 (Regulatory Service
Provider), and Sec. 38.258 (Additional Sources for Compliance)
Section 38.256 requires a DCM to have the ability to
comprehensively and accurately reconstruct all trading on its trading
facility. The requirement to have the ability to comprehensively and
accurately reconstruct trading appears in the statute itself and has
long been a part of the DCM requirements under former Core Principle
10.
Section 38.257 requires a DCM to comply with the regulations in
this subpart through a dedicated regulatory department, or by
delegation of that function to a regulatory service provider.
The Commission eliminated proposed rule 38.258 (which required a
DCM to adopt and enforce additional rules that are necessary to comply
with this core principle), and replaced it with new Sec. 38.258, which
allows a DCM to refer to the guidance and acceptable practices in
appendix B in order to demonstrate compliance with Core Principle 4.
The Commission received no comments discussing the costs or
benefits of Sec. Sec. 38.256, 35.257, and 38.258 and is adopting Sec.
38.256 with a minor modification, Sec. 35.257 as proposed, and Sec.
38.258 as noted above. In addition, these rules do not contain any
significant changes from existing DCM requirements, and thus it is
unlikely that additional costs will be incurred.
Section 15(a) Factors (Sec. Sec. 38.251-38.258)
1. Protection of market participants and the public. These rules
implementing Core Principle 4 reduce the likelihood that markets will
be subject to manipulation or other disruptions and ensure that market
participants are better able to hedge their risk by requiring that:
DCMs properly monitor their markets; market participants keep adequate
records; DCMs are able to adequately collect information on market
activity, including special considerations for physical-delivery
contracts and cash-settled contracts; and reasonable pre-trade risk
controls are in place that facilitate orderly markets and prevent
systemic disruptions that could harm market participants and the
public. Close monitoring of physical-delivery contracts helps prevent
the manipulation of prices, and the public benefits from futures prices
that reflect actual market conditions because those prices often form
the basis for transactions taking place in the physical market.
2. Efficiency, competitiveness and financial integrity of futures
markets. The rules for market monitoring and implementation of risk
controls, including pauses and halts, help to facilitate orderly,
efficient markets by requiring DCMs to establish and maintain risk
control mechanisms that would be able to prevent or reduce the risks
associated with a variety of market disruptions. By protecting against
disruptions and market manipulation, the rules enhance competitiveness
and promote the efficiency and financial integrity of DCM markets.
Market mispricing that is due to disruptions or manipulation interferes
with a market's efficiency by limiting its ability to reflect the value
of the underlying commodity. Markets that are prone to disruption or
manipulation have a severe competitive disadvantage to those without
such problems. These rules are designed to address and mitigate such
problems. Further, the rules are designed to prevent or mitigate
extreme volatility or other market disruptions that can lead to
unwarranted margin calls and losses of capital, which could otherwise
impair the financial integrity of the market and its participants.
3. Price discovery. Manipulation or other market disruptions
interfere with the discovery of a commodity's value in normal market
circumstances. These rules are designed to detect and, where possible,
prevent such market mispricing and to detect disconnects between
futures and underlying physical market prices. In physical-delivery
markets, such disconnects usually relate to market convergence. In
cash-settled markets, such disconnects usually relate to the integrity
of the index used to settle the futures contract. Under the new rules,
DCMs will need to monitor contract terms and resolve conditions that
are interfering with the price discovery process.
4. Sound risk management practices. Sound risk management relies
upon execution of hedge strategies at market prices that are free of
manipulation or other preventable disruptions. These rules are designed
to facilitate hedging at prices free of distortions that may be
preventable by adequate controls.
5. Other public interest considerations. The Commission has not
identified any effects that this rule will have on other public
interest considerations.
(6) Core Principle 5: Position Limitations or Accountability
Core Principle 5 requires that DCMs, for each contract and as
necessary and appropriate, adopt position limitation or position
accountability, and that, for any contract that is subject to a
position
[[Page 36683]]
limitation established by the Commission in part 151 of the
Commission's regulations,\603\ DCMs must set the position limit at a
level not higher than the position limitation established by the
Commission.
---------------------------------------------------------------------------
\603\ See ``Position Limits for Futures and Swaps,'' 76 FR
71626, Nov. 18, 2011.
---------------------------------------------------------------------------
Summary of Comments and Discussion
The Commission received several comments pertaining to the
Commission's codification of part 151 of its regulations. These
comments were appropriately addressed in the relevant rulemaking for
Position Limits for Futures and Swaps.\604\
---------------------------------------------------------------------------
\604\ Id.
---------------------------------------------------------------------------
(7) Core Principle 6: Emergency Authority
Sec. 38.351 (Additional Sources for Compliance and Appendix B)
Rule 38.351 refers applicants and DCMs to appendix B to part 38--
``Guidance on, and Acceptable Practices in, Compliance With Core
Principles'' for purposes of demonstrating compliance with the
requirements of Core Principle 6. The guidance for Core Principle 6
tracks the former guidance to previous Core Principle 6. As such, the
costs and benefits of administering emergency procedures pursuant to
current Core Principle 6 should be no different than the costs and
benefits of administering emergency procedures prior to the Dodd-Frank
Act. The Commission did not receive any comments discussing the costs
or benefits of these provisions.
(8) Core Principle 7: Availability of General Information
Sec. 38.401 (General Requirements)
Section 38.401(a) requires DCMs to have in place procedures for
disclosing to market authorities, market participants, and the public
accurate and relevant information pertaining to rules and regulations,
contract terms and conditions, and operations. Section 38.401(b)
requires that each DCM have procedures in place to ensure that, to the
best of its knowledge, any information or communication with the
Commission is accurate and complete. Section 38.401(c) requires DCMs to
post such information on their Web sites concurrent with the filing of
such information with the Commission. Section 38.401(d) requires DCMs
to update their rulebooks upon the effectiveness of a rule submission
or certification.
Costs
The few requirements in Sec. 38.401 that do not simply replicate
the statutory language were derived from previous guidance and
acceptable practices that reflect existing industry practices, and thus
should impose no new costs on DCMs or market participants. For example,
the accuracy requirement is unlikely to impose additional costs on
market participants because the statute already contains an accuracy
requirement; the rule simply adds additional context to the
requirement. The requirements for a DCM to place information on its web
site on the same business day as the filing of such information with
the Commission and to post new or amended rules on the date of
implementation are unlikely to result in additional costs to DCMs
because similar requirements existed in the guidance and acceptable
practices under the original Core Principle 7. No DCM commented on the
costs imposed by this rule.
Benefits
Market authorities, market participants, and the public all benefit
from access to accurate, relevant, and timely information pertaining to
contract terms and conditions, new product listings, new or amended
governance, trading and product rules, and other changes to information
previously disclosed by the DCM. The disclosure of accurate information
to the Commission will assist the Commission's oversight of the markets
by enabling the Commission to evaluate a DCM's compliance with the core
principles and to take prompt action to ensure transparent, fair, and
orderly markets.
Prompt posting of information pertaining to new product listings,
new rules, and rule amendments on the DCM's Web site will ensure that
market participants and the public have sufficient notice and time to
analyze proposed rule amendments, product listings/de-listings, and
rule certifications in advance of their taking effect and to be able to
plan their actions accordingly. Advance notice of rule amendments and
certifications is consistent with the goal of Core Principle 7 to make
pertinent information available to market participants and the public.
Section 15(a) Factors
1. Protection of market participants and the public. To protect
market participants and the public, the Commission has comprehensive
regulatory, surveillance, investigative, and enforcement programs. To
support these programs, the Commission must have access to accurate,
relevant, and timely information regarding contract terms and
conditions, new product listings, new or amended governance, trading
and product rules, and other changes to information previously
disclosed by the DCM. Additionally, prompt posting of information
pertaining to new product listings, new rules, and rule amendments on
the DCM's Web site will ensure that market participants and the public
have sufficient notice and time to analyze these changes and report any
problems to the Commission in advance of the changes taking effect.
2. Efficiency, competitiveness and financial integrity of futures
markets. In order to promote efficient, competitive, and financially
stable markets, the Commission must have access to accurate, relevant,
and timely information regarding contract terms and conditions, new
product listings, new or amended governance, trading and product rules,
and other changes to information previously disclosed by the DCM. The
Commission must have notice of these changes in order to analyze their
likely impact on the efficiency, competitiveness, and financial
integrity of the futures markets and to take action as necessary.
3. Price discovery. The disclosure of accurate information to the
Commission will assist the Commission's oversight of the markets and
protect market participants by enabling the Commission to evaluate a
DCM's compliance with the core principles.
4. Sound risk management practices. The disclosure of accurate
information to the Commission will assist the Commission's oversight of
the markets and protect market participants by enabling the Commission
to evaluate a DCM's compliance with the core principles, including Core
Principle 11 (Financial Integrity of Transactions). A detailed
discussion of Core Principle 11 in light of the section 15(a) factors
appears later in this release.
5. Other public interest considerations. The Commission has not
identified any effects that this rule will have on other public
interest considerations.
(9) Core Principle 8: Daily Publication of Trading Information
Sec. 38.451 (Reporting of Trade Information)
Core Principle 8 requires that a board of trade make public daily
information on settlement prices, volume, open interest, and opening
and closing ranges
[[Page 36684]]
for actively traded contracts on the contract market. Section 38.451
refers a DCM to part 16 of the Commission's regulations in order to
meet the compliance requirements of Core Principle 8. This rulemaking
also revises Sec. 16.01 with regards to the information a reporting
market must record and publish by adding swaps and options on swaps.
Also, Sec. 16.01 is revised to add the requirement that reporting
markets also report to the Commission information pertaining to ``the
total volume of block trades that are included in the total volume of
trading.''
Summary of Comments and Discussion
CME did not object to reporting block trades that are included in
the daily volume of trading, but noted that this new requirement will
require it to ascertain what systems changes will be necessary and how
long such changes will take to implement.\605\ CME did not provide any
cost or time estimates.
---------------------------------------------------------------------------
\605\ CME Comment Letter at 29 (Feb. 22, 2011).
---------------------------------------------------------------------------
The Commission believes that it is necessary for DCMs to report
trade information; the regulation provides the reporting markets
flexibility to make the necessary and appropriate changes to their
systems in a cost-effective manner while providing transparency to the
markets by means of basic summary trading information of that day's
trading session.
Costs
The cost of reporting volume for swaps should be similar to the
cost of reporting volume for futures and options. The Commission did
not receive any comments that provide otherwise. Further, the
Commission does not anticipate that DCMs that choose to list swaps will
need to make any changes to systems beyond those needed to report
prices and volume for any new contract. The requirement to publish the
total volume of block trading at the end of the day will be an added
cost for the DCM. This provision may require some changes to DCMs'
current systems. However, because DCMs already have or will have to
have systems in place to provide daily trading volumes under Sec.
16.01, any costs to now include the reporting of blocks should be
minimal. It is not feasible to quantify the costs of necessary system
changes, largely because it is unclear what system changes will be
adopted by DCMs. The Commission did not receive any comments stating
that the regulation imposes an unnecessary burden.
Benefits
The Commission allows DCMs significant flexibility in complying
with this rule. As such, DCMs are free to design a system that provides
the transparency required by part 16 in the most cost effective manner.
This rule complies with the statute and provides transparency to the
markets by requiring DCMs to publish end of day price and volume
summary information to the public and to the Commission.
Section 15(a) Factors
1. Protection of market participants and the public. The rule
complies with Core Principle 8 by ensuring that volume and price
information is publicly available on a daily basis. Market participants
and the public will be able to make economic decisions based on
accurate futures and swaps prices that are reported on a timely basis.
2. Efficiency, competitiveness, and financial integrity of futures
markets. The rule will promote the efficiency and competitiveness of
futures markets by ensuring that volume and price data for futures,
options, and swaps traded at all DCMs are publicly available.
Competitiveness may be enhanced to the extent that market participants
are able to compare prices of similar contracts at different DCMs.
3. Price discovery. The rule promotes price discovery by ensuring
that end of day trading data, including volume and prices, are
disseminated to the public. An important benefit of price discovery is
the availability of prices to market participants and the public who
may use this information to inform their economic decisions.
4. Sound risk management practices. The Commission has not
identified any effects that this rule will have on sound risk
management practices.
5. Other public interest considerations. The rule provides post-
trade transparency to the markets by requiring DCMs and SEFs to publish
end of day trading data including volume and prices to show the
activity that occurred during that day's trading session.
(10) Core Principle 9: Execution of Transactions
Sec. 38.501-38.506
The Commission received a number of comments pertaining to the
costs and/or benefits of proposed Sec. Sec. 38.501-38.506. As noted
above, the Commission is not finalizing these provisions at this time,
and expects and plans to take up the proposed rules under Core
Principle 9 when it considers the final SEF rulemaking. Comments
pertaining to these proposed rules, including those relative to costs
and/or benefits, will be considered in such future rulemaking.
(11) Core Principle 10: Trade Information
Sec. 38.551 (Audit Trail Required), Sec. 38.552 (Elements of an
Acceptable Audit Trail Program), and Sec. 38.553 (Enforcement of Audit
Trail Requirements)
Section 38.551 establishes the requirements of an acceptable audit
trail program to help ensure that DCMs can monitor and investigate any
customer or market abuses.
Section 38.552 sets forth the four program areas that a DCM must
address as part of an acceptable audit trail program, including
original source documents, transaction history database, electronic
analysis capability, and safe storage of all audit trail data.
Section 38.553(a) establishes the elements of an effective audit
trail enforcement program. Additionally, Sec. 38.553(b) requires that
an effective audit trail enforcement program must enable the DCM to
identify entities that are routinely non-compliant with the regulations
under Core Principle 10 and to levy meaningful sanctions when such
deficiencies are identified. The regulation prohibits DCMs from issuing
more than one warning letter for the same violation within a rolling
12-month time period.
Summary of Comments
CME and MGEX argued that the requirement for enforcement of an
audit trail program to annually audit all market participants would
essentially require the exchange to review every participant who enters
an order into the trading system, which would be onerous, costly, and
unproductive.\606\ MGEX suggested that DCMs should only be required to
review a sample of market participants.\607\
---------------------------------------------------------------------------
\606\ CME Comment Letter at 33-34 (Feb. 22, 2011), MGEX Comment
Letter at 7 (Feb. 22, 2011).
\607\ MGEX Comment Letter at 7 (Feb. 22, 2011).
---------------------------------------------------------------------------
Discussion
In response to comments that requiring exchanges to conduct annual
audits of all members and market participants would be onerous and
costly, the Commission is revising proposed Sec. 38.553 to apply only
to ``members and persons and firms subject to designated contract
market recordkeeping rules.'' With this change, the Commission limits
the universe of entities that a DCM must audit for compliance with Core
Principle 10. This
[[Page 36685]]
revision addresses commenters' concerns by making the annual audit
requirement less burdensome.
Additionally, this revision also responds to MGEX's comments that
the Commission should allow DCMs to test for audit trail compliance by
auditing only a sample of market participants. While the number of
persons and entities subject to audit has been reduced in the final
rule, the remaining population must still be audited annually to ensure
compliance. As explained above, this revision will decrease the burden
on DCMs.
The Commission believes it is essential for DCMs to have complete
and accurate access to trade information to facilitate trade
reconstructions and thereby detect customer and market abuses. The
Commission believes it is essential for DCMs to have complete and
accurate access to trade information to facilitate trade
reconstructions and thereby detect customer and market abuses. The
Commission has determined that the audit trail requirements and the
annual audits of members and entities subject to Commission or DCM
recordkeeping rules are the best way to achieve its policy objectives,
while providing DCMs with flexibility to achieve these objectives. The
Commission has considered the comments raised related to the cost of
ensuring that customer and market abuses can be detected, prosecuted,
and ultimately discouraged, and believes that the benefits of the rule
as finalized are substantial.
Costs
The costs associated with Core Principle 10 include the cost of
developing and maintaining an electronic history transaction database
to maintain a history of all orders and transactions entered into the
trading system and electronic analysis capability to permit the
exchange to reconstruct orders and trades. DCMs will also bear the cost
of developing and implementing a program to collect and maintain
original source documents for trades entered both manually and
electronically into the trading system. Core Principle 10 compliance
also imposes costs for developing and maintaining a safe storage system
for all the trade data collected and ensuring that such data is readily
accessible to exchange compliance staff. The Commission notes, however,
that almost all exchanges currently operating are in compliance with
these regulations. Therefore, existing DCMs should have already
established these programs and, as such, should have already borne the
costs necessary to comply with these requirements.
These requirements were previously explained in the guidance and
acceptable practices for Core Principle 10--Trade Information. The
Commission's RERs have frequently highlighted compliance with the
guidance and acceptable practices in the discussion of an exchange's
audit trail program. Specifically, past RERs have discussed exchanges'
practices regarding use of an electronic history transaction database,
electronic analysis capability, and safe storage systems. As such, the
Commission is simply codifying these existing practices and regulations
as rules.
DCMs will incur costs to ensure they employ appropriate resources
to enforce Core Principle 10's requirements, including the ability to
conduct annual compliance audits by hiring sufficient staff to review
the information and having in place adequate technology to retrieve and
store the information. It is not feasible to quantify the costs for
appropriate resources for audit trail and Core Principle 10 enforcement
because the factors necessary to determine what resources are
``appropriate'' vary widely from exchange to exchange, and the costs
for each variable depend upon the particular circumstances of each
exchange. For example, the number of participants who trade on a
particular exchange varies widely and the number of participants who
are members and persons and firms subject to Commission or DCM
recordkeeping rules directly corresponds to the number of annual
compliance audits a particular DCM will conduct to determine compliance
with all audit trail requirements.
While the Commission is imposing new requirements that specify
certain components that must be incorporated in audit trail reviews,
the Commission notes that most exchanges already have such resources in
place and conduct audit trail reviews in such a manner to comply with
these new regulations due to the RER process and recent
recommendations. What constitutes ``appropriate resources'' to oversee
and enforce the audit trail requirements is addressed on an
individualized basis in the specific RERs for each exchange.
Importantly, no DCM provided the Commission with information related to
the current cost of compliance and the estimated increase related to
codification of existing practices.
Benefits
Core Principle 10 and the associated regulations promote the
reliability, completeness, accuracy, and security of exchange order and
trade data. The ability of DCMs to recover, review, and reconstruct
trading transactions is imperative to monitor for potential customer
and market abuses. The requirements of Core Principle 10 ensure the
ability of DCMs to prosecute rule violations supported by evidence from
audit trail data and order and trade information. This furthers the
protection of market participants by requiring exchanges to have the
ability to adequately conduct market surveillance and prosecute rule
violations.
The requirement that exchanges issue no more than one warning
letter for the same violation within a rolling twelve-month time period
will ensure that instead of simply sending multiple warning letters,
exchanges levy meaningful fines and sanctions to deter recidivist
behavior and prevent future rule violations.
Section 15(a) Factors (Sec. Sec. 38.551-38.553)
1. Protection of market participants and the public. Sections
38.551-38.553 benefit the protection of market participants and the
public by requiring that DCMs maintain all order and trade information
so that rule violations that could harm market participants and the
public may be detected, reconstructed, investigated, and prosecuted. A
DCM cannot complete its surveillance and enforcement practices without
such audit trail data collection and requirements. The absence of these
regulations would result in an increased potential for violations to go
undetected. Such requirements strengthen DCMs' market oversight
capabilities and result in stronger protection of market participants
and the general public from rule violations and market abuses.
2. Efficiency, competitiveness, and financial integrity of futures
markets. The regulations under Core Principle 10 implemented in
Sec. Sec. 38.551-38.553 promote efficiency and competitiveness by
ensuring that DCMs can adequately monitor their markets for rule
violations and effectively prosecute and deter such rule violations.
These regulations strengthen market confidence by deterring such rule
violations, thereby promoting efficient pricing and a competitive
trading atmosphere.
3. Price discovery. Sections 38.551-38.553 benefit the price
discovery process of markets by allowing DCMs to detect and prosecute
rule violations that impede market prices from accurately reflecting
information pertaining to underlying fundamentals. Having a process by
which to detect, reconstruct, investigate, and prosecute rule
violations deters market participants
[[Page 36686]]
from engaging in activities which harm the market's price discovery
process.
4. Sound risk management practices. The Commission has not
identified any effects that this rule will have on sound risk
management practices.
5. Other public interest considerations. The Commission has not
identified any effects that this rule will have on other public
interest considerations.
(12) Core Principle 11: Financial Integrity of Transactions
Sec. 38.601-38.606
Section 38.601 provides that all transactions executed on or
through a DCM, other than transactions in security futures products,
must be cleared through a Commission-registered DCO. Section 38.602
provides that DCMs must adopt rules establishing minimum financial
standards for both member FCMs and IBs and non-intermediated market
participants. Section 38.603 provides that DCMs must adopt rules for
the protection of customer funds.
Section 38.604 requires that a DCM must routinely receive and
promptly review financial and related information from its members, and
conduct ongoing financial surveillance of the risk created by the
positions taken by an FCM's customers. Section 38.605 requires DCMs, as
self-regulatory organizations, to comply with the standards of amended
Sec. 1.52 to ensure the financial integrity of intermediaries by
establishing and carrying out an SRO program for the examination and
financial supervision of intermediaries. Section 38.606 provides that
DCMs may satisfy their financial surveillance responsibilities under
Sec. Sec. 38.604 and 38.605 by outsourcing such responsibilities to a
regulatory service provider if certain requirements are met.
Summary of Comments and Discussion
KCBT commented that because its rules incorporate by reference the
requirements of the CEA, the requirement to implement exchange rules
that mirror Commission regulations is duplicative, unnecessary and
burdensome.\608\
---------------------------------------------------------------------------
\608\ KCBT Comment Letter at 7 (Feb. 22, 2011).
---------------------------------------------------------------------------
The Commission believes the establishment of independent financial
integrity rules is important because it will provide evidence that: (i)
Each DCM has focused attention on the specific regulations promulgated
under the CEA; and (ii) such regulations are appropriately implemented.
Section 38.603 does not specify the exact rules to be implemented by
each DCM, but sets forth the substance of what the rules of each DCM
must address; therefore, a DCM would be unable to meet the requirements
of the rule by incorporating the CEA requirements by reference.
Costs
Section 38.601 imposes no new costs on DCMs, as all transactions on
a DCM are currently subject to mandatory clearing; this was required by
the former core principle, before it was amended by the Dodd-Frank Act.
Section 38.602 imposes no new costs as all DCMs are currently
required to have rules establishing minimum financial standards for
member FCMs and IBs pursuant to Core Principle 11. The Commission will
continue to review the financial standards that each DCM has
established to be certain that the DCM is in compliance with the rule.
The requirements of Sec. 38.603 relating to the protection of customer
funds are all existing requirements pursuant to former Designation
Criterion 5(b) and have been found to be effective in monitoring and
mitigating financial risk. By incorporating the substantive standards
from former designation criteria that have already been implemented by
registered DCMs, the Commission aims to minimize implementation costs.
However, the explicit requirement that DCMs adopt rules, as opposed to
solely incorporating the requirements of the CEA by reference, will
involve administrative costs on the part of DCMs, such as enacting the
appropriate rules and building the understanding within its staff of
those rules.
The requirements of Sec. 38.604 also reflect requirements pursuant
to former Designation Criterion 5(a). However, the rule does build on
the foundation of historical compliance by DCMs by explicitly requiring
intraday financial surveillance. The Commission believes that intraday
surveillance is necessary to account for possible intraday risk build-
up and to meet the requirements of the financial integrity core
principle. Because DCOs currently conduct intraday monitoring, DCMs
should already meet this requirement through the DCO(s) that provides
their clearing services. As the Commission notes in the preamble, an
arrangement between a DCO and a DCM, whereby the DCO is responsible to
a DCM for the performance of certain functions, including this
monitoring, will continue to be permitted by the Commission. Therefore,
intraday financial surveillance should not impose new costs on DCMs.
DCMs will not need to expend significant additional resources to
comply with Sec. 38.605 as all DCMs have existing SRO programs in
place and currently are in compliance with section 1.52, as well as the
guidance that has now been incorporated into section 1.52 from Division
of Trading and Markets Financial and Segregation Interpretations 4-1
and 4-2. Further, the JAC Agreement, as discussed above, is already in
place and operating effectively.
Section 38.606 provides DCMs with the option of outsourcing their
financial surveillance responsibilities if they would prefer not to do
such surveillance in house. Although Sec. Sec. 38.604 and 38.605
impose the actual surveillance requirements, those DCMs electing to
outsource such surveillance responsibilities will incur costs related
to conducting due diligence of the regulatory service provider and
making sure the DCM has adequate staff to monitor the provider. The
Commission is unable to quantify such costs because the rule does not
require a certain method of due diligence, and therefore the costs
would vary based on the practices and choices of each DCM.
Benefits
Section 38.601 is a codification of the statutory requirement in
Core Principle 11. Section 38.602 requires a DCM to establish and
maintain minimum financial standards for market participants, which is
essential to mitigating systemic risk. Implementing the requirements of
the core principle, which requires that each DCM has rules to ensure
the financial integrity of FCMs and IBs, achieves the Commission's
regulatory objectives by ensuring the financial integrity of the
transactions entered into by or through the facilities of the contract
market, while also providing flexibility as to how to meet the
requirements of the core principle.
Rule 38.603 implements the requirement of the core principle that
DCMs establish and enforce rules to ensure the protection of customer
funds. DCMs, as SROs, are well-positioned to undertake the
responsibility of establishing such rules and ensuring the compliance
of intermediaries with those rules. As a result, the requirements of
Sec. 38.603 enhance the protection of customers (who are both market
participants and members of the public) from the losses incurred by
fellow customers. This directly enhances the protection of market
participants and the public, and promotes sound risk management.
Moreover, by mitigating the loss of customer funds, which loss in turn
would damage all customers' confidence in the safety of the funds they
post as collateral for cleared
[[Page 36687]]
positions, these requirements mitigate systemic risk.
The intraday surveillance requirement in Sec. 38.604 requires that
a DCM continually survey each FCM's obligations created by its
customers. Satisfaction of this requirement is necessary for a DCM to
meet the requirements of the core principle to have rules ensuring the
financial integrity of market participants, as well as the protection
of customer funds. By conducting intraday surveillance and acting on
the results of the surveillance, DCMs will be able to address intraday
risks before they grow larger and therefore avoid losses to DCOs
carrying FCMs or customers.
For section 38.605, existing benefits include avoiding duplicative
review of members, as well as ensuring the financial integrity of FCMs
and IBs, protecting customer funds and contributing to market
confidence. In addition, because Sec. 38.606 provides a DCM with
options, it is more efficient and cost-effective as DCMs can choose
whether to allocate their own resources to this surveillance or to use
a regulatory service provider.
Section 15(a) Factors (Sec. Sec. 38.601-38.606)
1. Protection of market participants and the public. The rules
protect market participants and the public by ensuring the financial
integrity of DCM transactions via clearing of all transactions on a
DCM, financial surveillance of members and minimum standards for
members. The protection of customer funds rules protect customers from
the losses incurred by either other market participants or fellow
customers, thereby strengthening the financial integrity of the markets
and decreasing potential systemic risks.
2. Efficiency, competitiveness and financial integrity of futures
markets. Since most of these rules codify pre-existing requirements,
DCMs are already in compliance. As a result, the rules do not require
significant changes (i.e., costs), and therefore have minimal effect on
the competitiveness of futures markets. The addition of rules requiring
intraday financial surveillance will benefit the financial integrity of
the markets by requiring DCMs to have procedures that will foster DCMs
addressing intraday risks before they grow larger, thereby avoiding
losses to DCOs carrying FCMs or customers.
3. Price discovery. The Commission has not identified any effects
that this rule will have on price discovery.
4. Sound risk management practices. The rules requiring the
establishment of minimum financial standards for DCM market
participants promote sound risk management practices by ensuring that
market participants have a certain level of sophistication and
resources, which in turn, mitigates systemic risk.
5. Other public interest considerations. The Commission has not
identified any effects that this rule will have on other public
interest considerations.
Sec. 38.607 (Direct Access)
Section 38.607 requires a DCM that allows customers direct access
to its contract market to implement certain direct access controls and
procedures (such as automated pre-trade controls) in order to provide
member FCMs with tools to manage their financial risk.
Costs
As discussed in the preamble, a recent Futures Industry Association
(``FIA'') report stated that the majority of exchanges have policies
and tools in place that comply with the recommendation that mandatory
pre-trade controls be set at the exchange level.\609\ As a result,
these requirements will not impose significant costs on a majority of
DCMs. Those DCMs that do not have controls and procedures in place, but
do allow customers direct access to the contract market, will incur
costs in implementing these controls and procedures, and FCMs will
incur costs in utilizing the controls and procedures. The Commission is
unable to quantify such costs because the rule does not require a
certain set of controls and procedures, and therefore the costs would
vary based on the controls adopted by the individual DCM. In addition,
such costs would also vary depending on the DCM's existing
infrastructure, which varies markedly across exchanges. Moreover,
commenters did not discuss the costs of this provision.
---------------------------------------------------------------------------
\609\ See FIA report on ``Market Access Risk Management
Recommendations'' (April 2010), available at: http://www.futuresindustry.org/downloads/Market_Access-6.pdf.
---------------------------------------------------------------------------
Benefits
The requirements of this rule will enable an FCM to protect itself
when a customer has direct access to a DCM and completes a trade before
an FCM's systems have an opportunity to prevent the execution of such
trade, thereby avoiding losses that could extend to customers or the
DCO from trades that would exceed the parameters set by the FCM on the
DCM. Further, as discussed in the preamble, the benefits of risk
controls at the FCM, DCO and DCM level, discussed above, have been
recognized both domestically and internationally.
Section 15(a) Factors
1. Protection of market participants and the public. The final rule
promotes the protection of market participants and the public because
it enables an FCM to protect itself from its customers with direct
access to the DCM, thereby preventing customers from undertaking risks
that could bankrupt an FCM.
2. Efficiency, competitiveness and financial integrity of futures
markets. Automated controls will permit an FCM to enforce limitations
on its customers' trading via direct access, which will serve to
protect all market participants, which will also promote the efficient,
competitive, and financial integrity of futures markets.
3. Price discovery. The Commission has not identified any effects
that this rule will have on price discovery.
4. Sound risk management practices. Without the aid of controls at
the DCM-level, an FCM will be unable to protect itself from its
customers with direct access to the DCM. Therefore, the final rule
serves sound risk management practices by enabling FCMs to manage risk.
5. Other public interest considerations. The Commission has not
identified any effects that this rule will have on other public
interest considerations.
(13) Core Principle 12: Protection of Markets and Market Participants
Section 38.651 provides that a DCM must have and enforce rules that
are designed to promote fair and equitable trading and to protect the
market and market participants from abusive practices including
fraudulent, noncompetitive or unfair actions, committed by any party.
Costs and Benefits
Section Sec. 38.651 specifies DCMs' obligations under Core
Principle 12 relating to their compliance with Core Principles 2, 4 and
9, and the associated regulations. Accordingly, Sec. 38.651 does not
impose any additional costs beyond those discussed under each of the
respective Core Principles 2, 4 and 9.
(14) Core Principle 13: Disciplinary Procedures
Core Principle 13 consists of a series of rules that, among other
things, seek to ensure a fair, prompt, and effective disciplinary
program.\610\ A more
[[Page 36688]]
detailed description of the Core Principle 13 rules themselves is
contained in the preamble.
---------------------------------------------------------------------------
\610\ CME and MGEX stated that a number of the rules
implementing Core Principle 13 are overly prescriptive. See CME
Comment Letter at 35-36 (Feb. 22, 2011) and MGEX Comment Letter at 9
(Feb. 22, 2011). The Commission considered these comments in
preparing this release and discusses the costs and benefits of the
codification of rules in lieu of guidance and acceptable practices
in further detail in section C(1) above.
---------------------------------------------------------------------------
Sec. 38.701 (Enforcement Staff)
Rule 38.701 requires that a DCM must establish and maintain
sufficient enforcement staff and resources to effectively and promptly
prosecute possible rule violations.
Costs
The obligations imposed by Sec. 38.701 are not new; rather, the
requirements for DCMs to ensure adequate staff and resources stem from
recent RERs, in which Commission staff recommended that DCMs increase
their compliance staff levels and monitor the size of their staff and
increase the number of staff as appropriate.\611\ Accordingly, the
Commission does not anticipate that this provision will impose
additional costs on DCMs.
---------------------------------------------------------------------------
\611\ See Rule Enforcement Review of the Minneapolis Grain
Exchange (Aug. 27, 2009), Rule Enforcement Review of ICE Futures
U.S. (Feb. 2, 2010), and Rule Enforcement Review of the Chicago
Board of Trade and the Chicago Mercantile Exchange (Sept. 13, 2010)
for findings and recommendations pertaining to the adequate staff
size of DCM compliance departments.
---------------------------------------------------------------------------
Benefits
The Commission believes that adequate enforcement staff and
resources are essential to the effective performance of a DCM's
disciplinary program. Without an effective disciplinary program, a DCM
will be unable to effectively and promptly investigate and adjudicate
potential rule violations and deter future violations. Rule 38.701
ensures that DCMs monitor the size of their staff and increase the
number of staff appropriately as trading volume increases, new
responsibilities are assigned to compliance staff, or internal reviews
demonstrate that work is not completed in an effective or timely
manner. Rule 38.701 also ensures the independence of enforcement staff
and promotes disciplinary procedures that are free of potential
conflicts of interest by providing that a DCM's enforcement staff may
not include members of the exchange or persons whose interests conflict
with their enforcement duties.
Sec. 38.702 (Disciplinary Panels)
Rule 38.702 requires DCMs to have one or more ``review panels,
without imposing a specific requirement for DCMs to maintain a ``review
panel'' and a ``hearing panel.''
Costs
The requirement in the rule to establish disciplinary panels
reflects industry practices that have already been adopted by most
DCMs. Accordingly, the Commission anticipates that Sec. 38.702 will
not impose additional cost burdens on most DCMs. To the extent that the
rule does impose costs on DCMs, the Commission notes that since
disciplinary panel members are typically unpaid, any potential costs
associated with Sec. 38.702 would be limited to administrative costs
associated with establishing the disciplinary panel, which are likely
to vary by DCM. Finally, as described above, in response to concerns
raised by commenters, the Commission has removed the proposed
requirement to maintain distinct hearing panels and review panels,
thereby reducing the burden associated with the proposed rule.
Benefits
Rule 38.702 requires DCMs to establish one or more disciplinary
panels authorized to fulfill their obligations under the part 38 rules,
including, among other things, to issue notices of charges, conduct
hearings, render written decisions, and impose disciplinary sanctions.
These functions are critical components of a DCM's disciplinary program
and will deter violations of DCM rules, prevent recidivist behavior,
protect respondents by requiring procedural safeguards to ensure
fairness for all respondents in disciplinary actions, and protect
customers by requiring full customer restitution in any disciplinary
matter where customer harm is demonstrated.
In addition to providing these numerous benefits, Sec. 38.702
permits flexibility in the structure of DCMs' disciplinary bodies but
protects against conflicts of interest by ensuring that the same
individual is not invested with the authority to both issue and
adjudicate charges in the same manner.
Sec. 38.703-38.711 and Guidance
Rules 38.703-38.711, and the accompanying guidance, seek to ensure
a fair, prompt, and effective disciplinary program by, among other
things, requiring a notice of charges and providing respondents with a
right to representation, a reasonable period of time to file an answer
to charges, and the right to a fair hearing. The rules also outline
procedures for rendering disciplinary decisions and issuing
disciplinary sanctions and warning letters. In response to comments
requesting greater flexibility, the Commission is also converting
several proposed rules into guidance in order to reduce potential
incremental costs resulting from the final rules. This guidance will
cover notices of charges, the admission or failure to deny charges,
settlement offers, hearings, rights to appeal, summary fines, and
emergency disciplinary sanctions.
Summary of Comments and Discussion
The Commission did not receive any specific comments discussing
costs or benefits of proposed Sec. Sec. 38.703-38.716. However,
several commenters made general requests for greater flexibility across
all core principles. Accordingly, the Commission has modified certain
aspects of the proposed rules under Core Principle 13 where it believes
that flexibility can reasonably be afforded. To that end, the
Commission is converting the following proposed rules, in their
entirety, to guidance: proposed Sec. 38.707 (Admission or failure to
deny charges); proposed Sec. 38.709 (Settlement offers); proposed
Sec. 38.712 (Right to appeal); and proposed Sec. 38.716 (Emergency
disciplinary actions). In addition, the Commission is moving the
following specific requirements to guidance: the requirements under
paragraphs (a) and (b) of proposed Sec. 38.704, which allowed, but did
not require, a DCM to issue rules regarding failures to request a
hearing and expressly answer or deny a charge; the provision under
paragraph (b) of proposed Sec. 38.710, which provided that the DCM's
rules may provide that a sanction may be summarily imposed upon any
person whose actions impede the progress of a hearing; and the
provisions under proposed Sec. 38.715 that permitted, but did not
require, a DCM to adopt a summary fine schedule.
The Commission is also removing the following proposed provisions
from the final rules: paragraphs (a) and (b) under proposed Sec.
38.703 regarding the review of investigation reports when additional
evidence is needed or no reasonable basis exists for finding a
violation; the section of proposed Sec. 38.708 which was optional,
allowing a DCM's rule to provide that, except for good cause, a hearing
must be concerned only with those charges denied or sanctions set by
the panel for which a hearing has been requested; and the optional rule
under proposed Sec. 38.710(a)(7) which, in certain cases, allowed for
the cost of transcribing the record of the hearing to be borne by the
respondent.
Costs (Sec. 38.703-38.712 and Guidance)
While Sec. 38.701 and Sec. 38.702 impose specific requirements on
DCMs to have sufficient enforcement staff and
[[Page 36689]]
resources and to establish disciplinary panels, the remainder of the
Core Principle 13 regulations simply outline the policies and
procedures that a DCM's disciplinary program must follow. The
Commission notes that these Core Principle 13 regulations merely
reflect disciplinary concepts formerly found in Designation Criterion
6, part 8 of the Commission's regulations,\612\ and the guidance and
acceptable practices for former Core Principle 2. Accordingly, existing
exchanges generally have already established disciplinary programs and,
as such, have already expended the fees and costs necessary to comply
with the requirements under Sec. Sec. 38.703-38.712.
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\612\ Exchange Procedures for Disciplinary, Summary, and
Membership Denial Actions.
---------------------------------------------------------------------------
As discussed in the preamble, many of the new requirements
applicable to DCMs with respect to their disciplinary procedures were
derived from findings and recommendations made by Commission staff
through RERs.\613\ These recommendations represent what the Commission
staff believes are best practices and are typically adopted by DCMs as
the standard form of compliance. Therefore, while the codification of
certain disciplinary requirements may be new, Commission staff has
already expressed these expectations to the industry through RERs.
---------------------------------------------------------------------------
\613\ For example, the requirements in regulation 38.708
(Decisions) and regulation 38.710 (Disciplinary Sanctions) are based
on findings and recommendations in recent RERs.
---------------------------------------------------------------------------
The exact incremental costs incurred by DCMs to comply with the
specific requirements of final rules under Core Principle 13 cannot be
ascertained since they will vary depending on the DCM's current
disciplinary program. To ensure the effectiveness of their disciplinary
programs and provide procedural safeguards to potential respondents,
most DCMs already have disciplinary rules and procedures that are
similar to those required by the rules, even though they were not
previously required to do so by Commission regulation. Therefore, as a
practical matter, the rules may likely require DCMs to amend existing
disciplinary rules and procedures rather than creating them anew.
Accordingly, costs would likely be limited to the resources allocated
to amending existing rules and procedures to ensure compliance with the
final rules.
As described above, in response to commenters' request for greater
flexibility, the Commission has sought to reduce any incremental costs
imposed by the final rules by modifying certain rules where it believes
that flexibility can reasonably be afforded and the overall burden on
DCMs can be reduced. As described above, the Commission is moving
numerous proposed regulations from rules to guidance, as well as
removing certain provisions in their entirety. Finally, the Commission
expects the following additional modifications to the proposed rules to
also reduce the costs imposed by the rules on market participants: (1)
The rules regarding a respondent's answer to a notice of charges,
outlined in paragraphs (a), (b), and (c) of proposed Sec. 38.706, are
being replaced with a requirement that any rules adopted pursuant to
this rule be ``fair, equitable, and publically available;'' (2)
Proposed Sec. 38.714 is being modified so that it does not require
customer restitution if the amount of restitution, or the recipient,
cannot be reasonably determined.
Benefits
The regulations under Core Principle 13 protect market participants
and the public by ensuring that exchanges will discipline, suspend or
terminate the activities of members or market participants found to
have committed rule violations. To that end, the rules will ensure that
DCMs maintain fair, prompt, and effective disciplinary programs. The
rules will deter violations of DCM rules by requiring disciplinary
sanctions sufficient to deter recidivism underSec. 38.710 and by
restricting repeat warning letters in Sec. 38.711. The rules protect
respondents by requiring procedural safeguards to ensure fairness for
respondents. These include an adequate notice of charges under Sec.
38.703, the right to representation in Sec. 38.704, a reasonable
period of time to file an answer to charges under Sec. 38.705, right
to a hearing under Sec. 38.707, and a prompt written decision under
Sec. 38.708, among others. Finally, the rules protect customers by
requiring restitution where customer harm is demonstrated in Sec.
38.710.
The guidance provisions regarding settlement offers and Sec.
38.708 (Decisions) were based on the Commission's recommendation that
DCM disciplinary committees improve the documentation of their
disciplinary decisions. As discussed in the DCM NPRM, the Commission
believes that improved written documentation yields the following
benefits: (1) Disciplinary panels will be required to focus their
analysis more carefully in order to articulate the rationale for their
decisions; (2) DCM enforcement staff will gain a better understanding
of the evidentiary expectations to which different disciplinary panels
adhere; (3) DCM enforcement staff and respondents will both have an
improved record to base any appeals they may wish to file; and (4)
Improved review of the DCMs' disciplinary program by the Commission.
Section Sec. 38.710 (Disciplinary Sanctions), which provides that
all disciplinary penalties imposed by a DCM or its disciplinary panels
must be commensurate with the violations committed, and be sufficient
to deter recidivist activity, and Sec. 38.711 (Warning Letters), which
prohibits a DCM from issuing more than one warning letter in a rolling
12 month period, are also examples of recommendations made by the
Commission in RERs. As discussed in the DCM NPRM, these reflected DMO
staff's concern regarding the adequacy of sanctions.
Section 15(a) Factors (Sec. 38.701-38.712 and Guidance)
1. Protection of market participants and the public. The
regulations and guidance under Core Principle 13 benefit the protection
of market participants and the public by ensuring that exchanges
maintain sufficient enforcement staff and resources through Sec.
38.701 and will discipline, suspend or terminate the activities of
members or market participants found to have committed rule violations.
The regulations require that DCMs maintain fair, prompt, and effective
disciplinary programs to ensure fairness for all respondents in
disciplinary actions. Additionally, by requiring that DCMs levy
meaningful sanctions against persons and entities that violate DCM
rules under Sec. Sec. 38.710 and 38.711, the regulations seek to
promote the effectiveness of disciplinary sanctions and deter
recidivist behavior. Finally, to compensate customers who suffer harm,
the rules require full customer restitution in any disciplinary matter
where customer harm was demonstrated and where the amount of
restitution and the recipient can be reasonably determined under Sec.
38.710.
2. Efficiency, competitiveness and financial integrity of futures
markets. The regulations under Core Principle 13 promote the financial
integrity of the futures markets by ensuring that individuals and
entities that violate the rules of a DCM are appropriately sanctioned,
such sanctions are effective and discourage recidivist activity, and
customers who are harmed received full restitution under Sec. Sec.
38.710 and 38.711.
3. Price discovery. The Commission has not identified any effects
that these rules will have on price discovery other than those
identified above.
[[Page 36690]]
4. Sound risk management practices. The Commission has not
identified any effects that these rules will have on sound risk
management practices, other than those identified above.
5. Other public interest considerations. The regulations under Core
Principle 13 promote public interest considerations, such as market
integrity and customer protection, by establishing an enforcement
program through which DCMs can effectively prosecute members and market
participants who engage in abusive trading practices or violate other
DCM rules.
(15) Core Principle 14: Dispute Resolution
The new guidance for Core Principle 14 is essentially identical to
the prior guidance to former Core Principle 13. No comments were
provided related to the costs of Core Principle 14. Therefore, the
costs and benefits should be no different than the costs and benefits
of administering a dispute resolution program under former Core
Principle 13 prior to enactment of the Dodd-Frank Act.
(16) Core Principle 18: Recordkeeping
Sec. 38.951 (Additional Sources for Compliance)
Section 38.951 requires DCMs to maintain records, including trade
records and investigatory and disciplinary files, in accordance with
Commission regulations, Sec. 1.31, and in accordance with part 45 of
the Commission's regulations with respect to swap transactions.
Costs
The Commission did not receive any comments related to the costs of
this core principle. Although Sec. 38.951 incorporates by reference
the requirements of existing Sec. 1.31 and part 45, it does not impose
any additional burden or costs to which DCMs are not already subject
under current regulations. Regulation 38.951 merely references
recordkeeping obligations to which DCMs have always been subject under
Sec. 1.31 and to which DCMs are required to comply with respect to
swap transactions under part 45. Accordingly, DCMs will not bear any
new costs solely due to Sec. 38.951.
Benefits
Section Sec. 38.951 enables the Commission to obtain the books and
records of DCMs, which is essential to carrying out the Commission's
regulatory functions, including trade practice and market surveillance,
regulatory examinations, and enforcement examinations. Furthermore,
such books and records assist the Commission in prosecuting violations
of the CEA and Commission regulations.
(17) Core Principle 19: Antitrust Considerations
The guidance for Core Principle 19 is nearly identical to the
guidance for former Core Principle 18 and therefore the costs and
benefits of requiring DCMs to operate according to accepted antitrust
law should be no different than the costs and benefits associated with
the pre-existing guidance, prior to the enactment of the Dodd-Frank
Act.
(18) Core Principle 20: System Safeguards
Sec. 38.1051 (General Requirements)
Section 38.1051 establishes system safeguards requirements for all
DCMs, pursuant to new Core Principle 20 added under the Dodd-Frank Act.
The rules under Sec. 38.1051(a) and (b) require a DCM's program of
risk analysis and oversight to address six categories of risk analysis
and oversight and to follow generally accepted standards and best
practices with respect to the development, operation, reliability,
security, and capacity of automated systems. Section 38.1051(c)
specifically requires each DCM to maintain a business continuity-
disaster recovery (``BC-DR'') plan and BC-DR resources sufficient to
enable resumption of trading and of all of the responsibilities and
obligations of the DCM during the next business day following any
disruption of its operations. Section 38.1051(d) specifies the
requirement to be able to resume trading and clearing during the next
business day following a disruption for DCMs that are not determined to
be a critical financial market. The rules also require each DCM to
notify Commission staff of various system security-related events under
Sec. 38.1051(e) and (f), to provide relevant documents to the
Commission in Sec. 38.1051(g), and to conduct regular, periodic,
objective testing and review of automated systems under Sec.
38.1051(h). Finally, the rules under Sec. 38.1051(i) require each DCM
to coordinate its BC-DR plan with its members and market participants.
Summary of Comments
CME stated that the requirement for notice of all systems
malfunctions is overly broad and would require onerous reporting of
mundane and trivial incidents, and that the Commission should limit
required reporting only to material system failures.\614\ CME also
stated that the requirement that DCMs provide the Commission with
timely advance notice of all planned changes to automated systems that
may impact the reliability, security, or adequate scalable capacity of
such systems is an ``extremely onerous burden for DCMs'' and that the
requirement adds ``significant costs that are not at all commensurate
with any value created.'' \615\ CME claimed that any change to a system
could conceivably impact the operation of the system, and that it would
be inefficient and unproductive to report every planned change to their
automated systems.\616\ Finally, CME stated that the requirement that
DCMs provide timely advance notice of all planned changes to the DCM's
program of risk analysis and oversight is overly broad and is neither
necessary nor productive.\617\
---------------------------------------------------------------------------
\614\ CME Comment Letter at 36-37 (Feb. 22, 2011).
\615\ Id.
\616\ Id.
\617\ Id.
---------------------------------------------------------------------------
Discussion
In response to CME's concerns that the rule would require reporting
of insignificant system events, the Commission is adopting final rules
that require reporting only of significant system malfunctions and
advance notification only of material system changes.
Costs
Sec. 38.1051(a) and (b)
The Commission believes that DCMs generally will not incur
significant additional costs to achieve compliance with the
requirements described in Sec. 38.1051(a) and (b) because from the
time Core Principle 20 went into effect, all DCMs would need to have a
program addressing all six categories of risk analysis and oversight.
Former Core Principle 9 and Designation Criteria 4 provided for
essentially the same requirements which reflect activities that would
normally be conducted by the DCM in the course of following industry
standards, guidelines, and best practices for the management and
operation of automated systems. Additionally, the requirement to
maintain a program of risk analysis and oversight appears in Core
Principle 20 itself and was not the product of Commission discretion.
Sec. 38.1051(c)
The Commission believes that DCMs generally will not incur
significant additional costs to achieve compliance with the
requirements described in
[[Page 36691]]
Sec. 38.1051(c). The requirement to maintain a business continuity-
disaster recovery plan, business continuity disaster recovery
resources, emergency procedures, and backup facilities appears in the
core principle itself and was not the product of Commission discretion.
Additionally, the requirements in Sec. 38.1051(c) reflect industry
best practices; an exchange without the ability to resume operations
shortly after a disastrous event, which by definition implies that they
will not in that timeframe be able to operate out of their production
environment, cannot expect to retain its customer base. In the event
that an existing DCM is determined by the Commission to be a ``critical
financial market,'' substantial additional initial and ongoing costs
could be incurred due to the more stringent requirements in this
regard, set forth in Sec. 40.9. The Commission expects to notify a DCM
of its consideration of the DCM's status as a critical financial market
sufficiently in advance of any formal designation as such; further, the
Commission believes that any DCM subject to this designation would be
generating sufficient volume to reasonably support additional costs
incurred.
Sec. 38.1051(d)
The Commission does not believe that any additional material costs
will be incurred by DCMs in complying with the requirements listed in
Sec. 38.1051(d), as DCMs covered by this provision are already in
compliance with its requirements.
Sec. 38.1051(e)
The Commission does not believe that any material costs will be
incurred by DCMs in complying with the notification requirements listed
in Sec. 38.1051(e). Given the general operating stability of the
automated systems at existing DCMs, notification to Commission staff,
either via email or telephone, would be fairly infrequent and could
easily be combined with notifications distributed to market
participants. Several DCMs have automated notification systems; adding
an email address to these systems would not impose additional costs on
DCMs. Minimal additional cost due to DCM staff time could be incurred
in follow-up activities, including completing a systems outage
notification template developed by Commission staff. However, this
template closely follows standard technical post-mortem reporting
procedures, and is not expected to require more than one hour to
complete, at a cost of about $52. Additionally, the Commission notes
that it is reducing the burden of this provision by revising the
proposed rule to provide that DCMs must only promptly advise the
Commission of all significant system malfunctions, rather than all
system malfunctions.
Sec. 39.1051(f)
The Commission does not believe that any significant material costs
will be incurred by existing DCMs or applicants in complying with the
notification requirements listed in Sec. 38.1051(f). Commission staff
has developed notification templates for the notice requirements
contained in both (f)(1) and (2); these templates have been designed to
minimize additional work for DCM staff. As the templates largely follow
guidelines for best practices in automated systems management and
capacity planning, Commission staff believes that each notification
will require no more than two hours of DCM staff time (at a cost of
about $104). Commission notification of planned changes to a DCM's
program of risk analysis and oversight should also not impose
additional costs on DCMs, as copies of documents developed by DCM staff
for change planning purposes are expected to be sufficient in meeting
this requirement. Additionally, the Commission notes that it is
reducing the burden of this provision on DCMs by revising the proposed
rule to provide that, with respect to planned changes to automated
systems or risk analysis and oversight programs, a DCM must only
provide timely advance notification of material changes, rather than of
all changes.
Sec. 38.1051(g)
The Commission does not believe that any significant costs will be
incurred by existing DCMs or applicants in complying with the
requirements listed in Sec. 38.1051(g), as these documents and
procedures can be provided electronically with minimal additional DCM
staff effort, and would be produced by the DCM in the course of
following industry standards, guidelines and best practices for the
management and operation of automated systems. If the documents are
available electronically, the request can likely be met in under 15
minutes. Hardcopy responses would likely require no more than 30
minutes of DCM staff time.
Sec. 38.1051(h)
The Commission does not believe that any significant costs will be
incurred by existing DCMs in complying with the requirements listed in
Sec. 38.1051(h), as all DCMs should currently be performing this
testing and review in the course of following industry standards,
guidelines and best practices for the management and operation of
automated systems.
Sec. 38.1051(i)
The Commission does not believe that any significant costs will be
incurred by existing DCMs in complying with the requirements listed in
Sec. 38.1051(i), as all DCMs should meet the requirements of this
provision in the course of following industry standards (including
industry-wide tests conducted at least annually and sponsored by the
Futures Industry Association (``FIA'')), guidelines and best practices
for the management and operation of automated systems. Further,
compliance with sections (1) and (3) would generally result from the
development of contingency and disaster recovery plans following
generally accepted best practices and standards. Finally, industry-wide
testing currently conducted on an annual basis would result in
substantial compliance with part (2) of this section.
Benefits
Sophisticated computer systems are crucial to a DCM's ability to
meet its obligations and responsibilities. Safeguarding the
reliability, security, and capacity of such systems is essential to
mitigate systemic risk for the nation's financial sector as a whole.
The ability of DCMs to recover and resume trading promptly in the event
of a disruption of their operations is highly important to the U.S.
economy. Ensuring the resilience of the automated systems of DCMs is a
vitally important part of the Commission's mission and will be crucial
to the robust and transparent systemic risk management framework
established by the Dodd- Frank Act. DCM compliance with generally
accepted standards and best practices with respect to the development,
operation, reliability, security, and capacity of automated systems can
reduce the frequency and severity of automated system security breaches
or functional failures, thereby augmenting efforts to mitigate systemic
risk. Notice to the Commission concerning systems malfunctions, systems
security incidents, or any events leading to the activation of a DCM's
business continuity-disaster recovery (``BC-DR'') plan will assist the
Commission's oversight and its ability to assess systemic risk levels.
It would present unacceptable risks to the U.S. financial system if
futures and swaps markets that comprise critical components of the
world financial system were to become unavailable for an extended
period of time for any reason. Adequate system
[[Page 36692]]
safeguards are crucial to mitigate such risks and this regulation will
ensure such safeguards are in place.
Section 15(a) Factors
1. Protection of market participants and the public. Because
automated systems play a central and critical role in today's
electronic financial market environment, oversight of core principle
compliance by DCMs with respect to automated systems is an essential
part of effective oversight of both futures and swaps markets. Timely
reporting to the Commission of material system malfunctions, planned
changes to automated systems, and planned changes to programs of risk
analysis and oversight will facilitate the Commission's oversight of
futures and swaps markets, augment the Commission's efforts to monitor
systemic risk, and will further the protection of market participants
and the public by helping to ensure that automated systems are
available, reliable, secure, have adequate scalable capacity, and are
effectively overseen.
2. Efficiency, competitiveness, and financial integrity of futures
markets. Sophisticated computer systems are crucial to a DCM's ability
to meet its obligations and responsibilities. Safeguarding the
reliability, security, and capacity of such systems is also essential
to mitigation of system risk for the nation's financial sector as a
whole. This is particularly true in light of the fact that the over-
the-counter swaps market is estimated to have in excess of $600
trillion in outstanding contracts. The ability of DCMs to recover and
resume trading promptly in the event of a disruption of their
operations is highly important to the U.S. economy. Ensuring the
resilience of the automated systems of DCMs is a critical part of the
Commission's mission, and will be crucial to the robust and transparent
systemic risk management framework established by the Dodd-Frank Act.
Notice to the Commission concerning systems malfunctions, systems
security incidents, or any events leading to the activation of a DCM's
business continuity-disaster recovery plan will assist the Commission's
oversight and its ability to assess systemic risk levels. It would
present unacceptable risks to the U.S. financial system if futures and
swaps markets that comprise critical components of the world financial
system were to become unavailable for an extended period of time for
any reason, and adequate system safeguards and timely notice to the
Commission regarding the status of those safeguards are crucial to
mitigation of such risks.
3. Price discovery. The reliable function of sophisticated computer
systems and networks is vital to the fulfillment of a DCM's duties and
obligations, a crucial ingredient of adequate regulatory oversight, and
central to the robust, conservative, and transparent risk management
framework promulgated by the Dodd-Frank Act. Following generally
accepted standards and best practices with respect to the development,
operation, reliability, security, and capacity of automated systems
will reduce the incidence and severity of automated system security
breaches and functional failures, thereby providing reliable and
available venues for price discovery.
4. Sound risk management practices. Reliably functioning computer
systems and networks are crucial to comprehensive risk management, and
prompt notice to the Commission concerning systems malfunctions,
systems security incidents, or any events leading to the activation of
a DCM's business continuity-disaster recovery plan will assist the
Commission in its oversight role, and will bolster its ability to
assess systemic risk levels. Adequate system safeguards and timely
notice to the Commission regarding the status of those safeguards are
crucial to mitigation of potential systemic risks.
5. Other public interest considerations. The American economy and
the American public depend upon the availability of reliable and secure
markets for price discovery, hedging, and speculation. Ensuring the
adequate safeguarding and the reliability, security, and capacity of
the systems supporting these market functions is a core focus in the
Commission's role in monitoring and assessing the level of systemic
risk, and is central to its fulfillment of responsibilities given to it
by the Dodd-Frank Act.
(19) Core Principle 21: Financial Resources
Sec. 38.1101 (Financial Resources)
Section 38.1101(a) requires DCMs to maintain and calculate
sufficient financial resources to cover operating costs for at least
one year, calculated on a rolling basis, at all times, and requires any
entity operating as both a DCM and a DCO to comply with both the DCM
and DCO financial resources requirements.
Under section 38.1101(b), financial resources available to DCMs to
satisfy the applicable financial resources requirements would include
the DCM's own capital (assets in excess of liabilities) and any other
financial resource deemed acceptable by the Commission.
Sections 38.1101(c), (d), and (f) require each DCM, no less
frequently than at the end of each fiscal quarter, to calculate the
financial resources it needs to meet the requirements of Sec.
38.1101(a) and the current market value of each financial resource and
report this information to the Commission within a specified timeframe.
Section 38.1101(e) requires DCMs to maintain unencumbered liquid
financial assets, such as cash or highly liquid securities, equal to at
least six months' operating costs, or a committed line of credit or
similar facility.
Summary of Comments
GreenX stated that the proposed rules implementing Core Principle
21 could effectively require DCMs to maintain financial resources in
excess of one year's operating costs.\618\ GreenX suggested modifying
the rule so that the proposed six month liquidity requirement be
explicitly included in the financial resources required to cover a
DCM's operating costs for at least one year, or alternatively,
requested that the Commission perform a cost benefit analysis of the
proposed rule as written.\619\
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\618\ GreenX Comment Letter at 14-15 (Feb. 22, 2011).
\619\ Id. at 17-18.
---------------------------------------------------------------------------
GreenX also stated that revising the proposed rule to permit DCMs
to include committed lines of credit as an acceptable financial
resource would permit a DCM to reduce its operating costs by avoiding
the need to incur unnecessary interest charges, while still ensuring
that it has adequate funds available to pay its operating
expenses.\620\
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\620\ Id. at 16.
---------------------------------------------------------------------------
Several commenters requested an extended deadline for filing the
financial reports required as a result of Sec. 38.1101(f). CME stated
that the proposed 17 day filing deadline is not feasible and that
instead, the requirement should be consistent with the SEC's reporting
requirements.\621\ Similarly, GreenX stated that it has procedures in
place to comply with the SEC's requirements and that the proposed
requirements in this rule would require new programming and
resources.\622\ GreenX recommended extending the reporting deadline to
30 calendar days, noting that this is still more burdensome than the
requirements imposed by the SEC on national securities exchanges.\623\
The
[[Page 36693]]
Commission received no comments discussing the costs and benefits of
Sec. Sec. 38.1101(b) and 38.1101(d).
---------------------------------------------------------------------------
\621\ CME Comment Letter at 38 (Feb. 22, 2011).
\622\ GreenX Comment Letter at 20 (Feb. 22, 2011).
\623\ Id.
---------------------------------------------------------------------------
Discussion
As discussed in the preamble, the rule does not require each DCM to
maintain eighteen months of financial resources, but, rather, requires
each DCM to have at least twelve months of financial resources,
including six months of liquid financial resources. Each DCM has the
discretion to determine how to meet this requirement (e.g., six months
of illiquid financial resources combined with six months of liquid
ones, twelve months of illiquid financial resources with a line of
credit covering six months' worth of financial resources, or twelve
months of illiquid financial resources and six months of liquid ones).
There are similar proposed financial resources rules in the rulemakings
for each type of registered entity (i.e., SEFs, SDRs, and DCOs).
The provision in the rule text stating that acceptable financial
resources include a DCM's own capital and ``any other financial
resource deemed acceptable by the Commission'' was meant to capture
other types of resources on a case-by-case basis and provide
flexibility to both DCMs and the Commission. Accordingly, the
Commission has revised the rule text to state that a DCM's own capital
means its assets minus its liabilities calculated in accordance with
GAAP. The Commission believes that if a certain financial resource is
deemed to be an asset under GAAP, it is appropriate for inclusion in
the calculation for this rule. To the extent a certain financial
resource is not considered an asset under GAAP, but based upon the
facts and circumstances a DCM believes that the particular asset should
be so considered, Commission staff will work with the DCM to determine
whether such resource is acceptable.
The Commission is persuaded that the proposed 17 business day
filing deadline may be overly burdensome. The SEC requires its
quarterly reports on Form 10-Q to be filed with the SEC 40 calendar
days after the end of the fiscal quarter for accelerated filers and 45
calendar days after the end of the fiscal quarter for all other SEC-
registered entities. The SEC requires annual reports on Form 10-K to be
filed with the SEC 60 calendar days after the end of the fiscal year
for large accelerated filers, 75 calendar days for other accelerated
filers and 90 calendar days for non-accelerated filers. Accordingly,
the Commission is extending the 17 business day proposed filing
deadline to 40 calendar days for the required reports for the first
three quarters. This will harmonize the Commission's regulations with
the SEC's requirements for its Form 10-Q. Similarly, the Commission has
extended the filing deadline to 60 days for the fourth quarter report
to harmonize with the SEC deadlines for the Form 10-K. The Commission
does not believe that annual submissions are sufficient. The Commission
believes that prudent financial management requires DCMs to prepare and
review financial reports more frequently than annually, and expects
that DCMs currently are reviewing their finances on at least a
quarterly basis.
Costs
This is a new core principle for DCMs, so the requirement to
maintain and calculate the financial resources necessary to meet the
requirements of this rule may require an outlay of resources to achieve
compliance. However, the Commission has required recent DCM registrants
pursuant to their designation order to calculate and maintain a certain
level of financial resources and therefore some DCMs are already
generally in compliance with this requirement.
The Commission expects that most, if not all, DCMs already
calculate and prepare financial statements quarterly. Accordingly, the
Commission does not believe that the calculation of the financial
resources required to meet the requirements of this core principle
imposes a significant burden on DCMs. Extrapolation from the prepared
financial statements should be relatively straightforward, but will
require some resources on the part of DCMs, potentially including staff
and technology resources to calculate, monitor, and report financial
resources. Given the staffing and operational differences among DCMs,
the Commission is unable to accurately estimate or quantify the
additional costs DCMs may incur to comply with the new financial
resource rules, and no information was provided in the comments in
response to the NPRM. The proposed regulation imposes additional costs
on the Commission as staff will be required to review the filings
received from DCMs. However, once the first couple of filings have been
received and reviewed, Commission staff will be familiarized with the
financial resources of each DCM and the Commission expects that the
review will become increasingly more efficient.
Benefits
A DCM is obligated to ensure that trading occurs in a liquid, fair,
and financially secure trading facility. In order to fulfill its
responsibilities, a DCM must have appropriate minimum financial
resources on hand and on an ongoing basis to sustain operations for a
reasonable period of time. This includes a DCM having sufficient
resources to allow it to close out trading in a manner not disruptive
to the market, if necessary. The Commission believes that the benefits
of the rule requiring six months' worth of unencumbered liquid
financial assets are substantial. Specifically, this provision would
give a DCM time to liquidate the remaining financial assets it would
need to continue operating for the last six months of the required one
year period. If a DCM does not have six months' worth of unencumbered
liquid financial assets, it would be allowed to use a committed line of
credit or similar facility to satisfy the requirement. If a DCM does
not have the liquidity required under Sec. 38.1101(e), it is not
achieving the goal of the core principle, as it will be unable to pay
its creditors. Liquidity is implicit in the core principle requirement
that the financial resources be adequate. Additionally, the rules
ensure that the Commission can be certain that DCMs are in compliance
with the core principle as required by the Dodd-Frank Act. In addition,
the reporting requirements will facilitate the Commission's oversight
role of ensuring DCMs maintain sufficient financial resources, as
required by the core principle.
Section 15(a) Factors
1. Protection of market participants and the public. As discussed
herein, these rules implement the requirements of new Core Principle 21
pursuant to the Dodd-Frank Act. These requirements will enable a DCM to
fulfill its responsibilities of ensuring that trading occurs in a
liquid, fair, and financially secure trading facility by maintaining
appropriate minimum financial resources on hand and on an ongoing basis
to sustain operations for a reasonable period of time. As discussed, as
a result of these requirements, DCMs will also have the financial
resources necessary to close out trading in a manner not disruptive to
the market. By establishing uniform standards that further the goals of
avoiding market disruptions, financial losses, and systemic problems
that could arise from a DCM's failure to maintain adequate financial
resources, these rules will protect market participants and the public.
2. Efficiency, competitiveness and financial integrity of futures
markets. The rules also promote the financial
[[Page 36694]]
integrity of the futures markets by requiring DCMs to have adequate
operating resources (i.e., operating resources sufficient to fund both
current operations and ensure operations of sufficient length in the
future), and preventing those DCMs that lack these resources from
expanding in ways that may ultimately harm the broader financial market
(i.e., confining the operations of DCMs to levels their financial
resources can support).
3. Price discovery. The Commission has not identified any effects
that this rule will have on price discovery.
4. Sound risk management practices. By setting specific standards
with respect to how DCMs should assess and monitor the adequacy of
their financial resources, the rules promote sound risk management
practices and further the goal of minimizing systemic risk.
5. Other public interest considerations. The Commission has not
identified any effects that this rule will have on other public
interest considerations.
(20) Core Principle 23: Securities and Exchange Commission
The Dodd-Frank Act added new Core Principle 23, requiring that DCMs
keep any records relating to swaps defined in CEA section 1a(47)(A)(v),
as amended by the Dodd-Frank Act, open to inspection and examination by
the SEC. Consistent with the text of the core principle, the Commission
is adopting guidance that provides that each DCM should have
arrangements and resources for collecting and maintaining accurate
records pertaining to any swap agreements defined in section
1a(47)(A)(v) of the amended CEA, and should leave them open to
inspection and examination for a period of five years. The Commission
did not receive any comments discussing the costs or benefits of this
provision.
Costs
Core Principle 23 requires DCMs to keep records relating only to
security-based swaps open to inspection and examination by the SEC. The
accompanying guidance simply tracks the language of the Core Principle
and does not impose any additional substantive requirements on DCMs.
The five-year period is unlikely to impose significant costs on market
participants because the core principle already requires DCMs to keep
records relating to certain swaps open to inspection and examination by
the SEC; the guidance simply provides additional information with
respect to the duration of the obligation imposed by the core
principle. The Commission believes the five-year retention period is
reasonable and reflects industry standards; the recordkeeping
requirement under Core Principle 18 extends for a period of five years
and the SEC's relevant recordkeeping requirements typically extend for
a period of five years as well. Additionally, the requirement only
applies to security-based swaps.
Benefits
The Dodd-Frank Act was intended to establish a comprehensive, new
regulatory framework for swaps and security-based swaps. The
legislation was enacted to reduce risk, increase transparency, and
promote market integrity within the financial system. In order to
perform effective oversight and ensure the goals of Dodd-Frank are
realized, the regulatory agencies charged with overseeing the swaps
market must have access to accurate information regarding swap
transactions. The SEC shares jurisdiction over the regulation of the
swaps markets with the Commission and must have access to accurate
records relating to swaps in order to effectively oversee those
markets.
Section 15(a) Factors
1. Protection of market participants and the public. To protect
market participants and the public, the SEC has comprehensive
regulatory, surveillance, investigative, and enforcement programs. To
support these programs, the SEC must have access to accurate
information regarding swap agreements. Section 38.1201 and the
accompanying guidance ensure that DCMs keep accurate records relating
to certain swaps open to inspection and examination by the SEC for a
sufficient period of time of five years.
2. Efficiency, competitiveness and financial integrity of futures
markets. The SEC has comprehensive regulatory programs designed to
promote efficient, competitive, and financially stable markets. In
order to support these programs, the SEC must have access to accurate
information regarding swap agreements. Section 38.1201 and the
accompanying guidance ensure that DCMs keep accurate records relating
to certain swaps open to inspection and examination by the SEC for a
sufficient period of time of five years.
3. Price discovery. The Commission has not identified any effects
that this rule will have on price discovery.
4. Sound risk management practices. The Commission has not
identified any effects that this rule will have on sound risk
management practices.
5. Other public interest considerations. The Commission has not
identified any effects that this rule will have on other public
interest considerations.
IV. Text of Final Rules
List of Subjects
17 CFR Part 1
Commodity futures, Designated contract markets, Minimum financial
requirements for intermediaries, Reporting and recordkeeping
requirements.
17 CFR Part 16
Commodity futures, Reporting and recordkeeping requirements
17 CFR Part 38
Block transaction, Commodity futures, Designated contract markets,
Reporting and recordkeeping requirements, Transactions off the
centralized market.
For the reasons stated in the preamble, and under the authority of
7 U.S.C. 1, et seq., the Commodity Futures Trading Commission amends 17
CFR parts 1, 16, and 38 as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
0
1. Revise the authority citation for part 1 to read as follows:
Authority: 7 U.S.C. 1a, 2, 2a, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g,
6h, 6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3, 8,
9, 10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24, as
amended by Title VII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).
0
2. Revise Sec. 1.52 to read as follows:
Sec. 1.52 Self-regulatory organization adoption and surveillance of
minimum financial requirements.
(a) Each self-regulatory organization must adopt rules prescribing
minimum financial and related reporting requirements for members who
are registered futures commission merchants, registered retail foreign
exchange dealers, or registered introducing brokers. The self-
regulatory minimum financial and related reporting requirements must be
the same as, or more stringent than, the requirements contained in
Sec. Sec. 1.10 and 1.17 of this chapter, for futures commission
merchants and introducing brokers, and Sec. Sec. 5.7 and 5.12 of this
chapter for retail foreign exchange dealers; provided, however, a self-
regulatory organization may permit its member registrants that are
registered with the Securities and Exchange Commission as securities
brokers or
[[Page 36695]]
dealers to file (in accordance with Sec. 1.10(h) of this chapter) a
copy of their Financial and Operational Combined Uniform Single Report
under the Securities Exchange Act of 1934, Part II, Part IIA, or Part
II CSE, in lieu of Form 1-FR. The definition of adjusted net capital
must be the same as that prescribed in Sec. 1.17(c) of this chapter
for futures commission merchants and introducing brokers, and Sec.
5.7(b)(2) of this chapter for futures commission merchants offering or
engaging in retail forex transactions and for retail foreign exchange
dealers. (b) Each self-regulatory organization must establish and
operate a supervisory program for the purpose of assessing whether each
member registrant is in compliance with the applicable self-regulatory
organization and Commission rules and regulations governing minimum net
capital and related financial requirements, the obligation to segregate
customer funds, financial reporting requirements, recordkeeping
requirements, and sales practice and other compliance requirements. The
supervisory program also must address the following elements:
(1) Adequate levels and independence of audit staff. A self-
regulatory organization must maintain staff of an adequate size,
training, and experience to effectively implement a supervisory
program. Staff of the self-regulatory organization, including officers,
directors and supervising committee members, must maintain independent
judgment and its actions must not impair its independence nor appear to
impair its independence in matters related to the supervisory program.
The self-regulatory organization must provide annual ethics training to
all staff with responsibilities for the supervisory program.
(2) Ongoing surveillance. A self-regulatory organization's ongoing
surveillance of member registrants must include the review and analysis
of financial reports and regulatory notices filed by member registrants
with the designated self-regulatory organization.
(3) High-risk firms. A self-regulatory organization's supervisory
program must include procedures for identifying member registrants that
are determined to pose a high degree of potential financial risk,
including the potential risk of loss of customer funds. High-risk
member registrants must include firms experiencing financial or
operational difficulties, failing to meet segregation or net capital
requirements, failing to maintain current books and records, or
experiencing material inadequacies in internal controls. Enhanced
monitoring for high risk firms should include, as appropriate, daily
review of net capital, segregation, and secured calculations, to assess
compliance with self-regulatory and Commission requirements.
(4) On-site examinations. (i) A self-regulatory organization must
conduct routine periodic on-site examinations of member registrants.
Member futures commission merchants and retail foreign exchange dealers
must be subject to on-site examinations no less frequently than once
every eighteen months. A self-regulatory organization may establish a
risk-based method of establishing the scope of each on-site
examination, provided however, that the scope of each on-site
examination of a futures commission merchant or retail foreign exchange
dealer must include an assessment of whether the registrant is in
compliance with applicable Commission and self-regulatory organization
minimum capital and customer fund protection requirements,
recordkeeping, and reporting requirements.
(ii) A self-regulatory organization must establish the frequency of
on-site examinations of member introducing brokers that do not operate
pursuant to guarantee agreements with futures commission merchants or
retail foreign exchange dealers using a risk-based approach, provided
however, that each introducing broker is subject to an on-site
examination no less frequently than once every three years.
(iii) A self-regulatory organization must conduct on-site
examinations of member registrants in accordance with uniform audit
programs and procedures that have been submitted to the Commission.
(5) Adequate documentation. A self-regulatory organization must
adequately document all aspects of the operation of the supervisory
program, including the conduct of risk-based scope setting and the
risk-based surveillance of high-risk member registrants, and the
imposition of remedial and punitive action(s) for material violations.
(c) Any two or more self-regulatory organizations may file with the
Commission a plan for delegating to a designated self-regulatory
organization, for any registered futures commission merchant, retail
foreign exchange dealer, or introducing broker that is a member of more
than one such self-regulatory organization, the responsibility of:
(1) Monitoring and auditing for compliance with the minimum
financial and related reporting requirements adopted by such self-
regulatory organizations and the Commission in accordance with
paragraphs (a) and (b) of this section; and
(2) Receiving the financial reports necessitated by such minimum
financial and related reporting requirements.
(d) Any plan filed under this section may contain provisions for
the allocation of expenses reasonably incurred by the designated self-
regulatory organization among the self-regulatory organizations
participating in such a plan.
(e) A plan's designated self-regulatory organization must report
to:
(1) That plan's other self-regulatory organizations any violation
of such other self-regulatory organizations' rules and regulations for
which the responsibility to monitor, audit or examine has been
delegated to such designated self-regulatory organization under this
section; and
(2) The Commission any violation of a self-regulatory
organization's rules and regulations or any violation of the
Commission's regulations for which the responsibility to monitor, audit
or examine has been delegated to such designated self-regulatory
organization under this section.
(f) The self-regulatory organizations may, among themselves,
establish programs to provide access to any necessary financial or
related information.
(g) After appropriate notice and opportunity for comment, the
Commission may, by written notice, approve such a plan, or any part of
the plan, if it finds that the plan, or any part of it:
(1) Is necessary or appropriate to serve the public interest;
(2) Is for the protection and in the interest of customers;
(3) Reduces multiple monitoring and multiple auditing for
compliance with the minimum financial rules of the self-regulatory
organizations submitting the plan of any futures commission merchant,
retail foreign exchange dealer, or introducing broker that is a member
of more than one self-regulatory organization;
(4) Reduces multiple reporting of the financial information
necessitated by such minimum financial and related reporting
requirements by any futures commission merchant, retail foreign
exchange dealer, or introducing broker that is a member of more than
one self-regulatory organization;
(5) Fosters cooperation and coordination among the self-regulatory
organizations; and
(6) Does not hinder the development of a registered futures
association under section 17 of the Act.
(h) After the Commission has approved a plan, or part thereof,
under Sec. 1.52(g), a self-regulatory organization
[[Page 36696]]
relieved of responsibility must notify each of its members that are
subject to such a plan:
(1) Of the limited nature of its responsibility for such a member's
compliance with its minimum financial and related reporting
requirements; and
(2) Of the identity of the designated self-regulatory organization
that has been delegated responsibility for such a member.
(i) The Commission may at any time, after appropriate notice and
opportunity for hearing, withdraw its approval of any plan, or part
thereof, established under this section, if such plan, or part thereof,
ceases to adequately effectuate the purposes of section 4f(b) of the
Act or of this section.
(j) Whenever a registered futures commission merchant, a registered
retail foreign exchange dealer, or a registered introducing broker
holding membership in a self-regulatory organization ceases to be a
member in good standing of that self-regulatory organization, such
self-regulatory organization must, on the same day that event takes
place, give electronic notice of that event to the Commission at its
Washington, DC, headquarters and send a copy of that notification to
such futures commission merchant, retail foreign exchange dealer, or
introducing broker.
(k) Nothing in this section shall preclude the Commission from
examining any futures commission merchant, retail foreign exchange
dealer, or introducing broker for compliance with the minimum financial
and related reporting requirements to which such futures commission
merchant, retail foreign exchange dealer, or introducing broker is
subject.
(l) In the event a plan is not filed and/or approved for each
registered futures commission merchant, retail foreign exchange dealer,
or introducing broker that is a member of more than one self-regulatory
organization, the Commission may design and, after notice and
opportunity for comment, approve a plan for those futures commission
merchants, retail foreign exchange dealers, or introducing brokers that
are not the subject of an approved plan (under paragraph (g) of this
section), delegating to a designated self-regulatory organization the
responsibilities described in paragraph (c) of this section.
PART 16--REPORTS BY CONTRACT MARKETS AND SWAP EXECUTION FACILITIES
0
3. The authority citation for part 16 is revised to read as follows:
Authority: 7 U.S.C. 2, 6a, 6c, 6g, 6i, and 7, and 7b-3, as
amended by Pub. L. 111-203, 124 Stat. 1376.
0
4. The heading for part 16 is revised to read as set forth above.
0
5. Revise Sec. 16.01 to read as follows:
Sec. 16.01 Publication of market data on futures, swaps and options
thereon: trading volume, open contracts, prices, and critical dates.
(a) Trading volume and open contracts. (1) Each reporting market,
as defined in part 15 of this chapter, must separately record for each
business day the information prescribed in paragraphs (a)(2)(i) through
(vi) of this section for each of the following contract categories:
(i) For futures, by commodity and by futures expiration date;
(ii) For options, by underlying futures contracts for options on
futures contracts or by underlying physical for options on physicals,
and by put, by call, by expiration date and by strike price;
(iii) For swaps or class of swaps, by product type and by term life
of the swap; and
(iv) For options on swaps or classes of options on swaps, by
underlying swap contracts for options on swap contracts or by
underlying physical for options on swaps on physicals, and by put, by
call, by expiration date and by strike price.
(2) Each reporting market must record for each trading session the
following trading volume and open interest summary data:
(i) The option delta, where a delta system is used;
(ii) The total gross open contracts for futures, excluding those
contracts against which delivery notices have been stopped;
(iii) For futures products that specify delivery, open contracts
against which delivery notices have been issued on that business day;
(iv) The total volume of trading, excluding transfer trades or
office trades:
(A) For swaps and options on swaps, trading volume shall be
reported in terms of the number of contracts traded for standard-sized
contracts (i.e., contracts with a set contract size for all
transactions) or in terms of notional value for non-standard-sized
contracts (i.e., contracts whose contract size is not set and can vary
for each transaction).
(v) The total volume of futures/options/swaps/swaptions exchanged
for commodities or for derivatives positions that are included in the
total volume of trading; and
(vi) The total volume of block trades included in the total volume
of trading.
(b) Prices. (1) Each reporting market must record the following
contract types separately
(i) For futures, by commodity and by futures expiration;
(ii) For options, by underlying futures contracts for options on
futures contracts or by underlying physical for options on physicals,
and by put, by call, by expiration date and by strike price;
(iii) For swaps, by product type and contract month or term life of
the swap; and
(iv) For options on swaps or classes of options on swaps, by
underlying swap contracts for options on swap contracts or by
underlying physical for options on swaps on physicals, and by put, by
call, by expiration date and by strike price.
(2) Each reporting market must record for the trading session and
for the opening and closing periods of trading as determined by each
reporting market:
(i) The opening and closing prices of each futures, option, swap or
swaption;
(ii) The price that is used for settlement purposes, if different
from the closing price; and
(iii) The lowest price of a sale or offer, whichever is lower, and
the highest price of a sale or bid, whichever is higher, that the
reporting market reasonably determines accurately reflects market
conditions. Bids and offers vacated or withdrawn shall not be used in
making this determination. A bid is vacated if followed by a higher bid
or price and an offer is vacated if followed by a lower offer or price.
(3) If there are no transactions, bids, or offers during the
opening or closing periods, the reporting market may record as
appropriate:
(i) The first price (in lieu of opening price data) or the last
price (in lieu of closing price data) occurring during the trading
session, clearly indicating that such prices are the first and last
prices; or
(ii) Nominal opening or nominal closing prices that the reporting
market reasonably determines to accurately reflect market conditions,
clearly indicating that such prices are nominal.
(4) Additional information. Each reporting market must record the
following information with respect to transactions in commodity
futures, commodity options, swaps or options on swaps on that reporting
market:
(i) The method used by the reporting market in determining nominal
prices and settlement prices; and
(ii) If discretion is used by the reporting market in determining
the opening and/or closing ranges or the settlement prices, an
explanation that certain discretion may be employed by
[[Page 36697]]
the reporting market and a description of the manner in which that
discretion may be employed. Discretionary authority must be noted
explicitly in each case in which it is applied (for example, by use of
an asterisk or footnote).
(c) Critical dates. Each reporting market must report to the
Commission, for each futures contract, the first notice date and the
last trading date, and for each option contract, the expiration date in
accordance with paragraph (d) of this section.
(d) Form, manner and time of filing reports. Unless otherwise
approved by the Commission or its designee, reporting markets must
submit to the Commission the information specified in paragraphs (a),
(b), and (c) of this section as follows:
(1) Using the format, coding structure and electronic data
transmission procedures approved in writing by the Commission or its
designee; provided however, that the information must be made available
to the Commission or its designee in hard copy upon request;
(2) When each such form of the data is first available, but not
later than 7:00 a.m. on the business day following the day to which the
information pertains for the delta factor and settlement price and not
later than 12:00 p.m. for the remainder of the information. Unless
otherwise specified by the Commission or its designee, the stated time
is U.S. eastern standard time for information concerning markets
located in that time zone, and U.S. central time for information
concerning all other markets; and
(3) For information on reports to the Commission for swap or
options on swap contracts, refer to part 20 of this chapter.
(e) Publication of recorded information. (1) Reporting markets must
make the information in paragraph (a) of this section readily available
to the news media and the general public without charge, in a format
that readily enables the consideration of such data, no later than the
business day following the day to which the information pertains. The
information in paragraphs (a)(2)(iv) through (vi) of this section shall
be made readily available in a format that presents the information
together.
(2) Reporting markets must make the information in paragraphs
(b)(2) and (3) of this section readily available to the news media and
the general public, and the information in paragraph (b)(4)(ii) of this
section readily available to the general public, in a format that
readily enables the consideration of such data, no later than the
business day following the day to which the information pertains.
Information in paragraph (b)(4)(i) of this section must be made
available in the registered entity's rulebook, which is publicly
accessible on its Web site.
PART 38--DESIGNATED CONTRACT MARKETS
0
6. The authority citation for part 38 is revised to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6c, 6d, 6e, 6f, 6g, 6i, 6j,
6k, 6l, 6m, 6n, 7, 7a-2, 7b, 7b-1, 7b-3, 8, 9, 15, and 21, as
amended by the Dodd-Frank Wall Street Reform and Consumer Protection
Act, Pub. L. 111-203, 124 Stat. 1376 (2010).
0
7. Designate existing Sec. Sec. 38.1 through 38.6 as subpart A under
the following subpart heading:
Subpart A--General Provisions
* * * * *
Sec. 38.1 [Amended]
0
8. Amend Sec. 38.1 by removing the reference ``Parts 36 or 37 of this
chapter'' and adding in its place the reference ``parts 37 or 49 of
this chapter''.
0
9. Revise Sec. 38.2 to read as follows:
Sec. 38.2 Exempt provisions.
A designated contract market, the designated contract market's
operator and transactions traded on or through a designated contract
market under section 5 of the Act shall comply with all applicable
regulations under Title 17 of the Code of Federal Regulations, except
for the requirements of Sec. 1.35(e) through (j), Sec. 1.39(b), Sec.
1.44, Sec. 1.53, Sec. 1.54, Sec. 1.59(b) and (c), Sec. 1.62, Sec.
1.63(a) and (b) and (d) through (f), Sec. 1.64, Sec. 1.69, part 8,
Sec. 100.1, Sec. 155.2, and part 156.
0
10. Revise Sec. 38.3 to read as follows:
Sec. 38.3 Procedures for designation.
(a) Application procedures. (1) A board of trade seeking
designation as a contract market must file electronically, in a format
and manner specified by the Secretary of the Commission, the Form DCM
provided in appendix A of this part, with the Secretary of the
Commission at its Washington, DC headquarters at [email protected]
and the Division of Market Oversight at [email protected]. The
Commission will review the application for designation as a contract
market pursuant to the 180-day timeframe and procedures specified in
section 6(a) of the Act. The Commission shall approve or deny the
application or, if deemed appropriate, designate the applicant as a
contract market subject to conditions.
(2) The application must include information sufficient to
demonstrate compliance with the core principles specified in section
5(d) of the Act. Form DCM consists of instructions, general questions
and a list of exhibits (documents, information and evidence) required
by the Commission in order to determine whether an applicant is able to
comply with the core principles. An application will not be considered
to be materially complete unless the applicant has submitted, at a
minimum, the exhibits required in Form DCM. If the application is not
materially complete, the Commission shall notify the applicant that the
application will not be deemed to have been submitted for purposes of
starting the 180-day review period set forth in paragraph (a)(1) of
this section.
(3) The applicant must identify with particularity any information
in the application that will be subject to a request for confidential
treatment pursuant to Sec. 145.9 of this chapter.
(4) Section 40.8 of this chapter sets forth those sections of the
application that will be made publicly available, notwithstanding a
request for confidential treatment pursuant to Sec. 145.9 of this
chapter.
(5) If any information contained in the application or in any
exhibit is or becomes inaccurate for any reason, an amendment to the
application or a submission filed under part 40 of this chapter must be
filed promptly correcting such information.
(b) Reinstatement of dormant designation. Before listing or
relisting products for trading, a dormant designated contract market as
defined in Sec. 40.1 of this chapter must reinstate its designation
under the procedures of paragraphs (a)(1) and (2) of this section;
provided, however, that an application for reinstatement may rely upon
previously submitted materials that still pertain to, and accurately
describe, current conditions.
(c) Delegation of authority. (1) The Commission hereby delegates,
until it orders otherwise, to the Director of the Division of Market
Oversight or such other employee or employees as the Director may
designate from time to time, upon consultation with the General Counsel
or the General Counsel's designee, authority to notify the applicant
seeking designation under section 6(a) of the Act that the application
is materially incomplete and the running of the 180-day period is
stayed.
(2) The Director may submit to the Commission for its consideration
any matter that has been delegated in this paragraph.
[[Page 36698]]
(3) Nothing in this paragraph prohibits the Commission, at its
election, from exercising the authority delegated in paragraph (c)(1)
of this section.
(d) Request for transfer of designation. (1) Request for transfer
of designation, listed contracts and open interest. A designated
contract market that wants to request the transfer of its designation
from its current legal entity to a new legal entity, as a result of a
corporate reorganization or otherwise, must file a request with the
Commission for approval to transfer the designation, listed contracts
and positions comprising all associated open interest. Such request
must be filed electronically, in a format and manner specified by the
Secretary of the Commission, with the Secretary of the Commission at
its Washington, DC headquarters at [email protected] and the
Division of Market Oversight at [email protected].
(2) Timing of submission. The request must be filed no later than
three months prior to the anticipated corporate change; provided that
the designated contract market may file a request with the Commission
later than three months prior to the anticipated corporate change if
the designated contract market does not know and reasonably could not
have known of the anticipated change three months prior to the
anticipated corporate change. In such event, the designated contract
market shall be required to immediately file the request with the
Commission as soon as it knows of such change, with an explanation as
to the timing of the request.
(3) Required information. The request shall include the following:
(i) The underlying agreement that governs the corporate change;
(ii) A narrative description of the corporate change, including the
reason for the change and its impact on the designated contract market,
including its governance and operations, and its impact on the rights
and obligations of market participants holding the open interest
positions;
(iii) A discussion of the transferee's ability to comply with the
Act, including the core principles applicable to designated contract
markets, and the Commission's regulations thereunder;
(iv) The governing documents of the transferee including, but not
limited to, articles of incorporation and bylaws;
(v) The transferee's rules marked to show changes from the current
rules of the designated contract market;
(vi) A list of contracts, agreements, transactions or swaps for
which the designated contract market requests transfer of open
interest;
(vii) A representation by the transferee that it:
(A) Will be the surviving legal entity and successor-in-interest to
the transferor designated contract market and will retain and assume,
without limitation, all the assets and liabilities of the transferor;
(B) Will assume responsibility for complying with all applicable
provisions of the Act and the Commission's regulations thereunder,
including part 38 and Appendices thereto;
(C) Will assume, maintain and enforce all rules implementing and
complying with these core principles, including the adoption of the
transferor's rulebook, as amended in the request, and that any such
amendments will be submitted to the Commission pursuant to section
5c(c) of the Act and part 40 of the Commission's regulations; and
(D) Will comply with all self-regulatory responsibilities except if
otherwise indicated in the request, and will maintain and enforce all
self-regulatory programs.
(viii) A representation by the transferee that upon the transfer:
(A) All open interest in all contracts listed on the transferor
will be transferred to and represent equivalent open interest in all
such contracts listed on the transferee;
(B) It will assume responsibility for and maintain compliance with
the core principles for all contracts previously listed for trading
through the transferor, whether by certification or approval; and
(C) That none of the proposed rule changes will affect the rights
and obligations of any market participant with open positions
transferred to it and that the proposed rule changes do not modify the
manner in which such contracts are settled or cleared.
(ix) A representation by the transferee that market participants
will be notified of all changes to the transferor's rulebook prior to
the transfer and will be further notified of the concurrent transfer of
the contract market designation, and the related transfer of all listed
contracts and all associated open interest, to the transferee upon
Commission approval and issuance of an order permitting this transfer.
(4) Commission determination. The Commission will review a request
as soon as practicable and such request will be approved or denied
pursuant to a Commission order and based on the Commission's
determination as to the transferee's ability to continue to operate the
designated contract market in compliance with the Act and the
Commission's regulations thereunder.
(e) Request for withdrawal of application for designation. An
applicant for designation may withdraw its application submitted
pursuant to paragraphs (a)(1) and (2) of this section by filing such a
request with the Commission. Such request must be filed electronically,
in a format and manner specified by the Secretary of the Commission,
with the Secretary of the Commission at its Washington, DC
headquarters, at [email protected], and the Division of Market
Oversight, at [email protected]. Withdrawal of an application for
designation shall not affect any action taken or to be taken by the
Commission based upon actions, activities or events occurring during
the time that the application for designation was pending with the
Commission.
(f) Request for vacation of designation. A designated contract
market may vacate its designation under section 7 of the Act by filing
a request electronically, in a format and manner specified by the
Secretary of the Commission, with the Secretary of the Commission at
its Washington, DC headquarters at [email protected] and the
Division of Market Oversight at [email protected]. Vacation of
designation shall not affect any action taken or to be taken by the
Commission based upon actions, activities or events occurring during
the time that the facility was designated by the Commission.
0
11. In Sec. 38.4, revise paragraphs (a) and (b) to read as follows:
Sec. 38.4 Procedures for listing products and implementing designated
contract market rules.
(a) Request for Commission approval of rules and products. (1) An
applicant for designation, or a designated contract market, may request
that the Commission approve under section 5c(c) of the Act, any or all
of its rules and contract terms and conditions, and subsequent
amendments thereto, prior to their implementation or, notwithstanding
the provisions of section 5c(c)(4) of the Act, at any time thereafter,
under the procedures of Sec. 40.3 or Sec. 40.5 of this chapter, as
applicable. A designated contract market may label a future, swap or
options product in its rules as ``Listed for trading pursuant to
Commission approval,'' if the future, swap or options product and its
terms or conditions have been approved by the Commission, and it may
label as ``Approved by the Commission'' only those rules that have been
so approved.
[[Page 36699]]
(2) Notwithstanding the timeline under Sec. Sec. 40.3(c) and
40.5(c) of this chapter, the operating rules, and terms and conditions
of futures, swaps and option products that have been submitted for
Commission approval at the same time as an application for contract
market designation or an application under Sec. 38.3(b) of this part
to reinstate the designation of a dormant designated contract market,
as defined in Sec. 40.1 of this chapter, or while one of the foregoing
is pending, will be deemed approved by the Commission no earlier than
when the facility is deemed to be designated or reinstated.
(b) Self-certification of rules and products. Rules of a designated
contract market and subsequent amendments thereto, including both
operational rules and the terms or conditions of futures, swaps and
option products listed for trading on the facility, not voluntarily
submitted for prior Commission approval pursuant to paragraph (a) of
this section, must be submitted to the Commission with a certification
that the rule, rule amendment or futures, swap or options product
complies with the Act or rules thereunder pursuant to the procedures of
Sec. 40.6 of this chapter, as applicable. Provided, however, any rule
or rule amendment that would, for a delivery month having open
interest, materially change a term or condition of a swap or a contract
for future delivery in an agricultural commodity enumerated in section
1a(9) of the Act, or of an option on such contract or commodity, must
be submitted to the Commission prior to its implementation for review
and approval under Sec. 40.4 of this chapter.
* * * * *
0
12. Revise Sec. 38.5 to read as follows:
Sec. 38.5 Information relating to contract market compliance.
(a) Requests for information. Upon request by the Commission, a
designated contract market must file with the Commission information
related to its business as a designated contract market, including
information relating to data entry and trade details, in the form and
manner and within the time specified by the Commission in its request.
(b) Demonstration of compliance. Upon request by the Commission, a
designated contract market must file with the Commission a written
demonstration, containing supporting data, information and documents,
in the form and manner and within the time specified by the Commission,
that the designated contract market is in compliance with one or more
core principles as specified in the request, or that is requested by
the Commission to show that the designated contract market satisfies
its obligations under the Act.
(c) Equity interest transfers. (1) Equity interest transfer
notification. A designated contract market shall file with the
Commission a notification of each transaction that the designated
contract market enters into involving the transfer of ten percent or
more of the equity interest in the designated contract market.
(2) Timing of Notification. The equity transfer notice described in
paragraph (1) shall be filed electronically with the Secretary of the
Commission at its Washington, DC headquarters at [email protected]
and the Division of Market Oversight at [email protected], at the
earliest possible time but in no event later than the open of business
ten business days following the date upon which the designated contract
market enters into a firm obligation to transfer the equity interest.
(3) Rule filing. Notwithstanding the foregoing, any aspect of an
equity interest transfer described in paragraph (c)(1) of this section
that necessitates the filing of a rule as defined in part 40 of this
chapter shall comply with the requirements of 5c(c) of the Act and part
40 of this chapter, and all other applicable Commission regulations.
(d) Delegation of authority. The Commission hereby delegates, until
it orders otherwise, the authority set forth in paragraph (b) of this
section to the Director of the Division of Market Oversight or such
other employee or employees as the Director may designate from time to
time. The Director may submit to the Commission for its consideration
any matter that has been delegated in this paragraph. Nothing in this
paragraph prohibits the Commission, at its election, from exercising
the authority delegated in this paragraph.
0
13. Add Sec. 38.7 to subpart A to read as follows:
Sec. 38.7 Prohibited use of data collected for regulatory purposes.
A designated contract market may not use for business or marketing
purposes any proprietary data or personal information it collects or
receives, from or on behalf of any person, for the purpose of
fulfilling its regulatory obligations; provided however, that a
designated contract market may use such data or information for
business or marketing purposes if the person from whom it collects or
receives such data or information clearly consents to the designated
contract market's use of such data or information in such manner. A
designated contract market, where necessary, for regulatory purposes,
may share such data or information with one or more designated contract
markets or swap execution facilities registered with the Commission. A
designated contract market may not condition access to its trading
facility on a market participant's consent to the use of proprietary
data or personal information for business or marketing purposes.
0
14. Add Sec. 38.8 to subpart A to read as follows:
Sec. 38.8 Listing of swaps on a designated contract market.
(a) A designated contract market that lists for the first time a
swap contract for trading on its contract market must, either prior to
or at the time of such listing, file with the Commission a written
demonstration detailing how the designated contract market is
addressing its self-regulatory obligations and is fulfilling its
statutory and regulatory obligations with respect to swap transactions.
(b)(1) Prior to listing swaps for trading on or through a
designated contract market, each designated contract market must obtain
from the Commission a unique, alphanumeric code assigned to the
designated contract market by the Commission for the purpose of
identifying the designated contract market with respect to unique swap
identifier creation. (2) Each designated contract market must generate
and assign a unique swap identifier at, or as soon as technologically
practicable following, the time of execution of the swap, in a manner
consistent with the requirements of part 45.
0
15. Add Sec. 38.9 to subpart A to read as follows:
Sec. 38.9 Boards of trade operating both a designated contract market
and a swap execution facility.
(a) A board of trade that operates a designated contract market and
that intends to also operate a swap execution facility must separately
register, pursuant to the swap execution facility registration
requirements set forth in part 37 of this chapter, and on an ongoing
basis, comply with the core principles under section 5h of the Act, and
the swap execution facility rules under part 37 of this chapter.
(b) A board of trade that operates both a designated contract
market and a swap execution facility, and that uses the same electronic
trade execution system for executing and trading swaps that it uses in
its capacity as a designated contract market, must clearly identify to
market participants for each swap
[[Page 36700]]
whether the execution or trading of such swap is taking place on the
designated contract market or on the swap execution facility.
0
16. Add Sec. 38.10 to subpart A to read as follows:
Sec. 38.10 Reporting of swaps traded on a designated contract market.
With respect to swaps traded on and/or pursuant to the rules of a
designated contract market, each designated contract market must
maintain and report specified swap data as provided under parts 43 and
45 of this chapter.
0
17. Add subparts B through X to read as follows:
Subpart B--Designation as Contract Market
Sec.
38.100 Core Principle 1.
Subpart C--Compliance With Rules
38.150 Core Principle 2.
38.151 Access requirements.
38.152 Abusive trading practices prohibited.
38.153 Capacity to detect and investigate rule violations.
38.154 Regulatory services provided by a third party.
38.155 Compliance staff and resources.
38.156 Automated trade surveillance system.
38.157 Real-time market monitoring.
38.158 Investigations and investigation reports.
38.159 Ability to obtain information.
38.160 Additional sources for compliance.
Subpart D--Contracts Not Readily Subject to Manipulation
38.200 Core Principle 3.
38.201 Additional sources for compliance.
Subpart E--Prevention of Market Disruption
38.250 Core Principle 4.
38.251 General requirements.
38.252 Additional requirements for physical-delivery contracts.
38.253 Additional requirements for cash-settled contracts.
38.254 Ability to obtain information.
38.255 Risk controls for trading.
38.256 Trade reconstruction.
38.257 Regulatory service provider.
38.258 Additional sources for compliance.
Subpart F--Position Limitations or Accountability
38.300 Core Principle 5.
38.301 Position limitations and accountability.
Subpart G--Emergency Authority
38.350 Core Principle 6.
38. 351 Additional sources for compliance.
Subpart H--Availability of General Information
38.400 Core Principle 7.
38.401 General requirements.
Subpart I--Daily Publication of Trading Information
38.450 Core Principle 8.
38.451 Reporting of trade information.
Subpart J--Execution of Transactions
38.500 Core Principle 9.
Subpart K--Trade Information
38.550 Core Principle 10.
38.551 Audit trail required.
38.552 Elements of an acceptable audit trail program.
38.553 Enforcement of audit trail requirements.
Subpart L--Financial Integrity of Transactions
38.600 Core Principle 11.
38.601 Mandatory clearing.
38.602 General financial integrity.
38.603 Protection of customer funds.
38.604 Financial surveillance.
38.605 Requirements for financial surveillance program.
38.606 Financial regulatory services provided by a third party.
38.607 Direct access.
Subpart M--Protection of Markets and Market Participants
38.650 Core Principle 12.
38.651 Protection of Markets and Market Participants.
Subpart N--Disciplinary Procedures
38.700 Core Principle 13.
38.701 Enforcement staff.
38.702 Disciplinary panels.
38.703 Notice of charges.
38.704 Right to representation.
38.705 Answer to charges.
38.706 Denial of charges and right to hearing.
38.707 Hearings.
38.708 Decisions.
38.709 Final decisions.
38.710 Disciplinary sanctions.
38.711 Warning letters.
38.712 Additional sources for compliance.
Subpart O--Dispute Resolution
38.750 Core Principle 14.
38.751 Additional sources for compliance.
Subpart P--Governance Fitness Standards
38.800 Core Principle 15.
38.801 Additional sources for compliance.
Subpart Q--Conflicts of Interest
38.850 Core Principle 16.
38.851 Additional sources for compliance.
Subpart R--Composition of Governing Boards of Contract Markets
38.900 Core Principle 17.
Subpart S--Recordkeeping
38.950 Core Principle 18.
38.951 Additional sources for compliance.
Subpart T--Antitrust Considerations
38.1000 Core Principle 19.
38.1001 Additional sources for compliance.
Subpart U--System Safeguards
38.1050 Core Principle 20.
38.1051 General requirements.
Subpart V--Financial Resources
38.1100 Core Principle 21.
38.1101 General requirements.
Subpart W--Diversity of Boards of Directors
38.1150 Core Principle 22.
Subpart X--Securities and Exchange Commission
38.1200 Core Principle 23.
38.1201 Additional sources for compliance.
Subpart B--Designation as Contract Market
Sec. 38.100 Core Principle 1.
(a) In general. To be designated, and maintain a designation, as a
contract market, a board of trade shall comply with:
(1) Any core principle described in section 5(d) of the Act, and
(2) Any requirement that the Commission may impose by rule or
regulation pursuant to section 8a(5) of the Act.
(b) Reasonable discretion of the contract market. Unless otherwise
determined by the Commission by rule or regulation, a board of trade
described in paragraph (a) of this section shall have reasonable
discretion in establishing the manner in which the board of trade
complies with the core principles described in this subsection.
Subpart C--Compliance With Rules
Sec. 38.150 Core Principle 2.
(a) In general. The board of trade shall establish, monitor, and
enforce compliance with the rules of the contract market, including:
(1) Access requirements;
(2) The terms and conditions of any contracts to be traded on the
contract market; and
(3) Rules prohibiting abusive trade practices on the contract
market.
(b) Capacity of contract market. The board of trade shall have the
capacity to detect, investigate, and apply appropriate sanctions to any
person that violates any rule of the contract market.
(c) Requirement of rules. The rules of the contract market shall
provide the board of trade with the ability and authority to obtain any
necessary information to perform any function described in this
section, including the capacity to carry out such international
information-sharing agreements, as the Commission may require.
Sec. 38.151 Access requirements.
(a) Jurisdiction. Prior to granting any member or market
participant access to its markets, a designated contract market must
require that the member or market participant consent to its
jurisdiction.
[[Page 36701]]
(b) Impartial access by members, persons with trading privileges
and independent software vendors. A designated contract market must
provide its members, persons with trading privileges, and independent
software vendors with impartial access to its markets and services,
including:
(1) Access criteria that are impartial, transparent, and applied in
a non-discriminatory manner; and
(2) Comparable fee structures for members, persons with trading
privileges and independent software vendors receiving equal access to,
or services from, the designated contract market.
(c) Limitations on access. A designated contract market must
establish and impartially enforce rules governing denials, suspensions,
and revocations of a member's and a person with trading privileges'
access privileges to the designated contract market, including when
such actions are part of a disciplinary or emergency action by the
designated contract market.
Sec. 38.152 Abusive trading practices prohibited.
A designated contract market must prohibit abusive trading
practices on its markets by members and market participants. Designated
contract markets that permit intermediation must prohibit customer-
related abuses including, but not limited to, trading ahead of customer
orders, trading against customer orders, accommodation trading, and
improper cross trading. Specific trading practices that must be
prohibited by all designated contract markets include front-running,
wash trading, pre-arranged trading (except for certain transactions
specifically permitted under part 38 of this chapter), fraudulent
trading, money passes, and any other trading practices that a
designated contract market deems to be abusive. In addition, a
designated contract market also must prohibit any other manipulative or
disruptive trading practices prohibited by the Act or by the Commission
pursuant to Commission regulation.
Sec. 38.153 Capacity to detect and investigate rule violations.
A designated contract market must have arrangements and resources
for effective enforcement of its rules. Such arrangements must include
the authority to collect information and documents on both a routine
and non-routine basis, including the authority to examine books and
records kept by the designated contract market's members and by persons
under investigation. A designated contract market's arrangements and
resources must also facilitate the direct supervision of the market and
the analysis of data collected to determine whether a rule violation
occurred.
Sec. 38.154 Regulatory services provided by a third party.
(a) Use of third-party provider permitted. A designated contract
market may choose to utilize a registered futures association or
another registered entity, as such terms are defined under the Act,
(collectively, ``regulatory service provider''), for the provision of
services to assist in complying with the core principles, as approved
by the Commission. Any designated contract market that chooses to
utilize a regulatory service provider must ensure that its regulatory
service provider has the capacity and resources necessary to provide
timely and effective regulatory services, including adequate staff and
automated surveillance systems. A designated contract market will at
all times remain responsible for the performance of any regulatory
services received, for compliance with the designated contract market's
obligations under the Act and Commission regulations, and for the
regulatory service provider's performance on its behalf.
(b) Duty to supervise third party. A designated contract market
that elects to utilize a regulatory service provider must retain
sufficient compliance staff to supervise the quality and effectiveness
of the services provided on its behalf. Compliance staff of the
designated contract market must hold regular meetings with the
regulatory service provider to discuss ongoing investigations, trading
patterns, market participants, and any other matters of regulatory
concern. A designated contract market also must conduct periodic
reviews of the adequacy and effectiveness of services provided on its
behalf. Such reviews must be documented carefully and made available to
the Commission upon request.
(c) Regulatory decisions required from the designated contract
market. A designated contract market that elects to utilize a
regulatory service provider must retain exclusive authority in
decisions involving the cancellation of trades, the issuance of
disciplinary charges against members or market participants, and the
denials of access to the trading platform for disciplinary reasons. A
designated contract market may also retain exclusive authority in other
areas of its choosing. A designated contract market must document any
instances where its actions differ from those recommended by its
regulatory service provider, including the reasons for the course of
action recommended by the regulatory service provider and the reasons
why the designated contract market chose a different course of action.
Sec. 38.155 Compliance staff and resources.
(a) Sufficient compliance staff. A designated contract market must
establish and maintain sufficient compliance department resources and
staff to ensure that it can conduct effective audit trail reviews,
trade practice surveillance, market surveillance, and real-time market
monitoring. The designated contract market's compliance staff also must
be sufficient to address unusual market or trading events as they
arise, and to conduct and complete investigations in a timely manner,
as set forth in Sec. 38.158(b) of this part.
(b) Ongoing monitoring of compliance staff resources. A designated
contract market must monitor the size and workload of its compliance
staff annually, and ensure that its compliance resources and staff are
at appropriate levels. In determining the appropriate level of
compliance resources and staff, the designated contract market should
consider trading volume increases, the number of new products or
contracts to be listed for trading, any new responsibilities to be
assigned to compliance staff, the results of any internal review
demonstrating that work is not completed in an effective or timely
manner, and any other factors suggesting the need for increased
resources and staff.
Sec. 38.156 Automated trade surveillance system.
A designated contract market must maintain an automated trade
surveillance system capable of detecting and investigating potential
trade practice violations. The automated system must load and process
daily orders and trades no later than 24 hours after the completion of
the trading day. In addition, the automated trade surveillance system
must have the capability to detect and flag specific trade execution
patterns and trade anomalies; compute, retain, and compare trading
statistics; compute trade gains, losses, and futures-equivalent
positions; reconstruct the sequence of market activity; perform market
analyses; and support system users to perform in-depth analyses and ad
hoc queries of trade-related data.
[[Page 36702]]
Sec. 38.157 Real-time market monitoring.
A designated contract market must conduct real-time market
monitoring of all trading activity on its electronic trading
platform(s) to identify disorderly trading and any market or system
anomalies. A designated contract market must have the authority to
adjust trade prices or cancel trades when necessary to mitigate market
disrupting events caused by malfunctions in its electronic trading
platform(s) or errors in orders submitted by members and market
participants. Any trade price adjustments or trade cancellations must
be transparent to the market and subject to standards that are clear,
fair, and publicly available.
Sec. 38.158 Investigations and investigation reports.
(a) Procedures. A designated contract market must establish and
maintain procedures that require its compliance staff to conduct
investigations of possible rule violations. An investigation must be
commenced upon the receipt of a request from Commission staff or upon
the discovery or receipt of information by the designated contract
market that indicates a reasonable basis for finding that a violation
may have occurred or will occur.
(b) Timeliness. Each compliance staff investigation must be
completed in a timely manner. Absent mitigating factors, a timely
manner is no later than 12 months after the date that an investigation
is opened. Mitigating factors that may reasonably justify an
investigation taking longer than 12 months to complete include the
complexity of the investigation, the number of firms or individuals
involved as potential wrongdoers, the number of potential violations to
be investigated, and the volume of documents and data to be examined
and analyzed by compliance staff.
(c) Investigation reports when a reasonable basis exists for
finding a violation. Compliance staff must submit a written
investigation report for disciplinary action in every instance in which
compliance staff determines from surveillance or from an investigation
that a reasonable basis exists for finding a rule violation. The
investigation report must include the reason the investigation was
initiated; a summary of the complaint, if any; the relevant facts;
compliance staff's analysis and conclusions; and a recommendation as to
whether disciplinary action should be pursued.
(d) Investigation reports when no reasonable basis exists for
finding a violation. If after conducting an investigation, compliance
staff determines that no reasonable basis exists for finding a
violation, it must prepare a written report including the reason(s) the
investigation was initiated; a summary of the complaint, if any; the
relevant facts; and compliance staff's analysis and conclusions.
(e) Warning letters. No more than one warning letter may be issued
to the same person or entity found to have committed the same rule
violation within a rolling twelve month period.
Sec. 38.159 Ability to obtain information.
A designated contract market must have the ability and authority to
obtain any necessary information to perform any function required under
this subpart C of the Commission's regulations, including the capacity
to carry out international information-sharing agreements as the
Commission may require. Appropriate information-sharing agreements can
be established with other designated contract markets and swap
execution facilities, or the Commission can act in conjunction with the
designated contract market to carry out such information sharing.
Sec. 38.160 Additional sources for compliance.
Applicants and designated contract markets may refer to the
guidance in appendix B of this part to demonstrate to the Commission
compliance with the requirements of Sec. 38.150 of this part.
Subpart D--Contracts Not Readily Subject to Manipulation
Sec. 38.200 Core Principle 3.
The board of trade shall list on the contract market only contracts
that are not readily susceptible to manipulation.
Sec. 38.201 Additional sources for compliance.
Applicants and designated contract markets may refer to the
guidance in appendix C of this part to demonstrate to the Commission
compliance with the requirements of Sec. 38.200 of this part.
Subpart E--Prevention of Market Disruption
Sec. 38.250 Core Principle 4.
The board of trade shall have the capacity and responsibility to
prevent manipulation, price distortion, and disruptions of the delivery
or cash-settlement process through market surveillance, compliance, and
enforcement practices and procedures, including:
(a) Methods for conducting real-time monitoring of trading; and
(b) Comprehensive and accurate trade reconstructions.
Sec. 38.251 General requirements.
A designated contract market must:
(a) Collect and evaluate data on individual traders' market
activity on an ongoing basis in order to detect and prevent
manipulation, price distortions and, where possible, disruptions of the
physical-delivery or cash-settlement process;
(b) Monitor and evaluate general market data in order to detect and
prevent manipulative activity that would result in the failure of the
market price to reflect the normal forces of supply and demand;
(c) Demonstrate an effective program for conducting real-time
monitoring of market conditions, price movements and volumes, in order
to detect abnormalities and, when necessary, make a good-faith effort
to resolve conditions that are, or threaten to be, disruptive to the
market; and
(d) Demonstrate the ability to comprehensively and accurately
reconstruct daily trading activity for the purposes of detecting
trading abuses and violations of exchange-set position limits,
including those that may have occurred intraday.
Sec. 38.252 Additional requirements for physical-delivery contracts.
For physical-delivery contracts, the designated contract market
must demonstrate that it:
(a) Monitors a contract's terms and conditions as they relate to
the underlying commodity market and to the convergence between the
contract price and the price of the underlying commodity and show a
good-faith effort to resolve conditions that are interfering with
convergence; and
(b) Monitors the supply of the commodity and its adequacy to
satisfy the delivery requirements and make a good-faith effort to
resolve conditions that threaten the adequacy of supplies or the
delivery process.
Sec. 38.253 Additional requirements for cash-settled contracts.
(a) For cash-settled contracts, the designated contract market must
demonstrate that it:
(1) Monitors the pricing of the index to which the contract will be
settled; and
(2) Monitors the continued appropriateness of the methodology for
deriving the index and makes a good-faith effort to resolve conditions,
including amending contract terms where necessary, where there is a
threat of market manipulation, disruptions, or distortions.
(b) If a contract listed on a designated contract market is settled
by reference to
[[Page 36703]]
the price of a contract or commodity traded in another venue, including
a price or index derived from prices on another designated contract
market, the designated contract market must have rules or agreements
that allow the designated contract market access to information on the
activities of its traders in the reference market.
Sec. 38.254 Ability to obtain information.
(a) The designated contract market must have rules that require
traders in its contracts to keep records of their trading, including
records of their activity in the underlying commodity and related
derivatives markets, and make such records available, upon request, to
the designated contract market.
(b) A designated contract market with participants trading through
intermediaries must either use a comprehensive large-trader reporting
system (LTRS) or be able to demonstrate that it can obtain position
data from other sources in order to conduct an effective surveillance
program.
Sec. 38.255 Risk controls for trading.
The designated contract market must establish and maintain risk
control mechanisms to prevent and reduce the potential risk of price
distortions and market disruptions, including, but not limited to,
market restrictions that pause or halt trading in market conditions
prescribed by the designated contract market.
Sec. 38.256 Trade reconstruction.
The designated contract market must have the ability to
comprehensively and accurately reconstruct all trading on its trading
facility. All audit-trail data and reconstructions must be made
available to the Commission in a form, manner, and time that is
acceptable to the Commission.
Sec. 38.257 Regulatory service provider.
A designated contract market must comply with the regulations in
this subpart through a dedicated regulatory department, or by
delegation of that function to a registered futures association or a
registered entity (collectively, ``regulatory service provider''), as
such terms are defined in the Act and over which the designated
contract market has supervisory authority.
Sec. 38.258 Additional sources for compliance.
Applicants and designated contract markets may refer to the
guidance and acceptable practices in appendix B of this part to
demonstrate to the Commission compliance with the requirements of Sec.
38.250 of this part.
Subpart F--Position Limitations or Accountability
Sec. 38.300 Core Principle 5.
To reduce the potential threat of market manipulation or congestion
(especially during trading in the delivery month), the board of trade
shall adopt for each contract of the board of trade, as is necessary
and appropriate, position limitations or position accountability for
speculators. For any contract that is subject to a position limitation
established by the Commission, pursuant to section 4a(a), the board of
trade shall set the position limitation of the board of trade at a
level not higher than the position limitation established by the
Commission.
Sec. 38.301 Position limitations and accountability.
A designated contract market must meet the requirements of parts
150 and 151 of this chapter, as applicable.
Subpart G--Emergency Authority
Sec. 38.350 Core Principle 6.
The board of trade, in consultation or cooperation with the
Commission, shall adopt rules to provide for the exercise of emergency
authority, as is necessary and appropriate, including the authority:
(a) To liquidate or transfer open positions in any contract;
(b) To suspend or curtail trading in any contract; and
(c) To require market participants in any contract to meet special
margin requirements.
Sec. 38.351 Additional sources for compliance.
Applicants and designated contract markets may refer to the
guidance and/or acceptable practices in appendix B of this part to
demonstrate to the Commission compliance with the requirements of Sec.
38.350.
Subpart H--Availability of General Information
Sec. 38.400 Core Principle 7.
The board of trade shall make available to market authorities,
market participants, and the public accurate information concerning:
(a) The terms and conditions of the contracts of the contract
market; and
(b)(1) The rules, regulations and mechanisms for executing
transactions on or through the facilities of the contract market, and
(2) The rules and specifications describing the operation of the
contract market's:
(i) Electronic matching platform, or
(ii) Trade execution facility.
Sec. 38.401 General requirements.
(a) General. (1) A designated contract market must have procedures,
arrangements and resources for disclosing to the Commission, market
participants and the public accurate information pertaining to:
(i) Contract terms and conditions;
(ii) Rules and regulations pertaining to the trading mechanisms;
and
(iii) Rules and specifications pertaining to operation of the
electronic matching platform or trade execution facility.
(2) Through the procedures, arrangements and resources required in
paragraph (a) of this section, the designated contract market must
ensure public dissemination of information pertaining to new product
listings, new rules, rule amendments or other changes to previously-
disclosed information, in accordance with the timeline provided in
paragraph (c) of this section.
(3) A designated contract market shall meet the requirements of
this paragraph (a), by placing the information described in this
paragraph (a) on the designated contract market's Web site within the
time prescribed in paragraph (c) of this section.
(b) Accuracy requirement. With respect to any communication with
the Commission, and any information required to be transmitted or made
available to market participants and the public, including on its Web
site or otherwise, a designated contract market must provide
information that it believes, to the best of its knowledge, is accurate
and complete, and must not omit material information.
(c) Notice of regulatory submissions. (1) A designated contract
market, in making available on its Web site information pertaining to
new product listings, new rules, rule amendments or other changes to
previously-disclosed information, must place such information and
submissions on its Web site concurrent with the filing of such
information or submissions with the Secretary of the Commission.
(2) To the extent that a designated contract market requests
confidential treatment of any information filed with the Secretary of
the Commission, the designated contract market must post on its Web
site the public version of such filing or submission.
(d) Rulebook. A designated contract market must ensure that the
rulebook posted on its Web site is accurate,
[[Page 36704]]
complete, current and readily accessible to the public. A designated
contract market must publish or post in its rulebook all new or amended
rules, both substantive and non-substantive, on the date of
implementation of such new or amended rule, on the date a new product
is listed, or on the date any changes to previously-disclosed
information take effect.
Subpart I--Daily Publication of Trading Information
Sec. 38.450 Core Principle 8.
The board of trade shall make public daily information on
settlement prices, volume, open interest, and opening and closing
ranges for actively traded contracts on the contract market.
Sec. 38.451 Reporting of trade information.
A designated contract market must meet the reporting requirements
set forth in part 16 of this chapter.
Subpart J--Execution of Transactions
Sec. 38.500 Core Principle 9.
The board of trade shall provide a competitive, open, and efficient
market and mechanism for executing transactions that protects the price
discovery process of trading in the centralized market of the board of
trade. The rules of the board of trade may authorize, for bona fide
business purposes:
(a) Transfer trades or office trades;
(b) An exchange of:
(1) Futures in connection with a cash commodity transaction;
(2) Futures for cash commodities; or
(3) Futures for swaps; or
(c) A futures commission merchant, acting as principal or agent, to
enter into or confirm the execution of a contract for the purchase or
sale of a commodity for future delivery if the contract is reported,
recorded, or cleared in accordance with the rules of the contract
market or a derivatives clearing organization.
Subpart K--Trade Information
Sec. 38.550 Core Principle 10.
The board of trade shall maintain rules and procedures to provide
for the recording and safe storage of all identifying trade information
in a manner that enables the contract market to use the information:
(a) To assist in the prevention of customer and market abuses; and
(b) To provide evidence of any violations of the rules of the
contract market.
Sec. 38.551 Audit trail required.
A designated contract market must capture and retain all audit
trail data necessary to detect, investigate, and prevent customer and
market abuses. Such data must be sufficient to reconstruct all
transactions within a reasonable period of time and to provide evidence
of any violations of the rules of the designated contract market. An
acceptable audit trail must also permit the designated contract market
to track a customer order from the time of receipt through fill,
allocation, or other disposition, and must include both order and trade
data.
Sec. 38.552 Elements of an acceptable audit trail program.
(a) Original source documents. A designated contract market's audit
trail must include original source documents. Original source documents
include unalterable, sequentially identified records on which trade
execution information is originally recorded, whether recorded manually
or electronically. Records for customer orders (whether filled,
unfilled, or cancelled, each of which shall be retained or
electronically captured) must reflect the terms of the order, an
account identifier that relates back to the account(s) owner(s), and
the time of order entry. For open-outcry trades, the time of report of
execution of the order shall also be captured.
(b) Transaction history database. A designated contract market's
audit trail program must include an electronic transaction history
database. An adequate transaction history database includes a history
of all trades executed via open outcry or via entry into an electronic
trading system, and all orders entered into an electronic trading
system, including all order modifications and cancellations. An
adequate transaction history database also includes:
(1) All data that are input into the trade entry or matching system
for the transaction to match and clear;
(2) The customer type indicator code;
(3) Timing and sequencing data adequate to reconstruct trading; and
(4) Identification of each account to which fills are allocated.
(c) Electronic analysis capability. A designated contract market's
audit trail program must include electronic analysis capability with
respect to all audit trail data in the transaction history database.
Such electronic analysis capability must ensure that the designated
contract market has the ability to reconstruct trading and identify
possible trading violations with respect to both customer and market
abuse.
(d) Safe storage capability. A designated contract market's audit
trail program must include the capability to safely store all audit
trail data retained in its transaction history database. Such safe
storage capability must include the capability to store all data in the
database in a manner that protects it from unauthorized alteration, as
well as from accidental erasure or other loss. Data must be retained in
accordance with the recordkeeping requirements of Core Principle 18 and
the associated regulations in subpart S of this part.
Sec. 38.553 Enforcement of audit trail requirements.
(a) Annual audit trail and recordkeeping reviews. A designated
contract market must enforce its audit trail and recordkeeping
requirements through at least annual reviews of all members and persons
and firms subject to designated contract market recordkeeping rules to
verify their compliance with the contract market's audit trail and
recordkeeping requirements. Such reviews must include, but are not
limited to, the following:
(1) For electronic trading, audit trail and recordkeeping reviews
must include reviews of randomly selected samples of front-end audit
trail data for order routing systems; a review of the process by which
user identifications are assigned and user identification records are
maintained; a review of usage patterns associated with user
identifications to monitor for violations of user identification rules;
and reviews of account numbers and customer type indicator codes in
trade records to test for accuracy and improper use.
(2) For open outcry trading, audit trail and recordkeeping reviews
must include reviews of members' and market participants' compliance
with the designated contract market's trade timing, order ticket, and
trading card requirements.
(b) Enforcement program required. A designated contract market must
establish a program for effective enforcement of its audit trail and
recordkeeping requirements for both electronic and open-outcry trading,
as applicable. An effective program must identify members and persons
and firms subject to designated contract market recordkeeping rules
that have failed to maintain high levels of compliance with such
requirements, and levy meaningful sanctions when deficiencies are
found. Sanctions must be sufficient to deter recidivist behavior. No
more than one warning letter may be issued to the
[[Page 36705]]
same person or entity found to have committed the same rule violation
within a rolling twelve month period.
Subpart L--Financial Integrity of Transactions
Sec. 38.600 Core Principle 11.
The board of trade shall establish and enforce:
(a) Rules and procedures for ensuring the financial integrity of
transactions entered into on or through the facilities of the contract
market (including the clearance and settlement of the transactions with
a derivatives clearing organization); and
(b) Rules to ensure:
(1) The financial integrity of any:
(i) Futures commission merchant, and
(ii) Introducing broker; and
(2) The protection of customer funds.
Sec. 38.601 Mandatory clearing.
(a) Transactions executed on or through the designated contract
market must be cleared through a Commission-registered derivatives
clearing organization, in accordance with the provisions of part 39 of
this chapter. Notwithstanding the foregoing, transactions in security
futures products executed on or through the designated contract market
may alternatively be cleared through a clearing agency, registered
pursuant to section 17A of the Securities Exchange Act of 1934.
(b) [Reserved]
Sec. 38.602 General financial integrity.
A designated contract market must provide for the financial
integrity of its transactions by establishing and maintaining
appropriate minimum financial standards for its members and non-
intermediated market participants.
Sec. 38.603 Protection of customer funds.
A designated contract market must have rules concerning the
protection of customer funds. These rules shall address appropriate
minimum financial standards for intermediaries, the segregation of
customer and proprietary funds, the custody of customer funds, the
investment standards for customer funds, intermediary default
procedures and related recordkeeping. A designated contract market must
review the default rules and procedures of the derivatives clearing
organization that clears for such designated contract market to wind
down operations, transfer customers, or otherwise protect customers in
the event of a default of a clearing member or the derivatives clearing
organization.
Sec. 38.604 Financial surveillance.
A designated contract market must monitor members' compliance with
the designated contract market's minimum financial standards and,
therefore, must routinely receive and promptly review financial and
related information from its members, as well as continuously monitor
the positions of members and their customers. A designated contract
market must have rules that prescribe minimum capital requirements for
member futures commission merchants and introducing brokers. A
designated contract market must:
(a) Continually survey the obligations of each futures commission
merchant created by the positions of its customers;
(b) As appropriate, compare those obligations to the financial
resources of the futures commission merchant; and
(c) Take appropriate steps to use this information to protect
customer funds.
Sec. 38.605 Requirements for financial surveillance program.
A designated contract market's financial surveillance program for
futures commission merchants, retail foreign exchange dealers, and
introducing brokers must comply with the requirements of Sec. 1.52 of
this chapter to assess the compliance of such entities with applicable
contract market rules and Commission regulations.
Sec. 38.606 Financial regulatory services provided by a third party.
A designated contract market may comply with the requirements of
Sec. 38.604 (Financial Surveillance) and Sec. 38.605 (Requirements
for Financial Surveillance Program) of this part through the regulatory
services of a registered futures association or a registered entity
(collectively, ``regulatory service provider''), as such terms are
defined under the Act. A designated contract market must ensure that
its regulatory service provider has the capacity and resources
necessary to provide timely and effective regulatory services,
including adequate staff and appropriate surveillance systems. A
designated contract market will at all times remain responsible for
compliance with its obligations under the Act and Commission
regulations, and for the regulatory service provider's performance on
its behalf. Regulatory services must be provided under a written
agreement with a regulatory services provider that shall specifically
document the services to be performed as well as the capacity and
resources of the regulatory service provider with respect to the
services to be performed.
Sec. 38.607 Direct access.
A designated contract market that permits direct electronic access
by customers (i.e., allowing customers of futures commission merchants
to enter orders directly into a designated contract market's trade
matching system for execution) must have in place effective systems and
controls reasonably designed to facilitate the FCM's management of
financial risk, such as automated pre-trade controls that enable member
futures commission merchants to implement appropriate financial risk
limits. A designated contract market must implement and enforce rules
requiring the member futures commission merchants to use the provided
systems and controls.
Subpart M--Protection of Markets and Market Participants
Sec. 38.650 Core Principle 12.
The board of trade shall establish and enforce rules:
(a) To protect markets and market participants from abusive
practices committed by any party, including abusive practices committed
by a party acting as an agent for a participant; and
(b) To promote fair and equitable trading on the contract market.
Sec. 38.651 Protection of markets and market participants.
A designated contract market must have and enforce rules that are
designed to promote fair and equitable trading and to protect the
market and market participants from abusive practices including
fraudulent, noncompetitive or unfair actions, committed by any party.
The designated contract market must have methods and resources
appropriate to the nature of the trading system and the structure of
the market to detect trade practice and market abuses and to discipline
such behavior, in accordance with Core Principles 2 and 4, and the
associated regulations in subparts C and E of this part, respectively.
The designated contract market also must provide a competitive, open
and efficient market and mechanism for executing transactions in
accordance with Core Principle 9 and the associated regulations under
subpart J of this part.
Subpart N--Disciplinary Procedures
Sec. 38.700 Core Principle 13.
The board of trade shall establish and enforce disciplinary
procedures that authorize the board of trade to discipline, suspend, or
expel members or market participants that violate the rules of the
board of trade, or similar methods for performing the same functions,
including delegation of the functions to third parties.
[[Page 36706]]
Sec. 38.701 Enforcement staff.
A designated contract market must establish and maintain sufficient
enforcement staff and resources to effectively and promptly prosecute
possible rule violations within the disciplinary jurisdiction of the
contract market. A designated contract market must also monitor the
size and workload of its enforcement staff annually, and ensure that
its enforcement resources and staff are at appropriate levels. The
enforcement staff may not include either members of the designated
contract market or persons whose interests conflict with their
enforcement duties. A member of the enforcement staff may not operate
under the direction or control of any person or persons with trading
privileges at the contract market. A designated contract market's
enforcement staff may operate as part of the designated contract
market's compliance department.
Sec. 38.702 Disciplinary panels.
A designated contract market must establish one or more
disciplinary panels that are authorized to fulfill their obligations
under the rules of this subpart. Disciplinary panels must meet the
composition requirements of part 40 of this chapter, and must not
include any members of the designated contract market's compliance
staff or any person involved in adjudicating any other stage of the
same proceeding.
Sec. 38.703 Notice of charges.
If compliance staff authorized by a designated contract market or a
designated contract market disciplinary panel determines that a
reasonable basis exists for finding a violation and that adjudication
is warranted, it must direct that the person or entity alleged to have
committed the violation be served with a notice of charges and must
proceed in accordance with the rules of this section. A notice of
charges must adequately state the acts, conduct, or practices in which
the respondent is alleged to have engaged; state the rule, or rules,
alleged to have been violated (or about to be violated); and prescribe
the period within which a hearing on the charges may be requested. The
notice must also advise that the charged respondent is entitled, upon
request, to a hearing on the charges.
Sec. 38.704 Right to representation.
Upon being served with a notice of charges, a respondent must have
the right to be represented by legal counsel or any other
representative of its choosing in all succeeding stages of the
disciplinary process, except any member of the designated contract
market's board of directors or disciplinary panel, any employee of the
designated contract market, or any person substantially related to the
underlying investigations, such as material witness or respondent.
Sec. 38.705 Answer to charges.
A respondent must be given a reasonable period of time to file an
answer to a notice of charges. The rules of a designated contract
market governing the requirements and timeliness of a respondent's
answer to charges must be fair, equitable, and publicly available.
Sec. 38.706 Denial of charges and right to hearing.
In every instance where a respondent has requested a hearing on a
charge that is denied, or on a sanction set by the disciplinary panel,
the respondent must be given an opportunity for a hearing in accordance
with the requirements of Sec. 38.707 of this part.
Sec. 38.707 Hearings.
(a) A designated contract market must adopt rules that provide for
the following minimum requirements for any hearing conducted pursuant
to a notice of charges:
(1) The hearing must be fair, must be conducted before members of
the disciplinary panel, and must be promptly convened after reasonable
notice to the respondent. The formal rules of evidence need not apply;
nevertheless, the procedures for the hearing may not be so informal as
to deny a fair hearing. No member of the disciplinary panel for the
matter may have a financial, personal, or other direct interest in the
matter under consideration.
(2) In advance of the hearing, the respondent must be entitled to
examine all books, documents, or other evidence in the possession or
under the control of the designated contract market. The designated
contract market may withhold documents that are privileged or
constitute attorney work product, documents that were prepared by an
employee of the designated contract market but will not be offered in
evidence in the disciplinary proceedings, documents that may disclose a
technique or guideline used in examinations, investigations, or
enforcements proceedings, and documents that disclose the identity of a
confidential source.
(3) The designated contract market's enforcement and compliance
staffs must be parties to the hearing, and the enforcement staff must
present their case on those charges and sanctions that are the subject
of the hearing.
(4) The respondent must be entitled to appear personally at the
hearing, must be entitled to cross-examine any persons appearing as
witnesses at the hearing, and must be entitled to call witnesses and to
present such evidence as may be relevant to the charges.
(5) The designated contract market must require persons within its
jurisdiction who are called as witnesses to participate in the hearing
and to produce evidence. It must make reasonable efforts to secure the
presence of all other persons called as witnesses whose testimony would
be relevant.
(6) If the respondent has requested a hearing, a copy of the
hearing must be made and must become a part of the record of the
proceeding. The record must be one that is capable of being accurately
transcribed; however, it need not be transcribed unless the transcript
is requested by Commission staff or the respondent, the decision is
appealed pursuant to the rules of the designated contract market, or is
reviewed by the Commission pursuant to section 8c of the Act or part 9
of this chapter. In all other instances a summary record of a hearing
is permitted.
(b) [Reserved]
Sec. 38.708 Decisions.
Promptly following a hearing conducted in accordance with Sec.
38.707 of this part, the disciplinary panel must render a written
decision based upon the weight of the evidence contained in the record
of the proceeding and must provide a copy to the respondent. The
decision must include:
(a) The notice of charges or a summary of the charges;
(b) The answer, if any, or a summary of the answer;
(c) A summary of the evidence produced at the hearing or, where
appropriate, incorporation by reference of the investigation report;
(d) A statement of findings and conclusions with respect to each
charge, and a complete explanation of the evidentiary and other basis
for such findings and conclusions with respect to each charge;
(e) An indication of each specific rule that the respondent was
found to have violated; and
(f) A declaration of all sanctions imposed against the respondent,
including the basis for such sanctions and the effective date of such
sanctions.
Sec. 38.709 Final decisions.
Each designated contract market must establish rules setting forth
when a decision rendered pursuant to this
[[Page 36707]]
section will become the final decision of such designated contract
market.
Sec. 38.710 Disciplinary sanctions.
All disciplinary sanctions imposed by a designated contract market
or its disciplinary panels must be commensurate with the violations
committed and must be clearly sufficient to deter recidivism or similar
violations by other market participants. All disciplinary sanctions,
including sanctions imposed pursuant to an accepted settlement offer,
must take into account the respondent's disciplinary history. In the
event of demonstrated customer harm, any disciplinary sanction must
also include full customer restitution, except where the amount of
restitution, or to whom it should be provided, cannot be reasonably
determined.
Sec. 38.711 Warning letters.
Where a rule violation is found to have occurred, no more than one
warning letter may be issued per rolling 12-month period for the same
violation.
Sec. 38.712 Additional sources for compliance.
Applicants and designated contract markets may refer to the
guidance in appendix B of this part to demonstrate to the Commission
compliance with the requirements of Sec. 38.700 of this part.
Subpart O--Dispute Resolution
Sec. 38.750 Core Principle 14.
The board of trade shall establish and enforce rules regarding, and
provide facilities for alternative dispute resolution as appropriate
for, market participants and any market intermediaries.
Sec. 38.751 Additional sources for compliance.
Applicants and designated contract markets may refer to the
guidance and acceptable practices in appendix B of this part to
demonstrate to the Commission compliance with the requirements of Sec.
38.750 of this part.
Subpart P--Governance Fitness Standards
Sec. 38.800 Core Principle 15.
The board of trade shall establish and enforce appropriate fitness
standards for directors, members of any disciplinary committee, members
of the contract market, and any other person with direct access to the
facility (including any party affiliated with any person described in
this paragraph).
Sec. 38.801 Additional sources for compliance.
Applicants and designated contract markets may refer to the
guidance in appendix B of this part to demonstrate to the Commission
compliance with the requirements of Sec. 38.800 of this part.
Subpart Q--Conflicts of Interest
Sec. 38.850 Core Principle 16.
The board of trade shall establish and enforce rules:
(a) To minimize conflicts of interest in the decision-making
process of the contract market; and
(b) To establish a process for resolving conflicts of interest
described in paragraph (a) of this section.
Sec. 38.851 Additional sources for compliance.
Applicants and designated contract markets may refer to the
guidance and/or acceptable practices in appendix B of this part to
demonstrate to the Commission compliance with the requirements of Sec.
38.850 of this part.
Subpart R--Composition of Governing Boards of Contract Markets
Sec. 38.900 Core Principle 17.
The governance arrangements of the board of trade shall be designed
to permit consideration of the views of market participants.
Subpart S--Recordkeeping
Sec. 38.950 Core Principle 18.
The board of trade shall maintain records of all activities
relating to the business of the contract market:
(a) In a form and manner that is acceptable to the Commission; and
(b) For a period of at least 5 years.
Sec. 38.951 Additional sources for compliance.
A designated contract market must maintain such records, including
trade records and investigatory and disciplinary files, in accordance
with the requirements of Sec. 1.31 of this chapter, and in accordance
with part 45 of this chapter, if applicable.
Subpart T--Antitrust Considerations
Sec. 38.1000 Core Principle 19.
Unless necessary or appropriate to achieve the purposes of this
Act, the board of trade shall not:
(a) Adopt any rule or taking any action that results in any
unreasonable restraint of trade; or
(b) Impose any material anticompetitive burden on trading on the
contract market.
Sec. 38.1001 Additional sources for compliance.
Applicants and designated contract markets may refer to the
guidance and acceptable practices in appendix B of this part to
demonstrate to the Commission compliance with the requirements of Sec.
38.1000 of this part.
Subpart U--System Safeguards
Sec. 38.1050 Core Principle 20.
Each designated contract market shall:
(a) Establish and maintain a program of risk analysis and oversight
to identify and minimize sources of operational risk, through the
development of appropriate controls and procedures, and the development
of automated systems, that are reliable, secure, and have adequate
scalable capacity;
(b) Establish and maintain emergency procedures, backup facilities,
and a plan for disaster recovery that allow for the timely recovery and
resumption of operations and the fulfillment of the responsibilities
and obligations of the board of trade; and
(c) Periodically conduct tests to verify that backup resources are
sufficient to ensure continued order processing and trade matching,
transmission of matched orders to a designated clearing organization
for clearing, price reporting, market surveillance, and maintenance of
a comprehensive and accurate audit trail.
Sec. 38.1051 General requirements.
(a) A designated contract market's program of risk analysis and
oversight with respect to its operations and automated systems must
address each of the following categories of risk analysis and
oversight:
(1) Information security;
(2) Business continuity-disaster recovery planning and resources;
(3) Capacity and performance planning;
(4) Systems operations;
(5) Systems development and quality assurance; and
(6) Physical security and environmental controls.
(b) In addressing the categories of risk analysis and oversight
required under paragraph (a) of this section, a designated contract
market should follow generally accepted standards and best practices
with respect to the development, operation, reliability, security, and
capacity of automated systems.
(c) A designated contract market must maintain a business
continuity-disaster recovery plan and business continuity-disaster
recovery resources, emergency procedures, and backup facilities
[[Page 36708]]
sufficient to enable timely recovery and resumption of its operations
and resumption of its ongoing fulfillment of its responsibilities and
obligations as a designated contract market following any disruption of
its operations. Such responsibilities and obligations include, without
limitation, order processing and trade matching; transmission of
matched orders to a designated clearing organization for clearing;
price reporting; market surveillance; and maintenance of a
comprehensive audit trail. The designated contract market's business
continuity-disaster recovery plan and resources generally should enable
resumption of trading and clearing of the designated contract market's
products during the next business day following the disruption.
Designated contract markets determined by the Commission to be critical
financial markets are subject to more stringent requirements in this
regard, set forth in Sec. 40.9 of this chapter. Electronic trading is
an acceptable backup for open outcry trading in the event of a
disruption.
(d) A designated contract market that is not determined by the
Commission to be a critical financial market satisfies the requirement
to be able to resume trading and clearing during the next business day
following a disruption by maintaining either:
(1) Infrastructure and personnel resources of its own that are
sufficient to ensure timely recovery and resumption of its operations
and resumption of its ongoing fulfillment of its responsibilities and
obligations as a designated contract market following any disruption of
its operations; or
(2) Contractual arrangements with other designated contract markets
or disaster recovery service providers, as appropriate, that are
sufficient to ensure continued trading and clearing of the designated
contract market's products, and ongoing fulfillment of all of the
designated contract market's responsibilities and obligations with
respect to those products, in the event that a disruption renders the
designated contract market temporarily or permanently unable to satisfy
this requirement on its own behalf.
(e) A designated contract market must notify Commission staff
promptly of all:
(1) Electronic trading halts and significant systems malfunctions;
(2) Cyber security incidents or targeted threats that actually or
potentially jeopardize automated system operation, reliability,
security, or capacity; and
(3) Activation of the designated contract market's business
continuity-disaster recovery plan.
(f) A designated contract market must give Commission staff timely
advance notice of all material:
(1) Planned changes to automated systems that may impact the
reliability, security, or adequate scalable capacity of such systems;
and
(2) Planned changes to the designated contract market's program of
risk analysis and oversight.
(g) A designated contract market must provide to the Commission
upon request current copies of its business continuity-disaster
recovery plan and other emergency procedures, its assessments of its
operational risks, and other documents requested by Commission staff
for the purpose of maintaining a current profile of the designated
contract market's automated systems.
(h) A designated contract market must conduct regular, periodic,
objective testing and review of its automated systems to ensure that
they are reliable, secure, and have adequate scalable capacity. It must
also conduct regular, periodic testing and review of its business
continuity-disaster recovery capabilities. Both types of testing should
be conducted by qualified, independent professionals. Such qualified
independent professionals may be independent contractors or employees
of the designated contract market, but should not be persons
responsible for development or operation of the systems or capabilities
being tested. Pursuant to Core Principle 18 (Recordkeeping) and
Sec. Sec. 38.950 and 38.951 of this part, the designated contract
market must keep records of all such tests, and make all test results
available to the Commission upon request.
(i) To the extent practicable, a designated contract market should:
(1) Coordinate its business continuity-disaster recovery plan with
those of the members and other market participants upon whom it depends
to provide liquidity, in a manner adequate to enable effective
resumption of activity in its markets following a disruption causing
activation of the designated contract market's business continuity-
disaster recovery plan;
(2) Initiate and coordinate periodic, synchronized testing of its
business continuity-disaster recovery plan and the business continuity-
disaster recovery plans of the members and other market participants
upon whom it depends to provide liquidity; and
(3) Ensure that its business continuity-disaster recovery plan
takes into account the business continuity-disaster recovery plans of
its telecommunications, power, water, and other essential service
providers.
(j) Part 46 of this chapter governs the obligations of those
registered entities that the Commission has determined to be critical
financial markets, with respect to maintenance and geographic dispersal
of disaster recovery resources sufficient to meet a same-day recovery
time objective in the event of a wide-scale disruption. Section 40.9 of
this chapter establishes the requirements for core principle compliance
in that respect.
Subpart V--Financial Resources
Sec. 38.1100 Core Principle 21.
(a) In General. The board of trade shall have adequate financial,
operational, and managerial resources to discharge each responsibility
of the board of trade.
(b) Determination of adequacy. The financial resources of the board
of trade shall be considered to be adequate if the value of the
financial resources exceeds the total amount that would enable the
contract market to cover the operating costs of the contract market for
a 1-year period, as calculated on a rolling basis.
Sec. 38.1101 General requirements.
(a) General rule. (1) A designated contract market must maintain
financial resources sufficient to enable it to perform its functions in
compliance with the core principles set forth in section 5 of the Act
and regulations thereunder.
(2) Financial resources shall be considered sufficient if their
value is at least equal to a total amount that would enable the
designated contract market, or applicant for designation as such, to
cover its operating costs for a period of at least one year, calculated
on a rolling basis.
(3) An entity that is registered with the Commission as both a
designated contract market and a derivatives clearing organization also
shall comply with the financial resource requirements of Sec. 39.11 of
this chapter, demonstrating that it has sufficient financial resources
to operate the single, combined entity as both a designated contract
market and a derivatives clearing organization. In lieu of filing
separate quarterly reports under paragraph (a)(2) of this section and
Sec. 39.11(f) of this chapter, such entity shall file single quarterly
reports in accordance with Sec. 39.11.
(b) Types of financial resources. Financial resources available to
satisfy the requirements of paragraph (a) of this section may include:
(1) The designated contract market's own capital, calculated in
accordance with U.S. generally accepted accounting principles; and
[[Page 36709]]
(2) Any other financial resource deemed acceptable by the
Commission.
(c) Computation of financial resource requirement. A designated
contract market must, on a quarterly basis, based upon its fiscal year,
make a reasonable calculation of its projected operating costs over a
12-month period in order to determine the amount needed to meet the
requirements of paragraph (a) of this section. The designated contract
market shall have reasonable discretion in determining the methodology
used to compute such projected operating costs. The Commission may
review the methodology and require changes as appropriate.
(d) Valuation of financial resources. At appropriate intervals, but
not less than quarterly, a designated contract market must compute the
current market value of each financial resource used to meet its
obligations under paragraph (a) of this section. Reductions in value to
reflect market and credit risk (``haircuts'') must be applied as
appropriate.
(e) Liquidity of financial resources. The financial resources
allocated by the designated contract market to meet the requirements of
paragraph (a) of this section must include unencumbered, liquid
financial assets (i.e., cash and/or highly liquid securities) equal to
at least six months' operating costs. If any portion of such financial
resources is not sufficiently liquid, the designated contract market
may take into account a committed line of credit or similar facility
for the purpose of meeting this requirement.
(f) Reporting requirements. (1) Each fiscal quarter, or at any time
upon Commission request, a designated contract market must:
(i) Report to the Commission:
(A) The amount of financial resources necessary to meet the
requirements of paragraph (a) of this section; and
(B) The value of each financial resource available, computed in
accordance with the requirements of paragraph (d) of this section; and
(ii) Provide the Commission with a financial statement, including
the balance sheet, income statement, and statement of cash flows of the
designated contract market or of its parent company.
(2) The calculations required by this paragraph shall be made as of
the last business day of the designated contract market's fiscal
quarter.
(3) The designated contract market must provide the Commission
with:
(i) Sufficient documentation explaining the methodology used to
compute its financial requirements under paragraph (a) of this section;
(ii) Sufficient documentation explaining the basis for its
determinations regarding the valuation and liquidity requirements set
forth in paragraphs (d) and (e) of this section; and
(iii) Copies of any agreements establishing or amending a credit
facility, insurance coverage, or other arrangement evidencing or
otherwise supporting the designated contract market's conclusions.
(4) The reports shall be filed not later than 40 calendar days
after the end of the designated contract market's first three fiscal
quarters, and not later than 60 calendar days after the end of the
designated contract market's fourth fiscal quarter, or at such later
time as the Commission may permit, in its discretion, upon request by
the designated contract market.
(g) Delegation of authority. (1) The Commission hereby delegates,
until it orders otherwise, the authority to the Director of the
Division of Market Oversight or such other employee or employees as the
Director may designate from time to time, to:
(i) Determine whether a particular financial resource under
paragraph (b)(2) may be used to satisfy the requirements of paragraph
(a)(1) and (2) of this section;
(ii) Review and make changes to the methodology used to compute the
requirements of paragraph (c) of this section;
(iii) Request financial reporting from a designated contract market
(in addition to quarterly reports) under paragraph (f)(1) of this
section; and
(iv) Grant an extension of time for a designated contract market to
file its quarterly financial report under paragraph (f)(4) of this
section.
(2) The Director may submit to the Commission for its consideration
any matter that has been delegated in this paragraph. Nothing in this
paragraph prohibits the Commission, at its election, from exercising
the authority delegated in this paragraph.
Subpart W--Diversity of Board of Directors
Sec. 38.1150 Core Principle 22.
The board of trade, if a publicly traded company, shall endeavor to
recruit individuals to serve on the board of directors and the other
decision-making bodies (as determined by the Commission) of the board
of trade from among, and to have the composition of the bodies reflect,
a broad and culturally diverse pool of qualified candidates.
Subpart X--Securities and Exchange Commission
Sec. 38.1200 Core Principle 23.
The board of trade shall keep any such records relating to swaps
defined in section 1a(47)(A)(v) of the Act open to inspection and
examination by the Securities and Exchange Commission.
Sec. 38.1201 Additional sources for compliance.
Applicants and designated contract markets may refer to the
guidance and/or acceptable practices in appendix B of this part to
demonstrate to the Commission compliance with the requirements of Sec.
38.1200 of this part.
0
18. Revise appendix A to part 38 to read as follows:
BILLING CODE 6351-01-P
[[Page 36710]]
[GRAPHIC] [TIFF OMITTED] TR19JN12.067
[[Page 36711]]
[GRAPHIC] [TIFF OMITTED] TR19JN12.068
[[Page 36712]]
[GRAPHIC] [TIFF OMITTED] TR19JN12.069
[[Page 36713]]
[GRAPHIC] [TIFF OMITTED] TR19JN12.070
[[Page 36714]]
[GRAPHIC] [TIFF OMITTED] TR19JN12.071
[[Page 36715]]
[GRAPHIC] [TIFF OMITTED] TR19JN12.072
[[Page 36716]]
[GRAPHIC] [TIFF OMITTED] TR19JN12.073
[[Page 36717]]
[GRAPHIC] [TIFF OMITTED] TR19JN12.074
BILLING CODE 6351-01-C
0
19. Revise appendix B to part 38 to read as follows:
Appendix B to Part 38--Guidance on, and Acceptable Practices in,
Compliance With Core Principles
1. This appendix provides guidance on complying with core
principles, both initially and on an ongoing basis, to obtain and
maintain designation under section 5(d) of the Act and this part 38.
Where provided, guidance is set forth in paragraph (a) following the
relevant heading and can be used to demonstrate to the Commission
compliance with the selected requirements of a core principle, under
Sec. Sec. 38.3 and 38.5 of this part. The guidance for the core
principle is illustrative only of the types of matters a designated
contract market may address, as applicable, and is not intended to
be used as a mandatory checklist. Addressing the issues set forth in
this appendix would help the Commission in its consideration of
whether the designated contract market is in compliance with the
selected requirements of a core principle; provided however, that
the guidance is not intended to diminish or replace, in any event,
the obligations and requirements of applicants and designated
contract markets to comply with the regulations provided under this
part.
2. Where provided, acceptable practices meeting selected
requirements of core principles are set forth in paragraph (b)
following guidance. Designated contract markets that follow specific
practices outlined in the acceptable practices for a core principle
in this appendix will meet the selected requirements of the
applicable core principle; provided however, that the acceptable
practice is not intended to diminish or replace, in any event, the
obligations and requirements of applicants and designated contract
markets to comply with the regulations provided under this part 38.
The acceptable practices are for illustrative purposes only and do
not state the exclusive means for satisfying a core principle.
Core Principle 1 of section 5(d) of the Act: DESIGNATION AS
CONTRACT MARKET.--(A) IN GENERAL.--To be designated, and maintain a
designation, as a contract market, a board of trade shall comply
with--
(i) Any core principle described in this subsection; and
(ii) Any requirement that the Commission may impose by rule or
regulation pursuant to section 8a(5).
(B) REASONABLE DISCRETION OF CONTRACT MARKET.--Unless otherwise
determined by the Commission by rule or regulation, a board of trade
described in subparagraph (A) shall have reasonable discretion in
establishing the manner in which the board of trade complies with
the core principles described in this subsection.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 2 of section 5(d) of the Act: COMPLIANCE WITH
RULES--(A) IN GENERAL.--The board of trade shall establish, monitor,
and enforce compliance with the rules of the contract market,
including--
(i) Access requirements;
(ii) The terms and conditions of any contracts to be traded on
the contract market; and
(iii) Rules prohibiting abusive trade practices on the contract
market.
(B) CAPACITY OF CONTRACT MARKET.--The board of trade shall have
the capacity to detect, investigate, and apply appropriate sanctions
to any person that violates any rule of the contract market.
(C) REQUIREMENT OF RULES.--The rules of the contract market
shall provide the board of trade with the ability and authority to
obtain any necessary information to perform any function described
in this subsection, including the capacity to carry out such
international information-sharing agreements as the Commission may
require.
(a) Guidance. (1) Investigations and investigation reports--
Warning letters. The rules of a designated contract market may
authorize compliance staff to issue a warning letter to a person or
entity under investigation or to recommend that a disciplinary panel
take such an action.
(2) Additional rules required. A designated contract market
should adopt and enforce any additional rules that it believes are
necessary to comply with the requirements of subpart C of this
chapter
(b) Acceptable Practices. [Reserved.]
Core Principle 3 of section 5(d) of the Act: CONTRACTS NOT
READILY SUBJECT TO MANIPULATION.--The board of trade shall list on
the contract market only contracts that are not readily susceptible
to manipulation.
(a) Guidance. (1) Designated contract markets may list new
products for trading by self-certification under Sec. 40.2 of this
chapter or may submit products for Commission approval under Sec.
40.3 of this chapter.
(2) Guidance in appendix C to this part may be used as guidance
in meeting this core principle for both new products listings and
existing listed contracts.
(b) Acceptable Practices. [Reserved.]
Core Principle 4 of section 5(d) of the Act: PREVENTION OF
MARKET DISRUPTION.--The board of trade shall have the capacity and
responsibility to prevent manipulation, price distortion, and
disruptions of the delivery or cash-settlement process through
market surveillance, compliance, and enforcement practices and
procedures, including--
(A) Methods for conducting real-time monitoring of trading; and
(B) Comprehensive and accurate trade reconstructions.
(a) Guidance. The detection and prevention of market
manipulation, disruptions, and distortions should be incorporated
into the design of programs for monitoring trading activity.
Monitoring of intraday trading should include the capacity to detect
developing market anomalies, including abnormal price movements and
unusual trading volumes, and position-limit violations. The
designated contract market should have rules in place that allow it
broad powers to intervene to prevent or reduce market disruptions.
Once a threatened or actual disruption is detected, the designated
contract market should take steps to prevent the disruption or
reduce its severity.
(2) Additional rules required. A designated contract market
should adopt and enforce any additional rules that it believes are
necessary to comply with the requirements of subpart E of this part.
(b) Acceptable Practices. (1) General Requirements. Real-time
monitoring for market anomalies and position-limit violations are
the most effective, but the designated contract market may also
demonstrate that it has an acceptable program if some of the
monitoring is accomplished on a T+1 basis. An acceptable
[[Page 36718]]
program must include automated trading alerts to detect market
anomalies and position-limit violations as they develop and before
market disruptions occur or become more serious. In some cases, a
designated contract market may demonstrate that its manual processes
are effective.
(2) Physical-delivery contracts. For physical-delivery
contracts, the designated contract market must demonstrate that it
is monitoring the adequacy and availability of the deliverable
supply, which, if such information is available, includes the size
and ownership of those supplies and whether such supplies are likely
to be available to short traders and saleable by long traders at the
market value of those supplies under normal cash marketing
conditions. Further, for physical-delivery contracts, the designated
contract market must continually monitor the appropriateness of a
contract's terms and conditions, including the delivery instrument,
the delivery locations and location differentials, and the commodity
characteristics and related differentials. The designated contract
market must demonstrate that it is making a good-faith effort to
resolve conditions that are interfering with convergence of its
physical-delivery contract to the price of the underlying commodity
or causing price distortions or market disruptions, including, when
appropriate, changes to contract terms.
(3) Cash-settled contracts. At a minimum, an acceptable program
for monitoring cash-settled contracts must include access, either
directly or through an information-sharing agreement, to traders'
positions and transactions in the reference market for traders of a
significant size in the designated contract market near the
settlement of the contract.
(4) Ability to obtain information. With respect to the
designated contract market's ability to obtain information, a
designated contract market may limit the application of the
requirement to keep and provide such records only to those that are
reportable under its large-trader reporting system or otherwise hold
substantial positions.
(5) Risk controls for trading. An acceptable program for
preventing market disruptions must demonstrate appropriate trade
risk controls, in addition to pauses and halts. Such controls must
be adapted to the unique characteristics of the markets to which
they apply and must be designed to avoid market disruptions without
unduly interfering with that market's price discovery function. The
designated contract market may choose from among controls that
include: pre-trade limits on order size, price collars or bands
around the current price, message throttles, and daily price limits,
or design other types of controls. Within the specific array of
controls that are selected, the designated contract market also must
set the parameters for those controls, so long as the types of
controls and their specific parameters are reasonably likely to
serve the purpose of preventing market disruptions and price
distortions. If a contract is linked to, or is a substitute for,
other contracts, either listed on its market or on other trading
venues, the designated contract market must, to the extent
practicable, coordinate its risk controls with any similar controls
placed on those other contracts. If a contract is based on the price
of an equity security or the level of an equity index, such risk
controls must, to the extent practicable, be coordinated with any
similar controls placed on national security exchanges.
Core Principle 5 of section 5(d) of the Act: POSITION
LIMITATIONS OR ACCOUNTABILITY--(A) IN GENERAL.--To reduce the
potential threat of market manipulation or congestion (especially
during trading in the delivery month), the board of trade shall
adopt for each contract of the board of trade, as is necessary and
appropriate, position limitations or position accountability for
speculators.
(B) MAXIMUM ALLOWABLE POSITION LIMITATION.--For any contract
that is subject to a position limitation established by the
Commission pursuant to section 4a(a), the board of trade shall set
the position limitation of the board of trade at a level not higher
than the position limitation established by the Commission.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 6 of section 5(d) of the Act: EMERGENCY
AUTHORITY--The board of trade, in consultation or cooperation with
the Commission, shall adopt rules to provide for the exercise of
emergency authority, as is necessary and appropriate, including the
authority--
(A) To liquidate or transfer open positions in any contract;
(B) To suspend or curtail trading in any contract; and
(C) To require market participants in any contract to meet
special margin requirements.
(a) Guidance. In consultation and cooperation with the
Commission, a designated contract market should have the authority
to intervene as necessary to maintain markets with fair and orderly
trading and to prevent or address manipulation or disruptive trading
practices, whether the need for intervention arises exclusively from
the DCM's market or as part of a coordinated, cross-market
intervention. DCM rules should include procedures and guidelines to
avoid conflicts of interest in accordance with the provisions of
Sec. 40.9 of this chapter, and include alternate lines of
communication and approval procedures to address emergencies
associated with real-time events. To address perceived market
threats, the designated contract market should have rules that allow
it to take certain actions in the event of an emergency, as defined
in Sec. 40.1(h) of this chapter, including: imposing or modifying
position limits, price limits, and intraday market restrictions;
imposing special margin requirements; ordering the liquidation or
transfer of open positions in any contract; ordering the fixing of a
settlement price; extending or shortening the expiration date or the
trading hours; suspending or curtailing trading in any contract;
transferring customer contracts and the margin or altering any
contract's settlement terms or conditions; and, where applicable,
providing for the carrying out of such actions through its
agreements with its third-party provider of clearing or regulatory
services. In situations where a contract is fungible with a contract
on another platform, emergency action to liquidate or transfer open
interest must be as directed, or agreed to, by the Commission or the
Commission's staff. The DCM has the authority to independently
respond to emergencies in an effective and timely manner consistent
with the nature of the emergency, as long as all such actions taken
by the DCM are made in good faith to protect the integrity of the
markets. The Commission should be notified promptly of the DCM's
exercise of emergency action, explaining how conflicts of interest
were minimized, including the extent to which the DCM considered the
effect of its emergency action on the underlying markets and on
markets that are linked or referenced to the contract market and
similar markets on other trading venues. Information on all
regulatory actions carried out pursuant to a DCM's emergency
authority should be included in a timely submission of a certified
rule pursuant to part 40 of this chapter.
(b) Acceptable Practices. A designated contract market must have
procedures and guidelines for decision-making and implementation of
emergency intervention in the market. At a minimum, the DCM must
have the authority to liquidate or transfer open positions in the
market, suspend or curtail trading in any contract, and require
market participants in any contract to meet special margin
requirements. In situations where a contract is fungible with a
contract on another platform, emergency action to liquidate or
transfer open interest must be directed, or agreed to, by the
Commission or the Commission's staff. The DCM must promptly notify
the Commission of the exercise of its emergency authority,
documenting its decision-making process, including how conflicts of
interest were minimized, and the reasons for using its emergency
authority. The DCM must also have rules that allow it to take such
market actions as may be directed by the Commission.
Core Principle 7 of section 5(d) of the Act: AVAILABILITY OF
GENERAL INFORMATION.--The board of trade shall make available to
market authorities, market participants, and the public accurate
information concerning--
(A) The terms and conditions of the contracts of the contract
market; and
(B)(i) The rules, regulations, and mechanisms for executing
transactions on or through the facilities of the contract market;
and
(ii) The rules and specifications describing the operation of
the contract market's--
(I) Electronic matching platform; or
(II) Trade execution facility.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 8 of section 5(d) of the Act: DAILY PUBLICATION
OF TRADING INFORMATION.--The board of trade shall make public daily
information on settlement prices, volume, open interest, and opening
and closing ranges for actively traded contracts on the contract
market.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 9 of section 5(d) of the Act: EXECUTION OF
TRANSACTIONS.--``(A) IN
[[Page 36719]]
GENERAL.--The board of trade shall provide a competitive, open, and
efficient market and mechanism for executing transactions that
protects the price discovery process of trading in the centralized
market of the board of trade.
(B) RULES.--The rules of the board of trade may authorize, for
bona fide business purposes--
(i) Transfer trades or office trades;
(ii) An exchange of--
(I) Futures in connection with a cash commodity transaction;
(II) Futures for cash commodities; or
(III) Futures for swaps; or
(iii) A futures commission merchant, acting as principal or
agent, to enter into or confirm the execution of a contract for the
purchase or sale of a commodity for future delivery if the contract
is reported, recorded, or cleared in accordance with the rules of
the contract market or a derivatives clearing organization.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 10 of section 5(d) of the Act: TRADE
INFORMATION.--The board of trade shall maintain rules and procedures
to provide for the recording and safe storage of all identifying
trade information in a manner that enables the contract market to
use the information--
(A) To assist in the prevention of customer and market abuses;
and
(B) To provide evidence of any violations of the rules of the
contract market.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 11 of section 5(d) of the Act: FINANCIAL
INTEGRITY OF TRANSACTIONS.--The board of trade shall establish and
enforce--
(A) Rules and procedures for ensuring the financial integrity of
transactions entered into on or through the facilities of the
contract market (including the clearance and settlement of the
transactions with a derivatives clearing organization); and
(B) Rules to ensure--
(i) The financial integrity of any--
(I) Futures commission merchant; and
(II) Introducing broker; and
(ii) The protection of customer funds.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 12 of section 5(d) of the Act: PROTECTION OF
MARKETS AND MARKET PARTICIPANTS--The board of trade shall establish
and enforce rules--
(A) To protect markets and market participants from abusive
practices committed by any party, including abusive practices
committed by a party acting as an agent for a participant; and
(B) To promote fair and equitable trading on the contract
market.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 13 of section 5(d) of the Act: DISCIPLINARY
PROCEDURES.--The board of trade shall establish and enforce
disciplinary procedures that authorize the board of trade to
discipline, suspend, or expel members or market participants that
violate the rules of the board of trade, or similar methods for
performing the same functions, including delegation of the functions
to third parties.
(a) Guidance. (1) Notice of charges. If the rules of the
designated contract market so provide, a notice may also advise: (i)
That failure to request a hearing within the period prescribed in
the notice, except for good cause, may be deemed a waiver of the
right to a hearing; and (ii) That failure to answer or to deny
expressly a charge may be deemed to be an admission of such charge.
(2) Admission or failure to deny charges. The rules of a
designated contract market may provide that if a respondent admits
or fails to deny any of the charges, a disciplinary panel may find
that the violations alleged in the notice of charges for which the
respondent admitted or failed to deny any of the charges have been
committed. If the designated contract market's rules so provide,
then:
(i) The disciplinary panel should impose a sanction for each
violation found to have been committed;
(ii) The disciplinary panel should promptly notify the
respondent in writing of any sanction to be imposed pursuant to
paragraph (2)(i) of this section and shall advise the respondent
that it may request a hearing on such sanction within the period of
time, which shall be stated in the notice;
(iii) The rules of a designated contract market may provide that
if a respondent fails to request a hearing within the period of time
stated in the notice, the respondent will be deemed to have accepted
the sanction.
(3) Settlement offers. (i) The rules of a designated contract
market may permit a respondent to submit a written offer of
settlement at any time after an investigation report is completed.
The disciplinary panel presiding over the matter may accept the
offer of settlement, but may not alter the terms of a settlement
offer unless the respondent agrees.
(ii) The rules of a designated contract market may provide that,
in its discretion, a disciplinary panel may permit the respondent to
accept a sanction without either admitting or denying the rule
violations upon which the sanction is based.
(iii) If an offer of settlement is accepted, the panel accepting
the offer should issue a written decision specifying the rule
violations it has reason to believe were committed, including the
basis or reasons for the panel's conclusions, and any sanction to be
imposed, which should include full customer restitution where
customer harm is demonstrated, except where the amount of
restitution and to whom it should be provided cannot be reasonably
determined. If an offer of settlement is accepted without the
agreement of the enforcement staff, the decision should adequately
support the disciplinary panel's acceptance of the settlement. Where
applicable, the decision should also include a statement that the
respondent has accepted the sanctions imposed without either
admitting or denying the rule violations.
(iv) The respondent may withdraw his or her offer of settlement
at any time before final acceptance by a disciplinary panel. If an
offer is withdrawn after submission, or is rejected by a
disciplinary panel, the respondent should not be deemed to have made
any admissions by reason of the offer of settlement and should not
be otherwise prejudiced by having submitted the offer of settlement.
(4) Hearings. The rules of a designated contract market may
provide that a sanction may be summarily imposed upon any person
within its jurisdiction whose actions impede the progress of a
hearing.
(5) Right to appeal. The rules of a designated contract market
may permit the parties to a proceeding to appeal promptly an adverse
decision of a disciplinary panel in all or in certain classes of
cases. Such rules may require a party's notice of appeal to be in
writing and to specify the findings, conclusions, or sanctions to
which objection are taken. If the rules of a designated contract
market permit appeals, then both the respondent and the enforcement
staff should have the opportunity to appeal and the designated
contract market should provide for the following:
(i) The designated contract market should establish an appellate
panel that should be authorized to hear appeals of respondents. In
addition, the rules of a designated contract market may provide that
the appellate panel may, on its own initiative, order review of a
decision by a disciplinary panel within a reasonable period of time
after the decision has been rendered.
(ii) The composition of the appellate panel should be consistent
with the requirements set forth in part 40 of this chapter and
paragraph (4) of the acceptable practices for Core Principle 16, and
should not include any members of the designated contract market's
compliance staff, or any person involved in adjudicating any other
stage of the same proceeding. The rules of a designated contract
market should provide for the appeal proceeding to be conducted
before all of the members of the appellate panel or a panel thereof.
(iii) Except for good cause shown, the appeal or review should
be conducted solely on the record before the disciplinary panel, the
written exceptions filed by the parties, and the oral or written
arguments of the parties.
(iv) Promptly following the appeal or review proceeding, the
appellate panel should issue a written decision and should provide a
copy to the respondent. The decision issued by the appellate panel
should adhere to all the requirements of Sec. 38.708 of this part,
to the extent that a different conclusion is reached from that
issued by the disciplinary panel.
(6) Summary fines for violations of rules regarding timely
submission of records, decorum, or other similar activities. A
designated contract market may adopt a summary fine schedule for
violations of rules relating to the timely submission of accurate
records required for clearing or verifying each day's transactions,
decorum, attire, or other similar activities. A designated contract
market may permit its compliance staff, or a designated panel of
contract market officials, to summarily impose minor sanctions
against persons within the designated contract market's jurisdiction
for violating such rules. A designated contract market's summary
fine schedule may allow for warning letters to be issued for first-
time violations or violators. If
[[Page 36720]]
adopted, a summary fine schedule should provide for progressively
larger fines for recurring violations.
(7) Emergency disciplinary actions. (i) A designated contract
market may impose a sanction, including suspension, or take other
summary action against a person or entity subject to its
jurisdiction upon a reasonable belief that such immediate action is
necessary to protect the best interest of the marketplace.
(ii) Any emergency disciplinary action should be taken in
accordance with a designated contract market's procedures that
provide for the following:
(A) If practicable, a respondent should be served with a notice
before the action is taken, or otherwise at the earliest possible
opportunity. The notice should state the action, briefly state the
reasons for the action, and state the effective time and date, and
the duration of the action.
(B) The respondent should have the right to be represented by
legal counsel or any other representative of its choosing in all
proceedings subsequent to the emergency action taken. The respondent
should be given the opportunity for a hearing as soon as reasonably
practicable and the hearing should be conducted before the
disciplinary panel pursuant to the requirements of Sec. 38.707 of
this part.
(C) Promptly following the hearing provided for in this rule,
the designated contract market should render a written decision
based upon the weight of the evidence contained in the record of the
proceeding and should provide a copy to the respondent. The decision
should include a description of the summary action taken; the
reasons for the summary action; a summary of the evidence produced
at the hearing; a statement of findings and conclusions; a
determination that the summary action should be affirmed, modified,
or reversed; and a declaration of any action to be taken pursuant to
the determination, and the effective date and duration of such
action.
(b) Acceptable Practices. [Reserved.]
Core Principle 14 of section 5(d) of the Act: DISPUTE
RESOLUTION.--The board of trade shall establish and enforce rules
regarding, and provide facilities for alternative dispute resolution
as appropriate for, market participants and any market
intermediaries.
(a) Guidance. A designated contract market should provide
customer dispute resolution procedures that are: appropriate to the
nature of the market; fair and equitable; and available on a
voluntary basis, either directly or through another self-regulatory
organization, to customers that are non-eligible contract
participants.
(b) Acceptable Practices.
(1) Fair and equitable procedure. Every contract market shall
provide customer dispute resolution procedures that are fair and
equitable. An acceptable customer dispute resolution mechanism
would:
(i) Provide the customer with an opportunity to have his or her
claim decided by an objective and impartial decisionmaker;
(ii) Provide each party with the right to be represented by
counsel at the commencement of the procedure, at the party's own
expense;
(iii) Provide each party with adequate notice of the claims
presented against such party, an opportunity to be heard on all
claims, defenses and permitted counterclaims, and an opportunity for
a prompt hearing;
(iv) Authorize prompt, written, final settlement awards that are
not subject to appeal within the designated contract market; and
(v) Notify the parties of the fees and costs that may be
assessed.
(2) Voluntary Procedures. The use of dispute settlement
procedures shall be voluntary for customers other than eligible
contract participants as defined in section 1a(18) of the Dodd-Frank
Act, and may permit counterclaims as provided in Sec. 166.5 of this
chapter.
(3) Member-to-Member Procedures. If the designated contract
market also provides procedures for the resolution of disputes that
do not involve customers (i.e., member-to-member disputes), the
procedures for resolving such disputes must be independent of and
shall not interfere with or delay the resolution of customers'
claims or grievances.
(4) Delegation. A designated contract market may delegate to
another self-regulatory organization or to a registered futures
association its responsibility to provide for customer dispute
resolution mechanisms, provided, however, that in the event of such
delegation, the designated contract market shall in all respects
treat any decision issued by such other organization or association
with respect to such dispute as if the decision were its own,
including providing for the appropriate enforcement of any award
issued against a delinquent member.
Core Principle 15 of section 5(d) of the Act: GOVERNANCE FITNESS
STANDARDS.--The board of trade shall establish and enforce
appropriate fitness standards for directors, members of any
disciplinary committee, members of the contract market, and any
other person with direct access to the facility (including any party
affiliated with any person described in this paragraph).
(a) Guidance. (1) A designated contract market should have
appropriate eligibility criteria for the categories of persons set
forth in the Core Principle that should include standards for
fitness and for the collection and verification of information
supporting compliance with such standards. Minimum standards of
fitness for persons who have member voting privileges, governing
obligations or responsibilities, or who exercise disciplinary
authority are those bases for refusal to register a person under
section 8a(2) of the Act. In addition, persons who have governing
obligations or responsibilities, or who exercise disciplinary
authority, should not have a significant history of serious
disciplinary offenses, such as those that would be disqualifying
under Sec. 1.63 of this chapter. Members with trading privileges
but having no, or only nominal, equity, in the facility and non-
member market participants who are not intermediated and do not have
these privileges, obligations, responsibilities or disciplinary
authority could satisfy minimum fitness standards by meeting the
standards that they must meet to qualify as a ``market
participant.'' Natural persons who directly or indirectly have
greater than a ten percent ownership interest in a designated
contract market should meet the fitness standards applicable to
members with voting rights.
(2) The Commission believes that such standards should include
providing the Commission with fitness information for such persons,
whether registration information, certification to the fitness of
such persons, an affidavit of such persons' fitness by the contract
market's counsel or other information substantiating the fitness of
such persons. If a contract market provides certification of the
fitness of such a person, the Commission believes that such
certification should be based on verified information that the
person is fit to be in his or her position.
(b) Applicable Practices. [Reserved.]
Core Principle 16 of section 5(d) of the Act: CONFLICTS OF
INTEREST.--The board of trade shall establish and enforce rules--
(A) to minimize conflicts of interest in the decisionmaking
process of the contract market; and
(B) to establish a process for resolving conflicts of interest
described in subparagraph (A).
(a) Guidance. The means to address conflicts of interest in
decisionmaking of a contract market should include methods to
ascertain the presence of conflicts of interest and to make
decisions in the event of such a conflict. In addition, the
Commission believes that the contract market should provide for
appropriate limitations on the use or disclosure of material non-
public information gained through the performance of official duties
by board members, committee members and contract market employees or
gained through an ownership interest in the contract market.
(b) Acceptable Practices. All designated contract markets
(``DCMs'' or ``contract markets'') bear special responsibility to
regulate effectively, impartially, and with due consideration of the
public interest, as provided for in section 3 of the Act. Under Core
Principle 15, they are also required to minimize conflicts of
interest in their decisionmaking processes. To comply with this Core
Principle, contract markets should be particularly vigilant for such
conflicts between and among any of their self-regulatory
responsibilities, their commercial interests, and the several
interests of their management, members, owners, customers and market
participants, other industry participants, and other constituencies.
Acceptable practices for minimizing conflicts of interest shall
include the following elements:
(1) Board composition for contract markets
(i) At least thirty-five percent of the directors on a contract
market's board of directors shall be public directors; and
(ii) The executive committees (or similarly empowered bodies)
shall be at least thirty-five percent public.
(2) Public director
(i) To qualify as a public director of a contract market, an
individual must first be found, by the board of directors, on the
record, to have no material relationship with the contract market. A
``material relationship'' is one that reasonably could
[[Page 36721]]
affect the independent judgment or decisionmaking of the director.
(ii) In addition, a director shall be considered to have a
``material relationship'' with the contract market if any of the
following circumstances exist:
(A) The director is an officer or employee of the contract
market or an officer or employee of its affiliate. In this context,
``affiliate'' includes parents or subsidiaries of the contract
market or entities that share a common parent with the contract
market;
(B) The director is a member of the contract market, or an
officer or director of a member. ``Member'' is defined according to
section 1a(34) of the Commodity Exchange Act and Commission
Regulation 1.3(q);
(C) The director, or a firm with which the director is an
officer, director, or partner, receives more than $100,000 in
combined annual payments from the contract market, or any affiliate
of the contract market (as defined in subsection (2)(ii)(A)), for
legal, accounting, or consulting services. Compensation for services
as a director of the contract market or as a director of an
affiliate of the contract market does not count toward the $100,000
payment limit, nor does deferred compensation for services prior to
becoming a director, so long as such compensation is in no way
contingent, conditioned, or revocable;
(D) Any of the relationships above apply to a member of the
director's ``immediate family,'' i.e., spouse, parents, children and
siblings.
(iii) All of the disqualifying circumstances described in
subsection (2)(ii) shall be subject to a one-year look back.
(iv) A contract market's public directors may also serve as
directors of the contract market's affiliate (as defined in
subsection (2)(ii)(A)) if they otherwise meet the definition of
public director in this section (2).
(v) A contract market shall disclose to the Commission which
members of its board are public directors, and the basis for those
determinations.
(3) Regulatory oversight committee
(i) A board of directors of any contract market shall establish
a Regulatory Oversight Committee (``ROC'') as a standing committee,
consisting of only public directors as defined in section (2), to
assist it in minimizing actual and potential conflicts of interest.
The ROC shall oversee the contract market's regulatory program on
behalf of the board. The board shall delegate sufficient authority,
dedicate sufficient resources, and allow sufficient time for the ROC
to fulfill its mandate.
(ii) The ROC shall:
(A) Monitor the contract market's regulatory program for
sufficiency, effectiveness, and independence;
(B) Oversee all facets of the program, including trade practice
and market surveillance; audits, examinations, and other regulatory
responsibilities with respect to member firms (including ensuring
compliance with financial integrity, financial reporting, sales
practice, recordkeeping, and other requirements); and the conduct of
investigations;
(C) Review the size and allocation of the regulatory budget and
resources; and the number, hiring and termination, and compensation
of regulatory personnel;
(D) Supervise the contract market's chief regulatory officer,
who will report directly to the ROC;
(E) Prepare an annual report assessing the contract market's
self-regulatory program for the board of directors and the
Commission, which sets forth the regulatory program's expenses,
describes its staffing and structure, catalogues disciplinary
actions taken during the year, and reviews the performance of
disciplinary committees and panels;
(F) Recommend changes that would ensure fair, vigorous, and
effective regulation; and
(G) Review regulatory proposals and advise the board as to
whether and how such changes may impact regulation.
(4) Disciplinary panels
All contract markets shall minimize conflicts of interest in
their disciplinary processes through disciplinary panel composition
rules that preclude any group or class of industry participants from
dominating or exercising disproportionate influence on such panels.
Contract markets can further minimize conflicts of interest by
including in all disciplinary panels at least one person who would
qualify as a public director, as defined in subsections (2)(ii) and
(2)(iii) above, except in cases limited to decorum, attire, or the
timely submission of accurate records required for clearing or
verifying each day's transactions. If contract market rules provide
for appeal to the board of directors, or to a committee of the
board, then that appellate body shall also include at least one
person who would qualify as a public director as defined in
subsections (2)(ii) and (2)(iii) above.
Core Principle 17 of section 5(d) of the Act: COMPOSITION OF
GOVERNING BOARDS OF CONTRACT MARKETS.--The governance arrangements
of the board of trade shall be designed to permit consideration of
the views of market participants.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 18 of section 5(d) of the Act: RECORDKEEPING.--
The board of trade shall maintain records of all activities relating
to the business of the contract market--
(A) In a form and manner that is acceptable to the Commission;
and
(B) For a period of at least 5 years.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 19 of section 5(d) of the Act: ANTITRUST
CONSIDERATIONS.--Unless necessary or appropriate to achieve the
purposes of this Act, the board of trade shall not--
(A) Adopt any rule or taking any action that results in any
unreasonable restraint of trade; or
(B) Impose any material anticompetitive burden on trading on the
contract market.
(a) Guidance. An entity seeking designation as a contract market
may request that the Commission consider under the provisions of
section 15(b) of the Act, any of the entity's rules, including
trading protocols or policies, and including both operational rules
and the terms or conditions of products listed for trading, at the
time of designation or thereafter. The Commission intends to apply
section 15(b) of the Act to its consideration of issues under this
core principle in a manner consistent with that previously applied
to contract markets.
(b) Acceptable Practices. [Reserved.]
Core Principle 20 of section 5(d) of the Act: SYSTEM
SAFEGUARDS.--The board of trade shall--
(A) Establish and maintain a program of risk analysis and
oversight to identify and minimize sources of operational risk,
through the development of appropriate controls and procedures, and
the development of automated systems, that are reliable, secure, and
have adequate scalable capacity;
(B) Establish and maintain emergency procedures, backup
facilities, and a plan for disaster recovery that allow for the
timely recovery and resumption of operations and the fulfillment of
the responsibilities and obligations of the board of trade; and
(C) Periodically conduct tests to verify that backup resources
are sufficient to ensure continued order processing and trade
matching, price reporting, market surveillance, and maintenance of a
comprehensive and accurate audit trail.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 21 of section 5(d) of the Act: FINANCIAL
RESOURCES.--
(A) IN GENERAL.--The board of trade shall have adequate
financial, operational, and managerial resources to discharge each
responsibility of the board of trade.
(B) DETERMINATION OF ADEQUACY.--The financial resources of the
board of trade shall be considered to be adequate if the value of
the financial resources exceeds the total amount that would enable
the contract market to cover the operating costs of the contract
market for a 1-year period, as calculated on a rolling basis.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 22 of section 5(d) of the Act: DIVERSITY OF BOARD
OF DIRECTORS.--The board of trade, if a publicly traded company,
shall endeavor to recruit individuals to serve on the board of
directors and the other decision-making bodies (as determined by the
Commission) of the board of trade from among, and to have the
composition of the bodies reflect, a broad and culturally diverse
pool of qualified candidates.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 23 of section 5(d) of the Act: SECURITIES AND
EXCHANGE COMMISSION.--The board of trade shall keep any such records
relating to swaps defined in section 1a(47)(A)(v) open to inspection
and examination by the Securities and Exchange Commission.
(a) Guidance. A designated contract market should have
arrangements and resources for collecting and maintaining accurate
records pertaining to any swaps agreements defined in section
1a(47)(A)(v) of the Act, and should leave them open to inspection
and examination for a period of five years.
(b) Acceptable Practices. [Reserved.]
[[Page 36722]]
Appendix C--Demonstration of Compliance That a Contract Is Not Readily
Susceptible to Manipulation
(a) Futures Contracts--General Information. When a designated
contract market certifies or submits for approval contract terms and
conditions for a new futures contract, that submission should
include the following information:
(1) A narrative describing the contract, including data and
information to support the contract's terms and conditions, as set
by the designated contract market. When designing a futures
contract, the designated contract market should conduct market
research so that the contract design meets the risk management needs
of prospective users and promotes price discovery of the underlying
commodity. The designated contract market should consult with market
users to obtain their views and opinions during the contract design
process to ensure the contract's term and conditions reflect the
underlying cash market and that the futures contract will perform
the intended risk management and/or price discovery functions. A
designated contract market should provide a statement indicating
that it took such steps to ensure the usefulness of the submitted
contract.
(2) A detailed cash market description for physical and cash-
settled contracts. Such descriptions should be based on government
and/or other publicly-available data whenever possible and be
formulated for both the national and regional/local market relevant
to the underlying commodity. For tangible commodities, the cash
market descriptions for the relevant market (i.e., national and
regional/local) should incorporate at least three full years of data
that may include, among other factors, production, consumption,
stocks, imports, exports, and prices. Each of those cash market
variables should be fully defined and the data sources should be
fully specified and documented to permit Commission staff to
replicate the estimates of deliverable supply (defined in paragraph
(b)(1)(A) of this appendix C). Whenever possible, the Commission
requests that monthly or daily prices (depending on the contract)
underlying the cash settlement index be submitted for the most
recent three full calendar years and for as many of the current
year's months for which data are available. For contracts that are
cash settled to an index, the index's methodology should be provided
along with supporting information showing how the index is
reflective of the underlying cash market, is not readily subject to
manipulation or distortion, and is based on a cash price series that
is reliable, acceptable, publicly available and timely (defined in
paragraphs (c)(2) and (c)(3) of this appendix C). The Commission
recognizes that the data necessary for accurate and cogent cash
market analyses for an underlying commodity vary with the nature of
the underlying commodity. The Commission may require that the
designated contract market submit a detailed report on commodity
definitions and uses.
(b) Futures Contracts Settled by Physical Delivery. (1) For
listed contracts that are settled by physical delivery, the terms
and conditions of the contract should conform to the most common
commercial practices and conditions in the cash market for the
commodity underlying the futures contract. The terms and conditions
should be designed to avoid any impediments to the delivery of the
commodity so as to promote convergence between the price of the
futures contract and the cash market value of the commodity at the
expiration of a futures contract.
(i) Estimating Deliverable Supplies.
(A) General definition. The specified terms and conditions,
considered as a whole, should result in a ``deliverable supply''
that is sufficient to ensure that the contract is not susceptible to
price manipulation or distortion. In general, the term ``deliverable
supply'' means the quantity of the commodity meeting the contract's
delivery specifications that reasonably can be expected to be
readily available to short traders and salable by long traders at
its market value in normal cash marketing channels at the contract's
delivery points during the specified delivery period, barring
abnormal movement in interstate commerce. Typically, deliverable
supply reflects the quantity of the commodity that potentially could
be made available for sale on a spot basis at current prices at the
contract's delivery points. For a non-financial physical-delivery
commodity contract, this estimate might represent product which is
in storage at the delivery point(s) specified in the futures
contract or can be moved economically into or through such points
consistent with the delivery procedures set forth in the contract
and which is available for sale on a spot basis within the marketing
channels that normally are tributary to the delivery point(s).
Furthermore, an estimate of deliverable supply would not include
supply that is committed for long-term agreements (i.e., the amount
of deliverable supply that would not be available to fulfill the
delivery obligations arising from current trading). The size of
commodity supplies that are committed to long-term agreements may be
estimated by consulting with market participants. However, if the
estimated deliverable supply that is committed for long-term
agreements, or significant portion thereof, can be demonstrated by
the designated contract market to be consistently and regularly made
available to the spot market for shorts to acquire at prevailing
economic values, then those ``available'' supplies committed for
long-term contracts may be included in the designated contract
market's estimate of deliverable supply for that commodity. An
adequate measure of deliverable supply would be an amount of the
commodity that would meet the normal or expected range of delivery
demand without causing futures prices to become distorted relative
to cash market prices. Given the availability of acceptable data,
deliverable supply should be estimated on a monthly basis for at
least the most recent three years for which data are available. To
the extent possible and that data resources permit, deliverable
supply estimates should be constructed such that the data reflect,
as close as possible, the market defined by the contract's terms and
conditions, and should be formulated, whenever possible, with
government or publicly available data. All deliverable supply
estimates should be fully defined, have all underlying assumptions
explicitly stated, and have documentation of all data/information
sources in order to permit estimate replication by Commission staff.
(B) Accounting for variations in deliverable supplies. To assure
the availability of adequate deliverable supplies and acceptable
levels of commercial risk management utility, contract terms and
conditions should account for variations in the patterns of
production, consumption and supply over a period of years of
sufficient length to assess adequately the potential range of
deliverable supplies. This assessment also should consider
seasonality, growth, and market concentration in the production/
consumption of the underlying cash commodity. Deliverable supply
implications of seasonal effects are more straightforwardly
delineated when deliverable supply estimates are calculated on a
monthly basis and when such monthly estimates are provided for at
least the most recent three years for which data resources permit.
In addition, consideration should be given to the relative roles of
producers, merchants, and consumers in the production, distribution,
and consumption of the cash commodity and whether the underlying
commodity exhibits a domestic or international export focus. Careful
consideration also should be given to the quality of the cash
commodity and to the movement or flow of the cash commodity in
normal commercial channels and whether there exist external factors
or regulatory controls that could affect the price or supply of the
cash commodity.
(C) Calculation of deliverable supplies. Designated contract
markets should derive a quantitative estimate of the deliverable
supplies for the delivery period specified in the proposed contract.
For commodities with seasonal supply or demand characteristics, the
deliverable supply analysis should include that period when
potential supplies typically are at their lowest levels. The
estimate should be based on statistical data, when reasonably
available, covering a period of time that is representative of the
underlying commodity's actual patterns of production, patterns of
consumption, and patterns of seasonal effects (if relevant). Often,
such a relevant time period should include at least three years of
monthly deliverable supply estimates permitted by available data
resources. Deliverable supply estimates should also exclude the
amount of the commodity that would not be otherwise deliverable on
the futures contract. For example, deliverable supplies should
exclude quantities that at current price levels are not economically
obtainable or deliverable or were previously committed for long-term
agreements.
(2) Contract terms and conditions requirements for futures
contracts settled by physical delivery.
(i) For physical delivery contracts, an acceptable specification
of terms and conditions would include, but may not be limited to,
rules that address, as appropriate,
[[Page 36723]]
the following criteria and comply with the associated standards:
(A) Quality Standards. The terms and conditions of a commodity
contract should describe or define all of the economically
significant characteristics or attributes of the commodity
underlying the contract. In particular, the quality standards should
be described or defined so that such standards reflect those used in
transactions in the commodity in normal cash marketing channels.
Documentation establishing that the quality standards of the
contract's underlying commodity comply with those accepted/
established by the industry, by government regulations, and/or by
relevant laws should also be submitted. For any particular commodity
contract, the specific attributes that should be enumerated depend
upon the individual characteristics of the underlying commodity.
These may include, for example, the following items: grade, quality,
purity, weight, class, origin, growth, issuer, originator, maturity
window, coupon rate, source, hours of trading, etc. If the terms of
the contract provide for the delivery of multiple qualities of a
specific attribute of the commodity having different cash market
values, then a ``par'' quality should be specified with price
differentials applicable to the ``non-par'' qualities that reflect
discounts or premiums commonly observed or expected to occur in the
cash market for that commodity.
(B) Delivery Points and Facilities. Delivery point/area
specifications should provide for futures delivery at a single
location or at multiple locations where the underlying cash
commodity is normally transacted or stored and where there exists a
viable cash market(s). If multiple delivery points are specified and
the value of the commodity differs between these locations, contract
terms should include price differentials that reflect usual
differences in value between the different delivery locations. If
the price relationships among the delivery points are unstable and a
designated contract market chooses to adopt fixed locational price
differentials, such differentials should fall within the range of
commonly observed or expected commercial price differences. In this
regard, any price differentials should be supported with cash price
data for the delivery location(s). The terms and conditions of the
contracts also should specify, as appropriate, any conditions the
delivery facilities and/or delivery facility operators should meet
in order to be eligible for delivery. Specification of any
requirements for delivery facilities also should consider the extent
to which ownership of such facilities is concentrated and whether
the level of concentration would be susceptible to manipulation of
the futures contract's prices. Commodity contracts also should
specify appropriately detailed delivery procedures that describe the
responsibilities of deliverers, receivers and any required third
parties in carrying out the delivery process. Such responsibilities
could include allocation between buyer and seller of all associated
costs such as load-out, document preparation, sampling, grading,
weighing, storage, taxes, duties, fees, drayage, stevedoring,
demurrage, dispatch, etc. Required accreditation for third-parties
also should be detailed. These procedures should seek to minimize or
eliminate any impediments to making or taking delivery by both
deliverers and takers of delivery to help ensure convergence of cash
and futures at the expiration of a futures delivery month.
(C) Delivery Period and Last Trading Day. An acceptable
specification of the delivery period would allow for sufficient time
for deliverers to acquire the deliverable commodity and make it
available for delivery, considering any restrictions or requirements
imposed by the designated contract market. Specification of the last
trading day for expiring contracts should consider whether adequate
time remains after the last trading day to allow for delivery on the
contract.
(D) Contract Size and Trading Unit. An acceptable specification
of the delivery unit and/or trading unit would be a contract size
that is consistent with customary transactions, transportation or
storage amounts in the cash market (e.g., the contract size may be
reflective of the amount of the commodity that represents a
pipeline, truckload or railcar shipment). For purposes of increasing
market liquidity, a designated contract market may elect to specify
a contract size that is smaller than the typical commercial
transaction size, storage unit or transportation size. In such
cases, the commodity contract should include procedures that allow
futures traders to easily take or make delivery on such a contract
with a smaller size, or, alternatively, the designated contract
market may adopt special provisions requiring that delivery be made
only in multiple contracts to accommodate reselling the commodity in
the cash market. If the latter provision is adopted, contract terms
should be adopted to minimize the potential for default in the
delivery process by ensuring that all contracts remaining open at
the close of trading in expiring delivery months can be combined to
meet the required delivery unit size. Generally, contract sizes and
trading units should be determined after a careful analysis of
relevant cash market trading practices, conditions and deliverable
supply estimates, so as to ensure that the underlying market
commodity market and available supply sources are able to support
the contract sizes and trading units at all times.
(E) Delivery Pack. The term ``delivery pack'' refers to the
packaging standards (e.g., product may be delivered in burlap or
polyethylene bags stacked on wooden pallets) or non-quality related
standards regarding the composition of commodity within a delivery
unit (e.g., product must all be imported from the same country or
origin). An acceptable specification of the delivery pack or
composition of a contract's delivery unit should reflect, to the
extent possible, specifications commonly applied to the commodity
traded or transacted in the cash market.
(F) Delivery Instrument. An acceptable specification of the
delivery instrument (e.g., warehouse receipt, depository certificate
or receipt, shipping certificate, bill of lading, in-line transfer,
book transfer of securities, etc.) would provide for its conversion
into the cash commodity at a commercially-reasonable cost.
Transportation terms (e.g., FOB, CIF, freight prepaid to
destination) as well as any limits on storage or certificate daily
premium fees should be specified. These terms should reflect cash
market practices and the customary provision for allocating delivery
costs between buyer and seller.
(G) Inspection Provisions. Any inspection/certification
procedures for verifying compliance with quality requirements or any
other related delivery requirements (e.g., discounts relating to the
age of the commodity, etc.) should be specified in the contract
rules. An acceptable specification of inspection procedures would
include the establishment of formal procedures that are consistent
with procedures used in the cash market. To the extent that formal
inspection procedures are not used in the cash market, an acceptable
specification would contain provisions that assure accuracy in
assessing the commodity, that are available at a low cost, that do
not pose an obstacle to delivery on the contract and that are
performed by a reputable, disinterested third party or by qualified
designated contract market employees. Inspection terms also should
detail which party pays for the service, particularly in light of
the possibility of varying inspection results.
(H) Delivery (Trading) Months. Delivery months should be
established based on the risk management needs of commercial
entities as well as the availability of deliverable supplies in the
specified months.
(I) Minimum Price Fluctuation (Minimum Tick). The minimum price
increment (tick) should be set at a level that is equal to, or less
than, the minimum price increment commonly observed in cash market
transactions for the underlying commodity. Specifying a futures'
minimum tick that is greater than the minimum price increment in the
cash market can undermine the risk management utility of the futures
contract by preventing hedgers from efficiently establishing and
liquidating futures positions that are used to hedge anticipated
cash market transactions or cash market positions.
(J) Maximum Price Fluctuation Limits. Designated contract
markets may adopt price limits to: (1) Reduce or constrain price
movements in a trading day that may not be reflective of true market
conditions but might be caused by traders overreacting to news; (2)
Allow additional time for the collection of margins in times of
large price movements; and (3) Provide a ``cooling-off'' period for
futures market participants to respond to bona fide changes in
market supply and demand fundamentals that would lead to large cash
and futures price changes. If price limit provisions are adopted,
the limits should be set at levels that are not overly restrictive
in relation to price movements in the cash market for the commodity
underlying the futures contract.
(K) Speculative Limits. Specific information regarding the
establishment of speculative position limits are set forth in part
150, and/or part 151, as applicable, of the Commission's
regulations.
(L) Reportable Levels. Refer to Sec. 15.03 of the Commission's
regulations.
[[Page 36724]]
(M) Trading Hours. Should be set by the designated contract
market to delineate each trading day.
(c) Futures Contracts Settled by Cash Settlement. (1) Cash
settlement is a method of settling certain futures or option
contracts whereby, at contract expiration, the contract is settled
by cash payment in lieu of physical delivery of the commodity or
instrument underlying the contract. An acceptable specification of
the cash settlement price for commodity futures and option contracts
would include rules that fully describe the essential economic
characteristics of the underlying commodity (e.g., grade, quality,
weight, class, growth, issuer, maturity, source, rating, description
of the underlying index and index's calculation methodology, etc.),
as well as how the final settlement price is calculated. In
addition, the rules should clearly specify the trading months and
hours of trading, the last trading day, contract size, minimum price
change (tick size) and any limitations on price movements (e.g.,
price limits or trading halts).
(2) Cash settled contracts may be susceptible to manipulation or
price distortion. In evaluating the susceptibility of a cash-settled
contract to manipulation, a designated contract market should
consider the size and liquidity of the cash market that underlies
the listed contract in a manner that follows the determination of
deliverable supply as noted above in (b)(1). In particular,
situations susceptible to manipulation include those in which the
volume of cash market transactions and/or the number of participants
contacted in determining the cash-settlement price are very low.
Cash-settled contracts may create an incentive to manipulate or
artificially influence the data from which the cash-settlement price
is derived or to exert undue influence on the cash-settlement
price's computation in order to profit on a futures position in that
commodity. The utility of a cash-settled contract for risk
management and price discovery would be significantly impaired if
the cash settlement price is not a reliable or robust indicator of
the value of the underlying commodity or instrument. Accordingly,
careful consideration should be given to the potential for
manipulation or distortion of the cash settlement price, as well as
the reliability of that price as an indicator of cash market values.
Appropriate consideration also should be given to the commercial
acceptability, public availability, and timeliness of the price
series that is used to calculate the cash settlement price.
Documentation demonstrating that the settlement price index is a
reliable indicator of market values and conditions and is commonly
used as a reference index by industry/market agents should be
provided. Such documentation may take on various forms, including
carefully documented interview results with knowledgeable agents.
(3) Where an independent, private-sector third party calculates
the cash settlement price series, a designated contract market
should consider the need for a licensing agreement that will ensure
the designated contract market's rights to the use of the price
series to settle the listed contract.
(i) Where an independent, private-sector third party calculates
the cash settlement price series, the designated contract market
should verify that the third party utilizes business practices that
minimize the opportunity or incentive to manipulate the cash-
settlement price series. Such safeguards may include lock-downs,
prohibitions against derivatives trading by employees, or public
dissemination of the names of sources and the price quotes they
provide. Because a cash-settled contract may create an incentive to
manipulate or artificially influence the underlying market from
which the cash-settlement price is derived or to exert undue
influence on the cash-settlement computation in order to profit on a
futures position in that commodity, a designated contract market
should, whenever practicable, enter into an information-sharing
agreement with the third-party provider which would enable the
designated contract market to better detect and prevent manipulative
behavior.
(ii) Where a designated contract market itself generates the
cash settlement price series, the designated contract market should
establish calculation procedures that safeguard against potential
attempts to artificially influence the price. For example, if the
cash settlement price is derived by the designated contract market
based on a survey of cash market sources, the designated contract
market should maintain a list of such entities which all should be
reputable sources with knowledge of the cash market. In addition,
the sample of sources polled should be representative of the cash
market, and the poll should be conducted at a time when trading in
the cash market is active.
(iii) The cash-settlement calculation should involve
computational procedures that eliminate or reduce the impact of
potentially unrepresentative data.
(iv) The cash settlement price should be an accurate and
reliable indicator of prices in the underlying cash market. The cash
settlement price also should be acceptable to commercial users of
the commodity contract. The registered entity should fully document
that the settlement price is accurate, reliable, highly regarded by
industry/market agents, and fully reflects the economic and
commercial conditions of the relevant designated contract market.
(v) To the extent possible, the cash settlement price should be
based on cash price series that are publicly available and available
on a timely basis for purposes of calculating the cash settlement
price at the expiration of a commodity contract. A designated
contract market should make the final cash settlement price and any
other supporting information that is appropriate for release to the
public, available to the public when cash settlement is accomplished
by the derivatives clearing organization. If the cash settlement
price is based on cash prices that are obtained from non-public
sources (e.g., cash market surveys conducted by the designated
contract market or by third parties on behalf of the designated
contract market), a designated contract market should make available
to the public as soon as possible after a contract month's
expiration the final cash settlement price as well as any other
supporting information that is appropriate or feasible to make
available to the public.
(4) Contract terms and conditions requirements for futures
contracts settled by cash settlement.
(i) An acceptable specification of the terms and conditions of a
cash-settled commodity contract will also set forth the trading
months, last trading day, contract size, minimum price change (tick
size) and daily price limits, if any.
(A) Commodity Characteristics: The terms and conditions of a
commodity contract should describe the commodity underlying the
contract.
(B) Contract Size and Trading Unit: An acceptable specification
of the trading unit would be a contract size that is consistent with
customary transactions in the cash market. A designated contract
market may opt to set the contract size smaller than that of
standard cash market transactions.
(C) Cash Settlement Procedure: The cash settlement price should
be reliable, acceptable, publicly available, and reported in a
timely manner as described in paragraphs (c)(3)(iv) and (c)(3)(v) of
this appendix C.
(D) Pricing Basis and Minimum Price Fluctuation (Minimum Tick):
The minimum price increment (tick) should be set a level that is
equal to, or less than, the minimum price increment commonly
observed in cash market transactions for the underlying commodity.
Specifying a futures' minimum tick that is greater than the minimum
price increment in the cash market can undermine the risk management
utility of the futures contract by preventing hedgers from
efficiently establishing and liquidating futures positions that are
used to hedge anticipated cash market transactions or cash market
positions.
(E) Maximum Price Fluctuation Limits: Designated contract
markets may adopt price limits to: (1) Reduce or constrain price
movements in a trading day that may not be reflective of true market
conditions but might be caused by traders overreacting to news; (2)
Allow additional time for the collection of margins in times of
large price movements; and (3) Provide a ``cooling-off'' period for
futures market participants to respond to bona fide changes in
market supply and demand fundamentals that would lead to large cash
and futures price changes. If price-limit provisions are adopted,
the limits should be set at levels that are not overly restrictive
in relation to price movements in the cash market for the commodity
underlying the futures contract. For broad-based stock index futures
contracts, rules should be adopted that coordinate with New York
Stock Exchange (``NYSE'') declared Circuit Breaker Trading Halts (or
other market coordinated Circuit Breaker mechanism) and would
recommence trading in the futures contract only after trading in the
majority of the stocks underlying the index has recommenced.
(F) Last Trading Day: Specification of the last trading day for
expiring contracts should be established such that it occurs before
publication of the underlying third-party price index or
determination of the final settlement price. If the designated
contract market chooses to allow trading to occur through the
determination of the final
[[Page 36725]]
settlement price, then the designated contract market should show
that futures trading would not distort the final settlement price
calculation.
(G) Trading Months: Trading months should be established based
on the risk management needs of commercial entities as well as the
availability of price and other data needed to calculate the cash
settlement price in the specified months. Specification of the last
trading day should take into consideration whether the volume of
transactions underlying the cash settlement price would be unduly
limited by occurrence of holidays or traditional holiday periods in
the cash market. Moreover, a contract should not be listed past the
date for which the designated contract market has access to use a
proprietary price index for cash settlement.
(H) Speculative Limits: Specific rules and policies for
speculative position limits are set forth in part 150 and/or part
151, as applicable, of the Commission's regulations.
(I) Reportable Levels: Refer to Sec. 15.03 of the Commission's
regulations.
(J) Trading Hours: Should be set by the designated contract
market to delineate each trading day.
(d) Options on a Futures Contract. (1) The Commission's
experience with the oversight of trading in futures option contracts
indicates that most of the terms and conditions associated with such
trading do not raise any regulatory concerns or issues. The
Commission has found that the following terms do not affect an
option contract's susceptible to manipulation or its utility for
risk management. Thus, the Commission believes that, in most cases,
any specification of the following terms would be acceptable; the
only requirement is that such terms be specified in an automatic and
objective manner in the option contract's rules:
[cir] Exercise method;
[cir] Exercise procedure (if positions in the underlying futures
contract are established via book entry);
[cir] Strike price listing provisions, including provisions for
listing strike prices on a discretionary basis;
[cir] Strike price intervals;
[cir] Automatic exercise provisions;
[cir] Contract size (unless not set equal to the size of the
underlying futures contract); and
[cir] Option minimum tick should be equal to or smaller than
that of the underlying futures contract.
(2) Option Expiration & Last Trading Day. For options on futures
contracts, specification of expiration dates should consider the
relationship of the option expiration date to the delivery period
for the underlying futures contract. In particular, an assessment
should be made of liquidity in the underlying futures market to
assure that any futures contracts acquired through exercise can be
liquidated without adversely affecting the orderly liquidation of
futures positions or increasing the underlying futures contract's
susceptibility to manipulation. When the underlying futures contract
exhibits a very low trading activity during an expiring delivery
month's final trading days or has a greater risk of price
manipulation than other contracts, the last trading day and
expiration day of the option should occur prior to the delivery
period or the settlement date of the underlying future. For example,
the last trading day and option expiration day might appropriately
be established prior to first delivery notice day for option
contracts with underlying futures contracts that have very limited
deliverable supplies. Similarly, if the futures contract underlying
an option contract is cash settled using cash prices from a very
limited number of underlying cash market transactions, the last
trading and option expiration days for the option contract might
appropriately be established prior to the last trading day for the
futures contract.
(3) Speculative Limits. In cases where the terms of an
underlying futures contract specify a spot-month speculative
position limit and the option contract expires during, or at the
close of, the futures contract's delivery period, the option
contract should include a spot-month speculative position limit
provision that requires traders to combine their futures and option
position and be subject to the limit established for the futures
contract. Specific rules and policies for speculative position
limits are set forth in part 150 and/or part 151, as applicable, of
the Commission's regulations.
(4) Options on Physicals Contracts.
(i) Under the Commission's regulations, the term ``option on
physicals'' refers to option contracts that do not provide for
exercise into an underlying futures contract. Upon exercise, options
on physicals can be settled via physical delivery of the underlying
commodity or by a cash payment. Thus, options on physicals raise
many of the same issues associated with trading in futures contracts
regarding adequacy of deliverable supplies or acceptability of the
cash settlement price series. In this regard, an option that is cash
settled based on the settlement price of a futures contract would be
considered an ``option on physicals'' and the futures settlement
price would be considered the cash price series.
(ii) In view of the above, acceptable practices for the terms
and conditions of options on physicals contracts include, as
appropriate, those practices set forth above for physical-delivery
or cash-settled futures contracts plus the practices set forth for
options on futures contracts.
(e) Security Futures Products. The listing of security futures
products are governed by the special requirements of part 41 of the
Commission's regulations.
(f) Non-Price Based Futures Contracts. (1) Non-price based
contracts are typically construed as binary options, but also may be
designed to function similar to traditional futures or option
contracts.
(2) Where the contract is settled to a third party cash-
settlement series, the designated contract market should consider
the nature and sources of the data comprising the cash-settlement
calculation, the computational procedures, and the mechanisms in
place to ensure the accuracy and reliability of the index value. The
evaluation also considers the extent to which the third party has,
or will adopt, safeguards against unauthorized or premature release
of the index value itself or any key data used in deriving the index
value.
(3) The designated contract market should follow the guidance in
paragraph (c)(4) (Contract Terms and Conditions Requirements for
Futures Contracts Settled by Cash Settlement) of this appendix C to
meet compliance.
(g) Swap Contracts. (1) In general, swap contracts are an
agreement to exchange a series of cash flows over a period of time
based on reference price indices. When listing a swap for trading, a
swap execution facility or designated contract market should
determine that the reference price indices used for its contracts
are not readily susceptible to manipulation. Accordingly, careful
consideration should be given to the potential for manipulation or
distortion of the cash settlement price, as well as the reliability
of that price as an indicator of cash market values. Appropriate
consideration also should be given to the commercial acceptability,
public availability, and timeliness of the price series that is used
to calculate the cash settlement price. Documentation demonstrating
that the settlement price index is a reliable indicator of market
values and conditions and is highly regarded by industry/market
agents should be provided. Such documentation may take on various
forms, including carefully documented interviews with principal
market trading agents, pricing experts, marketing agents, etc.
Appropriate consideration also should be given to the commercial
acceptability, public availability, and timeliness of the price
series that is used to calculate the cash flows of the swap.
(i) Where an independent, private-sector third party calculates
the referenced price index, the designated contract market should
verify that the third party utilizes business practices that
minimize the opportunity or incentive to manipulate the cash-
settlement price series. Such safeguards may include lock-downs,
prohibitions against derivatives trading by employees, or public
dissemination of the names of sources and the price quotes they
provide. Because a cash-settled contract may create an incentive to
manipulate or artificially influence the underlying market from
which the cash-settlement price is derived or to exert undue
influence on the cash-settlement computation in order to profit on a
futures position in that commodity, a designated contract market
should, whenever practicable, enter into an information-sharing
agreement with the third-party provider which would enable the
designated contract market to better detect and prevent manipulative
behavior.
(ii) Where a designated contract market itself generates the
cash settlement price series, the designated contract market should
establish calculation procedures that safeguard against potential
attempts to artificially influence the price. For example, if the
cash settlement price is derived by the designated contract market
based on a survey of cash market sources, the designated contract
market should maintain a list of such entities which all should be
reputable sources with knowledge of the cash market. In addition,
the sample of sources polled should be representative of the cash
market, and the poll should be conducted at a time when trading in
the cash market is active.
[[Page 36726]]
(iii) The cash-settlement calculation should involve appropriate
computational procedures that eliminate or reduce the impact of
potentially unrepresentative data.
(2) Speculative Limits: Specific rules and policies for
speculative position limits are set forth in part 151 and/or part
151, as applicable, of the Commission's regulations.
(3) Intraday Market Restrictions: Designated contract markets or
swap execution facilities should have in place intraday market
restrictions that pause or halt trading in the event of
extraordinary price moves that may result in distorted prices. Such
restrictions need to be coordinated with other markets that may be a
proxy or a substitute for the contracts traded on their facility.
For example, coordination with NYSE rule 80.B Circuit Breaker
Trading Halts. The designated contract market or swap execution
facility should adopt rules to specifically address who is
authorized to declare an emergency; how the designated contract
market or swap execution facility will notify the Commission of its
decision that an emergency exists; how it will address conflicts of
interest in the exercise of emergency authority; and how it will
coordinate trading halts with markets that trade the underlying
price reference index or product.
(4) Settlement Method. The designated contract market or swap
execution facility should follow the guidance in paragraph (c)(4)
(Contract Terms and Conditions Requirements for Futures Contracts
Settled by Cash Settlement) of this appendix C to meet compliance,
or paragraph (b)(2) (Contract Terms and Conditions Requirements for
Futures Contracts Settled by Physical Delivery) of this appendix C,
as appropriate.
Issued in Washington, DC, on May 10, 2012, by the Commission.
David A. Stawick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Core Principles and Other Requirements for Designated
Contract Markets--Commission Voting Summary and Statements of
Commissioners
Appendix 1--Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Sommers,
Chilton, O'Malia and Wetjen voted in the affirmative; no
Commissioner voted in the negative.
Appendix 2--Statement of Chairman Gary Gensler
I support the final rulemaking on designated contract markets
DCMs, which includes rules, guidance and acceptable practices. It
advances important Dodd-Frank transparency reforms. The Dodd-Frank
Act squarely addresses the historically opaque swaps market though
its strong transparency provisions. A critical element is pre-trade
transparency--requiring standardized swaps between financial firms--
those that are cleared, made available for trading and not blocks--
to be traded on exchanges, such as DCMs, swap execution facilities
(SEFs) or foreign boards of trade (FBOTs). When markets are open and
transparent, prices are more competitive, markets are more efficient
and liquid, and costs are lowered for companies and their customers.
DCMs have long demonstrated the value of open and competitive
trading. DCMs, for the first time, will be able to list and trade
swaps, helping to bring the benefit of pre-trade transparency to the
swaps marketplace.
In addition, the Dodd-Frank Act incorporated the previously
existing eight statutory designation criteria for DCMs into the DCM
core principles and expanded the principles from 18 to 23. The final
rulemaking the Commission will consider today conforms to the Dodd-
Frank transparency reforms.
The final rulemaking benefits from extensive public comment and
provides exchanges rules, guidance and acceptable practices on
complying with Dodd-Frank's 23 core principles. In many instances,
we're codifying industry practices that the Commission has observed
and found appropriate to comply with these core principles. While
preserving a principles-based regime, these regulations will provide
greater legal certainty and transparency to DCMs in determining
their compliance obligations, and to market participants in
determining their obligations as DCM members, and will facilitate
the enforcement of such provisions.
The final rulemaking is consistent with the core principles-
based regime of the Commodity Exchange Act. It provides each DCM
with the flexibility to employ additional measures to address core
principle requirements.
As an example, the final rulemaking requires DCMs to put in
place effective pre-trade risk filters, including pauses and/or
trading halts to address extraordinary price movements that may
result in distorted prices or trigger market disruptions. The
rulemaking, though, also recognizes that pauses and halts comprise
only one category of risk controls, and that additional controls may
be necessary to be put in place by exchanges to reduce the potential
for market disruptions. The final guidance included in today's
rulemaking lists that exchanges may possibly implement price collars
or bands, maximum order size limits, and message throttles.
This rulemaking does not yet finalize the Commission's proposal
relating to core principle 9--which requires DCMs to provide an
open, competitive and efficient market and mechanism for
transactions that protects the price discovery process of the DCM's
central marketplace. I expect the Commission to consider a final
rule on this matter when it takes up the SEF rule this summer. The
additional time will allow the Commission to more fully analyze the
many public comments on these provisions, including comments on the
implications of exchange of futures for swap transactions, or so-
called ``EFS transactions,'' in relation to the transparency reforms
of Dodd-Frank, as well as the requirement for non-discriminatory
open access to clearing.
[FR Doc. 2012-12746 Filed 6-18-12; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: June 19, 2012