Federal Register, Volume 77 Issue 68 (Monday, April 9, 2012)[Federal Register Volume 77, Number 68 (Monday, April 9, 2012)]
[Rules and Regulations]
[Pages 21278-21310]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-7477]
[[Page 21277]]
Vol. 77
Monday,
No. 68
April 9, 2012
Part III
Commodity Futures Trading Commission
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17 CFR Parts 1, 23, 37, et al.
Customer Clearing Documentation, Timing of Acceptance for Clearing,
and Clearing Member Risk Management; Final Rule
Federal Register / Vol. 77 , No. 68 / Monday, April 9, 2012 / Rules
and Regulations
[[Page 21278]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 23, 37, 38, and 39
RIN 3038-0092, -0094
Customer Clearing Documentation, Timing of Acceptance for
Clearing, and Clearing Member Risk Management
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is adopting rules to implement new statutory provisions
enacted by Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act. These rules address: The documentation between a
customer and a futures commission merchant that clears on behalf of the
customer; the timing of acceptance or rejection of trades for clearing
by derivatives clearing organizations and clearing members; and the
risk management procedures of futures commission merchants, swap
dealers, and major swap participants that are clearing members. The
rules are designed to increase customer access to clearing, to
facilitate the timely processing of trades, and to strengthen risk
management at the clearing member level.
DATES: This rule will become effective October 1, 2012.
FOR FURTHER INFORMATION CONTACT: John C. Lawton, Deputy Director, 202-
418-5480, [email protected], and Christopher A. Hower, Attorney-Advisor,
202-418-6703, [email protected], Division of Clearing and Risk, and
Camden Nunery, Economist, 202-418-5723, Office of the Chief Economist,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street NW., Washington, DC 20581; and Hugh J. Rooney, Assistant
Director, 312-596-0574, [email protected], Division of Clearing and
Risk, Commodity Futures Trading Commission, 525 West Monroe Street,
Chicago, Illinois 60661.
SUPPLEMENTARY INFORMATION:
Table of Contents
yI. Background
II. Customer Clearing Documentation
A. Introduction
B. Summary of Comments
C. Discussion
III. Time Frames for Acceptance Into Clearing
A. Swap Dealer and Major Swap Participant Submission of Trades
B. Swap Execution Facility and Designated Contract Market
Processing of Trades
C. Clearing Member and Clearing Organization Acceptance for
Clearing
D. Post-Trade Allocation of Bunched Orders
IV. Clearing Member Risk Management
A. Introduction
B. Components of the Rule
V. Effective Dates
A. Summary of Comments
B. Discussion
VI. Consideration of Costs and Benefits
VII. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
I. Background
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street
Reform and Consumer Protection Act (``Dodd-Frank Act'').\1\ Title VII
of the Dodd-Frank Act amended the Commodity Exchange Act (``CEA'' or
``Act'') \2\ to establish a comprehensive new regulatory framework for
swaps. The legislation was enacted to reduce risk, increase
transparency, and promote market integrity within the financial system
by, among other things: (1) Providing for the registration and
comprehensive regulation of swap dealers and major swap participants;
(2) imposing clearing and trade execution requirements on standardized
derivative products; (3) creating rigorous recordkeeping and real-time
reporting 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.
Title VII also includes amendments to the federal securities laws to
establish a similar regulatory framework for security-based swaps under
the authority of the Securities and Exchange Commission (``SEC'').
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\1\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010).
\2\ 7 U.S.C. 1 et seq.
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A fundamental premise of the Dodd-Frank Act is that the use of
properly regulated central clearing can reduce systemic risk. Another
tenet of the Dodd-Frank Act is that open access to clearing by market
participants will increase market transparency and promote market
efficiency by enabling market participants to reduce counterparty risk
and by facilitating the offset of open positions. The Commission has
adopted extensive regulations addressing open access and risk
management at the derivatives clearing organization (``DCO'') level.\3\
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\3\ Derivatives Clearing Organization General Provisions and
Core Principles, 76 FR 69334 (Nov. 8, 2011).
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Clearing members provide the portals through which market
participants gain access to DCOs. Clearing members also provide the
first line of risk management. Accordingly, in three related
rulemakings, the Commission proposed regulations to increase customer
access to clearing,\4\ to facilitate the timely processing of
trades,\5\ and to strengthen risk management at the clearing member
level.\6\ In addition, in a fourth rulemaking, the Commission proposed
regulations relating to the allocation of bunched orders.\7\ The
Commission is issuing final rules in each of these areas.
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\4\ Customer Clearing Documentation and Timing of Acceptance for
Clearing, 76 FR 45730 (Aug. 1, 2011).
\5\ Requirements for Processing, Clearing, and Transfer of
Customer Positions, 76 FR 13101 (Mar. 10, 2011).
\6\ Clearing Member Risk Management, 76 FR 45724 (Aug. 1, 2011).
\7\ Adaption of Regulations to Incorporate Swaps, 76 FR 33066
(Jun. 7, 2011).
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More specifically, the regulations contained in this Adopting
Release were proposed in four separate notices of proposed rulemaking
(``NPRMs''). Sections 1.72, 1.74, 23.608, 23.610, 39.12(a)(1)(iv), and
39.12(b)(7) were proposed in Customer Clearing Documentation and Timing
of Acceptance for Clearing,\8\ sections 23.506, 37.702(b), and
38.601(b) were proposed in Requirements for Processing, Clearing, and
Transfer of Customer Positions,\9\ sections 1.73 and 23.609 were
proposed in Clearing Futures Commission Merchant Risk Management,\10\
and 1.35(a-1)(5)(iv) was proposed in Adaptation of Regulations to
Incorporate Swaps.\11\ The Commission is finalizing the rules contained
in this Adopting Release together because they address three
overarching, closely-connected aims: (1) Non-discriminatory access to
counterparties and clearing; (2) straight-through processing; and (3)
effective risk management among clearing members. Each of these
provides substantial benefits for the markets and market participants.
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\8\ See 76 FR 45730 (Aug. 1, 2011).
\9\ See 76 FR 13101 (Mar. 10, 2011).
\10\ See 76 FR 45724 (Aug. 1, 2011).
\11\ See 76 FR 33066 (Jun. 6, 2011).
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II. Customer Clearing Documentation
A. Introduction
As discussed in the notice of proposed rulemaking,\12\ industry
groups have developed a template for use by swap market participants in
negotiating execution-related agreements with counterparties to swaps
that are intended to be cleared.\13\ The template
[[Page 21279]]
includes optional annexes that make the clearing member to one or both
of the executing parties a party to the agreement (the trilateral
agreements). The trilateral agreements contain provisions that would
permit a customer's futures commission merchant (``FCM''), in
consultation with the swap dealer (``SD'') that is the customer's
counterparty, to establish specific credit limits for the customer's
swap transactions with the SD. The provisions further provide that the
FCM will only accept for clearing those transactions that fall within
these specific limits. The limits set for trades with the SD or MSP
might be less than the overall limits set for the customer for all
trades cleared through the FCM. The result would be to create a
``sublimit'' for the customer when trading with that SD or MSP.
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\12\ See 76 FR 45730 at 45731, Aug. 1, 2011.
\13\ See http://www.futuresindustry.org/downloads/ClearedDerivativesExecutionAgreement_June142001.pdf.
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When a trade is rejected for clearing, the parties to that trade
may incur significant costs. As the clearing of swaps increases
pursuant to the Dodd-Frank Act, the likelihood and size of such
potential costs could also increase, according to the proponents of the
trilateral agreements. The trilateral agreements were intended to limit
these potential costs.
The Commission expressed concern in the notice of proposed
rulemaking that such arrangements potentially conflict with the
concepts of open access to clearing and competitive execution of
transactions.\14\ To address these concerns and to provide further
clarity in this area, the Commission proposed Sec. 1.72 relating to
FCMs, Sec. 23.608 relating to SDs and MSPs, and Sec. 39.12(a)(1)(vi)
relating to DCOs. These regulations would prohibit arrangements
involving FCMs, SDs, MSPs, or DCOs that would (a) disclose to an FCM,
SD, or MSP the identity of a customer's original executing
counterparty; (b) limit the number of counterparties with whom a
customer may enter into a trade; (c) restrict the size of the position
a customer may take with any individual counterparty, apart from an
overall credit limit for all positions held by the customer at the FCM;
(d) impair a customer's access to execution of a trade on terms that
have a reasonable relationship to the best terms available; or (e)
prevent compliance with specified time frames for acceptance of trades
into clearing.
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\14\ Id. at 45732.
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B. Summary of Comments
The Commission received a total of 38 comment letters directed
specifically at the proposed documentation rules.\15\ Of the 38
commenters, 30 supported the proposed rules.\16\ They included asset
managers, market makers, trading platforms, clearing organizations,
bank/dealers, a non-profit organization, and a private citizen. Within
this group, some commenters addressed only certain aspects of the rules
and were silent on other sections and some requested clarification of
certain provisions.
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\15\ Comment files for each proposed rulemaking can be found on
the Commission Web site, www.cftc.gov. Commenters include: Chris
Barnard (``Barnard''); MarkitSERV (``Markit''); Swaps & Derivatives
Market Association (``SDMA''); Better Markets;
IntercontinentalExchange, Inc. (``ICE''); ISDA FIA (``ISDA''); The
Alternative Investment Management Association Ltd. (``AIMA''); CME
Group Inc. (``CME''); Morgan Stanley; Edison Electric Institute
(``EEI''); State Street Corporation (``State Street''); New York
Portfolio Clearing (``NYPC''); Asset Management Group of the
Securities Industry and Financial Markets Association (``SIFMA'');
Vanguard; AllianceBernstein L.P. (``Alliance Bernstein'');
Minneapolis Grain Exchange, Inc. (``MGEX''); Atlantic Trading USA
LLC; Belvedere Trading; Bluefin Trading, LLC; Chopper Trading LLC;
CTC Trading Group, LLC; DRW Holdings, LLC; Eagle Seven, LLC;
Endeavor Trading, LLC; Flow Traders US LLC; Geneva Trading USA, LLC;
GETCO; Hard Eight Futures; HTG Capital Partners; IMC Financial
Markets; Infinium Capital Management LLC; Kottke Associates, LLC;
Marquette Partners, LP; Nico Holdings LLC; Optiver US LLC; RGM
Advisors, LLC; Templar Securities, LLC; Tower Research Capital LLC;
TradeForecaster Global Markets LLC; Traditum Group, LLC; WH Trading
LLC; XR Trading LLC (``Trading Firms''); Managed Funds Association
(``MFA''); Arbor Research & Trading Inc. (``Arbor''); Eris Exchange
(``Eris''); ICI; DRW Trading Group (``DRW''); Spring Trading, Inc.
(``Spring Trading''); Javelin Capital Markets, LLC (``Javelin'');
The Committee on Investment of Employee Benefit Assets (``CIEBA'');
Citadel LLC (``Citadel''); Vizier Ltd. (``Vizier''); Federal Home
Loan Banks (``FHLB''); Jefferies & Company, Inc. (``Jeffries''); UBS
Securities LLC (``UBS''); Wells Fargo Securities (``WF'');
LCH.Clearnet Group Limited (``LCH''); D. E. Shaw group (``D. E.
Shaw''); Bank of America, Merrill Lynch, BNP Paribas, Citi, Credit
Suisse Securities (USA) LLC, Deutsche Bank AG, Goldman Sachs, HSBC,
J.P. Morgan, Morgan Stanley (``Banks''); Deutsche Bank (``DB'');
Societe Generale (``SG''); The Association of Institutional
Investors (``AII''); and The Committee on Capital Markets Regulation
(``Committee'').
\16\ AII, AIMA, AllianceBernstein, Arbor, Better Markets,
Barnard, CIEBA, Citadel, CME, D. E. Shaw, DRW, Eris, FHLB, ICE, ICI,
Javelin, Jeffries, LCH, Markit, MFA, MGEX, NYPC, SDMA, SIFMA, Spring
Trading, State Street, Trading Firms, Vanguard, Vizier, and WF.
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Eight commenters expressed opposition.\17\ They include bank/
dealers, an association of electric utilities, and an asset manager.
Within this group as well, some commenters addressed only certain
aspects of the rules and were silent on other sections and some
requested clarification of certain provisions.
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\17\ DB, ISDA, SG, UBS, Morgan Stanley, the Banks, EEI, and the
Committee.
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Three commenters in support--Arbor, Citadel, and Eris--urged the
Commission to make these rules a top priority in the final rulemaking
process. Numerous commenters stated that the proposed rules would
increase open access to clearing and execution, reduce risk, foster
competition, lower costs, and increase transparency. FHLB expressed the
view that the proposed rules will facilitate the transition to central
clearing. Barnard and Vanguard asserted that the proposed rules will
prevent conflicts of interest, and achieve clear walls between clearing
and trading activities involving FCMs and affiliates. Six commenters
went into detail why the trilateral agreements are bad for the markets,
noting that such agreements discourage competition and efficient
pricing, compromise anonymity, reduce liquidity, increase the time
between execution and clearing, introduce conflicts of interest, and
prevent the success of swap execution facilities (``SEFs'').\18\ SDMA
commented that while ``the SDMA is philosophically loathe to encourage
possible government [interference] with private contracts between two
parties,'' the proposed rules are necessary in their entirety in this
instance, and that the proposed rules are not overly prescriptive.
Vanguard, estimated that if it was required to enter into trilateral
agreements, it would have to negotiate approximately 4,800 new
trilateral agreements per year.\19\
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\18\ AIMA, Javelin, SG, SIFMA, Spring Trading, and Vanguard.
\19\ Vanguard.
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Seven commenters in opposition contended that without the
trilateral agreements, some market participants may have reduced access
to markets.\20\ (ISDA and the Committee did not address this issue.)
They asserted that the trilateral agreements facilitate risk management
and certainty of execution. DB believes that the trilateral agreements
provide a means of ensuring compliance with mandatory clearing. DB also
commented that if an SD does not know whether a swap will be cleared
prior to execution, it will not know whether it should apply risk
filters that take account of the swap as a cleared transaction or a
bilateral one. SG commented that the rules will decrease liquidity and
limit market participation, and that without the certainty of
trilateral agreements, the rules may foster competing and inconsistent
technology.
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\20\ Banks, DB, EEI, ISDA, Morgan Stanley, SG, and UBS.
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UBS believes that potential abuse of credit arrangements could be
more narrowly tailored than the proposed rule. The Banks asserted that
the credit filter infrastructure necessary to
[[Page 21280]]
maximize execution choice for customers while ensuring prudent risk
management is not currently available. The Banks suggested that instead
of prohibiting the trilateral agreements, the Commission could require
that the allocation of credit limits across executing counterparties be
specified by the customer, rather than the FCM, who would confirm the
customer's allocation to the identified executing counterparties.
Morgan Stanley requested clarification that the proposed rules only
apply to arrangements between clearing firms and executing swap dealers
and customers with respect to swaps, not futures. Morgan Stanley also
commented that the Commission should alter the language in proposed
Sec. 1.72 and Sec. 23.608 from ``relationship to the best terms
available'' to ``execution with an executing swap dealer of the
customer's choice.''
Spring Trading requested clarification that ``on terms that have a
reasonable relationship to the best terms available'' refers to the
best terms available on any market regulated by the Commission, which
would prohibit an FCM from establishing special hurdles for its
clearing customers in order to trade on a particular SEF.
C. Discussion
The Commission found persuasive the comments stating that the
proposed rules would increase open access to clearing and execution,
reduce risk, foster competition, lower costs, and increase
transparency. The Commmission notes that cleared futures markets have
operated for decades without any need for the types of provisions
prohibited by the rules. Similarly, trades executed over-the-counter
(``OTC'') have been successfully cleared by CME and ICE on behalf of
customers for approximately ten years without such provisions.
Specifically, the Commission believes that, as discussed by
numerous commenters, (1) disclosure of a customer's original executing
counterparty could have potentially anticompetitive effects, (2)
limiting the number of counterparties would hurt the customer's access
to the best price as well as general market liquidity, (3) restricting
the size of trades with particular counterparties also would hurt the
customer's access to the best price as well as general market
liquidity, and (4) restrictions on the number of counterparties and on
the size of trades with them would slow down acceptance for clearing
thereby causing the very problem the restrictions were purportedly
designed to address.
The Commission believes that the risks the trilateral agreements
were designed to address can be mitigated by other means without
incurring the negative consequences described above. Specifically, the
processing rules described in section III. below and the risk
management rules described in section IV. below would significantly
diminish the exposure of dealers, their counterparties, and their
respective FCMs to risk.
Moreover, the Commission notes that there are several sections of
the CEA and Commission regulations that support the premise underlying
these final rules. Section 4d(c) of the CEA, as amended by the Dodd-
Frank Act, directs the Commission to require FCMs to implement conflict
of interest procedures that address such issues the Commission
determines to be appropriate. Similarly, section 4s(j)(5), as added by
the Dodd-Frank Act, requires SDs and MSPs to implement conflict of
interest procedures that address such issues the Commission determines
to be appropriate. Section 4s(j)(5) also requires SDs and MSPs to
ensure that any persons providing clearing activities or making
determinations as to accepting clearing customers are separated by
appropriate informational partitions from persons whose involvement in
pricing, trading, or clearing activities might bias their judgment or
contravene the core principle of open access.
Pursuant to these provisions, the Commission promulgated Sec.
1.71(d) relating to FCMs and Sec. 23.605(d) relating to SDs and
MSPs.\21\ These regulations prohibit SDs and MSPs from interfering or
attempting to influence the decisions of affiliated FCMs with regard to
the provision of clearing services and activities, and prohibit FCMs
from permitting them to do so.
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\21\ ``Swap Dealer and Major Swap Participant Recordkeeping and
Reporting, Duties, and Conflicts of Interest Policies and
Procedures; Futures Commission Merchant and Introducing Broker
Conflicts of Interest Policies and Procedures; Swap Dealer, Major
Swap Participant, and Futures Commission Merchant Chief Compliance
Officer,'' available at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312b.
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Section 4s(j)(6) of the CEA prohibits an SD or MSP from adopting
any process or taking any action that results in any unreasonable
restraint on trade or imposes any material anticompetitive burden on
trading or clearing, unless necessary or appropriate to achieve the
purposes of the Act. To implement Section 4s(j)(6) of the CEA, the
Commission has promulgated Sec. 23.607 in a separate rulemaking.\22\
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\22\ Id.
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Section 2(h)(1)(B)(ii) of the CEA requires that DCO rules provide
for the non-discriminatory clearing of swaps executed bilaterally or
through an unaffiliated designated contract market (``DCM'') or SEF.
The Commission has adopted Sec. 39.12(b)(3) to implement this
provision.\23\
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\23\ 76 FR 69334, Nov. 8, 2011.
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The trilateral agreements potentially conflict with the recently-
adopted Sec. Sec. 1.71(d), 23.605(d), 23.607, and 39.12. As certain
commenters have stated, the provisions of the trilateral agreements
described above could lead to undue influence by FCMs on a customer's
choice of counterparties or undue influence by SDs on a customer's
choice of clearing member. They could constrain a customer's
opportunity to obtain competitive execution of the trade by limiting
the number of potential counterparties.
The documentation rules covered by this rulemaking are consistent
with, and complementary to, the recently adopted rules. The rules in
this Federal Register release address specific circumstances that have
been identified to the Commission by market participants, while the
previously adopted rules set forth more general principles. The
Commission believes that, in this case, market participants and the
general public would be best served by providing both the clarity of a
bright-line test for certain identifiable situations and the guidance
of more broadly-articulated principles.
Contrary to the assertion of some commenters, the rules do not
prohibit trilateral agreements; they prohibit certain provisions
whether contained in a trilateral or a bilateral agreement. The rules
have been tailored to address specific issues identified by market
participants.
The Commission emphasizes that nothing in these rules would
restrain an SD or MSP from establishing bilateral limits with each of
its counterparties. Further, nothing in these rules would impair an
SD's or MSP's ability to conduct due diligence with regard to each of
its counterparties, including evaluation of balance sheet, credit
ratings, overall market exposure, or similar factors.
The Commission is revising the language in Sec. Sec. 23.608 and
23.608(c) to clarify that, for swaps that will be submitted for
clearing, an SD or MSP may continue to manage its risk by limiting its
exposure to the counterparty with whom it is trading. This
[[Page 21281]]
clarification is intended to emphasize that SDs and MSPs may continue
to conduct appropriate risk management exercises. Moreover, the
Commission believes that this modification is responsive to the concern
raised by some commenters that until straight through processing is
achieved, SDs and MSPs will still need to manage risk to a counterparty
before a trade is accepted or rejected for clearing.\24\ Furthermore,
the Commission also believes that Sec. 23.608 does not preclude an SD
or MSP from requiring that a counterparty confirm that the counterparty
has an account with an FCM through which the counterparty will clear.
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\24\ ISDA.
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In response to the Morgan Stanley request for clarification, the
Commission confirms that the rules, as drafted, only apply to swaps. As
noted, similar provisions have never been needed and, therefore, were
not proposed for futures.
The Commission has determined not to modify the language in
Sec. Sec. 1.72 and 23.608 as suggested by Morgan Stanley from
``relationship to the best terms available'' to ``execution with an
executing swap dealer of the customer's choice.'' The rule should not
imply that customers may only trade with swap dealers. Moreover, some
swap markets operate anonymous central limit order books. In these
instances, the counterparty is immaterial; trading decisions are based
on solely the terms of the trade.
The Commission also has determined not to adopt the clarification
suggested by Spring Trading. Requiring execution on the best terms
available on any market regulated by the Commission could impose
burdensome search costs.\25\ Moreover, there could be operational costs
in establishing connectivity to every market. It is not clear how many
markets there will be or how compatible their systems will be with one
another or with the systems of all FCMs and SDs. Upon review of the
comments, the Commission is adopting Sec. Sec. 1.72, and
39.12(a)(1)(vi) as proposed, and Sec. 23.608 with the modification
described above.
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\25\ The Commission notes that this rule does not impose a best
execution requirement. This rule merely prohibits a contractual
provision that would impair a customer's access to execution of a
trade on terms that have a reasonable relationship to the best terms
available.
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III. Time Frames for Acceptance Into Clearing
A. Swap Dealer and Major Swap Participant Submission of Trades
1. Introduction
Section 731 of the Dodd-Frank Act amended the CEA by adding a new
section 4s, which sets forth a number of requirements for SDs and MSPs.
Specifically, section 4s(i) of the CEA establishes swap documentation
standards for those registrants. Section 4s(i) requires SDs and MSPs to
``conform with such standards as may be prescribed by the Commission by
rule or regulation that relate to timely and accurate confirmation,
processing, netting, documentation, and valuation of all swaps.''
Section 8a(5) of the CEA authorizes the Commission to promulgate such
regulations as, in the judgment of the Commission, are reasonably
necessary to effectuate any of the provisions or to accomplish any of
the purposes of the Act.\26\ Pursuant to these provisions, and in order
to ensure compliance with any mandatory clearing requirement issued
pursuant to section 2(h)(1) of the CEA and to promote the mitigation of
counterparty credit risk through the use of central clearing, the
Commission proposed Sec. 23.506.
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\26\ 7 U.S.C. 12a(5).
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As proposed, Sec. 23.506(a)(1) would require that SDs and MSPs
have the ability to route swaps that are not executed on a SEF or DCM
to a DCO in a manner that is acceptable to the DCO for the purposes of
risk management. Under Sec. 23.506(a)(2), as proposed, SDs and MSPs
would also be required to coordinate with DCOs to facilitate prompt and
efficient processing in accordance with proposed regulations related to
the timing of clearing by DCOs.
As proposed, Sec. 23.506(b) would set forth timing requirements
for submitting swaps to DCOs in those instances where the swap is
subject to a clearing mandate and in those instances when a swap is not
subject to a mandate. Under Sec. 23.506(b)(1), as proposed, an SD or
MSP would be required to submit a swap that is not executed on a SEF or
DCM, but is subject to a clearing mandate under section 2(h)(1) of the
CEA (and has not been electively excepted from mandatory clearing by an
end user under section 2(h)(7) of the CEA) as soon as technologically
practicable following execution of the swap, but no later than the
close of business on the day of execution.\27\
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\27\ The Commission notes that it is not expressing an opinion
at this time as to whether a mandatory clearing determination must
be made in conjunction with a mandatory trading determination.
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For those swaps that are not subject to a clearing mandate, but for
which both counterparties to the swap have elected to clear the swap,
under Sec. 23.506(b)(2), as proposed, the SD or MSP would be required
to submit the swap for clearing not later than the next business day
after execution of the swap, or the agreement to clear, if later than
execution. This time frame reflects the possibility that in the case of
a bilateral swap, the parties may need time to agree to terms that
would conform with a DCO's requirements for swaps it will accept for
clearing. As noted previously, any delay between execution and novation
to a clearinghouse potentially presents credit risk to the swap
counterparties and the DCO because the value of the position may change
significantly between the time of execution and the time of novation,
thereby allowing financial exposure to accumulate in the absence of
daily mark-to-market. The proposed regulation was designed to limit
this delay as much as reasonably possible.
2. Summary of Comments
MFA generally supported proposed Sec. Sec. 23.506(a) and
23.506(b).
CME commented that the regulations should not require any
particular system or methodology that SDs or MSPs must use for
submitting swaps to DCOs. Instead, the regulations should give each DCO
the flexibility to work with SDs and MSPs to implement various systems
and methodologies for swap submission, which may be subject to change
over time as cleared swap markets continue to develop and grow.
ISDA also indicated that the rule should permit SDs and MSPs,
coordinating with their DCOs, to be free to select the manner by which
they route their swaps to DCOs. ISDA, however, commented that it is not
apparent what proposed Sec. 23.506(a) adds to the Sec. 39.12(a)(3)
requirement that clearing members have adequate operational capacity to
meet obligations arising from their participation in DCOs. ISDA also
noted that market participants have for some time been developing
industry standards for the prompt and efficient processing of cleared
swap transactions, and it suggested that the Commission study these
standards and defer to them wherever possible.
MarkitSERV commented that the requirement to submit swaps ``as soon
as technologically practicable following
[[Page 21282]]
execution'' may be inappropriate in light of the Commission's proposed
rule regarding confirmation requirements, which requires that swap
transactions be confirmed within a certain time period after execution.
MarkitSERV suggested that the regulation reference the time of
confirmation as opposed to the time of execution. MarkitSERV also noted
that requiring SDs and MSPs to submit swaps for clearing ``no later
than the close of business on the day of execution'' fails to
accommodate transactions that occur late in the day and suggested a 24
hour time period.
MarkitSERV also commented that there are numerous benefits to using
third party middleware providers for routing and processing services,
and it suggested that the Commission permit swap counterparties to
control how they process transactions. According to MarkitSERV,
counterparties should be permitted to use independent third party
providers for confirming, routing, and satisfying the portfolio
reconciliation requirements proposed by the Commission. MarkitSERV also
suggested that the Commission clarify how proposed Sec. 23.506 would
interact with proposed Sec. 23.501, which requires confirmation of all
swaps, and with the then-proposed rules requiring reporting of swap
transactions to an SDR.\28\
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\28\ Swap Data Repositories: Registration Standards, Duties and
Core Principles, 76 FR 54538 (Oct. 31, 2011).
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FIA commented that SDs and MSPs are unlikely to submit a swap
directly to a DCO for clearing. Instead, they will first affirm the
swap by, for example, submitting the relevant details to an affirmation
platform and then submit the swap to their respective clearing members
for submission to a DCO.
FIA suggested that the Commission should require SDs and MSPs to
have a clearing arrangement in place with clearing members that, in
turn, have the capacity to route orders to a DCO in a manner acceptable
to it.
FIA also believes that the ``no later than close of business''
could not be satisfied by swaps that are entered into later in the day
and suggests the proposed rule be revised to provide the parties
greater flexibility to submit a swap for clearing within a reasonable
time as prescribed by the applicable DCO. Finally, to encourage the
voluntary use of clearing where such swaps are not required to be
cleared, FIA suggests that the proposed Sec. 23.506(b)(2) be revised
to permit the parties to submit such trades for clearing on any date to
which the parties and their respective clearing firms agree.
The Options Clearing Corporation (``OCC'') commented that the
phrase ``for purpose of risk management'' in proposed Sec. Sec.
23.506(a)(1) and 37.702(b)(1) creates ambiguity because a DCO may have
established routing requirements for reasons unrelated to risk
management such as increased efficiency or decreased administrative
costs. OCC believes that a party that submits transactions to a DCO for
clearing should be required to ensure that it has the ability to route
the transactions to the DCO in a manner that meets all of the DCO's
legitimate requirements, and not only those that are related to risk
management. OCC suggests that the Commission delete the phrase ``for
purpose of risk management'' and substitute the phrase ``for
clearing.''
SDMA supported the amendments to proposed Sec. 23.506, and
suggested that the Commission promulgate rules that ensure post-trade
and pre-trade integrity. According to SDMA, the buyer and seller must
know immediately whether their trade has been accepted for clearing.
Trade uncertainty, SDMA continued, caused by the time delay between the
time of trade execution and the time of trade acceptance into clearing,
undermines market integrity in the post-trade work process. SDMA also
stated that trade uncertainty also directly impedes liquidity,
efficiency, and market stability.
CME commented that the technology for SDs and MSPs to route swaps
to a DCO may be as simple as entering the necessary data in a web page.
It suggested that a more apt standard may be ``as soon as operationally
feasible.'' CME also believes that the proposed time frames for
submission of swaps are appropriate and operationally feasible, and it
is not aware of systemic obstacles to the coordination between DCOs,
MSPs, and SDs required under the proposed regulation.
FHLBanks commented that the time frames are appropriate provided
that the Commission establishes a cut-off time for determining the day
on which a swap is executed because it may not be ``technologically
practicable'' for a swap that is executed towards the end of a day to
be submitted for clearing that day. FHLBanks suggests the rule specify
that swaps executed after 4 p.m. New York time shall be deemed to be
executed on the following business day.
ISDA commented that submission by the close of business may not be
technologically practicable. In addition, ISDA suggested that trades
will need to go through an affirmation platform and clearing members
will need to screen trades for compliance with their own standards and
with DCO standards, and this may not occur before the end of the
business day. ISDA also expressed concern that mandatory, same day
submission may invite error because clearing members may focus on speed
over accuracy. ISDA suggested that the Commission impose an ``as soon
as reasonably and technologically practicable'' standard.
ISDA also commented that Sec. 23.506(b)(2) should not set forth a
time period for clearing. According to ISDA, limiting the flexibility
of parties voluntarily seeking to clear will only create disincentives
to such voluntarism, including confusion and potential legal
uncertainty. Thus, ISDA suggested that where parties voluntarily elect
to submit a swap for clearing, all aspects of that election should be
left to the parties to determine contractually.
Freddie Mac commented that swap dealers periodically enter
mismatched data and send swap confirmations that incorrectly reflect
the principal terms of transactions. As a result, Freddie Mac believes
that a standard for submitting clearing submissions that starts the
clock at execution would be confusing and impractical and it could be
detrimental to counterparties who are subject to undue pressure to
quickly assent to terms dictated by a market professional. Freddie Mac
also commented that establishing a close of business deadline for
submission of swaps for clearing would impair late day trading and
potentially reduce market integrity. Freddie Mac suggested that the
Commission modify proposed Sec. 23.506(b)(1) to provide that SDs and
MSPs are required to submit swaps that are not executed on a SEF or DCM
but that are subject to a clearing mandate as soon as commercially and
operationally practical for both parties but no later than 24 hours
after execution.
LCH commented that swaps not subject to mandatory clearing
obligations should not be subject to any timeline. LCH believes that a
DCO should be able to accept such trades whenever they are submitted,
provided that it has sufficient margin from both sides.
3. Discussion
Proposed Sec. 23.506(a) does not prescribe the manner by which SDs
or MSPs route their swaps to DCOs and provide for prompt and efficient
processing. It is possible that DCOs will enable SDs and MSPs to submit
their swaps to clearing via third-party platforms and other service
providers. DCOs will certainly specify the role of their clearing
members in the process.
[[Page 21283]]
The flexibility of the rule makes it consistent with the comments
of MFA, CME, ISDA, MarkitSERV, and FIA. The Commission concurs with
OCC's comment that a DCO may have requirements beyond risk management.
The issue raised by SDMA is addressed in the customer documentation
provisions.
As discussed above, any delay between the time of execution and the
time of clearing creates financial risk for the parties to the trade
and for their clearing FCMs. For trades that are not subject to a
clearing mandate, the parties are not bound by any submission deadlines
unless and until they voluntarily agree to have the trade cleared. Once
they make that decision, however, it will reduce risk for both the
parties, as well as their respective clearing members, to get the trade
submitted for clearing as soon as practicable. Therefore, in most cases
it seems likely that the parties will comply with the timing set forth
within the rule because it is in their own best interests to do so.
But, to leave ``all aspects'' to the parties, as ISDA suggested,
creates the possibility that one party could expose itself, its
counterparty, and its clearing member to unnecessary risk by delaying
submission.\29\ In light of all the comments, the Commission believes
that the timeframes for submission set forth in the proposed rules are
reasonable.
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\29\ See ISDA.
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The Commission is not defining ``business day'' in this rule, in
order to allow the entity accepting the trade for clearing, the DCO, to
establish its own definition. The Commission understands that a DCO may
choose to expand its business hours in order to offer a competitive
advantage, and that this rule should not prescribe when swaps may be
accepted for clearing. The Commission further believes that if a trade
is submitted for clearing near the end of a business day for a
particular DCO, but is ultimately not accepted or rejected before that
deadline, the DCO will determine whether the trade will be accepted or
rejected for clearing for the following day in accordance with Sec.
39.12.
The Commission is adopting Sec. 23.506(a)(1) with the amendment
suggested by OCC, changing ``for purposes of risk management'' to ``for
purposes of clearing.''
The Commission is adopting Sec. Sec. 23.506(a)(2) and 23.506(b) as
proposed.
B. Swap Execution Facility and Designated Contract Market Processing of
Trades
1. Introduction
For prompt and efficient clearing to occur, the rules, procedures,
and operational systems of the trading platform and the clearinghouse
must align. Vertically integrated trading and clearing systems
currently process high volumes of transactions quickly and efficiently.
The Commission believes that trading platforms and DCOs under separate
control should be able to coordinate with one another to achieve
similar results.
The Commission proposed Sec. Sec. 37.700 through 37.703 to
implement SEF Core Principle 7 (Financial Integrity of Transactions),
pursuant to its rulemaking authority under sections 5h(h) and 8a(5) of
the CEA.\30\ Core Principle 7 requires a SEF to ``establish and enforce
rules and procedures for ensuring the financial integrity of swaps
entered on or through the facilities of the swap execution facility,
including the clearing and settlement of the swaps pursuant to section
2(h)(1) [of the CEA].'' \31\ As originally proposed, Sec. 37.702(b)
would require a SEF to provide for the financial integrity of its
transactions cleared by a DCO by ensuring that the SEF has the capacity
to route transactions to the DCO in a manner acceptable to the DCO for
purposes of risk management.\32\ As part of the processing rulemaking,
the Commission proposed to renumber previous Sec. 37.702(b) as
paragraph (b)(1) and add a new paragraph (b)(2) to require the SEF to
additionally provide for the financial integrity of cleared
transactions by coordinating with each DCO to which it submits
transactions for clearing, in the development of rules and procedures
to facilitate prompt and efficient transaction processing in accordance
with the requirements of Sec. 39.12(b)(7) of the Commission's
regulations.\33\
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\30\ See Core Principles and Other Requirements for Swap
Execution Facilities, 76 FR 1214 (Jan. 7, 2011); 7 U.S.C. 7b-3(h);
and 7 U.S.C. 12a(5).
\31\ See section 5h(f)(7) of the CEA, 7 U.S.C. 7b-3(f)(7).
\32\ See 76 FR at 1248. Section 37.702(b), as originally
proposed, referred to ``ongoing'' risk management. In renumbering
and finalizing this provision herein, the Commission is deleting the
term ``ongoing'' because it is superfluous and could create
confusion when read in conjunction with other Commission regulations
that refer to ``risk management.'' See, e.g., proposed Sec. 39.13
relating to risk management for DCOs, 76 FR at 3720.
\33\ See 76 FR 13101 (Mar. 10, 2011) (setting forth time frames
for accepting or rejecting swaps for clearing).
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Similarly, the Commission previously proposed Sec. Sec. 38.600
through 38.607 to implement DCM Core Principle 11 (Financial Integrity
of Transactions) pursuant to its rulemaking authority under sections
5(d)(1) and 8a(5) of the CEA.\34\ Core Principle 11 requires a DCM to
``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.'' \35\
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\34\ See Core Principles and Other Requirements for Designated
Contract Markets, 75 FR 80572 (Dec. 22, 2010); 7 U.S.C. 7(d)(1); and
7 U.S.C. 12a(5).
\35\ See Section 5(d)(11) of the CEA, 7 U.S.C. 7(d)(11).
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As originally proposed, Sec. 38.601 would require that
transactions executed on or through a DCM, other than transactions in
security futures products, must be cleared through a registered DCO in
accordance with the provisions of part 39 of the Commission's
regulations.\36\ The Commission later proposed to renumber this
provision as paragraph (a) of proposed Sec. 38.601 and add a new
paragraph (b) to specifically require the DCM to coordinate with each
DCO to which it submits transactions for clearing, in the development
of DCO rules and procedures to facilitate prompt and efficient
transaction processing in accordance with the requirements of Sec.
39.12(b)(7) of the Commission's regulations.\37\
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\36\ See 75 FR at 80618.
\37\ See 76 FR 13101.
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2. Summary of Comments
FIA supported the rules and recommended that each SEF and DCM be
required to assure equal access to all DCOs that wish to clear trades
executed through the facilities of the SEF or DCM. According to FIA,
failure to grant such access would be inconsistent with section 2(h) of
the CEA as amended by the Dodd-Frank Act, which (1) provides for the
non-discriminatory clearing of swaps executed bilaterally or on an
unaffiliated SEF or DCM, and (2) provides that, with respect to a swap
that is entered into by a SD or MSP, the counterparty shall have the
sole right to select the DCO through which the swap is cleared.
LCH also concurred with both rules. It commented that it is of
paramount importance that: (1) A SEF or DCM seeking access to a DCO
must first be required to meet all regulatory requirements; (2) each
SEF and DCM
[[Page 21284]]
must code to each DCO's application programming interfaces; and (3)
each SEF and DCM must treat DCOs on a nondiscriminatory basis.
ISDA commented that coordination among the parties subject to the
Commission's new swap jurisdiction is critical to ensuring that the
rulemaking process is effective without disrupting the swap markets and
applauds this proposal. ISDA suggested that an existing standard
managed by ISDA and used between participating companies be adopted.
As noted above, OCC commented that the phrase ``for purpose of risk
management'' in proposed Sec. Sec. 23.506(a)(1) and 37.702(b)(1)
creates ambiguity because a DCO may have established routing
requirements for reasons unrelated to risk management such as increased
efficiency or decreased administrative costs. OCC believes that a party
that submits transactions to a DCO for clearing should be required to
ensure that it has the ability to route the transactions to the DCO in
a manner that meets all of the DCO's legitimate requirements, and not
only those that are related to risk management. OCC suggests that the
Commission delete the phrase ``for purpose of risk management'' and
substitute the phrase ``for clearing.''
3. Discussion
Rules, procedures, and operational systems, along the lines set
forth in the rules, currently work well for many exchange-traded
futures. Similar requirements could be applied across multiple
exchanges and clearinghouses for swaps. The parties would need to have
clearing arrangements in place with clearing members in advance of
execution. In cases where more than one DCO offered clearing services,
the parties also would need to specify in advance where the trade
should be sent for clearing.
The Commission concurs with OCC's comment that a DCO may have
requirements beyond risk management. To the extent that FIA, LCH, and
ISDA recommended that the Commission adopt additional requirements
beyond those set forth in the rule as proposed, the Commission believes
it is premature to adopt the additional requirements at the present
time. However, the Commission will monitor the implementation of this
rule and may propose amendments in the future.
The Commission is adopting Sec. 38.601 as proposed. The Commission
is adopting Sec. 37.702 with the amendment suggested by OCC changing
``for purposes of risk management'' to ``for purposes of clearing.''
C. Clearing Member and Clearing Organization Acceptance for Clearing
1. Introduction
As noted above, a goal of the Dodd-Frank Act is to reduce risk by
increasing the use of central clearing. Minimizing the time between
trade execution and acceptance into clearing is an important risk
mitigant.
This time lag potentially presents credit risk to the swap
counterparties, clearing members, and the DCO because the value of a
position may change significantly between the time of execution and the
time of novation, thereby allowing financial exposure to accumulate in
the absence of daily mark-to-market. Among the purposes of clearing are
the reduction of risk and the enhancement of financial certainty, and
this time lag diminishes the benefits of clearing swaps that Congress
sought to promote in the Dodd-Frank Act. A delay in clearing is also
inconsistent with other proposed regulations concerning product
eligibility and financial integrity of transactions insofar as the
delay reduces liquidity and increases risk.\38\
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\38\ See 76 FR 1214, Jan. 7, 2011.
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In this rulemaking, the Commission is seeking to expand access to,
and strengthen the financial integrity of, the swap markets subject to
Commission oversight by providing for prompt processing, submission,
and acceptance of swaps eligible for clearing by DCOs. This requires
setting an appropriate time frame for the processing and submission of
swaps for clearing, as well as a time frame for the clearing of swaps
by the DCO.
As originally proposed, Sec. 39.12(b)(7)(i) required DCOs to
coordinate with DCMs and SEFs to facilitate prompt and efficient
processing of trades. In response to a comment, the Commission later
proposed to require ``prompt, efficient, and accurate processing of
trades.'' \39\
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\39\ See letter from Robert Pickel, Executive Vice Chairman,
International Swaps and Derivatives Association, dated April 8,
2011.
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Recognizing the key role clearing members play in trade processing
and submission of trades to central clearing, the Commission also
proposed parallel provisions for coordination among DCOs and clearing
members. Proposed Sec. 39.12(b)(7)(i)(B) would require DCOs to
coordinate with clearing members to establish systems for prompt
processing of trades. Proposed Sec. Sec. 1.74(a) and 23.610(a) would
require reciprocal coordination with DCOs by FCMs, SDs, and MSPs that
are clearing members.
As originally proposed, Sec. 39.12(b)(7)(ii) required DCOs to
accept immediately upon execution all transactions executed on a DCM or
SEF.\40\ A number of DCOs and other commenters expressed concern that
this requirement could expose DCOs to unwarranted risk because DCOs
need to be able to screen trades for compliance with applicable
clearinghouse rules related to product and credit filters.\41\ The
Commission recognized that while immediate acceptance for clearing upon
execution currently occurs in some futures markets, it might not be
feasible for all cleared markets at this time. For example, where the
same cleared product is traded on multiple execution venues, a DCO
needs to be able to aggregate the risk of trades coming in to ensure
that a clearing member or customer has not exceeded its credit limits.
Accordingly, the Commission modified proposed Sec. 39.12(b)(7)(ii) to
permit DCOs to screen trades against applicable product and credit
criteria before accepting or rejecting them.\42\ Consistent with
principles of open access, the proposal would require that such
criteria be non-discriminatory with respect to trading venues and
clearing participants.
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\40\ See Requirements for Processing, Clearing, and Transfer of
Customer Positions, 76 FR 13101 (March 10, 2011).
\41\ See letter from Craig S. Donohue, Chief Executive Officer,
CME Group, dated April 11, 2011; letter from R. Trabue Bland, Vice
President and Assistant General Counsel, ICE, dated April, 11, 2011;
letter from Iona J. Levine, Group General Counsel and Managing
Director, LCH.Clearnet, dated April, 11, 2011; letter from William
H. Navin, Executive Vice President and General Counsel, Options
Clearing Corporation, dated April, 11, 2011; letter from John M.
Damgard, President, Futures Industry Association, dated April 14,
2011.
\42\ See 76 FR 45730, Aug. 1, 2011.
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Proposed Sec. 1.74(b) would set up a parallel requirement for
clearing FCMs; proposed Sec. 23.610(b) would set up a parallel
requirement for SDs and MSPs that are clearing members. These rules,
again, would apply a performance standard, not a prescribed method for
achieving it.
As originally proposed, Sec. Sec. 39.12(b)(7)(iii) and
39.12(b)(7)(iv) distinguished between swaps subject to mandatory
clearing and swaps not subject to mandatory clearing.\43\ Upon review
of the comments, the Commission concluded that this distinction was
unnecessary with regard to processing time frames. If a DCO lists a
product for clearing, it should be able to process it regardless of
whether clearing is mandatory or voluntary. Accordingly, the Commission
modified proposed Sec. 39.12(b)(7)(iii) to cover all trades not
executed on a DCM or SEF. It would require acceptance or rejection
[[Page 21285]]
by the DCO as quickly after submission as would be technologically
practicable if fully automated systems were used.
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\43\ See 76 FR 13101, Mar. 10, 2011.
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Proposed Sec. 1.74(b) would set up a parallel requirement for
clearing FCMs; proposed Sec. 23.610(b) would set up a parallel
requirement for SDs and MSPs that are clearing members. These rules,
again, would apply a performance standard, not a prescribed method for
achieving it.
The Commission also recognized that some trades on a DCM or SEF may
be executed non-competitively. Examples include block trades and
exchanges of futures for physicals (``EFPs''). A DCO may not be
notified immediately upon execution of these trades. Accordingly, the
proposal treated these trades in the same manner as trades that are not
executed on a DCM or SEF.
2. Summary of Comments
Eighteen \44\ commenters expressed support for the timing standard
as proposed by the Commission.
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\44\ AIMA, AllianceBernstein, Arbor, Barnard, CIEBA, Citadel,
DRW, Eris, FHLB, ICI, Javelin, Jeffries, MFA, SDMA, State Street,
Spring Trading, Trading Firms, and Vizier.
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CME recommended that the standard be revised to ``as quickly as
would be technologically practicable if fully automated systems and
filters were used or as quickly as possible if automated systems or
filters are not used.''
MGEX requested that the Commission codify the preamble text that
the new timing standard would require action in a matter of
``milliseconds or seconds or, at most, a few minutes, not hours or
days.'' MGEX also commented that proposed Sec. 39.12(b)(7) should be a
general acceptance and timing rule, not applicable for each specific
contract listed to be cleared. MGEX argued that the rule only should
apply to those swaps that a DCO has identified that it can and will
clear, as opposed to variations of contracts listed for clearing or any
contract not previously cleared by the DCO.
Morgan Stanley believes that the timing standard should be intended
to prohibit only those arrangements that prevent the use of automated
systems that are available in the market to facilitate clearing.
LCH suggested that the Commission modify proposed Sec. Sec.
39.12(7)(ii) and (iii) by adding the language ``and for which
sufficient margins have been received by the derivatives clearing
organization'' prior to accepting and confirming a trade for clearing.
NYPC requested clarification that in circumstances where a DCO
automatically receives matched trade data from a DCM or SEF on a
locked-in basis, no further systems development would be required in
order to satisfy the above-referenced requirements of proposed
regulations 1.74(a) and 39.12(b)(7)(i)(B).
Better Markets stated that the timing standard must be: (1)
Provided by the DCO or FCM; (2) capable of receiving and processing
trade data from multiple sources in real time; (3) able to screen
against standards such as price levels and block trade sizes as a
threshold matter; (4) able to decrease or increase available credit
real time; and (5) automatic push notification of acceptance or
rejection by the DCO or FCM. Better Markets also commented that systems
provided by a DCO or FCM must be open and require no special
capabilities on the part of the trade execution venue, and that once
data is input, the systems must function on a first-come-first-served
basis using a reliable and common time stamping regime, regardless of
affiliation or contractual relationship between the trading venue and
DCO or FCM. Better Markets noted that confirmation of acceptance or
rejection must not differ between trading venues based on affiliation
or relationship.
SG suggested that the Commission establish one or both of the
following: (1) Credit limits of customers and FCMs are stored at the
DCO and provided to SEFs in real time upon electronic demand; or (2) an
industry-wide utility that stores customer and FCM limits and provides
them to DCOs and SEFs in real time upon electronic demand.
3. Discussion
The Commission continues to believe that acceptance or rejection
for clearing in close to real time is crucial both for effective risk
management and for the efficient operation of trading venues.\45\
Rather than prescribe a specific length of time, the Commission is
implementing a standard that action be taken ``as quickly as would be
technologically practicable if fully automated systems were used.''
This standard would require action in a matter of milliseconds or
seconds or, at most, a few minutes, not hours or days. The Commission
recognizes that processing times may vary by product or market.
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\45\ See letter from James Cawley, Swaps and Derivatives Market
Association, dated April 19, 2011.
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This requirement is intended to be a performance standard, not the
prescription of a particular method of trade processing. The Commission
expects that fully automated systems will be in place at some DCOs,
FCMs, SDs, and MSPs. Others might have systems with some manual steps.
The use of manual steps would be permitted so long as the process could
operate within the same time frame as the automated systems.
As discussed by numerous commenters, the proposed standard
approximates real-time acceptance while providing flexibility to
accommodate different systems and procedures. Avoiding a large gap
between trade execution and acceptance for clearing is crucial to risk
management for DCOs, FCMs, and market participants.
The Commission notes that the time frame for acceptance by clearing
members and DCOs set forth in this section is stricter than the time
frames for submission by SDs and MSPs set forth in Section III.A.,
above. Where execution is bilateral and clearing is voluntary, the
delay between execution and submission to clearing is, of necessity,
within the discretion of the parties to some degree. The Commission
believes, however, that prudent risk management dictates that once a
trade has been submitted to a clearing member or a DCO, the clearing
member or DCO must accept or reject it as quickly as possible.
Assuring prompt acceptance or rejection for clearing also
undermines much of the stated rationale for the provisions in the
trilateral agreements. In those unusual circumstances in which trades
are rejected, the parties will know almost immediately and be able to
take appropriate steps to mitigate risk.
The Commission disagrees with CME's suggested standard of ``as
quickly as possible.'' The Commission believes that this standard would
introduce too much potential for delay. It could increase the very
risks that this final rulemaking is designed to reduce or eliminate.
In support of the final standard, the Commission notes that on
December 13, 2011, $4.1 billion of trades were executed on a trading
platform and cleared by a DCO within the time frame contemplated by the
proposed rules. Specifically, 21 interest rate swaps were executed and
cleared with an average time of 1.9 seconds and a quickest time of 1.3
seconds.\46\
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\46\ Katy Burne, UPDATE: Javelin, CME Claim Record Time To Clear
Rate Swaps, Dow Jones Newswires, Nasdaq (Dec. 14, 2011; accessed
Jan. 3, 2012) http://www.nasdaq.com/aspx/stock-market-news-story.aspx?storyid=201112141726dowjonesdjonline000739&title=updatejavelincme-claim-record-time-to-clear-rate-swaps.
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[[Page 21286]]
The Commission also disagrees with the MGEX suggestion that the
timing standard should be codified as ``milliseconds, seconds, or
minutes,'' because this would provide a window for trade acceptance
that might be too wide as faster systems become available. The
Commission believes that its proposed standard will allow for
innovation to bring faster trade acceptance or rejection to the market
most efficiently.
The Commission also disagrees with LCH's proposed addition of the
language ``and for which sufficient margins have been received by the
derivatives clearing organization'' prior to accepting and confirming a
trade for clearing. This standard may not be practicable for DCOs that
are linked to high-volume automated trading systems. Currently, many
DCOs in such circumstances calculate margin at the end of the day for
collection the next day. Nothing in the final rules, however, precludes
a DCO in its discretion from applying such a standard.
The Commission confirms NYPC's belief that in circumstances where a
DCO automatically receives matched trade data from a DCM or SEF on a
locked-in basis, no further systems development would be required.
The Commission believes that the comments of Better Markets and SG
are consistent with the intent of the rules but provide a level of
detail that the Commission believes is unnecessary at the present time,
and in some respects goes beyond what the Commission proposed. For
example, Better Markets recommended that DCOs and FCMs be able to
increase available credit in real-time and to have automatic push
notification of acceptance or rejection from clearing. The first could
conflict with risk management procedures that some DCOs or FCMs might
wish to use. The second is likely to be in place at many firms, but the
Commission continues to believe that it is appropriate to have a rule
that sets a performance standard rather than specifying a particular
means of achieving it. Fully automated systems would of course comply
with the performance standard. Accordingly, the Commission has decided
not to change the rule in the manner suggested by Better Markets and
SG. The Commission, however, will monitor the implementation of this
rule and may propose amendments in the future.
The Commission received numerous comments in the customer clearing
documentation rulemaking emphasizing that it is imperative for
effective risk management to have the shortest possible gap between
execution and clearing. To permit additional time as suggested by some
of the commenters on this rule would increase risk for DCOs, clearing
members, and market participants.
However, in light of commenters' concerns, the Commission is
adopting Sec. Sec. 1.75 and 23.611, which delegate to the Director of
the Division of Clearing and Risk the authority to establish an
alternative compliance schedule for requirements of Sec. Sec. 1.74 and
23.610 for swaps that are found to be technologically or economically
impracticable for an FCM, SD, or MSP affected by Sec. Sec. 1.74 or
23.610. The purpose of Sec. Sec. 1.75 and 23.611 is to facilitate the
ability of the Commission to provide a technologically practicable
compliance schedule for affected FCMs, SDs, or MSPs that seek to comply
in good faith with the requirements of Sec. Sec. 1.74 or 23.610.
In order to obtain an exception under Sec. Sec. 1.75 or 23.611, an
affected FCM, SD, or MSP must submit a request to the Director of the
Division of Clearing and Risk. FCMs, SDs, and MSPs submitting requests
must specify the basis in fact supporting their claims that compliance
with Sec. Sec. 1.74 or 23.610 would be technologically or economically
impracticable. Such a request may include a recitation of the specific
costs and technical obstacles particular to the entity seeking an
exception and the efforts the entity intends to make in order to ensure
compliance according to an alternative compliance schedule. An
exception granted under Sec. Sec. 1.75 or 23.611 shall not cause a
registrant to be out of compliance or deemed in violation of any
registration requirements.
Such requests for an alternative compliance schedule shall be acted
upon by the Director of the Division of Clearing and Risk or designees
thereto within 30 days from the time such a request is received. If not
acted upon within the 30 day period, such request will be deemed
approved.
The Commission is adopting Sec. Sec. 1.74, 23.610, and 39.12(b)(7)
as proposed.
D. Post-Trade Allocation of Bunched Orders
1. Introduction
Bunched orders are orders entered by an account manager on behalf
of multiple customers, which are executed as a block and later
allocated among participating customer accounts for clearing. Believing
that procedures used in the futures markets could be adapted for use in
the swaps markets, the Commission proposed Sec. 1.35(a-1)(5)(iv).\47\
It provided that allocations must be made as soon as practicable after
execution but in any event no later than the following times: (1) For
cleared transactions, sufficiently before the end of the day to ensure
that clearing records identify the customer accounts, and (2) for
uncleared trades, no later than the end of the day the swap was
executed.
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\47\ See 76 FR 33066 (Jun. 7, 2011).
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2. Summary of Comments
In comments filed in connection with proposed Sec. Sec. 1.74,
23.610, and 39.12(b)(7), BlackRock and State Street stated that the
Commission should clarify the rules to specifically allow for post-
trade allocation of block trades. BlackRock also commented that the
final rule should provide that at the time of trade execution,
confirmation of trade economics may be done at the block level, and a
two-hour delay be allowed before the trade must be submitted to a DCO
for clearing.
In comments also filed in connection with proposed Sec. Sec. 1.74,
23.610, and 39.12(b)(7), MFA and D. E. Shaw stated that it is not
necessary to delay trades for post-execution allocation of trades to
multiple funds. D. E. Shaw asserted that post-execution allocation is a
``red herring'' and should not prevent the Commission from mandating
real-time clearing in the proposal.
In a comment filed in connection with the proposed amendment to
Sec. 1.35, CME asserted that bunched orders in swaps should not be
subject to the same type of regulatory regime as bunched orders in
futures contracts because the ``futures model'' for treatment of
bunched orders is not a suitable model for block trades of swaps. After
a bunched trade in the futures market is accepted for clearing, an FCM
generally holds the positions in a suspense account while awaiting
allocation instructions from the asset manager. In contrast, the CME
believes that an FCM holding bunched orders for swaps in a suspense
account, while waiting for allocation instructions, may be exposed to
substantially greater risk considering larger transaction sizes and the
different risk profile of cleared swaps as compared to futures. CME
stated that a time frame of two hours should allow sufficient time for
asset managers to allocate block trades in swaps to their individual
customers' accounts.
In contrast, in comments also filed in connection with proposed
Sec. 1.35, SDMA stated that there should be no delay for bunched
orders that are allocated after execution. According to SDMA, the
process for swaps trade allocation
[[Page 21287]]
should be similar to that of the futures markets.
The Commission received no substantive comments regarding
allocation of uncleared trades.
3. Discussion
For many years in the futures markets, bunched orders have been
executed as a block for immediate acceptance into clearing and
allocated into individual accounts later in the day. Essentially, a
``stand-by'' clearing member guarantees the trades until they can be
allocated. Consequently, there is no need for a two-hour delay.
The proposed amendments would apply the same process to swaps. By
allowing post-trade allocation of bunched orders, the rule is
responsive to all the comments. By not permitting a two-hour delay the
rule is also responsive to the comments of State Street, MFA, D. E.
Shaw, and SDMA, but is contrary to the comments of CME and BlackRock.
The Commission does not find persuasive the arguments that cleared
swaps should be subject to a standard that differs in this regard from
the standard for cleared futures. The Commission believes that a two-
hour delay would create risk rather than mitigate it. First, the
counterparty or counterparties to the trade would incur a delay in
acceptance of their side into clearing because of the happenstance of
being opposite a bunched order. This result is untenable in fast-moving
markets. Second, the customers whose orders were being bunched would
also suffer the same delay thereby incurring the same risks.
The futures model has worked well for many years. In most
instances, the orders are successfully allocated and the stand-by FCM
ultimately is not required to clear any trades. In those cases where
there is a misallocation, it is corrected the next day and the stand-by
FCM is compensated by the account manager. All parties receive the
benefits of immediate acceptance into clearing. CME and BlackRock have
not demonstrated why these procedures would not work for swaps.
The Commission believes that a similar analysis applies to
uncleared swaps. Certainty of allocation by the end of the calendar day
that a swap is executed will reduce risk for both counterparties. The
Commission received no comments indicating otherwise.
The Commission is adopting Sec. 1.35(a-1)(5)(iv) as proposed.
IV. Clearing Member Risk Management
A. Introduction
CEA Section 3(b) provides that one of the purposes of the Act is to
ensure the financial integrity of all transactions subject to the Act
and to avoid systemic risk. CEA section 8a(5) authorizes the Commission
to promulgate such regulations that it believes are reasonably
necessary to effectuate any of the provisions or to accomplish any of
the purposes of the Act. Risk management systems are critical to the
avoidance of systemic risk, as evidenced by the statutory provisions
cited below.
CEA section 4s(j)(2) requires each SD and MSP to have risk
management systems adequate for managing its business. CEA section
4s(j)(4) requires each SD and MSP to have internal systems and
procedures to perform any of the functions set forth in Section 4s.
CEA section 4d requires FCMs to register with the Commission. It
further requires FCMs to segregate customer funds. CEA section 4f
requires FCMs to maintain certain levels of capital. CEA section 4g
establishes reporting and recordkeeping requirements for FCMs.
These provisions of law--and Commission regulations promulgated
pursuant to these provisions--create a web of requirements designed to
secure the financial integrity of the markets and the clearing system,
to avoid systemic risk, and to protect customer funds. Effective risk
management by SDs, MSPs, and FCMs is essential to achieving these
goals. For example, a poorly managed position in the customer account
may cause an FCM to become undersegregated. A poorly managed position
in the proprietary account may cause an FCM to fall out of compliance
with capital requirements.
Even more significantly, a failure of risk management can cause an
FCM to become insolvent and default to a DCO. This can disrupt the
markets and the clearing system and harm customers. Such failures have
been predominately attributable to failures in risk management.
Proposed Sec. 1.73 set forth risk management requirements that
would apply to clearing members that are FCMs; proposed Sec. 23.609
would apply to clearing members that are SDs or MSPs. These provisions
would require these clearing members to have procedures to limit the
financial risks they incur as a result of clearing trades and liquid
resources to meet the obligations that arise. The proposal required
each clearing member to:
(1) Establish credit and market risk-based limits based on position
size, order size, margin requirements, or similar factors;
(2) Use automated means to screen orders for compliance with the
risk-based limits;
(3) Monitor for adherence to the risk-based limits intra-day and
overnight;
(4) Conduct stress tests of all positions in the proprietary
account and all positions in any customer account that could pose
material risk to the futures commission merchant at least once per
week;
(5) Evaluate its ability to meet initial margin requirements at
least once per week;
(6) Evaluate its ability to meet variation margin requirements in
cash at least once per week;
(7) Evaluate its ability to liquidate the positions it clears in an
orderly manner, and estimate the cost of the liquidation at least once
per month; and
(8) Test all lines of credit at least once per quarter.
Each of these items has been observed by Commission staff as an
element of an existing sound risk management program at a DCO or an
FCM.
B. Components of the Rule
The Commission received a total of 15 comment letters directed
specifically at the proposed risk management rules.\48\ A discussion of
the comments received in response to each component of the rule
follows.
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\48\ Barnard; Futures Industry Association (``FIA''); SDMA;
Better Markets; ICE; CME; Freddie Mac; ISDA; MGEX; MFA; Citadel;
FHLB; Jeffries; Arbor; and Javelin.
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1. Establish Credit and Market Limits and Automated Screening of Orders
a. Summary of Comments
FIA stated that it does not believe that ``pre-execution''
screening of orders is feasible in all market situations. For instance,
the FIA noted four situations wherein ``pre-execution screening'' is
not possible given current technology. Specifically, FIA does not
believe that ``pre-execution'' screening is possible in the case of
floor execution, trading advisors using ``bunched'' orders, give-up
agreements, and traders using multiple trading platforms.
The CME also commented that automated screening is not feasible in
a floor trading environment. The CME suggested that the Commission
adopt the following language: ``automated or otherwise appropriate
means to screen orders for compliance with risk-base-limits.''
ISDA made comments consistent with CME and recommended a more
flexible approach. ISDA noted that the
[[Page 21288]]
regulation may not take into account the manner in which swaps are
executed.
b. Discussion
As noted previously, the Dodd-Frank Act requires the increased use
of central clearing. In particular, Section 2(h) establishes procedures
for the mandatory clearing of certain swaps. Central clearing will
provide more stability to the markets, and increase transparency for
market participants.\49\ As stated in the Committee report of the
Senate Committee on Banking, Housing, and Urban Affairs: ``Increasing
the use of central clearinghouses * * * will provide safeguards for
American taxpayers and the financial system as a whole.'' \50\
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\49\ The Dodd-Frank Wall Street Reform and Consumer Protection
Act: Title VII, Derivatives, Mark Jickling & Kathleen Ann Ruane, 5
(Aug. 30, 2010).
\50\ S. Rep. No. 111-176, at 32 (2010) (report of the Senate
Committee on Banking, Housing, and Urban Affairs).
---------------------------------------------------------------------------
The Commission has finalized extensive risk management standards at
the DCO level. Given the increased importance of clearing and the
expected entrance of new products and new participants into the
clearing system, the Commission believes that enhancing the safeguards
at the clearing member level is necessary as well.
Bringing swaps into clearing will increase the magnitude of the
risks faced by clearing members. In many cases, it will change the
nature of those risks as well. Many types of swaps have their own
unique set of risk characteristics. The Commission believes that the
increased concentration of risk in the clearing system combined with
the changing configuration of the risk warrant additional vigilance not
only by DCOs but by clearing members as well.
FCMs generally have extensive experience managing the risk of
futures. They generally have less experience managing the risks of
swaps. The Commission believes that it is a reasonable precaution to
require that certain safeguards be in place. It would ensure that FCMs,
who clear on behalf of customers, are subject to standards at least as
stringent as those applicable to SDs and MSPs, who clear only for
themselves. Failure to require SDs, MSPs, and FCMs that are clearing
members to maintain such safeguards would frustrate the regulatory
regime established in the CEA, as amended by the Dodd-Frank Act.
Accordingly, the Commission believes that applying the risk-management
requirements in the proposed rules to SDs, MSPs, and FCMs that are
clearing members are reasonably necessary to effectuate the provisions,
and to accomplish the purposes, of the CEA.
The Commission does not intend to prescribe the particular means of
fulfilling these obligations. As is the case with DCOs, clearing
members will have flexibility in developing procedures that meet their
needs. For example, items (1) and (2) could be addressed through simple
numerical limits on order or position size, or through more complex
margin-based limits. Further examples could include price limits that
would reject orders that are too far away from the market, or limits on
the number of orders that could be placed in a short time.
These proposals are consistent with international standards. In
August 2010, the International Organization of Securities Commissions
issued a report entitled ``Direct Electronic Access to Markets.'' \51\
The report set out a number of principles to guide markets, regulators,
and intermediaries. Principle 6 states that:
\51\ The report can be found at www.iosco.org.
A market should not permit DEA [direct electronic access] unless
there are in place effective systems and controls reasonably
designed to enable the management of risk with regard to fair and
orderly trading including, in particular, automated pre-trade
controls that enable intermediaries to implement appropriate trading
---------------------------------------------------------------------------
limits.
Principle 7 states that:
Intermediaries (including, as appropriate, clearing firms)
should use controls, including automated pre-trade controls, which
can limit or prevent a DEA Customer from placing an order that
exceeds a relevant intermediary's existing position or credit
limits.
Over the years, ``rogue'' traders have caused substantial financial
damage to both small and large firms. The size or sophistication of the
firm has not provided comprehensive protection. Traders have found ways
to exploit gaps in internal controls. Automated screening procedures,
such as Globex Credit Controls, are already in place in many markets
and have proven to be effective tools for reducing risk. Therefore, the
Commission believes that as proposed, the rule should require clearing
members to use automated means for screening orders executed on
automated trading systems.
In response to the comments, the Commission has determined that,
for non-automated markets such as open outcry exchanges or voice
brokers, the rules would permit other forms of internal controls. For
example, a clearing member cannot use an automated system to screen the
orders of a floor trader. Proprietary or customer orders executed by
open outcry or voice broker can be screened automatically if they are
routed automatically. Many orders, however, continue to be placed by
telephone. It is not practicable at this time to use automated means to
screen such orders. A clearing member, however, can actively monitor a
trader's activities and be in communication if the trader approaches a
limit. To incorporate this approach, the Commission is revising
Sec. Sec. 1.73(a)(2)(ii), 1.73(a)(2)(iii), and 23.609(a)(2)(ii) using
language suggested by ISDA. Specifically, as amended, these rules
provide that clearing members must ``establish and maintain systems of
risk controls reasonably designed to ensure compliance.''
The Commission believes that, as amended, the rules will be
responsive to the comments of FIA, CME, and ISDA. They will continue to
emphasize the key role that order screening can play in managing risk
while making accommodation for certain circumstances where automated
screening may not be possible or practicable at this time.
In response to the comments, the Commission has also determined to
make changes with regard to give-ups and bunched orders. Give-ups are
trades where the execution function and the clearing function are
performed by different firms. Revised paragraph (2)(iv) requires the
clearing firm, which bears the financial risk of the trade, to set
limits and communicate them to the executing firm, which would apply
them. This arrangement is consistent with current practice. The uniform
give-up contract contains a provision allowing a clearing firm to
establish limits on the trades it will accept from the executing firm.
To the extent the executing firm is an SD or MSP, and the clearing
firm is an affiliated FCM, the firms will also have to comply with the
conflict of interest rules for SD/MSPs and the conflict of interest
rules for FCMs.\52\ Those rules address appropriate partitions between
the trading units of an SD/MSP and the clearing units of an affiliated
FCM. For example, recently-promulgated Sec. 23.605(d)(1)(iv) prohibits
an SD/MSP
[[Page 21289]]
from interfering with the setting of risk tolerance levels by an
affiliated FCM.
---------------------------------------------------------------------------
\52\ See ``Swap Dealer and Major Swap Participant Recordkeeping
and Reporting, Duties, and Conflicts of Interest Policies and
Procedures; Futures Commission Merchant and Introducing Broker
Conflicts of Interest Policies and Procedures; Swap Dealer, Major
Swap Participant, and Futures Commission Merchant Chief Compliance
Officer,'' available at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312b.
---------------------------------------------------------------------------
As noted above, for bunched orders, typically one firm acts as a
``stand-by'' clearing firm for purposes of getting the trade executed,
but before the end of the day, the block is broken up and assigned
among multiple clearing members, each of whom is acting on behalf of a
particular customer.
Revised paragraph (2)(v)(A) requires the stand-by clearing firm to
establish limits for the block account and screen the order. Revised
paragraph (2)(v)(B) requires each ultimate clearing firm to establish
limits for each of its customers and enter an agreement with the
account manager under which the account manager would screen orders for
compliance. Revised paragraph (2)(v)(C) requires each ultimate clearing
firm to establish controls to enforce its limits. The revisions adjust
the rule to take into account the more complex procedures entailed in
processing bunched orders. They narrow the scope of the screening
required by various clearing participants from what was originally
proposed.
To the extent the account manager or one of the customers is an SD/
MSP and one of the clearing firms is an affiliated FCM, the firms also
will have to comply with the conflict of interest rules for SD/MSPs and
the conflict of interest rules for FCMs. As noted above, those rules
address appropriate partitions between the trading units of an SD/MSP
and the clearing units of an affiliated FCM.
2. Stress Tests
a. Summary of Comments
Chris Barnard and Better Markets both recommended that the
Commission require specific stress tests. Barnard recommended that the
Commission adopt a minimum standard and Better Markets recommended an
``extreme but plausible'' standard for stress tests. In addition,
Better Markets believes that stress test results should be reported to
the Commission and the relevant DCO. FHLB recommended that stress test
results be publicly disclosed. FHLB believes that public disclosure of
stress test results would allow customers to mitigate risk.
b. Discussion
Stress tests are an essential risk management tool. The purpose in
conducting stress tests is to determine the potential for significant
losses in the event of extreme market events and the ability of traders
and clearing members to absorb the losses.
The Commission intentionally refrained from setting specific stress
tests levels or a minimum threshold. The Commission believes that
clearing members are in the best position to design stress tests based
on their knowledge of markets and the types of customers they carry. In
addition, the Commission believes that specifying certain stress tests
might stifle innovation or cause firms to use minimum levels to meet
regulatory compliance rather than implementing a vigorous risk
management program. This approach is consistent with the approach
recently adopted by the Commission for DCO stress tests. The Commission
intends to monitor the implementation of this rule to determine whether
clearing members are routinely conducting stress tests reasonably
designed for the types of risk the clearing members and their customers
face.
The Commission believes that the concept of ``extreme but
plausible'' conditions is commonly used and was implicit in the
proposal. The Commission is adding the phrase to the rule text for
clarity.
The Commission believes that public disclosure of stress test
results could be a disincentive to aggressive stress testing. Moreover,
disclosure of results could have the effect of improper disclosure of
confidential position information.
The Commission is adopting the provisions as proposed, with
amendments to Sec. Sec. 1.73(a)(4) and 23.609(a)(4) to incorporate the
phrase ``extreme but plausible market conditions.''
3. Margin Evaluation
a. Summary of Comments
ISDA and FIA believe that the requirement to evaluate initial
margin once per week is unclear. ISDA pointed out that a clearing
member generally knows the amount of initial margin and collects it
promptly.
The Commission received no comments regarding Sec. Sec. 1.73(a)(6)
and 23.609(a)(6) regarding variation margin.
b. Discussion
The purpose of this provision is to require clearing firms to
evaluate their ability to deal with certain contingencies on a routine
basis. For example, a DCO might raise margin requirements, or option
positions might be exercised, or a customer might default on a margin
call. The clearing firm should make sure that it has resources
available to meet its continuing obligations under such circumstances.
The Commission is adopting Sec. Sec. 1.73(a)(5), 1.73(a)(6),
23.609(a)(5), and 23.609(a)(6) as proposed.
4. Estimated Cost of Liquidation
a. Summary of Comments
FIA commented that ``even in normal markets, estimating the costs
of liquidating such positions in an orderly manner will be difficult at
best. In times of market stress, such estimates will be impossible.''
b. Discussion
The Commission recognizes that estimating the cost of liquidation
is at times difficult. But the inevitable imprecision of any estimate
does not justify abandoning efforts to quantify potential losses.
The purpose of the calculation is to alert the clearing firm to
potential risks that might otherwise go undetected. This exercise could
lead a clearing firm to decide: (1) To arrange for additional financing
to cover a potential loss; or (2) to reduce the positions prior to a
period of market stress. Commission staff perform stress tests of FCM
positions and have alerted FCMs about potential losses. Based on
Commission staff's experience in this area, the Commission believes
that this is a topic that has not been fully addressed by some clearing
members in recent years.
In response to commenters, the Commission has decided to modify
Sec. 1.73(a)(7) to require estimation of liquidation costs once per
quarter, rather than once per month.
Additionally, the Commission is re-numbering Sec. 23.609(a)(7) to
Sec. 23.609(a)(8), and renumbering Sec. 23.609(a)(8) to Sec.
23.609(a)(7), in order to follow the parallel structure in Sec. 1.73.
The Commission is adopting Sec. Sec. 1.73(a)(8) and 23.609(a)(7)
with the modifications discussed above.
5. Testing Lines of Credit
a. Summary of Comments
The CME commented that the requirement to test lines of credit
should only be done on an annual basis rather than a quarterly basis.
The CME believes that quarterly testing is not cost efficient. ISDA
sought clarification on whether the test requires an actual drawing of
funds or an assessment of conditions precedent to drawing.
b. Discussion
The Commission accepts that quarterly testing might not be cost
efficient under all circumstances. Nonetheless, the Commission
encourages clearing members to test lines of credit more frequently
based on
[[Page 21290]]
market and credit events. For instance, if a line of credit is in place
with a bank that has recently suffered a credit rating downgrade, a
test may be appropriate.
The Commission believes that the actual drawing of funds is
essential to testing a line of credit. Among other things, the test
should ensure the ability of the bank or other institution to move the
funds in a timely fashion and that the clearing member can assess its
ability to approve the drawing and properly make accounting entries.
This approach is consistent with the approach the Commission recently
adopted for DCOs.
The Commission is adopting Sec. Sec. 1.73(a)(8) and 23.609(a)(7)
as proposed, but with an amendment to provide for annual--rather than
quarterly--testing of lines of credit.
6. Vagueness, Conflict, and/or Overlap Among Regulations
a. Summary of Comments
FIA expressed concern that paragraphs (a)(1) and (a)(4) through (6)
of Sec. 1.73 are too vague. FIA also expressed concern that the limits
required by Sec. 1.73 ``may conflict with the provisions of proposed
Rule 1.72(c), which provides that an FCM may set only `an overall limit
for all positions held by the customer' at the FCM. Further, such
limits may indirectly `limit' the number of counterparties with whom a
customer may enter into a trade, in apparent violation of proposed Rule
1.72(b).'' Regulation 1.72 was proposed in the customer clearing
documentation rules \53\ and is discussed in Part II, above.
---------------------------------------------------------------------------
\53\ See 76 FR 45730, Aug. 1, 2011.
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ISDA commented that the then-proposed Sec. 23.600 imposes a risk
management program for SDs and MSPs that must include ``policies and
procedures to monitor and manage, market, credit, liquidity, foreign
currency, legal, operational, and settlement risk, as well as controls
on business trading.'' ISDA believes that the broad requirements of
Sec. 23.600 that pertain to liquidity and funding make proposed Sec.
23.609(a)(5)-(8) redundant. The Commission recently promulgated Sec.
23.600 as a final rule.\54\
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\54\ ``Swap Dealer and Major Swap Participant Recordkeeping and
Reporting, Duties, and Conflicts of Interest Policies and
Procedures; Futures Commission Merchant and Introducing Broker
Conflicts of Interest Policies and Procedures; Swap Dealer, Major
Swap Participant, and Futures Commission Merchant Chief Compliance
Officer,'' available at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312b.
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b. Discussion
The Commission does not believe that Sec. 1.73 is too vague.
Paragraph (a)(1) addresses risk-based limits, paragraph (a)(4)
addresses stress tests, and paragraphs (a)(5) and (6) address margin.
While FIA asserts that these requirements are vague, it provides no
additional detail on the issue.
The regulation was intentionally drafted in a non-prescriptive
manner. Risk management is a complex process that requires firms to
make judgment calls on a daily basis. Moreover, each firm has a
different customer base, different resources, and a different risk
appetite. The Commission envisions that each clearing member will
comply with Sec. 1.73 using procedures and technology appropriate to
its business model and customer base. As drafted, these provisions
allow flexibility and innovation in complying with the regulation.
The Commission does not believe that Sec. Sec. 1.73 and 1.72
conflict. As proposed, Sec. 1.72(b) would prohibit limits as to the
number of counterparties, whereas Sec. 1.73 would require limits set
according to criteria such as position size or margin amount. FIA
asserts that the regulations could conflict because Sec. 1.73 may
``indirectly'' limit the number of counterparties. A position limit, of
course, can have the effect of limiting the number of counterparties in
the sense that if a trader can only execute 100 lots, the trader cannot
have more than 100 counterparties. But such an indirect result is
distinguishable from the conduct prohibited by Sec. 1.72(b)--the
deliberate setting of limits on the number of counterparties. The first
is a legitimate risk management tool; the second is an unnecessary
impediment to the free and open trading that would promote liquidity.
Section 1.72(c) would prohibit only limits on the size of positions
with specific counterparties. It does not prohibit limits tied to
executing firms. Moreover, it specifically provides that overall
position limits are permissible. Thus, there is no conflict between
Sec. 1.72(c) and Sec. 1.73.
The Commission also does not believe that the broad requirements of
the recently-promulgated Sec. 23.600 make proposed Sec. 1.73
redundant. Section 23.600 sets out broad principles applicable to all
SDs and MSPs. As proposed, Sec. 23.609 would apply only to those SDs
and MSPs that are clearing members of a DCO. The Commission believes
that if an SD or MSP takes on the additional risks and responsibilities
of clearing, it should undertake risk management procedures similar to
those undertaken by clearing FCMs for their proprietary accounts.
Clearing members pose risks to DCOs and users of DCOs that are not
posed by SDs and MSPs that are not clearing members.
V. Effective Dates
A. Summary of Comments
Arbor, Citadel, and Eris urged the Commission to prioritize the
entire rule in the final rulemaking process.
The Banks, DB, EEI, and ISDA commented that the Commission should
not rush this proposal.
Wells Fargo commented that the Commission should delay compliance
until most industry systems meet the real-time acceptance standard. LCH
requested that the Commission delay compliance for 9 months, if the
rules are adopted as proposed. AllianceBernstein commented that the
Commission's recently proposed phased implementation provides ample
time for the market to make final preparations, and no ``interim''
execution documentation arrangements are necessary. Morgan Stanley
stated that real-time clearing and risk limit compliance verification
cannot be developed quickly enough to abandon trilateral agreements.
B. Discussion
This rulemaking includes rules applicable to FCMs, SDs, MSPs, DCMs,
SEFs, and DCOs. In addressing implementation, it is important to
distinguish between FCMs, DCMs, and DCOs, on the one hand, and SDs,
MSPs, and SEFs, on the other.
FCMs, DCMs, and DCOs are currently involved in clearing swaps.
Entity definitions are not necessary for them. Product definitions are
not necessary for the implementation of the rules applicable to them.
The products currently being cleared as swaps by DCOs are commonly
characterized as such by market participants. To delay implementation
of these rules pending implementation of the further product definition
rules would be to deny market participants pricing, operational, and
risk-management benefits unnecessarily.
No firms are currently registered as SDs, MSPs, or SEFs. Therefore,
the rules applicable to these entities will have no practical effect
until other rulemakings are completed, such as the further entity
definition rulemaking. Nevertheless, many entities currently expect to
operate as SDs, MSPs, or SEFs, regardless of the precise contours of
the entity definitions. It would be more efficient for such entities,
particularly those that are currently active in the
[[Page 21291]]
markets, to develop their systems and procedures in anticipation of
being subject to these rules as soon as they become applicable. Indeed,
failing to take such measures would disadvantage those that did not
prepare for the imminent regulatory framework. This approach would also
avoid temporary gaps or discrepancies in the system of rules addressing
client clearing documentation, trade processing, and clearing member
risk management resulting from differing implementation schedules for
various entities.
As discussed above, the Commission believes that implementation of
these rules is essential to effective clearing of swaps. The Commission
has determined that for FCMs, DCMs, and DCOs, these rules shall become
effective October 1, 2012. For SDs and MSPs, these rules shall become
effective on the later of October 1, 2012, or the date that the
registration rules become effective.\55\ For SEFs, these rules shall
become effective on the later of October 1, 2012, or the date that the
rules implementing the core principles for SEFs become effective.\56\
The Commission believes that this approach strikes an appropriate
balance between those commenters who urged implementation as quickly as
possible and those who urged delayed implementation.
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\55\ Registration of Swap Dealers and Major Swap Participants,
77 FR 2613 (Jan. 19, 2012).
\56\ Core Principles and Other Requirements for Swap Execution
Facilities, 76 FR 1214 (Jan. 7, 2011).
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VI. Consideration of Costs and Benefits
Introduction
CEA Section 15(a) requires the CFTC to consider the costs and
benefits of its action before promulgating a regulation under the CEA,
specifying that the costs and benefits shall be evaluated in light of
five broad areas of market and public concern: (1) Protection of market
participants and the public; (2) efficiency, competitiveness and
financial integrity of futures markets; (3) price discovery; (4) sound
risk management practices; and (5) other public interest
considerations.\57\ To the extent that these final regulations repeat
the statutory requirements of the Dodd-Frank Act, they will not create
costs and benefits beyond those resulting from Congress's statutory
mandates in the Dodd-Frank Act. However, to the extent that the
regulations reflect the Commission's own determinations regarding
implementation of the Dodd-Frank Act's provisions, such Commission
determinations may result in other costs and benefits. It is these
other costs and benefits resulting from the Commission's determinations
pursuant to and in accordance with the Dodd-Frank Act that the
Commission considers with respect to the Section 15(a) factors.
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\57\ 7 U.S.C. 19(a).
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The regulations contained in this Adopting Release were proposed in
four separate notices of proposed rulemaking (``NPRMs''). Sections
1.72, 1.74, 23.608, 23.610, 39.12(a)(1)(iv), and 39.12(b)(7) were
proposed in Customer Clearing Documentation and Timing of Acceptance
for Clearing,\58\ sections 23.506, 37.702(b), and 38.601(b) were
proposed in Requirements for Processing, Clearing, and Transfer of
Customer Positions,\59\ sections 1.73 and 23.609 were proposed in
Clearing Futures Commission Merchant Risk Management,\60\ and 1.35(a-
1)(5)(iv) was proposed in Adaptation of Regulations to Incorporate
Swaps.\61\ The Commission is finalizing the rules contained in this
Adopting Release together because they address three overarching,
closely-connected aims: (1) Non-discriminatory access to counterparties
and clearing; (2) straight-through processing; and (3) effective risk
management among clearing members. Each of these provides substantial
benefits for the markets and market participants.
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\58\ See 76 FR 45730 (Aug. 1, 2011).
\59\ See 76 FR 13101 (Mar. 10, 2011).
\60\ See 76 FR 45724 (Aug. 1 2011).
\61\ See 76 FR 33066 (Jun. 6, 2011).
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The regulations related to non-discriminatory access concern
customer clearing documentation. Specifically, they prohibit FCMs, SDs,
MSPs, and DCOs from entering into agreements, including those known in
the industry as ``trilateral agreements,'' with terms restricting an
FCM's customer's ability to access all willing counterparties in the
market and obtain a swap on reasonably competitive terms.\62\ Open
access, unrestrained by contractual terms of this type, is critical to
the efficiency and financial integrity of the swap markets.
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\62\ See Sec. Sec. 1.72, 23.608, and 39.12(a).
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This first set of rules is designed to avoid the undesirable
consequences likely to result from trilateral agreements, which include
limits on the range of eligible counterparties with whom market
participants can transact, reduced competition for customers' business,
fragmentation of customers' trading limits at the FCM, and distorted
price discovery.\63\ Reduced competition in this context may lead to
wider spreads, higher transaction fees (i.e., increased costs for
customers), and reduced market efficiency. Moreover, limiting a market
participant's access to less than all willing counterparties, including
those offering trades on terms approximating the best available in the
market could undermine price discovery, and market efficiency. The
first cluster of rules seeks to mitigate these problems through
provisions fostering open access to all available counterparties and
democratized access to clearing services. To that end, it prevents
FCMs, SDs, MSPs, and DCOs from entering into any agreement that would:
(a) Disclose the identity of a customer's original executing
counterparty to the FCM, SD, or MSP; (b) limit the number of
counterparties available to the customer; (c) set any limits on the
size of position a customer may take (other than the general limit
established by their FCM); (d) impede a customer's access to trades
that approximate the best terms available; or (e) prevent compliance
with timeframes for processing swaps that are required by other parts
of these rules.
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\63\ Trilateral agreements were introduced in June 2011. On
August 1, 2011 the Commission issued the NPRM of this rule
prohibiting certain terms that are central to the trilateral
agreements and as a consequence, adoption of the agreements thus far
has been extremely limited.
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A second group of regulations mandates straight-through
processing--rapid processing of swap transactions, including rapid
submission to the DCO for acceptance or rejection from clearing--for
swaps required to be cleared or that the counterparties elect to clear.
In this regard, the regulations impose requirements on FCMs, SDs, MSPs,
DCMs, SEFs, and DCOs that, taken together, are designed to ensure that
counterparties know whether a swap will be accepted for clearing at, or
soon after, the time of execution which is a critical condition for
eliminating counterparty risk that undermines democratized access to
the swap markets.\64\ When two parties enter into a bilateral swap
transaction with the intention of clearing a swap, each party bears
counterparty risk with respect to the other until the swap enters
clearing. Once the swap enters clearing, the clearinghouse becomes the
counterparty to each side of the trade, which minimizes and
standardizes counterparty risk.To the extent that there is a period of
time between execution and clearing, counterparty risk may develop as
post-execution market movements impact the swap's value and each party
could face significant costs if the swap is
[[Page 21292]]
eventually rejected from clearing and subsequently broken. Both
counterparties run the risk that they may have to replace the swap
under different, less desirable terms if the market has moved against
them during the intervening time. In addition, SDs, whether providing
liquidity to a non-SD or SD counterparty, may have to unwind or offset
any positions they have taken on to hedge the original swap; this can
also be costly, again, particularly if the market has moved against
them since the execution of the original swap. Bilateral agreements
typically address such ``breakage'' costs, but the effectiveness of
those provisions could be compromised if either counterparty is
unwilling or unable to make the other whole for losses. Such costs are
potentially significant, particularly when the markets are volatile and
the latency period is long, giving SDs an incentive to discriminate
among counterparties on the basis of their credit quality. To mitigate
those costs and promote more democratized access to the markets, it is
critical that executed swap transactions be accepted or rejected from
clearing quickly.
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\64\ See Sec. Sec. 1.35, 1.74, 23.506, 23.610, 37.702, 38.601,
and 39.12(b) of the Commission's regulations.
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These rules contain several requirements that are designed to
ensure that swaps are processed and accepted or rejected promptly from
clearing, including requirements that FCMs, SDs, MSPs, SEFs, DCMs, and
DCOs coordinate with one another to ensure they have the capacity to
accept or reject trades ``as quickly as technologically practicable if
fully automated systems were used.'' For trades executed on a DCM or
SEF, the Commission anticipates that processing and submitting a trade
for clearing would be near real-time, thus substantially eliminating
the potential for significant counterparty risk accumulation during the
latency period. For trades that are not executed on an exchange, but
are required to be cleared, the rules require submission for clearing
``as soon as is technologically practicable after execution'' but no
later than by the close of business on the day of execution. Similarly,
swaps not executed on an exchange and for which clearing is elected by
the counterparties (but not required by law) must also be submitted for
clearing as soon as technologically practicable, but not later than the
day following the latter of execution or the decision to clear.
The Commission expects that these rules requiring coordination to
ensure rapid processing and acceptance or rejection of swaps for
clearing will be beneficial in several respects. First, they will
promote rapid adoption in the market of currently existing technologies
that will make possible near real-time processing of exchange traded
swaps. For trades that are pre-screened, or executed on an exchange,
this will virtually eliminate counterparty credit risks associated with
clearing rejection. The rules will also significantly reduce the amount
of time needed to process swaps that are not traded on an exchange;
although costs associated with latency-period counterparty credit risk
cannot be completely eliminated in this context, the rules will
substantially reduce the need to discriminate among potential
counterparties in off-exchange trades, as well as the potential costs
associated with rejected trades. By reducing or eliminating the
counterparty risk that could otherwise develop during the latency
period, these rules promote a market in which all eligible market
participants have access to counterparties willing to trade on terms
that approximate the best available terms in the market. This rule may
improve price discovery and promote market integrity.
The third set of rules in this Adopting Release requires that FCMs,
SDs, and MSPs who are clearing members of a DCO implement sound risk
management practices that help ensure their financial strength. A DCO's
financial strength depends on the continued financial strength of its
clearing members. The Commission believes that requiring clearing
members to engage in certain risk management procedures will provide
additional assurance of their ability to meet their financial
obligations to their respective DCOs, particularly in times of market
stress.
The third group of rules in this Adopting Release therefore
requires clearing members to establish overall risk-based position
limits for their proprietary trading accounts and each of their
customer accounts, and to screen trades for compliance with those
limits. The rules also require clearing members to monitor for
adherence to such risk-based position limits, both intra-day and
overnight; to conduct rigorous stress tests on significant accounts at
least once per week; to evaluate their ability to meet initial and
variation margin requirements at least once per week; to evaluate the
probable cost of liquidating various accounts at least once per month;
to test all lines of credit at least once per year; and to establish
procedures and records that ensure and verify their compliance with
these requirements. Many of these requirements reflect common practices
for clearing members. These rules promote consistent use of risk
management best practices among clearing members, while also allowing
flexibility to encourage innovation and adaptation to the specific
operating requirements of diverse clearing members. The Commission
anticipates that the requirements themselves will help to ensure that
clearing members and their respective DCOs remain financially sound
during periods of market stress. Moreover, the Commission believes that
the flexibility these requirements allow will minimize attendant costs
and enable members to adapt their risk management practices to new
market demands and develop more effective strategies for monitoring and
managing risk.
In the sections that follow, the Commission evaluates the costs and
benefits relevant to each of the three groups of rules pursuant to
Section 15(a) of the CEA. Each section specifically addresses the
individual Section 15(a) factors with respect to the rule group and
responds to comments pertaining to that group. In its analysis, the
Commission has endeavored, where possible, to quantify costs and
benefits. However, the costs and benefits are either indirect, highly
variable, or both and therefore are not subject to reliable
quantification at this time. Nevertheless, the Commission has
considered all the comments received, a broad range of costs and
benefits pertaining to democratized swap market access, improvements
and challenges in risk management, development and implementation of
necessary technology, market liquidity, and several others as detailed
below.
Cost Benefit Consideration by Rule Group
1. Customer Clearing Documentation
Sections 1.72, 23.608, and 39.12(a)(1)(vi) restrict FCMs, SDs and
MSPs, and DCOs, respectively, from entering into any arrangements that
would (a) disclose the identity of a customer's original executing
counterparty to any FCM, SD, or MSP; (b) limit the number of
counterparties with whom a customer may trade; (c) restrict the size of
a position that the customer may take with any individual counterparty
apart from the overall limit for all positions held by the customer at
the FCM; (d) limit a customer's access to trades on terms that have a
reasonable relationship to the best terms available; or (e) prevents
compliance with other regulations requiring rapid processing and
acceptance or rejection from clearing.
The Commission believes that these rules proscribe certain terms in
trilateral agreements that were proposed by some
[[Page 21293]]
SDs and FCMs. However, the Commission notes that trilateral agreements
were not used in swap markets prior to June 2011. SDs historically have
provided liquidity and managed risk without the use of trilateral
agreements, and the Commission understands that such agreements have
not yet been widely adopted. Therefore, it is unlikely that these
rules, by preventing certain terms in trilateral agreements, will cause
widespread changes in current market practices for managing
counterparty risk or for negotiating bilateral agreements.\65\
Moreover, the rules adopted in this Adopting Release will enhance risk
management in other ways, obviating any perceived need for terms in
trilateral agreements that can harm market competitiveness, efficiency,
and price discovery. In that context, the Commission concludes that
these changes are justified.
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\65\ To the extent that changes will occur, the costs attendant
to them are indirect and cannot be estimated without data that is
not available at this time.
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a. Protection of Market Participants \66\ and the Public
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\66\ The term ``market participants'' as it is used throughout
the cost benefit considerations section includes SDs, MSPs, FCMs,
and the customers of FCMs (i.e., SD, MSP, and non-SD/MSP swap
counterparties).
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The Commission is concerned that by giving FCMs the ability to
establish and communicate sub-limits on the positions a specific SD may
clear with a specific customer, the trilateral agreements may allow
FCMs to influence the amount of business that a customer conducts with
specific counterparties, or to constrain the number or choice of
counterparties with whom a customer is able to trade. This concern is
amplified because a number of FCMs have affiliated SDs who (along with
other SDs with whom the FCM-affiliated SD competes for swap transaction
business) are potential counterparties to the FCM's customers. To the
extent that FCMs could use terms in trilateral agreements to influence
a customer's choice from among potential SD counterparties, the
agreements could provide a means for FCMs to direct business toward an
associated SD (or to raise the cost of doing business with an
unassociated SD) to the diminution of competition to provide swap
liquidity generally; in this way, the agreement may work to the
disadvantage of those market participants that might benefit from
better competition. Moreover, by limiting a customer's range of
potential counterparties and the size of positions that may be entered
with specific counterparties, the FCM establishes a condition that in
some circumstances could preclude matching of the customer's order with
the counterparty that is willing to provide the best available terms in
the market at that time. This sub-optimal outcome increases costs for
the customer, and any systematic increases in costs to the customer
will indirectly impact prices that the public ultimately pays for
related goods and services.
In addition, such limitations also impose costs on potential
counterparties who are prevented from trading with customers by
restrictions in the trilateral agreements. If those counterparties are
dealers, they lose the opportunity to win that customer's business. If
those counterparties are non-dealers, they lose the liquidity that
would have otherwise been available to them as a consequence of the
customer's need to execute a swap. Last, an FCM could, intentionally or
unintentionally, signal to the market information about the customer
through designation notices. For example, clearing members may be more
likely to reduce a customer's limits during a time of market stress.
Communicating reductions on various sub-limits to potential SD
counterparties may signal (perhaps wrongly) that the credit quality of
the customer is deteriorating. This signal could make it more difficult
for the customer to transact at a time when their ability to transact
is particularly critical.
These potential costs to customers and the public will be
forestalled or altogether eliminated by these rules. These benefits,
however, are unquantifiable for several reasons. First, many of the
potential costs and benefits associated with trilateral agreements are
indirect and dispersed to a degree that they would be difficult to
estimate even if there were ample data available. Second, ample data is
not available. The Commission does not have any data that characterizes
pricing, liquidity, or other important variables in the presence and
absence of trilateral agreements. Last, trilateral agreements were
introduced in mid-June 2011, and the Commission believes that adoption
of trilateral agreements thus far has been extremely limited. Further,
the Commission believes that the NPRM of this rule, which was released
a few weeks after trilateral agreements were introduced, may be a
primary factor deterring rapid adoption of these agreements.\67\ To the
extent that this is correct, the current rate of adoption and impact on
the market is unlikely to be a reflection of what the impact of
trilateral agreements would be in the absence of this rule. In other
words, even if the Commission had the data necessary to estimate the
current impact of trilateral agreements (which it does not), those
estimates would not accurately reflect the potential impact of these
agreements. However, by prohibiting contractual terms that would limit
the number of potential counterparties, set sub-limits on a customer's
positions, or restrict a customer's access to terms reasonably related
to the best terms available in the market, these rules provide
significant protection to market participants.
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\67\ See 76 FR 45730, Aug. 1, 2011.
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With respect to the customer-identity nondisclosure requirement,
several commenters stated that protecting anonymity is critical as a
condition for open, efficient, and competitive swap markets.\68\
Maintaining the anonymity of a customer's counterparty prevents the
clearing member from sharing with any affiliated SDs competitively
sensitive information about its customers' counterparties--who may be
competitors and/or subsequent swap counterparties to the affiliated
SD--that affiliated SDs can use for their own gain (and that of the SD/
FCM affiliate group). This rule, together with the rule that prevents
FCMs from establishing sub-limits, prohibits arrangements that allow
FCMs to share competitively sensitive information that could undermine
competition to provide swap liquidity--including information that
provides transparency into customer swap positions and exposures. In so
doing, the rules better protect those swap counterparty market
participants that benefit from greater competition (e.g., as may be
reflected in improved bid/ask spreads) to provide the desired swaps.
The value of such protection would vary depending on the specific type
and timing of information that is communicated as well as the role and
incentives of the entity receiving that information relative to the
entity about which the information is disclosed. These factors are
highly variable and impracticable to quantify, and, as a consequence,
the Commission does not have adequate information to reasonably
estimate the additional costs that might be caused by such disclosures,
or the value of preventing such costs.
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\68\ See MFA, Arbor, SIFMA, D. E. Shaw, AIMA, and Vizer.
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In addition, SDs, FCMs, and FCM customers may soon expend resources
negotiating trilateral agreements. By prohibiting certain provisions
from inclusion in trilateral agreements, these rules reduce the
likelihood that SDs, FCMs, and customers will enter into them. To the
extent that this occurs,
[[Page 21294]]
SDs, FCMs, and customers will save the substantial costs that otherwise
would be required to negotiate such agreements.\69\ Vanguard, for
example, estimates that, if it was forced by SDs to implement
trilateral agreements, it may have to negotiate and enter into
approximately 4,800 new trilateral agreements per year.\70\ In
addition, those agreements would create significant administrative and
ongoing legal costs associated with review, periodic update, and, for
customers, compliance to monitor their own activities. Some commenters
suggested that the resources necessary to create and administer
trilateral agreements would divert resources from implementing market
infrastructure that is necessary to facilitate straight through
processing.\71\
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\69\ See AllianceBernstein, Citadel, D. E. Shaw, MFA, SIFMA, and
Vanguard.
\70\ See Vanguard.
\71\ See e.g., Citadel, Alliance Bernstein, and MFA.
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The Commission recognizes that prohibiting certain arrangements
that are currently in trilateral agreements may increase counterparty
risks (costs) that SDs face due to the possibility that swaps they
enter could be rejected from clearing. Trilateral agreements are
intended to increase the degree of the SD's certainty that trades with
certain customers and within certain limits will be accepted for
clearing. The prohibitions contained in the first group of rules are
likely to prevent SDs from using trilateral agreements in this way,
creating certain potential costs for the SDs who have established
trilateral agreements with some of their customers and the customers'
FCMs.\72\ However, as noted above, there are also significant costs
associated with trilateral agreements. Moreover, in the Commission's
judgment, provisions contained within the second cluster of rules
(i.e., rules pertaining to straight-through processing) will mitigate
the potential costs to SDs and other market participants substantially.
More specifically, as discussed below, the second group of rules
mitigates costs associated with pre-clearing-approval counterparty risk
through straight-through-processing requirements; the Commission
anticipates these rules will drive rapid implementation of existing
market technology to substantially narrow the window of counterparty
risk for SDs between execution and clearing acceptance/rejection.
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\72\ These costs, if compared against the baseline of current
market practice, depend on the extent to which trilateral agreements
containing terms proscribed in these rules are currently being used.
Based on anecdotal feedback from market participants, the Commission
believes that trilateral agreements have not yet been widely
adopted. Moreover, as suggested above, the Commission believes that
requiring more rapid swap processing and clearing determinations
will offset these costs, diminishing them significantly over time.
However, the Commission does not have sufficient data regarding the
number of trilateral agreements currently in place, or the number
and terms of swap transactions that they impact, to estimate these
costs.
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Moreover, commenters have suggested that in certain circumstances,
the sub-limits associated with trilateral agreements may actually
exacerbate the counterparty risk problem by delaying processing and
increasing the latency period during which counterparty exposure
develops.\73\ If a customer enters a swap with an SD without a
trilateral agreement in place, the FCM may need to check with and
adjust the limits of various SDs who do have trilateral agreements set
up with that customer before making a clearing determination. The
administrative requirements of these steps could delay clearing. By
prohibiting agreements that create such delays, the rules reduce the
latency period for some transactions, which also reduces the amount of
counterparty risk that can develop during that period.
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\73\ See e.g., AIMA, SIFMA, Vanguard, and MFA.
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Notwithstanding the inability to quantify in dollar terms the costs
of this change in risk avoidance and mitigation practice, in the
Commission's judgment the change is justified by the critical benefits
that the rules provide regarding open access to, and democratization
of, swap markets.
b. Efficiency, Competitiveness and Financial Integrity of Markets
These rules specifically prohibit any agreement that would limit a
customer's potential available counterparties. This prohibition
encourages competition among SD counterparties for the customer's
business, which is likely to reduce spreads and promote the customer's
ability to obtain swap positions on terms approaching or equaling the
best available terms in the market at that time. Accordingly, the
Commission expects the spreads and terms under which customers are able
to obtain swaps to improve when compared with a situation in which
customers' range of potential counterparties is constrained by
counterparty-specific sub-limits established by the FCM. It is possible
that the effect of greater competition on spreads and terms may be
mitigated by the impact of increased risk to the dealers, which is also
likely to impact spreads and terms. However, the Commission believes
that the latter effects will be minimized and diminish over time as the
processing of trades becomes more rapid.
As suggested above, counterparty-specific sub-limits increase
expenses related to monitoring and administrative requirements, and
commenters have stated that in some circumstances trilateral agreements
may actually slow swap processing. The prohibitions contained in these
rules will prevent such arrangements, thereby leading to greater swap
processing speed in those circumstances.
c. Price Discovery
If certain customers are prevented from accessing swaps on terms
that approximate the best available terms in the market at that time,
and then the terms of that trade are reported in real time, it risks
sending misleading signals to the market about the price at which
certain swaps are available. This result has the potential to undermine
price discovery. The prohibitions in these rules will help ensure that
customers in the market can access trades on approximately the best
terms available in the market, both in general by prohibiting
agreements that would prevent such an outcome, and more specifically by
prohibiting any (1) agreements that would limit the number of
counterparties with whom a customer may trade, and (2) counterparty-
specific sub-limits on the customer's positions.
d. Sound Risk Management Practices
By ensuring that customers are able to trade with all willing
counterparties in the market, the rules promote greater liquidity
available to the customer and to potential counterparties, which makes
it more likely they will be able to enter swaps and offset positions as
needed. This result is important for maintaining effective offsetting
positions as underlying positions change. Moreover, greater liquidity
may push transaction costs downward, which enables market participants
to execute their risk management strategies in a more cost-effective
manner.
To the extent that prohibiting certain terms typical of trilateral
agreements will reduce an SD's certainty about whether the swap will be
cleared, it may increase the SD's risk management costs. However, as
noted above, trilateral agreements did not appear until June 2011,
which suggests that SDs are capable of managing their risks effectively
in the absence of certain terms contained in those agreements. For
example, SDs conduct due diligence in order to evaluate their
counterparty's credit-worthiness, and may choose to negotiate terms in
the bilateral agreement that determine what
[[Page 21295]]
obligations each counterparty has in the event that a swap should be
rejected from clearing. SDs may have to adjust their risk management
strategies for the possibility that their counterparty may not be able
to meet the terms of the bilateral agreement if the trade is rejected.
If such bilateral agreements provide that the swap will be terminated
when rejected from clearing, the dealer may have to unwind or offset
certain aspects of positions that they have taken to offset the
original position. The Commission anticipates that SDs will account for
these potential additional costs in the terms and pricing of the swaps
they offer. In most cases, however, the risk management strategies
described above reflect current market practice. Therefore, much of the
costs associated with those practices are not a function of these
rules. Last, these potential costs will be mitigated by faster
processing, and, in cases where prescreening or near real-time post-
execution screening are possible, eliminated.\74\
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\74\ Several commenters pointed out that in an environment where
real-time clearing determinations are made, bilateral execution
agreements are not necessary. As evidence, commenters pointed to
Clearport, Globex, and WebICE. Each of these platforms facilitate
real-time clearing determinations, and each does so without
bilateral execution agreements. See e.g., SDMA and Javelin.
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Some SDs have posited that market liquidity for some customers may
decrease because SDs will not provide swaps to counterparties whose
credit quality is lower unless a trilateral agreement is executed. The
Commission recognizes that any factor that undermines SDs' confidence
that swaps will be cleared may cause them to avoid certain trades or to
increase the price at which they are willing to offer swaps to certain
counterparties. However, because SDs have been providing liquidity to
market participants for years in the absence of trilateral agreements,
and adoption of such agreements is not yet widespread, the Commission
does not believe that preventing certain provisions of these agreements
will significantly reduce liquidity in swap markets. Moreover, certain
aspects of these rules, such as requirements for rapid swap processing
and clearing determinations, are likely to promote additional liquidity
by reducing the counterparty risk that could develop for SDs between
the time of execution and clearing.\75\
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\75\ See section 2, Timing of Acceptance of Trades for Clearing,
below.
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e. Other Public Interest Considerations
The Commission has not identified additional public interest
considerations beyond those discussed above.
f. Response to Comments
Several commenters noted that the benefits of the proposed rules
include: reduced systemic risk; \76\ reduced barriers to entry and
greater competition among liquidity providers, clearing members, and
execution venues; \77\ enhanced market depth and liquidity; \78\
substantially reduced transaction costs; \79\ narrower bid-ask spreads;
\80\ and increased access to best execution via the freedom to execute
with any counterparty in the market.\81\ D. E. Shaw and MFA commented
that the proposed rules would preserve anonymity among trading
participants, and facilitate the development of electronic trading and
central limit order books.
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\76\ See AllianceBernstein, Arbor, CBA, CIEBA, Citadel, D. E.
Shaw, and MFA.
\77\ See AllianceBernstein, Arbor, Citadel, D. E. Shaw, and MFA.
\78\ Id.
\79\ See AllianceBernstein, Arbor, and CIEBA.
\80\ See AllianceBernstein, Citadel, D. E. Shaw, and MFA.
\81\ See AllianceBernstein, Citadel, D. E. Shaw, and MFA.
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Additionally, several commenters remarked that without the final
rules, the framework for trilateral agreements would substantially
increase costs for market participants.\82\ AllianceBernstein suggested
that without the proposed rules, resources would be diverted from
forward-looking technological solutions for clearing certainty, and
instead used to prop-up legacy systems for credit intermediation.\83\
Vanguard stated that the trilateral agreement will introduce
significant costs and delays to the timeline for swaps clearing
implementation because parties will be forced to execute a myriad of
documents as a pre-condition to clearing and trading.
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\82\ See AllianceBernstein, Citadel, D. E. Shaw, MFA, SIFMA, and
Vanguard.
\83\ See also MFA, Citadel.
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Moreover, multiple commenters stated that while they are generally
loathe to encourage regulations that interfere with private contracts
between two parties, they believe that the undesirable consequences of
trilateral agreements, such as limiting a customer's choice of
counterparties and trading venues, impairing their access to the best
terms available, the potential for anticompetitive effects, creating
barriers to entry for new liquidity providers, delaying adoption of
technology that will enable real time processing and clearing
determinations, and precluding anonymity that is a necessary condition
for trading on central limit order books, justify these rules.\84\ In
this vein commenters maintained that the largest SDs have sufficient
power deriving from their role as swap liquidity providers to coerce at
least some market participants into signing ``optional'' trilateral
agreements, and expressed concern that the agreement could rapidly
become an industry standard despite the resistance of buy-side
firms.\85\ The Commission agrees that it is necessary, in this case, to
establish rules that prevent trilateral agreements from being used to
limit open and competitive swap markets.
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\84\ See SDMA, AIMA, Trading Firms, MFA, Arbor, DRW, and
Jeffries.
\85\ See AIMA, Trading Firms, CIEBA, Citadel.
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In supporting the use of trilateral agreements some commenters have
suggested that they are analogous to the FIA/FOA sponsored
International Uniform Brokerage Execution Services (``Give-Up'')
Agreement (``Futures Give-Up Agreement''), which is used in the futures
markets. The Futures Give-Up Agreement is between an executing broker,
clearing broker, and customer, and allows the clearing broker to
``place limits or conditions on the positions it will accept for the
give-up for customer's account.'' \86\ Commenters expressed the opinion
that the risks faced by executing brokers and clearing firms in futures
markets are substantially similar to the risks faced by SDs and
clearing members in the swap markets, and therefore the use of
trilateral agreements should be acceptable.\87\
---------------------------------------------------------------------------
\86\ See Morgan Stanley, FIA/ISDA, Banks.
\87\ See Morgan Stanley.
---------------------------------------------------------------------------
However, the Commission is not persuaded that the points of
similarity between Futures Give-Up Agreements and trilateral agreements
provide sufficient evidence to demonstrate that the latter may be used
in swap markets without adverse effects on market participants as
discussed above. The two types of agreements are distinguishable in
important respects. The parties to a Futures Give-Up Agreement include
a customer and two brokers acting on behalf of the customer. The
parties do not include the customer's trading counterparty in the
relevant transaction. Moreover, Futures Give-Up Agreements do not: (a)
Disclose the identity of a customer's original executing counterparty
to any FCM, SD, or MSP; (b) limit the number of counterparties with
whom a customer may trade; (c) restrict the size of a position that the
customer may take with any individual counterparty apart
[[Page 21296]]
from the overall limit for all positions held by the customer at the
FCM; (d) limit a customer's access to execution of trades on terms that
have a reasonable relationship to the best terms available; or (e)
prevent compliance with other regulations requiring rapid processing
and acceptance or rejection from clearing.
Some commenters suggested that by specifying the types, size, and
volume of trades that they are willing to engage in with certain
customers, trilateral agreements help increase the range of
counterparties with whom SDs are willing to trade.\88\ There is not
sufficient data available to the Commission to evaluate these
assertions, and commenters did not provide any data to support them.
The Commission acknowledges that factors reducing an SD's certainty
about whether a swap will be cleared could prompt it to limit its
business with certain counterparties or to change the terms under which
it offers swaps to certain counterparties, but the trilateral
agreements could also constrain either the range of counterparties with
whom an SD is willing to trade, the size of positions it is willing to
offer to certain counterparties, or both.\89\ In other words, while
some commenters are concerned that prohibiting certain terms in
trilateral agreements may constrain liquidity, the Commission
recognizes that trilateral agreements also constrain liquidity. It is
not knowable at this time which force is likely to have the greater
constrictive effect on the liquidity that an SD is willing to provide
to certain counterparties. Moreover, as stated above, some aspects of
these rules, including the straight-through-processing and risk
management provisions, are likely to substantially reduce, if not
eliminate, SD latency exposure and encourage SDs to provide greater
liquidity. Accordingly, in the Commission's judgment, proscribing
certain terms of trilateral agreements (with their negative
implications for competition, efficiency and price discovery) is the
preferable approach from a systemic standpoint to promote liquidity.
---------------------------------------------------------------------------
\88\ See Morgan Stanley, UBS, and EEI.
\89\ The first page of the FIA-ISDA Cleared Derivatives
Execution Agreement states that ``EXECUTION PARTIES MAY REQUEST THAT
A FORM OF THIS AGREEMENT (OR THE ANNEXES HERETO) BE EXECUTED AS A
CONDITION TO ENTERING INTO TRANSACTIONS INTENDED TO BE CLEARED.''
See http://www.futuresindustry.org/downloads/ClearedDerivativesExecutionAgreement_June142001.pdf.
---------------------------------------------------------------------------
Commenters opposed to the rules stated that prohibiting trilateral
agreements would require buy-side and sell-side firms to subject
themselves to risks that they do not face today and would make it
necessary for dealers to expend resources negotiating bilateral
agreements with customers and evaluating the customer's credit prior to
executing a transaction.\90\ However, this would only be true to the
extent that trilateral agreements are (1) being used today to mitigate
certain risks, and (2) make it unnecessary to negotiate bilateral
agreements and evaluate a customer's counterparty risk. As stated
above, the Commission believes that trilateral agreements are not
widely used at this time and, thus, are providing dealers risk
protection only to a limited extent. Moreover, it does not appear that
trilateral agreements obviate the need to negotiate what might happen
in the event of breakage; the Commission, therefore, does not believe
that prohibiting certain provisions of trilateral agreements is likely
to significantly impact the expenses associated with bilateral
agreements.\91\
---------------------------------------------------------------------------
\90\ See Banks, Morgan Stanley.
\91\ See http://www.futuresindustry.org/downloads/ClearedDerivativesExecutionAgreement_June142001.pdf. The trilateral
agreement template includes terms dictating what happens in the
event that a swap is rejected from clearing. The CFTC believes,
therefore, that these terms are likely negotiated and addressed even
where trilateral agreements are used.
---------------------------------------------------------------------------
Furthermore, commenters opposed to the rules stressed that the
trilateral agreements are optional.\92\ They also noted that the
trilateral agreements ``do not affirmatively limit'' a customer's
ability to trade with willing counterparties or prohibit dealers and
customers from entering positions greater than the sub-limit
established by the FCM.\93\ However, even in the absence of
``affirmative'' limitations, the agreement may have much the same
effect. Some commenters stated that certain dealers have expressed
unwillingness to continue providing swaps to certain customers if they
did not sign a trilateral agreement; the agreement itself contemplates
this possibility.\94\ The Commission's concern with conduct of this
type is heightened by information suggesting that a relatively small
number of dealers provide a significant amount of swap liquidity
available.\95\ Under these circumstances, each dealer that refuses to
offer swaps in the absence of a trilateral agreement may significantly
reduce liquidity available to a customer. Absent sufficient competition
to provide liquidity, dealers may be able to impose restrictive,
undesirable trilateral agreement terms on customers.
---------------------------------------------------------------------------
\92\ See FIA/ISDA.
\93\ See Morgan Stanley. See also FIA/ISDA, Banks.
\94\ See n.71, above.
\95\ See the OCC's Quarterly Report on Bank Trading and
Derivatives Activities Third Quarter 2011, available at http://www.occ.gov/topics/capital-markets/financial-markets/trading/derivatives/dq311.pdf, which states, ``Derivatives activity in the
U.S. banking system continues to be dominated by a small group of
large financial institutions. Five large commercial banks represent
96% of the total banking industry notional amounts and 85% of
industry net current credit exposure.'' While the report only
includes data related to positions held by U.S. banks, and
incorporates derivatives that are not swaps, anecdotal evidence also
supports the likelihood that a relatively small dealer population
accounts for significant portions of swap liquidity.
---------------------------------------------------------------------------
Commenters in favor of trilateral agreements suggested that concern
about anti-competitive behavior could be addressed by allowing the
customer to determine how their overall limit at the clearinghouse is
allocated across potential counterparties. The Commission agrees that
such an approach would mitigate the concern that FCMs could use
trilateral agreements to influence a customer's choice of
counterparties in an anti-competitive manner. However, it would not
allow customers to take positions in excess of previously established
sub-limits with certain counterparties without walking through the
process of reallocating sub-limits, a process that could be time
consuming. This result risks delay of swap processing and clearing
determinations, or inducement of market participants to select
suboptimal offers that comply with pre-established limits to avoid the
delay. Such a delay could be particularly problematic in volatile
market situations, where the ability to enter into positions quickly
may be necessary in order to manage risk effectively.
2. Timing of Acceptance of Trades for Clearing
Taken as a whole, the regulations in this cluster require SEFs,
DCMs, SDs, MSPs, and DCOs to coordinate in order to facilitate real-
time acceptance or rejection of trades for clearing, including through
development of the technology necessary to do so. In the case of
cleared trades, the swaps must be processed and submitted to the DCO as
soon as technologically practicable using fully automated systems. In
the case of non-cleared trades, the swaps will be processed and
submitted to the DCO as soon as is technologically practicable, but
allows for processing to take slightly longer. More specifically:
Regarding Clearing Members
Sections 1.74 and 23.610 require that FCMs, and SDs and MSPs,
respectively, coordinate with the DCO to accept or reject trades for
clearing ``as quickly as
[[Page 21297]]
would be technologically practicable if fully automated systems were
used'' and do so by one of the following methods: (1) Pre-screening
orders; (2) enabling the DCO to screen orders using criteria
established by the FCM, SD or MSP; or (3) setting up systems that
enable the DCO to communicate with and receive a reply from the FCM,
SD, or MSP as soon as would be practicable if fully automated systems
were used.
Section 23.506 requires SDs and MSPs to: (1) Have the capacity to
submit swaps that are not executed on a DCM or SEF (``OTC swaps'') to
the DCO for clearing in a way that is acceptable to the DCO; (2) work
with the DCO to process swaps in a manner that is ``prompt and
efficient'' and that complies with 39.12(b)(7); (3) submit bilateral
swaps to the DCO as soon as is technologically practicable but no
later, if it is a swap subject to mandatory clearing, than the close of
business on the day of execution, or, if it is a swap not subject to
mandatory clearing, no later than the end of the following business day
from the later of execution or the date when the parties decide to
clear.
Section 1.35 requires that for bunched trades that are cleared,
post-trade allocations must occur on the day of execution, so that
clearing records properly reflect the ultimate customers. (Bunched
trades that are cleared are not given a delay for post-trade allocation
before being submitted for clearing.) For bunched trades that are not
cleared, post-trade allocations must happen by the end of the day they
are executed.
Regarding Execution Platforms
Section 38.601 requires that transactions executed on or through a
DCM, other than transactions in security futures products, must be
cleared on a DCO, and the DCM must work with DCOs to ensure ``prompt
and efficient'' transaction processing such that the DCO can comply
with Sec. 39.12(b)(7). Section 37.702(b) requires that SEFs coordinate
with DCOs in order to route transactions to the DCO in a manner
acceptable to the DCO, and to develop rules and procedures that
facilitate prompt transaction processing in accordance with Sec.
39.12(b)(7).
Regarding DCOs
Section 39.12(b)(7) requires DCOs: (1) To coordinate with SEFs and
DCMs to develop rules and procedures that facilitate ``prompt,
efficient, and accurate'' processing of transactions received by the
DCO; (2) to coordinate with FCMs, SDs, and MSPs to set up systems that
enable the clearing member or the DCO acting on its behalf to accept or
reject trades for clearing as swiftly as if fully automated systems
were used; (3) for trades executed on SEFs or DCMs, to establish rules
to accept or reject trades for clearing as fast as if fully automated
systems were used, and to accept all trades for which both executing
parties have a clearing member, and that satisfy the criteria of the
DCO; and (4) for trades that are not executed on SEFs or DCMs, but that
are for contracts listed by the DCO, to satisfy requirements similar to
those applicable to trades that are executed on SEFs or DCMs.
a. Protection of Market Participants and the Public
The Commission anticipates that this group of rules will provide
significant benefits to market participants. First, by requiring that
SEFs, DCMs, SDs, and MSPs coordinate in ways that will lead to faster
processing and acceptance or rejection of swaps for clearing, the rules
reduce the latency period during which counterparty risk can accumulate
for parties who have executed a swap that they intend to clear. If,
following a long latency period, the swap is rejected from clearing and
is cancelled as a consequence, the SD will be forced to recoup breakage
costs from their counterparty to the extent that their bilateral
agreement provides and their counterparty is able to meet the terms of
that agreement; the SD also may need to unwind or offset any position
it has established, potentially at a loss. SDs have pointed out that
the size of many swap transactions, as well as the illiquidity and
volatility of these markets, create the potential for these risks to be
substantial,\96\ so by reducing the time between execution and
clearing, these rules provide considerable benefits to SDs. Moreover,
for swaps where real-time acceptance or rejection from clearing occurs,
the latency period, and the potential for post-execution termination
costs, is eliminated.
---------------------------------------------------------------------------
\96\ SDs, however, did not provide estimates of or seek to
quantify such risks.
---------------------------------------------------------------------------
Likewise, non-SD market participants will be able to better judge
their counterparty risk and hedging strategies. The possibility exists
that a non-SD market participant could have to unwind or offset other
positions at a loss if a swap position is cancelled unexpectedly, or
need to create the same position but on less favorable terms if the
market has moved against them. It is also possible that the non-SD
market participant may not be able to negotiate terms with the SD that
would allow it to recoup much or all of the costs associated with the
cancelled swap. Reducing or eliminating the latency period through more
rapid processing and acceptance or rejection of swaps from clearing
will reduce those costs to the benefit of both SD and non-SD market
participants. If there is less time between execution and clearing,
there will be less time for counterparty exposure to develop, which
mitigates the need for extensive due diligence or for elaborate
procedures to address breakage costs.
With respect to costs, some capital investment will be necessary to
develop the processes and implement the technology necessary to meet
the requirements specified in these rules. However, in the case of
DCMs, SDs, MSPs, and DCOs, the Commission believes that many entities
are already using procedures and technology that comply with the
standards in some measure. The necessary investments, therefore, will
be incremental and will depend significantly on the current processes
and technology in place at each of these institutions. Moreover, many
of these entities may have to modify or upgrade their systems in order
to comply with other aspects of the Dodd-Frank Act. The costs necessary
to adjust technology platforms to meet these other requirements are
being considered in each of those rules, and so the costs attributable
to these rules are only those that create improvements that would not
otherwise be made pursuant to those other rules. The incremental costs
attributable to these rules cannot be quantified, due to the
flexibility the rules provide regulated entities to meet the applicable
standards and to the differing technology already in use by those
entities, but the Commission anticipates that the necessary capital
expenditures by some entities may be significant. However, as discussed
above, the benefits of such technology and procedures are substantial
as well, and, based on comments, the Commission believes potentially of
a magnitude to offset the costs of implementing such systems. Citadel
believes the rules will save enough resources to benefit the economy as
a whole, and SDMA estimates that the total benefits for corporate
America will have a value of approximately $15 billion annually.\97\
---------------------------------------------------------------------------
\97\ See Citadel and SDMA. Neither commenter provided
calculations to substantiate their estimates, so the Commission is
not able to verify their accuracy. However, as stated above, the
Commission does believe that the benefits of such systems and
procedures will be substantial.
---------------------------------------------------------------------------
[[Page 21298]]
b. Efficiency, Competitiveness, and Financial Integrity of the Markets
The general requirement that processing and acceptance or rejection
from clearing must occur ``as quickly as is technologically
practicable'' or ``as quickly as is technologically practicable if
fully automated systems are used'' creates an enforceable standard that
provides SEFs, DCMs, SDs, MSPs, and DCOs the freedom to establish
systems that meet their unique operational needs and that is, in their
judgment, most cost effective. By accommodating innovation, and further
system improvements, this approach will promote continued improvements
in the reliability and efficiency of these systems that, indirectly,
may benefit financial market efficiency generally.
Rapid processing and acceptance or rejection from clearing will
help to ensure that eligible counterparties are not exposed in
transactions that are ultimately rejected from clearing and broken.
With respect to dealers, this helps to ensure that they will be
available to other eligible customers by reducing the amount of their
balance sheet that is ``tied up'' supporting transactions that are
eventually rejected from clearing and broken. By limiting the duration
of transactional exposure, the rules' rapid processing requirements
serve to help protect market liquidity that dealers in significant part
provide.\98\
---------------------------------------------------------------------------
\98\ See n. 77, above.
---------------------------------------------------------------------------
Required coordination among SEFs, DCMs, SDs, MSPs, and DCOs,
together with the requirements for rapid processing and acceptance or
rejection from clearing, is likely to promote broad adoption of
standardized technologies and processes. The rules, in this respect,
will provide an incentive to further improvements in the speed of
processing, and may reduce switching costs for customers by ensuring
that their technology platforms are able to interface with a wide array
of FCMs and counterparties without significant modifications. Lower
switching costs, in turn, are conducive to greater competition among SD
counterparties and lower bid-ask spreads may result.
Limit order books \99\ cannot exist in an environment where there
is uncertainty about clearing because each participant will want to
identify its potential counterparty and evaluate its creditworthiness
in order to manage risks that could develop if the trade is rejected
from clearing. Enabling clearing members and exchanges to pre-screen
orders in real time for compliance with clearing member limits for each
customer facilitates the development of a central limit order book and
the pure price competition it affords by ensuring that each trade
executed on the exchange will proceed to clearing. This certainty, and
the central limit order book that it makes possible, enables anonymous,
exchange-based execution. This execution method is an effective
mechanism for providing all-to-all market access, placing all eligible
market participants on equal footing when bidding on or offering
positions; the only distinguishing characteristic among them is the
price they bid or offer. Participants do not need to know the identity
of entities on the other side of the trade or to concern themselves
with the creditworthiness of those entities because each participant
knows they will be facing the clearinghouse as their counterparty.
---------------------------------------------------------------------------
\99\ A Central Limit Order Book (CLOB) is a system used by many
exchanges to consolidate and match orders. An open CLOB exposes
available pricing and market depth for listed products. Market
participants are allowed to see limit orders that have been placed
but have not yet been executed or cancelled. Usually, exchanges use
open CLOBs to match customer trade orders with a ``price time
priority.''
---------------------------------------------------------------------------
Efficiency, certainty of clearing, and liquidity in the U.S. based
swap markets are attractive characteristics that may prompt additional
customers and dealers to send business to U.S.-based exchanges. To the
extent that this occurs, it will promote greater liquidity and
competition.
c. Price Discovery
Pre-trade price transparency is enhanced by central limit order
books, where market participants can view the prices at which market
participants are willing to ``buy'' or ``sell'' certain positions. Pre-
screening capabilities help to ensure that only bids and offers from
parties whose transactions will be accepted for clearing are
represented in the central limit order book. This promotes the
integrity of the order book, and the informational value of the bids
and offers contained within it, which promotes effective price
discovery.
To the extent that a swap moves from execution to acceptance or
rejection from clearing and receives an answer in real time that speed
eliminates the need for SDs to price idiosyncratic counterparty risk
(i.e. risk that is different than that posed by the clearinghouse as a
counterparty) into the swap. This result means that the price at which
a swap is transacted more accurately reflects the price that other
market participants would receive for the same product at that time.
Therefore, the prices reported in real time have greater informational
value for all market participants.
d. Sound Risk Management Practices
If an SD is uncertain whether a trade will clear, it will not know
whether it should account for idiosyncratic counterparty risk because
it will not know whether the clearinghouse or their counterparty will
face them for the life of the swap.\100\ Or, if the agreement between
the SD and the customer counterparty calls for the trade to be
cancelled in the event of clearing rejection, the SD's hedging
strategies will be complicated by uncertainty until the clearing
outcome is known. Faster processing and acceptance or rejection of
trades from clearing facilitates sound risk management by eliminating
these uncertainties, or at least by reducing the period of time during
which they are relevant. This result makes it easier and potentially
less costly for dealers to develop and execute sound risk management
strategies.
---------------------------------------------------------------------------
\100\ See DB.
---------------------------------------------------------------------------
Similarly, faster processing and acceptance or rejection from
clearing makes it easier and potentially less costly for other non-SD
market participants to manage their risk effectively. The more
certainty SDs have that a trade will clear, the less they need to
charge for clearing-acceptance risk. This result makes it less
expensive for non-SD market participants to acquire the positions they
need to execute their risk management strategies. It also obviates the
need that an SD would otherwise have to evaluate counterparty credit-
worthiness, which may decrease the amount of time required for a market
participant to execute a needed trade. In volatile markets, this
increased speed can be valuable, if not essential, when managing
complex risks.
On the other hand, some processes will still be manual even after
these rules are adopted. This result may be true particularly for swap
transactions that are executed bilaterally and then communicated to
clearing members. Speed requirements may increase the possibility of
errors in manual processes. The potential range of mistakes and range
of costs associated with those mistakes is broad, and impossible to
estimate. However, market participants have an incentive to avoid such
mistakes, and the Commission anticipates that the requirements related
to the timing of acceptance or rejection from clearing will encourage
automated, straight-through processing, which over time is likely to
reduce the number of manual processes and therefore the number of
opportunities for errors.
Also, while these rules require clearing members, SEFs, DCMs, and
[[Page 21299]]
DCOs to develop the ability to process swaps and make clearing
determinations in a timeframe that is likely to be a matter of
milliseconds, seconds, or at most, a few minutes, bilateral
transactions will still take some amount of time to submit to the
appropriate clearing member. The rules require SDs and MSPs to submit
OTC swaps for clearing as soon as is technologically practicable and in
no case later than the close of business on the date of execution for
swaps that are required to be cleared, and in no case later than the
end of the business day following execution or the decision to clear
(whichever is later) for swaps that are not required to be cleared.
Moreover, until the mandatory clearing regime becomes effective, all
OTC swaps will be subject to the requirement that they be submitted for
clearing as soon as is technologically practicable but in no case later
than the day following execution or the decision to clear (whichever is
later). Therefore, some time lapse between execution and clearing as
well as some breakage risk will remain for OTC swaps and that risk may
be greater prior to the mandatory clearing regime becoming effective.
However, the Commission notes that these rules establish timelines
for submission to clearing that are considerably shorter than what some
market participants practice today. Moreover, the close of business on
the date of execution and the end of the business day following
execution or the decision to clear (whichever is later) are outer
bounds on the timeline for submitting swaps to clearing. The rules
still require these swaps to be submitted ``as soon as is
technologically practicable,'' which in many cases will likely be
sooner than these outer limits. Last, to the extent that market
participants bear breakage cost risk, they have an incentive to submit
OTC swaps for clearing promptly and to implement and promote
technological improvements that will allow them to do so. Each of these
considerations are likely to significantly reduce the amount of time
between execution and submission for clearing for OTC swaps, and
therefore, are likely to mitigate the breakage risks that
counterparties face when engaging in OTC transactions.
e. Other Public Interest Considerations
As described above, rapid and predictable clearing provides
substantial benefits for both SDs and other market participants. As
market entities come into compliance with these rules, the Commission
anticipates that rapid processing and clearing determinations will make
the U.S. markets more attractive to foreign entities, which could
further increase liquidity and reduce spreads.
Also, the Commission observes that much of the technology that will
be necessary to meet these requirements has been implemented in certain
venues with marked success.\101\ This circumstance, together with the
fact that many market participants already may have systems capable of
at least partial compliance, will serve to limit the overall outlay
necessary to bring regulated entities into compliance.
---------------------------------------------------------------------------
\101\ See e.g., Arbor, Eris, CME, SDMA, Vanguard, and Javelin.
---------------------------------------------------------------------------
f. Response to Comments
Many commenters agreed that the technology for real time acceptance
or rejection already exists in other cleared derivatives markets and is
currently being rolled out for cleared OTC swaps.\102\ Commenters also
noted that the benefits of the rules far exceed any incremental costs
in upgrading infrastructure, and that any required infrastructure
upgrades would be minimal due to existing industry capabilities.\103\
Furthermore, Citadel stated that any costs to upgrade existing
infrastructure have already been factored into industry investment
plans, because many SDs, FCMs, DCOs, and SEFs are already launching
real-time acceptance.
---------------------------------------------------------------------------
\102\ See AllianceBernstein, Arbor, Citadel, D.E. Shaw, Eris,
Javelin, MFA, SDMA, and State Street.
\103\ See AllianceBernstein, Arbor, D.E. Shaw, MFA, and SDMA.
---------------------------------------------------------------------------
Eris noted that it is currently able to execute and clear interest
rate swaps. Arbor stated that it supports both the Globex and Clearport
solutions for swaps because they are proven, work well, and would be
inexpensive alternatives for market participants to implement. Arbor
continued to state that because such workflow and technology are
currently used by clearinghouses and clearing members today, these
technologies could be ported quickly into the cleared swaps context.
Finally, Arbor remarked that by compelling market adoption of workflow
and systems currently deployed in other cleared markets, implementation
will be less costly and more rapid.
Javelin calculated that Clearport's daily trade volume increased
from 139,177 contracts in 2005 to over 450,000 contracts today. Javelin
also noted that Clearport covers multiple asset classes including
credit and interest rates, and is interfacing with over 16,000
registered users, and Globex had average daily volume of 6,368,000
contracts in interest rates during August 2011 and total exchange
average daily volume of 14,420,000 contracts during the same period.
Commenters opposed to the rules doubted that ``market-wide real-
time'' clearing and risk limit compliance verification can be developed
quickly enough or provided with sufficient reliability to eliminate the
``functional benefits'' of trilateral agreements.\104\ One commenter
posited that to provide real-time clearing on a broad basis would
require systems that have the capacity to share information, calculate
risk metrics on a portfolio basis, adjust limits accordingly, and
disseminate information in ways that are not currently possible and
that are unlikely to be possible in the near future.\105\
---------------------------------------------------------------------------
\104\ See Morgan Stanley, and Banks.
\105\ See Morgan Stanley.
---------------------------------------------------------------------------
However, the Commission is not persuaded by these opposing
commenters' arguments, which pivot on an assumption that the
Commission's determination to prohibit certain provisions commonly
contained in trilateral agreements is premised on a faulty belief that
the functional benefits of trilateral agreements will be entirely
eliminated in the near term. Such a belief, however, is not the premise
for the Commission's determination. Rather, after careful consideration
of costs and benefits associated with trilateral agreements, the
Commission believes that certain provisions common to these agreements
generate unacceptable costs and, thus, should be prohibited. In
reaching this determination, the Commission has not concluded, and need
not conclude, that the trilateral agreements, judged in isolation, are
devoid of value.
Moreover, the Commission believes that significant improvements in
straight through processing and in the speed of processing and clearing
determinations can be achieved even when the ideal is not yet
attainable. In that regard, the Commission notes that the system
requirements delineated by commenters opposed to the rules describe
``requirements'' that the Commission does not believe are necessary to
straight through processing or real time clearing determinations.\106\
Several commenters noted that some technologies existing today provide
near real-time clearing determinations with respect to certain
swaps.\107\ Those
[[Page 21300]]
systems function effectively despite the fact that they do not achieve
the ideal system requirements described by other commenters. The
Commission, therefore, believes that while many of the ``requirements''
described by some commenters are desirable, they are not essential to
swap processing and clearing determinations that comply with these
rules. Furthermore, the Commission believes that improvements that
significantly mitigate the risks associated with counterparty exposure
that trilateral agreements seek to address are possible with existing
technology.
---------------------------------------------------------------------------
\106\ Id.
\107\ See SDMA, Vanguard, State Street, Arbor, Eris, CME, and
Javelin. Multiple commenters cited Clearport as an example of
immediate post-trade (or ''low latency'') solution that is already
providing clearing acceptance/rejection decisions within
milliseconds of execution in some markets. Similarly, commenters
cited Globex and WebICE as examples of platforms that provide pre-
trade screens against customer limits set by FCMs, which enables
``perfect settlement'' (i.e. every trade that is executed is
accepted immediately for clearing) for the markets in which they
operate. Commenters generally cited these examples as evidence that
the requisite technology for real time clearing determinations
already exists, and could be applied more broadly in order to
facilitate compliance with the rules adopted in this release.
---------------------------------------------------------------------------
One commenter suggested that sub-limits with individual dealers
need not delay clearing of swaps because the same technology that is
used to satisfy the Commission's requirements for clearing in real time
could be used to automate the sub-limits.\108\ However, commenters
generally agreed that real-time clearing determinations would mitigate
or eliminate any legitimate need for sub-limits or the agreements
necessary to establish them, a perspective that the Commission finds
persuasive.\109\ Once the technology necessary for straight through
processing and real time clearing determinations is in place, the
economic rationale that commenters have advanced in favor of sub-limits
will no longer be relevant, and therefore the elements of trilateral
agreements that are prohibited in the first part of these rules will
not assist SDs with risk management.
---------------------------------------------------------------------------
\108\ See Morgan Stanley.
\109\ See e.g., SDMA, AIMA, Vanguard, AllianceBernstein, Trading
Firms, and MFA. In addition, Morgan Stanley, ISDA/FIA, Banks, and
EEI implicitly acknowledge that real-time clearing determinations
mitigate the need for trilateral agreements by arguing that
trilateral agreements are a useful risk management tool because
real-time clearing determinations are not yet possible in all parts
of the market.
---------------------------------------------------------------------------
3. Clearing Member Risk Management
This cluster of rules establishes risk management requirements for
FCMs, SDs, and MSPs who are clearing members. Section 1.73 of the
Commission's regulations requires FCMs who are clearing members to: (1)
Establish limits for proprietary accounts and customer accounts based
on position size, order size, margin requirements, etc.; (2) ensure
that trades received by the FCM for automated or non-automated
execution, that are executed bilaterally then delivered to the FCM, or
that are executed by a broker and then delivered to the FCM, are
screened by either the FCM or the broker (whichever encounters the
transaction first) for compliance with overall position limits at the
FCM for each customer; (3) monitor for compliance with overall position
limits at the FCM for each customer both intraday and overnight; (4)
conduct stringent stress tests for all positions that could impact its
financial strength at least once per week; (5) evaluate its ability to
meet initial margin requirements at least once per week; (6) evaluate
its ability to, and the cost of, liquidating positions in its
proprietary and customer accounts at least once per month; (7) test all
lines of credit at least once per year; and (8) establish procedures
and maintain records to ensure and document compliance with these
requirements.
Section 23.609 requires SDs and MSPs who are clearing members to do
all the same things to manage risk, with the exception that bilateral
execution, ``give up'' agreements, and bunched orders are not addressed
in this section, because SDs and MSPs may only clear customer trades if
they are also registered as FCMs.
a. Protection of Market Participants
Several reported incidents over the last 15 years involving so
called ``rogue traders''\110\ highlight the protective import of these
rules. The rules in the second group require FCMs to establish overall
position limits for each of their customers and promote the
establishment of systems capable of more effectively pre-screening
orders for compliance with these overall position limits. Automated
screening mechanisms that are external to those of an FCM's customer
provide a second layer of defense against evasion by rogue traders
within the customer's organization. The Commission believes that these
measures will help protect against rogue trading, thereby protecting
market participants, who past events have shown to be vulnerable to
harm from such conduct.\111\
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\110\ See e.g., Report of the Board of Banking Supervision
Inquiry Into the Circumstances of the Collapse of Barings, (Jul. 18,
1995), available at: http://www.prmia.org/pdf/Case_Studies/Barings_Case_Study.pdf; Factbox: Rise and Fall of the SocGen Rogue
Trader, Reuters (Jan. 27, 2008), available at http://www.reuters.com/article/2008/01/27/us-socgen-factbox-idUSL2733740320080127.
\111\ A key purpose of risk management procedures is to minimize
the chance of a firm incurring losses that exceed its risk appetite.
For example, in 1999, a CFTC-regulated futures commission merchant
filed bankruptcy after a trader exceeded his trading limits. This
event highlights the potential damage that occurs from a poorly
designed risk management program or from a lack internal controls.
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With respect to the risk management requirement that each clearing
member establish overall position limits for each customer, the rules
promote restrictions that help prevent individual customers from
establishing positions sufficiently large to jeopardize the financial
health of their clearing member if they were to default. This is a
critical safeguard that, due to its importance and relative simplicity,
the Commission anticipates many clearing members may already have in
place. But, by implementing these rules, the Commission is ensuring
that every clearing member uses such safeguards to help ensure that
they, and the DCOs on which they clear trades, remain financially sound
even during times of financial market turbulence.
The risk management requirements do prescribe certain timelines for
regular testing and evaluation; however, they do not dictate (1)
specific levels for position limits set by clearing members, or (2)
specific methodologies of testing with respect to the clearing member's
ability to meet margin requirements, the cost of liquidating positions,
or stress testing positions that could have a material impact on the
entity's financial strength. This flexibility gives market participants
the opportunity to implement the requirements in ways that are suited
to their operational patterns and minimize costs associated with
changes and upgrades to existing technology systems. Moreover, it
allows market participants ample room to innovate and adapt the most
effective procedures as the market continues to evolve. This
flexibility for innovation and adaptation is critical to the long term
success of risk management practices. Over time the markets will
continue to evolve with changes in products, connections among
institutions, regulatory requirements, and broader economic realities.
Each of these dynamic realities has the potential to impact the
effectiveness of specific risk management strategies, making it
essential for firms to continue adapting their approaches. The rules
benefit FCMs, their counterparties, and the public by giving FCMs the
flexibility they need to continue developing effective risk management
strategies that address current market realities.
Clearing members that do not currently practice one or more of the
requirements established by this cluster of rules will incur some
incremental costs to comply with them. Some initial investment will be
required to develop
[[Page 21301]]
and implement processes necessary for compliance, and ongoing costs
will be incurred as such entities engage in repeated testing. The
incremental cost for each entity will depend on the degree to which its
current practices are or are not in compliance, as well as the
procedures they select and implement in order to comply. The Commission
does not have, and has not been provided by commenters with, the
information required to estimate those costs either on a per-entity or
aggregate basis. However, the Commission expects that while the costs
may be material for a small number of entities, most clearing members
are currently using risk management strategies that are largely
compliant with these requirements and, therefore, the incremental cost
for most entities and for the market as a whole is likely to be
relatively low.
b. Efficiency, Competitiveness, and Financial Integrity of the Markets
With clearing mandates in place, the financial integrity of swap
markets will depend significantly on the financial strength of DCOs.
Moreover, the financial health of a DCO is dependent upon the strength
of its clearing members and those members' ability to meet any
obligations pursuant to the terms of their agreement with the DCO. By
requiring clearing members to implement sound risk management
practices, the rules mitigate the risk that those members could
experience financial strain that could undermine the financial strength
of the DCO.
In addition, by requiring that DCOs coordinate with clearing
members and that clearing members coordinate with account managers who
execute trades before submitting them to the clearing member, the rules
promote market integrity by making it more difficult for market
participants to circumvent the overall position limit established by
their clearing member.
c. Price Discovery
The Commission does not expect these rules to materially affect
price discovery.
d. Sound Risk Management Practices
As mentioned above, prescreening of trades for compliance with
overall position limits set by the clearing member will help guard
against the activities of rogue traders, particularly those that may be
operating within one of the clearing members' customers. Intraday and
overnight monitoring of compliance with overall position limits is an
additional line of defense against the same risk, but also serves to
help protect the clearing member against any such activities within its
own ranks. In this way, the rules mandate processes that provide a
deterrent against and a screen for rogue trading, and help to protect
market participants from these relatively infrequent, but potentially
catastrophic, risks.
Moreover, in situations where automated screening may not be
possible, such as with bunched trades and give-up trades, the rules
still specify requirements that should effect pre-screening of trades
against overall position limits with the clearing member. Non-automated
systems may be slightly slower, but the manual screens still provide
some measure of protection against the activities of rogue traders.
Even in situations where non-automated screening occurs post-execution,
as is the case with screens on floor traders, manual systems--if
carefully and rigorously practiced--can provide effective protection
against excessive exposure. In the case of floor traders, the clearing
member may monitor the trader's positions throughout the day and
intervene in person when the trader exceeds allowable limits, forcing
him to close out positions immediately in order to come under such
limits, even if he must close out those positions at a loss. Such
monitoring reduces the opportunity that the trader has to exceed
appropriate limits, and the amount of time that such excesses can last,
thus limiting the associated potential risk for his firm and the
clearing member.
Also, as stated above, the flexibility that is implicit in these
requirements is particularly critical as a precondition to innovation
regarding testing methodologies. Clearing members might develop many
different approaches to stress tests, one or more of which may be
particularly well suited to a particular firm and set of market
conditions, but which may not be well suited to other firms and market
conditions. Flexibility is critical to enabling continued development
and testing of new methodologies. It is likely to benefit the
individual entities that engage in such innovation and testing, as well
as a broader array of market participants introduced to developments at
industry gatherings and through informal transfer of intellectual
capital as personnel move between firms.
The requirement for each clearing member to evaluate its ability to
meet margin requirements at least once per week is a valuable tool to
help clearing firms avoid liquidity crises, which could jeopardize the
solvency of otherwise healthy clearing members. Margin calls can come
as a result of significant movements in the price of the underlying
commodity, or as a consequence of changes in price volatility.
Counterparties may choose to exercise options at unanticipated times,
which may have significant repercussions for a clearing member's margin
requirements. Additionally, a clearing member's cash position may be
negatively impacted if one of its customers becomes unable to meet
margin calls on large positions. Clearing members must have sufficient
liquidity to meet margin calls from the DCO, even at a time when the
clearing member may have a depleted cash position due to the failure of
its customers to meet margin requirements. Such stress tests may help
to ensure that the clearing member has a clear sense for how much
liquidity may be necessary in such circumstances, and may encourage
them to preserve ample liquidity.
Testing lines of credit also helps clearing members to ensure that
(1) the credit provider is able to honor its commitment, and (2) the
clearing member can access the line in a timely fashion. Liquidity
crises seldom play out in slow motion, and time is likely to be of the
essence when a clearing member needs to access its credit line.
Therefore, it is important for the clearing member's staff to know how
to access the line quickly and reliably when it is needed. By requiring
annual testing, the rules guard against the danger that an episode of
financial strain for the member could be exacerbated by an inability to
access its credit line in a timely manner. Such preventable problems
could be fatal for the firm in the midst of a liquidity crisis.
e. Other Public Interest Considerations
The Commission understands that the past several years' events in
the financial markets have tested and strained the public's confidence
in financial institutions' management of risks. To the extent that
these regulations promote broader implementation of sound risk-
management practices, they may serve to strengthen such public
confidence in the integrity of the affected markets. Such public
confidence, if justified by improved risk-management practices, is
critical to the overall health and functioning of the swaps and
commodity markets.
To the extent that sound risk management practices are broadened,
these regulations will help to promote such confidence, and as such
will benefit the financial markets and the American public who
ultimately
[[Page 21302]]
benefits from the health of these markets.
f. Response to comments
Chris Barnard and Better Markets both recommend that the Commission
require specific stress tests, and FHLB recommends that stress test
results be publicly disclosed.\112\ FHLB believes that public
disclosure of stress test results would allow customers to mitigate
risk.
---------------------------------------------------------------------------
\112\ See section IV.B(2)(a), above.
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The purpose of stress tests is for clearing members to monitor the
potential losses they would face in the event of extreme market events
as well as their ability to absorb such losses.
The Commission has chosen not to set specific thresholds or
specifying methodologies for stress tests for three reasons. First,
appropriate thresholds and methodologies depend, at least in part, on
the types of customers and positions that characterize each clearing
member's business. The clearing member is best positioned to account
for these factors when developing an appropriate test. Second, the
Commission believes that specifying certain stress test thresholds
could prompt firms to focus tests on those minimum levels in order to
meet regulatory requirements rather than establishing thresholds that
further achieve the goal of maintaining a vigorous risk management
program. Third, the Commission believes that specifying particular
methodologies for stress testing would stifle innovation, which would
undermine the effectiveness of stress tests as the swap markets and
their clearing members continue to evolve.\113\
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\113\ The Commission also notes that the approach taken in this
rule is consistent with the approach recently adopted by the
Commission for DCO stress tests. The Commission intends to monitor
to determine whether the tests conducted by clearing members are
reasonably designed for the types of risk the clearing members and
their customers face.
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The Commission considered FHLB's recommendation but believes that
public disclosure of stress test results could be a disincentive to
aggressive stress testing, which would undermine the intent of this
rule and the strength of the FCM's risk management program, and in so
doing, increase risk to the DCO. Moreover, disclosure of results could
have the effect of improper disclosure of confidential position
information. Last, additional rules have been enacted limiting the
range of assets in which FCMs can invest customer funds,\114\ and
requiring careful segregation of customer funds,\115\ both of which are
designed to protect customers in the event that an FCM should become
insolvent. With these considerations in view, the Commission has chosen
not to require FCMs to make the results of their stress tests public.
---------------------------------------------------------------------------
\114\ See Investment of Customer Funds and Funds Held in an
Account for Foreign Futures and Foreign Options Transactions, 76 FR
78776 (Dec. 19, 2011).
\115\ See Protection of Cleared Swaps Customer Contracts and
Collateral; Conforming Amendments to the Commodity Broker Bankruptcy
Provisions, 77 FR 6336 (Feb. 7, 2012).
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The CME commented that clearing members should only be required to
test lines of credit on an annual basis rather than a quarterly basis
because they believe that more frequent testing is not cost efficient.
ISDA inquired as to whether an institution must actually draw funds in
order to properly test a line of credit.
The Commission agrees that quarterly testing might not be cost
efficient in every situation, and therefore has established an annual
testing requirement in the Adopting Release. However, the Commission
encourages clearing members to test lines of credit more frequently
based on any developments that might impact the ability of the lender
to provide the line of credit, or the clearing member's ability to
access it in a timely manner. Various market events, credit events, and
operational changes could lead to a situation where testing lines of
credit would be appropriate. For example, if, the clearing member
changes personnel or reorganizes in a manner that changes the
individuals who would be responsible for accessing the credit line, the
Commission believes that it would be beneficial to test lines of
credit.
The Commission believes that the actual drawing of funds is
essential to testing a line of credit. Among other things, the test
should ensure the ability of the bank or other institution to move the
funds in a timely fashion, which is likely to be particularly important
at times when the firm most needs the additional liquidity provided by
the line of credit.
VII. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires that agencies
consider whether the regulations they propose will have a significant
economic impact on a substantial number of small entities.\116\ The
final rules set forth in this release would affect FCMs, SDs, MSPs,
DCOs, DCMs, and SEFs. The Commission has already established certain
definitions of ``small entities'' to be used in evaluating the impact
of its rules on such entities in accordance with the RFA.
---------------------------------------------------------------------------
\116\ 5 U.S.C. 601 et seq.
---------------------------------------------------------------------------
In the Commission's ``Policy Statement and Establishment of
Definitions of `Small Entities' for Purposes of the Regulatory
Flexibility Act,'' \117\ the Commission concluded that registered FCMs
should not be considered to be small entities for purposes of the RFA.
The Commission's determination in this regard was based, in part, upon
the obligation of registered FCMs to meet the capital requirements
established by the Commission. Likewise, the Commission determined
``that, for the basic purpose of protection of the financial integrity
of futures trading, Commission regulations can make no size distinction
among registered FCMs.'' \118\ Thus, with respect to registered FCMs,
the Commission believes that the final rules will not have a
significant economic impact on a substantial number of small entities.
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\117\ 47 FR 18618 (Apr. 30, 1982).
\118\ Id. at 18619.
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Like FCMs, SDs will be subject to minimum capital and margin
requirements, and are expected to comprise the largest global firms.
Moreover, the Commission is required to exempt from designation as an
SD any entity that engages in a de minimis level of swaps dealing in
connection with transactions with or on behalf of customers. Based, in
part, on that rationale, the Commission previously has determined that
SDs should not be considered to be ``small entities'' for purposes of
the RFA.\119\ Thus, with respect to SDs, the Commission believes that
the final rules will not have a significant economic impact on a
substantial number of small entities.
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\119\ See ``Registration of Swap Dealers and Major Swap
Participants,'' 77 FR 2613, 2620 (Jan. 19, 2012); ``Business Conduct
Standards for Swap Dealers and Major Swap Participants with
Counterparties,'' 77 FR 9734, 9803-04 (Feb. 17, 2012).
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Further, the Commission previously has determined that large
traders are not ``small entities'' for RFA purposes, with the
Commission considering the size of a trader's position to be the only
appropriate test for the purpose of large trader reporting. The
Commission similarly has noted that MSPs, by definition, will maintain
substantial positions in swaps, creating substantial counterparty
exposure that could have serious adverse effects on the financial
stability of the United States banking system or financial markets.
Based, in part, on those facts, the Commission previously has
determined that MSPs should not be considered to be ``small entities''
for purposes of the RFA.\120\
[[Page 21303]]
Thus, with respect to MSPs, the Commission believes that the final
rules will not have a significant economic impact on a substantial
number of small entities.\121\
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\120\ Id.
\121\ In a recent rulemaking, the Commission discussed the
applicability of the RFA with respect to SDs and MSPs as follows:
``The Commission is carrying out Congressional mandates by proposing
these rules. The Commission is incorporating registration of SDs and
MSPs into the existing registration structure applicable to other
registrants. In so doing, the Commission has attempted to accomplish
registration of SDs and MSPs in the manner that is least disruptive
to ongoing business and most efficient and expeditious, consistent
with the public interest, and accordingly believes that these
registration rules will not present a significant economic burden on
any entity subject thereto.'' ``Swap Dealer and Major Swap
Participant Recordkeeping and Reporting, Duties, and Conflicts of
Interest Policies and Procedures; Futures Commission Merchant and
Introducing Broker Conflicts of Interest Policies and Procedures;
Swap Dealer, Major Swap Participant, and Futures Commission Merchant
Chief Compliance Officer,'' available at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312b.
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Certain of the final rules set forth in this release will affect
DCMs, SEFs, and DCOs, some of which will be designated as systemically
important DCOs. The Commission previously has determined that DCMs,
SEFs, and DCOs are not ``small entities'' for purposes of the RFA.\122\
In determining that these registered entities are not ``small
entities,'' the Commission reasoned that it designates a contract
market, or registers a DCO or SEF, only if the entity meets a number of
specific criteria, including the expenditure of sufficient resources to
establish and maintain an adequate self-regulatory program.\123\
Because DCMs, SEFs, and DCOs are required to demonstrate compliance
with Core Principles, including principles concerning the maintenance
or expenditure of financial resources, the Commission determined that
such registered entities are not ``small entities'' for the purposes of
the RFA. Thus, with respect to DCMs, SEFs, and DCOs, the Commission
believes that the final rules will not have a significant economic
impact on a substantial number of small entities.
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\122\ 76 FR 44776, 44789 (July 27, 2011) (``Provisions Common to
Registered Entities''); see 66 FR 45604, 45609 (Aug. 29, 2001); 47
FR 18618, 18619 (Apr. 30, 1982).
\123\ See, e.g., Core Principle 2 applicable to SEFs under
Section 733 of the Dodd-Frank Act.
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Accordingly, pursuant to Section 605(b) of the RFA, 5 U.S.C.
605(b), the Chairman, on behalf of the Commission, certifies that these
rules and rule amendments will not have a significant economic impact
on a substantial number of small entities.
B. Paperwork Reduction Act
1. Customer Clearing Documentation
Pursuant to the Paperwork Reduction Act (``PRA''),\124\ the
Commission may not conduct or sponsor, and a registrant is not required
to respond to, a collection of information unless it displays a
currently valid Office of Management and Budget (``OMB'') control
number. The final rules set forth in this Adopting Release relating to
Customer Clearing Documentation will result in new collection of
information requirements within the meaning of the PRA.
---------------------------------------------------------------------------
\124\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
Accordingly, the Commission requested control numbers for the
required collection of information. The Commission has submitted this
notice of final rulemaking along with supporting documentation for
OMB's review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.
The title for this collection of information is ``Customer Clearing
Documentation and Timing of Acceptance for Clearing.'' The OMB has
assigned this collection control number 3038-0092.
The collection of information under these regulations is necessary
to implement certain provisions of the CEA, as amended by the Dodd-
Frank Act. Specifically, it is essential to reducing risk and fostering
open access to clearing and execution of customer transactions on a DCM
or SEF on terms that have a reasonable relationship to the best terms
available by prohibiting restrictions in customer clearing
documentation of SDs, MSPs, FCMs, or DCOs that could delay or block
access to clearing, increase costs, and reduce market efficiency by
limiting the number of counterparties available for trading. These
regulations are also crucial both for effective risk management and for
the efficient operation of trading venues among SDs, MSPs, FCMs, and
DCOs.
Many responses to this collection of information will be mandatory.
The Commission protects proprietary information according to the
Freedom of Information Act 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.'' The Commission is also
required to protect certain information contained in a government
system of records according to the Privacy Act of 1974, 5 U.S.C. 552a.
a. Information Provided by Reporting Entities/Persons
SDs, MSPs, FCMs, and DCOs will be required to develop and maintain
written customer clearing documentation in compliance with Sec. Sec.
1.72, 23.608, and 39.12. Section 39.12(b)(7)(i)(B) requires DCOs to
coordinate with clearing members to establish systems for prompt
processing of trades. Sections 1.74(a) and 23.610(a) require reciprocal
coordination with DCOs by FCMs, SDs, and MSPs that are clearing
members.
The annual burden associated with these regulations is estimated to
be 16 hours, at an annual cost of $1,600 for each FCM, SD, and MSP.
Burden means the total time, effort, or financial resources expended by
persons to generate, maintain, retain, disclose, or provide information
to or for a federal agency. The Commission has characterized the annual
costs as initial costs because the Commission anticipates that the cost
burdens will be reduced dramatically over time as the documentation and
procedures required by these regulations become increasingly
standardized within the industry.
Sections 1.72 and 23.608 require each FCM, SD, and MSP to ensure
compliance with these regulations. Maintenance of contracts is prudent
business practice and the Commission anticipates that SDs and MSPs
already maintain some form of this documentation. Additionally, the
Commission believes that much of the existing customer clearing
documentation already complies with these rules, and therefore that
compliance will require a minimal burden.
In addition to the above, the Commission anticipates that FCMs,
SDs, and MSPs will spend an average of another 16 hours per year
drafting and, as needed, updating customer clearing documentation to
ensure compliance required by Sec. Sec. 1.72 and 23.608.
For each DCO, the annual burden associated with these regulations
is estimated to be 40 hours, at an annual cost of $4,000. Burden means
the total time, effort, or financial resources expended by persons to
generate, maintain, retain, disclose, or provide information to or for
a federal agency. The Commission has characterized the annual costs as
initial costs because the Commission anticipates that the cost burdens
will be reduced dramatically over time as the documentation and
procedures required by the regulations
[[Page 21304]]
are implemented. Any additional expenditure related to Sec. 39.12
likely would be limited to the time required to review--and, as needed,
amend--existing documentation and procedures.
Section 39.12(b)(7) requires each DCO to coordinate with clearing
members to establish systems for prompt processing of trades. The
Commission believes that this is currently a practice of DCOs.
Accordingly, any additional expenditure related to Sec. 39.12(b)(7)
likely would be limited to the time initially required to review--and,
as needed, amend--existing trade processing procedures to ensure that
they conform to all of the required elements and to coordinate with
FCMs, SDs, and MSPs to establish reciprocal procedures.
The Commission anticipates that DCOs will spend an average of 20
hours per year drafting--and, as needed, updating--the written policies
and procedures to ensure compliance required by Sec. 39.12, and 20
hours per year coordinating with FCMs, SDs, and MSPs on reciprocal
procedures.
The hour burden calculations below are based upon a number of
variables such as the number of FCMs, SDs, MSPs, and DCOs in the
marketplace and the average hourly wage of the employees of these
registrants that would be responsible for satisfying the obligations
established by the proposed regulation.
There are currently 134 FCMs and 14 DCOs based on industry data.
SDs and MSPs are new categories of registrants. Accordingly, it is not
currently known how many SDs and MSPs will become subject to these
rules, and this will not be known to the Commission until the
registration requirements for these entities become effective. The
Commission believes there will be approximately 125 SDs and MSPs who
will be required to comply with the recordkeeping requirements of the
proposed rules. The Commission estimated the number of affected
entities based on industry data.
According to recent Bureau of Labor Statistics, the mean hourly
wage of an employee under occupation code 11-3031, ``Financial
Managers,'' (which includes operations managers) that is employed by
the ``Securities and Commodity Contracts Intermediation and Brokerage''
industry is $74.41.\125\ Because SDs, MSPs, FCMs, and DCOs include
large financial institutions whose operations management employees'
salaries may exceed the mean wage, the Commission has estimated the
cost burden of these proposed regulations based upon an average salary
of $100 per hour.
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\125\ http://www.bls.gov/oes/current/oes113031.htm.
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Accordingly, the estimated hour burden was calculated as follows:
Developing Written Procedures for Compliance, and Maintaining
Records Documenting Compliance for SDs and MSPs. This hourly burden
arises from the requirement that SDs and MSPs make and maintain records
documenting compliance related to client clearing documentation.
Number of registrants: 125.
Frequency of collection: As needed.
Estimated number of annual responses per registrant: 1.
Estimated aggregate number of annual responses: 125.
Estimated annual hour burden per registrant: 16 hours.
Estimated aggregate annual hour burden: 2,000 burden hours [125
registrants x 16 hours per registrant].
Developing Written Procedures for Compliance, and Maintaining
Records Documenting Compliance for FCMs. This hourly burden arises from
the requirement that FCMs make and maintain records documenting
compliance related to client clearing documentation.
Number of registrants: 134.
Frequency of collection: As needed.
Estimated number of annual responses per registrant: 1.
Estimated aggregate number of annual responses: 134.
Estimated annual hour burden per registrant: 16 hours.
Estimated aggregate annual hour burden: 2,144 burden hours [134
registrants x 16 hours per registrant].
Drafting and Updating Trade Processing Procedures for DCOs. This
hour burden arises from the time necessary to develop and periodically
update the trade processing procedures required by the regulations.
Number of registrants: 14.
Frequency of collection: Initial drafting, updating as needed.
Estimated number of annual responses per registrant: 1.
Estimated aggregate number of annual responses: 14.
Estimated annual hour burden per registrant: 40 hours.
Estimated aggregate annual hour burden: 560 burden hours [14
registrants x 40 hours per registrant].
Based upon the above, the aggregate hour burden cost for all
registrants is 4,704 burden hours and $470,400 [4,704 x $100 per hour].
2. Time Frames for Acceptance into Clearing
The Commission believes that the final rules set forth in this
Adopting Release relating to the Time Frames for Acceptance into
Clearing will not impose any new information collection requirements
that require approval of OMB under the PRA.
3. Clearing Member Risk Management
The final rules contained in this Adopting Release relating to
Clearing Member Risk Management will result in new collection of
information requirements within the meaning of the PRA. Accordingly,
the Commission requested control numbers for the required collection of
information. The Commission has submitted this notice of final
rulemaking along with supporting documentation for OMB's review in
accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The title for this
collection of information is ``Clearing Member Risk Management.'' An
agency may not conduct or sponsor, and a person is not required to
respond to, a collection of information unless it displays a currently
valid control number. The OMB has assigned this collection control
number 3038-0094.
The collection of information under these regulations is necessary
to implement certain provisions of the CEA, as amended by the Dodd-
Frank Act. Specifically, it is essential both for effective risk
management and for the efficient operation of trading venues on which
SDs, MSPs, and FCMs participate. The position risk management
requirement established by the rules diminishes the chance for a
default, thus ensuring the financial integrity of markets as well as
customer protection.
Responses to this collection of information will be mandatory. The
Commission protects proprietary information according to the Freedom of
Information Act 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.'' The Commission is also
required to protect certain information contained in a government
system of records according to the Privacy Act of 1974, 5 U.S.C. 552a.
a. Information Provided by Reporting Entities/Persons
SDs, MSPs, and FCMs will be required to develop and monitor
procedures for position risk management in accordance with Sec. Sec.
1.73 and 23.609.
[[Page 21305]]
The annual burden associated with these regulations is estimated to
be 524 hours, at an annual cost of $52,400 for each FCM, SD, and MSP.
Burden means the total time, effort, or financial resources expended by
persons to generate, maintain, retain, disclose, or provide information
to or for a federal agency. The Commission has characterized the annual
costs as initial costs because the Commission anticipates that the cost
burdens will be reduced dramatically over time as the documentation and
procedures required by the regulations become increasingly standardized
within the industry.
This hourly burden primarily results from the position risk
management obligations that will be imposed by Sec. Sec. 1.73 and
23.609. Sections 1.73 and 23.609 will require each FCM, SD, and MSP to
establish and enforce procedures to establish risk-based limits,
conduct stress testing, evaluate the ability to meet initial and
variation margin, test lines of credit, and evaluate the ability to
liquidate, in an orderly manner, the positions in the proprietary and
customer accounts and estimate the cost of the liquidation. The
Commission believes that each of these items is currently an element of
existing risk management programs at a DCO or an FCM. Accordingly, any
additional expenditure related to Sec. Sec. 1.73 and 23.609 likely
will be limited to the time initially required to review and, as
needed, amend, existing risk management procedures to ensure that they
encompass all of the required elements and to develop a system for
performing these functions as often as required.
In addition, Sec. Sec. 1.73 and 23.609 will require each FCM, SD,
and MSP to establish written procedures to comply, and maintain records
documenting compliance. Maintenance of compliance procedures and
records of compliance is prudent business practice and the Commission
anticipates that FCMs, SDs, and MSPs already maintain some form of this
documentation.
With respect to the required position risk management, the
Commission estimates that FCMs, SDs, and MSPs will spend an average of
2 hours per trading day, or 504 hours per year, performing the required
tests. The Commission notes that the specific information required for
these tests is of the type that would be performed in a prudent market
participant's ordinary course of business.
In addition to the above, the Commission anticipates that FCMs,
SDs, and MSPs will spend an average of 16 hours per year drafting and,
as needed, updating the written policies and procedures to ensure
compliance required by Sec. Sec. 1.73 and 23.609, and 4 hours per year
maintaining records of the compliance.
The hour burden calculations below are based upon a number of
variables such as the number of FCMs, SDs, and MSPs in the marketplace
and the average hourly wage of the employees of these registrants that
will be responsible for satisfying the obligations established by the
regulations.
There are currently 134 FCMs based on industry data. SDs and MSPs
are new categories of registrants. Accordingly, it is not currently
known how many SDs and MSPs will become subject to these rules, and
this will not be known to the Commission until the registration
requirements for these entities become effective. The Commission
believes there will be approximately 125 SDs and MSPs who will be
required to comply with the recordkeeping requirements of the proposed
rules. The Commission estimated the number of affected entities based
on industry data.
According to recent Bureau of Labor Statistics, the mean hourly
wage of an employee under occupation code 11-3031, ``Financial
Managers,'' (which includes operations managers) that is employed by
the ``Securities and Commodity Contracts Intermediation and Brokerage''
industry is $74.41.\126\ Because SDs, MSPs, and FCMs include large
financial institutions whose operations management employees' salaries
may exceed the mean wage, the Commission has estimated the cost burden
of these regulations based upon an average salary of $100 per hour.
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Accordingly, the estimated hour burden was calculated as follows:
Developing and Conducting Position Risk Management Procedures for
SDs and MSPs. This hourly burden arises from the requirement that SDs
and MSPs establish and perform testing of clearing member risk
management procedures.
Number of registrants: 125.
Frequency of collection: Daily.
Estimated number of responses per registrant: 252 [252 trading
days].
Estimated aggregate number of responses: 31,500 [125 registrants x
252 trading days].
Estimated annual burden per registrant: 504 hours [252 trading days
x 2 hours per record].
Estimated aggregate annual hour burden: 63,000 hours [125
registrants x 252 trading days x 2 hours per record].
Developing Written Procedures for Compliance, and Maintaining
Records Documenting Compliance for SDs and MSPs. This hourly burden
arises from the requirement that SDs and MSPs make and maintain records
documenting compliance related to clearing member risk management.
Number of registrants: 125.
Frequency of collection: As needed.
Estimated number of annual responses per registrant: 1.
Estimated aggregate number of annual responses: 125.
Estimated annual hour burden per registrant: 20 hours.
Estimated aggregate annual hour burden: 2,500 burden hours [125
registrants x 20 hours per registrant].
Developing and Conducting Position Risk Management Procedures for
FCMs. This hourly burden arises from the requirement that FCMs
establish and perform testing of clearing member risk management
procedures.
Number of registrants: 134.
Frequency of collection: Daily.
Estimated number of responses per registrant: 252 [252 trading
days].
Estimated aggregate number of responses: 33,768 [134 registrants x
252 trading days].
Estimated annual burden per registrant: 504 hours [252 trading days
x 2 hours per record].
Estimated aggregate annual hour burden: 67,536 hours [134
registrants x 252 trading days x 2 hours per record].
Developing Written Procedures for Compliance, and Maintaining
Records Documenting Compliance for FCMs. This hourly burden arises from
the requirement that FCMs make and maintain records documenting
compliance related to clearing member risk management.
Number of registrants: 134.
Frequency of collection: As needed.
Estimated number of annual responses per registrant: 1.
Estimated aggregate number of annual responses: 134.
Estimated annual hour burden per registrant: 20 hours.
Estimated aggregate annual hour burden: 2,680 burden hours [134
registrants x 20 hours per registrant].
Based upon the above, the aggregate hour burden cost for all
registrants is 135,716 burden hours and $13,571,600 [227,416 x $100 per
hour].
In addition to the per hour burden discussed above, the Commission
anticipates that SDs, MSPs, and FCMs may incur certain start-up costs
in connection with the recordkeeping obligations. Such costs may
include the expenditures related to re-programming or updating existing
recordkeeping technology and systems to enable the SD, MSP, or FCM to
collect, capture,
[[Page 21306]]
process, maintain, and re-produce any newly required records. The
Commission believes that SDs, MSPs, and FCMs generally could adapt
their current infrastructure to accommodate the new or amended
technology and thus no significant infrastructure expenditures would be
needed. The Commission estimates the programming burden hours
associated with technology improvements to be 60 hours.
According to recent Bureau of Labor Statistics, the mean hourly
wages of computer programmers under occupation code 15-1021 and
computer software engineers under program codes 15-1031 and 1032 are
between $34.10 and $44.94.\127\ Because SDs, MSPs, and FCMs generally
will be large entities that may engage employees with wages above the
mean, the Commission has conservatively chosen to use a mean hourly
programming wage of $60 per hour. Accordingly, the start-up burden
associated with the required technological improvements is $3,600 [$60
x 60 hours] per affected registrant or $932,400 [$3,600 x 259
registrants] in the aggregate.
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List of Subjects
17 CFR Part 1
Conflicts of interest, Futures commission merchants, Major swap
participants, Swap dealers.
17 CFR Part 23
Conflicts of interests, Futures commission merchants, Major swap
participants, Swap dealers.
17 CFR Part 37
Swaps, Swap execution facilities.
17 CFR Part 38
Block transaction, Commodity futures, Designated contract markets,
Transactions off the centralized market.
17 CFR Part 39
Derivatives clearing organizations, Risk management, Swaps.
For the reasons stated in the preamble, amend 17 CFR parts 1, 23,
37, 38, and 39 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. Amend Sec. 1.35 by revising paragraph (a-1)(5)(iv) to read as
follows:
Sec. 1.35 Records of commodity interest and cash commodity
transactions.
* * * * *
(a-1) * * *
(5) * * *
(iv) Allocation. Orders eligible for post-execution allocation must
be allocated by an eligible account manager in accordance with the
following:
(A) Allocations must be made as soon as practicable after the
entire transaction is executed, but in any event no later than the
following times: For cleared trades, account managers must provide
allocation information to futures commission merchants no later than a
time sufficiently before the end of the day the order is executed to
ensure that clearing records identify the ultimate customer for each
trade. For uncleared trades, account managers must provide allocation
information to the counterparty no later than the end of the calendar
day that the swap was executed.
(B) Allocations must be fair and equitable. No account or group of
accounts may receive consistently favorable or unfavorable treatment.
(C) The allocation methodology must be sufficiently objective and
specific to permit independent verification of the fairness of the
allocations using that methodology by appropriate regulatory and self-
regulatory authorities and by outside auditors.
* * * * *
0
3. Add Sec. 1.72 to read as follows:
Sec. 1.72 Restrictions on customer clearing arrangements.
No futures commission merchant providing clearing services to
customers shall enter into an arrangement that:
(a) Discloses to the futures commission merchant or any swap dealer
or major swap participant the identity of a customer's original
executing counterparty;
(b) Limits the number of counterparties with whom a customer may
enter into a trade;
(c) Restricts the size of the position a customer may take with any
individual counterparty, apart from an overall limit for all positions
held by the customer at the futures commission merchant;
(d) Impairs a customer's access to execution of a trade on terms
that have a reasonable relationship to the best terms available; or
(e) Prevents compliance with the timeframes set forth in Sec.
1.74(b), Sec. 23.610(b), or Sec. 39.12(b)(7) of this chapter.
0
4. Add Sec. 1.73 to read as follows:
Sec. 1.73 Clearing futures commission merchant risk management.
(a) Each futures commission merchant that is a clearing member of a
derivatives clearing organization shall:
(1) Establish risk-based limits in the proprietary account and in
each customer account based on position size, order size, margin
requirements, or similar factors;
(2) Screen orders for compliance with the risk-based limits in
accordance with the following:
(i) When a clearing futures commission merchant provides electronic
market access or accepts orders for automated execution, it shall use
automated means to screen orders for compliance with the limits;
(ii) When a clearing futures commission merchant accepts orders for
non-automated execution, it shall establish and maintain systems of
risk controls reasonably designed to ensure compliance with the limits;
(iii) When a clearing futures commission merchant accepts
transactions that were executed bilaterally and then submitted for
clearing, it shall establish and maintain systems of risk management
controls reasonably designed to ensure compliance with the limits;
(iv) When a firm executes an order on behalf of a customer but
gives it up to another firm for clearing,
(A) The clearing futures commission merchant shall establish risk-
based limits for the customer, and enter into an agreement in advance
with the executing firm that requires the executing firm to screen
orders for compliance with those limits in accordance with paragraph
(a)(2)(i) or (ii) as applicable; and
(B) The clearing futures commission merchant shall establish and
maintain systems of risk management controls reasonably designed to
ensure compliance with the limits.
(v) When an account manager bunches orders on behalf of multiple
customers for execution as a block and post-trade allocation to
individual accounts for clearing:
(A) The futures commission merchant that initially clears the block
shall establish risk-based limits for the block account and screen the
order in accordance with paragraph (a)(2)(i) or (ii) as applicable;
(B) The futures commission merchants that clear the allocated
trades
[[Page 21307]]
on behalf of customers shall establish risk-based limits for each
customer and enter into an agreement in advance with the account
manager that requires the account manager to screen orders for
compliance with those limits; and
(C) The futures commission merchants that clear the allocated
trades on behalf of customers shall establish and maintain systems of
risk management controls reasonably designed to ensure compliance with
the limits.
(3) Monitor for adherence to the risk-based limits intra-day and
overnight;
(4) Conduct stress tests under extreme but plausible conditions of
all positions in the proprietary account and in each customer account
that could pose material risk to the futures commission merchant at
least once per week;
(5) Evaluate its ability to meet initial margin requirements at
least once per week;
(6) Evaluate its ability to meet variation margin requirements in
cash at least once per week;
(7) Evaluate its ability to liquidate, in an orderly manner, the
positions in the proprietary and customer accounts and estimate the
cost of the liquidation at least once per quarter; and
(8) Test all lines of credit at least once per year.
(b) Each futures commission merchant that is a clearing member of a
derivatives clearing organization shall:
(1) Establish written procedures to comply with this regulation;
and
(2) Keep full, complete, and systematic records documenting its
compliance with this regulation.
(3) All records required to be maintained pursuant to these
regulations shall be maintained in accordance with Commission
Regulation 1.31 (17 CFR 1.31) and shall be made available promptly upon
request to representatives of the Commission and to representatives of
applicable prudential regulators.
0
5. Add Sec. 1.74 to read as follows:
Sec. 1.74 Futures commission merchant acceptance for clearing.
(a) Each futures commission merchant that is a clearing member of a
derivatives clearing organization shall coordinate with each
derivatives clearing organization on which it clears to establish
systems that enable the futures commission merchant, or the derivatives
clearing organization acting on its behalf, to accept or reject each
trade submitted to the derivatives clearing organization for clearing
by or for the futures commission merchant or a customer of the futures
commission merchant as quickly as would be technologically practicable
if fully automated systems were used; and
(b) Each futures commission merchant that is a clearing member of a
derivatives clearing organization shall accept or reject each trade
submitted by or for it or its customers as quickly as would be
technologically practicable if fully automated systems were used; a
clearing futures commission merchant may meet this requirement by:
(1) Establishing systems to pre-screen orders for compliance with
criteria specified by the clearing futures commission merchant;
(2) Establishing systems that authorize a derivatives clearing
organization to accept or reject on its behalf trades that meet, or
fail to meet, criteria specified by the clearing futures commission
merchant; or
(3) Establishing systems that enable the clearing futures
commission merchant to communicate to the derivatives clearing
organization acceptance or rejection of each trade as quickly as would
be technologically practicable if fully automated systems were used.
0
6. Add Sec. 1.75 to read as follows:
Sec. 1.75 Delegation of authority to the Director of the Division of
Clearing and Risk to establish an alternative compliance schedule to
comply with futures commission merchant acceptance for clearing.
(a) The Commission hereby delegates to the Director of the Division
of Clearing and Risk or such other employee or employees as the
Director may designate from time to time, the authority to establish an
alternative compliance schedule for requirements of Sec. 1.74 for
swaps that are found to be technologically or economically
impracticable for an affected futures commission merchant that seeks,
in good faith, to comply with the requirements of Sec. 1.74 within a
reasonable time period beyond the date on which compliance by such
futures commission merchant is otherwise required.
(b) A request for an alternative compliance schedule under this
section shall be acted upon by the Director of the Division of Clearing
and Risk within 30 days from the time such a request is received, or it
shall be deemed approved.
(c) An exception granted under this section shall not cause a
registrant to be out of compliance or deemed in violation of any
registration requirements.
(d) Notwithstanding any other provision of this section, in any
case in which a Commission employee delegated authority under this
section believes it appropriate, he or she may submit to the Commission
for its consideration the question of whether an alternative compliance
schedule should be established. Nothing in this section shall be deemed
to prohibit the Commission, at its election, from exercising the
authority delegated in this section.
PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS
0
7. Revise the authority citation for part 23 to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,
9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.
0
8. Add subpart I to read as follows:
Subpart I--Swap Documentation
Sec.
23.500-23.505 [Reserved]
23.506 Swap processing and clearing.
Subpart I--Swap Documentation
Sec. Sec. 23.500-23.505 [Reserved]
Sec. 23.506 Swap processing and clearing.
(a) Swap processing. (1) Each swap dealer and major swap
participant shall ensure that it has the capacity to route swap
transactions not executed on a swap execution facility or designated
contract market to a derivatives clearing organization in a manner
acceptable to the derivatives clearing organization for the purposes of
clearing; and
(2) Each swap dealer and major swap participant shall coordinate
with each derivatives clearing organization to which the swap dealer,
major swap participant, or its clearing member submits transactions for
clearing, to facilitate prompt and efficient swap transaction
processing in accordance with the requirements of Sec. 39.12(b)(7) of
this chapter.
(b) Swap clearing. With respect to each swap that is not executed
on a swap execution facility or a designated contract market, each swap
dealer and major swap participant shall:
(1) If such swap is subject to a mandatory clearing requirement
pursuant to section 2(h)(1) of the Act and an exception pursuant to
2(h)(7) is not applicable, submit such swap for clearing to a
derivatives clearing organization as soon as technologically
practicable after execution of the swap, but no later than the close of
business on the day of execution; or
(2) If such swap is not subject to a mandatory clearing requirement
pursuant to section 2(h)(1) of the Act but is accepted for clearing by
any derivatives clearing organization and
[[Page 21308]]
the swap dealer or major swap participant and its counterparty agree
that such swap will be submitted for clearing, submit such swap for
clearing not later than the next business day after execution of the
swap, or the agreement to clear, if later than execution.
0
9. Add Sec. 23.608 to subpart J, as added at 77 FR 20128, April 3,
2012, effective June 4, 2012, to read as follows:
Sec. 23.608 Restrictions on counterparty clearing relationships.
No swap dealer or major swap participant entering into a swap to be
submitted for clearing with a counterparty that is a customer of a
futures commission merchant shall enter into an arrangement that:
(a) Discloses to the futures commission merchant or any swap dealer
or major swap participant the identity of a customer's original
executing counterparty;
(b) Limits the number of counterparties with whom a customer may
enter into a trade;
(c) Restricts the size of the position a customer may take with any
individual counterparty, apart from an overall limit for all positions
held by the customer with the swap dealer or major swap participant;
(d) Impairs a customer's access to execution of a trade on terms
that have a reasonable relationship to the best terms available; or
(e) Prevents compliance with the timeframes set forth in Sec.
1.74(b), Sec. 23.610(b), or Sec. 39.12(b)(7) of this chapter.
0
10. Add Sec. 23.609 to subpart J, as added at 77 FR 20128, April 3,
2012, effective June 4, 2012, to read as follows:
Sec. 23.609 Clearing member risk management.
(a) With respect to clearing activities in futures, security
futures products, swaps, agreements, contracts, or transactions
described in section 2(c)(2)(C)(i) or section 2(c)(2)(D)(i) of the Act,
commodity options authorized under section 4c of the Act, or leveraged
transactions authorized under section 19 of the Act, each swap dealer
or major swap participant that is a clearing member of a derivatives
clearing organization shall:
(1) Establish risk-based limits based on position size, order size,
margin requirements, or similar factors;
(2) Screen orders for compliance with the risk-based limits in
accordance with the following:
(i) For transactions subject to automated execution, the clearing
member shall use automated means to screen orders for compliance with
the risk-based limits; and
(ii) For transactions subject to non-automated execution, the
clearing member shall establish and maintain systems of risk controls
reasonably designed to ensure compliance with the limits.
(3) Monitor for adherence to the risk-based limits intra-day and
overnight;
(4) Conduct stress tests under extreme but plausible conditions of
all positions at least once per week;
(5) Evaluate its ability to meet initial margin requirements at
least once per week;
(6) Evaluate its ability to meet variation margin requirements in
cash at least once per week;
(7) Evaluate its ability to liquidate the positions it clears in an
orderly manner, and estimate the cost of the liquidation; and
(8) Test all lines of credit at least once per year.
(b) Each swap dealer or major swap participant that is a clearing
member of a derivatives clearing organization shall:
(1) Establish written procedures to comply with this regulation;
and
(2) Keep full, complete, and systematic records documenting its
compliance with this regulation.
(3) All records required to be maintained pursuant to these
regulations shall be maintained in accordance with Commission
Regulation Sec. 1.31 and shall be made available promptly upon request
to representatives of the Commission and to representatives of
applicable prudential regulators.
0
11. Add Sec. 23.610 to subpart J, as added at 77 FR 20128, April 3,
2012, effective June 4, 2012, to read as follows:
Sec. 23.610 Clearing member acceptance for clearing.
(a) Each swap dealer or major swap participant that is a clearing
member of a derivatives clearing organization shall coordinate with
each derivatives clearing organization on which it clears to establish
systems that enable the clearing member, or the derivatives clearing
organization acting on its behalf, to accept or reject each trade
submitted to the derivatives clearing organization for clearing by or
for the clearing member as quickly as would be technologically
practicable if fully automated systems were used; and
(b) Each swap dealer or major swap participant that is a clearing
member of a derivatives clearing organization shall accept or reject
each trade submitted by or for it as quickly as would be
technologically practicable if fully automated systems were used; a
clearing member may meet this requirement by:
(1) Establishing systems to pre-screen orders for compliance with
criteria specified by the clearing member;
(2) Establishing systems that authorize a derivatives clearing
organization to accept or reject on its behalf trades that meet, or
fail to meet, criteria specified by the clearing member; or
(3) Establishing systems that enable the clearing member to
communicate to the derivatives clearing organization acceptance or
rejection of each trade as quickly as would be technologically
practicable if fully automated systems were used.
0
12. Add Sec. 23.611 to subpart J, as added at 77 FR 20128, April 3,
2012, effective June 4, 2012, to read as follows:
Sec. 23.611 Delegation of authority to the Director of the Division
of Clearing and Risk to establish an alternative compliance schedule to
comply with clearing member acceptance for clearing.
(a) The Commission hereby delegates to the Director of the Division
of Clearing and Risk or such other employee or employees as the
Director may designate from time to time, the authority to establish an
alternative compliance schedule for requirements of Sec. 23.610 for
swaps that are found to be technologically or economically
impracticable for an affected swap dealer or major swap participant
that seeks, in good faith, to comply with the requirements of Sec.
23.610 within a reasonable time period beyond the date on which
compliance by such swap dealer or major swap participant is otherwise
required.
(b) A request for an alternative compliance schedule under this
section shall be acted upon by the Director of the Division of Clearing
and Risk within 30 days from the time such a request is received, or it
shall be deemed approved.
(c) An exception granted under this section shall not cause a
registrant to be out of compliance or deemed in violation of any
registration requirements.
(d) Notwithstanding any other provision of this section, in any
case in which a Commission employee delegated authority under this
section believes it appropriate, he or she may submit to the Commission
for its consideration the question of whether an alternative compliance
schedule should be established. Nothing in this section shall be deemed
to prohibit the Commission, at its election, from exercising the
authority delegated in this section.
[[Page 21309]]
0
13-14. Revise part 37 to read as follows:
PART 37--SWAP EXECUTION FACILITIES
Sec.
Subparts A-G [Reserved]
Subpart H--Financial Integrity of Transactions
37.700 [Reserved]
37.701 [Reserved]
37.702 General financial integrity.
37.703 [Reserved]
Subparts I-K [Reserved]
Authority: 7 U.S.C. 1a, 2, 5, 6, 6c, 7, 7a-2, 7b-3 and 12a, as
amended by the Dodd-Frank Wall Street Reform and Consumer Protection
Act, Pub. L. 111-203, 124 Stat. 1376.
Subparts A-G [Reserved]
Subpart H--Financial Integrity of Transactions
Sec. 37.700 [Reserved]
Sec. 37.701 [Reserved]
Sec. 37.702 General financial integrity.
(a) [Reserved]
(b) For transactions cleared by a derivatives clearing
organization:
(1) By ensuring that the swap execution facility has the capacity
to route transactions to the derivatives clearing organization in a
manner acceptable to the derivatives clearing organization for purposes
of clearing; and
(2) By coordinating with each derivatives clearing organization to
which it submits transactions for clearing, in the development of rules
and procedures to facilitate prompt and efficient transaction
processing in accordance with the requirements of Sec. 39.12(b)(7) of
this chapter.
Sec. 37.703 [Reserved]
Subparts I-K [Reserved]
PART 38--DESIGNATED CONTRACT MARKETS
0
15. Revise the authority citation for part 38 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.
0
16. Designate existing Sec. Sec. 38.1 through 38.6 as the contents of
added subpart A under the following heading:
Subpart A--General Provisions
* * * * *
0
17. Add subpart L to read as follows:
Subpart L--Financial Integrity of Transactions
Sec.
38.600 [Reserved]
38.601 Mandatory clearing.
38.602-38.606 [Reserved]
Subpart L--Financial Integrity of Transactions
Sec. 38.601 [Reserved]
Sec. 38.601 Mandatory clearing.
(a) Transactions executed on or through the designated contract
market, other than transactions in security futures products, must be
cleared through a registered derivatives clearing organization, in
accordance with the provisions of part 39 of this chapter.
(b) A designated contract market must coordinate with each
derivatives clearing organization to which it submits transactions for
clearing, in the development of rules and procedures to facilitate
prompt and efficient transaction processing in accordance with the
requirements of Sec. 39.12(b)(7) of this chapter.
Sec. Sec. 38.602-38.606 [Reserved]
PART 39--DERIVATIVES CLEARING ORGANIZATIONS
0
18. Revise the authority citation for part 39 to read as follows:
Authority: 7 U.S.C. 2, and 7a-1 as amended by the Dodd-Frank
Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, 124
Stat. 1376.
Subpart B--Compliance With Core Principles
0
19. In Sec. 39.12, add paragraphs (a)(1)(vi) and (b)(7) to read as
follows:
Sec. 39.12 Participant and product eligibility.
(a) * * *
(1) * * *
(vi) No derivatives clearing organization shall require as a
condition of accepting a swap for clearing that a futures commission
merchant enter into an arrangement with a customer that:
(A) Discloses to the futures commission merchant or any swap dealer
or major swap participant the identity of a customer's original
executing counterparty;
(B) Limits the number of counterparties with whom a customer may
enter into trades;
(C) Restricts the size of the position a customer may take with any
individual counterparty, apart from an overall limit for all positions
held by the customer at the futures commission merchant;
(D) Impairs a customer's access to execution of a trade on terms
that have a reasonable relationship to the best terms available; or
(E) Prevents compliance with the time frames set forth in Sec.
1.74(b), Sec. 23.610(b), or Sec. 39.12(b)(7) of this chapter.
* * * * *
(b) * * *
(7) Time frame for clearing. (i) Coordination with markets and
clearing members.
(A) Each derivatives clearing organization shall coordinate with
each designated contract market and swap execution facility that lists
for trading a product that is cleared by the derivatives clearing
organization in developing rules and procedures to facilitate prompt,
efficient, and accurate processing of all transactions submitted to the
derivatives clearing organization for clearing.
(B) Each derivatives clearing organization shall coordinate with
each clearing member that is a futures commission merchant, swap
dealer, or major swap participant to establish systems that enable the
clearing member, or the derivatives clearing organization acting on its
behalf, to accept or reject each trade submitted to the derivatives
clearing organization for clearing by or for the clearing member or a
customer of the clearing member as quickly as would be technologically
practicable if fully automated systems were used.
(ii) Transactions executed competitively on or subject to the rules
of a designated contract market or swap execution facility. A
derivatives clearing organization shall have rules that provide that
the derivatives clearing organization will accept or reject for
clearing as quickly after execution as would be technologically
practicable if fully automated systems were used, all contracts that
are listed for clearing by the derivatives clearing organization and
are executed competitively on or subject to the rules of a designated
contract market or a swap execution facility. The derivatives clearing
organization shall accept all trades:
(A) For which the executing parties have clearing arrangements in
place with clearing members of the derivatives clearing organization;
(B) For which the executing parties identify the derivatives
clearing organization as the intended clearinghouse; and
(C) That satisfy the criteria of the derivatives clearing
organization, including but not limited to applicable
[[Page 21310]]
risk filters; provided that such criteria are non-discriminatory across
trading venues and are applied as quickly as would be technologically
practicable if fully automated systems were used.
(iii) Swaps not executed on or subject to the rules of a designated
contract market or a swap execution facility or executed non-
competitively on or subject to the rules of a designated contract
market or a swap execution facility. A derivatives clearing
organization shall have rules that provide that the derivatives
clearing organization will accept or reject for clearing as quickly
after submission to the derivatives clearing organization as would be
technologically practicable if fully automated systems were used, all
swaps that are listed for clearing by the derivatives clearing
organization and are not executed on or subject to the rules of a
designated contract market or a swap execution facility or executed
non-competitively on or subject to the rules of a designated contract
market or a swap execution facility. The derivatives clearing
organization shall accept all trades:
(A) That are submitted by the parties to the derivatives clearing
organization, in accordance with Sec. 23.506 of this chapter;
(B) For which the executing parties have clearing arrangements in
place with clearing members of the derivatives clearing organization;
(C) For which the executing parties identify the derivatives
clearing organization as the intended clearinghouse; and
(D) That satisfy the criteria of the derivatives clearing
organization, including but not limited to applicable risk filters;
provided that such criteria are non-discriminatory across trading
venues and are applied as quickly as would be technologically
practicable if fully automated systems were used.
* * * * *
Issued in Washington, DC, on March 20, 2012, by the Commission.
David A. Stawick,
Secretary of the Commission.
Appendices to Customer Clearing Documentation, Timing of Acceptance for
Clearing, and Clearing Member Risk Management--Commission Voting
Summary and Statements of Commissioners
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendix 1--Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Sommers,
Chilton, and Wetjen voted in the affirmative; Commissioner O'Malia
voted in the negative.
Appendix 2--Statement of Chairman Gensler
I support today's final rulemaking on clearing which will
promote market participants' access to central clearing, increase
market transparency, foster competition, support market efficiency,
and bolster risk management. These rules include provisions on
client clearing documentation, so-called `straight-through'
processing, bunched orders, and clearing member risk management.
These final rules have all benefited from broad public comment.
One of the primary goals of the Dodd-Frank Wall Street Reform
and Consumer Protection Act (Dodd-Frank Act) is to lower risks to
the public by increasing the use of central clearing and to promote
the financial integrity of the markets and the clearing system.
These rules are an important step in furtherance of these goals.
First, the final rule does so by establishing requirements for
the documentation between a Futures Commission Merchant (FCM) and
its customers and between a Swap Dealer and its counterparties. This
rule will foster bilateral clearing arrangements between customers
and their FCM. The rule will promote competition in the provision of
clearing services and swap liquidity to the broad public by limiting
one FCM or Swap Dealer from restricting a customer or counterparty
access to other market participants.
Second, the final rule does so by setting standards for the
timely processing of trades through so-called `straight-through'
processing or sending transactions promptly to the clearinghouse
upon execution. This lowers risk to the markets by minimizing the
time between submission and acceptance or rejection of trades for
clearing. These regulations would require and establish uniform
standards for prompt processing, submission and acceptance for
clearing of swaps eligible for clearing. Such uniform standards,
similar to the practices in the futures markets, lower risk because
they allow market participants to get the prompt benefit of clearing
rather than having to first enter into a bilateral transaction that
would subsequently be moved into a clearinghouse.
Third, the final rule does so by allowing asset managers to
allocate bunched orders for swaps consistent with long established
rules for allocating bunched orders for futures. This will help
promote access to clearing of swaps for pension funds, mutual funds
and other clients of asset managers.
Lastly, the final rule does so by strengthening the risk
management procedures of clearing members. One of the primary goals
of the Dodd-Frank Act was to reduce the risk that swaps pose to the
economy. The final rule would require clearing members that are
FCMs, Swap Dealers, and major swap participants to establish risk-
based limits on their customer and house accounts. The rule also
would require clearing members to establish procedures to, amongst
other provisions, evaluate their ability to meet margin
requirements, as well as liquidate positions as needed. These risk
filters and procedures would help secure the financial integrity of
the markets and the clearing system.
[FR Doc. 2012-7477 Filed 4-6-12; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: April 9, 2012