2013-19791
[Federal Register Volume 78, Number 158 (Thursday, August 15, 2013)]
[Rules and Regulations]
[Pages 49663-49680]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-19791]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 39
RIN 3038-AC98
Enhanced Risk Management Standards for Systemically Important
Derivatives Clearing Organizations
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is adopting final regulations to implement enhanced risk
management standards for systemically important derivatives clearing
organizations that include increased financial resources requirements
for systemically important derivatives clearing organizations that are
involved in activities with a more complex risk profile or that are
systemically important in multiple jurisdictions, the prohibited use of
assessments by systemically important derivatives clearing
organizations in calculating their available default resources, and
enhanced system safeguards for systemically important derivatives
clearing organizations for business continuity and disaster recovery
(``BC-DR''). This final rule also implements special enforcement
authority over systemically important derivatives clearing
organizations granted to the Commission under section 807(c) of the
Dodd-Frank Wall Street Reform and Consumer Protection Act (``Dodd-Frank
Act'').
[[Page 49664]]
DATES: The rules will become effective October 15, 2013. Systemically
important derivatives clearing organizations must comply with Sec.
39.29 and Sec. 39.30 no later than December 31, 2013.
FOR FURTHER INFORMATION CONTACT: Ananda Radhakrishnan, Director, 202-
418-5188, [email protected], Robert B. Wasserman, Chief Counsel,
202-418-5092, [email protected], M. Laura Astrada, Associate Chief
Counsel, 202-418-7622, [email protected], or Tracey Wingate, Special
Counsel, 202-418-5319, [email protected], Division of Clearing and
Risk, Commodity Futures Trading Commission, Three Lafayette Centre,
1155 21st Street NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Core Principles for DCOs
B. Designation of Systemically Important Derivatives Clearing
Organizations Under Title VIII of the Dodd-Frank Act
C. Standards for SIDCOs Under Title VIII of the Dodd-Frank Act
D. Principles for Financial Market Infrastructures
E. Existing Prudential Requirements
F. Risk Management Standards for SIDCOs
II. Regulation 39.29
A. Regulation 39.29(a)
B. Regulation 39.29(b)
III. Regulation 39.30
IV. Regulation 39.31
V. Compliance Dates
VI. Consideration of Costs and Benefits
A. Introduction
B. Background
C. Benefits and Costs of the Final Rule
D. Section 15(a) Factors
VII. Related Matters
A. Paperwork Reduction Act
B. Regulatory Flexibility Act
VIII. Text of Final Rules
I. Background
A. Core Principles for DCOs
On July 21, 2010, President Obama signed the Dodd-Frank Act.\1\
Title VII of the Dodd-Frank Act, entitled the ``Wall Street
Transparency and Accountability Act of 2010,'' \2\ amended the
Commodity Exchange Act (``CEA'' or the ``Act'') \3\ to establish a
comprehensive regulatory framework for over-the-counter (``OTC'')
derivatives, including 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 mandatory clearing and trade execution
requirements on clearable swap contracts; (3) creating rigorous
recordkeeping and real-time reporting regimes; and (4) enhancing the
Commission's rulemaking and enforcement authorities with respect to,
among others, all registered entities and intermediaries subject to the
Commission's oversight.
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\1\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the
Dodd-Frank Act may be accessed at http://www.cftc.gov/idc/groups/public/@swaps/documents/file/hr4173_enrolledbill.pdf.
\2\ Section 701 of the Dodd-Frank Act.
\3\ 7 U.S.C. 1 et seq.
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Section 725(c) of the Dodd-Frank Act amended section 5b(c)(2) of
the CEA, which sets forth core principles that a derivatives clearing
organization (``DCO'') must comply with to register and maintain
registration with the Commission. The core principles were originally
added to the CEA by the Commodity Futures Modernization Act of 2000
(``CFMA''),\4\ and in 2001, the Commission issued guidance on DCO
compliance with these core principles.\5\ However, in furtherance of
the goals of the Dodd-Frank Act to reduce risk, increase transparency,
and promote market integrity, the Commission, pursuant to the
Commission's enhanced rulemaking authority,\6\ withdrew the 2001
guidance and adopted regulations establishing standards for compliance
with the DCO core principles.\7\
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\4\ See Commodity Futures Modernization Act of 2000, Public Law
106-554, 114 Stat. 2763 (2000).
\5\ See A New Regulatory Framework for Clearing Organizations,
66 FR 45604 (Aug. 29, 2001) (final rule) (adopting 17 CFR part 39,
app. A).
\6\ See section 725(c) of the Dodd-Frank Act (explicitly giving
the Commission authority to promulgate rules regarding the core
principles pursuant to its rulemaking authority under section 8a(5)
of the CEA, 7 U.S.C. 12a(5)).
\7\ See Derivatives Clearing Organization General Provisions and
Core Principles, 76 FR 69334 (Nov. 8, 2011) (final rule).
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As noted in the preamble to the adopting release for subparts A and
B of part 39 of the Commission's regulations, the regulations that
implement the DCO core principles, the Commission sought to provide
legal certainty for market participants, strengthen the risk management
practices of DCOs, and increase overall confidence in the financial
system by assuring the public that DCOs are meeting minimum risk
management standards.\8\ These risk management standards include, in
part:
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\8\ Id. at 69335.
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(1) With respect to financial resources, (a) Core Principle B,
which requires DCOs to have ``adequate financial, operational, and
managerial resources, as determined by the Commission, to discharge
each responsibility of the [DCO],'' \9\ and (b) Commission regulation
39.11, which requires a DCO to maintain sufficient financial resources
to meet its financial obligations to its clearing members
notwithstanding a default by the clearing member creating the largest
financial exposure for the DCO in extreme but plausible market
conditions,\10\ and permits the inclusion of assessment powers to meet
a limited portion of the DCO's default resources requirement; \11\ and
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\9\ Core Principle B also expressly requires DCOs to ``possess
financial resources that, at a minimum, exceed the total amount that
would (I) enable the organization to meet its financial obligations
to its members and participants notwithstanding a default by the
member or participant creating the largest financial exposure for
that organization in extreme but plausible market conditions; and
(II) enable the [DCO] to cover operating costs of the [DCO] for a
period of 1 year (as calculated on a rolling basis).'' Section
5b(c)(2)(B) of the CEA, 7 U.S.C. 7a-1(c)(2)(B) (emphasis added).
\10\ 17 CFR 39.11(a)(1) (implementing Core Principle B
pertaining to financial resources).
\11\ See 17 CFR 39.11(d)(2)(iii) (requiring a DCO to apply a 30
percent haircut to the value of potential assessments); see also 17
CFR 39.11(d)(2)(iv) (permitting a DCO to count the value of
assessments, after the 30 percent haircut, to meet up to 20 percent
of its default obligations).
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(2) with respect to business continuity, (a) Core Principle I,
which requires DCOs to ``establish and maintain emergency procedures,
backup facilities, and a plan for disaster recovery that allows for (I)
the timely recovery and resumption of operations of the [DCO], and (II)
the fulfillment of each obligation and responsibility of the [DCO],''
\12\ and (b) Commission regulation 39.18, which requires a DCO to
maintain a BC-DR plan, emergency procedures, and physical,
technological, and personnel resources sufficient to enable the DCO to
resume daily processing, clearing, and settlement no later than the
next business day following the disruption of its operations.\13\
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\12\ Core Principle I also requires DCOs to ``establish and
maintain a program of risk analysis and oversight to identify and
minimize sources of operational risk through the development of
appropriate controls and procedures, and automated systems, that are
reliable, secure, and have adequate scalable capacity,'' and
``periodically conduct tests to verify that the backup resources of
the [DCO] are sufficient to ensure daily processing, clearing, and
settlement.'' Section 5b(c)(2)(I) of the CEA, 7 U.S.C. 7a-
1(c)(2)(I).
\13\ 17 CFR 39.18(e)(3) (implementing Core Principle I
pertaining to system safeguards).
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B. Designation of Systemically Important Derivatives Clearing
Organizations Under Title VIII of the Dodd-Frank Act
Title VIII of the Dodd-Frank Act, entitled ``Payment, Clearing, and
Settlement Supervision Act of 2010,'' \14\
[[Page 49665]]
was enacted to mitigate systemic risk in the financial system and
promote financial stability.\15\ Section 804 of the Dodd-Frank Act
requires the Financial Stability Oversight Council (``Council'') \16\
to designate those financial market utilities (``FMUs'') that the
Council determines are, or are likely to become, systemically
important.\17\ An FMU includes ``any person that manages or operates a
multilateral system for the purpose of transferring, clearing, or
settling payments, securities, or other financial transactions among
financial institutions or between financial institutions and the
person.'' \18\ As noted by the Council,
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\14\ Section 801 of the Dodd-Frank Act.
\15\ Section 802(b) of the Dodd-Frank Act.
\16\ The Council was established by section 111 of the Dodd-
Frank Act. In general, the Council is tasked with identifying
``risks to the financial stability of the United States that could
arise from the material financial distress or failure, or ongoing
activities, of large, interconnected bank holding companies or
nonbank financial companies, or that could arise outside the
financial services marketplace,'' promoting ``market discipline, by
eliminating expectations on the part of shareholders, creditors, and
counterparties of such companies that the Government will shield
them from losses in the event of failure,'' and responding ``to
emerging threats to the stability of the United States financial
system.'' Section 112(a)(1) of the Dodd-Frank Act.
\17\ Section 804(a)(1) of the Dodd-Frank Act. The term
``systemically important'' means ``a situation where the failure of
or a disruption to the functioning of a financial market utility . .
. could create, or increase, the risk of significant liquidity or
credit problems spreading among financial institutions or markets
and thereby threaten the stability of the financial system of the
United States.'' Section 803(9) of the Dodd-Frank Act; see also
Authority to Designate Financial Market Utilities as Systemically
Important, 76 FR 44763, 44774 (July 27, 2011) (final rule).
\18\ Section 803(6)(A) of the Dodd-Frank Act. In section
803(6)(B) of the Dodd-Frank Act, the term expressly excludes
designated contract markets, registered futures associations, swap
data repositories, and swap execution facilities registered under
the Commodity Exchange Act (7 U.S.C. 1 et seq.), or national
securities exchanges, national securities associations, alternative
trading systems, security-based swap data repositories, and swap
execution facilities registered under the Securities Exchange Act of
1934 (15 U.S.C. 78a et seq.), solely by reason of their providing
facilities for comparison of data respecting the terms of settlement
of securities or futures transactions effected on such exchange or
by means of any electronic system operated or controlled by such
entities, provided that the exclusions in this clause apply only
with respect to the activities that require the entity to be so
registered; and any broker, dealer, transfer agent, or investment
company, or any futures commission merchant, introducing broker,
commodity trading advisor, or commodity pool operator, solely by
reason of functions performed by such institution as part of
brokerage, dealing, transfer agency, or investment company
activities, or solely by reason of acting on behalf of a financial
market utility or a participant therein in connection with the
furnishing by the financial market utility of services to its
participants or the use of services of the financial market utility
by its participants, provided that services performed by such
institution do not constitute critical risk management or processing
functions of the financial market utility.
FMUs form a critical part of the nation's financial
infrastructure. They exist in many markets to support and facilitate
the transfer, clearing or settlement of financial transactions, and
their smooth operation is integral to the soundness of the financial
system and the overall economy. However, their function and
interconnectedness also concentrate a considerable amount of risk in
the financial system due, in large part, to the interdependencies,
either directly through operational, contractual or affiliation
linkages, or indirectly through payment, clearing, and settlement
processes. In other words, problems at one FMU could trigger
significant liquidity and credit disruptions at other FMUs or
financial institutions.\19\
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\19\ 76 FR at 44763.
In determining whether an FMU is systemically important, the
Council uses a two-stage designation process, applying certain
statutory considerations \20\ and other metrics to assess, among other
things, ``whether possible disruptions [to the functioning of an FMU]
are potentially severe, not necessarily in the sense that they
themselves might trigger damage to the U.S. economy, but because such
disruptions might reduce the ability of financial institutions or
markets to perform their normal intermediation functions.'' \21\ On
July 18, 2012, the Council designated eight FMUs as systemically
important under Title VIII.\22\ Two of these designated FMUs are CFTC-
registered DCOs \23\ for which the Commission is the Supervisory
Agency.\24\ Such designated CFTC-registered DCOs are also known as
systemically important derivatives clearing organizations
(``SIDCOs'').\25\
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\20\ Under section 804(a)(2) of the Dodd-Frank Act, in
determining whether an FMU is or is likely to become systemically
important, the Council must take into consideration the following:
(A) The aggregate monetary value of transactions processed by the
FMU; (B) the aggregate exposure of an FMU to its counterparties; (C)
the relationship, interdependencies, or other interactions of the
FMU with other FMUs or payment, clearing, or settlement activities;
(D) the effect that the failure of or a disruption to the FMU would
have on critical markets, financial institutions, or the broader
financial system; and (E) any other factors the Council deems
appropriate.
\21\ 76 FR at 44766.
\22\ See Press Release, Financial Stability Oversight Council,
Financial Stability Oversight Council Makes First Designations in
Effort to Protect Against Future Financial Crises (July 18, 2012),
available at http://www.treasury.gov/press-center/press-releases/Pages/tg1645.aspx.
\23\ Chicago Mercantile Exchange, Inc. (``CME'') and ICE Clear
Credit LLC (``ICE Clear Credit'') are the CFTC-registered DCOs that
were designated systemically important by the Council, for which
CFTC is the Supervisory Agency. While The Options Clearing
Corporation (``OCC''), a CFTC-registered DCO, was designated
systemically important by the Council, the Securities and Exchange
Commission (``SEC'') serves as OCC's Supervisory Agency.
\24\ See section 803(8)(A) of the Dodd-Frank Act (defining
``Supervisory Agency'' as ``the Federal agency that has primary
jurisdiction over a designated [FMU] under Federal banking,
securities, or commodity futures laws'').
\25\ Specifically, under Commission regulations, a systemically
important derivatives clearing organization is a ``financial market
utility that is a derivatives clearing organization registered under
Section 5b of the Act, which has been designated by the Financial
Stability Oversight Council to be systemically important and for
which the Commission acts as the Supervisory Agency pursuant to
Section 803(8) of the [Dodd-Frank Act].'' See 17 CFR 39.2.
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C. Standards for SIDCOs Under Title VIII of the Dodd-Frank Act
Section 805 of the Dodd-Frank Act directs the Commission to
consider relevant international standards and existing prudential
requirements when prescribing risk management standards governing the
operations related to payment, clearing, and settlement activities for
FMUs that are (1) designated as systemically important by the Council,
and (2) engaged in activities for which the Commission is the
Supervisory Agency.\26\ Under Title VIII, the objectives and principles
for these risk management standards are to: (1) Promote risk
management; (2) promote safety and soundness; (3) reduce systemic
risks; and (4) support the stability of the broader financial
system.\27\ As outlined in section 805(c), these standards may address
such areas as: ``(1) Risk management policies and procedures; (2)
margin and collateral requirements; (3) participant or counterparty
default policies and procedures; (4) the ability to complete timely
clearing and settlement of financial transactions; (5) capital and
financial resources requirements for designated [FMUs]; and (6) other
areas that are necessary to achieve the objectives and principles in
[section 805(b) of the Dodd-Frank Act].''
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\26\ See section 805(a)(2) of the Dodd-Frank Act. The Commission
notes that it also has the authority to prescribe risk management
standards governing the operations related to payment, clearing, and
settlement activities for FMUs that are designated as systemically
important by the Council and that are engaged in activities for
which the Commission is the appropriate financial regulator.
Furthermore, section 805 establishes a review mechanism by which the
Council may intervene if the Board of Governors of the Federal
Reserve System (the ``Board'') determines that the existing risk
management standards set by the Commission ``are insufficient to
prevent or mitigate significant liquidity, credit, operational, or
other risks to the financial markets or to the financial stability
of the United States.'' Section 805(a)(2)(B) of the Dodd-Frank Act.
\27\ Section 805(b) of the Dodd-Frank Act.
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The Commission has reviewed the risk management standards set forth
in part 39 of the Commission's regulations in light of recently
promulgated relevant international standards and existing prudential
requirements to identify
[[Page 49666]]
those areas in which additional risk management standards for SIDCOs
would be necessary and appropriate.
D. Principles for Financial Market Infrastructures
1. Overview
The Commission has determined that the international standards most
relevant to the risk management of SIDCOs, for purposes of meeting the
Commission's obligation pursuant to section 805(a)(2)(A) of the Dodd-
Frank Act, are the Principles for Financial Market Infrastructures
(``PFMIs''), which were developed by the Bank for International
Settlements' Committee on Payment and Settlement Systems (``CPSS'') and
the Technical Committee of the International Organization of Securities
Commissions (``IOSCO'') (collectively, ``CPSS-IOSCO'').\28\ The
Commission notes that the adoption and implementation of the PFMIs by
numerous foreign jurisdictions highlights the role these principles
play in creating a global, unified set of international risk management
standards for central counterparties (``CCPs'').\29\ Moreover, the
Commission, which is a member of the Board of IOSCO, is working towards
implementing rules and regulations that are fully consistent with the
PFMIs by the end of 2013.\30\
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\28\ See Bank for International Settlements' Committee on
Payment and Settlement Systems and Technical Committee of the
International Organization of Securities Commissions, ``Principles
for Financial Market Infrastructures,'' (April 2012), available at
http://www.iosco.org/library/pubdocs/pdf/IOSCOPD377.pdf; see also
Financial Stability Board, ``OTC Derivatives Market Reforms: Third
Progress Report on Implementation,'' (June 15, 2012), available at
http://www.financialstabilityboard.org/publications/r_120615.pdf
(noting publication of the PFMIs as achieving ``an important
milestone in the global development of a sound basis for central
clearing of all standardised OTC derivatives'').
\29\ In Asia, Singapore has adopted the PFMIs into its financial
regulations pertaining to FMIs. See Monetary Authority of Singapore,
``Supervision of Financial Market Infrastructures in Singapore,''
(January 2013), available at http://www.mas.gov.sg/~/media/MAS/
About%20MAS/Monographs%20and%20information%20papers/MASMonograph--
Supervision--of--Financial--Market--Infrastructures--in--
Singapore%202.pdf. In addition, Australia, Canada and the European
Union have publicly indicated their intent to adopt the PFMIs. See
Reserve Bank of Australia, ``Consultation on New Financial Stability
Standards,'' (August 2012), available at http://www.rba.gov.au/payments-system/clearing-settlement/consultations/201208-new-fin-stability-standards/index.html; Canadian Securities Administrators
Consultation Paper 91-406 ``Derivatives: OTC Central Counterparty
Clearing,'' (June 20, 2012), available at http://www.osc.gov.on.ca/documents/en/Securities-Category9/csa_20120620_91-406_counterparty-clearing.pdf; and Regulation (EU) No 648/2012 of the
European Parliament and of the Council on OTC Derivatives, Central
Counterparties and Trade Repositories, preamble paragraph 90, 2012
O.J. (L 201), available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2012:201:FULL:EN:PDF.
In the United States, the SEC adopted a final rule that
incorporates heightened risk management standards for CCPs that
clear security-based swaps, based on, in part, the PFMIs' ``cover
two'' standard for CCPs engaged in a more complex risk profile or
that are systemically important in multiple jurisdictions. See 17
CFR 240.17Ad-22(b)(3) (2013) (requiring, in relevant part, SEC-
registered clearing agencies (i.e., CCPs) to maintain sufficient
financial resources to withstand, at a minimum, a default by the
participant family to which they have the largest exposure in
extreme but plausible conditions, provided that a security-based
swap clearing agency, (i.e., a CCP that clears security-based swaps)
shall maintain sufficient financial resources to withstand, at a
minimum, a default by the two participant families to which it has
the largest exposure in extreme but plausible market conditions).
\30\ Part 39 of the Commission's regulations was informed by the
consultative report for the PFMIs and incorporates the vast majority
of the standards set forth in the PFMIs. See Financial Resources
Requirements for Derivatives Clearing Organizations, 75 FR 63113
(Oct. 14, 2010); Risk Management Requirements for Derivatives
Clearing Organizations, 76 FR 3698 (Jan. 20, 2011); see also Bank
for International Settlements' Committee on Payment and Settlement
Systems and Technical Committee of the International Organization of
Securities Commissions, ``Principles for Financial Market
Infrastructures: Consultative Report,'' (March 2011), available at
http://www.iosco.org/library/pubdocs/pdf/IOSCOPD350.pdf (``CPSS-
IOSCO Consultative Report'').
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The PFMIs establish international risk management standards for
financial market infrastructures (``FMIs''), including CCPs, that
facilitate clearing and settlement.\31\ In February 2010, CPSS-IOSCO
launched a review of the existing sets of international standards for
FMIs in support of a broader effort by the Financial Stability Board
(``FSB'') \32\ to strengthen core financial infrastructures and markets
by ensuring that gaps in international standards are identified and
addressed.\33\ CPSS-IOSCO endeavored to incorporate in its review
process lessons from the 2008 financial crisis and the experience of
using the existing international standards, as well as policy and
analytical work by other international committees including the Basel
Committee on Banking Supervision (``BCBS'').\34\ The PFMIs replace
CPSS-IOSCO's previous recommendations applicable to CCPs.\35\ In
issuing the PFMIs, CPSS-IOSCO sought to strengthen and harmonize
existing international standards and incorporate new specifications for
CCPs clearing OTC derivatives.\36\ The stated objectives of the PFMIs
are to enhance the safety and efficiency of FMIs and, more broadly,
reduce systemic risk and foster transparency and financial
stability.\37\
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\31\ The PFMIs define a ``financial market infrastructure'' as a
``multilateral system among participating institutions, including
the operator of the system, used for the purposes of clearing,
settling, or recording payments, securities, derivatives, or other
financial transactions.'' See PFMIs, Introduction, 1.8.
\32\ The FSB is an international organization that coordinates
with national financial authorities and international policy
organizations to develop and promote effective regulatory,
supervisory, and other financial sector policies. See generally
http://www.financialstabilityboard.org.
\33\ PFMIs, Background, 1.6.
\34\ Id.
\35\ The international standards for FMIs, prior to the
publication of the PFMIs, included the ``Recommendations for
Securities Settlement Systems'' published by CPSS in 2001, the
``Core Principles for Systemically Important Payment Systems''
published by CPSS-IOSCO in 2001, and the ``Recommendations for
Central Counterparties'' published by CPSS-IOSCO in 2004
(collectively the ``CPSS-IOSCO Principles and Recommendations'').
See PFMIs, Background, 1.4 and 1.5.
\36\ Id. at Introduction, 1.2.
\37\ Id. at Background, 1.15.
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The PFMIs set out 24 principles addressing various risk components
of an FMI's operations, including, as most relevant to this final rule,
credit and operational risk.\38\
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\38\ Pursuant to the PFMIs, key risks faced by FMIs include
legal, credit, liquidity, general business, custody, investment, and
operational risks. See id. at Overview of Key Risks in Financial
Market Infrastructures, 2.1.
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2. Principle 4: Credit Risk
Principle 4 addresses the risk that a counterparty to the CCP will
be unable to fully meet its financial obligations when due.\39\
Specifically, Principle 4 states that a ``CCP should cover its current
and potential future exposures to each participant fully with a high
degree of confidence using margin and other prefunded financial
resources.'' \40\ Additionally, Principle 4 provides that a CCP
involved in activities with a more complex risk profile \41\ or that is
systemically important in multiple jurisdictions should maintain
additional financial resources sufficient to cover a wide range of
potential stress scenarios, including, but not limited to, the default
of the two participants and their affiliates that would potentially
cause the largest aggregate credit exposure to the CCP in extreme but
plausible market conditions.\42\
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\39\ The PFMIs define ``credit risk'' as the ``risk that a
counterparty, whether a participant or other entity, will be unable
to meet fully its financial obligations when due, or at any time in
the future.'' Id. at Annex H: Glossary.
\40\ Id. at Principle 4: Credit Risk, Key Consideration 4.
\41\ Such activities ``with a more complex risk profile''
include clearing financial instruments that are characterized by
discrete jump-to-default price changes or that are highly correlated
with potential participant defaults. Id. at Principle 4: Credit
Risk, Explanatory Note 3.4.19.
\42\ Id. at Principle 4: Credit Risk. Financial resources
sufficient to cover the default of the two participants and their
affiliates creating the largest credit exposure in extreme but
plausible circumstances are sometimes referred to as cover two. All
other CCPs, under the PFMIs, are required to maintain financial
resources sufficient to cover a wide range of potential stress
scenarios, which includes, but is not limited to, the default of the
participant and its affiliates that would potentially cause the
largest aggregate credit exposure to the CCP in extreme but
plausible market conditions, otherwise known as ``cover one.'' Id.
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[[Page 49667]]
More generally, Principle 4 states that all FMIs should establish
explicit rules and procedures to address any credit losses they may
face as a result of an individual or combined default among its
participants with respect to any of their obligations to the FMI.\43\
These rules and procedures should also address how potentially
uncovered credit losses would be allocated, how the funds an FMI may
borrow from liquidity providers would be repaid, and how an FMI would
replenish the financial resources used during a stress event, such as a
default, so that the FMI can continue to operate in a safe and sound
manner.\44\
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\43\ Id. at Principle 4: Credit Risk, Key Consideration 7.
\44\ Id.
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3. Principle 17: Operational Risk
Principle 17 addresses the risk of deficiencies in information
systems or internal processes, human errors, management failures, or
disruptions from external events that will result in the reduction or
deterioration of services provided by the FMI.\45\ Principle 17 states
that ``[b]usiness continuity management should aim for timely recovery
of operations and fulfilment [sic] of the FMI's obligations, including
in the event of a wide-scale or major disruption.'' \46\ Additionally,
an FMI's business continuity plan ``should incorporate the use of a
secondary site and should be designed to ensure that critical
information technology (IT) systems can resume operations within two
hours following disruptive events.'' \47\
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\45\ Id. at Overview of Key Risks in Financial Market
Infrastructures, 2.9.
\46\ Id. at Principle 17: Operational Risk.
\47\ Id. at Key Consideration 6.
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4. The Role of the PFMIs in International Banking Standards
Where a CCP is prudentially supervised in a jurisdiction that does
not have domestic rules and regulations that are consistent with the
PFMIs, the implementation of certain international banking regulations
will have significant cost implications for that CCP and its market
participants.
In July 2012, the BCBS,\48\ the international body that sets
standards for the regulation of banks, published the ``Capital
Requirements for Bank Exposures to Central Counterparties'' (``Basel
CCP Capital Requirements''), which sets forth interim rules governing
the capital charges arising from bank exposures to CCPs related to OTC
derivatives, exchange-traded derivatives, and securities financing
transactions.\49\ The Basel CCP Capital Requirements create financial
incentives for banks \50\ to clear financial derivatives with CCPs that
are licensed in a jurisdiction where the relevant regulator has adopted
rules or regulations that are consistent with the PFMIs. Specifically,
the Basel CCP Capital Requirements introduce new capital charges based
on counterparty risk for banks conducting financial derivatives
transactions through a CCP.\51\ These new capital charges relate to a
bank's trade exposure and default fund exposure to a CCP.\52\
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\48\ The BCBS is comprised of senior representatives of bank
supervisory authorities and central banks from around the world,
including Argentina, Australia, Belgium, Brazil, Canada, China,
France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan,
Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia,
Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the
United Kingdom, and the United States. See Bank for International
Settlements' Basel Committee on Banking Supervision, ``Basel III: A
Global Regulatory Framework for More Resilient Banks and Banking
Systems,'' (December 2010; revised June 2011), available at http://www.bis.org/publ/bcbs189.htm (``Basel III: A Global Regulatory
Framework'').
\49\ See Bank for International Settlements' Basel Committee on
Banking Supervision, ``Capital Requirements for Bank Exposures to
Central Counterparties,'' (July 2012), available at www.bis.org/publ/bcbs227.pdf (``Basel CCP Capital Requirements''). The Basel CCP
Capital Requirements are one component of Basel III, a framework
that is part of ``a comprehensive set of reform measures, developed
by the [BCBS], to strengthen the regulation, supervision and risk
management of the banking sector.'' See Bank for International
Settlements' Web site for a compilation of documents that form the
regulatory framework of Basel III, available at http://www.bis.org/bcbs/basel3.htm.
\50\ ``Bank'' is defined in accordance with the Basel framework
to mean bank, banking group, or other entity (i.e., bank holding
company) whose capital is being measured. See Basel III: A Global
Regulatory Framework, Definition of Capital, paragraph 51, at 12.
The term ``bank,'' as used herein, also includes subsidiaries and
affiliates of the banking group or other entity. The Commission
notes that a bank may be a client and/or a clearing member of a
SIDCO.
\51\ See Basel CCP Capital Requirements, Annex 4, section II,
6(i).
\52\ ``Trade exposure'' is a measure of the amount of loss a
bank is exposed to based on the size of its position, given a CCP's
failure. Under the Basel CCP Capital Requirements, ``trade
exposure'' is defined to include the current and potential future
exposure of a bank acting as either a clearing member or a client to
a CCP arising from OTC derivatives, exchange traded derivatives
transactions, or securities financing transactions, as well as
initial margin. See Basel CCP Capital Requirements, Annex 4, section
I, A: General Terms. ``Current exposure'' includes variation margin
that is owed by the CCP but not yet been received by the clearing
member or client. Id. at n. 2. ``Default fund exposure'' is a
measure of the loss a bank acting as a clearing member is exposed to
arising from the use of its contributions to the CCP's mutualized
default fund resources. See Basel CCP Capital Requirements, Annex 4,
section I, A: General Terms. BIS defines ``potential future
exposure'' as ``the additional exposure that a counterparty might
potentially assume during the life of a contract or set of contracts
beyond the current replacement cost of the contract or set of
contracts.'' See Bank for International Settlements' Committee on
Payment and Settlement Systems, ``A Glossary of Terms Used in
Payment and Settlement Systems,'' (March 2003), available at http://www.bis.org/publ/cpss00b.pdf.
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The capital charges for trade exposure are based upon a function
that multiplies exposure by risk weight. Risk weight is a measure that
represents the likelihood that the loss to which the bank is exposed
will be incurred, and the extent of that loss. The risk weight assigned
under the BCBS standards varies significantly depending on whether or
not the counterparty is a ``qualified'' CCP (``QCCP'').\53\ A ``QCCP''
is defined as an entity that (1) is licensed to operate as a CCP, and
is permitted by the appropriate regulator to operate as such, and (2)
is prudentially supervised in a jurisdiction where the relevant
regulator has established and publicly indicated that it applies to the
CCP on an ongoing basis, domestic rules and regulations that are
consistent with the PFMIs.\54\ If a bank transacts through a QCCP
acting either as (1) a clearing member of a CCP for its own account or
for clients,\55\ or (2) a client of a clearing member that enters into
an OTC derivatives transaction with the clearing member acting as a
financial intermediary, then the risk weight is 2 percent for purposes
of calculating the counterparty risk.\56\ If
[[Page 49668]]
the CCP is non-qualifying, then the risk weight is the same as a
bilateral OTC derivative trade and the bank applies the corresponding
bilateral risk-weight treatment, which is at least 20 percent if the
CCP is a bank, or as high as 100 percent if the CCP is a corporate
financial institution.\57\
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\53\ See id. at Annex 4, section IX., Exposures to Qualifying
CCPs, paragraphs 110-119 (describing the methodology for calculating
a bank's trade exposure to a qualified CCP); see also id. at
paragraph 126 (describing the methodology for calculating a bank's
trade exposure to a non-qualifying CCP).
\54\ Id. at section I, A: General Terms.
\55\ The term ``client'' as used herein refers to a customer of
a bank.
\56\ Id. at section IX: Central Counterparties, paragraphs 110
and 114. Client trade exposures are risk-weighted at 2 percent if
the following two conditions are met: (1) the offsetting
transactions are identified by the CCP as client transactions and
collateral to support them is held by the CCP and/or clearing
member, as applicable, under arrangements that prevent losses to the
client due to the default or insolvency of the clearing member, or
the clearing member's other clients, or the joint default or
insolvency of the clearing member and any of its other clients, and
(2) relevant laws, regulations, contractual or administrative
arrangements provide that the offsetting transactions with the
defaulted or insolvent clearing member are highly likely to continue
to be indirectly transacted through the CCP, or by the CCP, should
the clearing member default or become insolvent. However, in certain
circumstances, risk weight may increase. Specifically, if the first
condition is not met (i.e., where a client is not protected from
losses in the case that the clearing member and another client of
the clearing member jointly default or become jointly insolvent),
but the second condition is met, the bank's trade exposure is risk-
weighted at 4 percent. If neither condition is met, the bank must
capitalize its exposure to the CCP as a bilateral trade. Id. at
paragraphs 115 and 116.
\57\ See Bank for International Settlements' Basel Committee on
Banking Supervision, ``Consultative Document: Capitalisation of Bank
Exposures to Central Counterparties,'' (November 2011; revised July
2012), paragraph 28, available at http://www.bis.org/publ/bcbs206.pdf (stating that ``the applicable risk weight [for clearing
member trades with a non-qualifying CCP] would be at least 20% (if
the CCP is a bank) or 100% (if it is a corporate financial
institution according to the definition included in paragraph 272 of
the Basel framework, revised by Basel III''); see also Basel III: A
global regulatory framework for more resilient banks and banking
systems (June 2011), paragraph 102, available at http://www.bis.org/publ/bcbs189.pdf (revising paragraph 272 of the Basel framework).
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With respect to default fund exposure, whenever a clearing member
bank is required to capitalize for exposures arising from default fund
contributions to a QCCP, the clearing member bank may apply one of two
methodologies for determining the capital requirement: The risk-
sensitive approach, or the 1250 percent risk-weight approach.\58\ The
risk-sensitive approach considers various factors in determining the
risk weight for a bank's default exposure to a QCCP, such as (1) the
size and quality of a QCCP's financial resources, (2) the counterparty
credit risk exposures of such CCP, and (3) the application of such
financial resources via the CCP's loss bearing waterfall in the event
one or more clearing members default.\59\ The 1250 percent risk-weight
approach allows a clearing member bank to apply a 1250 percent risk
weight to its default fund exposures to the QCCP, subject to an overall
cap of 20 percent on the risk-weighted assets from all trade exposures
to the QCCP.\60\ In other words, banks with exposures to QCCPs have a
cap on their default fund exposure. In contrast, a clearing member bank
with exposures to a non-qualified CCP must apply a risk weight of 1250
percent with no cap for default fund exposures.\61\
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\58\ See Basel CCP Capital Requirements, Annex 4, section IX,
paragraphs 121-125. The Commission notes that the 1250 percent risk
weight represents the reciprocal of the 8 percent capital ratio,
which is the percentage of a bank's capital to its risk-weighted
assets (i.e., 1250 percent times 8 percent equals 100 percent).
\59\ Id. at paragraph 122.
\60\ Id. at paragraph 125. See also Basel CCP Capital
Requirements, Annex 4, section IX, paragraphs 125 (explaining that
``More specifically, under [the 1250 percent risk-weight] approach,
the Risk Weighted Assets (RWA) for both bank i's trade and default
fund exposures to each CCP are equal to: Min {(2% * TEi + 1250% *
DFi); (20% * TEi){time} where TEi is bank i's trade exposure to the
CCP, as measured by the bank according to paragraphs 110 to 112 of
this Annex; and DFi is bank i's pre-funded contribution to the CCP's
default fund.'').
\61\ Id. at paragraph 127.
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Thus, the Basel CCP Capital Requirements provide incentives for
banks to clear derivatives through CCPs that are QCCPs by setting lower
capital charges for exposures arising from derivatives cleared through
a QCCP and setting significantly higher capital charges for exposures
arising from derivatives cleared through non-qualifying CCPs. The
increased capital charges for transactions through non-qualifying CCPs
may have significant business and operational implications for U.S.
DCOs, particularly SIDCOs that operate internationally and are not
QCCPs.\62\ Specifically, banks faced with much higher capital charges
might transfer their OTC derivatives business away from such SIDCO to a
QCCP in order to benefit from the preferential capital charges provided
by the Basel CCP Capital Requirements. Alternatively, banks might
reduce or discontinue their OTC business altogether. Banks might also
pass on to their customers the higher costs of transacting with a non-
qualifying DCO as a result of the higher capital treatment.
Accordingly, customers using such banks as intermediaries would have an
incentive to transfer their business to an intermediary that clears at
a QCCP. In short, a SIDCO's failure to be a QCCP may cause it to face a
competitive disadvantage retaining members and customers.
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\62\ The Commission notes that the failure of SIDCOs to be QCCPs
may negatively impact the broader US derivatives market as well. For
example, higher clearing costs may result in fewer transactions, and
less overall liquidity.
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As discussed further below in Section VI, the incentives noted in
the foregoing paragraph have important implications for the cost and
benefit considerations required by section 15(a) of the CEA.
E. Existing Prudential Requirements
In April 2011, a year before the PFMIs were published, the Board
proposed regulation HH, which sets forth, in part, risk management
standards for those FMUs, for which the Board is the Supervisory
Agency, that have been designated systemically important by the Council
under Title VIII.\63\ The Board, in proposing regulation HH, stated
that the risk management standards most relevant to the risk management
of FMUs, and the most appropriate basis for setting initial risk
management standards under Title VIII, were the then-current
international risk management standards set by CPSS-IOSCO's Principles
and Recommendations.\64\ The Board did note, in both its proposed and
final rulemaking, that CPSS-IOSCO intended to update and replace the
CPSS-IOSCO Principles and Recommendations with the PFMIs, and the Board
anticipated at that time that it would review the PFMIs, consult with
other appropriate agencies and the Council, and seek public comment on
the adoption of the revised international standards.\65\
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\63\ Notice of Proposed Rulemaking for Financial Market
Utilities (``Regulation HH''), 76 FR 18445 (April 4, 2011)
(Financial Market Utilities) (proposing regulation HH in accordance
with section 805 of the Dodd-Frank Act, which directed the Board to
establish risk management standards governing the operations related
to the payment, clearing, and settlement activities of those FMUs
that have been designated as systemically important by the Council
for which the Board is the Supervisory Agency. Note, however, that
FMUs that are registered as clearing agencies with the SEC under
section 17A of the Securities Exchange Act of 1934, or that are
registered as DCOs with the CFTC under section 5b of the CEA are
expressly exempt from regulation HH.).
\64\ Id. at 18447.
\65\ Id. at 18448; see also Financial Market Utilities
(``Regulation HH''), 77 FR 45907, 45908 (Aug. 2, 2012) (final rule).
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F. Risk Management Standards for SIDCOs
As noted above, the CEA specifies certain core principles that all
DCOs must comply with in order to register and maintain registration
with the Commission. Core Principle B sets out minimum financial
resources requirements for all DCOs and expressly states that a DCO
must have ``adequate financial, operational, and managerial resources,
as determined by the Commission, to discharge each responsibility of
the DCO.'' \66\ Moreover, under Core Principle I, a DCO must have
procedures, facilities, and a disaster recovery plan that allow it to,
on an emergency basis, have a ``timely recovery and resumption'' of its
operations, and fulfill each of its obligations and
responsibilities.\67\ In light of the statutory language described
above, and because the failure of or a disruption to the functioning of
a SIDCO could ``create, or increase, the risk of significant liquidity
or credit problems spreading among financial institutions or markets
and thereby threaten the stability of the financial system of the
United States,'' \68\ the Commission, in
[[Page 49669]]
accordance with section 5b(c)(2) of the Act \69\ and section 805 of the
Dodd-Frank Act,\70\ proposed heightened requirements to increase the
minimum financial resources requirements for SIDCOs,\71\ restrict the
use of assessments in meeting such obligations,\72\ enhance the system
safeguards for SIDCOs,\73\ and grant the Commission special enforcement
authority over SIDCOs pursuant to section 807 of the Dodd-Frank
Act.\74\
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\66\ Section 5b(c)(2)(B) of the CEA, 7 U.S.C. 7a-1(c)(2)(B)
(emphasis added).
\67\ Section 5b(c)(2)(I) of the CEA, 7 U.S.C. 7a-1(c)(2)(I).
\68\ See supra discussion in n.17.
\69\ Section 5b(c)(2) of the CEA, 7 U.S.C. 7a-1(c)(2).
\70\ See section 805(a)(2) of the Dodd-Frank Act.
\71\ See Financial Resources Requirements for Derivatives
Clearing Organizations, 75 FR 63113, 63119-63120 (Oct. 14, 2010).
\72\ Id.
\73\ See Risk Management Requirements for Derivatives Clearing
Organizations, 76 FR 3698, 3726-3727 (Jan. 20, 2011).
\74\ Id. at 3727.
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First, the Commission proposed to increase the amount of financial
resources a SIDCO must maintain in order to comply with Core Principle
B and Commission regulation 39.11.\75\ Regulation 39.11, in part, (1)
requires a DCO to maintain sufficient financial resources to meet its
financial obligations to its clearing members notwithstanding a default
by the clearing member creating the largest financial exposure for the
DCO in extreme but plausible market conditions, provided that if a
clearing member controls another clearing member or is under common
control with another clearing member, affiliated clearing members shall
be deemed to be a single clearing member for the purposes of this
provision; \76\ and (2) permits a DCO to include the value of potential
assessments, subject to a 30 percent haircut, in calculating up to 20
percent of the default resource requirements.\77\ For SIDCOs, the
Commission proposed a regulation that would require a SIDCO to (1)
maintain sufficient financial resources to meet the SIDCO's financial
obligations to its clearing members notwithstanding a default by the
two clearing members creating the largest combined financial exposure
for the SIDCO in extreme but plausible market conditions,\78\ and (2)
only count the value of assessments, after a 30 percent haircut, to
meet up to 20 percent of the resources required to meet obligations
arising from a default by the clearing member creating the second
largest financial exposure.\79\
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\75\ See section 5b(c)(2)(B)(ii)(I) of the CEA, 7 U.S.C. 7a-
1(c)(2)(B)(ii)(I); see also 75 FR at 63116.
\76\ See 17 CFR 39.11(a)(1); see also 75 FR 63114 (noting that
for purposes of determining the largest financial exposure for DCOs
under Core Principle B, the treatment of commonly controlled
affiliates as a single entity is necessary because the default of
one affiliate could have an impact on the ability of the other to
meet its financial obligations to the DCO).
\77\ 17 CFR 39.11(d)(2)(iii) and (iv).
\78\ 75 FR at 63119.
\79\ Id.
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In addition to financial resources requirements, the Commission
also proposed to improve system safeguards for SIDCOs by enhancing
certain BC-DR procedures.\80\ Core Principle I requires a DCO to
establish and maintain emergency procedures, backup facilities, and a
plan for disaster recovery that allows for the timely recovery and
resumption of operations.\81\ Pursuant to Commission regulation 39.18,
the required recovery time objective would be no later than the next
business day.\82\ However, because the systemic importance of SIDCOs
carries with it a responsibility to be reliably available on a near-
continuous basis to fulfill their obligations, the Commission proposed
a regulation that would require a SIDCO to have a BC-DR plan with the
objective of enabling, and the physical, technological, and personnel
resources sufficient to enable, the SIDCO to recover its operations and
resume daily processing, clearing, and settlement no later than two
hours following the disruption, including a wide-scale disruption.\83\
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\80\ See 76 FR at 3726-3727.
\81\ See section 5(c)(2)(I)(ii)(I) of the CEA, 7 U.S.C. 7a-
1(c)(2)(I)(ii)(I).
\82\ See 17 CFR 39.18(e)(3).
\83\ 76 FR at 3726. Chicago Mercantile Exchange Inc. (``CME
Clearing'') and ICC, the two existing SIDCOs, must comply with
regulation 39.30, including the two-hour recovery time objective
requirement, by December 31, 2013. Thereafter, any DCO that is
designated as systemically important by the Council for which the
Commission is the Supervisory Agency will be required to comply with
regulation 39.30 within one year after designation by the Council.
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As part of the Commission's proposed regulations for SIDCOs, the
Commission also included special enforcement authority over SIDCOs \84\
pursuant to section 807(c) of the Dodd-Frank Act, which would grant the
Commission authority under the provisions of subsections (b) through
(n) of section 8 of the Federal Deposit Insurance Act (``FDIA'') \85\
in the same manner and to the same extent as if the SIDCO were an
insured depository institution and the Commission were the appropriate
federal banking agency for such insured depository institution.\86\
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\84\ Id. at 3727.
\85\ See 12 U.S.C. 1818 (b)-(n) (granting authority for
enforcement powers).
\86\ 76 FR at 3727.
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The Commission requested comments on the proposed regulations,\87\
including comments on the potential competitive effects of imposing
higher risk standards on SIDCOs as a subset of DCOs.\88\ The Commission
received thirteen comment letters from the public regarding the
proposed SIDCO rules. Several commenters advocated that any new
Commission regulations correspond with applicable international
standards.\89\
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\87\ The comment period for the proposed rule on Financial
Resources Requirements for Derivatives Clearing Organizations, which
proposed the increased financial resources requirements for SIDCOs,
initially closed on December 13, 2010, but was extended until June
3, 2011. The comment period for the proposed rule on Risk Management
Requirements for Derivatives Clearing Organizations, which proposed
a two hour recovery time and special enforcement authority, closed
on April 25, 2011.
\88\ See 75 FR at 63117.
\89\ See infra n. 110 and 125.
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Because efforts to finalize the PFMIs were ongoing, new rules could
have put SIDCOs at a competitive disadvantage vis-[agrave]-vis foreign
CCPs not yet subject to comparable rules, and, at the time, no DCO had
been designated as systemically important by the Council, the
Commission concluded it would be premature to finalize the SIDCO
regulations in the Derivatives Clearing Organization Core Principles
adopting release.\90\ Instead, the Commission decided, consistent with
section 805(a)(1) of the Dodd-Frank Act,\91\ to monitor domestic and
international developments concerning CCPs and reconsider the proposed
SIDCO regulations in light of such developments.\92\
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\90\ See 76 FR at 69352 (Derivatives Clearing Organization Core
Principles) (final rule).
\91\ The Commission notes again that section 805(a)(1) of the
Dodd-Frank Act requires the Commission to consider international
standards in promulgating risk management rules.
\92\ Id.
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As discussed above, since the final adoption of subparts A and B of
part 39 of the Commission's regulations implementing the DCO core
principles, there have been significant domestic and international
developments, including (1) the publication of the final PFMIs in April
2012,\93\ (2) the designation of two registered DCOs for which the
Commission is the Supervisory Agency, as systemically important by the
Council,\94\ and (3) the adoption of the Basel CCP Capital Requirements
in July 2012,\95\ which provide for significantly less favorable
capital treatment for bank exposures to CCPs unless the relevant
regulator of the CCP establishes regulations that are consistent with
the PFMIs by the end of
[[Page 49670]]
2013.\96\ Given these developments and requests from market
participants to harmonize CFTC regulations with the PFMIs,\97\ the
Commission believes the time is ripe to finalize the previously
proposed SIDCO regulations.
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\93\ See supra n. 28.
\94\ See supra n. 23, 24.
\95\ See supra n. 48; see also discussion in section I. D. 4.
\96\ See Bank for International Settlements' Basel Committee on
Banking Supervision, ``Basel III Counterparty Credit Risk and
Exposures to Central Counterparties--Frequently Asked Questions,''
(November 2012; revised December 2012), available at http://www.bis.org/publ/bcbs237.pdf) (stating that if (1) a CCP regulator
has provided a public statement on the status of a CCP (QCCP or non-
qualifying), then banks will treat exposures to this CCP
accordingly. Otherwise, the bank will determine whether a CCP is
qualifying based on the criteria in the definition of a QCCP in
Annex 4, Section 1 of the Basel CCP Capital Requirements; (2) during
2013, if a CCP regulator has not yet implemented the PFMIs, but has
publicly stated that it is working towards implementing these
principles, the CCPs that are regulated by the CCP regulator may be
treated as QCCPs. However, a CCP regulator may still declare a
specific CCP non-qualifying; and (3) after 2013, if a CCP regulator
has yet to implement the PFMIs, then the bank will determine whether
a CCP subject to such a CCP regulator's jurisdiction is qualifying
on the basis of the criteria outlined in the definition of a QCCP in
Annex 4, Section 1 of the Basel CCP Capital Requirements.).
\97\ See, e.g., CME Group Inc., letter dated May 3, 2013 (``CME
2013 Letter'') (stating that the PFMIs establish ``more demanding
international risk management and related standards for payment,
clearing and settlement systems, including central counterparties''
and that in recognition of ``the systemic protections and robustness
of designated CCPs who adhere to the PFMIs,'' the Basel CCP Capital
Requirements provide ``capital incentives for exposures to such
QCCPs relative to non-Qualified CCPs.'' Moreover, the letter states
that it ``is important to [Chicago Mercantile Exchange Inc.] to be
designated a QCCP . . . in order for [its] market participants to
obtain optimal capital treatment for their business at [Chicago
Mercantile Exchange Inc. . . .]'').
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II. Regulation 39.29
A. Proposed Regulation 39.29(a)
Regulation 39.29(a), as proposed, would have required SIDCOs to
maintain sufficient financial resources to meet financial obligations
to its clearing members notwithstanding a default by the two clearing
members creating the largest combined financial exposure for the SIDCO
in extreme but plausible market conditions.\98\
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\98\ See 75 FR at 63119.
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The Commission received nine comment letters from market
participants regarding the specific requirements set forth in proposed
regulation 39.29(a).\99\ The majority of these commenters expressed
concern that heightened requirements for SIDCOs could place them at a
competitive disadvantage vis-[agrave]-vis other DCOs and foreign CCPs
that clear and settle similar OTC derivatives.\100\
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\99\ Comments on proposed regulation 39.29(a) include the
following: See The Options Clearing Corporation, December 10, 2010
letter (``OCC December Letter''); Michael Greenberger, December 10,
2010 letter (``Greenberger Letter''); CME Group Inc., letter dated
December 13, 2010 (``CME December Letter''); CME 2013 Letter;
International Swaps and Derivatives Association, Inc., letter dated
December 10, 2010) (``ISDA Letter''); Americans for Financial
Reform, letter dated December 13, 2010 (``AFR Letter''); Futures
Industry Association, letter dated December 13, 2010 (``FIA
Letter''); LCH. Clearnet Group Limited, letter dated December 10,
2010 (``LCH December Letter''); ICE Clear Credit LLC, letter dated
April 26, 2013 (``ICC Letter''). The comment files for each proposed
rulemaking can be found on the Commission's Web site at
www.cftc.gov.
\100\ See CME December Letter at 7; FIA Letter at 2; LCH
December Letter at 1. More broadly, Chris Barnard argued that all
DCOs are SIDCOs ``[g]iven their aggregate nature and high levels of
interconnectedness.'' See Chris Barnard, letter, dated May 10, 2011,
(``Barnard Letter'') at 2.
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Two commenters, Mr. Michael Greenberger and LCH. Clearnet Group
Limited (``LCH''), generally supported the proposed financial resources
requirements for SIDCOs.\101\ ICE Clear Credit LLC (``ICC''), one of
the two existing SIDCOs, stated that it currently is in compliance with
the proposed cover two requirement and acknowledged ``the importance of
clearing houses with more complex risk management requirements
maintaining robust financial resources.'' \102\ Both the International
Swaps and Derivatives Association (``ISDA'') and Americans for
Financial Reform (``AFR'') suggested alternative approaches to the
proposed cover two requirement for SIDCOs.\103\ ISDA encouraged the
Commission to consider ``whether the appropriate size of a SIDCO's
financial resources should be determined following an assessment by the
Commission of the specific risks posed by the relevant SIDCO and the
individual products it clears, rather than set to a uniform level that
may be either insufficient or overly conservative.'' \104\ AFR stated
that a SIDCO's minimum financial resources requirements should be based
on risk exposure as well as the number of defaults because while in ``a
concentrated market, a single default can have great consequence,'' and
in ``a more diverse market, the probability of multiple defaults is
greater and is a more meaningful scenario.'' \105\
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\101\ See Greenberger Letter at 6; LCH December Letter at 3.
\102\ See ICC Letter at 2.
\103\ See ISDA Letter at 8; AFR Letter at 3.
\104\ See ISDA Letter at 8.
\105\ See AFR Letter at 3.
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OCC, however, disagreed with the necessity to impose a cover two
requirement on all SIDCOs.\106\ OCC argued that the Commission should
not impose a rigid financial resources requirement on every SIDCO
because mandating the default of the two largest clearing members for
purposes of calculating the financial resources requirement does not
necessarily have a beneficial result in that ``it restricts the ability
of a DCO to measure its resources against those contingencies that it
deems to be the most likely threats to its liquidity and solvency.''
\107\ OCC agreed that all clearing organizations should consider
possible simultaneous defaults by multiple clearing members but that
the simultaneous defaults of a clearing organization's two largest
clearing members, at least in the context of how that might occur
within OCC, seem extremely implausible.\108\ OCC did state that ``the
clearing of OTC derivatives presents unique risk management concerns,
and, depending on the particular product and applicable risk management
framework, perhaps even heightened concerns that warrant special
regulatory treatment.'' \109\ Additionally, OCC argued for
international consistency on this issue, and encouraged the Commission
to follow the PFMIs and ``avoid taking final action on the Proposed
Rules prior to receiving greater clarity in terms of the positions and
proposals that European and U.K. legislators and regulators and CPSS[-
]IOSCO eventually adopt.'' \110\
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\106\ See OCC December Letter at 2, 5, and 6.
\107\ Id. at 2. In addition, OCC argued that the proposed
regulation did not fully consider the costs associated with meeting
the cover two standard nor the risk of driving clearing volume to
clearinghouses that are not required to meet the cover two standard.
Id.
\108\ Id. at 6.
\109\ Id. at 5.
\110\ Id. at 12.
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The Futures Industry Association (``FIA'') and, in its initial
comment letter, CME commented that the proposed cover two requirement
for SIDCOs could competitively disadvantage SIDCOs in both domestic and
international markets.\111\ FIA stated that the proposed regulation
would create a two-tier system between those DCOs designated as
systemically important and those DCOs that are not designated as
such.\112\ FIA believes that the two-tier system could put SIDCOs ``at
a competitive disadvantage to the extent that they need to increase
margin or guaranty fund requirements to cover the additional cost of
covering the risk of loss resulting from the default of the second
largest clearing member.'' \113\ In this regard, FIA recommended that
the Commission require all DCOs, not just SIDCOs, to maintain
sufficient financial resources to withstand the default of the two
clearing members creating the largest combined financial exposure for
[[Page 49671]]
the DCO in extreme but plausible market conditions.\114\
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\111\ See FIA Letter at 2, CME December Letter at 7-8.
\112\ See FIA Letter at 2.
\113\ Id.
\114\ Id.
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CME's initial comment letter echoed FIA's approach, arguing that
having lower financial resources requirements for DCOs that are not
SIDCOs would allow those DCOs to offer lower guaranty fund and margin
requirements.\115\ According to CME, this ``would likely attract
additional volume to at least some non-systemically important DCOs and
transform them into de facto SIDCOs.'' \116\ CME argued that until such
time as a ``de facto SIDCO'' was designated as systemically important
by the Council, SIDCOs would be competitively disadvantaged because the
``de facto SIDCO'' would be operating under the lower and less costly
general regulatory standards for DCOs.\117\ CME argued that such a
result would disregard the objectives of Title VIII.\118\ CME suggested
that the Commission, in lieu of adopting the proposed regulation, adopt
a regulation that subjects SIDCOs to more frequent stress testing
(e.g., bi-monthly rather than monthly) and reporting requirements
(e.g., monthly rather than quarterly).\119\ Following publication of
the PFMIs and the Basel CCP Capital Requirements, CME submitted a
supplemental comment letter stating that its subsidiary, CME Clearing
began offering clearing services for the interest rate swap and credit
default swap markets.\120\ As a result, CME Clearing has three distinct
guaranty funds: one for interest rate swap products (``IRS Guaranty
Fund''), one for credit default swap products (``CDS Guaranty Fund''),
and one for futures and other cleared OTC products (``Base Guaranty
Fund'').\121\ Moreover, CME stated that the IRS Guaranty Fund and the
CDS Guaranty Fund are already sized to the cover two standard.\122\
While CME stated that it is satisfied with the size of the Base
Guaranty Fund, which is currently set to meet a cover one standard, CME
anticipates that the Commission will promulgate a cover two standard as
part of the Commission's implementation of the standards set forth in
the PFMIs.\123\ As such, CME requested that the Commission ``consider
the impact to clearing firms when specifying the timelines associated
with compliance with the cover [two] standard and suggests as long a
time horizon as possible for implementation,'' with ``an effective date
of the end of 2013, or later to the extent practicable to maintain QCCP
status in accordance with BCBS 227, which we believe would assist in
minimizing the impact to the clearing firm community.'' \124\
---------------------------------------------------------------------------
\115\ See CME December Letter at 7.
\116\ Id.
\117\ Id. at 7-8.
\118\ Id. at 8.
\119\ Id.
\120\ CME 2013 Letter at 2.
\121\ CME 2013 Letter at 2-3.
\122\ CME 2013 Letter at 3.
\123\ Id.
\124\ Id.
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Additionally, LCH, which was supportive of the proposal, urged the
Commission ``to minimize the divergence'' between U.S.-regulated CCPs
and other CCPs and ensure a level playing field between SIDCOs and
other large CCPs around the world by conforming as much as possible the
Commission's final rules on SIDCOs to the global standards set forth by
the PFMIs.\125\
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\125\ See LCH December Letter at 1-2 (citing to the Bank for
International Settlements' Committee on Payment and Settlement
Systems September 2010 report entitled Market Structure Developments
in the Clearing Industry: Implications for Financial Stability for
the opinion that ``regulatory complexity, and with it the potential
for regulatory arbitrage, may increase, especially when competing
CCPs are regulated by different authorities and/or are located in
different jurisdictions.'' Id. at 4.
---------------------------------------------------------------------------
The Commission notes that Core Principle B requires DCOs to have
``adequate financial, operational, and managerial resources, as
determined by the Commission, to discharge each responsibility of the
DCO.'' \126\ Pursuant to Core Principle B, at a minimum, DCOs must be
able to meet a cover one requirement. As discussed above, because of
the impact that the failure of or a disruption to the operations of a
SIDCO could have on the U.S. financial markets, the Commission proposed
increased standards for SIDCOs. However, after consideration of the
comments, and consistent with the directive in section 805 of the Dodd-
Frank Act to consider relevant international standards and existing
prudential requirements, the Commission is adopting regulation 39.29(a)
with a revision in order to harmonize U.S. regulations with
international CCP risk management standards.\127\
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\126\ Section 5b(c)(2)(B) of the CEA, 7 U.S.C. 7a-1(c)(2)(B).
\127\ The Commission finds the comments arguing for
international regulatory consistency to be persuasive and recognizes
the importance of harmonizing U.S. regulations with international
CCP risk management standards.
---------------------------------------------------------------------------
Specifically, rather than apply the cover two requirement to all
SIDCOs, the revised regulation 39.29(a) would parallel the financial
resources standard in Principle 4 of the PFMIs and only require a SIDCO
that is systemically important in multiple jurisdictions or that is
involved in activities with a more complex risk profile to maintain
financial resources sufficient to enable it to meet its financial
obligations to its clearing members notwithstanding a default by the
two clearing members creating the largest combined financial exposure
for the SIDCO in extreme but plausible market conditions, provided that
if a clearing member controls another clearing member or is under
common control with another clearing member, affiliated clearing
members shall be deemed to be a single clearing member for the purposes
of this provision.\128\
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\128\ See supra n. 41, 42. Moreover, the same proviso regarding
the treatment of affiliate clearing members as set out in
39.11(a)(1), i.e., that ``if a clearing member controls another
clearing member or is under common control with another clearing
member, affiliated clearing members shall be deemed to be a single
clearing member for the purposes of this provision'' is incorporated
in regulation 39.29(a) and is repeated in the rule text for clarity.
See also 75 FR 63116 (stating that as DCOs, SIDCOs are still subject
to Title VII and the regulations thereunder, except to the extent
that the Commission proposes higher standards pursuant to Title
VIII).
---------------------------------------------------------------------------
Thus, regulation 39.29(a) will promote consistency and efficiency
in the financial markets by holding SIDCOs to the same cover two
standard as similarly situated foreign CCPs. Additionally, because the
PFMIs set forth international risk management standards for CCPs, this
international harmonization should mitigate some of the competition
concerns raised by the commenters. Moreover, adoption of this revised
regulation is part of the Commission's broader efforts to adopt and
implement regulations that are consistent with the PFMIs so that SIDCOs
operating internationally can be considered QCCPs. Such QCCP status
should help a SIDCO avoid competitive harm internationally by providing
bank clearing members and clients with the opportunity to obtain the
more favorable capital charges set forth by the Basel CCP Capital
Requirements.\129\
---------------------------------------------------------------------------
\129\ See supra section I.D.4. for a more detailed discussion on
the role of the PFMIs in international banking. See also CME 2013
Letter at 2 (stating that ``it is important to CME [Clearing] to be
designated a QCCP . . . in order for [its] market participants to
obtain optimal capital treatment for their business at CME
[Clearing] . . .'').
---------------------------------------------------------------------------
After careful review and consideration of the comments, and in
light of international standards and prudential regulations, the
Commission is adopting a regulation 39.29(a), as revised, to require
the cover two standard for those SIDCOs that are systemically important
in multiple jurisdictions or that are involved in activities with a
more complex risk profile.
[[Page 49672]]
B. Proposed Regulation 39.29(b)
Regulation 39.29(b), as proposed, would have precluded SIDCOs from
counting the value of assessments in calculating the resources
available to meet the obligations arising from a default by the
clearing member creating the single largest financial exposure,\130\
but would have permitted SIDCOs to count the value of assessments,
after a 30 percent haircut, in calculating the resources available to
meet up to 20 percent of the obligations arising from a default of the
clearing member creating the second largest financial exposure.\131\
---------------------------------------------------------------------------
\130\ See 75 FR at 63117. Accordingly, SIDCOs would have to hold
a greater percentage of financial resources in margin and guaranty
funds. Id.
\131\ Id.
---------------------------------------------------------------------------
The Commission received five comment letters from market
participants regarding the specific requirements set forth in proposed
regulation 39.29(b).\132\ FIA agreed with the Commission's proposed
limitation on the use of assessments by SIDCOs, stating that the
proposed limitation was reasonable, prudent, and sufficient to ensure
that a SIDCO does not unduly rely on its assessment power.\133\ In
contrast, AFR argued that the use of assessments in calculating the
resources available to meet a SIDCO's obligations under proposed
regulation 39.29(b) should be prohibited.\134\ AFR emphasized that a
DCO should be financially viable at all times, regardless of whether it
might be able to call on its members to provide additional
capital.\135\ In addition, ICC, one of the two existing SIDCOs, stated
that it does not rely upon its right of assessment to meet the cover
two standard \136\ and CME, the parent company of the other existing
SIDCO, stated that ``each of [CME Clearing's] guaranty funds are pre-
funded by the respective clearing members.'' \137\ More broadly, Chris
Barnard commented that the use of assessments by DCOs may cause pro-
cyclical problems and increase systemic risk in times of financial
stress.\138\
---------------------------------------------------------------------------
\132\ See AFR Letter; FIA Letter; Barnard Letter; ICC Letter;
CME 2013 Letter.
\133\ See FIA Letter at 3.
\134\ See AFR Letter at 3.
\135\ Id. AFR also argued that DCOs should be prohibited from
including assessments in meeting their financial resources
requirements as well.
\136\ See ICC Letter at 2.
\137\ See CME 2013 Letter at 3, n.7.
\138\ See Barnard Letter at 2.
---------------------------------------------------------------------------
The Commission recognizes the potential pro-cyclical effects of
assessments and agrees that a SIDCO should not be permitted to use the
value of assessments in calculating the resources available to meet its
obligations under regulation 39.29(a). ``Pro-cyclicality,'' as defined
in the PFMIs, refers to ``changes in risk-management practices that are
positively correlated with market, business, or credit cycle
fluctuations and that may cause or exacerbate financial instability.''
\139\ In the context of assessments, a SIDCO's call for additional
capital from its clearing members in order to cover any losses in a
default scenario (generally needed on an expedited basis) may trigger
greater distress on the financial markets, which presumably have
already been weakened. In other words, in a stressed market where
credit is tightening and margin calls are increased, a SIDCO's
assessment of additional claims upon its clearing members may well
exacerbate already weakened financial markets by potentially forcing
clearing members and/or their customers to deleverage in falling asset
markets, which will further drive down asset prices and stifle
liquidity, or force clearing members to default in their obligations to
the SIDCO. This in turn could start a downward spiral which, combined
with restricted credit, might lead to additional defaults of clearing
members and/or their customers, and would play a significant role in
the destabilization of the financial markets. In striking a balance
between the need for SIDCOs to effectively and efficiently use their
resources and the mitigation of pro-cyclical behaviors, the Commission
believes prefunding default obligations is the appropriate mechanism
for SIDCOs to meet their default resource obligations.
---------------------------------------------------------------------------
\139\ See PFMIs, Definitions; see also Principle 5: Collateral,
Explanatory Note 3.5.6; see also Bank for International Settlements'
Committee on the Global Financial System, ``The Role of Margin
Requirements and Haircuts in Procyclicality,'' CGFS Papers No. 36
(March 2010), available at http://www.bis.org/publ/cgfs36.htm.
---------------------------------------------------------------------------
As discussed above, Core Principle B requires DCOs to have
``adequate financial, operational, and managerial resources, as
determined by the Commission, to discharge each responsibility of the
DCO.'' \140\ Moreover, the PFMIs require a CCP to use prefunded
financial resources to cover current and potential future
exposures,\141\ which may include initial margin, contributions to a
prefunded default arrangement (e.g., a guaranty fund), and a specified
portion of the CCP's own funds.\142\ In addition, the PFMIs encourage
CCPs to address pro-cyclicality in their margin arrangements \143\ and
state that ``a CCP could consider increasing the size of its prefunded
default arrangements to limit the need and likelihood of large or
unexpected margin calls in times of market stress.'' \144\ Prefunding
financial resources requires market participants to pay more during
times of relative market stability and low-market volatility through
prefunded default arrangement contributions.\145\ However, paying more
during a period of economic stability or even an upturn may ``result in
additional protection and [be] potentially less costly and less
disruptive adjustments in periods of high market volatility.'' \146\
---------------------------------------------------------------------------
\140\ Section 5b(c)(2)(B) of the CEA, 7 U.S.C. 7a-1(c)(2)(B).
\141\ See supra n. 40 and accompanying text.
\142\ See PFMIs, Principle 4: Credit Risk, Explanatory Note
3.4.17 (stating that a CCP typically uses a sequence of prefunded
financial resources, often referred to as a ``waterfall,'' to manage
its losses caused by participant defaults. The waterfall may include
a defaulter's initial margin, the defaulter's contribution to a
prefunded default arrangement, a specified portion of the CCP's own
funds, and other participants' contributions to a prefunded default
arrangement).
\143\ Id. at Principle 6: Margin, Explanatory Note 3.6.10.
\144\ Id.
\145\ Id.
\146\ Id.
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The Commission believes the role of a SIDCO, in part, is to add
stability and confidence in the financial markets, and to the extent
that the prohibition of the inclusion of the value of assessments by
SIDCOs in meeting their default resource requirements helps to stem
pro-cyclicality and the potential weakening of financial markets, the
Commission is in favor of this approach. Moreover, prohibition of the
inclusion of the value of assessments will help ensure that a SIDCO
has, when needed, adequate resources to discharge each of its
responsibilities.
Accordingly, after consideration of the comments, relevant
international standards, and existing prudential requirements, the
Commission is adopting regulation 39.29(b) with a revision to prohibit
the use of assessments by SIDCOs in calculating financial resources
available to meet the SIDCO's obligations under regulation 39.29(a).
III. Regulation 39.30
Regulation 39.30(a), as proposed, would have required a SIDCO to
have a BC-DR plan, that has the objective of, and the physical,
technological, and personnel resources sufficient to, enable the SIDCO
to recover operations and resume daily processing, clearing, and
settlement no later than two hours following a disruption,\147\
including a wide-scale disruption.\148\
---------------------------------------------------------------------------
\147\ See 76 FR at 3726.
\148\ The following definitions pertaining to system safeguards
were codified at 17 CFR 39.18(a):
A ``recovery time objective'' is defined as ``the time period
within which an entity should be able to achieve recovery and
resumption of clearing and settlement of existing and new products,
after those capabilities become temporarily inoperable for any
reason up to or including a wide-scale disruption.'' A ``wide-scale
disruption'' is defined as ``an event that causes a severe
disruption or destruction of transportation, telecommunications,
power, water, or other critical infrastructure components in a
relevant area, or an event that results in an evacuation or
unavailability of the population in a relevant area.'' ``Relevant
area'' is defined as ``the metropolitan or other geographic area
within which a derivatives clearing organization has physical
infrastructure or personnel necessary for it to conduct activities
necessary to the clearing and settlement of existing and new
products. The term `relevant area' also includes communities
economically integrated with, adjacent to, or within normal
commuting distance of that metropolitan or other geographic area.''
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[[Page 49673]]
In order to achieve the specified recovery time objective (``RTO'')
in proposed regulation 39.30(a), proposed regulation 39.30(b) would
have required SIDCOs to maintain a geographic dispersal of physical,
technological, and personnel resources.\149\ Pursuant to proposed
regulation 39.30(b)(1), physical and technological resources would have
to be located outside the relevant area of the infrastructure the
entity normally relies upon to conduct activities necessary to the
clearance and settlement of existing and new contracts, and the entity
could not rely on the same critical transportation, telecommunications,
power, water, or other critical infrastructure components the entity
normally relies upon for such activities.\150\ Additionally, proposed
regulation 39.30(b)(2) would have required SIDCOs to maintain personnel
sufficient to meet the RTO after interruption of normal clearing by a
wide-scale disruption affecting the relevant area, who live and work
outside the relevant area.\151\ To avoid duplication and maximize
flexibility, proposed regulation 39.30(b)(3) \152\ provided that SIDCOs
could use the outsourcing provisions applicable to non-SIDCO DCOs as
set forth in regulation 39.18(f).\153\
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\149\ See 76 FR at 3726-3727.
\150\ Id.
\151\ Id. at 3727.
\152\ Id.
\153\ See 17 CFR 39.18(f) (stating, in relevant part, that a DCO
may maintain the resources required under BC-DR procedures
enumerated in regulation 39.18(e)(1) by ``either (1) Using its own
employees as personnel, and property that it owns, licenses, or
leases (own property); or (2) Through written contractual
arrangements with another derivatives clearing organization or other
service provider (outsourcing).'')
---------------------------------------------------------------------------
Regulation 39.30(c), as proposed, would have required that each
SIDCO conduct regular, periodic tests of its BC-DR plans and resources,
and of its capacity to achieve the required RTO in the event of a wide-
scale disruption.\154\ Additionally, proposed regulation 39.30(c)
incorporated the provisions of regulation 39.18(j) concerning testing
by DCOs, including the purpose of the testing, the conduct of the
testing, and reporting and review of the testing.\155\
---------------------------------------------------------------------------
\154\ See 76 FR at 3727.
\155\ See id; see also 17 CFR 39.18(j).
---------------------------------------------------------------------------
The Commission received five comment letters regarding the specific
requirements set forth in proposed regulation 39.30(a).\156\ One
commenter stated that the recovery time for its technology systems is
currently approximately two hours based upon past disaster recovery
tests,\157\ and three commenters opposed the two-hour RTO.\158\ ICC,
one of the two existing SIDCOs, acknowledged ``the importance of
maintaining market integrity during disruptive events'' and noted that
a two-hour RTO is consistent with Principle 17 of the PFMIs.\159\ In
addition, ICC stated that the ``two-hour benchmark is unlikely to
require [it] to hire additional personnel or to require a different
level of cross-training related to its wide-scale disruption plan,''
and that it ``is unlikely that [ICC] will incur any additional backup
technology costs related to the CFTC's proposed RTO.\160\
---------------------------------------------------------------------------
\156\ Comments on proposed regulation 39.30 include the
following: See Intercontinental Exchange, Inc. letter dated March
21, 2011 (``ICE Letter''); OCC letter dated March 21, 2011 (``OCC
Letter''); CME Group Inc., letter dated March 21, 2011 (``CME March
Letter''); ICC Letter; and CME 2013 Letter. The Commission received
no comments regarding proposed regulation 39.30(b) or 39.30(c).
\157\ See ICC Letter at 2.
\158\ See ICE Letter at 7-8; CME March Letter at 14-15; OCC
Letter at 19-20.
\159\ ICC Letter at 2.
\160\ Id.
---------------------------------------------------------------------------
Both Intercontinental Exchange, Inc. (``ICE'') and CME, on the
other hand, expressed concern that requiring a more stringent RTO for
SIDCOs would impose significant costs.\161\ ICE argued that ``assigning
an RTO to a SIDCO instead of assigning the objective the RTO is
intended to achieve adds significant cost to a SIDCO's business
continuity program but does not necessarily increase overall resilience
of the financial system.'' \162\ ICE and CME also highlighted the
approach referenced in the Interagency Paper on Sound Practices to
Strengthen the Resilience of the U.S. Financial System (the ``Sound
Practices Paper''),\163\ published in 2003, which argued for a same-
business-day RTO with a two-hour RTO as an aspirational goal for
clearing and settlement organizations.\164\ CME urged the Commission to
adopt the same approach as the Sound Practices Paper for SIDCOs, i.e.,
the same-business-day RTO with a two-hour RTO on a voluntary
basis.\165\ In addition, CME stated that ``[m]oving to a 2-hour RTO
would impose enormous costs on SIDCOs, and the CFTC has provided no
cost/benefit analysis in connection with this aspect of the proposed
Regulation.'' \166\ Nonetheless, in a supplemental comment letter, CME
stated that ``in light of the systemic importance of CME [Clearing]'s
clearing functions and the intended benefits, including compliance with
the PFMI requirements for critical information technology, CME
[Clearing] has obtained budget approval and allocated resources towards
a two hour RTO and will be working throughout 2013 towards achieving a
two hour RTO.'' \167\
---------------------------------------------------------------------------
\161\ See ICE Letter at 7; CME March Letter at 14.
\162\ ICE Letter at 8.
\163\ See the Federal Reserve Board, the Office of the
Comptroller of the Currency and the Securities and Exchange
Commission, ``Interagency Paper on Sound Practices to Strengthen the
Resilience of the U.S. Financial System'' (the ``Sound Practices
Paper''), 68 FR 17809 (April 11, 2003).
\164\ Id. at 17812 (stating that core clearing and settlement
organizations should develop the capacity to recover and resume
clearing and settlement activities within the business day on which
the disruption occurs with the overall goal of achieving recovery
and resumption within two hours after an event).
\165\ CME March Letter at 15.
\166\ CME March Letter at 14.
\167\ CME 2013 Letter at 4 (CME also acknowledges that
``Principle 17 of the PFMIs states that a BC-DR Plan should be
designed to ensure that critical information technology systems can
resume operations within two hours following disruptive events.'')
(emphasis added).
---------------------------------------------------------------------------
OCC commented that, though a laudable goal, a two-hour RTO was not
consistently achievable without sacrificing core DCO functions and
increasing the risks of error and backlogs.\168\ In addition, OCC
argued that in its experience, it often takes three hours to fully
recover and meet its responsibilities and avoid significant market
disruption.\169\ OCC also argued that further efforts to reduce RTO
would not be cost-effective and could increase rather than decrease
reliability risk.\170\
---------------------------------------------------------------------------
\168\ OCC Letter at 19.
\169\ Id.
\170\ Id.
---------------------------------------------------------------------------
With respect to commenters' concerns that the proposed regulation
will significantly increase costs on SIDCOs, the Commission recognizes
these concerns but notes that a systemic importance designation under
Title VIII means that the failure of a SIDCO to meet its obligations
will have a greater impact on the U.S. financial system than the
failure of a DCO not so designated. Thus, the Commission believes the
financial system has a vested interest in enhancing risk management
requirements for SIDCOs to increase a SIDCO's financial resiliency and
to
[[Page 49674]]
mitigate the risk of significant liquidity or credit problems spreading
among financial institutions or markets, threatening the stability of
the U.S. financial system. In the event of a wide-scale disruption, the
resiliency of the U.S. financial markets might depend on the rapid
recovery of SIDCOs to support critical market functions and thereby
allow other market participants (i.e., the counterparties) to process
their transactions. In addition, in such a scenario, it is reasonable
to assume that there will be other market participants in locations not
affected by the disruption that will need to clear and settle pending
transactions as well. In short, the failure of a SIDCO to complete core
clearing and settlement functions within a rapid period could create
systemic liquidity and credit dislocations on a global scale.
Additionally, the Commission notes that while it may be true that a
two-hour RTO was an aspirational goal in 2003, standards and technology
have advanced in the last ten years. As discussed above, the current
international standard for CCPs, as set forth by the PFMIs, is to have
a BC-DR plan that incorporates a two-hour RTO.\171\ Specifically, the
PFMIs state that an FMI's business continuity plan ``should incorporate
the use of a secondary site and should be designed to ensure that
critical information technology systems can resume operations within
two hours following disruptive events.'' \172\ Because the two-hour RTO
is the international standard and foreign CCPs are anticipated to
operate under this timeframe, any competitive disadvantages to SIDCOs
in implementing this regulation should be mitigated because all
similarly situated CCPs will likely be operating under this standard.
Indeed, ICC, one of the two existing SIDCOs, has stated that it is
unlikely that it will need to hire additional personnel or incur
additional technology costs to meet this standard.\173\ Moreover, as
discussed above, CME Clearing, the other existing SIDCO, ``has obtained
budget approval and allocated resources towards a two hour RTO and will
be working throughout 2013 towards achieving a two hour RTO.'' \174\
---------------------------------------------------------------------------
\171\ See supra n. 46, 47 (referring to the PFMIs, Principle 17:
Operational Risk).
\172\ Id.
\173\ See supra n. 160 and accompanying text.
\174\ CME 2013 Letter at 4.
---------------------------------------------------------------------------
The Commission believes that enhancing the system safeguard
requirements a SIDCO must maintain under Core Principle I will increase
stability in the financial markets and is therefore consistent with
Title VIII's objectives. Moreover, regulation 39.30(a) will promote
regulatory consistency for SIDCOs and similarly situated CCPs because
the two-hour RTO is the international standard, under the PFMIs, for
CCPs operating in other jurisdictions. As discussed above, the
Commission is fully committed to adopting and implementing regulations
that are consistent with the PFMIs to ensure that SIDCOs are QCCPs
under the Basel CCP Capital Requirements so that banks transacting
through SIDCOs can receive preferential capital treatment.\175\
Therefore, the Commission is adopting regulation 39.30(a) as proposed.
---------------------------------------------------------------------------
\175\ See supra section I.D.4.
---------------------------------------------------------------------------
The Commission did not receive any comments regarding proposed
regulations 39.30(b) or 39.30(c). Therefore, for reasons stated in the
proposal, the Commission is adopting regulations 39.30(b) and 39.30(c)
as proposed.\176\ However, to mitigate costs, the Commission notes that
regulation 39.30(b) should be interpreted in a manner consistent with
the PFMIs, which state ``[a] particular site may be primary for certain
functions and secondary for others. It is not intended that an FMI
would be required to have numerous separate secondary sites for each of
its essential functions.'' \177\
---------------------------------------------------------------------------
\176\ See 76 FR at 3726-3727.
\177\ See PFMIs, Principle 17: Operations Risk.
---------------------------------------------------------------------------
IV. Regulation 39.31
Regulation 39.31 proposed to codify the special enforcement
authority granted to the Commission over SIDCOs pursuant to section
807(c) of the Dodd-Frank Act, which states that for purposes of
enforcing the provisions of Title VIII of the Dodd-Frank Act, a SIDCO
is subject to, and the Commission has authority under, provisions (b)
through (n) of section 8 of the FDIA\178\ in the same manner and to the
same extent as if the SIDCO were an insured depository institution and
the Commission were the appropriate Federal banking agency for such
insured depository institution.\179\ The Commission did not receive any
comment letters on this proposed regulation, which tracks the statutory
text in section 807 of the Dodd-Frank Act. Therefore, for reasons
stated in the proposal, the Commission is adopting regulation 39.31 as
proposed.
---------------------------------------------------------------------------
\178\ See also 12 U.S.C. 1818(b)-(n) (granting authority for
enforcement powers).
\179\ 76 FR at 3727. The Commission notes that Title VIII
preserved and expanded the CFTC's examination and enforcement
authority with respect to designated entities within its
jurisdiction. See Cong. Rec. 156 S5924-5 (daily ed. July 14, 2010)
(statement of Sen. Lincoln that Title VIII ``preserves and expands
the CFTC's and SEC's examination and enforcement authorities with
respect to designated entities within their respective
jurisdictions,'' and that ``the authorities granted in Title VIII
are intended to be both additive and complementary to the
authorities granted to the CFTC and SEC in Title VII and to those
agencies' already existing legal authorities. The authority provided
in Title VIII to the CFTC and SEC with respect to designated
clearing entities and financial institutions engaged in designated
activities would not and is not intended to displace the CFTC's and
SEC's regulatory regime that would apply to these institutions or
activities.'').
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V. Effective Date and Compliance Dates
For purposes of publication in the Code of Federal Regulations, all
of the rules adopted herein will have an effective date of 60 days
after publication in the Federal Register. The Commission received
three comments, however, requesting additional time to come into
compliance with these rules. Regarding the compliance date of
regulation 39.29, OCC requested that DCOs be afforded a reasonable
amount of time to raise ``any material amount of additional resources''
and requested a delayed implementation of two years.\180\ CME stated
that the financial resources that DCOs are required to maintain will
increase dramatically and requested an implementation period of no less
than 180 days.\181\ Regarding the compliance date of regulation 39.30,
the Commission had proposed a compliance date of one year after
publication of the final rules or July 12, 2012.\182\ OCC commented
that this is a short and burdensome deadline that will be difficult to
meet and encouraged the Commission to adopt a two-year compliance
period for the requirements applicable to SIDCOs.\183\ The Commission
received no comments regarding regulation 39.31.
---------------------------------------------------------------------------
\180\ OCC December Letter at 11.
\181\ CME December Letter at 8.
\182\ See 76 FR at 3714.
\183\ OCC March Letter at 21.
---------------------------------------------------------------------------
Given the mandate to implement these standards, and the necessity
of SIDCOs to fulfill their obligations on a near continuous basis,
after careful consideration of the comments received, the Commission is
extending the compliance date for regulations 39.29 and 39.30 to
December 31, 2013.
VI. Consideration of Costs and Benefits
A. Introduction
Section 15(a) requires the Commission to consider the costs and
benefits of its actions before promulgating a regulation under the CEA
or issuing certain orders.\184\
[[Page 49675]]
Section 15(a) further specifies that the costs and benefits shall be
evaluated in light of five broad areas of market and public concern:
(1) Protection of market participants and the public; (2) efficiency,
competitiveness, and financial integrity of futures markets; (3) price
discovery; (4) sound risk management practices; and (5) other public
interest considerations. The Commission's cost and benefit
considerations in accordance with section 15(a) are discussed below.
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\184\ 7 U.S.C. 19(a).
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B. Background
In this final rulemaking, the Commission is adopting regulations to
implement enhanced risk management standards for SIDCOs.\185\
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\185\ See supra section I.A. through I.F. for a more detailed
discussion on the risk management standards for SIDCOs, including
the designation process for SIDCOs and standards for SIDCOs under
Title VIII of the Dodd-Frank Act.
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As noted above, consistent with the DCO core principles and section
805 of the Dodd-Frank Act, which requires the Commission to consider
relevant international and existing prudential requirements when
prescribing risk management standards for SIDCOs, the Commission
proposed the following enhanced requirements for SIDCOs: \186\
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\186\ See supra section I.F. for discussion on the risk
management standards for SIDCOs proposed by the Commission.
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(1) Regulation 39.29(a) which would require a SIDCO to maintain
sufficient resources to meet a ``cover two'' standard in order to
comply with Core Principle B; \187\ (2) regulation 39.29(b) which would
strictly limit the value of assessments that could be used in meeting
that requirement; \188\ (3) regulation 39.30 which would require a
SIDCO to have a BC-DR plan with a two-hour RTO in order to comply with
Core Principle I (``two-hour RTO''); \189\ and (4) regulation 39.31
which, under section 807(c) of the Dodd-Frank Act, grants the
Commission special enforcement authority over SIDCOs.\190\
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\187\ Id.
\188\ Id.
\189\ Id.
\190\ Id.
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As also discussed above, after the Commission proposed the SIDCO
risk management standards and received comments, the PFMIs were
published.\191\ The PFMIs establish international risk management
standards for FMIs, including CCPs, that facilitate clearing and
settlement.\192\ The PFMIs also play a significant role in the Basel
CCP Capital Requirements, which introduce new capital charges based on
counter party risk for banks conducting financial derivatives
transactions through a CCP.\193\ These capital charges vary
significantly depending on whether or not the counterparty is a QCCP,
that is, a CCP that is subject to regulations consistent with the
PFMIs.\194\ Effectively, the Basel CCP Capital Requirements incentivize
banks to clear derivatives through QCCPs by setting lower capital
charges for exposures arising from derivatives cleared through a QCCP
and setting significantly higher capital charges for exposures arising
from derivatives cleared through non-qualifying CCPs.\195\ As discussed
further below, these differences in capital charges are extremely
important in considering whether to adopt requirements for SIDCOs,
which are consistent with the PFMIs, or requirements that fall short of
that standard.
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\191\ See supra section I.D.1. for a general discussion on the
PFMIs.
\192\ Id.
\193\ See supra section I.D.4. for a discussion on the role of
the PFMIs in international banking standards.
\194\ Id.
\195\ Id.
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In light of the directive of section 805 of the Dodd-Frank Act to
consider relevant international standards and existing prudential
requirements when prescribing risk management standards for designated
systemically important FMUs, as well as the recent publication of the
PFMIs, and public comments on the proposed SIDCO regulations, the
Commission has determined it is necessary and appropriate to finalize
the proposed enhanced risk management standards for SIDCOs. However, in
order to harmonize the proposed regulations with the existing
international standards set forth by the PFMIs, as requested by some
commenters,\196\ the Commission has revised proposed regulation
39.29(a) and 39.29(b). Rather than apply the cover two requirement to
all SIDCOs, revised regulation 39.29(a) parallels the financial
resources standard in Principle 4 of the PFMIs and only requires a
SIDCO that is systemically important in multiple jurisdictions or that
is involved in activities with a more complex risk profile to maintain
financial resources sufficient to meet the cover two requirement.\197\
Revised regulation 39.29(b), which is also consistent with Principle 4
of the PFMIs, prohibits a SIDCO from the use of assessments in
calculating its financial resources available to meet the SIDCO's
obligations under regulation 39.29(a).\198\
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\196\ See OCC December Letter at 12 (OCC requesting that the
Commission avoid taking final action on the proposed SIDCO
regulations until the adoption of the PFMIs to ensure consistency
with international regulations) and LCH December Letter at 1-2 (LCH
urging the Commission to conform as much as possible the
Commission's final rules on SIDCOs to the global standards set forth
in the PFMIs).
\197\ See supra section II. for a discussion on the proposed and
revised rule text of regulation 39.29.
\198\ Id.
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The Commission considered the following alternatives: (1) Not to
adopt any of the proposed SIDCO risk management regulations, (2) to
adopt the SIDCO risk management regulations only as proposed, or (3) to
adopt the proposed SIDCO risk management regulations with revisions
consistent with relevant international standards and existing
prudential requirements. As detailed above, the Commission has
concluded it is necessary and appropriate in this final rulemaking to
adopt regulation 39.29, as revised, regulation 39.30, as proposed, and
regulation 39.31, as proposed.\199\
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\199\ See supra discussion I.C. and I.F.
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In the discussion that follows, the Commission considers the costs
and benefits of the final rulemaking in light of the comments it
received and section 15(a) of the CEA. As the requirement in regulation
39.31 is imposed by the Dodd-Frank Act, any associated costs and
benefits are the result of statutory directives as determined by
Congress, not an act of Commission discretion.
For the remaining regulations in this rulemaking, 39.29(a) (cover
two), 39.29(b) (prohibition of assessments) and 39.30 (two-hour RTO),
the Commission considers the costs and benefits attributable to these
enhanced requirements against the DCO regulatory framework established
in part 39, which provides minimum risk standards for DCOs and sets the
baseline for cost and benefit considerations. Specifically, regulation
39.11 (implementing DCO Core Principle B) sets a cover one standard as
the minimum financial resources requirement for all DCOs whereas
regulation 39.29(a) sets a cover two financial resources requirement
for all SIDCOs engaged activities with a more complex risk profile or
that are systemically important in multiple jurisdictions. Regulation
39.11 permits the inclusion of assessment powers, to a limited extent,
in calculating whether a DCO meets its default resources requirement,
whereas regulation 39.29(b) prohibits the use of assessments by SIDCOs
in meeting those obligations. Regulation 39.18 requires a DCO to have
an RTO of no later than the next business day following the disruption
of its operations whereas regulation 39.30 (implementing DCO Core
Principle I) requires SIDCOs to have a BC-DR plan with a two-hour
[[Page 49676]]
RTO following the disruption of its operations.
The Commission invited public comment on all aspects of the
proposed SIDCO rulemaking but did not receive any comments with
quantitative data from which the Commission could calculate the costs
and benefits of the proposed enhanced requirements. The Commission did
receive qualitative comments on the Commission's proposed consideration
of costs and benefits generally, as well as specifically to the
requirements central to this final rule: Cover two, use of assessments
and two-hour RTO. These comments are summarized below in connection
with the Commission's consideration of the costs and benefits of the
final rules being promulgated herein.
C. Benefits and Costs of the Final Rule
1. Benefits
As explained in the subsections that follow, this final rule
promotes the financial strength, operational security and reliability
of SIDCOs, reduces systemic risk, and increases the stability of the
broader U.S. financial system. In addition, the regulations harmonize
U.S regulations with international standards which will, in important
ways, place SIDCOs on a level playing field with their competitors in
the global financial markets:
a. Regulation 39.29(a): Cover Two
The cover two requirement increases the financial stability of
certain SIDCOs which, in turn, increases the overall stability of the
US financial markets. This is so because enhancing a SIDCO's financial
resources requirements from the minimum of cover one to a more
stringent cover two standard helps to ensure the affected SIDCO will
have greater financial resources to meet its obligations to market
participants, including in the case of defaults by multiple clearing
members. These added financial resources lessen the likelihood of the
SIDCO's failure which, given the designation of systemically important,
could threaten the stability of the US financial system.\200\ By
bolstering certain SIDCOs' resources, regulation 39.29(a) contributes
to the financial integrity of the financial markets and reduces the
likelihood of systemic risk from spreading through the financial
markets due to one of those SIDCOs' failure or disruption.
---------------------------------------------------------------------------
\200\ See supra section I.B.
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According to commenters, existing SIDCOs already fund their default
resources using a cover two standard for products with a more complex
risk profile.\201\ Although the benefit associated with regulation
39.29(a) is somewhat lessened by the already established practice of
cover two by the relevant SIDCOs, there is a long-term benefit of
setting the cover two standard as the new regulatory minimum to ensure
that even in periods of apparent stability and low market volatility,
these SIDCOs will continue to have increased financial resource
requirements and, ultimately, greater financial stability. This
approach of obtaining resources in such low-stress periods avoids the
need to call for additional resources from clearing members during less
stable, more volatile times, which would have pro-cyclical effects on
the U.S. financial markets.\202\ In addition, the cover two requirement
will apply to SIDCOs deemed systemically important in multiple
jurisdictions.
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\201\ See ICC Letter at 1. See also CME 2013 Letter at 2-3.
\202\ See supra section II.B. for discussion on the pro-cyclical
impact of assessments.
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b. Regulation 39.29(b): Prohibited Use of Assessments To Meet
Regulation 39.29(a) Obligations
As discussed below and throughout this release, the Commission
believes that prohibiting the use of assessments by a SIDCO in meeting
its default resource obligations (i.e. those under regulations
39.11(a)(1) and 39.29(a)) increases the financial stability of the
SIDCO, which in turn, increases the overall stability of the U.S.
financial markets.
Assessment powers are more likely to be exercised during periods of
financial market stress. If during such a period, a clearing member
defaults and the loss to the SIDCO is sufficiently large to deplete (1)
the collateral posted by the defaulting entity, (2) the defaulting
entity's default fund contribution, and (3) the remaining pre-funded
default fund contributions, a SIDCO's exercise of assessment powers
over the non-defaulting clearing members may exacerbate a presumably
already weakened financial market. The demand by a SIDCO for more
capital from its clearing members could force one or more additional
clearing members into default because they cannot meet the assessment.
The inability to meet the assessment could lead clearing members and/or
their customers to de-leverage (i.e., sell off their positions) in
falling asset markets, which further drives down asset prices and may
result in clearing members and/or their customers defaulting on their
obligations to each other and/or to the SIDCO. In such extreme
circumstances, assessments could trigger a downward spiral and lead to
the destabilization of the financial markets. Prohibiting the use of
assessments by a SIDCO in meeting default resources obligations is
intended to require the SIDCO to retain more financial resources
upfront, i.e. to prefund its financial resources requirement to cover
its potential exposure.
The increase in prefunding of financial resources by a SIDCO may
increase costs to clearing members of that SIDCO (e.g. requiring
clearing members to post additional funds with the SIDCO),\203\ but it
also reduces the likelihood that the SIDCO will require additional
capital infusions during a time of financial stress when raising such
additional capital is expensive relative to market norms. By increasing
prefunded financial resources, a SIDCO becomes less reliant on the
ability of its clearing members to pay an assessment, more secure in
its ability to meets its obligations, and more viable in any given
situation, even in the case of multiple defaults of clearing members.
Accordingly, regulation 39.29(b) increases the financial security and
reliability of the SIDCO which will thereby further increase the
overall the stability of the U.S. financial markets.
---------------------------------------------------------------------------
\203\ Id.
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c. Regulation 39.30: Two-Hour RTO
A two-hour RTO in a SIDCO's BC-DR plan increases the soundness and
operating resiliency of the SIDCO, which in turn, increases the overall
stability of the U.S. financial markets.
Given the significant role SIDCOs play within the financial market
infrastructure and the need to preserve, to the greatest extent
practicable, their near-continuous operation, regulation 39.30
prescribes an enhanced RTO of two hours. The two-hour RTO ensures that
even in the event of a wide-scale disruption, the potential negative
effects upon U.S. financial markets be minimized because the affected
SIDCO will recover rapidly and resume its critical market functions,
thereby allowing other market participants to process their
transactions, even those participants in locations not directly
affected by the disruption. The two-hour RTO increases a SIDCO's
operational resiliency by requiring the SIDCO to have the resources and
technology necessary to resume operations promptly. This resiliency, in
turn, increases the overall stability of the U.S. financial markets.
[[Page 49677]]
d. Benefits of QCCP Status
As discussed above,\204\ the international Basel CCP Capital
Requirements provide incentives for banks to clear derivatives through
CCPs that are qualified CCPs or ``QCCPs'' by setting lower capital
charges for exposures arising from derivatives cleared through a QCCP
and setting significantly higher capital charges for exposures arising
from derivatives cleared through non-qualifying CCPs.\205\ The enhanced
risk management standards for SIDCOs adopted in this final rulemaking
are consistent with the international standards set forth in the PFMIs
and address part of the remaining divergences between part 39 of the
Commission's regulations and the PFMIs, which will provide an
opportunity for SIDCOs to gain QCCP status. The Commission believes
there is a benefit for a SIDCO if it is able to offer to its clearing
members and their customers the favorable capital treatment under the
Basel CCP Capital Requirements.
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\204\ See supra section I. D. 4. for a discussion of the Basel
CCP Capital Requirements.
\205\ Id.
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2. Costs
The Commission requested but did not receive any quantitative data
or specific cost estimates associated with the proposed regulations.
However, in qualitative terms, the Commission recognizes that this
final rule may impose important costs on SIDCOs depending on the
financial resources requirements and system safeguards procedures the
SIDCOs currently implement. In other words, the costs range from
minimal (to the extent SIDCOs are already operating, or planning to
operate, consistent with the final rules) to significant (for those who
are not).\206\
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\206\ For example, ICC, one of the two existing SIDCOs, stated
that it already implements the ``cover two'' requirement, that it
does not rely upon its right of assessment in meeting that
requirement, and that it is unlikely to incur significant costs in
implementing the two hour RTO. See ICC Letter at 1-2. In addition,
CME Clearing, the other existing SIDCO, implements the ``cover two''
requirement for two of its three guaranty funds, has each of its
guaranty funds pre-funded by the respective clearing members, and,
though the cost will be significant, has already ``obtained budget
approval and allocated resources towards a two hour RTO.'' See CME
2013 Letter at 2-4.
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To the extent costs increase, the Commission has considered that
higher trading costs for market participants (i.e. increased clearing
fees, guaranty fund contributions, and margin fees, etc.) may
discourage market participation and result in decreased liquidity and
reduced price discovery. However, the Commission has also considered
the costs to market participants and the public if these regulations
are not adopted. Significantly, without these regulations to ensure
that SIDCOs operate under certain enhanced risk management standards,
in a manner that is consistent with internationally accepted standards,
the financial integrity and security of the U.S. financial markets
would be at a greater risk relative to international markets. This,
too, could adversely affect the attractiveness of the U.S. financial
markets subject to the Commission's jurisdiction as compared to foreign
competitors. In addition, without the final rule, SIDCOs would not have
the opportunity to gain QCCP status, thereby putting them at a
significant competitive disadvantage in the global financial markets
which, again, would be to the detriment of their clearing members and
their customers. The Commission notes that to the extent it addresses
the remaining divergences between part 39 of the Commission's
regulations and the PFMIs through future rulemakings, and these
rulemakings, along with the regulations adopted herein, do not provide
an opportunity for non-SIDCO DCOs to obtain QCCP status, this would
place such non-SIDCO DCOs at a competitive disadvantage to SIDCOs.
Moreover, the resulting cost to the DCOs would be the inability to
offer the favorable capital treatment under the Basel CCP Capital
Requirements to their customers and clearing members.
a. Regulation 39.29(a): Cover Two
The cost of the cover two requirement for certain SIDCOs includes
the opportunity cost of the additional financial resources needed to
satisfy the guaranty fund requirements for the risk of loss resulting
from the default of the second largest clearing member.\207\
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\207\ In the event that these additional resources need to be
raised by the SIDCO, as opposed to reallocated, this cost is the
funding cost for raising these additional resources. In addition, to
the extent that there is uncertainty over whether cover two applies
(for example, as in the case of whether a DCO gets deemed to be
systemically important in multiple jurisdictions or whether a given
product is, indeed, of a more complex risk profile), the cost of
cover two is the opportunity cost (funding cost) of the additional
financial resources weighted by the likelihood that cover two will
apply.
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As discussed above in more detail, the Commission received comments
from market participants addressing the costs associated with a cover
two standard.\208\ OCC argued that if heightened risk management
standards are imposed on a DCO in such a way as to substantially
increase the costs for clearing members and their customers to clear
transactions through a SIDCO rather than a non-SIDCO, there is risk of
undermining the goals of both Titles VII and VIII of the Dodd-Frank Act
by driving clearing volume to less-regulated clearinghouses.\209\ FIA
commented that the cover two requirement would put SIDCOs at a
competitive disadvantage to other DCOs to the extent that they need to
increase margin or guaranty fund requirements to cover the default of
the second largest clearing member.\210\ FIA recommended that the
Commission adopt an alternative approach by extending the cover two
requirement to all DCOs, not just SIDCOs, and allow ample time for DCOs
to come into compliance.\211\ CME stated that a cover two requirement
would allow some DCOs to offer lower guaranty fund and margin
requirements, which would attract additional volume to that DCO and
make it a de facto SIDCO. SIDCOs would then be at a competitive
disadvantage relative to the de facto SIDCO until such time as the de
facto SIDCO was designated as a SIDCO.\212\ ICC, one of the two
existing SIDCOs, on the other hand, is in compliance with the cover two
requirement and therefore, would not incur additional costs to meet the
cover two requirement.\213\
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\208\ See section II. for a discussion on comments received on
the proposed regulation 39.29(a).
\209\ Id.
\210\ Id.
\211\ Id.
\212\ Id.
\213\ ICC Letter at 2.
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As noted above, and in comment letters from CME and ICC,\214\
SIDCOs already implement the cover two standard for products with a
more complex risk profile, and therefore, the costs of compliance with
cover two should be mitigated given these existing practices.\215\
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\214\ See supra n. 23 (designation of CME and ICC as SIDCOs).
\215\ See ICC Letter at 1-2. See also CME 2013 Letter at 2-3.
---------------------------------------------------------------------------
However, there are likely to be costs associated with the
uncertainty as to whether a SIDCO is deemed systemically important in
multiple jurisdictions and what constitutes a product with a more
complex risk profile. These costs are associated with business
planning, i.e. how to fund a cover two requirement. In addition, the
possibility exists that some market participants will port their
positions from a SIDCO that either (1) is deemed systemically important
in multiple jurisdictions or (2) clears products of a more complex risk
profile to another SIDCO for which neither (1) nor (2) applies or to
another DCO that is not
[[Page 49678]]
systemically important because the value of the cover two protection to
these market participants is less than the price at which that
protection is being offered. These market participants will transact
with DCOs that operate under cover one, which is a lower financial
resources requirement, and thus, get the benefit of lower transactional
fees and forego the enhanced protections associated with the SIDCOs.
Such an event adversely impacts the reduction in systemic risk that the
cover two standard affords. However, the potential cost to the SIDCO
and to the goal of systemic risk reduction is likely mitigated because
(a) not every product offered by the SIDCO is available at other DCOs
and (b) a SIDCO may offer benefits not available to a DCO that is not
designated as systemically important,\216\ thereby reducing the
likelihood that market participants will port their positions to other
DCOs.
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\216\ For example under Title VIII, a SIDCO may establish and
maintain an account with the Federal Reserve Bank if permitted to do
so by such Federal Reserve Bank and by the Board. See section 806(a)
of the Dodd-Frank Act.
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b. Regulation 39.29(b): Prohibition on the Use of Assessments in
Calculation of Default Resources To Meet Obligations Under Regulation
39.29(a)
The costs associated with the prohibited use of assessments by
SIDCOs in calculating the SIDCO's obligations under regulation 39.29(a)
include the opportunity cost of the additional financial resources
needed to replace the value of such assessments. This may require an
infusion of additional capital. The cost of this regulation should be
mitigated for SIDCOs because neither CME Clearing nor ICC, the two
existing SIDCOs, rely on assessments to meet their default fund
obligations for products with a more complex risk profile.\217\
Additionally, analogous to the case with the cover two standard, market
participant demand may shift from a SIDCO to a DCO with a lower
capitalization requirement.
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\217\ See ICC Letter at 2 (stating that ICC ``does not rely upon
(count) [its] right of assessment to meet the [``cover two''
requirement]''). See also CME 2013 Letter at 3, n.7.
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c. Regulation 39.30: Two-Hour RTO
The Commission recognizes that a two-hour RTO may increase
operational costs for SIDCOs by requiring additional resources,
including personnel, technological and geographically dispersed
resources, in order to comply with the final rule. Moreover, the
implementation of a two-hour RTO is expected to impose one-time costs
to set up the enhanced resources as well as recurring costs to operate
the additional resources. However, as noted above, the Commission
requested but did not receive quantitative data from which to estimate
the dollar costs associated with implementing a two-hour RTO, and in
particular the costs of moving from a next day RTO, the minimum
standard established by the DCO core principles and regulation 39.18,
to a two-hour RTO as required by regulation 39.30. The Commission did,
however, receive qualitative comments regarding the costs associated
with the two-hour RTO, which are discussed in more detail above. For
example, CME, ICE and OCC all initially opposed the enhanced RTO,
citing to the increase of costs associated with the proposed regulation
39.30. However, more recently, the Commission received comments from
CME and ICC acknowledging the importance of the two-hour RTO and their
intent to implement a two-hour RTO.\218\
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\218\ See ICC Letter at 2 (noting that the two-hour RTO is
consistent with Principle 17 of the PFMIs, and stating that it is
unlikely to incur ``any significant additional personnel training
cost associated with the CFTC's proposed RTO of two hours'' or ``any
additional backup technology costs related to the CFTC's proposed
RTO.''). See also CME 2013 Letter at 4 (noting that ``in light of
the systemic importance of CME [Clearing]'s clearing functions and
the intended benefits, including compliance with the PFMI
requirements for critical information technology, CME [Clearing] has
obtained budget approval and allocated resources towards a two hour
RTO and will be working throughout 2013 towards achieving a two hour
RTO.'').
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D. Section 15(a) Factors
1. Protection of Market Participants and the Public
The enhanced financial resources requirements and system safeguard
requirements for SIDCOs, as set forth in this final rulemaking, will
further the protection of market participants and the public by
increasing the financial stability and operational security of SIDCOs,
and more broadly, increase the stability of the U.S. financial markets.
A designation of systemic importance under Title VIII means the failure
of a SIDCO or the disruption of its clearing and settlement activities
could create or increase the risk of significant liquidity or credit
problems spreading among financial institutions or markets, thereby
threatening the stability of the U.S. financial markets. The
regulations contained in this final rule are designed to help ensure
that SIDCOs continue to function even in extreme circumstances,
including multiple defaults by clearing members and wide-scale
disruptions. While there may be increased costs associated with the
implementation of the final rules, these costs are mitigated by the
countervailing benefits of the increased safety and soundness of the
SIDCOs and the reduction of systemic risk, which protect market
participants and the public form the adverse consequences that would
result from a SIDCO failure or a disruption in its functioning.
2. Efficiency, Competitiveness, and Financial Integrity
The regulations set forth in this final rulemaking will promote
financial strength and stability of SIDCOs, as well as, more broadly,
efficiency and greater competition in the global markets. The
regulations promote efficiency insofar as SIDCOs that operate with
enhanced financial resources as well as increased system safeguards are
more secure and are less likely to fail. The regulations promote
competition because they are consistent with the international
standards set forth in the PFMIs and will help to ensure that SIDCOs
are afforded the opportunity to gain QCCP status and thus avoid an
important competitive disadvantage relative to similarly situated
foreign CCPs that are QCCPs. Additionally, by increasing the stability
and strength of the SIDCOs, the regulations in the final rule help to
ensure that SIDCOs can meet their obligations in the most extreme
circumstances and can resume operations even in the face of wide-scale
disruption, which contributes to the financial integrity of the
financial markets. In requiring more SIDCO financial resources to be
pre-funded by (1) expanding the potential losses those resources are
intended to cover and (2) restricting the means for satisfying those
resource requirements, i.e. through prohibiting the use of assessments
in determining guarantee fund contributions, the requirements of this
final rule seek to lessen the incidence of pro-cyclical demands for
additional funding resources and, in so doing, promote both financial
integrity and market stability.\219\
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\219\ See supra n. 139 and accompanying text for a discussion of
pro-cyclicality.
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3. Price Discovery
The regulations in the final rulemaking enhance risk management
standards for SIDCOs which may result in increased public confidence,
which, in turn, might lead to expanded participation in the affected
markets, i.e. products with a more complex risk profile. The expanded
participation in these markets (i.e. greater transactional
[[Page 49679]]
volume) may have a positive impact on price discovery. Conversely, the
Commission notes that these enhanced risk management standards are also
associated with additional costs and to the extent that SIDCOs pass
along the additional costs to their clearing members and customers,
participation in the affected markets may decrease and have a negative
impact on price discovery. However, it is the Commission's belief that
such higher transactional costs should be greatly offset by the lower
capital charges granted to clearing members and customers clearing
derivative transactions through SIDCOs that are deemed QCCPs.
4. Sound Risk Management Practices
The regulations in the final rulemaking contribute to the sound
risk management practices of SIDCOs because the requirements promote
the safety and soundness of the SIDCOs by (1) enhancing the financial
resources requirements, which provide greater certainty for market
participants that all obligations will be honored by the SIDCOs and (2)
enhancing system safeguards to facilitate the continuous operation and
rapid recovery of activities, which provide certainty and security to
market participants that potential disruptions will be reduced and, by
extension, the risk of loss of capital and liquidity will be reduced.
5. Other Public Interest Considerations
The Commission notes the strong public interest for jurisdictions
to either adopt the PFMIs or establish standards consistent with the
PFMIs in order to allow CCPs licensed in the relevant jurisdiction to
gain QCCP status. As emphasized throughout this rulemaking, SIDCOs that
gain QCCP status will avoid a competitive disadvantage in the financial
markets by avoiding the much higher capital charges imposed by the
Basel CCP Capital Requirements. Moreover, because ``enhancements to the
regulation and supervision of systemically important financial market
utilities . . . are necessary . . . to support the stability of the
broader financial system,'' \220\ adopting these rules promotes the
public interest in a more stable broader financial system.
---------------------------------------------------------------------------
\220\ See section 804(a)(4) of the Dodd-Frank Act (Congressional
findings).
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VII. Related Matters
A. Paperwork Reduction Act
The Commission may not conduct or sponsor, and a registered entity
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 Commission's adoption of Sec. Sec. 39.28, 39.29,
39.30, and 39.31 (DCO) imposes no new information collection
requirements on registered entities within the meaning of the Paperwork
Reduction Act.\221\ The OMB has previously assigned control numbers for
the required collections of information under a prior related final
rulemaking to which this rulemaking relates.\222\ The titles for the
previous collections of information are ``Part 40, Provisions Common to
Registered Entities'', OMB control number 3038-0093, ``Financial
Resources Requirements for Derivatives Clearing Organizations, OMB
control number 3038-0066,'' ``Information Management Requirements for
Derivatives Clearing Organizations, OMB control number 3038-0069,''
``General Regulations and Derivatives Clearing Organizations, OMB
control number 3038-0081,'' and ``Risk Management Requirements for
Derivatives Clearing Organizations, OMB control number 3038-0076.''
This rulemaking is applicable to a subset of DCOs designated as SIDCOs,
who must comply with existing information collection requirements for
DCOs.
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\221\ 44 U.S.C. 3501 et seq.
\222\ 76 FR 69334 at 69428.
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B. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) requires that agencies
consider whether the rules they propose will have a significant
economic impact on a substantial number of small entities and, if so,
provide a regulatory flexibility analysis respecting the impact. The
rules proposed by the Commission will affect only DCOs designated as
SIDCOs. The Commission has previously established certain definitions
of ``small entities'' to be used by the Commission in evaluating the
impact of its regulations on small entities in accordance with the RFA.
The Commission has previously determined that DCOs are not small
entities for the purpose of the RFA.\223\ Accordingly, the Chairman, on
behalf of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b)
that the proposed rules will not have a significant economic impact on
a substantial number of small entities.
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\223\ See ``A New Regulatory Framework for Clearing
Organizations,'' 66 FR 45604, 45609 (Aug. 29, 2001), ``17 CFR part
40 Provisions Common to Registered Entities,'' 75 FR 67282 (November
2, 2010), and ``Provisions Common to Registered Entities,'' 76 FR
44776, 44789 (July 27, 2011).
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List of Subjects in 17 CFR Part 39
Commodity futures, Consumer protection, Enforcement authority,
Financial resources, Reporting and recordkeeping requirements, Risk
management.
For the reasons stated in the preamble, amend 17 CFR part 39 as
follows:
PART 39--DERIVATIVES CLEARING ORGANIZATIONS
0
1. The authority citation for part 39 is revised 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 C also issued under 12 U.S.C. 5464.
0
2. Add subpart C to read as follows:
Subpart C--Provisions Applicable to Systemically Important Derivatives
Clearing Organizations
Sec.
39.28 Scope.
39.29 Financial resources requirements.
39.30 System safeguards.
39.31 Special enforcement authority.
Subpart C--Provisions Applicable to Systemically Important
Derivatives Clearing Organizations
Sec. 39.28 Scope.
(a) The provisions of this subpart C apply to any derivatives
clearing organization, as defined in section 1a(15) of the Act and
Sec. 1.3(d) of this chapter,
(1) Which is registered or deemed to be registered with the
Commission as a derivatives clearing organization, is required to
register as such with the Commission pursuant to section 5b(a) of the
Act, or which voluntarily registers as such with the Commission
pursuant to section 5b(b) or otherwise; and
(2) Which is a systemically important derivatives clearing
organization as defined in Sec. 39.2.
(b) A systemically important derivatives clearing organization is
subject to the provisions of subparts A and B of this part 39 except to
the extent different requirements are imposed by provisions of this
subpart C.
(c) A systemically important derivatives clearing organization
shall provide notice to the Commission in advance of any proposed
change to its rules, procedures, or operations that could materially
affect the nature or level of risks presented by the systemically
important derivatives clearing organization, in accordance with the
requirements of Sec. 40.10 of this chapter.
[[Page 49680]]
Sec. 39.29 Financial resources requirements.
(a) General rule. Notwithstanding the requirements of Sec.
39.11(a)(1), a systemically important derivatives clearing organization
that is systemically important in multiple jurisdictions or that is
involved in activities with a more complex risk profile shall maintain
financial resources sufficient to enable it to meet its financial
obligations to its clearing members notwithstanding a default by the
two clearing members creating the largest combined financial exposure
for the systemically important derivatives clearing organization in
extreme but plausible market conditions; Provided that if a clearing
member controls another clearing member or is under common control with
another clearing member, affiliated clearing members shall be deemed to
be a single clearing member for the purposes of this provision.
(b) Valuation of financial resources. Notwithstanding the
requirements of Sec. 39.11(d)(2), assessments for additional guaranty
fund contributions (i.e., guarantee fund contributions that are not
pre-funded) shall not be included in calculating the financial
resources available to meet a systemically important derivatives
clearing organization's obligations under paragraph (a) of this
section.
Sec. 39.30 System safeguards.
(a) Notwithstanding Sec. 39.18(e)(3), the business continuity and
disaster recovery plan described in Sec. 39.18(e)(1) for each
systemically important derivatives clearing organization shall have the
objective of enabling, and the physical, technological, and personnel
resources described in Sec. 39.18(e)(1) shall be sufficient to enable,
the derivatives clearing organization to recover its operations and
resume daily processing, clearing, and settlement no later than two
hours following the disruption, for any disruption including a wide-
scale disruption.
(b) To ensure its ability to achieve the recovery time objective
specified in paragraph (a) of this section in the event of a wide-scale
disruption, each systemically important derivatives clearing
organization must maintain a degree of geographic dispersal of
physical, technological and personnel resources consistent with the
following:
(1) For each activity necessary to the clearance and settlement of
existing and new contracts, physical and technological resources,
sufficient to enable the entity to meet the recovery time objective
after interruption of normal clearing by a wide-scale disruption, must
be located outside the relevant area of the infrastructure the entity
normally relies upon to conduct that activity, and must not rely on the
same critical transportation, telecommunications, power, water, or
other critical infrastructure components the entity normally relies
upon for such activities;
(2) Personnel, sufficient to enable the entity to meet the recovery
time objective after interruption of normal clearing by a wide-scale
disruption affecting the relevant area in which the personnel the
entity normally relies upon to engage in such activities are located,
must live and work outside that relevant area;
(3) The provisions of Sec. 39.18(f) shall apply to these resource
requirements.
(c) Each systemically important derivatives clearing organization
must conduct regular, periodic tests of its business continuity and
disaster recovery plans and resources and its capacity to achieve the
required recovery time objective in the event of a wide-scale
disruption. The provisions of Sec. 39.18(j) apply to such testing.
(d) The requirements of this section shall apply to a derivatives
clearing organization not earlier than one year after such derivatives
clearing organization is designated as systemically important.
Sec. 39.31 Special enforcement authority.
For purposes of enforcing the provisions of Title VIII of the Dodd-
Frank Act, a systemically important derivatives clearing organization
shall be subject to, and the Commission has authority under the
provisions of subsections (b) through (n) of section 8 of the Federal
Deposit Insurance Act (12 U.S.C. 1818) in the same manner and to the
same extent as if the systemically important derivatives clearing
organization were an insured depository institution and the Commission
were the appropriate Federal banking agency for such insured depository
institution.
Issued in Washington, DC, on August 9, 2013, by the Commission.
Melissa D. Jurgens,
Secretary of the Commission.
Appendix to Final Rule on Enhanced Risk Management Standards for
Systemically Important Derivatives Clearing Organizations--Commission
Voting Summary
Note: The following appendix will not appear in the Code of
Federal Regulations
Appendix 1--Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Chilton,
O'Malia, and Wetjen voted in the affirmative.
[FR Doc. 2013-19791 Filed 8-14-13; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: August 15, 2013