FR Doc 2010-25322[Federal Register: October 14, 2010 (Volume 75, Number 198)]
[Proposed Rules]
[Page 63113-63120]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr14oc10-27]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 39 and 140
RIN 3038-AC98, 3038-AD02
Financial Resources Requirements for Derivatives Clearing
Organizations
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)
is proposing rules to implement new statutory provisions enacted by
Title VII and Title VIII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Dodd-Frank Act). The proposed regulations
establish financial resources requirements for derivatives clearing
organizations (DCOs) for the purpose of ensuring that they maintain
sufficient financial resources to enable them to perform their
functions in compliance with the Commodity Exchange Act and the Dodd-
Frank Act.
DATES: Submit comments on or before December 13, 2010.
ADDRESSES: You may submit comments, identified by RIN number, by any of
the following methods:
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Agency Web Site: http://www.cftc.gov. Follow the
instructions for submitting comments on the Web site.
E-mail: [email protected]. Include the RIN number in
the subject line of the message.
Fax: 202-418-5521.
Mail: David A. Stawick, Secretary of the Commission,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW., Washington, DC 20581.
Hand Delivery/Courier: Same as mail above.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
http://www.cftc.gov. You should submit only information that you wish
to make available publicly. If you wish the Commission to consider
information that may be exempt from disclosure under the Freedom of
Information Act, a petition for confidential treatment of the exempt
information may be submitted according to the established procedures in
CFTC Regulation 145.9.\1\
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\1\ Commission regulations referred to herein are found at 17
CFR Ch. 1.
FOR FURTHER INFORMATION CONTACT: John C. Lawton, Deputy Director and
Chief Counsel, 202-418-5480, [email protected], Phyllis P. Dietz,
Associate Director, 202-418-5449, [email protected], or Eileen A.
Donovan, Special Counsel, 202-418-5096, [email protected], Division of
Clearing and Intermediary Oversight, Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21 Street, NW., Washington, DC
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20581.
SUPPLEMENTARY INFORMATION:
I. Background
A. Title VII
On July 21, 2010, President Obama signed the Dodd-Frank Act.\2\
Title VII of the Dodd-Frank Act \3\ amended the Commodity Exchange Act
(CEA) \4\ to establish a comprehensive regulatory framework to reduce
risk, increase transparency, and promote market integrity within the
financial system by, among other things: (1) Providing for the
registration and comprehensive regulation of swap dealers and major
swap participants; (2) imposing clearing and trade execution
requirements on standardized derivative products; (3) creating rigorous
recordkeeping and real-time reporting regimes; and (4) enhancing the
Commission's rulemaking and enforcement authorities with respect to all
registered entities and intermediaries subject to the Commission's
oversight.
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\2\ 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./
LawRegulation/OTCDERIVATIVES/index.htm.
\3\ Pursuant to Section 701 of the Dodd-Frank Act, Title VII may
be cited as the ``Wall Street Transparency and Accountability Act of
2010.''
\4\ 7 U.S.C. 1 et seq.
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Section 725(c) of the Dodd-Frank Act amends Section 5b(c)(2) of the
CEA, which sets forth core principles with which a DCO must comply to
be registered and to maintain registration as a DCO.
The core principles were added to the CEA by the Commodity Futures
Modernization Act of 2000 (CFMA).\5\ Consistent with the CFMA's
principles-based approach to regulation, the Commission did not adopt
implementing rules and regulations, but instead promulgated guidance
for DCOs on compliance with the core principles.\6\ However under
Section 5b(c)(2), as amended by the Dodd-Frank Act, Congress expressly
confirmed that the Commission may adopt implementing rules and
regulations pursuant to its rulemaking authority under Section 8a(5) of
the CEA.\7\
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\5\ See Commodity Futures Modernization Act of 2000, Public Law
106-554, 114 Stat. 2763 (2000).
\6\ See Appendix A to Part 39, 17 CFR Part 39. The Commission
notes that it intends to propose removal of Appendix A, in its
entirety, as part of a future proposed rulemaking.
\7\ Section 8a(5) of the CEA authorizes the Commission to
promulgate such regulations as, in the judgment of the Commission,
are reasonably necessary to effectuate any of the provisions or to
accomplish any of the purposes of the CEA.
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The Commission continues to believe that, where possible, each DCO
should be afforded an appropriate level of discretion in determining
how to operate its business within the statutory framework. At the same
time, the Commission recognizes that specific bright-line regulations
may be necessary in order to facilitate DCO compliance with a given
core principle, and ultimately, to protect the integrity of the U.S.
clearing system. Accordingly, in developing the proposed regulation,
the Commission has endeavored to strike an appropriate balance between
establishing general prudential standards and prescriptive
requirements.
Core Principle B, as amended by the Dodd-Frank Act, requires a DCO
to possess financial resources that, at a minimum, exceed the total
amount that would enable the DCO to meet its financial obligations to
its clearing members \8\ notwithstanding a default by
[[Page 63114]]
the clearing member creating the largest financial exposure for the DCO
in extreme but plausible market conditions; and enable the DCO to cover
its operating costs for a period of 1 year, as calculated on a rolling
basis. The Commission is proposing to adopt Regulation 39.11 to
establish requirements that a DCO will have to meet in order to comply
with Core Principle B.
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\8\ The term ``clearing members'' refers to entities that have a
direct financial relationship to a DCO, regardless of the DCO's
organizational structure, i.e., whether or not the DCO is a
membership organization. Clearing members include futures commission
merchants (FCMs) that clear on behalf of customers or themselves,
and non-FCMs that clear solely on behalf of themselves. See also the
definition of the term ``clearing member'' in CFTC Regulation
1.3(c).
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B. Title VIII
Section 802(b) of the Dodd-Frank Act states that the purpose of
Title VIII is to mitigate systemic risk in the financial system and to
promote financial stability. Section 804 authorizes the Financial
Stability Oversight Council (Council) to designate entities involved in
clearing and settlement as systemically important.\9\
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\9\ Commission staff has been engaged in discussions with staff
of other members of the Council concerning which entities might
qualify.
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Section 805(a) of the Dodd-Frank Act allows the Commission to
prescribe regulations for those DCOs that the Council has determined
are systemically important. The Commission is also proposing to adopt
some additional or enhanced requirements for systemically important
DCOs (SIDCOs).
The Commission requests comment on all aspects of the proposed
rules, as well as comment on the specific provisions and issues
highlighted in the discussion below. The Commission further requests
comment on an appropriate effective date for final rules, once adopted.
II. Proposed Regulations
A. DCOs
1. Amount of Financial Resources Required
As a central counterparty, a DCO must have sufficient financial
resources to be able to withstand a potential default by one of its
clearing members.\10\ In the event of a default, a DCO would continue
to have obligations to the clearing members that are owed variation
settlement payments and, therefore, the DCO must have sufficient liquid
resources to meet those obligations in a timely fashion. Proposed
Regulation 39.11(a)(1) would require 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. This standard is consistent with the standard set forth in
Core Principle B, and is also consistent with current international
standards.\11\
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\10\ Each DCO determines for itself what constitutes a
``default,'' but generally a clearing member is considered to be in
default when it fails to fulfill any obligation to the DCO.
\11\ In November 2004, the Task Force on Securities Settlement
Systems, jointly established by the Committee on Payment and
Settlement Systems (CPSS) of the central banks of the Group of Ten
countries and the Technical Committee of the International
Organization of Securities Commissions (IOSCO), issued its
Recommendations for Central Counterparties. Under Recommendation 5,
a central counterparty must maintain sufficient financial resources
to withstand, at a minimum, a default by the participant to which it
has the largest exposure in extreme but plausible market conditions.
However, the Commission notes that CPSS and IOSCO are currently
reviewing this standard and it may be revised.
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There may be some instances in which one clearing member controls
another clearing member or in which a clearing member is under common
control with another clearing member. The Commission proposes to treat
such affiliated clearing members as a single entity for purposes of
determining the largest financial exposure because the default of one
affiliate could have an impact on the ability of the other to meet its
financial obligations to the DCO.\12\ However, to the extent that each
affiliated clearing member is treated as a separate entity by the DCO,
with separate capital requirements, separate guaranty fund obligations,
and separate potential assessment liability, the Commission requests
comment on whether a different approach might be warranted.
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\12\ For example, the positions of each clearing member would be
margined separately and would be stress tested separately. However,
losses of each would be aggregated and gains would not offset
losses.
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Separately, proposed Regulation 39.11(a)(2) would require a DCO to
maintain sufficient financial resources to cover its operating costs
for at least one year, calculated on a rolling basis. This standard is
consistent with the standard set forth in amended Core Principle B. It
is also consistent with established accounting standards, under which
an entity's ability to continue as a going concern comes into question
if there is evidence that the entity may be unable to continue to meet
its obligations in the next 12 months without substantial disposition
of assets outside the ordinary course of business, restructuring of
debt, externally forced revisions of its operations, or similar
actions.\13\
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\13\ See American Institute of Certified Public Accountants
Auditing Standards Board Statement of Auditing Standards No. 59, The
Auditor's Consideration of an Entity's Ability to Continue as a
Going Concern, as amended.
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2. Types of Financial Resources
a. Default Resources
Proposed Regulation 39.11(b)(1) lists the types of financial
resources that would be available to a DCO to satisfy the requirements
of proposed Regulation 39.11(a)(1): (1) The margin of the defaulting
clearing member; (2) the DCO's own capital; (3) the guaranty fund
deposits of the defaulting clearing member and non-defaulting clearing
members; (4) default insurance; (5) if permitted by the DCO's rules,
potential assessments for additional guaranty fund contributions on
non-defaulting clearing members; and (6) any other financial resource
deemed acceptable by the Commission. A DCO would be able to request an
informal interpretation from CFTC staff on whether or not a particular
financial resource may be acceptable to the Commission.
In the event of a default by one of its clearing members, a DCO
would first seize the margin of the defaulting clearing member. If the
margin were insufficient to cure the default, the DCO might use its own
capital to cover the shortfall. Currently, Commission regulations do
not prescribe capital requirements for DCOs. The Commission invites
comment on whether it should consider adopting such requirements and if
so, what those requirements should be.
Clearing members also are typically required to maintain a deposit,
in the form of cash and/or securities, in a guaranty fund, which may be
used by the DCO to cover any loss sustained as a result of the failure
of a clearing member to discharge its obligations to the DCO. In the
event of a default, the DCO may draw on the defaulting clearing
member's deposit to satisfy its counterparty obligations. If the
deposit is insufficient, the DCO may draw on the guaranty fund deposits
of non-defaulting clearing members.
In addition, a DCO may have an assessment power that allows it to
demand additional funds from non-defaulting clearing members, up to a
specified amount, if the guaranty fund has been exhausted. The size of
a clearing member's potential assessment obligation is usually
established by a formula set forth in the DCO's rules.
Unlike margin or a guaranty fund, assessment powers are not
resources on
[[Page 63115]]
hand but a promise to pay. A clearing member, however, may have a
strong financial incentive to pay an assessment. If a clearing member
failed to pay its assessment obligation, that failure would be treated
as a default and the clearing member would be subject to liquidation of
its positions and forfeiture of the margin in its proprietary account.
Thus, in addition to a potential general interest in maintaining the
viability of the DCO going forward, a non-defaulting clearing member
may have a specific incentive to pay an assessment depending on the
size and profitability of its positions and the margin on deposit
relative to the size of the assessment.
No U.S. futures clearinghouse has ever had to exercise its
assessment power. In light of the apparent low probability of a default
of such magnitude as to require assessments, the use of assessment
power as a backstop rather than increasing the size of guaranty funds
seems to have been an efficient allocation of capital. The growth in
clearing of swaps, however, creates new risks that the Commission must
evaluate.
The Commission is proposing that DCOs put rules and procedures in
place to ensure timely payment of assessments by clearing members.
First, each DCO must require its clearing members to have the ability
to meet an assessment within the time frame of a normal variation
settlement cycle. Second, each DCO must monitor, on a continual basis,
each clearing member's financial and operational capacity to pay
potential assessments.
As discussed below, the Commission is proposing to limit the degree
to which assessment powers may be considered to be an available
financial resource. The Commission invites comment on whether these
limits and requirements are appropriate. More generally, the Commission
is also seeking comment on whether assessment powers should be
considered to be a financial resource available to satisfy the
requirements of proposed Regulation 39.11(a)(1).
b. Operating Resources
Proposed Regulation 39.11(b)(2) lists the types of financial
resources that would be available to a DCO to satisfy the requirements
of proposed Regulation 39.11(a)(2): (1) The DCO's own capital; and (2)
any other financial resource deemed acceptable by the Commission. A DCO
would be able to request an informal interpretation from CFTC staff on
whether or not a particular financial resource may be acceptable to the
Commission. The Commission invites commenters to recommend particular
financial resources, and explain the basis, for inclusion in the final
regulation. In this regard, the Commission notes that the proposed rule
does not specify that a DCO must hold equity capital. The Commission
requests comment on whether such a provision would be appropriate.
c. Allocation of Resources
Proposed Regulation 39.11(b)(3) would allow a DCO to allocate a
financial resource, in whole or in part, to satisfy the requirements of
either proposed Regulation 39.11(a)(1) (default risk) or proposed
Regulation 39.11(a)(2) (operating costs), but not both, and only to the
extent the use of that financial resource is not otherwise limited by
the CEA, Commission regulations, the DCO's rules, or any contractual
arrangements to which the DCO is a party. In the event that a default
would force a DCO to cease operations, the DCO would need sufficient
financial resources to cover the default and conduct an orderly wind
down of its business.
3. Computation of the Financial Resources Requirement
Proposed Regulation 39.11(c)(1) would require a DCO to perform
stress testing on a monthly basis in order to make a reasonable
calculation of the financial resources it needs to meet the
requirements of proposed Regulation 39.11(a)(1). In the first instance,
the DCO would have reasonable discretion in determining the methodology
it uses to make the calculation.\14\ Because effective stress testing
involves a great deal of judgment, the Commission is not proposing that
DCOs test a particular scenario. Rather, the proposed regulation
requires DCOs to take into account both historical data and
hypothetical situations. (By definition, a stress test using only
historical data would never cover a market move setting a new record.)
Within those guidelines, DCOs would have discretion in selecting
scenarios, subject to Commission review.
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\14\ This is consistent with DCO Core Principle A, which gives a
DCO ``reasonable discretion in establishing the manner in which it
complies with the core principles.'' See Section 5b(c)(2)(A) of the
CEA, 7 U.S.C. 7a-1(c)(2)(A).
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The Commission would review the methodology and require changes as
appropriate. The methodology must address any unique risks associated
with particular products, such as the jump to default risk and
compounding effects of credit default swaps.
Because of the comprehensive nature of the stress tests required
for determining the size of the financial resources package, the
Commission is proposing that these tests be conducted monthly. As will
be discussed in a later rulemaking,\15\ the Commission is likely to
require more frequent stress testing in connection with DCO risk
management programs. Such tests would be conducted for different
purposes and might use different inputs. The Commission requests
comment on whether monthly tests are appropriate for purposes of
calculating required financial resources.
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\15\ The Commission will propose, at a later time, additional
regulations to implement Core Principle D (risk management).
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Proposed Regulation 39.11(c)(2) would require a DCO to make a
reasonable calculation each month of the financial resources it needs
to meet the requirements of proposed Regulation 39.11(a)(2). In the
first instance, the DCO would have reasonable discretion in determining
the methodology it uses to make the calculation. However, the
Commission may review the methodology and require changes as
appropriate.
4. Valuation of Financial Resources
Proposed Regulation 39.11(d)(1) would require a DCO, no less
frequently than monthly, to calculate the current market value of each
financial resource used to meet its obligations under proposed
Regulation 39.11(a). A DCO would be required to perform the valuation
at other times as appropriate, because market values may fluctuate and
proposed Regulation 39.11(a) requires the DCO to be able to meet its
obligations on a rolling basis. When valuing a financial resource, a
DCO would be required to reduce the value, as appropriate, to reflect
any market or credit risk specific to that particular resource, i.e.,
apply a haircut. The Commission would permit each DCO to exercise its
discretion in determining the applicable haircuts. However, such
haircuts would have to be evaluated on a quarterly basis, would be
subject to Commission review, and would have to be acceptable to the
Commission.
Notwithstanding a DCO's general discretion in applying haircuts,
proposed Regulation 39.11(d)(2)(i) would require a 30 percent haircut
on the value of a DCO's assessment power. This is because in the event
of a default, the defaulting clearing member would not be able to pay
its assessment and other clearing members might also be unable or
unwilling to pay. Based on the significant percentage of total margin
that may be attributable to a few of the largest clearing members,
failure to pay
[[Page 63116]]
assessments could approach the 30 percent level. The Commission invites
comment on whether this proposed valuation of assessments is
appropriate.
To further increase the likelihood that the DCO will have resources
immediately available to meet a default, the Commission is proposing
that, in calculating the financial resources available to meet its
obligations, a DCO may only count the value of assessments, after the
haircut, to meet up to 20 percent of the resources requirement
generated by the stress testing. The Commission requests comment on
this restriction.
5. Liquidity of Financial Resources
In assessing the adequacy of a DCO's financial resources, the
liquidity of resources must be considered. For example, the time span
of an intra-day settlement cycle (from the time positions are marked to
market until the time clearing members are required to pay) may be only
a few hours. In the event of a clearing member defaulting on a payment
to the DCO during the intra-day settlement cycle, the DCO would need
access to liquid assets easily convertible to cash. DCOs often use
committed lines of credit to provide this liquidity.
Proposed Regulation 39.11(e)(1) would require a DCO to have
financial resources sufficiently liquid to enable the DCO to fulfill
its obligations as a central counterparty during a one-day settlement
cycle.
In particular, the proposed regulations would require a DCO to have
sufficient capital in the form of cash to cover the average daily
settlement variation pay per clearing member over the last fiscal
quarter. For purposes of this calculation, if a clearing member had
pays in both its house and customer accounts, the amount would be the
sum of the two pays. If the clearing member had a pay in its house
account and a collect in its customer account, the amount would be that
of the house pay. If the clearing member had collects in both of its
accounts, that day's variation settlement would not be included in the
calculation. The DCO would be permitted to take into account a
committed line of credit or similar facility for the purpose of meeting
the remainder of the liquidity requirement.
The Commission requests comment on the proposed liquidity
standards. In particular, the Commission requests comment on whether
the liquidity requirement should cover more than a one-day cycle. The
Commission also requests comment on what standards might be applicable
to lines of credit. For example, should the Commission require that
there be a diversified set of providers or that a line of credit have
same-day drawing rights?
Proposed Regulation 39.11(e)(2) would require DCOs to maintain
unencumbered liquid financial assets in the form of cash or highly
liquid securities, equal to six months' operating costs. The Commission
believes that having six months' worth of unencumbered liquid financial
assets would give a DCO time to liquidate the remaining financial
assets it would need to continue operating for the last six months of
the required one-year period. If a DCO does not have six months' worth
of unencumbered liquid financial assets, it may use a committed line of
credit or similar facility to satisfy this requirement.
The Commission notes that a committed line of credit or similar
facility is not listed in proposed Regulations 39.11(b)(1) or
39.8(b)(2) as a financial resource available to a DCO to satisfy the
requirements of proposed Regulations 39.11(a)(1) and 39.11(a)(2),
respectively. A DCO may only use a committed line of credit or similar
facility to meet the liquidity requirements set forth in proposed
Regulations 39.11(e)(1) and 39.11(e)(2).
To the extent that a DCO relies on a guaranty fund, adequate
liquidity is crucial. To address liquidity concerns, proposed
Regulation 39.11(e)(3) provides that: (i) Assets in a guaranty fund
must have minimal credit, market, and liquidity risks and must be
readily accessible on a same-day basis, (ii) cash balances must be
invested or placed in safekeeping in a manner that bears little or no
principal risk, and (iii) letters of credit are not a permissible asset
for a guaranty fund.
6. Reporting Requirements
Under proposed Regulation 39.11(f)(1), at the end of each fiscal
quarter, or at any time upon Commission request, a DCO would be
required to report to the Commission: (i) The amount of financial
resources necessary to meet the requirements set forth in the
regulation; and (ii) the value of each financial resource available to
meet those requirements. The DCO would have to include with its report
a financial statement, including the balance sheet, income statement,
and statement of cash flows, of the DCO or its parent company (if the
DCO does not have an independent financial statement and the parent
company's financial statement is prepared on a consolidated basis). If
one of the financial resources a DCO is using to meet the regulation's
requirements is a guaranty fund, the DCO would also have to report the
value of each individual clearing member's guaranty fund deposit.
Proposed Regulation 39.11(f)(2) requires a DCO to provide the
Commission with sufficient documentation that explains both the
methodology it used to calculate its financial requirements and the
basis for its determinations regarding valuation and liquidity. The DCO
also must provide copies of any agreements establishing or amending a
credit facility, insurance coverage, or other arrangement that
evidences or otherwise supports its conclusions. The sufficiency of the
documentation would be determined by the Commission in its sole
discretion.
A DCO would have 17 business days\16\ from the end of the fiscal
quarter to file its report, but would also be able to request an
extension of time from the Commission.
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\16\ This filing deadline is consistent with the deadline
imposed on FCMs for the filing of monthly financial reports. See 17
CFR 1.10(b).
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B. SIDCOs
As DCOs, SIDCOs would remain subject to the requirements of Title
VII and the regulations thereunder, except to the extent the Commission
promulgated higher standards pursuant to Title VIII. With regard to
Core Principle B, the Commission is proposing higher standards in two
respects, as described below.
1. Amount of Financial Resources Required
Because the failure of a SIDCO to meet its obligations would have a
greater impact on the financial system than the failure of other DCOs,
the Commission is proposing that SIDCOs be required to meet a higher
standard. Specifically, proposed Regulation 39.29(a) would require a
SIDCO to maintain sufficient financial resources 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.
A fundamental premise of the Dodd-Frank Act is that more over-the-
counter (OTC) products must be brought into the cleared environment.
Although no U.S. futures clearinghouse has ever had more than one
clearing member default at a time, the size and complexity of the OTC
derivatives markets may increase the chance that more than one clearing
member could default simultaneously. Consequently, the Commission has
determined that SIDCOs should be
[[Page 63117]]
subject to regulations that increase their ability to contain the
effects of such defaults.
2. Valuation of Financial Resources
In order to add another layer of protection for SIDCOs, proposed
Regulation 39.29(b) would require that a SIDCO may not count the value
of assessments to meet the obligations arising from a default by the
clearing member creating the single largest financial exposure. This
means that a SIDCO would be required to hold a greater percentage of
its financial resources in margin and the guaranty fund than a DCO that
is not a SIDCO.
However, because the Commission believes that assessment powers can
be a capital efficient means of providing a back-up source of funding,
the Commission is proposing to permit SIDCOs to count the value of
assessments, after the 30 percent haircut, to meet up to 20 percent of
the obligations arising from a default by the clearing member creating
the second largest financial exposure. This is the standard proposed
for non-systemically important DCOs in connection with the largest
potential exposure.
The Commission requests comment on the proposed higher standards
for SIDCOs. In particular, the Commission requests comment on the
potential competitive effects of imposing higher standards on a subset
of DCOs.
III. Technical Amendments
Proposed Regulation 140.94 would allow the Commission to delegate
the authority to perform certain functions that are reserved to the
Commission under proposed Regulation 39.11. Specifically, the Director
of the Division of Clearing and Intermediary Oversight would be given
the authority to deem a financial resource acceptable under proposed
Regulations 39.11(b)(1)(vi) and (b)(2)(ii); to review methodology and
require changes under proposed Regulations 39.11(c)(1) and (c)(2); to
request information under proposed Regulation 39.11(f)(1); and to grant
an extension of the filing deadline for financial reports in accordance
with proposed Regulation 39.11(f)(4).
IV. Related Matters
A. 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.\17\
The rules proposed by the Commission will affect only DCOs (some of
which will be 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.\18\ The Commission has previously
determined that DCOs are not small entities for the purpose of the
RFA.\19\ 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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\17\ 5 U.S.C. 601 et seq.
\18\ 47 FR 18618 (Apr. 30, 1982).
\19\ See 66 FR 45605, 45609 (August 29, 2001).
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B. Paperwork Reduction Act
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a
currently valid control number. OMB has not yet assigned a control
number to the new collection. The Paperwork Reduction Act of 1995 (PRA)
\20\ imposes certain requirements on Federal agencies (including the
Commission) in connection with their conducting or sponsoring any
collection of information as defined by the PRA. This proposed
rulemaking would result in new collection of information requirements
within the meaning of the PRA. The Commission therefore is submitting
this proposal to the Office of Management and Budget (OMB) for review.
If adopted, responses to this collection of information would be
mandatory. The Commission will protect proprietary information
according to the Freedom of Information Act and 17 CFR Part 145,
``Commission Records and Information.'' In addition, section 8(a)(1) of
the CEA strictly prohibits the Commission, unless specifically
authorized by the CEA, from making public ``data and information that
would separately disclose the business transactions or market positions
of any person and trade secrets or names of customers.'' The Commission
is also required to protect certain information contained in a
government system of records according to the Privacy Act of 1974, 5
U.S.C. 552a.
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\20\ 44 U.S.C. 3501 et seq.
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1. Information Provided by Reporting Entities/Persons
The proposed regulations require each respondent to file
information with the Commission on a quarterly basis, which would
result in four annual responses per respondent. Commission staff
estimates that each respondent would expend 10 hours to prepare each
filing required under the proposed regulations. Commission staff
estimates that it would receive filings from 12 respondents annually.
Accordingly the burden in terms of hours would in the aggregate be 40
hours annually per respondent and 480 hours annually for all
respondents.
Commission staff estimates that respondents could expend up to
$1,840 annually, based on an hourly wage rate of $46, to comply with
the proposed regulations. This would result in an aggregated cost of
$22,080 per annum (12 respondents x $1,840).
2. Information Collection Comments
The Commission invites the public and other federal agencies to
comment on any aspect of the reporting and recordkeeping burdens
discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission
solicits comment in order to: (i) Evaluate whether the proposed
collection of information is necessary for the proper performance of
the functions of the Commission, including whether the information will
have practical utility; (ii) evaluate the accuracy of the Commission's
estimate of the burden of the proposed collection of information; (iii)
determine whether there are ways to enhance the quality, utility, and
clarity of the information to be collected; and (iv) minimize the
burden of the collection of information on those who are to respond,
including through the use of automated collection techniques or other
forms of information technology.
Comments may be submitted directly to the Office of Information and
Regulatory Affairs, by fax at (202) 395-6566 or by e-mail at
[email protected]. Please provide the Commission with a copy
of submitted comments so that all comments can be summarized and
addressed in the final rule preamble. Refer to the Addresses section of
this notice of proposed rulemaking for comment submission instructions
to the Commission. A copy of the supporting statements for the
collections of information discussed above may be obtained by visiting
RegInfo.gov. OMB is required to make a decision concerning the
collection of information between 30 and 60 days after publication of
this document in the Federal Register. Therefore, a comment is best
assured of having its full effect if OMB receives it within 30 days of
publication.
[[Page 63118]]
C. Cost-Benefit Analysis
Section 15(a) of the CEA requires that the Commission, before
promulgating a regulation under the CEA or issuing an order, consider
the costs and benefits of its action. By its terms, Section 15(a) does
not require the Commission to quantify the costs and benefits of a new
regulation or determine whether the benefits of the rule outweigh its
costs. Rather, Section 15(a) simply requires the Commission to
``consider the costs and benefits'' of its action.
Section 15(a) further specifies that costs and benefits shall be
evaluated in light of the following considerations: (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. Accordingly, the Commission could, in its discretion,
give greater weight to any one of the five considerations and could, in
its discretion, determine that, notwithstanding its costs, a particular
regulation was necessary or appropriate to protect the public interest
or to effectuate any of the provisions or to accomplish any of the
purposes of the CEA.
The Commission has evaluated the costs and benefits of the proposed
regulations in light of the specific considerations identified in
Section 15(a) of the CEA, as follows:
1. Protection of market participants and the public. The proposed
regulations would require DCOs to continually assess and monitor the
adequacy of their financial resources under standards established by
the Commission. This would further the goal of avoiding market
disruptions and financial losses to market participants and the general
public.
2. Efficiency and competition. The proposed regulations would
promote financial strength and stability, thereby fostering efficiency
and a greater ability to compete in the broader financial markets. The
proposed regulations would reward efficiency insofar as DCOs that
operate efficiently would have lower operating costs and therefore
would require fewer resources to comply with the regulations.
3. Financial integrity of futures markets and price discovery. The
proposed regulations are designed to ensure that DCOs can sustain their
market operations and meet their financial obligations to market
participants, thus contributing to the financial integrity of the
futures and options markets as a whole. This, in turn, further supports
the price discovery and risk transfer functions of such markets.
4. Sound risk management practices. The proposed regulations, by
setting specific standards with respect to how DCOs should assess,
monitor, and report the adequacy of their financial resources, would
contribute to their maintenance of sound risk management practices and
further the goal of minimizing systemic risk.
5. Other public considerations. As highlighted by recent events in
the global credit markets, maintaining sufficient financial resources
is a critical aspect of any financial entity's risk management system,
and ultimately contributes to the goal of stability in the broader
financial markets. Therefore, the Commission believes it is prudent to
include financial resources requirements for entities applying to
become or operating as DCOs.
Accordingly, after considering the five factors enumerated in the
CEA, the Commission has determined to propose the regulations set forth
below.
List of Subjects in 17 CFR Parts 39 and 140
Commodity futures, Reporting and recordkeeping requirements.
For the reasons stated in the preamble, the Commission proposes to
amend 17 CFR parts 39 and 140 as follows:
PART 39--DERIVATIVES CLEARING ORGANIZATIONS
1. The authority citation for part 39 is revised to read as
follows:
Authority: 7 U.S.C. 7a-1 as amended by Pub. L. 111-203, 124
Stat. 1376.
2. Add Sec. 39.11 to read as follows:
Sec. 39.11 Financial resources requirements.
(a) General rule. A derivatives clearing organization shall
maintain financial resources sufficient to cover its exposures with a
high degree of confidence and to enable it to perform its functions in
compliance with the core principles set out in section 5b of the Act. A
derivatives clearing organization shall identify and adequately manage
its general business risks and hold sufficient liquid resources to
cover potential business losses that are not related to clearing
members' defaults, so that the derivatives clearing organization can
continue to provide services as an ongoing concern. Financial resources
shall be considered sufficient if their value, at a minimum, exceeds
the total amount that would:
(1) Enable the derivatives clearing organization to meet its
financial obligations to its clearing members notwithstanding a default
by the clearing member creating the largest financial exposure for the
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, the affiliated clearing members shall be deemed to be a single
clearing member for purposes of this provision; and
(2) Enable the derivatives clearing organization to cover its
operating costs for a period of at least one year, calculated on a
rolling basis.
(b) Types of financial resources. (1) Financial resources available
to satisfy the requirements of paragraph (a)(1) may include:
(i) Margin of a defaulting clearing member;
(ii) The derivatives clearing organization's own capital;
(iii) Guaranty fund deposits;
(iv) Default insurance;
(v) Potential assessments for additional guaranty fund
contributions, if permitted by the derivatives clearing organization's
rules; and
(vi) Any other financial resource deemed acceptable by the
Commission.
(2) Financial resources available to satisfy the requirements of
paragraph (a)(2) may include:
(i) The derivatives clearing organization's own capital; and
(ii) Any other financial resource deemed acceptable by the
Commission.
(3) A financial resource may be allocated, in whole or in part, to
satisfy the requirements of either paragraph (a)(1) or paragraph
(a)(2), but not both paragraphs, and only to the extent the use of such
financial resource is not otherwise limited by the Act, Commission
regulations, the derivatives clearing organization's rules, or any
contractual arrangements to which the derivatives clearing organization
is a party.
(c) Computation of financial resources requirement. (1) A
derivatives clearing organization shall, on a monthly basis, perform
stress testing that will allow it to make a reasonable calculation of
the financial resources needed to meet the requirements of paragraph
(a)(1). The derivatives clearing organization shall have reasonable
discretion in determining the methodology used to compute such
requirements, provided that the methodology must take into account both
historical data and hypothetical scenarios. The Commission
[[Page 63119]]
may review the methodology and require changes as appropriate.
(2) A derivatives clearing organization shall, on a monthly basis,
make a reasonable calculation of its projected operating costs over a
12-month period in order to determine the amount needed to meet the
requirements of paragraph (a)(2) of this section. The derivatives
clearing organization shall have reasonable discretion in determining
the methodology used to compute such projected operating costs. The
Commission may review the methodology and require changes as
appropriate.
(d) Valuation of financial resources. (1) At appropriate intervals,
but not less than monthly, a derivatives clearing organization shall
compute the current market value of each financial resource used to
meet its obligations under paragraph (a) of this section. Reductions in
value to reflect market and credit risk (haircuts) shall be applied as
appropriate and evaluated on a monthly basis.
(2) If assessments for additional guaranty fund contributions are
permitted by the derivatives clearing organization's rules, in
calculating the financial resources available to meet its obligations
under paragraph (a)(1) of this section:
(i) The derivatives clearing organization shall have rules
requiring that its clearing members have the ability to meet an
assessment within the time frame of a normal variation settlement
cycle;
(ii) The derivatives clearing organization shall monitor, on a
continual basis, the financial and operational capacity of its clearing
members to meet potential assessments;
(iii) The derivatives clearing organization shall apply a 30
percent haircut to the value of potential assessments, and
(iv) The derivatives clearing organization shall only count the
value of assessments, after the haircut, to meet up to 20 percent of
those obligations.
(e) Liquidity of financial resources. (1) The derivatives clearing
organization shall effectively measure, monitor, and manage its
liquidity risks, maintaining sufficient liquid resources such that it
can, at a minimum, fulfill its cash obligations when due. The
derivatives clearing organization shall hold assets in a manner where
the risk of loss or of delay in its access to them is minimized. The
financial resources allocated by the derivatives clearing organization
to meet the requirements of paragraph (a)(1) of this section shall be
sufficiently liquid to enable the derivatives clearing organization to
fulfill its obligations as a central counterparty during a one-day
settlement cycle. The derivatives clearing organization shall have
sufficient capital in the form of cash to meet the average daily
settlement variation pay per clearing member over the last fiscal
quarter. If any portion of the remainder of the financial resources is
not sufficiently liquid, the derivatives clearing organization may take
into account a committed line of credit or similar facility for the
purpose of meeting this requirement.
(2) The financial resources allocated by the derivatives clearing
organization to meet the requirements of paragraph (a)(2) of this
section must include unencumbered, liquid financial assets (i.e., cash
and/or highly liquid securities) equal to at least six months'
operating costs. If any portion of such financial resources is not
sufficiently liquid, the derivatives clearing organization may take
into account a committed line of credit or similar facility for the
purpose of meeting this requirement.
(3)(i) Assets in a guaranty fund shall have minimal credit, market,
and liquidity risks and shall be readily accessible on a same-day
basis;
(ii) Cash balances shall be invested or placed in safekeeping in a
manner that bears little or no principal risk; and
(iii) Letters of credit shall not be a permissible asset for a
guaranty fund.
(f) Reporting requirements. (1) Each fiscal quarter, or at any time
upon Commission request, a derivatives clearing organization shall:
(i) Report to the Commission;
(A) The amount of financial resources necessary to meet the
requirements of paragraph (a);
(B) The value of each financial resource available, computed in
accordance with the requirements of paragraph (d); and
(C) How the derivatives clearing organization meets the liquidity
requirements of paragraph (e);
(ii) Provide the Commission with a financial statement, including
the balance sheet, income statement, and statement of cash flows, of
the derivatives clearing organization or of its parent company; and
(iii) Report to the Commission the value of each individual
clearing member's guaranty fund deposit, if the derivatives clearing
organization reports having guaranty funds deposits as a financial
resource available to satisfy the requirements of paragraph (a)(1) of
this section.
(2) The calculations required by this paragraph shall be made as of
the last business day of the derivatives clearing organization's fiscal
quarter.
(3) The derivatives clearing organization shall provide the
Commission with:
(i) Sufficient documentation explaining the methodology used to
compute its financial resources requirements under paragraph (a) of
this section,
(ii) Sufficient documentation explaining the basis for its
determinations regarding the valuation and liquidity requirements set
forth in paragraphs (d) and (e) of this section, and
(iii) Copies of any agreements establishing or amending a credit
facility, insurance coverage, or other arrangement evidencing or
otherwise supporting the derivatives clearing organization's
conclusions.
(4) The report shall be filed not later than 17 business days after
the end of the derivatives clearing organization's fiscal quarter, or
at such later time as the Commission may permit, in its discretion,
upon request by the derivatives clearing organization.
3. Add Sec. 39.29 to read as follows:
Sec. 39.29 Financial resources requirements.
(a) General rule. Notwithstanding the requirements of Sec.
39.11(a)(1) of this part, a systemically important derivatives clearing
organization 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.
(b) Valuation of financial resources. Notwithstanding the
requirements of Sec. 39.11(d)(2) of this part, if assessments for
additional guaranty fund contributions are permitted by the
systemically important derivatives clearing organization's rules, in
calculating the financial resources available to meet its obligations
under paragraph (a) of this section:
(1) The systemically important derivatives clearing organization
may not count the value of assessments to meet the obligations arising
from a default by the clearing member creating the largest financial
exposure for the systemically important derivatives clearing
organization in extreme but plausible market conditions; and
(2) The systemically important derivatives clearing organization
may only count the value of assessments, after the haircut set forth in
Sec. 39.11(d)(2)(iii) of this part, to meet up to 20 percent of the
obligations arising from a default by the clearing member
[[Page 63120]]
creating the second largest financial exposure for the systemically
important derivatives clearing organization in extreme but plausible
market conditions.
PART 140--ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION
4. The authority citation for part 140 continues to read as
follows:
Authority: 7 U.S.C. 2 and 12a.
5. In Sec. 140.94, revise paragraphs (a)(4) and (a)(5) and add a
new paragraph (a)(6) to read as follows:
Sec. 140.94 Delegation of authority to the Director of the Division
of Clearing and Intermediary Oversight.
(a) * * *
(4) All functions reserved to the Commission in Sec. 5.12 of this
chapter, except for those relating to nonpublic treatment of reports
set forth in Sec. 5.12(i) of this chapter;
(5) All functions reserved to the Commission in Sec. 5.14 of this
chapter; and
(6) All functions reserved to the Commission in Sec. Sec.
39.11(b)(1)(vi), (b)(2)(ii), (c)(1), (c)(2), (f)(1), and (f)(4) of this
chapter.
* * * * *
Issued in Washington, DC, on October 1, 2010, by the Commission.
David A. Stawick,
Secretary of the Commission.
[FR Doc. 2010-25322 Filed 10-13-10; 8:45 am]
BILLING CODE P
Last Updated: October 14, 2010