I am voting for the final rule establishing procedures for granting registration exemptions to foreign derivatives clearing organizations (Exempt DCOs) to clear swaps for certain U.S. persons (Final Rule).  The Final Rule exercises the exemptive authority provided by Congress in the Commodity Exchange Act (CEA)[1] in a limited, pragmatic manner that will provide U.S. financial services firms that operate globally with access to foreign clearinghouses and cleared swaps in order to more effectively manage the risks arising from their global operations.

In July of last year, I dissented from the proposed exempt DCO rule, because it also would have permitted Exempt DCOs to clear for U.S. customers, but only through foreign intermediaries.  In doing so, the proposed rule would have subjected U.S. customer accounts to foreign bankruptcy and other regulations, promoted the use of foreign intermediaries at the expense of U.S. firms, and exceeded this agency’s limited exemptive authority.[2]  Enabling U.S. customers to clear swaps and amass large positions in non-U.S. markets in this manner would not only pose risks to those customers, but also could have presented systemic risks to the U.S. financial system.

In response to commenters who expressed similar objections, the Final Rule does not contain the concerning provisions.  Neither registered FCMs nor their foreign intermediary counterparts can clear for U.S. person customers.  With respect to clearing for U.S. persons, the Final Rule restricts clearing by an Exempt DCO to only U.S. firms that become clearing members of the Exempt DCO along with certain of their affiliates and persons associated with those firms in the manner identified in the definition of “proprietary account” in section 1.3 of our regulations.  In addition, registered FCMs, including U.S. firms, can also clear at exempt DCOs, but only for themselves and persons associated with the FCMs in the manner provided in the definition of “proprietary account.”  These sophisticated market participants are well equipped to assess the risks of clearing swaps under the foreign regime.  Furthermore, by requiring that they be members of the Exempt DCO (or clear through an affiliate that is a member), the Commission assures that such entities have taken affirmative actions to assess and accept those risks.  The margin funds and related obligations of these persons must also be segregated from customer funds held by registered FCMs thereby minimizing any impact on U.S. customers of the cleared positions at Exempt DCOs.  These limitations are a reasonable, practical approach to implementing the authority provided to the Commission to exempt certain foreign DCOs without adding uncertain risk into our system of fully registered DCOs and FCMs.

Furthermore, the Commission has, on an ad hoc basis, previously granted registration exemptions to four foreign clearinghouses limited to proprietary swap positions with effectively the same conditions and limitations as provided in the Final Rule.  The Final Rule will therefore maintain consistency with the existing exemptions.

The Final Rule also contains fairly detailed daily, quarterly, and annual reporting requirements, as well as special event notice requirements.  These requirements allow the Commission to monitor U.S. person clearing activity at the Exempt DCO on a daily basis and keep the Commission informed of any material changes to the regulatory and financial status of the Exempt DCO in its home jurisdiction.  While the Exempt DCOs will be able to operate under the compliance regime and oversight of its home country regulator, the CFTC can maintain limited, but up-to-date oversight of the activities that are relevant for U.S. market participants and that could have an impact on our financial system.

As noted above, the Final Rule does not permit registered FCMs to clear U.S. customer swaps at Exempt DCOs.  In the Commission’s initial 2018 proposal to establish a framework for Exempt DCOs, the Commission proposed this prohibition.  The Commission explained:

Section 4d(f)(1) of the CEA makes it unlawful for any person to accept money, securities, or property (i.e., funds) from a swaps customer to margin a swap cleared through a DCO unless the person is registered as an FCM.  Any swaps customer funds held by a DCO are also subject to the segregation requirements of section 4d(f)(2) of the CEA, and in order for a customer to receive protection under this regime, particularly in an insolvency context, its funds must be carried by an FCM, and deposited with a registered DCO.  Absent that chain of registration, the swaps customer’s funds may not be treated as customer property under the U.S. Bankruptcy Code and the Commission’s regulations.  Because of this, it has been the Commission’s policy to allow exempt DCOs to clear only proprietary positions of U.S. persons and FCMs.[3]

The Final Rule notes that the Commission may revisit the prohibition on U.S. customer clearing in the future.  While I agree with the outcome in the Final Rule as to customer clearing given the Commission’s interpretation of CEA Section 4d(f), if the above interpretation changes, whether by a change to the statute or by other appropriate means, I could support a further amendment of the Final Rule.  Any such change should place U.S. FCMs on an equal footing with their foreign counterparts when competing for U.S. customer clearing at Exempt DCOs.  In addition, such a change should not create an advantage for unregistered Exempt DCOs over registered DCOs who comply with all of our regulations.

Finally, I note that CEA Section 5b(h) provides for the registration exemption if the foreign DCO is subject to “comparable, comprehensive supervision and home country regulation.”  Under the Final Rule, to demonstrate comparability, the DCO must be subject to home country regulations that are consistent with, and the DCO must “observe in all material respects,” the “Principles for Financial Market Infrastructures”[4] (PFMIs) applicable to central counterparties.

Several commenters objected to this approach to comparability determinations on a number of grounds.  These commenters stated that the Commission should not substitute a commitment to adhere to the PFMIs for its own examination and assessment as to the comparability and comprehensiveness of the actual foreign regulations.  As the PFMIs are only general principles, even when the PFMIs are implemented, material differences may exist between the PFMI-compliant regime and the Commission’s DCO core principles and regulations.  Commenters further argued that Congress intended for the Commission to analyze comparability only by direct comparison to the CTFC’s laws and regulations.

Over the past two years, I have expressed concerns over the erosion of the Commission’s standards and role in finding comparability for various CFTC regulations.  The Commission’s approach has been increasingly deferential to other regulators, which has the potential to permit the importation of increased risks into the U.S. financial system.

In this regard, I too have some concerns about the use of the PFMIs as a standard for comparability.  However, for the purpose of granting DCO registration exemptions, I believe the approach taken in the Final Rule is reasonable.  I have consistently said that comparability determinations should involve a detailed examination of the other jurisdiction’s standards, but also should be outcomes based.  Regulators around the world take substantively different approaches to regulating DCOs, but that does not mean any one approach is necessarily better or worse than another as to its expected outcome.  The PFMIs tend to be more general in nature than the DCO core principles and regulations in the CEA and CFTC regulations.  However, regarding the general outcome of DCO regulation, the PFMIs–which the CFTC has contributed to and incorporated in regulation[5]–are consistent with our DCO core principles.  Furthermore, given the limited scope of the Final Rule in that it applies only to clearing of proprietary positions, using the PFMIs to find comparability is not unwarranted.  Finally, the Final Rule allows for the Commission to assess the extent to which the home country regulations are consistent with the PFMIs and the extent to which the applying DCO is observing the PFMIs.  As such, I believe the approach taken in the Final Rule is reasonable.

In conclusion, the Final Rule creates a limited, practical set of policies and procedures for granting exemptions from registration for foreign DCOs.  The Exempt DCOs can only clear swaps for U.S. persons who are proprietary traders and who are able to assess the specific risks of clearing at the Exempt DCO.  The U.S. customer accounts at registered FCMs will not be commingled with accounts used for Exempt DCO clearing.  Finally, U.S. FCMs are not put at a competitive disadvantage to their foreign counterparts.  For these reasons, I support the changes made to the proposed rule that result in an appropriate, codified approach to exempting foreign DCOs who meet appropriate standards.