[Federal Register: June 22, 2000 (Volume 65, Number 121)]
[Proposed Rules]
[Page 39027-39033]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr22jn00-33]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 39
RIN 3038-AB57
A New Regulatory Framework for Clearing Organizations
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed Rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (Commission) is
proposing a new Part 39 of its rules that would apply to clearing
organizations, as defined in the proposed rules. This proposal,
centered on broad, flexible, core principles, is part of an initiative
described in separate companion releases published in this edition of
the Federal Register proposing a new regulatory framework applicable to
multilateral transaction execution facilities and market
intermediaries, in addition to clearing organizations. These notices
propose far-reaching and fundamental changes to modernize Federal
regulation of commodity futures and option markets.
DATE: Comments must be received by August 7, 2000.
ADDRESSES: Comments should be sent to the Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street, NW, Washington,
DC 20581, attention: Office of the Secretariat. Comments may be sent by
facsimile transmission to (202) 418-5521 or, by e-mail to
[email protected]. Reference should be made to ``clearing
organizations reinvention.''
FOR FURTHER INFORMATION CONTACT: Paul M. Architzel, Chief Counsel,
Division of Economic Analysis, Alan L. Seifert, Deputy Director,
Division of Trading and Markets, or Lois J. Gregory, Special Counsel,
Division of Trading and Markets, Commodity Futures Trading Commission,
Three Lafayette Centre, 1155 21st Street, NW, Washington, DC 20581.
Telephone (202) 418-5260 or e-mail [[email protected]],
[[email protected]], or [[email protected]].
SUPPLEMENTARY INFORMATION:
[[Page 39028]]
I. Background
The Commission is proposing a new Part 39 regulatory framework that
would apply to clearing organizations (i.e., entities that perform a
credit enhancement function by becoming a universal counterparty to
market participants or by operating a facility for the netting of
obligations and payments). This proposal, centered on broad, flexible,
core principles, is part of an initiative described in separate
companion releases published in this edition of the Federal Register
proposing a new regulatory framework applicable to multilateral
transaction execution facilities and to market intermediaries.
Clearing organizations perform valuable functions in exchange-
traded futures and option markets. They serve to mitigate counterparty
credit risk, facilitate the netting and offsetting of contractual
obligations, and decrease systemic risk. The development of similar
clearing facilities for the clearing of over-the-counter derivatives
should be encouraged.\1\ However, the performance of these functions
may raise concerns regarding concentration of financial and credit risk
in a single entity. Accordingly, clearing organizations should be
subject to regulatory oversight to ensure that such facilities are
capitalized sufficiently and that they establish and implement a risk
management program that is designed to control the credit concentration
risk associated with centralized clearing. The Commission notes that it
currently oversees the clearing organizations that are associated or
affiliated with U.S. futures and option exchanges.\2\
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\1\ See the Report of the President's Working Group on Financial
Markets, Over the Counter Derivatives Markets and the Commodity
Exchange Act (Nov. 1999).
\2\ The Commission is aware of the standards set forth in the
Bank of International Settlements' 1993 Lamfalussy Report on
multilateral netting systems, the recommendations with respect to
clearing and settlement of securities transactions of the Group of
Thirty, a private sector group representing leading banking and
securities firms from around the world, and the recommendations of
the President's Working Group in response to the market break of
October, 1987. Currently existing clearing organizations for U.S.
futures and options exchanges meet or exceed these standards and
recommendations as a result of the Commission's review of these
entities' rules and procedures and the Commission's ongoing
oversight program. These standards and recommendations, along with
others, were taken into account in formulation proposed part 39.
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The Commission is proposing to require, pursuant to proposed part
39 of its regulations, that certain transactions be cleared only by
recognized clearing organizations (RCOs). An entity may become
recognized by the Commission by effectively demonstrating that it
satisfies core principles covering, among other areas, financial
resources, risk management, treatment of client funds and settlement
procedures. U.S. clearing organizations that currently perform clearing
services for transactions executed on domestic futures and option
exchanges generally satisfy the core principles and, thus, would not be
required to make any additional showing or change their method of
operation. Consistent with recommendations made in the President's
Working Group report, \3\ the Commission recognizes that the form and
degree of regulatory oversight imposed upon a clearing organization
should be consistent with the types of instruments and markets for
which it clears and the class of market participants for whom it
clears. Part 39 would specify entities other than and in addition to
RCOs that could serve as clearing organizations for transactions
executed pursuant to part 35 of the Commission's regulations or
effected on an exempt multilateral transaction execution facility under
part 36 of the Commission's regulations. These entities may be: (1) A
securities clearing agency regulated by the Securities and Exchange
Commission (SEC); (2) a clearing system organized as, among other
things, a bank, and subject to the jurisdiction of the Board of
Governors of the Federal Reserve System; or (3) a foreign clearing
organization that demonstrates to the Commission that it: (a) Is
subject to home country regulation and oversight comparable to the
standards set forth by the Commission for recognition of clearing
organizations under part 39; and (b) is a party to and abides by
appropriate and adequate information-sharing agreements.
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\3\ See footnote 1, above.
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II. The Proposed Rules
Proposed part 39 rules would require that every transaction
effected on a designated contract market, recognized futures exchange
or derivatives transaction facility, if cleared, be cleared by an RCO.
RCOs also would be authorized to clear transactions that are exempt
under part 35 or part 36. RCOs would not be required by part 39 to be
affiliated with any of the foregoing entities. Moreover, nothing in the
Commission's rules prohibits an RCO from clearing any other type of
cash market or derivative instrument.\4\ In addition to RCOs, the
following entities also are authorized to clear transactions exempt
under part 35 or part 36 of the Commission's rules: (1) Securities
clearing agencies subject to the supervisory jurisdiction of the SEC;
(2) clearing systems organized as a bank, bank subsidiary, bank
affiliate, or Edge Act corporation; \5\ or (3) foreign clearing
organizations that demonstrate to the Commission that they are: (i)
Subject to home country regulation and oversight comparable to the
standards set forth by the Commission for recognition of clearing
organizations under part 39; and (ii) parties to appropriate and
adequate information-sharing agreements. The Commission would defer to
oversight by the clearing organization's primary regulator in
connection with the clearance of such exempt transactions.
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\4\ Indeed, the benefits of clearing noted above could be
enhanced were RCOs to clear both cash market and derivative
instruments. In this regard, the Commission seeks comment on what
obstacles, if any, exist to combining such clearing functions in an
RCO, whether such obstacles are specific to particular commodities
and what steps can be taken to address them.
\5\ 12 U.S.C. 611 et seq. An Edge Act corporation is an
organization chartered by the Federal Reserve to engage in
international banking operations. The Federal Reserve Board acts
upon applications by U.S. and foreign banking organizations to
establish Edge Act corporations. It also examines Edge Act
corporations and their subsidiaries. The Edge Act corporation gets
its name from Senator Walter Edge of New Jersey, the sponsor of the
original legislation to permit formation of such organization.
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To be recognized as an RCO, an entity must have already been
clearing nondormant contracts on a U.S.-designated contract market as
of January 1, 2000, or must apply to the Commission for recognition as
an RCO under part 39. An application would address how the core
principles would be satisfied by the applicant's proposed rules,
procedures, and framework for operation by addressing the matters set
forth in the guidance provided to applicants in the appendix to part
39.
A clearing organization seeking recognition would be deemed
recognized sixty days after the Commission received the application,
unless it appeared that the applicant and/or its rules or procedures
might violate a specific provision of the Commodity Exchange Act (Act),
or the Commission's regulations or the form and content requirements of
part 39. In that event, the Commission could notify the applicant that
the Commission would review the proposal under the procedures of
section 6 of the Act.\6\ An
[[Page 39029]]
entity seeking recognition as an RCO may request that the Commission
approve its initial set of rules under section 5a(a)(12)(A) of the Act
and Commission regulations thereunder.
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\6\ Section 6 of the Act is applicable to clearing organizations
as well as contract markets. Commission Regulation 1.41(a)(3)
defines the term ``contract market'' to include a clearing
organization that clears trades for a contract market. The authority
of the Commission to define and treat a clearing organization as a
contract market for purposes of the Act and the Commission's
regulations was upheld in Board of Trade Clearing Corporation v.
U.S., (DCDC Jan 11, 1978), '77-'80 CCH Dec. para. 20,534.
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Part 39 rules would provide that, after an entity was recognized as
an RCO, it would submit new rules and rule amendments to the Commission
pursuant to proposed amended Commission regulation 1.41. An RCO also
could request the Commission to approve new rules or rule amendments
under section 5a(a)(12)(A) of the Act and Commission regulation 1.41.
An RCO also could request the Commission to issue an order considering
whether the RCO, in adopting and implementing a rule, endeavored to
take the least anticompetitive means of achieving the objective,
purposes, and policies of the Act.
The fraud and manipulation provisions of the Act would apply with
respect to transactions cleared by an RCO.
III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601-611,
requires that agencies, in proposing regulations, consider the impact
of those regulations on small entities. Information of the type that
would be required under the proposed rule does not involve any small
organizations.
B. Paperwork Reduction Act
Part 39 contains information collection requirements. As required
by the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)), the
Commission has submitted a copy of this part to the Office of
Management and Budget (``OMB'') for its review.
Collection of Information
Submissions of Applicants for Recognition as Recognized Clearing
Organizations, OMB Control Number 3038-XXXX.
The burden associated with the proposed new part is estimated to be
2,000 hours which will result from new submission requirements for
first-time applicants for recognition as Recognized Clearing
Organizations.
The estimated burden of the proposed new part was calculated as
follows:
Estimated number of respondents: 10.
Reports Annually by each respondent: 1.
Total Annual Responses: 10.
Estimated Average Number of Hours Per Response: 200.
Estimated Total Number of Hours of Annual Burden in Fiscal Year:
2,000.
Organizations and individuals desiring to submit comments on the
information collection requirements should direct them to the Office of
Information and Regulatory Affairs, OMB, Room 10235 New Executive
Office Building, Washington, DC 20503, Attention: Desk Officer for the
Commodity Futures Trading Commission.
The Commission considers comments by the public on this proposed
collection of information in--
� Evaluating whether the proposed collection of information
is necessary for the proper performance of the functions of the
Commission, including whether the information will have a practical
use;
� Evaluating the accuracy of the Commission's estimate of
the burden of the proposed collection of information, including the
validity of the methodology and assumptions used;
� Enhancing the quality, usefulness, and clarity of the
information to be collected; and
� Minimizing the burden of collection of information on
those who are to respond, including through the use of appropriate
automated electronic, mechanical, or other technological collection
techniques or other forms of information technology, e.g., permitting
electronic submission of responses.
OMB is required to make a decision concerning the collection of
information contained in these proposed regulations between 30 and 60
days after publication of this document in the Federal Register. A
comment to OMB is best assured of having its full effect if OMB
receives it within 30 days of publication. This does not affect the
deadline for the public to comment to the Commission on the proposed
regulations.
Copies of the information collection submission to OMB are
available from the CFTC Clearance Officer, 1155 21st Street, NW,
Washington, DC 20581, (202) 418-5160.
List of Subjects in 17 CFR Part 39
Clearing, Clearing organizations, Commodity futures, Consumer
protection.
In consideration of the foregoing, and pursuant to the authority
contained in Sections 2, 6(c), 7a, and 12a(5) of the U.S.C., the
Commission proposes to amend Chapter I of Title 17 of the Code of
Federal Regulations by adding Part 39 to read as follows:
PART 39--RECOGNIZED CLEARING ORGANIZATIONS
Sec.
39.1 Definitions and Scope.
39.2 Permitted Clearing.
39.3 Conditions for Recognition as a Recognized Clearing
Organization
39.4 Procedures for Recognition.
39.5 Enforceability.
39.6 Fraud and Manipulation in Connection with transactions
cleared by a Recognized Clearing Organizations.
Appendix A to Part 39--Application Guidance
Authority: 7 U.S.C. 2, 6(c), 7a, 12a(5).
Sec. 39.1 Definitions and Scope.
(a) Definitions. For purposes of this part:
(1) Clearing organization means a person, entity or association
thereof, which performs a credit enhancement function in connection
with transactions executed on a designated contract market or pursuant
to parts 35-38 of this chapter by becoming a universal counterparty to
market participants or by operating a facility for the netting of
obligations and payments of such transactions; but does not include
those netting arrangements specified in Sec. 35.2(d)(1) and (d)(2), nor
does it include an entity that is a single counterparty offering to
enter into, or entering into, bilateral transactions with multiple
counterparties.
(b) Scope. (1) This section applies to all cleared transactions
effected on or through a designated contract market, a recognized
futures exchange under part 38 of this chapter, a derivatives
transaction facility under part 37 of this chapter, an exempt
multilateral transaction execution facility under part 36 of this
chapter, and to exempt bilateral transactions under part 35 of this
chapter.
(2) A clearing organization that has been recognized by the
Commission under Sec. 39.3 of this part shall be deemed to be a
contract market for purposes of the Act, and Commission rules
thereunder; provided, however, a recognized clearing organization shall
be exempt from all provisions of the Act and Commission regulations
thereunder except as reserved in Sec. 39.5 of this part.
Sec. 39.2 Permitted clearing.
(a) Any transaction effected on a designated contract market,
recognized futures exchange, or derivatives transaction facility, if
cleared, shall be cleared by a recognized clearing organization.
(b) A transaction effected pursuant to Part 35 or Part 36 of this
chapter, if cleared, shall be cleared by any of the following
authorized clearing organizations:
(1) A recognized clearing organization under this part;
[[Page 39030]]
(2) A securities clearing agency subject to the supervisory
jurisdiction of the Securities and Exchange Commission;
(3) A clearing system organized as a bank, bank subsidiary,
affiliate of a bank, or Edge Act corporation established under the
Federal Reserve Act authorized to engage in international banking or
financial activities, and subject to the jurisdiction of the Federal
Reserve or Comptroller of the Currency; or
(4) A foreign clearing organization that demonstrates to the
Commission that it:
(i) Is subject to home country regulation and oversight comparable
to the standards set forth by the Commission for recognition of
clearing organizations under this part; and
(ii) Is a party to and abides by appropriate and adequate
information-sharing arrangements.
(c) Transactions not specified in Sec. 39.1(b)(1) of this part may
also be cleared by a recognized clearing organization.
Sec. 39.3 Conditions for Recognition as a Recognized Clearing
Organization.
To be recognized by the Commission under this part 39 as a
recognized clearing organization, an entity:
(a) Need not be affiliated with a designated contract market or
recognized futures exchange under part 38 of this chapter, derivatives
transaction facility under part 37 of this chapter or exempt
multilateral transaction execution facility under part 36 of this
chapter;
(b) Must have rules and procedures relating to its governance and
the operation of its clearing function; and
(c) Must initially, and on a continuing basis, meet and adhere to
the following fourteen core principles:
(1) Financial resources: Adequate capital resources to fulfill its
guarantee function without interruption in various market conditions.
(2) Participant and product eligibility: Appropriate admission and
continuing eligibility standards for members or participants of the
organization and defined criteria for instruments it will accept for
clearing.
(3) Risk management: Ability to manage the risks associated with
carrying out its guarantee function through the use of appropriate
tools and procedures.
(4) Settlement procedures: Ability to complete settlements on a
timely basis under varying circumstances, to maintain an adequate
record of the flow of funds associated with each transaction it clears,
and to comply with the terms and conditions of any permitted netting or
offset arrangements with other clearing organizations.
(5) Treatment of client funds: Adequate standards and procedures
designed to protect and ensure the safety of client funds.
(6) Default rules and procedures: Rules and procedures designed to
allow for efficient, fair, and safe management of events when members
or participants become insolvent or otherwise default on their
obligations to the clearing organization.
(7) Rule enforcement: Adequate arrangements and resources for the
effective monitoring and enforcement of compliance with its rules and
for resolution of disputes.
(8) System safeguards: An adequate program of oversight and risk
analysis to ensure that its automated systems function properly and
have adequate capacity, security, and emergency and disaster recovery
procedures.
(9) Governance: Have fitness standards for owners or operators with
greater than ten percent interest or an affiliate of such an owner, and
for members of the governing board, and have a means to address
conflicts of interest in making decisions.
(10) Reporting: Provision to the Commission of all information
necessary for the Commission to conduct its oversight function of the
clearing organization's activities.
(11) Recordkeeping: Maintain full books and records of all
activities related to business as a recognized clearing organization in
a form and manner acceptable to the Commission for a period of five
years.
(12) Public information: Public disclosure of information
concerning the rules and operating procedures governing its clearing
and settlement systems, including default procedures.
(13) Information sharing: Enter into and abide by the terms of all
appropriate and applicable domestic and international information-
sharing agreements and use relevant information obtained from such
agreements in carrying out the clearing organization's risk management
program.
(14) Competition: Endeavor to avoid unreasonable restraints of
trade or imposing any burden on competition not necessary or
appropriate in furtherance of the objectives of the Act or the
regulations thereunder.
Sec. 39.4 Procedures for Recognition.
(a) Recognition by certification. A clearing organization that
cleared for at least one nondormant contract within the meaning of
Sec. 5.4 of this chapter on January 1, 2000, will be recognized by the
Commission as a recognized clearing organization upon receipt by the
Commission at its Washington, DC, headquarters of a copy of the
clearing organization's rules and a certification by the clearing
organization that it meets the conditions for recognition under this
part.
(b) Recognition by application. A clearing organization shall be
recognized by the Commission as a recognized clearing organization
sixty days after receipt by the Commission of an application for
recognition unless notified otherwise during that period, if:
(1) The application demonstrates that the applicant satisfies the
conditions for recognition under this part;
(2) The submission is labeled as being submitted pursuant to this
part;
(3) The submission includes a copy of the applicant's rules and a
brief explanation of how the rules satisfy each of the conditions for
recognition under Sec. 39.3 of this part;
(4) The applicant does not amend or supplement the application for
recognition, except as requested by the Commission or for correction of
typographical errors, renumbering or other nonsubstantive revisions,
during that period; and
(5) The applicant has not instructed the Commission in writing
during the review period to review the application pursuant to
procedures under section 6 of the Act.
(6) Attached to this part as Appendix A is guidance to applicants
concerning how the core principles set forth above could be satisfied.
(c) Termination of Part 39 Review. During the sixty-day period for
review pursuant to paragraph (b) of this section, the Commission shall
notify the applicant seeking recognition that the Commission is
terminating review under this section and will review the proposal
under the procedures of section 6 of the Act, if it appears that the
application fails to meet the conditions for recognition under this
part. This termination notification will state the nature of the issues
raised and the specific condition of recognition that the application
appears to violate, is contrary to or fails to meet. Within ten days of
receipt of this termination notification, the applicant seeking
recognition may request that the Commission render a decision whether
to recognize the clearing organization or to institute a proceeding to
disapprove the proposed submission under procedures specified in
section 6 of the Act by notifying the Commission that the applicant
seeking recognition views
[[Page 39031]]
its submission as complete and final as submitted.
(d) Delegation of Authority. (1) The Commission hereby delegates,
until it orders otherwise, to the Director of the Division of Trading
and Markets or the Director's delegatee, with the concurrence of the
General Counsel or the General Counsel's delegatee, authority to notify
an entity seeking recognition under paragraph (b) of this section that
review under those procedures is being terminated.
(2) The Director of the Division of Trading and Markets may submit
to the Commission for its consideration any matter which has been
delegated in this paragraph.
(3) Nothing in the paragraph prohibits the Commission, at its
election, from exercising the authority delegated in paragraph (d)(1)
of this section.
(e) Request for Commission Approval of Rules. (1) An applicant for
recognition as a recognized clearing organization may request that the
Commission approve any or all of its rules and subsequent amendments
thereto, at the time of recognition or thereafter, under section
5a(a)(12) of the Act and Sec. 1.41 of this chapter. The recognized
clearing organization may label such rules as having been approved by
the Commission. In addition, rules of the recognized clearing
organization not submitted pursuant to Sec. 39.4(b)(3) shall be
submitted to the Commission pursuant to Sec. 1.41 of this chapter.
(2) An applicant seeking recognition as a recognized clearing
organization may request that the Commission consider under the
provisions of section 15 of the Act any of the entity's rules or
policies at the time of recognition or thereafter.
(f) Request for withdrawal of recognition. A recognized clearing
organization may withdraw from Commission recognition by filing with
the Commission at its Washington, DC, headquarters such a request.
Withdrawal from recognition shall not affect any action taken or to be
taken by the Commission based upon actions, activities, or events
occurring during the time that the clearing organization was recognized
by the Commission.
Sec. 39.5 Enforceability.
In accordance with the proviso in Sec. 39.1(b)(2), sections 1a,
2(a)(1), 4, 4b, 4c, 4d, 4g, 4i, 4o, 5(7), the rule disapproval
procedures of sections 5a(a)(12), 5b, 6, 6b, 6c, 8(a), 8(c), 8a(6),
8a(7), 8a(9), 8c(a), 8c(b), 8(c)(c), 8(c)(d), 9(a), 9(f), 20 and 22 of
the Act and Secs. 1.3, 1.20, 1.24, 1.25, 1.26, 1.27 1.31, 1.38, 1.41,
33.10, parts 15-21, part 39, and part 190 of this chapter continue to
apply.
Sec. 39.6 Fraud and Manipulation in Connection with transactions
cleared by a Recognized Clearing Organization.
It shall be unlawful for any person, directly or indirectly, in or
in connection with any transaction cleared by a recognized clearing
organization:
(a) To cheat or defraud or attempt to cheat or defraud any other
person;
(b) Willfully to make or cause to be made to any other person any
false report or statement thereof or cause to be entered for any person
any false record thereof; or
(c) Willfully to deceive or attempt to deceive any other person by
any means whatsoever.
Appendix A to Part 39--Application Guidance
This appendix provides guidance to applicants for recognition as
recognized clearing organizations in connection with satisfying each
of the core principles of Sec. 39.4. In addressing the core
principles, applicants should address the matters set forth below.
Core Principle 1--Financial Resources. Adequate Capital Resources
to Fulfill the Guarantee Function Without Interruption in Various
Market Conditions
In addressing core principle 1, applicants should describe or
otherwise document:
1. The amount of resources dedicated to supporting the clearing
function:
a. The amount of resources available to the clearing
organization and the sufficiency of those resources such that no
break in clearing operations would occur in a variety of market
conditions; and
b. The level of member/participant default such resources could
support as demonstrated through use of a hypothetical default
scenario that explains assumptions and variables factored into the
illustration.
2. The nature of resources dedicated to supporting the clearing
function:
a. The type of the resources, including their liquidity, and how
they could be accessed and applied by the clearing organization
without delay; and
b. Any legal or operational impediments or conditions to access.
Core Principle 2--Participant and Product Eligibility. Appropriate
Admission and Continuing Eligibility Standards for Members or
Participants of the Organization and Defined Criteria for
Instruments it Will Accept for Clearing
In addressing core principle 2, applicants should describe or
otherwise document:
1. Member/participant admission criteria:
a. How admission standards for its clearing members would
contribute to the soundness and integrity of operations; and
b. Matters such as whether these criteria would be in the form
of organization rules that apply to all clearing members, whether
different levels of membership would relate to different levels of
net worth, income, and creditworthiness of members, and whether
margin levels, position limits and other controls would vary in
accordance with these levels.
2. Member/participant continuing eligibility criteria:
a. A program for monitoring the financial status of its members;
and
b. Whether/how the clearing organization would be able to change
continuing eligibility criteria in accordance with changes in a
member's financial status.
3. Criteria for instruments acceptable for clearing:
a. How the clearing organization would establish specific
criteria for the types of derivatives it will clear; and
b. How those criteria take into account the different risks
inherent in clearing different derivatives and how they affect
maintenance of assets to support the guarantee function in varying
risk environments.
4. Clearing function for each instrument:
a. The clearing function for each instrument the organization
undertakes to clear; and
b. How different functions would be made known to participants.
Core Principle 3--Risk Management. Ability to Manage the Risks
Associated With Carrying Out the Guarantee Function Through the Use
of Appropriate Tools and Procedures
In addressing core principle 3, applicants should describe or
otherwise document:
1. Use of risk analysis tools and procedures:
a. How the adequacy of the overall level of financial resources
would be tested on an ongoing periodic basis in a variety of market
conditions; and
b. How the organization would use specific risk management tools
including stress testing and value at risk calculations.
2. Use of collateral:
a. How appropriate forms and levels of collateral would be
established and collected;
b. How amounts would be adequate to secure prudentially
obligations arising from clearing transactions and performing as
central counterparty;
c. Why particular margin levels would be appropriate for a
contract cleared and the clearing member clearing the contract;
d. The appropriateness of required or allowed forms of margin
given the liquidity and related requirements of the clearing
organization;
e. How the clearing organization would ensure appropriate
valuation of open positions and valuation of collateral assets; and
f. The proposed margin collection schedule and how it would
synchronize with changes in the value of market positions and
collateral values.
3. Use of credit limits:
If and how systems would be implemented that would prevent
members and other market participants from exceeding appropriate
credit limits; and
4. Appropriate use of cross margin reduction programs:
How collateral assets subject to cross-margining programs would
provide for clear,
[[Page 39032]]
fair, and efficient loss-sharing arrangements in the event of a
program participant default.
Core Principle 4--Settlement Procedures. Ability To Complete
Settlements on a Timely Basis Under Varying Circumstances, To
Maintain an Adequate Record of the Flow of Funds Associated With
Each Transaction it Clears, and To Comply With the Terms and
Conditions of Any Permitted Netting or Offset Arrangements With
Other Clearing Organizations
In addressing core principle 4, applicants should describe or
otherwise document:
1. Settlement timeframe:
a. Procedures for completing settlements on a timely basis
during times of normal operating conditions; and
b. Procedures for completing settlements on a timely basis in
varying market circumstances including during a period when a
significant participant or member has defaulted.
2. Recordkeeping:
a. The nature and quality of the information collected
concerning the flow of funds involved in clearing and settlement;
and
b. How the flow of funds associated with each cleared
transaction would be recorded, maintained and easily accessed.
3. Appropriate interfaces with other clearing organizations:
How compliance with the terms and conditions of any permitted
netting or offset arrangements with other clearing organizations
would be met, including, among others, common banking or common
clearing programs.
Core Principle 5--Treatment of Client Funds. Standards and
Procedures Designed To Protect and Ensure the Safety of Client
Funds
In addressing core principle 5, applicants should describe or
otherwise document:
1. Safe custody:
a. The safekeeping of client funds, whether in accounts, in
depositories, or with custodians, and how it would meet industry
standards of safety;
b. Any written terms regarding the legal status of the funds and
the specific conditions or prerequisites for movement of the funds;
and
c. How the deposit of client funds in accounts in depositories
or with custodians would also ensure adequate diversification of
concentration of risk.
2. Segregation between customer and proprietary funds:
a. Requirements for segregation and requiring members or
participants that clear trades executed on behalf of customers to
segregate customer accounts and funds; and
b. Requirements or restrictions regarding commingling customer
with proprietary funds, obligating customer funds for any purpose
other than to purchase, clear, and settle the products the clearing
organization is clearing, and any other aspects of customer fund
segregation.
3. Investment standards:
How customer funds would be invested to meet high standards of
safety and the proposed recordkeeping regarding all details of such
investments.
Core Principle 6--Default Rules and Procedures. Rules and
Procedures Designed To Allow for Efficient, Fair, and Safe
Management of Events When Members or Participants Become Insolvent
or Otherwise Default on Their Obligations to the Clearing
Organization
In addressing core principle 6, applicants should describe or
otherwise document:
1. Definition of default:
a. The definition of default and how it would be established and
enforced; and
b. How it would address failure to meet margin requirements, the
insolvent financial condition of a member or participant, failure to
comply with certain rules, failure to maintain eligibility
standards, actions taken by other regulatory bodies, or other
events.
2. Remedial action:
The authority pursuant to which, and how, the clearing
organization would take appropriate action in the event of the
default of a member which may include, among other things, closing
out positions, replacing positions, set-off, and applying margin;
3. Process to address shortfalls:
Procedures for the prompt, fair, and safe application of
Clearing Organization and/or member financial resources to eliminate
any monetary shortfall resulting from a default.
4. Customer priority rule:
Rules and procedures regarding priority of customer accounts
over proprietary accounts of intermediary members or participants
and where applicable, in the context of other programs, such as
specialized margin reduction programs like cross-margining or
trading links with other exchanges.
Core Principle 7--Rule Enforcement. Adequate Arrangements and
Resources for the Effective Monitoring and Enforcement of
Compliance With its Rules and for Resolution of Disputes
In addressing core principle 7, applicants should describe or
otherwise document:
1. Surveillance:
Arrangements and resources for the effective monitoring of
compliance with rules including any clearing practice and financial
surveillance programs.
2. Enforcement:
a. Arrangements and resources for effective enforcement of rules
and authority and ability to discipline and limit or suspend a
member's or participant's activities; and
b. Authority and ability to terminate a member's or
participant's activities pursuant to clear and fair standards.
3. Dispute resolution:
Arrangements and resources for resolution of disputes between
customers and members, and between members.
Core Principle 8--System Safeguards. An Adequate Program of
Oversight and Risk Analysis to Ensure That Its Automated Systems
Function Properly and have Adequate Capacity, Security, and
Emergency and Disaster Recovery Procedures
In addressing core principle 8, applicants should describe or
otherwise document:
1. Oversight/risk analysis program:
a. Any program of oversight and risk analysis and whether it
addresses appropriate principles for the oversight of automated
systems to ensure that its clearing system functions properly and
has adequate capacity and security;
b. Emergency procedures and a plan for disaster recovery; and
c. Periodic testing of back-up facilities and ability to ensure
daily processing, clearing, and settlement of transactions.
2. Appropriate periodic objective system reviews/testing:
a. Any program for the periodic objective testing and review of
the system; and
b. Confirmation that such testing and review would be performed
by an independent third-party professional that is a certified
member of the Information Systems Audit and Control Association with
an appropriate level of experience in the industry.
Core Principle 9--Governance. Have Fitness Standards for Owners or
Operators With Greater Than Ten Percent Interest, or an Affiliate
of Such an Owner, and for Members of the Governing Board, and Have
a Means to Address Conflicts of Interest in Making Decisions
In addressing core principle 9, applicants should describe or
otherwise document:
1. Appropriate standards for fitness for clearing organization
owners, operators, affiliates of owners or operators, and members of
the governing board based on disqualification standards under
section 8a(2) of the Act.
2. Collection and verification of information supporting
compliance with standards:
a. Verification information could be registration information or
certification of fitness or affidavit of fitness by outside counsel
based on other verified information.
3. Methods to ascertain presence of conflicts of interest and
methods of making decisions in that event.
Core Principle 10--Reporting. Provision to the Commission of all
Information Necessary for the Commission to Conduct its Oversight
Function of the Recognized Clearing Organization's Activities
In addressing core principle 10, applicants should describe or
otherwise document:
1. Information necessary for the Commission to perform its
oversight activities of the recognized clearing organization's
activities:
a. All information available to or generated by the clearing
organization that will be made available to the Commission as
appropriate to enable the Commission to perform properly its
oversight function, including counterparties and their positions,
stress test results, internal governance, legal proceedings, and
other clearing activities;
b. The types of information which are not believed to be
necessary to provide to the Commission and why; and
c. The information the organization intends to make routinely
available to members/participants or the general public.
2. Provision of information:
a. The manner in which all relevant information will be provided
to the Commission whether by electronic or other means; and
[[Page 39033]]
b. The means by which any information will be made available to
members/participants and/or the general public.
Core Principle 11--Recordkeeping. Maintaining Complete Books and
Records of all Activities Related to Business as a Recognized
Clearing Organization in a Form and Manner Acceptable to the
Commission for a Period of Five Years
In addressing core principle 11, applicants should describe or
otherwise document:
1. Maintaining records of all activities related to the function
of a clearing organization:
a. The different activities related to the function of the
clearing organization for which the organization intends to keep
books or records; and
b. Any activity related to the function of a clearing
organization for which the organization does not intend to keep
books or records and why this is not viewed as necessary.
2. Maintenance of full books and records in a form and manner
acceptable to the Commission:
3. How the entity would satisfy the requirements of Commission
Regulation 1.31 including:
a. What ``complete'' would encompass with respect to each type
of book or record that would be maintained;
b. How books or records would be compiled and maintained with
respect to each type of activity for which such books or records
would be kept;
c. Confirmation that books and records would be open to
inspection by any representative of the Commission or of the U.S.
Department of Justice;
d. How long books and records would be readily available and how
they would be made readily available during the first two years; and
e. How long books and records would ultimately be maintained
(and confirmation that, in any event, they would be maintained for
at least five years).
Core Principle 12--Public Information. Disclosure of Information
Concerning the Rules and Operating Procedures Governing its
Clearing and Settlement Systems, Including Default Procedures
In addressing core principle 12, applicants should describe or
otherwise document:
1. Disclosure of information regarding rules and operating
procedures governing clearing and settlement systems:
a. Which rules and operating procedures governing clearing and
settlement systems should be disclosed to the public, to whom they
would be disclosed, and how they would be disclosed;
b. What other information would be available regarding the
operation, purpose and effect of rules;
c. How member/participants may become familiar with such
procedures before participating in operations; and
d. How member/participants will be informed of their specific
rights and obligations preceding a default and upon a default, and
of the specific rights, options and obligations of the clearing
organization preceding and upon the participant's default.
Core Principle 13--Information Sharing. Entering Into and Abiding
by the Terms of all Appropriate and Applicable Domestic and
International Information-Sharing Agreements and Using Relevant
Information Obtained from such Agreements in Carrying out the
Recognized Clearing Organization's Risk Management Program
In addressing core principle 13, applicants should describe or
otherwise document:
1. Becoming a party to applicable appropriate domestic and
international information-sharing agreements and arrangements:
a. The utility of entering into various types of information-
sharing arrangements;
b. The different types of domestic and international
information-sharing arrangements, both formal and informal, which
the clearing organization views as appropriate and applicable to its
operations; and
c. The specific information-sharing agreements or other
arrangements to which the clearing organization would become a party
and how it would abide by the terms of these agreements.
2. Using information obtained from information-sharing
arrangements in carrying out risk management and surveillance
programs:
a. How information obtained from any information-sharing
arrangements would be used to further the objectives of the clearing
organization's risk management program and any of its surveillance
programs including financial surveillance and continuing eligibility
of its members/participants;
b. How accurate information is expected to be obtained and the
mechanisms or procedures which would make timely use and application
of all information; and
c. The types of information expected to be shared and how that
information would be shared.
Core Principle 14--Competition. Endeavoring to Avoid Unreasonable
Restraints of Trade or Imposing Any Burden on Competition not
Necessary or Appropriate in Furtherance of the Objectives of the
Act or the Regulations Thereunder
In addressing core principle 14, applicants should describe or
otherwise document:
1. Avoiding unreasonable restraints of trade:
a. Terms and conditions of access and provision of services;
b. Any contracts or agreements to which the organization is a
party which contain any noncompete clauses or limitations on future
activity which may compete with the interests of either party to the
contract.
2. Avoiding burdening competition:
a. Any practice of the clearing organization that may appear to
affect the competitiveness of any other entity or the practice of
any entity that may appear to affect the competitive ability of the
clearing organization; and
b. The extent to which the entity has endeavored to adopt a rule
or practice that is the least anticompetitive means of achieving the
objective, purposes and policies of the Act.
Issued in Washington, D.C. on June 8, 2000, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 00-14916 Filed 6-21-00; 8:45 am]
BILLING CODE 6351-01-U
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