2011-11-8 CFTC Final Rule on DCO Core Principles

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69334 Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011/ Rules and Regulations

1See Dodd-Frank Wall Street Reform andConsumer Protection Act, Public Law 111–203, 124Stat. 1376 (2010). The text of the Dodd-Frank Act

may be accessed at http://www.cftc.gov/ LawRegulation/OTCDERIVATIVES/index.htm.

2Pursuant to Section 701 of the Dodd-Frank Act,Title VII may be cited as the ‘‘Wall StreetTransparency and Accountability Act of 2010.’’

37 U.S.C. 1 et seq.4See Commodity Futures Modernization Act of

2000, Public Law 106–554, 114 Stat. 2763 (2000).5See 66 FR 45604 (Aug. 29, 2001) (adopting 17

CFR part 39, app. A).6Section 8a(5) of the CEA authorizes the

Commission to promulgate such regulations ‘‘as, inthe judgment of the Commission, are reasonablynecessary to effectuate any of the provisions or toaccomplish any of the purposes of [the CEA].’’ 7U.S.C. 12a(5).

COMMODITY FUTURES TRADINGCOMMISSION

17 CFR Parts 1, 21, 39, and 140

RIN 3038–AC98

Derivatives Clearing OrganizationGeneral Provisions and CorePrinciples

AGENCY: Commodity Futures TradingCommission.

ACTION: Final rule.

SUMMARY: The Commodity FuturesTrading Commission (Commission) isadopting final regulations to implementcertain provisions of Title VII and TitleVIII of the Dodd-Frank Wall StreetReform and Consumer Protection Act(Dodd-Frank Act) governing derivativesclearing organization (DCO) activities.More specifically, the regulationsestablish the regulatory standards for

compliance with DCO Core Principles A(Compliance), B (Financial Resources),C (Participant and Product Eligibility), D(Risk Management), E (SettlementProcedures), F (Treatment of Funds), G(Default Rules and Procedures), H (RuleEnforcement), I (System Safeguards), J(Reporting), K (Recordkeeping), L(Public Information), M (InformationSharing), N (Antitrust Considerations),and R (Legal Risk) set forth in Section5b of the Commodity Exchange Act(CEA). The Commission also is updatingand adding related definitions; adoptingimplementing rules for DCO chief compliance officers (CCOs); revisingprocedures for DCO applicationsincluding the required use of a newForm DCO; adopting procedural rulesapplicable to the transfer of a DCOregistration; and adding requirementsfor approval of DCO rules establishing aportfolio margining program forcustomer accounts carried by a futurescommission merchant (FCM) that is alsoregistered as a securities broker-dealer(FCM/BD). In addition, the Commissionis adopting certain technicalamendments to parts 21 and 39, and isadopting certain delegation provisionsunder part 140.

DATES: The rules will become effective January 9, 2012. DCOs must complywith §§39.11; 39.12; 39.13 (except for39.13(g)(8)(i)); and 39.14 by May 7,2012; with §§ 39.10(c); 39.13(g)(8)(i);39.18; 39.19; and 39.20 by November 8,2012; and all other provisions of theserules by January 9, 2012.

FOR FURTHER INFORMATION CONTACT:Phyllis P. Dietz, Deputy Director, (202)418–5449, [email protected]; John C.Lawton, Deputy Director, (202) 418–5480, [email protected]; Robert B.

Wasserman, Chief Counsel, (202) 418–5092, [email protected]; Eileen A.Donovan, Associate Director, (202) 418–5096, [email protected]; JonathanLave, Special Counsel, (202) 418–5983,

[email protected], Division of Clearing andRisk; and Jacob Preiserowicz, SpecialCounsel, (202) 418–5432,

[email protected], Division of

Swap Dealer and IntermediaryOversight, Commodity Futures TradingCommission, Three Lafayette Centre,1155 21st Street NW., Washington, DC20581; and Julie A. Mohr, DeputyDirector, (312) 596–0568,

[email protected]; and Anne C. Polaski,Special Counsel, (312) 596–0575,[email protected], Division of Clearingand Risk, Commodity Futures TradingCommission, 525 West Monroe Street,Chicago, Illinois 60661.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. BackgroundA. Title VII of the Dodd-Frank ActB. Title VIII of the Dodd-Frank ActC. Regulatory Framework for DCOs

II. Part 1 Amendments—DefinitionsIII. Part 39 Amendments—General Provisions

A. ScopeB. DefinitionsC. Procedures for RegistrationD. Procedures for Implementing DCO Rules

and Clearing New ProductsE. Reorganization of Part 39F. Technical Amendments

IV. Part 39 Amendments—Core PrinciplesA. Compliance with Core PrinciplesB. Financial ResourcesC. Participant and Product Eligibility

D. Risk ManagementE. Settlement ProceduresF. Treatment of FundsG. Default Rules and ProceduresH. Rule EnforcementI. System Safeguards

J. ReportingK. RecordkeepingL. Public InformationM. Information SharingN. Antitrust ConsiderationsO. Legal Risk ConsiderationsP. Special Enforcement Authority for

SIDCOsV. Part 140 Amendments—Delegations of

AuthorityVI. Effective Dates

VII. Section 4(c)VIII. Consideration of Costs and BenefitsIX. Related Matters

A. Regulatory Flexibility ActB. Paperwork Reduction Act

I. Background

A. Title VII of the Dodd-Frank Act

On July 21, 2010, President Obamasigned the Dodd-Frank Act.1 Title VII of

the Dodd-Frank Act 2 amended theCEA 3 to establish a comprehensivestatutory framework to reduce risk,increase transparency, and promotemarket integrity within the financialsystem by, among other things: (1)Providing for the registration andcomprehensive regulation of swapdealers and major swap participants; (2)

imposing clearing and trade executionrequirements on standardized derivativeproducts; (3) creating rigorousrecordkeeping and real-time reportingregimes; and (4) enhancing theCommission’s rulemaking andenforcement authorities with respect toall registered entities and intermediariessubject to the Commission’s oversight.

Section 725(c) of the Dodd-Frank Actamended Section 5b(c)(2) of the CEA,which sets forth core principles withwhich a DCO must comply in order to

be registered and to maintainregistration as a DCO.

The core principles were added to theCEA by the Commodity FuturesModernization Act of 2000 (CFMA).4 The Commission did not adoptimplementing rules and regulations, butinstead promulgated guidance for DCOson compliance with the coreprinciples.5 Under Section 5b(c)(2) of the CEA, as amended by the Dodd-FrankAct, Congress expressly confirmed thatthe Commission may adoptimplementing rules and regulationspursuant to its rulemaking authorityunder Section 8a(5) of the CEA.6

In light of Congress’s explicitaffirmation of the Commission’sauthority to adopt regulations toimplement the core principles, theCommission has chosen to adoptregulations (which have the force of law) rather than guidance (which doesnot have the force of law). By issuingregulations, the Commission expects toincrease legal certainty for DCOs,clearing members, and marketparticipants, and prevent DCOs fromlowering risk management standards forcompetitive reasons and taking on morerisk than is prudent. The imposition of legally enforceable standards provides

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69335Federal Register / Vol. 76, No. 216 / Tuesday, November 8, 2011/ Rules and Regulations

7See 76 FR 44763 (July 27, 2011) (FSOC authorityto designate financial market utilities assystemically important; final rule).

8The Commission is reserving for a future finalrulemaking certain proposed amendments relatingto participant and product eligibility. See 76 FR

13101 (Mar. 10, 2011) (requirements for processing,clearing, and transfer of customer positions(Straight-Through Processing)); and 76 FR 45730(Aug. 1, 2011) (customer clearing documentationand timing of acceptance for clearing (CustomerClearing)).

9The Commission is reserving for a future finalrulemaking regulations to implement DCO CorePrinciples O (Governance Fitness Standards) and Q (Composition of Governing Boards) (76 FR 722 (Jan.6, 2011) (Governance)); and Core Principle P(Conflicts of Interest) (75 FR 63732 (Oct. 18, 2010)(Conflicts of Interest)).

10See Section 5b(i) of the CEA, 7 U.S.C 7a–1(i).11See 76 FR 13101 (Mar. 10, 2011) (Straight-

Through Processing); 76 FR 3698 (Jan. 20, 2011)(Core Principles C, D, E, F, G, and I (RiskManagement)); 75 FR 78185 (Dec. 15, 2010) (CorePrinciples J, K, L, and M (InformationManagement)); 75 FR 77576 (Dec. 13, 2010) (CorePrinciples A, H, N, and R (General Regulations));and 75 FR 63113 (Oct. 14, 2010) (Core Principle B(Financial Resources)).

12See 76 FR 25274 (May 4, 2011) (extending orre-opening comment periods for multiple Dodd-Frank proposed rulemakings); see also 76 FR 16587(Mar. 24, 2011) (re-opening 30-day comment periodfor reporting requirement with clause omitted in thenotice of proposed rulemaking).

13Comment files for each proposed rulemakingcan be found on the Commission Web site,www.cftc.gov.

assurance to market participants and thepublic that DCOs are meeting minimumrisk management standards. This canserve to increase market confidencewhich, in turn, can increase openinterest and free up resources thatmarket participants might otherwisehold in order to compensate for weakerDCO risk management practices.

Regulatory standards also can reducesearch costs that market participantswould otherwise incur in determiningthat DCOs are managing risk effectively.

B. Title VIII of the Dodd-Frank Act

Section 802(b) of the Dodd-Frank Actstates that the purpose of Title VIII is tomitigate systemic risk in the financialsystem and promote financial stability.Section 804 authorizes the FinancialStability Oversight Council (FSOC) todesignate entities involved in clearingand settlement as systemicallyimportant.7

Section 805(a) of the Dodd-Frank Actallows the Commission to prescriberegulations for those DCOs that theCouncil has determined are systemicallyimportant (SIDCOs). The Commissionproposed heightened requirements forSIDCO financial resources and systemsafeguards for business continuity anddisaster recovery.

Section 807(c) of the Dodd-Frank Actprovides the Commission with specialenforcement authority over SIDCOs,which the Commission proposed tocodify in its regulations.

C. Regulatory Framework for DCOs

The Commission, now responsible forregulating swaps markets as well asfutures markets, has undertaken anunprecedented rulemaking initiative toimplement the Dodd-Frank Act. As partof this initiative, the Commission hasissued a series of eight proposedrulemakings that, together, wouldestablish a comprehensive regulatoryframework for the clearing andsettlement activities of DCOs. Throughthese proposed regulations, theCommission sought to enhance legalcertainty for DCOs, clearing members,and market participants, to strengthen

the risk management practices of DCOs,and to promote financial integrity forswaps and futures markets.

In this notice of final rulemaking, theCommission is adopting regulations toimplement 15 DCO core principles: A(Compliance), B (Financial Resources),C (Participant and Product Eligibility),8

D (Risk Management), E (SettlementProcedures), F (Treatment of Funds),G (Default Rules and Procedures), H(Rule Enforcement), I (SystemSafeguards), J (Reporting), K(Recordkeeping), L (Public Information),M (Information Sharing), N (AntitrustConsiderations), and R (Legal Risk).9 Inaddition, the Commission is adopting

regulations to implement the CCOprovisions of Section 725 of the Dodd-Frank Act.10

The final rules adopted herein wereproposed in five separate notices of proposed rulemaking.11 Each proposedrulemaking was subject to an initial 60-day public comment period and a re-opened comment period of 30 days.12 After the second comment periodended, the Commission informed thepublic that it would continue to acceptand consider late comments and did sountil August 25, 2011. The Commissionreceived a total of approximately 119

comment letters directed specifically atthe proposed rules, in addition to manyother comments applicable to the Dodd-Frank Act rulemaking initiative moregenerally.13 The Chairman andCommissioners, as well as Commissionstaff, participated in numerous meetingswith representatives of DCOs, FCMs,trade associations, public interestgroups, traders, and other interestedparties. In addition, the Commission hasconsulted with other U.S. financialregulators including the Board of Governors of the Federal ReserveSystem and Securities and ExchangeCommission (SEC).

The Commission is mindful of the benefits of harmonizing its regulatory

framework with that of its counterpartsin foreign countries. The Commissionhas therefore monitored global advisory,legislative, and regulatory proposals,and has consulted with foreignregulators in developing the proposedand final regulations for DCOs.

The Commission is of the view thateach DCO should be afforded an

appropriate level of discretion indetermining how to operate its businesswithin the legal framework established

by the CEA, as amended by the Dodd-Frank Act. At the same time, theCommission recognizes that specific,

bright-line regulations may be necessaryto facilitate DCO compliance with agiven core principle and, ultimately, toprotect the integrity of the U.S.derivatives clearing system.Accordingly, in developing theproposed regulations and in finalizingthe regulations adopted herein, takinginto consideration public comments and

views expressed by U.S. and foreignregulators, the Commission hasendeavored to strike an appropriate

balance between establishing generalprudential standards and specificrequirements.

In determining the scope and contentof the final rules, the Commission hastaken into account concerns raised bycommenters regarding the implicationsof specific rules for smaller versus largerDCOs, DCOs that do not clear customerpositions versus those with a traditionalcustomer model, clearinghouses that areregistered as both a DCO and asecurities clearing agency, and

clearinghouses that operate in foreignjurisdictions as well as in the UnitedStates. The Commission addresses theseissues in its discussion of specific ruleprovisions, below.

The Commission has carefullyconsidered the costs and benefitsassociated with each proposed rule,with particular attention to publiccomments. For the reasons discussed inthis notice of final rulemaking, in theanalyses of specific rule provisions aswell as in the formal cost-benefitanalysis, the Commission hasdetermined that the final rules

appropriately balance the costs and benefits associated with oversight andsupervision of DCOs pursuant to theCEA, as amended by the Dodd-FrankAct.

The Commission is herein adoptingregulations to implement the coreprinciples applicable to DCOs, toimplement CCO requirementsestablished under the Dodd-Frank Act,and to update the regulatory frameworkfor DCOs to reflect standards andpractices that have evolved over the pastdecade since the enactment of the


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14See Section 4s of the CEA, 7 U.S.C. 6s.15See 76 FR 33818 (June 9, 2011) (Protection of

Cleared Swaps Customer Contracts and Collateral;Conforming Amendments to the Commodity BrokerBankruptcy Provisions); 76 FR 33066 (June 7, 2011)(Adaptation of Regulations to Incorporate Swaps).

CFMA. The Commission is largelyadopting final rules as proposed,although there are a number of proposedprovisions that, upon furtherconsideration in light of commentsreceived, the Commission hasdetermined to either revise or decline toadopt. In the discussion below, theCommission highlights topics of

particular interest to commenters anddiscusses comment letters that arerepresentative of the views expressed onthose topics. The discussion does notexplicitly respond to every commentsubmitted; rather, it addresses the mostsignificant issues raised by the proposedrulemakings and it analyzes those issuesin the context of specific comments.

The final rules include a number of technical revisions to the proposed ruletext, intended variously to clarifycertain provisions, standardizeterminology within part 39, conformterminology to that used in other parts

of the Commission’s rules, and moreprecisely state regulatory standards andrequirements. These are non-substantivechanges. For example, the proposedDCO rules used the terms ‘‘contract’’and ‘‘product’’ interchangeably, andsome provisions used the statutorylanguage ‘‘contracts, agreements andtransactions’’ to refer to the productssubject to Commission regulation. In thefinal rules adopted herein, theCommission has revised theterminology to uniformly refer to‘‘products,’’ which encompassescontracts, agreements, and transactions,except where the language of the rule

codifies statutory language. In thosecases, the rule text is unchanged.

For easy reference and for purposes of clarification, in this notice of finalrulemaking the Commission ispublishing the complete part 39 ascurrently adopted. This means thatcertain longstanding rules that are not

being amended (e.g., § 39.8 (formerlydesignated as §39.7, fraud inconnection with the clearing of transactions of a DCO), and rulesrecently adopted (§39.5, review of swaps for Commission determination onclearing requirement) are being re-

published along with the newly-adoptedrules. Rules that have been proposed butnot yet adopted in final form areidentified in part 39 as ‘‘reserved.’’

II. Part 1 Amendments—Definitions

The Commission proposed to amendthe definitions of ‘‘clearing member,’’‘‘clearing organization,’’ and ‘‘customer’’found in §1.3 of its regulations toconform the definitions with theterminology and substantive provisionsof the CEA, as amended by the Dodd-Frank Act. The Commission also

proposed to add to §1.3, definitions for‘‘clearing initial margin,’’ ‘‘customerinitial margin,’’ ‘‘initial margin,’’‘‘margin call,’’ ‘‘spread margin,’’ and‘‘variation margin.’’

ISDA commented that the margindefinitions are appropriate for futuresand cleared derivatives, but less readilyapplicable in the uncleared OTC

derivatives context. It suggested that thedefinitions should expressly providethat they apply only to clearedtransactions. The Commission notes thatsome of the definitions by their termsalready apply only to cleared trades,e.g., ‘‘clearing initial margin.’’ Otherterms, however, have applicability to

both cleared and uncleared trades, e.g.,‘‘initial margin.’’ 14

The Commission proposed to define‘‘spread margin’’ as ‘‘reduced initialmargin that takes into accountcorrelations between certain relatedpositions held in a single account.’’Better Markets commented that thedefinition of ‘‘spread margin’’ omits keycharacteristics of netting initial marginwhich are needed to precisely definespread margin. Better Markets proposedto define it as ‘‘initial margin relating totwo positions in a single account thathas been reduced from the aggregateinitial margin otherwise applicable tothe two positions by application of analgorithm that measures statisticalcorrelations between the historic pricemovements of the two positions.’’ TheCommission is adopting the definitionof ‘‘spread margin’’ as proposed becauseit believes that Better Markets’

definition adds unnecessary details thatcould have the unintended effect of imposing substantive marginmethodology requirements in adefinition.

In light of proposed rulemakingsissued after the Commission proposedthe definition of ‘‘customer; commoditycustomer; swap customer,’’ theCommission is making certain technicalmodifications.15 First, instead of placingthe definition in §1.3, which serves asthe general definition section for all of the Commission’s regulations, thisdefinition is being moved to § 39.2,

which sets forth definitions applicableonly to regulations found in part 39 oras otherwise explicitly provided. Thisaccommodates the need for furtherconsideration of other proposals beforea global definition is adopted, whilesatisfying the need for a definition forpurposes of part 39 as adopted herein.

Second, the Commission has madecertain technical changes to the rule textin connection with the definition’sredesignation in 39.2 and to conformphraseology when incorporating byreference definitions that appear in theCEA and §1.3. These changes includelimiting the term to ‘‘customer,’’

because the terms ‘‘commodity

customer’’ and ‘‘swap customer’’ are notused in Part 39.

The Commission is adopting the otherdefinitions as proposed.

III. Part 39 Amendments—GeneralProvisions

A. Scope—§ 39.1

As originally proposed, §39.1included an updated statement of scopeand definitions applicable to otherprovisions in part 39. The Commissionlater revised proposed § 39.1 to includeonly the statement of scope. TheCommission did not receive any

comments on the statement of scope,which was updated to includereferences to the definition of ‘‘derivatives clearing organization’’ innewly-renumbered Section 1(a)(15) of the CEA and §1.3(d) of theCommission’s regulations. TheCommission is adopting §39.1 asproposed.

B. Definitions—§39.2

The Commission proposed definitionsof the terms ‘‘back test,’’ ‘‘compliancepolicies and procedures,’’ ‘‘customeraccount ’’ or ‘‘customer origin,’’ ‘‘house

account’’ or ‘‘house origin,’’ ‘‘keypersonnel,’’ ‘‘stress test,’’ and‘‘systemically important derivativesclearing organization.’’ The definitionsset forth in proposed §39.2 would applyspecifically to provisions contained inpart 39 and such other rules as mayexplicitly cross-reference thesedefinitions. The Commission isadopting the definitions as proposed,with the exceptions discussed below.

CME Group, Inc. (CME) commentedthat the proposed definition of ‘‘compliance policies and procedures’’was too broad. That definition was

proposed as an adjunct to the proposedrules for a DCO’s CCO. The Commissionis not adopting a definition of ‘‘compliance policies and procedures,’’as it has concluded that a DCO’scompliance policies and procedureswill likely encompass a limited, self-evident body of documents, and aregulatory definition could invite morescrutiny than is necessary or helpful tothe DCO or the Commission.

The Commission proposed to define‘‘stress test’’ as ‘‘a test that compares theimpact of a potential price move, change





16See discussion of stress tests in sectionIV.D.7.c, below.

17See 76 FR 44776 at 44783–84 (July 27, 2011)(Provisions Common to Registered Entities; finalrule).

18See id. for further discussion of this topic.

19See 76 FR 722 (Jan. 6, 2011) (Governance); and75 FR 63732 (Oct. 18, 2010) (Conflicts of Interest).

in option volatility, or change in otherinputs that affect the value of a position,to the financial resources of a [DCO],clearing member, or large trader todetermine the adequacy of suchfinancial resources.’’ Better Markets,Inc. (Better Markets) expressed the viewthat a stress test can only be useful if ittests unprecedented circumstances of

illiquidity, and that basing the test onhistoric price data would make itmeaningless. In response to thiscomment, the Commission is modifyingthe definition in one respect. The word‘‘extreme’’ is being inserted after theword ‘‘potential’’ to make clear that astress test does not include typicalevents. The Commission furtheraddresses Better Markets’ concerns in itsdiscussion of stress tests in§ 39.13(h)(3).16

The Commission proposed to definethe term ‘‘systemically importantderivatives clearing organization’’ to

mean ‘‘a financial market utility that isa derivatives clearing organizationregistered under Section 5b of the Act(7 U.S.C. 7a–1), which has beendesignated by the Financial StabilityOversight Council to be systemicallyimportant.’’ The Options ClearingCorporation (OCC) submitted acomment on this definition inconnection with the Commission’sproposed §40.10 (special certificationprocedures for submission of certainrisk-related rules by SIDCOs).17 OCCpointed out that, under this proposeddefinition, a DCO could be a SIDCOeven if the Commission were not its

Supervisory Agency pursuant to Section803(8) of the Dodd-Frank Act. TheCommission, recognizing that someDCOs like OCC may be regulated bymore than one federal agency, isadopting a revised definition to clarifythat the term ‘‘systemically importantderivatives clearing organization’’means a ‘‘financial market utility that isa derivatives clearing organizationregistered under Section 5b of the Act,which has been designated by theFinancial Stability Oversight Council to

be systemically important and for whichthe Commission acts as the Supervisory

Agency pursuant to Section 803(8) of the Dodd-Frank Wall Street Reform andConsumer Protection Act.’’ 18

The Commission also is making atechnical change to the definition of ‘‘customer account or customer origin.’’The proposed definition would provide,in part, that ‘‘[a] customer account is

also a futures account, as that term isdefined by Sec. 1.3(vv) of this chapter.’’The Commission is removing thisreference and defining ‘‘customeraccount or customer origin’’ to mean ‘‘aclearing member account held on behalf of customers, as that term is defined inthis section, and which is subject tosection 4d(a) or section 4d(f) of the

Act.’’ This clarifies that the termencompasses both customer futuresaccounts and customer cleared swapsaccounts, respectively.

Similarly, the Commission is makinga technical revision to the term ‘‘houseaccount or house origin’’ to delete theproposed reference to proprietaryaccounts, which are currently defined in§ 1.3(y) only in terms of futures andoptions (not swaps). The term ‘‘houseaccount or house origin’’ is now definedas a ‘‘clearing member account which isnot subject to section 4d(a) or 4d(f) of the Act.’’

In connection with the proposal toadopt a definitions section designated as§ 39.2, the Commission proposed torescind the existing §39.2, whichexempted DCOs from all Commissionregulations except those explicitlyenumerated in the exemption. Thisaction would result in clarifying theapplicability of §1.49 (denomination of customer funds and location of depositories) to DCOs and, insofar as therule exempted DCOs from regulationsrelating to DCO governance andconflicts of interest, those regulationsare expected to themselves be replaced

by rules to implement DCO CorePrinciples O (Governance FitnessStandards), P (Conflicts of Interest), andQ (Composition of Governing Boards).19 The Commission did not receive anycomments on the proposed rescission of the exemption provided by existing§ 39.2 and is herein rescinding thatexemption, as proposed.

C. Procedures for Registration as aDCO—§39.3

The Commission proposed severalrevisions to its procedures for DCOregistration, including the eliminationof the 90-day expedited review period

and the required use of an applicationform, proposed Form DCO. TheCommission is adopting §39.3 asproposed, and is adopting the FormDCO with the revisions discussed

below.

1. Form DCO

The Commission proposed to reviseappendix A to part 39, ‘‘ApplicationGuidance and Compliance with Core

Principles,’’ by removing the existingguidance and substituting the FormDCO in its place. An application forDCO registration would consist of thecompleted Form DCO, which wouldinclude all applicable exhibits, and anysupplemental information submitted tothe Commission.

CME commented that the proposed

Form DCO would require the applicantto create and submit to the Commissiona large number of documents. Itquestioned why certain documents werenecessary and whether Commissionstaff would be able to meaningfullyreview all of the materials within the180-day timeframe contemplated in theproposed regulations.

The Commission is adopting the FormDCO as proposed, except for themodifications discussed below. TheCommission notes that the Form DCOstandardizes and clarifies theinformation that the Commission hasrequired from DCO applicants in thepast and the Form DCO ExhibitInstructions, in an effort to reduce the

burden on applicants, state that ‘‘If anyExhibit requires information that isrelated to, or may be duplicative of,information required to be included inanother Exhibit, Applicant maysummarize such information andprovide a cross-reference to the Exhibitthat contains the required information.’’Based on the Commission’s experiencewith the DCO registration process overthe past decade, it believes that its staff can meaningfully review the requiredinformation within the 180-day time

frame. In addition, the Commission believes that by standardizinginformational requirements, the FormDCO will allow the Commission toprocess applications more quickly andefficiently. This will benefit applicantsas well as free Commission staff tohandle other regulatory matters.

CME specifically questioned whether,as part of the Form DCO cover sheet,applicants should be required toidentify and list ‘‘all outside serviceproviders and consultants, includingaccountants and legal counsel.’’ Thiscomment mischaracterizes the

information required by the Form DCO,which requires contact information forenumerated outside service providers(Certified Public Accountant, legalcounsel, records storage or management,

business continuity/disaster recovery)and ‘‘other’’ outside service providers‘‘such as consultants, providing servicesrelated to this application.’’ Suchcontact information is helpful to theCommission staff in processing theapplication and making a determinationas to whether the applicant has obtainedthe services it needs to effectively





20This requirement focuses on outside services‘‘related to this application.’’ Similarly, if the

applicant intends to use the services of an outsideservice provider (including services of its clearingmembers or market participants), to enable it tocomply with any of the core principles, theapplicant must submit as exhibit A–10 allagreements entered into or to be entered into between the applicant and the outside serviceprovider, and identify: (1) The services that will beprovided; (2) the staff who will provide theservices; and (3) the core principles addressed bysuch arrangement. This exhibit does not requirethat the applicant submit information anddocumentation related to all outside serviceproviders. Rather, the requirement is directed atcontractual arrangements related to compliancewith the core principles, i.e., the DCO’s core business functions.

operate as a DCO.20 Nonetheless, inresponse to CME’s comments and inorder to clarify the scope of requestingcontact information for ‘‘any otheroutside service providers,’’ theCommission has decided to revisesection 12.e. of the Form DCO coversheet to provide for contact informationfor any ‘‘Professional consultant

providing services related to thisapplication.’’

CME commented that proposedexhibit A–1, which would require theapplicant to produce a chartdemonstrating in detail how its rules,procedures, and policies address eachDCO core principle, is not necessary.The Commission believes exhibit A–1 isnecessary because it will provide a clearpicture of which rules, procedures, andpolicies address each DCO coreprinciple. The chart will greatly assistCommission staff in tracking andevaluating the materials supplied by the

applicant and should reduce the needfor staff to seek follow-up clarificationsfrom the applicant. Again, this will alsoreduce the costs to the applicant.

CME commented that the Commissionhas not explained its reasons forrequiring an applicant to supply‘‘telephone numbers, mobile phonenumbers and email addresses of allofficers, managers, and directors of theDCO,’’ as provided in proposed exhibitA–6. The Commission notes that theexhibit A–6 instructions request contactand other information for ‘‘currentofficers, directors, governors, generalpartners, LLC managers, and membersof all standing committees.’’ The exhibitis not directed at ‘‘all managers’’ or ‘‘alldirectors,’’ but rather at those personswho are in key decision-makingpositions (for example, key personnel,directors serving on a board of directorsand a manager or managing member of a DCO organized in the form of a limitedliability corporation). The purpose of obtaining contact information is toenable the Commission to start buildingan emergency contact database.

CME commented that proposedexhibit A–7 would require the applicantto list all jurisdictions where theapplicant and its affiliates are doing

business, and the registration status of the applicant and its affiliates. CMEquestioned the Commission’s need forsuch information with respect toaffiliates of the applicant. The

Commission believes that suchinformation is necessary because itallows the Commission to develop amore complete understanding of theapplicant’s entire corporateorganizational structure includingpotential financial commitments andregulatory obligations of the applicant’saffiliates inclusive of its parentorganization.

CME commented that proposedexhibit B–3, which would require theapplicant to provide proof that each of its physical locations meets all buildingand fire codes, and that it has running

water and a heating, ventilation and airconditioning system, and adequateoffice technology, is not necessary. TheCommission believes that it is importantfor an applicant to demonstrate that ithas a physical presence capable of supporting clearing and settlementservices and is not a ‘‘shoestring’’operation. Typically, Commission staff will conduct a site visit to an applicant’sheadquarters and other facilities, andone of the purposes of such visits is toevaluate the suitability of theapplicant’s physical facilities. Sitevisits, however, are conducted after a

DCO application is deemed to bematerially complete, and there areinstances when it might not be feasibleto conduct a site visit. Accordingly, ata minimum, a narrative statementdiscussing the applicant’s physicalfacilities and office technology must besubmitted to the Commission as part of the application package so that staff cancomplete its initial review for ‘‘adequate* * * operational resources’’ underCore Principle B.

In response to CME’s comments, theCommission has decided to reviseexhibit B–3 to require the following:

(3) A narrative statement demonstrating theadequacy of Applicant’s physicalinfrastructure to carry out businessoperations, which includes a principalexecutive office (separate from any personaldwelling) with a U.S. street address (notmerely a post office box number). For itsprincipal executive office and other facilitiesApplicant plans to occupy in carrying out itsDCO functions, a description of the space(e.g., location and square footage), use of thespace (e.g., executive office, data center), andthe basis for Applicant’s right to occupy thespace (e.g., lease, agreement with parentcompany to share leased space).

(4) A narrative statement demonstrating theadequacy of the technological systemsnecessary to carry out Applicant’s businessoperations, including a description of Applicant’s information technology andtelecommunications systems and a timetablefor full operability.

CME questioned the value of proposed exhibits C–1(9) and C–2(5),

which would, respectively, require anapplicant to provide a list of current andprospective clearing members, and toforecast expected volumes and openinterest at launch date, six months, andone year thereafter. The Commission

believes that this information isimportant because it would enable theCommission to understand the natureand level of the DCO’s expected start-upactivities and to appropriately evaluatewhether the applicant has adequateresources to manage the expectedvolume of business.

CME questioned the benefits of what

it termed the ‘‘incredibly burdensome’’requirements of proposed exhibit D–2(b)(3), which would require anapplicant to explain why a particularmargin methodology was chosen overother potentially suitablemethodologies, and to include acomparison of margin levels that wouldhave been generated by using such otherpotential methodologies. To addressCME’s comment, the Commission isrevising exhibit D–2(b)(3) to require anexplanation of whether other marginingmethodologies were considered and, if so, explain why they were not chosen.

This information will be sufficient inthe first instance and, when evaluatingan applicant’s proposed marginmethodology, Commission staff canrequest additional information if neededto complete its review for compliancewith Core Principle D and § 39.13 (riskmanagement).

The Commission proposed to requireuse of the Form DCO by a registeredDCO when requesting an amendment toits DCO registration order. CME andMinneapolis Grain Exchange, Inc.(MGEX) suggested that the Form DCO bemodified so that a currently registered

DCO would not have to expend as muchtime and resources to complete anamendment request as a new applicantfor DCO registration, unless there areextenuating circumstances. In responseto this suggestion, the Commission isrevising the Form DCO GeneralInstructions to clarify that if the FormDCO is being filed as an amendment toa pending application for registration orfor the purpose of amending an existingregistration order, the applicant needonly submit the information andexhibits relevant to the application





21See 76 FR 54538 (Sept. 1, 2011) (SDRs:Registration Standards, Duties and Core Principles;final rule); 75 FR 80572 (Dec. 22, 2010) (CorePrinciples and Other Requirements for DesignatedContract Markets); 76 FR 1214 (Jan. 7, 2011) (CorePrinciples and Other Requirements for SwapExecution Facilities).

22For example, the Commission has removed thespecific cross-references located in exhibit P to

Form DCO to the proposed conflicts of interestrules, 75 FR 63732 (Oct. 18, 2010) (Conflicts of Interest), and replaced such references with adescription of the required information. When theCommission finalizes such proposed rules, theCommission intends to make technical changes tothe Form DCO to include cross-references to suchfinal rules where, in the opinion of theCommission, doing so will facilitate compliancewith the Form DCO, the CEA and/or Commissionregulations.

23As a technical matter, the Commission isremoving proposed §39.3(g)(1) and adoptingproposed §39.3(h) as §39.3(f); proposed §39.3(g)(1)was a typographical error which repeats adelegation of authority already provided by§ 39.3(b)(2)(i).

24See 76 FR 44464, at 44473–44474 (July 26,2011) (Process for Review of Swaps for MandatoryClearing; final rule).

25See 76 FR 44776 (July 27, 2011) (ProvisionsCommon to Registered Entities; final rule).

26Section 4d(h) of the CEA, 7 U.S.C. 6d(h).27Section 15(c)(3)(C) of the SEA, 15 U.S.C.

78o(c)(3).

amendment or request for an amendedregistration order.

CME also noted that a DCO applicantwould be required to represent that itsForm DCO submission is true, correct,and complete. It suggested that theCommission modify this language sothat the applicant is required to certifythat, ‘‘to the best of its knowledge,’’ itsForm DCO submission is true, correct,and complete ‘‘in all material respects.’’The Commission is revising thelanguage as suggested by CME, inrecognition of the fact that some of theinformation contained in the exhibitsmay have been provided by third partiesand there is a limit to the reach of anapplicant’s due diligence with respect tosuch information.

In addition to the above changes, theCommission has made non-substantiveeditorial changes to the Form DCO forpurposes of internal consistency and

conformity with the Form SDR for swapdata repositories (SDRs) and proposedForm DCM and Form SEF for designatedcontract markets (DCMs) and swapexecution facilities (SEFs),respectively.21 The Commission alsohas made changes to Form DCO toremove references to proposedregulations that remain pending.22

2. Request for Transfer of Registrationand Open Interest—§ 39.3(h)

The Commission proposed §39.3(h)to clarify the procedures that a DCOmust follow when requesting thetransfer of its DCO registration andpositions comprising open interest forclearing and settlement, in anticipationof a corporation change.23 TheCommission received a comment fromOCC suggesting that a request to transfera DCO’s registration and open interest

should be published in the FederalRegister for public comment.

The Commission recognizes the valueof public comment, but it hasdetermined not to formalize the publiccomment process through publication inthe Federal Register. This procedurecould unnecessarily delay the reviewprocess and completion of the transfer,

and the Commission believes thatposting the request on its Web site,which it currently does for DCOregistration applications, will providean opportunity for public commentwithout potential delay.

3. Technical Amendments

The Commission proposed a set of technical amendments to § 39.3 toupdate filing procedures, to conformvarious provisions to reflect theelimination of the 90-day expeditedreview period for DCO applications, andto correct terminology in the delegation

provisions of §39.3(g). The Commissiondid not receive any comments on theproposed technical amendments and theCommission is adopting theamendments as proposed.

D. Procedures for Implementing DCORules and Clearing New Products—§39.4

1. Acceptance of Certain New Productsfor Clearing—§ 39.4(c)(2)

The Commission proposed a technicalamendment to existing §39.4(c)(2),which would require a DCO to certify tothe Commission the terms and

conditions of new over-the-counter(OTC) products that it intended to clear.The Commission proposed removing thereference to new products ‘‘not tradedon a designated contract market or aregistered derivatives transactionexecution facility’’ and inserting areference to new products ‘‘not tradedon a designated contract market or aregistered swap execution facility.’’ Theproposed provision would retain thereference to filing the terms andconditions of the new product‘‘pursuant to the procedures of §40.2 of this chapter.’’

Since proposing that technical

amendment, the Commission hasadopted a new §39.5 (review of swapsfor Commission determination onclearing requirement) 24 and revisions to§ 40.2 (listing products for trading bycertification).25 As a result, a DCOseeking to clear new products that arenot traded on a designated contract

market or swap execution facility mustsubmit to the Commission the terms andconditions of the product pursuant tothe procedures of §39.5, not § 40.2. TheCommission is therefore adopting atechnical revision to conform§ 39.4(c)(2) to the current proceduralrequirements.

2. Holding Securities in a FuturesPortfolio Margining Account—§39.4(e)

The CEA, as amended by Section 713of the Dodd-Frank Act, permits,pursuant to an exemption, rule orregulation, futures and options onfutures to be held in a portfoliomargining account that is carried as asecurities account and approved by theSEC.26 Reciprocally, the SecuritiesExchange Act of 1934 (SEA), asamended by Section 713 of the Dodd-Frank Act, permits, pursuant to anexemption, rule, or regulation, cash andsecurities to be held in a portfolio

margining account that is carried as afutures account and approved by theCommission.27 Those provisions of theCEA and SEA further requireconsultation between the Commissionand the SEC in drafting implementingregulations. As a first step towardmeeting this goal, proposed § 39.4(e)would establish the proceduralrequirements applicable to a DCOseeking approval for a futures portfoliomargining account program.

OCC, Newedge USA, LLC (Newedge),New York Portfolio Clearing, LLC(NYPC), and MetLife Inc. urged theCommission to propose rules that would

permit portfolio margining, not justestablish procedural requirements. TheCommission agrees that it shouldpropose substantive portfolio marginingrules, but it must move forward onproposing substantive rules with theSEC’s participation.

Accordingly, the Commission isadopting the procedural requirements asproposed and anticipates consultingwith the SEC in the future to determinethe substantive requirements it wouldimpose in approving a futures portfoliomargining program and, additionally, ingranting an exemption under Section

4(c) of the CEA to permit futures andoptions on futures to be held in asecurities portfolio margining account.The Dodd-Frank Act does not set adeadline for these actions, and theCommission believes that it is importantto give this matter due consideration,

both in terms of consultation with theSEC and, more broadly, in obtainingindustry views on the topic before





28As part of the reorganization of Part 39, §39.6(Enforceability) is being redesignated as §39.7 and§ 39.7 (Fraud in connection with the clearing of transactions on a derivatives clearing organization)is being redesignated as § 39.8.

29After these technical amendments wereproposed, the Commission adopted a final rulegoverning the process for review of swaps formandatory clearing. That rule was designated as§ 39.5, and the former §39.5 was redesignated as§39.8. See 76 FR at 44473 (July 26, 2011) (Process

for Review of Swaps for Mandatory Clearing; finalrule). In connection with adoption of the technicalamendments described above, the provisionsregarding fraud in connection with the clearing of transactions on a DCO (former §39.7) are nowredesignated as § 39.8.

30Section 5b(c)(2)(A) of the CEA, 7 U.S.C. 7a–1(c)(2)(A).

31See Section 5b(i) of the CEA; 7 U.S.C. 7a–1(b)(i).

32See http://www.websters-online-dictionary.org/ definitions/enforce.

33See Section 5b(i)(2)(E) of the CEA, 7 U.S.C. 7a–1(b)(i)(2)(E), which requires the CCO to ‘‘ensurecompliance with this Act (including regulations)relating to agreements, contracts, or transactions,including each rule prescribed by the Commissionunder this section.’’

proposing substantive regulations orother guidance.

E. Reorganization of Part 39

With the adoption of regulationsrelating to implementation of the coreprinciples and other provisions of theDodd-Frank Act, the Commission isreorganizing part 39 of its regulations

into two subparts, with a new appendix.Subpart A, ‘‘General ProvisionsApplicable to Derivatives ClearingOrganizations’’ contains §§ 39.1 through39.8, which are general provisionsincluding procedural requirements forDCO applications and other activitiessuch as transfer of a DCO registration,clearing of new products, andsubmission of swaps for a mandatoryclearing determination. Subpart A alsoincludes pre-existing provisionsregarding enforceability and fraud inconnection with clearing transactionson a DCO.28 Subpart B, ‘‘Compliancewith Core Principles,’’ contains §§39.9through 39.27, which are rules thatimplement the core principles underSection 5b of the CEA, as amended bythe Dodd-Frank Act.

As discussed above, the Commissionis replacing appendix A ‘‘ApplicationGuidance and Compliance with CorePrinciples,’’ with a new appendix topart 39, ‘‘Form DCO DerivativesClearing Organization Application forRegistration.’’

F. Technical Amendments

With the objective of listing all DCOreporting requirements in a new §39.19,

the Commission proposed redesignating§ 39.5(a) and (b) (information relating toDCOs) as proposed §§ 39.19(c)(5)(i) and(ii), respectively, in substantially thesame form. The Commission alsoproposed removing § 39.5(c) (largetrader reporting by DCOs), redesignating§ 39.5(d) (special calls) as § 21.04 (andcurrent § 21.04 as §21.05), and adding§ 21.06, which would delegate authorityunder §21.04 to the Director of theDivision of Clearing and Risk.

The Commission did not receive anycomments on these proposals.Therefore, the Commission is adopting

these revisions as proposed, except fornon-substantive changes to§§ 39.19(c)(5)(i) and (c)(5)(ii) to clarifythe language.29

IV. Part 39 Amendments—ComplianceWith Core Principles

Proposed §39.9 would establish thescope of the rules contained in subpartB of part 39, stating that all provisionsof subpart B apply to DCOs. TheCommission did not receive anycomments on the statement of scope,and the Commission is adopting §39.9as proposed.

A. Core Principle A—Compliance WithCore Principles—§39.10

1. Core Principle A

Core Principle A,30 as amended by theDodd-Frank Act, requires a DCO tocomply with each core principle setforth in Section 5b(c)(2) of the CEA andany requirement that the Commissionmay impose by rule or regulationpursuant to Section 8a(5) of the CEA.Core Principle A also provides a DCOwith reasonable discretion to establishthe manner by which it complies witheach core principle. Proposed§§ 39.10(a) and 39.10(b) would codifythese provisions, respectively. TheCommission received no comments onthese proposed rules and is adopting therules as proposed.

2. Designation of a Chief ComplianceOfficer—§ 39.10(c)(1)

Section 725(b) of the Dodd-Frank Actadded a new paragraph (i) to Section 5bof the CEA to require each DCO todesignate an individual as its CCO,responsible for the DCO’s compliancewith the CEA and Commission

regulations and the filing of an annualcompliance report.31 In proposed§ 39.10(c), the Commission set forthimplementing requirements that wouldlargely track the language of Section5b(i).

Under the introductory provision of proposed §39.10(c)(1), each DCO would

be required to appoint a CCO with ‘‘thefull responsibility and authority todevelop and enforce in consultationwith the board of directors or the seniorofficer, appropriate compliance policiesand procedures, as defined in §39.1(b),to fulfill the duties set forth in the Actand Commission regulations.’’ As

previously noted, the Commission is notadopting the definition of ‘‘compliancepolicies and procedures’’ included inproposed § 39.1(b).

CME commented that the text of theDodd-Frank Act does not require a CCOto ‘‘enforce’’ compliance policies andprocedures and it suggested that §39.10should not do so. According to CME, itis important to separate the functions of monitoring and advising on complianceissues from what it considers ‘‘seniormanagement functions’’ of enforcing

and supervising compliance policies.The Commission believes that

Congress intended that the CCO havethe full responsibility and authority toenforce compliance in consultation withthe board of directors or the seniorofficer. Given the specified duties of theCCO set forth in Section 5b(i)(2), theCommission finds ample support forthis interpretation and is adopting therule as proposed.

First, one definition of the term‘‘enforce’’ is ‘‘to ensure observance of laws and rules,’’ 32 and among the CCOduties set forth by the Dodd-Frank Actis the requirement that the CCO ‘‘ensurecompliance.’’ 33 Second, Section5b(i)(2)(C) requires a CCO to ‘‘resolveany conflicts of interest that may arise’’in consultation with the board of theDCO or the senior officer of the DCO.This duty clearly indicates that the CCOis more than just an advisor tomanagement and must have the abilityto enforce compliance with the CEA andCommission regulations. The authorityto resolve conflicts of interest is more anenforcement function than an auditfunction. Finally, Section 5b(i)(2)(D)requires the CCO to ‘‘be responsible foradministering each policy.’’

While the CEA does not explicitly usethe word ‘‘enforce,’’ the Commission

believes that the use of this word in§ 39.10(c)(1) is appropriate to capturethe meaning of Section 5b(i)(2)(C), i.e.,that CCOs must have the authority tofulfill their statutory and regulatoryobligations. Moreover, it is consistentwith the statutory directive for the CCOto ensure compliance with the CEA.These considerations are particularlyimportant given that the CCO of a DCOhas unique responsibilities inconnection with the DCO’s critical rolein providing financial integrity to

derivatives markets. In particular, a CCOmust have the ability to effectivelyaddress rules and practices that couldcompromise compliance with fair andopen access requirements (CorePrinciple C), risk management


http://www.websters-online-dictionary.org/definitions/enforce







34See further discussion of a CCO’s duties insection IV.A.7, below.

35See 76 FR 54538 (Sept. 1, 2011) (SDRs:Registration Standards, Duties and Core Principles;final rule). 367 U.S.C. 7a–1(i)(2)(A).

requirements (Core Principle D), andfinancial resource requirements (CorePrinciple B).

The Commission, however, recognizesthat the term ‘‘enforce’’ could imply thatthe DCO’s CCO must have directsupervisory authority over employeesnot otherwise in his or her direct chainof command, or that the CCO has

independent authority to disciplineemployees or terminate employment tofacilitate compliance with the CEA andthe Commission’s regulations. To avoidconfusion, the Commission hereinclarifies that the term ‘‘enforce,’’ as usedin § 39.10(c)(1), is not intended toinclude the authority to superviseemployees not in the CCO’s direct chainof command, or the authority toterminate employment or disciplineemployees for conduct that results innoncompliance. The Commission notesthat a DCO is not precluded fromconferring such authority on its CCO;

however, such action would be at theDCO’s discretion and is not required by§ 39.10(c)(1).34

3. Individuals Qualifying To Serve as aCCO—§39.10(c)(1)(i)

Proposed § 39.10(c)(1)(i) wouldrequire a DCO to designate anindividual with the background andskills appropriate for fulfilling theresponsibilities of the CCO position.The Commission asked whetheradditional qualifications should beimposed and, in particular, whether theCommission should restrict the CCOposition from being held by an attorney

who represents the DCO or its board of directors, such as an in-house or generalcounsel. The Commission explainedthat the rationale for such a restrictionwould be based on concern that theinterests of representing the DCO’s

board of directors or management could be in conflict with the duties of theCCO. Related to this, the Commissionspecifically sought comment on whetherthere is a need for a regulation requiringthe DCO to insulate a CCO from unduepressure and coercion. It further askedif it is necessary to adopt rules toaddress the potential conflict between

and among compliance interests,commercial interests, and ownershipinterests of a DCO and, if there is noneed for such rules, requested commenton how such potential conflicts would

be addressed.CME, OCC, MGEX, and the Kansas

City Board of Trade ClearingCorporation (KCC) commented thatadditional restrictions should not beimposed. MGEX commented that

smaller DCOs will need to maximize theutility of each employee. It also arguedthat there is little risk if a CCO servesas in-house counsel because attorneyshave additional ethical duties whichcan complement the duties andobligations of a CCO. According toMGEX, if a conflict arose, the attorneycould step out of one or both of the

roles.Better Markets commented that there

is potential conflict between a CCO andin-house counsel because in-housecounsel is an advocate for the DCO orits board of directors regarding anycontroversy that may relate to regulatorycompliance, while a CCO’s duty is toensure compliance. It suggested that theCommission prohibit a CCO fromserving as in-house counsel.

The Commission is adopting§ 39.10(c)(1)(i) as proposed. TheCommission has considered prohibitinga CCO from working in the DCO’s legal

department or serving as generalcounsel, consistent with theCommission’s approach to the CCO of an SDR.35 However, in response topublic comments and in light of the factthat all currently registered DCOs havesome form of compliance programalready in place, with one or more staff members assigned to carry outcompliance officer functions, theCommission has determined that thepotential costs of hiring additional staff to satisfy such requirement could resultin imposing an unnecessary burden onDCOs, particularly smaller ones. The

Commission recognizes, however, that aconflict of interest could compromise aCCO’s ability to effectively fulfill his orher responsibilities as a CCO. TheCommission therefore expects that assoon as any conflict of interest becomesapparent, a DCO would immediatelyimplement a back-up plan forreassignment or other measures toaddress the conflict and ensure that theCCO’s duties can be performed withoutcompromise.

MGEX and KCC also recommendedthat the Commission should permit theChief Regulatory Officer to function as

the CCO. Presumably, the commentersare referring to circumstances in whicha DCO (which typically would not havea Chief Regulatory Officer) is alsoregistered as a DCM (which typicallywould have a Chief Regulatory Officer).The Commission notes that the ruledoes not prohibit the person serving asCCO from also serving as the Chief Regulatory Officer.

4. CCO Reporting Structure—§ 39.10(c)(1)(ii)

Section 5b(i)(2)(A) of the CEArequires that a CCO report directly tothe board of directors or the seniorofficer of the DCO.36 Proposed§ 39.10(c)(1)(ii) would codify thisrequirement. The proposed rule also

would require the board of directors orthe senior officer to approve thecompensation of the CCO.

In the notice of proposed rulemaking,the Commission sought comment as tothe degree of flexibility that should beprovided in the reporting structure of the CCO. Specifically, the Commissionrequested comment on: (i) Whether itwould be more appropriate for a CCO toreport to the senior officer or the boardof directors; (ii) as between the seniorofficer or board of directors, whichgenerally is a stronger advocate of compliance matters within anorganization; and (iii) whether the

proposed rules allow for sufficientflexibility with regard to a DCO’s

business structure.CME, MGEX, and KCC commented

that the proposed rules would provideDCOs with the appropriate degree of flexibility. CME, however, believes itwould be ‘‘logical’’ for a CCO to reportto the senior officer, and that the boardof directors should overseeimplementation of compliance policiesand ensure that compliance issues areresolved effectively and expeditiously

by the senior officer with the assistanceof the CCO. MGEX noted that each DCO

may have a different business andreporting structure and believes thatrigid rules may hinder the effectivenessand independence of the CCO.

Better Markets observed that, in thepast, businesses have placed financialinterests over other considerations likerisk management and have created aclimate where people were unwilling tospeak out against financialconsiderations for fear of being fired.Better Markets suggested that thereshould be a strong reporting andworking relationship between the CCOand independent directors, and

suggested that independent directorshave sole responsibility to designate orterminate the CCO and to setcompensation levels for the CCO.

The Commission is adopting§ 39.10(c)(1)(ii) as proposed, decliningto prescribe whether the CCO can onlyreport to the board of directors or to thesenior officer. The Commissionappreciates Better Markets’ concern thata CCO who reports to the senior officermay be swayed by financial





37See discussion in section IV.J.5.h. (TheCommission is adopting proposed §39.19(c)(4)(xi)as a renumbered §39.19(c)(4)(ix)).

387 U.S.C. 7a–1(i)(2).

considerations. However, the Dodd-Frank Act permits alternative reportingstructures and the Commission has not

been presented with a compellingreason to conclude that the structureand operations of a DCO require theimposition of this limitation on theability of a DCO’s board andmanagement to establish lines of

authority appropriate to the particularDCO.

CME asked the Commission to clarifythat the term ‘‘senior officer’’ may applyto the senior officer of a division that isengaged in clearing activities. TheCommission notes that Section5b(i)(2)(A) of the CEA requires a CCO to‘‘report directly to the board or to thesenior officer of the derivatives clearingorganization.’’ If the division engaged inclearing activities is the registered DCO,then the senior officer of that divisionwould be the ‘‘senior officer’’ forpurposes of this provision.

Finally, Better Markets suggested thatcompliance should be addressed on anentire-group basis by a senior CCO.According to Better Markets, a singlesenior CCO should have overallresponsibility for each affiliated andcontrolled entity, even if the individualentities within the group have CCOs.The final rules do not require a businessorganization to have a ‘‘senior’’ CCO asBetter Markets suggested. TheCommission believes this would beoverly prescriptive and that a DCOshould have the flexibility to managecompliance functions across divisionsor affiliates to accommodate its

particular organizational structure.5. Annual Compliance Meeting—§ 39.10(c)(1)(iii)

Proposed § 39.10(c)(1)(iii) wouldrequire a CCO to meet with the board of directors or the senior officer at leastonce a year to discuss the effectivenessof the DCO’s compliance policies andprocedures, as well as theadministration of those policies andprocedures by the CCO. Better Marketssuggested that a CCO meet with the

board of directors at least quarterly. Nocomments were received on the

proposed topics to be discussed at theannual meeting.The Commission is adopting

§ 39.10(c)(1)(iii) in modified form. Thefinal rule retains the requirement thatthe CCO meet with the board of directors or senior officer annually, buteliminates the required topics to bediscussed at the meeting. As theCommission noted in the notice of proposed rulemaking, the requirementfor an annual discussion would notpreclude the board of directors or thesenior officer from meeting with the

CCO more frequently. While morefrequent communication between theCCO and the DCO’s board or seniorofficer may be desirable, theCommission has concluded thatadopting requirements to that effectwould be overly prescriptive. Similarly,upon further consideration, theCommission has concluded that the

purpose of the meeting should be self-evident (i.e., compliance) and it is notnecessary for the Commission, byregulation, to prescribe the business thatmust be conducted at that meeting.

6. Change in the Designation of theCCO—§ 39.10(c)(1)(iv)

Proposed §39.10(c)(1)(iv) wouldrequire that a change in the designationof the individual serving as the CCO bereported to the Commission, inaccordance with the requirements of proposed § 39.19(c)(4)(xi). TheCommission received no comments on

the proposed rule and is adopting theprovision as proposed.37

7. Duties of the CCO—§39.10(c)(2)

Section 5b(i)(2) of the CEA, added bySection 725(a) of the Dodd-Frank Act,sets forth the duties of a CCO,38 andproposed §39.10(c)(2) would codifythose enumerated duties in paragraphs(c)(2)(i)–(vii).

The Commission received commentson the CCO’s duties from CME, KCC,and OCC. In general, the commentersexpressed the view that the proposedregulations are too broad because theyimproperly provide the CCO with whatCME calls ‘‘senior managementfunctions’’ like enforcing andsupervising compliance policies.Instead, the commenters believe that therole of a CCO is only to serve as anauditor who monitors compliance andinforms senior management of noncompliance. The Commission hascarefully considered the comments andis adopting the rule as proposed, exceptas discussed below.

CME acknowledged that proposed§ 39.10(c)(2)(ii) mirrors the language inthe Dodd-Frank Act. However, CME

believes that Congress did not intend to

mean ‘‘resolve’’ in the executive ormanagerial sense such that the CCOalone would examine the facts anddetermine and affect the course of action. CME believes that Congressintended the CCO to identify, advise,and escalate, as appropriate, and toassist senior management in resolvingconflicts of interest.

KCC also believes that the board of directors or senior officer should resolveany conflict of interest in consultationwith the CCO. KCC commented thatcompliance policies and proceduresshould be administered by DCO staff and not by the CCO. According to KCC,a DCO’s staff is most familiar with theday-to-day operations of the DCO and is

in the best position to manage thepolicies and procedures. KCC believesthat a CCO’s role should be that of oversight of the DCO’s complianceprogram and filing an annual report.

The Commission disagrees withassertions that a CCO should only assistsenior management in resolvingconflicts of interest or that the board orsenior management should resolveconflicts of interest in consultation withthe CCO. Section 5b(i)(2)(C) of the CEAstates that a CCO shall ‘‘in consultationwith the board of the derivativesclearing organization, a body performing

a function similar to the board of thederivatives clearing organization, or thesenior officer of the derivatives clearingorganization, resolve any conflicts of interest that may arise.’’ Given thisexpress statutory direction, theCommission is not revising theproposed rule.

The Commission points out that aCCO’s duty to administer compliancepolicies and procedures is set forth inSection 5b(i)(2)(D) of the CEA. Itrequires a CCO to ‘‘be responsible foradministering each policy andprocedure that is required to beestablished pursuant to this section.’’ By

administering compliance policies andprocedures, a CCO is not required toperform staff functions that havecompliance implications. Rather, theCCO is responsible for oversight of suchfunctions.

The Commission is revising§ 39.10(c)(2)(iii) to require a CCO tohave the duty of ‘‘[e]stablishing andadministering written policies andprocedures reasonably designed toprevent violation of the Act.’’ This doesnot change the substance of therequirement or alter the implementationof the statutory standard, as it is

consistent with § 39.10(c)(1) whichrequires a CCO to ‘‘develop * * *appropriate policies and procedures* * * to fulfill the duties set forth in theAct and Commission regulations.’’ TheCommission believes that the revisedlanguage eliminates the possibility of ambiguity and prevents too narrow areading of the reference to policies andprocedures that are ‘‘required’’ underthe CEA.

CME described as ‘‘impracticable’’ theproposed standard that a CCO must’’ensure’’ a DCO’s compliance and





39See also 76 FR at 54584 (Sept. 1, 2011) (SDRs:Registration Standards, Duties and Core Principles;final rule) (adopting §49.22(d)(4), which appliesthis standard to the CCO of an SDR). 407 U.S.C. 7a–1(i)(3).

suggested that an appropriate and‘‘achievable’’ standard would be torequire a CCO to put in place measures‘‘reasonably designed to ensurecompliance’’ with the CEA andCommission regulations.

The Commission is revising§ 39.10(c)(2)(iv) in response to CME’scomment. Although Section 5b(i)(2)(E)of the CEA requires a CCO to ‘‘ensure’’compliance, the Commission agrees thata CCO cannot fully guaranteecompliance because, as a practicalmatter, he or she will have to rely tosome extent on information provided byother DCO employees or representativesof the DCO’s service providers.Accordingly, §39.10(c)(2)(iv) is beingmodified to include as a duty of theCCO, ‘‘[t]aking reasonable steps toensure compliance with the Act andCommission regulations * * * ’’ (addedtext in italics). The Commission believesthat this revision addresses CME’s

concern while retaining the emphasison the CCO’s actions rather thanfocusing on the nature of measures putin place by the CCO.39

CME recommended that theCommission revise proposed§ 39.10(c)(2)(vi) to require a CCO to‘‘[e]stablish[] appropriate procedures[for] the handling, managementresponse, remediation, retesting, andclosing of noncompliance issues,’’ andto eliminate the requirement that a CCO‘‘follow[]’’ such procedures. Accordingto CME, this is a function of seniormanagement and Congress did not

intend for a CCO to exercise seniormanagement functions. OCC agrees withCME.

Specifically, CME suggested thatproposed §39.10(c)(2)(vi) be modified toeliminate the requirement that a CCO‘‘follow’’ appropriate procedures

because following procedures is afunction of senior management.However, a CCO’s performance of this‘‘senior management’’ function isexplicitly set forth in Section 5b(i)(2)(G)of the CEA, which states that ‘‘[t]hechief compliance officer shall * * *establish and follow appropriate

procedures for the handling,management response, remediation,retesting, and closing of noncomplianceissues.’’ The Commission does not

believe that CME has provided apersuasive basis for its suggestedmodification of §39.10(c)(2)(vi), and theCommission is adopting the provisionas proposed.

Finally, the Commission, on its owninitiative, is revising §39.10(c)(2)(vii) toeliminate the requirement that a CCOestablish a compliance manual. Whilehaving a compliance manual is a goodpractice, incorporating this requirementinto a regulation may be overlyprescriptive and the Commission hasconcluded that a DCO should have

discretion as to the vehicles throughwhich it will carry out its complianceprogram.

8. Annual Report—§39.10(c)(3)

Section 5b(i)(3) of the CEA, added bySection 725(b) of the Dodd-Frank Act,requires a CCO to prepare an annualreport that describes the DCO’scompliance with the CEA, regulationspromulgated under the CEA, and eachpolicy and procedure of the DCO,including the code of ethics andconflicts of interest policies.40 Implementation of these statutoryrequirements was addressed at proposed§ 39.10(c)(3)(i), (c)(3)(ii)(A), and (c)(3)(v)and (v).

With respect to proposed§ 39.10(c)(3)(i), CME suggested that theCommission eliminate it and KCCcommented that the requirement for aDCO to show compliance with respectto the CEA and Commission regulationsis ambiguous and overreaching. KCCalso suggested that the scope of theannual report should not go beyondreviewing the DCO core principles andidentifying the compliance policies andprocedures that are in place to satisfythe core principles.

Although paragraph (i) mirrors thelanguage and requirements set forth inSection 5b(i)(3)(A)(i) of the CEA, toaddress CME’s and KCC’s comments,the Commission has decided to revisethe language of §§ 39.10(c)(3)(i) and (ii)to avoid submission of duplicativeinformation and to clarify the scope of the annual report content requirementswithout altering the nature of theinformation that must be included inthe report pursuant to the CEA. Final§ 39.10 (c)(3)(i) requires that the annualreport ‘‘[c]ontain a description of thederivatives clearing organization’s

written policies and procedures,including the code of ethics and conflictof interest policies.’’ Final §39.10(c)(3)(ii) requires that the report ’’[r]eview each core principle andapplicable Commission regulations, andwith respect to each: (A) Identify thecompliance policies and procedures thatare designed to ensure compliance withthe core principle.’’ The Commissionnotes that by specifying ‘‘written’’policies and procedures, the rule more

precisely establishes the scope of § 39.10(c)(3)(i).

Proposed §§ 39.10(c)(3)(iii) and(c)(3)(iv) would require that the annualreport list any material changes tocompliance policies and proceduressince the last annual report and describethe DCO’s financial, managerial, andoperational resources for compliance

with the Act and Commissionregulations, respectively. TheCommission did not receive anycomments on these provisions and isadopting §§39.10(c)(3)(iii) and (c)(3)(iv)as proposed.

Proposed §39.10(c)(3)(v) wouldrequire that the annual report‘‘[d]escribe any material compliancematters, including incidents of noncompliance, since the date of thelast annual report and describe thecorresponding action taken.’’ CMEsuggested that the provision be revisedto require that the annual report identify

only material compliance issues thatwere not properly addressed by theDCO.

The Commission is adopting§ 39.10(c)(3)(v) as proposed becausereceiving such information will enablethe Commission to assess whether theDCO is addressing compliance matterseffectively. It also will enable theCommission to become aware of possible future compliance issues acrossDCOs and to proactively identify bestpractices. An annual report thatidentifies only material complianceissues would not provide sufficientinformation.

Finally, the Commission on its owninitiative is not adopting proposed§ 39.10(c)(3)(vi) because information of this nature is not essential to theCommission’s evaluation of the DCO’scompliance program and, if it is relevantto a material compliance matter, it will

be provided to the Commissionpursuant to §39.10(c)(3)(v).

9. Submission of Annual Report to theCommission—§39.10(c)(4)

Proposed §39.10(c)(4) would set forththe requirements for submitting anannual report to the Commission.

Except as noted below, the Commissionis adopting the rule as proposed.Better Markets suggested that the

Commission change proposed§ 39.10(c)(4)(i) to require a CCO topresent the finalized annual report tothe board of directors and executivemanagement prior to its submission tothe Commission. Better Markets alsosuggested that the independent directorsas well as the entire board should berequired to review and approve thereport in its entirety and to detail anydisagreement with any portion. In





41See Section 5b(i)(3)(B)(ii) of the CEA, 7 U.S.C.7a–1(i)(3)(B)(ii).

42Section 5b(c)(2)(B) of the CEA, 7 U.S.C. 7a–1(c)(2)(B).

addition, Better Markets commentedthat a CCO should be required to file thereport with the Commission, either asapproved or with statements of disagreement.

The Commission is not revisingproposed §39.10(c)(4)(i) per BetterMarkets’ suggestion. The Commission

believes that a DCO should have the

flexibility to determine whether theannual report will be provided to the

board of directors, the senior officer, or both. The Commission also is notrequiring the board of directors toapprove or submit comments on thereport given that the board of directorsmight not have sufficient information toapprove or disagree with the report. Inaddition, there is a risk that the boardmight try to influence the CCO tochange the report if it were required toexpress approval. The Commissionnotes that the rules do not prohibit the

board, any of its members, or the senior

officer from approving or disagreeingwith aspects of the annual report.Proposed § 39.10(c)(4)(ii) would

require that the annual report include acertification by the CCO that, to the bestof his or her knowledge and reasonable

belief, and under penalty of law, theannual report is accurate and complete.CME commented that the Commissionshould require the DCO’s senior officer,and not the CCO, to make the necessarycertification in the annual compliancereport. According to CME, ‘‘the best wayto achieve the goal of a robust effectivecompliance program, and to close theloop on creating a culture of compliance, is to require the registrant’ssenior officer—and not the CCO—tocomplete the required certification.’’

KCC commented that a CCO shouldnot have to certify ‘‘under penalty of law’’ that the annual report is accurateand complete, and a CCO should certifyinstead that to the best of his or herknowledge and belief the annual reportis accurate and complete.

The Commission is adopting§ 39.10(c)(4)(ii) as proposed. The CEArequires (1) the CCO to sign the annualreport and (2) that the annual reportcontain a certification that, under

penalty of law, the compliance report isaccurate and complete.41 Accordingly,the Commission believes the regulationaccurately reflects Congressional intent.

10. Annual Report Confidentiality

CME suggested that Commissionregulations should expressly state thatannual reports are confidentialdocuments that are not subject to publicdisclosure by listing annual reports as a

specifically exempt item in part 145 of the Commission’s regulations. TheCommission has not proposed and isnot adopting CME’s proposal, whichwould provide blanket confidentiality toall annual reports submitted by CCOs of DCOs, even though the Commissionmay determine that there is informationcontained in a report that should be

public. Accordingly, a DCO mustpetition for confidential treatment of itsannual report under § 145.9 if it wantsthe Commission to determine that aparticular annual report should besubject to confidentiality.

11. Insulating the CCO From UndueInfluence

The notice of proposed rulemakingsolicited comments as to whether theCommission should adopt regulationsthat require a DCO to insulate its CCOfrom undue pressure and coercion. CMEcommented that the current regulations

are sufficient to protect a CCO fromundue influence and it does not believeadditional regulations are necessary.The Commission agrees with CME andis not adopting such regulations.

12. Recordkeeping—§39.10(c)(5)

Proposed §39.10(c)(5) would requirea DCO to maintain: (i) A copy of thepolicies and procedures adopted infurtherance of compliance with the CEAand Commission regulations; (ii) copiesof materials, including written reportsprovided to the board of directors or thesenior officer in connection with reviewof the annual report; and (iii) any

records relevant to the DCO’s annualreport, including work papers andfinancial data. The DCO would berequired to maintain these records inaccordance with §1.31 and proposed§ 39.20. The Commission did notreceive any comment letters discussingproposed §39.10(c)(5). The Commissionhas adopted §39.10(c)(5) as proposed,except that the Commission hasmodified §39.10(c)(5)(A) to refer to ‘‘allcompliance policies and procedures’’rather than ‘‘the compliance policiesand procedures, as defined in §39.1(b)’’in light of the Commission’s decision

not to adopt a definition of compliancepolicies and procedures, as discussed insection III.B, above.

B. Core Principle B—Financial Resources—§ 39.11

Core Principle B,42 as amended by theDodd-Frank Act, requires a DCO topossess financial resources that, at aminimum, exceed the total amount thatwould enable the DCO to meet its

financial obligations to its clearingmembers notwithstanding a default bythe clearing member creating the largestfinancial exposure for the DCO inextreme but plausible market conditionsand to cover its operating costs for aperiod one year, as calculated on arolling basis. Proposed § 39.11 wouldcodify these requirements. The

Commission received a total of 18comments on the proposed regulations.The Commission considered each of these comments in formulating the finalregulations discussed below.

1. Amount of Financial ResourcesRequired—§§39.11(a) and 39.11(b)(3)

Proposed §39.11(a)(1) would requirea DCO to maintain sufficient financialresources to meet its financialobligations to its clearing membersnotwithstanding a default by theclearing member creating the largestfinancial exposure for the DCO inextreme but plausible marketconditions, and proposed §39.11(a)(2)would require a DCO to maintainsufficient financial resources to cover itsoperating costs for at least one year,calculated on a rolling basis. Proposed§ 39.11(b)(3) would allow a DCO toallocate a financial resource, in whole orin part, to satisfy the requirements of either proposed § 39.11(a)(1) orproposed §39.11(a)(2), but not both, andonly to the extent that use of thatfinancial resource is not otherwiselimited by the CEA, Commissionregulations, the DCO’s rules, or anycontractual arrangements to which the

DCO is a party.The Futures Industry Association

(FIA) recommended that all DCOs berequired to maintain resources sufficientto withstand the default of the twoclearing members representing thelargest financial exposure to the DCO,

but that the Commission give DCOsreasonable time to come intocompliance with the enhancedrequirement.

The International Swaps andDerivatives Association (ISDA) alsosuggested that, in the clearing of certainOTC derivatives such as eligible credit

default swaps and interest rate swaps, aDCO should have sufficient financialresources that, at a minimum, enable itto withstand a potential default by twoof its largest clearing members, asmeasured by the two clearing memberswith the largest obligations to the DCOin extreme but plausible marketconditions. ISDA further suggested,however, that this heightened financialresource level may not be appropriatefor all other OTC or other derivativesproducts, and offered to work with theCommission to determine the





43See Bank for International Settlements’Committee on Payment and Settlement Systems andTechnical Committee of the InternationalOrganization of Securities Commissions,‘‘Recommendations for Central Counterparties,’’CPSS Publ’n No. 64 (November 2004), available athttp://www.bis.org/publ/cpss64.pdf.

44See Bank for International Settlements’Committee on Payment and Settlement Systems andTechnical Committee of the InternationalOrganization of Securities Commissions,‘‘Principles for financial market infrastructures:Consultative report,’’ CPSS Publ’n No. 94 (March2011), available at http://www.bis.org/publ/ cpss94.pdf (CPSS–IOSCO Consultative Report).

45CPSS–IOSCO Consultative Report, Principle 4:Credit Risk, at 30.

appropriate standard for derivatives inother asset classes.

Similarly, Mr. Chris Barnardrecommended that consideration begiven to differentiating risk, andtherefore resource requirements by

broad derivative/product class, or atleast by exchange-traded and OTCderivative types.

Better Markets suggested that thedefault rate used in the stress test forDCOs should be the larger of (1) themember representing the largestexposure to the DCO, and (2) themembers constituting at least 25 percentof the exposures in aggregate to theDCO. Americans for Financial Reform(AFR) stated that the calculation inproposed §39.11(a)(1) should be basedon risk exposure as well as number of defaults.

LCH.Clearnet Group Limited (LCH)concurred with all the provisions setforth by the Commission under

proposed §39.11(a). NYPC alsoexpressed support for proposed§§ 39.11(a)(1) and 39.11(a)(2).

The Commission is adopting§ 39.11(a) as proposed. Section 39.11(a)is consistent with Core Principle B asamended by the Dodd-Frank Act. As theCommission noted in its notice of proposed rulemaking, § 39.11(a)(1) isalso consistent with the Bank forInternational Settlements’ Committee onPayment and Settlement Systems andthe Technical Committee of theInternational Organization of SecuritiesCommissions (CPSS–IOSCO)

Recommendations for CentralCounterparties (CCPs), issued in 2004(2004 CPSS–IOSCORecommendations).43 The Commissionrecognizes that those recommendationseventually will be replaced by thePrinciples for Financial MarketInfrastructures (FMIs), which arecurrently being developed by CPSS andIOSCO and are expected to be finalizedin 2012.44 For financial resourcesrequirements for CCPs, CPSS andIOSCO are considering threealternatives: (1) A ‘‘cover one’’minimum requirement for all CCPs; (2)a ‘‘cover two’’ minimum requirement for

all CCPs; and (3) either a ‘‘cover one’’or a ‘‘cover two’’ minimum requirementfor a particular CCP, depending uponthe risk and other characteristics of theparticular products it clears, the marketsit serves, and the number and type of participants it has.45 The Commissionmay reconsider §39.11(a)(1) once CPSSand IOSCO have finished their work.

MGEX noted that proposed§ 39.11(b)(3) would prohibit a DCO fromusing a financial resource for bothdefault and operating cost purposes.While MGEX agreed this seems a logicalapproach to take to avoid counting anasset’s value for two different purposes,MGEX stated that there are practicalimplications to consider. As a DCM andDCO, MGEX keeps one basic set of financial records that are compliantwith various accounting standards.MGEX recommended that theCommission’s proposal should not beinterpreted to require a DCO to formally

divide some assets and accounts. TheCommission confirms that §39.11(b)(3)does not require a DCO to formallydivide its assets or accounts. TheCommission is adopting §39.11(b)(3) asproposed.

2. Treatment of Affiliated ClearingMembers—§ 39.11(a)(1)

Proposed §39.11(a) would state, inpart: ‘‘A [DCO] shall maintain financialresources sufficient to cover itsexposures with a high degree of confidence and to enable it to performits functions in compliance with thecore principles set out in Section 5b of

the [CEA] * * * Financial resourcesshall be considered sufficient if theirvalue, at a minimum, exceeds the totalamount that would: (1) Enable the[DCO] to meet its financial obligationsto its clearing members notwithstandinga default by the clearing membercreating the largest financial exposurefor the [DCO] in extreme but plausiblemarket conditions; Provided that if aclearing member controls anotherclearing member or is under commoncontrol with another clearing member,the affiliated clearing members shall bedeemed to be a single clearing member

for purposes of this provision * * * ’’In the notice of proposed rulemaking,the Commission stated: ‘‘There may besome instances in which one clearingmember controls another clearingmember or in which a clearing memberis under common control with anotherclearing member. The Commissionproposes to treat such affiliated clearingmembers as a single entity for purposesof determining the largest financial

exposure because the default of oneaffiliate could have an impact on theability of the other to meet its financialobligations to the DCO. However, to theextent that each affiliated clearingmember is treated as a separate entity bythe DCO, with separate capitalrequirements, separate guaranty fundobligations, and separate potential

assessment liability, the Commissionrequests comment on whether adifferent approach might be warranted.’’

CME noted that it treats affiliatedclearing members as separate entities,with separate capital requirements,separate guaranty fund obligations, andseparate potential assessment liability.While CME acknowledged that thedefault of one affiliate may impact theability of another affiliated clearingmember to meet its financial obligationsto the DCO, CME suggested thatcircumstances may exist in which aclearing member is sufficiently

independent to continue operatingnotwithstanding a default by an affiliate.CME rules allow, but do not require,emergency action to be taken against aclearing member based upon thefinancial or operational condition of anaffiliate (whether or not that affiliate isalso a clearing member). CME urged theCommission to take a similar approach

by revising the language of proposed§ 39.11(a) to state that ‘‘if a clearingmember controls another clearingmember or is under common controlwith another clearing member, theaffiliated clearing members may bedeemed to be a single clearing member

* * *.’’LCH agreed with the Commission’s

proposed requirement that the DCOmust treat any clearing member, eithercontrolled by another clearing memberor under common control with anotherclearing member, as a single clearingmember for the purposes of § 39.11(a)(1).

The Commission is adopting§ 39.11(a)(1) as proposed. TheCommission believes this treatmentappropriately addresses the potentialrisks of affiliates. The Commission notesthat aggregating the potential losses of

affiliated clearing members for purposesof this calculation would provide morecoverage in the event of a default.

3. Operating Costs—§39.11(a)(2)

Proposed §39.11(a)(2) would requirea DCO to maintain sufficient financialresources to cover its operating costs forat least one year, calculated on a rolling

basis.OCC commented that while the

statutory requirement that a DCO haveone year of operating costs, based on arolling period, may be a reasonable


http://www.bis.org/publ/cpss64.pdf









46The Commission recognizes that assessmentpowers are also a promise to pay, but as theCommission noted in the notice of proposed

rulemaking, a clearing member may have a strongfinancial incentive to pay an assessment. If aclearing member failed to pay its assessmentobligation, that failure would be treated as a defaultand the clearing member would be subject toliquidation of its positions and forfeiture of themargin in its house account. Thus, in addition toa potential general interest in maintaining theviability of the DCO going forward, a non-defaultingclearing member may have a specific incentive topay an assessment, depending on the size andprofitability of its positions and the margin ondeposit relative to the size of the assessment.

47See discussion of the prohibition on acceptingletters of credit as initial margin in section IV.F.5, below.

standard to ensure that a DCO is notforced out of business while there is stillopen interest in the contracts it clears,the requirement should be calculated

based on essential operating expensesfor the rolling period. According toOCC, an appropriate wind-down budgetwould include projected revenuesduring the wind-down and would not

include expenses associated withactivities having value only to a DCOthat intends to remain in business (e.g.,product development, technologicalenhancements, lobbying activities,investor education, etc.).

ISDA stated that it is appropriate thata DCO hold equity capital sufficient tocover its operating costs and likely exitcosts during any liquidation and thiscapital should be separate from anyDCO equity contribution to the requireddefault resources.

Eurex Clearing AG (Eurex) agreed thathaving a requirement for operating

resources is reasonable, especially inview of the flexibility implied in theCommission’s proposed rules for typesof financial resources, but cautionedthat the one-year time frame may beunnecessarily long.

FIA supported this aspect of theCommission’s proposal, including therequirement that a DCO not bepermitted to ‘‘double-count’’ itsresources to cover both this and thedefault resources requirement.

The Commission is adopting§ 39.11(a)(2) as proposed. TheCommission notes that the language in§ 39.11(a)(2) is virtually identical to that

of Core Principle B.4. Types of Financial Resources—§ 39.11(b)

Proposed §39.11(b)(1) lists the typesof financial resources that would beavailable to a DCO to satisfy therequirements of proposed §39.11(a)(1):(1) The margin of the defaulting clearingmember; (2) The DCO’s own capital; (3)the guaranty fund deposits of thedefaulting clearing member and non-defaulting clearing members; (4) defaultinsurance; (5) if permitted by the DCO’srules, potential assessments for

additional guaranty fund contributionson non-defaulting clearing members;and (6) any other financial resourcedeemed acceptable by the Commission.Proposed §39.11(b)(2) lists the types of financial resources that would beavailable to a DCO to satisfy therequirements of proposed §39.11(a)(2):(1) The DCO’s own capital and (2) anyother financial resource deemedacceptable by the Commission.

In the notice of proposed rulemaking,the Commission noted that a DCOwould be able to request an informal

interpretation from Commission staff onwhether or not a particular financialresource may be acceptable to theCommission. The Commission alsoinvited commenters to recommendparticular financial resources forinclusion in the final regulation.

ISDA encouraged the Commission togive prudent consideration to the use of

standby letters of credit as an additionalfinancial resource, given that manyletter-of-credit issuing banks will be anaffiliate of a clearing member.

Natural Gas Exchange Inc. (NGX)requested that the Commission considerthe acceptability of letters of credit as anasset of the guaranty fund and clarify inthe final rule that letters of credit areacceptable as an asset of the guarantyfund if subject to certain safeguards.NGX also requested that theCommission make clear in the finalregulation that it will interpret proposed§§ 39.11(b)(1)(vi) and 39.11(b)(2)(ii)

broadly so as to permit a demonstration,on a case-by-case basis, that a DCOmeets the overall policies of theregulation through a specific mix of financial resources.

Mr. Barnard recommended splittingthe types of financial resourcespermitted under proposed § 39.11(b)(1)into two classes: Class A would consistof the financial resources listed inparagraphs (b)(i) through (b)(iii), andwould be required to make up thesignificant part of the total financialresources, and class B would consist of the financial resources listed inparagraphs (b)(iv) through (b)(vi), onwhich larger prudential haircuts would

be required. MGEX suggested thatproposed §39.11(b)(2) should retain theability for a DCO to provide itsexplanation and methodology forincluding a particular financialresource. MGEX further suggested thatthe list of potential financial resourcesshould be broad and not pruned tooquickly, particularly by initialregulation.

Eurex commented that theCommission’s proposed list of financialresources in proposed § 39.11(b)(1) isappropriate.

The Commission is adopting§ 39.11(b) as proposed, except for atechnical amendment to clarify thescope of the use of margin as a financialresource to cover a default. Asproposed, the Commission is notincluding letters of credit as anacceptable financial resource becausethey are only a promise by a bank to payand not an asset that can be sold.46

However, both § 39.11(b)(1) and§ 39.11(b)(2) permit ‘‘any other financialresource deemed acceptable by theCommission,’’ which means that theCommission could evaluate the use of letters of credit on a case-by-case

basis.47 The Commission also received

inquiries from a few DCOs as to whether

the Commission would deem projectedrevenue an acceptable financial resourceto satisfy the requirements of § 39.11(a)(2). The Commission expectsthat projected revenue generally would

be deemed acceptable for establishedDCOs that can demonstrate a historicalrecord of revenue, but not for DCOapplicants or relatively new DCOs withno such record.

With respect to any financial resourcethat is not enumerated in § 39.11(b) andfor which a DCO seeks a determinationas to its acceptability based on theDCO’s particular circumstances, DCOstaff should contact Commission staff prior to submitting the DCO’s quarterlyfinancial resources report.

The Commission is modifying§ 39.11(b)(1)(i) to more precisely reflectthe fact that the use of margin as afinancial resource available to satisfythe requirements of paragraph (a)(1) issubject to limitations imposed by theCommission and a DCO, e.g., relating tothe use of customer margin to cover adefault. As proposed, §39.11(b)(1)(i)would permit the use of ‘‘[m]argin of adefaulting clearing member.’’ Theprovision now refers to ‘‘[m]argin to theextent permitted under parts 1, 22, and

190 of this chapter and under the rulesof the derivatives clearingorganization.’’

5. Capital Requirement

Proposed §§39.11(b)(1) and (b)(2) listthe DCO’s own capital as a type of financial resource that would beavailable to a DCO to satisfy therequirements of proposed §§39.11(a)(1)and (a)(2), respectively. In the notice of proposed rulemaking, the Commissionnoted that Commission regulations donot prescribe capital requirements forDCOs. The Commission invited





48See CPSS–IOSCO Consultative Report,Principle 15: General Business Risk, at 70.

comment on whether it should consideradopting such requirements and if so,what those requirements should be.

J.P. Morgan Chase & Co. (J.P. Morgan)commented that if a DCO enumerates itsown capital as part of its waterfall, thatDCO should be required to providesufficient assurances that the capitalwill be available to meet those

obligations and will not be reallocatedto serve other purposes at the DCO’sdiscretion. In a separate comment letteron the proposed risk managementrequirements for DCOs, J.P. Morganoffered its support for regulations thatwould require a DCO to retain in asegregated deposit account, on a rolling

basis, 50 percent of its earnings from theprevious 4 years. In addition, J.P.Morgan stated that it would beappropriate for at least 50 percent of theretained earnings to have a first lossposition. J.P. Morgan also recommendedthat the DCO contribution be subject to

a minimum floor of $50 million.Mr. Michael Greenberger

recommended that the Commissionrequire DCOs to set aside a reasonableamount of capital, equal to an averagesize of one contract for that DCO, so thata DCO would have sufficient financialresources to absorb a default. Inaddition, Mr. Greenberger suggested thatcapital requirements for DCOs mustrequire that the DCOs’ capital be highlyliquid so that a DCO can cure a defaultin a timely manner.

Eurex noted that clearingorganizations exhibit a variety of

organizational and capital structuresand suggested the Commission shouldallow DCOs to determine their ownmixes of protective measures, whichmight include the DCO’s own capital.Nevertheless, Eurex expressed supportfor an initial capital requirement of $25million for DCOs.

OCC commented that an equitycapital requirement for DCOs is notappropriate because DCOs relyprimarily on member-suppliedresources, such as clearing funddeposits and margin, to meet theirobligations. According to OCC, most, if not all, DCOs have little capital inrelation to their obligations. OCCsuggested that the critical question froma safeness and soundness standpoint iswhether DCOs have adequate financialresources, not the form in which suchresources are held.

CME stated that the financialresources requirements contained inCore Principle B are better suited toachieve the goal of ensuring adequatecapitalization of DCOs, and that furthercapital requirements would beunnecessary and essentially duplicative.

KCC commented that, with proposed§ 39.11(a)(1) requiring a DCO tomaintain sufficient financial resourcesto meets its financial obligations, aseparate capital requirement would beredundant. KCC also stated that onerouscapital requirements placed on DCOscould have an anti-competitive effect.

NYPC cautioned that mandating thatDCOs hold specific forms or amounts of capital could have a chilling effect oncompetition, at odds with the principlesof the CEA by potentially shutting outvarious forms of organizationalstructures for DCOs. NYPC noted thatCore Principle B requires that DCOsmaintain sufficient financial resourcesto perform their functions as centralcounterparties in compliance with theCEA. NYPC suggested that whether suchfinancial resources are derived from aDCO’s own capital or other financialresources deemed acceptable to the

Commission should be inconsequentialto the extent such statutorily prescribedfunctions are fulfilled.

MGEX stated that it does not supportadopting specific capital requirementsfor DCOs. MGEX noted that theproposed regulation already requires aDCO to be able to withstand the defaultof its largest clearing member in extreme

but plausible market conditions. MGEXfurther noted that a DCO’s capital isonly one element of the financialresources necessary to cover that risk,and suggested that a DCO should be able

to determine how it best needs toallocate that risk among its variousfinancial resources.

The Commission is not adopting acapital requirement for DCOs at thistime. The Commission believes that it isappropriate to provide flexibility toDCOs in designing their financialresources structure so long as theaggregate amount is sufficient. TheCommission notes, however, that one of the principles in the CPSS–IOSCOConsultative Report would require anFMI to ‘‘hold sufficiently liquid netassets funded by equity to cover

potential general business losses so thatit can continue providing services as agoing concern.’’ 48 CPSS and IOSCO areconsidering, and requesting commenton, the establishment of a specificminimum quantitative requirement forliquid net assets funded by equity. If such a requirement is established, theCommission may consider a similarrequirement for DCOs at that time.

6. Assessments—§§ 39.11(b)(1)(v) and39.11(d)(2)

Proposed §39.11(b)(1)(v) would list‘‘potential assessments for additionalguaranty fund contributions, if permitted by the [DCO]’s rules’’ as atype of financial resource that would beavailable to a DCO to satisfy therequirements of proposed §39.11(a)(1).Proposed §39.11(d)(2) would require aDCO: (i) To have rules requiring that itsclearing members have the ability tomeet an assessment within the timeframe of a normal variation settlementcycle; (ii) to monitor, on a continual

basis, the financial and operationalcapacity of its clearing members to meetpotential assessments; (iii) to apply a 30percent haircut to the value of potentialassessments; and (iv) to only count thevalue of assessments, after the haircut,to meet up to 20 percent of its defaultresources requirement. The Commissionrequested comment on whether these

limits and requirements are appropriateand, more generally, whetherassessment powers should beconsidered to be a financial resourceavailable to satisfy the requirements of proposed § 39.11(a)(1).

With regard to proposed§§ 39.11(d)(2)(i) and (ii), OCCcommented that the requirement thatclearing members be able to meet anassessment within the time frame of anormal variation settlement cycle is anaggressive but appropriate standard thatits clearing members would be able tomeet in most circumstances, but that

DCOs should have discretion to extendthis deadline on a case-by-case basiswhere appropriate to avoid severestrains on clearing member liquidity inunusual circumstances. OCC objected tothe requirement that DCOs mustmonitor ‘‘on a continual basis’’ aclearing member’s ability to meetpotential assessments, which OCCclaimed is overly burdensome anddifficult to administer. OCC suggestedthat a monthly review is reasonable andadequate.

NYPC requested that the Commissionclarify how the requirement of proposed

§ 39.11(d)(2)(i) would be imposed onDCOs that conduct both end-of-day andintraday settlements each business day.In order to ensure that a uniformstandard is applied across clearingmembers of all DCOs, whether the DCOconducts one or two settlements per

business day, NYPC recommended thatthe Commission clarify that a DCO’srules should require clearing membersto have the ability to meet anassessment within one business day.

With regard to proposed§ 39.11(d)(2)(ii), NYPC requested that





the Commission provide guidance as tohow it expects DCOs to determinewhether a clearing member has thecapacity to meet a potential assessment.In addition, NYPC expressed concernthat the ‘‘continual’’ monitoring of clearing members’ ability to meetpotential assessments, which NYPC

believes implies daily or even real-time

monitoring, would be extremelydifficult, if not impossible, toadminister. NYPC suggested that itwould be reasonable and morepracticable for the Commission torequire that monitoring of clearingmembers’ ability to meet potentialassessments be included as a mandatorycomponent of the periodic financialreviews of clearing members that DCOsalready conduct in the ordinary courseof business.

In response to these comments, theCommission is revising §39.11(d)(2)(i)to read as follows (added text in italics):

‘‘The derivatives clearing organizationshall have rules requiring that itsclearing members have the ability tomeet an assessment within the timeframe of a normal end-of-day variationsettlement cycle.’’ In response to OCC’scomment, the Commission notes that§ 39.11(d)(2)(i) requires a DCO to haverules requiring that its clearing membershave the ability to meet an assessmentwithin the time frame of a normal end-of-day variation settlement cycle, butwould permit a DCO, in its discretion,to provide some flexibility to clearingmembers as to timing.

In addition, the requirement in

§ 39.11(d)(2)(ii) that a DCO mustmonitor the financial and operationalcapacity of its clearing members to meetpotential assessments ‘‘on a continual

basis’’ was intended to mean only thatthe DCO must perform such monitoringoften enough to enable it to becomeaware of any potential problems in atimely manner. To eliminate possibleambiguity, the Commission is revisingthe final rule by removing the phrase‘‘on a continual basis.’’ Thus,§ 39.11(d)(2)(ii) establishes a standardwhereby a DCO must monitor itsclearing members, but the DCO can

meet the standard through the exerciseof its judgment in response to particularcircumstances, e.g., a DCO might havereason to evaluate certain clearingmembers on a daily basis and evaluateothers only as part of routine, periodicfinancial reviews.

With regard to proposed§§ 39.11(d)(2)(iii), FIA commented thatthe 30 percent haircut and 20 percentcap are reasonable and prudentsafeguards, sufficient to ensure that aDCO does not unduly rely on itsassessment power. J.P. Morgan

supported the proposal and alsorecommended that regulators adopt arisk-based analysis to determine thelikelihood that a clearing member will

be able to meet its assessmentobligations across all DCOs. Mr.Greenberger, citing J.P. Morgan’scomments, agreed that it is absolutelycritical that the Commission promulgate

rules that would determine a clearingmember’s risk of default and itsavailability of financial resources acrossall clearinghouses. Similarly, ISDAsuggested that the Commission evaluatethe potential impact of multipleassessments from different DCOs on thesame clearing member or affiliate groupin a short time-frame.

CME suggested that a DCO should berequired to completely exclude thepotential defaulting firm’s assessmentliability in calculating its availableassessment resources. CME alsocommented that, in light of the

requirements of proposed§§ 39.11(d)(2)(i) and (ii), and the factthat a clearing member that failed to payan assessment would itself be in defaultto the DCO, it does not believe that afurther haircut on assessments isnecessary, and it is aware of no validreason to cap the use of assessments at20 percent as proposed.

KCC noted that the inclusion of assessment powers as financialresources is necessary for it to meet itsobligations in the unlikely event of adefault. KCC agreed that a reasonablehaircut on the value of a DCO’s

assessment power may be a prudentmeasure, but stated that the proposedlimits are unreasonable and excessiveand seem arbitrary. KCC suggested thata better approach would be for the DCOto be allowed the latitude to determineclearing member assessment haircuts onan individual basis, based on eachclearing member’s financial capabilities.

MGEX recommended that theCommission allow each DCO to provideits methodology and support for whyany assessment might be considered afinancial resource and how much.MGEX stated that the 30 percent haircutand 20 percent cap seem arbitrary andprescriptive. MGEX stated that the DCOshould have the discretion to determinean appropriate haircut based on theclearing member’s liquidity.

Better Markets commented that theproposed haircuts for assessments areinadequate. According to BetterMarkets, it would be far more prudentto require funding of risk that can beanticipated in stress tests and rely onassessments as a financial resource onlyfor conditions that are not anticipated instress tests.

LCH recommended that potentialassessments not be allowed to satisfythe requirements of proposed§ 39.11(a)(1) because, in LCH’s view, itis of the utmost importance that a DCO’sresources following a clearing memberdefault be immediately andunconditionally available. LCHsuggested that assessments should be

allowed as part of the DCO’s ‘‘waterfall’’of protections, but should not be takeninto account to meet the specific testoutlined under proposed §39.11(a)(1).

AFR urged the Commission toprohibit DCOs from includingassessment powers in their calculationof financial resources because it isunclear, in a time of broad marketdistress, whether a DCO’s memberswould be willing and able to pay theirassessments.

The Commission is adopting§ 39.11(d)(2)(iii) as proposed. In view of the wide range of comments on thisissue, the Commission believes the rulestrikes an appropriate balance. The 30percent haircut recognizes that thedefaulting firm, which by definition willnot be paying an assessment, mightrepresent a significant segment of theDCO’s total risk. The 20 percent caprecognizes that given the contingentnature of assessments, they should only

be relied upon as a last resort. Inresponse to ISDA’s comment, theCommission expects that as part of theevaluation of a clearing member’s riskprofile, a DCO would take intoconsideration the potential exposure of the clearing member at other DCOs, to

the extent that it is able to obtain suchinformation, including the possibility of assessments. The Commission notes, inresponse to MGEX’s and KCC’scomments, that a DCO may determineclearing member assessment haircuts onan individual basis because§ 39.11(d)(2)(iii) only requires a 30percent haircut on an aggregate basis.

7. Computation of the FinancialResources Requirement—§ 39.11(c)(1)

Proposed §39.11(c)(1) would requirea DCO to perform stress testing on amonthly basis in order to make a

reasonable calculation of the financialresources it needs to meet therequirements of proposed §39.11(a)(1).The DCO would have reasonablediscretion in determining themethodology used to make thecalculation, but would be required totake into account both historical dataand hypothetical situations. In thenotice of proposed rulemaking, theCommission requested comment onwhether monthly tests are appropriate.

MGEX commented that monthlyreporting seems reasonable as it already





49Reverse stress tests are stress tests that requirea firm to assess scenarios and circumstances thatwould render its business model unviable, therebyidentifying potential business vulnerabilities.Reverse stress testing starts from an outcome of business failure and identifies circumstances wherethis might occur. This is different from generalstress testing, which tests for outcomes arising fromchanges in circumstances. See http:// www.fsa.gov.uk/pages/About/What/International/ stress _testing/firm _s/reverse _stress _testing/ index.shtml.

50See discussion of §39.13(h)(3) in sectionIV.D.7.c, below.

performs stress tests on a routine basis.MGEX further commented that allowingDCOs discretion in selecting stress testscenarios is appropriate.

CME suggested that annual stresstesting would suffice for operating costs

because operating costs are generallystatic. With regard to default coverage,CME suggested that stress testing should

be done no less than monthly.LCH expressed concern over the

requirement that the DCO perform stresstesting only on a monthly basis. InLCH’s view, stress testing should becarried out by the DCO on at least adaily basis, and LCH strongly urged theCommission to amend its proposalaccordingly. LCH suggested thatmonthly stress testing is inadequate, asexperience has shown that marketconditions and member positions canchange rapidly during periods of marketturmoil.

ISDA suggested that reverse stress

tests49

should be required fordetermining the size of the financialresources package and that there should

be public disclosure of the stress testsand their results.

Mr. Barnard agreed that stress testingshould be carried out at least monthly,and suggested that back testing should

be carried out daily. Mr. Barnard alsosuggested that the Commissionspecifically refer to reverse stress testingin proposed §39.11(c)(1) because, in hisview, it is a useful tool for managingexpectations and for helping the DCO toanticipate financial resourcesrequirements in extreme conditions.

FIA recommended that theCommission make clear its expectationthat the DCOs will, at a minimum: (1)Conduct a range of stress tests thatreflect the DCO’s product mix; (2)include the most volatile periods thathave been experienced by the marketsfor which the DCO provides clearingservices; (3) take into account thedistribution of cleared positions

between clearing members and theircustomers; and (4) test for unanticipatedlevels of volatility and for breakdownsin correlations within and acrossproduct classes.

Mr. Greenberger recommended thathistorical market data that led up to thepassage of the Dodd-Frank Act be taken

into account in determining marketconditions that could be defined asextreme but plausible.

Better Markets commented that thepassive role of the Commission inmeasuring the financial requirementsfor a DCO is inappropriate in light of theimportance of this function. Better

Markets proposed that the methodology,the historical data set, and thehypothetical scenarios be: (1) Jointlydeveloped by the DCO and theCommission and (2) reviewed wheneverordered by the Commission, but no lessfrequently than quarterly. BetterMarkets also recommended that theCommission explicitly recognize theimportance of illiquidity in developinghypothetical scenarios.

AFR stated that it is critical that theCommission play a central role inestablishing the standards by whichDCOs will measure their exposure tofuture risks. AFR urged the Commissionto define minimal standards that willensure that DCO stress tests arestringent and incorporate realisticmetrics of worst-case scenarios thatDCOs may experience.

The Commission is adopting§ 39.11(c)(1) as proposed. TheCommission believes it is appropriate toallow the DCO discretion in designingstress tests because stress testing is anexercise that inherently entails theexercise of judgment at various stages.Furthermore, §39.11(c)(1) allows the

Commission to evaluate the testing andrequire changes as appropriate. Inresponse to the LCH comment, theCommission notes that there is adistinction between the type of stresstesting carried out under this rule forthe purpose of sizing the overallfinancial resource package and the typeof stress testing carried out under§ 39.13(h)(3) for the purpose of ascertaining the risks that may be posedto the DCO by individual traders andclearing members. The former is acomprehensive test across all clearingmembers and all products with the goal

of identifying the firms posing thegreatest risk to the DCO and quantifyingthat risk. The regulations would requiresuch testing to be completed monthly.The latter is targeted testing addressingthe specific risks of specific positions atspecific firms. The regulations wouldrequire such testing to be completed oneither a daily or weekly basis, asdescribed in §39.13(h)(3).50

8. Valuation of Financial Resources—§ 39.11(d)(1)

Proposed §39.11(d)(1) would requirea DCO, no less frequently than monthly,to calculate the current market value of each financial resource used to meet itsobligations under proposed §39.11(a).When valuing a financial resource, a

DCO would be required to reduce thevalue, as appropriate, to reflect anymarket or credit risk specific to thatparticular resource, i.e., apply a haircut.The Commission would permit eachDCO to exercise its discretion indetermining the applicable haircuts.However, the haircuts would have to beevaluated on a monthly basis, would besubject to Commission review, andwould have to be acceptable to theCommission.

OCC suggested that the proposedregulations should be modified orinterpreted to accommodate the use of a true portfolio margining model that

values collateral based on itsrelationship to an overall portfolio inlieu of applying fixed haircuts onmargin collateral.

ISDA stated that it would support anappropriate haircut for defaultinsurance, potential assessments, andpossibly other financial resourcesdeemed acceptable by the Commission,as determined by the Commission uponreview of the relevant DCO.

FIA expressed reservations about theability of a DCO to be paid promptlyunder the terms of a default insurancepolicy. FIA therefore recommended that

default insurance coverage be subjectedto a 30 percent haircut and a 20 percentcap, similar to the policies that theCommission has proposed to apply to aDCO’s assessment power.

In discussions with Commission staff,Federal Reserve and Federal ReserveBank of New York staff suggested thatthe liquidity of a financial resourceshould be an additional factor indetermining an appropriate haircut.Considerations should include whetherit is easy to value the financial resource(e.g., whether the pricing is transparent)and whether the financial resource

could be divested in a short time periodunder normal market conditions. TheCommission agrees that liquidity is animportant factor in valuing financialresources.

Accordingly, the Commission isrevising §39.11(d)(1) to read as follows(added text in italics): ‘‘At appropriateintervals, but not less than monthly, aderivatives clearing organization shallcompute the current market value of each financial resource used to meet itsobligations under paragraph (a) of thissection. Reductions in value to reflect


http://www.fsa.gov.uk/pages/About/What/International/stress_testing/firm_s/reverse_stress_testing/index.shtml



















credit, market, and liquidity risks(haircuts) shall be applied asappropriate and evaluated on a monthly

basis.’’ In response to OCC’s comments,the Commission notes that § 39.11(d)(1)does not prohibit the valuation methoddescribed by OCC in its comment letter.

The Commission believes§ 39.11(d)(1) takes a balanced approach

by permitting a DCO to exercise itsdiscretion in determining applicablehaircuts for each of its financialresources but making those haircutssubject to Commission review andapproval. Section 39.11(d)(1) requires aDCO to perform such valuations no lessfrequently than monthly, which meansthe Commission would expect a DCO toperform such valuations morefrequently when appropriate, such asduring periods of market volatility.

9. Liquidity of Financial Resources—§ 39.11(e)

Proposed §39.11(e)(1) would requirea DCO to have financial resourcessufficiently liquid to enable the DCO tofulfill its obligations as a centralcounterparty during a one-daysettlement cycle, including sufficientcapital in the form of cash to meet theaverage daily settlement variation payper clearing member over the last fiscalquarter. The DCO would be permitted totake into account a committed line of credit or similar facility for the purposeof meeting the remainder of theliquidity requirement. In the notice of proposed rulemaking, the Commissionrequested comment on whether the

liquidity requirement should covermore than a one-day cycle. TheCommission also requested comment onwhat standards might be applicable tolines of credit—e.g., should theCommission require that there be adiversified set of providers, or that aline of credit have same-day drawingrights?

Proposed §39.11(e)(2) would requirea DCO to maintain unencumberedliquid financial assets in the form of cash or highly liquid securities, equal tosix months’ operating costs. The DCOwould be permitted to take into account

a committed line of credit or similarfacility to satisfy this requirement.Proposed §39.11(e)(3) would require

that: (i) Assets in a guaranty fund haveminimal credit, market, and liquidityrisks and be readily accessible on asame-day basis, (ii) cash balances beinvested or placed in safekeeping in amanner that bears little or no principalrisk, and (iii) letters of credit not be apermissible asset for a guaranty fund.

OCC recommended that the proposedregulations be modified or interpreted toprovide DCOs some flexibility in

determining the means of managingtheir ‘‘cash’’ liquidity needs by allowingDCOs to use secured credit facilities andtri-party repo facilities in addition tocash held in demand deposit accountsto satisfy the cash requirement. OCCobserved that permitting thesealternatives would allow a DCO to holda significant portion of its financial

resources in the form of U.S. Treasuries,with the ability to convert theTreasuries to cash as needed. Accordingto OCC, cash must generally be held at

banks, which presents a credit risk.NGX suggested that immediately

accessible bank lines of credit should beacceptable to cover the cashrequirement where the underlyingcommodity is itself traded in a liquidmarket.

CME suggested the phrase ‘‘averagedaily settlement variation pay perclearing member over the last fiscalquarter’’ in proposed §39.11(e)(1) issomewhat ambiguous. CME assumedthat the Commission intended to refer tothe average daily variation pay for asingle clearing member, not the averagedaily settlement variation pay for allclearing members.

CME also commented that theCommission’s approach is notwarranted given the potential amount of cash at issue and the reliability of liquidity facilities for short-term cashneeds. CME suggested that theCommission revise the last sentence of proposed §39.11(e)(1) to read asfollows: ‘‘If any portion of suchfinancial resources is not sufficiently

liquid, the derivatives clearingorganization may take into account acommitted line of credit or similarfacility for purposes of meeting theserequirements.’’

In response to the Commission’srequest for comment on what standardsmight be applicable to a liquidityfacility, CME stated that reviews andevaluations by Commission staff duringregular DCO audits are a sufficientcheck on the adequacy and soundnessof a committed line of credit, and thatthe Commission should not attempt toprescribe the terms and conditions of a

DCO’s liquidity facility.KCC found the language in proposed§ 39.11(e) to be ambiguous. KCCinterpreted the average daily settlementvariation pay per clearing member overthe last fiscal quarter to mean thecumulative average of the pay-ins pereach clearing member divided by thenumber of clearing members. In KCC’sview, a line of credit with same-daydrawing rights should be considered asliquid as cash and therefore should beallowed to be used by the DCO to fulfillits financial obligations during a one-

day settlement cycle. KCC commentedthat the liquidity requirement shouldcover no more than one day of marketprice movement.

LCH was unclear on what theCommission intends to mean inproposed §39.11(e)(1) by requiring thatthe DCO should allocate financialresources to meet the requirements of

§ 39.11(a)(1) and fulfill its arisingobligations during a ‘‘one-daysettlement cycle.’’ LCH suggested thatthe requirement instead should be thatthe DCO is obliged to fulfill its arisingobligations ‘‘as they fall due.’’Additionally, LCH suggested that therequirement that the DCO must have‘‘sufficient capital in the form of cash tomeet the average daily settlementvariation pay per clearing member overthe last fiscal quarter’’ is insufficient.LCH recommended that thisrequirement be replaced by a test thatthe DCO can meet its liquidity

requirements ‘‘following the default of the clearing member(s) creating thelargest liquidity requirement understressed market conditions over thequarter.’’

Mr. Greenberger suggested that thestandards for a committed line of creditor similar facility must be narrowly andstrictly defined, so that the party caneasily use such highly liquid line of credit or similar facility. Mr.Greenberger further suggested thatgreater participation by clearingmembers in a committed line of creditor a similar instrument at times of market distress would not provide

necessary liquidity but rather wouldincrease systemic risk.

Eurex noted that proposed §39.11(e)requires DCOs to monitor the liquidityof assets and agreed that low-credit risk,highly liquid assets should compriseguaranty funds and that this rule wouldserve important purposes.

FIA recommended that theCommission clarify that the cashrequirement is intended to measure theaverage (and not the aggregate) clearingmember variation margin requirement.FIA further recommended that theCommission permit a DCO to satisfy thisrequirement through the use of cash orcash equivalents, including U.S.government securities and repurchaseagreements involving highly liquidsecurities if such repurchase agreementmatures within one business day or isreversible upon demand. FIAadditionally recommended that thisaspect of the Commission’s proposal bemodified to clarify that DCOs arepermitted to satisfy the liquidityrequirement through the establishmentof committed repo facilities. FIAsupported allowing a DCO to obtain a





51CFTC Interpretative Letter 03–31 concerned a bank that requested an interpretation that a trustdeposit account product it developed would beacceptable for the deposit of customer segregatedfunds in accordance with Commission Regulation1.20. Based on an analysis of the account, staff of the Commission’s Division of Clearing andIntermediary Oversight issued an interpretation thatthe account would be acceptable as a depositlocation because the account would be properlytitled and covered by appropriateacknowledgements by the bank, and the funds inthe account would at all times be immediatelyavailable for withdrawal on demand.

52See CPSS–IOSCO Consultative Report,Principle 7: Liquidity Risk, at 46.

committed line of credit or similarcredit facility to cover the remainder of its default resources requirement, butrecommended that this proposal bestrengthened by the diversification of credit providers, with concentrationlimits of 25 percent per provider.

MGEX commented that proposed§ 39.11(e)(1) requires some clarity.

MGEX interpreted it to mean that a DCOmust have cash that will cover theaverage of all the clearing members’average daily settlement variation pays,which to MGEX would seem a logicaland practical application. Rather thanadopting multiple liquidityrequirements (i.e., cash, clearingmember default coverage, six months’worth of operating expenses), MGEXsuggested the process could besimplified to address the most relevant,which appeared to MGEX to be theclearing member default coverage. Inaddition, MGEX recommended that

proposed §39.11(e) should permitcombining and then totaling its liquidityof financial resources as a single-entityDCO/DCM.

AFR stated that DCOs should berequired to have sufficient cash to fulfilltheir obligations for 10 business daysand that lines of credit should not counttoward liquidity requirements.

NYPC commented that, to the extentthe proposed requirement is intended toexclude cash equivalents, such as U.S.Treasury securities, the standard isinappropriate. NYPC recommended thatthe Commission allow DCOs to satisfytheir liquidity needs through the use of any combination of cash held indemand deposit accounts, bankaccounts meeting the requirements of CFTC Interpretative Letter 03–31,51 andsecured credit facilities and repurchaseagreements that allow DCOs to convertU.S. Treasury securities and other highquality collateral into cash on a same-day basis.

In response to the comments, theCommission is revising §39.11(e)(1) toprovide greater clarity. In addition, theCommission is modifying the ‘‘cash’’requirement to include ‘‘U.S. Treasuryobligations and high quality, liquid,

general obligations of a sovereign

nation.’’ This conforms the requirementto existing liquidity practices and, inparticular, it accommodates acceptablepractices of foreign-based DCOs.However, the Commission is notincluding bank lines of credit as anacceptable financial resource formeeting the ‘‘cash’’ requirement becausethey are only a promise by the bank to

pay and not an asset that can be sold.The Commission is revising § 39.11(e)(1)

by deleting the following language:‘‘The derivatives clearing organizationshall have sufficient capital in the formof cash to meet the average dailysettlement pay per clearing memberover the last fiscal quarter. If anyportion of the remainder of the financialresources is not sufficiently liquid, thederivatives clearing organization maytake into account a committed line of credit or similar facility for the purposeof meeting this requirement.’’

The Commission is replacing the

deleted language with the following:‘‘[(ii)] The derivatives clearingorganization shall maintain cash, U.S.Treasury obligations, or high quality,liquid, general obligations of a sovereignnation, in an amount greater than orequal to an amount calculated asfollows: (A) Calculate the average dailysettlement pay for each clearing memberover the last fiscal quarter; (B) Calculatethe sum of those average dailysettlement pays; and (C) Using that sum,calculate the average of its clearingmembers’ average pays. (iii) Thederivatives clearing organization maytake into account a committed line of credit or similar facility for the purposeof meeting the remainder of therequirement under paragraph (e)(1)(ii) of this section.’’

The Commission notes that, in theCPSS–IOSCO Consultative Report, CPSSand IOSCO are considering a minimumliquidity requirement for CCPs thatwould be either: (1) A ‘‘cover one’’minimum requirement for all CCPs; (2)a ‘‘cover two’’ minimum requirement forall CCPs; or (3) a ‘‘cover one’’ or ‘‘covertwo’’ minimum requirement for anindividual CCP, depending on theparticular risk and other characteristics

of the particular products that it clears,the markets it serves, and the numberand type of participants it has.52 TheCommission might revisit the issue afterCPSS and IOSCO determine whatstandard they will adopt.

10. Reporting Requirements—§ 39.11(f)

Proposed §39.11(f) would require aDCO to report to the Commission, at theend of each fiscal quarter or at any time

upon Commission request: (i) Theamount of financial resources necessaryto meet the requirements set forth in theregulation; and (ii) the value of eachfinancial resource available to meetthose requirements. The DCO would berequired to include with its report afinancial statement (including the

balance sheet, income statement, and

statement of cash flows) of the DCO orits parent company. A DCO would have17 business days from the end of thefiscal quarter to file its report, but wouldalso be able to request an extension of time from the Commission.

NYPC suggested that, in light of thescope of information required to besubmitted in the quarterly report (i.e.,information regarding default riskfinancial resources and operatingfinancial resources), the Commissionshould require that such reports be filednot later than 30 calendar days, ratherthan 17 business days, following the

end of the DCO’s fiscal quarter.ISDA suggested that a DCO seeking anextension of the 17-day reportingdeadline should be required to requestthe extension at least seven businessdays before the deadline.

KCC noted that it does not prepare astatement of cash flows on a monthly

basis, only on an annual basis as part of its audited financial statements. KCCcommented that a monthly profit/lossstatement is sufficient for determiningits financial operating needs.

MGEX suggested the Commissionshould consider a DCO’s privacyconcerns when permitting reasonable

discretion in the data the DCO providesin the monthly reports required by theproposed regulations. MGEX stated thatsome detail as to projected revenue andexpenses must remain proprietary if itinvolves potential businessopportunities or other strategic businessdecisions, and that DCOs have alegitimate concern that confidentialfinancial information could be subject toFreedom of Information Act requests.

The Commission is adopting §39.11(f)as proposed. The Commission notes thatthe 17-business-day filing deadline isconsistent with the deadline imposed

on FCMs for the filing of monthlyfinancial reports under §1.10(b).Moreover, a DCO may request anextension if it is unable to meet thedeadline. The Commission does not

believe it is appropriate to require aDCO to request an extension at leastseven business days before the deadline,

because a DCO may not know that farin advance that it will be unable to meetthe deadline. With regard to theconfidentiality of the informationcontained in the reports, theCommission notes that Core Principle L





53Section 5b(c)(2)(C) of the CEA, 7 U.S.C. 7a–

1(c)(2)(C).54Core Principle C, as well as the other coreprinciples that are discussed herein, refer to‘‘members of, and participants in’’ a DCO. TheCommission interprets this phrase to mean personswith clearing privileges, and has used the term‘‘clearing member’’ in describing the requirementsof each core principle and in the text of theproposed regulations described herein. TheCommission is also amending the definition of ‘‘clearing member’’ in §1.3(c), adopted herein, tomean ‘‘any person that has clearing privileges suchthat it can process, clear and settle trades througha derivatives clearing organization on behalf of itself or others. The derivatives clearingorganization need not be organized as amembership organization.’’

and §39.21(c)(4) require a DCO topublicly disclose the size andcomposition of the financial resourcespackage available in the event of aclearing member default. A DCO mayrequest confidential treatment under§ 145.9 for other information submittedto the Commission under theseregulations.

11. SIDCOs—§39.29

Proposed §39.29(a) would require aSIDCO to maintain sufficient financialresources to meet its financialobligations to its clearing membersnotwithstanding a default by the twoclearing members creating the largestcombined financial exposure for theSIDCO in extreme but plausible marketconditions. Proposed § 39.29(b) wouldrequire that a SIDCO not count the valueof assessments to meet the obligationsarising from a default by the clearing

member creating the single largestfinancial exposure and only count thevalue of assessments, after a 30 percenthaircut, to meet up to 20 percent of theobligations arising from a default by theclearing member creating the secondlargest financial exposure. TheCommission believes that it would bepremature to take action regarding§ 39.29 at this time. The FSOC has notyet designated any DCOs as systemicallyimportant. As previously noted, theCPSS–IOSCO Principles for FinancialMarket Infrastructures, which areexpected to be finalized in 2012, will

address minimum financial resourcesrequirements for CCPs. Similarly,certain foreign regulators, including theEuropean Union, are also consideringrequirements in this area for the CCPsthey regulate. The Commission isconcerned that SIDCOs would be put ata competitive disadvantage if they areforced to comply with theserequirements before non-U.S. CCPs aresubject to comparable standards. TheCommission is closely monitoringdevelopments on this issue and isprepared to revisit the issue if the

European Union or other foreignregulators move closer toimplementation. Moreover, because itmay be some time before any DCO isdesignated a SIDCO, the Commission

believes it would be prudent toreconsider the regulation of SIDCOs inlight of developments that may occur inthe interim. The Commission expects toconsider all the proposed rules relatingto SIDCOs together.

C. Core Principle C—Participant and Product Eligibility—§39.12

1. Participant Eligibility

Core Principle C,53 as amended by theDodd-Frank Act, requires each DCO toestablish appropriate admission andcontinuing eligibility standards formembers of, and participants in, theDCO,54 including sufficient financialresources and operational capacity tomeet the obligations arising fromparticipation. Core Principle C furtherrequires that such participation andmembership requirements be objective,

be publicly disclosed, and permit fairand open access. Core Principle C alsorequires that each DCO establish andimplement procedures to verifycompliance with each participation andmembership requirement, on an ongoing

basis. Proposed § 39.12(a) would codifythese requirements and establish theminimum requirements that a DCO

would have to meet in order to complywith Core Principle C.

Although there is potential tension between the goals of ‘‘fair and openaccess’’ and ‘‘sufficient financialresources and operational capacity tomeet obligations arising fromparticipation in the derivatives clearingorganization,’’ the Commission believesthe rules that it is adopting herein strikean appropriate balance. TheCommission has crafted the provisionsof §39.12 and related rules, e.g., the riskmanagement requirements, to establisha regulatory framework that it believes

can ensure that a DCO’s participationrequirements do not unreasonablyrestrict any entity from becoming aclearing member while, at the sametime, limiting risk to the DCO and itsclearing members. The Commissionexpects that more widespreadparticipation will reduce theconcentration of clearing memberportfolios, thereby diversifying risk,increasing market liquidity, andincreasing competition among clearingmembers.

a. Fair and Open Access—§39.12(a)(1)

Proposed §39.12(a) would require aDCO to establish appropriate admissionand continuing participationrequirements for clearing members of the DCO, which are objective, publiclydisclosed, and risk-based. Proposed§ 39.12(a)(1) would require a DCO to

have participation requirements thatpermit fair and open access, settingforth specific standards.

The Managed Funds Association(MFA), BlackRock, Inc. (BlackRock),State Street Corporation (State Street),and the Committee on Capital MarketsRegulation (CCMR) supported theproposed rules. J.P. Morgan, ISDA, andFIA expressed support for the fair andopen access provisions as long as thereis prudent risk management.

According to MFA, more inclusiveDCO participation requirements would

benefit DCOs and the markets by: (1)Reducing DCO concentration risk; (2)

increasing diversity of marketparticipants involved in DCOgovernance; (3) enhancing competitionin the provision of clearing services; and(4) lowering overall costs for non-clearing members. State Street agreedthat more widespread participationcould increase competition by allowingmore entities to become clearingmembers. Blackrock commented thatthe proposed rule would allow a diversegroup of entities to become clearingmembers, which would increasecompetition, promote more inclusiveDCO participation requirements, and

lower costs to customers of clearingmembers.

Each of the provisions of § 39.12(a)(1)are discussed below.

b. Less Restrictive Standards—§ 39.12(a)(1)(i)

To achieve fair and open access,proposed §39.12(a)(1)(i) would prohibita DCO from adopting a particularrestrictive participation requirement if itcould adopt a less restrictiverequirement that would not materiallyincrease risk to the DCO or its clearingmembers. BlackRock, the Swaps &

Derivatives Market Association (SDMA),CME, LCH, Citadel, and CCMRsupported the proposed rule. CCMRcommented that the proposed rulewould help to encourage an openmarketplace.

KCC, ICE, and MGEX did not supportthe proposed rule. According to KCC,the test is highly subjective and would

be difficult to implement in practice.ICE commented that the proposal wouldrequire a DCO to dilute current prudentrisk management practices. MGEXcommented that the proposed rule





would require DCOs to consider onlyobjective, hard number risk factors,which would force DCOs to bear otherrisks such as financial fraudconvictions. MGEX suggested that theCommission should provide DCOs withlatitude when determining the risks towhich it will expose itself.

The Commission is adopting

§ 39.12(a)(1)(i) as proposed, except forthe addition of clarifying language toprovide that a DCO shall not adoptrestrictive clearing member standards if less restrictive requirements ‘‘thatachieve the same objective and’’ thatwould not materially increase risk to thederivatives clearing organization orclearing members could be adopted. Therule balances the dual Congressionalmandate to provide for fair and openaccess while ensuring that suchincreased access does not materiallyincrease risk. Because the rule does notrequire a DCO to provide access that

materially increases risk to the DCO orclearing members, the Commission doesnot agree with ICE that the rule willsubject a DCO to increased risk.

The Commission does not agree withKCC that the rule will be highlysubjective or difficult to implement inpractice. The rule provides a DCO withdiscretion to balance restrictions onparticipation with legitimate riskmanagement concerns and, in thisregard, a DCO is in the best position inthe first instance to determine theoptimal balance. Only in circumstanceswhere there is a question as to theimpact of the rule would the

Commission ask a DCO to justify the balance that the DCO has struck.

In response to MGEX’s comment, theCommission notes that the rule does notrequire a DCO to rely solely onobjective, hard number risk factors. Therule permits a DCO to rely on bothqualitative and quantitative analyses,providing each DCO with latitude todetermine how it can facilitate openaccess while determining the risks towhich it will expose itself.

Except for certain bright-lineparticipation requirements (e.g., capitalrequirements for clearing members), the

Commission has not provided morespecific guidance as to what participanteligibility requirements are permissibleunder Core Principle C. Such aclarification would only serve to limit aDCO’s flexibility to formulateparticipation requirements.

The Commission encourages eachDCO to conduct a self-assessment tomake sure that it can provide reasonedsupport to justify a conclusion that itsrules do not violate the ‘‘less restrictive’’standard contained in §39.12(a)(1)(i).Such an analysis should take into

consideration the interaction of thisprovision with the other provisions of § 39.12(a).

c. Clearing Member Qualification—§ 39.12(a)(1)(ii)

Proposed §39.12(a)(1)(ii) wouldrequire a DCO to permit a marketparticipant to become a clearing

member if it meets the DCO’sparticipation requirements. SDMA,LCH, and CCMR supported theproposed rule. According to CCMR, theproposed rule would help to encouragean open marketplace.

KCC commented that the proposedrule is not workable because a DCO maynot have the operational capacity toadmit all applicants that satisfy theDCO’s membership requirements. KCCproposed that the regulation clarify thata DCO may set limits on the number of market participants that may beadmitted in light of the DCO’s ownoperational constraints.

The Commission is adopting§ 39.12(a)(1)(ii) as proposed. TheCommission is concerned thatpermitting a DCO to set a limit on thenumber of market participants that may

become clearing members could enablea DCO to evade the open accessrequirement imposed by Core PrincipleC. If a DCO were able to demonstratethat operational constraints prevented itfrom admitting additional clearingmembers, the DCO could petition theCommission for an exemption.

d. Non-Discriminatory Treatment—

§ 39.12(a)(1)(iii)Proposed §39.12(a)(1)(iii) wouldprohibit participation requirements thathave the effect of excluding or limitingclearing membership of certain types of market participants unless the DCO candemonstrate that the restriction isnecessary to address credit risk ordeficiencies in the participants’operational capabilities that wouldprevent them from fulfilling theirobligations as clearing members. LCHand SDMA supported the proposed rule.CME commented that in addition tocredit risk and deficiencies in

operational capabilities, legal riskshould be included in the text of thisregulation as a basis upon which a DCOmay exclude or limit clearingmembership of certain types of participants.

KCC did not support the proposedrule, commenting that a DCO’s right toexclude or place limitation on certainclearing members should not be subjectto ex-post determinations as to thenecessity of such restrictions, as theDCO itself is in the best position tomonitor the risks posed by the activities

of its clearing members. According toKCC, the proposed rule would limit therisk management capabilities of a DCO,and DCOs should be accorded flexibilityin their assessments of the operationalcapabilities of potential clearingmembers.

The Commission is adopting§ 39.12(a)(1)(iii) as proposed. CME’s

concerns regarding heightened legalrisk, such as the inability to attachproperty of a foreign clearing memberunder foreign law, are encompassedwithin the ‘‘credit risk’’ consideration.The Commission expects that most, if not all, bases for membership exclusionor limitation will fall within eitherfinancial or operational considerations.In addition, the Commission does not

believe the rule would limit a DCO’srisk management capabilities as KCCsuggested because it would not preventa DCO from excluding or limitingcertain types of market participants

from clearing if such participationwould introduce genuine risk thatcannot be adequately managed by theDCO. The Commission expects thatDCOs will review their existingparticipation requirements forcompliance with this rule.

e. Prohibition of Swap DealerRequirement—§ 39.12(a)(1)(iv)

Proposed §39.12(a)(1)(iv) wouldprohibit a DCO from requiring thatclearing members be swap dealers. LCHcommented that, in the event of default,it relies on non-defaulting clearingmembers to hedge the defaulting

member’s swap portfolio; to provideliquidity for such hedging; to bid onhedged portfolios; and, in extremecircumstances, to accept a forcedallocation of swaps, which could be arisky, unhedged swaps portfolio. LCHcommented that a clearing member whois not a swap dealer may not be able toparticipate in a DCO’s defaultmanagement process.

The Commission is adopting§ 39.12(a)(1)(iv) as proposed. It isimportant to note that the regulationwould not preclude participation byswap dealers (on which LCH currentlyrelies). It simply requires that a DCOprovide clearing access to other entitiesthat could also participate in a DCO’sdefault management process, even if toa lesser extent. Broader access issupported by other Commissionregulations, e.g., § 39.12(a)(3), whichmandates that a DCO require its clearingmembers to have adequate operationalcapacity to participate in defaultmanagement activities; § 39.12(b)(5),which requires a DCO to select contractunits for clearing purposes thatmaximize liquidity, facilitate





55Section 5b(c)(2)(C)(i)(I) of the CEA; 7 U.S.C. 7a–1(c)(2)(C)(i)(I).

transparency in pricing, promote openaccess, and allow for effective riskmanagement; and §39.16(c)(2)(iii),which permits a DCO to require itsclearing members to accept anallocation, provided that any allocationmust be proportional to the size of theclearing member’s positions at the DCO.Thus, a DCO should be able to establish

participation requirements that allow itto rely on non-defaulting clearingmembers to hedge a defaultingmember’s swap portfolio, to provideliquidity for such hedging, to bid onhedged portfolios, and to accept a forcedallocation of swaps.

f. Prohibition of Swap Portfolio or SwapTransaction Volume Requirements—§ 39.12(a)(1)(v)

Proposed § 39.12(a)(1)(v) wouldprohibit a DCO from requiring clearingmembers to maintain a swap portfolio of any particular size, or that clearing

members meet a swap transactionvolume threshold.According to State Street, such

requirements are intended tosystematically favor membership forfinancial institutions that are alsosubstantial dealers in swaps. They donot take into account the riskmanagement capabilities of many DCOmembers such as State Street, which areable to closely monitor risk exposuresand effectively liquidate exposuresthrough networks of interdealerrelationships. The Commission believesthat such requirements would have theeffect of permitting only large swapdealers to provide clearing services.This would be inconsistent with CorePrinciple C. Accordingly, theCommission is adopting §39.12(a)(1)(v)as proposed.

g. Financial Resources—§39.12(a)(2)(i)

Core Principle C mandates that eachDCO must ensure that its clearingmembers have ‘‘sufficient financialresources and operational capacity tomeet obligations arising fromparticipation in the [DCO].’’ 55 Proposed§ 39.12(a)(2)(i) would require a DCO toestablish participation requirements that

require clearing members to have accessto sufficient financial resources to meetobligations arising from participation inthe DCO in extreme but plausiblemarket conditions. The financialresources could include a clearingmember’s capital, a guarantee from aclearing member’s parent, or a creditfacility funding arrangement.

CME commented that it supports theinclusion of parent guarantees and

credit facility funding arrangements asacceptable financial resources forclearing members, provided that eachDCO retains the flexibility to determinethe particular terms and conditions of such arrangements. LCH, however,commented that credit facilities orfunding arrangements should not beallowed for the purposes of fulfilling

financial participation requirements.According to LCH, all clearing members’resources should be immediately andunconditionally available. ISDA alsocommented that a credit facility fundingarrangement from an unaffiliated entityshould not be available to satisfyclearing member financial resourcerequirements. ISDA did not believe thatsuch funding would be reliable.

MGEX commented that testing forextreme but plausible market conditionswould have minimal value because thetest would be based on historicalrecords or it would be based on future

assumptions that are based on staticconditions. MGEX believes that theproposed rule would require a DCO todevise tests for clearing members to useand would require a DCO to conduct thetests and provide the results to clearingmembers. MGEX commented that thisspecific rule seems unnecessary becauseDCOs have other methods to addressrisk, like increasing and decreasingmargin. It noted further that it alreadyrequires clearing members to be in goodfinancial standing, which includesminimum capital requirements and arequirement to provide a parentguarantee in certain circumstances.

The Commission is adopting§ 39.12(a)(2)(i) with the modificationdescribed below. Per CME’s comment,the rule provides a DCO with theflexibility to determine what constitutessufficient financial resources to meetobligations arising from participation inthe DCO in extreme but plausiblemarket conditions, and to determinewhat financial resources are available toa clearing member to satisfy thisrequirement.

Regarding the comments of LCH andISDA, the rule does not require a DCOto allow clearing members to use a

credit facility funding arrangement tomeet financial resource requirements.Because such arrangements can serve asan important source of liquidity forclearing members, the Commission hasnot prohibited their possible use tosatisfy clearing member financialresource requirements. The Commissionis modifying §39.12(a)(2)(i) to clarify aDCO’s discretion, by rephrasing thesecond sentence to read as follows: ‘‘Aderivatives clearing organization maypermit such financial resources toinclude, without limitation, a clearing

member’s capital, a guarantee from theclearing member’s parent, or a creditfacility funding arrangement.’’ Toaddress concerns about reliability, aDCO can consider requiring that a creditfacility funding arrangement besupported by multiple lenders.

Finally, the Commission does not believe that MGEX’s comment provides

a basis for revising the proposed rule.As an initial matter, Core Principle Crequires each DCO to establishparticipation standards that require aclearing member to have sufficientfinancial resources to meet obligationsarising from participation in the DCO.Core Principle B requires a DCO tomaintain financial resources that wouldenable it to meet its financial obligationsin ‘‘extreme but plausible’’ marketconditions. The Commission believesthat it is appropriate for a DCO tosubject its clearing members to acomparable financial standard to

support its own compliance withstatutory requirements. A DCO wouldhave discretion in setting the terms of any tests to determine whether clearingmembers’ financial resources aresufficient to meet their obligations inextreme but plausible marketconditions.

h. Capital Requirements Must MatchCapital to Risk—§ 39.12(a)(2)(ii)

Proposed § 39.12(a)(2)(ii) wouldrequire a DCO to establish capitalrequirements that are based onobjective, transparent, and commonlyaccepted standards, which

appropriately match capital to risk. Thecapital requirements also would have to

be scalable so that they are proportionalto the risks posed by clearing members.

J.P. Morgan, MFA, ISDA, State Street,SDMA, Citadel LLC (Citadel), BetterMarkets, and FIA supported theproposed rule. According to BetterMarkets, the proposed rule is animportant change of practices that willopen DCO membership to more marketparticipants while protecting the riskmanagement system. FIA commentedthat a DCO, when it sets capitalrequirements, should take into account

a clearing member’s risk-derivedexposures and its potential assessmentobligations at each clearing organizationof which it is a member. FIArecommended that a DCO should allowan FCM to clear positions in proportionto its capital net of those other risk-derived exposures and assessmentobligations.

The Commission is adopting§ 39.12(a)(2)(ii) as proposed, with onemodification. In response to a commentfrom staff of the Federal Reserve and theFederal Reserve Bank of New York, the





56See transcript of December 16, 2010Commission meeting at 77–81 available atwww.cftc.gov (discussing $50 million threshold;Commission staff stating that of 126 FCMs, 63currently have capital above $50 million and most

Continued

Commission is deleting the phrase ‘‘sothat they are proportional’’ from therule. This is to make clear that a DCOshould take into account nonlinear risk.In response to FIA’s comment, theCommission notes that in settingscalable requirements, a DCO shouldtake into consideration risks that aclearing member carries as a result of

positions cleared at other DCOs, to theextent that it is able to obtain suchinformation.

i. Minimum Capital Requirement—§ 39.12(a)(2)(iii)

Proposed § 39.12(a)(2)(iii) wouldprohibit a DCO from setting a minimumcapital requirement of more than $50million for any person that seeks to

become a clearing member in order toclear swaps. Pierpont Securities LLC(Pierpont), Better Markets, SDMA,Newedge, MFA, Citadel, and Jefferies &Company (Jefferies) supported theproposed rule.

Jefferies commented that the proposedrule would allow it to participate moreactively in the swap market. Jefferies

believes that taken together, theprovisions of proposed §39.12(a)provide a DCO with more thansufficient authority to assure thefinancial integrity and efficientoperation of its swaps clearingactivities.

Newedge commented that theproposed rule should not increase riskto a DCO because a DCO can mitigaterisk by, among other things, imposingposition limits, stricter margin

requirements, or stricter default depositrequirements on lesser capitalizedclearing members. Newedge proposedthat the Commission prohibit DCOsfrom imposing a requirement thatclearing members have an internaltrading desk capable of liquidating orhedging a defaulting clearing member’spositions. It said that there is no needfor such a requirement because a non-defaulting member can handle a defaultevent in a variety of ways, includinghaving a contingent default manager.Newedge noted that under proposed§ 39.16(c)(2)(iii), any obligation of a

clearing member to participate in anauction, or to accept the allocation of adefaulting clearing member’s positions,would be proportionate to the size of theclearing member’s own position at theDCO. Thus, a clearing member should

be able to hedge an allocated positionand carry the position over time withouthaving to take a substantial charge to itscapital.

MFA commented that the thresholdshould not impose additional risk on aDCO because a DCO could ensure thesafety of itself and clearing members by

scaling each clearing member’s netcapital obligation in proportion to thatclearing member’s risk exposure. MFAexpressed concern that a DCO couldcomply with the $50 million net capitalrequirement but impose a non-risk-

based and excessive threshold guarantyfund contribution requirement thatwould unnecessarily exclude clearing

members. MFA proposed that theregulations require that such scaling bedetermined by objective, risk-basedmethodologies that are based onreasonable stress and default scenarios,and the tests be consistently applied toall clearing members, without use of ‘‘tiers’’ that could have discriminatoryor anti-competitive effects.

J.P. Morgan, the U.K. FinancialServices Authority (FSA), CME, KCC,ISDA, IntercontinentalExchange, Inc.(ICE), State Street, Federal Home LoanBanks (FHLBanks), the SecuritiesIndustry and Financial Markets

Association (SIFMA), and LCHexpressed the view that the proposedrule could increase risk and theprobability of default, and require DCOsto accept members who might not beable to participate in the defaultmanagement process. FSA, KCC, andCME commented that a DCO must havereasonable discretion to determine theappropriate capital requirements for itsclearing members based upon the DCO’sanalysis of the particular characteristicsof the swaps that it clears.

J.P. Morgan, however, commentedthat a cap on a member’s minimumcapital requirement would not impact

the systemic stability of a DCO as longas: (1) Clearing members clear houseand client business in proportion totheir available capital; (2) DCOs employreal-time risk management processes toensure compliance with this principle;(3) DCOs hold a sufficient amount of margin and funded default guaranteefunds; and (4) the Commission monitorsclearing members to ensure that they areable to meet their financial obligationswith respect to all DCOs of which theyare members.

LCH and ISDA commented that thelower threshold could increase risk

because a $50 million threshold wouldallow a clearing member to meet theeligibility requirements of multipleDCOs.

LCH, CME, and FSA commented thatthe smaller firms may be unable toparticipate in the default managementprocess. LCH and ISDA also commentedthat members should not be able tooutsource default management to thirdparties because they may not besufficiently reliable in times of stress.

In addition, according to ISDA, therecould be conflict-of-interest issues

because the unaffiliated third partywould not have ‘‘skin in the game.’’ Asa result, through the actions of theunaffiliated third party, a clearingmember could be assigned an unsuitablepart of a defaulting clearing member’sproprietary portfolio and/or at a sub-optimal valuation and/or wronglyaccept customer positions from the

defaulting clearing member. Thisconflict-of-interest concern isexacerbated where the entity to whomthe default management obligations areoutsourced is a ‘‘competing’’ clearingmember in the same DCO.

State Street and SDMA, however,commented that clearing membersshould be permitted to enter intocommitted arrangements with non-affiliated firms to perform defaultmanagement functions. According toSDMA, there is no evidence to suggestthat a legal arrangement with a third-party dealer somehow lessens the

integrity to the system. Assuming thelegal and financial arrangements between such firms are sufficientlystrong to ensure performance whenneeded, State Street commented thatthere is no appreciable difference

between the default managementcapacity of the traditional dealer-affiliated clearing member and a non-dealer clearing member outsourcingcertain functions to a non-affiliate.

Finally, SIFMA commented that theappropriate minimum capitalrequirement would be $300 million,while ISDA commented that if theCommission cannot monitor risk across

all DCOs, a $1 billion capitalrequirement would be appropriate.

After carefully considering thecomments, the Commission is adopting§ 39.12(a)(2)(iii) as proposed. TheCommission believes, as noted innumerous comments, that the rule willincrease the number of firms clearingswaps, which will make markets morecompetitive, increase liquidity, reduceconcentration, and reduce systemic risk.The Commission also believes that, asexplained below, the $50 millionthreshold will not significantly increaserisk or lead to admission of clearing

members who are unable tomeaningfully and responsiblyparticipate in the clearing process.

As an initial matter, the Commissionemphasizes that the $50 millionthreshold is not arbitrary. That numberwas arrived at by reviewing the capitalof registered FCMs.56 This amount







FCMs with capital below that amount are notclearing members).

57Clearing FCM and non-clearing FCM data foradjusted net capital and excess net capital wasprovided by FCM registrants and is available on theCommission Web site. The other data is non-public.

Ownership equity data was provided by FCMregistrants through the monthly financialstatements that are submitted to the Commission.The data from the monthly financial statementsreside in the Commission’s RSR Express system,and all data for clearing non-FCMs was provided by

the DCOs to the Commission’s Risk SurveillanceGroup during the course of its routine oversightactivities.

58See 76 FR 45724 (Aug. 1, 2011) (ClearingMember Risk Management).

captures firms that the Commission believes have the financial, operational,and staffing resources to participate inclearing swaps without posing anunacceptable level of risk to a DCO.This capital threshold is considered to

be appropriate, particularly in light of other proposed rules (such as scalingcapital and risk exposure and breakingdown large swap positions into smaller

units for more diversified allocation inthe event of a clearing member default).

The Commission considered whetherto increase the capital threshold to$300 million as proposed by SIFMA or$1 billion as proposed by ISDA. TheCommission analyzed the reduction inthe number of firms that would beeligible to clear at CME, ICE Clear US,

KCC, MGEX, and OCC using thesethresholds. As set forth in the table

below, depending on the basis used tomeasure capital, a capital threshold of $300 million would reduce the numberof firms able to clear by 38–51 percent.A capital threshold of $1 billion wouldreduce the number of firms able to clear

by 62–65 percent. The Commission believes that this reduction inparticipation would be contrary to the

Congressional mandate for open accessto clearing.57

The Commission does not believe thatthe rule will increase risk. Section39.12(a)(2)(ii) requires DCOs to imposecapital requirements that are scalable tothe risks posed by clearing members.Accordingly, a small clearing membershould not be able to expose a DCO tosignificant risk even if it is able to clearat multiple DCOs because its exposureat each DCO would be limited. DCOsthat participate in the Shared MarketInformation System (SHAMIS) will beable to see a clearing member’s pays andcollects across participating DCOs, anda DCO also could on its own initiative

require clearing members to directlyreport their clearing activity at otherDCOs. The Commission also will be ableto monitor clearing member exposure bymeans of DCO end-of-day reportingunder the reporting requirements of § 39.19(c)(1)(i), which the Commissionis adopting herein. It will also be ableto monitor the financial strength of clearing members that are registrantspursuant to financial reportingrequirements.

In addition, the Commission isadopting other rules that will reinforcea DCO’s oversight of its clearing

members. In this regard, § 39.12(a)(4)requires a DCO to verify, on an ongoing basis, the compliance of each clearingmember with each participationrequirement; §39.12(a)(5) requires aDCO to require all clearing members tofile periodic financial statements andtimely information that concerns any

financial or business developments thatmay materially affect the clearingmembers’ ability to continue to complywith participation requirements; and§ 39.13(h)(5) further requires a DCO toadopt rules that require clearingmembers to maintain current riskmanagement policies and proceduresand requires a DCO to review suchpolicies and procedures on a periodic

basis. The Commission also hasproposed requirements for clearingmember risk management.58

The Commission does not believe thatthe $50 million threshold would lead to

a DCO having to admit clearingmembers that are unable to participatein the default management process. Asdiscussed above, the regulation does notpreclude highly-capitalized entities(such as swap dealers) fromparticipating in a DCO as clearingmembers. Thus, the addition of smallerclearing members does not eliminate therole that larger clearing members canplay in default management—it merelyspreads the risk.

The Commission wishes to emphasizethat it will review DCO membershiprules as a package in light of all of the

provisions of §39.12(a). Thus, a DCOmay not circumvent § 39.12(a)(2)(iii) byenacting some additional financialrequirement that effectively renders the$50 million threshold meaningless forsome potential clearing members. Suchan arrangement would violate§ 39.12(a)(1)(i) (less restrictive

alternatives), or §39.12(a)(1)(iii)(exclusion of certain types of firms).As discussed below, under

§ 39.12(a)(3), a DCO’s participationrequirements must include provisionsfor adequate operational capacity. Thisrequirement should be read inconjunction with § 39.12(a)(1)(i), whichprohibits restrictive clearing memberstandards if less restrictive standardscould be adopted; §39.12(a)(1)(iii),which prohibits DCOs from excludingcertain types of market participantsfrom clearing membership if they canfulfill the obligations of clearingmembership; and §39.16(c)(2)(iii),

which permits a DCO to require aclearing member to participate in anauction or to accept allocations of adefaulting clearing member’s customeror house positions, provided theallocated positions are proportional tothe size of the clearing member’spositions at the DCO and are permittedto be outsourced to a qualified thirdparty subject to safeguards imposed bythe DCO.

Several commenters discussed the useof outsourcing to satisfy defaultmanagement obligations. TheCommission believes that open access to

clearing and effective risk managementneed not be viewed as conflicting goals.Subject to appropriate safeguards,outsourcing of certain obligations can bean effective means of harmonizing thesegoals. For example, a small clearingmember might have less ability tocontribute meaningfully to a DCO’s





59See discussion of revised § 39.16(c)(2)(iii) insection IV.G.4, below.

60See discussion of §39.13(h)(5) in sectionIV.D.7.e, below.

61See 76 FR at 45729–45730 (Aug. 1, 2011)(Clearing Member Risk Management).

62See Section 5b(c)(2)(C)(ii) of the CEA; 7 U.S.C.7a–1(c)(2)(C)(ii).

auction process acting on its own thanif an entity with greater expertise in therelevant markets acted in its place.

Therefore, the Commission believesthat it would be inconsistent with§ 39.12(a)(1)(i) and § 39.12(a)(1)(iii) for aDCO to prohibit outsourcing.Accordingly, as discussed below, theCommission is adopting revised default

procedure rules to require a DCO topermit outsourcing to qualified thirdparties of obligations to participate inauctions or in allocations, subject toappropriate safeguards imposed by theDCO.59

Finally, the Commission hasdetermined that it will not permit aDCO to require members to post aminimum amount of liquid margin ordefault guarantee contributions, or toparticipate in a liquidity facility per J.P.Morgan’s suggestion. The Commission

believes that the rules are sufficient toensure that each member has adequate

resources to withstand anothermember’s default and suchrequirements could be used by a DCO toevade the open access to clearingintended by the Dodd-Frank Act.

j. Operational Requirements—§ 39.12(a)(3)

Proposed §39.12(a)(3) would requirea DCO to require its clearing membersto have adequate operational capacity tomeet their obligations arising fromparticipation in the DCO. Therequirements would include, but not belimited to: The ability to processexpected volumes and values of

transactions cleared by a clearingmember within required time frames,including at peak times and on peakdays; the ability to fulfill collateral,payment, and delivery obligationsimposed by the DCO; and the ability toparticipate in default managementactivities under the rules of the DCOand in accordance with proposed§ 39.16.

LCH, FIA, Jefferies, and SDMAcommented that the Commission hascorrectly identified the operationalrequirements. Jefferies commented thatdemonstrating sufficient operational

capacity is more important than capitalconsiderations. According to SDMA,these operational requirements aredirectly related to the core business of the clearing member and provide theservices needed and relied upon by theDCO to clear trades. SDMA also believesthat DCOs should be prohibited fromimposing operational requirements thatare not part of a clearing member’s core

business because they create

discriminatory barriers to clearing, andit points to the following as examples of discriminatory operational eligibilityrequirements: Clearing members must(1) Have both execution and clearingcapabilities; (2) provide end-of-dayprices to mark its positions; and (3) haveextensive experience in clearing swapsor ‘‘sophistication.’’

J.P. Morgan and FIA commented thata DCO must ensure that each memberhas risk management resources to assistthe DCO in its risk management process,and FIA suggested that the final rulesadd appropriate risk managementrequirements as a participant eligibilitycriterion, or make clear that nothing inthe proposed rules is intended toprevent a DCO from adopting suchrequirements.

ISDA commented that the ability to bid for portfolios of other clearingmembers of the DCO is criticallyimportant. According to ISDA, anappropriate risk management frameworkfor a clearing member may be broadlycategorized as follows: (1) Board andsenior management oversight; (2)organizational structure; and (3) strongsystems and procedures for controlling,monitoring and reporting risk.

Finally, State Street commented that aclearing member must be able todemonstrate it can carry out itsobligations to a DCO under a defaultscenario. That demonstration couldinclude having the capacity to tradeswaps using experienced swap traders,and the ability to execute transactions inthe market by having appropriate

trading relationships. A clearingmember must also demonstrate anability to monitor positions, calculatepotential losses and market risk,perform stress tests, and maintainliquidity, among numerous otherrequirements.

The Commission is adopting§ 39.12(a)(3) as proposed. TheCommission believes that the rulecorrectly identifies the necessaryoperational requirements and isconcerned that the heightenedoperational requirements suggested bysome commenters could allow a DCO to

evade the open access to DCO clearingintended by the Dodd-Frank Act. TheCommission emphasizes that under therule, any operational requirements must

be necessary to meet clearingobligations. In addition, theCommission is adopting §39.13(h)(5)herein, which requires a DCO to adoptrules requiring clearing members tomaintain current written riskmanagement policies and procedures.60

The Commission has also proposedrules requiring clearing members thatare FCMs (proposed § 1.73) and swapdealers and major swap participants(proposed §23.609) to engage in specificrisk management activities.61

k. Monitoring, Reporting, andEnforcement—§39.12(a)(4)

Core Principle C requires each DCO to‘‘establish and implement procedures toverify, on an ongoing basis, thecompliance of each clearing memberwith each participation requirement of the derivatives clearing organization.’’ 62 Proposed §39.12(a)(4) would codifythese requirements.

OCC supported the proposed rule ‘‘if interpreted reasonably.’’ J.P. Morgancommented that a clearing member mayhave committed to additional unfundedassessments at more than oneclearinghouse and proposes that theCommission and DCOs monitor clearing

members to ensure that they havesufficient liquid resources to supportthe business they clear at each DCO.According to J.P. Morgan, a DCO shouldmonitor exposures against risk-basedposition limits on a real-time basis.

The Commission is adopting§ 39.12(a)(4) as proposed. In response to

J.P. Morgan’s comments, theCommission notes that in monitoringfirms, a DCO should take intoconsideration risks that the firm facesoutside of that DCO. The Commissionfurther notes that it is not prescribingthe means by which DCOs shouldmonitor compliance.

l. Reporting Requirements—§39.12(a)(5)

Proposed §39.12(a)(5)(i) wouldmandate that a DCO require all clearingmembers, including those that are notFCMs, to file with the DCO periodicfinancial reports containing anyfinancial information that the DCOdetermines is necessary to assesswhether participation requirements aremet on an ongoing basis. The proposedrule also would mandate that a DCOrequire clearing members that are FCMsto file the financial reports that arespecified in §1.10 of the Commission’s

regulations with the DCO, and wouldrequire the DCO to review all suchfinancial reports for risk managementpurposes. Proposed §39.12(a)(5)(i)would also require a DCO to require itsclearing members that are not FCMs tomake the periodic financial reports thatthey file with the DCO available to theCommission upon the Commission’s





63See discussion of §39.17 in section IV.H, below.

64See 76 FR 13101 (Mar. 10, 2011) (Straight-Through Processing).

65See 76 FR 45730 (Aug. 1, 2011) (CustomerClearing).

66As proposed, §39.12(b)(1)(vii) referred toaddressing any ‘‘unique’’ risk characteristics of aproduct. The Commission is revising this provisionin the final rule to refer to any ‘‘unusual’’ riskcharacteristics to clarify that such characteristicsare not limited to those that are one of a kind.

request. Proposed § 39.12(a)(5)(ii) wouldmandate that a DCO adopt rules thatrequire clearing members to provide tothe DCO, in a timely manner,information that concerns any financialor business developments that maymaterially affect the clearing members’ability to continue to comply withparticipation requirements.

LCH commented that a DCO basedoutside the U.S. may have clearingmembers that are not subject to theCommission’s jurisdiction and would beregulated in their home jurisdiction.LCH proposed this provision be revisedsuch that only FCMs and U.S.-basedmembers that are not FCMs are requiredto provide this information to theCommission upon request. According toLCH, all other members should berequired to submit the information tothe DCO only or to their equivalent localregulator.

LCH and MGEX commented thatproposed §39.12(a)(5)(ii) would be moreappropriately imposed on clearingmembers themselves, rather than on theDCO. KCC suggested that theCommission should evaluate itsstatutory authority to enact theproposed rule. MGEX commented thatthe proposed rules appear to requireclearing members to report to each DCOwith which they clear, which wouldcreate an additional, duplicative burdenon clearing members. MGEX suggestedthat the Commission regulate theclearing members directly. As analternative, MGEX proposed a newindustry group similar to the Joint Audit

Committee (JAC) in which each DCOwould be represented and participate indeveloping an overall risk managementprogram that would be used in fulfillingthe new proposed requirements.

The Commission is adopting§ 39.12(a)(5) with modifications to (1)provide that the financial informationprovided by non-FCM clearing membersmay be submitted by the clearingmembers to the Commission pursuant toDCO rules or may be submitted to theCommission by the DCO, in either case,upon the Commission’s request; and (2)eliminate the proposed requirement that

the DCO must review clearing members’financial reports for risk managementpurposes.

The rule is intended to addresscircumstances where the Commissionmust obtain information in thepossession of a clearing member. TheCommission anticipates such requestswill be few in number. However, whenthose occasions arise, the Commissionmust be able to obtain the informationas expeditiously as possible. The ruleaddresses this need by allowing theCommission to obtain the information

directly from the source and tominimize the burden on DCOs. Inresponse to the comments, theCommission is revising the rule toprovide that a DCO may either providethe requested information directly to theCommission or require clearingmembers to provide the information tothe Commission.

The Commission is eliminating therequirement that the DCO must reviewclearing members’ financial reports forrisk management purposes. Uponfurther consideration, the Commissionhas concluded that although a DCO mayreview such financial reports for severalreasons, including risk management andto ensure that clearing memberscontinue to meet participationrequirements, it is not necessary to beprescriptive in this regard.

In response to MGEX suggestion of anew industry group, Commission staff isconsidering such a step.

The Commission is making certaintechnical revisions to §39.12(a)(5) inconnection with these changes.

m. Enforcement of ParticipationRequirements—§39.12(a)(6)

Proposed §39.12(a)(6) would requirea DCO to enforce compliance with itsparticipation requirements and establishprocedures for the suspension andorderly removal of clearing membersthat no longer meet the requirements.MGEX commented that the proposedrule goes beyond the language of theDodd-Frank Act.


§ 39.12(a)(6) as proposed. A DCO musthave the ability to enforce compliancewith its participation requirements or itsclearing members may not satisfy theserequirements. A DCO also must haveprocedures for the suspension andorderly removal of clearing membersthat no longer meet the requirements.Otherwise, the enforcement process maynot be orderly and could introduceadditional risk to the DCO. Thisrequirement complements §39.17,adopted herein, which implements CorePrinciple H (Rule Enforcement).63

2. Product Eligibility

Core Principle C requires that eachDCO establish appropriate standards fordetermining the eligibility of agreements, contracts, or transactionssubmitted to the DCO for clearing.Proposed §39.12(b) would codify theserequirements.

a. General Comments

Citadel and MFA supported theproposed rules. To ensure non-

discriminatory clearing, Citadel andMFA recommended the Commissionmake explicit that a DCO must providehighly standardized mechanisms andprocedures for establishing connectivitywith SEFs and any other permittedtrading venue. According to Citadel,these mechanisms and procedures must

be objective, commercially reasonable,

publicly available, and treat allapplicant execution facilities in anunbiased manner. Citadel and MFA alsoproposed that the rules mandate that aDCO keep the clearing acceptanceprocess anonymous (i.e., without thecustomer’s clearing member knowingthe identity of the customer’s executingcounterparty).

The Commission agrees that a DCOmust provide mechanisms forestablishing connectivity with SEFs andDCMs, which would provide executingcounterparties with fair and openaccess. The Commission has proposed

rules addressing this issue.64

TheCommission also has proposed rulesthat address the anonymity issue.65

b. Products Eligible for Clearing—§ 39.12(b)(1)

Proposed §39.12(b)(1) would requirea DCO to establish appropriaterequirements for determining theeligibility of agreements, contracts, ortransactions submitted to the DCO forclearing, taking into account the DCO’sability to manage the risks associatedwith such agreements, contracts, ortransactions. Factors to be considered indetermining product eligibility wouldinclude but would not be limited to: (1)Trading volume; (2) liquidity; (3)availability of reliable prices; (4) abilityof market participants to use portfoliocompression with respect to a particularswap product; (5) ability of the DCO andclearing members to gain access to therelevant market for purposes of creatingand liquidating positions; (6) ability of the DCO to measure risk for purposes of setting margin requirements; and (7)operational capacity of the DCO andclearing members to address any uniquerisk characteristics of a product.66

OCC noted that the factors to be

considered are already among thefactors that a DCO would naturallyconsider and that OCC in fact considers,and it suggested that the application of





67This is also consistent with §39.16(c)(2)(ii),adopted herein and discussed in section IV.G.4, below, which requires a DCO to adopt rules that setforth the actions that a DCO may take in the eventof a default, which must include the prompttransfer, liquidation, or hedging of the defaultingclearing member’s positions, and which mayinclude the auctioning or allocation of suchpositions to other clearing members.

this new rule be limited to swaps. OCCalso noted that the trading volume of new products is often unknown andunpredictable and suggested that factornot be a barrier to accepting a productfor clearing.

MGEX commented that the proposedrule considers legitimate factors, butmandating that a DCO establish

eligibility requirements is not necessary,other than requirements for the contractsize of swaps. Like OCC, MGEX notedthat DCOs already use these factors aspart of their sound business judgment inmaking these types of decisions. MGEXrecommended that the Commissionissue suggested guidelines or coreprinciples and, on an as-needed basis,request that a DCO file with theCommission the rationale supporting itsconclusion that a contract qualifies forclearing.

LCH expressed concerns withproposed § 39.12(b)(1)(iv) and

commented that compression serviceshave been developed only when swapmarkets are relatively large and well-established, and the introduction of cleared facilities has largely pre-datedthe introduction of compressionservices. According to LCH, makingswap clearing contingent on swapportfolio compression may have theeffect of permitting fewer swaps to becleared. LCH proposed that theCommission encourage the use of compression services where suitableand available, but not constrain theability of a DCO to clear a given swap

based on the availability of suchservices.LCH also commented that it is

imperative that a DCO have the abilityto ‘‘transfer,’’ ‘‘auction,’’ or ‘‘allocate’’cleared swaps. LCH proposed that thefactor listed in proposed §39.12(b)(1)(v),the ‘‘[a]bility of the [DCO] and clearingmembers to gain access to the relevantmarket for purposes of creating andliquidating positions’’ be modified toreflect these additional actions.

The Commission agrees with LCH thata DCO must have the ability to‘‘transfer,’’ ‘‘auction,’’ or ‘‘allocate’’cleared swaps and it is revising

§ 39.12(b)(1)(v) to incorporate LCH’ssuggestion.67 The Commission isotherwise adopting Section 39.12(b)(1)as proposed. The Commission believesthat setting forth the minimum factors

that all DCOs must consider whendetermining contract eligibility isnecessary to prevent a DCO fromseeking to clear transactions that presentan unacceptable level of risk. TheCommission also believes that OCC’sand LCH’s concerns are unfounded. Therule provides factors to be consideredand does not prohibit a DCO from

accepting a product for clearing if itdoes not satisfy one of the factors.Finally, the Commission is declining tolimit the rule to swaps because it

believes the eligibility factors areapplicable to all products cleared by aDCO. The Commission is also decliningto issue suggested guidelines or coreprinciples, or to request that a DCO filewith the Commission the rationale forwhy a contract qualifies for clearing.The Commission believes that§ 39.12(b)(1) is not burdensome because,as MGEX and OCC commented, thesefactors are already considered by DCOs.

In contrast, filing rationales on an as-needed basis could be burdensome tothe DCO and the Commission, andwould not serve to mitigate risk moreeffectively.

c. Economic Equivalence—§39.12(b)(2)

Proposed §39.12(b)(2) would requirea DCO to adopt rules providing that allswaps with the same terms andconditions (as defined by templatesestablished under DCO rules) submittedto the DCO for clearing are economicallyequivalent within the DCO and may beoffset with each other within the DCO.

ISDA, CME, and FIA commented that

the term ‘‘template’’ is inappropriate.According to ISDA, ‘‘template’’ has noclear meaning, and it assumes that theterm refers to the contract specificationscurrently used by a variety of futuresfacilities. ISDA noted that thedevelopment of specific templates forswap transactions is a mixed business/technological project that requiressignificant discussion involving eachDCO and its market participants. Itsuggested that the Commission’sregulations guide the meaning of ‘‘template’’ to achieve as muchindividual transactional variability as

possible within the transaction or rangeof transactions that a template maycover.

CME commented that references to‘‘templates’’ are confusing because swapdealers generally maintain standardtemplates for documenting their tradingrelationships, and their counterpartiesfrequently negotiate changes to thosetemplates. According to CME, a DCOdoes not define the templates used byOTC participants, and DCO rules do notfunction as templates from whichcounterparties may negotiate. Rather, a

DCO sets forth in its rulebook theproduct specifications of each contractit accepts for clearing, including swaps.CME suggested that the Commissionrevise § 39.12(b)(2) to state as follows(change in italics): ‘‘A [DCO] shall adoptrules providing that all swaps with thesame terms and conditions, as defined

by product specifications established

under [DCO] rules, submitted to the[DCO] for clearing are economicallyequivalent within the [DCO] and may beoffset with each other within the[DCO].’’

FIA requested that Commissionconfirm that economically equivalentswaps must have the same cash flows,values, and liquidation dates. FIA alsosuggested that terms and conditions of such templates—for example, events of default—should also be consistent withmarket practice.

Finally, KCC commented that theproposed rule is redundant because

Chapter 21 of the KCC rulebook alreadydefines the terms and conditions forswaps that KCC will clear.

The Commission is revising§ 39.12(b)(2) as suggested by CME tosubstitute the phrase ‘‘productspecifications’’ for the word‘‘templates.’’ As noted above, somecommenters found the use of the word‘‘templates’’ confusing. TheCommission’s intent was to ensure thata DCO sets the specifications for clearedproducts. The Commission is otherwiseadopting the rule as proposed.

In response to FIA, the Commissionconfirms that it regards cash flows,

values, and liquidation dates as termsand conditions encompassed by thisrule. The Commission, however,declines to require that terms andconditions be consistent with marketpractice. The Commission believes thata DCO should have the flexibility todetermine whether to conform termsand conditions to market practice.

d. Non-Discriminatory Treatment of Swaps—§39.12(b)(3)

Proposed §39.12(b)(3) would requirea DCO to provide for non-discriminatoryclearing of a swap executed bilaterally

or on or subject to the rules of anunaffiliated SEF or DCM. FIA and MFAcommented in support of the proposedrule.

OCC suggested that it should not bedeemed a violation of §39.12(b)(3) for aDCO to require a SEF or DCM desiringto transmit swaps to the DCO forclearing to enter into a non-exclusiveclearing agreement on non-discriminatory terms similar to thoseoffered by the DCO to other SEFs orDCMs for clearing of similar products.OCC believes that such agreements are







70See 76 FR 13101 (Mar. 10, 2011) (Straight-Through Processing).

71 Id.

necessary and appropriate for purposesof addressing matters between theparties such as information sharing andfurnishing price data by the exchange tothe DCO.

LCH suggested that the Commissionclarify that ‘‘non-discriminatory’’includes costs, technology, and otherrelated considerations. LCH also

suggested that the Commission imposethe reverse requirements on executionvenues such as DCMs and SEFs, so thatthose venues are also required toprovide trade feeds to DCOs on a non-discriminatory basis.

The Commission is adopting§ 39.12(b)(3) as proposed. In response toOCC, the Commission notes that therule does not prohibit a DCO fromrequiring a SEF or DCM desiring totransmit swaps to the DCO for clearingto enter into a non-exclusive clearingagreement on non-discriminatory termssimilar to those offered by the DCO to

other SEFs or DCMs for clearing of similar products. The Commissionagrees that such agreements arenecessary and appropriate for purposesof addressing matters between theparties such as information sharing andfurnishing price data by the exchange tothe DCO. The Commission notes that itexpects DCOs to review clearingagreements for compliance with§ 39.12(b)(3), the open accessrequirements of Core Principle C, andany relevant requirements of other coreprinciples.

In response to LCH’s comment, theCommission notes that the requirement

applies to the factors LCH enumerated.The Commission also notes that LCH’ssuggestion regarding trading venues isoutside the scope of this rulemaking

e. Prohibition on Requirement ThatExecuting Party Is a Clearing Member—§ 39.12(b)(4)

Proposed §39.12(b)(4) would prohibita DCO from requiring one of the originalexecuting parties to be a clearingmember in order for a contract,agreement, or transaction to be eligiblefor clearing.

CME concurred with the

Commission’s analysis and fullysupported the proposed regulation. FIA,Citadel, and MFA also supported theproposed regulation.

MFA suggested strengthening theproposed rule. According to MFA, whena non-clearing member trades withanother non-clearing member, theclearing process should be identical andas prompt as when one of the parties isa clearing member, so long as thetransaction satisfies the relevant DCO’srules, requirements, and standardsotherwise applicable to such trades.

MFA believes that providing this paritywould allow new liquidity providers toefficiently and effectively enter into andcompete within the market.

MFA also suggested that theCommission revise the proposed rule toprohibit a DCO from adopting rules orengaging in conduct that is prejudicialto non-clearing members as compared toclearing members with respect toeligibility or the timing of clearing orprocessing of trades generally. TheCommission has addressed this issue inthe recently proposed rules on clearingdocumentation.68

ISDA commented that rules barringtrades that don’t involve a clearingmember as a party are inappropriate inestablished DCOs, but new DCOs mayneed to roll out products andprocedures in a contained way.According to ISDA, ‘‘initial decisions onwhich market constituencies shouldhave access to clearing must be thesubject of legitimate, reasoned decision-making by each DCO with regard to itsability to properly serve eachconstituency and each constituency’sreadiness to participate in a clearedmarket.’’

Finally, NGX commented that if theproposed rule were applied to a non-intermediated DCO such as NGX, therule would require a fundamentalrestructuring of the manner in whichthe DCO admits members, guaranteestrades, and provides risk management.DCOs like NGX require all participantsto become clearing participants at theDCO, and they do not clear contractsthat involve non-clearing participants.

The Commission is adopting§ 39.12(b)(4) as proposed. In response tothe comments of ISDA and NGX, theCommission notes that some DCOscurrently have only direct participants,i.e., participants that do not offer clientclearing. NGX, for example, providesdirect access to commercial end userswho clear for themselves. TheCommission notes that, consistent withprinciples of open access, a DCO musthave rules in place to offer clientclearing promptly if an FCM or acustomer requests access. However,from a cost-benefit perspective, theCommission would expect that any DCOinvestment in building systems would

be proportionate to evidence of demandfor the service.

Finally, in a separate rulemaking, theCommission has proposed rules thataddress MFA’s suggestion that trades

between indirect clearing members

should have parity with trades betweenclearing members.69

f. Product Standardization—§ 39.12(b)(5)

Proposed §39.12(b)(5) would requirea DCO to select contract unit sizes andother product terms and conditions thatmaximize liquidity, facilitate

transparency in pricing, promote openaccess, and allow for effective riskmanagement.70 To the extentappropriate to further these objectives, aDCO would be required to selectcontract units for clearing purposes thatwere smaller than the contract units inwhich trades submitted for clearingwere executed. 71

ISDA supported the goals identified by the Commission; however, itcommented that ‘‘unit size’’ is not ameaningful concept in swaptransactions because contract size is notstandardized. According to ISDA, the

only meaningful size limit is thesmallest unit of relevant currency orrelevant underlying. ISDA suggestedthat the Commission avoid focusing on‘‘unit size’’ and instead articulate itsultimate objectives, as it has, leavingDCOs with the discretion to set suitableterms and conditions to further thoseobjectives.

FIA did not support the requirementthat a DCO select contract unit sizes

because FIA does not believe that theswap market has evolved to the pointwhere DCOs can do this. FIA also doesnot believe the market is at a pointwhere it would be appropriate for aDCO to establish templates regardingthe terms and conditions of standardized swaps eligible for clearing.FIA believes that requiring swaps to fitwithin artificial, prescribed templateswould be disruptive to the market andwould not benefit customers. FIA,however, would support a requirementthat DCOs study this matter and submita report to the Commission on thefeasibility of establishing templatesregarding the terms and conditions of standardized swaps as soon aspracticable.

Finally, LCH commented that it is not

appropriate to require a DCO to selectcontract units for clearing purposes thatare smaller than the contract units inwhich trades submitted for clearingwere executed. According to LCH, aDCO clearing swaps should be able toaccept such swaps in any size, andswaps submitted for clearing should not





72This provision was originally designated as§ 39.12(b)(7)(v) in 76 FR 13101 (Mar. 10, 2011)(Straight-Through Processing). It was later proposedto be renumbered as §39.12(b)(8) in 76 FR 45730(Aug. 1, 2011) (Customer Clearing). Section39.12(b)(7), as currently proposed (76 FR at 13110),will be addressed in a separate final rulemaking.

be broken down into sub-units. LCHsuggested that the Commission strike§ 39.12(b)(5) and that any rulesaddressing average size of exposuretraded in the swap markets be addressedin rules pertaining to trading andexecution venues.

The Commission is adopting§ 39.12(b)(5) as proposed. The

Commission believes that standardizingproducts, including swaps, by requiringa DCO to determine product terms andconditions, including product size, willincrease liquidity, lower prices, andincrease participation. In addition,standardized products should make iteasier for members to accept a forcedallocation in the event of bankruptcy.

The Commission recognizes thatstandardized products may create basisrisk for some hedge positions. However,this circumstance has long existed inthe futures markets. The Commission

believes that the benefits of

standardization, such as competitivepricing, liquid markets, and openaccess, outweigh the costs of imperfecthedging.

In response to LCH, the Commissionnotes that the product unit size of aparticular swap executed bilaterallymay reflect the immediatecircumstances of the two parties to thetransaction. Once submitted forclearing, it may be possible to split thetrade into smaller units withoutcompromising the interests of the twooriginal parties. Smaller units canpromote liquidity by permitting more

parties to trade the product, facilitateopen access by permitting more clearingmembers to clear the product, and aidrisk management by enabling a DCO, inthe event of a default, to have morepotential counterparties for liquidation.The Commission notes that under therule, DCOs retain some discretion indetermining how best to promoteliquidity, facilitate open access, and aidrisk management.

g. Novation—§39.12(b)(6)

Proposed §39.12(b)(6) would requirea DCO that clears swaps to have rules

providing that upon acceptance of aswap: (i) The original swap isextinguished; (ii) the original swap isreplaced by equal and opposite swaps

between clearing members and the DCO;(iii) the terms of the cleared swapsconform to templates established underDCO rules; and (iv) if a swap is cleared

by a clearing member on behalf of acustomer, all terms of the swap, ascarried in the customer account on the

books of the clearing member, mustconform to the terms of the clearedswap established under the DCO’s rules.

Newedge supported this rule, inparticular, the requirement forstandardization.

CME, FIA, and ICE commented thatthe proposed rule appears to presumethe use of a ‘‘principal’’ model for allcleared swaps, even those swaps clearedon behalf of customers. CME noted thatat CME, an FCM clearing customer

business acts as an agent forundisclosed principals (i.e., the FCM’scustomers) vis-a-vis CME andguarantees its customers’ performanceto CME. CME suggested that in order topreserve the agency model for customer-cleared swaps, the Commission shouldadopt a revised §39.12(b)(6)(ii) toprovide that, upon acceptance of a swapfor clearing, ‘‘the original swap isreplaced by equal and opposite swapswith the DCO.’’ As previously noted,CME also commented that the use of theterm ‘‘template’’ is confusing. Itsuggested that the Commission revise

§ 39.12(b)(6)(iii) to state: ‘‘All terms of the cleared swaps must conform toproduct specifications established under[DCO] rules.’’

FIA commented that the proposedrule would conflict with the FCMs’position that, with respect to customerpositions, FCMs are acting as agent, andnot as principal, for customers inexecuting and clearing swaps (andfutures) on behalf of customers. FIAsuggested that the proposed rule berevised to confirm that, in clearingswaps on behalf of customers, a clearingmember shall be deemed a guarantor

and agent of a cleared swap and not aprincipal.ICE noted that U.S. futures markets

may clear on an open offer basis, whichallows straight-through processing. ICEcommented that the Commission shouldnot preclude open offer clearing of swaps by requiring the underlying swapto be novated.

Finally, LCH suggested that theCommission revise the rule so that theobligation would fall on the clearingmember rather than the DCO becausethe provisions relate to the clearingmember’s books and records, not theDCO’s.

The Commission is adopting§ 39.12(b)(6) with modifications toclarify its intended meaning. Inresponse to the comments from CME,FIA, and ICE, the Commission isrevising §39.12(b)(6)(ii) to provide thata DCO that clears swaps must have rulesproviding that, upon acceptance of aswap by the DCO for clearing, ‘‘[t]heoriginal swap is replaced by an equaland opposite swap between thederivatives clearing organization andeach clearing member acting as

principal for a house trade or acting asagent for a customer trade.’’

In response to the comment fromCME, the Commission is revising§ 39.12(b)(6)(iii) to substitute the phrase‘‘product specifications’’ for the word‘‘templates.’’ This is consistent with thechange to §39.12(b)(2), discussed above.

In response to the comment by ICE,

the Commission notes that ‘‘open offer’’systems are acceptable under the rule.Effectively, under an open offer systemthere is no ‘‘original’’ swap betweenexecuting parties that needs to benovated; the swap that is created uponexecution is between the DCO and theclearing member, acting either asprincipal or agent.

Finally, with regard to LCH’scomment, the Commission believes thatit is proper for the requirement to fall onthe DCO. The DCO is the centralcounterparty and is responsible for thetransaction going forward.

h. Confirmation of Terms—§39.12(b)(8)Proposed §39.12(b)(8) would require

a DCO to have rules that provide that allswaps submitted to the DCO for clearingmust include written documentationthat memorializes all of the terms of thetransaction and legally supersedes anyprevious agreement.72 The confirmationof all terms of the transaction would berequired to take place at the same timeas the swap is accepted for clearing.

CME suggested that the Commissionrevise the proposed regulation to requirea DCO to ‘‘provide each clearingmember carrying a cleared swap with a

definitive record of the terms of theagreement, which will serve as aconfirmation of the swap.’’

ISDA commented that it is not clearwhat efficiencies the proposed rulewould achieve for the parties to theswap in confirming through a DCO. Itsuggested that the Commission be lessprescriptive and recognize that the actof clearing a swap transaction through aDCO in and of itself should produce adefinitive written record, tailored to theparticular category of swap transaction

by the DCO and its market constituency,which fulfills the Commission’s

objective of facilitating the timelyprocessing and confirmation of swapsnot executed on a SEF or a DCM.

FIA requested that the Commissionclarify the obligations of the partiesunder this proposed rule. According toFIA, the rule appears to place





73The notice of proposed rulemaking states:‘‘Proposed §39.12(b)(7)(v) would require that DCOsaccepting a swap for clearing provide thecounterparties with a definitive written record of the terms of their agreement, which will serve asa confirmation of the swap.’’ 76 FR at 13105–13106(Mar. 10, 2011) (Straight-Through Processing).

74See 75 FR 81519, at 81521 (Dec. 28, 2010)(Confirmation, Portfolio Reconciliation, andPortfolio Compression Requirements for SwapDealers and Major Swap Participants) (‘‘if a swapis executed bilaterally, but subsequently submittedto a DCO for clearing, the DCO will require adefinitive written record of all terms to thecounterparties’ agreement prior to novation by theDCO’’).

75Section 5b(c)(2)(D) of the CEA, 7 U.S.C. 7a–1(c)(2)(D).

responsibility on the parties to the swapto submit a written confirmation of theterms of the transaction to the DCO,which, upon acceptance by the DCO,will supersede any prior documents andserve as the confirmation of the trade.However, the notice of proposedrulemaking places responsibility on theDCO, explaining that the proposed rule

‘‘would require that DCOs accepting aswap for clearing provide thecounterparties with a definitive writtenrecord of the terms of their agreement,which will serve as a confirmation of the swap.’’ Further, the proposed ruleappears to apply to all swaps submittedfor clearing, but the notice of proposedrulemaking appears to limit therequirement to swaps not executed on aSEF or DCM, noting that swapsexecuted on a SEF or DCM areconfirmed upon execution.73

OCC commented that the terms andconditions applicable to a cleared swap

would already be specified in the DCOrules or product specifications, and itdoes not think it is necessary for a DCOto provide a confirmation that is similarin form to detailed trade documentationsuch as an ISDA Master Agreement.OCC believes that the term ‘‘writtendocumentation’’ should be interpreted

broadly to mean any documentation thatsufficiently memorialized the agreementof the counterparties with respect to theterms of a swap, which may consist of a confirmation (electronic or otherwise)that confirms the values agreed upon forterms that can be varied by the parties.

MarkitSERV noted that the proposed

rule would require a confirmation of allterms of the transaction at the time theswap is accepted for clearing, andcommented that the rule is unclear as towhether, when a swap is to besubmitted for clearing, confirmationwould ever be required of the pre-clearing initial transaction between theoriginal counterparties. In contrast, theCommission has elsewhere stated that itexpects a DCO to require pre-clearingtransactions to be confirmed beforeclearing.74 MarkitSERV also noted thatwhen a transaction is not rapidlyaccepted for clearing the parties will

still be responsible for confirming thetransaction under Commissionregulations. It recommended that theCommission clarify that when atransaction is not accepted for clearingwithin the time frame established formandatory confirmation the partiesshould be permitted to satisfy theirconfirmation obligations by confirming

the transaction prior to clearing.The Commission is adopting

§ 39.12(b)(8) in modified form to read asset forth in the regulatory text of thisfinal rule.

The change to the heading isresponsive to the comment by FIA thatit was unclear whether the rule appliedto all cleared swaps or only to those thatare executed bilaterally. Regardless of the execution venue, confirmation of acleared swap is ultimately provided bythe DCO. In the case of a trading facilitywith a central limit order book,execution and acceptance for clearing

are simultaneous and confirmationoccurs at that time. In all other cases,there is an interim time betweenexecution and acceptance, or rejection,for clearing.

The Commission notes that applicableconfirmation requirements may dependon the length of time between executionand acceptance or rejection for clearing.For example, if a trade executed on aSEF is accepted for clearing withinseconds, the DCO notification wouldserve as the single confirmation. But, if a trade is executed bilaterally and latersubmitted for clearing, there may needto be an initial bilateral confirmationthat is later superseded by the clearingconfirmation.

The changes to the text are responsiveto the comments of FIA, CME, ISDA,OCC, and MarkitSERV. As FIA pointedout, the proposed rule text seems toplace the confirmation obligation on thesubmitting parties, while the discussionin the notice of proposed rulemakingplaces it on the DCO. Consistent withthe language in the discussion and therecommendations of FIA, CME, andISDA, the revised rule clarifies thatDCOs provide confirmations of clearedtrades. This interpretation was implicit

in the proposal given that the secondsentence of the rule provides thatconfirmation takes place when the trade‘‘is accepted’’ for clearing.

D. Core Principle D—Risk Management—§ 39.13

Core Principle D, 75 as amended bythe Dodd-Frank Act, requires each DCOto ensure that it possesses the ability tomanage the risks associated with

discharging the responsibilities of theDCO through the use of appropriatetools and procedures. It further requireseach DCO to measure its creditexposures to each clearing member notless than once during each business dayand to monitor each such exposureperiodically during the business day.Core Principle D also requires each DCO

to limit its exposure to potential lossesfrom defaults by clearing members,through margin requirements and otherrisk control mechanisms, to ensure thatits operations would not be disruptedand that non-defaulting clearingmembers would not be exposed tolosses that non-defaulting clearingmembers cannot anticipate or control.Finally, Core Principle D provides thata DCO must require margin from eachclearing member sufficient to coverpotential exposures in normal marketconditions and that each model andparameter used in setting such margin

requirements must be risk-based andreviewed on a regular basis. TheCommission proposed to adopt §39.13to establish requirements that a DCOwould have to meet in order to complywith Core Principle D.

1. General—§39.13(a)

Proposed §39.13(a) would require aDCO to ensure that it possesses theability to manage the risks associatedwith discharging its responsibilitiesthrough the use of appropriate tools andprocedures. The Commission did notreceive any comments on proposed

§ 39.13(a) and is adopting § 39.13(a) asproposed.

2. Risk Management Framework—§ 39.13(b)

Proposed §39.13(b) would require aDCO to establish and maintain writtenpolicies, procedures, and controls,approved by its board of directors,which establish an appropriate riskmanagement framework that, at aminimum, clearly identifies anddocuments the range of risks to whichthe DCO is exposed, addresses themonitoring and management of the

entirety of those risks, and provides amechanism for internal audit. Inaddition, proposed § 39.13(b) wouldrequire a DCO to regularly review itsrisk management framework and updateit as necessary.

Mr. Barnard recommended that theCommission comprehensively andexplicitly address all elements thatmake up a risk management framework,including organizational structure,governance, risk functions, internalcontrols, compliance, internal audit,





76Mr. Barnard also recommended that theCommission focus more on operational risk and therole of reporting and public disclosures. Withrespect to operational risk, the Commission notesthat it is adopting §39.18 herein, which addressessystem safeguards, and which is discussed insection I, below. Reporting and public informationare addressed in §§39.19 and 39.21, respectively,also adopted herein, which are discussed insections J and L, respectively, below.

77See CPSS–IOSCO Consultative Report,Principle 2: Governance, Key Consideration 5, at 23.

78See 75 FR at 63750 (Oct. 18, 2010) (Conflictsof Interest). In that proposed rulemaking, theprovisions relating to the Risk ManagementCommittee were designated as §39.13(g). In thefinal rulemaking with respect to that proposal,those provisions will be redesignated as §39.13(d).

79However, the Commission has proposed rulesregarding a CCO for futures commission merchants,swap dealers, and major swap participants, at 75 FR70881 (Nov. 19, 2010) (Designation of a Chief Compliance Officer; Required Compliance Policies;and Annual Report of a Futures CommissionMerchant, Swap Dealer, or Major Swap Participant),with respect to which Better Markets filed acomment letter.

and legal functions.76 In particular, withrespect to organizational structure, Mr.Barnard noted that reporting lines andthe allocation of responsibilities andauthority within a DCO should be clear,complete, well-defined and enforced.

The Commission believes that a DCOshould adopt a comprehensive anddocumented risk management

framework that addresses all of thevarious types of risks to which it isexposed and the manner in which theymay relate to each other. TheCommission believes that a written riskpolicy is important because it will helpto ensure the DCO has carefullyconsidered its risk managementframework, and it will provide guidanceto DCO management, staff, and marketparticipants. It will also allow theCommission to assess the DCO’s riskmanagement framework moreefficiently. The risks to be addressedmay include, but are not limited to,

legal risk, credit risk, liquidity risk,custody and investment risk,concentration risk, default risk,operational risk, market risk, and

business risk. However, the Commissiondoes not believe that it is necessary toexplicitly list such risks in the finalrule.

MGEX commented that thedocumentary and proceduralrequirements of proposed §39.13(b)would impose heavy costs and turn thegoal of practical risk management intoone of paperwork compliance, and thatwhile having a framework containing allthe various policies can be beneficial for

DCOs, the development andimplementation of such policies must

be flexible and left to each DCO. TheCommission notes that DCOs generallyalready have certain written riskmanagement policies, procedures andcontrols, although the substance, levelof detail, and integration of each DCO’sdocumentation of such policies,procedures and controls may vary. TheCommission believes that §39.13(b)provides DCOs with the appropriateamount of flexibility with regard to thedocumentation of their risk managementframeworks, without imposing

significant additional costs upon DCOs.OCC noted that its risk managementpolicies are highly complex and areembodied in multiple separate writtendocuments, and much of its day-to-day

operations are related to riskmanagement. OCC stated that theCommission should make it clear thatthe proposal would not require the

board to approve every documentrelated to risk management, as it would

be burdensome and wouldinappropriately require the board tomicro-manage the day-to-day functions

of a DCO. OCC indicated that it does not believe that the function of thecommittee that is responsible for theoversight of its risk managementactivities would be enhanced by thecreation of additional written policies,procedures, and controls.

The Commission recognizes thatmany of the day-to-day functions of aDCO are related to risk management,and §39.13(b) is not intended to requirethat a DCO’s board must approve everydocument at a DCO that addresses riskmanagement issues nor is it intended torequire that a DCO’s board must

approve every day-to-day decisionregarding the implementation of theDCO’s risk management framework.

CME and ICE took the position that aDCO’s Risk Management Committeeshould have the authority to approvethe written policies, procedures, andcontrols that establish a DCO’s riskmanagement framework, noting that thiswould be consistent with proposed§ 39.13(c), which would require a DCO’sChief Risk Officer to make appropriaterecommendations to the DCO’s RiskManagement Committee or board of directors, as applicable, regarding theDCO’s risk management function.

The Commission believes that aDCO’s risk management frameworkshould be subject to the approval of its

board of directors. The Commissionrecognizes that a DCO’s RiskManagement Committee may play acrucial role in the development of therisk management policies of a DCO.However, the board has the ultimateresponsibility for the management of theDCO’s risks. Requiring board approvalof a DCO’s risk management frameworkis also consistent with proposedinternational standards.77

In addition, a requirement that a

DCO’s board approve its riskmanagement framework is consistentwith § 39.13(c), which permits a DCO’sChief Risk Officer to make appropriaterecommendations to the DCO’s RiskManagement Committee regarding theDCO’s risk management functions.Although the board would approve theframework, it could delegate defineddecision-making authority to the RiskManagement Committee in connection

with the implementation of theframework. The Commission is adopting§ 39.13(b) as proposed.

3. Chief Risk Officer—§39.13(c)

Proposed §39.13(c) would require aDCO to have a Chief Risk Officer (CRO)who would be responsible for theimplementation of the risk management

framework and for making appropriaterecommendations regarding the DCO’srisk management functions to the DCO’sRisk Management Committee or boardof directors, as applicable. In a separaterulemaking, the Commission hasproposed to adopt § 39.13(d) to requireDCOs to have a Risk ManagementCommittee with defined compositionrequirements and specified minimumfunctions.78

Better Markets commented that theproposal should provide substantiveparameters for a CRO and that the CROrules applicable to FCMs should beapplied to DCOs. Mr. Greenbergerindicated that the CRO of a DCO should

be subject to the same rules regardingreporting and independence as theCROs of other registered entities.

The Commission does not believe thatit is necessary to further define theresponsibilities of a DCO’s CRO in thefinal rule. The Commission notes that ithas not proposed any rules regarding aCRO for FCMs or any other registeredentities, as suggested by Better Marketsand Mr. Greenberger.79

As noted in the notice of proposedrulemaking, given the importance of therisk management function and the

comprehensive nature of theresponsibilities of a DCO’s CCO, whichare governed by §39.10, as adopted inthis rulemaking, the Commissionexpects that a DCO’s CRO and its CCOwould be two different individuals. TheCommission is adopting §39.13(c) asproposed.

4. Measurement of Credit Exposure—§ 39.13(e)

Proposed §39.13(e) would require aDCO to: (1) Measure its credit exposureto each clearing member and mark tomarket such clearing member’s openpositions at least once each business





80See CPSS–IOSCO Consultative Report,Principle 6: Margin, Key Consideration 4, at 40.

81See Section 5b(c)(2)(D)(iii) of the CEA, 7 U.S.C.7a–1(c)(2)(D)(iii).

day; and (2) monitor its credit exposureto each clearing member periodicallyduring each business day. Proposed§ 39.13(e) was a prerequisite forproposed §39.14(b), which wouldaddress daily settlements based on aDCO’s measurement of its creditexposures to its clearing members.

LCH commented that a DCO should

be required to measure its creditexposures ‘‘several times each businessday’’ and that a DCO should be obligedto recalculate initial and variationmargin requirements more than onceeach business day. By contrast, OCCrequested that the Commission clarifythat the proposed requirement that aDCO monitor its credit exposure to eachclearing member periodically duringeach business day would not require aDCO to update clearing memberpositions on an intra-day basis forpurposes of monitoring risk, whichwould not be practical, and that intra-

day monitoring of credit exposures based on periodic revaluation of beginning-of-day positions would besufficient to comply with the proposedrule.

The Commission does not believe thata DCO should be required to mark eachclearing member’s open positions tomarket and recalculate initial andvariation margin requirements morethan once each business day, and notesthat the requirement that a DCO monitorits credit exposure to each clearingmember periodically during each

business day could be satisfied throughintra-day monitoring of credit exposures

based on periodic revaluation of beginning-of-day positions as suggested by OCC.

However, as discussed in sectionIV.E.2, below, §39.14(b) requires a DCOto effect a settlement with each clearingmember at least once each business day,and to have the authority andoperational capacity to effect asettlement with each clearing member,on an intraday basis, either routinely,when thresholds specified by the DCOare breached, or in times of extrememarket volatility. Therefore, in order tocomply with §39.14(b), a DCO would be

required to have the authority andoperational capacity to mark eachclearing member’s open positions tomarket and recalculate initial andvariation margin requirements, on anintraday basis, under the circumstancesdefined in § 39.14(b).

The Commission is adopting§ 39.13(e) as proposed, except that theCommission is making a technicalrevision by replacing the phrase ‘‘suchclearing member’s open positions’’ withthe phrase ‘‘such clearing member’sopen house and customer positions’’ to

eliminate possible ambiguity and toclarify the Commission’s intent toreflect current industry practice andinclude both house and customerpositions, not just house positions. TheCommission notes that §39.13(e) isconsistent with internationalrecommendations.80

5. Limitation of Exposure to PotentialLosses From Defaults—§ 39.13(f)

Proposed §39.13(f) would require aDCO, through margin requirements andother risk control mechanisms, to limitits exposure to potential losses fromdefaults by its clearing members toensure that: (1) Its operations would not

be disrupted; and (2) non-defaultingclearing members would not be exposedto losses that nondefaulting clearingmembers cannot anticipate or control.The language of proposed §39.13(f) isvirtually identical to the language inSection 5b(c)(2)(D)(iii) of the CEA, as

amended by the Dodd-Frank Act.FIA supported the proposal andMGEX stated that it appeared reasonableif applied appropriately. FIAacknowledged that clearing membersunderstand and accept that they aresubject to losses in the event of a defaultof another clearing member but notedthat these potential losses must bemeasurable and subject to a reasonablecap over a period of simultaneous ormultiple defaults. MGEX suggested thatthe Commission adopt an interpretationthat each clearing member, by becominga clearing member, can reasonablyanticipate that another clearing membermay potentially default and that a DCOcan apply its rules accordingly.

The Commission believes that everyclearing member is aware that anotherclearing member may default. TheCommission also notes that thepotential losses resulting from such adefault will be mitigated to the extentthat a DCO is bound to comply with theCEA, Commission regulations, and itsown rules, particularly with regard tofinancial resources and default rulesand procedures.

KCC commented that there wouldappear to be little cost/benefit

justification for duplicating the statutorylanguage of the core principle in theform of a rule.81 The Commission

believes that codifying provisions of theCEA does not impose an additional coston a DCO because a DCO must satisfysuch requirements to comply with thelaw. At the same time, the Commission

believes that codifying this statutory

provision provides a DCO with a singlelocation in which to identify theminimum standards necessary to fulfillthe requirements of Core Principle D.The Commission is adopting § 39.13(f)as proposed.

6. Margin Requirements—§39.13(g)

a. General

Several commenters made generalcomments about margin requirementsthat did not address specific provisionsof proposed §39.13(g). The Commissionhas summarized those comments, andresponded to those comments, below.

KCC expressed its belief that theCommission’s detailed proposed marginrequirements are not consistent with theDodd-Frank Act’s changes to the CEA,which simply require that a DCO’smargin models and parameters must be‘‘risk-based.’’ The Commission notesthat Section 5b(c)(2) of the CEA, asamended by the Dodd-Frank Act,

requires a DCO to comply with thestatutory core principles ‘‘and anyrequirement that the Commission mayimpose by rule or regulation pursuant tosection 8a(5).’’ As noted in section I.A,above, legally enforceable standards setforth in regulations serve to increaselegal certainty, prevent DCOs fromlowering risk management standards forcompetitive reasons, and increasemarket confidence. These goals areespecially important with respect tomargin, which is one of the key toolsused by DCOs in managing risk.Therefore, the Commission believes it is

appropriate to impose more detailedmargin requirements than thosecontained in the statutory language of Core Principle D.

ISDA urged the Commission to adoptrules requiring DCOs to adopt riskmethodologies that would reduce theimpact that customer account risk hason the size of default fundcontributions. ISDA noted that thiswould enable DCOs to better guarantythe portability of client portfolios, butwould increase risk to the DCO;however, ISDA stated that this increasedrisk could be addressed by increasing

the risk margin of the customer account.The Commission has not proposed andis not adopting such rules. TheCommission believes that a DCO shouldhave reasonable discretion to determinehow it will calculate the amounts of anydefault fund contributions that it mayrequire from its clearing members, andthe extent to which customer risk will

be a factor in such calculations.MFA and Citadel stated that it is

important that a DCO’s process forsetting initial margin be transparent inorder to give all market participants





82See e.g., http://www.cmegroup.com/clearing/ cme-core-cme-clearing-online-risk-engine.html andhttps://www.theice.com/publicdocs/ice _trust/ ICE _Margin _Simulation _Calculator _Training _Presentation.pdf.

83The term ‘‘initial margin’’ is now defined in§ 1.3(lll), adopted herein.

84See 2004 CPSS–IOSCO Recommendations at21.

85See CPSS–IOSCO Consultative Report,Principle 6: Margin, Key Consideration 3, at 40.

86As proposed, §39.13(g)(2)(i) referred toaddressing any ‘‘unique’’ characteristics of, or risksassociated with, particular products or portfolios.The Commission is revising this provision in thefinal rule to refer to any ‘‘unusual’’ characteristicsof, or risks associated with, particular products orportfolios to clarify that such characteristics or risksare not limited to those that are one of a kind. Seealso n. 66, above.

87 In the notice of proposed rulemaking, theCommission defined jump-to-default risk asreferring to the possibility that a CDS portfolio withlarge net sales of protection on an underlyingreference entity could experience significant losses

Continued

certainty as to the margin they canexpect the DCO to assess. Therefore,MFA and Citadel urged the Commissionto adopt final rules that would requirea DCO to make available to all marketparticipants, at no cost, a margincalculation utility, so that they would beable to replicate the calculation of themargin that the DCO would assess.

The Commission notes that it isadopting §§39.21(c)(3) and (d) herein,which require a DCO to discloseinformation concerning its margin-setting methodology on its Web site.However, the Commission is notrequiring a DCO to provide a margincalculation utility to market participantsfree of cost, although the Commissionnotes that some DCOs have chosen to doso.82 The Commission believes thatwhether a DCO will provide a margincalculation utility to marketparticipants, and whether and howmuch it might charge for such a utility,

is a business decision that should be leftto the discretion of a DCO.The FHLBanks indicated that it may

be appropriate, in some circumstances,for a DCO to waive its initial marginrequirements with respect to certainhighly creditworthy customers of aclearing member. Therefore, theFHLBanks urged the Commission togrant DCOs discretion to waive initialmargin requirements when doing sowould not pose risk to the DCO or itsclearing members. In light of the factthat the Dodd-Frank Act requires theremoval of reliance on credit ratings, theFHLBanks recommended that the

Commission adopt alternative criteria by which a DCO could exercise suchdiscretionary waivers, or alternativelygrant DCOs discretion to establish theirown criteria, subject to Commissionapproval, or to guidelines established bythe Commission in the final rule.

The Commission has not proposed arule that would permit it to grant DCOsthe discretion to waive initial marginrequirements and it is not adopting sucha rule, as requested by the FHLBanks.Even if there were an objective way todefine highly creditworthy customers,the Commission does not believe that

permitting such waivers wouldconstitute prudent risk management.

b. Amount of Initial Margin Required—§ 39.13(g)(1)

Proposed §39.13(g)(1) would requirethat the initial margin 83 that a DCO

requires from each clearing membermust be sufficient to cover potentialexposures in normal market conditionsand that each model and parameter usedin setting initial margin requirementsmust be risk-based and reviewed on aregular basis. The Commission invitedcomment regarding whether a definitionof ‘‘normal market conditions’’ should

be included in the proposed regulationand, if so, how normal marketconditions should be defined.

MFA, BlackRock, and Citadelexpressed their support for the proposal.CME and OCC commented that theCommission should not define normalmarket conditions, while ISDA statedthat the Commission should definenormal market conditions. TheCommission noted in the notice of proposed rulemaking that the 2004CPSS–IOSCO Recommendationsdefined ‘‘normal market conditions’’ as‘‘price movements that produce changes

in exposures that are expected to breachmargin requirements or other riskcontrol mechanisms only 1 percent of the time, that is, on average on only onetrading day out of 100.’’ 84 The CPSS–IOSCO Consultative Report waspublished subsequent to the issuance of proposed §39.13(g)(1). The CPSS–IOSCO Consultative Report replaced theconcept of ‘‘normal market conditions’’with a proposed requirement that‘‘[i]nitial margin should meet anestablished single-tailed confidencelevel of at least 99 percent for eachproduct that is margined on a product

basis, each spread within or betweenproducts for which portfolio marginingis permitted, and for each clearingmember’s portfolio losses.’’ 85 TheCommission had also proposed similarrequirements for a 99 percentconfidence level in proposed§ 39.13(g)(2)(iii), discussed below.Therefore, in adopting § 39.13(g)(1), theCommission is declining to adopt theproposed explicit requirement thatinitial margin must be sufficient tocover potential exposures in normalmarket conditions, in order to avoid anyambiguity over the meaning of ‘‘normalmarket conditions.’’

FIA recommended that parametersused in setting initial marginrequirements should be reviewedmonthly and models should bereviewed annually and on an ad hoc

basis if substantive changes are made,whereas OCC took the position that theCommission should permit a DCO touse its reasonable discretion in

determining what constitutes a ‘‘regular basis’’ for reviewing margin models andparameters. The Commission hasdetermined not to specify theappropriate frequency of review, as itmay differ based on the characteristicsof particular products and markets, andthe nature of the margin models andparameters that apply to those products

and markets. However, although§ 39.13(g)(1) would permit a DCO toexercise its discretion in determininghow often it should review its marginmodels and parameters, the Commissionwould apply a reasonableness standardin determining whether the frequency of reviews conducted by a particular DCOwas appropriate.

Moreover, as discussed in sectionIV.D.6.d, below, §39.13(g)(3) requiresthat a DCO’s systems for generatinginitial margin requirements, includingthe DCO’s theoretical models, must bereviewed and validated by a qualified

and independent party, on a regular basis. As the Commission noted in thenotice of proposed rulemaking, theCommission would expect a DCO toobtain an independent validation priorto implementation of a new marginmodel and when making any significantchange to a model that is in use by theDCO. This express expectation wouldaddress FIA’s suggestion that a DCOshould be required to review its marginmodels on an ad hoc basis if substantivechanges are made. For the reasonsdiscussed, the Commission is adopting§ 39.13(g)(1) with the modificationdescribed above.

c. Methodology and Coverage

(1) General—§ 39.13(g)(2)(i)

Proposed §39.13(g)(2)(i) wouldrequire a DCO to establish initial marginrequirements that are commensuratewith the risks of each product andportfolio, including any uniquecharacteristics of, or risks associatedwith, particular products or portfolios.86 In particular, proposed §39.13(g)(2)(i)would require a DCO that clears creditdefault swaps (CDS) to appropriatelyaddress jump-to-default risk in settinginitial margins.87 The Commission


http://www.cmegroup.com/clearing/cme-core-cme-clearing-online-risk-engine.html


https://www.theice.com/publicdocs/ice_trust/ICE_Margin_Simulation_Calculator_Training_Presentation.pdf






















over a very short period of time following anunexpected event of default by the reference entity.

88The term ‘‘variation margin’’ is now defined in§ 1.3(ooo), adopted herein.

89See discussion of §39.13(h)(6)(ii) in sectionIV.D.7.f, below.

90See Section 2(h)(1)(B) of the CEA, 7 U.S.C.2(h)(1)(B).

91See discussion of §39.12(b)(2) in sectionIV.C.2.c, above.

92Section 731 of the Dodd-Frank Act amendedthe CEA to insert Section 4s. See Section4s(e)(3)(A)(ii) of the CEA, 7 U.S.C. 6s(e)(3)(A)(ii).

93NGX estimated that the impact of transitioningfrom its current two-day requirement to a five-dayrequirement for all of the energy products that itclears would lead to an approximate 60 percentincrease in initial margins.

invited comment regarding whetherthere are specific risks that should beidentified and addressed in theproposed regulation in addition tojump-to-default risk.

CME and Nadex, Inc. (Nadex)expressed the opinion that it would not

be beneficial to attempt to identifyadditional specific risks that a DCO

must address in determining initialmargins and LCH commented that thereference to jump-to-default risk shouldeither be removed or amended to coverall other products that are subject tojump-to-default risk. The Commissionagrees with CME and Nadex that it isnot necessary to identify additionalspecific risks in the regulation, and alsoagrees with LCH that the reference tojump-to-default risk should generallyapply to any product that may besubject to such risk. Therefore, theCommission is adopting a revised§ 39.13(g)(2)(i) that eliminates the

specific reference to CDS. TheCommission has also added the phrase‘‘or similar jump risk.’’ This is intendedto address the possibility of a largepayment obligation in a productaccumulating in a very short period of time following an extreme market event.

(2) Liquidation Time—§ 39.13(g)(2)(ii)

Proposed § 39.13(g)(2)(ii) wouldrequire a DCO to use margin models thatgenerate initial margin requirementssufficient to cover the DCO’s potentialfuture exposures to clearing members

based on price movements in theinterval between the last collection of variation margin 88 and the time withinwhich the DCO estimates that it would

be able to liquidate a defaulting clearingmember’s positions (liquidation time).As proposed, a DCO would have to usea liquidation time that is a minimum of five business days for cleared swaps thatwere not executed on a DCM, and aliquidation time that is a minimum of one business day for all other productsthat it clears, although it would berequired to use longer liquidation times,if appropriate, based on the uniquecharacteristics of particular products orportfolios. The Commission invited

comment regarding whether theminimum liquidation times specified inproposed § 39.13(g)(2)(ii) wereappropriate, or whether there wereminimum liquidation times that weremore appropriate.

LCH suggested that ‘‘or transfer’’should be inserted after ‘‘liquidate’’ inthe proposed rule and that an

appropriate liquidation period should be a period that would be sufficient toenable a DCO to adequately hedge orclose out a defaulting member’s risk.The Commission does not believe that itis appropriate to add ‘‘or transfer,’’ or tointerpret the liquidation period toinclude the time that would besufficient to hedge a defaulting clearing

member’s positions. In a worst-casescenario, a DCO would need to liquidatea defaulting clearing member’spositions, and the time it would take todo so should be the relevantconsideration in setting initial marginrequirements.

ISDA commented that a DCO shouldcontinually monitor the risk associatedwith concentration in participants’positions, and if a DCO determines thata participant’s cleared portfolio is solarge that it could not be liquidatedwithin the liquidation period assumedin the DCO’s default management plan,

the DCO should have the discretion toinclude an extra charge forconcentration risk in the initial marginrequirements of that participant. FIAmade similar comments but suggestedthat prudent risk management shouldrequire the imposition of concentrationmargin in appropriate circumstances.FIA further noted that when a DCOimposes concentration margin on aclearing member, the additional marginshould be included in the DCO’sminimum margin calculations for anycustomers of the clearing member thatgenerate the increased risk.

Although the regulations adopted by

the Commission herein do notspecifically address concentrationmargin as described by ISDA and FIA,they do not limit a DCO’s discretion toimpose extra charges on its clearingmembers for concentration risk. Itshould also be noted that §39.13(h)(6),adopted herein,89 requires a DCO to takeadditional actions with respect toparticular clearing members, whenappropriate, based on the application of objective and prudent risk managementstandards, which actions may includeimposing enhanced marginrequirements.

Numerous commenters objected to theproposed difference in requirementsthat would subject swaps that wereeither executed bilaterally or executedon a SEF to a minimum five-dayliquidation time, while permittingequivalent swaps that were executed ona DCM to be subject to a minimum one-day liquidation time. Commentersvariously argued that the proposed one-day/five-day distinction for swap

transactions depending on the venue of execution would: (1) Be inconsistentwith the open access provisions of Section 2(h)(1)(B) of the CEA 90 and/orproposed § 39.12(b)(2) 91 (GFI GroupInc. (GFI), VMAC, LCC (VMAC),BlackRock, Wholesale Markets Brokers’Association, Americas (WMBAA), andFX Alliance Inc. (FXall)); (2) be

inconsistent with Congressional intent,expressed in Section 731 of the Dodd-Frank Act,92 which recognizes adifference in risk between cleared anduncleared swaps that could beaddressed by differential marginrequirements, but does not differentiate

between the risk of swaps executed ona DCM and those executed on a SEF(Asset Management Group of theSecurities Industry and FinancialMarkets Association (AMG)); (3)discriminate against trades not executedon DCMs by requiring DCOs to imposehigher margin requirements for swaps

that are executed on SEFs than forswaps that are executed on DCMs (GFI,VMAC, MarketAxess Corporation(MarketAxess), WMBAA, TradewebMarkets LLC (Tradeweb), NodalExchange, LLC (Nodal), and FXall); (4)raise the cost of clearing for swapstraded on a SEF (National EnergyMarketers Association (NEM), NGX, andBlackRock); 93 (5) put SEFs at acompetitive disadvantage to DCMs (GFI,MarketAxess, and BlackRock); (6)artificially restrict the ability of marketparticipants, including asset managers,to select the best means of execution fortheir swap transactions (BlackRock); (7)

penalize market participants that desireto effect swap transactions on a SEFrather than a DCM (WMBAA andTradeweb); (8) undermine the goal of the Dodd-Frank Act to promote tradingof swaps on SEFs (Tradeweb and FXall);(9) potentially create detrimentalarbitrage between standardized swapstraded on a SEF and futures contractswith the same terms and conditionstraded on a DCM (Nodal); (10) imposeonerous and unnecessary administrativecosts on DCOs, which would likely bepassed on to clearing members and theircustomers (VMAC and BlackRock); (11)

create a disincentive for DCOs topractice appropriate defaultmanagement ‘‘drills’’ to reduce the





94Citadel further commented that excessivemargin requirements relative to risk exposure couldadversely affect market liquidity and deter clearing.

95FIA also commented that liquidation timesshould be set at times appropriate to manage theliquidation of the vast majority of the portfolioscarried by a DCO’s clearing members, and notnecessarily that of the largest clearing member.

96NYMEX, now CME, has cleared OTC swapsgenerally with a one day liquidation time since2002. CME currently offers more than 1,000products for clearing through its ClearPort system.

97 In particular, ICE Clear Credit LLC and CMEuse a five-day liquidation time for credit defaultswaps and LCH and CME use a five-day liquidationtime for interest rate swaps.

98E.g., the 950,000 trades in LCH’s SwapClearhave an aggregate notional principal amount of over$295 trillion. Source: http://www.lch.com/swaps/ swapclear _ for _clearing _members/.

99See Section 2(h)(1)(B) of the CEA and§ 39.12(b)(2), adopted herein (swaps submitted to aDCO with the same terms and conditions areeconomically equivalent within the DCO and may be offset with each other within the DCO).

100See 76 FR 41048 (July 13, 2011) (AgriculturalCommodity Definition; final rule).

liquidation time of portfolios of swaps(ISDA); (12) remove the incentive forDCOs to detail, practice and leverageclearing member expertise in defaultmanagement (FIA); (13) discouragevoluntary clearing (NGX); and (14)require DCOs and clearing members tomanage margin calls and netting basedon the execution platform for the

relevant swaps (VMAC and BlackRock).In addition, a number of commenters

argued that there was no basis forconcluding that swaps executed on aSEF would be less liquid than swapsexecuted on a DCM (GFI, WMBAA,NGX, MarketAxess, AMG, and FXall).

BlackRock recommended that theCommission require a DCO to use aconsistent liquidation time for clearedswaps that are executed on SEFs andDCMs.

Commenters variously contended thata liquidation time of five business daysmay be excessive for some swaps (CME

and Citadel94

), a one-day liquidationperiod is too short (LCH), a one-dayliquidation period is appropriate forswaps executed on a DCM or a SEF(AMG), and a two-day liquidationperiod is appropriate for cleared swaps(NGX).

Various commenters encouraged theCommission to permit a DCO todetermine the appropriate liquidationtime for all products that it clears basedon the unique characteristics andliquidity of each relevant product orportfolio (CME, MFA, ISDA, LCH,NYPC, NGX, FIA,95 Nadex, Citadel, andFXall) or to grant DCOs such discretion

subject to a one-day minimum for allproducts, including cleared swaps (GFI,VMAC, MarketAxess, Nodal, WMBAA,and Tradeweb).

FIA and ISDA commented that theappropriate liquidation time should bederived from a DCO’s defaultmanagement plan and the results of itsperiodic testing of such plan. FIAfurther stated that a DCO should adjustits minimum margin requirements if itsperiodic testing of its defaultmanagement plan demonstrates that adefaulting clearing member’s positionscould be resolved in a shorter period of

time. Similarly, NGX stated that theCommission should permit a DCO todemonstrate through back testing andstress testing that a particular type of cleared transaction should be subject toa shorter liquidation time.

MFA and Citadel recommended thatif the Commission were to mandateminimum liquidation times in the finalrules, it should allow DCOs to apply forexemptions for specific groups of swapsif market conditions prove that suchminimum liquidation times areexcessive. Citadel further recommendedthat the Commission make it explicit

that the Commission may re-evaluateand, if necessary, re-calibrate suchminimum liquidation times as marketsevolve.

The Commission is persuaded by theviews expressed by numerouscommenters that requiring differentminimum liquidation times for clearedswaps that are executed on a DCM andequivalent cleared swaps that areexecuted on a SEF could have negativeconsequences. Therefore, after furtherconsideration, the Commission hasdetermined not to mandate differentminimum liquidation times for cleared

swaps based on their venue of execution, and has further determinedthat the same minimum liquidation timeshould be used with respect to clearedswaps that are executed bilaterally. Thisapproach is consistent with the openaccess requirements of Section2(h)(1)(B) of the CEA and § 39.12(b)(2),adopted herein.

The Commission also acknowledgesthe concerns expressed by commentersthat a five-day liquidation period may

be excessive for some swaps. Forexample, for a number of years, CMEand ICE have successfully cleared swaps

based on physical commodities using a

one-day liquidation time.96 By contrast,as noted in the notice of proposedrulemaking, several DCOs currently usea five-day liquidation time indetermining margin requirements forcertain swaps based on financialinstruments.97 These differences reflectdifferences in the risk characteristics of the products.

The Commission has carefullyconsidered whether it should prescribeany liquidation time or, alternatively,permit each DCO to exercise itsdiscretion in applying liquidation times

based on the risk profile of particular

products or portfolios. In this regard, theCommission notes that even without aspecified minimum liquidation time,under Sections 5b(c)(2)(D) and 8a(7)(D)of the CEA, the Commission can requirea DCO to adjust its margin methodology

if it determines that the current marginlevels for a product or portfolio areinadequate based on back testing orcurrent market volatility.

Weighing the advantages anddrawbacks of the alternatives, theCommission believes that a bright-linerequirement, with a provision formaking exceptions, will best serve the

public interest. While a DCO will stillhave considerable latitude in settingrisk-based margin levels, theCommission has determined thatestablishing a minimum liquidationtime will provide legal certainty for anevolving marketplace, will offer apractical means for assuring that thethousands of different swaps that aregoing to be cleared subject to theCommission’s oversight will haveprudent minimum margin requirements,and will prevent a potential ‘‘race to the

bottom’’ by competing DCOs. Moreover,given the large number of swaps already

cleared, this alleviates the need for theCommission, with its limited staff resources, to evaluate immediately theliquidation time for each swap that iscleared.98

Taking into account theseconsiderations, and in response to thecomments, the Commission is adopting§ 39.13(g)(2)(ii) with a number of modifications. First, the final rulerequires a DCO to use the sameliquidation time for a product whetherit is executed on a DCM, a SEF, or

bilaterally. This addresses thecompetitive concerns raised bynumerous commenters and recognizes

that once a swap is cleared, its riskprofile is not affected by the method bywhich it was executed.99

Second, the final rule provides thatthe minimum liquidation time for swaps

based on certain physical commodities,i.e., agricultural commodities,100 energy,and metals, is one day. For all otherswaps, the minimum liquidation time isfive days. This distinction is based onthe differing risk characteristics of theseproduct groups and is consistent withexisting requirements that reflect therisk assessments DCOs have made overthe course of their experience clearing

these types of swaps. The longerliquidation time, currently five days forcredit default swaps at ICE Clear Credit,LLC, and CME, and for interest rate


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101See e.g., Cleared OTC Interest Rate Swaps at7 (Aug. 2011), available at http:// www.cmegroup.com/clearing/cme-core-cme-clearing-online-risk-engine.html; ICE Clear Credit Clearing Rules, Schedule 401 (Jul. 16, 2011)available at https://www.theice.com/publicdocs/ clear _credit/ICE _Clear _Credit _Rules.pdf.

102The liquidation of the Lehman interest rateswap portfolio in the fall of 2008 demonstrates thatthe actual liquidation time for a swap portfoliocould be longer than 5 days. Between September 15,2008 (the day Lehman Bros. Holdings declared bankruptcy) and October 3, 2008, LCH and‘‘OTCDerivnet,’’ an interest rate derivatives forumof major market dealers, wound down the clearedOTC interest rate swap positions of Lehman Bros.Special Financing Inc. (LBSFI). This portfolio had

a notional value of $9 trillion and consisted of 66,390 trades across 5 major currencies. LCH andOTCDerivnet competitively auctioned off LBSFI’sfive hedge currency portfolios to their members between September 24 and October 3, 2008. Themargin held by LCH proved sufficient to cover thecosts incurred. Source: LCH Press Release of October 8, 2008, available at: http:// www.lchclearnet.com/Images/2008-10- 08%20SwapClear%20default _tcm6–46506.pdf.

103As proposed, §39.13(g)(2)(ii) referred to the‘‘unique’’ characteristics of particular products orportfolios. The Commission is revising this phrasein the final rule to refer to the ‘‘specific’’characteristics of a particular product or portfolioto clarify that such characteristics are not limitedto those that are one of a kind.

104 In a technical revision, the Commission haseliminated the phrase, ‘‘whether the swaps arecarried in a customer account subject to Section4d(a) or 4d(f) of the Act, or carried in a houseaccount,’’ because it is superfluous.

105The terms ‘‘customer account or customerorigin’’ and ‘‘house account or house origin’’ arenow defined in §39.2, adopted herein.

106 ISDA contended that if there were arequirement to have individualized client accounts,the appropriate confidence level should be higherthan 99 percent because the funds available to aDCO to manage a client account default would bereduced.

107MGEX requested that the Commission clarifythat this proposed requirement applies to the netaccount of each clearing member and not theunderlying accounts at each clearing member. TheCommission did not intend proposed§ 39.13(g)(2)(iii)(C), which would refer to ‘‘[e]achaccount held by a clearing member at the DCO, bycustomer origin and house origin * * *, ’’ to applyto individual customer accounts by beneficialowner. However, the Commission notes that§ 39.13(g)(2)(iii)(D), as proposed and as adoptedherein, applies the 99 percent confidence levelrequirement to ‘‘[e]ach swap portfolio, by beneficial

owner.’’108KCC also expressed its belief that ultra-high

confidence level modeling does not protect againstrisk as well as direct margin intervention by theDCO in the case of significant market movements,such as retaining the right to review recent pricemovements to re-establish margins at a higher leveland retaining the right to demand special marginfrom certain clearing members. The Commission believes that a DCO should retain the right to takesuch actions in addition to, rather than instead of,using a 99 percent confidence level, as required by§ 39.13(g)(2)(iii). For example, § 39.13(h)(6)(ii),discussed below, requires a DCO to take additionalactions with respect to particular clearing members,when appropriate, including imposing enhancedmargin requirements.

swaps at LCH and CME, is based ontheir assessment of the higher riskassociated with these products.101 Contributing factors include aconcentration of positions amongclearing members, the number andvariety of products listed, thecomplexity of the portfolios, the long-dated expiration time for many swaps,

and the challenges of the liquidationprocess in the event of a default.102

Third, to provide further flexibility,the Commission is adding a provisionspecifying that, by order, theCommission may provide for a differentminimum liquidation time for particularproducts or portfolios. As marketsevolve, it may become appropriate toease the requirement for certain swapssubject to the five-day minimum.Conversely, analysis may reveal that forother products or portfolios the five-dayor one-day minimum is insufficient. TheCommission believes that in light of the

novelty, complexity, and potentialmagnitude of the risk posed by financialswaps, prudential considerations dictatethat this type of fine-tuning should beused in appropriate circumstances.Such an order could be granted uponthe Commission’s initiative or inresponse to a petition from a DCO.

In this regard, the Commissionemphasizes that it is retaining theproposed requirement that a DCO mustuse longer liquidation times, if appropriate, based on the specificcharacteristics of particular products orportfolios.103 Such longer liquidationtimes may be based on a DCO’s testing

of its default management plan. If a DCOdetermines that a longer liquidationtime is appropriate for a particularswap, the Commission would expectthat the DCO would use the same longerliquidation time for the equivalentswaps that it clears, whether the swapsare executed on a DCM, a SEF, or

bilaterally. Among the factors that DCOs

should consider in establishingminimum liquidation times are: (i)Average daily trading volume in aproduct; (ii) average daily open interestin a product; (iii) concentration of openinterest; (iv) availability of a predictable

basis relationship with a highly liquidproduct; and (v) availability of multiplemarket participants in related markets totake on positions in the market inquestion. The Commission would alsoconsider these factors in determiningwhether a particular liquidation timewas appropriate.


§ 39.13(g)(2)(ii) revised to read as setforth in the regulatory text of this finalrule.104

(3) Confidence Level—§ 39.13(g)(2)(iii)

Proposed §39.13(g)(2)(iii) wouldrequire that the actual coverage of theinitial margin requirements produced bya DCO’s margin models, along withprojected measures of the models’performance, would have to meet aconfidence level of at least 99 percent,

based on data from an appropriatehistoric time period with respect to: (A)each product that is margined on a

product basis; (B) each spread within or between products for which there is adefined spread margin rate, as describedin proposed § 39.13(g)(3); (C) eachaccount held by a clearing member atthe DCO, by customer origin and houseorigin,105 and (D) each swap portfolio,

by beneficial owner. The Commissioninvited comment regarding whether aconfidence level of 99 percent isappropriate with respect to allapplicable products, spreads, accounts,and swap portfolios.

Alice Corporation supported theproposed 99 percent confidence level,

especially for new swaps and swapswith non-linear characteristics. ISDAcommented that the proposed 99percent confidence level is appropriategiven current levels of mutualization ina DCO default fund and mutualization

in omnibus client accounts.106 MGEXstated that it did not oppose theproposed 99 percent confidence levelfor each account held by a clearingmember at a DCO, by customer originand house origin.107

FIA opposed the proposed 99 percentrequirement because it sets an artificialfloor that may remove the incentive for

DCOs to conduct the rigorous analysisnecessary to establish an appropriateconfidence level. FIA further stated thatif a different regulatory scheme thanloss mutualization for the protection of customer funds were to be adopted forcleared swaps, a much higher level of confidence may be required.

CME, Nadex, KCC,108 and Citadeltook the position that the Commissionshould not prescribe a specificconfidence level, but should insteadcontinue to give each DCO thediscretion to determine the appropriateconfidence levels. CME and Nadexnoted that one or more of the followingfactors could be considered by a DCO indetermining the appropriate confidencelevels: the particular characteristics of the products and portfolios it clears, thedepth of the underlying markets, theexistence of multiple venues tradingsimilar products on which a defaultingclearing member’s portfolio could beliquidated or hedged, the duration of theproducts, the size of the DCO and itssystemic importance, its customer base,or its other risk management tools.

The Commission does not agree suchdiscretion is appropriate and has





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109See CPSS–IOSCO Consultative Report,Principle 6: Margin, Key Consideration 3, at 40. Inaddition, on September 15, 2010, the EuropeanCommission (EC) proposed the European Market

Infrastructure Regulation (EMIR), available at http:// ec.europa.eu/internal _market/financial-markets/ docs/derivatives/20100915 _ proposal _en.pdf, ‘‘toensure implementation of the G20 commitments toclear standardized derivatives [which can beaccessed at http://www.g20.org/Documents/ pittsburgh _summit _leaders _statement _250909.pdf, and that Central Counterparties (CCPs) comply withhigh prudential standards * * *,’’ among otherthings, and expressed its intent to be consistentwith the Dodd-Frank Act. (EMIR, at 2–3). The EMIRrequires that margins ‘‘* * * shall be sufficient tocover losses that result from at least 99 per cent of the exposures movements over an appropriate timehorizon * * *.’’ (EMIR, Article 39, paragraph 1, at46).

110See 2004 CPSS–IOSCO Recommendations at23.

111See discussion of §39.15(b)(2), adoptedherein, in section IV.F.3, below.

112For purposes of clarification, certainreferences to customer origin in §§39.13 and 39.19have been replaced with references to ‘‘eachcustomer origin’’ to clarify the distinction betweencustomer positions in futures and optionssegregated pursuant to Section 4d(a) of the CEA,and customer positions in swaps segregatedpursuant to Section 4d(f) of the CEA.

determined to establish a minimumconfidence level. The Commission

believes that a minimum confidencelevel will provide legal certainty for anevolving marketplace, will offer apractical means for assuring marketparticipants that the thousands of different products that are going to becleared subject to the Commission’s

oversight will have prudent minimummargin requirements, and will prevent apotential ‘‘race to the bottom’’ bycompeting DCOs. Moreover, given thelarge number of products alreadycleared, this alleviates the need for theCommission, with its limited staff resources, to evaluate immediately theconfidence level requirements for eachproduct that is cleared.

The Commission is adopting theproposed minimum 99 percentconfidence level. This is consistent withproposed international standards.109 Moreover, given the potential costs of

default, the Commission agrees withthose commenters who stated that a 99percent level is appropriate. Anindividual DCO may determine to set ahigher confidence level, in itsdiscretion.

NASDAQ OMX Commodities ClearingCompany (NOCC) supported anapproach that would allow DCOs to setmargin requirements for new and low-volume products at a lower coveragelevel if the potential losses resultingfrom such products are minimal.According to NOCC, this would allowDCOs to include more products andmarket participants by attracting them at

an early stage without materiallyincreasing the risk of the DCO.

VMAC suggested that the Commissionadd to the requirement that initialmargin levels must be based upon ‘‘anestablished confidence level of at least99 percent,’’ language that states ‘‘or,subject to specific authorization fromthe CFTC, a lower confidence level.’’ Inparticular, VMAC commented thatalthough a DCO should be required to

demonstrate that the given confidencelevel results in an initial margin amountwhich is sufficient to allow the DCO tofully discharge its obligations upon aclearing member default, a DCO shouldnot be required to collect marginsubstantially in excess of its obligationsto clearing members in a defaultscenario.

The Commission is not modifying thelanguage of §39.13(g)(2)(iii) in a mannerthat would permit DCOs to set marginrequirements at a lower coverage levelfor new and low-volume products, asrecommended by NOCC, or provide fora lower confidence level subject tospecific Commission authorization, assuggested by VMAC. In the notice of proposed rulemaking, the Commissionnoted that the 2004 CPSS–IOSCORecommendations stated that ‘‘[m]arginrequirements for new and low-volumeproducts might be set at a lowercoverage level [than the major products

cleared by a CCP] if the potential lossesresulting from such products areminimal.’’ 110 However, the CPSS–IOSCO Consultative Report, which wasissued subsequent to the Commission’sproposed rules, does not contain similarlanguage. The Commission believes thatit is prudent to apply the same standardto all products.

OCC and NYPC encouraged theCommission to modify its proposal tomake clear that, when swaps arecommingled in either a Section 4d(a)futures account or a Section 4d(f)cleared swaps account, pursuant to§ 39.15(b)(2),111 the 99 percent test neednot be separately applied to the swapspositions alone. The Commission agreeswith OCC and NYPC that if swaps andfutures are held in the same customeraccount pursuant to rules approved bythe Commission or a 4d order issued bythe Commission, as specified in§ 39.15(b)(2), the 99 percent test wouldapply to the entire commingled account,and not just the swap positions, under§ 39.13(g)(2)(iii)(D). Therefore, theCommission is modifying§ 39.13(g)(2)(iii)(D) to add ‘‘includingany portfolio containing futures and/oroptions and held in a commingled

account pursuant to § 39.15(b)(2) of thispart,’’ after ‘‘[e]ach swap portfolio.’’ TheCommission is making similarmodifications in § 39.13(g)(7) withrespect to back testing requirements,which are discussed in section IV.D.6.g,

below.OCC also requested that the

Commission clarify that, in the case of

a margin system that calculates marginfor all positions in an account on the

basis of the net risk of those positions based upon historical price correlationsrather than on a product or a pre-defined spread basis, the 99 percentconfidence level would be applied onlyon an account-by-account basis, and notto individual products, product groups,

or specified spread positions. NYPCmade a similar request, stating that itshistorical Value at Risk (VaR)-basedmargin model calculates initial marginrequirements at the portfolio level,rather than on a product or spread basis.

The Commission notes that, asproposed, § 39.13(g)(2)(iii)(A) wouldrequire the application of the 99 percentconfidence level to ‘‘[e]ach product (thatis margined on a product basis)’’ and§ 39.13(g)(2)(iii)(B) would require theapplication of the 99 percent confidencelevel to ‘‘[e]ach spread within or

between products for which there is a

defined spread margin rate * * *.’’ TheCommission’s intent was that§§ 39.13(g)(2)(iii)(A) and (B) wouldapply to products and pre-definedspreads under margin models thatcalculate initial margin requirements ona product and pre-defined spread basis,respectively. Further, with respect tomargin models that do not calculatemargin on a product or pre-definedspread basis, the 99 percent requirementwould apply with respect to eachaccount held by a clearing member atthe DCO by house origin and by eachcustomer origin, and to each swapportfolio, by beneficial owner, pursuantto §§39.13(g)(2)(iii)(C) and (D),respectively.112

In order to clarify the Commission’sintent, the Commission is adopting§ 39.13(g)(2)(iii)(A) to read as follows:‘‘[e]ach product for which thederivatives clearing organization uses aproduct-based margin methodology,’’while striking ‘‘(that is margined on aproduct basis).’’ In addition, theCommission is adopting§ 39.13(g)(2)(iii)(B) to read as follows:‘‘[e]ach spread within or betweenproducts for which there is a definedspread margin rate,’’ while striking ‘‘as

described in paragraph (g)(4) of thissection.’’

LCH commented that theCommission’s approach to settingmargin based on products and spreads,while appropriate for futures, is not


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113See CPSS–IOSCO Consultative Report,Principle 6: Margin, Explanatory Note 3.6.7, at 43.

114The Commission also notes that the CPSS–IOSCO Consultative Report recommends that aCCP’s initial margin models should beindependently validated at least on a yearly basis.CPSS–IOSCO Consultative Report, Principle 6:Margin, Explanatory Note 3.6.8, at 43. TheCommission is not requiring an annual validationat this time, although it may revisit this issue in thefuture.

115Section 39.18(j)(2), as proposed, and asadopted herein, states that testing shall beconducted by qualified, independent professionals.Such qualified independent professionals may beindependent contractors or employees of thederivatives clearing organization, but shall not bepersons responsible for development or operation of

the systems or capabilities being tested.116 In particular, OCC noted that the Office of theComptroller of the Currency, the Department of theTreasury, the Federal Reserve System and theFederal Deposit Insurance Corporation recentlyproposed revisions to their risk-based capitalguidelines, which would require that, with respectto the validation of banks’ internal risk models,‘‘[t]he review personnel [would] not necessarilyhave to be external to the bank in order to achievethe required independence’’ but that ‘‘[a] bankshould ensure that individuals who perform thereview are not biased in their assessment due totheir involvement in the development,implementation, or operation of the models.’’ See76 FR 1890, at 1897 (Jan. 11, 2011) (Risk-BasedCapital Guidelines: Market Risk).

suitable or sufficient for swaps. LCHproposed that the key requirement forswaps should be for the DCO to ensurethat it has enough margin and guaranteefunds to cover its exposures, and for theDCO to prove this on an individualclient and clearing member basis. TheCommission did not intend to suggestthat swaps should be margined pursuantto a product-based margin methodology,nor that they should be subject todefined spread margin rates. TheCommission recognizes that swaps areoften margined on a portfolio basis andspecifically addressed swap portfoliosin §39.13(g)(2)(iii)(D). The Commissionwould also like to clarify that a 99percent confidence level, as applied toswap portfolios, means that eachportfolio is covered 99 percent of thetime, and not that a collection of portfolios is covered 99 percent of thetime on an aggregate basis.

The Commission is adopting§ 39.13(g)(2)(iii) with the modificationsdescribed above.

(4) Appropriate Historic Time Period—§ 39.13(g)(2)(iv)

Proposed § 39.13(g)(2)(iv) wouldrequire each DCO to determine theappropriate historic time period of datathat it would use for establishing the 99percent confidence level based on thecharacteristics, including volatilitypatterns, as applicable, of each product,spread, account, or portfolio.

LCH recommended that theCommission define the ‘‘historic timeperiod’’ as a minimum of one calendaryear in order to provide for adequatehistorical observations. TheCommission believes that a DCO should

be permitted to exercise its discretionwith respect to the appropriate timeperiods that should be used, based onthe characteristics, including volatilitypatterns, as applicable, of the relevantproducts, spreads, accounts, orportfolios. The Commission also notesthat proposed international standardsdo not specify a historic time period

that would be appropriate in allcircumstances, recognizing that either ashorter or a longer historic time periodmay be appropriate based on thevolatility patterns of a particularproduct.113 The Commission expectsthat DCOs would include periods of significant financial stress. Therefore,the Commission is adopting§ 39.13(g)(2)(iv) as proposed.

d. Independent Validation—§ 39.13(g)(3)

Proposed §39.13(g)(3) would requirethat a DCO’s systems for generatinginitial margin requirements, includingthe DCO’s theoretical models, must bereviewed and validated by a qualifiedand independent party, on a regular

basis. The Commission invitedcomment regarding whether a qualifiedand independent party must be a thirdparty or whether there may becircumstances under which anemployee of a DCO could be consideredto be independent.

In the notice of proposed rulemaking,the Commission explained that avalidation should include acomprehensive analysis to ensure thatsuch systems and models achieve theirintended goals. The Commission alsonoted that, although the proposedregulation did not define the meaning of ‘‘regular basis,’’ the Commission would

expect that, at a minimum, a DCOwould obtain such an independentvalidation prior to implementation of anew margin model and when makingany significant change to a model thatwas in use by the DCO.114 TheCommission further stated thatsignificant changes would be those thatcould materially affect the nature orlevel of risks to which a DCO would beexposed, and that the Commissionwould expect a DCO to obtain anindependent validation prior to anysignificant change that would relax riskmanagement standards. However, the

Commission noted that if a DCO neededto adopt a significant change in anexpedited manner to enhance riskprotections, the Commission wouldexpect the DCO to obtain anindependent validation promptly afterthe change was made.

CME, OCC, MGEX, and KCC allexpressed the view that an employee of a DCO could be independent inappropriate circumstances. CMEcommented that permitting employeesof a DCO to conduct the requiredreviews would be consistent withproposed §39.18(j)(2), which wouldallow employees of a DCO to conduct

the required testing of a DCO’s businesscontinuity and disaster recoverysystems, provided that such employeesare not the persons responsible fordeveloping or operating the systems

being tested.115 OCC and MGEX tookthe position that employees of a DCOcould be independent as long as theyare not, or have not been, involved indesigning the models, and OCC furtherstated that internal personnel must nototherwise be biased due to theirinvolvement in implementation of themodels.116 However, FIA argued that

margin models should be required to bevalidated by an independent third partywith expertise in risk and the product

being cleared.The Commission recognizes that a

third party could be more critical of aDCO’s margin model than an employeeof a DCO, even if that employee is‘‘qualified and independent.’’ However,the Commission also believes that athird party could be less critical if, forexample, it seeks to provide services tothe DCO or the industry in the future.

The Commission agrees with CME,OCC, MGEX, and KCC that an employee

of a DCO could be a ‘‘qualified andindependent party,’’ and thus couldreview and validate the DCO’s systemsfor generating initial marginrequirements, under appropriatecircumstances. It would probably bemore costly for a DCO to use a thirdparty for this purpose rather than anemployee.

On balance, the Commission believesthat it may be appropriate for a DCO tohave an employee review and validateits margin systems. Therefore, theCommission is adopting §39.13(g)(3)with the addition of a sentence statingthat ‘‘[s]uch qualified and independentparties may be independent contractorsor employees of the derivatives clearingorganization, but shall not be personsresponsible for development oroperation of the systems and models

being tested.’’ This is consistent withthe language contained in §39.18(j)(2),as adopted herein, as well as the





117 Id.118For a description of SPAN, see CME’s Web

site, at http://www.cmegroup.com/clearing/risk-management/span-overview.html#works.

119See id. for a description of SPAN parameters.Therefore, §39.13(g)(1), which requires that a DCOreview its margin models and parameters, on aregular basis, requires a broader review than would be met by compliance with §39.13(g)(3).

120 In addition to the other comments discussedherein, Alice Corporation noted that it supportedthe cautious approach taken by the Commissionand that offsets across products with differentmaturities and risk profiles should be avoidedwhere possible, and ISDA stated that spreadmargins should only permitted when a DCO candemonstrate a strong correlation in stressed marketconditions and agrees to periodic public disclosureof its methodology and results. With respect toISDA’s comment, the Commission notes that

§ 39.13(g)(2)(iii), discussed in section IV.D.6.c.(3),above, requires a DCO to ensure that the actualcoverage of its initial margin requirements, alongwith projected measures of the performance of itsmargin models, must meet an establishedconfidence level of at least 99 percent, based ondata from an appropriate historic time period, for,among other things, spreads within or betweenproducts for which there is a defined spread marginrate, for each account held by a clearing memberat the DCO, by customer and house origin, and foreach swap portfolio, by beneficial owner, and§ 39.13(g)(7), discussed in section IV.D.6.g, below,imposes related back testing requirements. Inaddition, §39.21(c)(3), discussed in section IV.L, below, requires a DCO to publicly disclose itsmargin methodology.

proposed approach of other financialregulators.117 The Commission alsonotes that the reference to independentcontractors as well as employees in theadded language will also prohibit a DCOfrom using a particular third party toconduct the validation if that third partywas or is responsible for development oroperation of the relevant systems and

models.KCC requested that the Commission

clarify that the CRO or other comparablepersonnel with responsibility for overallrisk management at the DCO wouldmeet the requirements of a ‘‘qualifiedand independent party.’’ TheCommission does not believe that aDCO’s CRO or personnel responsible foroverall risk management wouldcategorically qualify as an ‘‘independentparty.’’ This determination would needto be made on a case-by-case basisdepending on whether the CRO or othersimilar person was or is responsible for

development or operation of the systemsand models being tested.MGEX requested that the Commission

clarify whether the requirement forindependent validation would apply tothe primary risk-based portfolio systemsuch as SPAN,118 or each DCO’sanalysis program for determiningmargins, noting its belief that requiringindependent tests on the latter would beexcessive. It is not clear what MGEXmeans by ‘‘each DCO’s analysis programfor determining margins.’’ However,§ 39.13(g)(3) requires independentvalidation with respect to a DCO’sunderlying model, e.g., SPAN or OCC’sSTANS model, as well as themethodology used to compute theinputs to any such model. On the otherhand, a DCO would not be required toobtain an independent validation of achange in SPAN parameters asdescribed by CME.119

OCC commented that, as described inthe notice of proposed rulemaking, the‘‘could materially affect’’ standard isdeficient in two respects in that: (1) Itfails to include any reference to thelikelihood that a change would actuallymaterially affect the nature or level of risk, and (2) it omits any reference to the

direction of the change in level of risk.OCC contended that a more appropriatestandard would be to provide thatsignificant changes are those that ‘‘arereasonably likely to materially change

the nature or increase the level of risksto which the DCO would be exposed.’’

In response to this comment, theCommission is modifying the standardto provide that significant changes arethose for which there is a reasonablepossibility that they would materiallyaffect the nature or level of risks towhich a DCO would be exposed. While

this standard identifies the likelihoodthat a change would materially affectthe nature or level of such risks, theCommission believes that it is moreappropriate than identifying significantchanges as only those that are‘‘reasonably likely to materially change’’the nature or level of such risks.

The Commission does not believe thatsignificant changes should be limited tothose that are likely to increase the levelof risks. As described in the notice of proposed rulemaking, the Commissionwould expect a DCO to obtain anindependent validation prior to any

significant change that would relax riskmanagement standards, but theCommission would permit a DCO toobtain an independent validationpromptly after a significant change thatwould enhance risk protections, inappropriate circumstances. A DCOshould obtain such a validation even if the change were designed to enhancerisk protections, in order to ensure thatthe change would be effective inachieving its objective.

OCC also requested that theCommission clarify that the addition of a new product or new underlying

interest would not inherently bedeemed to trigger the independentevaluation requirement. TheCommission believes that whether theaddition of a new product or a newunderlying interest would trigger theindependent validation requirementwould need to be determined on a case-

by-case basis, depending on whetherthere is a reasonable possibility thatsuch addition will materially change thenature or level of risks to which theDCO would be exposed. One examplewould be if the addition necessitates asignificant change to the margin model

as it applies to the new product or newunderlying interest. Thus, the additionof a futures contract based on a new

broad-based securities index where theDCO already clears futures contracts

based on broad-based securities indexesmight not require a significant change tothe applicable margin model. However,the addition of a new category of swaps,even if the DCO already clears swaps,might require a significantly differentmargin model. Another example might

be if a swap cleared by a DCO becamesubject to a clearing mandate and the

risk profile changed because of changesin volume and open interest.

e. Spread and Portfolio Margins—§ 39.13(g)(4)(i)

Proposed § 39.13(g)(4)(i) wouldpermit a DCO to allow reductions ininitial margin requirements for relatedpositions (spread margins), if the price

risks with respect to such positionswere significantly and reliablycorrelated. Under the proposedregulation, the price risks of differentpositions would only be considered to

be reliably correlated if there were atheoretical basis for the correlation inaddition to an exhibited statisticalcorrelation. Proposed §39.13(g)(4)(i)would include a non-exclusive list of possible theoretical bases, including thefollowing: (A) The products on whichthe positions are based are complementsof, or substitutes for, each other; (B) oneproduct is a significant input into the

other product(s); (C) the products sharea significant common input; or (D) theprices of the products are influenced bycommon external factors. TheCommission requested commentregarding the appropriateness of requiring a theoretical basis for thecorrelation between related positions

before reductions in initial marginrequirements would be permitted. Inaddition, proposed §39.13(g)(4)(ii)would require a DCO to regularly reviewits spread margins and the correlationson which they are based.120

KCC and OCC addressed the proposedrequirement that the price risks of

related positions would only beconsidered to be reliably correlated, andthus be eligible for initial marginreductions, if there were a theoretical

basis for the correlation in addition to


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121A defined spread margin rate may also applyto three related products, e.g., the Chicago Board of Trade’s soybean crush spread with respect tosoybeans, soybean oil and soybean meal.

an exhibited statistical correlation. KCCcontended that the proposedrequirement would be difficult for theCommission to implement andunnecessary because DCOs have noincentive to offer margin reductions inthe absence of high correlation betweenpositions. KCC further noted that theproposal does not detail what level of

observed statistical correlation isrequired, and the proposed requirementto articulate a theoretical basis is vague.

OCC also questioned theappropriateness of the requirement thatthere must be a theoretical basis for thecorrelation, noting that a theoretical

basis for correlation is, by definition,theoretical and may not be directlyobservable or verifiable except throughthe correlation. OCC stated that it isdifficult to imagine a correlation forwhich no theoretical basis can beconstructed, and in many if not mostcases, the theoretical basis for any

significant correlation is obvious.The Commission continues to believethat reductions in initial marginrequirements should only be allowed if a DCO is able to articulate a reasonabletheoretical explanation for an observedstatistical correlation to ensure that thepositions are reliably correlated. TheCommission notes that it is a matter of

basic statistics that correlation does notequal causation. The world is repletewith examples of events or data that arehighly correlated at various points intime but for which there is notheoretical relationship. If there is notheoretical relationship, a DCO has no

basis to believe that a statisticalrelationship—no matter how strong—isstable, and a margin based on such arelationship may be insufficient tocapture price variation.

Several commenters addressed theappropriateness of applying proposed§ 39.13(g)(4) to portfolio-based marginsystems. LCH commented that thespread margin measure which theCommission proposed is unsuited andinappropriate for swaps clearing andthat the Portfolio Approach to InterestRate Scenarios (PAIRS), the historicalsimulation method that LCH uses, is

more suitable to non-standardizedswaps. Therefore, LCH urged theCommission to amend proposed§ 39.13(g)(4) to afford recognition to thistechnique. OCC requested that theCommission acknowledge that itsSTANS methodology meets therequirements of proposed §39.13(g)(4),noting that STANS currently relies onover 20 million separate correlations.OCC stated that it would be impracticalto attempt to document or evenarticulate the ‘‘theoretical basis’’ for allof these correlations even though it

believes that they would be supportableon a theoretical level, and further

believes that its systems for determiningand reviewing the validity of thecorrelations it uses are sufficient toensure that OCC does not allowunjustified margin offsets. NYPCrequested that the Commission clarifythat §39.13(g)(4) would not be

applicable to margin models thatcalculate initial margin requirements atthe account level, including NYPC’shistorical VaR-based margin model.

The Commission intends §39.13(g)(4)to apply to portfolio-based marginmodels as well as product-based marginmodels. For some products, DCOsestablish defined spread margin rates,pursuant to a product-based marginmethodology. Typically, this occurswhere there is a bilateral correlation,e.g., a March-June calendar spread or acorrelation between two relatedproducts.121 For other products, there

may be multilateral correlations forwhich margin is calculated on aportfolio basis, pursuant to a portfolio-

based margin methodology. In the latterinstance, there is not a defined marginamount or margin reduction for adefined portfolio that remains the sameover time. Instead, margin isrecalculated each day for eachindividual portfolio.

Therefore, the Commission isadopting §39.13(g)(4), with severalmodifications, in order to clarify thatmargin reductions calculated on aportfolio basis are also permissible if they meet the standards of theregulation. First, the Commission ischanging the heading of the provisionfrom ‘‘[s]pread margins’’ to ‘‘[s]preadand portfolio margins.’’ TheCommission is also removing theparenthetical ‘‘(spread margins)’’ afterthe clause in § 39.13(g)(4)(i) that states‘‘[a] derivatives clearing organizationmay allow reductions in initial marginrequirements for related positions.’’Finally, the Commission is changing thereference to ‘‘spread margins’’ in§ 39.13(g)(4)(ii) to ‘‘margin reductions.’’These changes are designed to make itclear that §39.13(g)(4) applies to

reductions in initial marginrequirements for related positions,whether a DCO uses a product-basedmargin model or a portfolio-basedmargin model.

Better Markets and Mr. Greenbergercommented that § 39.13(g)(4) mustrequire that the relationship betweenpositions be calculated using the same

standards (with respect to volatility andliquidity requirements) that are appliedto the calculation of initial margin forthe individual positions. TheCommission agrees with Better Marketsand Mr. Greenberger and, as discussedabove, spread and portfolio marginswould also be subject to a 99 percentcoverage standard.

f. Price Data—§ 39.13(g)(5)

Proposed §39.13(g)(5) would requirea DCO to have a reliable source of timely price data to measure its creditexposure accurately, and to have writtenprocedures and sound valuation modelsfor addressing circumstances wherepricing data is not readily available orreliable.

Interactive Data Corporationexpressed its belief that the concept of ‘‘sound valuation models’’ should beexpanded further with additionalprescriptive guidance in four key

dimensions, including: (1) Leveraginggreater trade transparency; (2) usingmultiple sources; (3) mitigating conflictsof interest; and (4) sourcing of independent price data.

The Commission does not believe thatit is necessary to be more specific orprescriptive with respect to thisrequirement, and is adopting§ 39.13(g)(5) as proposed. As theCommission noted in the notice of proposed rulemaking, the nature of theapplicable valuation models wouldnecessarily depend on the particularproducts and the available sources of any relevant pricing data.

g. Daily Review and Back Tests—§§ 39.13(g)(6) and (g)(7)

Proposed §39.13(g)(6) would requirea DCO to determine the adequacy of itsinitial margin requirements for eachproduct, on a daily basis, with respectto those products that are margined ona product basis.

Proposed §39.13(g)(7) would requirea DCO to conduct certain back tests. TheCommission has defined ‘‘back test’’ in§ 39.2, adopted herein, as ‘‘a test thatcompares a derivatives clearingorganization’s initial margin

requirements with historical pricechanges to determine the extent of actual margin coverage.’’

For purposes of proposed§ 39.13(g)(7)(i) and (ii), the introductoryparagraph of proposed §39.13(g)(7)would require that, in conducting backtests, a DCO use historical price changedata based on a time period that isequivalent in length to the historic timeperiod used by the applicable marginmodel for establishing the minimum 99percent confidence level or a longertime period. The applicable time period





122MGEX correctly understands that theCommission’s reference to ‘‘each account held by aclearing member at the DCO, by origin, house andcustomer’’ in proposed §39.13(g)(7)(iii) was notintended to apply to individual accounts by beneficial owner, although proposed§ 39.13(g)(7)(iii) would require monthly back testswith respect to initial margin requirements for eachswap portfolio, by beneficial owner.

123The Commission believes that each DCOshould determine what ‘‘significant volatility’’means based upon the volatility patterns of eachindividual product or swap portfolio that it clears.

124The Commission has not defined a‘‘significant position,’’ leaving that determination tothe discretion of each DCO, as the size of a positionthat would be a ‘‘significant position’’ may varydepending on the nature of the particular productor the composition of the particular account.

125See discussion of the addition of the samelanguage to §39.13(g)(2)(iii)(D), in sectionIV.D.6.c.(3), above.

was separately specified for the backtests required by proposed§ 39.13(g)(7)(iii), as discussed below.

Proposed § 39.13(g)(7)(i) wouldrequire a DCO, on a daily basis, toconduct back tests with respect toproducts that are experiencingsignificant market volatility.Specifically, a DCO would be required

to test the adequacy of its initial marginrequirements and its spread marginrequirements for such products that aremargined on a product basis.

Proposed § 39.13(g)(7)(ii) wouldrequire a DCO, on at least a monthly

basis, to conduct back tests to test theadequacy of its initial marginrequirements and spread marginrequirements for each product that ismargined on a product basis. TheCommission requested commentregarding whether initial marginrequirements for all products should besubject to back tests on a monthly basisor whether some other time period, suchas quarterly, would be sufficient to meetprudent risk management standards.

Proposed § 39.13(g)(7)(iii) wouldrequire a DCO, on at least a monthly

basis, to conduct back tests to test theadequacy of its initial marginrequirements for each clearing member’saccounts, by customer origin and houseorigin, and each swap portfolio, by

beneficial owner, over at least theprevious 30 days. In the notice of proposed rulemaking, the Commissionnoted that, since the composition of such accounts and swap portfolios maychange on a daily basis, it was

anticipated that back tests with respectto such accounts and portfolios wouldinvolve a review of the initial marginrequirements for each account andportfolio as it existed on each dayduring the 30-day period. TheCommission also requested commentregarding whether initial marginrequirements for all clearing members’accounts, by origin, and swap portfolios,

by beneficial owner, should be subjectto back tests on a monthly basis orwhether some other time period, such asquarterly (based on the previousquarter’s historical data), would be

sufficient to meet prudent riskmanagement standards.Several commenters addressed the

appropriate frequency of back tests and/or the appropriate historic time periodfor the analysis of price change data.FIA commented that initial marginrequirements should be back testedmonthly. MGEX stated that it was notopposed to a monthly back testingrequirement with respect to proposed§ 39.13(g)(7)(iii) based on itsunderstanding that the Commissionintended that the DCO must look at its

clearing member’s net account and noteach underlying customer account withthe exception of swaps.122

LCH took the position that back testsshould be conducted at least on a daily

basis for all products cleared by a DCO.However, LCH argued that such backtests should be conducted at theportfolio level because margining

techniques appropriate for swaps, suchas LCH’s PAIRS methodology, do notallow for the disaggregation of initialmargin and spread margin requirementsat a product level. LCH also commentedthat, for back tests to be statisticallymeaningful, the applicable historic timeperiod should be a minimum of onecalendar year.

KCC stated that it may be appropriatefor the Commission to further define‘‘significant market volatility,’’ forpurposes of proposed §39.13(g)(7)(i),123 but that, more generally, any back-testing requirements should be based on

a discretionary, risk-baseddetermination by the DCO. In addition,KCC expressed its belief that the backtesting period should be subject to thediscretion of the DCO in light of then-current market conditions, i.e.,imposing a specific back-testing periodmay inappropriately reflect anexaggerated or understated level of market volatility.

NOCC took the position that products,customers or spread credits shouldreach a specified volume or riskexposure level before being required to

be back tested with the proposed

frequencies so long as the DCO candemonstrate that it is meeting the coreprinciple objectives underlyingproposed § 39.13(f).

NYPC requested that the Commissionclarify that proposed §§39.13(g)(6) and(g)(7)(i)–(ii) would not be applicable tomargin models that calculate initialmargin requirements at the accountlevel, including NYPC’s historical VaR-

based margin model. OCC also stated its belief that it would not be subject to therequirement for daily review inproposed §39.13(g)(7)(i), as it does notmargin on a product basis, but noted

that it does conduct daily back testingon all accounts, i.e., on a portfolio basis.

The Commission is adopting§ 39.13(g)(6), eliminating the languagestating ‘‘for each product (that ismargined on a product basis),’’ in orderto correct a potential inconsistency

between the text of the rule and thenotice of proposed rulemaking. In thenotice of proposed rulemaking, theCommission stated that ‘‘[d]aily review

and periodic back testing are essential toenable a DCO to provide adequatecoverage of the DCO’s risk exposures toits clearing members.’’ As proposed,§ 39.13(g)(6) would only require a DCOto determine the adequacy of its initialmargin requirements, on a daily basis,for products that were margined on aproduct basis. The adequacy of a DCO’sinitial margin requirements for futuresand options on futures productsmargined on a portfolio basis, and forswap portfolios, would not have beensubject to such daily review. TheCommission believes that such a result

is untenable, as one of the mostrudimentary steps in risk managementis to conduct daily review of margincoverage, i.e., to determine whether anymargin breaches have occurred.Moreover, the Commission believes thatthe change will not impose any burden

because it believes that all DCOscurrently conduct some form of dailyreview of the adequacy of their initialmargin requirements, whether they usea product-based or a portfolio-basedmargin methodology.

The Commission is adopting§ 39.13(g)(7)(i) with modifications thatrequire a DCO to conduct back tests, ona daily basis, to test the adequacy of itsinitial margin requirements with respectto products or swap portfolios that areexperiencing significant marketvolatility: (a) For that product if theDCO uses a product-based marginmethodology; (b) for each spreadinvolving that product if there is adefined spread margin rate; (c) for eachaccount held by a clearing member atthe DCO that contains a significantposition 124 in that product, by houseorigin and by each customer origin; and(d) for each such swap portfolio,including any portfolio containing

futures and/or options and held in acommingled account pursuant to§ 39.15(b)(2),125 by beneficial owner.

Similarly, the Commission is adopting§ 39.13(g)(7)(ii) with modifications that





126 Id.

127The Commission does not believe that it isappropriate to adopt a regulation establishing anexemption process with respect to back testingrequirements based on volume or risk exposure orotherwise.

128LCH also expressed its belief that a DCOshould also collect margin from all affiliated legalentities within a house account on a gross basisunless there is legal certainty of the DCO’s right tooffset risks across the affiliates in the event of the

default of the group or one or more of i ts affiliatedlegal entities. The Commission has not proposedand is not adopting such a requirement. However,although §39.13(g)(8)(i) permits a DCO to collectinitial margin for its clearing members’ houseaccounts on a net basis, it does not require it to doso, and a DCO could determine to collect housemargin in the manner suggested by LCH.

129See further discussion of these costs in sectionVII, below. NYPC also commented that given thenecessary technology builds, it would need morethan three years to come into compliance withproposed §§39.13(g)(8)(i) and 39.13(h)(2). TheCommission believes that the modifications to§ 39.13(g)(8)(i), discussed in this section, wouldminimize any technology changes that would benecessary in order to comply with §39.13(g)(8)(i).

require a DCO to conduct back tests, onat least a monthly basis: (a) For eachproduct for which the DCO uses aproduct-based margin methodology; (b)for each spread for which there is adefined spread margin rate; (c) for eachaccount held by a clearing member atthe DCO, by house origin and by eachcustomer origin; and (d) for each swap

portfolio, including any portfoliocontaining futures and/or options andheld in a commingled account pursuantto § 39.15(b)(2),126 by beneficial owner.As adopted, §39.13(g)(7) no longercontains a paragraph (iii) as paragraph(ii) now describes all monthly backtesting requirements.

As originally proposed, §39.13(g)(7)would only require daily back testingfor products that were experiencingsignificant market volatility if the DCOused a product-based marginmethodology, and for spreads involvingthat product if there was a defined

spread margin rate. It would not requiredaily back testing for each account, bycustomer origin and house origin, thatcontained a significant position in thatproduct, whether the DCO used aproduct-based or a portfolio-basedmargin methodology, or for each swapportfolio that was experiencingsignificant market volatility. As withrespect to §39.13(g)(6), there was apotential inconsistency in the treatmentof different positions. There is noreasonable basis to require daily backtests solely with respect to products thatare experiencing significant marketvolatility for which the DCO uses a

product-based margin methodology andspreads involving such products if thereis a defined spread margin rate, and notto require daily back tests with respectto accounts, by customer origin andhouse origin, which contain significantpositions in those products simply

because the DCO uses a portfolio-basedmargin methodology. Similarly, there isno justification for requiring daily backtests with respect to products that areexperiencing significant marketvolatility and not requiring daily backtests with respect to swap portfolios thatare experiencing significant market

volatility. A DCO should be required toconduct daily back tests when theinstruments that it clears are subject tosignificant market volatility, whetherthe DCO bases its initial marginrequirements on a product-based or aportfolio-based margin methodology,and whether those instruments arefutures, options on futures, or swaps.

Although OCC stated that it currentlyconducts daily back tests on allaccounts on a portfolio basis, and LCH

expressed its view that back tests should be conducted on a daily basis for allproducts and swap portfolios cleared bya DCO, the Commission has determinedto permit a DCO to conduct back testson at least a monthly basis whensignificant market volatility is notpresent. FIA and MGEX supportedmonthly back testing. Apart from KCC’s

contention that back testing should besubject to the discretion of the DCO, andNOCC’s suggestion that DCOs should beable to obtain an exemption from theproposed frequencies for products,customers and spread credits that havenot reached a specified volume or riskexposure level,127 none of thecommenters indicated that back testsshould be conducted less frequentlythan monthly. Moreover, a particularDCO would be able to exercise itsdiscretion to conduct back tests on amore frequent basis than that required

by the Commission’s regulation.

The Commission has not proposedand is not adopting LCH’s suggestionthat the applicable historic time periodfor the price change data used for backtesting should be a minimum of onecalendar year. However, theCommission is removing the proposedlanguage from the introductoryparagraph of §39.13(g)(7) regarding thetime periods for historical price changesthat must be used in the required backtests and is revising the introductoryparagraph to require a DCO to use anappropriate time period but not lessthan the previous 30 days for all of the

back tests required by §§39.13(g)(7)(i)and (ii).

h. Customer Margin

(1) Gross Margin for Customer Accounts—§39.13(g)(8)(i)

Proposed §39.13(g)(8)(i) wouldrequire a DCO to collect initial marginon a gross basis for each clearingmember’s customer account equal to thesum of the initial margin amounts thatwould be required by the DCO for eachindividual customer within that accountif each individual customer were aclearing member and would prohibit a

DCO from netting positions of differentcustomers against one another. Theproposed regulation would permit aDCO to collect initial margin for itsclearing members’ house accounts on anet basis.

Better Markets and LCH (with asuggested exception described below)

supported proposed §39.13(g)(8)(i).128 CME, KCC, OCC, ICE, NYPC, FIA, andthe Commodity Markets Council (CMC)argued against the adoption of proposed§ 39.13(g)(8)(i).

KCC and ICE pointed out that DCOsthat perform net margining have not hadany clearing member defaults orcustomer losses, including during the

2008 financial crisis.Various commenters opposed the

proposal based on the potential extentand costs of operational and technologychanges that would need to be made byclearing members and DCOs: (1) Toconvert net margining systems to grossmargining systems, and (2) to permitclearing members to provide individualcustomer position information to DCOs,and DCOs to receive individualcustomer position information andcalculate the margin required for eachindividual customer account (CME,KCC, ICE, NYPC, and CMC).

OCC stated that the only means bywhich it could calculate marginrequirements on a customer-by-customer basis within a clearingmember’s omnibus futures customers’account would be to create subaccountsfor each customer. CME, NYPC, KCC,and FIA commented that DCOs do notcurrently receive position-levelinformation for each individualcustomer of their clearing members.CME and FIA expressed concern aboutthe costs associated with clearingmembers having to provide individualcustomer position information, andCME indicated that DCOs would incur

costs in processing the informationreceived from clearing members in orderto calculate margin requirements onindividual customer accounts on a daily

basis. NYPC also stated that theadoption of proposed §39.13(g)(8)(i)would require it to make significantchanges to its systems.129

KCC stated that managing grosscustomer margin at the DCO level





130The Commission is including the phrase ‘‘tothe extent not inconsistent with other Commissionregulations’’ because, in a separate rulemaking, theCommission has proposed regulations that wouldrequire FCM clearing members to provide dailyinformation identifying the positions of individualcleared swaps customers to the relevant DCO andthat would require such DCOs to calculate the

amount of collateral required for each clearedswaps customer of such clearing members on adaily basis. If these regulations are adopted, theywill supersede the provisions of §39.13(g)(8)(i) tothe extent that they are inconsistent with suchprovisions, with respect to cleared swaps. See 76FR 33818 (June 9, 2011) (Protection of ClearedSwaps Customer Contracts and Collateral;Conforming Amendments to the Commodity BrokerBankruptcy Provisions).

The Commission is also making a conformingamendment by inserting ‘‘and may not permit itsclearing members to’’ in the sentence that nowreads as follows (added text in italics): ‘‘Aderivatives clearing organization may not, and may not permit its clearing members to, net positions of different customers against one another.’’.

131See, e.g., Margins Handbook, http:// www.nfa.futures.org/NFA-compliance/publication-library/margins-handbook.pdf, at 34; CME Rule930.J.; ICE Futures U.S. Inc. Rule 5.04; and CBOEFutures Exchange, LLC Rule 516.

would require a DCO to assume the roleof a back-office account managementservice, requiring continuous updatesfrom each clearing member regardingcustomer positions. KCC further notedthat DCOs would be required to adjustthe timing deadlines for marginpayments, DCOs’ ability to track marginrequirements closely with market

movements would be decreased, andDCOs may face difficulty in relayingvariation margin payment informationto their settlement banks quickly.

ICE noted that converting to a grossmargining system would be a majoroperational change for clearing firmsand DCOs that use net margining.However, ICE also stated that mostDCOs currently use gross margining,including ICE Trust (now ICE ClearCredit LLC) and ICE Clear U.S.,although ICE Clear Europe uses netmargining. In particular, ICE stated thatgross margining would require

reengineering of firms’ end-of-dayprocessing. According to ICE, changeswould need to be made to such DCOs’margining technology, data submission/input mechanism and margin reportingspecifications, and clearing firms ortheir service providers would need toimplement software updates. ICE notedthat changes to position reporting,reconciliation and marginingmethodology are challenging technologychanges for clearing members and theirthird-party software vendors andtypically take at least six to nine monthsto complete. However, ICE indicated

that an implementation period of atleast 12 months would allow DCOs thatcurrently use net margining, and theirclearing members, to adequately testand implement the systems necessaryfor gross margining.

CME, KCC, and CMC all argued thatrequiring clearing members to reportgross customer positions by beneficialowner to DCOs is not necessary in orderto accomplish reasonable and adequate‘‘modified’’ gross margining.Specifically, CME and KCC urged theCommission to permit a version of grossmargining of customer accounts that

would only require clearing members toreport gross customer positions to DCOs(not by beneficial owner) and thatwould allow clearing firms to submitpositions as spreadable for thoseaccounts that have recognized calendarspreads or spreads between correlatedproducts. However, CME furtherrepresented that ‘‘[t]his version of grossmargining will sometimes lead to lessthan aggregate gross margins as a resultof optimal spreading that occasionallyoccurs between accounts. Nevertheless,it approximates aggregate gross margins

without imposing significant costs onthe industry.’’

In light of the various concerns raised by CME, KCC, ICE, NYPC, and CMCregarding the operational andtechnology changes that would beneeded and related costs of requiring aDCO to obtain individual customerposition information from its clearing

members and to use such information tocalculate the margin requirements foreach individual customer, theCommission is modifying§ 39.13(g)(8)(i). In particular, theCommission is adding a provision,which states that ‘‘[f]or purposes of calculating the gross initial marginrequirement for each clearing member’scustomer account(s), to the extent notinconsistent with other Commissionregulations, a derivatives clearingorganization may require its clearingmembers to report the gross positions of each individual customer to the

derivatives clearing organization, or itmay permit each clearing member toreport the sum of the gross positions of its customers to the derivatives clearingorganization.’’130

Thus, the Commission is providing aDCO with the discretion to eithercalculate customer gross marginrequirements based on individualcustomer position information that itobtains from its clearing members or

based on the sum of the gross positionsof all of a clearing member’s customersthat the clearing member provides to theDCO, without forwarding individual

customer position information to theDCO. In either case, the customer grossmargin requirement determined by aDCO must equal ‘‘the sum of the initialmargin amounts that would be required

by the derivatives clearing organizationfor each individual customer within thataccount if each individual customer

were a clearing member.’’ The customergross margin collected by a DCO maynot be subject to ‘‘spreading thatoccasionally occurs between accounts’’that may lead to ‘‘less than aggregategross margins,’’ as described by CME.

CME commented that proposed§ 39.13(g)(8)(i) was unclear regardinghow DCOs would be expected to treatcustomer omnibus accounts of non-clearing FCMs and foreign brokers forwhich the clearing firm carrying theaccount generally does not know theidentities of individual customerswithin the omnibus accounts. Undercurrent industry practice, omnibusaccounts report gross positions to theirclearing members and clearing memberscollect margins on a gross basis forpositions held in omnibus accounts.131 The Commission does not intend toalter this current practice by adopting§ 39.13(g)(8)(i). Therefore, theCommission is adding a provision,

which states that ‘‘[f]or purposes of thisparagraph, a derivatives clearingorganization may rely, and may permitits clearing members to rely, upon thesum of the gross positions reported tothe clearing members by each domesticor foreign omnibus account that theycarry, without obtaining informationidentifying the positions of eachindividual customer underlying suchomnibus accounts.’’

The Commission believes that givinga DCO the option of permitting itsclearing members to provide the sum of their customers’ gross positions to a

DCO, without the need to provideindividual customer positioninformation to the DCO, allows DCOs toprovide their clearing members with amuch less costly alternative to requiringclearing members to provide individualcustomer position information to theDCO, and requiring the DCO to calculatethe gross margin requirement for eachcustomer of each clearing member.

The Commission recognizes that§ 39.13(g)(8)(i), even as modified, willrequire DCOs and their clearingmembers to incur certain costs.However, the Commission continues to

believe, as stated in the notice of proposed rulemaking, that grossmargining of customer accounts will: (a)More appropriately address the risksposed to a DCO by its clearing members’customers than net margining; (b) willincrease the financial resourcesavailable to a DCO in the event of a


http://www.nfa.futures.org/NFA-compliance/publication-library/margins-handbook.pdf









132 ICE commented that the Commission’srationale for gross margining, i.e., that it wouldincrease the financial resources available to a DCOin the event of a customer default, is based uponthe mutualization of customer risk to protect theDCO. ICE stated its belief that this rationaleconflicts with the reasoning behind the proposalthat DCOs individually segregate cleared swapscustomer funds to protect such customers fromfellow customer risk. The Commission notes,however, that gross margining is not only consistent

with, but will be instrumental in achieving,complete legal segregation for cleared swapsaccounts. See 76 FR 33818 (June 9, 2011)(Protection of Cleared Swaps Customer Contractsand Collateral; Conforming Amendments to theCommodity Broker Bankruptcy Provisions).

133As pointed out in the CPSS–IOSCOConsultative Report, under certain circumstancesgross margining may also increase the portability of customer positions in an FCM insolvency. That is,a gross margining requirement would increase thelikelihood that there will be sufficient collateral ondeposit in support of a customer position to enablethe DCO to transfer it to a solvent FCM. See CPSS–IOSCO Consultative Report, Principle 14:Segregation and Portability, Explanatory Notes3.14.6 and 3.14.8, at 67–68.

134See 76 FR 33818 (June 9, 2011) (Protection of Cleared Swaps Customer Contracts and Collateral;Conforming Amendments to the Commodity BrokerBankruptcy Provisions).

135See Financial markets: OTC derivatives,central counterparties and trade repositories(amend. Directive 98/26/EC), COD/2010/0250 (June7, 2011), available at http:// www.europarl.europa.eu/oeil/ FindByProcnum.do?lang=en&procnum=COD/2010/ 0250.

136

As originally proposed, §39.19(c)(1)(iv) wouldrequire each DCO to report to the Commission, ona daily basis, the end-of-day positions for eachclearing member, by customer origin and houseorigin. See 75 FR 78185 (Dec. 15, 2010)(Information Management). The preamble in thenotice of proposed rulemaking (76 FR 3698 (Jan. 20,2011) (Risk Management)), described a proposedamendment to proposed §39.19(c)(1)(iv) to add‘‘and for customer origin, separately, the grosspositions of each beneficial owner.’’ However, thisclause was inadvertently omitted from the languageof the regulation in the notice of proposedrulemaking. Therefore, the Commissionsubsequently issued a correction at 76 FR 16588(Mar. 24, 2011) (Risk Management Requirements forDerivatives Clearing Organizations; Correction).

customer default; 132 and (c) withrespect to cleared swaps, will supportthe requirement in § 39.13(g)(2)(iii) thata DCO must margin each swap portfolioat a minimum 99 percent confidencelevel.

The Commission believes that theclearing of swaps will increase the riskthat DCOs face. Gross margining will

maximize the amount of money DCOshold. Because a DCO may not haveaccess to customer initial margincollected by and held at an FCM if theDCO collects initial margin on a net

basis, if the FCM defaults, theCommission believes that holding grossinitial margin at a DCO is the safestmechanism by which DCOs can protectthemselves from increased risk. If a DCOis unable to obtain customer margin inthe event of default, there is significantrisk of contagion. Consequently, if moremargin is held at the DCO, the potentialrisk that the failure of one clearing

member will propagate throughout thefinancial system to other clearingmembers and other entities isdecreased.133

CME and KCC commented thatproposed §39.13(g)(8)(i) would requireclearing members to ‘‘pass-through’’ themargin deposits that they receive fromtheir customers to the DCO, thusrequiring clearing members to apply totheir customers the DCO’s standards foracceptable collateral as well as theDCO’s concentration limits with respectto collateral types. CME indicated thatthis would add pressure with respect tothe available collateral pool, and argued

that the Commission should not imposesuch additional and costly constraintson market participants in the absence of significant and demonstrable benefits.The Commission notes that, although as

a business matter clearing members maydetermine to ‘‘pass-through’’ the margindeposits that they receive from theircustomers to the relevant DCO,proposed §39.13(g)(8)(i) does notrequire that a clearing member onlyaccept from its customers those types of margin assets that are acceptable for theclearing member to deposit with the

DCO.KCC requested that the Commission

clarify whether the requirement tocollect gross customer margin imposesan obligation on the DCO to determinethe defaulting customer accounts in acustomer default situation (whichwould be costly and burdensome) andstated that having the total customergross margin available to the DCO in theevent of a customer default is a prudentrisk management technique. TheCommission notes that Commissionrules currently permit a DCO tocommingle the initial margin with

respect to all of a clearing member’scustomers in a single customer originaccount at the DCO and to apply theentire customer origin account to coverlosses with respect to a customerdefault, whether the DCO collects initialmargin on a net basis or on a gross basis.The Commission does not intend§ 39.13(g)(8)(i), by its terms, to alter thisapproach.

In a separate rulemaking, however,the Commission has proposed to requireDCOs to legally segregate customerfunds and assets margining swappositions that are held by a clearingmember at the DCO in a commingled

cleared swaps customer account.134 Inaddition, European Union legislation,although not yet finalized, wouldrequire central counterparties to provideindividual customer segregation incertain circumstances.135 As previouslynoted, gross margining will beinstrumental if individual customersegregation is adopted. OCC requestedthat the Commission restrict theapplicability of proposed §39.13(g)(8)(i)to futures customer accounts at both theclearing level and the FCM level, tomake it clear that it does not intend toimpose these margin requirements on

accounts that are restricted to securitiesproducts (with respect to an entity thatis both a DCO and an SEC-regulatedclearing agency). OCC is correct that

§ 39.13(g)(8)(i) applies only to customerand house accounts, cleared by a DCO,which contain futures, options onfutures, and/or swap positions that aresubject to the jurisdiction of theCommission. It does not apply toaccounts that only contain securitiesproducts that are subject to thejurisdiction of the SEC.

LCH requested that the Commissionallow DCOs operating from non-U.S.jurisdictions to offer ‘‘net omnibus’’account structures for associated entitiesoperating under the same group orumbrella structure to customers outsidethe U.S. The treatment of customers isoutside the scope of this rulemaking.However, to the extent a DCO is clearingproducts subject to the Commission’sjurisdiction, this rule would apply at theclearing level regardless of the locationof the DCO or the customer.

The Commission is adopting§ 39.13(g)(8)(i) with the modifications

described above. The Commissionrecognizes that DCOs that currently usenet margining, or that use a ‘‘modified’’version of gross margining, as well astheir clearing members and their serviceproviders, will need time to make thenecessary operational and technologyenhancements that will facilitate grossmargining, as described herein.Therefore, the Commission is adoptingan effective date that is 12 months afterthe publication of final §39.13(g)(8)(i) inthe Federal Register.

(2) End-of-Day Position Reporting—§ 39.19(c)(1)(iv)

Proposed §39.19(c)(1)(iv) wouldrequire each DCO to report to theCommission, on a daily basis, the end-of-day positions for each clearingmember, by customer origin and houseorigin; and for customer origin,separately, the gross positions of each

beneficial owner.136 As noted by KCC and CMC, the

Commission currently receives certaininformation about the ownership andcontrol of reportable positions throughits large trader reporting program, underParts 15 through 21 of the Commission’s


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137For example, the Commission recentlyadopted final rules on Large Trader Reporting forPhysical Commodity Swaps at 76 FR 43851 (July22, 2011).

138See further discussion of §39.19, adoptedherein, in section IV.J, below.

139The term ‘‘customer initial margin’’ is nowdefined in §1.3(kkk), adopted herein.

140A DCO’s initial margin requirements are alsoreferred to herein as ‘‘clearing initial margin’’requirements. ‘‘Clearing initial margin’’ is definedas ‘‘initial margin posted by a clearing member witha [DCO]’’ in §1.3(j jj), adopted herein.

141Section 5b(c)(2)(D)(iii) of the CEA, 7 U.S.C.7a–1(c)(2)(D)(iii).

regulations. Commission staff reviewsthe effectiveness of this program on aregular basis, and will continue to adoptenhancements where appropriate.137 The large trader reporting system,however, does not currently apply tomany swaps that are, or may be, cleared.The Commission may need informationabout large swap positions to assess the

risk profile of a DCO or a clearing FCM.CME, KCC, MGEX, FIA, and CMC

commented that clearing members donot generally have informationidentifying the underlying customers incustomer omnibus accounts carried on

behalf of non-clearing member FCMs,foreign brokers, hedge funds orcommodity pools, and therefore clearingmembers cannot reasonably be expectedto report such information to DCOs, andDCOs cannot reasonably be expected toreport such information to theCommission. The Commission notesthat a DCO may be able to obtain such

information under its own rules. Forexample, CME Rule 960 requires aclearing member to immediatelydisclose the identities and positions of the beneficial owners of any omnibusaccount to CME upon its request.

MGEX expressed its concern that thesignificant costs resulting fromcompliance with a requirement for theroutine daily reporting of all grosscustomer positions by beneficial ownercould lead to further consolidation inthe industry at the FCM, clearingmember, and DCO levels.

The Commission is not adopting theproposed requirement in

§ 39.19(c)(1)(iv) that a DCO providedaily reports to the Commission of thegross positions of each beneficial ownerwithin each clearing member’s customerorigin account. However, theCommission is adopting§ 39.19(c)(5)(iii),138 which requires aDCO to provide this information to theCommission upon the Commission’srequest, in the format and manner, andwithin the time, specified by theCommission.

For example, the Commission couldrequest that a DCO provide informationabout customer positions by beneficialowner, on a case-by-case basis, withrespect to a particular clearing member,customer, or product. Moreover, theCommission could request that suchinformation be provided for a particularday, month, or until further notice bythe Commission. In recent years, theCommission has worked cooperatively

with several DCOs to obtain informationabout cleared swap positions. TheCommission notes that any potentialcosts should be substantially reduced bythe modified requirement that a DCOprovide information to the Commissionidentifying the positions of beneficialowners of customer accounts only uponCommission request and not on a daily

basis.

(3) Customer Initial MarginRequirements—§39.13(g)(8)(ii)

Proposed §39.13(g)(8)(ii) wouldrequire a DCO to require its clearingmembers to collect customer initialmargin 139 from their customers for non-hedge positions at a level that is greaterthan 100 percent of the DCO’s initialmargin requirements 140 with respect toeach product and swap portfolio.Proposed §39.13(g)(8)(ii) would permita DCO to have reasonable discretion indetermining the percentage by which

customer initial margins would have toexceed the DCO’s initial marginrequirements with respect to particularproducts or swap portfolios. However,under the proposed regulation, theCommission could review suchpercentage levels and require differentpercentage levels if the Commissiondeemed the levels insufficient to protectthe financial integrity of the clearingmembers or the DCO in accordance withCore Principle D.141

OCC stated its view that exchanges,which have historically set customerlevel margin requirements, shouldcontinue to do so, rather than DCOs,noting that clearing organizations wouldordinarily have no means to enforcecustomer level margin requirements.

KCC stated that it generally supportsthe concept that clearing membersshould collect customer initial margin ata level above that of DCO initial margin,

but requested that the Commissionclarify the circumstances in which itmay deem the ratio of customer initialmargin to DCO initial margininsufficient to protect the DCO.Although the FHLBanks opposed theproposal, they recommended that if theCommission were to adopt it, the

Commission should provide additionalguidance and/or establish criteria forDCOs with respect to setting therequired amount of excess margin.MGEX noted that although it currently

maintains a 130 percent requirement,this is a decision that should be left toeach DCO and its clearing members todetermine. Because the circumstancesfor each DCO or the nature of itsclearing members vary, it would bedifficult to provide the generalclarification or criteria that KCC and theFHLBanks are seeking, because such a

determination would need to be madeon a case-by-case basis.

MFA argued that a requirement that aDCO must require its clearing membersto collect customer initial margin at alevel that is greater than the DCO’sinitial margin requirements would beinappropriate because DCOs do nothave information about individualcustomers’ creditworthiness and such arequirement would impair marketliquidity by limiting the trading activityof certain market participants, resultingin greater market concentration. Citadeland the FHLBanks made similar

comments.ICE stated that FCMs are best able todetermine how much to charge abovethe initial margin requirement becausethey have complete visibility into theircustomers’ positions, and theCommission should not place thisrequirement on a DCO, but shouldaddress this with FCMs through anotherset of rules. FIA opposed the proposedrule stating that the amount of excessmargin, if any, that an FCM may requirefrom its customers is a credit decisionthat should be made by each FCM basedon its analysis of the creditworthiness of the particular customer, including the

nature of the customer’s trading activityand its record of meeting margin calls.

Currently DCMs require their FCMmembers to impose customer initialmargin requirements that are a specifiedpercentage higher than the DCO’s initialmargin requirements, generally in theneighborhood of 125 percent to 140percent, as determined by the DCM.DCMs generally permit FCM membersto impose customer initial marginrequirements for hedge positions thatare equal to the applicable maintenancemargin requirements (which aregenerally the same as the applicable

clearing initial margin requirements).This rule simply shifts theresponsibility for establishing customerinitial margin requirements from DCMsto DCOs.

DCOs have greater expertise in riskmanagement and a direct financial stakein whether their clearing members’customers, and consequently theirclearing members, are able to meet theirmargin obligations. Moreover, it isanticipated that some DCOs will clearfungible swaps that may be listed onmultiple SEFs. SEFs may or may not





142See discussion of §39.13(h)(5), adoptedherein, in section IV.D.7.e, below.

143OCC commented that its STANS marginsystem calculates margin based on all positions inan account and not on a position-by-position basis;therefore it would not be able to furnish clearingmembers with a number representing the initialmargin on a particular position without conductingsubaccounting for each customer. OCC also noted

that since STANS requirements are data-driven ona month-to-month, and even a day-to-day, basisthey can vary in ways that cannot be readilypredicted. The Commission is adopting§ 39.13(g)(8)(i) herein, which requires a DCO tocollect initial margin on a gross basis for its clearingmembers’ customer accounts. Therefore, a clearingmember (or the DCO) will be required to determinethe initial margin that must be posted with the DCOwith respect to each customer’s positions. Even if that amount changes from day to day as a result of the application of a portfolio-based margin system,a DCO could require that its clearing memberscollect customer initial margin in an amount thatis a given percentage in excess of 100 percent of thedaily clearing initial margin requirement withrespect to each customer.

144See, e.g., CME Rule 8G930.E (‘‘IRS Clearingmembers may call for additional performance bondat their discretion.’’) (available at http:// www.cmegroup.com/rulebook/CME/I/8G/ ) andInternational Derivatives Clearinghouse, LLC Rule614(g) (‘‘A Clearing Member may call, at any t ime,for [margin] above and beyond the minimumsrequired by the Clearinghouse.’’) (available athttp://www.idch.com/pdfs/idch/ 20100901rulebook.pdf ).

145MFA stated that it would be highly burdensome to distinguish between hedge and non-hedge positions for purposes of the application of differentiated margining, especially in a portfolio

margining context. As noted in n. 143, above, aDCO that uses a portfolio-based margin modelcould require that its clearing members collectcustomer initial margin in an amount that is a givenpercentage in excess of 100 percent of the dailyclearing initial margin requirement with respect toeach customer. If all of a particular customer’spositions were hedge positions, the DCO couldpermit the clearing member to collect customerinitial margin in an amount that equals the amountof clearing initial margin with respect to thatcustomer’s positions. It is only in thosecircumstances where a hedger may also engage inspeculative trading that it may be difficult todistinguish between positions for purposes of theapplication of differentiated margining in aportfolio margining context.

impose customer initial marginrequirements on their members forcleared swaps. Requirements set byDCOs may be less susceptible topressure to being lowered forcompetitive reasons. Finally, DCOs will

be the only self-regulatory organizationsthat will be in a position to set customerinitial margin requirements for swaps

that are executed bilaterally, andvoluntarily cleared. Moreover, DCOswill have the opportunity to reviewwhether their clearing members arecollecting customer initial margin, asrequired by the DCO, during theirreviews of the risk managementpolicies, procedures, and practices of their clearing members, pursuant to§ 39.13(h)(5).142

Section 39.13(g)(8)(ii) permits a DCOto exercise its discretion in determiningthe appropriate percentage by which thecustomer initial margin for a particularproduct or swap portfolio should exceed

the clearing initial margin,143

as DCMsdo today with respect to futures andoptions. This percentage should be

based on the nature and volatilitypatterns of the particular product orswap portfolio, and the DCO’s relatedevaluation of the potential risks posed

by customers in general to their clearingmembers and, in turn, the potentialrisks posed by such clearing members ingeneral to the DCO, rather than thecreditworthiness of particularcustomers. Consequently, a DCO willretain the flexibility to establish anappropriate percentage for customerinitial margin that applies to each

product that it clears, which will applyto all of its clearing FCMs and all of their customers. However, as is also thecase today, such clearing FCMs wouldremain free to exercise their discretionto determine whether they will collectadditional margin over and above that

amount either from all of theircustomers, or from particular customers

based on such customers’ riskprofiles.144

The Commission continues to believethat requiring a DCO to require itsclearing members to collect customerinitial margin in a percentage higherthan 100 percent of the clearing initial

margin, for non-hedge positions,provides a valuable cushion of readilyavailable customer margin. Citadelstated that the market’s extensiveexperience in a range of cleared marketsdemonstrates preparedness for theregular exchange of margin betweenclearing members and their customersfor cleared OTC derivatives, even wheremargin calls occur more frequently thanonce daily, and that frequent exchangeof margin is also current market practicefor uncleared trades. However, themaintenance of such a cushion wouldenable clearing members to deposit

additional margin with a DCO on behalf of their customers, as necessitated byadverse market movements, without theneed for the clearing members to makesuch frequent margin calls to theircustomers. In addition, many clearingmembers choose to deposit excessmargin with their DCOs to provide theirown cushion, which may in someinstances obviate the need to transferfunds to the DCO on a daily basis inorder to meet variation marginrequirements.

ISDA, FIA, and the FHLBankscommented that if the Commission wereto adopt proposed § 39.13(g)(8)(ii), it

should clarify the meaning of ‘‘non-hedge positions.’’ The FHLBanks alsostated that the Commission shouldprovide guidance regarding how thedetermination as to whether a positionis a hedge or a non-hedge positionwould be made, whether by the DCO,the clearing member, or the customer,and expressed the belief that a clearingmember’s customers should beresponsible for determining andcertifying, to their clearing members orDCOs, whether their swap positions are‘‘hedge’’ or ‘‘non-hedge’’ positions.

Several commenters have argued that

there is no basis for distinguishing between hedge positions and non-hedgepositions in determining whether suchpositions should be subject to customerinitial margin requirements in excess of

clearing initial margin requirements.145 LCH stated that it does not believe thata DCO or a clearing member shoulddistinguish in any way between acustomer’s hedge and non-hedgepositions because: (1) if the two parts of the hedge are carried by the sameclearing member within the same DCO,such hedges would in any event

implicitly be recognized by the DCO’srisk calculations and the provisionwould be unnecessary; and (2) if one orthe other leg of the hedge is uncleared,or is carried by a different clearingmember, or by the same or anotherclearing member at another DCO, norecognition of the offsetting hedgeshould be allowed either by the DCO(s)or by the clearing member(s), as neitherparty would have the economic benefitof the hedged transaction. TheCommission notes that thecategorization of a position as a hedgefor purposes of this regulation does not

affect the margin collected by the DCO;it only affects the additional incrementthat the clearing member collects fromits customer.

Freddie Mac indicated that theCommission should considereliminating the proposed requirementfor increased customer initial margin for‘‘non-hedge positions,’’ noting thatcustomers with non-hedge positions arenot inherently riskier or more likely tomiss margin calls than customers with‘‘hedge positions.’’

As previously noted, DCMs havehistorically drawn a distinction betweenhedge positions and non-hedge

positions in setting customer initialmargin requirements, and theCommission believes that it isreasonable to assume that hedgers maypresent less risk than speculators, inthat losses on their derivatives positionsshould be offset by gains on thepositions whose risks they are hedging.The relevant consideration is therelative risks posed by hedgers versusnon-hedgers, rather than the


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146See 75 FR 80174 (Dec. 21, 2010) (FurtherDefinition of ‘‘Swap Dealer,’’ ‘‘Security-Based SwapDealer,’’ ‘‘Major Swap Participant,’’ ‘‘MajorSecurity-Based Swap Participant’’ and ‘‘EligibleContract Participant’’).

147See 75 FR 80747 (Dec. 23, 2010) (End-UserException to Mandatory Clearing).

148The Commission has proposed a definition of ‘‘hedging or mitigating commercial risk,’’ to becodified at §1.3(ttt), for the purposes of thedefinition of ‘‘Major Swap Participant,’’ 75 FR at80214–80215 (Further Definition of ‘‘Swap Dealer,’’‘‘Security-Based Swap Dealer,’’ ‘‘Major SwapParticipant,’’ ‘‘Major Security-Based SwapParticipant’’ and ‘‘Eligible Contract Participant’’).

149The Commission does not believe that itwould be practical for the Commission to revieweach clearing member of each DCO to determinewhether the clearing member is prohibiting itscustomers from making impermissible withdrawalsfrom their accounts.

150See http://www.nfa.futures.org/NFA- compliance/publication-library/margins- handbook.pdf, at 45.

151See discussion of §39.13(h)(5), adoptedherein, in section IV.D.7.e, below.

creditworthiness of particularcustomers.

Freddie Mac recommended that, if theCommission does not eliminate thedistinction between hedge and non-hedge positions, the Commission shouldclarify that, for purposes of § 39.13(g)(8)(ii): (1) ‘‘hedge positions’’would include all swaps that hedge or

mitigate any form of a customer’s business risks; (2) such swaps mayqualify as ‘‘hedge positions’’ regardlessof whether they qualify as ‘‘bona fidehedging transactions’’ under the CEAand §1.3(z) or qualify as hedges underapplicable accounting standards; and (3)such swaps may qualify as ‘‘hedgepositions’’ regardless of the nature of theentity that holds such positions (e.g.,whether it is a financial entity or a non-financial entity). Freddie Mac indicatedthat such treatment would be consistentwith Commission proposals for defininghedging for purposes of other Dodd-

Frank Act rules, including the definitionof a ‘‘major-swap participant’’ 146 andrules relating to the availability of theend-user exception to mandatoryclearing.147

The Commission intends to interpret‘‘hedge positions,’’ for purposes of § 39.13(g)(8)(ii), as referring to those thatmeet either the definition set forth in§ 1.3(z), or the definition set forth in§ 1.3(ttt), when, and in the form inwhich, it is ultimately adopted.148 TheCommission also believes that, as iscurrently the practice, it would be thecustomer’s responsibility to identify its

positions as hedge positions to itsclearing FCM.The Commission is adopting

§ 39.13(g)(8)(ii) as proposed.

(4) Withdrawal of Customer InitialMargin—§ 39.13(g)(8)(iii)

Proposed § 39.13(g)(8)(iii) wouldrequire a DCO to require its clearingmembers to prohibit their customersfrom withdrawing funds from theiraccounts with such clearing membersunless the net liquidating value plus themargin deposits remaining in thecustomer’s account after the withdrawalwould be sufficient to meet the

customer initial margin requirementswith respect to the products or swapportfolios in the customer’s account,which were cleared by the DCO.

LCH agreed with the underlyingrequirement, but stated that it should beimposed in rules that directly apply toclearing members rather than in rulesapplicable to DCOs. KCC also supported

the concept but noted that DCM rulesalready require customers to maintainminimum margin levels and that theserestrictions are generally tested by aclearing member’s risk department andthe clearing member’s self-regulatoryorganization during examinations. KCCfurther noted that DCOs do not have fullaccess to information regarding eachcustomer’s financial condition. MGEXtook the position that theCommission 149 or a clearing member’sdesignated self-regulatory organization(DSRO) should monitor compliancewith such a requirement rather than the

DCO, indicating that it would not beeconomically feasible for the DCO to doso.

As noted in the notice of proposedrulemaking, the requirement stated in§ 39.13(g)(8)(iii) is consistent with thedefinition of ‘‘Margin Funds Availablefor Disbursement’’ in the MarginsHandbook prepared by the JAC.150 Therefore, DSROs currently reviewFCMs to determine whether they areappropriately prohibiting theircustomers from withdrawing funds fromtheir futures accounts unless the netliquidating value plus the margindeposits remaining in such customers’accounts after the withdrawal would besufficient to meet the customer initialmargin requirements with respect tosuch accounts. However, it is unclear towhat extent this requirement wouldapply to cleared swaps accounts whensuch swaps are executed on a DCMwhich participates in the JAC.Moreover, clearing members which onlyclear swaps that are executed on a SEFwill not be subject to the requirementsset forth in the Margins Handbook orsubject to review by a DSRO.

The Commission anticipates that, at aminimum, DCOs will be able to review

whether their clearing members areensuring that customers do not makewithdrawals from their accounts unlessthe specified conditions are met, whenthey conduct reviews of their clearing

members’ risk management policies,procedures, and practices pursuant to§ 39.13(h)(5).151

The Commission is adopting§ 39.13(g)(8)(iii) as proposed.

i. Time Deadlines—§39.13(g)(9)

Proposed §39.13(g)(9) would requirea DCO to establish and enforce time

deadlines for initial and variationmargin payments.LCH submitted a comment letter

indicating that it agrees with theproposal, but stated that it should applyonly to a DCO’s clearing members sincea DCO has no direct relationship withclients of its clearing members.Consistent with its original intent, theCommission is adopting §39.13(g)(9)with a modification to make it clear thatit only applies to time deadlines forinitial and variation margin payments toa DCO by its clearing members.

7. Other Risk Control Mechanisms

a. Risk Limits—§ 39.13(h)(1)(i)Proposed §39.13(h)(1)(i) would

require a DCO to impose risk limits oneach clearing member, by customerorigin and house origin, in order toprevent a clearing member fromcarrying positions where the riskexposure of those positions exceeds athreshold set by the DCO relative to theclearing member’s financial resources,the DCO’s financial resources, or both.The Commission believes that an FCMengages in excess risk-taking if it, or itscustomers, take on positions that requirefinancial resources that exceed this

threshold. The DCO would havereasonable discretion in determining: (1)the method of computing risk exposure;(2) the applicable threshold(s); and (3)the applicable financial resources,provided however, that the ratio of exposure to capital would have toremain the same across all capitallevels. For example, if a DCO set limitsunder which margin could not exceed200 percent of capital, the limit for a$100 million clearing member would be$200 million and the limit for a $200million clearing member would be $400million. The Commission could review

any of these determinations and requiredifferent methods, thresholds, orfinancial resources, as appropriate.

Proposed §39.13(h)(1)(ii) would allowa DCO to permit a clearing member toexceed the threshold(s) appliedpursuant to paragraph (h)(1)(i) providedthat the DCO required the clearingmember to post additional initial marginthat the DCO deemed sufficient toappropriately eliminate excessive risk











152See discussion of §39.13(h)(6), adoptedherein, in section IV.D.7.f, below.

153KCC further noted that, in its case, theexchange in turn receives the relevant large traderreports from the Commission.

exposure at the clearing member. TheCommission could review the amount of additional initial margin and require adifferent amount, as appropriate.

J.P. Morgan and Alice Corporationsupported the proposal to require DCOsto establish risk-based position limitsfor their clearing members. J.P. Morganindicated that in setting such position

limits applicable to any one clearingmember, a DCO should consider itsoverall exposure to clearing members inthe aggregate. The Commission agreesthat this would be prudent and expectsthat DCOs would take intoconsideration the aggregate exposure inestablishing individual levels. J.P.Morgan further took the position thatDCOs should monitor exposures againstthese limits on a real time basis. Asdiscussed in section IV.D.4, above,§ 39.13(e)(2) requires a DCO to monitorits credit exposure to each clearingmember periodically during each

business day.FIA stated that it generally agreeswith the proposed requirement that ‘‘theratio of exposure to capital must remainthe same across all capital levels’’ butindicated that the rule should makeclear that, in computing the ratio of exposure to capital, a clearing member’scapital should be calculated net of allrisk exposures and potential assessmentobligations at other clearingorganizations of which it is a clearingmember. The Commission agrees that itwould be appropriate for a DCO toconsider a clearing member’s exposuresto other clearing organizations, to the

extent that it is able to obtain suchinformation, in determining a clearingmember’s applicable financial resourcesfor the purpose of setting appropriaterisk limits.

CME argued that a requirement thatDCOs impose risk limits for everyclearing member would be overlyprescriptive and unnecessary, providedthat a DCO collects adequate margin, itsstress-test results regarding the clearingmember’s exposures are acceptable, andit employs concentration margining(whereby the DCO would set a level of risk at which it would begin to charge

higher margins based on indicativestress-test levels). In other words, CMEsuggested that risk limits may beunnecessary if a DCO sets a level of riskat which it would begin to charge highermargins based on stress test results withrespect to a clearing member. However,§ 39.13(h)(1)(ii) would allow a DCO topermit a clearing member to exceed anestablished risk limit provided that theDCO required the clearing member topost additional margin. Although CME’sproposed approach is worded slightlydifferently, the effect would be the same

as that of §39.13(h)(1)(ii), i.e., a clearingmember could only exceed a definedrisk level if it posted additional margin.

MGEX indicated that the proposedrule requiring DCOs to impose risklimits on each clearing member mightnot be practical, adding additional costwith little benefit, noting that DCOscurrently address credit and default risk

via margins and security deposits on adaily basis and conduct risk reviews.Rather, according to MGEX, a DCOshould be looking for risk signs andfocusing on those that are most relevant.The Commission believes that theestablishment of risk limits for clearingmembers would impose little additionalcost on DCOs since DCOs are alreadyrequired to monitor their clearingmembers’ capital levels and their ownfinancial resources, as well as thetrading activity of their clearingmembers. On the other hand, theCommission believes that the

establishment of such risk limits wouldadd significant risk management benefits to the benefits alreadyconferred by margins, security deposits,and reviews of clearing members’ riskmanagement policies and procedures.

The Commission is adopting§ 39.13(h)(i) as proposed, except for atechnical revision that replaces thephrase ‘‘by customer orgin and houseorigin’’ with ‘‘by house origin and byeach customer origin,’’ which conformsthe language with other provisions of part 39. OCC requested that theCommission clarify that proposed§ 39.13(h)(i) would not apply to

securities accounts of broker-dealersthat are not FCMs and do no futures

business. The Commission does notintend for §39.13(h)(i) to apply to suchaccounts. The Commission is alsoadopting §39.13(h)(ii) as proposed.

b. Large Trader Reports—§39.13(h)(2)

Proposed §39.13(h)(2) would requirea DCO to obtain from its clearingmembers, copies of all reports that suchclearing members are required to filewith the Commission pursuant to part17 of the Commission’s regulations, i.e.,large trader reports. Large trader reports

are necessary for stress testing to ensurethat FCMs and their customers have nottaken on too much risk. A DCO would

be required to obtain such reportsdirectly from the relevant reportingmarket if the reporting marketexclusively listed self-cleared contracts,and would therefore be required to filesuch reports on behalf of clearingmembers pursuant to §17.00(i).

Proposed §39.13(h)(2) would furtherrequire a DCO to review the large traderreports that it receives from its clearingmembers, or reporting markets, as

applicable, on a daily basis to ascertainthe risk of the overall portfolio of eachlarge trader. A DCO would be requiredto review positions for each large trader,across all clearing members carrying anaccount for the large trader. A DCOwould also be required to takeadditional actions with respect to suchclearing members in order to address

any risks posed by a large trader, whenappropriate. Such actions wouldinclude those actions specified inproposed § 39.13(h)(6).152

FIA supported the proposal to requireDCOs to obtain copies of all large traderreports that are filed with theCommission. MGEX commented thatthe Commission should provide largetrader reports to each DCO rather thanimposing a requirement that wouldrequire clearing members to makeredundant filings. KCC argued that theproposed requirement that DCOs obtainlarge trader reports from clearing

members is duplicative because a DCOreceives large trader information fromthe exchange.153

MGEX recommended that theCommission perform the review of largetrader reports itself or permit a clearingmember’s DSRO to perform such reviewinstead of DCOs.

NYPC recommended that theCommission not adopt proposed§ 39.13(h)(2) because the Commissionhas expended considerable resources tomodify its own internal programs andprocesses in order to glean potentiallyrelevant financial and risk management

information from the large trader datathat it receives from clearing membersand DCMs, and even if DCOs hadcomparable financial and humanresources that they could deploy forsuch a purpose, the information thatthey would obtain would frequently befragmented and inconclusive, giventhat—unlike the Commission—no singleDCO will ever have access toinformation relating to the futures,option and swap positions that arecleared by other DCOs or to unclearedswaps. NYPC further argued that giventhe necessary technology builds, itwould need more than three years tocome into compliance with proposed§§ 39.13(g)(8)(i) and 39.13(h)(2).

OCC indicated that it should be therole of a clearing member’s DSRO torequire that an FCM submit sufficientinformation to permit the DSRO toidentify customer accounts that couldpotentially cause a clearing member to





154The Commission is modifying the language inproposed §39.13(h)(2), which would have referredto ‘‘positions at all clearing members carryingaccounts for each such large trader’’ by revising it

to read as follows: ‘‘futures, options, and swapscleared by the [DCO] which are held by all clearingmembers carrying accounts for each such largetrader.’’ This will make it clear that the Commissionis not attempting to require a DCO to review a largetrader’s positions that were cleared by another DCO,as it would not typically have access to informationabout such positions. The technical change from‘‘positions’’ to ‘‘futures, options, and swaps’’

conforms the language with other provisions of part39.155See discussion of §39.13(h)(3), adopted

herein, in section IV.D.7.c, below.156 ISDA also stated that further clarity regarding

how the Commission intends to apply the largetrader definition to swaps is needed. TheCommission notes that it has begun this process byadopting final rules for Large Trader Reporting forPhysical Commodity Swaps, in a new part 20, at 76FR 43851 (July 22, 2011). Since these large traderreporting rules were adopted subsequent to theCommission’s proposal of §39.13(h)(2), theCommission is modifying §39.13(h)(2) to refer toreports required to be filed with the Commission by, or on behalf of, clearing members pursuant toparts 17 and 20 of this chapter.

157See further discussion of §39.2 in sectionIII.B, above.

default, and that if DCOs were requiredto perform all tasks required by theproposed rules alone, they would berequired to build new surveillancesystems and significantly increase theirsurveillance staff.

In response to suggestions that theCommission should conduct therequired review of large trader reports,

the Commission notes that it doesreview large trader reports for financial,market, and risk surveillance purposes.However, the Commission believes thatDCOs should also have an obligation toreview large trader reports for thoselarge traders whose trades they clear, fortheir own risk surveillance purposes,even though as noted by NYPC, theymay not have access to informationrelating to positions cleared by otherDCOs or to uncleared swaps. Moreover,§ 39.13(h)(2) requires a DCO to reviewsuch large trader reports with a viewtoward taking any necessary additional

actions with respect to such largetraders’ clearing members in order toaddress risks posed by such largetraders to the DCO.

In addition, it would not be feasiblefor a clearing member’s DSRO to reviewlarge trader reports. DSRO designationsapply to FCMs that are members of multiple DCMs. Therefore, clearingmembers that only trade for their ownaccounts do not have a DSRO. Clearingmembers that solely clear SEF-executedtrades also will not have DSROs.Moreover, risk management ultimatelyis the responsibility of each DCO. A

DSRO would not be in a position toanalyze the daily risk of the overallportfolio of each large trader at aparticular DCO, nor to take anyadditional actions to address such risksat a particular DCO.

KCC stated that it is the clearingmember’s obligation to determine thefinancial fitness of large tradercustomers, in that clearing membershave better, more direct informationregarding the credit quality of thecustomer and the exposures of thecustomer under positions the customermay hold outside the DCO. KCC statedits belief that imposing a duplicative

requirement on DCOs would achievelittle risk management benefit at a highcost. The Commission agrees thatclearing members must determine thefinancial capacity of their customersand they may have information which aparticular DCO may not have regardingpositions that they may clear for theircustomers on other DCOs.154 However,

this does not obviate the need for eachrelevant DCO to ascertain the risks thatthe large trader poses to that DCO basedon the information which the DCO isable to obtain through large traderreports.

ISDA noted that while the expansionof oversight required by proposed§§39.13(h)(2) and § 39.13(h)(3)155 may

provide benefits, many DCOs do notcurrently have the systems orinfrastructure to monitor or assess non-clearing member risk.156

In response to ISDA’s comment, aswell as other comments that in order tocomply with §39.13(h)(2), DCOs wouldneed technology builds (NYPC), newsurveillance systems and additionalsurveillance staff (OCC), and that therewould be a high cost (KCC), theCommission notes that some DCOsalready receive and review large traderreports for risk surveillance purposes ona daily basis. In fact, KCC stated in itscomment letter that ‘‘KCC would alsoremind the Commission that DCOcompliance staff review the reportableposition files that they receive on adaily basis to ascertain large trader risksthat [clearing members] face.’’ Inaddition, at least five years ago,Commission staff began recommendingthat DCOs do so, if they had not already

been doing so, in DCO reviews thatCommission staff has conducted todetermine whether such DCOs were incompliance with relevant coreprinciples under the CEA.

The Commission is modifying§ 39.13(h)(2) to require a DCO to obtain

large trader reports either from itsclearing members or from a DCM or aSEF for which it clears, which arerequired to be filed with theCommission by, or on behalf of, suchclearing members. However, theCommission does not believe that it is

practical or appropriate for a DCO torely on the Commission to provide largetrader reports to the DCO.

The Commission is adopting§ 39.13(h)(2) with the modificationsdescribed above.

c. Stress Tests—§ 39.13(h)(3)

Proposed §39.13(h)(3) would require

a DCO to conduct certain daily andweekly stress tests. The Commission hasdefined a ‘‘stress test’’ in §39.2, adoptedherein, as ‘‘a test that compares theimpact of potential extreme pricemoves, changes in option volatility,and/or changes in other inputs thataffect the value of a position, to thefinancial resources of a derivativesclearing organization, clearing member,or large trader, to determine theadequacy of such financialresources.’’157

Proposed §39.13(h)(3)(i) wouldrequire a DCO to conduct daily stresstests with respect to each large traderwho poses significant risk to a clearingmember or the DCO in the event of default, including positions at allclearing members carrying accounts forthe large trader. The DCO would havereasonable discretion in determiningwhich traders to test and themethodology used to conduct the stresstests. However, the Commission couldreview the selection of accounts and themethodology and require changes, asappropriate.

Proposed §39.13(h)(3)(ii) wouldrequire a DCO to conduct stress tests atleast once a week with respect to each

account held by a clearing member atthe DCO, by customer origin and houseorigin, and each swap portfolio, by

beneficial owner, under extreme butplausible market conditions. The DCOwould have reasonable discretion indetermining the methodology used toconduct the stress tests. However, theCommission could review themethodology and require anyappropriate changes. The Commissionrequested comment regarding whetherall clearing member accounts, by origin,and all swap portfolios should besubject to such stress tests on a weekly

basis or whether some other timeperiod, such as monthly, would besufficient to meet prudent riskmanagement standards.

Several commenters addressed dailystress testing. FIA recommended that allof the proposed stress tests should beconducted on a daily basis. LCH statedits belief that stress testing requirementsshould not be extended to cover largetraders that are clients of clearing





158As noted above, proposed §39.13(h)(3)(i)would not require daily stress tests on each largetrader, but only with respect to those large traderswho pose significant risk to a clearing member orthe DCO in the event of default.

159NOCC made a similar comment with respectto the frequency of back testing, which is discussedin section IV.D.6.g,, above. The Commission doesnot believe that it is appropriate to adopt aregulation establishing an exemption process withrespect to stress testing requirements based onvolume or risk exposure or otherwise.

160A DCO that is dually-registered as a securitiesclearing agency would not be subject to the stresstesting requirements of §39.13(h)(3)(ii) with respectto an account that only contains securitiespositions. However, such a DCO would be subjectto the requirements of §39.13(h)(3)(ii) with respectto any relevant account that contains positions ininstruments regulated by the Commission, even if

that account also contains securities positions. Inthis regard, the Commission is revising§ 39.13(h)(3)(ii) to refer to ‘‘each clearing memberaccount, by house origin and by each customerorigin, and each swap portfolio, including anyportfolio containing futures and/or options andheld in a commingled account pursuant to§ 39.15(b)(2) of this part, * * *’’

161See discussion of §§39.13(g)(6) and (g)(7) insection IV.D.6.g, above.

members but that the proposed weeklystress tests should be conducted daily.OCC stated that it did not see asufficient benefit to justify the increasedDCO resources that would be requiredto undertake daily stress tests on eachlarge trader,158 noting that the costswould be passed on to clearing membersand their customers. MGEX indicated

that a requirement for daily stresstesting of large traders seems excessivesince the data may be dated even afterone day and may not be more relevantthan doing an average stress test over aweekly or monthly period. MGEX alsoexpressed the view that the value of stress testing large traders is diminishedif they have accounts with differentclearing members.

As stated above, proposed§ 39.13(h)(3)(i) would require a DCO toinclude positions at all clearingmembers carrying accounts for the largetrader in the required stress tests. The

Commission is making the same changeto § 39.13(h)(3)(i) that it is making to§ 39.13(h)(2) by replacing the referenceto ‘‘positions at all clearing memberscarrying accounts for each such largetrader’’ with ‘‘futures, options, andswaps cleared by the derivativesclearing organization, which are held byall clearing members carrying accountsfor each such large trader.’’

KCC stated its belief that thefrequency of stress testing should be leftto the discretion of the DCO and should

be risk-based in light of prevailingmarket conditions. NOCC indicated that

products, customers or spread creditsshould reach a specified volume or riskexposure level before being required to

be stress tested with the proposedfrequencies so long as the DCO candemonstrate that it is meeting the coreprinciple objectives underlyingproposed § 39.13(f).159

The Commission believes that it isappropriate to specify the minimumfrequency of stress tests as set forth in§ 39.13(h)(3). As noted above, severalcommenters supported certain dailystress testing requirements. With theexception of KCC’s and NOCC’s

comments, no commenters suggestedthat stress tests should be conductedless frequently than weekly.

LCH recommended that theCommission prescribe that the stressscenarios used by the DCO in its testingshould be adapted for current marketconditions such that price or marketshifts should not be translated literally,

but rather proportionally. TheCommission believes that §39.13(h)(3)should explicitly permit DCOs to

exercise reasonable discretion indetermining the methodology to be usedin conducting the required stress tests.The Commission would recognize theapproach suggested by LCH to be anappropriate element of a DCO’s stresstesting methodology, but does not

believe that it is necessary to adopt sucha prescriptive requirement.

OCC indicated that for regulatoryreasons associated with OCC’s status asa dual SEC/Commission registrant,OCC’s system does not consolidate allpositions into a single ‘‘customerorigin’’ and ‘‘house origin’’ for each

clearing member, but rather permitsmultiple account types, including a firm(proprietary) account that incorporates

both securities and futures positions, asecurities customers’ account, a regularfutures customer segregated fundsaccount subject to Section 4d of theCEA, separate segregated funds accountsfor cross-margining arrangements asprovided in various Commission ordersapproving such arrangements, andothers. OCC further stated that becauseof the mathematical properties of therisk measures that it uses, itsunconsolidated account level stresstesting is more rigorous than if suchstress testing were conducted at thelevel of each origin as a whole andargued that it makes sense to aggregatepositions for stress testing in the samemanner as they would be aggregated ornetted for liquidation purposes.Therefore, OCC requested that theCommission clarify that this method of stress testing at the unconsolidatedaccount level based on appropriatehistorical data would meet therequirements of proposed§ 39.13(h)(3)(ii). The Commission agreeswith OCC that it would be appropriatefor a DCO to conduct the stress tests

required by §39.13(h)(3)(ii) with respectto separate house origin and customerorigin accounts such as the houseaccount that incorporates both securitiesand futures positions identified byOCC,160 separate customer accounts

subject to Sections 4d(a) and 4d(f) of theCEA, respectively, or cross-marginingaccounts.

OCC also argued that while therequirement of conducting stress testsunder ‘‘extreme but plausible’’ marketconditions may be appropriate fordetermining the adequacy of a clearingorganization’s resources for

withstanding the default of its largestparticipant, it would be inappropriatefor measuring the adequacy of anindividual clearing member’s margindeposits. In particular, OCC expressedits belief that stress testing the positions,including margin assets, in clearingmember accounts on a daily basis toensure a positive liquidating value atmore than a 99 percent confidence levelis adequate and appropriate and thatDCOs should have the ability to coverfor more extreme market conditionsthrough the use of additional financialresources, including clearing fund

deposits.A stress test, as defined by theCommission, is not designed to measurethe adequacy of a clearing member’smargin deposits or to ensure that marginassets in clearing members’ accountsmeet a 99 percent confidence level.Rather, these are the functions of thedaily review and back testing required

by §§39.13(g)(6) and (g)(7), adoptedherein.161 Stress tests address theadequacy of the applicable financialresources to cover losses resulting frompotential extreme price moves, changesin option volatility, and/or changes inother inputs that affect the value of a

position. In other words, if margindeposits would be sufficient to coverlosses 99 percent of the time, stress testswould determine whether otherfinancial resources would be availableand sufficient to cover losses theremaining 1 percent of the time. Suchother financial resources could includethe capital of the clearing member or theDCO, or a DCO’s guaranty fund.

The Commission is adopting§ 39.13(h)(3) with the modificationsdescribed above.

d. Portfolio Compression—§39.13(h)(4)

Proposed §39.13(h)(4)(i) wouldrequire a DCO to offer multilateralportfolio compression exercises, on aregular basis, for its clearing membersthat clear swaps, to the extent that such





162This also addresses the FHLBanks’ commentthat the Commission should specify what types of swaps are to be included in portfolio compressionexercises.

exercises are appropriate for thoseswaps that it clears. The Commissionrequested comment regarding whethersuch exercises should be offeredmonthly, quarterly, or on anotherfrequency. In addition, the Commissionrequested comment regarding whetherthe frequency of such exercises shouldvary for different categories of swaps.

Proposed §39.13(h)(4)(ii) wouldmandate that a DCO require its clearingmembers to participate in allmultilateral portfolio compressionexercises offered by the DCO, to theextent that any swap in the applicableportfolio was eligible for inclusion inthe exercise, unless including the swapwould be reasonably likely tosignificantly increase the risk exposureof the clearing member.

Proposed §39.13(h)(4)(iii) wouldpermit a DCO to allow clearing membersparticipating in such exercises to setrisk tolerance limits for their portfolios,provided that the clearing memberscould not set such risk tolerances at anunreasonable level or use such risktolerances to evade the requirements of proposed § 39.13(h)(4).

CME commended the Commission forrecognizing the importance of portfoliocompression exercises as an importantrisk management tool. CME furthersuggested that the Commission refrainfrom prescribing the frequency of suchexercises, stating its belief that eachDCO is best positioned to determine theoptimal frequency of portfoliocompression exercises for the swapsthat it clears, based on the unique

characteristics of the particular productsand markets. On the other hand, theFHLBanks stated that the Commissionshould specify how often portfoliocompression exercises are to take place.The Commission agrees with CME andis retaining the language that simplyrefers to ‘‘a regular basis.’’

ISDA requested that the Commissionclarify the meaning of ‘‘multilateralportfolio compression’’ in theseproposals. ISDA stated that if theCommission is referring to positionnetting, then it agrees that a DCO mustoffer such exercises. However, ISDA

indicated that if it refers to the provisionof multilateral portfolio compressionservices such as those currentlyprovided by entities such as TriOptima,DCOs should not be required to buildsuch duplicative services, which would

be likely to delay their roll-out of comprehensive clearing services. TheCommission agrees that a DCO shouldnot be required to incur the expense of

building its own multilateralcompression services. Therefore, theCommission is modifying therequirement to make it clear that

although a DCO may develop its ownportfolio compression services if itchooses, it is only required to makesuch exercises available to its clearingmembers if applicable portfoliocompression services have beendeveloped by a third party for thoseswaps that it clears.162

The FHLBanks urged the Commission

to further define ‘‘reasonably likely toincrease risk exposure to a clearingmember’’ to include the risk exposuresof a clearing member’s customers, andalso stated their view that a clearingmember’s customers must have theability to ‘‘opt-out’’ of portfoliocompression requirements to the extentthat those customers’ swap positionsneed to be retained for hedge accountingand other business purposes. Inparticular, the FHLBanks expressedtheir concern that the proposal’sambiguities would cause the internalrisk management strategies of entities

that are not swap dealers or major swapparticipants to be adversely affected,noting that portfolio compression couldpotentially jeopardize hedge accountingtreatment for customers’ swaptransactions and disrupt anticipatedcash flows.

LCH stated that it strongly supportsthe use of compression services and

believes that they should be encouraged by the Commission to the greatest extentpossible, but it would not necessarilyalways be appropriate for a DCO torequire its clearing members toparticipate in all such exercises. First,LCH noted that a DCO’s clearingmembers may not always be subject tothe Commission’s supervision and maynot be required to engage in suchcompression activities; thereforeimposing such a requirement on theDCO may discourage such firms from

becoming clearing members of that DCOand thereby have the perverse effect of discouraging such firms from clearing.Second, LCH stated that a clearingmember may have legitimate reasons fornot participating in such compressionexercises at all times, or for notsubmitting all eligible swaps to suchexercises. Therefore, LCH took the

position that the use of compressionservices should be encouraged butshould not be compulsory, andsuggested that the Commissioneliminate § 39.13 (h)(4)(ii) in its entirety.For the reasons stated by LCH and theFHLBanks, the Commission ismodifying §39.13(h)(4) to provide thatparticipation in compression exercises

by clearing members and theircustomers would be voluntary.

e. Clearing Members’ Risk ManagementPolicies and Procedures—§39.13(h)(5)

Proposed §39.13(h)(5) would imposeseveral requirements upon DCOsrelating to their clearing members’ riskmanagement policies and procedures.

Specifically, a DCO would be requiredto adopt rules that: (a) require itsclearing members to maintain currentwritten risk management policies andprocedures (proposed§ 39.13(h)(5)(i)(A)); (b) ensure that theDCO has the authority to request andobtain information and documents fromits clearing members regarding their riskmanagement policies, procedures, andpractices, including, but not limited to,information and documents relating tothe liquidity of their financial resourcesand their settlement procedures(proposed §39.13(h)(5)(i)(B)); and (c)require its clearing members to makeinformation and documents regardingtheir risk management policies,procedures, and practices available tothe Commission upon the Commission’srequest (proposed §39.13(h)(5)(i)(C)).

In addition, proposed §39.13(h)(5)(ii)would require a DCO to review the riskmanagement policies, procedures, andpractices of each of its clearing memberson a periodic basis and document suchreviews. The Commission invitedcomment regarding whether it shouldrequire that a DCO must conduct riskreviews of its clearing members on anannual basis or within some other time

frame. The Commission also requestedcomment regarding whether it shouldrequire that such reviews be conductedin a particular manner, e.g., whetherthere must be an on-site visit or whetherany particular testing should berequired. In addition, the Commissioninvited comment regarding whether,and to what extent, a DCO should bepermitted to vary the method and depthof such reviews based upon the nature,risk profiles, or other regulatorysupervision of particular clearingmembers.

ISDA and FIA supported the proposed

requirement in §39.13(h)(5)(i)(A) thatclearing members must have writtenrisk management policies andprocedures. FIA also recommended thatclearing members should be required tohave adequate staff and systems tomonitor customer risk on a real-time ornear-real time basis and to routinely testtheir risk management procedures undertheoretical stress scenarios.

NGX stated that the requirement thatclearing members have and follow riskmanagement policies is a sensiblerequirement in the context of the





163For example, in a separate rulemaking,proposed §23.600 would set forth detailed

requirements for the risk management programs of swap dealers and major swap participants, andwould require such entities to maintain writtenprocedures and policies describing their RiskManagement Programs. See 75 FR 71397 (Nov. 23,2010) (Regulations Establishing and Governing theDuties of Swap Dealers and Major SwapParticipants). Such swap dealers and major swapparticipants may or may not be clearing members.

164See 76 FR 45724 (Aug. 1, 2011) (ClearingMember Risk Management). In that rulemaking, theCommission has proposed to require FCMs, swapdealers, and major swap participants, each of whichare clearing members, to adopt certain specified riskmanagement procedures, including writtenprocedures to comply with the proposedrequirements.

165 In another context, e.g., a DCM has adopted arule that requires the operator of a DCM-approveddelivery facility to ’’ * * * make such reports, keepsuch records and permit such facility visitation asthe Exchange, the Commodity Futures TradingCommission or any other applicable governmentagency may require * * * .’’ See CBOT Rule 703.A.

typical, intermediatedclearinghouse.However, NGX arguedthat such requirements should not applyto a non-intermediated DCO such asNGX, where clearing participants arecommercial end users, trading andclearing for their own accounts, andnone of the clearing participants areexposed to the default risk of any other

clearing participant or to that of fellowcustomers of a clearing participant.

The Commission believes that it isappropriate for a DCO to require all of its clearing members to maintain writtenrisk management policies andprocedures, regardless of whether suchclearing members have customer

business or are exclusively self-clearing.As noted above, the Commission

believes that written policies are acrucial component of any riskmanagement framework. Moreover,§ 39.13(h)(5)(i)(A) does not specify thenature or extent of the required written

risk management policies andprocedures, which could vary asappropriate to a particular type of clearing member, subject to therequirements of any other applicableCommission regulations.163

The Commission has not proposedand is not adopting the additionalrequirements suggested by FIA,described above, as part of thisrulemaking. However, the Commissionhas proposed additional requirementswith respect to clearing members’ riskmanagement policies and procedures ina separate rulemaking applicabledirectly to clearing members.164

With respect to the proposedrequirement in §39.13(h)(5)(i)(C) that aDCO must have rules requiring itsclearing members to make informationregarding their risk managementpolicies, procedures, and practicesavailable to the Commission, MGEXstated that the Commission should seekaccess to a clearing member’s riskmanagement policies and processesdirectly and a DCO should not act as anunnecessary conduit between the

Commission and clearing members. TheCommission notes that even if it were topropose a regulation to impose such arequirement directly on clearingmembers in the future, it does notpreclude the Commission fromrequiring DCOs to impose thisrequirement on their clearing membersat this time.165

LCH stated that it concurs with theprovisions of proposed § 39.13(h)(5) butsuggested that the Commission limit therequirements under proposed paragraph(h)(5)(C) so that they would beapplicable only to those clearingmembers that are subject to theCommission’s oversight and not to allclearing members of a DCO regardless of the jurisdiction in which they operate.The Commission notes that riskmanagement practices of clearingmembers of registered DCOs, to theextent that such clearing members areclearing products subject to the

Commission’s oversight, are of importance to the Commission in itscapacity as the regulator of the DCO. Forpurposes of risk management oversight,there is no basis for differentiatingamong clearing members because of their registration status or domicile.Although the Commission does notdirectly supervise non-registrants, theCommission has previously adoptedrules that apply to clearing members,whether or not they are Commissionregistrants, e.g., §§1.35(b) and (c)(recordkeeping requirements), and Part17 of the Commission’s regulations(reporting requirements). Section

39.13(h)(5)(C) is consistent with theCommission’s approach with respect tosuch other rules, and is an appropriatecomponent of the regulatory frameworkfor DCO risk management.

With regard to the proposedrequirement in §39.13(h)(5)(ii) that aDCO must review the risk managementpolicies, procedures, and practices of each of its clearing members on aperiodic basis, FIA stated that allclearing members should be subject toon-site audits at least annually. NGXsuggested that if the Commissionrequires non-intermediated DCOs to

require their members to have writtenrisk management policies, theCommission should provide guidancethat a non-intermediated DCO wouldnot be required to conduct on-site auditsof clearing participants and that theDCO would meet its obligations to

review the policies of such clearingparticipants if it does so only on a for-cause basis.

The Commission is adopting§ 39.13(h)(5)(ii) as proposed, withoutprescribing the specific frequency,depth, or methodology of such reviews,and without specifying when an on-siteaudit may or may not be appropriate.

The Commission believes that such areview is important to ensure that eachclearing member’s risk managementframework is sufficient and properlyimplemented. The Commission also

believes that a DCO should be permittedto exercise reasonable discretion withrespect to each of these matters, basedupon the nature, risk profiles, or otherregulatory supervision of particularclearing members. The requirement thatsuch reviews must be conducted on a‘‘periodic basis’’ means that reviewsmust be conducted routinely and,therefore, the requirement would not

permit a DCO to only conduct suchreviews on a for-cause basis.A number of commenters noted that

many clearing members are clearingmembers of multiple DCOs and thuscould be subject to multiple duplicativerisk reviews. CME, OCC, MGEX, ICE,and NYPC indicated that this would be

burdensome for such clearing members.For example, MGEX noted ‘‘the burdena clearing member may be faced withdue to duplication of efforts andassociated costs.’’ KCC indicated thatsuch duplicative reviews would achievelittle with great expenditure of resources.

OCC and NYPC also expressed theirconcerns about the costs to DCOs. Inparticular, OCC noted that requiringDCOs to conduct such reviews wouldimpose a very high cost on a DCO thatis not integrated with a DCM. NYPCnoted its concern that the Commissionmay be underestimating the immensityof conducting such reviews in that aclearing member’s risk managementplan will not address solely the risksassociated with clearing membership,

but will be integrated and cover the broad spectrum of risks, includingmarket, credit, liquidity, capital, and

operational risk, that are associated withthe entirety of the clearing member’ssecurities, banking and futures business,much of which may have nothing to dowith business through the DCO.

In order to address NYPC’s specificconcern, the Commission is modifying§ 39.13(h)(5)(i)(A) to add the qualifier‘‘which address the risks that suchclearing members may pose to thederivatives clearing organization’’ after‘‘risk management policies andprocedures’’ and is adding the samequalifier in §39.13(h)(5)(ii) after ‘‘risk





166Section 5b(c)(2)(E) of the CEA, 7 U.S.C. 7a–1(c)(2)(E) (Core Principle E).

167Without addressing any specific aspect of proposed §39.14, LCH commented that it agreeswith the Commission’s proposals for settlementprocedures.

management policies, procedures, andpractices of each of its clearingmembers.’’

To reduce the potential burden of duplicative risk reviews of clearingmembers that are clearing members of multiple DCOs, CME and NYPC urgedthe Commission to give each DCOreasonable discretion regarding the

frequency, scope, or manner in which itconducts risk reviews of its clearingmembers, taking into account variousfactors including other regulatorysupervision, or review by agovernmental entity or self-regulatoryorganization, of particular firms. Othercommenters variously suggested thatrisk reviews should be conducted by theCommission (OCC and MGEX), by theclearing member’s DSRO or a similarDCO industry group (KCC, OCC, ICE,and MGEX), or by NFA (OCC).

The Commission notes that thecurrent DSRO system is not a viableoption for reviewing clearing members’risk management policies, proceduresand practices. Because DSROs are onlyresponsible for conductingexaminations of DCM-member FCMs’compliance with financial requirements,clearing members that only engage inhouse trading do not have a DSRO, norwill clearing members that solely clearSEF-executed trades. Moreover, suchexaminations do not address all of therisk issues which would concern aparticular DCO. Furthermore, even if thecurrent DSRO system were expanded toinclude DCOs, or a similar industrygroup composed of DCOs were formed,

it would be impractical to allocate theresponsibility to one DCO to analyze therisk management policies, proceduresand practices of a common clearingmember, on behalf of all relevant DCOs,when each DCO may impose differentrisk management requirements on itsclearing members and each DCO mayhave differing margin methodologiesthat call for different risk managementresponses from clearing members.

The Commission does not believe thatit should assume the sole oversight of the risk management policies,procedures, and practices of clearing

members of DCOs. The Commissionconducts risk surveillance with respectto both DCOs and clearing members;however, this cannot replace a DCO’sobligation to ensure that its clearingmembers are appropriately managingthe risks that such clearing memberspose to that particular DCO. Similarly,it does not appear that NFA would bean efficient alternative. The Commissionrecognizes that certain DCMs haveentered into regulatory servicesagreements with NFA, and that NFA hasthereby assumed certain audit

responsibilities with respect to FCMsthat are members of those DCMs.However, a DCO remains in the bestposition to review the risk managementpolicies, procedures, and practices of itsclearing members in the context of theirobligations to that particular DCO.

The Commission is adopting§ 39.13(h)(5) with the modifications

described above.

f. Additional Authority—§39.13(h)(6)

Proposed §39.13(h)(6) would requirea DCO to take additional actions withrespect to particular clearing members,when appropriate, based on theapplication of objective and prudentrisk management standards. Suchactions could include, but would not belimited to: (i) Imposing enhancedcapital requirements; (ii) imposingenhanced margin requirements; (iii)imposing position limits; (iv)prohibiting an increase in positions; (v)

requiring a reduction of positions; (vi)liquidating or transferring positions; and(vii) suspending or revoking clearingmembership.

KCC stated that it generally supportsthe concept that DCOs should imposeheightened risk managementrequirements on clearing members astheir risk profiles change and requestedthat the Commission clarify whethereach of the potential heightened riskmanagement requirements enumeratedin proposed § 39.13(h)(6)(i)–(vii) must

be explicitly delineated in DCO rules orin the DCO’s clearing membership

agreement. The Commission believesthat a DCO must have the authority andability to take appropriate additionalactions with respect to particularclearing members, as described in§ 39.13(h)(6), but how the DCO assertssuch authority, whether by rule orcontractual agreement, should be left tothe discretion of the DCO.

J.P. Morgan expressed the view thathigher margin multipliers should beadopted for members who present ahigher risk profile as a result of excessive concentration of risk cleared,reduced creditworthiness, or otherfactors affecting a particular member,and that such margin multipliers should

be documented in risk managementpolicies applicable to all members.

J.P. Morgan’s concern that marginmultipliers should be applied toclearing members with a higher riskprofile, is addressed in §39.13(h)(1),adopted herein and discussed in sectionIV.D.7.a, above, which requires a DCOto impose risk limits on each clearingmember.

The Commission is adopting§ 39.13(h)(6) as proposed.

E. Core Principle E—Settlement Procedures—§39.14

Core Principle E,166 as amended bythe Dodd-Frank Act, requires a DCO to:(1) Complete money settlements on atimely basis, but not less frequently thanonce each business day; (2) employmoney settlement arrangements toeliminate or strictly limit its exposure tosettlement bank risks (including creditand liquidity risks from the use of banksto effect money settlements); (3) ensurethat money settlements are final wheneffected; (4) maintain an accurate recordof the flow of funds associated withmoney settlements; (5) possess theability to comply with the terms andconditions of any permitted netting oroffset arrangement with another clearingorganization; (6) establish rules thatclearly state each obligation of the DCOwith respect to physical deliveries; and(7) ensure that it identifies and manageseach risk arising from any of its

obligations with respect to physicaldeliveries. The Commission proposed§ 39.14 to establish requirements that aDCO would have to meet in order tocomply with Core Principle E.167

1. Definitions—§39.14(a)

‘‘Settlement’’ was defined in proposed§ 39.14(a)(1) to include: (i) Payment andreceipt of variation margin for futures,options, and swap positions; (ii)payment and receipt of optionpremiums; (iii) deposit and withdrawalof initial margin for futures, options,and swap positions; (iv) all payments

due in final settlement of futures,options, and swap positions on the finalsettlement date with respect to suchpositions; and (v) all other cash flowscollected from or paid to each clearingmember, including but not limited to,payments related to swaps such ascoupon amounts. ‘‘Settlement bank’’was defined in proposed §39.14(a)(2) as‘‘a bank that maintains an account eitherfor the [DCO] or for any of its clearingmembers, which is used for the purposeof transferring funds and receivingtransfers of funds in connection withsettlements with the [DCO].’’

ISDA and FIA commented thatposting of variation margin on swapsshould not be viewed as ‘‘settling’’ thepresent value of the trade and noted thatprice alignment interest would still bepaid on variation margin. ISDA statedthat, similarly, initial margin is not‘‘paid’’ by a clearing member to a DCO





168E.g., a DCO could establish thresholds thatrelate to the extent of market volatility, or withrespect to a particular clearing member, the extentof losses that it has suffered on a particular day orwhether it has reached a risk limit established bythe DCO pursuant to §39.13(h)(1)(i), which isdiscussed in section IV.D.7.a, above.

169See CPSS–IOSCO Consultative Report,Principle 6: Margin, Key Consideration 4, at 40;EMIR, Article 39, paragraph 3, at 46.

170NEM stated that REMs ‘‘sell electricity andnatural gas to consumers as a competitivealternative to the local utility’’ and ‘ ‘often purchasewholesale physical natural gas and electricity on aspot (delivery) month (day) basis and also purchaseswaps to lock in prices for any consumers whowant a long-term fixed price contract.’’

171NGX stated that it ‘‘operates a trading andclearing system for energy products that provideselectronic trading, central counterparty clearing anddata services to the North American natural gas,electricity and oil markets.’’

but is often posted with a securityinterest granted by the clearing member.FIA also commented that the depositand withdrawal of initial margin is notproperly defined as a settlement.

NGX stated that, with the exception of a relatively small power contract, itsclearing model does not require dailyvariation margin payments and

collections from its clearingparticipants; rather, it holds collateral(initial margin) in an account at adepository bank rather than in asettlement account, and additionalcollateral may be called for as required.Therefore, NGX stated that it would beclearer when applied to the NGX model,to use the term ‘‘payment and receipt’’rather than the term ‘‘deposit’’ whenreferring to initial margin.

The Commission proposed a broaddefinition of ‘‘settlement’’ in§ 39.14(a)(1) to encompass all cash flows

between clearing members and a DCO.The Commission recognizes thataccounts that are used for the paymentand receipt of variation margin arefrequently called settlement accounts,while accounts that are used for thedeposit and withdrawal of initial marginmay be called deposit accounts, orcustody accounts, if the initial margindeposited therein is in the form of securities. The definition of ‘‘settlement

bank’’ in §39.14(a)(2) was intended toencompass any bank that a DCO uses forsettlements, as defined in §39.14(a)(1),whether the relevant accounts are calledsettlement accounts, deposit accounts,or custody accounts. In order to avoid

confusion, the Commission is modifying§ 39.14(a)(2) to define a settlement banksimply as ‘‘a bank that maintains anaccount either for the [DCO] or for anyof its clearing members, which is usedfor the purpose of any settlementdescribed in paragraph (a)(1) above.’’The Commission is adopting§ 39.14(a)(1) as proposed, except for anon-substantive change, which replaceseach reference to ‘‘futures, options, andswap positions’’ with ‘‘futures, options,and swaps.’’

2. Daily Settlements—§39.14(b)

Proposed §39.14(b) would require aDCO to effect a settlement with eachclearing member at least once each

business day, and to have the authorityand operational capacity to effect asettlement with each clearing member,on an intraday basis, either routinely,when thresholds specified by the DCOwere breached, or in times of extrememarket volatility.

CME expressed its support for intra-day settlements. LCH suggested that aDCO must measure its credit exposures‘‘several times each business day,’’ and

should be obliged to recalculate initialand variation margin requirements morethan once each business day. J.P.Morgan stated that intraday margin callsshould be made with greater frequencyfor clearing members who have a higherrisk profile.

The Commission does not believe thatit is necessary to adopt a requirement

that all DCOs recalculate initial andvariation margin requirements morethan once each business day or anexplicit requirement for intraday margincalls for clearing members with a higherrisk profile. The Commission believesthat it has struck the appropriate

balance in §39.14(b), by requiring aDCO to conduct daily settlements, whilepermitting a DCO to exercise itsdiscretion regarding whether it willconduct routine intraday settlements, orwhether it will settle positions on anintraday basis only when certainthresholds are breached 168 or in times

of extreme market volatility. Thisapproach is also generally consistentwith proposed internationalstandards.169 A particular DCO coulddetermine to conduct routine intradaysettlements, as some have done, or toconduct intraday settlements forparticular clearing members based ontheir risk profiles.

NEM, NGX, and NOCC all requestedthat the Commission afford recognitionto a clearing model that does not requiredaily variation margin payments andcollections but permits accrualaccounting with respect to certain

energy products.NEM noted that most Retail EnergyMarketers (REMs) 170 use an accrualaccounting practice that recognizesrevenues and costs after energy deliveryto their retail customers and thatclearing solutions that require dailycash settlements would eithercomplicate their accounting practices orsignificantly impact REM cash flows.

NGX stated that its clearing modelgenerally does not require dailyvariation margin payments andcollections, and that settlement on its

energy contracts 171 occurs only on amonthly basis, after clearing participantobligations have been netted, consistentwith practices in the cash market andwith the end-user nature of the vastmajority of NGX clearing participants.NGX noted that, therefore, the type of daily settlement risk that proposed§ 39.14 addresses is not present in the

NGX model and the degree of risk in themonthly settlement process is reduced.

Although NOCC supported adoptionof proposed §39.14(b) for traditionalfutures and cleared swaps, it indicatedthat it intends to develop aclearinghouse that will seek registrationas a DCO to clear energy products,including commercial forward contractsthat it believes will be outside the scopeof regulation as futures contracts or asswaps under the CEA, as well asfinancial forwards that it believes willfall within the definition of swaps underthe CEA. NOCC stated that while gains

and losses on the commercial forwardcontracts and financial forwards that itintends to clear are calculated daily,they are accrued throughout thedelivery period and following thedelivery period, and are not cash settleduntil final payment occursapproximately three weeks after themonth in which the commodity isdelivered. NOCC proposed that theCommission adopt a rule that wouldpermit exemptions for alternative riskmanagement frameworks, which wouldprovide NOCC with the ability todemonstrate to the Commission that

daily accrual settlement of variationmargin is a sound practice appropriatelytailored to the unique characteristics of the cash energy markets and marketparticipants for which NOCC is seekingto provide the benefits of clearing.

The Commission has not proposedand is not adopting a rule permittingexemptions for alternative riskmanagement frameworks. However, aparticular DCO may petition theCommission for an exemption if it

believes that it can demonstrate that thedaily accrual of gains and lossesprovides the same protection to the DCOas would daily variation marginpayments and collections. Therefore,the Commission is adding a clause to§ 39.14(b) that states ‘‘[e]xcept asotherwise provided by Commissionorder’’ prior to the requirement that aDCO ‘‘shall effect a settlement with eachclearing member at least once each

business day.’’





172See Section 5b(c)(2)(E)(ii) of the CEA, 7 U.S.C.7a–1(c)(2)(E)(ii).

173See CPSS–IOSCO Consultative Report,Principle 9: Money Settlements, Key Consideration3, at 54.

174Some DCOs have their own settlementaccounts at each settlement bank used by theirclearing members, in which case a clearingmember’s settlement bank is also the DCO’ssettlement bank, and transfers between a clearingmember’s settlement account and a DCO’ssettlement account are made internally. Other DCOspermit their clearing members to use settlement banks at which such DCOs do not have their ownsettlement accounts, and settlement transfers aremade between a clearing member’s settlement bankand the DCO’s settlement bank. In either event, thesettlement bank with the largest share of settlementactivity will always be a bank at which the DCOmaintains a settlement account, as all settlementactivity will involve the DCO.

3. Settlement Banks—§39.14(c)

The introductory paragraph of proposed §39.14(c) would require aDCO to employ settlement arrangementsthat eliminate or strictly limit itsexposure to settlement bank risks,including the credit and liquidity risksarising from the use of such banks toeffect settlements with its clearingmembers.

OCC commented that it would not bepossible for a DCO to ‘‘eliminate’’ allexposure to settlement bank risks andthat the Commission had not providedany guidance as to what it means to‘‘strictly limit’’ such exposure. TheCommission notes that the language inthe introductory paragraph of proposed§ 39.14(c), which would require a DCOto ‘‘employ settlement arrangementsthat eliminate or strictly limit itsexposure to settlement bank risks,including the credit and liquidity risksarising from the use of such banks to

effect settlements * * *,’’ is virtuallyidentical to the statutory language inCore Principle E.172 The Commission isadopting the introductory paragraph of § 39.14(c) with two modifications. First,in response to OCC’s comment, theCommission is adding the words ‘‘asfollows:’’ at the end of the sentence, inorder to clarify that a DCO that complieswith §39.14(c)(1), (2), and (3), discussed

below, will be deemed to have‘‘employ[ed] settlement arrangementsthat eliminate or strictly limit itsexposure to settlement bank risks’’within the meaning of §39.14(c). TheCommission is also insertingparentheses around the letter ‘‘s’’ in theword ‘‘banks’’ in order to clarify that theCommission is not intending to requirethat a DCO must have more than onesettlement bank in all circumstances.However, a DCO will need to have morethan one settlement bank to the extentthat it is reasonably necessary in orderto eliminate or strictly limit the DCO’sexposures to settlement bank risks,pursuant to §39.14(c)(3), as furtherdiscussed below.

4. Criteria for Acceptable SettlementBanks—§§ 39.14(c)(1) and (c)(2)

Proposed §39.14(c)(1) would requirea DCO to have documented criteria withrespect to those banks that areacceptable settlement banks for the DCOand its clearing members, includingcriteria addressing the capitalization,creditworthiness, access to liquidity,operational reliability, and regulation orsupervision of such banks. Proposed§ 39.14(c)(2) would require a DCO tomonitor each approved settlement bank

on an ongoing basis to ensure that such bank continues to meet the criteriaestablished pursuant to §39.14(c)(1).Proposed §§39.14(c)(1) and (c)(2) areconsistent with internationalrecommendations.173

NYPC agreed with the proposedrequirement that DCOs must articulatethe standards that they apply to the

selection of settlement banks.OCC indicated that a DCO may have

to deviate from its written policies onthe selection of clearing banks during amajor market disruption, as thosesettlement banks that are the bestoptions available at the time may notmeet the technical criteria set forth in aDCO’s written policies. TheCommission agrees with OCC that aDCO may have to deviate from itswritten policies during a major marketdisruption. However, whether theCommission would permit a DCO to doso would need to be addressed in the

context of the particular major marketdisruption, e.g., based on an analysis of whether all available settlement banksno longer meet such written criteria.

MGEX commented that the FederalReserve and other banking authoritiesare in the best position to review a

bank’s financial condition. NYPCrecommended that the Commissionmodify the proposed rule to reflect thefact that the only criteria that are likelyto be susceptible to observation by aDCO are a bank’s operational reliability,regulatory capital, and the rating of itsparent bank holding company. TheCommission agrees that the FederalReserve and other banking authoritiesmay be in the best position to review a

bank’s financial condition and that thereis certain information about settlement

banks to which a DCO will not haveregular access. Nonetheless, a DCO hasa responsibility to undertake reasonableefforts to ensure that its settlement

bank(s) continue to meet the criteriaestablished by the DCO. A DCO may beable to obtain pertinent informationfrom public sources, and it should beable to request and obtain informationfrom an approved settlement bank,which demonstrates whether the bank

continues to meet the criteriaestablished by the DCO.

The Commission is adopting§ 39.14(c)(1) with a modification thatreplaces the language that states: ‘‘withrespect to those banks that areacceptable settlement banks for thederivatives clearing organization and itsclearing members’’ with ‘‘that must bemet by any settlement bank used by the

derivatives clearing organization or itsclearing members.’’ In addition, theCommission is inserting parenthesesaround the letter ‘‘s’’ in the word‘‘banks.’’ Consistent with themodification to the introductoryparagraph of §39.14(c) described above,these modifications also clarify thatthere may be circumstances in which it

may be appropriate for a DCO to use asingle settlement bank. The Commissionis adopting §39.14(c)(2) as proposed.

5. Monitoring and Addressing Exposureto Settlement Banks—§39.14(c)(3)

Proposed §39.14(c)(3) would requirea DCO to monitor the full range andconcentration of its exposures to its ownand its clearing members’ settlement

banks and assess its own and itsclearing members’ potential losses andliquidity pressures in the event that thesettlement bank with the largest share of settlement activity were to fail.174 ADCO would be required to: (i) maintainsettlement accounts at additionalsettlement banks; (ii) approve additionalsettlement banks for use by its clearingmembers; (iii) impose concentrationlimits with respect to its own or itsclearing members’ settlement banks;and/or (iv) take any other appropriateactions if any such actions arereasonably necessary in order toeliminate or strictly limit suchexposures.

OCC commented that the requirementthat a DCO monitor its clearingmembers’ exposure to the settlement

banks used by such clearing members

could result in a massive duplication of effort and would be very burdensomefor the DCO. Therefore, OCC suggestedthat clearing members or their primaryregulators should be responsible formonitoring clearing members’ exposureto their settlement banks.

The Commission does not agree withOCC that proposed §39.14(c)(3) couldresult in a massive duplication of effort.The focus of the monitoring required by§ 39.14(c)(3) is on a DCO’s exposuresand its clearing members’ potentiallosses insofar as they may createexposures for the DCO. Therefore, each





175See CPSS–IOSCO Consultative Report,Principle 9: Money Settlements, Explanatory Note,3.9.5, at 56.

176CME also expressed concern that, as drafted,the proposed regulation appears to require a DCOto approve at least two more settlement banks, because of the reference to ‘‘settlement banks’’ inthe plural.

177However, NGX stated that where a DCO hasdaily settlements or monthly settlements in agreater amount, requiring more than one settlement bank may materially reduce systemic risk withoutadverse effects.

DCO must conduct the requiredmonitoring as each DCO’s exposures areunique to that DCO. In addition, thisprovision of §39.14(c)(3) is consistentwith proposed internationalstandards.175

NYPC commented that since initialand variation margin requirementsfluctuate daily, proposed §39.14(c)(3)

would require DCOs to monitor theirexposures to all settlement banks andnot merely the largest. The Commissionagrees with NYPC. Proposed§ 39.14(c)(3) would require a DCO to‘‘monitor the full range andconcentration of its exposures to its ownand its clearing members’ settlement

banks,’’ which means that a DCO mustconduct such monitoring with respect toall such settlement banks. The referenceto ‘‘the settlement bank with the largestshare of settlement activity’’ was madein the context of requiring a DCO toassess the potential impact of the failure

of such bank.CME and OCC requested that theCommission clarify that a DCO wouldonly be required to take any of theactions specified in proposed§ 39.14(c)(3)(i)–(iv), if the specific actionwere reasonably necessary in order toeliminate or strictly limit exposures tosettlement banks, and that a DCO wouldnot be required to take all of thespecified actions in all cases. CMEsupported this interpretation and OCCstated its belief that these requirementswould be reasonable if the final rulewere expressly limited in this manner.The Commission is modifying

§ 39.14(c)(3)(i)–(iv) to clarify theCommission’s intent to obligate a DCOto employ any one or more of theactions specified in (i) through (iv), onlyif any one or more of such actions isreasonably necessary in order toeliminate or strictly limit suchexposures.

CME, ICE, MGEX, and KCC variouslycommented that prescribingconcentration limits and requiring thata DCO and its clearing membersmaintain multiple settlement bankswould impose significant expenses onthe DCO, its clearing members, and their

customers. CME, MGEX, and NYPCstated their belief that it would bedifficult to comply with this regulationgiven the limited number of banks thatare qualified and willing to serve assettlement banks.176 CME also

commented that the meaning of ‘‘concentration limits’’ is unclear, andstated its belief that it would be unwiseto impose artificial limits on the numberof clearing members or the size of clearing member accounts at a particularsettlement bank.

ICE took the position that hardconcentration limits could increase

systemic risk because a DCO wouldneed to distribute funds across multiple

banks. ICE indicated that as settlementfunds increased, highly rated bankswould eventually be consumed by theconcentration limits and DCOs mayhave to open accounts with lower rated

banks. ICE further commented thatconcentration limits could act as aconstraint on customer choice, in that if one bank had a large number of settlement customers, there would benatural concentration of settlementflows, and the DCO could have to directcustomers not to use their chosen bank.

NYPC also questioned whethercurrent settlement banks would bewilling to continue to act in that role if the Commission required a DCO andsome of its clearing members to transfertheir business to other banks. NYPCstated that this would leave the existingsettlement banks with an expensiveinfrastructure supported by fewer clientaccounts.

MGEX stated its belief that requiringa DCO to oversee clearing members’

banks and establishing credit orconcentration limits would be intrusiveand suggested that the final rule shouldprovide DCOs with flexibility.

The Commission notes that proposed§ 39.14(c)(3)(iii) would require a DCO toimpose concentration limits withrespect to its own or its clearingmembers’ settlement banks if suchaction were reasonably necessary inorder to eliminate or strictly limit itsexposures to such settlement banks.Section 39.14(c)(3) would provide aDCO with other possible options foraddressing such exposures. Forexample, a DCO could open an accountat an additional settlement bankpursuant to §39.14(c)(3)(i), or approvean additional settlement bank for use by

its clearing members pursuant to§ 39.14(c)(3)(ii), without imposingconcentration limits, if doing so wouldmean that such limits would not bereasonably necessary. In addition,proposed §39.14(c)(3)(iv) would allow aDCO to take other appropriate actions,which could obviate the potential needfor concentration limits.

KCC commented that identifyingmultiple settlement banks for use byclearing members could increase aDCO’s operational risk by fragmentingthe DCO’s margin pool. KCC suggested

that there is no need for multiplesettlement banks because there would

be little effect on the operations of aDCO if a non-systemically significantsettlement bank failed. KCC noted thatthe Federal Deposit InsuranceCorporation generally facilitates thetransfer of the accounts and operationsof a failed bank to a successor

institution or a bridge bank with little orno disruption to depositors at the failed

bank. KCC further stated that a DCO’ssettlement account is essentially a pass-through account and DCOs generally donot maintain large, long-term balancesin the account. According to KCC, evenif a DCO held significant guaranty fundsor security deposits at a settlement

bank, such assets would likely be heldin a trust or custody account, whichwould be unavailable to creditors of thefailed institution and would generally

be available to the DCO within a shortperiod of time following the insolvency

of the settlement bank. KCC also notedthat a requirement that DCOs identifyadditional settlement banks for use byclearing members would cause asignificant rise in bank service fees forDCOs and clearing members.

NGX noted that proposed § 39.14(c)generally refers to settlement banks, inthe plural, assuming that all DCOs willmaintain accounts with at least twosettlement banks. NGX questioned the

benefit of requiring all DCOs, regardlessof size, to use multiple settlement

banks. According to NGX, settlementrisk varies across DCOs, and the type of

daily settlement risk the proposed ruleaddresses is not present at a DCO likeNGX, which does not engage in dailyvariation margin payments andcollections from its clearingparticipants. NGX stated that the ruleshould take account of the level of settlement activity because requiring aDCO with a relatively small need forsettlement services to divide the flow of funds may cause the DCO to be lessattractive, bear higher costs, and be lesscompetitive with larger DCOs, whilehaving a negligible impact on systemicrisk.177 NGX also commented that therule could result in increasedoperational risk at a DCO like NGX withcomplex contract settlement anddelivery that requires a settlement bankto have specialized expertise and tomaintain specialized processes andoperational capabilities. NGX requestedthat the Commission provide theflexibility to permit a DCO to





178

For example, it appears that CME may haveinterpreted proposed §39.14(c)(3)(ii) in thisunintended manner, since it stated that ‘‘we do not believe the CFTC should require clearing membersto have accounts at multiple settlement banks,which may prove to be an impossible (and/orextremely costly) requirement to satisfy.’’ It appearsthat KCC may also have interpreted proposed§ 39.14(c)(3)(ii) in this manner, in light of itscomment that a requirement that DCOs identifyadditional settlement banks for use by clearingmembers would cause a significant rise in bankservice fees for DCOs and clearing members. Thereis no reason that providing greater choice toclearing members regarding which single settlement bank they could elect to use would cause a rise in bank service fees for clearing members.

179 ISDA also requested that the Commissionclarify how the proposed requirement would becompatible with the fact that title transfer of initialmargin may not occur when it is posted to a DCO.Title transfer is not a necessary element of settlement finality. Although in some jurisdictionsa clearing member may need to transfer title tomargin collateral to a DCO in order for the DCO toeffectively exert control over such collateral, inother jurisdictions a clearing member may transfermargin collateral to a DCO and grant a securityinterest to the DCO without transfer of title.

180See Section 5b(c)(2)(E)(iii) of the CEA, 7 U.S.C.7a–1(c)(2)(E)(iii).

18111 U.S.C. 546(e).

182See Section 5b(c)(2)(E)(iv) of the CEA, 7 U.S.C.7a–1(c)(2)(E)(iv).

183Prior to amendment by the Dodd Frank Act,Core Principle E provided, in part, that a [DCO]applicant shall have the ability to ‘‘* * *[m]aintain an adequate record of the flow of fundsassociated with each transaction that the applicantclears. * * *’’

184See Section 5b(c)(2)(E)(v) of the CEA, 7 U.S.C.7a–1(c)(2)(E)(v).

demonstrate that the use of a singlesettlement bank is appropriate from

both a policy and a financialperspective.

As noted above, the Commission doesnot intend to require a DCO to use morethan one settlement bank if theparticular DCO otherwise employssettlement arrangements that eliminate

or strictly limit its exposure tosettlement bank risks. The Commissionunderstands that the number of banksthat are willing to serve settlementfunctions might be limited, particularlyfor smaller DCOs. The Commissionfurther understands that it might becostly for some DCOs that currentlyonly have one settlement bank to use anadditional settlement bank. However,pursuant to §39.14(c)(3), a DCO would

be required to have a second settlement bank, if it were reasonably necessary inorder to eliminate or strictly limit theDCO’s exposures to settlement bank

risks.The Commission is modifying§§ 39.14(c)(3)(i) and (ii) to refer to ‘‘oneor more’’ additional settlement banks, sothat it will be clear that a DCO wouldnot necessarily be required to maintainsettlement accounts with more than oneadditional settlement bank or to approvemore than one additional settlement

bank that its clearing members couldchoose to use, under the specifiedcircumstances. In addition, theCommission is modifying§ 39.14(c)(3)(iii) to similarly clarify thata DCO may only be required to imposeconcentration limits with respect to

‘‘one or more’’ of its own or its clearingmembers’ settlement banks, under thespecified circumstances. TheCommission is also modifying§ 39.14(c)(3)(ii) by replacing ‘‘for use byits clearing members’’ with ‘‘that itsclearing members could choose to use’’to make it clear that the Commission isnot suggesting that a single clearingmember might be required to use morethan one settlement bank.178

The Commission is adopting§ 39.14(c)(3) with the modificationsdescribed above.

6. Settlement Finality—§ 39.14(d)

Proposed §39.14(d) would require aDCO to ensure that settlement fundtransfers are irrevocable andunconditional when the DCO’s accountsare debited or credited. In addition, theproposed regulation would require thata DCO’s legal agreements with itssettlement banks must state clearlywhen settlement fund transfers wouldoccur and a DCO was required toroutinely confirm that its settlement

banks were effecting fund transfers asand when required by those legalagreements.

ISDA and FIA requested that the ruleallow for the correction of errors.179 TheCommission agrees with ISDA and FIAthat settlement finality should notpreclude the correction of errors, and isadding a clause to §39.14(d) thatexplicitly provides that a DCO’s legalagreements with its settlement banksmay provide for the correction of errors.

In addition, the Commission is addingthe modifier ‘‘no later than’’ before‘‘when the derivatives clearingorganization’s accounts are debited orcredited’’ in recognition of the fact thata DCO’s legal agreements with itssettlement banks may provide forsettlement finality prior to the timewhen the DCO’s accounts are debited orcredited, e.g., upon the bank’sacceptance of a settlement instruction.

KCC commented that a DCO cannever effectively ensure that settlementpayments are irrevocable, given theexistence of a legal risk that a settlementpayment may be deemed to be aninappropriate transfer pursuant toapplicable bankruptcy law. Therefore,KCC urged the Commission to eliminatethe requirement or to restate the rule asa requirement to monitor operationalrisks related to settlement finality. TheCommission does not believe that it isappropriate to do so. Core Principle Erequires a DCO to ‘‘ensure that moneysettlements are final when effected.’’ 180 In addition, Section 546(e) of the U.S.Bankruptcy Code181 provides that a

bankruptcy trustee may not avoid atransfer that is a margin payment or asettlement payment made to a DCO by

a clearing member, or made to a clearingmember by a DCO (with the exceptionof fraudulent transfers). However, theCommission is modifying § 39.14(d) tostate that ‘‘[a DCO] shall ensure thatsettlements are final when effected byensuring that it has entered into legal agreements that state that settlementfund transfers are irrevocable and

unconditional * * *’’ (added text initalics).

The Commission is adopting§ 39.14(d) with the modificationsdescribed above.

7. Recordkeeping—§ 39.14(e)

Proposed §39.14(e) would require aDCO to maintain an accurate record of the flow of funds associated with eachsettlement.

KCC expressed its general support of the concept of maintaining accuraterecords of settlement fund flows, butstated that it may be prudent for the

Commission to further clarify the extentto which the additional recordkeepingapplies to cross-margining and nettingarrangements that a DCO may have inplace with certain clearing members andtheir customers. The language in§ 39.14(e) is virtually identical to theCore Principle E language, which theDodd-Frank Act added to the CEA.182 Moreover, this language is similar to thelanguage that had been contained inCore Principle E prior to its amendment

by the Dodd-Frank Act.183 Therefore, proposed § 39.14(e) would

not impose any additionalrecordkeeping requirements. TheCommission believes that therequirement that a DCO must maintainan accurate record of the flow of fundsassociated with each settlement wouldnecessarily require the maintenance of an accurate record with respect to anycross-margining or nettingarrangements, without the need toseparately address such arrangements.The Commission is adopting § 39.14(e)as proposed.

8. Netting Arrangements—§39.14(f)

Proposed §39.14(f) would incorporateCore Principle E’s requirement that a

DCO must possess the ability to complywith each term and condition of anypermitted netting or offset arrangementwith any other clearing organization.184





185Section 5b(c)(2)(F) of the CEA, 7 U.S.C. 7a–1(c)(2)(F) (Core Principle F).

186Such ‘‘assets’’ would include any securities orproperty that clearing members deposit with a DCOin order to satisfy initial margin obligations, whichare also sometimes referred to as ‘‘collateral.’’Proposed §39.15 uses the term ‘‘assets’’ rather than‘‘securities or property’’ or ‘‘collateral’’ in order to be consistent with the statutory language.


188The DCO’s rule filing would also need tocomply with the procedural requirements of § 40.5(a).

The Commission did not receive anycomment letters discussing §39.14(f)and is adopting §39.14(f) as proposed.

9. Physical Delivery—§39.14(g)

Proposed §39.14(g) would require aDCO to establish rules clearly statingeach obligation that the DCO hasassumed with respect to physical

deliveries, including whether it has anobligation to make or receive delivery of a physical instrument or commodity, orwhether it indemnifies clearingmembers for losses incurred in thedelivery process, and to ensure that therisks of each such obligation areidentified and managed.

KCC commented that it generallysupports the concept of proposed§ 39.14(g), but requested that theCommission clarify that a DCO may bedeemed to have satisfied its obligationto establish rules relating to physicaldeliveries if the rules of the exchange

that lists the cleared contracts clearlydelineates such physical deliveryobligations. The Commission notes thatthe rules referenced in §39.14(g) must

be enforceable by and against the DCO.If a DCO were integrated with a DCMand the DCM’s rules were enforceable

by and against the DCO, then it may bethat the DCM’s rules would satisfy therequirements of §39.14(g). However,such compliance would need to bedetermined on a case-by-case basis. TheCommission is adopting §39.14(g) asproposed, except for a technical revisionthat replaces ‘‘contracts, agreements andtransactions’’ with ‘‘products’’ to ensureconsistency with other provisions inpart 39.

F. Core Principle F—Treatment of Funds—§ 39.15

Core Principle F, 185 as amended bythe Dodd-Frank Act, requires a DCO to:(i) Establish standards and proceduresthat are designed to protect and ensurethe safety of its clearing members’ fundsand assets; (ii) hold such funds andassets in a manner by which tominimize the risk of loss or of delay inthe DCO’s access to the assets andfunds; and (iii) only invest such funds

and assets in instruments with minimalcredit, market, and liquidity risks. TheCommission proposed § 39.15 toestablish requirements that a DCOwould have to meet in order to complywith Core Principle F.

1. Required Standards and Procedures—§ 39.15(a)

Proposed §39.15(a) would require aDCO to establish standards and

procedures that are designed to protectand ensure the safety of funds andassets belonging to clearing membersand their customers.186 TheCommission did not receive anycomments on proposed § 39.15(a) and isadopting the provision as proposed.

2. Segregation—§ 39.15(b)(1)

Proposed §39.15(b)(1) would requirea DCO to comply with the segregationrequirements of Section 4d of the CEAand Commission regulationsthereunder, or any other applicableCommission regulation or orderrequiring that customer funds and assets

be segregated, set aside, or held in aseparate account.

LCH suggested that the Commissionclarify the meaning of ‘‘segregated’’ andlimit the segregation requirement to thefunds of clearing members’ clients. LCHalso urged the Commission to limit

these requirements to client businesscleared by the DCO under the FCMclearing structure, noting that a DCO

based outside the United States mayoffer client clearing services throughalternative structures and that it did not

believe it would be appropriate forclients clearing under these non-U.S.structures to be subject to thesegregation requirements of Section 4dof the CEA, but rather to therequirements set out by the DCO’s homeor other regulators.

FIA recommended that the proposedrule be revised to make clear that a DCO

should keep margin posted by clearingmembers to support proprietarypositions separate from the DCO’s ownassets, noting that although proprietaryfunds held at a DCO are not subject tothe segregation provisions of the CEA, itis essential that these funds areprotected in the event of the default of the DCO. The Commission has notproposed and is not adopting FIA’ssuggestion that the Commission expandthe applicability of § 39.15(b)(1) in thismanner.

BlackRock and FHLBanks expressedtheir views on specific segregationmodels. The Commission has proposedrules in a separate rulemaking regardingthe segregation of cleared swapscustomer contracts and collateral, andthe Commission will addressBlackRock’s and FHLBanks’ comments

in connection with the final rulemakingfor that proposal.187

The comments submitted by LCH,FIA, BlackRock, and FHLBanks alladdress the substance or applicability of segregation requirements. Proposed§ 39.15(b)(1) would not have imposedany additional substantive segregationrequirements upon a DCO. It would

simply require a DCO to comply withthe substantive segregationrequirements of the CEA and otherCommission regulations or orders,which are currently applicable or whichmay become applicable in the future. Inparticular, §39.15(b)(1) is not intendedto extend the extraterritorial reach of existing segregation requirements

beyond that which may already exist insuch requirements. However, in order toclarify the Commission’s intent in thisregard, the Commission has added‘‘applicable’’ before ‘‘segregationrequirements’’ in § 39.15(b)(1). In

addition, the Commission wishes toclarify that its current segregationrequirements apply to a non-U.S. basedDCO with respect to clearing membersthat are registered as FCMs, whetherthey are clearing business for U.S. basedcustomers or non-U.S. based customers.Such requirements do not apply withrespect to clearing members that arenon-U.S. based and that are notregistered as FCMs, nor required to beregistered as FCMs.

The Commission is adopting§ 39.15(b)(1) with the modificationdescribed above.

3. Commingling of Futures, Options onFutures, and Swap Positions—§ 39.15(b)(2)

Proposed §39.15(b)(2)(i) wouldpermit a DCO to commingle, and a DCOto permit clearing member FCMs tocommingle, customer positions infutures, options on futures, and swaps,and any money, securities, or propertyreceived to margin, guarantee, or securesuch positions, in an account subject tothe requirements of Section 4d(f) of theCEA (cleared swaps account), pursuantto DCO rules that have been approved

by the Commission under § 40.5 of the

Commission’s regulations. The DCO’srule filing 188 would have to include, ata minimum, the following: (A) anidentification of the futures, options onfutures, and swaps that would becommingled, including contractspecifications or the criteria that would





189As noted in the Commission’s notice of proposed rulemaking regarding the protection of

cleared swaps customer contracts and collateral, 76FR at 33818 (June 9, 2011) (Protection of ClearedSwaps Customer Contracts and Collateral;Conforming Amendments to the Commodity BrokerBankruptcy Provisions), if the complete legalsegregation model is adopted for cleared swaps, aDCO could more easily justify the approval of rulesor the issuance of a 4d order allowing thecommingling of futures, options, and swaps, sincethe impact of any different risk from the product being brought into the portfolio would be limitedto the customer who chooses to trade that product.In such case, the Commission may still wish toobtain and review all of the information specifiedin proposed §39.15(b)(2)(i), although its specificconcerns may be minimized. However, if thecomplete legal segregation model is adopted for

cleared swaps, and after the Commission obtainsexperience with respect to considering requests tocommingle futures, options, and swaps under§ 39.15(b)(2) in an environment where that marginmodel applies, the Commission may revisit itsongoing need for all of the information listed in§ 39.15(b)(2)(i).

190A rule submitted for prior approval would beapproved unless the rule is inconsistent with theCEA or the Commission’s regulations. See Section5c(c)(5) of the CEA, 7 U.S.C. 7a–2(c)(5); and 75 FRat 44793–44794 (Provisions Common to RegisteredEntities; final rule).

191E.g., CME and FIA raised operational concernsin the event the Commission adopts a differentsegregation regime for each type of customeraccount. Those comments will be considered inconnection with the Commission’s proposalregarding the appropriate segregation regime forcleared swaps accounts. See 76 FR 33818 (June 9,2011) (Protection of Cleared Swaps CustomerContracts and Collateral; Conforming Amendmentsto the Commodity Broker Bankruptcy Provisions).

192E.g., LCH suggested additional factors that theCommission should consider before a DCO or itsclearing members should be able to commingle, andoffer offsets between, futures, options on futures,and swaps, including: (a) clients must hold theirfutures, options, and swaps under the same accountstructure and within the same legal entity, and (b)

the DCO must margin the futures, options, andswaps using the same margin model; and ELXexpressed the view that in order for a customer togain the portfolio margining benefits of commingling futures, options, and swaps executedon a SEF, it would be necessary for a customer toclear its futures, options, and swaps through thesame DCO.

193LCH stated that all offset assumptions in theDCO’s margin calculations must, at a minimum, bereplicated in the DCO’s stress testing and must berecalibrated frequently. The Commission notes thatpermitted spread and portfolio margins areaddressed in §39.13(g)(4), discussed in sectionIV.D.6.e, above, and back testing of such spread andportfolio margins is addressed in §39.13(g)(7),discussed in section IV.D.6.g, above.

be used to define eligible futures,options on futures, and swaps; (B) ananalysis of the risk characteristics of theeligible products; (C) a description of whether the swaps would be executed

bilaterally and/or executed on a DCMand/or a SEF; (D) an analysis of theliquidity of the respective markets forthe futures, options on futures, and

swaps that would be commingled, theability of clearing members and the DCOto offset or mitigate the risks of suchproducts in a timely manner, withoutcompromising the financial integrity of the account, and, as appropriate,proposed means for addressinginsufficient liquidity; (E) an analysis of the availability of reliable prices foreach of the eligible products; (F) adescription of the financial, operational,and managerial standards orrequirements for clearing members thatwould be permitted to commingle theeligible products; (G) a description of

the systems and procedures that would be used by the DCO to oversee suchclearing members’ risk management of the commingled positions; (H) adescription of the financial resources of the DCO, including the composition andavailability of a guaranty fund withrespect to the commingled products; (I)a description and analysis of the marginmethodology that would be applied tothe commingled products, includingany margin reduction applied tocorrelated positions, and any applicablemargin rules with respect to bothclearing members and customers; (J) ananalysis of the ability of the DCO tomanage a potential default with respectto any of the commingled products; (K)a discussion of the procedures that theDCO would follow if a clearing memberdefaulted, and the procedures that aclearing member would follow if acustomer defaulted, with respect to anyof the commingled products; and (L) adescription of the arrangements forobtaining daily position data from each

beneficial owner of the commingledproducts.189

Proposed §39.15(b)(2)(ii) wouldaddress situations where customerpositions in futures, options on futures,and cleared swaps could be carried ina futures account subject to Section4d(a) of the CEA. Proposed§ 39.15(b)(2)(ii) would incorporate theinformational requirements of proposed§ 39.15(b)(2)(i), but would require a

DCO to file a petition with theCommission for an order pursuant toSection 4d(a) of the CEA, permitting theDCO and its clearing members tocommingle customer positions infutures, options on futures, and swapsin a futures account (4d order).

Proposed §39.15(b)(2)(iii)(A) wouldprovide that the Commission mayrequest additional information insupport of a rule submission and that itmay approve the rules in accordancewith §40.5.190 Proposed§ 39.15(b)(2)(iii)(B) would provide thatthe Commission could request

additional information in support of apetition and that it could issue a 4dorder in its discretion.

As noted in the notice of proposedrulemaking, in the case of a ruleapproval under §39.15(b)(2)(i), as wellas the issuance of an order under§ 39.15(b)(2)(ii), the Commission wouldtake action pursuant to Section 4d of theCEA (permitting commingling) andSection 4(c) of the CEA (exempting theDCO and clearing members from therequirement to hold customer positionsin a 4d(a) or 4d(f) account, asapplicable).

The Commission requested comment

on whether it should take the sameapproach (rule submission or petitionfor an order) with respect to the futuresaccount and the cleared swap accountand, if so, what that approach should

be. In addition, the Commissionrequested comment on whether theenumerated informational requirementsfully capture the relevant considerationsfor making a determination on eitherrule approval or the granting of anorder, and whether the Commission’sanalysis should take into considerationthe type of account in which thepositions would be carried, the

particular type of products that would be involved, or the financial resources

of the clearing members that would holdsuch accounts. The Commission furtherrequested comment on what, if any,additional or heightened requirementsshould be imposed to manage theincreased risks introduced to a futuresaccount that also holds cleared swaps.

In some instances, commentersaddressed topics that are more properly

considered by the Commission inconnection with a separaterulemaking,191 that relate to substantiverequirements that the Commissionmight impose as a condition of approving a rule or granting an orderunder § 39.15(b)(2),192 or that relate toother provisions adopted herein.193 TheCommission is not addressing thosecomments in its discussion of § 39.15(b)(2) because they are not withinthe scope of the proposal.

CME, FIA, and MFA expressed theirgeneral support for the adoption of rulesthat would allow commingling of

customer positions in futures, optionson futures, and cleared swaps. Inparticular, CME indicated that suchcommingling could achieve important

benefits with respect to greater capitalefficiency which would result frommargin reductions for correlatedpositions, and that adoption of aregulation permitting such comminglingwould be consistent with the publicinterest, in accordance with Section 4(c)of the CEA. CME further stated that‘‘[h]aving positions in a single accountcan also enhance risk managementpractices and systemic risk containment

by allowing the customer’s portfolio to






195This conforming terminology, which appearselsewhere in part 39, streamlines the rule textwithout changing the meaning of the provision. Thescope of part 39 covers only those products subjectto the Commission’s oversight and would notinclude, for example, options on securities.Refinements in the definitions of products subjectto Commission oversight will be addressed in thefuture.

196 J.P. Morgan also suggested that DCOs couldmaintain liquidity by requiring clearing members tomake guarantee fund contributions or by requiringclearing members to participate in a liquidityfacility. The Commission has not proposed and isnot adopting such requirements.

197See CPSS–IOSCO Consultative Report,Principle 5: Collateral, at 37.

be handled in a coordinated fashion ina transfer or liquidation scenario.’’

CME stated its belief that it would belogical to apply the same methodology(rule submission or petition for anorder) with respect to the futuresaccount and the cleared swaps account,and that a rule submission would be the

most efficient and optimal approach.The Commission is retaining theproposed distinction whereby theCommission may permit futures to becommingled in a Section 4d(f) clearedswaps account subject to a rule approvalprocess, and may permit cleared swapsto be commingled in a Section 4d(a)futures account subject to a 4d order. Inthe latter instance, the 4d petitionprocess would provide additionalprocedural protections in that: (1)Review of a 4d petition by theCommission is not subject to the timelimits that apply to a request for rule

approval under §40.5; and (2) theCommission may impose conditions ina 4d order, as appropriate. TheCommission has determined that, at thistime, it is appropriate to provide theseadditional procedural protections beforeexposing futures customers to the risksof swaps that may be commingled in afutures account. As also noted in othercontexts in this notice of finalrulemaking, DCOs have greaterexperience in clearing futures. Swapswill expose DCOs to risks that can differin their nature and magnitude.However, as the Commission and the

industry gain more experience withcleared swaps, the Commission mayrevisit this issue in the future.

The Commission is adopting CME’ssuggestion that it revise§ 39.15(b)(2)(i)(L) to remove thereference to obtaining daily positiondata ‘‘from each beneficial owner.’’Therefore, §39.15(b)(2)(i)(L), asmodified, requires a DCO to submit ‘‘[a]description of the arrangements forobtaining daily position data withrespect to futures, options on futures,and swaps in the account,’’ withoutspecifying the level of detail or the

source of the daily position data that theDCO must obtain. As noted by CME, theCommission could request additionalinformation from the DCO, in support of its request for rule approval or petitionfor a 4d order, pursuant to§ 39.15(b)(2)(iii).

The Commission is also makingconforming changes to § 39.15(b)(2), toreplace a reference to ‘‘cleared swapaccount’’ with ‘‘cleared swaps account’’to achieve consistency with theterminology in another Commission

rulemaking; 194 is revising the referencesto ‘‘futures, options on futures, andswap positions’’ and ‘‘futures, optionson futures, and swaps’’ to read ‘‘futures,options, and swaps;’’ 195 is replacing areference to ‘‘contract’’ with ‘‘product;’’and is correcting the references to§ 39.15(b)(2)(i) and (ii) in§ 39.15(b)(iii)(A) and (B), respectively.

The Commission is adopting§ 39.15(b)(2) with the modificationsdescribed above.

4. Holding of Funds and Assets—§ 39.15(c)

The introductory paragraph of proposed §39.15(c) would require that aDCO hold funds and assets belonging toclearing members and their customersin a manner that minimizes the risk of loss or of delay in the DCO’s access tothose funds and assets. The Commissiondid not receive any comment lettersdiscussing the introductory paragraph of

proposed §39.15(c) and is adopting theprovision as proposed.

5. Types of Assets—§39.15(c)(1)

Proposed §39.15(c)(1) would requirea DCO to limit the assets it accepts asinitial margin to those that haveminimal credit, market, and liquidityrisks, and prohibit a DCO fromaccepting letters of credit as initialmargin.

LCH agreed with the provisions of proposed §39.15(c), but added that therules might more properly require thata DCO must be able to convert anyfunds and assets held promptly into

cash, and should prove that it is able todo so on an ongoing basis. J.P. Morganstated that it is necessary for DCOs tomaintain sufficient liquidity, and thatthis could be achieved by requiring thatclearing members post a minimumamount of liquid (cash and qualifyinggovernment securities) margin, amongother things.196

The Commission believes that thestandard of ‘‘minimal credit, market,and liquidity risks’’ is sufficient and

that it is not necessary to modify thelanguage of the regulation to include anexplicit requirement that a DCO must beable to convert funds and assetspromptly into cash or to require thatclearing members must post a minimumamount of cash and qualifyinggovernment securities. Moreover, therequirement that a DCO shall limit the

assets that it accepts as initial margin tothose that have ‘‘minimal credit, market,and liquidity risks’’ is consistent withinternational recommendations.197

OCC expressed its belief that theproposal places an excessive focus onthe types of assets that may be used asmargin and that the Commission’scentral focus should be on whether aDCO’s procedures and risk managementsystems are sufficient to provide a highdegree of assurance that a portfolio,including margin assets, can beliquidated with a positive liquidationvalue. OCC further noted its concern

that some of the collateral that itcurrently accepts as initial margin,including less-liquid stocks and long-dated Treasury securities, would nolonger be permitted under the proposedrule. OCC explained that its ‘‘collateralin margins’’ or ‘‘CIM’’ program looks ateach type of collateral as an asset withspecific risk characteristics rather thanas a fixed value, and it recognizes bothpositive and negative correlations withother assets and liabilities in aparticular account.

As an example, OCC stated that eventhough XYZ stock may be less liquidthan other stocks, it may have a greater

value than a more liquid stock when itis used as margin for a short position inXYZ call options. Therefore, OCC urgedthe Commission not to impose astandard of ‘‘minimal credit, market,and liquidity risk,’’ or not to adopt aninterpretation of such a standard in amanner that would reduce theopportunities for diversification of collateral and use of assets that mayhave specific risk-reducing properties ina particular portfolio. In particular, OCCstated that ‘‘[w]here a DCO is capable of reflecting the risk of certain assets in itsmargin model, we see no reason why

less liquid instruments or instrumentswith higher than average credit ormarket risks should not be acceptablefor initial margin.’’

The Commission agrees that a DCOshould be permitted to accept assets asinitial margin if such assets havespecific risk-reducing properties in aparticular portfolio and the DCO’smargin model is capable of appropriately reflecting the risk of those





198The Commission notes that the minimuminitial and variation margin requirementsreferenced in Section 4s(e)(3)(D) of the CEA, 7U.S.C. 6s(e)(3)(D), apply to uncleared swaps.

NGX also stated its view that in a non-intermediated model, such as that operated byNGX, the DCO is familiar with its clearingparticipants, and can exercise a degree of discretionin accepting letters of credit without the same riskmanagement challenges that may be faced by anintermediated DCO.

199The FHLBanks further noted that theprohibition on letters of credit may unnecessarilyconstrain certain end-users from clearing swaps because they may be precluded from pledging otherassets, e.g., by loan covenants.

200 ICE noted that the CPSS–IOSCO ConsultativeReport did not prohibit any type of collateral.

201Redesignation of this provision and severalother provisions proposed as part of §39.15 is anon-substantive change that moves the provisionsto the risk management rules for marginrequirements. As a risk management rule, theprovision implements Core Principle D, Section5b(c)(2)(D)(iii) of the CEA, which provides that‘‘Each [DCO], through margin requirements andother risk control mechanisms, shall limit theexposure of the [DCO] to potential losses fromdefaults by members and participants of the[DCO].’’

assets. Accordingly, although theCommission is retaining the standard of minimal credit, market, and liquidityrisk, it is revising the provision to addthe following: ‘‘A [DCO] may take intoaccount the specific risk-reducingproperties that particular assets have ina particular portfolio.’’ As illustrated byOCC, an asset that would not generally

be acceptable could be acceptable foruse in connection with a particularportfolio.

Freddie Mac requested that theCommission clarify that DCOs mayaccept collateral types beyond thosespecified as permitted investmentsunder §1.25. Section 39.15(c) does notprohibit a DCO from accepting collateraltypes that are not specified as permittedinvestments under § 1.25. TheCommission believes that it isappropriate to permit DCOs to retain theflexibility to accept a broader range of assets that meet the general requirement

of ‘‘minimal credit, market, andliquidity risks’’ than those which areappropriate investments for fundsreceived from clearing members.

Several comment letters specificallydiscussed the proposal to prohibit theuse of letters of credit as initial margin.The commenters disagreed with theCommission’s proposed requirementthat a DCO may not accept letters of credit for this purpose. CME stated thatletters of credit provide an absoluteassurance of payment and, therefore, theissuing bank must honor the demandeven in circumstances where the DCO(the beneficiary) breached its duty to theclearing member and even if theclearing member is unable to reimbursethe bank for its payment. CME alsostated that it was not aware of anyinstances in the cleared derivativesindustry in which a beneficiary of aletter of credit posted as collateral hadsought to draw upon the letter of creditand had not been promptly paid by theissuer. CME noted that letters of credithave been especially useful for clearingmembers to post as collateral for late-day margin calls. ICE and NOCCsimilarly commented that letters of credit should be permitted to serve as

non-cash collateral. NGX indicated thatletters of credit are consistent withSection 4s(e)(3)(D) of the CEA, whichprovides that the financial regulatorsshall establish comparable capitalrequirements and minimum initial andvariation margin requirements,including the use of non-cash collateral,for swap dealers.198

Many commenters suggested thatletters of credit should be acceptable if they are subject to appropriateconditions. OCC recommended that theCommission should allow letters of credit as long as a DCO sets criteria withrespect to issuers, diversifiesconcentration of risk among issuers, andlimits the proportion of a clearing

member’s margin requirement that can be represented by letters of credit. Inaddition, OCC stated that it would beappropriate for the Commission toprohibit a DCO from accepting a letterof credit from a clearing member if theletter of credit is issued by an institutionaffiliated with the clearing member.

Similarly, FIA suggested that a DCOshould be permitted to accept letters of credit on a case-by-case basis subject tothe credit quality of the bank andappropriate limits on the percentage of a clearing member’s marginrequirements that can be met by letters

of credit. FIA also indicated that DCOsshould limit the aggregate value of letters of credit that may be issued byany one bank.

FHLBanks wrote that ‘‘a hard and fastprohibition against letters of credit isinappropriate because it fails to takeinto account that a letter of credit issued

by a highly creditworthy entity couldcontain terms that would make the letterof credit just as liquid as a fundedasset.’’ 199

CME stated that it only accepts lettersof credit that comply with its specifiedterms and conditions, includingpayment within one hour of notification

of a draw, from issuers that it hasreviewed and approved and that meetits criteria for issuing banks. CMEfurther noted that it conducts periodicreviews of approved banks and usescaps and concentration limits inconnection with letters of credit.

NGX stated that it has accepted lettersof credit that comply with itsrequirements regarding timing andacceptable institutions, for many years,and has successfully drawn on suchletters of credit.

Several commenters warned of thepotential risks associated with

prohibiting letters of credit, includinghigher costs for clearing members andtheir customers (OCC), the placement of

U.S. DCOs at a disadvantage to foreignclearing houses (ICE),200 and increasedsystemic risk as a result of decreasedvoluntary clearing (NOCC).

The Commission acknowledges thatDCOs have historically been permittedto exercise their discretion regardingwhether and to what extent they wouldaccept letters of credit for initial margin

for futures and options. Certain DCOshave accepted such letters of creditwithout incident and continue to do so.On the other hand, as stated in thenotice of proposed rulemaking, letters of credit are unfunded financial resourceswith respect to which funds might benot be available when they are mostneeded by the DCO. Moreover, theinitial margin of a defaulting clearingmember would typically be the firstasset tapped to cure the clearingmember’s default. Taking into account

both the strong track record of letters of credit in connection with cleared

futures and options on futures and thepotentially greater risks of clearedswaps, the Commission is modifying theprovision to permit DCOs to acceptletters of credit as initial margin forfutures and options on futures.However, the Commission hasdetermined to maintain an additionalsafeguard for swaps at this time byprohibiting a DCO from accepting lettersof credit as initial margin for swaps. Incases where futures and swaps aremargined together, the Commission hasdetermined that letters of credit may not

be accepted. The Commission will

monitor developments in this area andmay revisit this issue in the future.The Commission is adopting

§ 39.15(c)(1), redesignated as§ 39.13(g)(10),201 with the modificationdescribed above.

6. Valuation and Haircuts—§§ 39.15(c)(2) and 39.15(c)(3)

Proposed §39.15(c)(2) would requirea DCO to use prudent valuationpractices to value assets posted as initialmargin on a daily basis. Proposed§ 39.15(c)(3) would require a DCO toapply appropriate reductions in value toreflect the market and credit risk of the

assets that it accepts in satisfaction of





202Credit, market, and liquidity risks are conceptsthat are not mutually exclusive, and thisarticulation of the types of risks to be evaluated bya DCO appears in the CEA (Core Principle F,Treatment of Funds (requiring that ‘‘[f]unds andassets invested by a [DCO] shall be held ininstruments with minimal credit, market, andliquidity risks’’), and ‘‘minimal credit, market, andliquidity risks’’ is set forth as the standard for assetsacceptable for a guaranty fund (§39.11(e)(3)(i)), andas the standard for assets acceptable as initialmargin (§ 39.13(g)(10)).

203See CPSS–IOSCO Consultative Report,Principle 5: Collateral, Explanatory Note 3.5.4, at38.

20476 FR 13101 (March 10, 2011) (Straight-Through Processing).

initial margin obligations and toevaluate the appropriateness of itshaircuts on at least a quarterly basis.

OCC commented that if a DCO canonly accept instruments with minimalrisk, then haircuts should either not berequired at all or should be very small.The Commission notes that, as definedin §39.15(c)(3), haircuts are

‘‘appropriate reductions in value toreflect market and credit risk.’’ This isa flexible standard that would allow aDCO to determine the extent of thehaircut based on the extent of the riskposed by the instrument deposited asinitial margin.

OCC further stated that proposed§ 39.15(c)(3) is ambiguous regardingwhat OCC would be required to test ona quarterly basis. OCC explained that itsSTANS margin methodology does notapply fixed haircuts to securitiesdeposited as collateral, but rather treatscollateral as part of a clearing member’soverall portfolio, revisiting each‘‘haircut’’ or valuation on a security-by-security, account-by-account, and day-

by-day basis. Thus, OCC stated that itchecks the adequacy of its haircutsthrough back testing and not through aperiodic review.

The general language of § 39.15(c)(3),requiring a DCO to ‘‘apply appropriatereductions in value to reflect market andcredit risk * * * to the assets that itaccepts in satisfaction of initial marginobligations’’ and to ‘‘evaluate theappropriateness of such haircuts on atleast a quarterly basis,’’ is broad enoughto encompass the method of daily

valuation and back testing described byOCC.

The Commission is adopting§ 39.15(c)(2), redesignated as§ 39.13(g)(11), as proposed. TheCommission is adopting a technicalrevision to §39.15(c)(3), redesignated as§ 39.13(g)(12), by adding a reference to‘‘liquidity’’ risk to conform theterminology used to describe haircuts(proposed as ‘‘appropriate reductions invalue to reflect market and credit risk’’)with the terminology used in§ 39.13(g)(10), which refers to assets thathave ‘‘minimal credit, market, and

liquidity risks.’’202

The Commission isalso making a non-substantive revisionto replace the phrase ‘‘including in

stressed market conditions’’ with‘‘taking into consideration stressedmarket conditions.’’

7. Concentration Limits—§ 39.15(c)(4)

Proposed §39.15(c)(4) would requirea DCO to apply appropriate limitationson the concentration of assets posted asinitial margin, as necessary, in order to

ensure the DCO’s ability to liquidatethose assets quickly with minimaladverse price effects. The proposedregulation also would require a DCO toevaluate the appropriateness of itsconcentration limits, on at least amonthly basis.

OCC indicated that the proposed rulewas not clear regarding whether itwould be sufficient to imposeconcentration charges rather thanimposing concentration limits, butargued that if the margin systemadequately penalizes concentration of risk, it does not believe that fixed

concentration limits are required. TheCommission agrees that concentrationcharges, rather than concentrationlimits, may be appropriate in certaincircumstances, and is modifying theprovision to permit a DCO to apply‘‘appropriate limitations or charges onthe concentration of assets posted asinitial margin’’ and to ‘‘evaluate theappropriateness of any suchconcentration limits or charges, on atleast a monthly basis.’’ The inclusion of concentration charges as an acceptablealternative to concentration limits isconsistent with internationalrecommendations.203

CME stated its view that theCommission should not prescribe thefrequency of a DCO’s reviews of itsconcentration limits and it urged theCommission to revise §39.15(c)(4) toreplace ‘‘on at least a monthly basis’’with ‘‘on a regular basis.’’ TheCommission believes that it isappropriate to require a DCO to evaluatethe appropriateness of its concentrationlimits (or charges) on at least a monthly

basis and notes that § 39.15(c)(4)provides a DCO with the discretion todetermine the nature of such evaluation.


§ 39.15(c)(4), redesignated as§ 39.13(g)(13), with the modificationsdescribed above.

8. Pledged Assets—§39.15(c)(5)

Under proposed § 39.15(c)(5), if aDCO were to permit its clearingmembers to pledge assets for initialmargin while retaining such assets inaccounts in the names of such clearing

members, the DCO would have toensure that the assets are unencumberedand that the pledge has been validlycreated and validly perfected in therelevant jurisdiction. The Commissiondid not receive any commentsdiscussing proposed § 39.15(c)(5) and isadopting the provision, redesignated as§ 39.13(g)(14), as proposed.

9. Permitted Investments—§39.15(d)

Proposed §39.15(d) would requirethat clearing members’ funds and assetsthat are invested by a DCO must be heldin instruments with minimal credit,market, and liquidity risks and that anyinvestment of customer funds or assets

by a DCO must comply with §1.25 of the Commission’s regulations.Moreover, the proposed regulationwould apply the limitations containedin § 1.25 to all customer funds andassets, whether they are the funds andassets of futures and options customers

subject to the segregation requirementsof Section 4d(a) of the CEA, or the fundsand assets of cleared swaps customerssubject to the segregation requirementsof Section 4d(f) of the CEA.

The Commission did not receive anycomment letters discussing proposed§ 39.15(d). The Commission is adoptingthe provision, redesignated as §39.15(e),as proposed.

10. Transfer of Customer Positions—§ 39.15(d)

The Commission proposedregulations addressing the processing,clearing, and transfer of customer

positions by swap dealers (SDs), majorswap participants (MSPs), FCMs, SEFs,DCMs, and DCOs.204 Proposed§ 39.15(d) would require a DCO to haverules providing that, upon the request of a customer and subject to the consent of the receiving clearing member, the DCOwould promptly transfer all or a portionof such customer’s portfolio of positionsand related funds from the carryingclearing member of the DCO to anotherclearing member of the DCO, withoutrequiring the close-out and rebooking of the positions prior to the requestedtransfer.

MFA, Citadel, and FHLBankssupported the proposal. MFA andCitadel suggested that the Commissionclarify that associated margin shouldtransfer simultaneously with thetransferred positions.

LCH also suggested that the sectionshould be revised to require that thetransfer of positions and related funds

be effected simultaneously. LCH believes that absent such a provision, a





205Section 5b(c)(2)(G) of the CEA, 7 U.S.C. 7a–1(c)(2)(G) (Core Principle G).

DCO could be understood to be requiredto transfer either the positions or thefunds, but not both, and such anobligation would expose the DCO to riskduring the customer transfer.

FIA agreed with the Commission thata customer should not be required toclose-out and re-book positions as acondition of transferring such positions,

and that a clearing member should notunnecessarily interfere with acustomer’s request to transfer positions.However, FIA noted that a DCO will nothave the immediate ability to determinewhich positions carried in a clearingmember’s omnibus account belong to aparticular customer. FIA suggested thata DCO’s rules provide that the customersubmit its request to transfer itspositions to the clearing membercarrying the positions, not to the DCO.FIA also suggested that the Commissionrevise the proposed rule to confirm thata clearing member is required to transfer

a customer’s positions only after thatcustomer has met all contractualobligations, including outstandingmargin calls and any additional marginrequired to support any remainingpositions.

OCC also noted that a customer willnot ask a DCO directly to transfer acustomer position. Like FIA, OCC

believes that any such transfer must besubject to all legitimate conditions orrestrictions established by the DCO inconnection with its clearing of swaps.

CME stated that it fully supports theconcept of applying the same standards

to transfer of customer cleared swaps ashave historically been applied totransfer of customer futures. It notedthat a customer request to transfer itsaccount is made not to a DCO but to theFCM that carries the customer’saccount.

ISDA commented that any transferrule must provide that a party seekingtransfer not be in default to its existingclearing member. ISDA believes that thetransfer rule must take into account anycross-cleared or cross-marginedtransactions and in the case where onlya portion of a customer’s portfolio istransferred, clearing members must havethe ability to condition the transfer onthe posting of additional margin by thecustomer.

KCC commented that this rule is notnecessary because KCC has neverrequired a futures position to be closedout and re-booked prior to transfer fromthe carrying clearing member to anotherclearing member, nor would KCCrequire a wheat calendar swap to beclosed out and re-booked prior totransfer. The Commission notes thatsuch a requirement has been imposed

by other clearinghouses in connectionwith swaps.

In response to concerns raised bycommenters, the Commission is revising§ 39.15(d) to read as set forth in theregulatory text of this final rule.

The language making it explicit thatpositions and margin be transferred atthe same time is responsive to the

comments of MFA, Citadel, and LCHand consistent with prudent riskmanagement procedures. The languageclarifying that a customer transferinstruction would go to a clearingmember and not directly to the DCO isresponsive to the comments of FIA,OCC, and CME. The requirement that acustomer may not be in default isresponsive to the comments of FIA andISDA and consistent with the statementin the notice of proposed rulemakingthat transfers should be subject tocontractual requirements. Therequirement that positions at both

clearing members will have appropriatemargin is responsive to the comments of MFA, Citadel, and ISDA and consistentwith the statement in the notice of proposed rulemaking that transfersshould be subject to contractualrequirements.

G. Core Principle G—Default Rules and Procedures—§39.16

Core Principle G,205 as amended bythe Dodd-Frank Act, requires each DCOto have rules and procedures designedto allow for the efficient, fair, and safemanagement of events during whichclearing members become insolvent orotherwise default on their obligations tothe DCO. In addition, Core Principle Grequires each DCO to clearly state itsdefault procedures, make its defaultrules publicly available, and ensure thatit may take timely action to containlosses and liquidity pressures and tocontinue meeting its obligations. TheCommission proposed § 39.16 toestablish requirements that a DCOwould have to meet in order to complywith Core Principle G.

1. General—§39.16(a)

Proposed §39.16(a) would require a

DCO to adopt rules and proceduresdesigned to allow for the efficient, fair,and safe management of events duringwhich clearing members becomeinsolvent or default on the obligations of such clearing members to the DCO.

The Commission did not receive anycomment letters discussing proposed§ 39.16(a), although LCH stated that itconcurs with all the provisions set outunder proposed § 39.16. The

Commission is adopting §39.16(a) asproposed.

2. Default Management Plan—§ 39.16(b)

Proposed §39.16(b) would require aDCO to maintain a current writtendefault management plan that delineatesthe roles and responsibilities of its

board of directors, its Risk Management

Committee, any other committee thathas responsibilities for defaultmanagement, and the DCO’smanagement, in addressing a default,including any necessary coordinationwith, or notification of, other entitiesand regulators. The proposed regulationalso would require the defaultmanagement plan to address anydifferences in procedures with respectto highly liquid contracts (such ascertain futures) and less liquid contracts(such as certain swaps). In addition,proposed §39.16(b) would require aDCO to conduct and document a test of

its default management plan on at leastan annual basis.OCC agreed with the proposal for

annual testing of a DCO’s defaultmanagement plan, while ISDA statedthat such tests should be conducted atleast on a semi-annual basis. FIAindicated that the default managementplan should be subject to frequent,periodic testing. The Commission

believes that it is appropriate andsufficient to require at least annualtesting of a DCO’s default managementplan. A particular DCO could determineto test its plan on a semi-annual or other

periodic basis, in its discretion.ISDA expressed its view thatregulators should review and sign off onthe default management plans of DCOs.KCC requested that the Commissionclarify that the default management planconcepts in proposed § 39.16(b) may besatisfied by annual testing of the DCO’sexisting set of default rules andprocedures. The Commission does not

believe that it is necessary to adopt anexplicit requirement that theCommission review and approve aDCO’s default management plan.However, Commission staff will reviewa DCO’s default management plan in thecontext of the Commission’s ongoingDCO review program, including adetermination of whether a DCO’s‘‘existing set of default rules andprocedures’’ meet the requirements of § 39.16(b).

The Commission is making atechnical revision to §39.16(b),removing the parentheticals andsubstituting the word ‘‘products’’ for theword ‘‘contracts.’’ The sentence nowreads: ‘‘Such plan shall address anydifferences in procedures with respect





206This is consistent with the segregationrequirements of Section 4d of the CEA and §1.20of the Commission’s regulations. 207See discussion in section IV.C.1.i, above.


to highly liquid products and less liquidproducts.’’

3. Default Procedures—§39.16(c)(1)

Proposed §39.16(c)(1) would requirea DCO to adopt procedures that wouldpermit the DCO to take timely action tocontain losses and liquidity pressuresand to continue meeting its obligations

in the event of a default on theobligations of a clearing member to theDCO.

The Commission did not receive anycomment letters discussing proposed§ 39.16(c)(1) and is adopting§ 39.16(c)(1) as proposed.

4. Default Rules—§39.16(c)(2)

Proposed §39.16(c)(2) would requirea DCO to include certain identifiedprocedures in its default rules. Inparticular, proposed §39.16(c)(2)(i)would require a DCO to set forth itsdefinition of a default. Proposed

§ 39.16(c)(2)(ii) would require a DCO toset forth the actions that it is able to takeupon a default, which must include theprompt transfer, liquidation, or hedgingof the customer or proprietary positionsof the defaulting clearing member, asapplicable. Proposed §39.16(c)(2)(ii)would further state that such procedurescould also include, in the DCO’sdiscretion, the auctioning or allocationof such positions to other clearingmembers. Proposed §39.16(c)(2)(iii)would require a DCO to include in itsdefault rules any obligations that theDCO imposed on its clearing members

to participate in auctions, or to acceptallocations, of a defaulting clearingmember’s positions, and wouldspecifically provide that any allocationwould have to be proportional to thesize of the participating or acceptingclearing member’s positions at the DCO.

Proposed § 39.16(c)(2)(iv) wouldrequire that a DCO’s default rulesaddress the sequence in which thefunds and assets of the defaultingclearing member and the financialresources maintained by the DCO would

be applied in the event of a default.Proposed §39.16(c)(2)(v) would require

that a DCO’s default rules contain aprovision that customer margin posted by a defaulting clearing member couldnot be applied in the event of aproprietary default.206 Proposed§ 39.16(c)(2)(vi) would require that aDCO’s default rules contain a provisionthat proprietary margins posted by adefaulting clearing member would haveto be applied in the event of a customer

default, if the relevant customer marginwere insufficient to cover the shortfall.

The Commission did not receive anycomment letters discussing proposed§ 39.16(c)(2)(i), (ii) or (iii). TheCommission is adopting §39.16(c)(2)(i)as proposed. The Commission is makingtechnical revisions to §§39.16(c)(2)(ii),(iii), (v) and (vi), as well as §39.16(d)(3),

by replacing each use of the word‘‘proprietary’’ with ‘‘house.’’

As discussed above in connectionwith participant eligibility requirementsunder § 39.12,207 the Commission isrevising §39.16(c)(2)(iii) to require aDCO that imposes obligations on itsclearing members to participate inauctions or to accept allocations of adefaulting clearing member’s positions,to permit its clearing members tooutsource these obligations to qualifiedthird parties, subject to appropriatesafeguards imposed by the DCO. TheCommission believes that it is importantto permit outsourcing, whilerecognizing that it is essential to limitparticipation only to qualified thirdparties. Accordingly, a DCO’s rules mayimpose appropriate terms andconditions on outsourcingarrangements, addressing, for example,the necessary qualifications to beeligible to act in the clearing member’splace and conflicts of interest issues.Thus, for example, a clearing membercould hire a qualified third party to actas its agent in an auction. TheCommission cautions, however, that anyDCO imposing terms and conditionsthat could indirectly deny fair and open

access and therefore are not‘‘appropriate,’’ i.e., not supported bysound risk management policies, mayrun afoul of Core Principle C and§ 39.12.

The Commission is also making twoadditional technical revisions to§ 39.16(c)(2)(iii). First, the Commissionis replacing ‘‘a defaulting clearingmember’s positions’’ with ‘‘the customeror house positions of the defaultingclearing member,’’ to correct anoversight in the proposed language.Second, the Commission is revising§ 39.16(c)(2)(iii)(A) to provide that any

allocation shall be ‘‘[p]roportional to thesize of the participating or acceptingclearing member’s positions in the same

product class at the derivatives clearingorganization’’ (added text in italics) toclarify the Commission’s intent.

With respect to proposed§ 39.16(c)(2)(iv), OCC agreed that itwould be appropriate to require DCOs toadopt rules that would define thesequence in which the funds and assetsof a defaulting clearing member and the

financial resources maintained by theDCO would be applied in the event of a default.

Freddie Mac expressed concern withthe broad discretion that would be givento DCOs to determine the sequence inwhich financial resources would beapplied in the event of a clearingmember default, and recommended that

DCOs should be required to place non-customer resources (e.g., clearingmember guaranty funds and their owncapital) ahead of non-defaultingcustomer collateral in the risk waterfall.In particular, Freddie Mac indicatedthat if the Commission does not requireindividual segregation of customercollateral, it should require DCOs toplace non-defaulting customers at the

bottom of the risk waterfall. FreddieMac stated that the Commission shoulddefer adoption of proposed §39.16(c)until after adoption of rules relating tocustomer segregation.

The Commission is adopting§ 39.16(c)(2)(iv) to require that a DCOadopt rules that identify the sequence of its default waterfall, as proposed,without imposing any substantiverequirements with respect to suchsequence, as suggested by Freddie Mac.The Commission is addressing the issueof the application of the collateral of non-defaulting swaps customers in aseparate pending rulemaking,208 butdoes not believe that it is appropriate todefer the adoption of proposed§ 39.16(c) until that rulemaking iscomplete.

The Commission is making atechnical revision to § 39.16(c)(2)(iv) byinserting ‘‘and its customers’’ after ‘‘thefunds and assets of the defaultingclearing member’’ to correct anoversight in the proposed language.

ISDA commented that proposed§ 39.16(c)(2)(v), which would require aDCO to adopt ‘‘[a] provision thatcustomer margin posted by a defaultingclearing member shall not be applied inthe event of a proprietary default’’should be revised to replace the words‘‘in the event of’’ with ‘‘to cover lossesin respect of’’; otherwise, ISDA believedthat customer margin would not be able

to be applied even to cover customerlosses. The Commission agrees withISDA and is modifying §39.16(c)(2)(v)

by replacing ‘‘in the event of’’ with ‘‘tocover losses with respect to’’ and hasmade a similar modification to§ 39.16(c)(2)(vi).

CME recommended that theCommission replace ‘‘proprietary





209See discussion of §39.21 in section IV.L, below.

210Section 5b(c)(2)(H) of the CEA, 7 U.S.C. 7a–1(c)(2)(H).

211See discussion of rule enforcement reportingin section IV.J.5.j, below.

212See id. (The Commission is adopting§ 39.19(c)(4)(xiii) as a renumbered § 39.19(c)(4)(xi)).

213Section 5b(c)(2)(I) of the CEA, 7 U.S.C. 7a–1(c)(2)(I).

margins posted by a defaulting clearingmember’’ in § 39.16(c)(2)(vi) with‘‘proprietary margins, positions and anyother assets in the account of thedefaulting clearing member.’’ CMEargued that the Commission’s proposedreference to ‘‘proprietary margins posted

by a defaulting clearing member’’ is toonarrow in scope, since in the event of

a clearing member default (whetheroriginating in the customer origin or thehouse origin), a DCO would likelyliquidate positions in the defaultingclearing member’s house account andthen apply excess funds and not justproprietary margins to cure the default.The Commission agrees that‘‘proprietary margins posted by adefaulting clearing member’’ is toonarrow and is replacing the phrase in§ 39.16(c)(2)(vi) with ‘‘house funds andassets of a defaulting clearing member.’’The Commission believes that ‘‘housefunds and assets’’ is broad enough to

include ‘‘proprietary margins, positionsand any other assets,’’ as suggested byCME, and is consistent with thelanguage in § 39.16(c)(2)(iv) and § 39.15.The Commission is similarly replacing‘‘customer margin posted by adefaulting clearing member’’ in§ 39.16(c)(2)(v) with ‘‘the funds andassets of a defaulting clearing member’scustomers’’ and is replacing ‘‘customermargin’’ in § 39.16(c)(2)(vi) with‘‘customer funds and assets.’’

ISDA commented that proposed§ 39.16(c)(2)(vi) should be revised toinsert the word ‘‘excess’’ immediately

before the words ‘‘proprietary margins’’to make it clear that proprietary marginis to be applied first to cover proprietarylosses, noting that the use of proprietarymargin to cover customer losses aheadof proprietary losses would hasten themutualization of losses among clearingmembers, which would likely result inhigher margin levels being imposedwith respect to customer positions inorder to avoid that outcome. TheCommission agrees with ISDA and ismodifying §39.16(c)(2)(vi) by inserting‘‘excess’’ before ‘‘house funds and assetsof a defaulting clearing member,’’ assuggested by ISDA.

The Commission is adopting§ 39.16(c)(2) with the modificationsdescribed above.

5. Publication of Default Rules—§ 39.16(c)(3)

Proposed §39.16(c)(3) would requirethat a DCO must make its default rulespublicly available, and would cross-reference § 39.21, adopted herein, whichalso addresses this requirement.209

The Commission did not receive anycomment letters discussing proposed§ 39.16(c)(3) and is adopting§ 39.16(c)(3) as proposed.

6. Insolvency of a Clearing Member—§ 39.16(d)

Proposed §39.16(d)(1) would requirea DCO to adopt rules that require a

clearing member to provide promptnotice to the DCO if the clearingmember becomes the subject of a

bankruptcy petition, a receivershipproceeding, or an equivalentproceeding, e.g., a foreign liquidationproceeding. Proposed §39.13(d)(2)would require a DCO to review theclearing member’s continuing eligibilityfor clearing membership, upon receiptof such notice. Proposed § 39.16(d)(3)would require a DCO to take anyappropriate action, in its discretion,with respect to the clearing member orits positions, including but not limited

to liquidation or transfer of positions,and suspension or revocation of clearingmembership, upon receipt of suchnotice.

CME recommended that, in order topreserve a DCO’s right to takeappropriate steps before a clearingmember files for, or is placed into,

bankruptcy, the Commission shouldamend proposed §§39.16(d)(2) and (3)to require DCOs to take appropriateactions ‘‘no later than upon receipt’’ of notice that the clearing member is thesubject of a bankruptcy petition orsimilar proceeding. The Commission isadopting §39.16(d) with the

modifications to §§39.16(d)(2) and (3)suggested by CME. In addition, theCommission is making a technicalrevision to §39.16(d)(3) by replacing thephrase ‘‘with respect to such clearingmember or its positions’’ with thephrase ‘‘with respect to such clearingmember or its house or customerpositions.’’ This revision eliminatespossible ambiguity in the reference to‘‘its positions,’’ which was intended toreflect current industry practice andinclude both house and customerpositions, not just house positions.

H. Core Principle H—RuleEnforcement—§ 39.17

Core Principle H,210 as amended bythe Dodd-Frank Act, requires a DCO tomaintain adequate arrangements andresources for the effective monitoringand enforcement of compliance with itsrules and resolution of disputes. It alsorequires a DCO to have the authorityand ability to discipline, limit, suspend,or terminate the activities of a member

or participant due to a violation by themember or participant of any rule of theDCO. It further requires that a DCOreport to the Commission regarding ruleenforcement activities and sanctionsimposed against clearing members.

Proposed §39.17 would codify theserequirements, adding a provision thatwould require a DCO to report to the

Commission in accordance withproposed §39.19(c)(4)(xiii). Asproposed, § 39.19(c)(4)(xiii) wouldrequire a DCO to report the initiation of a rule enforcement action against aclearing member or the imposition of sanctions against a clearing member, nolater than two business days after theDCO takes such action. As discussed inconnection with rules implementingCore Principle J (Reporting), theCommission is adopting that reportingrequirement with a modification thatonly requires a DCO to report sanctionsimposed against a clearing member.211

The Commission received nocomments on proposed § 39.17. TheCommission is adopting § 39.17 asproposed, but with a change to thecross-reference to § 39.19(c)(4)(xiii) in§ 39.17(a)(3) to reflect the redesignationof that provision as §39.19(c)(4)(xi).212

I. Core Principle I—SystemSafeguards—§39.18

Core Principle I,213 as amended by theDodd-Frank Act, requires a DCO toestablish and maintain a program of riskanalysis and oversight that identifiesand minimizes sources of operationalrisk through the development of

appropriate controls and procedures,and automated systems that are reliable,secure and have adequate scalablecapacity. Core Principle I also requiresthat the emergency procedures, back-upfacilities, and disaster recovery plansthat a DCO is obligated to establish andmaintain specifically allow for thetimely recovery and resumption of theDCO’s operations and the fulfillment of each obligation and responsibility of theDCO. Finally, Core Principle I requiresthat a DCO periodically conduct tests toverify that the DCO’s back-up resourcesare sufficient to ensure daily processing,clearing, and settlement.

Proposed §39.18 would codify theobligations contained in Core PrincipleI and delineate the minimumrequirements that a DCO would berequired to satisfy in order to complywith Core Principle I. Proposed §39.18also would define the terms ‘‘relevant





214For example, paragraph (a)(2) of theapplication guidance to Core Principle 9 (prior toamendment by the Dodd-Frank Act) for contractmarkets noted that ‘‘Any program of independenttesting and review of [an automated] system should be performed by a qualified, independentprofessional.’’ 17 CFR part 38, appendix B at CorePrinciple 9, paragraph (a)(2).

area,’’ ‘‘recovery time objective,’’ and‘‘wide-scale disruption’’ for purposes of that section.

The Commission received one generalcomment from LCH. LCH generally‘‘concurred with all the provisions setout under proposed rule 39.18,’’ buturged the Commission to align theseprovisions with the CPSS–IOSCO

standards, and to phase in suchstandards.

As discussed below, the Commissionreceived comments on proposed§§ 39.18 (h), (j), and (k), and proposed§ 39.30(a).

The Commission did not receive anycomments specifically related to thedefinitions contained in proposed§ 39.18(a); proposed §§ 39.18(b),(c) and(d), which would address the requiredprogram of risk analysis and oversight;proposed §39.18(e), which wouldrequire a DCO to have a businesscontinuity and disaster recovery (BC–

DR) plan and resources sufficient toenable the DCO to resume dailyprocessing, clearing and settlement nolater than the next business dayfollowing a disruption; proposed§ 39.18(f), which would addressoutsourcing by a DCO of resourcesrequired to meet its responsibilities withrespect to business continuity anddisaster recovery plans; proposed§ 39.18(g), which would delineatecertain exceptional events upon theoccurrence of which a DCO would beobligated to notify promptly theCommission’s Division of Clearing and

Risk; proposed §39.18(h)(1), whichwould require a DCO to provide timelyadvance notice to the Division of Clearing and Risk of certain plannedchanges to automated systems; orproposed §39.18(i), which would setforth certain records that a DCO would

be required to maintain. TheCommission is adopting each of theseprovisions as proposed, except that theCommission is replacing ‘‘contracts’’with ‘‘products’’ in §39.18(a) and isadding ‘‘of the derivatives clearingorganization’s’’ before ‘‘own andoutsourced resources’’ in §39.18(f)(2)(ii)

for clarification.1. Notice of Changes to Program of RiskAnalysis and Oversight—§39.18(h)(2)

Proposed §39.18(h)(2) would requirea DCO to give Division of Clearing andRisk staff ‘‘timely advance notice’’ of ‘‘planned changes to the DCO’s programof risk analysis and oversight.’’ CMEcommented that this is an‘‘extraordinarily broad requirement’’and urged the Commission to‘‘appropriately consider[] context andrelative risks.’’

The Commission is adopting§ 39.18(h)(2) as proposed. The provisionmerely requires that DCOs submit suchnotice as part of their planning process.The Commission expects that staff willevaluate compliance with thisprovision, as with all other provisions,giving appropriate consideration tocontext and relative risks.

2. Testing—§ 39.18(j)

Proposed §39.18(j) would set forththe requirements for the testing that aDCO must conduct of its automatedsystems and BC–DR plans. Proposed§ 39.18(j)(1) would require that DCOsconduct regular, periodic, and objectivetesting and review of (i) their automatedsystems, to ensure that such systems arereliable, secure, and have adequatescalable capacity, and (ii) their BC–DRcapabilities, to ensure that the DCO’s

backup resources meet the standards setforth in proposed § 39.18(e). Proposed§ 39.18(j)(2) would require that thesetests ‘‘be conducted by qualified,independent professionals * * * [who]may be independent contractors oremployees [of the DCO] but shall not bepersons responsible for development oroperation of the capabilities beingtested.’’ Proposed § 39.18(j)(3) wouldrequire that reports setting forth theprotocols for, and the results of, suchtests ‘‘be communicated to, andreviewed by, senior management of the[DCO]’’ and that ‘‘[p]rotocols of testswhich result in few or no exceptionsshall be subject to more searchingreview.’’

ICE, OCC, and MGEX objected to theobligation that the testing required by§ 39.18(j) be performed by ‘‘qualified,independent professionals.’’ ICEcontended that the proper standardshould be to have qualified,independent professionals review,rather than conduct testing of, systemsor capabilities. Similarly, OCCsuggested that the testing could beoverseen, rather than conducted, by anindependent professional. MGEXobjected more generally to therequirement that tests of its BC–DRcapabilities be performed by

‘‘independent professionals’’ andexpressly objected to the proposal’sprohibition on the use of any employeeswho participated in the development orthe operation of the systems orcapabilities being tested to fulfill thisrole. MGEX argued that such personsare the most qualified persons to run thetests. KCC requested that a DCO’s CROor other similar official qualify as an‘independent professional’ for purposesof the testing rule.

The Commission is adopting § 39.18(j)as proposed. The Commission notes that

the obligation that the required testingof automated systems and BC–DRcapabilities be performed by qualified,independent professionals is consistentwith the Commission’s historicalpractice of requiring independenttesting of systems where appropriate.214

The Commission recognizes thatpersons charged with developing oroperating a system are frequently calledupon to test that system. TheCommission believes, however, that theactive involvement and direction of qualified, independent professionals inthe testing process is needed to ensureobjective and accurate results.

MGEX’s requested approach wouldresult in tests being conducted only bypersons with an inherent conflict of interest (because negative results of thetests might call into question the workof those who developed or operate thesystems) and, separately, would denythe DCO the benefit of an independent

analysis of the workings of the system.Accordingly, while some testing of aDCO’s automated systems and BC–DRcapabilities may be conducted bypersons who design or operate suchsystem or capabilities, the Commissionhas decided to retain the requirementthat the objective testing performed tosatisfy §39.18(j) must be conducted byqualified, independent persons, asdefined therein. While a DCO’s CROmay appropriately serve this function if he or she has the appropriate trainingand experience to be ‘‘qualified’’ in thiscontext, and the appropriate role in the

organization to be ‘‘independent,’’ theCommission does not believe it would

be advisable to determine that theperson serving in such a role isnecessarily qualified and independent.

3. Coordination of BC–DR Plans WithMembers and Providers of EssentialServices—§39.18(k)

Proposed §39.18(k) would requirethat a DCO to the extent practicable: (1)Coordinate its BC–DR plan with those of its clearing members, in a manneradequate to enable effective resumptionof daily processing, clearing, and

settlement following a disruption; (2)initiate and coordinate periodic,synchronized testing of its BC–DR plansand the plans of its clearing members;and (3) ensure that its BC–DR plan takesinto account the plans of its providers





215Section 5b(c)(2)(J) of the CEA, 7 U.S.C. 7a–1(c)(2)(J).

216See 76 FR at 44790 (July 27, 2011) (ProvisionsCommon to Registered Entities; final rule).

of essential services, includingtelecommunications, power, and water.

MGEX proposed that industry-sponsored events should suffice tosatisfy the requirement that a DCO mustcoordinate its BC–DR plan with those of its members. Similarly, KCC requestedthat the Commission clarify thatcoordination would be deemed to be

satisfied if the DCO reviews the BC–DRplans of its clearing members andessential service providers andsubsequently provides to such partiesthe DCO’s own BC–DR plan. KCC statedthat it does not believe that coordinationshould involve extensive efforts atachieving specific consistency betweenthe procedures of each party, as eachhas a distinct business model that facesvarying operational risks.

NYPC objected to the requirementcontained in proposed §39.18(k)(3).NYPC noted that its business continuityplan (BCP) would be invoked any time

a service provider ceases to provide anessential service, regardless of whetherthat service provider has invoked itsown BCP, and thus such informationwould not necessarily give DCOs anyadditional insight into their own BCP.Similarly, CME noted that, while itobtains representations that its majorvendors have disaster recovery plans,CME does not control, or generally haveaccess to, the details of the proprietaryplans of those service providers.

The Commission is adopting§ 39.18(k) as proposed. With respect tothe requirements of §§ 39.18(k)(1) and

(2), the Commission recognizes thatparticipation in industry-sponsoredevents, such as the annual testingconducted by FIA, serves as animportant assessment of theconnectivity between the systems of DCOs and their members (including

backup sites), but such participationwould not, in and of itself, satisfy therequirements of these regulations. Thelevel of participation of a particularDCO in a particular industry test is leftto the discretion of the DCO, anddifferent DCOs may participate in suchtests to different extents. Moreover,

while such industry-sponsored eventsmay be helpful, it is the responsibilityof each DCO—not that of an industryorganization—to ensure that thefunctionality of clearing will bemaintained between the DCO and itsmembers. The Commission believes thata DCO will best be able to meet itsresponsibilities reliably in a wide-areadisaster that affects a DCO and itsclearing members if the DCO hasactively worked together with thoseclearing members to coordinate theirplans and has obtained some evidence

that such plans will appropriately meshwhen implemented.

While it is true that a DCO shouldhave backup arrangements thatpromptly can be engaged to address afailure of essential services, it is likelythat most DCOs will prepare for atemporary, rather than an indefinite,loss of such services. Among the

benefits provided by coordination of aDCO’s BCP with that of providers of essential services is an insight into theperiod of time for which the DCOshould be prepared to provide suchservices itself.

The Commission recognizes that aservice provider may reasonably bereluctant to provide sensitive details of its own BCP, such as the preciselocation of backup facilities, and notesthat the proposed requirement isprefaced with the limitation that a DCOis required to obtain this informationonly ‘‘to the extent practicable.’’Nonetheless, merely obtaining arepresentation that states that a serviceprovider has a backup plan—with nodetail as to the Recovery Time Objective(RTO) of that service provider, and noinsight into how that service provider’sBCP might affect the BCP of the DCO—would likely be insufficient.

4. Recovery Time Objective—§39.18(a)

Proposed §39.18(a) would define anRTO as the period within which anentity should be able to achieverecovery and resumption of clearing andsettlement of existing and new contractsafter those capabilities become

temporarily inoperable for any reasonup to a wide-scale disruption, anddefines a wide-scale disruption as anevent that causes a severe disruption ordestruction of transportation,telecommunications, power, water orother critical infrastructure componentsin a relevant area, or an event thatresults in an evacuation orunavailability of the population in arelevant area. Proposed §39.18(e)(3)would require that a DCO have an RTOof the next business day, whileproposed §39.30(a) would require that aSIDCO have an RTO of two hours.

ICE noted that proposed § 39.18(a)does not specify a minimum time thata wide-scale disruption must beaccommodated, and that costs would behigher if the unavailability of staff in therelevant area that must beaccommodated is the total loss of personnel. ICE suggested that one weekwould allow relocation of personneloutside the affected area.

The Commission is adopting§§ 39.18(a) and 39.18(e)(3) as proposed.However, as discussed above inconnection with the financial resources

requirements, the Commission believesthat it would be premature to takeaction regarding §39.30 at this time.The Commission will consider theproposals relating to SIDCOs together inthe future.

J. Core Principle J—Reporting Requirements—§39.19

Core Principle J,215

as amended by theDodd-Frank Act, requires a DCO toprovide the Commission with allinformation that the Commissiondetermines to be necessary to conductoversight of the DCO. The Commissionproposed §39.19 to establishrequirements that a DCO would have tomeet in order to comply with CorePrinciple J. Under proposed §39.19,certain reports would have to be made

by a DCO to the Commission: (1) On aperiodic basis (daily, quarterly, orannually), (2) where the reportingrequirement is triggered by theoccurrence of a significant event; and (3)upon request by the Commission.Section 39.19(a) states the generalrequirement of Core Principle J. TheCommission did not receive anycomment letters discussing §39.19(a)and is adopting the provision asproposed.

1. Submission of Reports—§39.19(b)

The Commission proposed §39.19(b)to establish procedural requirements forelectronic submission of reports anddetermination of time zones applicableto filing deadlines. The Commissionreceived no comments and is adopting

§§ 39.19(b)(1) and (2) as proposed. Forpurposes of clarification, theCommission is also adopting§ 39.19(b)(3) to provide a definition of ‘‘business day’’ as ‘‘the intraday periodof time starting at the business hour of 8:15 a.m. and ending at the businesshour of 4:45 p.m., on all days exceptSaturdays, Sundays, and Federalholidays.’’ This is consistent with thedefinition of ‘‘business day’’ set forth in§ 40.1(a).216

2. Daily Reporting—§39.19(c)(1)

Proposed §39.19(c)(1) would requirea DCO to submit daily reports with

certain initial margin and variationmargin data as well as other cash flowsfor each clearing member. Morespecifically, §39.19(c)(1)(i) wouldrequire a DCO to report both the initialmargin requirement for each clearingmember, by customer origin and houseorigin, and the initial margin on depositfor each clearing member, by origin.





217This requirement would apply to optionstransactions only to the extent a DCO uses futures-style margining for options.

218See further discussion of reports of beneficialownership in section IV.D.6.h.(2), above.

219MGEX noted that it is already ‘‘internallyperforming these tasks’’ in reference to the severaldaily reporting requirements. KCC has also notedthat it already submits trading activity andpositions by each clearing member by origin on adaily basis in file formats prescribed by theCommission.

220The Commission notes that its staff is in theprocess of developing a plan for uniformsubmission of DCO reports.

221See further discussion of the costs and benefitsof the reporting requirements in section VII.J, below.

222See further discussion of the quarterlyreporting requirement under §39.11(f) in sectionIV.B.10, above.

223See 76 FR at 736 (Jan. 6, 2011) (Governance).

Proposed §39.19(c)(1)(ii) would requirea DCO to report the daily variationmargin collected and paid by the DCO,listing the mark-to-market amountcollected from or paid to each clearingmember, by origin.217

Proposed § 39.19(c)(1)(iii) wouldrequire a DCO to report all other cashflows relating to clearing and settlement

including, but not limited to, optionpremiums and payments related toswaps such as coupon amounts,collected from or paid to each clearingmember, by origin. Proposed§ 39.19(c)(1)(iv) would require a DCO toreport the end-of-day positions for eachclearing member, by customer originand house origin.

In addition, as discussed in sectionIV.D.6.h.(2), above, in connection withthe Commission’s proposal to requireDCOs to collect initial margin forcustomer accounts on a gross basisunder proposed § 39.13(g)(8)(i), theCommission further proposed anaddition to proposed §39.19(c)(1)(iv)that would also require DCOs to report,for each clearing member’s customeraccount, the end-of-day positions of each beneficial owner. The Commissionis adopting §39.19(c)(1) with twomodifications. First, the Commission isnot requiring reporting of customerpositions by beneficial owner, exceptupon Commission request.218 Second,as discussed below, the Commission isrenumbering the paragraphs in§ 39.19(c)(1) and adding a newparagraph (ii) to clarify the applicabilityof the daily reporting requirements to

FCM/BDs. In addition, the Commissionis replacing ‘‘by customer origin andhouse origin’’ with ‘‘by house origin and

by each customer origin’’; and isreplacing ‘‘options on futures positions’’with ‘‘options positions.’’

MGEX and KCC commented thatwhile such information is available tothem,219 they are concerned that if theCommission mandates a specific form of delivery, the cost to DCOs will besignificantly higher than expected.MGEX referred to its recent experiencewith the Trade Capture Reportinginitiative conversion to the

Commission’s new FIXML standards,which was more costly and timeconsuming than expected. KCC

commented that all of the data proposedto be reported to the Commission isalready made readily available to theCommission in varying degrees, andthere is little need for the Commissionto require the increasing level of detailed information in specifiedformats. In addition, MGEX expressedconcern with the Commission’s

potential data storage capacitylimitations. MGEX concluded that thecombination of these two factors suggestthat the burden of the daily reportingrequirements on DCOs and theCommission outweigh the value of thesereports.

MGEX suggested that requiring suchdata on an as-needed, rather than adaily, basis would limit the burden onDCOs and the Commission whileensuring relevancy as to the data beingrequested. KCC asked that theCommission reconsider the amount anddetail of information necessary for its

oversight role. While CME supportedthe proposed reporting requirement, itsuggested that the Commission workwith DCOs to determine the form andmanner of delivery.

As mentioned in the notice of proposed rulemaking, many DCOsalready provide the Commission withmuch of the data required under thisprovision. The Commission recognizesthat the daily reporting requirementsmay place an additional burden on aDCO, particularly if the DCO mustemploy a specific form of delivery thatit does not already have in place.

However, establishment of anautomated reporting system is a one-time cost, and a uniform reportingformat for all DCOs is necessary tofacilitate the Commission’s ability toreceive data promptly and quicklydisseminate it within the agency.220

The overall purpose of receiving thedaily data is to enable Commission staff to analyze the data on a regular basis sothat it can detect certain trends orunusual activity on a timely basis.Receiving such data less frequentlywould significantly reduce itsusefulness. While there may be initialcosts for DCOs to set up the reportingsystems, there should be little cost toDCOs on a continuing basis.221 Finally,MGEX’s suggestion to require such dataon an as-needed basis does not furtherthe objective of enhanced risksurveillance, given that the purpose of gathering the data is to identify and

address potential problems at theearliest possible time.

OCC expressed concern that thereporting requirements make noaccommodation for clearing membersthat are FCM/BDs, with respect to theirsecurities positions. In response toOCC’s comment, the Commission isadding a new paragraph (ii) to

§ 39.19(c)(1) to clarify the limitedapplicability of the daily reportingrequirements to securities positions.The final rule provides that ‘‘The reportshall contain the information required

by paragraph (c)(1)(i) of this section for(A) all futures positions, and options onfutures positions, as applicable; (B) allswaps positions; and (C) all securitiespositions that are held in a customeraccount subject to Section 4d of the Actor are subject to a cross-marginingagreement.’’

3. Quarterly Reporting—§39.19(c)(2)

The Commission is adopting§ 39.19(c)(2), requirements for quarterlyreporting of financial resources, asproposed.222

4. Annual Reporting—§39.19(c)(3)

Proposed §39.19(c)(3) would requirea DCO to submit a report of the CCO andan audited financial statement annually,as required by § 39.10(c). TheCommission received no comments onproposed §39.19(c)(3), and theCommission is adopting §39.19(c)(3) asproposed.

The Commission notes that in aseparate proposed rulemaking

implementing Core Principle O(Governance Fitness Standards), itproposed a new § 39.24(b)(4) whichwould require annual verification thatdirectors, members of the disciplinarypanel and disciplinary committee,clearing members, persons with directaccess, and certain affiliates of a DCO,satisfy applicable fitness standards.223 In connection with this, theCommission subsequently proposed tocross-reference this annual reportingobligation as a renumbered§ 39.19(c)(3)(iii). At such time as theCommission may adopt the verification

requirement as a final rule, § 39.19(c)(3)will be amended accordingly.

5. Event-Specific Reporting—§ 39.19(c)(4)

a. Decrease in Financial Resources—§ 39.19(c)(4)(i)

Under proposed § 39.19(c)(4)(i), aDCO would be required to report to the





224KCC mentioned that changes in the level of excess permanent margin deposited by clearingmembers, changes in the minimum marginrequirements on contracts or in the level of theguarantee pool requirements, and changes in thelevel of assessments that can be levied againstclearing members in the event of a default, couldcause financial resources to drop more than 10percent within the ordinary course of business.OCC stated it would cross the 10 percent thresholdon an almost monthly basis, i.e., the day aftermonthly expirations occur.

225See discussion of proposed § 39.19(c)(4)(xiv)(finalized as §39.19(c)(4)(xii)) in section IV.J.5.k, below.

226Section 1.12(b)(2) requires an FCM to give 24hours notice to the Commission if it ‘‘knows orshould have known’’ that its adjusted net capital isat any time less than 110 percent of the amountrequired by the Commission’s net capital rule.

227Section 1.12(g)(1) requires an FCM to providewritten notice within two business days of asubstantial reduction in capital as compared to thatlast reported in a financial report if there is areduction in net capital of 20 percent or more.

Commission a 10 percent decrease inthe total value of the financial resourcesrequired to be maintained by the DCOunder §39.11(a), either from the lastquarterly report. or from the value as of the close of the previous business day.Such notification would alert theCommission of potential strain on theDCO’s financial resources, either

gradual or precipitous.The Commission invited comments

regarding possible alternatives as towhat would be considered a significantdrop in the value of financial resources.Although many commenters opposedusing the 10 percent threshold as a

barometer for a ‘‘significant’’ decrease,no commenter questioned theCommission’s objective in obtaining thistype of information in a timely manner.

MGEX commented that 10 percent isan arbitrary threshold and it is notuncommon for financial resources tofluctuate by 10 percent even in a stablemarket. Similarly, OCC and KCC statedthat the threshold is arbitrary and wouldmost likely be crossed on a frequent

basis during the ordinary course of business.224 In addition, KCC suggestedthat this requirement is duplicative, asa material drop in financial resourceswould already be required to bereported by the proposed requirement toreport all material adverse changes(Material Adverse Change ReportingRequirement).225

OCC, Better Markets, and Mr. Barnardwere also concerned about the types of financial resources to consider whencalculating a decrease. OCC suggested it

is counterproductive to report adecrease in financial resources as aresult of a decrease in marginrequirements, which is a sign of riskreduction. Similarly, Better Marketssuggested that coincidental increases inmargin-based financial resources, whichcould fluctuate substantially, couldoffset decreases by more importantfinancial resources. In addition, Mr.Barnard raised concerns regarding: (1)Grouping all types of financial resourcestogether for purposes of calculatingdecreases, and (2) whether onlyrequiring a report of a decrease in

financial resources is sufficient.

Several commenters proposed using adifferent threshold: (1) OCC suggested25 percent; (2) MGEX suggestedallowing a DCO to determine whatconstitutes a material decrease or, as analternative, adopting a threshold of 30percent over a five-day period and 25percent when compared to the previousquarter; and (3) Better Markets

suggested adopting a threshold of 5percent of non-margin-based financialresources. NYPC recommended takingan approach similar to the FCM ‘‘earlywarning’’ reporting requirement.226

To compensate for an upwardsadjustment of the financial resourcesrequirement, Better Markets suggestedalso requiring a report if the ratio of financial resources to minimumrequired levels decreases to 1 to 1. Mr.Barnard suggested splitting financialresources into two groups: (1) The more‘‘robust’’ financial resources (a DCO’sown capital and guaranty fund), and (2)

market or risk-related items (margins);and requiring a report for a decrease ineither amount or a decrease in the totalof both amounts. Mr. Barnard alsosuggested requiring a DCO to report acalculation of its ‘‘solvency ratio’’(available financial resources/financialresources requirements) and a 5 percentor more drop in such ratio.

In response to commenters’ objectionsto setting the level at 10 percent, theCommission is setting the reportingthreshold at a level of 25 percent for

both the daily and quarterly financialresources decreases. As noted, OCCsuggested 25 percent while MGEX

suggested 25 percent for the quarterlyand 30 percent for a report covering any5-day period. MGEX did not explainwhy there should be a distinction

between the percentage decreasetriggering the quarterly and shorter-termreports. The Commission believes that a25 percent level addresses thecommenters’ concerns about ‘‘noise’’while providing the Commission withnotification of material decreases.

The Commission is not excludingcertain financial resources from thedecrease calculation as suggested byseveral commenters. Although there are

certain financial resources that mayfluctuate in the ordinary course of business, the Commission believes thatsetting the reporting threshold levelhigher should resolve many of theseissues because fewer fluctuations thatoccur in the ordinary course of businesswould trigger the higher 25 percentthreshold. Additionally, the purpose of

the financial resources requirement inCore Principle B and as codified in theCommission’s regulations is to ensurethat a DCO has adequate resources tocover the default of the clearing memberwith the largest exposure. Financialresources are looked at in the aggregate.Thus, fluctuations during the ordinarycourse of business, even coincidental

decreases in financial resources, allreflect the financial health of the DCOat that time.

The Commission is not replacing thefinancial resources percentage decreasereporting requirement with arequirement similar to the FCM ‘‘earlywarning’’ reporting requirement, assuggested by NYPC. While FCMs dohave an ‘‘early warning’’ reportingrequirement, this is only in addition toan FCM’s requirement to also reportdecreases of 20 percent pursuant to§ 1.12(g)(1).227 In fact, even with thenew financial resources reporting

requirement for DCOs, DCOs still havea lesser reporting requirement thanFCMs in this regard: DCOs are onlyrequired to report 25 percent decreases,while FCMs are required to report 20percent decreases in addition toreporting decreases below certainthresholds (the ‘‘early warning’’requirement).

The Commission is adopting themodified §39.19(c)(4)(i) reportingrequirement described herein. TheCommission does not consider it to beduplicative of the Material AdverseChange Reporting Requirement, or thequarterly financial resource reporting

requirement under § 39.11(f), assuggested by KCC. Each reportingrequirement, including the financialresources reporting requirement, relatesto specific circumstances that theCommission has determined to bematerial and which, based on itsexperience in conducting financial risksurveillance, the Commission believeswarrants notification. The MaterialAdverse Change Reporting Requirementis intended to cover more unusualchanges that are not readily identifiablein advance but would nonetheless be of interest to Commission staff in

conducting its oversight of a DCO. TheCommission is also not requiring thesolvency ratio decrease reportingrequirement suggested by Mr. Barnard.The Commission believes that receivingreports regarding financial resourcesdecreases will serve the purpose of alerting the Commission to possiblefinancial distress at a DCO, without





228See discussion of §39.19(c)(4)(iv) in sectionIV.J.5.d, below.

229As a technical matter, ICE Clear soughtclarification in the rule text regarding the referenceto §39.11(a), pointing out that § 39.11(a) sets thestandard for financial resources and §39.11(b) liststhe financial resources available to satisfy thosestandards. ICE Clear recommended that§ 39.19(c)(4)(i) be revised to refer to both §§39.11(a)and (b). The Commission declines to include areference to §39.11(b) as the purpose of the cross-reference is to incorporate by reference thestandard, not the means for satisfying the standard.

230CME referred to the immediate notice requiredunder proposed §§ 39.19(c)(4)(v)–(ix).

231See further discussion of the Material AdverseChange Reporting Requirement in section IV.J.5.k, below.

unnecessarily burdening a DCO withadditional reporting requirements.

NYPC pointed out that the proposedrule language referring to a decrease inthe ‘‘total value of financial resources’’could be read to refer to the totalcombined default and operatingresources. It also raised a question as towhether the reference to financial

resources ‘‘required to be maintained* * * under § 39.11(a)’’ referred to theminimum amount ‘‘required’’ or if itwas intended to encompass all financialresources ‘‘available to satisfy’’ therequirements.

The Commission intends thereporting requirement in §39.19(c)(4)(i)to refer only to financial resourcesavailable to cover a default inaccordance with § 39.11(a)(1). Asignificant change in the amount of financial resources available to meetoperating expenses is addressed by§ 39.19(c)(4)(iv).228 In response to the

interpretive issues raised by NYPC, theCommission is revising the language in§ 39.19(c)(4)(i) to clarify that thedecrease in financial resources refers toa decrease in resources ‘‘available tosatisfy the requirements under§ 39.11(a)(1)’’ so it is clear that thereporting requirement applies only todefault resources and refers to thoseresources available to the DCO to satisfythe default resource requirements, evenif the amount of those resources exceedsthe minimum amount that is required

by § 39.11(a)(1).229 The Commission notes that it should

be apprised when a DCO experiences a25 percent decrease in the value of itsdefault resources from the value as of the close of the previous business day,even if their value has increasedsubstantially since the last quarterlyreport. Such a change could signal asignificant change in a DCO’s riskprofile and early reporting will enablethe Commission to take appropriatemeasures to facilitate proper riskmanagement at the DCO.

b. Decrease in Ownership Equity—§ 39.19(c)(4)(ii)

Proposed § 39.19(c)(4)(ii) would

require a DCO to report an expected 20percent decrease in ownership equity

two business days prior to the event (ortwo business days following the event,if the DCO does not and reasonablyshould not have known prior to theevent). Such report must include proforma financial statements (or currentfinancial statements) reflecting theanticipated condition of the DCOfollowing the decrease (or current

condition). The report is intended toalert the Commission of major plannedevents that would significantly affectownership equity, most of which areevents of which the DCO would haveadvance knowledge, such as areinvestment of capital, dividendpayment, or a major acquisition.

Better Markets commented that adecrease in ownership equity is anextraordinary event which wouldwarrant notification for even a 5 percentdecrease, the threshold the SEC uses fortriggering reporting of acquisition of

beneficial ownership of a class of

shares. While a decrease in ownershipequity can have a significant effect onthe financial resources of a DCO, theCommission determined that 20 percentis a level that would represent asignificant decrease and yet would notoccur on a frequent basis. TheCommission believes that setting thethreshold lower than 20 percent wouldunnecessarily increase the potential

burden on DCOs as well as on theCommission, which could then beresponsible for reviewing a largernumber of reports.

Better Markets also suggested that five business days advance notice is more

appropriate and would not pose asignificant burden for DCOs. Whilechanging the requirement to five

business days does not itself pose anadditional burden on a DCO, theCommission is adopting the two-daynotification requirement, as proposed.The Commission has determined thatrequiring the report two days prior tosuch an event is sufficient for itspurposes in reviewing the transaction,particularly given the confidentialnature of such a transaction.

OCC expressed concern that it would be problematic to provide the necessary

financial statements within the timeframe required; OCC stated that it runsfinancial statements on a monthly basis,thus it would not have them readilyavailable within two days. Rather, OCCsuggested keeping the notification timeframe at two days, but allowing up to 30days, or when the financial statementsare ready, whichever occurs first, toprovide the financial statements. TheCommission is adopting the two-dayrequirement, as proposed. A 20 percentdecrease in ownership equity isgenerally a major, planned event and

the Commission believes it would behighly unusual for a DCO not to havefinancial statements prepared inconnection with such a transaction.

The Commission is adopting§ 39.19(c)(4)(ii) as proposed.

c. Six-Month Liquid Asset Test—§ 39.19(c)(4)(iii)

Proposed § 39.19(c)(4)(iii) wouldrequire immediate notice of a deficit inthe six months of liquid assets required

by § 39.11(e)(2). CME expressed concernwith other ‘‘immediate notice’’events,230 stating that this would requirea DCO to immediately notify theCommission, in the specific form andmanner requested, even before the DCOattends to the situation and gathers allthe relevant information. CMErecommended only requiring ‘‘prompt’’notice, which would require the DCO tonotify the Commission ‘‘quickly andexpeditiously,’’ while allowing the DCOto first attend to the situation at handand ensure that the informationreported to the Commission is correctand accurate. CME also suggested‘‘prompt’’ notice for the MaterialAdverse Change Reporting Requirement.

The Commission is adopting the ruleas proposed and retaining the‘‘immediate’’ reporting requirement for

both §39.19(c)(4)(iii) and the MaterialAdverse Change ReportingRequirement.231 While the Commissionappreciates that in such situations aDCO would be busy attending to thematter at hand, the burden to contactthe Commission is minimal. The

Commission does not specify aparticular form or manner of delivery,so as to minimize the burden on theDCO. Moreover, the Commission isconcerned that using a time frame of ‘‘prompt’’ would leave too much opento interpretation by the DCO and couldlead to untimely notices.

d. Change in Working Capital (CurrentAssets)—§39.19(c)(4)(iv)

Proposed §39.19(c)(4)(iv) wouldrequire a DCO to report to theCommission no later than two businessdays after working capital is negative.The report must include a current

balance sheet of the DCO. BetterMarkets commented that allowing aDCO two days to report negativeworking capital is too much time, giventhe potential gravity of the situation,and that anything less than arequirement of immediate notification is‘‘simply indefensible.’’





232MGEX also commented on the highlyconfidential nature of changes in ownership,corporate or organizational structure. TheCommission believes MGEX’s concerns areaddressed by the Commission’s procedures fornonpublic records and confidential treatmentrequests set forth in Part 145 of the Commission’sregulations.

As with the ownership equitydecrease reporting requirement, OCCcommented that it is problematic tosubmit a balance sheet in two businessdays. OCC suggested keeping thenotification requirement at two days,

but allowing up to 30 days (or sooner if ready) to provide a balance sheet.


§ 39.19(c)(4)(iv) as proposed, except thatit is revising certain terminology toclarify the intended meaning of the term‘‘working capital.’’ While theCommission agrees that negativeworking capital is a serious matter,immediate reporting is not necessary tofurther the Commission’s purpose inobtaining this information. TheCommission is allowing up to two daysfor notification because immediatenotification would require a DCO to putin place a potentially expensive systemto allow for real-time tracking of working capital. Nonetheless, a DCO is

expected to have a general knowledge of the level of its working capital at alltimes. By allowing two days fornotification, a DCO will have time tocompute whether working capital isnegative if it has reason to believe thatthis may be the case, without beingrequired to implement a real-timenotification system. Thus, the purposeof the two business days is actually togive a DCO time to become aware of itsobligation to report, not to allow theDCO to wait two days after it becomesaware of the situation.

The Commission is also requiring theDCO to submit a balance sheet within

two business days of the DCOexperiencing negative working capital.Given that a DCO would be expected toupdate its balance sheet upon realizingthat it has negative working capital, theCommission does not believe thisrequirement imposes an additional

burden on the DCO.As ‘‘working capital’’ is not a defined

term, the Commission is substituting theterm ‘‘current assets’’ for ‘‘workingcapital’’ for purposes of clarification.Thus, ‘‘negative working capital’’ nowrefers to a situation when currentliabilities exceed current assets. Section

39.19(c)(4)(iv) now reads as follows:‘‘Change in current assets. No later thantwo business days after currentliabilities exceed current assets; thenotice shall include a balance sheet thatreflects the derivatives clearingorganization’s current assets and currentliabilities and an explanation as to thereason for the negative balance.’’

e. Intraday Initial Margin Calls—§ 39.19(c)(4)(v)

Proposed § 39.19(c)(4)(v) wouldrequire a DCO to report to the

Commission any intraday margin call toa clearing member, no later than onehour following the margin call. Severalcommenters stated that the requirementis unnecessary and a burden on DCOs,while other commenters requestedcertain modifications to the proposal.

The Commission is not adopting theintraday margin call reporting

requirement in proposed§ 39.19(c)(4)(v). While such informationcould provide early notice of potentialproblems at a DCO, the Commission hasconcluded that the requirement would

be overly burdensome to DCOs giventhe amount of work commentersindicated it would entail. In addition,the Commission will still receive muchof the same information as part of eachDCO’s daily reporting under§ 39.19(c)(1), and unusual intradayinitial margin calls that reflect amaterial adverse change will still bereported under the Material Adverse

Change Reporting Requirement.f. Issues Related to Clearing Members—§§ 39.19(c)(4)(vi)–(ix)

Proposed §§39.19(c)(4)(vi)–(ix) wouldrequire a DCO to report the followingissues related to clearing members: (1) Adelay in collection of initial margin; (2)a request to clearing members to reducepositions; (3) a determination by theDCO to transfer or liquidate a clearingmember position; and (4) a default of aclearing member. The Commissionreceived comments suggesting that thesereporting requirements are unnecessaryor, at the very least, require some

modification. KCC suggested notadopting these requirements altogether,

because notification of these eventswould still be required under theMaterial Adverse Change ReportingRequirement.

The Commission has concluded thatdelays in the collection of initial marginare not necessarily signs of a financialproblem at either the DCO or its clearingmembers. The Commission therefore isnot adopting the requirement to reportsuch delays under proposed§ 39.19(c)(4)(vi). Nonetheless, if a delayis evidence of a material adverse change

in the financial condition of a clearingmember, it would still have to bereported under the Material AdverseChange Reporting Requirement.

The Commission is adopting theremainder of these reportingrequirements as proposed. However, itis redesignating proposed§§ 39.19(c)(4)(vii)–(ix) as§§ 39.19(c)(4)(v)–(vii). These reportingrequirements relate to events that occurinfrequently but can be of significanceto the Commission’s risk surveillanceprogram even if they do not rise to the

level of having ‘‘a material adversefinancial impact’’ on the DCO orrepresent ‘‘a material adverse change inthe financial condition of any clearingmember’’ under the Material AdverseChange Reporting Requirement. Thus,with respect to these reports, theCommission is not relying on theMaterial Adverse Change Reporting

Requirement as suggested by KCC.In connection with these proposed

requirements, the Commission alsoproposed removing §1.12(f)(1) in lightof the fact that its requirements weresubstantially similar to those beingproposed as § 39.19(c)(4)(viii). TheCommission did not receive anycomments on this proposal and isremoving §1.12(f)(1) as proposed.

g. Change in Ownership or Corporate orOrganizational Structure—§ 39.19(c)(4)(x)

Proposed §39.19(c)(4)(x) would

require a DCO to report certain changesin ownership or corporate ororganizational structure. In general,such reports must be submitted to theCommission three months in advance of the anticipated change. With theexception of the change discussed

below, the Commission is adopting§ 39.19(c)(4)(x) as proposed,redesignated as § 39.19(c)(4)(viii).

Proposed § 39.19(c)(4)(x)(A)(2)(redesignated as § 39.19(c)(4)(viii)(A)(2))would require a DCO to report thecreation of a new subsidiary, or theelimination of a current subsidiary, of the DCO or its parent company. CMEcommented that the creation orelimination of a separate subsidiary of the DCO’s parent company would notserve the Commission’s purpose of conducting effective oversight of theDCO or enhance the Commission’sability to conduct timely analysis of aDCO’s activities. CME added that theplans of a DCO’s parent company tocreate (or eliminate) a subsidiary may behighly confidential.232 CME urged theCommission to eliminate such reportingrequirement, asserting that ‘‘the value of this information to the [Commission] isquestionable, and the burdens

associated with providing it may besubstantial.’’ CME did not provide anyexplanation as to why the burden of reporting might be substantial.

While information about corporatechanges that potentially impact a DCO’s





233As proposed, the provision referred to theDCO’s ‘‘parent company.’’ The Commission isadopting a technical amendment to refer to the‘‘parent(s)’’ to clarify that there could be more thanone parent, such as in the case of a DCO owned bya joint venture, and the parent need not have anyparticular corporate form. For purposes of thesereporting requirements, a ‘‘parent’’ is a directparent, not an entity further up the chain of ownership.

234Core Principle H provides in relevant part that‘‘each derivatives clearing organization shall * * *(iii) report to the Commission regarding ruleenforcement activities and sanctions imposedagainst members and participants. * * * ’’ See alsodiscussion of §39.17 in section IV.H, above.

financial standing or operations ishelpful to the Commission in itsoversight of a DCO, to avoid creating anunintended burden on DCOs andCommission staff, particularly where aDCO is part of a complex corporatestructure, the Commission is modifying§ 39.19(c)(4)(viii)(A)(2) to eliminate therequirement to report a change in

subsidiaries of the DCO’s parentcompany. Thus, § 39.19(c)(4)(viii)(A)now requires only that a DCO report‘‘[a]ny anticipated change in theownership or corporate ororganizational structure of the [DCO] orits parent(s) that would: * * * (2)Create a new subsidiary or eliminate acurrent subsidiary of the [DCO].* * * 233

h. Change in Key Personnel—§ 39.19(c)(4)(xi)

Proposed § 39.19(c)(4)(xi) wouldrequire a DCO to report the departure oraddition of any person who qualifies as‘‘key personnel,’’ as defined in § 39.2,no later than two business daysfollowing the change. KCC suggestedrequiring a report ‘‘within a reasonableperiod of time.’’ The Commission notesthat key personnel are not likely tochange often, and KCC did not provideany explanation as to why the two

business day notification period isinappropriate. The Commission isadopting §39.19(c)(4)(xi) as proposed,

but redesignated as §39.19(c)(4)(ix).

i. Change in Credit Facility FundingArrangement—§39.19(c)(4)(xii)

Proposed § 39.19(c)(4)(xii) wouldrequire a DCO to report no later thanone business day after a DCO changesan existing credit facility fundingarrangement, is notified that sucharrangement has changed, or knows orreasonably should have known that thearrangement will change. KCCcommented that this requirement isduplicative: such reports would already

be required by the Material AdverseChange Reporting Requirement. CMEhad no objection to the requirement toreport such changes, but opposed therequirement to notify the Commissionwhen it knows that the arrangement willchange in the future, stating that itserves little purpose to notify theCommission without knowing what willchange. CME suggested that the

requirement should be to report to theCommission after the terms havechanged. Conversely, Better Marketsopposed several components of theproposed rule, asserting that it is ‘‘toonarrow and too loose,’’ allowing one

business day is too long, and thestandard of reporting when the DCO‘‘knows or reasonably should have

known’’ is insufficient. Better Marketssuggested expanding the reportingrequirement to cover alternative sourcesof liquidity such as access tocommercial paper and repurchaseagreement markets. It also suggestedrequiring such a report (i) immediately,and (ii) when ‘‘there is a reasonablelikelihood that the arrangement maychange.’’

The Commission is modifying the ruleas suggested by CME by removing thefollowing: ‘‘or knows or reasonablyshould have known that thearrangement will change.’’ Thus, a DCO

is required to report a change in a creditfacility funding arrangement no laterthan one business day after it changesthe arrangement or is notified that sucharrangement has changed. The provisionis also being redesignated as§ 39.19(c)(4)(x). The Commission is notadopting KCC’s suggestion to rely on theMaterial Adverse Change ReportingRequirement because a change in acredit facility funding arrangementwould be of specific interest to theCommission in its conduct of DCOoversight, but such a change is notlikely to rise to the level of being amaterial adverse change. The

Commission also is declining to adoptBetter Markets’ recommendations

because they would result in the filingof multiple reports, many of limitedusefulness, which, on balance, wouldplace an unnecessary burden on DCOsand Commission staff. Nonetheless, theCommission notes that unusual marketconditions such as those that mightlimit a DCO’s access to commercialpaper or ability to enter into repurchaseagreements, thereby adversely affectingthe DCO’s liquidity, could constitute amaterial adverse change that wouldhave to be reported under the Material

Adverse Change Reporting Requirement.j. Rule Enforcement—§39.19(c)(4)(xiii)

Proposed §39.19(c)(4)(xiii) wouldrequire a DCO to report the initiation of a rule enforcement action against aclearing member or the imposition of sanctions against a clearing member, nolater than two business days after theDCO takes such action. Severalcommenters observed that this wouldresult in multiple reports with littleuseful information. They further notedthat the DCO would otherwise inform

the Commission about serious financialissues, as a matter of current practiceand pursuant to the Material AdverseChange Reporting Requirement. MGEXrecommended that the Commission notadopt the rule enforcement reportingrequirement. OCC and CMErecommended that the Commission notadopt the enforcement reporting

requirement as proposed.MGEX commented that requiring

notification of the initiation of ruleenforcement is unnecessary andpremature, noting that manyinvestigations are unrelated to financialrisk and many are routine. OCC made asimilar comment. MGEX expressedconcern about the harm such a reportcould cause to a clearing member’sreputation by notifying the Commission

before there has been any determinationof any guilt. MGEX also noted that theCommission is already routinelyinformed or is aware of ongoing or

potential actions.OCC stated that the proposedenforcement reports would serve nopurpose because if there were seriousfinancial issues, the DCO would alreadyhave been in regular contact with theCommission long before the DCOreached the stage of initiating a ruleenforcement action. Thus, OCC believesthese reports would not serve as aneffective early warning sign. OCCfurther opposed this reportingrequirement because a clearing membercould appeal a decision after a sanctionis imposed. OCC recommendednotification to the Commission within

30 days after a final decision on adisciplinary matter.

CME believes it is unclear when thenotification requirement would betriggered, and that there are situationswhen it is unclear when an enforcementaction is considered to be initiated.

The Commission is adopting the rulewith modifications. While theCommission considers informationabout enforcement actions to be usefulin its oversight of a DCO’s ruleenforcement program under CorePrinciple H, and more broadly in itsoversight of a DCO’s overall risk

management program, the Commissionhas concluded that the requirement, asproposed, could result in the reportingof many events that are not material tothe Commission’s oversight of a DCO.234 The Commission recognizes that manyenforcement actions may be based onrelatively minor offenses and are





235Because of the potential impact on a DCO of an adverse change in the financial condition of a

clearing member, this reporting requirement wouldapply to ‘‘any’’ clearing member, including one thatis solely a BD engaging in securities activities.

236See discussion of timing requirements insection IV.J.5.c, above.

237The Commission is also making a technicalnon-substantive change by substituting the word‘‘shall’’ for the word ‘‘must’’ to conform thisprovision with other provisions in §39.19.

238See 76 FR at 736 (Jan. 6, 2011) (Governance).239 Id.

unlikely to have a significant impact ona DCO’s ability to manage risk related tothe provision of clearing and settlementservices.

Therefore, the Commission isadopting the regulation with amodification such that it would onlyrequire the reporting of sanctionsagainst clearing members, no later than

two business days after the DCO takessuch action, and would not require thereporting of the initiation of ruleenforcement actions. The Commission isalso redesignating the provision as§ 39.19(c)(4)(xi). The Commission notesthat events or circumstances that rise tothe level of having a material adverseimpact on a DCO’s ability to complywith the requirements of Part 39, orrelate to a material adverse change inthe financial condition of any clearingmember, whether or not they form the

basis of an enforcement action, willhave to be formally reported under

§ 39.19(c)(4)(xii)(B) or (C), respectively.Last, OCC requested clarification as towhether the rule enforcement reportingrequirement applies to DCOenforcement activities involving aclearing member that is only registeredas a BD. The Commission confirms thatthe requirement to report the impositionof sanctions against clearing membersdoes not apply to a DCO’s clearingmembers that are registered as BDs onlyand engaged solely in securities-basedtransactions. However, insofar as such aclearing member’s actions might have amaterial adverse impact on the DCO’sability to comply with the requirementsof Part 39 or would constitute a materialadverse change in the financialcondition of a clearing member, theDCO would be required to submit aMaterial Adverse Change Report, asdiscussed below.

k. Financial Condition and Events(Material Adverse Change ReportingRequirement)—§ 39.19(c)(4)(xiv)

Proposed §39.19(c)(4)(xiv) wouldrequire a DCO to immediately notify theCommission after the DCO knows orreasonably should have known of certain material adverse changes, i.e.,

the institution of any legal proceedingswhich may have a material adversefinancial impact on the DCO; any event,circumstance or situation that materiallyimpedes the DCO’s ability to complywith part 39 of the Commission’sregulations and is not otherwiserequired to be reported; or a materialadverse change in the financialcondition of any clearing member that isnot otherwise required to be reported.235

CME and OCC are opposed to this‘‘catch-all’’ requirement. In particular,CME is concerned that the requirementis too broad and thus would include areporting requirement for anything thatis technically in violation of Part 39,e.g., even if the DCO’s email or Web sitegoes down temporarily. OCC alsocommented that the requirement is

unnecessary because the Commissionwill be receiving adequate reporting asa result of other reporting requirementsin Part 39 and the reportingrequirements for FCMs. Alternatively,CME suggested requiring ‘‘prompt’’notice, rather than ‘‘immediate’’ notice.

The Commission is adopting§ 39.19(c)(4)(xiv) as proposed, butredesignated as §39.19(c)(4)(xii). CME’sconcerns are unwarranted as thereporting requirement would onlyrequire reporting incidents that couldhave a material adverse effect on theDCO. A Web site temporarily going

down would not necessarily beexpected to have a ‘‘material’’ adverseeffect on the DCO. However, if it didhave a material adverse impact, theCommission would expect it to bereported. The Commission recognizesthat it is requiring a DCO to exercise itsdiscretion in the first instance todetermine what events trigger thisreporting requirement, but theCommission considers this to be anappropriate responsibility for a DCO.

Moreover, while the Commission will be getting information as a result of other Part 39 and FCM reportingrequirements, there may be certain

conditions or events that couldmaterially impact a DCO that theCommission could not anticipate, yetabout which it would still be importantfor the Commission to be notified. Thisis especially important in light of theCommission’s decision not to adoptcertain proposed reportingrequirements, as discussed above.

The Commission is also keeping thetiming of the reporting requirement as‘‘immediate’’ rather than ‘‘prompt,’’ asthese are material changes for whichimmediate notification is essential andfor which the more ambiguous

‘‘prompt’’ is not appropriate.236

l. Financial Statements MaterialInadequacies—§ 39.19(c)(4)(xv)

Proposed §39.19(c)(4)(xv) wouldrequire a DCO to report materialinadequacies in its financial statements.The Commission received no commentson this requirement, and the

Commission is adopting§ 39.19(c)(4)(xv) as proposed(redesignated as §39.19(c)(4)(xiii)), withthe exception of a technical revision toadd a reference to ‘‘in a financialstatement’’ so that the language nowreads ‘‘If a derivatives clearingorganization discovers or is notified byan independent public accountant of the

existence of any material inadequacy ina financial statement, such derivativesclearing organization shall give notice.* * *’’ 237

m. Action of Board of Directors or RiskManagement Committee—§ 39.19(c)(4)(xvi)

In a separate proposed rulemakingthat would implement Core Principle P(Conflicts of Interest), the Commissionproposed §39.25(b), which wouldrequire a DCO to report when the boardof directors of a DCO rejects arecommendation or supersedes anaction of the DCO’s Risk ManagementCommittee, or when the RiskManagement Committee rejects arecommendation or supersedes anaction of its subcommittee.238 Inconnection with this, the Commissionsubsequently proposed to crossreference this reporting obligation inproposed §39.19(c)(4)(xvi). At suchtime as the Commission may adopt thereporting requirement in §39.25(b) as afinal rule, §39.19(c)(4) will be amendedaccordingly.

n. Election of Board of Directors—§ 39.19(c)(4)(xvii)

In a separate proposed rulemakingthat would implement Core Principles P(Conflicts of Interest) and Q (Composition of Governing Boards), theCommission proposed §40.9(b)(1)(iii),which would require a DCO to reportcertain information to the Commissionafter each election of its board of directors.239 In connection with this, theCommission subsequently proposed tocross-reference this reporting obligationin proposed §39.19(c)(4)(xvii). At suchtime as the Commission may adopt thereporting requirement in §40.9(b)(1)(iii)as a final rule, §39.19(c)(4) will be

amended accordingly.o. System Safeguards—§ 39.19(c)(4)(xviii)

Proposed §39.19(c)(4)(xviii) wouldrequire a DCO to report certainexceptional events and planned changesas required by §39.18(g) and § 39.18(h),





240See discussion of system safeguards reportingin section IV.I, above.

241Section 5b(c)(2)(K) of the CEA, 7 U.S.C. 7a–1(c)(2)(K).

242See, e.g., § 1.31 of the Commission’sregulations.

243See 75 FR 76574 (Dec. 8, 2010) (Swap DataRecordkeeping and Reporting Requirements).

244Section 5b(c)(2)(L) of the CEA, 7 U.S.C. 7a–1(c)(2)(L).

245The statutory language refers to fees chargedto ‘‘members and participants,’’ and theCommission interprets this phrase to mean feescharged to ‘‘clearing members.’’

246 In particular, Better Markets stated that, at aminimum, a DCO should be required to publiclydisclose (i) the adequacy of its financial resources,measured by the required level of financialresources under Commission rules, and (ii) to theextent they must be reported to the Commission, areduction in financial resources, decrease in

ownership equity, or change in ownership orcorporate structure.

247Section 5b(c)(2)(M) of the CEA, 7 U.S.C. 7a–1(c)(2)(M).

respectively. The Commission receivedno comments on this reportingrequirement, and the Commission isadopting § 39.19(c)(4)(xviii),redesignated as § 39.19(c)(4)(xvi), asproposed.240

K. Core Principle K—Recordkeeping—§ 39.20

Core Principle K,241 as amended bythe Dodd-Frank Act, requires a DCO tomaintain records of all activities relatedto the business of the DCO as a DCO, ina form and manner that is acceptable tothe Commission and for a period of notless than 5 years. The Commissionproposed §39.20 to establishrequirements that a DCO would have tomeet in order to comply with CorePrinciple K.

Under proposed §39.20(b), a DCOwould have to maintain records of allactivities related to its business as aDCO ‘‘for a period of not less than 5

years,’’ except for swap data that must be maintained in accordance with theSDR rules in part 45 of theCommission’s regulations. Mr. Barnardexpressed the view that limiting recordretention to five years is insufficient andrecords should be required to be keptindefinitely.

The Commission is adopting §39.20as proposed. The Commission believesthat codifying the statutory minimumrequirement of five years is appropriate,noting that a five-year minimum isconsistent with other Commissionrecordkeeping requirements.242 Inaddition, the exception for swap datarecordkeeping addresses situationswhere the Commission has previouslydetermined that a five-year minimummay not be sufficient.243

L. Core Principle L—PublicInformation—§39.21

Core Principle L,244 as amended bythe Dodd-Frank Act, requires a DCO toprovide market participants sufficientinformation to enable the marketparticipants to identify and evaluateaccurately the risks and costs associatedwith using the DCO’s services. Morespecifically, a DCO is required to make

available to market participantsinformation concerning the rules andoperating and default proceduresgoverning its clearing and settlement

systems and also to disclose publiclyand to the Commission the terms andconditions of each contract, agreement,and transaction cleared and settled bythe DCO, each clearing and other feecharged to members,245 the DCO’smargin-setting methodology, dailysettlement prices, and other mattersrelevant to participation in the DCO’s

clearing and settlement activities.Proposed §39.21 would require a

DCO to provide market participantswith sufficient information to enable themarket participants to identify andevaluate accurately the risks and costsassociated with using the services of theDCO. In particular, proposed§§ 39.21(c)(2), (3) and (4) would requirea DCO to disclose publicly and to theCommission information concerning itsmargin-setting methodology and the sizeand composition of the financialresource package available in the eventof a clearing member default.

KCC, MGEX, and NGX variouslycommented that DCO fees and charges,margin methodology and financialresource information are confidentialand should not be required to bepublicly disclosed for the followingreasons: (1) It is intellectual property,(2) there is no correlation between theavailability of such information and thedecision whether to invest in or tradewith a DCO, and (3) privately heldcompanies (or non-intermediated DCOsin the case of NGX) should not have todisclose such information. MGEX alsosuggested that making margin

methodology information available tothe public could lead to marketmanipulation by those who mightattempt to influence the margin level.MGEX suggested that the rule shouldonly require making the financialresource package information availableupon request by a clearing member thathas signed the DCO’s confidentialityagreement. Conversely, Better Markets

believes that §39.21 does not go farenough and that many of the DCOreports required by §39.19 should also

be required to be disclosed to thepublic, as the Dodd-Frank Act requires

that market participants and the public be informed of the risks and otherpotential consequences of transactingwith a DCO.246 Similarly, Mr. Barnard

suggested requiring public disclosure of all items of public interest, includingevent-specific reports under§ 39.19(c)(4), except for those thatwould expose business-specificconfidential issues.

The Commission is adopting §39.21as proposed, except for proposed§ 39.21(c)(7), which would require the

public disclosure of information relatedto governance and conflicts of interestin accordance with provisions that wereproposed in a separate rulemaking. Atsuch time as the Commission adoptsthose provisions, § 39.21 will beamended accordingly. The requirementto publicly disclose clearing and otherfees charged by the DCO, marginmethodology and financial resourcesinformation comes directly from CorePrinciple L. Moreover, the Commission

believes that concerns regarding theconfidential nature of this informationare unfounded because such

information would seem to befundamental to a clearing member orpotential clearing member’s assessmentof the strengths and weaknesses of aDCO. This does not necessarily requiredisclosure of proprietary information;certain DCOs, e.g., CME, alreadydisclose this type of information ontheir Web sites.

The Commission is not revising therule to incorporate Better Markets’ orMr. Barnard’s proposals. From apractical standpoint, some of theinformation Better Markets and Mr.Barnard have requested to be publicly

disclosed is otherwise going to be publicinformation, particularly if the DCO is apublic company, and thus subject toSEC filing requirements. Regardless, theCommission does not interpret CorePrinciple L as requiring disclosure of allof the financial workings of a DCO.

M. Core Principle M—InformationSharing—§39.22

Core Principle M,247 as amended bythe Dodd-Frank Act, requires a DCO toenter into and abide by the terms of each appropriate and applicabledomestic and international information-sharing agreement and to use relevant

information obtained under suchagreements in carrying out its riskmanagement program. The Commissionproposed §39.22 to codify the statutoryrequirement.

Proposed §39.22 would require aDCO to enter into certain information-sharing agreements and use relevantinformation obtained from those





248Section 5b(c)(2)(N) of the CEA, 7 U.S.C. 7a–1(c)(2)(N).

249See Section 5(d)(19) of the CEA, 7 U.S.C.7(d)(19) (DCM Core Principle 19).

250Section 5b(c)(2)(R) of the CEA, 7 U.S.C. 7a–1(c)(2)(R).

25112 U.S.C. 1818.252The Commission has already delegated

authority to the Director of the Division of Clearingand Risk to: (1) consolidate multiple swapsubmissions from one DCO or subdivide asubmission as appropriate for review under§ 39.5(b)(2); and request information from a DCO toassist the Commission’s review of a clearingrequirement that has been stayed under §39.5(d)(3).See 76 FR at 44474 (July 26, 2011) (Process forReview of Swaps for Mandatory Clearing; finalrule).

agreements in carrying out the riskmanagement program of the DCO.MGEX is opposed to sharingconfidential information such asproprietary intellectual property. MGEXalso asked for further clarity to be ableto comment further on this requirement.

The Commission is adopting §39.22as proposed. The provision purposely

lacks specific details to allow each DCOthe discretion to make its owndetermination as to which information-sharing agreements are necessary andappropriate, including taking intoaccount confidentiality concerns. DCOsmay seek further guidance fromCommission staff if they have specificquestions about existing or potentialinformation-sharing arrangements.

N. Core Principle N—Antitrust Considerations—§39.23

Core Principle N,248 as amended bythe Dodd-Frank Act, conforms thestandard for DCOs with the standardapplied to DCMs under Core Principle19.249 Proposed §39.23 would codifyCore Principle N. CME commented thatthe proposed regulation is adequate, andthe Commission is adopting the rule asproposed.

O. Core Principle R—Legal Risk—§ 39.27

Section 725(c) of the Dodd-Frank Actsets forth a new Core Principle R (LegalRisk).250 Core Principle R requires aDCO to have a well-founded,transparent, and enforceable legalframework for each aspect of the DCO’s

activities. Proposed §39.27 would setforth the required elements of such alegal framework. The Commissionsolicited comment as to the legal risksaddressed in proposed § 39.27 andwhether the rule should addressadditional legal risks.

CME commented that proposed§ 39.27(c)(1), which would require aDCO that provides clearing servicesoutside the United States to identify andaddress all conflict of law issues, shouldonly require a DCO to identify andaddress any ‘‘material’’ conflict of lawissues. The Commission agrees withCME that a DCO should not be

burdened to identify non-materialconflict of law issues and has revised§ 39.27(c)(1) to provide that such a DCOmust identify and address ‘‘any materialconflict of law issues.’’ The Commissionis otherwise adopting the rule asproposed.

P. Special Enforcement Authority for SIDCOs

Under Section 807(c) of the Dodd-Frank Act, for purposes of enforcing theprovisions of Title VIII, a SIDCO issubject to, and the Commission hasauthority under the provisions of subsections (b) through (n) of Section 8of, the Federal Deposit Insurance Act 251 in the same manner and to the sameextent as if the SIDCO were an insureddepository institution and theCommission were the appropriateFederal banking agency for such insureddepository institution. Proposed §39.31would codify this special authority. TheCommission did not receive anycomments on this provision.Nevertheless, as discussed above inconnection with the proposals relatingto SIDCO financial resources and systemsafeguards for SIDCOs, the Commissionis not finalizing the rules relating toSIDCOs at this time. The Commission

expects to consider all the proposalsrelating to SIDCOs together in thefuture.

V. Part 140 Amendments—Delegationsof Authority

Under §140.94, the Commissiondelegates the authority to performcertain functions that are reserved to theCommission to the Director of theDivision of Clearing and Risk. Inconnection with the regulations theCommission is adopting herein, as wellas previously adopted § 39.5, theCommission is amending § 140.94 todelegate authority to perform certainfunctions to the Director of the Divisionof Clearing and Risk, as discussed

below.With respect to DCO applications,

under §140.94(a)(6), the Commission isdelegating authority to determinewhether a DCO application is materiallycomplete under § 39.3(a)(2), and torequest that an applicant submitsupplemental information in order forthe Commission to process a DCOapplication under §39.3(a)(3).

In addition to the authority delegatedto the Director of the Division of Clearing and Risk in connection with

the Commission’s final rulemaking for§39.5,252 § 140.94(a)(7) delegatesauthority to request specific additional

information as part of a DCO’s swapsubmission under §39.5(b)(3)(ix).

Section 140.94(a)(8) delegatesauthority to grant an extension of timefor a DCO to file its annual compliancereport under §39.10(c)(4)(iv).

With respect to financial resourcesrequirements for DCOs, §140.94(a)(9)delegates authority to: (1) determine

whether a particular financial resourcemay be used to satisfy the requirementsof § 39.11(a)(1) under § 39.11(b)(1)(vi);(2) determine whether a particularfinancial resource may be used to satisfythe requirements of § 39.11(a)(2) under§ 39.11(b)(2)(ii); (3) review themethodology used to compute therequirements of §39.11(a)(1) and requirechanges as appropriate under§ 39.11(c)(1); (4) review themethodology used to compute therequirements of §39.11(a)(2) and requirechanges as appropriate under§ 39.11(c)(2); (5) request financialreporting from a DCO (in addition to thequarterly reports) under §39.11(f)(1);and (6) grant an extension of time for aDCO to file its quarterly financial reportunder § 39.11(f)(4).

Section 140.94(a)(10) delegatesauthority to request the periodicfinancial reports of a DCO’s clearingmembers that are not FCMs under§ 39.12(a)(5)(i)(B).

With respect to risk managementrequirements, § 140.94(a)(11) delegatesauthority to: (1) Review percentagelevels for customer initial marginrequirements and require differentpercentage levels if levels are deemed

insufficient under § 39.13(g)(8)(ii); (2)review methods, thresholds, andfinancial resources and require theapplication of different methods,thresholds, and financial resources asappropriate (relating to risk limits onclearing members) under§ 39.13(h)(1)(i)(C); (3) review theamount of additional initial marginrequired of a clearing member permittedto exceed its risk threshold and requirea different amount as appropriate under§ 39.13(h)(1)(ii); (4) review the selectionof accounts and methodology used indaily stress testing of large trader

positions and require changes asappropriate under § 39.13(h)(3)(i); (5)review methodology for weekly stresstesting of clearing member accounts andswap portfolios and require changes asappropriate under § 39.13(h)(3)(ii); and(6) request clearing member informationand documents regarding their riskmanagement policies, procedures, andpractices under §39.13(h)(5)(i)(A).

With respect to rule submissions and4d petitions relating to the comminglingof futures, options on futures, andcleared swaps in a cleared swaps





253See 76 FR at 3715–3716 (Jan. 20, 2011) (RiskManagement).

2547 U.S.C. 6(c). 2557 U.S.C. 19(a).

account or futures account, respectively,§ 140.94(a)(12) delegates authority torequest additional information insupport of a rule submission, under§ 39.15(b)(2)(iii)(A), and to requestadditional information in support of a4d petition, under §39.15(b)(2)(iii)(B).

With respect to DCO reportingrequirements, § 140.94(a)(13) delegates

authority to: (1) Grant an extension of time for filing of reports required to befiled annually under §39.19(c)(3)(iv); (2)request that a DCO file informationrelated to its business as a clearingorganization, including informationrelating to trade and clearing details,under §39.19(c)(5)(i); (3) request that aDCO file a written demonstration thatthe DCO is in compliance with one ormore core principles and relevant ruleprovisions under §39.19(c)(5)(ii); and(4) request that a DCO file, for eachclearing member, by customer origin,the end-of day positions for each

beneficial owner under §39.19(c)(5)(iii).Finally, § 140.94(a)(14) delegatesauthority to permit a DCO to refrainfrom publishing on its Web siteinformation that is otherwise required to

be published under §39.21(d).

VI. Effective Dates

For purposes of publication in theCode of Federal Regulations, all of therules adopted herein will have aneffective date of 60 days afterpublication in the Federal Register. TheCommission received a number of comments, however, that discussed aDCO’s need for time to develop

appropriate systems and procedures tocome into compliance with some of therules. The Commission is extending thedate by which DCOs must come intocompliance for certain rules as follows:

DCOs must comply with the followingrules 180 days after publication in theFederal Register: Financial resources—§ 39.11; participant and producteligibility—§ 39.12; risk management—§ 39.13 (except gross margin—§ 39.13(g)(8)(i)); and settlementprocedures—§39.14.

DCOs must comply with the followingrules 1 year after publication in the

Federal Register: chief complianceofficer—§ 39.10(c); gross margin—§ 39.13(g)(8)(i); system safeguards—§ 39.18; reporting—§39.19; andrecordkeeping—§39.20.

VII. Section 4(c)

Proposed §§ 39.15(b)(2)(i) and39.15(b)(2)(ii) would establishprocedures for permitting futures andoptions on futures to be carried in acleared swaps account (subject toSection 4d(f) of the CEA), and forcleared swaps to be carried in a futures

account (subject to Section 4d(a) of theCEA), respectively. In connection withproposing those rules, the Commissionproposed to grant an exemption underSection 4(c) of the CEA and requestedcomment on its proposed exemption.253

Section 4(c) of the CEA provides that,in order to promote responsibleeconomic or financial innovation and

fair competition, the Commission, byrule, regulation or order, after noticeand opportunity for hearing, mayexempt any agreement, contract, ortransaction, or class thereof, includingany person or class of persons offering,entering into, rendering advice orrendering other services with respect to,the agreement, contract, or transaction,from the contract market designationrequirement of Section 4(a) of the CEA,or any other provision of the CEA otherthan certain enumerated provisions, if the Commission determines that theexemption would be consistent with the

public interest.254

Proper treatment of customer fundsrequires, among other things,segregation of customer money,securities and property received tomargin, guarantee, or secure positions infutures or options on futures, in anaccount subject to Section 4d(a) of theCEA (i.e., a futures account), andsegregation of customer money,securities and property received tomargin, guarantee, or secure positions incleared swaps, in an account subject toSection 4d(f) of the CEA (i.e., a clearedswaps account). Customer fundsrequired to be held in a futures account

cannot be commingled with non-customer funds and cannot be held inan account other than an accountsubject to Section 4d(a), absentCommission approval in the form of arule, regulation or order. Section 4d(f) of the CEA mirrors these limitations asapplied to customer positions in clearedswaps.

Under the proposed exemption, aDCO and its clearing members would beexempt from complying with thesegregation requirements of Section4d(a) when holding customer segregatedfunds in a cleared swaps account

subject to Section 4d(f) of the CEA,instead of a futures account; andsimilarly, a DCO and its clearingmembers would be exempt fromcomplying with the segregationrequirements of Section 4d(f) whenholding customer funds related tocleared swap positions in a futuresaccount subject to Section 4d(a) of theCEA, instead of a cleared swaps

account. For the reasons discussed below, the Commission has determinedto grant the exemption under Section4(c) of the CEA.

In the notice of proposed rulemaking,the Commission expressed its view thatthe adoption of proposed§§ 39.15(b)(2)(i) and 39.15(b)(2)(ii)would promote responsible economic

and financial innovation and faircompetition, and would be consistentwith the ‘‘public interest,’’ as that termis used in Section 4(c) of the CEA.However, the Commission solicitedpublic comment on whether theproposed regulations would satisfy therequirements for exemption underSection 4(c) of the CEA.

The Commission received onecomment. CME supported theCommission’s conclusion, agreeing thatin appropriate circumstances, thecommingling of customer positions infutures, options on futures, and clearedswaps could achieve important benefitswith respect to greater capital efficiencyresulting from margin reductions forcorrelated positions. CME believes thatadoption of a regulation permitting suchcommingling would be consistent withthe public interest, adding that‘‘[h]aving positions in a single accountcan also enhance risk managementpractices and systemic risk containment

by allowing the customer’s portfolio to be handled in a coordinated fashion ina transfer or liquidation scenario.’’

In light of the foregoing, theCommission finds that permitting thecommingling of positions pursuant to

§§ 39.15(b)(2)(i) and 39.15(b)(2)(ii) willpromote responsible economic andfinancial innovation and faircompetition, and is consistent with the‘‘public interest,’’ as that term is used inSection 4(c) of the CEA.

VIII. Considerations of Costs andBenefits

Section 15(a) of the CEA requires theCommission to ‘‘consider the costs and

benefits’’ of its actions beforepromulgating a regulation.255 Inparticular, these costs and benefits must

be evaluated in light of five broad areas

of market and public concern: (1)Protection of market participants andthe public; (2) efficiency,competitiveness, and financial integrityof futures markets; (3) price discovery;(4) sound risk management practices;and (5) other public interestconsiderations. In conducting itsevaluation, the Commission may, in itsdiscretion, give greater weight to anyone of the five enumerated areas and itmay determine that, notwithstanding





256See, e.g., Fisherman’s Doc Co-op., Inc v.Brown, 75 F.3d 164 (4th Cir. 1996); Center for AutoSafety v. Peck, 751 F.2d 1336 (D.C. Cir. 1985)(noting that an agency has discretion to weighfactors in undertaking cost-benefit analysis).

Section 3 of the CEA states the purposes of the Act:It is the purpose of this Act to serve the publicinterests described in subsection (a) through asystem of effective self-regulation of tradingfacilities, clearing systems, market participants andmarket professionals under the oversight of theCommission. To foster these public interests, it isfurther the purpose of this Act to deter and preventprice manipulation or any other disruptions tomarket integrity; to ensure the financial integrity of all transactions subject to this Act and theavoidance of systemic risk; to protect all marketparticipants from fraudulent or other abusive salespractices and misuses of customer assets; and topromote responsible innovation and faircompetition among boards of trade, other marketsand market participants.

257See Letter from Better Markets dated June 3,2011; Letter from MFA dated March 21, 2011(comment file for 76 FR 3698 (Risk Management)).

costs, a particular rule is necessary toprotect the public interest or toeffectuate any of the provisions or toaccomplish any of the purposes of theCEA.256

In the following discussion, theCommission presents its considerationsof the costs and benefits of the finalrulemaking in light of the comments it

received, other relevant data andinformation, and the five broad areas of market and public concern as required

by section 15(a) of the CEA.

A. Background

A derivatives clearing organization(DCO) is an entity registered with theCommission through which derivativestransactions are cleared and settled. ADCO acts as a central counterparty,serving principally to ensureperformance of the contractualobligations of the original counterpartiesto derivatives transactions and to

manage and mitigate counterparty riskand systemic risk in the markets theyserve. This is accomplished byinterposing the DCO between thecounterparties so that the DCO becomesthe buyer to every seller and the sellerto every buyer. Upon novation by theoriginal parties to a transaction, thecontractual obligations of the originalparties to one another are extinguishedand replaced by a pair of equal andopposite transactions between the DCOand the counterparties or their agents.

The DCO’s role as centralcounterparty potentially exposes the

DCO itself to risk from every user whosetransactions are cleared through theDCO. Conversely, if a DCO itself fails orsuffers a risk of failure, theconsequences for the market at large arelikely to be serious and widespread.Effective risk management, therefore, iscritical to the functioning of amarketplace in which swaps are clearedthrough DCOs.

Clearing members are the entities thatdeal directly with DCOs. They may beacting on their own behalf or as agents.DCOs establish rules and riskmanagement requirements for theirclearing members, which typicallyinclude specified levels of financialresources, operational capacity, and riskmanagement capability; deposit of risk-

based initial margin and payment of daily variation margin sized to covercurrent and potential losses of themember; and contribution to a guarantyfund that can be used in the event of aclearing member default. Theserequirements lower systemic risk byreducing the likelihood of a clearingmember default and, in the event aclearing member default does occur,reducing the likelihood that it willresult in the default of other marketparticipants.

Additionally, unlike bilateralderivatives transactions where parties

do not know the exposures theircounterparties have to other marketparticipants, as a result of themultilateral nature of centralizedclearing, DCOs have a real-time, morecomplete picture of each clearingmember’s risk exposure to multipleparties. Thus the DCO can moreeffectively and quickly identifydeveloping risk exposures for individualclearing members and better managethese risks if clearing members becomedistressed.

B. General Comments and Considerations

The Dodd-Frank Act is intended tofacilitate stability in the financialsystem of the United States by reducingrisk, increasing transparency, andpromoting market integrity. Toaccomplish these objectives, amongother things, the Dodd-Frank Actprovides for the mandatory clearing of certain swaps by DCOs and explicitlyauthorizes the Commission topromulgate rules to establishappropriate standards for DCOs incarrying out their risk mitigationfunction. Regulatory standards for DCOswill serve to assure market participants

that credit and other risks associatedwith cleared swap transactions are beingappropriately managed by DCOs. This,in turn, can promote the use of clearedswaps. Regulatory standards also canfoster market confidence in the integrityof the derivatives clearing system.

In this final rulemaking, theCommission is adopting regulations toimplement 15 DCO core principles: A(Compliance), B (Financial Resources),C (Participant and Product Eligibility), D(Risk Management), E (SettlementProcedures), F (Treatment of Funds), G

(Default Rules and Procedures), H (RuleEnforcement), I (System Safeguards), J(Reporting), K (Recordkeeping), L(Public Information), M (InformationSharing), N (Antitrust Considerations),and R (Legal Risk). In addition, theCommission is adopting regulations toimplement the Chief Compliance Officerprovisions of Section 725 of the Dodd-

Frank Act, and to update the regulatoryframework for DCOs to reflect standardsand practices that have evolved over thepast decade since the enactment of theCFMA.

This rulemaking process hasgenerated an extensive record, which isdiscussed at length throughout thisnotice as it relates to the substantiveprovisions in the final rules. A numberof commenters expressed the view thatthere would be significant costsassociated with implementing andcomplying with proposed rules. TheCommission also received comments

from KCC, CME, and OCC who statedgenerally that the cost-benefit analysispresented in the proposed rulemakingswas insufficient. The Commission hascarefully considered alternativessuggested by commenters, and in anumber of instances, for reasonsdiscussed in detail above, has adoptedsuch alternatives or modifications to theproposed rules where, in theCommission’s judgment, the alternativeor modified standard accomplishes thesame regulatory objective in a morecost-effective manner.

The Commission invited comments

on the comprehensive or ‘‘systemic’’costs and benefits of the proposed rules.MFA and Better Markets addressed thisissue stating that the Commission’s cost-

benefit analyses presented in the noticesof proposed rulemaking may haveunderstated the benefits of the proposedrules.257 MFA commented that the coststo market participants would besubstantial if the Commission does notadopt the proposed regulations. BetterMarkets commented that the onlyreasonable way to consider costs and

benefits of any of the Commission’s ruleproposals under Dodd-Frank is to viewthem as a whole. According to BetterMarkets:

It is undeniable that the Proposed Rules areintended and designed to work as a system.Costing-out individual components of theProposed Rules inevitably double countscosts which are applicable to multipleindividual rules. It also prevents theconsideration of the full range of benefits thatarise from the system as a whole thatprovides for greater stability, reduces





systemic risk and protects taxpayers and thepublic treasury from future bailouts.

Better Markets believes that the benefits must include the avoided riskof a new financial crisis and the bestmeasure of this benefit is the cost of the2008 financial crisis, which is stillaccumulating. It cited Andrew G.Haldane, Executive Director, FinancialStability of the Bank of England, whoestimated that the worldwide cost of thecrisis in terms of lost output was

between $60 trillion and $200 trillion,depending primarily on the long termpersistence of the effects.

The Commission agrees with BetterMarkets that the DCO rules operate inan integrated, systemic manner toensure that the risks associated withcleared swap transactions are beingappropriately managed or addressed byDCOs. When implemented in theirentirety, these rules have the potentialto significantly change not only the

aggregate risk profile of the entirederivatives clearing industry, but alsothe allocation of risks among DCOs,clearing firms, and market participants.The final rules require DCOs to admitfirms as clearing members that maydiffer substantially from existingmembers with respect to size, riskprofiles, specializations, and riskmanagement abilities. The rules alsohelp create an environment in whichDCOs will compete for the business of clearing trades of different sizes, and of many different derivatives products—

both futures and swaps. In a potentially

much more diverse range of bothparticipants and products, these finalrules will allow, and in some casesrequire, DCOs to make use of a numberof risk management tools, including,among others, periodic valuation of financial resources; a potentially morerigorous design for margins; stresstesting and back testing for financialresources and margin, respectively; andadditional rules and proceduresdesigned to allow for management of events associated with a clearingmember defaulting on its obligations tothe DCO. These rules help reduce the

potential for DCO default, and thepotential follow-on effects on financialmarkets as a whole. In addition, thedaily, quarterly, annual, and event-specific reporting requirements forDCOs enhance the tools available to theCommission in conducting its financialrisk surveillance in connection withderivatives clearing by DCOs.

Certain of the regulationspromulgated in this final rulemakingmerely codify the requirements of theCEA, as amended by the Dodd-FrankAct, e.g., §§ 39.10(a) and (b) (compliance

with core principles); 39.17 (ruleenforcement); 39.22 (informationsharing); and 39.23 (antitrustconsiderations). For such provisions,the Commission has not consideredalternatives to the statute’s prescribedrequirements, even though a DCO mayincur costs to comply with theseprovisions. As these requirements are

imposed by the Dodd-Frank Act, anyassociated costs and benefits are theresult of statutory directives, aspreviously determined by the Congress,that govern DCO activities independentof the Commission’s regulations. By itsterms, CEA Section 15(a) requires theCommission to consider and evaluatethe prospective costs and benefits of regulations and orders of theCommission prior to their issuance; itdoes not require the Commission toevaluate the costs and benefits of theactions or mandates of the Congress.

In its notice of proposed rulemaking,

the Commission requested data or otherinformation in connection with its cost- benefit considerations. The Commissionreceived only a few commentsproviding quantitative information onthe costs of the proposed rules. Itreceived two comments on the benefitsof the proposed rules.

The Commission invited but did notreceive public comments specific to, orrelated to, its consideration of costs and

benefits for proposed §§1.3, 39.1, 39.2,39.4, 39.9, 39.16, 39.18, 39.20, 39.21,and 39.27. However, the Commissionreceived comments on substantiveprovisions of those proposed rules and

such comments are addressed above.The following discussion summarizes

the Commission’s consideration of thecosts and benefits of the final rulespursuant to CEA Section 15(a).

C. Form DCO—§ 39.3(a)(2)

Section 5b(c)(1) of the CEA providesthat ‘‘[a] person desiring to register as aderivatives clearing organization shallsubmit to the Commission anapplication in such form and containingsuch information as the Commissionmay require for the purpose of makingthe determinations required forapproval under paragraph (2).’’Paragraph (2), which sets forth the 18core principles applicable to DCOs,further provides in paragraph (i) that‘‘[t]o be registered and to maintainregistration as a derivatives clearingorganization, a derivatives clearingorganization shall comply with eachcore principle described in thisparagraph and any requirement that theCommission may impose by rule orregulation pursuant to section 8a(5) [of the CEA].’’ Accordingly, the standardfor approval of DCO registration is the

applicant’s ability to satisfy the DCOcore principles.

Proposed §39.3(a)(2) would requirethat any person seeking to register as aDCO submit a completed Form DCO,which would be provided as anappendix to part 39 of the Commission’sregulations. The Form DCO, composed

of a cover sheet and list of exhibits,would replace the general guidancecontained in Appendix A to Part 39,‘‘Application Guidance and ComplianceWith Core Principles’’ (Guidance),which was adopted by the Commissionin 2001. In accordance with Section5b(c) of the Act, the Form DCO isdesigned to elicit a demonstration thatan applicant can satisfy each of the DCOcore principles. Toward this end, theForm DCO requires submission of extensive information about anapplicant’s intended operations. Thisinformation has been required of

applicants under the previousGuidance, and the use of the Form DCOdoes not represent a departure insubstance from the Commission’spractices over the past decade.

Rather, as explained in the proposedrulemaking, the Form DCO wasdesigned to standardize and clarify theinformation that the Commission hasrequired from DCO applicants in thepast, in an effort to facilitate a morestreamlined and efficient applicationprocess. The Commission has learnedfrom experience that the generalguidance contained in the previous

Appendix A did not provide sufficientlyspecific instructions to applicants. As aresult, the registration process has beenprolonged in some cases because of theneed for Commission staff to provideapplicants with additional guidanceabout the nature of the information thatthe Commission requires to concludethat the applicant has demonstrated itsability to comply with the coreprinciples.

The Commission did not receivecomments specifically with respect toits cost-benefit analysis of proposed§ 39.3(a)(2) or to its Paperwork

Reduction Act estimate that the cost of preparing a completed applicationwould be $100,000. The Commissionnotes that applicants for DCOregistration will incur direct costsassociated with the preparation of thecompleted Form DCO. However,

because the Form DCO to a large extentcaptures information that has already

been required by the Commission underthe Guidance or, with respect to newcore principles, captures informationthat tracks the statutory





258Exhibits O, P, and Q, relating to therequirements of Core Principles O (GovernanceFitness Standards), P (Conflicts of Interest), and Q (Composition of Governing Boards), respectively.

259See discussion in Section III.C.1, above.

requirements,258 the use of the FormDCO will not impose greater costs thanhave been imposed in the past. In fact,

by providing greater clarity as to whatis expected from an applicant and byreducing the need for Commission staff to request, and the applicant to provide,supplementary information, the FormDCO should reduce costs for applicants.

As discussed in more detail in thisnotice of final rulemaking, theCommission received two commentletters that addressed the proposedForm DCO.259 The comments did notoppose the concept of the Form DCO.The comments were directed at the largeamount of information required and thenecessity of submitting certain specificinformation. One of the comment lettersfocused on the use of the Form DCO foramending an existing DCO registration,and the Commission has provided aclarification to address thatcommenter’s concerns. The Commission

has determined to adopt the final FormDCO largely as proposed, but it hasmodified several of the exhibits inresponse to specific comments.

The Commission has evaluated thecosts and benefits of the required use of Form DCO, under § 39.3(a)(2), in light of the specific considerations identified inSection 15(a) of the CEA as follows:

1. Protection of Market Participants andthe Public

Costs

Applicants currently incur costs indemonstrating compliance with the core

principles. As described above, basedon the staff’s experience in processingDCO applications over the last ten years,the Commission believes that use of theForm DCO will not increase, and oftenmay decrease, the time and expenseassociated with applying for registrationas a DCO for future applicants.

Benefits

The Commission expects that use of the Form DCO will promote theprotection of market participants andthe public. Given the critical role thatDCOs play in providing financialintegrity to the markets for which they

clear—which now include swaps aswell as futures markets—it is essentialthat the Commission conduct acomprehensive and thorough review of all DCO applications. Such review isessential for the protection of marketparticipants and the public insofar as itserves to limit the performance of DCO

functions to only those entities thathave provided adequate demonstrationthat they are capable of satisfying thecore principles.

2. Efficiency, Competitiveness, andFinancial Integrity

Costs

As noted, the Commission believesthat use of the Form DCO will notincrease, and often may decrease, thetime and expense associated withapplying for registration as a DCO forfuture applicants.

Benefits

The Commission expects that use of the Form DCO will promote efficiency,competitiveness, and financial integrity.As discussed above, the CEA requiresthat prospective DCO registrants submitan application and comply with the coreprinciples. In connection with theserequirements, in 2001, the Commission

adopted the Guidance to assistapplicants in preparing applicationmaterials. However, the Commission’sexperience with protracted reviews of draft applications and materiallyincomplete final submissions hasindicated a need for streamlining theapplication process.

By requiring the use of Form DCO, theCommission is promoting increasedefficiency by providing greater clarity toapplicants before they undertake theapplication process, thereby facilitatingthe submission of a materially completefinal application in the first instance.

This will also reduce the need forsubmission of supplemental materialsand consultation between applicantsand the Commission staff. The resultwill be more cost effective andexpeditious review and approval of applications. This will benefitapplicants as well as free Commissionstaff to handle other regulatory matters.

In addition, use of the Form DCOmakes available to the public theCommission’s informationalrequirements so that all prospectiveapplicants have a heightenedunderstanding of what is involved in

the preparation and processing of anapplication. It promotes greatertransparency in the process and willenhance competition among DCOs bymaking it easier for qualified applicantsto undertake and navigate theapplication process in a timely manner.

The Form DCO is designed to addressan applicant’s ability to comply with thecore principles. Compliance with thecore principles is essential to ensure thefinancial integrity of the derivativesclearing process and of derivativesmarkets, generally. In particular, the

required information in Form DCOExhibits B (financial resources), D (riskmanagement), E (settlementprocedures), F (treatment of funds), G(default rules and procedures) and I(system safeguards) elicits importantinformation supporting the applicant’sability to operate a financially soundclearing organization that can provide

reliable clearing and settlement servicesand appropriately manage the risksassociated with its role as a centralcounterparty.

3. Price Discovery

The Commission does not anticipatethat use of the Form DCO will impactthe price discovery process.

4. Sound Risk Management Practices

Costs

As noted, the Commission believesthat use of the Form DCO will notincrease, and often may decrease, the

time and expense associated withapplying for registration as a DCO forfuture applicants.

Benefits

The Commission expects that use of the Form DCO will promote sound riskmanagement practices. Use of the FormDCO will reinforce sound riskmanagement by requiring an applicantto examine its proposed riskmanagement program through thepreparation of a series of detailedexhibits. The submission of exhibitsrelating to risk management also make

it easier for Commission staff to analyzeand evaluate an applicant’s ability tocomply with Core Principle D (riskmanagement, which includesmonitoring and addressing creditexposure through margin requirementsand other risk control mechanisms).Sound risk management practices arerequired by the CEA and Commissionregulations, and are essential to theeffective functioning of a DCO.

5. Other Public Interest Considerations

Costs

As noted, the Commission believes

that use of the Form DCO will notincrease, and often may decrease, thetime and expense associated withapplying for registration as a DCO forfuture applicants.

Benefits

There are considerable benefits to thepublic in standardizing andstreamlining the DCO applicationprocess in terms of more efficient use of Commission resources and more cost-effective and transparent requirementsfor applicants. DCOs play a key role in





260The Commission believes that even in theabsence of this specific rule many DCOs wouldemploy well-qualified persons to perform theresponsibilities of the statutorily-required CCO. Insuch circumstances this rule would not result inany additional costs for a DCO.

261As noted in section IV.A.3, above, the rules donot require that the person designated as the CCO

hold that position, exclusively. A CCO may havedual responsibilities so long as the CCO caneffectively carry out his or her duties as the CCO.Accordingly, depending on the skills and background of the personnel within a particularDCO, a DCO may be able to use an existing staff member to perform the duties of the CCO.

262 In light of the variations that exist todayamong DCO compliance programs, including thequalifications of DCO compliance personnel, theCommission does not believe it is feasible toquantify the incremental costs associated with§ 39.10(c).

supporting the financial integrity of derivatives markets, and this role takeson even greater significance with theDodd-Frank requirements for swapsclearing. A coherent and comprehensiveapproach to DCO registration is neededto ensure that only qualified applicantswill be approved and that they arecapable of satisfying the requirements of

the core principles and Commissionregulations.

D. Chief Compliance Officer—§39.10(c)

Section 725(b) of the Dodd-Frank Actadded a new paragraph (i) to Section 5bof the CEA to require each DCO todesignate an individual as its CCO,responsible for the DCO’s compliancewith the CEA and Commissionregulations and the filing of an annualcompliance report.

The provisions regarding the CCO inproposed §39.10(c) would largelycodify Section 5b(i) of the CEA. Thereare certain provisions, however, thateffectuate or implement the statutoryrequirements. For example, theproposed rules would require that theCCO have the appropriate backgroundand skills for the position and not bedisqualified from registration underSections 8a(2) or 8a(3) of the CEA; meetwith the board of directors or the seniorofficer at least once a year to discuss theDCO’s compliance program; andperform duties including establishing acode of ethics. In addition, with respectto the annual report, the proposed ruleswould set forth certain contentrequirements (e.g., discussing areas for

compliance program improvement andlisting any material changes tocompliance policies and proceduressince the last annual report) andprocedural requirements (e.g.,submitting the annual report to the

board of directors or senior officer priorto submitting the report to theCommission, and submitting the annualreport not more than 90 days after theend of the DCO’s fiscal year unless theCommission grants an extension of time.)

As discussed in detail above, theCommission received a number of

comments that supported the proposedrules for CCOs and the annualcompliance report, and other commentsthat suggested alternatives orrefinements to the Commission’sproposed rules. Commenters did notprovide any quantitative data regardingthe costs to either DCOs or marketparticipants and the public. TheCommission addressed those commentsabove and, where appropriate, the finalrules reflect commenters’ suggestions.

One commenter, MGEX, expressedconcerns that relate to the Commission’s

implementation of the complianceframework established by Congress.MGEX stated that the regulationsregarding organizational structure andreporting lines seem ‘‘excessive and

beyond what was contemplated by thepassage of the Dodd-Frank Act.’’ It also

believes that the regulations do not‘‘guarantee improved market protection,

which is one of the main goals of theDodd-Frank Act.’’

The Commission does not agree withMGEX that the rules exceed what wascontemplated by Congress. To a greatextent the rules codify the relevantprovisions of the CEA, as amended, andit was Congress, not the Commission,that specified the complianceframework that the Commission is nowimplementing. The additionalrequirements set forth by the rules aredesigned to increase the CCO’seffectiveness and ensure that the annualreport is a useful compliance and

oversight tool.MGEX also commented that ‘‘the ruleswill impose a cost and burden on themarket that will be passed along to themarket participants which decreases theoverall efficiency and risk mitigation.’’MGEX did not provide any details tosupport its conclusion.

The Commission disagrees withMGEX that the Commission’s rules willimpose such a significant burden on themarket and market participants. Theprincipal costs of the CCO requirementresult from the statutory provisions of the CEA which, as amended by theDodd-Frank Act, requires each DCO to

designate a CCO and submit an annualcompliance report. Although theCommission’s rules would imposecertain additional costs in order toimplement this statutory requirement,these additional costs are not expectedto significantly increase costs to theDCO or market participants. Forexample, a DCO may incur higher coststo the extent that it needs to pay ahigher salary to a person who has thequalifications set forth in the rule toperform the statutory and regulatoryduties of the CCO.260 The Commission

believes that such costs are appropriate

because it has determined that a CCOshould have these qualifications to beeffective, and notes that the standardsare general enough to providereasonable discretion to the DCO in itsdesignation of a CCO.261 Similarly, a

DCO may have to incur higher costs interms of staff time to prepare an annualreport that contains the informationrequired by §39.10(c)(3), as opposed toa less comprehensive annual report.However, the Commission believes thatthe annual report must contain adequateinformation if it is to be useful to theDCO and the Commission. The

Commission does not anticipate thatthese costs of hiring a qualified CCO, orof preparing a more detailed annualreport, will be significantly higher thanthe costs to the DCO imposed by the

basic statutory requirements for theCCO.262

For purposes of the PaperworkReduction Act, the notice of proposedrulemaking estimated the cost of preparing the annual report to be $8000to $9000 per year. The Commissionreceived no comments on this estimate.The Commission received commentsthat the annual report should be more

limited than proposed. The Commissionnotes that those comments did notsuggest limiting the annual report toachieve a more favorable cost-benefitratio, and the Commission addressedthose comments above.

The Commission has evaluated thecosts and benefits of § 39.10(c) in lightof the specific considerations identifiedin Section 15(a) of the CEA as follows:


Costs

As discussed above, there are likely to be direct costs to DCOs in connectionwith designating a qualified CCO andannually preparing a comprehensivecompliance report. To the extent thatthe Commission’s regulations imposemore specific or supplementalrequirements when compared to thoserequirements explicitly imposed bySection 5b(i) of the CEA, thoseincremental costs are not likely to besignificant. While it is possible thatthose incremental costs will be passedalong to clearing members and marketparticipants in the form of increasedclearing fees, the size of thoseincremental costs, when spread across

recipients of clearing services, are likelyto be negligible.





263The Commission also proposed §39.29 whichwould apply certain stricter requirements toSIDCOs. As discussed above, the Commission is nottaking action on those proposed rules as part of thisfinal rulemaking.

264See discussion in Section IV.B, above.

Benefits

The Commission believes that theCCO rules will protect marketparticipants and the public bypromoting compliance with the coreprinciples and Commission regulationsthrough the designation and effectivefunctioning of the CCO, and theestablishment of a framework forpreparation of a meaningful annualreview of a DCO’s compliance program.While there may be incremental costsassociated with imposition of theCommission’s regulatory standards,those costs may be mitigated by thecountervailing benefits of an effectivecompliance program that fostersfinancial integrity of the clearingprocess and responsible riskmanagement practices to protect thepublic from the adverse consequencesthat would result from a DCO failure.

The annual compliance report, inparticular, will help the DCO and the

Commission to assess whether the DCOhas mechanisms in place to adequatelyaddress compliance issues and whetherthe DCO remains in compliance withthe core principles and theCommission’s regulations. Suchcompliance will protect marketparticipants and the public.


Costs

The Commission believes thatdesignation of a qualified CCO who willeffectively perform required duties,

including the preparation of an annualcompliance report, will not increasecosts and is likely to lead to reductionof costs, in terms of the efficiency,competitiveness, and financial integrityof the derivatives markets.

Benefits

Clearing is a critical component of theefficient, competitive, and financiallysound functioning of derivativesmarkets. The financial integrity of thesemarkets, in particular, is achievedthrough layers of protection.Requirements for an effective DCO

compliance program will add a newlayer of protection to ensure that theDCO remains compliant with the CEAand Commission regulations, especiallyrelating to Core Principles B (financialresources), D (risk management), E(settlement procedures), F (treatment of funds), G (default rules and procedures),I (system safeguards), and N (antitrustconsiderations).

An effective CCO will provide benefits to DCOs and the markets theyserve by implementing measures thatenhance the safety and efficiency of

DCOs and reduce systemic risk. Reliableand financially sound DCOs areessential for the stability of thederivatives markets they serve, and forthe greater public which benefits from asound financial system.

3. Price Discovery

The Commission does not anticipate

that §39.10(c) will impact the pricediscovery process.


Costs

The Commission does not believe thatthe CCO provisions will impose costs interms of sound risk managementpractices. To the contrary, theCommission perceives there to be

benefits that will result from its CCOimplementing regulations.

Benefits

The regulatory provisions that

interpret or implement the statutoryrequirements for the CCO and annualreport serve to enhance the standardsfor a DCO’s compliance program whichwill necessarily emphasize riskmanagement compliance because of itssignificance to the overall purpose andfunctioning of the DCO. Compliancewith Core Principle D (riskmanagement) and related regulationsencompasses, among other things,measurement and monitoring of creditexposures to clearing members,implementation of effective risk-basedmargin methodologies, and appropriatecalculation and back testing of margin

levels. It is the responsibility of the CCOto ensure that the DCO is compliantwith Core Principle D and theregulations thereunder, and is otherwiseengaged in appropriate risk managementactivities in accordance with the DCO’sown rules, policies and procedures.


The Commission does not believe thatthe rule will have a material effect onpublic interest considerations other thanthose identified above.

E. Financial Resources—§39.11

Section 5b(c)(2)(B) of the CEA, CorePrinciple B, as amended by the Dodd-Frank Act, requires a DCO to possessfinancial resources that, at a minimum,exceed the total amount that wouldenable the DCO to meet its financialobligations to its clearing membersnotwithstanding a default by theclearing member creating the largestfinancial exposure for the DCO inextreme but plausible marketconditions, and to cover its operatingcosts for a period of one year, calculatedon a rolling basis.

Proposed §39.11 would codify theserequirements and set forth additionalstandards for the types of financialresources that are acceptable(§ 39.11(b)); computation of the amountof financial resources required to satisfythe statutory default and operationalresources requirements (§39.11(c));valuation of financial resources

(§ 39.11(d)); liquidity of financialresources (§39.11(e)); and quarterlyreporting of financial resources(§ 39.11(f)).263

As discussed in more detail above, theCommission received comment lettersrequesting further clarity as to theproposed requirements. TheCommission also received commentletters that discussed how the proposedrules might impose costs or burdens onDCOs.264 Two commenters objected tothe requirement that DCOs mustmonitor ‘‘on a continual basis’’ aclearing member’s ability to meet

potential assessments, which one of thecommenters characterized as ‘‘overly burdensome and difficult toadminister.’’ Regarding the proposedrestrictions on the use of assessmentpowers, another commenter stated thatthe inclusion of assessment powers as afinancial resource is necessary for it tomeet its obligations in the event of adefault. Two commenters recommendedthat the Commission permit letters of credit to be considered in the financialresources computation. Finally, severalDCOs urged the Commission to allowU.S. Treasuries, in addition to cash, asa financial resource sufficient to meet

the proposed financial resourceliquidity requirement.

As discussed above, in proposing thata DCO ‘‘monitor, on a continual basis,the financial and operational capacity of its clearing members to meet potentialassessments,’’ the Commission did notintend to require real-time monitoring of clearing members. Rather, the purposeof the provision was to require a DCOto monitor often enough to enable it to

become aware of any potential problemsin a timely manner. The Commissionhas modified §39.11(d)(2)(ii) to removethe ‘‘continual basis’’ standard, leaving

the DCO to exercise its discretion indetermining the appropriate frequencyof periodic reviews or more frequentreviews as circumstances warrant inconnection with particular clearingmembers.

The Commission is permitting DCOsto include potential clearing member





265Commenters did not provide the Commissionwith quantitative data regarding such costs.

assessments in calculating defaultfinancial resources, as proposed, subjectto the limitations of §39.11(d)(2)(iii) (30percent haircut) and § 39.11(d)(2)(iv)(DCO may count the value of assessments, after the haircut, to meetup to 20 percent of its default resourcesrequirement). The comments on thisproposal were varied. Some commenters

stated that the Commission hadproposed an appropriate, balancedapproach; others stated that thelimitations on assessments were toostrict; and still others stated that theCommission should not permitassessments to count at all.

It is the Commission’s view that, inlight of recent market events and as ageneral matter, it is not prudent topermit a DCO to rely on letters of credit.However, for the reasons discussedabove, the Commission would considerpermitting letters of credit to beincluded as a DCO financial resource on

a very limited case-by-case basis.Finally, the Commission is revising

§ 39.11(e)(1) so that, in addition to cash,a DCO may use U.S. Treasuryobligations and high quality, liquid,general obligations of a sovereign nationto satisfy financial resource liquidityrequirements. This revised standardreflects the current practices of U.S. andforeign-based DCOs.

The Commission has evaluated thecosts and benefits of § 39.11 in light of the specific considerations identified inSection 15(a) of the CEA as follows:


Costs

The regulations require DCOs to takespecific actions to ensure that they areable to meet the statutory requirementsfor covering default and operatingexpenses. These actions includemonthly stress testing to calculate whatthose financial obligations are, andquarterly reporting to the Commissionto demonstrate the adequacy of financialresources in terms of dollar amount andliquidity. DCOs will incur direct costs

related to staffing and technologyprogramming to calculate, monitor, andreport financial resources.

Existing DCOs will have alreadyimplemented certain practices andsystems for tracking and managingfinancial resources in order to complywith Core Principle B, as originallyenacted in 2000. Given the staffing andoperational differences among DCOs,the Commission is unable to accuratelyestimate or quantify the additional costsDCOs may incur to comply with the

new financial resource rules.265 Moreover, the cost-effects of newcleared products and new marketparticipants clearing those products aretoo speculative and uncertain for theCommission to be able to quantify orestimate at this time. Such costs or

benefits will depend upon a number of variables that are not estimable orquantifiable at this time, such as thenature and number of the new productsthat become subject to clearing, thenature and number of marketparticipants that enter into transactionsinvolving such products, and theresulting costs or benefits to suchmarket participants from the clearing of such products.

As to costs associated withrestrictions the Commission is imposingon the types and valuation of financialresources that may be counted asfinancial resources for purposes of

satisfying Core Principle B, those toowill vary among DCOs. For example, forDCOs that do not include potentialclearing member assessments in theircalculations of financial resources, thelimitations on assessments will notresult in increased costs. For DCOs thatto any extent rely on potentialassessments, the new limitations mightrequire revisions to their defaultmanagement plans, an increase inguaranty fund requirements, or aninfusion of additional capital. The samewould apply to letters of credit thatcannot be considered to be financial

resources for purposes of complyingwith Core Principle B, absent relief.Again, because of the range of circumstances of different DCOs, it isnot feasible to estimate or quantify thecosts of the safeguards imposed by theCommission’s financial resource rules.

Benefits

The financial resource rules establishuniform standards that further the goalsof avoiding market disruptions andfinancial losses to market participantsand the general public, and avoidingsystemic problems that could arise froma DCO’s failure to maintain adequatedefault or operating resources. While itis not possible to estimate or quantifythe benefits to market participants andthe public in facilitating the financialsoundness of a DCO, the Commission

believes that a DCO failure, regardless of the size of the DCO, could adverselyaffect the financial markets, marketparticipants, and the public.


Costs

As discussed in connection withfactor 1 above, quantification orestimation of these costs and benefits isnot readily feasible. For some DCOs, thefinancial resource rules will have little

or no direct or indirect impact. Forothers, the impact may be moresubstantial. Although there may bedisparate impact among DCOs, overallthe rules are not expected to imposesignificant costs in terms of efficiency,competitiveness, or financial integrity of derivatives markets.

Benefits

The regulations promote financialstrength and stability, thereby fosteringefficiency and a greater ability tocompete in the broader financialmarkets. The regulations promotecompetition by preventing DCOs that

lack adequate financial safeguards fromexpanding in ways that may ultimatelyharm the broader financial market. Theregulations promote efficiency insofar asDCOs that operate with adequatefinancial resources are less likely to fail.The regulations are designed to ensurethat DCOs can meet their financialobligations to market participants, thuscontributing to the financial integrity of the derivatives markets as a whole.

As highlighted by recent events in theglobal financial markets, maintainingsufficient financial resources is a criticalaspect of any financial entity’s risk

management system, and ultimatelycontributes to the goal of stability in the broader financial markets. Therefore,the Commission believes it is prudent toinclude financial resourcesrequirements for entities applying to

become or operating as DCOs. Finally,Congress has determined that a DCOmust comply with Core Principle B toachieve the purposes of the CEA and theCommission has determined that § 39.11sets forth the minimum standards for aDCO to do so.

3. Price Discovery

The Commission does not believe thatthis rule will have a material effect onprice discovery.


Costs

Adequate financial resources are acorollary to strong risk management. Tothe extent that the financial resourcerules result in additional costs, thesecosts are associated with implementingthe practices and procedures that arenecessary to ensure a DCO has adequatefinancial resources.





Benefits

The regulations, by setting specificstandards with respect to how DCOsshould assess, monitor, and report theadequacy of their financial resources,contribute to DCOs’ maintenance of sound risk management practices andfurther the goal of minimizing systemicrisk. The reporting requirements, inparticular, will enable the Commissionto conduct more thorough andmeaningful oversight of DCOs that willcontribute to improved riskmanagement by DCOs overall.


Costs

The Commission has not identifiedany public interest considerations thatwould be negatively affected by theprovisions of the financial resourcerules that effectuate or implement thestatutory requirements of Core PrincipleB (financial resources).

Benefits

The benefits to the public of a DCOmaintaining adequate financialresources are discussed above.

F. Participant and Product Eligibility—§ 39.12

Participant Eligibility

Section 5b(c)(2)(C) of the CEA, CorePrinciple C, as amended by the Dodd-Frank Act, requires each DCO toestablish appropriate admission andcontinuing eligibility standards formembers of, and participants in, the

DCO, including sufficient financialresources and operational capacity tomeet the obligations arising fromparticipation. Core Principle C furtherrequires that such participation andmembership requirements be objective,

be publicly disclosed, and permit fairand open access. Core Principle C alsorequires that each DCO establish andimplement procedures to verifycompliance with each participation andmembership requirement, on an ongoing

basis.As discussed above, the Commission

crafted the provisions of proposed

§ 39.12(a) and related rules to establisha regulatory framework thataccomplishes two goals: (1) to providefor fair and open access, while (2)limiting risk to the DCO and its clearingmembers. The provisions in§ 39.12(a)(1) provide for fair and openaccess in a number of ways. A DCO isprohibited from adopting restrictiveclearing member standards if lessrestrictive requirements that would notmaterially increase risk to the DCO orclearing members could be adopted(§ 39.12(a)(1)(i)); a DCO must allow all

market participants who satisfyparticipation requirements to becomeclearing members (§ 39.12(a)(1)(ii)); thestandards must be non-discriminatory(§ 39.12(a)(1)(iii)); and they may notrequire clearing members to be swapdealers (§39.12(a)(1)(iv)), or clearingmembers to maintain a swap portfolio of any particular size or meet a swap

transaction volume threshold(§ 39.12(a)(1)(v)).

Section 39.12(a)(2) facilitates greaterparticipation by requiring that capitalrequirements for clearing members be

based on objective, transparent, andcommonly accepted standards thatappropriately match capital to risk(§ 39.12(a)(2)(i)); and by setting theminimum capital requirement at notmore than $50 million (§39.12(a)(2)(ii)).

A number of commenters supportedthe proposed rules. They asserted thatincreased access to clearing wouldstimulate competition and diversifyrisk. A number of other commentersopposed aspects of the proposed rules,particularly the $50 million capitalstandard. They argued that theseprovisions could increase risk byproviding access to firms withinsufficient financial resources oroperational capacity.

The Commission did not receive anycomments that quantified the costsassociated with the proposedparticipation rules. Instead, commentersfocused on qualitative considerations,including how the proposed ruleswould affect market participants, marketrisk, efficiency, competitiveness, the

financial integrity of futures markets,and price discovery.

The Commission is adopting theseprovisions essentially as proposed.

The Commission has evaluated thecosts and benefits of the proposedregulations in light of the specificconsiderations identified in Section15(a) of the CEA, as follows:


Costs

The participant eligibility rules mayresult in costs beyond those incurred in

the normal course of operating a DCO orclearing firm, but such potential costsare, at this time, speculative in natureand impossible to estimate or quantify.By providing access to clearing toadditional firms, the rules could imposecosts on DCOs, other clearing members,or customers if a firm admitted toclearing membership in a DCO pursuantto these rules failed to meet itsobligations. Any such costs dependupon a number of factors that are notpresently knowable, quantifiable, orestimable.

It is not possible to estimate orquantify these costs in a reliable way fora number of reasons. The historicalrecord prior to the enactment of theDodd-Frank Act with respect to theoperation of clearing organizationsprovides little guidance as to the coststhat may be incurred in the future in theunlikely event of a default at a DCO.

Defaults at DCOs are very rare and thecircumstances of each one are unique.Moreover, the Dodd-Frank Act andimplementing regulations will alter thelandscape significantly. Existing DCOsand FCMs will be clearing newproducts. New DCOs and FCMs willenter the market. Mandatory clearingwill bring new products andparticipants to DCOs and FCMs. Theinteraction of all these factors creates awide range of uncertainty as to thenature of the potential consequences of a default under the new regulatoryregime. In sum, the Commission

believes that the possible futurecircumstances leading to and potentialresulting consequences of a DCO defaultare too speculative and uncertain to beable to quantify or estimate the resultingcosts to DCOs, clearing members, ormarket participants with any precisionor degree of magnitude.

Whatever these potential costs, theCommission believes that theparticipant eligibility rules will reducethe risk that clearing members will infact incur such costs. First, increasedaccess to clearing membership shouldreduce concentration at any one clearingmember and diversify risk. Second, the

rules contain risk managementprovisions specifically designed tominimize the likelihood and extent of defaults. The provisions in § 39.12(a)(2)set forth requirements that mandateDCOs: Require that all clearing membershave sufficient financial resources tomeet obligations arising fromparticipation in the DCO(§ 39.12(a)(2)(i)); establish capitalrequirements that are scalable so thatthey are proportional to the risks posed

by clearing members (§39.12(a)(2)(ii));require that clearing members haveadequate operational capacity to meet

obligations arising from participation inthe DCO (§39.12(a)(3)); verify thecompliance of each clearing memberwith the requirements of the DCO(§ 39.12(a)(4)); satisfy certain reportingrequirements (§39.12(a)(5)); and havethe ability to enforce participationrequirements (§ 39.12(a)(6)).

For reasons similar to those describedabove, it is also not feasible to quantifyor estimate this reduction in costs withany confidence. Based on its judgmentand experience with the regulation andoperation of clearing organizations, the





266Proposed §39.12(b)(7) will be addressed in aseparate rulemaking.

Commission believes that these ruleswill lower the risk that clearingmembers will in fact incur such costs.However, the possible futurecircumstances leading to and potentialresulting consequences of a futuredefault are too speculative anduncertain to quantify or estimate, eitherunder the current regulatory regime or

under the rules being adopted by theCommission.

Benefits

Greater access to clearing should benefit market participants byincreasing competition among clearingmembers. Allowing more firms to clearshould increase competition amongclearing firms on both price and servicewhich should, in turn, reduce costs tomarket participants. Further, thesafeguards in § 39.12(a)(2) will benefitDCOs, clearing members, and marketparticipants by reducing risk.

Reductions in risk also benefit thegeneral public by decreasing theprobability of a systemic failure.

For the reasons described above inconnection with costs, it is alsoimpractical to quantify or estimate these

benefits associated with reductions inrisk to clearing members, marketparticipants, and the public.


Costs

The considerations under this factorare very similar to the considerations

under the previous factor with respectto participant eligibility requirements.Quantification or estimation of thesecosts and benefits is not feasible for thereasons set forth under the first factor.The potential increase in risk of defaultresulting from open access is mitigated

by the decrease in risk resulting fromdiversification of risk, increasedcompetition, and the safeguards setforth in § 39.12(a)(2).

Benefits

By opening access the rules shouldincrease competition among clearing

members thereby resulting in increasedefficiency in the provision of clearingservices. The safeguards in the rulessuch as the requirement that DCOsimpose risk limits on clearing memberswill enhance the financial integrity of the DCO and its clearing members.

3. Price Discovery

Costs

The Commission has not identifiedany way in which the rules will impairprice discovery.

Benefits

Increased competition among clearingmembers could bring more participantsinto the markets which could result inmore competitive pricing and enhancedprice discovery.


CostsAccording to some commenters, the

open access rules could hinder soundrisk management practices by admittingclearing members unable to participatein the default management process.Other commenters assert that the rulesprovide appropriate protections andwill facilitate sound risk managementpractices. The Commission believes thatthe open access rules, when coupledwith the default management rulesdiscussed below, will not impair soundrisk management practices. Under therules, clearing members will be required

to demonstrate that they haveoperational capacity to carry out theirresponsibilities as well as sufficientfinancial resources to meet theirobligations.

Benefits

As explained above, the provisions in§ 39.12(a)(2) require that DCOs establisha risk management framework withrespect to their members. In addition,open access should lead todiversification of risk at DCOs and allowadditional firms to assist in theresolution of any defaults.


Costs

The Commission has not identifiedany other public interest considerationsthat would be negatively affected by thepotential costs of the eligibilityrequirements.

Benefits

The CEA, as amended by the Dodd-Frank Act, requires DCOs to allow foropen access and, therefore, broaderparticipation. The Commission believes

that greater participation in clearingcould increase liquidity in the markets.This could help prevent pricemanipulation or other anti-competitivepractices because it will be harder toorganize concerted efforts to achievesuch ends. Finally, Congress hasdetermined that a DCO must complywith Core Principle C to achieve thepurposes of the CEA and theCommission has determined that§ 39.12(a) sets forth the minimumstandards for a DCO to comply with theCEA’s participation requirements.

Product Eligibility

Core Principle C also requires a DCOto establish ‘‘appropriate standards fordetermining the eligibility of agreements, contracts, or transactionssubmitted to the [DCO] for clearing.’’Section 39.12(b) implements thisprovision.

Proposed §39.12(b)(1) would requirea DCO to establish requirements fordetermining product eligibility takinginto account the DCO’s ability tomanage risks associated with theproduct. Proposed §§39.12(b)(2) and(b)(3) would codify section 2(h)(1)(B) of the CEA. Proposed § 39.12(b)(4) wouldprohibit a DCO from requiring anexecuting party to be a clearing memberin order for the product to be eligible forclearing. Proposed § 39.12(b)(5) wouldrequire a DCO to select contract unitsfor clearing purposes that maximizeliquidity, facilitate transparency,promote open access, and allow for

effective risk management. Proposed§ 39.12(b)(6) would require novationupon acceptance of a swap. Finally,proposed §39.12(b)(8) would require aDCO to confirm the terms of a swap atthe time the swap is accepted forclearing.266

The Commission did not receive anycomments directly addressing cost-

benefit considerations. The Commissiondid receive several comments onsubstantive provisions that bear onthose considerations. One commentersuggested that §39.12(b)(4) may be animpediment to the development of new

DCOs. Several commenters suggestedthat it would be impractical orinappropriate for a DCO to establishunit sizes for clearing that differ fromthe unit size at execution (§ 39.12(b)(5)).

The Commission also received severalcomments requesting clarification of certain provisions. As discussed above,the Commission has made changes tothese rules that are responsive to thecomments.

The Commission is adopting§ 39.12(b) largely as proposed withseveral clarifying amendments asdiscussed above.

The Commission has evaluated thecosts and benefits of § 39.12(b) in lightof the specific considerations identifiedin Section 15(a) of the CEA, as follows:


Costs

The Commission has not identifiedany new costs arising out of §§ 39.12(b)(1), 39.12(b)(6), or





267Section 5b(c)(2)(D) of the CEA; 7 U.S.C. 7a–1(c)(2)(D).

39.12(b)(8). DCOs currently perform riskanalysis before accepting new productsfor clearing, currently novate tradesupon acceptance, and currently issueconfirmations to clearing members.

As noted, one commenter suggestedthat prohibiting a DCO from requiringone of the original executing parties to

be a clearing member in order for a

contract to be eligible for clearing may be an impediment to the development of new DCOs. The Commission believesthat, to the contrary, such restrictions onproduct eligibility for clearing increaseoverall costs for market participants,and that prohibiting such restrictionswill lead to lower overall costs. Suchrestrictions deny the availability and

benefits of clearing to non-clearingmembers. Open access will enable non-clearing members to obtain the benefitsof clearing and increase competition inclearing and trading, thereby increasingliquidity, and reducing costs.

The commenters who questioned theunit size provision did not elaborate onthe costs. It is not feasible to quantifythese costs for a number of reasons. Therule provides DCOs with significantflexibility in selecting unit sizes.Different DCOs may select differentsizes for the same or similar products.Numerous SEFs will also be makingjudgments concerning unit size whichwill influence the decisions of DCOsand traders. Some products will besubject to mandatory clearing and othersto voluntary clearing. The unpredictableinteraction of these variables creates awide range of uncertainty as to the

nature of the consequences of theselection of unit sizes by DCOs. Similarconsiderations apply to the otherprovisions of §39.12(b). In sum, theCommission believes that the possiblefuture circumstances leading to, and thepotential resulting consequences of, theimplementation of §39.12(b) are toospeculative and uncertain to be able toquantify or estimate resulting costs withany precision or degree of magnitude.

Benefits

The Commission believes that§ 39.12(b) will protect market

participants and the public in manyways. First, these provisions are likelyto facilitate the standardization of swaps, thereby eliminating differences

between the terms of a swap as clearedat the DCO level and as carried at thecustomer level. Any such outstandingdifferences would raise both customerprotection and systemic risk concerns.From a customer protection standpoint,if the terms of the swap at the customerlevel differ from those at the clearinglevel, then the customer still has a

bilateral position opposite its

counterparty. The customer is stillexposed to the credit risk of thecounterparty and the position would not

be able to be offset against otherpositions at the DCO. Similarly, from asystemic perspective, any differences interms between the trades wouldeliminate the possibility of multilateraloffset and thereby diminish liquidity.

Second, §39.12(b) can promoteliquidity by permitting more parties totrade the product and by permittingmore clearing members to clear theproduct. Third, it can enhance riskmanagement by enabling a DCO, in theevent of a default, to have morepotential counterparties for liquidation.

Fourth, these provisions will supportthe requirement in section 2(h)(1)(B) of the CEA and proposed §39.12(b)(2) thata DCO must adopt rules providing thatall swaps with the same terms andconditions submitted to the DCO areeconomically equivalent within theDCO and may be offset with each other.

Fifth, clearing will eliminate the needfor a counterparty to ascertain thecredit-worthiness of each of itscounterparties. This will promoteliquidity, competition, and financialintegrity to the benefit of all marketparticipants.


Costs

The Commission has not identifiedany ways in which the proposals wouldreduce efficiency, competitiveness, orfinancial integrity.

Benefits

The rules should increaseparticipation by clearing members,which should increase competitionamong clearing members to provideservices to customers. In addition, therules will lead to standardization of products. Finally, the rules will allowfor more clearing through novation,which should result in increased open

interest and liquidity. In turn, thisshould lead to more competitive andefficient markets. As noted above,smaller units can promote liquidity andencourage prospective clearing membersto bid on positions and enable them toaccept a forced allocation in the eventof a clearing member’s default. Thisfacilitates open access, and at same timepromotes risk management by enablinga DCO, in the event of a default, to beable to rely on more potentialcounterparties for liquidation.

3. Price Discovery

Costs

The Commission has not identifiedany ways in which the rules wouldreduce price discovery.

Benefits

As discussed above, the rules will

increase competition, which shouldenhance price discovery by bringingmore participants into the markets. Inaddition, standardization means thatprices observed on different trades aremore directly comparable, which canimprove price discovery.


Costs

The Commission has not identifiedany ways in which the rules wouldimpair sound risk managementpractices.

Benefits

The rules require DCOs to establishappropriate standards for determiningthe eligibility of contracts submitted tothe DCO for clearing taking into accountthe DCO’s ability to manage risksassociated with the product. Suchstandards are a sound risk managementpractice.


Costs

The Commission has not identifiedany ways in which the rules wouldharm any other public interest

considerations.Benefits

As discussed above, open access,increased competition, greater liquidity,improved price discovery, and greaterfinancial integrity are all benefits of therules. All these factors will benefit thegeneral public, which may notparticipate in these markets directly butmay feel their impact on the largereconomy.

G. Risk Management—§ 39.13

In General

Core Principle D,267

as amended bythe Dodd-Frank Act, requires each DCOto ensure that it possesses the ability tomanage the risks associated withdischarging the responsibilities of theDCO through the use of appropriatetools and procedures. It further requireseach DCO to measure its creditexposures to each clearing member notless than once during each business dayand to monitor each such exposure





268The Commission notes that ‘‘[t]he existence of significant outstanding notional exposures, tradingliquidity, and adequate pricing data’’ is one of thefactors the Commission must consider in reviewingwhether a swap or group or class of swaps is subjectto the mandatory clearing requirement in CEASection 2(h)(1). See Section 2(h)(2)(D) of the CEA.To enable the Commission to make thisdetermination, the Commission requires DCOs that

periodically during the business day.Core Principle D also requires each DCOto limit its exposure to potential lossesfrom defaults by clearing members,through margin requirements and otherrisk control mechanisms, to ensure thatits operations would not be disruptedand that non-defaulting clearingmembers would not be exposed to

losses that non-defaulting clearingmembers cannot anticipate or control.Finally, Core Principle D provides thata DCO must require margin from eachclearing member sufficient to coverpotential exposures in normal marketconditions and that each model andparameter used in setting such marginrequirements must be risk-based andreviewed on a regular basis.

The Commission proposed § 39.13 toestablish requirements that a DCOwould have to meet in order to complywith Core Principle D. For a number of provisions of proposed § 39.13, the

Commission did not receive anycomments on the associated costs or oncost-benefit analysis. The Commissiondiscussed in the notice of proposedrulemaking and above why it believes aDCO must satisfy each of thoseprovisions to be in compliance with theCore Principle D and why it isappropriate for market participants toincur any costs associated withimplementing each of those provisions.The Commission also addressedcomments that suggested alternativestandards, frameworks, or procedures.Where appropriate, the Commissionrevised the proposed rules. To avoid

repetition, the Commission incorporates by reference the above discussion of § 39.13.

Commenters raised concerns aboutthe costs of §§ 39.13(g)(2)(ii) (minimumliquidation time), 39.13(g)(2)(iii)(margin confidence level), 39.13(g)(8)(i)(gross margin), 39.13(h)(1)(i) (risklimits), 39.13(h)(2) (large trader reports),and 39.13(h)(5)(ii) (clearing member riskreview) or the Commission’s cost-

benefit analysis relating to these rules.The Commission’s consideration of thecosts and benefits associated with theserules is discussed in greater detail

below.Minimum Liquidation Time

As proposed, § 39.13(g)(2)(ii) wouldrequire a DCO to use a liquidation timethat is a minimum of five business daysfor cleared swaps that are not executedon a DCM, and a liquidation time thatis a minimum of one business day forall other products that it clears,although it would be required to uselonger liquidation times, if appropriate,

based on the unique characteristics of particular products or portfolios.

Numerous commenters objected to theproposed difference in requirementsthat would subject swaps that wereeither executed bilaterally or executedon a SEF to a minimum five-dayliquidation time, while permittingequivalent swaps that were executed ona DCM to be subject to a minimum one-day liquidation time. The Commission

did not receive any comments thatquantified the costs of this rule.

As to the actual periods proposed,commenters variously contended that aliquidation time of five business daysmay be excessive for some swaps, a one-day liquidation period is too short, aone-day liquidation period isappropriate for swaps executed on aDCM or a SEF, and a two-dayliquidation period is appropriate forcleared swaps.

Some commenters encouraged theCommission to permit a DCO todetermine the appropriate liquidation

time for all products that it clears basedon the unique characteristics andliquidity of each relevant product orportfolio. Two commentersrecommended that if the Commissionwere to mandate minimum liquidationtimes in the final rules, it should allowDCOs to apply for exemptions forspecific groups of swaps if marketconditions prove that such minimumliquidation times are excessive.

Upon consideration of the comments,the Commission is adopting§ 39.13(g)(2)(ii) with a number of modifications. First, the final rule

requires a DCO to use the sameliquidation time for a product whetherit is executed on a DCM, a SEF, or

bilaterally. Second, the final ruleprovides that the minimum liquidationtime for swaps based on certain physicalcommodities, i.e., agriculturalcommodities, energy, and metals, aswell as futures and options, is one day.For all other swaps, the minimumliquidation time is five days. Third, toprovide further flexibility, theCommission is adding a provisionspecifying that, by order, theCommission may provide for a differentminimum liquidation time for particular

products or portfolios.The Commission has evaluated the

costs and benefits of the proposedregulations in light of the specificconsiderations identified in Section15(a) of the CEA, as follows:


Costs

The Commission anticipates thatusing only one criterion—i.e., thecharacteristic of the commodity

underlying a swap—to determineliquidation time could result in less-than-optimal margin calculations. Forsome products, a five-day minimummay prove to be excessive and tie upmore funds than are strictly necessaryfor risk management purposes. For otherproducts, a one-day or even a five-dayperiod may be insufficient and expose a

DCO and market participants toadditional risk.

The Commission believes that it is notfeasible to estimate or quantify thesecosts reliably. In addition to theliquidation time frame, the marginrequirements for a particular instrumentdepend upon a variety of characteristicsof the instrument and the markets inwhich it is traded, including the riskcharacteristics of the instrument, itshistorical price volatility, and liquidityin the relevant market. Determiningsuch margin requirements does notsolely depend upon such quantitative

factors, but also requires expertjudgment as to the extent to which suchcharacteristics and data may be anaccurate predictor of future market

behavior with respect to suchinstruments, and applying suchjudgment to the quantitative results.Thousands of different swap productsmay be subject to clearing. Determiningthe risk characteristics, price volatility,and market liquidity of even a samplefor purposes of determining aliquidation time specifically for suchinstrument would be a formidable taskfor the Commission to undertake and

any results would be subject to a rangeof uncertainty. Reliable data is notreadily available for many swaps thatprior to the Dodd-Frank Act wereexecuted in unregulated markets.

Given the amount of uncertainty inestimating margin requirements usingeither a five-day liquidation time or aone-day liquidation time, the amount of uncertainty in estimating the cost of using one rather than the other iscompounded. For all the reasons statedin the previous paragraph, the possiblerange within which the size of thedifference would fall is very large. Insum, in the absence of a reasonably

feasible and reliable methodology at thepresent time for the Commission to usein calculating the appropriate marginrequirements for swaps with either five-day or one-day liquidation times,268 the





submit swaps to the Commission for a mandatoryclearing determination to submit data and otherinformation that would enable the Commission toeffectively consider this factor. See§ 39.5(b)(3)(ii)(A), 76 FR at 44473 (July 26, 2011)(Process for Review of Swaps for MandatoryClearing; final rule). Not only is this type of information needed for the Commission to considerthe statutory factors and make the determinationsas to which swaps should be subject to mandatoryclearing, but it also would be needed to calculateappropriate margin amounts for such swaps, werethe Commission to attempt such calculations.

Commission believes that possiblefuture circumstances surroundingmargin levels are too speculative anduncertain to be able to quantify orestimate the resulting costs to DCOs,clearing members, or the public fromthe rule with any precision or degree of magnitude.

Moreover, any potential costs of this

rule may be mitigated by the provisionthat allows DCOs to request, or theCommission on its own initiative tomake, a determination that theliquidation time for a particular contractis too long or too short. As marketsevolve, it may become appropriate toease the requirement for certain swapssubject to the five-day minimum.Conversely, analysis may reveal that forother products or portfolios the five-dayor one-day minimum is insufficient.This procedure could serve to reducecosts that may arise from application of the rule.

Benefits

A minimum liquidation time is astandard input in value-at-risk modelsused by DCOs to compute a confidenceinterval to estimate their risk. Thevalue-at-risk confidence intervalprotects DCOs, their clearing members,market participants, and the public byfixing the probability that a default willoccur and the position cannot beliquidated in time.

The five-day/one-day distinction fordifferent types of swaps is based on theease of liquidation of different productgroups and is consistent with existingrequirements that reflect the riskassessments DCOs have made over thecourse of their experience clearing thesetypes of swaps. Several DCOs havedetermined that these are theappropriate standards for theseinstruments and apply it to their marginrequirements. The Commission believesthat this is a reasonable and prudentjudgment.

A minimum standard is designed toprevent DCOs from competing byoffering lower margin requirements thanother DCOs and, as a result, taking onmore risk than is prudent. In addition,

the Commission is concerned that aDCO may misjudge the appropriate

liquidation time frame because of limited experience with clearing andmanaging the risks of financial swaps. Aminimum liquidation time frame shouldprevent DCOs from taking on too muchrisk.

While it is not possible to estimate orquantify the benefits to market

participants and the public infacilitating the financial soundness of DCOs, the Commission believes that aDCO failure, regardless of the size of theDCO, could adversely affect thefinancial markets, market participants,and the public. This rule will diminishthe chances that such a failure willoccur.


Costs

The considerations under this factorare similar to the considerations under

the first factor.

Benefits

The rule will promote efficiency,competitiveness and financial integrity

by establishing a minimum standard forall DCOs. While a DCO will still haveconsiderable latitude in setting risk-

based margin levels, the Commissionhas determined that establishing aminimum liquidation time will providelegal certainty for an evolvingmarketplace, will offer a practical meansfor assuring that the thousands of different swaps that are going to be

cleared subject to the Commission’soversight will have prudent minimummargin requirements, and will helpprevent a potential ‘‘race to the bottom’’

by competing DCOs. Competitionamong DCOs will be channeled to otherareas such as level of service.

The Commission believes that default by a clearing member could have asignificant, adverse effect on marketparticipants or the public. Marketparticipants may have to incur the costsof making up any shortfall in marginthrough guaranty fund deposits and/orassessments, and any costs associatedwith participation in an auction orallocation of the positions of adefaulting clearing member. In a worstcase scenario, a default by a clearingmember may undermine the financialintegrity of the DCO, which could haveserious and widespread consequencesfor the U.S. financial markets. This ruleprotects market participants and thepublic from bearing these costs byrequiring a DCO to follow certainminimum standards in establishingmargin requirements.

3. Price Discovery



Costs

Because the rule simply establishes

minimums, it will not hinder theexercise of sound risk managementpractices. The rule specifically requiresDCOs to use longer liquidation times if appropriate for particular products.

Benefits

As discussed under the first twofactors, the rule will foster sound riskmanagement practices.


The Commission has not identifiedany costs or benefits beyond thosediscussed under the first factor.

Margin Confidence LevelAs proposed, § 39.13(g)(2)(iii) would

require a DCO’s initial margin models tomeet an established confidence level of at least 99% based on data from anappropriate historical period.

A number of commenters stated thateach DCO should have discretion toestablish confidence levels based on theparticular characteristics of the productsand portfolios it clears and theirunderlying markets. However, a numberof other commenters stated that a 99%confidence level was the properminimum.

The Commission is adopting the ruleas proposed.The Commission has evaluated the

costs and benefits of the proposedregulation in light of the specificconsiderations identified in Section15(a) of the CEA, as follows:


Costs

A 99% confidence level will requirethat more money be held as margin ascompared to a lower confidence level.There is an opportunity cost to clearing

members holding this money as margin.The Commission believes that it is notfeasible to estimate or quantify this costreliably. In addition to the confidencelevel, the margin requirements for aparticular instrument depend upon avariety of characteristics of theinstrument and the markets in which itis traded, including the riskcharacteristics of the instrument, itshistorical price volatility, and liquidityin the relevant market. Determiningsuch margin requirements does notsolely depend upon such quantitative





269 Id.270See CPSS–IOSCO Consultative Report,

Principle 6: Margin, Key Consideration 3, at 40;EMIR, Article 39, paragraph 1, at 46.

271As discussed in section IV.D.6.h.(1), above,certain DCOs already use a version of grossmargining, in which case the costs of complyingwith § 39.13(g)(8)(i) would be considerably less.

factors, but also requires expertjudgment as to the extent to which suchcharacteristics and data may be anaccurate predictor of future market

behavior with respect to suchinstruments, and applying suchjudgment to the quantitative results.Thousands of different swap productsmay be subject to clearing. Determiningthe risk characteristics, price volatility,and market liquidity of even a samplefor purposes of determining aconfidence level specifically for suchinstrument would be a formidable taskfor the Commission to undertake andany results would be subject to a rangeof uncertainty. Reliable data is notreadily available for many swaps thatprior to the Dodd-Frank Act wereexecuted in unregulated markets. Insum, in the absence of a reasonablyfeasible and reliable methodology at thepresent time for the Commission to use

in calculating the margin requirementsfor swaps,269 the Commission believesthat possible future circumstancessurrounding margin levels are toospeculative and uncertain to be able toquantify or estimate the resulting coststo DCOs, clearing members, or thepublic from the rule with any precisionor degree of magnitude.

Benefits

A minimum confidence level isessential to protect market participantsand the public. A minimum confidencelevel will prevent DCOs from competing

with respect to how much risk they arewilling to take on or from misjudgingthe amount of risk they would take onif they operated under lower standards.In addition, it will provide assurance tomarket participants that every DCO hassufficient margin to effectively managea default.

Some DCOs currently apply the 99percent standard. Others use 95–99percent for some contracts dependingon facts and circumstances.International standards currentlyrecommend 99 percent.270 In view of

the increased risk that DCOs will face asa result of clearing swaps, theCommission believes that protection of market participants and the publicdictates that the minimum standard onthis key risk management elementshould be set in accordance withcurrent best practices among DCOs andinternational standards.


Costs

The considerations under this factorare very similar to the considerationsunder the first factor.

Benefits

The rule will promote efficiency,competitiveness and financial integrity by establishing a minimum standard forall DCOs. While a DCO will still haveconsiderable latitude in setting risk-

based margin levels, the Commissionhas determined that establishing aminimum confidence level will providelegal certainty for an evolvingmarketplace, will offer a practical meansfor assuring that the thousands of different swaps that are going to becleared subject to the Commission’soversight will have prudent minimummargin requirements, and will prevent apotential ‘‘race to the bottom’’ by

competing DCOs. As noted above, theCommission is adopting a 99% standardin order to conform to current bestpractices among DCOs as well asinternational standards. Competitionamong DCOs will be channeled to otherareas such as level of service.

The Commission believes that default by a clearing member could have asignificant, adverse effect on marketparticipants and the public. Marketparticipants may have to incur the costsof making up any shortfall in marginthrough guaranty fund deposits and/orassessments, and any costs associated

with participation in an auction orallocation of the positions of adefaulting clearing member. In a worstcase scenario, a default by a clearingmember may undermine the financialintegrity of the DCO, which could havesignificant negative consequences forthe financial stability of U.S. financialmarkets. As highlighted by recent eventsin the global financial markets, theability to manage the risks associatedwith clearing is critical to the goal of stability in the broader financialmarkets. This rule protects marketparticipants and the public from bearing

these costs by requiring a DCO to followcertain minimum standards inestablishing margin requirements.

3. Price Discovery



Costs

Because the rule simply establishesminimums, it will not hinder theexercise of sound risk management

practices. The rule specifically requiresDCOs to use higher confidence levels if appropriate for particular products.

Benefits

As discussed under the first twofactors, the rule will foster sound riskmanagement practices.

5. Other Public Interest ConsiderationsThe Commission does not believe that

the rule will have a material effect onpublic interest considerations other thanthose identified above.

Gross Margin

As proposed, § 39.13(g)(8)(i) wouldrequire a DCO to collect initial marginon a gross basis for customer accounts.

Two commenters supported theproposal. Several commenters statedthat the provision of individualcustomer position information to DCOsmay entail significant, costly, and time-consuming changes to systemsinfrastructure at the clearing memberlevel and the DCO level.

In light of the various concernsregarding the operational andtechnology changes that would beneeded and related costs of requiring aDCO to obtain individual customerposition information from its clearingmembers and to use such information tocalculate the margin requirements foreach individual customer, theCommission is modifying§ 39.13(g)(8)(i). As amended, the ruleprovides a DCO with the discretion toeither calculate customer gross margin

requirements based on individualcustomer position information that itobtains from its clearing members or

based on the sum of the gross positionsof all of a clearing member’s customersthat the clearing member provides to theDCO, without forwarding individualcustomer position information to theDCO.

The Commission has evaluated thecosts and benefits of the proposedregulation in light of the specificconsiderations identified in Section15(a) of the CEA, as follows:


Costs

Three kinds of costs could result froma change from net to gross margining,for those DCOs that currently use netmargining.271 First, gross marginingcould change the loss that customers of a clearing member may face in the event





272Offsetting this effect is the potential for afailing FCM to misappropriate customer funds. Thatpotential is greater under net margining.

273The Commission has proposed rules thatwould not permit this in the case of swaps. See 76FR 33818 (June 9, 2011) (Protection of ClearedSwaps Customer Contracts and Collateral;Conforming Amendments to the Commodity BrokerBankruptcy Provisions).

of default by a fellow customer of thatclearing member. Under net margining,a greater portion of customer margin isheld at the clearing member and therebyinsulated from the DCO, so that non-defaulting customers face lower risk of losing their margin deposits to the DCOif a fellow customer defaults. Grossmargining gives a DCO access to the

margin deposits of non-defaultingcustomers of a defaulting FCM.272 Inthis sense, gross margining could shift aportion of the default risk from the DCOto fellow customers.273

It is not possible to estimate orquantify these costs—which would onlyarise in the event of a default of acustomer—in a reliable way for anumber of reasons. The historical recordprior to the enactment of the Dodd-Frank Act with respect to the operationof clearing organizations provides littleguidance as to the costs that may beincurred in the future in the unlikely

event of a default at a DCO. Defaults atDCOs are very rare and thecircumstances of each one are unique.Moreover, the Dodd-Frank Act andimplementing regulations will alter thelandscape significantly. Existing DCOsand FCMs will be clearing newproducts. New DCOs and FCMs willenter the market. Mandatory clearingwill bring new products andparticipants to DCOs and FCMs. Theinteraction of all these factors creates awide range of uncertainty as to thenature of the potential consequences of a default under the new regulatory

regime. In sum, the Commission believes that the possible futurecircumstances leading to and potentialresulting consequences of a futuredefault are too speculative anduncertain to be able to quantify orestimate the resulting costs to clearingmembers with any precision or degreeof magnitude.

Second, because gross marginingmeans that more customer margin isheld at the DCO, rather than the FCM,gross margining also means that anyreturn on this margin (e.g., interestearned) is earned by the DCO, rather

than the FCM. This is largely a transfer between those parties. If there is nooffsetting change in other terms of therelationship between customers, FCMsand DCOs, gross margining leads to a

cost for FCMs and a benefit to DCOsfrom this change.

Third, gross margining could result inchanges in operating costs for DCOs andclearing members. Gross marginingcould require the DCO to possess moredetailed information about customerpositions. The provision of individualcustomer position information to DCOs

may entail significant, costly, and time-consuming changes to systemsinfrastructure at the clearing firm leveland the DCO level. For example, NYPCstated that its preliminary cost estimatefor compliance with the customer grossmargin and large trader reportrequirements contained in proposed§§ 39.13(g)(8)(i) and 39.13(h)(2) wasapproximately 128,650 hours and $14.5million.

In order to reduce the potential costs,the Commission has revised§ 39.13(g)(8)(i) to allow a DCO to permitan FCM to provide the DCO with thesum of the gross positions of all of itscustomers so that the DCO maycalculate the applicable gross marginrequirement based on that sum. Underthis scenario, a DCO will not have toestablish a framework to receive eachcustomer’s position information andcalculate the initial margin requirementapplicable to each customer’s positions.The Commission believes thisalternative framework will besignificantly less expensive for marketparticipants. Whether a DCO chooses tomake the calculation based onindividual customer positioninformation or the sum of customers’

gross positions submitted by theclearing member, the clearing member’scustomer gross margin requirement will

be the same.NYPC also commented that such

implementation costs couldsignificantly deter new clearinghouseslike NYPC from launching. However,NYPC did not provide an estimate forthe costs of a new clearinghouse systemcapable of gross margining in relation tothe cost of retrofitting an existing netmargin system. The Commission

believes that retrofitting an existingsystem may be more expensive than

implementing a new system fromscratch, and that it is unclear whetheradditional implementation costs woulddeter any new clearinghouses.

Benefits

The Commission believes that theclearing of swaps will increase the riskthat DCOs face. Gross margining willincrease the amount of money thatDCOs hold. Under gross margining, theamount of margin at the DCO moreaccurately approximates the risks posedto a DCO by its clearing members’

customers than net margining andincreases the financial resourcesavailable to a DCO in the event of acustomer default.

A DCO may not be able to collectinitial customer margin from an FCM if the FCM defaults. This could have aserious adverse impact on the financialstability of a DCO, non-defaulting

customers, and potentially widermarkets. In this regard, a significantcustomer default leading to an FCMdefault could strain a DCO’s financialresources, causing it to exhaust theinitial margin available to cover thedefault and forcing other clearingmembers and/or the DCO to incurrelated costs. In the worst case, an FCMdefault resulting from a large customerdefault could cause a DCO to fail if itsfinancial resources are inadequate tocover the losses it incurs as a result of the default. Gross margining providesthe DCO with a larger financial cushion

that can be tapped in the event of adefault. Initial margin is the DCO’s first‘‘line of defense’’ in managing a default,and a larger initial margin held at theDCO will help compensate for theDCO’s inability to collect additionalmargin from a defaulting clearingmember. This rule protects marketparticipants and the public from bearingthese costs by requiring a DCO to holdadditional margin.


Costs


Benefits

The rule promotes efficiency,competitiveness, and financial integrity

by providing that the amount of marginat the DCO more accuratelyapproximates the risks posed to a DCO

by its clearing members’ customers and by increasing the financial resourcesavailable to a DCO in the event of acustomer default.

3. Price Discovery



The considerations relating to soundrisk management practices are verysimilar to the considerations under thefirst factor.


The Commission does not believe thatthe rule will have a material effect on





public interest considerations other thanthose identified above.

Risk Limits

As proposed, § 39.13(h)(1)(i) wouldrequire a DCO to impose risk limits oneach clearing member, by customerorigin and house origin, in order toprevent a clearing member from

carrying positions where the riskexposure of those positions exceeds athreshold set by the DCO relative to theclearing member’s financial resources,the DCO’s financial resources, or both.

Several commenters supported therule as an appropriate risk managementprocedure. Two commenters suggestedthat the rule is overly prescriptive. TheCommission did not receive anycomments that quantified the costs of this rule.

The Commission is adopting§ 39.13(h)(i) as proposed.

The Commission has evaluated thecosts and benefits of the proposed

regulation in light of the specificconsiderations identified in Section15(a) of the CEA, as follows:


Costs

Some DCOs already set limits andwill not incur any costs. Others willincur the costs of calculating limits foreach clearing member. Such costs will

be incremental because all DCOscurrently have procedures formonitoring clearing member risk andmay already have informal triggers or

alerts in place. For clearing members,the rule would impose opportunitycosts to the extent the limits constraintheir activities.

Under the rule each DCO would havediscretion to set limits for each clearingmember. It would be pure conjecture forthe Commission to estimate what levelsDCOs would set for their clearingmembers and how much that wouldconstrain such clearing members. EachDCO would rely on the informedjudgment of its risk managementcommittee and/or risk management staff to assess the risks and resources of each

clearing member and arrive at theapplicable limits for each one.Estimating the extent to which thiswould constrain clearing members iseven more speculative. That wouldentail a guess as to the risk appetite of each clearing member. In sum, theCommission believes that possiblefuture circumstances surrounding risklimits are too speculative and uncertainto be able to quantify or estimate theresulting costs to DCOs, clearingmembers, or the public with anyprecision or degree of magnitude.

Benefits

The rule will benefit marketparticipants by reducing the ability of clearing members and their customers toassume excessive risks. This willdiminish the chances of default with allthe attendant consequences previouslydiscussed.


Costs


Benefits

Because the rule provides DCOs thediscretion to tailor the limits for eachclearing member in accordance with theDCO’s assessment of the risk that theclearing member poses, it will fosterefficiency and competitiveness in themarkets. Because it will decrease thechance of default it will foster financialintegrity.

The Commission believes that default by a clearing member could have asignificant, adverse effect on marketparticipants or the public. Marketparticipants may have to incur the costsof making up any shortfall in marginthrough guaranty fund deposits and/orassessments, and any costs associatedwith participation in an auction orallocation of the positions of adefaulting clearing member. In a worstcase scenario, a default by a clearingmember may undermine the financial

integrity of the DCO, which could haveserious and widespread consequencesfor the stability of U.S. financialmarkets. This rule protects marketparticipants and the public from bearingthese costs by requiring a DCO toanalyze the risk posed by each clearingmember and impose appropriate limits.

3. Price Discovery



Costs


Benefits

Risk limits are a sound riskmanagement practice currentlyemployed by several DCOs. The rulewill extend the practice across all DCOs.




Large Trader Reports

As proposed, §39.13(h)(2) wouldrequire a DCO to obtain from its clearingmembers, copies of all reports that suchclearing members are required to filewith the Commission pursuant to part

17 of the Commission’s regulations, i.e.,large trader reports. Proposed§ 39.13(h)(2) would further require aDCO to review the large trader reportsthat it receives from its clearingmembers on a daily basis to ascertainthe risk of the overall portfolio of eachlarge trader.

One commenter supported theproposal. One commenter argued thatthe proposed requirement that DCOsobtain large trader reports from clearingmembers is duplicative because a DCOreceives large trader information fromthe exchange. One commenter stated

that a DCO would need new technologyto implement the rule. One commenterstated that a DCO would needadditional surveillance staff.

The Commission is modifying§ 39.13(h)(2) to require a DCO to obtainlarge trader reports either from itsclearing members or from a DCM or aSEF for which it clears.

The Commission has evaluated thecosts and benefits of the proposedregulations in light of the specificconsiderations identified in Section15(a) of the CEA, as follows:

1. Protection of Market Participants and

the PublicCosts

The Commission notes that someDCOs already receive large traderreports from DCMs and review largetrader reports for risk surveillancepurposes on a daily basis. For them, thisrule imposes no additional cost. Forother DCOs, the receipt and analysis of large trader information may entailsignificant, costly, and time-consumingchanges to systems infrastructure.Clearing members could also incur coststo provide large trader reports to DCOs.

For example, NYPC stated that itspreliminary cost estimate forcompliance with the customer grossmargin and large trader reportrequirements contained in proposed§§ 39.13(g)(8)(i) and 39.13(h)(2) wasapproximately 128,650 hours and $14.5million.

In order to reduce costs, theCommission modified § 39.13(h)(2) topermit a DCO to obtain large traderreports either from its clearing membersor from a DCM or a SEF for which itclears. The latter approach would





274To the extent that some DCOs would conductrisk reviews in the absence of a rule, theincremental benefits of the rule are reduced. Evenfor these DCOs, however, a rule provides the marketwith the benefit of greater certainty that riskreviews of members will be continued in the future.

275Figures used in the estimate are based on thejudgment of Commission staff with experienceoverseeing DCO reviews of clearing member risk.

276For example, 20 hours supervisor time perreview × $250/hr plus 80 hours analyst time perreview × $150/hr = $17,000 × 40 reviews =$680,000.

eliminate duplicative reporting forclearing members and wouldsignificantly reduce costs for DCOs byenabling them to obtain the data from asingle source.

Benefits

Currently, at some DCOs, the receiptand analysis of large trader reports is an

integral part of their risk managementprograms. Extension of this practice toall DCOs would benefit marketparticipants and the public. Proactiveanalysis of this information allowsDCOs to identify and to addressincipient problems in customeraccounts before they get out of hand. Inparticular, large trader reports are anessential part of a rigorous riskmanagement system because theyprovide information that is required forstress testing.

A default by a clearing member couldhave a significant, adverse effect on

market participants or the public.Market participants may have to incurthe costs of making up any shortfall inmargin through guaranty fund depositsand/or assessments, and any costsassociated with participation in anauction or allocation of the positions of a defaulting clearing member. In a worstcase scenario, a default by a clearingmember may undermine the financialintegrity of the DCO, which could haveserious and widespread consequencesfor the stability of U.S. financialmarkets. This rule protects marketparticipants and the public by requiring

a DCO to analyze the potential risks atan earlier stage.



3. Price Discovery





The Commission does not believe thatthe rule will have a material effect onpublic interest considerations other thanthose identified above.

Clearing Member Risk Review

As proposed, § 39.13(h)(5)(ii) wouldrequire each DCO to review the riskmanagement policies, procedures, and

practices of each of its clearing memberson a periodic basis.

Several commenters asserted that thereview would be burdensome for suchclearing members. The Commission didnot receive any comments thatquantified the costs of this rule.

The Commission is adopting the rulewith two modifications. These changes

clarify that a DCO’s review need onlycover those procedures of a clearingmember which address the risks thatsuch clearing member may pose to theDCO.

The Commission has evaluated thecosts and benefits of § 39.13(h)(5)(ii) inlight of the specific considerationsidentified in Section 15(a) of the CEA,as follows:


Costs

Those DCOs that currently conduct

risk reviews of their clearing membersare not likely to incur any additionalcosts as a result of the rule.274 ThoseDCOs that do not currently have such aprogram will incur costs to build onexisting procedures for reviewingapplicants for clearing membership inorder to develop programs for ongoingreview of clearing members. Clearingmembers will incur costs in workingwith the DCOs that review them.Commission staff intends to work withthe DCOs to develop arrangementsdesigned to avoid duplicative effortswithout compromising the requirementthat each DCO maintain anunderstanding of the risks of each of itsclearing members.

In recognition that each DCO has aunique product mix and set of rules, therule does not prescribe the specificfrequency, depth, or methodology of such reviews, nor does it specify whenan on-site audit may or may not beappropriate. Nevertheless, based on theCommission’s experience overseeingDCOs that currently conduct riskreviews of clearing members, theCommission estimates the approximatecosts of this rule as follows.275

The Commission estimates that a risk

review by a large DCO typically wouldrequire on the order of 100 person-hoursof work by a supervisor and several riskanalysts. This includes preparation, anon-site visit, and drafting the report. The

Commission also estimates that a largeDCO would perform, on average, 40 riskreviews a year, although the numberwould vary depending on the number of clearing members a particular DCO has,and other circumstances. TheCommission estimates compensationcosts on the order of $150 an hour forrisk analysts, and $250 an hour for a

supervisor. Based on these estimates,the Commission estimates that theannual cost to a large DCO would beroughly on the order of $700,000.276 Costs for particular DCOs are likely tovary from this amount based on the sizeof the DCO, the DCO’s management andcompensation practices, and the DCO’sexercise of the flexibility allowed by therule provision. In light of the potentialconsequences of risk managementfailures by clearing members discussed

below, and of the Commission’sjudgment that DCOs are the marketparticipants in the best position to

review clearing member riskmanagement programs, the Commission believes that the benefits of thisprovision would justify the costs even if costs proved to be substantially largerthan the Commission’s estimate.

Benefits

Rigorous risk management programsat clearing members benefit marketparticipants by providing safeguards toprevent default. Clearing members are atthe front line of risk management. TheCommission believes that risk reviewsare important to ensure that eachclearing member’s risk managementframework is sufficient and properlyimplemented. The Commission believesthat a clearing member’s DCO shouldundertake the review because that DCOis in the best position to review the riskmanagement policies, procedures, andpractices of its clearing members in thecontext of the clearing members’obligations under the DCO’s rules.


Costs


Benefits

Ensuring that each clearing memberhas proper risk management proceduresfor each DCO at which it clears willpromote efficiency and competitivenessin the clearing process by ensuring thatthe clearing member is in compliance





with each such DCO’s rules andencouraging the exercise of bestpractices. The rule will foster financialintegrity for the reasons set forth underthe first factor.

The Commission believes that default by a clearing member could have asignificant, adverse effect on marketparticipants and the public. Market

participants may have to incur the costsof making up any shortfall in marginthrough guaranty fund deposits and/orassessments, and any costs associatedwith participation in an auction orallocation of the positions of adefaulting clearing member. In a worstcase scenario, a default by an FCM mayundermine the financial integrity of theDCO, which could have serious andwidespread consequences for thestability of U.S. financial markets. Thisrule protects market participants andthe public from bearing these costs byrequiring a DCO to periodically review

the risk management procedures of eachof its clearing members.

3. Price Discovery



The considerations under this factorare similar to the considerations underthe first factor.




H. Settlement Procedures—§39.14(c)(3)

Section 5b(c)(2)(E) of the CEA, CorePrinciple E, as amended by the Dodd-Frank Act, requires a DCO to: (1)complete money settlements on a timely

basis, but not less frequently than onceeach business day; (2) employ moneysettlement arrangements to eliminate orstrictly limit its exposure to settlement

bank risks (including credit andliquidity risks from the use of banks toeffect money settlements); (3) ensure

that money settlements are final wheneffected; (4) maintain an accurate recordof the flow of funds associated withmoney settlements; (5) possess theability to comply with the terms andconditions of any permitted netting oroffset arrangement with another clearingorganization; (6) establish rules thatclearly state each obligation of the DCOwith respect to physical deliveries; and(7) ensure that it identifies and manageseach risk arising from any of itsobligations with respect to physicaldeliveries.

The Commission proposed § 39.14 toimplement Core Principle E. With theexception of proposed § 39.14(c), thecommenters did not address the costs of the proposed rule or the Commission’sconsideration of costs and benefits.

Proposed §39.14(c)(3) would requirea DCO to ‘‘monitor the full range andconcentration of its exposures to its own

and its clearing members’ settlement banks and assess its own and itsclearing members’ potential losses andliquidity pressures in the event that thesettlement bank with the largest share of settlement activity were to fail.’’ Itwould further require that a DCO (i)maintain settlement accounts atadditional settlement banks; (ii) approveadditional settlement banks for use byits clearing members; (iii) imposeconcentration limits with respect to itsown or its clearing members’ settlement

banks; and/or (iv) take any otherappropriate actions reasonably

necessary in order to eliminate orstrictly limit such exposures.As discussed above, several

commenters expressed concern thatthese provisions would impose costlyrequirements that are unnecessary orcould have unintended adverseconsequences. In this regard, onecommenter claimed that therequirement to monitor clearingmembers’ exposure to their settlement

banks could result in a duplication of effort that would be burdensome for aDCO. Commenters also stated that thereare a limited number of banks that arequalified and willing to serve as

settlement banks; as such, it may bedifficult for smaller DCOs to maintainmore than one settlement bank given theassociated costs. Further, commentersstated that imposing concentrationlimits could increase systemic risk

because a DCO would need to distributefunds across multiple banks and assettlement funds increased, highly rated

banks would eventually reach theapplicable concentration limit,potentially forcing DCOs to openaccounts with lower rated banks.

None of the commenters providedquantitative data or information to

support their assertions as to thepotential costs and burdens of compliance with §39.14(c)(3), and noneaddressed the benefits of the rule.

As discussed above, the Commission believes that there are risks associatedwith a DCO concentrating all its fundsin a single settlement bank. Bank failurein such a circumstance could haveadverse consequences for the DCO, itsclearing members, and their customers.However, the Commission alsoacknowledges the concerns expressed

by commenters, particularly given the

settlement practices and procedures thatDCOs currently maintain in the absenceof such a regulation.

Accordingly, the Commission ismodifying §39.14(c)(3) to eliminate anyimplied requirement that all DCOs mustmaintain settlement accounts at morethan one bank, and is retaining therequirement that a DCO monitor

exposure to its settlement bank(s) andthose of its clearing members, includingan ongoing assessment of the effect tothe DCO of a failure of the settlement

bank that has the largest share of settlement activity. It is also clarifyingits intent to qualify the need to takeactions set forth in §39.14(c)(3)(i)–(iv)(such as imposing concentration limits)‘‘to the extent that any such action oractions are reasonably necessary inorder to eliminate or strictly limit suchexposures.’’ Thus, the Commission isproviding DCOs with more flexibilitythan would have been provided under

the proposed rule which, in turn,should reduce the costs associated withcompliance.

The Commission has evaluated thecosts and benefits of § 39.14(c)(3) inlight of the specific considerationsidentified in Section 15(a) of the CEA,as follows:


Costs

A DCO’s monitoring of its exposure toits settlement bank(s) and those of itsclearing members is a sound business

practice in which a DCO should beengaged notwithstanding the rule.Nevertheless, the Commission believesthe rule will require commitment of DCO staff resources, the costs of whichcould be passed along to clearingmembers and market participants aspart of the DCO’s clearing fees. Suchcosts could vary significantly acrossDCOs given differences in operationaland risk management procedures,settlement arrangements, and fee pricingpractices. Given these circumstances,the Commission is unable to quantifythe costs attributable to theCommission’s rule, and no commenterprovided an estimate. As a generalmatter, however, the Commission ismindful that the measures set forth in§ 39.14(c)(3)(i)–(iv), specifically therequirement that DCOs take actions thatare ‘‘reasonably necessary in order toeliminate or strictly limit’’ exposure tosettlement banks, could cause DCOs toincur costs. Such costs could include,for example, the costs of establishing anaccount at an additional settlement

bank, which would entail evaluating the bank to ensure that it meets the DCO’s





277Section 5b(c)(2)(F) of the CEA; 7 U.S.C. 7a–1(c)(2)(F) (Core Principle F).

278The Commission notes that proposed39.15(c)(1) regarding types of assets that can beaccepted as initial margin has been redesignated as§ 39.13(g)(10) under the risk management rules.

criteria for a settlement bank, reviewingaccount agreements, and establishingconnectivity to the bank. There may also

be fees charged by a bank for standbyservices if the bank is not used as theprimary settlement bank, or there may

be other account-related fees. TheCommission is unable to ascertain thespecific amount of any such costs for

DCOs because of the varying nature of settlement bank arrangements acrossDCOs.

Benefits

Use of multiple settlement banks byDCOs, as well as imposition of concentration limits and othersafeguards provided for in§ 39.14(c)(3)(i)–(iv), when reasonablynecessary, could help insulate the DCOand its members from the risk of default

by a settlement bank. This in turn couldprovide market participants and thepublic with greater protection fromdisruption of markets, as well as theclearing and settlement system.

Affording a DCO flexibility inmanaging its settlement bankarrangements and, to a lesser degree,those of its clearing members, benefitsmarket participants and the public byreducing the costs and potentialinefficiencies associated withmaintaining settlement arrangementswith multiple settlement banks whenthat might not yield a concomitant

benefit in the form of risk reduction.The rule sets forth general standardswhile permitting each DCO to tailor itssettlement bank arrangements to its

unique circumstances and risktolerances.


Costs

Quantification or estimation of coststo efficiency, competitiveness, andfinancial integrity of markets are notreadily ascertainable, and no commenterprovided an estimate.

Benefits

The rule permits DCOs to obtainsettlement services from a single bank if

the size and needs of the DCO, as wellas the availability of suitable settlement bank services, makes the use of morethan one settlement bank cost-prohibitive and it is not reasonablynecessary to have more than onesettlement bank in order to eliminate orstrictly limit the DCO’s exposures. Moreefficient use of DCO resources can resultin enhanced efficiency and financialintegrity of the markets for which theDCO clears. Particularly for smallerDCOs, it may not be practical to obtainsettlement services from more than one

settlement bank because of the costs of evaluating a bank’s suitability toperform settlement functions, reviewingaccount agreements, and establishingconnectivity to the bank. There also may

be account-related fees charged by a bank, including fees for standbyservices, if the bank is used as a back-up settlement bank and not the primary

settlement bank.

3. Price Discovery

The Commission has not identifiedany ways in which §39.14(c)(3) couldaffect price discovery.


Costs

The Commission has not identifiedany ways in which §39.14(c)(3) couldimpair sound risk managementpractices.

Benefits

The Commission regards an effectivesettlement framework as a sound riskmanagement practice because it reducesthe risks associated with a bank’spotential failure to make timelysettlement. The requirements that aDCO monitor risk exposures tosettlement banks and addressdiversification concerns, as reasonablynecessary, are important adjuncts to aDCO’s overall risk managementpractices.

5. Other Public Interest Considerations.

The Commission has not identifiedany other costs or benefits that should

be taken into account.

I. Treatment of Funds—§39.15

Core Principle F, as amended by theDodd-Frank Act, requires a DCO to: (i)Establish standards and procedures thatare designed to protect and ensure thesafety of its clearing members’ fundsand assets; (ii) hold such funds andassets in a manner by which tominimize the risk of loss or of delay inthe DCO’s access to the assets andfunds; and (iii) only invest such fundsand assets in instruments with minimalcredit, market, and liquidity risks.277

Proposed §39.15 would establishminimum standards for DCOcompliance with Core Principle F.Among other things, it would set forthstandards for the types of assets thatcould be accepted as initial margin. Inthis regard, proposed §39.15(c)(1)would require a DCO to limit the assetsit accepts as initial margin to those thathave minimal credit, market, andliquidity risk. It would further specify

that a DCO may not accept letters of credit as initial margin.

The Commission received commentson substantive aspects of the proposedrules, and it has addressed thosecomments above. The Commission alsoreceived several comments on potentialcosts associated with the proposed§ 39.15(c)(1) prohibition on the

acceptance of letters of credit as initialmargin.278 CME asserted that theprohibition is unnecessary becauseletters of credit provide an absoluteassurance of payment and, therefore, theissuing bank must honor the demandeven in circumstances where the

beneficiary is unable to reimburse the bank for its payment. Other commenterssuggested that letters of credit should beacceptable if they are subject toappropriate conditions. Finally, severalcommenters warned of the potentialrisks associated with prohibiting lettersof credit, including higher costs for

clearing members and their customers,the potential placement of U.S. DCOs ata disadvantage as compared to foreignclearing houses, and increased systemicrisk as a result of decreased voluntaryclearing.

Taking into account both the strongtrack record of letters of credit inconnection with cleared futures andoptions on futures and the potentiallygreater risks of cleared swaps, theCommission has determined to modifythe rule to permit letters of credit inconnection with cleared futures andoptions on futures but to retain theprohibition on letters of credit as initialmargin for swaps. Certain DCOs haveaccepted letters of credit as initialmargin for futures and options onfutures for a number of years withoutincident and continue to do so. On theother hand, letters of credit are only apromise by a bank to pay, not an assetthat can be sold. The Commission isconcerned that the potential losses thatswap market participants could incurmay be of a greater magnitude thanpotential losses with respect to futuresand options. Initial margin is the firstfinancial resource that a DCO will applyin the event of a clearing member

default. If a DCO were to need to drawon a letter of credit posted by a clearingmember whose customers had sufferedsuch losses, the larger the amount thatit would need to draw, the greater therisk that the issuing bank may be unableto pay under the terms of the letter of credit. Accordingly, the Commission ismodifying the proposal as described.





279Section 5b(c)(2)(J) of the CEA, 7 U.S.C. 7a–1(c)(2)(J).

The Commission has evaluated thecosts and benefits of § 39.13(g)(10) inlight of the specific considerationsidentified in Section 15(a) of the CEA,as follows:


Costs

The prohibition on accepting letters of credit as initial margin for swaps mayimpose higher costs for clearingmembers because they will have todeposit cash or other assets that haveminimal credit, market, and liquidityrisk for those products. This couldincrease costs for market participantsand decrease capital efficiency. It mayalso place U.S. DCOs at a disadvantageto those foreign clearing houses thatpermit letters of credit to be used asinitial margin for swaps. TheCommission notes, however, that inresponse to the comments it has

modified the rule to permit letters of credit for futures. Therefore, futuresmarket participants will not incur anycosts as a result of this provision.

It is not possible to estimate orquantify these costs for a number of reasons. The Dodd-Frank Act andimplementing regulations willsignificantly affect the manner in whichswaps are developed, traded, executed,and cleared. Existing DCOs and FCMswill be clearing new products. NewDCOs and FCMs will enter the market.Mandatory clearing will bring newproducts and participants to DCOs and

FCMs. The interaction of all thesefactors creates a wide range of uncertainty as to which products will becleared, what their margin requirementswill be, and the extent to which clearingmembers would post letters of credit asmargin if permitted. Under thesecircumstances, the potentialopportunity costs that may arise fromthe deposit of cash or other assets ratherthan letters of credit depends on avariety of future circumstances andactions of market participants thatcannot be known or predicted at thepresent time. In sum, the Commission

believes that the possible futurecircumstances involving the posting of letters of credit as margin is toospeculative and uncertain to be able toquantify or estimate the resulting coststo clearing members with any precisionor degree of magnitude.

Benefits

One of the primary functions of aDCO is to guarantee financialperformance, which includesperforming daily variation settlement.Daily pays are made in cash, and to the

extent a DCO relies on margin depositsto meet its end-of-day obligations, itmust have access to sufficient cash orhighly liquid assets. Similarly, initialmargin may be tapped by a DCO in theevent of a clearing member default. Bylimiting the use of letters of credit, theDCO will avoid the possibility that aletter of credit would be dishonored

when presented to the issuing bank.Thus, requiring initial margin in the

form of assets that can be immediatelysold provides greater financialprotection to the DCO, clearingmembers, and market participants.


Costs

As noted above, there could becompetitive disadvantages to DCOs if foreign competitors do not imposesimilar restrictions on initial margindeposits. In addition, the prospect of

increased costs may reduce voluntaryclearing of swaps, which would beinconsistent with the goals of the Dodd-Frank Act and could potentially lead tosystemic risk.

Benefits

A DCO can be more efficient infacilitating payments if it has readilyavailable liquid assets as opposed to aconditional obligation that must bepresented for payment. Holding actualassets provides greater assurance of financial integrity to the clearingprocess, as the DCO will not have to

bear the costs of possible default on thepart of the issuing bank. Even anirrevocable letter of credit can bedishonored, with the DCO’s onlyrecourse being a lawsuit.

3. Price Discovery

The Commission does not believe thisrule will have a material effect on pricediscovery.


Costs

The Commission does not believe thisrule will have a material adverse impact

on sound risk management practices.Benefits

The Commission expects thatprohibiting the use of letters of credit asinitial margin for swaps could serve tostrengthen a DCO’s risk managementprogram. It eliminates the risk of fundsnot being available if a letter of creditwere to be dishonored, which couldhave a significant impact because initialmargin is the first financial resource to

be tapped in the event of a clearingmember default.

5. Other Public Considerations

The Commission does not believe thisrule will have a material impact onpublic interest considerations other thanthose discussed above.

J. Reporting—§39.19

Core Principle J,279 as amended by theDodd-Frank Act, requires a DCO to

provide the Commission with allinformation that the Commissiondetermines to be necessary to conductoversight of the DCO.

The Commission proposed § 39.19 toestablish minimum requirements that aDCO would have to meet in order tocomply with Core Principle J. Underproposed §39.19, certain reports wouldhave to be made by a DCO to theCommission (1) On a periodic basis(daily, quarterly, or annually); (2) wherethe reporting requirement is triggered bythe occurrence of a significant event;and (3) upon request by the

Commission.The rules would require DCOs toprovide information that theCommission has determined isnecessary to conduct oversight of DCOs.The proposed reporting regime wouldassist the Commission in monitoring thefinancial strength and operationalcapabilities of a DCO and in evaluatingwhether a DCO’s risk managementpractices are effective. The requiredreports also would assist theCommission in taking prompt action asnecessary to identify incipient problemsand address them at an early stage. Aself-reporting program of this type

enhances the Commission’s ability toconduct oversight given its limitedresources which do not permit routineon-site surveillance of DCOs.

The proposed rules would requiresubmission of information electronicallyand in a form and manner prescribed bythe Commission. These generalprocedural standards would provideflexibility to the Commission inestablishing and updating uniformformat and delivery protocols thatwould assist the Commission inconducting timely review of submissions. In this regard, the

transmission of information using auniform format would enableCommission staff to sort and interpretdata without the need to convert thedata into a format that provides thenecessary functionality, e.g., it would bedesigned to provide the Commissionwith the ability to compare data acrossDCOs when necessary.

A number of commenters discussedcosts associated with proposed §39.19





in the form of comments on thesubstantive provisions of the proposedrule. For example, a number of commenters discussed whetheralternative reporting requirements might

better inform the Commission of potential risks. Some commentersquestioned the need for certaininformation and some commenters

questioned the feasibility of thereporting requirements. TheCommission has addressed thosecomments above.

The Commission also receivedcomments that directly addressed twoareas of the Commission’s cost-benefitanalysis of proposed § 39.19: (1) Thecost of preparing and submitting dailyand annual audited financial reports;and (2) the cost of reporting a 10 percentdecrease in financial resources. Thosecomments are discussed in detail below.

a. Cost of Preparing and SubmittingDaily and Annual Reports

Proposed §39.19(c) would require aDCO to submit various periodic reportsfor the purposes of risk surveillance andoversight of the DCO’s compliance withthe core principles and Commissionregulations. In the notice of proposedrulemaking, the Commission observedthat the information that would bereported was information readilyavailable to a DCO and which, in certaininstances, was already being reported tothe Commission. The Commissionrequested data or other information thatcould quantify or qualify costs.

Only NYPC provided an estimate of

the fixed cost of implementing anautomated system for daily reporting. Ina comment letter submitted by NYPC,the cost was estimated at $582,000.

In a follow-up phone conversationwith representatives of NYPC,Commission staff discussed the basis forNYPC’s estimate that implementing anautomated system for daily reportingwould cost $582,000. Staff was told thatNYPC already provides certain dailyreports to the Commission, but that theadditional data that it would have toreport under the proposal (not includingthe proposed gross margin data or large

trader data) would necessitateimplementing an automated system.NYPC representatives confirmed thatthe estimate was for a one-time cost, notthe cost of generating and transmittingthe actual daily reports. NYPC alsoconfirmed that the cost of generatingand transmitting the actual daily reportswould be minimal.

The Commission was able to estimatethe costs of providing reports andpresented this information in thePaperwork Reduction Act discussion. Itestimated that daily reporting could

require a DCO to expend up to $8,280per year, and an annual report couldrequire a DCO to expend up to $482,110per year.

KCC and MGEX commented that thevariable cost for daily reporting could besignificantly more than theCommission’s estimates if theCommission were to require a costly

format and method of delivery. MGEXalso commented that the Commissionmay have underestimated the cost of providing the annual report (auditedfinancial report under §39.19(c)(3)(ii)),and that the Commission’s estimate is‘‘extremely excessive, particularly whenmost of [the annual reportingrequirements do] not appear to berequired by the Dodd-Frank Act.’’Finally, MGEX believes that theproposed rules will not guaranteeincreased market participation orimprove legitimate risk managementand hedging activity, and the additional

costs will create barriers to entry anddecrease DCO competition.Although KCC and MGEX commented

that the costs of preparing the reportsmay be greater than the Commission’sestimates, neither DCO provided analternative estimate. Nor did theysuggest alternative reportingrequirements that would achieve thepurposes of the CEA with a morefavorable cost-benefit ratio. As to theestimated costs of the required formatand method of delivery, theCommission notes that it based itsestimate on the cost of using theSHAMIS system. The Commission has

no basis for concluding that the cost of using an alternative system would beless substantial and it received nocomments on this.

The Commission believes that thecosts that DCOs will incur to implementa system to provide such information tothe Commission are necessary andjustified. As explained above, theCommission has determined that theinformation required in the reports isnecessary for the Commission toconduct adequate oversight of DCOs,particularly given its limited ability toconduct on-site reviews.

b. Reporting a 10 Percent Decrease inFinancial Resources

Under proposed § 39.19(c)(4)(i), aDCO would be required to report adecrease of 10 percent in the total valueof its financial resources either from (1)the value reported in the DCO’s lastquarterly report or (2) from the value asof the close of the previous businessday. This would allow the Commissionto more quickly identify and addressfinancial problems at the DCO. Asdiscussed above, the Commission raised

the reporting threshold from 10 percentto 25 percent in response to commentsthat a higher percentage might yieldmore meaningful results. In addition,the higher threshold is likely to reducethe number of reports that might besubmitted under this requirement.

NYPC commented that compliancewith the proposed reporting

requirement would necessitate anexpenditure of approximately 15,000hours and $1.7 million. NYPC explainedthat this estimate reflects implementinga system that would track defaultresources and working capital,combined. After talking withCommission staff, NYPC submitted acomment letter that provided apreliminary estimate of approximately4,600 hours and $566,000 for designing,

building, and testing a reporting systemfor a decline in default resources only.

Based on NYPC’s initial commentletter, the Commission believes that the

material costs associated with§ 39.19(c)(4)(i) are the initialinvestments made by a DCO to developand implement a system (automated ornot) to alert the DCO that the valuationthreshold has been met. As discussedabove, it is important for theCommission to be apprised of a 25%reduction in default resources because itcould indicate that the DCO’s financialresources are strained and correctiveaction may be needed.

The Commission has evaluated thecosts and benefits of § 39.19 in light of the specific considerations identified in

Section 15(a) of the CEA as follows:1. Protection of Market Participants andthe Public

Costs

Section 39.19 requires DCOs toprovide information that theCommission has determined isnecessary for oversight of DCOs and toprovide that information in a timeframe, format, and delivery method thatwill enable effective use of theinformation. To the extent that DCOs donot already have an infrastructure forpreparing and transmitting reports, they

will incur one-time costs to put such aframework in place.

Benefits

The comprehensive regulatoryreporting program will enhanceprotection of market participants andthe public by promoting more in-depthand effective oversight by theCommission. The reports will assist theCommission’s Risk Surveillance staff inmonitoring clearing house risk andevaluating DCOs’ management andmitigation of that risk. In addition, the





2805 U.S.C. 601 et seq.28147 FR 18618 (Apr. 30, 1982).282See 66 FR 45604, at 45609 (Aug. 29, 2001)

(New Regulatory Framework for ClearingOrganizations).

28344 U.S.C. 3501 et seq.

284See 75 FR at 63119 (Oct. 14, 2010) (FinancialResources) (requirement to file quarterly reports);see also discussion of the financial resourcesreporting requirements in section IV.B.10, above.

See 75 FR at 77583–77584 (Dec. 13, 2010)(General Regulations) (proposed requirements: (i)For the CCO to submit an annual report to theCommission; (ii) to retain a copy of the policies andprocedures adopted in furtherance of compliancewith the CEA; (iii) to retain copies of materials,including written reports provided to the board of directors in connection with the board’s review of the annual report; and (iv) to retain any recordsrelevant to the annual report, including, but notlimited to, work papers and other documents thatform the basis of the report, and memoranda,correspondence, other documents, and records thatare (a) created, sent or received in connection withthe annual report and (b) contain conclusions,opinions, analyses, or financial data related to theannual report); see also discussion of § 39.10 insection IV.A, above.

See 75 FR at 78193 (Dec. 15, 2010) (InformationManagement) (proposed requirements to filespecified information with the Commission (i)periodically, on a daily, quarterly, and annual basis;(ii) as specified events occur; and (iii) uponCommission request); see also discussion of reporting requirements in section IV.J, above.

See 75 FR at 78196 (Dec. 15, 2010) (InformationManagement) (proposed requirement to maintainrecords of all activities related to its business as aDCO, including all information required to becreated, generated, or reported under part 39,including but not limited to the results of andmethodology used for all tests, reviews, andcalculations); see also discussion of recordkeepingrequirements in section IV.K, above.

information will assist the Commissionto identify incipient problems andaddress them at an early stage.


Costs

The Commission does not believe thatthe reporting requirements willadversely impact efficiency,competitiveness, or the financialintegrity of derivatives markets.

Benefits

The reporting requirements willprotect the financial integrity of derivatives markets because they willsupport effective and timely oversight of DCOs. This will help to minimize therisk of default and the impact defaultwould have on the markets.

3. Price Discovery

The Commission does not believe that

§ 39.19 will have a material impact onprice discovery.


Costs

The Commission does not believe thatthe reporting requirements willadversely impact sound riskmanagement practices.

Benefits

The reporting requirements areexpected to enhance sound riskmanagement practices because theCommission will be able to more

effectively evaluate a DCO’s riskmanagement practices on an on-going basis. The Commission staff can build aknowledge base that will supportprompt action if there are adversechanges in trends or financial profiles.


The Commission does not believe thisrule will have a material impact onpublic interest considerations other thanthose discussed above. Effectiveoversight of DCOs will enhance thesafety and efficiency of DCOs andreduce systemic risk. Safe and reliableDCOs are essential not only for the

stability of the derivatives markets theyserve but also the public which relies onthe prices formed in these markets forall manner of commerce.

IX. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act(‘‘RFA’’) requires that agencies considerwhether the rules they propose willhave a significant economic impact ona substantial number of small entitiesand, if so, provide a regulatory

flexibility analysis respecting theimpact.280 The rules adopted herein willaffect only DCOs). The Commission haspreviously established certaindefinitions of ‘‘small entities’’ to be used

by the Commission in evaluating theimpact of its regulations on smallentities in accordance with the RFA.281 The Commission has previously

determined that DCOs are not smallentities for the purpose of the RFA.282 Accordingly, the Chairman, on behalf of the Commission, hereby certifiespursuant to 5 U.S.C. 605(b) that theserules will not have a significanteconomic impact on a substantialnumber of small entities. The Chairmanmade the same certification in theproposed rulemakings, and theCommission did not receive anycomments on the RFA in relation to anyof those rulemakings.

B. Paperwork Reduction Act

The Commission may not conduct orsponsor, and a registered entity is notrequired to respond to, a collection of information unless it displays acurrently valid Office of Managementand Budget (OMB) control number. TheCommission’s adoption of §§ 39.3 (DCOregistration application requirements),39.10 (annual compliance report andrecordkeeping), 39.11 (financialresources quarterly report), 39.14(settlement recordkeeping), 39.18(system safeguards reporting andrecordkeeping), 39.19 (periodic andevent-specific reporting), and 39.20(general recordkeeping), imposes new

information collection requirements onregistered entities within the meaning of the Paperwork Reduction Act.283

Accordingly, the Commissionrequested and OMB assigned controlnumbers for the required collections of information. The Commission hassubmitted this notice of finalrulemaking along with supportingdocumentation for OMB’s review inaccordance with 44 U.S.C. 3507(d) and5 CFR 1320.11. The titles for thesecollections of information are‘‘Financial Resources Requirements forDerivatives Clearing Organizations,

OMB control number 3038–0066,’’‘‘Information ManagementRequirements for Derivatives ClearingOrganizations, OMB control number3038–0069,’’ ‘‘General Regulations andDerivatives Clearing Organizations,OMB control number 3038–0081,’’ and‘‘Risk Management Requirements for

Derivatives Clearing Organizations,OMB control number 3038–0076.’’Many of the responses to this newcollection of information are mandatory.

The Commission protects proprietaryinformation according to the Freedom of Information Act and 17 CFR part 145,‘‘Commission Records andInformation.’’ In addition, Section

8(a)(1) of the CEA strictly prohibits theCommission, unless specificallyauthorized by the Act, from makingpublic ‘‘data and information thatwould separately disclose the businesstransactions or market positions of anyperson and trade secrets or names of customers.’’ The Commission also isrequired to protect certain informationcontained in a government system of records according to the Privacy Act of 1974, 5 U.S.C. 552a.

The regulations require eachrespondent to file certain informationwith the Commission and to maintain

certain records.284 The Commissionreceived comments from NYPC andMGEX regarding the estimated costs of preparing and submitting daily reports.It also received comments from MGEXregarding costs associated with annualreports and the proposed rules ingeneral.

NYPC and MGEX commented that thecosts associated with the rules in theInformation Management proposedrulemaking would be higher than the





285See 75 FR at 78193 (Dec. 15, 2010)(Information Management). In the PaperworkReduction Act discussion, the Commissionestimated that daily reporting would result in anaggregated cost of $8,280 initially (12 respondents× $690) and $16,800 per annum (12 respondents ×

$1,400). Annual reporting would result in anaggregated cost of $5,785,320 per annum (12respondents × $482,110).

286 In a follow-up phone conversation withrepresentatives of NYPC, Commission staff

discussed the basis for NYPC’s estimate thatimplementing an automated system for dailyreporting would cost $582,000. Commission staff was told that NYPC already provides certain dailyreports to the Commission’s Risk SurveillanceGroup, but that the additional data that it wouldhave to report under the Information ManagementNPRM (not including the gross margin data or largetrader data) would necessitate implementing anautomated system. NYPC representatives confirmedthat the estimate was for a one-time cost, not thecost of generating and transmitting the actual dailyreports. NYPC also confirmed that the cost of generating and transmitting the actual daily reportswould be minimal.

287See 76 FR at 3716–3717 (Jan. 20, 2011) (RiskManagement).

288See further discussion of the costs and benefitsassociated with the reporting requirements insection VII.J, above.

Commission estimated.285 With respectto daily reporting, NYPC commentedthat designing, building, and testing theapplication necessary to automate theprocess of producing daily reportswould require approximately 5,200hours and cost $582,000.286 MGEXcommented that the cost to a DCO could

be significantly more than the estimated

cost if the Commission were to requirea costly format and method of delivery.

With respect to annual reporting,MGEX commented that the Commissionmay have underestimated the associatedcosts because the Commission did notaddress the costs of building reportingmethods, forms, programs, or theallocation of labor resources. Inaddition, MGEX believes that theestimated costs associated with theannual report are ‘‘extremely excessive,particularly when most of [the annualreport requirements do] not appear to berequired by the Dodd-Frank Act.’’

MGEX further commented that theproposed rules will not guaranteeincreased market participation orimprove legitimate risk managementand hedging activity, and the additionalcosts would create barriers to entry anddecreased DCO competition.

Finally, with respect to the estimatedcosts identified in the Risk Managementnotice of proposed rulemaking,287 MGEX noted that the Commission hadestimated the total hours for theproposed collection of information to be50 hours per year per respondent for theadditional reporting requirements at anannual cost of $500 per respondent (50

hours × $10). MGEX stated its belief thatthese estimates, both in hours and cost,are extremely low, and that it did notappear that the Commission hadaccounted for the costs to implement a

system; collect, forward and formatdata; monitor and enforce compliance;and document compliance with theproposed rulemaking. MGEX noted thatthe costs are not limited to reporting tothe Commission for many of theproposed rules, and that reporting may

be the least expensive facet. MGEXspecifically identified reporting the

gross position of each beneficial owneras a requirement for which theCommission did not provide any costestimates.

Although MGEX commented that thecosts of the proposed requirements may

be greater than the costs theCommission set forth in the InformationManagement and Risk Managementproposed rulemakings, and that theCommission did not estimate the costsof building reporting methods, forms,programs, or the allocation of laborresources, MGEX did not provide anestimate of these costs. Nor did MGEX

suggest alternative reportingrequirements that would achieve thepurposes of the CEA with a morefavorable cost-benefit ratio.

As to the estimated costs of therequired format and method of delivery,the Commission notes that the estimatesof these costs were based on the cost of using the SHAMIS system. There wasno basis for concluding that the cost of using an alternative system would bemore substantial and the Commissionreceived no comment to that effect.Moreover, Core Principle J requires aDCO to provide reports to theCommission, and all DCOs will have to

bear these costs in order to comply withCore Principle J. Core Principle Jrequires each DCO ‘‘to provide to theCommission all information that theCommission determines to be necessaryto conduct oversight of the [DCO].’’ Asdiscussed above and in the InformationManagement proposed rulemaking, theCommission believes that the daily andannual reporting requirements providethe Commission with information that isimportant to its oversight of a DCO toensure the DCO is in compliance withthe core principles. This can lead toincreased market participation and

improve legitimate risk managementand hedging activity. Accordingly, theCommission believes the collection of information related to the reportingrules is necessary to achieve thepurposes of the CEA, particularly inlight of the Dodd-Frank Act clearingmandate for swaps.288

The Commission has considered thecomments of NYPC and MGEX but is

declining to revise the estimated costs.The Commission believes that itsoriginal estimates remain appropriatefor PRA purposes.

List of Subjects

17 CFR Part 1

Brokers, Commodity futures,

Consumer protection, Definitions,Swaps.

17 CFR Part 21

Brokers, Commodity futures,Reporting and recordkeepingrequirements.

17 CFR Part 39

Definitions, Commodity futures,Reporting and recordkeepingrequirements, Swaps, Business andindustry, Participant and producteligibility, Risk management, Settlementprocedures, Treatment of funds, Defaultrules and procedures, System

safeguards, Enforcement authority,Application form.

17 CFR Part 140

Authority delegations (Governmentagencies), Conflict of interests,Organization and functions(Government agencies).

For the reasons stated in thepreamble, amend 17 CFR parts 1, 21, 39,and 140 as follows:

PART 1—GENERAL REGULATIONSUNDER THE COMMODITY EXCHANGEACT

■ 1. The authority citation for part 1 isrevised to read as follows:

Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c,6d, 6e, 6f, 6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o,6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a, 13a–1,16, 16a, 19, 21, 23, and 24, as amended byPub. L. 111–203, 124 Stat. 1376.

■ 2. Amend §1.3 to revise paragraphs(c) and (d), remove and reserveparagraph (k), and add paragraphs (aaa),(bbb), (ccc), (ddd), (eee), and (fff) to readas follows:

§1.3 Definitions.

* * * * *(c) Clearing member. This term meansany person that has clearing privilegessuch that it can process, clear and settletrades through a derivatives clearingorganization on behalf of itself or others.The derivatives clearing organizationneed not be organized as a membershiporganization.

(d) Clearing organization or derivatives clearing organization. Thisterm means a clearinghouse, clearingassociation, clearing corporation, orsimilar entity, facility, system, or





organization that, with respect to anagreement, contract, or transaction—

(1) Enables each party to theagreement, contract, or transaction tosubstitute, through novation orotherwise, the credit of the derivativesclearing organization for the credit of the parties;

(2) Arranges or provides, on a

multilateral basis, for the settlement ornetting of obligations resulting fromsuch agreements, contracts, ortransactions executed by participants inthe derivatives clearing organization; or

(3) Otherwise provides clearingservices or arrangements that mutualizeor transfer among participants in thederivatives clearing organization thecredit risk arising from such agreements,contracts, or transactions executed bythe participants.

(4) Exclusions. The terms clearingorganization and derivatives clearingorganization do not include an entity,facility, system, or organization solely

because it arranges or provides for—(i) Settlement, netting, or novation of

obligations resulting from agreements,contracts or transactions, on a bilateral

basis and without a centralcounterparty;

(ii) Settlement or netting of cashpayments through an interbank paymentsystem; or

(iii) Settlement, netting, or novation of obligations resulting from a sale of acommodity in a transaction in the spotmarket for the commodity.

* * * * *(k) [Reserved]

* * * * *(aaa) Clearing initial margin. This

term means initial margin posted by aclearing member with a derivativesclearing organization.

(bbb) Customer initial margin. Thisterm means initial margin posted by acustomer with a futures commissionmerchant, or by a non-clearing memberfutures commission merchant with aclearing member.

(ccc) Initial margin. This term meansmoney, securities, or property posted bya party to a futures, option, or swap asperformance bond to cover potential

future exposures arising from changes inthe market value of the position.(ddd) Margin call. This term means a

request from a futures commissionmerchant to a customer to post customerinitial margin; or a request by aderivatives clearing organization to aclearing member to post clearing initialmargin or variation margin.

(eee) Spread margin. This term meansreduced initial margin that takes intoaccount correlations between certainrelated positions held in a singleaccount.

(fff) Variation margin. This termmeans a payment made by a party to afutures, option, or swap to cover thecurrent exposure arising from changesin the market value of the position sincethe trade was executed or the previoustime the position was marked to market.

■ 3. Amend §1.12 to remove and

reserve paragraph (f)(1).PART 21—SPECIAL CALLS

■ 4. The authority citation for part 21 isrevised to read as follows:

Authority: 7 U.S.C. 1a, 2, 2a, 4, 6a, 6c, 6f,6g, 6i, 6k, 6m, 6n, 7, 7a, 12a, 19 and 21, asamended by Pub. L. 111–203, 124 Stat. 1376;5 U.S.C. 552 and 552(b), unless otherwisenoted.

■ 5. Redesignate §21.04 as §21.05.■ 6. Add a new § 21.04 to read asfollows:

§ 21.04 Special calls for information on

customer accounts or related clearedpositions.

Upon special call by the Commission,each futures commission merchant,clearing member or foreign broker shallprovide information to the Commissionconcerning customer accounts or relatedpositions cleared on a derivativesclearing organization in the format andmanner and within the time provided

by the Commission in the special call.

■ 7. Add §21.06 to read as follows:

§ 21.06 Delegation of authority to theDirector of the Division of Clearing and

Risk.The Commission hereby delegates,

until the Commission orders otherwise,the special call authority set forth in§ 21.04 to the Director of the Division of Clearing and Risk to be exercised bysuch Director or by such other employeeor employees of such Director asdesignated from time to time by theDirector. The Director of the Division of Clearing and Risk may submit to theCommission for its consideration anymatter which has been delegated in thissection. Nothing in this section shall bedeemed to prohibit the Commission, at

its election, from exercising theauthority delegated in this section to theDirector.

PART 39—DERIVATIVES CLEARINGORGANIZATIONS

■ 8. Revise part 39 to read as follows:

Subpart A—General Provisions Applicableto Derivatives Clearing Organizations

Sec.39.1 Scope.39.2 Definitions.39.3 Procedures for registration.

39.4 Procedures for implementingderivatives clearing organization rulesand clearing new products.

39.5 Submission of swaps for Commissiondetermination regarding clearingrequirements.

39.6 [Reserved]39.7 Enforceability.39.8 Fraud in connection with the clearing

of transactions on a derivatives clearing

organization.Subpart B—Compliance With CorePrinciples

39.9 Scope.39.10 Compliance with core principles.39.11 Financial resources.39.12 Participant and product eligibility.39.13 Risk management.39.14 Settlement procedures.39.15 Treatment of funds.39.16 Default rules and procedures.39.17 Rule enforcement.39.18 System safeguards.39.19 Reporting.39.20 Recordkeeping.39.21 Public information.

39.22 Information sharing.39.23 Antitrust considerations.39.24 [Reserved]39.25 [Reserved]39.26 [Reserved]39.27 Legal risk considerations.

Appendix A to Part 39—Form DCODerivatives Clearing OrganizationApplication for Registrations

Authority: 7 U.S.C. 7a–1 as amended byPub. L. 111–203, 124 Stat. 1376.

Subpart A—General ProvisionsApplicable to Derivatives ClearingOrganizations

§39.1 Scope.

The provisions of this subpart Aapply to any derivatives clearingorganization as defined under section1a(15) of the Act and § 1.3(d) of thischapter which is registered or deemedto be registered with the Commission asa derivatives clearing organization, isrequired to register as such with theCommission pursuant to section 5b(a) of the Act, or which voluntarily applies toregister as such with the Commissionpursuant to section 5b(b) or otherwise.

§39.2 Definitions.

For the purposes of this part,Back test means a test that compares

a derivatives clearing organization’sinitial margin requirements withhistorical price changes to determinethe extent of actual margin coverage.

Customer means a person trading inany commodity named in the definitionof commodity in section 1a(9) of the Actor in § 1.3 of this chapter, or in anyswap as defined in section 1a(47) of theAct or in §1.3 of this chapter; Provided,however, an owner or holder of a house





account as defined in this section shallnot be deemed to be a customer withinthe meaning of section 4d of the Act, theregulations that implement sections 4dand 4f of the Act and § 1.35, and suchan owner or holder of such a houseaccount shall otherwise be deemed to bea customer within the meaning of theAct and §§1.37 and 1.46 of this chapter

and all other sections of these rules,regulations, and orders which do notimplement sections 4d and 4f of the Act.

Customer account or customer originmeans a clearing member account heldon behalf of customers, as that term isdefined in this section, and which issubject to section 4d(a) or section 4d(f)of the Act.

House account or house origin meansa clearing member account which is notsubject to section 4d(a) or 4d(f) of theAct.

Key personnel means derivativesclearing organization personnel who

play a significant role in the operationsof the derivatives clearing organization,the provision of clearing and settlementservices, risk management, or oversightof compliance with the Act andCommission regulations and orders. Keypersonnel include, but are not limitedto, those persons who are or perform thefunctions of any of the following: chief executive officer; president; chief compliance officer; chief operatingofficer; chief risk officer; chief financialofficer; chief technology officer; andemergency contacts or persons who areresponsible for business continuity ordisaster recovery planning or program

execution.Stress test means a test that compares

the impact of potential extreme pricemoves, changes in option volatility,and/or changes in other inputs thataffect the value of a position, to thefinancial resources of a derivativesclearing organization, clearing member,or large trader, to determine theadequacy of such financial resources.

Systemically important derivativesclearing organization means a financialmarket utility that is a derivativesclearing organization registered undersection 5b of the Act, which has been

designated by the Financial StabilityOversight Council to be systemicallyimportant and for which theCommission acts as the SupervisoryAgency pursuant to section 803(8) of theDodd-Frank Wall Street Reform andConsumer Protection Act.

§ 39.3 Procedures for registration.

(a) Application procedures. (1) Anorganization desiring to be registered asa derivatives clearing organization shallfile electronically an application forregistration with the Secretary of the

Commission in the format and mannerspecified by the Commission. TheCommission will review the applicationfor registration as a derivatives clearingorganization pursuant to the 180-daytimeframe and procedures specified insection 6(a) of the Act. The Commissionmay approve or deny the application or,if deemed appropriate, register the

applicant as a derivatives clearingorganization subject to conditions.

(2) Application. Any person seekingto register as a derivatives clearingorganization, any applicant amendingits pending application, or anyregistered derivatives clearingorganization seeking to amend its orderof registration (applicant), shall submitto the Commission a completed FormDCO, which shall include a cover sheet,all applicable exhibits, and anysupplemental materials, includingamendments thereto, as provided in theappendix to this part 39 (application).

An applicant, when filing a Form DCOfor purposes of amending its pendingapplication or requesting an amendmentto an existing registration, is onlyrequired to submit exhibits and updatedinformation that are relevant to therequested amendment and are necessaryto demonstrate compliance with thecore principles affected by the requestedamendment. The Commission will notcommence processing an applicationunless the applicant has filed theapplication as required by this section.Failure to file a completed applicationwill preclude the Commission fromdetermining that an application is

materially complete, as provided insection 6(a) of the Act. Upon its owninitiative, an applicant may file with itscompleted application additionalinformation that may be necessary orhelpful to the Commission in processingthe application.

(3) Submission of supplemental information. The filing of a completedapplication is a minimum requirementand does not create a presumption thatthe application is materially complete orthat supplemental information will not

be required. At any time during theapplication review process, the

Commission may request that theapplicant submit supplementalinformation in order for the Commissionto process the application. Theapplicant shall file electronically suchsupplemental information with theSecretary of the Commission in theformat and manner specified by theCommission.

(4) Application amendments. Anapplicant shall promptly amend itsapplication if it discovers a materialomission or error, or if there is amaterial change in the information

provided to the Commission in theapplication or other informationprovided in connection with theapplication.

(5) Public information. The followingsections of all applications to become aregistered derivatives clearingorganization will be public: first page of the Form DCO cover sheet, proposed

rules, regulatory compliance chart,narrative summary of proposed clearingactivities, documents establishing theapplicant’s legal status, documentssetting forth the applicant’s corporateand governance structure, and any otherpart of the application not covered by arequest for confidential treatment,subject to §145.9 of this chapter.

(b) Stay of application review. (1) TheCommission may stay the running of the180-day review period if an applicationis materially incomplete, in accordancewith section 6(a) of the Act.

(2) Delegation of authority. (i) TheCommission hereby delegates, until itorders otherwise, to the Director of theDivision of Clearing and Risk or theDirector’s designee, with theconcurrence of the General Counsel orthe General Counsel’s designee, theauthority to notify an applicant seekingdesignation under section 6(a) of the Actthat the application is materiallyincomplete and the running of the 180-day period is stayed.

(ii) The Director of the Division of Clearing and Risk may submit to theCommission for its consideration anymatter which has been delegated in thisparagraph.

(iii) Nothing in this paragraphprohibits the Commission, at itselection, from exercising the authoritydelegated in paragraph (b)(2)(i) of thissection.

(c) Withdrawal of application for registration. An applicant forregistration may withdraw itsapplication submitted pursuant toparagraph (a) of this section by filingelectronically such a request with theSecretary of the Commission in theformat and manner specified by theCommission. Withdrawal of anapplication for registration shall not

affect any action taken or to be taken bythe Commission based upon actions,activities, or events occurring during thetime that the application for registrationwas pending with the Commission.

(d) Reinstatement of dormant registration. Before listing or relistingproducts for clearing, a dormantregistered derivatives clearingorganization as defined in § 40.1 of thischapter must reinstate its registrationunder the procedures of paragraph (a) of this section; provided, however, that anapplication for reinstatement may rely





upon previously submitted materialsthat still pertain to, and accuratelydescribe, current conditions.

(e) Request for vacation of registration. A registered derivativesclearing organization may vacate itsregistration under section 7 of the Act

by filing electronically such a requestwith the Secretary of the Commission in

the format and manner specified by theCommission. Vacation of registrationshall not affect any action taken or to betaken by the Commission based uponactions, activities or events occurringduring the time that the entity wasregistered by the Commission.

(f) Request for transfer of registrationand open interest. (1) In anticipation of a corporate change that will result in thetransfer of all or substantially all of aderivatives clearing organization’s assetsto another legal entity, the derivativesclearing organization shall submit arequest for approval to transfer the

derivatives clearing organization’sregistration and positions comprisingopen interest for clearing andsettlement.

(2) Timing of submission and other procedural requirements. (i) The requestshall be submitted no later than threemonths prior to the anticipatedcorporate change, or as otherwisepermitted under § 39.19(c)(4)(viii)(C) of this part.

(ii) The derivatives clearingorganization shall submit a request fortransfer by filing electronically such arequest with the Secretary of the

Commission in the format and mannerspecified by the Commission.(iii) The derivatives clearing

organization shall submit a confirmationof change report pursuant to§ 39.19(c)(4)(viii)(D) of this part.

(3) Required information. The requestshall include the following:

(i) The underlying agreement thatgoverns the corporate change;

(ii) A narrative description of thecorporate change, including the reasonfor the change and its impact on thederivatives clearing organization’sfinancial resources, governance, andoperations, and its impact on the rightsand obligations of clearing members andmarket participants holding thepositions that comprise the derivativesclearing organization’s open interest;

(iii) A discussion of the transferee’sability to comply with the Act,including the core principles applicableto derivatives clearing organizations,and the Commission’s regulationsthereunder;

(iv) The governing documents of thetransferee, including but not limited toarticles of incorporation and bylaws;

(v) The transferee’s rules marked toshow changes from the current rules of the derivatives clearing organization;

(vi) A list of products for which thederivatives clearing organizationrequests transfer of open interest;

(vii) A representation by thederivatives clearing organization that itis in compliance with the Act, includingthe core principles applicable toderivatives clearing organizations, andthe Commission’s regulationsthereunder; and

(viii) A representation by thetransferee that it understands that thederivatives clearing organization is aregulated entity that must comply withthe Act, including the core principlesapplicable to derivatives clearingorganizations, and the Commission’sregulations thereunder, in order tomaintain its registration as a derivativesclearing organization; and further, thatthe transferee will continue to comply

with all self-regulatory requirementsapplicable to a derivatives clearingorganization under the Act and theCommission’s regulations thereunder.

(4) Commission determination. TheCommission will review a request assoon as practicable, and based on theCommission’s determination as to thetransferee’s ability to continue tooperate the derivatives clearingorganization in compliance with the Actand the Commission’s regulationsthereunder, such request will beapproved or denied pursuant to aCommission order.

§ 39.4 Procedures for implementingderivatives clearing organization rules andclearing new products.

(a) Request for approval of rules. Anapplicant for registration, or a registeredderivatives clearing organization, mayrequest, pursuant to the procedures of § 40.5 of this chapter, that theCommission approve any or all of itsrules and subsequent amendmentsthereto, including operational rules,prior to their implementation or,notwithstanding the provisions of section 5c(c)(2) of the Act, at any timethereafter, under the procedures of § 40.5 of this chapter. A derivativesclearing organization may label as,‘‘Approved by the Commission,’’ onlythose rules that have been so approved.

(b) Self-certification of rules. Proposednew or amended rules of a derivativesclearing organization not voluntarilysubmitted for prior Commissionapproval pursuant to paragraph (a) of this section must be submitted to theCommission with a certification that theproposed new rule or rule amendmentcomplies with the Act and rules

thereunder pursuant to the proceduresof §40.6 of this chapter.

(c) Acceptance of new products for clearing. (1) A dormant derivativesclearing organization within themeaning of §40.1 of this chapter maynot accept for clearing a new productuntil its registration as a derivativesclearing organization is reinstated under

the procedures of §39.3 of this part;provided however, that an applicationfor reinstatement may rely uponpreviously submitted materials that stillpertain to, and accurately describe,current conditions.

(2) A derivatives clearing organizationthat accepts for clearing a new productthat is a swap shall comply with therequirements of §39.5 of this part.

(d) Orders regarding competition. Anapplicant for registration or a registeredderivatives clearing organization mayrequest that the Commission issue anorder concerning whether a rule or

practice of the organization is the leastanticompetitive means of achieving theobjectives, purposes, and policies of theAct.

(e) Holding securities in a futures portfolio margining account. Aderivatives clearing organizationseeking to provide a portfolio marginingprogram under which securities would

be held in a futures account as definedin §1.3(vv) of this chapter, shall submitrules to implement such portfoliomargining program for Commissionapproval in accordance with § 40.5 of this chapter. Concurrent with thesubmission of such rules for

Commission approval, the derivativesclearing organization shall petition theCommission for an order under section4d of the Act.

§ 39.5 Review of swaps for Commissiondetermination on clearing requirement.

(a) Eligibility to clear swaps. (1) Aderivatives clearing organization shall

be presumed eligible to accept forclearing any swap that is within agroup, category, type, or class of swapsthat the derivatives clearingorganization already clears. Suchpresumption of eligibility, however, is

subject to review by the Commission.(2) A derivatives clearing organizationthat wishes to accept for clearing anyswap that is not within a group,category, type, or class of swaps that thederivatives clearing organization alreadyclears shall request a determination bythe Commission of the derivativesclearing organization’s eligibility toclear such a swap before accepting theswap for clearing. The request, whichshall be filed electronically with theSecretary of the Commission, shalladdress the derivatives clearing





organization’s ability, if it accepts theswap for clearing, to maintaincompliance with section 5b(c)(2) of theAct, specifically:

(i) The sufficiency of the derivativesclearing organization’s financialresources; and

(ii) The derivative clearingorganization’s ability to manage the

risks associated with clearing the swap,especially if the Commission determinesthat the swap is required to be cleared.

(b) Swap submissions. (1) Aderivatives clearing organization shallsubmit to the Commission each swap, orany group, category, type, or class of swaps that it plans to accept forclearing. The derivatives clearingorganization making the submissionmust be eligible under paragraph (a) of this section to accept for clearing thesubmitted swap, or group, category,type, or class of swaps.

(2) A derivatives clearing organization

shall submit swaps to the Commission,to the extent reasonable and practicableto do so, by group, category, type, orclass of swaps. The Commission may inits reasonable discretion consolidatemultiple submissions from onederivatives clearing organization orsubdivide a derivatives clearingorganization’s submission asappropriate for review.

(3) The submission shall be filedelectronically with the Secretary of theCommission and shall include:

(i) A statement that the derivativesclearing organization is eligible toaccept the swap, or group, category,

type, or class of swaps for clearing anddescribes the extent to which, if theCommission were to determine that theswap, or group, category, type, or classof swaps is required to be cleared, thederivatives clearing organization will beable to maintain compliance withsection 5b(c)(2) of the Act;

(ii) A statement that includes, but isnot limited to, information that willassist the Commission in making aquantitative and qualitative assessmentof the following factors:

(A) The existence of significantoutstanding notional exposures, trading

liquidity, and adequate pricing data;(B) The availability of rule framework,capacity, operational expertise andresources, and credit supportinfrastructure to clear the contract onterms that are consistent with thematerial terms and trading conventionson which the contract is then traded;

(C) The effect on the mitigation of systemic risk, taking into account thesize of the market for such contract andthe resources of the derivatives clearingorganization available to clear thecontract;

(D) The effect on competition,including appropriate fees and chargesapplied to clearing; and

(E) The existence of reasonable legalcertainty in the event of the insolvencyof the relevant derivatives clearingorganization or one or more of itsclearing members with regard to thetreatment of customer and swap

counterparty positions, funds, andproperty;

(iii) Product specifications, includingcopies of any standardized legaldocumentation, generally acceptedcontract terms, standard practices formanaging any life cycle eventsassociated with the swap, and the extentto which the swap is electronicallyconfirmable;

(iv) Participant eligibility standards, if different from the derivatives clearingorganization’s general participanteligibility standards;

(v) Pricing sources, models, and

procedures, demonstrating an ability toobtain sufficient price data to measurecredit exposures in a timely andaccurate manner, including anyagreements with clearing members toprovide price data and copies of executed agreements with third-partyprice vendors, and information aboutany price reference index used, such asthe name of the index, the source thatcalculates it, the methodology used tocalculate the price reference index andhow often it is calculated, and whenand where it is published publicly;

(vi) Risk management procedures,including measurement and monitoring

of credit exposures, initial and variationmargin methodology, methodologies forstress testing and back testing,settlement procedures, and defaultmanagement procedures;

(vii) Applicable rules, manuals,policies, or procedures;

(viii) A description of the manner inwhich the derivatives clearingorganization has provided notice of thesubmission to its members and asummary of any views on thesubmission expressed by the members(a copy of the notice to members shall

be included with the submission); and

(ix) Any additional informationspecifically requested by theCommission.

(4) The Commission must havereceived the submission by the open of

business on the business day precedingthe acceptance of the swap, or group,category, type, or class of swaps forclearing.

(5) The submission will be madeavailable to the public and posted onthe Commission Web site for a 30-daypublic comment period. A derivativesclearing organization that wishes to

request confidential treatment forportions of its submission may do so inaccordance with the procedures set outin §145.9(d) of this chapter.

(6) The Commission will review thesubmission and determine whether theswap, or group, category, type, or classof swaps described in the submission isrequired to be cleared. The Commission

will make its determination not laterthan 90 days after a completesubmission has been received, unlessthe submitting derivatives clearingorganization agrees to an extension. Thedetermination of when such submissionis complete shall be at the solediscretion of the Commission. In makinga determination that a clearingrequirement shall apply, theCommission may impose such termsand conditions to the clearingrequirement as the Commissiondetermines to be appropriate.

(c) Commission-initiated reviews. (1)

The Commission, on an ongoing basis,will review swaps that have not beenaccepted for clearing by a derivativesclearing organization to make adetermination as to whether the swapsshould be required to be cleared. Inundertaking such reviews, theCommission will use informationobtained pursuant to Commissionregulations from swap data repositories,swap dealers, and major swapparticipants, and any other availableinformation.

(2) Notice regarding anydetermination made under paragraph(c)(1) of this section will be made

available to the public and posted onthe Commission Web site for a 30-daypublic comment period.

(3) If no derivatives clearingorganization has accepted for clearing aparticular swap, group, category, type,or class of swaps that the Commissionfinds would otherwise be subject to aclearing requirement, the Commissionwill:

(i) Investigate the relevant facts andcircumstances;

(ii) Within 30 days of the completionof its investigation, issue a public reportcontaining the results of the

investigation; and(iii) Take such actions as theCommission determines to be necessaryand in the public interest, which mayinclude requiring the retaining of adequate margin or capital by parties tothe swap, group, category, type, or classof swaps.

(d) Stay of clearing requirement. (1)After making a determination that aswap, or group, category, type, or classof swaps is required to be cleared, theCommission, on application of acounterparty to a swap or on its own





initiative, may stay the clearingrequirement until the Commissioncompletes a review of the terms of theswap, or group, category, type, or classof swaps and the clearing arrangement.

(2) A counterparty to a swap thatwishes to apply for a stay of the clearingrequirement for that swap shall submita written request to the Secretary of the

Commission that includes:(i) The identity and contact

information of the counterparty to theswap;

(ii) The terms of the swap subject tothe clearing requirement;

(iii) The name of the derivativesclearing organization clearing the swap;

(iv) A description of the clearingarrangement; and

(v) A statement explaining why theswap should not be subject to a clearingrequirement.

(3) A derivatives clearing organizationthat has accepted for clearing a swap, or

group, category, type, or class of swapsthat is subject to a stay of the clearingrequirement shall provide anyinformation requested by theCommission in the course of its review.

(4) The Commission will complete itsreview not later than 90 days afterissuance of the stay, unless thederivatives clearing organization thatclears the swap, or group, category,type, or class of swaps agrees to anextension.

(5) Upon completion of its review, theCommission may:

(i) Determine, subject to any termsand conditions as the Commissiondetermines to be appropriate, that theswap, or group, category, type, or classof swaps must be cleared; or

(ii) Determine that the clearingrequirement will not apply to the swap,or group, category, type, or class of swaps, but clearing may continue on anon-mandatory basis.

§39.6 [Reserved]

§ 39.7 Enforceability.

An agreement, contract or transactionsubmitted to a derivatives clearingorganization for clearing shall not be

void, voidable, subject to rescission, orotherwise invalidated or renderedunenforceable as a result of:

(a) A violation by the derivativesclearing organization of the provisionsof the Act or of Commission regulations;or

(b) Any Commission proceeding toalter or supplement a rule under section8a(7) of the Act, to declare anemergency under section 8a(9) of theAct, or any other proceeding the effectof which is to alter, supplement, orrequire a derivatives clearing

organization to adopt a specific rule orprocedure, or to take or refrain fromtaking a specific action.

§ 39.8 Fraud in connection with theclearing of transactions on a derivativesclearing organization.

It shall be unlawful for any person,directly or indirectly, in or in

connection with the clearing of transactions by a derivatives clearingorganization:

(a) To cheat or defraud or attempt tocheat or defraud any person;

(b) Willfully to make or cause to bemade to any person any false report orstatement or cause to be entered for anyperson any false record; or

(c) Willfully to deceive or attempt todeceive any person by any meanswhatsoever.

Subpart B—Compliance with CorePrinciples

§39.9 Scope.The provisions of this subpart B apply

to any derivatives clearing organization,as defined under section 1a(15) of theAct and §1.3(d) of this chapter, whichis registered or deemed to be registeredwith the Commission as a derivativesclearing organization, is required toregister as such with the Commissionpursuant to section 5b(a) of the Act, orwhich voluntarily registers as such withthe Commission pursuant to section5b(b) or otherwise.

§ 39.10 Compliance with core principles.

(a) To be registered and to maintainregistration as a derivatives clearingorganization, a derivatives clearingorganization shall comply with eachcore principle set forth in section5b(c)(2) of the Act and any requirementthat the Commission may impose byrule or regulation pursuant to section8a(5) of the Act; and

(b) Subject to any rule or regulationprescribed by the Commission, aregistered derivatives clearingorganization shall have reasonablediscretion in establishing the manner bywhich it complies with each coreprinciple.

(c) Chief compliance officer —(1)Designation. Each derivatives clearingorganization shall establish the positionof chief compliance officer, designate anindividual to serve as the chief compliance officer, and provide thechief compliance officer with the fullresponsibility and authority to developand enforce, in consultation with the

board of directors or the senior officer,appropriate compliance policies andprocedures, to fulfill the duties set forthin the Act and Commission regulations.

(i) The individual designated to serveas chief compliance officer shall havethe background and skills appropriatefor fulfilling the responsibilities of theposition. No individual who would bedisqualified from registration undersections 8a(2) or 8a(3) of the Act mayserve as a chief compliance officer.

(ii) The chief compliance officer shall

report to the board of directors or thesenior officer of the derivatives clearingorganization. The board of directors orthe senior officer shall approve thecompensation of the chief complianceofficer.

(iii) The chief compliance officer shallmeet with the board of directors or thesenior officer at least once a year.

(iv) A change in the designation of theindividual serving as the chief compliance officer of the derivativesclearing organization shall be reportedto the Commission in accordance withthe requirements of § 39.19(c)(4)(ix) of

this part.(2) Chief compliance officer duties.The chief compliance officer’s dutiesshall include, but are not limited to:

(i) Reviewing the derivatives clearingorganization’s compliance with the coreprinciples set forth in section 5b of theAct, and the Commission’s regulationsthereunder;

(ii) In consultation with the board of directors or the senior officer, resolvingany conflicts of interest that may arise;

(iii) Establishing and administeringwritten policies and proceduresreasonably designed to prevent violationof the Act;

(iv) Taking reasonable steps to ensurecompliance with the Act andCommission regulations relating toagreements, contracts, or transactions,and with Commission regulationsprescribed under section 5b of the Act;

(v) Establishing procedures for theremediation of noncompliance issuesidentified by the chief complianceofficer through any compliance officereview, look-back, internal or externalaudit finding, self-reported error, orvalidated complaint; and

(vi) Establishing and followingappropriate procedures for the handling,

management response, remediation,retesting, and closing of noncomplianceissues.

(3) Annual report. The chief compliance officer shall, not less thanannually, prepare and sign a writtenreport that covers the most recentlycompleted fiscal year of the derivativesclearing organization, and provide theannual report to the board of directorsor the senior officer. The annual reportshall, at a minimum:

(i) Contain a description of thederivatives clearing organization’s





written policies and procedures,including the code of ethics and conflictof interest policies;

(ii) Review each core principle andapplicable Commission regulation, andwith respect to each:

(A) Identify the compliance policiesand procedures that are designed toensure compliance with the core

principle;(B) Provide an assessment as to the

effectiveness of these policies andprocedures;

(C) Discuss areas for improvement,and recommend potential or prospectivechanges or improvements to thederivatives clearing organization’scompliance program and resourcesallocated to compliance;

(iii) List any material changes tocompliance policies and proceduressince the last annual report;

(iv) Describe the financial,managerial, and operational resourcesset aside for compliance with the Actand Commission regulations; and

(v) Describe any material compliancematters, including incidents of noncompliance, since the date of thelast annual report and describe thecorresponding action taken.

(4) Submission of annual report to theCommission. (i) Prior to submitting theannual report to the Commission, thechief compliance officer shall providethe annual report to the board of directors or the senior officer of thederivatives clearing organization forreview. Submission of the report to the

board of directors or the senior officer

shall be recorded in the board minutesor otherwise, as evidence of compliancewith this requirement.

(ii) The annual report shall besubmitted electronically to the Secretaryof the Commission in the format andmanner specified by the Commissionnot more than 90 days after the end of the derivatives clearing organization’sfiscal year, concurrently withsubmission of the fiscal year-endaudited financial statement that isrequired to be furnished to theCommission pursuant to §39.19(c)(3)(ii)of this part. The report shall include a

certification by the chief complianceofficer that, to the best of his or herknowledge and reasonable belief, andunder penalty of law, the annual reportis accurate and complete.

(iii) The derivatives clearingorganization shall promptly submit anamended annual report if material errorsor omissions in the report are identifiedafter submission. An amendment mustcontain the certification required underparagraph (c)(4)(ii) of this section.

(iv) A derivatives clearingorganization may request from the

Commission an extension of time tosubmit its annual report in accordancewith §39.19(c)(3) of this part.

(5) Recordkeeping. (i) The derivativesclearing organization shall maintain:

(A) A copy of all compliance policiesand procedures and all other policiesand procedures adopted in furtheranceof compliance with the Act and

Commission regulations;(B) Copies of materials, including

written reports provided to the board of directors or the senior officer inconnection with the review of theannual report under paragraph (c)(4)(i)of this section; and

(C) Any records relevant to the annualreport, including, but not limited to,work papers and other documents thatform the basis of the report, andmemoranda, correspondence, otherdocuments, and records that are created,sent, or received in connection with theannual report and contain conclusions,

opinions, analyses, or financial datarelated to the annual report.(ii) The derivatives clearing

organization shall maintain records inaccordance with §1.31 of this chapterand §39.20 of this part.

§ 39.11 Financial resources.

(a) General. A derivatives clearingorganization shall maintain financialresources sufficient to cover itsexposures with a high degree of confidence and to enable it to performits functions in compliance with thecore principles set out in section 5b of the Act. A derivatives clearing

organization shall identify andadequately manage its general businessrisks and hold sufficient liquidresources to cover potential businesslosses that are not related to clearingmembers’ defaults, so that thederivatives clearing organization cancontinue to provide services as anongoing concern. Financial resourcesshall be considered sufficient if theirvalue, at a minimum, exceeds the totalamount that would:

(1) Enable the derivatives clearingorganization to meet its financialobligations to its clearing members

notwithstanding a default by theclearing member creating the largestfinancial exposure for the derivativesclearing organization in extreme butplausible market conditions; Providedthat if a clearing member controlsanother clearing member or is undercommon control with another clearingmember, the affiliated clearing membersshall be deemed to be a single clearingmember for purposes of this provision;and

(2) Enable the derivatives clearingorganization 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 satisfythe requirements of paragraph (a)(1) of this section may include:

(i) Margin to the extent permittedunder parts 1, 22, and 190 of thischapter and under the rules of the

derivatives clearing organization;(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 clearingorganization’s rules; and

(vi) Any other financial resourcedeemed acceptable by the Commission.

(2) Financial resources available tosatisfy the requirements of paragraph(a)(2) of this section 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 satisfythe requirements of either paragraph(a)(1) or paragraph (a)(2) of this section,

but not both paragraphs, and only to theextent the use of such financial resourceis not otherwise limited by the Act,Commission regulations, the derivativesclearing organization’s rules, or anycontractual arrangements to which thederivatives clearing organization is aparty.

(c) Computation of financial resourcesrequirement. (1) A derivatives clearingorganization shall, on a monthly basis,perform stress testing that will allow itto make a reasonable calculation of thefinancial resources needed to meet therequirements of paragraph (a)(1) of thissection. The derivatives clearingorganization shall have reasonablediscretion in determining themethodology used to compute suchrequirements, provided that themethodology must take into account

both historical data and hypotheticalscenarios. The Commission may reviewthe methodology and require changes asappropriate.

(2) A derivatives clearing organizationshall, on a monthly basis, make areasonable calculation of its projectedoperating costs over a 12-month periodin order to determine the amountneeded to meet the requirements of paragraph (a)(2) of this section. Thederivatives clearing organization shallhave reasonable discretion indetermining the methodology used tocompute such projected operating costs.The Commission may review the





methodology and require changes asappropriate.

(d) Valuation of financial resources.(1) At appropriate intervals, but not lessthan monthly, a derivatives clearingorganization shall compute the currentmarket value of each financial resourceused to meet its obligations underparagraph (a) of this section. Reductions

in value to reflect credit, market, andliquidity risks (haircuts) shall beapplied as appropriate and evaluated ona monthly basis.

(2) If assessments for additionalguaranty fund contributions arepermitted by the derivatives clearingorganization’s rules, in calculating thefinancial resources available to meet itsobligations under paragraph (a)(1) of this section:

(i) The derivatives clearingorganization shall have rules requiringthat its clearing members have theability to meet an assessment within the

time frame of a normal end-of-dayvariation settlement cycle;

(ii) The derivatives clearingorganization shall monitor the financialand operational capacity of its clearingmembers to meet potential assessments;

(iii) The derivatives clearingorganization shall apply a 30 percenthaircut to the value of potentialassessments, and

(iv) The derivatives clearingorganization shall only count the valueof assessments, after the haircut, to meetup to 20 percent of those obligations.

(e) Liquidity of financial resources. (1)(i) The derivatives clearing organizationshall effectively measure, monitor, andmanage its liquidity risks, maintainingsufficient liquid resources such that itcan, at a minimum, fulfill its cashobligations when due. The derivativesclearing organization shall hold assetsin a manner where the risk of loss or of delay in its access to them is minimized.

(ii) The financial resources allocated by the derivatives clearing organizationto meet the requirements of paragraph(a)(1) of this section shall be sufficientlyliquid to enable the derivatives clearingorganization to fulfill its obligations as

a central counterparty during a one-daysettlement cycle. The derivativesclearing organization shall maintaincash, U.S. Treasury obligations, or highquality, liquid, general obligations of asovereign nation, in an amount greaterthan or equal to an amount calculatedas follows:

(A) Calculate the average dailysettlement pay for each clearing memberover the last fiscal quarter;

(B) Calculate the sum of those averagedaily settlement pays; and

(C) Using that sum, calculate theaverage of its clearing members’ averagepays.

(iii) The derivatives clearingorganization may take into account acommitted line of credit or similarfacility for the purpose of meeting theremainder of the requirement underparagraph (e)(1)(ii) of this section.

(2) The financial resources allocated by the derivatives clearing organizationto meet the requirements of paragraph(a)(2) of this section must includeunencumbered, liquid financial assets(i.e., cash and/or highly liquidsecurities) equal to at least six months’operating costs. If any portion of suchfinancial resources is not sufficientlyliquid, the derivatives clearingorganization may take into account acommitted line of credit or similarfacility for the purpose of meeting thisrequirement.

(3)(i) Assets in a guaranty fund shall

have minimal credit, market, andliquidity risks and shall be readilyaccessible on a same-day basis;

(ii) Cash balances shall be invested orplaced 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 derivativesclearing 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 financialresource available, computed inaccordance with the requirements of paragraph (d) of this section; and

(C) The manner in which thederivatives clearing organization meetsthe liquidity requirements of paragraph(e) of this section;

(ii) Provide the Commission with afinancial statement, including the

balance sheet, income statement, andstatement of cash flows, of thederivatives clearing organization or of its parent company; and

(iii) Report to the Commission the

value of each individual clearingmember’s guaranty fund deposit, if thederivatives clearing organization reportshaving guaranty funds deposits as afinancial resource available to satisfythe requirements of paragraph (a)(1) of this section.

(2) The calculations required by thisparagraph shall be made as of the last

business day of the derivatives clearingorganization’s fiscal quarter.

(3) The derivatives clearingorganization shall provide theCommission with:

(i) Sufficient documentationexplaining the methodology used tocompute its financial resourcesrequirements under paragraph (a) of thissection,

(ii) Sufficient documentationexplaining the basis for itsdeterminations regarding the valuationand liquidity requirements set forth in

paragraphs (d) and (e) of this section,and

(iii) Copies of any agreementsestablishing or amending a creditfacility, insurance coverage, or otherarrangement evidencing or otherwisesupporting the derivatives clearingorganization’s conclusions.

(4) The report shall be filed not laterthan 17 business days after the end of the derivatives clearing organization’sfiscal quarter, or at such later time as theCommission may permit, in itsdiscretion, upon request by thederivatives clearing organization.

§ 39.12 Participant and product eligibility.

(a) Participant eligibility. Aderivatives clearing organization shallestablish appropriate admission andcontinuing participation requirementsfor clearing members of the derivativesclearing organization that are objective,publicly disclosed, and risk-based.

(1) Fair and open access forparticipation. The participationrequirements shall permit fair and openaccess;

(i) A derivatives clearing organizationshall not adopt restrictive clearingmember standards if less restrictive

requirements that achieve the sameobjective and that would not materiallyincrease risk to the derivatives clearingorganization or clearing members could

be adopted;(ii) A derivatives clearing organization

shall allow all market participants whosatisfy participation requirements to

become clearing members;(iii) A derivatives clearing

organization shall not exclude or limitclearing membership of certain types of market participants unless thederivatives clearing organization candemonstrate that the restriction is

necessary to address credit risk ordeficiencies in the participants’operational capabilities that wouldprevent them from fulfilling theirobligations as clearing members.

(iv) A derivatives clearingorganization shall not require thatclearing members be swap dealers.

(v) A derivatives clearing organizationshall not require that clearing membersmaintain a swap portfolio of anyparticular size, or that clearing membersmeet a swap transaction volumethreshold.





(2) Financial resources. (i) Theparticipation requirements shall requireclearing members to have access tosufficient financial resources to meetobligations arising from participation inthe derivatives clearing organization inextreme but plausible marketconditions. A derivatives clearingorganization may permit such financial

resources to include, without limitation,a clearing member’s capital, a guaranteefrom the clearing member’s parent, or acredit facility funding arrangement. Forpurposes of this paragraph, ‘‘capital’’means adjusted net capital as defined in§ 1.17 of this chapter, for futurescommission merchants, and net capitalas defined in §240.15c3–1of this title,for broker-dealers, or any similar riskadjusted capital calculation for all otherclearing members.

(ii) The participation requirementsshall set forth capital requirements thatare based on objective, transparent, and

commonly accepted standards thatappropriately match capital to risk.Capital requirements shall be scalable tothe risks posed by clearing members.

(iii) A derivatives clearingorganization shall not set a minimumcapital requirement of more than $50million for any person that seeks to

become a clearing member in order toclear swaps.

(3) Operational requirements. Theparticipation requirements shall requireclearing members to have adequateoperational capacity to meet obligationsarising from participation in thederivatives clearing organization. The

requirements shall include, but are notlimited to: the ability to processexpected volumes and values of transactions cleared by a clearingmember within required time frames,including at peak times and on peakdays; the ability to fulfill collateral,payment, and delivery obligationsimposed by the derivatives clearingorganization; and the ability toparticipate in default managementactivities under the rules of thederivatives clearing organization and inaccordance with §39.16 of this part.

(4) Monitoring. A derivatives clearing

organization shall establish andimplement procedures to verify, on anongoing basis, the compliance of eachclearing member with each participationrequirement of the derivatives clearingorganization.

(5) Reporting. (i) A derivativesclearing organization shall require allclearing members, including non-futures commission merchants, toprovide to the derivatives clearingorganization periodic financial reportsthat contain any financial informationthat the derivatives clearing

organization determines is necessary toassess whether participationrequirements are being met on anongoing basis.

(A) A derivatives clearingorganization shall require clearingmembers that are futures commissionmerchants to provide the financialreports that are specified in § 1.10 of

this chapter to the derivatives clearingorganization.

(B) A derivatives clearing organizationshall require clearing members that arenot futures commission merchants tomake the periodic financial reportsprovided pursuant to paragraph (a)(5)(i)of this section available to theCommission upon the Commission’srequest or, in lieu of imposing thisrequirement, a derivatives clearingorganization may provide such financialreports directly to the Commission uponthe Commission’s request.

(ii) A derivatives clearing organization

shall adopt rules that require clearingmembers to provide to the derivativesclearing organization, in a timelymanner, information that concerns anyfinancial or business developments thatmay materially affect the clearingmembers’ ability to continue to complywith participation requirements.

(6) Enforcement. A derivativesclearing organization shall have theability to enforce compliance with itsparticipation requirements and shallestablish procedures for the suspensionand orderly removal of clearingmembers that no longer meet the

requirements.(b) Product eligibility. (1) Aderivatives clearing organization shallestablish appropriate requirements fordetermining the eligibility of agreements, contracts, or transactionssubmitted to the derivatives clearingorganization for clearing, taking intoaccount the derivatives clearingorganization’s ability to manage therisks associated with such agreements,contracts, or transactions. Factors to beconsidered in determining producteligibility include, but are not limitedto:

(i) Trading volume;(ii) Liquidity;(iii) Availability of reliable prices;(iv) Ability of market participants to

use portfolio compression with respectto a particular swap product;

(v) Ability of the derivatives clearingorganization and clearing members togain access to the relevant market forpurposes of creating, liquidating,transferring, auctioning, and/orallocating positions;

(vi) Ability of the derivatives clearingorganization to measure risk for

purposes of setting marginrequirements; and

(vii) Operational capacity of thederivatives clearing organization andclearing members to address anyunusual risk characteristics of aproduct.

(2) A derivatives clearing organizationshall adopt rules providing that all

swaps with the same terms andconditions, as defined by productspecifications established underderivatives clearing organization rules,submitted to the derivatives clearingorganization for clearing areeconomically equivalent within thederivatives clearing organization andmay be offset with each other within thederivatives clearing organization.

(3) A derivatives clearing organizationshall provide for non-discriminatoryclearing of a swap executed bilaterallyor on or subject to the rules of anunaffiliated swap execution facility or

designated contract market.(4) A derivatives clearing organizationshall not require that one of the originalexecuting parties be a clearing memberin order for a product to be eligible forclearing.

(5) A derivatives clearing organizationshall select product unit sizes and otherterms and conditions that maximizeliquidity, facilitate transparency inpricing, promote open access, and allowfor effective risk management. To theextent appropriate to further theseobjectives, a derivatives clearingorganization shall select product unitsfor clearing purposes that are smaller

than the product units in which tradessubmitted for clearing were executed.

(6) A derivatives clearing organizationthat clears swaps shall have rulesproviding that, upon acceptance of aswap by the derivatives clearingorganization for clearing:

(i) The original swap is extinguished;(ii) The original swap is replaced by

an equal and opposite swap between thederivatives clearing organization andeach clearing member acting asprincipal for a house trade or acting asagent for a customer trade;

(iii) All terms of a cleared swap must

conform to product specificationsestablished under derivatives clearingorganization rules; and

(iv) If a swap is cleared by a clearingmember on behalf of a customer, allterms of the swap, as carried in thecustomer account on the books of theclearing member, must conform to theterms of the cleared swap establishedunder the derivatives clearingorganization’s rules.

(7) [Reserved](8) Confirmation. A derivatives

clearing organization shall provide each





clearing member carrying a clearedswap with a definitive written record of the terms of the transaction which shalllegally supersede any previousagreement and serve as a confirmationof the swap. The confirmation of allterms of the transaction shall take placeat the same time as the swap is acceptedfor clearing.

§ 39.13 Risk management.

(a) General. A derivatives clearingorganization shall ensure that itpossesses the ability to manage the risksassociated with discharging theresponsibilities of the derivativesclearing organization through the use of appropriate tools and procedures.

(b) Documentation requirement. Aderivatives clearing organization shallestablish and maintain written policies,procedures, and controls, approved byits board of directors, which establish anappropriate risk management framework

that, at a minimum, clearly identifiesand documents the range of risks towhich the derivatives clearingorganization is exposed, addresses themonitoring and management of theentirety of those risks, and provides amechanism for internal audit. The riskmanagement framework shall beregularly reviewed and updated asnecessary.

(c) Chief risk officer. A derivativesclearing organization shall have a chief risk officer who shall be responsible forimplementing the risk managementframework, including the procedures,

policies and controls described inparagraph (b) of this section, and formaking appropriate recommendations tothe derivatives clearing organization’srisk management committee or board of directors, as applicable, regarding thederivatives clearing organization’s riskmanagement functions.

(d) [Reserved](e) Measurement of credit exposure. A

derivatives clearing organization shall:(1) Measure its credit exposure to

each clearing member and mark tomarket such clearing member’s openhouse and customer positions at leastonce each business day; and

(2) Monitor its credit exposure to eachclearing member periodically duringeach business day.

(f) Limitation of exposure to potential losses from defaults. A derivativesclearing organization, through marginrequirements and other risk controlmechanisms, shall limit its exposure topotential losses from defaults by itsclearing members to ensure that:

(1) The operations of the derivativesclearing organization would not bedisrupted; and

(2) Non-defaulting clearing memberswould not be exposed to losses thatnon-defaulting clearing members cannotanticipate or control.

(g) Margin requirements. (1) General.Each model and parameter used insetting initial margin requirements shall

be risk-based and reviewed on a regular basis.

(2) Methodology and coverage. (i) Aderivatives clearing organization shallestablish initial margin requirementsthat are commensurate with the risks of each product and portfolio, includingany unusual characteristics of, or risksassociated with, particular products orportfolios, including but not limited tojump-to-default risk or similar jumprisk.

(ii) A derivatives clearing organizationshall use models that generate initialmargin requirements sufficient to coverthe derivatives clearing organization’spotential future exposures to clearing

members based on price movements inthe interval between the last collectionof variation margin and the time withinwhich the derivatives clearingorganization estimates that it would beable to liquidate a defaulting clearingmember’s positions (liquidation time);

provided, however, that a derivativesclearing organization shall use:

(A) A minimum liquidation time thatis one day for futures and options;

(B) A minimum liquidation time thatis one day for swaps on agriculturalcommodities, energy commodities, andmetals;

(C) A minimum liquidation time thatis five days for all other swaps; or(D) Such longer liquidation time as is

appropriate based on the specificcharacteristics of a particular product orportfolio; provided further that theCommission, by order, may establishshorter or longer liquidation times forparticular products or portfolios.

(iii) The actual coverage of the initialmargin requirements produced by suchmodels, along with projected measuresof the models’ performance, shall meetan established confidence level of atleast 99 percent, based on data from anappropriate historic time period, for:

(A) Each product for which thederivatives clearing organization uses aproduct-based margin methodology;

(B) Each spread within or betweenproducts for which there is a definedspread margin rate;

(C) Each account held by a clearingmember at the derivatives clearingorganization, by house origin and byeach customer origin; and

(D) Each swap portfolio, includingany portfolio containing futures and/oroptions and held in a commingled

account pursuant to § 39.15(b)(2) of thispart, by beneficial owner.

(iv) A derivatives clearingorganization shall determine theappropriate historic time period basedon the characteristics, includingvolatility patterns, as applicable, of eachproduct, spread, account, or portfolio.

(3) Independent validation. A

derivatives clearing organization’ssystems for generating initial marginrequirements, including its theoreticalmodels, must be reviewed and validated

by a qualified and independent party,on a regular basis. Such qualified andindependent parties may beindependent contractors or employeesof the derivatives clearing organization,

but shall not be persons responsible fordevelopment or operation of the systemsand models being tested.

(4) Spread and portfolio margins. (i)A derivatives clearing organization mayallow reductions in initial margin

requirements for related positions if theprice risks with respect to suchpositions are significantly and reliablycorrelated. The price risks of differentpositions will only be considered to bereliably correlated if there is atheoretical basis for the correlation inaddition to an exhibited statisticalcorrelation. That theoretical basis mayinclude, but is not limited to, thefollowing:

(A) The products on which thepositions are based are complements of,or substitutes for, each other;

(B) One product is a significant inputinto the other product(s);

(C) The products share a significantcommon input; or

(D) The prices of the products areinfluenced by common external factors.

(ii) A derivatives clearing organizationshall regularly review its marginreductions and the correlations onwhich they are based.

(5) Price data. A derivatives clearingorganization shall have a reliable sourceof timely price data in order to measurethe derivatives clearing organization’scredit exposure accurately. Aderivatives clearing organization shallalso have written procedures and sound

valuation models for addressingcircumstances where pricing data is notreadily available or reliable.

(6) Daily review. On a daily basis, aderivatives clearing organization shalldetermine the adequacy of its initialmargin requirements.

(7) Back tests. A derivatives clearingorganization shall conduct back tests, asdefined in § 39.2 of this part, using anappropriate time period but not lessthan the previous 30 days, as follows:

(i) On a daily basis, a derivativesclearing organization shall conduct back





tests with respect to products or swapportfolios that are experiencingsignificant market volatility, to test theadequacy of its initial marginrequirements, as follows:

(A) For that product if the derivativesclearing organization uses a product-

based margin methodology;(B) For each spread involving that

product if there is a defined spreadmargin rate;

(C) For each account held by aclearing member at the derivativesclearing organization that contains asignificant position in that product, byhouse origin and by each customerorigin; and

(D) For each such swap portfolio,including any portfolio containingfutures and/or options and held in acommingled account pursuant to§ 39.15(b)(2) of this part, by beneficialowner.

(ii) On at least a monthly basis, a

derivatives clearing organization shallconduct back tests to test the adequacyof its initial margin requirements, asfollows:

(A) For each product for which thederivatives clearing organization uses aproduct-based margin methodology;

(B) For each spread for which there isa defined spread margin rate;

(C) For each account held by aclearing member at the derivativesclearing organization, by house originand by each customer origin; and

(D) For each swap portfolio, includingany portfolio containing futures and/oroptions and held in a commingled

account pursuant to §39.15(b)(2) of thispart, by beneficial owner.

(8) Customer margin. (i) Gross margin.(A) A derivatives clearing organizationshall collect initial margin on a gross

basis for each clearing member’scustomer account(s) equal to the sum of the initial margin amounts that would

be required by the derivatives clearingorganization for each individualcustomer within that account if eachindividual customer were a clearingmember.

(B) For purposes of calculating thegross initial margin requirement for

each clearing member’s customeraccount(s), to the extent not inconsistentwith other Commission regulations, aderivatives clearing organization mayrequire its clearing members to reportthe gross positions of each individualcustomer to the derivatives clearingorganization, or it may permit eachclearing member to report the sum of the gross positions of its customers tothe derivatives clearing organization.

(C) For purposes of this paragraph(g)(8), a derivatives clearingorganization may rely, and may permit

its clearing members to rely, upon thesum of the gross positions reported tothe clearing members by each domesticor foreign omnibus account that theycarry, without obtaining informationidentifying the positions of eachindividual customer underlying suchomnibus accounts.

(D) A derivatives clearing

organization may not, and may notpermit its clearing members to, netpositions of different customers againstone another.

(E) A derivatives clearing organizationmay collect initial margin for itsclearing members’ house accounts on anet basis.

(ii) Customer initial marginrequirements. A derivatives clearingorganization shall require its clearingmembers to collect customer initialmargin, as defined in § 1.3 of thischapter, from their customers, for non-hedge positions, at a level that is greaterthan 100 percent of the derivativesclearing organization’s initial marginrequirements with respect to eachproduct and swap portfolio. Thederivatives clearing organization shallhave reasonable discretion indetermining the percentage by whichcustomer initial margins must exceedthe derivatives clearing organization’sinitial margin requirements with respectto particular products or swapportfolios. The Commission may reviewsuch percentage levels and requiredifferent percentage levels if theCommission deems the levelsinsufficient to protect the financial

integrity of the clearing members or thederivatives clearing organization.

(iii) Withdrawal of customer initial margin. A derivatives clearingorganization shall require its clearingmembers to ensure that their customersdo not withdraw funds from theiraccounts with such clearing membersunless the net liquidating value plus themargin deposits remaining in acustomer’s account after suchwithdrawal are sufficient to meet thecustomer initial margin requirementswith respect to all products and swapportfolios held in such customer’s

account which are cleared by thederivatives clearing organization.(9) Time deadlines. A derivatives

clearing organization shall establish andenforce time deadlines for initial andvariation margin payments to thederivatives clearing organization by itsclearing members.

(10) Types of assets. A derivativesclearing organization shall limit theassets it accepts as initial margin tothose that have minimal credit, market,and liquidity risks. A derivativesclearing organization may take into

account the specific risk-reducingproperties that particular assets have ina particular portfolio. A derivativesclearing organization may accept lettersof credit as initial margin for futures andoptions on futures but shall not acceptletters of credit as initial margin forswaps.

(11) Valuation. A derivatives clearing

organization shall use prudent valuationpractices to value assets posted as initialmargin on a daily basis.

(12) Haircuts. A derivatives clearingorganization shall apply appropriatereductions in value to reflect credit,market, and liquidity risks (haircuts), tothe assets that it accepts in satisfactionof initial margin obligations, taking intoconsideration stressed marketconditions, and shall evaluate theappropriateness of such haircuts on atleast a quarterly basis.

(13) Concentration limits or charges.A derivatives clearing organization shallapply appropriate limitations or chargeson the concentration of assets posted asinitial margin, as necessary, in order toensure its ability to liquidate such assetsquickly with minimal adverse priceeffects, and shall evaluate theappropriateness of any suchconcentration limits or charges, on atleast a monthly basis.

(14) Pledged assets. If a derivativesclearing organization permits itsclearing members to pledge assets forinitial margin while retaining suchassets in accounts in the names of suchclearing members, the derivativesclearing organization shall ensure that

such assets are unencumbered and thatsuch a pledge has been validly createdand validly perfected in the relevantjurisdiction.

(h) Other risk control mechanisms—(1) Risk limits. (i) A derivatives clearingorganization shall impose risk limits oneach clearing member, by house originand by each customer origin, in order toprevent a clearing member fromcarrying positions for which the riskexposure exceeds a specified thresholdrelative to the clearing member’s and/orthe derivatives clearing organization’sfinancial resources. The derivatives

clearing organization shall havereasonable discretion in determining:(A) The method of computing risk

exposure;(B) The applicable threshold(s); and(C) The applicable financial resources

under this provision; provided however,that the ratio of exposure to capital mustremain the same across all capitallevels. The Commission may reviewsuch methods, thresholds, and financialresources and require the application of different methods, thresholds, orfinancial resources, as appropriate.





(ii) A derivatives clearing organizationmay permit a clearing member to exceedthe threshold(s) applied pursuant toparagraph (h)(1)(i) of this sectionprovided that the derivatives clearingorganization requires the clearingmember to post additional initial marginthat the derivatives clearingorganization deems sufficient to

appropriately eliminate excessive riskexposure at the clearing member. TheCommission may review the amount of additional initial margin and require adifferent amount of additional initialmargin, as appropriate.

(2) Large trader reports. A derivativesclearing organization shall obtain fromits clearing members or from a relevantdesignated contract market or swapexecution facility, copies of all reportsthat are required to be filed with theCommission by, or on behalf of, suchclearing members pursuant to parts 17and 20 of this chapter. A derivatives

clearing organization shall review suchreports on a daily basis to ascertain therisk of the overall portfolio of each largetrader, including futures, options, andswaps cleared by the derivativesclearing organization, which are held byall clearing members carrying accountsfor each such large trader, and shall takeadditional actions with respect to suchclearing members, when appropriate, asspecified in paragraph (h)(6) of thissection, in order to address any risksposed by any such large trader.

(3) Stress tests. A derivatives clearingorganization shall conduct stress tests,as defined in §39.2 of this part, as

follows:(i) On a daily basis, a derivatives

clearing organization shall conductstress tests with respect to each largetrader who poses significant risk to aclearing member or the derivativesclearing organization, including futures,options, and swaps cleared by thederivatives clearing organization, whichare held by all clearing memberscarrying accounts for each such largetrader. The derivatives clearingorganization shall have reasonablediscretion in determining which tradersto test and the methodology used to

conduct such stress tests. TheCommission may review the selection of accounts and the methodology andrequire changes, as appropriate.

(ii) On at least a weekly basis, aderivatives clearing organization shallconduct stress tests with respect to eachclearing member account, by houseorigin and by each customer origin, andeach swap portfolio, including anyportfolio containing futures and/oroptions and held in a commingledaccount pursuant to §39.15(b)(2) of thispart, by beneficial owner, under extreme

but plausible market conditions. Thederivatives clearing organization shallhave reasonable discretion indetermining the methodology used toconduct such stress tests. TheCommission may review themethodology and require changes, asappropriate.

(4) Portfolio compression. A

derivatives clearing organization shallmake portfolio compression exercisesavailable, on a regular and voluntary

basis, for its clearing members that clearswaps, to the extent that such exercisesare appropriate for those swaps that itclears; provided, however, a derivativesclearing organization is not required todevelop its own portfolio compressionservices, and is only required to makesuch portfolio compression exercisesavailable, if applicable portfoliocompression services have beendeveloped by a third party.

(5) Clearing members’ risk

management policies and procedures.(i) A derivatives clearing organizationshall adopt rules that:

(A) Require its clearing members tomaintain current written riskmanagement policies and procedures,which address the risks that suchclearing members may pose to thederivatives clearing organization;

(B) Ensure that it has the authority torequest and obtain information anddocuments from its clearing membersregarding their risk managementpolicies, procedures, and practices,including, but not limited to,

information and documents relating tothe liquidity of their financial resourcesand their settlement procedures; and

(C) Require its clearing members tomake information and documentsregarding their risk managementpolicies, procedures, and practicesavailable to the Commission upon theCommission’s request.

(ii) A derivatives clearing organizationshall review the risk managementpolicies, procedures, and practices of each of its clearing members, whichaddress the risks that such clearingmembers may pose to the derivativesclearing organization, on a periodic

basis and document such reviews.(6) Additional authority. A derivatives

clearing organization shall takeadditional actions with respect toparticular clearing members, whenappropriate, based on the application of objective and prudent risk managementstandards including, but not limited to:

(i) Imposing enhanced capitalrequirements;

(ii) Imposing enhanced marginrequirements;

(iii) Imposing position limits;

(iv) Prohibiting an increase inpositions;

(v) Requiring a reduction of positions;(vi) Liquidating or transferring

positions; and(vii) Suspending or revoking clearing

membership.

§ 39.14 Settlement procedures.

(a) Definitions—(1) Settlement. Forpurposes of this section, ‘‘settlement’’means:

(i) Payment and receipt of variationmargin for futures, options, and swaps;

(ii) Payment and receipt of optionpremiums;

(iii) Deposit and withdrawal of initialmargin for futures, options, and swaps;

(iv) All payments due in finalsettlement of futures, options, andswaps on the final settlement date withrespect to such positions; and

(v) All other cash flows collected fromor paid to each clearing member,including but not limited to, payments

related to swaps such as couponamounts.

(2) Settlement bank. For purposes of this section, ‘‘settlement bank’’ means a

bank that maintains an account eitherfor the derivatives clearing organizationor for any of its clearing members,which is used for the purpose of anysettlement described in paragraph (a)(1)above.

(b) Daily settlements. Except asotherwise provided by Commissionorder, a derivatives clearingorganization shall effect a settlementwith each clearing member at least once

each business day, and shall have theauthority and operational capacity toeffect a settlement with each clearingmember, on an intraday basis, eitherroutinely, when thresholds specified bythe derivatives clearing organization are

breached, or in times of extreme marketvolatility.

(c) Settlement banks. A derivativesclearing organization shall employsettlement arrangements that eliminateor strictly limit its exposure tosettlement bank risks, including thecredit and liquidity risks arising fromthe use of such bank(s) to effect

settlements with its clearing members,as follows:(1) A derivatives clearing organization

shall have documented criteria thatmust be met by any settlement bankused by the derivatives clearingorganization or its clearing members,including criteria addressing thecapitalization, creditworthiness, accessto liquidity, operational reliability, andregulation or supervision of such

bank(s).(2) A derivatives clearing organization

shall monitor each approved settlement





bank on an ongoing basis to ensure thatsuch bank continues to meet the criteriaestablished pursuant to paragraph (c)(1)of this section.

(3) A derivatives clearing organizationshall monitor the full range andconcentration of its exposures to its ownand its clearing members’ settlement

bank(s) and assess its own and its

clearing members’ potential losses andliquidity pressures in the event that thesettlement bank with the largest share of settlement activity were to fail. Aderivatives clearing organization shalltake any one or more of the followingactions, to the extent that any suchaction or actions are reasonablynecessary in order to eliminate orstrictly limit such exposures:

(i) Maintain settlement accounts atone or more additional settlement

banks; and/or(ii) Approve one or more additional

settlement banks that its clearing

members could choose to use; and/or(iii) Impose concentration limits withrespect to one or more of its own or itsclearing members’ settlement banks;and/or

(iv) Take any other appropriateactions.

(d) Settlement finality. A derivativesclearing organization shall ensure thatsettlements are final when effected byensuring that it has entered into legalagreements that state that settlementfund transfers are irrevocable andunconditional no later than when thederivatives clearing organization’saccounts are debited or credited;

provided, however, a derivativesclearing organization’s legal agreementswith its settlement banks may providefor the correction of errors. Aderivatives clearing organization’s legalagreements with its settlement banksshall state clearly when settlement fundtransfers will occur and a derivativesclearing organization shall routinelyconfirm that its settlement banks areeffecting fund transfers as and whenrequired by such legal agreements.

(e) Recordkeeping. A derivativesclearing organization shall maintain anaccurate record of the flow of funds

associated with each settlement.(f) Netting arrangements. Aderivatives clearing organization shallpossess the ability to comply with eachterm and condition of any permittednetting or offset arrangement with anyother clearing organization.

(g) Physical delivery. With respect toproducts that are settled by physicaltransfers of the underlying instrumentsor commodities, a derivatives clearingorganization shall:

(1) Establish rules that clearly stateeach obligation that the derivatives

clearing organization has assumed withrespect to physical deliveries, includingwhether it has an obligation to make orreceive delivery of a physicalinstrument or commodity, or whether itindemnifies clearing members for lossesincurred in the delivery process; and

(2) Ensure that the risks of each suchobligation are identified and managed.

§ 39.15 Treatment of funds.

(a) Required standards and procedures. A derivatives clearingorganization shall establish standardsand procedures that are designed toprotect and ensure the safety of fundsand assets belonging to clearingmembers and their customers.

(b) Segregation of funds and assets.(1) Segregation. A derivatives clearingorganization shall comply with theapplicable segregation requirements of section 4d of the Act and Commissionregulations thereunder, or any other

applicable Commission regulation ororder requiring that customer funds andassets be segregated, set aside, or heldin a separate account.

(2) Commingling of futures, options,and swaps. (i) Cleared swaps account.In order for a derivatives clearingorganization and its clearing members tocommingle customer positions infutures, options, and swaps, and anymoney, securities, or property receivedto margin, guarantee or secure suchpositions, in an account subject to therequirements of section 4d(f) of the Act,the derivatives clearing organization

shall file rules for Commission approvalpursuant to §40.5 of this chapter. Suchrule submission shall include, at aminimum, the following:

(A) Identification of the futures,options, and swaps that would becommingled, including productspecifications or the criteria that would

be used to define eligible futures,options, and swaps;

(B) Analysis of the risk characteristicsof the eligible products;

(C) Identification of whether theswaps would be executed bilaterallyand/or executed on a designatedcontract market and/or a swapexecution facility;

(D) Analysis of the liquidity of therespective markets for the futures,options, and swaps that would becommingled, the ability of clearingmembers and the derivatives clearingorganization to offset or mitigate the riskof such futures, options, and swaps ina timely manner, without compromisingthe financial integrity of the account,and, as appropriate, proposed means foraddressing insufficient liquidity;

(E) Analysis of the availability of reliable prices for each of the eligibleproducts;

(F) A description of the financial,operational, and managerial standardsor requirements for clearing membersthat would be permitted to comminglesuch futures, options, and swaps;

(G) A description of the systems and

procedures that would be used by thederivatives clearing organization tooversee such clearing members’ riskmanagement of any such commingledpositions;

(H) A description of the financialresources of the derivatives clearingorganization, including the compositionand availability of a guaranty fund withrespect to the futures, options, andswaps that would be commingled;

(I) A description and analysis of themargin methodology that would beapplied to the commingled futures,options, and swaps, including any

margin reduction applied to correlatedpositions, and any applicable marginrules with respect to both clearingmembers and customers;

(J) An analysis of the ability of thederivatives clearing organization tomanage a potential default with respectto any of the futures, options, or swapsthat would be commingled;

(K) A discussion of the proceduresthat the derivatives clearingorganization would follow if a clearingmember defaulted, and the proceduresthat a clearing member would follow if a customer defaulted, with respect toany of the commingled futures, options,

or swaps in the account; and(L) A description of the arrangements

for obtaining daily position data withrespect to futures, options, and swaps inthe account.

(ii) Futures account. In order for aderivatives clearing organization and itsclearing members to comminglecustomer positions in futures, options,and swaps, and any money, securities,or property received to margin,guarantee or secure such positions, inan account subject to the requirementsof section 4d(a) of the Act, thederivatives clearing organization shall

file with the Commission a petition foran order pursuant to section 4d(a) of theAct. Such petition shall include, at aminimum, the information requiredunder paragraph (b)(2)(i) of this section.

(iii) Commission action. (A) TheCommission may request additionalinformation in support of a rulesubmission filed under paragraph(b)(2)(i) of this section, and may grantapproval of such rules in accordancewith §40.5 of this chapter.

(B) The Commission may requestadditional information in support of a





petition filed under paragraph (b)(2)(ii)of this section, and may issue an orderunder section 4d of the Act in itsdiscretion.

(c) Holding of funds and assets. Aderivatives clearing organization shallhold funds and assets belonging toclearing members and their customersin a manner which minimizes the risk

of loss or of delay in the access by thederivatives clearing organization to suchfunds and assets.

(d) Transfer of customer positions. Aderivatives clearing organization shallhave rules providing that the derivativesclearing organization will promptlytransfer all or a portion of a customer’sportfolio of positions and related fundsat the same time from the carryingclearing member of the derivativesclearing organization to another clearingmember of the derivatives clearingorganization, without requiring theclose-out and re-booking of the

positions prior to the requested transfer,subject to the following conditions:(1) The customer has instructed the

carrying clearing member to make thetransfer;

(2) The customer is not currently indefault to the carrying clearing member;

(3) The transferred positions will haveappropriate margin at the receivingclearing member;

(4) Any remaining positions will haveappropriate margin at the carryingclearing member; and

(5) The receiving clearing member hasconsented to the transfer.

(e) Permitted investments. Funds and

assets belonging to clearing membersand their customers that are invested bya derivatives clearing organization shall

be held in instruments with minimalcredit, market, and liquidity risks. Anyinvestment of customer funds or assets

by a derivatives clearing organizationshall comply with §1.25 of this chapter,as if all such funds and assets comprisecustomer funds subject to segregationpursuant to section 4d(a) of the Act andCommission regulations thereunder.

§ 39.16 Default rules and procedures.

(a) General. A derivatives clearing

organization shall adopt rules andprocedures designed to allow for theefficient, fair, and safe management of events during which clearing members

become insolvent or default on theobligations of such clearing members tothe derivatives clearing organization.

(b) Default management plan. Aderivatives clearing organization shallmaintain a current written defaultmanagement plan that delineates theroles and responsibilities of its board of directors, its risk managementcommittee, any other committee that a

derivatives clearing organization mayhave that has responsibilities for defaultmanagement, and the derivativesclearing organization’s management, inaddressing a default, including anynecessary coordination with, ornotification of, other entities andregulators. Such plan shall address anydifferences in procedures with respect

to highly liquid products and less liquidproducts. A derivatives clearingorganization shall conduct anddocument a test of its defaultmanagement plan at least on an annual

basis.(c) Default procedures. (1) A

derivatives clearing organization shalladopt procedures that would permit thederivatives clearing organization to taketimely action to contain losses andliquidity pressures and to continuemeeting its obligations in the event of adefault on the obligations of a clearingmember to the derivatives clearing

organization.(2) A derivatives clearing organizationshall adopt rules that set forth its defaultprocedures, including:

(i) The derivatives clearingorganization’s definition of a default;

(ii) The actions that the derivativesclearing organization may take upon adefault, which shall include the prompttransfer, liquidation, or hedging of thecustomer or house positions of thedefaulting clearing member, asapplicable, and which may include, inthe discretion of the derivatives clearingorganization, the auctioning orallocation of such positions to other

clearing members;(iii) Any obligations that the

derivatives clearing organizationimposes on its clearing members toparticipate in auctions, or to acceptallocations, of the customer or housepositions of the defaulting clearingmember, provided that:

(A) The derivatives clearingorganization shall permit a clearingmember to outsource to a qualified thirdparty, authority to act in the clearingmember’s place in any auction, subjectto appropriate safeguards imposed bythe derivatives clearing organization;

(B) The derivatives clearingorganization shall permit a clearingmember to outsource to a qualified thirdparty, authority to act in the clearingmember’s place in any allocations,subject to appropriate safeguardsimposed by the derivatives clearingorganization; and

(C) Any allocation shall beproportional to the size of theparticipating or accepting clearingmember’s positions in the same productclass at the derivatives clearingorganization;

(iv) The sequence in which the fundsand assets of the defaulting clearingmember and its customers and thefinancial resources maintained by thederivatives clearing organization would

be applied in the event of a default;(v) A provision that the funds and

assets of a defaulting clearing member’scustomers shall not be applied to cover

losses with respect to a house default;(vi) A provision that the excess house

funds and assets of a defaulting clearingmember shall be applied to cover losseswith respect to a customer default, if therelevant customer funds and assets areinsufficient to cover the shortfall; and

(3) A derivatives clearing organizationshall make its default rules publiclyavailable as provided in §39.21 of thispart.

(d) Insolvency of a clearing member.(1) A derivatives clearing organization

shall adopt rules that require a clearingmember to provide prompt notice to the

derivatives clearing organization if it becomes the subject of a bankruptcypetition, receivership proceeding, or theequivalent;

(2) No later than upon receipt of suchnotice, a derivatives clearingorganization shall review the continuingeligibility of the clearing member forclearing membership; and

(3) No later than upon receipt of suchnotice, a derivatives clearingorganization shall take any appropriateaction, in its discretion, with respect tosuch clearing member or its house orcustomer positions, including but notlimited to liquidation or transfer of

positions, suspension, or revocation of clearing membership.

§ 39.17 Rule enforcement.

(a) General. Each derivatives clearingorganization shall:

(1) Maintain adequate arrangementsand resources for the effectivemonitoring and enforcement of compliance with the rules of thederivatives clearing organization andthe resolution of disputes;

(2) Have the authority and ability todiscipline, limit, suspend, or terminatethe activities of a clearing member due

to a violation by the clearing member of any rule of the derivatives clearingorganization; and

(3) Report to the Commissionregarding rule enforcement activitiesand sanctions imposed against clearingmembers as provided in paragraph (a)(2) of this section, in accordance with§ 39.19(c)(4)(xi) of this part.

(b) Authority to enforce rules. The board of directors of the derivativesclearing organization may delegateresponsibility for compliance with therequirements of paragraph (a) of this





section to the risk managementcommittee, unless the responsibilitiesare otherwise required to be carried out

by the chief compliance officer pursuantto the Act or this part.

§ 39.18 System safeguards.

(a) Definitions. For purposes of thissection:

Recovery time objective means thetime period within which an entityshould be able to achieve recovery andresumption of clearing and settlement of existing and new products, after thosecapabilities become temporarilyinoperable for any reason up to orincluding a wide-scale disruption.

Relevant area means the metropolitanor other geographic area within which aderivatives clearing organization hasphysical infrastructure or personnelnecessary for it to conduct activitiesnecessary to the clearing and settlementof existing and new products. The term‘‘relevant area’’ also includescommunities economically integratedwith, adjacent to, or within normalcommuting distance of thatmetropolitan or other geographic area.

Wide-scale disruption means an eventthat causes a severe disruption ordestruction of transportation,telecommunications, power, water, orother critical infrastructure componentsin a relevant area, or an event thatresults in an evacuation orunavailability of the population in arelevant area.

(b) General —(1) Program of risk analysis. Each derivatives clearing

organization shall establish andmaintain a program of risk analysis andoversight with respect to its operationsand automated systems to identify andminimize sources of operational riskthrough:

(i) The development of appropriatecontrols and procedures; and

(ii) The development of automatedsystems that are reliable, secure, andhave adequate scalable capacity.

(2) Resources. Each derivativesclearing organization shall establish andmaintain resources that allow for thefulfillment of each obligation and

responsibility of the derivatives clearingorganization in light of the risksidentified pursuant to paragraph (b)(1)of this section.

(3) Verification of adequacy. Eachderivatives clearing organization shallperiodically verify that resourcesdescribed in paragraph (b)(2) of thissection are adequate to ensure dailyprocessing, clearing, and settlement.

(c) Elements of program. A derivativesclearing organization’s program of riskanalysis and oversight with respect toits operations and automated systems,

as described in paragraph (b) of thissection, shall address each of thefollowing categories of risk analysis andoversight:

(1) Information security;(2) Business continuity and disaster

recovery planning and resources;(3) Capacity and performance

planning;

(4) Systems operations;(5) Systems development and qualityassurance; and

(6) Physical security andenvironmental controls.

(d) Standards for program. Inaddressing the categories of risk analysisand oversight required under paragraph(c) of this section, a derivatives clearingorganization shall follow generallyaccepted standards and industry bestpractices with respect to thedevelopment, operation, reliability,security, and capacity of automatedsystems.

(e) Business continuity and disaster recovery. (1) Plan and resources. Aderivatives clearing organization shallmaintain a business continuity anddisaster recovery plan, emergencyprocedures, and physical, technological,and personnel resources sufficient toenable the timely recovery andresumption of operations and thefulfillment of each obligation andresponsibility of the derivatives clearingorganization following any disruption of its operations.

(2) Responsibilities and obligations.The responsibilities and obligationsdescribed in paragraph (e)(1) of this

section shall include, withoutlimitation, daily processing, clearing,and settlement of transactions cleared.

(3) Recovery time objective. Thederivatives clearing organization’s

business continuity and disasterrecovery plan described in paragraph(e)(1) of this section, shall have theobjective of, and the physical,technological, and personnel resourcesdescribed therein shall be sufficient to,enable the derivatives clearingorganization to resume daily processing,clearing, and settlement no later thanthe next business day following the

disruption.(f) Location of resources; outsourcing.A derivatives clearing organization maymaintain the resources required underparagraph (e)(1) of this section either:

(1) Using its own employees aspersonnel, and property that it owns,licenses, or leases (own resources); or

(2) Through written contractualarrangements with another derivativesclearing organization or other serviceprovider (outsourcing).

(i) Retention of responsibility. Aderivatives clearing organization that

enters into such a contractualarrangement shall retain completeliability for any failure to meet theresponsibilities specified in paragraph(e) of this section, although it is free toseek indemnification from the serviceprovider. The outsourcing derivativesclearing organization must employpersonnel with the expertise necessary

to enable it to supervise the serviceprovider’s delivery of the services.

(ii) Testing. The testing referred to inparagraph (j) of this section shallinclude all of the derivatives clearingorganization’s own and outsourcedresources, and shall verify that all suchresources will work effectively together.

(g) Notice of exceptional events. Aderivatives clearing organization shallnotify staff of the Division of Clearingand Risk promptly of:

(1) Any hardware or softwaremalfunction, cyber security incident, ortargeted threat that materially impairs,

or creates a significant likelihood of material impairment, of automatedsystem operation, reliability, security, orcapacity; or

(2) Any activation of the derivativesclearing organization’s businesscontinuity and disaster recovery plan.

(h) Notice of planned changes. Aderivatives clearing organization shallgive staff of the Division of Clearing andRisk timely advance notice of all:

(1) Planned changes to automatedsystems that are likely to have asignificant impact on the reliability,security, or adequate scalable capacityof such systems; and

(2) Planned changes to the derivativesclearing organization’s program of riskanalysis and oversight.

(i) Recordkeeping. A derivativesclearing organization shall maintain,and provide to Commission staff promptly upon request, pursuant to§ 1.31 of this chapter, current copies of its business continuity plan and otheremergency procedures, its assessmentsof its operational risks, and records of testing protocols and results, and shallprovide any other documents requested

by Commission staff for the purpose of maintaining a current profile of the

derivatives clearing organization’sautomated systems.(j) Testing.—(1) Purpose of testing. A

derivatives clearing organization shallconduct regular, periodic, and objectivetesting and review of:

(i) Its automated systems to ensurethat they are reliable, secure, and haveadequate scalable capacity; and

(ii) Its business continuity anddisaster recovery capabilities, usingtesting protocols adequate to ensure thatthe derivatives clearing organization’s

backup resources are sufficient to meet





the requirements of paragraph (e) of thissection.

(2) Conduct of testing. Testing shall beconducted by qualified, independentprofessionals. Such qualified,independent professionals may beindependent contractors or employeesof the derivatives clearing organization,

but shall not be persons responsible for

development or operation of the systemsor capabilities being tested.

(3) Reporting and review. Reportssetting forth the protocols for, andresults of, such tests shall becommunicated to, and reviewed by,senior management of the derivativesclearing organization. Protocols of testswhich result in few or no exceptionsshall be subject to more searchingreview.

(k) Coordination of businesscontinuity and disaster recovery plans.A derivatives clearing organizationshall, to the extent practicable:

(1) Coordinate its business continuityand disaster recovery plan with those of its clearing members, in a manneradequate to enable effective resumptionof daily processing, clearing, andsettlement following a disruption;

(2) Initiate and coordinate periodic,synchronized testing of its businesscontinuity and disaster recovery planand the plans of its clearing members;and

(3) Ensure that its business continuityand disaster recovery plan takes intoaccount the plans of its providers of essential services, includingtelecommunications, power, and water.

§ 39.19 Reporting.

(a) General. Each derivatives clearingorganization shall provide to theCommission the information specifiedin this section and any otherinformation that the Commission deemsnecessary to conduct its oversight of aderivatives clearing organization.

(b) Submission of reports. (1) Unlessotherwise specified by the Commissionor its designee, each derivatives clearingorganization shall submit theinformation required by this section tothe Commission electronically and in a

format and manner specified by theCommission.(2) Time zones. Unless otherwise

specified by the Commission or itsdesignee, any stated time in this sectionis Central time for informationconcerning derivatives clearingorganizations located in that time zone,and Eastern time for informationconcerning all other derivatives clearingorganizations.

(3) Unless otherwise specified by theCommission or its designee, businessday means the intraday period of time

starting at the business hour of 8:15 a.m.and ending at the business hour of 4:45p.m., on all days except Saturdays,Sundays, and Federal holidays.

(c) Reporting requirements. Eachregistered derivatives clearingorganization shall provide to theCommission or other person as may berequired or permitted by this paragraph

the information specified below:(1) Daily reporting. (i) A report

containing the information specified bythis paragraph (c)(1), which shall becompiled as of the end of each tradingday and shall be submitted to theCommission by 10 a.m. on the following

business day:(A) Initial margin requirements and

initial margin on deposit for eachclearing member, by house origin and

by each customer origin;(B) Daily variation margin, separately

listing the mark-to-market amountcollected from or paid to each clearing

member, by house origin and by eachcustomer origin;(C) All other daily cash flows relating

to clearing and settlement including, butnot limited to, option premiums andpayments related to swaps such ascoupon amounts, collected from or paidto each clearing member, by houseorigin and by each customer origin; and

(D) End-of-day positions for eachclearing member, by house origin and

by each customer origin.(ii) The report shall contain the

information required by paragraph(c)(1)(i) of this section for:

(A) All futures positions, and options

positions, as applicable;(B) All swaps positions; and(C) All securities positions that are

held in a customer account subject tosection 4d of the Act or are subject toa cross-margining agreement.

(2) Quarterly reporting. A report of thederivatives clearing organization’sfinancial resources as required by§ 39.11(f) of this part; provided that,additional reports may be required byparagraph (c)(4)(i) of this section or§ 39.11(f) of this part.

(3) Annual reporting —(i) Annual report of chief compliance officer. The

annual report of the chief complianceofficer required by §39.10 of this part.(ii) Audited financial statements.

Audited year-end financial statementsof the derivatives clearing organizationor, if there are no financial statementsavailable for the derivatives clearingorganization itself, the consolidatedaudited year-end financial statements of the derivatives clearing organization’sparent company.

(iii) [Reserved](iv) Time of report. The reports

required by this paragraph (c)(3) shall be

submitted concurrently to theCommission not more than 90 days afterthe end of the derivatives clearingorganization’s fiscal year; provided that,a derivatives clearing organization mayrequest from the Commission anextension of time to submit a report,provided the derivatives clearingorganization’s failure to submit the

report in a timely manner could not beavoided without unreasonable effort orexpense. Extensions of the deadline will

be granted at the discretion of theCommission.

(4) Event-specific reporting —(i)Decrease in financial resources. If thereis a decrease of 25 percent in the totalvalue of the financial resourcesavailable to satisfy the requirementsunder §39.11(a)(1) of this part, eitherfrom the last quarterly report submittedunder §39.11(f) of this part or from thevalue as of the close of the previous

business day, the derivatives clearing

organization shall report such decreaseto the Commission no later than one

business day following the day the 25percent threshold was reached. Thereport shall include:

(A) The total value of the financialresources:

(1) As of the close of business the daythe 25 percent threshold was reached,and

(2) If reporting a decrease in valuefrom the previous business day, the totalvalue of the financial resourcesimmediately prior to the 25 percentdecline;

(B) A breakdown of the value of eachfinancial resource reported in each of paragraphs (c)(4)(i)(A)(1) and (2) of thissection, calculated in accordance withthe requirements of §39.11(d) of thispart, including the value of eachindividual clearing member’s guarantyfund deposit if the derivatives clearingorganization reports guaranty funddeposits as a financial resource; and

(C) A detailed explanation for thedecrease.

(ii) Decrease in ownership equity. Nolater than two business days prior to anevent which the derivatives clearingorganization knows or reasonablyshould know will cause a decrease of 20percent or more in ownership equityfrom the last reported ownership equity

balance as reported on a quarterly oraudited financial statement required to

be submitted by paragraph (c)(2) or(c)(3)(ii), respectively, of this section;

but in any event no later than two business days after such decrease inownership equity for events that causedthe decrease about which thederivatives clearing organization did notknow and reasonably could not have





known prior to the event. The reportshall include:

(A) Pro forma financial statementsreflecting the derivatives clearingorganization’s estimated future financialcondition following the anticipateddecrease for reports submitted prior tothe anticipated decrease and currentfinancial statements for reports

submitted after such a decrease; and(B) Details describing the reason for

the anticipated decrease or decrease inthe balance.

(iii) Six-month liquid asset requirement. Immediate notice when aderivatives clearing organization knowsor reasonably should know of a deficitin the six-month liquid assetrequirement of §39.11(e)(2).

(iv) Change in current assets. No laterthan two business days after currentliabilities exceed current assets; thenotice shall include a balance sheet thatreflects the derivatives clearing

organization’s current assets and currentliabilities and an explanation as to thereason for the negative balance.

(v) Request to clearing member toreduce its positions. Immediate notice,of a derivatives clearing organization’srequest to a clearing member to reduceits positions because the derivativesclearing organization has determinedthat the clearing member has exceededits exposure limit, has failed to meet aninitial or variation margin call, or hasfailed to fulfill any other financialobligation to the derivatives clearingorganization. The notice shall include:

(A) The name of the clearing member;(B) The time the clearing member wascontacted;

(C) The number of positions by whichthe derivatives clearing organizationrequested the reduction;

(D) All products that are the subjectof the request; and

(E) The reason for the request.(vi) Determination to transfer or

liquidate positions. Immediate notice, of a determination that any position aderivatives clearing organization carriesfor one of its clearing members must beliquidated immediately or transferredimmediately, or that the trading of anyaccount of a clearing member shall beonly for the purpose of liquidation

because that clearing member has failedto meet an initial or variation margincall or has failed to fulfill any otherfinancial obligation to the derivativesclearing organization. The notice shallinclude:

(A) The name of the clearing member;(B) The time the clearing member was

contacted;(C) The products that are subject to

the determination;

(D) The number of positions that aresubject to the determination; and

(E) The reason for the determination.(vii) Default of a clearing member.

Immediate notice, upon the default of aclearing member. An event of defaultshall be determined in accordance withthe rules of the derivatives clearingorganization. The notice of default shall

include:(A) The name of the clearing member;(B) The products the clearing member

defaulted upon;(C) The number of positions the

clearing member defaulted upon; and(D) The amount of the financial

obligation.(viii) Change in ownership or

corporate or organizational structure.(A) Reporting requirement. Anyanticipated change in the ownership orcorporate or organizational structure of the derivatives clearing organization orits parent(s) that would:

(1) Result in at least a 10 percentchange of ownership of the derivativesclearing organization,

(2) Create a new subsidiary oreliminate a current subsidiary of thederivatives clearing organization, or

(3) Result in the transfer of all orsubstantially all of the assets of thederivatives clearing organization,including its registration as a derivativesclearing organization to another legalentity.

(B) Required information. The reportshall include: a chart outlining the newownership or corporate ororganizational structure; a brief

description of the purpose and impactof the change; and any relevantagreements effecting the change andcorporate documents such as articles of incorporation and bylaws. With respectto a corporate change for which aderivatives clearing organizationsubmits a request for approval totransfer its derivatives clearingorganization registration and openinterest under §39.3(f) of this part, theinformational requirements of thisparagraph (c)(4)(viii)(B) shall besatisfied by the derivatives clearingorganization’s compliance with

§ 39.3(f)(3).(C) Time of report. The report shall besubmitted to the Commission no laterthan three months prior to theanticipated change; provided that thederivatives clearing organization mayreport the anticipated change to theCommission later than three monthsprior to the anticipated change if thederivatives clearing organization doesnot know and reasonably could not haveknown of the anticipated change threemonths prior to the anticipated change.In such event, the derivatives clearing

organization shall immediately reportsuch change to the Commission as soonas it knows of such change.

(D) Confirmation of change report.The derivatives clearing organizationshall report to the Commission theconsummation of the change no laterthan two business days following theeffective date of the change.

(ix) Change in key personnel. No laterthan two business days following thedeparture, or addition of persons whoare key personnel as defined in§ 39.1(b), a report that includes, asapplicable, the name of the person whowill assume the duties of the positionon a temporary basis until a permanentreplacement fills the position.

(x) Change in credit facility funding arrangement. No later than one businessday after a derivatives clearingorganization changes an existing creditfacility funding arrangement it mayhave in place, or is notified that such

arrangement has changed, including butnot limited to a change in lender,change in the size of the facility, changein expiration date, or any other materialchanges or conditions.

(xi) Sanctions. Notice of action taken,no later than two business days after thederivatives clearing organizationimposes sanctions against a clearingmember.

(xii) Financial condition and events.Immediate notice after the derivativesclearing organization knows orreasonably should have known of:

(A) The institution of any legal

proceedings which may have a materialadverse financial impact on thederivatives clearing organization;

(B) Any event, circumstance orsituation that materially impedes thederivatives clearing organization’sability to comply with this part and isnot otherwise required to be reportedunder this section; or

(C) A material adverse change in thefinancial condition of any clearingmember that is not otherwise requiredto be reported under this section.

(xiii) Financial statements material inadequacies. If a derivatives clearingorganization discovers or is notified byan independent public accountant of theexistence of any material inadequacy ina financial statement, such derivativesclearing organization shall give notice of such material inadequacy within 24hours, and within 48 hours after givingsuch notice file a written report statingwhat steps have been and are beingtaken to correct the materialinadequacy.

(xiv) [Reserved](xv) [Reserved](xvi) System safeguards. A report of:





(A) Exceptional events as required by§ 39.18(g) of this part; or

(B) Planned changes as required by§ 39.18(h) of this part.

(5) Requested reporting. (i) Uponrequest by the Commission, aderivatives clearing organization shallfile with the Commission suchinformation related to its business as a

clearing organization, includinginformation relating to trade andclearing details, in the format andmanner specified, and within the timeprovided, by the Commission in therequest.

(ii) Upon request by the Commission,a derivatives clearing organization shallfile with the Commission a writtendemonstration, containing suchsupporting data, information anddocuments, that the derivatives clearingorganization is in compliance with oneor more core principles and relevantprovisions of this part, in the format and

manner specified, and within the timeprovided, by the Commission in therequest.

(iii) Upon request by the Commission,a derivatives clearing organization shallfile with the Commission, for eachcustomer origin of each clearingmember, the end-of-day gross positionsof each beneficial owner, in the formatand manner specified, and within thetime provided, by the Commission inthe request. Nothing in this paragraphshall affect the obligation of aderivatives clearing organization tocomply with the daily reporting

requirements of paragraph (c)(1) of thissection.

§ 39.20 Recordkeeping.

(a) Requirement to maintaininformation. Each derivatives clearingorganization shall maintain records of all activities related to its business as aderivatives clearing organization. Suchrecords shall include, but are notlimited to, records of:

(1) All cleared transactions, includingswaps;

(2) All information necessary torecord allocation of bunched orders forcleared swaps;

(3) All information required to becreated, generated, or reported underthis part 39, including but not limitedto the results of and methodology usedfor all tests, reviews, and calculations inconnection with setting and evaluatingmargin levels, determining the valueand adequacy of financial resources,and establishing settlement prices;

(4) All rules and procedures requiredto be submitted pursuant to this part 39and part 40 of this chapter, including allproposed changes in rules, procedures

or operations subject to § 40.10 of thischapter; and

(5) Any data or documentationrequired by the Commission or by thederivatives clearing organization to besubmitted to the derivatives clearingorganization by its clearing members, or

by any other person in connection withthe derivatives clearing organization’s

clearing and settlement activities.(b) Form and manner of maintaining

information. (1) General. The recordsrequired to be maintained by thischapter shall be maintained inaccordance with the provisions of §1.31of this chapter, for a period of not lessthan 5 years, except as provided inparagraph (b)(2) of this section.

(2) Exception for swap data. Eachderivatives clearing organization thatclears swaps must maintain swap datain accordance with the requirements of part 45 of this chapter.

§ 39.21 Public information.

(a) General. Each derivatives clearingorganization shall provide to marketparticipants sufficient information toenable the market participants toidentify and evaluate accurately therisks and costs associated with using theservices of the derivatives clearingorganization. In furtherance of thisobjective, each derivatives clearingorganization shall have clear andcomprehensive rules and procedures.

(b) Availability of information. Eachderivatives clearing organization shallmake information concerning the rulesand the operating and default

procedures governing the clearing andsettlement systems of the derivativesclearing organization available to marketparticipants.

(c) Public disclosure. Each derivativesclearing organization shall disclosepublicly and to the Commissioninformation concerning:

(1) The terms and conditions of eachcontract, agreement, and transactioncleared and settled by the derivativesclearing organization;

(2) Each clearing and other fee thatthe derivatives clearing organizationcharges its clearing members;

(3) The margin-setting methodology;

(4) The size and composition of thefinancial resource package available inthe event of a clearing member default;

(5) Daily settlement prices, volume,and open interest for each contract,agreement, or transaction cleared orsettled by the derivatives clearingorganization;

(6) The derivatives clearingorganization’s rules and procedures fordefaults in accordance with § 39.16 of this part; and

(7) Any other matter that is relevantto participation in the clearing and

settlement activities of the derivativesclearing organization.

(d) Publication of information. Thederivatives clearing organization shallmake its rulebook, a list of all currentclearing members, and the informationlisted in paragraph (c) of this sectionreadily available to the general public,in a timely manner, by posting such

information on the derivatives clearingorganization’s Web site, unlessotherwise permitted by the Commission.The information required in paragraph(c)(5) of this section shall be madeavailable to the public no later than the

business day following the day to whichthe information pertains.

§ 39.22 Information sharing.

Each derivatives clearing organizationshall enter into, and abide by the termsof, each appropriate and applicabledomestic and international information-sharing agreement, and shall userelevant information obtained from eachsuch agreement in carrying out the riskmanagement program of the derivativesclearing organization.

§ 39.23 Antitrust considerations.

Unless necessary or appropriate toachieve the purposes of the Act, aderivatives clearing organization shallnot adopt any rule or take any actionthat results in any unreasonablerestraint of trade, or impose anymaterial anticompetitive burden.

§39.24 [Reserved]

§39.25 [Reserved]

§39.26 [Reserved]

§ 39.27 Legal risk considerations.

(a) Legal authorization. A derivativesclearing organization shall be dulyorganized, legally authorized to conduct

business, and remain in good standingat all times in the relevant jurisdictions.If the derivatives clearing organizationprovides clearing services outside theUnited States, it shall be duly organizedto conduct business and remain in goodstanding at all times in the relevantjurisdictions, and be authorized by theappropriate foreign licensing authority.

(b) Legal framework. A derivativesclearing organization shall operatepursuant to a well-founded, transparent,and enforceable legal framework thataddresses each aspect of the activities of the derivatives clearing organization. Asapplicable, the framework shall providefor:

(1) The derivatives clearingorganization to act as a counterparty,including novation;

(2) Netting arrangements;(3) The derivatives clearing

organization’s interest in collateral;





(4) The steps that a derivativesclearing organization would take toaddress a default of a clearing member,including but not limited to, theunimpeded ability to liquidate collateraland close out or transfer positions in atimely manner;

(5) Finality of settlement and fundstransfers that are irrevocable and

unconditional when effected (no laterthan when a derivatives clearingorganization’s accounts are debited andcredited); and

(6) Other significant aspects of thederivatives clearing organization’soperations, risk managementprocedures, and related requirements.

(c) Conflict of laws. If a derivativesclearing organization provides clearingservices outside the United States:

(1) The derivatives clearingorganization shall identify and address

any material conflict of law issues. Thederivatives clearing organization’scontractual agreements shall specify achoice of law.

(2) The derivatives clearingorganization shall be able todemonstrate the enforceability of itschoice of law in relevant jurisdictionsand that its rules, procedures, andcontracts are enforceable in all relevantjurisdictions.

Appendix to Part 39—Form DCO

Derivatives Clearing OrganizationApplication for Registrations

BILLING CODE 6351–01–P





































































































BILLING CODE 6351–01–C

PART 140—ORGANIZATION,FUNCTIONS, AND PROCEDURES OFTHE COMMISSION

■ 9. The authority citation for part 140continues to read as follows:

Authority: 7 U.S.C. 2 and 12a.

■ 10. Amend §140.94 by revising the

section heading and paragraph (a)(5),redesignating paragraph (a)(6) asparagraph (a)(7), revise newlyredesignated paragraph (a)(7), and addnew paragraphs (a)(6) and (a)(8) through(a)(14) to read as follows:

§ 140.94 Delegation of authority to theDirector of the Division of Clearing andRisk.

(a) * * *

(5) All functions reserved to theCommission in §5.14 of this chapter;

(6) All functions reserved to theCommission in §§39.3(a)(2) and (a)(3) of this chapter;

(7) All functions reserved to theCommission in §§ 39.5(b)(2), (b)(3)(ix),and (d)(3) of this chapter;

(8) All functions reserved to theCommission in § 39.10(c)(4)(iv) of thischapter;

(9) All functions reserved to theCommission in §§39.11(b)(1)(vi),

(b)(2)(ii), (c)(1), (c)(2), (f)(1) and (f)(4) of this chapter;(10) All functions reserved to the

Commission in § 39.12(a)(5)(i)(B) of thischapter;

(11) All functions reserved to theCommission in §§39.13(g)(8)(ii),(h)(1)(i)(C), (h)(1)(ii), (h)(3)(i), (h)(3)(ii),and (h)(5)(i)(A) of this chapter;

(12) The authority to requestadditional information in support of arule submission under§ 39.15(b)(2)(iii)(A) of this chapter andin support of a petition pursuant to

section 4d of the Act under§ 39.15(b)(2)(iii)(B) of this chapter;

(13) All functions reserved to theCommission in §§ 39.19(c)(3)(iv),(c)(5)(i), (c)(5)(ii), and (c)(5)(iii) of thischapter; and

(14) All functions reserved to theCommission in § 39.21(d) of thischapter.

Issued in Washington, DC, on October 18,

2011, by the Commission.David A. Stawick,

Secretary of the Commission.

Appendices to Derivatives ClearingOrganization General Provisions andCore Principles—Commission VotingSummary and Statements of Commissioners

Note: The following appendices will notappear in the Code of Federal Regulations





Appendix 1—Commission VotingSummary

On this matter, Chairman Gensler andCommissioners Dunn and Chilton votedin the affirmative; CommissionersSommers and O’Malia voted in thenegative.

Appendix 2—Statement of Chairman

Gary GenslerI support the final rulemaking on core

principles for derivatives clearingorganizations (DCOs). Centralizedclearing has been a feature of the U.S.futures markets since the late-19thcentury. Clearinghouses havefunctioned both in clear skies andduring stormy times—through the GreatDepression, numerous bank failures,two world wars, and the 2008 financialcrisis—to lower risk to the economy.Importantly, centralized clearingprotects banks and their customers fromthe risk of either party failing.

When customers don’t clear theirtransactions, they take on their dealer’scredit risk. We have seen over manydecades, however, that banks do fail.Centralized clearing protects all marketparticipants by requiring daily mark tomarket valuations and requiringcollateral to be posted by both parties sothat both the swap dealer and itscustomers are protected if either fails. Itlowers the interconnectedness betweenfinancial entities that helped spread riskthroughout the economy when banks

began to fail in 2008.Today’s rulemaking will establish

certain regulatory requirements forDCOs to implement important coreprinciples that were revised by theDodd-Frank Act. We recognize the needfor very robust risk managementstandards, particularly as more swapsare moved into central clearinghouses.We have incorporated the newest draftCommittee on Payment and SettlementSystems (CPSS)-InternationalOrganization of Securities Commissions(IOSCO) standards for centralcounterparties into our final rules.

First, the financial resources and riskmanagement requirements will

strengthen financial integrity andenhance legal certainty forclearinghouses. We’re adopting arequirement that DCOs collect initialmargin on a gross basis for its clearingmember’s customer accounts Forinterest rates and financial index swaps,such as credit default swaps, we aremaintaining, as proposed, a minimummargin for a five-day liquidation period.This is consistent with current marketpractice, and many commentersrecommended this as a minimum. Forthe clearing of physical commodity

swaps, such as on energy, metals andagricultural products, we are requiringmargin that is risk-based but consistentwith current market practice—aminimum of one day. Maintaining aminimum five day liquidation periodfor interest rates and credit defaultswaps is appropriate not only as it isconsistent with current market practice,

but also as these markets are the mostsystemically relevant for theinterconnected financial system. Historyshows that, in 2008, it took five daysafter the failure of Lehman Brothers forthe clearinghouse to transfer Lehman’sinterest rate swaps positions to otherclearing members. These financialresource requirements, and particularlythe margin requirements, are critical forsafety and soundness as more swaps aremoved into central clearing.

Second, the rulemaking implementsthe Dodd-Frank Act’s requirement foropen access to DCOs. The participant

eligibility requirements promote fairand open access to clearing.Importantly, the rule addresses how afutures commission merchant can

become a member of a DCO. The rulepromotes more inclusiveness whileallowing DCO to scale a member’sparticipation and risk based upon itscapital. This improves competition thatwill benefit end-users of swaps, whileprotecting DCOs’ ability manage risk.

Third, the reporting requirements willensure that the Commission has theinformation it needs to monitor DCOcompliance with the CommodityExchange Act and Commission

regulations.Fourth, the rules formalize the DCO

application procedures to bring aboutgreater uniformity and transparency inthe application process and facilitategreater efficiency and consistency inprocessing applications.

These reforms will both lower risk inthe financial system and strengthen themarket by making many of the processesmore efficient and consistent.

Appendix 3—Statement of Commissioner Jill Sommers

The final rules adopted by the

Commission today for derivativesclearing organizations (DCOs) willimplement a key component of theDodd-Frank Wall Street Reform andConsumer Protection Act (Dodd-Frank)to facilitate centralized clearing of bothexchange-traded and over-the-counterswaps. While I fully support thecentralized clearing of swaps, Ireluctantly cannot support the finalDCO rules.

In my opinion, the rules areneedlessly prescriptive, internallyinconsistent, and depart from the

Commission’s time-tested principles- based oversight regime, with little to noexplanation of the costs and benefits of doing so, or even a rationale other thanan overarching belief that prescriptiverules will increase legal certainty andprevent a race to the bottom bycompeting clearinghouses. A fewexamples will illustrate my point.

Rule 39.11(a)(1) requires a DCO tomaintain sufficient financial resourcesto cover a default by its largest clearingmember. Rule 39.11(a)(2) requires aDCO to maintain sufficient financialresources to cover its operating costs fora period of at least one year. Rules39.11(b)(1) and (b)(2) list the types of financial resources deemed sufficientlyliquid to meet the requirements of Rules39.11(a)(1) and (a)(2). The preamble tothe rules states that letters of credit arenot an acceptable financial resource forpurposes of Rules 39.11(a)(1) or (a)(2),

but may be allowed on a case-by-case

basis. Letters of credit are also bannedfor purposes of Rule 39.11(e)(1) (cashobligations), and Rule 39.11(e)(3)(guaranty fund obligations), neither of which allow for a case-by-casedetermination. When it comes to initialmargin, letters of credit are allowed forfutures and options withoutqualification, but banned for swaps.

These distinctions, in my opinion, arenot legally or factually justifiable. Theability to draw on safe, liquid assets iscritical in all of the situations describedabove. We should treat letters of creditthe same way unless there is acompelling reason not to. This is

especially true given the fact that banning their use as initial margin forswaps will have the perverse,unintended consequence of disincentivizing voluntary clearing bycommercial end-users who support theirswaps positions using letters of credit—a result that is directly at odds with thegoals of Dodd-Frank.

Another example can be found inRule 39.13(g)(2)(ii), which establishes aone-day minimum liquidation time forcalculating initial margin for futures andoptions, a one-day minimum liquidationtime for swaps on agricultural, metal,

and energy commodities, and a five-dayminimum liquidation time for all otherswaps. In the cost-benefit analysis, theCommission states that ‘‘using only onecriterion—i.e., the characteristic of thecommodity underlying a swap—todetermine liquidation time could resultin less-than-optimal margincalculations.’’ The Commission goes onto describe the complex nature of calculating appropriate margin levels,which includes the ability to assessquantitative factors such as the riskcharacteristics of the instrument traded,





289Derivatives Clearing Organizations (to becodified at 17 CFR pts. 1, 21, 39, and 140), available

at: http://www.cftc.gov/PressRoom/Events/ opaevent _cftcdoddfrank101811 (the ‘‘DCO FinalRule’’).

290See Kathryn Chen et al., An Analysis of CDSTransactions: Implications for Public Reporting,Federal Reserve Bank of New York Staff Report no.517 (September 2011), available at: http:// www.newyorkfed.org/research/staff _reports/ sr517.pdf (stating that ‘‘[c]learing-eligible productswithin our sample traded on more days and hadmore intraday transactions than non-clearingeligible products’’).

291See section 3(b) of the Commodity ExchangeAct (CEA), 7 U.S.C. 5(b) (stating that ‘‘[i]t is thepurpose of this Act to serve the public interests* * * through a system of effective self-regulationof trading facilities, clearing systems, market

participants and market professionals under theoversight of the Commission.’’).

292The DCO Final Rule, supra note 289, at 387–388 (to be codified at 17 CFR 39.12(a)(1)).

293See letter, dated March 21, 2011, from theUnited Kingdom Financial Services Authority(‘‘FSA’’), available at http://comments.cftc.gov/

its historical price volatility andliquidity in the relevant market, as wellas ‘‘expert judgment as to the extent towhich such characteristics and data may

be an accurate predictor of futuremarket behavior with respect to suchinstruments, and [the application of]such judgment to the quantitativeresults.’’ We then explain that theCommission is not capable of determining the risk characteristics,price volatility and market liquidity of even a sample of swaps for purposes of determining an appropriate liquidationtime for specific swaps.

In the face of our admitted inability todetermine appropriate liquidation timesfor particular swaps, we are picking aone-day time for some, based on theunderlying commodity, and a five-daytime for all others, even though this‘‘could result in less-than-optimalmargin calculations.’’ This defies

common sense.The only reason we give for

eliminating the long-standing discretionof the acknowledged experts, i.e., theDCOs, to determine the appropriateliquidation times for the transactionsthey clear is to prevent a feared race tothe bottom by DCOs who will competeto clear swaps in the future. Weacknowledge, however, that DCOs haveused reasonable and prudent judgmentin establishing liquidation times in thepast, including DCOs that currentlycompete in the swaps clearing space.The Commission gives no reason for its

belief that there may be a race to the bottom if we do not establish this lessthan ideal methodology. Nor does theCommission acknowledge the existenceof other safeguards in the rules that giveus strong tools for policing a potentialrace to the bottom.

With the passage of Dodd-Frank,Congress gave the Commission broadauthority to regulate swap transactions,swap markets and swap marketparticipants. I do not believe, however,that Congress intended for theCommission to strip DCOs of theflexibility to determine the manner in

which they comply with coreprinciples, as we have done with theserules. Our registered DCOs have a strongtrack record of prudent riskmanagement, including during thefinancial crisis, and there is no reasonto believe they will not continue to usetheir expert judgment in a responsiblefashion. Moreover, unnecessary andinflexible rules, such as these, willprevent DCOs from quickly adapting tochanging market conditions for noapparent benefit. I therefore dissent.

Appendix 4—Statement of Commissioner Scott O’Malia

Today, the Commission approved afinal rulemaking on the operation of derivatives clearing organizations (each,a ‘‘DCO’’).289 Of the Dodd-Frankrulemakings that the Commission has sofar undertaken, this rulemaking isamong the most important. I have beena strong proponent of clearing. In theaftermath of the Enron crisis, Iwitnessed first-hand how the creation of ClearPort ameliorated counterpartycredit fears in the energy merchantmarkets and restored liquidity to thosemarkets. I am certain that clearing willsimilarly benefit the swaps market,290 particularly by significantly expandingexecution on electronic platforms,thereby increasing price transparencyand discovery. Moreover, as we haveseen in the 2008 financial crisis,clearing has the potential to mitigatesystemic risk, by ensuring that swap

counterparties—not hardworkingAmerican taxpayers—post collateral tosupport their exposures.

The main goal of this final rulemakingis to ensure that clearing contributes tothe integrity of the United Statesfinancial system by, among other things,allowing entities other than the largestdealer banks to offer clearing services tocommercial and financial end-users. Ifully support this goal. However, in anattempt to achieve this goal, thisrulemaking abandons the principles-

based regulatory regime whichpermitted DCOs to perform soadmirably in the 2008 financial crisis.Instead, the final rulemaking sets fortha series of prescriptive requirements. Idisagree with this approach. DCO riskmanagement poses complex andmultidimensional challenges. One DCOmay have a significantly different riskprofile than another. Consequently, eachDCO must have sufficient discretion tomatch requirements to risks. The role of the Commission is to oversee theexercise of such discretion, not toprevent such exercise.291

Additionally, I am mindful of the costof clearing and want to ensure that suchcost does not constitute a barrier toentry. Certain provisions in this finalrulemaking may impose substantialcosts without corresponding benefits.Such provisions may discourage marketparticipants from executing transactionssubject to mandatory clearing, even if

they need such transactions toprudently hedge risks, or from clearingon a voluntary basis. By creatingperverse incentives to keep risk outsideof the regulatory framework, and toleave it within our commercial andfinancial enterprises, the DCO rulesundermine a fundamental purpose of the Dodd-Frank Act—namely, theexpansion of clearing.

I will elaborate on each concern inturn.

Participant Eligibility: One-Size DoesNot Fit All

This final rulemaking prohibits a DCOfrom requiring more than $50 million incapital from any entity seeking to

become a swaps clearing member. Thisnumber makes a great headline, mainly

because it is so low. It also sends anunequivocal message to DCOs that haveclearing members that are primarilydealer banks. However, in adopting andinterpreting this requirement, theCommission may unwisely limit therange of legitimate actions that DCOscan take to manage their counterpartyrisks. By imposing such limitations, theCommission is introducing costs toclearing that it fails to detail and

explore.Let me be plain. I oppose

anticompetitive behavior. However, anentity with $50 million in capitalizationmay not be an appropriate clearingmember for every DCO. The $50 millionthreshold prevents DCOs from engagingin anticompetitive behavior but alsoprohibits DCOs from taking legitimate,risk-reducing actions. Instead of adopting this prescriptive requirement,the Commission should have providedprinciples-based guidance to DCOs onthe other components of fair and openaccess, such as the standard for less

restrictive participationrequirements.292 By taking a moreprinciples-based approach, theCommission could have been in greateraccord with international regulators,one of which explicitly cautionedagainst the $50 million threshold.293


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PublicComments/CommentList.aspx?id=957 (stating that ‘‘whilst capital thresholds or otherparticipation eligibility threshold limitations may be a potential tool to help ensure fair and openaccess to [central counterparties (‘‘CCPs’’)], toimpose them on clearing arrangements for productsthat have complex or unique characteristics couldlead to increased risk to the system in the short tomedium term.’’)

294See Risk Management Requirements forDerivatives Clearing Organizations, 76 FR 3698,3791 (Jan. 20, 2011).

295See the DCO Final Rule, supra note 289, at 83to 84 (further stating that ‘‘of 126 FCMs, 63currently have capital above $50 million and mostFCMs with capital below that amount are notclearing members.’’).

296 Id. at 83.297 Id. at 388 (to be codified at 17 CFR

39.12(a)(2)(ii)) (further stating that ‘‘[c]apitalrequirements shall be scalable to risks posed byclearing members’’.).

298 Id. (to be codified at 17 CFR 39.12(a)(2)(i)).299 Id. Additionally, the notice of proposed

rulemaking states: ‘‘Proposed §§39.12(a)(2)(ii) and

39.12(a)(2)(iii), considered together, would requirea DCO to admit any person to clearing membershipfor the purpose of clearing swaps, if the person had$50 million in capital, but would permit a DCO torequire each clearing member to hold capitalproportional to its risk exposure. Thus, if a clearingmember’s risk exposure were to increase in a non-linear manner, the DCO could increase the clearingmember’s corresponding scalable capitalrequirement in a non-linear manner.’’ 76 FR at3701.

300See Matthew Leising, ‘‘ICE Clear Credit’sMember Rules Too Exclusive, Small Firms Say,’’Bloomberg, Aug. 9, 2011, available at: http:// www.bloomberg.com/news/2011-08-09/ice-clear-credit-s-member-rules-too-exclusive-small-firms- say.html .

301The DCO Final Rule, supra note 289, at 85–86.

302The final rulemaking requires DCOs to imposerisk limits on clearing members. See id. at 399 to400 (to be codified at 17 CFR 39.13(h)(1)).

303See supra note.304See the DCO Final Rule, supra note 289, at 399

to 400 (to be codified at 17 CFR 39.13(h)(1)(i)(C))(stating that ‘‘[t]he Commission may review suchmethods, thresholds, and financial resources andrequire the application of different methods,thresholds, or financial resources, as appropriate.’’).

Basis for the $50 Million?

How did the Commission determinethat the $50 million threshold isappropriate? It is not really evident fromthe notice of proposed rulemaking.294 Inthe final rulemaking, the Commissionstates that the $50 million threshold wasderived from the fact that most

registered futures commissionmerchants (‘‘FCMs’’) that are currentlyDCO clearing members have at least $50million in capital.295

The final rulemaking, however, doesnot answer a number of questions thatare crucial to determining whether the$50 million threshold is appropriate forall swap transactions. These questionsinclude, without limitation: What typesof products do the referenced FCMscurrently clear? Are there differences

between the capital distributions of FCMs that clear different products? If so, what are such differences?

The answers to these questions are

important because FCMs may needdifferent amounts of capital to supporttheir exposures to different products.Assume, for example, that the averagecapitalization of FCMs clearingagricultural futures is $50 million.Further assume that an FCM has $50million in capital, and is seeking to

become a clearing member. TheCommission may reasonably concludethat such FCM would have theresources to clear agricultural futures. Itmay also reasonably conclude that suchFCM would have the resources to clearagricultural swaps that have the same

terms and conditions as agriculturalfutures. The Commission cannotreasonably conclude, however, thatsuch FCM would have the resources toclear credit default swaps.

By not setting forth the answers toquestions such as these, the finalrulemaking creates the impression thatthe $50 million threshold is arbitrary,and renders vulnerable its conclusionthat the threshold ‘‘captures firms thatthe Commission believes have thefinancial, operational, and staffingresources to participate in clearing

swaps without posing an unacceptablelevel of risk to a DCO.’’296

Anticompetitive behavior? Orlegitimate, risk-reducing action?

The final rulemaking recognizes thatDCOs may increase capital requirementsfor legitimate, risk-reducing reasons. Infact, the final rulemaking requires a

DCO to ‘‘set forth capital requirementsthat * * * appropriately match capitalto risk.’’ 297 Further, the finalrulemaking mandates DCOs to ‘‘requireclearing members to have access tosufficient financial resources to meetobligations arising from participation inthe [DCO] in extreme but plausiblemarket conditions.’’ 298 The finalrulemaking states that a DCO ‘‘maypermit such financial resources toinclude, without limitation, a clearingmember’s capital.’’ 299

The final rulemaking, however,provides little insight on how the

Commission intends to differentiate between (i) a required risk-basedincrease in capital requirements and (ii)an illegitimate attempt to circumventthe $50 million threshold to squashcompetition. To use an examplegrounded in reality—ICE Clear Creditrecently lowered its minimum capitalrequirement for clearing members to$100 million. However, it added arequirement that clearing members holdexcess net capital equal to 5 percent of their segregated customer funds. Uponlearning about the additionalrequirement, at least two existing FCMscomplained that it violates fair and open

access.300 The final rulemaking givesvery little guidance on the criteria thatthe Commission will apply inadjudicating a dispute such as this. Thepreamble to the final rulemaking simplystates: ‘‘A DCO may not * * * [enact]some additional financial requirement

that effectively renders the $50 millionthreshold meaningless for somepotential clearing members.’’ It furtherstates that such a requirement would violate the other components of fair andopen access, such as ‘‘§39.12(a)(1)(i)(less restrictive alternatives), or§ 39.12(a)(1)(iii) (exclusion of certaintypes of firms).’’ 301 This vague

statement provides no legal certainty or bright lines for DCOs and potentialclearing members to follow.

If I were running a DCO, I would beextremely confused. On the one hand,the final rulemaking requires me tomatch capital requirements to risk. Onthe other hand, the preamble suggeststhat I cannot increase capitalrequirements (or any other financialrequirement), if that would prohibitsome entities with $50 million incapitalization from becoming clearingmembers. How should I resolve thisconundrum?

Hidden CostsIf a DCO took a narrow interpretation

of the reference to financial requirements in the preamble, then ithas only one alternative: (i) Admit anyentity with $50 million in capital as aclearing member and (ii) impose strictrisk limits.302 How strict could suchlimits be? To lend some context to this$50 million threshold, a recent reportfrom the staff of the Federal ReserveBank of New York observed that $50million tended to be the notional valueof one single transaction in a creditdefault swap index with relatively high

liquidity.303

Assuming that the Commission doesnot require the DCO to increase its risklimits,304 where does this situationleave the DCO? The DCO would need toincur the cost of (i) evaluatingapplications from all entities with $50million in capital, (ii) operationallyconnecting to such entities, and (iii)potentially defending itself againstclaims from such entities that the risklimits or financial requirements are toostringent. The DCO may pass on suchcosts to clearing members, which maypass on such costs to commercial andfinancial end-users. In the meantime,such entities, when admitted, may beunable to clear any significant volume



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305 Interestingly, the preamble notes that at leasttwo commenters agreed that a DCO maylegitimately use such increases to moderate the riskof a member with only $50 million in capital.Specifically, the preamble states: ‘‘Newedgecommented that the proposed rule should notincrease risk to a DCO because a DCO can mitigaterisk by, among other things, imposing positionlimits, stricter margin requirements, or stricterdefault deposit requirements on lesser capitalizedclearing members.’’ The preamble also states: ‘‘J.P.Morgan, however, commented that a cap on amember’s minimum capital requirement would not

impact the systemic stability of a DCO as long as* * * DCOs hold a sufficient amount of margin andfunded default guarantee funds.’’ Id. at 80 to 82. Itis therefore unclear why the cost-benefit analysisdid not address the potential for such increases.

306See id. at 387 (to be codified at 17 CFR39.12(a)(1)(iii)) (stating that ‘‘[a] derivatives clearingorganization shall not exclude or limit clearingmembership of certain types of market participantsunless the derivatives clearing organization candemonstrate that the restriction is necessary toaddress credit risk or deficiencies in theparticipants’ operational capabilities that wouldprevent them from fulfilling their obligations asclearing members.’’ The regulation contains nofurther detail regarding what type of demonstrationwould be sufficient.).

307 In legal parlance, the $50 million threshold isneither necessary nor sufficient to determiningwhether a DCO has violated fair and open access.The threshold is not necessary because a DCO canset an even lower minimum capital requirementand still violate fair and open access if anotherrequirement ‘‘excludes or limits clearingmembership of certain types of marketparticipants.’’ Id. (to be codified at 17 CFR39.12(a)(1)(iii)). The threshold is not sufficient because, even if the DCO accepts all entities with$50 million in capital as clearing members, theCommission may still hold that DCO violated fairand open access if it imposes ‘‘some additionalfinancial requirement that effectively renders the$50 million threshold meaningless.’’ Id. at 85–86.

308 In such guidance, the Commission could havedetailed the information that a DCO would need toprovide in order to demonstrate that it could notadopt a less restrictive participation requirementwithout materially increasing its own risk. TheCommission could have also discussed the weightthat DCOs should accord to a particular level of capitalization, depending on whether the relevantclearing member (i) engages in businesses otherthan the intermediation of futures or swaps, or (ii)participates at multiple DCOs rather than one DCO.

309See supra note. I note that the Commissionand FSA share jurisdiction over three DCOs

clearing swaps—namely, LCH.Clearnet Limited, ICEClear Europe Limited, and CME Clearing Europe.How the Commission and FSA will resolveconflicting regulation remains to be seen.

310See Bank for International Settlements’Committee on Payment and Settlement Systems andTechnical Committee of the InternationalOrganization of Securities Commissions (‘‘CPSS–IOSCO’’), ‘‘Recommendations for CentralCounterparties,’’ CPSS Publ’n No. 64 (November2004), available at: http://www.bis.org/publ/ cpss64.pdf (the ‘‘CPSS–IOSCO Recommendations’’).Section 4.2.2 of the CPSS–IOSCORecommendations state: ‘‘To reduce the likelihoodof a participant’s default and to ensure timelyperformance by the participant, a CCP shouldestablish rigorous financial requirements for

participation. Participants are typically required tomeet minimum capital standards. Some CCPsimpose more stringent capital requirements if exposures of or carried by a participant are large orif the participant is a clearing participant. Capitalrequirements for participation may also takeaccount of the types of products cleared by a CCP.In addition to capital requirements, some CCPsimpose standards such as a minimum credit ratingor parental guarantees.’’

311See CPSS–IOSCO, ‘‘Principles for financialmarket infrastructures: Consultative report,’’ CPSSPubl’n No. 94 (March 2011), available at: http:// www.bis.org/publ/cpss94.pdf (the ‘‘CPSS–IOSCOConsultation’’). The CPSS–IOSCO Consultation,which CPSS–IOSCO has not adopted as final, doesnot set forth any requirement or suggestion thatresembles the $50 million threshold. Instead, theConsultation, like the Recommendations,emphasizes the importance of ‘‘risk-based’’ CCPparticipation criteria that are not undulydiscriminatory. Specifically, Section 3.16.6 of theCPSS–IOSCO Consultation states: ‘‘Participationrequirements based solely on a participant’s size aretypically insufficiently related to risk and deservecareful scrutiny.’’ Whereas the Consultation mayhave intended to comment on restrictively highCCP participation requirements, the same logicapplies to restrictively low CCP participationrequirements. Neither are risk-based.

312See Core Principles and Other Requirementsfor Designated Contract Markets, 75 FR 80572 (Dec.22, 2010).

313See the DCO Core Principles, supra note 289,at 393–394 (to be codified at 17 CFR 39.13(g)(2)(ii)).

of transactions, for themselves or forcustomers, especially in asset classessuch as credit default swaps. Under thisscenario, rather than leading to fair andopen access, the $50 million thresholdmay actually impede access to clearing

by commercial and financial end-users, because the threshold would increasetheir costs without introducing

meaningful competition among FCMsoffering clearing services.

If, on the other hand, a DCO took amore aggressive interpretation of thereference to financial requirements inthe preamble, then it may have otheralternatives to mitigate risks thatadmitting an entity with $50 million incapital may introduce. For example, itmay increase margin requirements. Itmay also increase guaranty fundcontributions for all clearing members,in proportion to their clearing activity.In other words, a DCO may increase theoverall cost of clearing in order tocompensate for the risks of having lessercapitalized new clearing members.

What are the potential effects of suchincreases? It is difficult to determinefrom our cost-benefit analysis. Theanalysis does not identify increases inmargin or guaranty fund contributionsas potential costs, much less attempt toquantify such costs.305 However, if theincreases in costs are significant, and if such increases apply to a wide range of clearing members (because the DCOfears being accused of unjustifieddiscrimination),306 then such increaseswould most definitely influencewhether commercial and financialentities voluntarily clear or even enterinto hedges in the first place.

Principles-Based Regulation Is a BetterSolution

I propose a simple solution thatwould have addressed the confusionand hidden costs resulting from the $50million threshold. The Commissionshould have eliminated the threshold.The threshold adds no value to the othercomponents of fair and open access.307 Given that the final rulemakingrightfully requires a DCO to properlymanage its risks, one or more DCOswould inevitably impose some sort of financial requirement that wouldprevent entities with $50 million (ormore) in capital from directlyparticipating in clearing. At that point,the Commission would not be able toopine on such a requirement withoutlooking to the other components of fairand open access. As a result, it wouldhave served the Commission well tohave focused in the first instance onsetting forth principles-based guidance

on such components.308 Moreover,principles-based guidance would have

brought the Commission into greateraccord with certain internationalregulators,309 current internationalstandards on CCP regulation,310 as well

as the proposed revisions to suchstandards.311

Costs Without Benefits: MinimumLiquidation Time Requirements

I have consistently highlighted thatour rulemakings are interconnected andthat the Commission has an obligationto analyze the cost impact across

rulemakings. In this instance, I amconcerned about the relationship

between this final rulemaking and ourproposal interpreting core principle 9for designated contract markets (DCMs),which may be finalized in the future.312 Although this relationship may result insignificant costs for the market, thisfinal rulemaking fails to disclose suchcosts.

Specifically, this final rulemakingrequires a DCO to calculate marginusing different minimum liquidationtimes for different products. A DCOmust calculate margin for (i) futures

based on a one-day minimumliquidation time, (ii) agricultural,energy, and metals swaps based on aone-day minimum liquidation time, and(iii) all other swaps based on a five-dayminimum liquidation time.313

No Policy Basis for MinimumLiquidation Times

As a preliminary matter, this finalrulemaking creates the impression thatthese requirements are arbitrary, like the$50 million threshold. Although thefinal rulemaking characterizes theserequirements as ‘‘prudent,’’ it sets forth













314See id. at 126–127.315According to the final rulemaking, such

factors are: ‘‘(i) Average daily trading volume in aproduct; (ii) average daily open interest in aproduct; (iii) concentration of open interest; (iv)availability of a predictable basis relationship witha highly liquid product; and (v) availability of multiple market participants in related markets totake on positions in the market in question.’’ Id. at129.

316 Instead of considering the five factors, theCommission appears to have simply codified theminimum liquidations times that certain DCOscurrently use for swaps. For example, theCommission justifies setting a minimum liquidationtime of five days for swaps referencing non-physicalcommodities as follows: ‘‘The longer liquidationtime, currently five days for credit default swaps atICE Clear Credit LLC and CME, and for interest rateswaps at LCH and CME, is based on theirassessment of the higher risk associated with theseproducts.’’ Id. at 127–128. Given that thisjustification appears to focus on credit defaultswaps and interest rate swaps, it is unclear how theCommission concluded that a five-day minimumliquidation time is appropriate for swaps thatreference financial commodities but are neithercredit default swaps nor interest rate swaps.

31775 FR at 80616.318According to information that I have received

from one DCM, the proposal would forceconversion of 628 futures and options contracts toswap contracts. Moreover, according to the Off-Market Volume Study (May-2010 through July-2010) prepared by Commission staff, the proposal

would force conversion of approximately 493futures and options contracts. See Off-MarketVolume Study, available at: http://www.cftc.gov/ LawRegulation/DoddFrankAct/Rulemakings/ DF _12 _DCMRules/index.htm.

319See 75 FR at 80589–90.320See letter, dated February 22, 2011, from

NYSE Liffe U.S., available at: http:// comments.cftc.gov/PublicComments/ ViewComment.aspx?id=27910&SearchText =. Seealso letter, dated February 22, 2011, from ELXFutures, L.P., available at: http://comments.cftc.gov/ PublicComments/ ViewComment.aspx?id=27873&SearchText=. See further letter, dated February 22, 2011, from ErisExchange, LLC, available at: http:// comments.cftc.gov/PublicComments/ ViewComment.aspx?id=27853&SearchText =.

321See section 3(b) of the CEA, 7 U.S.C. 5(b).322See the DCO Final Rule, supra note 289, at 394

(to be codified at 17 CFR 39.13(g)(2)(ii)(D)).323The petition is available at: http://

www.cftc.gov/PressRoom/PressReleases/pr5724-09. The petition was filed on July 28, 2009. TheCommission issued an order granting the petitionon September 16, 2011. The order does not appearon the Commission Web site.

no justification for thischaracterization.314 According to thefinal rulemaking, DCOs should considerat least five factors in establishingminimum liquidation times for itsproducts, including trading volume,open interest, and predictablerelationships with highly liquidproducts.315 In setting forth such

factors, the Commission is holdingDCOs to a higher standard than it holdsitself. The final rulemaking presents noevidence that the Commissionconsidered any of the five factors indetermining minimum liquidationtimes.316

Negative Implications for Competition

More importantly, when theserequirements are juxtaposed against ourproposal interpreting DCM coreprinciple 9, the potential of theserequirements to disrupt alreadyestablished futures markets becomes

apparent. In the proposal, which isentitled Core Principles and Other Requirements for Designated Contract Markets, the Commission proposed, in adeparture from previous interpretationsof DCM core principle 9, to prohibit aDCM from listing any contract fortrading unless an average of 85 percentor greater of the total volume of suchcontract is traded on the centralizedmarket, as calculated over a twelve (12)month period.317 If the Commissionfinalizes such proposal, then DCMs mayneed to delist hundreds of futurescontracts.318 Financial contracts may be

affected, along with contracts inagricultural commodities, energycommodities, and metals.

According to the proposal, DCMs mayconvert delisted futures contracts toswap contracts.319 However, if thefutures contracts reference financialcommodities, then this final rulemakingwould require that a DCO margin such

swap contracts using a minimumliquidation time of five days instead of one day for futures. If nothingsubstantive about the contracts changeother than their characterization (i.e.,futures to swaps), then how can theCommission justify such a substantialincrease in minimum liquidation timeand margin? An increase of thismagnitude may well result in a chillingof activity in the affected contracts.Such chilling would be an example of the type of market disruption that theCEA was intended to avoid.

I believe this has severe implicationsfor competition. As commenters to theDCM proposal noted, marketparticipants generally execute newfutures contracts outside the DCMcentralized market until the contractsattract sufficient liquidity. Attractingsuch liquidity may take years.320 Let usassume that an established DCM alreadylists a commercially viable futurescontract on a financial commodity thatmeets the 85 percent threshold. Evenwithout the DCM proposal and this finalrulemaking, a DCM seeking to compete

by listing a futures contract with thesame terms and conditions already facesan uphill battle. Now with the DCM

proposal, the competitor DCM wouldhave to also face the constant threat of

being required to convert the futurescontract into a swap contract.

With this final rulemaking, thecompetitor DCM (or a competitor swapexecution facility (SEF)) faces theadditional threat that, by virtue of suchconversion, the contract would bemargined using a five-day minimumliquidation time. In contrast, theincumbent futures contract—which mayhave the same terms and conditions as

the new ‘‘swap’’ contract—would still be margined using a one-day minimumliquidation time. It is difficult toimagine a DCM (or a competitor SEF)willing to compete given the twinSwords of Damocles that it would needto confront. By dissuading suchcompetition, this final rulemaking andthe DCM proposal undermine the

‘‘responsible innovation and faircompetition among boards of trade’’ thatthe CEA was intended to promote.321

Some may argue that this finalrulemaking would not have the negativeeffects that I articulated because itexplicitly permits the Commission toestablish, either sua sponte or uponDCO petition, longer or shorterliquidation times for particular productsor portfolios.322 I would argue thatrequiring market participants, duringthe pendency of such a petition, to paymargin calculated using a five-dayminimum liquidation time would likely

cause a substantial number of marketparticipants to withdraw from themarket, thereby chilling activity—perhaps irrevocably—in the contract. Iwould further argue that the additionalcost that (i) a DCM would incur topersuade a DCO to file a petition withthe Commission and (ii) a DCM or DCOwould incur to prepare such a petition,when coupled with the possibility thatthe Commission may deny suchpetition, would likely deter a DCM fromseeking to compete with an incumbentfutures contract. After all, theCommission may take a long time toconsider any DCO petition. Forexample, the Commission tookapproximately two years to approve apetition to reduce the minimumliquidation time for certain contracts onthe Dubai Mercantile Exchange fromtwo days to one day.323 Thus, thispower to petition the Commission forrelief may be of little value to offset thelikely stifling of competition.

Return to Principles-Based Regulation

What should the Commission havedone to avoid market disruption and acurtailment in competition? Again, theCommission should have retained a

principles-based regime, and shouldhave permitted each DCO to determinethe appropriate minimum liquidationtime for its products, using the fivefactors articulated above. Determining


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324See the DCO Final Rule, supra note 289, at315–316 (stating that ‘‘[i]n addition to theliquidation time frame, the margin requirements fora particular instrument depend upon a variety of characteristics of the instrument and the markets inwhich it is traded, including the risk characteristicsof the instrument, its historical price volatility, andliquidity in the relevant market. Determining suchmargin requirements does not solely depend uponsuch quantitative factors, but also requires expertjudgment as to the extent to which suchcharacteristics and data may be an accuratepredictor of future market behavior with respect tosuch instruments, and applying such judgment tothe quantitative results * * * Determining the riskcharacteristics, price volatility, and market liquidityof even a sample for purposes of determining aliquidation time specifically for such instrumentwould be a formidable task for the Commission toundertake and any results would be subject to arange of uncertainty.’’).

325See supra note 310. With respect to minimumliquidation times, Section 4.4.3 of the CPSS–IOSCORecommendations simply state: ‘‘Marginrequirements impose opportunity costs on CCPparticipants. So, a CCP needs to strike a balance between greater protection for itself and higheropportunity costs for its participants. For thisreason, margin requirements are not designed to

cover price risk in all market conditions.Nonetheless, a CCP should estimate the interval between the last margin collection before defaultand the liquidation of positions in a particularproduct, and hold sufficient margin to coverpotential losses over that interval in normal marketconditions.’’

326See also supra note 311. Like the CPSS–IOSCO Recommendations, the CPSS–IOSCOConsultation also advocates a principles-basedmodel for estimating minimum liquidation times.Section 3.6.7 of the CPSS–IOSCO Consultationstates: ‘‘A CCP should select an appropriate close-out period for each product cleared by the CCP, anddocument the close-out periods and related analysisfor each product type. A CCP should base its close-out period upon historical price and liquidity datawhen developing its initial margin methodology.Historical data should include the worst events that

occurred in the selected time period for the productcleared as well as simulated data projections thatwould capture potential events outside of thehistorical data. In certain instances, a CCP mayneed to determine margin levels using a shorterhistorical period to reflect better new or currentvolatility in the market. Conversely, a CCP mayneed to determine margin levels based on a longerperiod in order to reflect past volatility. The close-out period should be set based on anticipated close-out times in stressed market conditions. Close-outperiods should be set on a product-specific basis,as less-liquid products might require significantlylonger close-out periods. A CCP should alsoconsider and address position concentrations,which can lengthen close-out timeframes and addto price volatility during close outs.’’

327The Commission acknowledged as much in itscost-benefit analysis. The analysis states: ‘‘The

Commission anticipates that using only onecriterion—i.e., the characteristic of the commodityunderlying a swap—to determine liquidation timecould result in less-than-optimal margincalculations. For some products, a five-dayminimum may prove to be excessive and tie upmore funds than are strictly necessary for riskmanagement purposes. For other products, a one-day or even a five-day period may be insufficientand expose a DCO and market participants toadditional risk.’’ The DCO Final Rule, supra note289, at 315.

328 Id. at 127 to 128 (stating ‘‘ * * * the final ruleprovides that the minimum liquidation time forswaps based on certain physical commodities, i.e.,agricultural commodities, energy, and metals, is oneday. For all other swaps, the minimum liquidationtime is five days. This distinction is based on thediffering risk characteristics of these product groups

and is consistent with existing requirements thatreflect the risk assessments DCOs have made overthe course of their experience clearing these typesof swaps. The longer liquidation time, currently fivedays for credit default swaps at ICE Clear Credit,LLC, and CME, and for interest rate swaps at LCHand CME, is based on their assessment of the higherrisk associated with these products.’’).

329 Id. at 396 (to be codified at 17 CFR39.13(g)(6)).

330 Id. at 396–397 (to be codified at 17 CFR39.13(g)(7)).

331 Id. at 383–387 (to be codified at 17 CFR39.11(c)(1) and (f)).

332See United States Commodity Futures TradingCommission, International Monetary Fund—

Financial Sector Assessment Program: Self-Assessment of IOSCO Objectives and Principles of Securities Regulation, August 2009, available at:http://www.treasury.gov/resource-center/ international/standards-codes/Documents/ Securities%20CFTC%20Self%20Assessment%208– 28–09.pdf (the ‘‘FSAP Assessment’’) (describing thecapabilities of the Risk Surveillance Group withinthe Division of Clearing and Risk (formerly knownas the Division of Clearing and IntermediaryOversight): ‘‘After identifying traders or FCMs atrisk, the RSG estimates the magnitude of the risk.The SRM system enables RSG staff to calculate thecurrent performance bond requirement for anytrader or FCM. This amount is generally designedto cover approximately 99% of potential one-daymoves * * * SRM also enables RSG staff to conductstress tests. RSG staff can determine how much aposition would lose in a variety of circumstancessuch as extreme market moves. This is aparticularly important tool with respect to optionpositions. As noted, the non-linear nature of options means that the loss resulting from a givenprice change may be many multiples greater for anoption position than for a futures position in thesame market. Moreover, the complexity of optionpositions can result in situations where the greatest

loss does not correspond to the most extreme pricemove.’’).The FSAP Assessment also describes the ability

of the RSG to check DCO stress testing of its defaultresources: ‘‘The RSG compares the risk posed by thelargest clearing member to a DCO’s financialresource package. The RSG analyzes not only thesize of the DCO package but also its composition.In the event of a default, a DCO must have accessto sufficient liquidity to meet its obligations as acentral counterparty on very short notice.’’

333See Exec. Order No. 13,563, 76 Fed. Reg. 3821(Jan. 21, 2011); Exec. Order No. 13,579, 76 Fed. Reg.41,587 (July 14, 2011).

334See, e.g., Business Roundtable and the United States Chamber of Commerce vs. SEC, No. 10–1305,2011 U.S. App. LEXIS 14988 (July 22, 2011).

appropriate margin requirementsinvolves quantitative and qualitativeexpertise. Such expertise resides in theDCOs and not in the Commission. In itscost-benefit analysis, the finalrulemaking admits as much.324 Returning to a principles-based regimewould have also better aligned withcurrent international standards on CCP

regulation,325 as well as the revisions tosuch standards.326

The ‘‘Race to the Bottom’’ ArgumentSimply Cannot Withstand Scrutiny

Some may argue that, by not imposingminimum liquidation times, the

Commission may enable a ‘‘race to the bottom,’’ where DCOs would compete by offering the lowest margin. As aconceptual matter, given that theCommission has not demonstrated thatthe minimum liquidation times that ithas decided to mandate are ‘‘prudent,’’it cannot demonstrate that the one-dayor five-day period would prevent a

‘‘race to the bottom.’’ 327 As an empiricalmatter, the Commission must havedecided that DCOs currently competingto clear interest rate swaps and creditdefault swaps have not entered into a‘‘race to the bottom,’’ because the finalrulemaking codifies the existing five-day minimum liquidation time thatsuch competing DCOs voluntarilyadopted.328

Finally, the Commission has moreeffective tools to prevent any ‘‘race tothe bottom.’’ First, this final rulemakingrequires a DCO to determine theadequacy of its initial margin

requirements on a daily basis.329

Second, this final rulemaking requires aDCO to conduct back testing of its initialmargin requirements on a daily ormonthly basis.330 Third, this finalrulemaking requires a DCO to stress testits default resources at least once amonth, and to report to the Commissionthe results of such stress testing at leastonce every fiscal quarter.331 Fourth, theCommission has the ability toindependently back test and stress testDCO initial margin requirements.332

Consequently, the Commission would be able to detect any ‘‘race to the bottom’’ that would cause any DCO tohave insufficient initial margin to coverits risks.

Cost-Benefit Analysis: We Can Do Better

I have always emphasized that theCommission must engage in more

rigorous cost-benefit analyses of itsrulemakings. At various points in myspeeches and writings, I have urged theCommission to (i) focus on theeconomic effects of its rulemakings,

both cumulative and incremental, (ii)quantify the costs and benefits of itsrulemakings, both cumulative andincremental, and (iii) better justify thechoice of a prescriptive requirementwhen a less-costly and equally effectiveprinciples-based alternative is available.Only by engaging in more rigorous cost-

benefit analyses would the Commissionfulfill the mandates of two ExecutiveOrders 333 and render our rulemakingsless vulnerable to legal challenge.334

I have read the cost-benefit analysis inthis final rulemaking with great interest.I can confirm that such analysis islonger than previous analyses.Unfortunately, increased length doesnot ensure an improvement in analysisand content.


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335See the DCO Final Rule, supra note 289, at315–316.

336See supra note 318. The Off-Market VolumeSurvey does not include contracts listed on newDCMs, such as NYSE Liffe U.S., ELX Futures, L.P.,or Eris Exchange, LLC. However, the existence of such survey is proof that the Commission has theability to identify contracts that DCM core principle9 may affect.

337See supra note 332. See pages 252 to 268 of the FSAP Assessment for a full description of thecapabilities of the RSG.

338The DCO Final Rule, supra note 289, at 344.

339See supra note 310.340See supra note 311.341See, e.g., id. at 132 (stating that requiring

DCOs to calibrate margin to cover price movementsat a 99 percent confidence interval accords withPrinciple 6 of the CPSS–IOSCO Consultation).

Although I have numerous concernswith the cost-benefit analysis, myprimary concern relates to its failure toattempt meaningful quantification. Inmultiple places in the cost-benefitanalysis, the Commission concludesthat the costs of a particular requirementare difficult or impossible to estimate. Incertain instances, the statement may be

accurate. If the Commission truly cannotquantify the costs in those instances,then that fact alone should cause theCommission to proceed with caution if it is going to abandon the existingprinciples-based regime. In otherinstances, however, I find the statementto be puzzling, given the capabilitiesand expertise of the Risk SurveillanceGroup (‘‘RSG’’) and the DCO ReviewGroup (‘‘DRG’’) in our Division of Clearing and Risk (formerly known asthe Division of Clearing andIntermediary Oversight).

I would like to highlight two such

instances where the Commission hasnot utilized its own data to quantify thecosts associated with its policydecisions. First, with respect to theminimum liquidation timerequirements, the Commission statesthat ‘‘it is not feasible to estimate orquantify these costs reliably.’’ TheCommission justifies such conclusion

by stating that (i) ‘‘reliable data is notavailable for many swaps that prior tothe Dodd-Frank Act were executed inunregulated markets,’’ and (ii) it would

be too difficult for the Commission toestimate margin using either a one-dayor five-day minimum liquidation timefor any particular product.335 Whereasthese statements may be accurate forcertain swaps, they are not accurate forfutures contracts currently listed on aDCM that will be converted to swapcontracts under the pending DCMproposal. However potentiallyincomplete, the Off-Market VolumeStudy (May 2010 through July 2010)accompanying the DCM proposalentitled Core Principles and Other Requirements for Designated Contract Markets 336 demonstrates that theCommission has the ability to identify atleast a sample of the futures contracts

that may be potentially converted toswap contracts. It is true that the DCOusually impounds the minimumliquidation time in the risk arrays thatit uses to calculate margin, and the RSG

cannot change such risk arrays easily.However, the RSG can ask the DCO toprovide the assumptions underlying therisk arrays, including the minimumliquidation time (usually one day). Thenthe RSG can modify such assumptionsto estimate margin calculations using afive-day minimum liquidation time.337 Would these calculations be imperfect?

Yes. However, any attempt, even animperfect one, undertaken by theCommission to understand the cost of our rulemakings or to justify our policydecisions is better than no attempt at all.

Another instance that I would like tohighlight pertains to letters of credit.This final rulemaking prohibits DCOsfrom accepting letters of credit as (i)initial margin for swaps contracts (butnot futures contracts) or (ii) as guaranteefund contributions. In the cost-benefitanalysis, the Commission states that, ‘‘itis not possible to estimate or quantify[the] cost’’ of the prohibition.338 In

response to questions from me andcertain of my colleagues, however, theDRG prepared a memorandum on theuse of letters of credit as initial margin.Although this memorandum is non-public, it is part of the administrativerecord for this final rulemaking. Thismemorandum details, among otherthings: (i) the number and identity of certain DCOs accepting and/or holdingletters of credit as initial margin; (ii) thepercentage of total initial margin ondeposit across all DCOs that letters of credit constitute; and (iii) the potentialdisproportionate impact on energy andagricultural end-users of disallowingletters of credit. Whereas thememorandum may focus on the use of letters of credit as initial margin forfutures contracts, the Commissionproposal for DCM core principle 9 mayforce conversion of numerous energyand agricultural futures contracts intoswaps contracts. Yet, the cost-benefitanalysis contains none of theinformation in the memorandum, evenin aggregate and anonymous form. Inthe interests of transparency, theCommission should have found a wayto share this information with thepublic.

The Commission (or its predecessor)has regulated the futures markets sincethe 1930s. The Commission hasoverseen DCOs clearing swaps since atleast 2001. We can do better than this.If the Commission needs to re-proposea rulemaking to provide quantitativeestimates of its costs and benefits, so beit. Given the foundational nature of this

rulemaking, as well as otherrulemakings that are forthcoming, it ismore important for the Commission toachieve the most reasonable balance

between costs and benefits, rather thanto finish the rulemaking fast.

International Coordination: We Must DoBetter.

In closing, I would mention my strongdesire for the Commission to ensure thatits policies do not create disadvantagesfor United States businesses and thatour rules comport with internationalstandards. It is becoming increasinglyclear that the schedule for financialreform is converging among the G–20nations. It is less clear that thesubstantive policies underlyingfinancial reform are experiencing thesame convergence. We must be morecognizant of the effects of such lack of convergence on dually-registeredentities, and the incentives created bysuch divergence for regulatory arbitrage.

This final rulemaking illustrates theinconsistent approach that theCommission has taken towardsinternational coordination to date. First,although the final rulemaking notes thatthe CPSS–IOSCO Recommendationsembody the current internationalstandards on CCP regulation, the finalrulemaking does not attempt to comportwith the CPSS–IOSCORecommendations.339 Instead, the finalrulemaking attempts to comport withthe CPSS–IOSCO Consultation, whichhas not been finalized.340 In general,

both the CPSS–IOSCO

Recommendations and the CPSS–IOSCO Consultation are lessprescriptive than the final rulemaking.

Second, while the final rulemakingdoes note the rare instance where itsprescriptive requirements comport withthe CPSS–IOSCO Consultation,341 itdoes not reveal where its prescriptiverequirements depart from the CPSS–IOSCO Consultation. For example, as Istated above, the CPSS–IOSCOConsultation actually sets forthprinciples-based considerations forparticipant eligibility and margincalculation.

Finally, the final rulemaking statesthat the Commission will review anumber of its provisions after CPSS andIOSCO finish their work, which is likelyto occur in 2012. Whereas I supportsuch a review, the statement begs thefollowing questions: What legalcertainty are these regulations offering





DCOs, clearing members, and marketparticipants if the Commission changessuch regulations in 2012? Also, what arethe implications of requiring DCOs toincur costs to comport with prescriptiverequirements now when theCommission might change suchrequirements next year? If changes areforeseeable, shouldn’t the Commission

adopt a phasing or delayedimplementation plan to allow the

international coordination process toreach completion before our rules andtheir costs become effective? If, in thealternative, the Commission will not beinfluenced by international standards,what are the costs of such non-convergence?

As we are finalizing foundational

rulemakings, we can no longer rely onan inconsistent approach. We need to

produce a more coherent plan forinternational coordination.

Conclusion

Due to the above concerns, Irespectfully dissent from the decision of the Commission to approve this finalrulemaking for publication in theFederal Register.

[FR Doc. 2011–27536 Filed 11–7–11; 8:45 am]BILLING CODE 6351–01–P