2011-19365
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Federal Register, Volume 76 Issue 147 (Monday, August 1, 2011)[Federal Register Volume 76, Number 147 (Monday, August 1, 2011)]
[Proposed Rules]
[Pages 45730-45738]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-19365]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 23, and 39
RIN 3038-AD51
Customer Clearing Documentation and Timing of Acceptance for
Clearing
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)
is proposing rules to implement new statutory provisions enacted by
Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection
Act. These proposed rules address: The documentation between a customer
and a futures commission merchant that clears on behalf of the
customer, and the timing of acceptance or rejection of trades for
clearing by derivatives clearing organizations and clearing members.
DATES: Submit comments on or before September 30, 2011.
ADDRESSES: You may submit comments, identified by RIN number 3038-AD51,
by any of the following methods:
Agency Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments
through the Web site.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Mail: David A. Stawick, Secretary of the Commission,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW., Washington, DC 20581.
Courier: Same as mail above.
Please submit your comments using only one method. RIN number,
3038-AD51, must be in the subject field of responses submitted via e-
mail, and clearly indicated on written submissions. All comments must
be submitted in English, or if not, accompanied by an English
translation. Comments will be posted as received to http://www.cftc.gov. You should submit only information that you wish to make
available publicly. If you wish the CFTC to consider information that
you believe is exempt from disclosure under the Freedom of Information
Act, a petition for confidential treatment of the exempt information
may be submitted according to the procedures established in Sec. 145.9
of the CFTC's regulations.\1\
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\1\ 17 CFR 145.9.
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The CFTC reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from http://www.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of this action will be retained in the public comment file
and will be considered as required under the Administrative Procedure
Act and other applicable laws, and may be accessible under the Freedom
of Information Act.
FOR FURTHER INFORMATION CONTACT: John C. Lawton, Deputy Director and
Chief Counsel, 202-418-5480, jlawton@cftc.gov, or Christopher A. Hower,
Attorney-Advisor, 202-418-6703, chower@cftc.gov, Division of Clearing
and Intermediary Oversight, Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street
Reform and Consumer Protection Act (Dodd-Frank Act).\2\ Title VII of
the Dodd-Frank Act amended the Commodity Exchange Act (CEA or Act) \3\
to establish a comprehensive new regulatory framework for swaps. The
legislation was enacted to reduce risk, increase transparency, and
promote market integrity within the financial system by, among other
things: (1) Providing for the registration and comprehensive regulation
of swap dealers and major swap participants; (2) imposing clearing and
trade execution requirements on standardized derivative products; (3)
creating rigorous recordkeeping and real-time reporting
[[Page 45731]]
regimes; and (4) enhancing the Commission's rulemaking and enforcement
authorities with respect to, among others, all registered entities and
intermediaries subject to the Commission's oversight. Title VII also
includes amendments to the federal securities laws to establish a
similar regulatory framework for security-based swaps under the
authority of the Securities and Exchange Commission (SEC).
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\2\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010).
\3\ 7 U.S.C. 1 et seq.
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II. Proposed Regulations
A. Introduction
A fundamental premise of the Dodd-Frank Act is that the use of
properly regulated central clearing can reduce systemic risk. Another
tenet of the Dodd-Frank Act is that open access to clearing by market
participants will increase market transparency and promote market
efficiency by enabling market participants to reduce counterparty risk
and by facilitating offset of open positions. The Commission has
proposed extensive regulations addressing open access at the
derivatives clearing organization (DCO) level.\4\
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\4\ See, e.g., 76 FR 3698 (Jan. 20, 2011) (Risk Management
Requirements for Derivatives Clearing Organizations).
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Clearing members provide the portals through which market
participants gain access to DCOs as well as the first line of risk
management. Accordingly, the Commission is proposing regulations to
facilitate customer access to clearing and to bolster risk management
through timely processing. The proposals address: (i) The documentation
between a customer and a futures commission merchant (FCM) that clears
on behalf of the customer; and (ii) the timing of acceptance or
rejection of trades for clearing by DCOs and clearing members.
B. Customer Clearing Documentation
Section 4d(c) of the CEA, as amended by the Dodd-Frank Act, directs
the Commission to require FCMs to implement conflict of interest
procedures that address such issues the Commission determines to be
appropriate. Similarly, section 4s(j)(5), as added by the Dodd-Frank
Act, requires SDs and MSPs to implement conflict of interest procedures
that address such issues the Commission determines to be appropriate.
Section 4s(j)(5) also requires SDs and MSPs to ensure that any persons
providing clearing activities or making determinations as to accepting
clearing customers are separated by appropriate informational
partitions from persons whose involvement in pricing, trading, or
clearing activities might bias their judgment or contravene the core
principle of open access.
Pursuant to these provisions, the Commission has proposed Sec.
1.71(d)(1) relating to FCMs and Sec. 23.605(d)(1) relating to SDs and
MSPs.\5\ These regulations would prohibit SDs and MSPs from interfering
or attempting to influence the decisions of affiliated FCMs with regard
to the provision of clearing services and activities and would prohibit
FCMs from permitting them to do so.
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\5\ 75 FR 70152 (Nov. 17, 2010) (Implementation of Conflicts of
Interest Policies and Procedures by Futures Commission Merchants and
Introducing Brokers); 75 FR 71391 (Nov. 23, 2010) (Implementation of
Conflicts of Interest Policies and Procedures by Swap Dealers and
Major Swap Participants).
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Section 4s(j)(6) of the CEA prohibits an SD or MSP from adopting
any process or taking any action that results in any unreasonable
restraint on trade or imposes any material anticompetitive burden on
trading or clearing, unless necessary or appropriate to achieve the
purposes of the Act. The Commission has proposed Sec. 23.607 to
implement this provision.\6\
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\6\ 75 FR 91397 (Nov. 23, 2010) (Regulations Establishing Duties
of Swap Dealers and Major Swap Participants).
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Section 2(h)(1)(B)(ii) of the CEA requires that DCO rules provide
for the non-discriminatory clearing of swaps executed bilaterally or
through an unaffiliated designated contract market (DCM) or swap
execution facility (SEF). The Commission has proposed Sec. 39.12(b)(2)
to implement this provision.\7\
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\7\ 76 FR 3698 (Jan. 20, 2011) (Risk Management Requirements for
Derivatives Clearing Organizations); 76 FR 13101 (March 10, 2011)
(Requirements for Processing, Clearing, and Transfer of Customer
Positions).
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On June 16, 2011, the Futures Industry Association (FIA) and the
International Swap and Derivatives Association (ISDA), published an
FIA-ISDA Cleared Derivatives Execution Agreement (Agreement) as a
template for use by swap market participants in negotiating execution-
related agreements with counterparties to swaps that are intended to be
cleared.\8\ The Agreement was developed with the assistance of a
committee comprised of representatives of certain FIA and ISDA member
firms which included both swap dealers and buy-side firms. More than 60
organizations provided input during the development of the document.\9\
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\8\ See press release, ``FIA and ISDA Publish Documentation for
Cleared Swaps'' (June 16, 2011) at http://www.futuresindustry.org.
\9\ Id.
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FIA and ISDA emphasized that the use of the agreement is voluntary
and may not be necessary and appropriate under all circumstances.\10\
FIA and ISDA recognized that many of the provisions in the Agreement
will be superseded by new regulatory requirements and the rules of swap
execution venues and clearing organizations.\11\
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\10\ Id.
\11\ Id.
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The Agreement includes optional annexes that make the clearing
member to one or both of the executing parties a party to the Agreement
(the Tri-party annexes). Some of the participants in the process, as
well as some market participants that were not included, have expressed
concern to the Commission that aspects of the Tri-party annexes may be
inconsistent with certain principles of the Dodd-Frank Act.\12\
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\12\ See, e.g., letter dated April 11, 2011 from Stuart J.
Kaswell, Executive Vice President, Managing Director, and General
Counsel, Managed Funds Association; letter dated April 19, 2011 from
James Cawley, Swaps & Derivatives Market Association. These letters
can be found in the Commission's comment file for 76 FR 13101.
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Specifically, concerns arise in connection with certain provisions
that would permit a customer's FCM, in consultation with the SD, to
establish specific credit limits for the customer's swap transactions
with the SD, and to declare that with regard to trades with that SD,
the FCM will only accept for clearing those transactions that fall
within these specific limits.\13\ The limits set for trades with the SD
might be less than the overall limits set for the customer for all
trades cleared through the FCM. The result would be to create a
``sublimit'' for the customer for trades with that SD. Some market
participants have stated that the setting of such ``sublimits'' would
result in restrictions of customer counterparties because, without such
``sublimits,'' the customer may enter into transactions with whomever
it chooses, up to its overall limit with the FCM.\14\
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\13\ See Kaswell letter at 9.
\14\ Id. at 10.
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Generally, in cleared markets, an FCM does not know the identity of
its customer's executing counterparty. Another effect of such sublimits
would be to disclose the identity of the customer's counterparty to the
FCM. In many instances, the FCM and the customer's counterparty--the
SD--might be affiliated entities. Some market participants have stated
that such disclosure may lead to ``greater information exchange''
between the FCM and the affiliated SD, which would
[[Page 45732]]
``force the customer to execute with the clearing member's trading desk
affiliate.'' \15\ A third effect of such sublimits could be to delay
acceptance of the trades into clearing while the FCM verifies
compliance with the sublimits.
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\15\ Id.
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Arrangements with these effects potentially conflict with the
concepts of open access to clearing and execution of customer
transactions on a DCM or SEF on terms that have a reasonable
relationship to the best terms available. More specifically, they
potentially conflict with proposed Sec. Sec. 1.71(d)(1), 23.605(d)(1),
23.608, and 39.12. As certain market participants have stated, tri-
party agreements of the type described above could lead to undue
influence by FCMs on a customer's choice of counterparties (or,
conversely, undue influence by SDs on a customer's choice of clearing
member). Therefore, they could constrain a customer's opportunity to
obtain execution of the trade on the terms that have a reasonable
relationship to the best terms available by limiting the number of
potential counterparties.\16\
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\16\ The Commission previously proposed Sec. 155.7, an
execution standard that would apply to swaps available for trading
on a DCM or SEF to ensure fair dealing and protect against fraud and
other abusive practices. 75 FR 80638, 80648 (Dec. 22, 2010). The
proposed rule would require Commission registrants to execute swaps
available for trading on a DCM or SEF on terms that have a
reasonable relationship to the best terms available.
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To address these concerns and to provide further clarity in this
area, the Commission is now proposing Sec. 1.72 relating to FCMs,
Sec. 23.608 relating to SDs and MSPs, and Sec. 39.12(a)(1)(vi)
relating to DCOs. These new regulations would prohibit arrangements
involving FCMs, SDs, MSPs, or DCOs that would (a) disclose to an FCM,
SD, or MSP the identity of a customer's original executing
counterparty; (b) limit the number of counterparties with whom a
customer may enter into a trade; (c) restrict the size of the position
a customer may take with any individual counterparty, apart from an
overall credit limit for all positions held by the customer at the FCM;
(d) impair a customer's access to execution of a trade on terms that
have a reasonable relationship to the best terms available; or (e)
prevent compliance with specified time frames for acceptance of trades
into clearing.
The Commission believes that implementation of the proposal would
reduce risk and foster open access to clearing, as well as execution of
customer trades on terms that have a reasonable relationship to the
best terms available. Restrictions of the sort prohibited by the
proposed rules could increase risk by delaying or blocking access to
clearing. They could increase costs and reduce market efficiency by
limiting the number of counterparties available for trading. They could
restrict access to clearing by limiting the potential clearing members
with which a customer could deal.
The Commission is not proposing to dictate here what happens to a
trade that is rejected for clearing by an FCM or a DCO. Three outcomes
are possible: (i) The parties could try to clear the trade through
another DCO or FCM; (ii) the trade could revert to a bilateral
transaction; or (iii) the parties could break the trade. The parties
should agree in advance, subject to applicable law, which alternative
will apply and how to measure and apportion any resulting losses. The
Commission believes that the proposals herein will decrease the
likelihood that trades will be rejected and diminish the potential for
loss in cases where rejection does occur.
The Commission requests comment on whether the proposals will
achieve the intended goals and on the costs and benefits of the
proposed means of achieving those goals. In particular, the Commission
requests comment on:
Whether the proposal would increase open access to
clearing and execution of customer transactions on a DCM or SEF on
terms that have a reasonable relationship to the best terms available;
Whether the proposal could decrease open access to
clearing in any way; and
Whether the proposals would increase risk to DCOs, FCMs,
SDs, or MSPs in any way.
C. Time Frames for Acceptance Into Clearing
As noted above, a goal of the Dodd-Frank Act is to reduce risk by
increasing the use of central clearing. Minimizing the time between
trade execution and acceptance into clearing is an important risk
mitigant. The Commission recently proposed Sec. 39.12(b)(7) regarding
time frames for clearing.\17\ Upon review of the comments received, the
Commission is now proposing a revised version of that provision.\18\
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\17\ 76 FR 13101 (March 10, 2011) (Requirements for Processing,
Clearing, and Transfer of Customer Positions).
\18\ The Commission continues to review comments on other
aspects of the March 10 proposal and they will be addressed
separately.
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As previously proposed, Sec. 39.12(b)(7)(i) required DCOs to
coordinate with designated contract markets (DCMs) and swap execution
facilities (SEFs) to facilitate prompt and efficient processing of
trades. In response to a comment, the Commission now proposes to
require prompt, efficient, and accurate processing of trades.\19\
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\19\ See letter from Robert Pickel, Executive Vice Chairman,
International Swaps and Derivatives Association, dated April 8,
2011.
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Recognizing the key role clearing members play in trade processing
and submission of trades to central clearing, the Commission is also
now proposing parallel provisions for coordination among DCOs and
clearing members. Proposed Sec. 39.12(b)(7)(i)(B) would require DCOs
to coordinate with clearing members to establish systems for prompt
processing of trades. Proposed Sec. Sec. 1.74(a) and 23.610(a) would
require reciprocal coordination with DCOs by FCMs, SDs, and MSPs that
are clearing members.
As previously proposed, Sec. 39.12(b)(7)(ii) required DCOs to
accept immediately upon execution all transactions executed on a DCM or
SEF. A number of DCOs and other commenters expressed concern that this
requirement could expose DCOs to unwarranted risk because DCOs need to
be able to screen trades for compliance with applicable clearinghouse
rules related to product and credit filters.\20\ The Commission
recognizes that while immediate acceptance for clearing upon execution
currently occurs in some futures markets, it might not be feasible for
all cleared markets at this time. For example, where the same cleared
product is traded on multiple execution venues, a DCO needs to be able
to aggregate the risk of trades coming in to ensure that a clearing
member or customer has not exceeded its credit limits. Accordingly, the
Commission is proposing to modify Sec. 39.12(b)(7)(ii) to permit DCOs
to screen trades against applicable product and credit criteria before
accepting or rejecting them. Consistent with principles of open access,
the proposal would require that such criteria be non-discriminatory
with respect to trading venues and clearing participants.
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\20\ See letter from Craig S. Donohue, Chief Executive Officer,
CME Group, dated April 11, 2011; letter from R. Trabue Bland, Vice
President and Assistant General Counsel, ICE, dated April 11, 2011;
letter from Iona J. Levine, Group General Counsel and Managing
Director, LCH.Clearnet, dated April 11, 2011; letter from William H.
Navin, Executive Vice President and General Counsel, Options
Clearing Corporation, dated April 11, 2011; letter from John M.
Damgard, President, Futures Industry Association, dated April 14,
2011.
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The Commission continues to believe that acceptance or rejection
for clearing in close to real time is crucial both for effective risk
management and for the
[[Page 45733]]
efficient operation of trading venues.\21\ Rather than prescribe a
specific length of time, the Commission is proposing as a standard that
action be taken ``as quickly as would be technologically practicable if
fully automated systems were used.'' The Commission anticipates that
this standard would require action in a matter of milliseconds or
seconds or, at most, a few minutes, not hours or days.\22\
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\21\ See letter from James Cawley, Swaps and Derivatives Market
Association, dated April 19, 2011.
\22\ The Commission notes that processing times may vary by
market or product.
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This is intended to be a performance standard, not the prescription
of a particular method of trade processing. The Commission expects that
fully automated systems will be in place at some DCOs, FCMs, SDs, and
MSPs. Others might have systems with some manual steps. This would be
permitted so long as the process could operate within the same time
frame as the automated systems.
The Commission recognizes that some trades on a DCM or SEF are
executed non-competitively. Examples include block trades and exchanges
of futures for physicals (EFPs). A DCO may not be notified immediately
upon execution of these trades. Accordingly, as discussed below, they
will be treated in the same manner as trades that are not executed on a
DCM or SEF.
As previously proposed, Sec. Sec. 39.12(b)(7)(iii) and
39.12(b)(7)(iv) distinguished between swaps subject to mandatory
clearing and swaps not subject to mandatory clearing. Upon review of
the comments, the Commission believes that this distinction is
unnecessary with regard to processing time frames. If a DCO lists a
product for clearing, it should be able to process it regardless of
whether clearing is mandatory or voluntary. Therefore, newly proposed
Sec. 39.12(b)(7)(iii) would cover all trades not executed on a DCM or
SEF. It would require acceptance or rejection by the DCO as quickly
after submission as would be technologically practicable if fully
automated systems were used.
Proposed Sec. 1.74(b) would set up a parallel requirement for
clearing FCMs; proposed Sec. 23.610(b) would set up a parallel
requirement for SDs and MSPs that are clearing members. These rules,
again, would apply a performance standard, not a prescribed method for
achieving it.
The Commission notes that from both a timing perspective and a risk
perspective, the most efficient method would be to screen all orders
using predetermined criteria established by the rules of the DCO and
the provisions of the clearing documentation between the customer and
its clearing member. In such a case all trades would be accepted for
clearing upon execution because the clearing member and DCO would have
already applied their credit and product filters.
A less efficient means would be for the clearing member to
authorize the DCO to screen trades on its behalf and to accept or
reject according to criteria set by the clearing member. The least
efficient would be for the DCO to send a message to the clearing member
for each trade requesting acceptance or rejection.
The Commission requests comment on the costs and benefits of the
proposal. In particular, the Commission requests comment on whether the
performance standard is appropriate and workable.
III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) requires that agencies
consider whether the regulations they propose will have a significant
economic impact on a substantial number of small entities.\23\ The
Commission previously has established certain definitions of ``small
entities'' to be used in evaluating the impact of its regulations on
small entities in accordance with the RFA.\24\ The proposed regulations
would affect FCMs, DCOs, SDs, and MSPs.
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\23\ 5 U.S.C. 601 et seq.
\24\ 47 FR 18618, Apr. 30, 1982.
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The Commission previously has determined, however, that FCMs should
not be considered to be small entities for purposes of the RFA.\25\ The
Commission's determination was based, in part, upon the obligation of
FCMs to meet the minimum financial requirements established by the
Commission to enhance the protection of customers' segregated funds and
protect the financial condition of FCMs generally.\26\ The Commission
also has previously determined that DCOs are not small entities for the
purpose of the RFA.\27\
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\25\ Id. at 18619.
\26\ Id.
\27\ See 66 FR 45605, 45609, Aug. 29, 2001.
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SDs and MSPs are new categories of registrants. Accordingly, the
Commission has not previously addressed the question of whether such
persons are, in fact, small entities for purposes of the RFA. Like
FCMs, SDs will be subject to minimum capital and margin requirements
and are expected to comprise the largest global financial firms. The
Commission is required to exempt from SD registration any entities that
engage in a de minimis level of swap dealing in connection with
transactions with or on behalf of customers. The Commission anticipates
that this exemption would tend to exclude small entities from
registration. Accordingly, for purposes of the RFA for this rulemaking,
the Commission is hereby proposing that SDs not be considered ``small
entities'' for essentially the same reasons that FCMs have previously
been determined not to be small entities and in light of the exemption
from the definition of SD for those engaging in a de minimis level of
swap dealing.
The Commission also has previously determined that large traders
are not ``small entities'' for RFA purposes.\28\ In that determination,
the Commission considered that a large trading position was indicative
of the size of the business. MSPs, by statutory definition, maintain
substantial positions in swaps or maintain outstanding swap positions
that create substantial counterparty exposure that could have serious
adverse effects on the financial stability of the United States banking
system or financial markets. Accordingly, for purposes of the RFA for
this rulemaking, the Commission is hereby proposing that MSPs not be
considered ``small entities'' for essentially the same reasons that
large traders have previously been determined not to be small entities.
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\28\ Id. at 18620.
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Accordingly, the Chairman, on behalf of the Commission, hereby
certifies pursuant to 5 U.S.C. 605(b) that the proposed regulations
will not have a significant economic impact on a substantial number of
small entities. The Commission invites the public to comment on whether
SDs and MSPs should be considered small entities for purposes of the
RFA.
B. Paperwork Reduction Act
The Paperwork Reduction Act (PRA) \29\ imposes certain requirements
on Federal agencies (including the Commission) in connection with their
conducting or sponsoring any collection of information as defined by
the PRA. This proposed rulemaking would result in new collection of
information requirements within the meaning of the PRA. The Commission
therefore is submitting this proposal to the Office of Management and
Budget (OMB) for review in accordance with 44 U.S.C. 3507(d) and 5 CFR
1320.11. The title for this collection of information is
[[Page 45734]]
``Customer Clearing Documentation and Timing of Acceptance for
Clearing.'' An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it displays
a currently valid control number. The OMB has not yet assigned this
collection a control number.
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\29\ 44 U.S.C. 3501 et seq.
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The collection of information under these proposed regulations is
necessary to implement certain provisions of the CEA, as amended by the
Dodd-Frank Act. Specifically, it is essential to reducing risk and
fostering open access to clearing and execution of customer
transactions on a DCM or SEF on terms that have a reasonable
relationship to the best terms available by prohibiting restrictions in
customer clearing documentation of SDs, MSPs, FCMs, or DCOs that could
delay or block access to clearing, increase costs, and reduce market
efficiency by limiting the number of counterparties available for
trading. The proposed regulations are also crucial both for effective
risk management and for the efficient operation of trading venues among
SDs, MSPs, FCMs, and DCOs.
If the proposed regulations are adopted, responses to this
collection of information would be mandatory. The Commission will
protect proprietary information according to the Freedom of Information
Act and 17 CFR part 145, ``Commission Records and Information.'' In
addition, section 8(a)(1) of the CEA strictly prohibits the Commission,
unless specifically authorized by the CEA, from making public ``data
and information that would separately disclose the business
transactions or market positions of any person and trade secrets or
names of customers.'' The Commission is also required to protect
certain information contained in a government system of records
according to the Privacy Act of 1974, 5 U.S.C. 552a.
1. Information Provided by Reporting Entities/Persons
SDs, MSPs, FCMs, and DCOs would be required to develop and maintain
written customer clearing documentation in compliance with proposed
regulations 1.72, 23.608, and 39.12. Proposed regulation
39.12(b)(7)(i)(B) would require DCOs to coordinate with clearing
members to establish systems for prompt processing of trades. Proposed
regulations 1.74(a) and 23.610(a) require reciprocal coordination with
DCOs by FCMs, SDs, and MSPs that are clearing members.
The annual burden associated with these proposed regulations is
estimated to be 16 hours, at an annual cost of $1,600 for each FCM, SD,
and MSP. Burden means the total time, effort, or financial resources
expended by persons to generate, maintain, retain, disclose, or provide
information to or for a federal agency. The Commission has
characterized the annual costs as initial costs because the Commission
anticipates that the cost burdens will be reduced dramatically over
time as the documentation and procedures required by the proposed
regulations become increasingly standardized within the industry.
Proposed Sec. Sec. 1.72 and 23.608 would require each FCM, SD, and
MSP to ensure compliance with the proposed regulations. Maintenance of
contracts is prudent business practice and the Commission anticipates
that SDs and MSPs already maintain some form of this documentation.
Additionally, the Commission believes that much of the existing
customer clearing documentation already complies with the proposed
rules, and therefore that compliance will require a minimal burden.
In addition to the above, the Commission anticipates that FCMs,
SDs, and MSPs will spend an average of 16 hours per year drafting and,
as needed, updating customer clearing documentation to ensure
compliance required by proposed Sec. Sec. 1.72 and 23.608.
For each DCO, the annual burden associated with these proposed
regulations is estimated to be 40 hours, at an annual cost of $4,000.
Burden means the total time, effort, or financial resources expended by
persons to generate, maintain, retain, disclose, or provide information
to or for a federal agency. The Commission has characterized the annual
costs as initial costs as the Commission anticipates that the cost
burdens will be reduced dramatically over time as once the
documentation and procedures required by the proposed regulations are
implemented, any additional expenditure related to Sec. 39.12 likely
would be limited to the time required to review and, as needed, amend,
existing documentation and procedures.
Proposed 39.12(b)(7) would require each DCO to coordinate with
clearing members to establish systems for prompt processing of trades.
The Commission believes that this is currently a practice of DCOs.
Accordingly, any additional expenditure related to Sec. 39.12(b)(7)
likely would be limited to the time initially required to review and,
as needed, amend, existing trade processing procedures to ensure that
they conform to all of the required elements and to coordinate with
FCMs, SDs, and MSPs to establish reciprocal procedures.
The Commission anticipates that DCOs will spend an average of 20
hours per year drafting and, as needed, updating the written policies
and procedures to ensure compliance required by proposed Sec. 39.12,
and 20 hours per year coordinating with FCMs, SDs, and MSPs on
reciprocal procedures.
The hour burden calculations below are based upon a number of
variables such as the number of FCMs, SDs, MSPs, and DCOs in the
marketplace and the average hourly wage of the employees of these
registrants that would be responsible for satisfying the obligations
established by the proposed regulation.
There are currently 134 FCMs and 14 DCOs based on industry data.
SDs and MSPs are new categories of registrants. Accordingly, it is not
currently known how many SD and MSPs will become subject to these
rules, and this will not be known to the Commission until the
registration requirements for these entities become effective after
July 16, 2011, the date on which the Dodd-Frank Act becomes effective.
While the Commission believes there will be approximately 200 SD and 50
MSPs, it has taken a conservative approach, for PRA purposes, in
estimating that there will be a combined number of 300 SDs and MSPs who
will be required to comply with the recordkeeping requirements of the
proposed rules. The Commission estimated the number of affected
entities based on industry data.
According to recent Bureau of Labor Statistics, the mean hourly
wage of an employee under occupation code 11-3031, ``Financial
Managers,'' (which includes operations managers) that is employed by
the ``Securities and Commodity Contracts Intermediation and Brokerage''
industry is $74.41.\30\ Because SDs, MSPs, FCMs, and DCOs include large
financial institutions whose operations management employees' salaries
may exceed the mean wage, the Commission has estimated the cost burden
of these proposed regulations based upon an average salary of $100 per
hour.
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Accordingly, the estimated hour burden was calculated as follows:
Developing Written Procedures for Compliance, and Maintaining
Records Documenting Compliance for SDs and MSPs. This hourly burden
arises from the proposed requirement that SDs and MSPs make and
maintain records documenting compliance related to client clearing
documentation.
[[Page 45735]]
Number of registrants: 300.
Frequency of collection: as needed.
Estimated number of annual responses per registrant: 1.
Estimated aggregate number of annual responses: 300.
Estimated annual hour burden per registrant: 16 hours.
Estimated aggregate annual hour burden: 4,800 burden hours [300
registrants x 16 hours per registrant].
Developing Written Procedures for Compliance, and Maintaining
Records Documenting Compliance for FCMs. This hourly burden arises from
the proposed requirement that FCMs make and maintain records
documenting compliance related to client clearing documentation.
Number of registrants: 134.
Frequency of collection: as needed.
Estimated number of annual responses per registrant: 1.
Estimated aggregate number of annual responses: 134.
Estimated annual hour burden per registrant: 16 hours.
Estimated aggregate annual hour burden: 2,144 burden hours [134
registrants x 16 hours per registrant].
Drafting and Updating Trade Processing Procedures for DCOs. This
hour burden arises from the time necessary to develop and periodically
update the trade processing procedures required by the proposed
regulations.
Number of registrants: 14.
Frequency of collection: Initial drafting, updating as needed.
Estimated number of annual responses per registrant: 1.
Estimated aggregate number of annual responses: 14.
Estimated annual hour burden per registrant: 40 hours.
Estimated aggregate annual hour burden: 560 burden hours [14
registrants x 40 hours per registrant].
Based upon the above, the aggregate hour burden cost for all
registrants is 7,504 burden hours and $750,400 [7,504 x $100 per hour].
2. Information Collection Comments
The Commission invites the public and other federal agencies to
comment on any aspect of the recordkeeping burdens discussed above.
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments
in order to: (i) Evaluate whether the proposed collection of
information is necessary for the proper performance of the functions of
the Commission, including whether the information will have practical
utility; (ii) evaluate the accuracy of the Commission's estimate of the
burden of the proposed collection of information; (iii) determine
whether there are ways to enhance the quality, utility, and clarity of
the information to be collected; and (iv) minimize the burden of the
collection of information on those who are to respond, including
through the use of automated collection techniques or other forms of
information technology.
Comments may be submitted directly to the Office of Information and
Regulatory Affairs, by fax at (202) 395-6566 or by e-mail at
OIRAsubmissions@omb.eop.gov. Please provide the Commission with a copy
of submitted comments so that all comments can be summarized and
addressed in the final rule preamble. Refer to the Addresses section of
this notice of proposed rulemaking for comment submission instructions
to the Commission. A copy of the supporting statements for the
collections of information discussed above may be obtained by visiting
RegInfo.gov. OMB is required to make a decision concerning the
collection of information between 30 and 60 days after publication of
this document in the Federal Register. Therefore, a comment is best
assured of having its full effect if OMB receives it within 30 days of
publication.
C. Consideration of Costs and Benefits Under Section 15(a) of the CEA
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its action before promulgating a regulation under
the CEA. Section 15(a) of the CEA specifies that costs and benefits
shall be evaluated in light of five broad areas of market and public
concern: (1) Protection of market participants and the public; (2)
efficiency, competitiveness, and financial integrity of futures
markets; (3) price discovery; (4) sound risk management practices; and
(5) other public interest considerations. The Commission may in its
discretion give greater weight to any one of the five enumerated areas
and could in its discretion determine that, notwithstanding its costs,
a particular order is necessary or appropriate to protect the public
interest or to effectuate any of the provisions or to accomplish any of
the purposes of the CEA.
The proposed rules have two major components: (i) The documentation
between a customer and a futures commission merchant that clears on
behalf of the customer; and (ii) the timing of acceptance or rejection
of trades for clearing by derivatives clearing organizations and
clearing members. The discussion below will consider each component in
light of the section 15(a) concerns.
A. Documentation Between a Customer and Futures Commission Merchant
That Clears on Behalf of the Customer
The Commission is proposing regulations that would prohibit
arrangements involving FCMs, SDs, MSPs, or DCOs that would (a) disclose
to an FCM, SD, or MSP the identity of a customer's counterparty; (b)
limit the number of counterparties with whom a customer may enter into
swaps; (c) restrict the size of the position a customer may take with
any individual counterparty, apart from an overall limit for all
positions held by the customer at the FCM; (d) impair a customer's
access to execution of trades on a DCM or SEF on terms that have a
reasonable relationship to the best terms available; or (e) prevent
compliance with specified time frames for acceptance of trades into
clearing.
1. Protection of Market Participants and the Public
This measure protects the customer from any discriminatory behavior
by potential clearing members or counterparties and helps ensure that
customers have open access to the markets and an opportunity to obtain
execution on competitive terms. The proposal would also promote
financial integrity by removing potential obstacles such as more
documentation requirements imposed by dealers or unnecessary
restrictions on trading by a third-party, and by accelerating the
timeframe for acceptance or rejection of a trade for clearing thereby
reducing risk of delay or uncertainty as to whether a swap will be
accepted or rejected for clearing. For example, by contrast, under a
tri-party agreement, an FCM might have to evaluate each customer
transaction not only against the customer's overall credit limit but
also against a sub-limit for each counterparty which can delay
acceptance.
As far as costs are concerned, the possibility of ``breakage''
remains for SDs and other counterparties. However, this concern is
mitigated by the timelines required in the second section of this rule,
which reduce the likelihood that a SD would have time to enter into
other transactions before the one in view is accepted or rejected for
clearing. Similarly, if a SD has to enter into a replacement trade, the
costs will be mitigated by the tight timeline, because the SD would
know quickly whether the trade was accepted or rejected for clearing.
As noted above, the process of evaluating individual transactions
against counterparty sub-limits could
[[Page 45736]]
delay notification of acceptance or rejection for clearing. In the
absence of this rule, the cost to trade will have to account for these
factors and additional market risk during that time.
2. Efficiency, Competitiveness, and Financial Integrity of Futures
Markets
This rule helps prevent the disclosure, to the FCM, of the identity
of the counterparty of its customer. Such lack of disclosure promotes
integrity in the market by ensuring that all participants who meet
certain qualifying criteria for trading have open access to all
available counterparties because intermediaries will be unable to set
sub-limits by counterparty. Moreover, in the absence of this rule, tri-
party agreements or other similar arrangements among FCMs, SDs or MSPs
and customers could result in matching processes that have the
potential to be time intensive. Preventing these agreements will
promote faster matching which may increase liquidity through lower
transaction costs.
This rule also prevents customers from being penalized (or having
distorted commercial incentives) in their choice of FCM due to previous
transactions with a given FCM or SD. As a consequence, this rule also
has the potential to promote competition among FCMs to deliver services
efficiently. Lastly, this rule would reduce duplicative risk management
because DCOs and their members already have access to information
necessary to perform credit analysis on individual customers and
counterparties. SDs would be unnecessarily duplicating work that has
already been done.
3. Price Discovery
By not forcing a customer to transact with counterparties who may
be offering less attractive terms, this rule may improve pricing. In
addition, adhering to time frames specified for acceptance of trades
into clearing helps to prevent stale prices.
4. Sound Risk Management Practices
The rule does not affect the risk management structure of FCMs.
Moreover, by preventing customers from learning their counterparty's
identity, the responsibility for risk management remains clear. The FCM
must be responsible for evaluating each customer's credit risk. It
cannot rely on a counterparty to conduct due diligence. Moreover,
preserving anonymity in the market increases the number of available
counterparties, which leads to a more liquid market, thereby reducing
risk.
As mentioned before, to the extent that the SD experiences
``breakage,'' it exposes a SD to counterparty risk which is a potential
cost. However, by facilitating quicker acceptance or rejection into
clearing, the proposal would mitigate such costs by compressing the
time within which the counterparty exposure would exist.
B. Timing of Acceptance or Rejection of Trades for Clearing by
Derivatives Clearing Organizations and Clearing Members
The Commission is proposing regulations that would require prompt,
efficient, and accurate processing of trades, and require DCOs to
coordinate with clearing members to establish systems for prompt
processing of trades.
1. Protection of Market Participants
Rapid processing protects market participants from acting on bad
information by making additional trades under the presumption that an
initial trade has gone through if that trade may, in fact, not clear.
As mentioned, compressing the time for acceptance or rejection for
clearing also reduces the time within exposures can accumulate if a
trade is rejected.
As far as costs are concerned, coordination among the DCOs, FCMs,
SDs and MSPs in order to design and implement a system to clear
transactions ``as quickly as would be technologically practicable if
fully automated systems were used'' will likely require capital
investment and personnel hours in some instances. The Commission
believes, however, that DCOs and clearing members may already be using
procedures that comply with the standard. To the extent that
participants do not currently have automated systems, they made need to
install or upgrade existing systems to comply.
2. Efficiency, Competitiveness, and Financial Integrity of Futures
Markets
Rapid clearing helps ensure that eligible counterparties will not
be tied up in transactions that do not clear. They will be available to
other eligible customers. This increases both competitiveness and
efficiency of the market. In addition, extensive coordination among the
DCOs, FCMs, SDs, and MSPs has the potential to standardize processes
and technologies to support this rule. That reduces switching costs for
customers and increases competitiveness.
Costs will be incurred in developing systems and procedures for
those products and participants where the proposed standards are not
currently being met. The Commission anticipates, however, that
eventually such costs would be compensated for by increased efficiency
and market integrity. The Commission does not know at this time, and
requests comment on, how many parties will need to upgrade their
systems, if any. Additionally, the Commission requests comment from the
public as to what the costs might be to upgrade existing systems or
install new systems to comply with the proposed regulation.
3. Price Discovery
Requiring rapid clearing encourages screening for credit worthiness
of customers. That helps ensure that only bids and offers of qualified
parties are contained in the limit order book which helps protect its
informational value. Moreover, pricing feedback from cleared
transactions will reach the market more quickly.
4. Sound Risk Management Practices
Timely clearing allows each party to the transaction to act more
quickly if they need to implement a hedge or other transactions related
to the swap. This reduces the risk associated with potential adverse
movements of the market while waiting for clearing to occur. However,
if some of the processes are manual, the mandate for greater speed
increases the possibility of errors.
5. Other Public Interest Considerations
Rapid clearing makes U.S. based DCOs, FCMs, SDs, and MSPs more
attractive as service providers for global swap business. Furthermore,
the proposal would facilitate achievement of the overarching Dodd-Frank
Act mandate to promote clearing.
List of Subjects
17 CFR Part 1
Conflicts of interest, Futures commission merchants, Major swap
participants, Swap dealers.
17 CFR Part 23
Conflicts of interests, Futures commission merchants, Major swap
participants, Swap dealers.
17 CFR Part 39
Derivatives clearing organizations, Risk management, Swaps.
In light of the foregoing, the Commission hereby proposes to amend
part 1; part 23, as proposed to be added at 75 FR 71390, November 23,
2010, and further amended at 75 FR 81530, December 28, 2010; and part
39, as proposed to be amended at 76 FR 13101, March 10, 2011, of Title
17 of the Code of Federal Regulations as follows:
[[Page 45737]]
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
1. The authority citation for part 1 is revised to read as follows:
Authority: 7 U.S.C. 1a, 2, 2a, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f,
6g, 6h, 6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3,
8, 9, 10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24, as
amended by Title VII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).
2. Add Sec. 1.72 to part 1 to read as follows:
Sec. 1.72 Restrictions on customer clearing arrangements.
No futures commission merchant providing clearing services to
customers shall enter into an arrangement that:
(a) Discloses to the futures commission merchant or any swap dealer
or major swap participant the identity of a customer's original
executing counterparty;
(b) Limits the number of counterparties with whom a customer may
enter into a trade;
(c) Restricts the size of the position a customer may take with any
individual counterparty, apart from an overall limit for all positions
held by the customer at the futures commission merchant;
(d) Impairs a customer's access to execution of a trade on terms
that have a reasonable relationship to the best terms available; or
(e) Prevents compliance with the time frames set forth in Sec.
1.73(a)(9)(ii), Sec. 23.609(a)(9)(ii), or Sec. 39.12(b)(7) of this
chapter.
3. Add Sec. 1.74 to part 1 to read as follows:
Sec. 1.74 Futures commission merchant acceptance for clearing.
(a) Each futures commission merchant that is a clearing member of a
derivatives clearing organization shall coordinate with each
derivatives clearing organization on which it clears to establish
systems that enable the futures commission merchant, or the derivatives
clearing organization acting on its behalf, to accept or reject each
trade submitted to the derivatives clearing organization for clearing
by or for the futures commission merchant or a customer of the futures
commission merchant as quickly as would be technologically practicable
if fully automated systems were used; and
(b) Each futures commission merchant that is a clearing member of a
derivatives clearing organization shall accept or reject each trade
submitted by or for it or its customers as quickly as would be
technologically practicable if fully automated systems were used; a
clearing futures commission merchant may meet this requirement by:
(1) Establishing systems to pre-screen orders for compliance with
criteria specified by the clearing futures commission merchant;
(2) Establishing systems that authorize a derivatives clearing
organization to accept or reject on its behalf trades that meet, or
fail to meet, criteria specified by the clearing futures commission
merchant; or
(3) Establishing systems that enable the clearing futures
commission merchant to communicate to the derivatives clearing
organization acceptance or rejection of each trade as quickly as would
be technologically practicable if fully automated systems were used.
PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS
4. The authority citation for part 23 is revised to read as
follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,
9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.
5. Add Sec. 23.608 to part 23, subpart J, to read as follows:
Sec. 23.608 Restrictions on counterparty clearing relationships.
No swap dealer or major swap participant entering into a cleared
swap with a counterparty that is a customer of a futures commission
merchant shall enter into an arrangement that:
(a) Discloses to the futures commission merchant or any swap dealer
or major swap participant the identity of a customer's original
executing counterparty;
(b) Limits the number of counterparties with whom a customer may
enter into a trade;
(c) Restricts the size of the position a customer may take with any
individual counterparty, apart from an overall limit for all positions
held by the customer at the futures commission merchant;
(d) Impairs a customer's access to execution of a trade on terms
that have a reasonable relationship to the best terms available; or
(e) Prevents compliance with the time frames set forth in Sec.
1.73(a)(9)(ii), Sec. 23.609(a)(9)(ii), or Sec. 39.12(b)(7) of this
chapter.
6. Add Sec. 23.610 to part 23, subpart J, to read as follows:
Sec. 23.610 Clearing member acceptance for clearing.
(a) Each swap dealer or major swap participant that is a clearing
member of a derivatives clearing organization shall coordinate with
each derivatives clearing organization on which it clears to establish
systems that enable the clearing member, or the derivatives clearing
organization acting on its behalf, to accept or reject each trade
submitted to the derivatives clearing organization for clearing by or
for the clearing member as quickly as would be technologically
practicable if fully automated systems were used; and
(b) Each swap dealer or major swap participant that is a clearing
member of a derivatives clearing organization shall accept or reject
each trade submitted by or for it as quickly as would be
technologically practicable if fully automated systems were used; a
clearing member may meet this requirement by:
(1) Establishing systems to pre-screen orders for compliance with
criteria specified by the clearing member;
(2) Establishing systems that authorize a derivatives clearing
organization to accept or reject on its behalf trades that meet, or
fail to meet, criteria specified by the clearing member; or
(3) Establishing systems that enable the clearing member to
communicate to the derivatives clearing organization acceptance or
rejection of each trade as quickly as would be technologically
practicable if fully automated systems were used.
PART 39--DERIVATIVES CLEARING ORGANIZATIONS
7. Revise the authority citation for part 39 to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6d, 7a-1, 7a-2, and 7b as
amended by the Dodd-Frank Wall Street Reform and Consumer Protection
Act, Pub. L. 111-203, 124 Stat. 1376.
Subpart B--Compliance With Core Principles
8. In Sec. 39.12, add paragraph (a)(1)(vi) to read as follows:
(a) * * *
(1) * * *
(vi) No derivatives clearing organization shall require as a
condition of accepting a swap for clearing that a futures commission
merchant enter into an arrangement with a customer that:
(A) Discloses to the futures commission merchant or any swap dealer
or major swap participant the identity of a customer's original
executing counterparty;
(B) Limits the number of counterparties with whom a customer may
enter into trades;
(C) Restricts the size of the position a customer may take with any
individual counterparty, apart from an overall limit for all positions
held by the customer at the futures commission merchant;
[[Page 45738]]
(D) Impairs a customer's access to execution of a trade on terms
that have a reasonable relationship to the best terms available; or
(E) Prevents compliance with the time frames set forth in Sec.
1.73(a)(9)(ii), Sec. 23.609(a)(9)(ii), or Sec. 39.12(b)(7) of this
chapter.
9. Amend Sec. 39.12 by:
a. Redesignating paragraph (b)(7)(v) as paragraph (b)(8); and
b. Revising Sec. 39.12(b)(7) to read as follows:
(i) Coordination with markets and clearing members
(A) Each derivatives clearing organization shall coordinate with
each designated contract market and swap execution facility that lists
for trading a product that is cleared by the derivatives clearing
organization in developing rules and procedures to facilitate prompt,
efficient, and accurate processing of all transactions submitted to the
derivatives clearing organization for clearing.
(B) Each derivatives clearing organization shall coordinate with
each clearing member that is a futures commission merchant, swap
dealer, or major swap participant to establish systems that enable the
clearing member, or the derivatives clearing organization acting on its
behalf, to accept or reject each trade submitted to the derivatives
clearing organization for clearing by or for the clearing member or a
customer of the clearing member as quickly as would be technologically
practicable if fully automated systems were used.
(ii) Transactions executed competitively on or subject to the rules
of a designated contract market or swap execution facility. A
derivatives clearing organization shall have rules that provide that
the derivatives clearing organization will accept or reject for
clearing as quickly after execution as would be technologically
practicable if fully automated systems were used, all contracts that
are listed for clearing by the derivatives clearing organization and
are executed competitively on a designated contract market or a swap
execution facility. The derivatives clearing organization shall accept
all trades:
(A) For which the executing parties have clearing arrangements in
place with clearing members of the derivatives clearing organization;
(B) For which the executing parties identify the derivatives
clearing organization as the intended clearinghouse; and
(C) That satisfy the criteria of the derivatives clearing
organization, including but not limited to applicable risk filters;
provided that such criteria are non-discriminatory across trading
venues and are applied as quickly as would be technologically
practicable if fully automated systems were used.
(iii) Swaps not executed on or subject to the rules of a designated
contract market or a swap execution facility or executed non-
competitively on or subject to the rules of a designated contract
market or a swap execution facility. A derivatives clearing
organization shall have rules that provide that the derivatives
clearing organization will accept or reject for clearing as quickly
after submission to the derivatives clearing organization as would be
technologically practicable if fully automated systems were used, all
swaps that are listed for clearing by the derivatives clearing
organization and are not executed on a designated contract market or a
swap execution facility. The derivatives clearing organization shall
accept all trades:
(A) That are submitted by the parties to the derivatives clearing
organization, in accordance with Sec. 23.506 of this chapter;
(B) For which the executing parties have clearing arrangements in
place with clearing members of the derivatives clearing organization;
(C) For which the executing parties identify the derivatives
clearing organization as the intended clearinghouse; and
(D) That satisfy the criteria of the derivatives clearing
organization, including but not limited to applicable risk filters;
provided that such criteria are non-discriminatory across trading
venues and are applied as quickly as would be technologically
practicable if fully automated systems were used.
Issued in Washington, DC, on July 19, 2011, by the Commission.
David A. Stawick,
Secretary of the Commission.
Appendices to Customer Clearing Documentation and Timing of Acceptance
for Clearing--Commission Voting Summary and Statements of Commissioners
Note: The following appendices will not appear in the Code of
Federal Regulations
Appendix 1--Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Dunn and
Chilton voted in the affirmative; Commissioners O'Malia and Sommers
voted in the negative.
Appendix 2--Statement of Chairman Gary Gensler
I support the proposed rulemaking for customer clearing
documentation and timing of acceptance for clearing. The proposed
rule promotes market participants' access to central clearing,
increases market transparency and supports market efficiency. This
proposal will foster bilateral clearing arrangements between
customers and their futures commission merchants. This proposal also
re-proposes certain time-frame provisions of the Commission's
proposed rule in February related to straight-through processing.
[FR Doc. 2011-19365 Filed 7-29-11; 8:45 am]
BILLING CODE P
Last Updated: August 1, 2011
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