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Proposed Rule

Customer Clearing Documentation and Timing of Acceptance for Clearing

Action

Notice Of Proposed Rulemaking.

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.

Unified Agenda

Derivatives Clearing Organizations: Requirements for Processing, Clearing, and Transfer of Customer Positions

5 actions from March 10th, 2011 to January 2012

  • March 10th, 2011
  • April 11th, 2011
    • NPRM Comment Period End
  • May 4th, 2011
  • June 3rd, 2011
    • NPRM Comment Period Extended End
  • January 2012
    • Final Action
 

Table of Contents Back to Top

DATES: Back to Top

Submit comments on or before September 30, 2011.

ADDRESSES: Back to Top

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 § 145.9 of the CFTC's regulations. [1]

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: Back to Top

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: Back to Top

I. Background Back to Top

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 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).

II. Proposed Regulations Back to Top

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]

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 § 1.71(d)(1) relating to FCMs and § 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.

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 § 23.607 to implement this provision. [6]

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 § 39.12(b)(2) to implement this provision. [7]

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]

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]

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]

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]

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 “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.

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 §§ 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]

To address these concerns and to provide further clarity in this area, the Commission is now proposing § 1.72 relating to FCMs, § 23.608 relating to SDs and MSPs, and § 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 § 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]

As previously proposed, § 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]

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 § 39.12(b)(7)(i)(B) would require DCOs to coordinate with clearing members to establish systems for prompt processing of trades. Proposed §§ 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, § 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 § 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.

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 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]

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, §§ 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 § 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 § 1.74(b) would set up a parallel requirement for clearing FCMs; proposed § 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 Back to Top

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.

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]

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.

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 “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.

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 §§ 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 §§ 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 § 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 § 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 § 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.

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.

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 × 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 × 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 × 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 × $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 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 Back to Top

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:

begin regulatory text

PART 1—GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT Back to Top

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 § 1.72 to part 1 to read as follows:

§ 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 § 1.73(a)(9)(ii), § 23.609(a)(9)(ii), or § 39.12(b)(7) of this chapter.

3. Add § 1.74 to part 1 to read as follows:

§ 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 Back to Top

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 § 23.608 to part 23, subpart J, to read as follows:

§ 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 § 1.73(a)(9)(ii), § 23.609(a)(9)(ii), or § 39.12(b)(7) of this chapter.

6. Add § 23.610 to part 23, subpart J, to read as follows:

§ 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 Back to Top

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 Back to Top

8. In § 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;

(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 § 1.73(a)(9)(ii), § 23.609(a)(9)(ii), or § 39.12(b)(7) of this chapter.

9. Amend § 39.12 by:

a. Redesignating paragraph (b)(7)(v) as paragraph (b)(8); and

b. Revising § 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 § 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 Back to Top

Note:

The following appendices will not appear in the Code of Federal Regulations

Appendix 1—Commission Voting Summary Back to Top

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 Back to Top

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.

end regulatory text

[FR Doc. 2011-19365 Filed 7-29-11; 8:45 am]

BILLING CODE P

Footnotes Back to Top

2. See Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010).

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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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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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6. 75 FR 91397 (Nov. 23, 2010) (Regulations Establishing Duties of Swap Dealers and Major Swap Participants).

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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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8. See press release, “FIA and ISDA Publish Documentation for Cleared Swaps” (June 16, 2011) at http://www.futuresindustry.org.

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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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13. See Kaswell letter at 9.

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14. Id. at 10.

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16. The Commission previously proposed § 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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17. 76 FR 13101 (March 10, 2011) (Requirements for Processing, Clearing, and Transfer of Customer Positions).

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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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19. See letter from Robert Pickel, Executive Vice Chairman, International Swaps and Derivatives Association, dated April 8, 2011.

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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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21. See letter from James Cawley, Swaps and Derivatives Market Association, dated April 19, 2011.

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22. The Commission notes that processing times may vary by market or product.

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24. 47 FR 18618, Apr. 30, 1982.

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25. Id. at 18619.

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27. See 66 FR 45605, 45609, Aug. 29, 2001.

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28. Id. at 18620.

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