77 fr 21278 - customer clearing documentation, timing of acceptance for clearing, and clearing...

7/31/2019 77 FR 21278 - Customer Clearing Documentation, Timing of Acceptance for Clearing, And Clearing Member Risk

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21278 Federal Register / Vol. 77, No. 68 / Monday, April 9, 2012 / Rules and Regulations

1See Dodd-Frank Wall Street Reform andConsumer Protection Act, Public Law 111203, 124Stat. 1376 (2010).

27 U.S.C. 1 et seq.3Derivatives Clearing Organization General

Provisions and Core Principles, 76 FR 69334 (Nov.8, 2011).

4Customer Clearing Documentation and Timingof Acceptance for Clearing, 76 FR 45730 (Aug. 1,

2011).5Requirements for Processing, Clearing, andTransfer of Customer Positions, 76 FR 13101 (Mar.10, 2011).

6Clearing Member Risk Management, 76 FR45724 (Aug. 1, 2011).

7Adaption of Regulations to Incorporate Swaps,76 FR 33066 (Jun. 7, 2011).

8See 76 FR 45730 (Aug. 1, 2011).9See 76 FR 13101 (Mar. 10, 2011).10See 76 FR 45724 (Aug. 1, 2011).11See 76 FR 33066 (Jun. 6, 2011).12See 76 FR 45730 at 45731, Aug. 1, 2011.13See http://www.futuresindustry.org/downloads/

ClearedDerivativesExecutionAgreement_June142001.pdf.

COMMODITY FUTURES TRADINGCOMMISSION

17 CFR Parts 1, 23, 37, 38, and 39

RIN 30380092, 0094

Customer Clearing Documentation,Timing of Acceptance for Clearing, andClearing Member Risk Management

AGENCY: Commodity Futures TradingCommission.ACTION: Final rule.

SUMMARY: The Commodity FuturesTrading Commission (Commission orCFTC) is adopting rules to implementnew statutory provisions enacted byTitle VII of the Dodd-Frank Wall StreetReform and Consumer Protection Act.These rules address: The documentation

between a customer and a futurescommission merchant that clears on

behalf of the customer; the timing ofacceptance or rejection of trades forclearing by derivatives clearingorganizations and clearing members;and the risk management procedures offutures commission merchants, swapdealers, and major swap participantsthat are clearing members. The rules aredesigned to increase customer access toclearing, to facilitate the timelyprocessing of trades, and to strengthenrisk management at the clearing memberlevel.

DATES: This rule will become effectiveOctober 1, 2012.

FOR FURTHER INFORMATION CONTACT:JohnC. Lawton, Deputy Director, 2024185480,[email protected],and ChristopherA. Hower, Attorney-Advisor, 2024186703, [email protected],Division ofClearing and Risk, and Camden Nunery,Economist, 2024185723, Office of theChief Economist, Commodity FuturesTrading Commission, Three LafayetteCentre, 1155 21st Street NW.,Washington, DC 20581; and Hugh J.Rooney, Assistant Director, 3125960574, [email protected],Division ofClearing and Risk, Commodity FuturesTrading Commission, 525 West MonroeStreet, Chicago, Illinois 60661.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. BackgroundII. Customer Clearing Documentation

A. IntroductionB. Summary of CommentsC. Discussion

III. Time Frames for Acceptance Into ClearingA. Swap Dealer and Major Swap

Participant Submission of TradesB. Swap Execution Facility and Designated

Contract Market Processing of TradesC. Clearing Member and Clearing

Organization Acceptance for Clearing

D. Post-Trade Allocation of BunchedOrders

IV. Clearing Member Risk ManagementA. IntroductionB. Components of the Rule

V. Effective DatesA. Summary of CommentsB. Discussion

VI. Consideration of Costs and BenefitsVII. Related Matters

A. Regulatory Flexibility ActB. Paperwork Reduction Act

I. Background

On July 21, 2010, President Obamasigned the Dodd-Frank Wall StreetReform and Consumer Protection Act(Dodd-Frank Act).1 Title VII of theDodd-Frank Act amended theCommodity Exchange Act (CEA orAct) 2 to establish a comprehensivenew regulatory framework for swaps.The legislation was enacted to reducerisk, increase transparency, and promotemarket integrity within the financialsystem by, among other things: (1)Providing for the registration andcomprehensive regulation of swapdealers and major swap participants; (2)imposing clearing and trade executionrequirements on standardized derivativeproducts; (3) creating rigorousrecordkeeping and real-time reportingregimes; and (4) enhancing theCommissions rulemaking andenforcement authorities with respect to,among others, all registered entities andintermediaries subject to theCommissions oversight. Title VII alsoincludes amendments to the federalsecurities laws to establish a similar

regulatory framework for security-basedswaps under the authority of theSecurities and Exchange Commission(SEC).

A fundamental premise of the Dodd-Frank Act is that the use of properlyregulated central clearing can reducesystemic risk. Another tenet of theDodd-Frank Act is that open access toclearing by market participants willincrease market transparency andpromote market efficiency by enablingmarket participants to reducecounterparty risk and by facilitating theoffset of open positions. The

Commission has adopted extensiveregulations addressing open access andrisk management at the derivativesclearing organization (DCO) level.3

Clearing members provide the portalsthrough which market participants gainaccess to DCOs. Clearing members also

provide the first line of riskmanagement. Accordingly, in threerelated rulemakings, the Commissionproposed regulations to increasecustomer access to clearing,4 to facilitatethe timely processing of trades,5 and tostrengthen risk management at theclearing member level.6 In addition, ina fourth rulemaking, the Commission

proposed regulations relating to theallocation of bunched orders.7 TheCommission is issuing final rules ineach of these areas.

More specifically, the regulationscontained in this Adopting Release wereproposed in four separate notices ofproposed rulemaking (NPRMs).Sections 1.72, 1.74, 23.608, 23.610,39.12(a)(1)(iv), and 39.12(b)(7) wereproposed in Customer ClearingDocumentation and Timing ofAcceptance for Clearing,8 sections23.506, 37.702(b), and 38.601(b) wereproposed in Requirements for

Processing, Clearing, and Transfer ofCustomer Positions,9 sections 1.73 and23.609 were proposed in ClearingFutures Commission Merchant RiskManagement,10 and 1.35(a1)(5)(iv) wasproposed in Adaptation of Regulationsto Incorporate Swaps.11 TheCommission is finalizing the rulescontained in this Adopting Releasetogether because they address threeoverarching, closely-connected aims: (1)Non-discriminatory access tocounterparties and clearing; (2) straight-through processing; and (3) effectiverisk management among clearingmembers. Each of these provides

substantial benefits for the markets andmarket participants.

II. Customer Clearing Documentation

A. Introduction

As discussed in the notice ofproposed rulemaking,12 industry groupshave developed a template for use byswap market participants in negotiatingexecution-related agreements withcounterparties to swaps that areintended to be cleared.13 The template

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21279Federal Register / Vol. 77, No. 68 / Monday, April 9, 2012 / Rules and Regulations

14 Id. at 45732.

15

Comment files for each proposed rulemakingcan be found on the Commission Web site,www.cftc.gov.Commenters include: Chris Barnard(Barnard); MarkitSERV (Markit); Swaps &Derivatives Market Association (SDMA); BetterMarkets; IntercontinentalExchange, Inc. (ICE);ISDA FIA (ISDA); The Alternative InvestmentManagement Association Ltd. (AIMA); CMEGroup Inc. (CME); Morgan Stanley; EdisonElectric Institute (EEI); State Street Corporation(State Street); New York Portfolio Clearing(NYPC); Asset Management Group of theSecurities Industry and Financial MarketsAssociation (SIFMA); Vanguard;AllianceBernstein L.P. (Alliance Bernstein);Minneapolis Grain Exchange, Inc. (MGEX);Atlantic Trading USA LLC; Belvedere Trading;Bluefin Trading, LLC; Chopper Trading LLC; CTCTrading Group, LLC; DRW Holdings, LLC; Eagle

Seven, LLC; Endeavor Trading, LLC; Flow TradersUS LLC; Geneva Trading USA, LLC; GETCO; HardEight Futures; HTG Capital Partners; IMC FinancialMarkets; Infinium Capital Management LLC; KottkeAssociates, LLC; Marquette Partners, LP; NicoHoldings LLC; Optiver US LLC; RGM Advisors,LLC; Templar Securities, LLC; Tower ResearchCapital LLC; TradeForecaster Global Markets LLC;Traditum Group, LLC; WH Trading LLC; XRTrading LLC (Trading Firms); Managed FundsAssociation (MFA); Arbor Research & TradingInc. (Arbor); Eris Exchange (Eris); ICI; DRWTrading Group (DRW); Spring Trading, Inc.(Spring Trading); Javelin Capital Markets, LLC(Javelin); The Committee on Investment ofEmployee Benefit Assets (CIEBA); Citadel LLC(Citadel); Vizier Ltd. (Vizier); Federal HomeLoan Banks (FHLB); Jefferies & Company, Inc.(Jeffries); UBS Securities LLC (UBS); WellsFargo Securities (WF); LCH.Clearnet GroupLimited (LCH); D. E. Shaw group (D. E. Shaw);Bank of America, Merrill Lynch, BNP Paribas, Citi,Credit Suisse Securities (USA) LLC, Deutsche BankAG, Goldman Sachs, HSBC, J.P. Morgan, MorganStanley (Banks); Deutsche Bank (DB); SocieteGenerale (SG); The Association of InstitutionalInvestors (AII); and The Committee on CapitalMarkets Regulation (Committee).

16AII, AIMA, AllianceBernstein, Arbor, BetterMarkets, Barnard, CIEBA, Citadel, CME, D. E. Shaw,DRW, Eris, FHLB, ICE, ICI, Javelin, Jeffries, LCH,Markit, MFA, MGEX, NYPC, SDMA, SIFMA, SpringTrading, State Street, Trading Firms, Vanguard,Vizier, and WF.

17DB, ISDA, SG, UBS, Morgan Stanley, the Banks,EEI, and the Committee.

18AIMA, Javelin, SG, SIFMA, Spring Trading,and Vanguard.

19Vanguard.20Banks, DB, EEI, ISDA, Morgan Stanley, SG, and

UBS.

includes optional annexes that make theclearing member to one or both of theexecuting parties a party to theagreement (the trilateral agreements).The trilateral agreements containprovisions that would permit acustomers futures commissionmerchant (FCM), in consultation withthe swap dealer (SD) that is the

customers counterparty, to establishspecific credit limits for the customersswap transactions with the SD. Theprovisions further provide that the FCMwill only accept for clearing thosetransactions that fall within thesespecific limits. The limits set for tradeswith the SD or MSP might be less thanthe overall limits set for the customerfor all trades cleared through the FCM.The result would be to create asublimit for the customer whentrading with that SD or MSP.

When a trade is rejected for clearing,the parties to that trade may incursignificant costs. As the clearing ofswaps increases pursuant to the Dodd-Frank Act, the likelihood and size ofsuch potential costs could also increase,according to the proponents of thetrilateral agreements. The trilateralagreements were intended to limit thesepotential costs.

The Commission expressed concernin the notice of proposed rulemakingthat such arrangements potentiallyconflict with the concepts of openaccess to clearing and competitiveexecution of transactions.14 To addressthese concerns and to provide furtherclarity in this area, the Commissionproposed 1.72 relating to FCMs, 23.608 relating to SDs and MSPs, and 39.12(a)(1)(vi) relating to DCOs. Theseregulations would prohibitarrangements involving FCMs, SDs,MSPs, or DCOs that would (a) discloseto an FCM, SD, or MSP the identity ofa customers original executingcounterparty; (b) limit the number ofcounterparties with whom a customermay enter into a trade; (c) restrict thesize of the position a customer may takewith any individual counterparty, apartfrom an overall credit limit for all

positions held by the customer at theFCM; (d) impair a customers access toexecution of a trade on terms that havea reasonable relationship to the bestterms available; or (e) preventcompliance with specified time framesfor acceptance of trades into clearing.

B. Summary of Comments

The Commission received a total of 38comment letters directed specifically at

the proposed documentation rules.15 Ofthe 38 commenters, 30 supported theproposed rules.16 They included assetmanagers, market makers, tradingplatforms, clearing organizations, bank/dealers, a non-profit organization, and aprivate citizen. Within this group, somecommenters addressed only certainaspects of the rules and were silent on

other sections and some requestedclarification of certain provisions.

Eight commenters expressedopposition.17 They include bank/dealers, an association of electricutilities, and an asset manager. Withinthis group as well, some commentersaddressed only certain aspects of therules and were silent on other sectionsand some requested clarification ofcertain provisions.

Three commenters in supportArbor,Citadel, and Erisurged theCommission to make these rules a top

priority in the final rulemaking process.Numerous commenters stated that theproposed rules would increase openaccess to clearing and execution, reducerisk, foster competition, lower costs, andincrease transparency. FHLB expressedthe view that the proposed rules willfacilitate the transition to centralclearing. Barnard and Vanguard asserted

that the proposed rules will preventconflicts of interest, and achieve clearwalls between clearing and tradingactivities involving FCMs and affiliates.Six commenters went into detail whythe trilateral agreements are bad for themarkets, noting that such agreementsdiscourage competition and efficientpricing, compromise anonymity, reduceliquidity, increase the time betweenexecution and clearing, introduceconflicts of interest, and prevent thesuccess of swap execution facilities(SEFs).18 SDMA commented thatwhile the SDMA is philosophically

loathe to encourage possiblegovernment [interference] with privatecontracts between two parties, theproposed rules are necessary in theirentirety in this instance, and that theproposed rules are not overlyprescriptive. Vanguard, estimated that ifit was required to enter into trilateralagreements, it would have to negotiateapproximately 4,800 new trilateralagreements per year.19

Seven commenters in oppositioncontended that without the trilateralagreements, some market participantsmay have reduced access to markets.20

(ISDA and the Committee did notaddress this issue.) They asserted thatthe trilateral agreements facilitate riskmanagement and certainty of execution.DB believes that the trilateralagreements provide a means of ensuringcompliance with mandatory clearing.DB also commented that if an SD doesnot know whether a swap will becleared prior to execution, it will notknow whether it should apply riskfilters that take account of the swap asa cleared transaction or a bilateral one.SG commented that the rules willdecrease liquidity and limit marketparticipation, and that without the

certainty of trilateral agreements, therules may foster competing andinconsistent technology.

UBS believes that potential abuse ofcredit arrangements could be morenarrowly tailored than the proposedrule. The Banks asserted that the creditfilter infrastructure necessary to

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21 Swap Dealer and Major Swap ParticipantRecordkeeping and Reporting, Duties, and Conflictsof Interest Policies and Procedures; FuturesCommission Merchant and Introducing BrokerConflicts of Interest Policies and Procedures; SwapDealer, Major Swap Participant, and FuturesCommission Merchant Chief Compliance Officer,available at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312b.

22 Id.2376 FR 69334, Nov. 8, 2011.

maximize execution choice forcustomers while ensuring prudent riskmanagement is not currently available.The Banks suggested that instead ofprohibiting the trilateral agreements, theCommission could require that theallocation of credit limits acrossexecuting counterparties be specified bythe customer, rather than the FCM, who

would confirm the customers allocationto the identified executingcounterparties.

Morgan Stanley requestedclarification that the proposed rulesonly apply to arrangements betweenclearing firms and executing swapdealers and customers with respect toswaps, not futures. Morgan Stanley alsocommented that the Commission shouldalter the language in proposed 1.72and 23.608 from relationship to the

best terms available to execution withan executing swap dealer of thecustomers choice.

Spring Trading requested clarificationthat on terms that have a reasonablerelationship to the best terms availablerefers to the best terms available on anymarket regulated by the Commission,which would prohibit an FCM fromestablishing special hurdles for itsclearing customers in order to trade ona particular SEF.

C. Discussion

The Commission found persuasive thecomments stating that the proposedrules would increase open access toclearing and execution, reduce risk,foster competition, lower costs, and

increase transparency. TheCommmission notes that cleared futuresmarkets have operated for decadeswithout any need for the types ofprovisions prohibited by the rules.Similarly, trades executed over-the-counter (OTC) have been successfullycleared by CME and ICE on behalf ofcustomers for approximately ten yearswithout such provisions.

Specifically, the Commission believesthat, as discussed by numerouscommenters, (1) disclosure of acustomers original executingcounterparty could have potentially

anticompetitive effects, (2) limiting thenumber of counterparties would hurtthe customers access to the best priceas well as general market liquidity, (3)restricting the size of trades withparticular counterparties also wouldhurt the customers access to the bestprice as well as general market liquidity,and (4) restrictions on the number ofcounterparties and on the size of tradeswith them would slow down acceptancefor clearing thereby causing the veryproblem the restrictions werepurportedly designed to address.

The Commission believes that therisks the trilateral agreements weredesigned to address can be mitigated byother means without incurring thenegative consequences described above.Specifically, the processing rulesdescribed in section III. below and therisk management rules described insection IV. below would significantly

diminish the exposure of dealers, theircounterparties, and their respectiveFCMs to risk.

Moreover, the Commission notes thatthere are several sections of the CEAand Commission regulations thatsupport the premise underlying thesefinal rules. Section 4d(c) of the CEA, asamended by the Dodd-Frank Act, directsthe Commission to require FCMs toimplement conflict of interestprocedures that address such issues theCommission determines to beappropriate. Similarly, section 4s(j)(5),as added by the Dodd-Frank Act,requires SDs and MSPs to implementconflict of interest procedures thataddress such issues the Commissiondetermines to be appropriate. Section4s(j)(5) also requires SDs and MSPs toensure that any persons providingclearing activities or makingdeterminations as to accepting clearingcustomers are separated by appropriateinformational partitions from personswhose involvement in pricing, trading,or clearing activities might bias theirjudgment or contravene the coreprinciple of open access.

Pursuant to these provisions, theCommission promulgated 1.71(d)relating to FCMs and 23.605(d)relating to SDs and MSPs.21 Theseregulations prohibit SDs and MSPs frominterfering or attempting to influencethe decisions of affiliated FCMs withregard to the provision of clearingservices and activities, and prohibitFCMs from permitting them to do so.

Section 4s(j)(6) of the CEA prohibitsan SD or MSP from adopting anyprocess or taking any action that resultsin any unreasonable restraint on trade orimposes any material anticompetitive

burden on trading or clearing, unlessnecessary or appropriate to achieve thepurposes of the Act. To implementSection 4s(j)(6) of the CEA, the

Commission has promulgated 23.607in a separate rulemaking.22

Section 2(h)(1)(B)(ii) of the CEArequires that DCO rules provide for thenon-discriminatory clearing of swapsexecuted bilaterally or through anunaffiliated designated contract market(DCM) or SEF. The Commission hasadopted 39.12(b)(3) to implement this

provision.23The trilateral agreements potentially

conflict with the recently-adopted 1.71(d), 23.605(d), 23.607, and 39.12.As certain commenters have stated, theprovisions of the trilateral agreementsdescribed above could lead to undueinfluence by FCMs on a customerschoice of counterparties or undueinfluence by SDs on a customers choiceof clearing member. They couldconstrain a customers opportunity toobtain competitive execution of thetrade by limiting the number ofpotential counterparties.

The documentation rules covered bythis rulemaking are consistent with, andcomplementary to, the recently adoptedrules. The rules in this Federal Registerrelease address specific circumstancesthat have been identified to theCommission by market participants,while the previously adopted rules setforth more general principles. TheCommission believes that, in this case,market participants and the generalpublic would be best served byproviding both the clarity of a bright-line test for certain identifiablesituations and the guidance of more

broadly-articulated principles.

Contrary to the assertion of somecommenters, the rules do not prohibittrilateral agreements; they prohibitcertain provisions whether contained ina trilateral or a bilateral agreement. Therules have been tailored to addressspecific issues identified by marketparticipants.

The Commission emphasizes thatnothing in these rules would restrain anSD or MSP from establishing bilaterallimits with each of its counterparties.Further, nothing in these rules wouldimpair an SDs or MSPs ability toconduct due diligence with regard to

each of its counterparties, includingevaluation of balance sheet, creditratings, overall market exposure, orsimilar factors.

The Commission is revising thelanguage in 23.608 and 23.608(c) toclarify that, for swaps that will besubmitted for clearing, an SD or MSPmay continue to manage its risk bylimiting its exposure to the counterpartywith whom it is trading. This

http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312b


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24 ISDA.25The Commission notes that this rule does not

impose a best execution requirement. This rulemerely prohibits a contractual provision that wouldimpair a customers access to execution of a tradeon terms that have a reasonable relationship to thebest terms available.

267 U.S.C. 12a(5).27The Commission notes that it is not expressing

an opinion at this time as to whether a mandatory

clearing determination must be made inconjunction with a mandatory tradingdetermination.

clarification is intended to emphasizethat SDs and MSPs may continue toconduct appropriate risk managementexercises. Moreover, the Commission

believes that this modification isresponsive to the concern raised bysome commenters that until straightthrough processing is achieved, SDs andMSPs will still need to manage risk toa counterparty before a trade is acceptedor rejected for clearing.24 Furthermore,the Commission also believes that 23.608 does not preclude an SD orMSP from requiring that a counterpartyconfirm that the counterparty has anaccount with an FCM through which thecounterparty will clear.

In response to the Morgan Stanleyrequest for clarification, theCommission confirms that the rules, asdrafted, only apply to swaps. As noted,similar provisions have never beenneeded and, therefore, were not

proposed for futures.The Commission has determined not

to modify the language in 1.72 and23.608 as suggested by Morgan Stanleyfrom relationship to the best termsavailable to execution with anexecuting swap dealer of the customerschoice. The rule should not imply thatcustomers may only trade with swapdealers. Moreover, some swap marketsoperate anonymous central limit order

books. In these instances, thecounterparty is immaterial; tradingdecisions are based on solely the terms

of the trade.The Commission also has determined

not to adopt the clarification suggestedby Spring Trading. Requiring executionon the best terms available on anymarket regulated by the Commissioncould impose burdensome searchcosts.25 Moreover, there could beoperational costs in establishingconnectivity to every market. It is notclear how many markets there will be orhow compatible their systems will bewith one another or with the systems ofall FCMs and SDs. Upon review of thecomments, the Commission is adopting

1.72, and 39.12(a)(1)(vi) as proposed,and 23.608 with the modificationdescribed above.

III. Time Frames for Acceptance IntoClearing

A. Swap Dealer and Major SwapParticipant Submission of Trades

1. Introduction

Section 731 of the Dodd-Frank Actamended the CEA by adding a newsection 4s, which sets forth a number ofrequirements for SDs and MSPs.Specifically, section 4s(i) of the CEAestablishes swap documentationstandards for those registrants. Section4s(i) requires SDs and MSPs toconform with such standards as may

be prescribed by the Commission byrule or regulation that relate to timelyand accurate confirmation, processing,netting, documentation, and valuationof all swaps. Section 8a(5) of the CEAauthorizes the Commission topromulgate such regulations as, in thejudgment of the Commission, arereasonably necessary to effectuate any of

the provisions or to accomplish any ofthe purposes of the Act.26 Pursuant tothese provisions, and in order to ensurecompliance with any mandatoryclearing requirement issued pursuant tosection 2(h)(1) of the CEA and topromote the mitigation of counterpartycredit risk through the use of centralclearing, the Commission proposed 23.506.

As proposed, 23.506(a)(1) wouldrequire that SDs and MSPs have theability to route swaps that are notexecuted on a SEF or DCM to a DCO ina manner that is acceptable to the DCOfor the purposes of risk management.Under 23.506(a)(2), as proposed, SDsand MSPs would also be required tocoordinate with DCOs to facilitateprompt and efficient processing inaccordance with proposed regulationsrelated to the timing of clearing byDCOs.

As proposed, 23.506(b) would setforth timing requirements for submittingswaps to DCOs in those instances wherethe swap is subject to a clearingmandate and in those instances when aswap is not subject to a mandate. Under 23.506(b)(1), as proposed, an SD orMSP would be required to submit a

swap that is not executed on a SEF orDCM, but is subject to a clearingmandate under section 2(h)(1) of theCEA (and has not been electivelyexcepted from mandatory clearing by anend user under section 2(h)(7) of theCEA) as soon as technologicallypracticable following execution of theswap, but no later than the close of

business on the day of execution.27

For those swaps that are not subjectto a clearing mandate, but for which

both counterparties to the swap haveelected to clear the swap, under 23.506(b)(2), as proposed, the SD orMSP would be required to submit theswap for clearing not later than the next

business day after execution of theswap, or the agreement to clear, if later

than execution. This time frame reflectsthe possibility that in the case of a

bilateral swap, the parties may needtime to agree to terms that wouldconform with a DCOs requirements forswaps it will accept for clearing. Asnoted previously, any delay betweenexecution and novation to aclearinghouse potentially presentscredit risk to the swap counterpartiesand the DCO because the value of theposition may change significantly

between the time of execution and thetime of novation, thereby allowingfinancial exposure to accumulate in the

absence of daily mark-to-market. Theproposed regulation was designed tolimit this delay as much as reasonablypossible.

2. Summary of Comments

MFA generally supported proposed 23.506(a) and 23.506(b).

CME commented that the regulationsshould not require any particular systemor methodology that SDs or MSPs mustuse for submitting swaps to DCOs.Instead, the regulations should giveeach DCO the flexibility to work withSDs and MSPs to implement varioussystems and methodologies for swapsubmission, which may be subject tochange over time as cleared swapmarkets continue to develop and grow.

ISDA also indicated that the ruleshould permit SDs and MSPs,coordinating with their DCOs, to be freeto select the manner by which theyroute their swaps to DCOs. ISDA,however, commented that it is notapparent what proposed 23.506(a)adds to the 39.12(a)(3) requirementthat clearing members have adequateoperational capacity to meet obligationsarising from their participation in DCOs.ISDA also noted that market

participants have for some time beendeveloping industry standards for theprompt and efficient processing ofcleared swap transactions, and itsuggested that the Commission studythese standards and defer to themwherever possible.

MarkitSERV commented that therequirement to submit swaps as soonas technologically practicable following



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28Swap Data Repositories: RegistrationStandards, Duties and Core Principles, 76 FR 54538(Oct. 31, 2011).

execution may be inappropriate inlight of the Commissions proposed ruleregarding confirmation requirements,which requires that swap transactions

be confirmed within a certain timeperiod after execution. MarkitSERVsuggested that the regulation referencethe time of confirmation as opposed tothe time of execution. MarkitSERV also

noted that requiring SDs and MSPs tosubmit swaps for clearing no later thanthe close of business on the day ofexecution fails to accommodatetransactions that occur late in the dayand suggested a 24 hour time period.

MarkitSERV also commented thatthere are numerous benefits to usingthird party middleware providers forrouting and processing services, and itsuggested that the Commission permitswap counterparties to control how theyprocess transactions. According toMarkitSERV, counterparties should bepermitted to use independent third

party providers for confirming, routing,and satisfying the portfolioreconciliation requirements proposed bythe Commission. MarkitSERV alsosuggested that the Commission clarifyhow proposed 23.506 would interactwith proposed 23.501, which requiresconfirmation of all swaps, and with thethen-proposed rules requiring reportingof swap transactions to an SDR.28

FIA commented that SDs and MSPsare unlikely to submit a swap directlyto a DCO for clearing. Instead, they willfirst affirm the swap by, for example,submitting the relevant details to anaffirmation platform and then submitthe swap to their respective clearingmembers for submission to a DCO.

FIA suggested that the Commissionshould require SDs and MSPs to have aclearing arrangement in place withclearing members that, in turn, have thecapacity to route orders to a DCO in amanner acceptable to it.

FIA also believes that the no laterthan close of business could not besatisfied by swaps that are entered intolater in the day and suggests theproposed rule be revised to provide theparties greater flexibility to submit aswap for clearing within a reasonable

time as prescribed by the applicableDCO. Finally, to encourage thevoluntary use of clearing where suchswaps are not required to be cleared,FIA suggests that the proposed 23.506(b)(2) be revised to permit theparties to submit such trades forclearing on any date to which theparties and their respective clearingfirms agree.

The Options Clearing Corporation(OCC) commented that the phrasefor purpose of risk management inproposed 23.506(a)(1) and37.702(b)(1) creates ambiguity because aDCO may have established routingrequirements for reasons unrelated torisk management such as increasedefficiency or decreased administrative

costs. OCC believes that a party thatsubmits transactions to a DCO forclearing should be required to ensurethat it has the ability to route thetransactions to the DCO in a mannerthat meets all of the DCOs legitimaterequirements, and not only those thatare related to risk management. OCCsuggests that the Commission delete thephrase for purpose of riskmanagement and substitute the phrasefor clearing.

SDMA supported the amendments toproposed 23.506, and suggested thatthe Commission promulgate rules that

ensure post-trade and pre-tradeintegrity. According to SDMA, the buyerand seller must know immediatelywhether their trade has been acceptedfor clearing. Trade uncertainty, SDMAcontinued, caused by the time delay

between the time of trade execution andthe time of trade acceptance intoclearing, undermines market integrity inthe post-trade work process. SDMA alsostated that trade uncertainty alsodirectly impedes liquidity, efficiency,and market stability.

CME commented that the technologyfor SDs and MSPs to route swaps to aDCO may be as simple as entering the

necessary data in a web page. Itsuggested that a more apt standard may

be as soon as operationally feasible.CME also believes that the proposedtime frames for submission of swaps areappropriate and operationally feasible,and it is not aware of systemic obstaclesto the coordination between DCOs,MSPs, and SDs required under theproposed regulation.

FHLBanks commented that the timeframes are appropriate provided that theCommission establishes a cut-off timefor determining the day on which aswap is executed because it may not be

technologically practicable for a swapthat is executed towards the end of aday to be submitted for clearing thatday. FHLBanks suggests the rule specifythat swaps executed after 4 p.m. NewYork time shall be deemed to beexecuted on the following business day.

ISDA commented that submission bythe close of business may not betechnologically practicable. In addition,ISDA suggested that trades will need togo through an affirmation platform andclearing members will need to screentrades for compliance with their own

standards and with DCO standards, andthis may not occur before the end of the

business day. ISDA also expressedconcern that mandatory, same daysubmission may invite error becauseclearing members may focus on speedover accuracy. ISDA suggested that theCommission impose an as soon asreasonably and technologically

practicable standard.ISDA also commented that

23.506(b)(2) should not set forth a timeperiod for clearing. According to ISDA,limiting the flexibility of partiesvoluntarily seeking to clear will onlycreate disincentives to suchvoluntarism, including confusion andpotential legal uncertainty. Thus, ISDAsuggested that where parties voluntarilyelect to submit a swap for clearing, allaspects of that election should be left tothe parties to determine contractually.

Freddie Mac commented that swapdealers periodically enter mismatched

data and send swap confirmations thatincorrectly reflect the principal terms oftransactions. As a result, Freddie Mac

believes that a standard for submittingclearing submissions that starts theclock at execution would be confusingand impractical and it could bedetrimental to counterparties who aresubject to undue pressure to quicklyassent to terms dictated by a marketprofessional. Freddie Mac alsocommented that establishing a close of

business deadline for submission ofswaps for clearing would impair lateday trading and potentially reduce

market integrity. Freddie Mac suggestedthat the Commission modify proposed 23.506(b)(1) to provide that SDs andMSPs are required to submit swaps thatare not executed on a SEF or DCM butthat are subject to a clearing mandate assoon as commercially and operationallypractical for both parties but no laterthan 24 hours after execution.

LCH commented that swaps notsubject to mandatory clearingobligations should not be subject to anytimeline. LCH believes that a DCOshould be able to accept such tradeswhenever they are submitted, provided

that it has sufficient margin from bothsides.

3. Discussion

Proposed 23.506(a) does notprescribe the manner by which SDs orMSPs route their swaps to DCOs andprovide for prompt and efficientprocessing. It is possible that DCOs willenable SDs and MSPs to submit theirswaps to clearing via third-partyplatforms and other service providers.DCOs will certainly specify the role oftheir clearing members in the process.



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29See ISDA.

30See Core Principles and Other Requirements forSwap Execution Facilities, 76 FR 1214 (Jan. 7,2011); 7 U.S.C. 7b3(h); and 7 U.S.C. 12a(5).

31See section 5h(f)(7) of the CEA, 7 U.S.C. 7b3(f)(7).

32See 76 FR at 1248. Section 37.702(b), asoriginally proposed, referred to ongoing riskmanagement. In renumbering and finalizing thisprovision herein, the Commission is deleting theterm ongoing because it is superfluous and couldcreate confusion when read in conjunction withother Commission regulations that refer to riskmanagement. See, e.g., proposed 39.13 relating torisk management for DCOs, 76 FR at 3720.

33See 76 FR 13101 (Mar. 10, 2011) (setting forthtime frames for accepting or rejecting swaps forclearing).

34See Core Principles and Other Requirements forDesignated Contract Markets, 75 FR 80572 (Dec. 22,2010); 7 U.S.C. 7(d)(1); and 7 U.S.C. 12a(5).

35See Section 5(d)(11) of the CEA, 7 U.S.C.7(d)(11).

36See 75 FR at 80618.37See 76 FR 13101.

The flexibility of the rule makes itconsistent with the comments of MFA,CME, ISDA, MarkitSERV, and FIA. TheCommission concurs with OCCscomment that a DCO may haverequirements beyond risk management.The issue raised by SDMA is addressedin the customer documentationprovisions.

As discussed above, any delaybetween the time of execution and thetime of clearing creates financial risk forthe parties to the trade and for theirclearing FCMs. For trades that are notsubject to a clearing mandate, theparties are not bound by any submissiondeadlines unless and until theyvoluntarily agree to have the tradecleared. Once they make that decision,however, it will reduce risk for both theparties, as well as their respectiveclearing members, to get the tradesubmitted for clearing as soon as

practicable. Therefore, in most cases itseems likely that the parties will complywith the timing set forth within the rule

because it is in their own best intereststo do so. But, to leave all aspects tothe parties, as ISDA suggested, createsthe possibility that one party couldexpose itself, its counterparty, and itsclearing member to unnecessary risk bydelaying submission.29 In light of all thecomments, the Commission believesthat the timeframes for submission setforth in the proposed rules arereasonable.

The Commission is not defining

business day in this rule, in order toallow the entity accepting the trade forclearing, the DCO, to establish its owndefinition. The Commissionunderstands that a DCO may choose toexpand its business hours in order tooffer a competitive advantage, and thatthis rule should not prescribe whenswaps may be accepted for clearing. TheCommission further believes that if atrade is submitted for clearing near theend of a business day for a particularDCO, but is ultimately not accepted orrejected before that deadline, the DCOwill determine whether the trade will be

accepted or rejected for clearing for thefollowing day in accordance with 39.12.

The Commission is adopting 23.506(a)(1) with the amendmentsuggested by OCC, changing forpurposes of risk management to forpurposes of clearing.

The Commission is adopting 23.506(a)(2) and 23.506(b) asproposed.

B. Swap Execution Facility andDesignated Contract Market Processingof Trades

1. Introduction

For prompt and efficient clearing tooccur, the rules, procedures, andoperational systems of the tradingplatform and the clearinghouse must

align. Vertically integrated trading andclearing systems currently process highvolumes of transactions quickly andefficiently. The Commission believesthat trading platforms and DCOs underseparate control should be able tocoordinate with one another to achievesimilar results.

The Commission proposed 37.700through 37.703 to implement SEF CorePrinciple 7 (Financial Integrity ofTransactions), pursuant to itsrulemaking authority under sections5h(h) and 8a(5) of the CEA.30 CorePrinciple 7 requires a SEF to establishand enforce rules and procedures forensuring the financial integrity of swapsentered on or through the facilities ofthe swap execution facility, includingthe clearing and settlement of the swapspursuant to section 2(h)(1) [of theCEA].31 As originally proposed, 37.702(b) would require a SEF toprovide for the financial integrity of itstransactions cleared by a DCO byensuring that the SEF has the capacityto route transactions to the DCO in amanner acceptable to the DCO forpurposes of risk management.32 As partof the processing rulemaking, theCommission proposed to renumber

previous 37.702(b) as paragraph (b)(1)and add a new paragraph (b)(2) torequire the SEF to additionally providefor the financial integrity of clearedtransactions by coordinating with eachDCO to which it submits transactionsfor clearing, in the development of rulesand procedures to facilitate prompt andefficient transaction processing inaccordance with the requirements of 39.12(b)(7) of the Commissionsregulations.33

Similarly, the Commission previouslyproposed 38.600 through 38.607 to

implement DCM Core Principle 11(Financial Integrity of Transactions)pursuant to its rulemaking authorityunder sections 5(d)(1) and 8a(5) of theCEA.34 Core Principle 11 requires aDCM to establish and enforce-(A) rulesand procedures for ensuring thefinancial integrity of transactionsentered into on or through the facilities

of the contract market (including theclearance and settlement of thetransactions with a derivatives clearingorganization); and (B) rules to ensure(i) the financial integrity of any(I)futures commission merchant; and (II)introducing broker; and (ii) theprotection of customer funds. 35

As originally proposed, 38.601would require that transactionsexecuted on or through a DCM, otherthan transactions in security futuresproducts, must be cleared through aregistered DCO in accordance with theprovisions of part 39 of the

Commissions regulations.36

TheCommission later proposed to renumberthis provision as paragraph (a) ofproposed 38.601 and add a newparagraph (b) to specifically require theDCM to coordinate with each DCO towhich it submits transactions forclearing, in the development of DCOrules and procedures to facilitateprompt and efficient transactionprocessing in accordance with therequirements of 39.12(b)(7) of theCommissions regulations.37


FIA supported the rules and

recommended that each SEF and DCMbe required to assure equal access to allDCOs that wish to clear trades executedthrough the facilities of the SEF or DCM.According to FIA, failure to grant suchaccess would be inconsistent withsection 2(h) of the CEA as amended bythe Dodd-Frank Act, which (1) providesfor the non-discriminatory clearing ofswaps executed bilaterally or on anunaffiliated SEF or DCM, and (2)provides that, with respect to a swapthat is entered into by a SD or MSP, thecounterparty shall have the sole right toselect the DCO through which the swap

is cleared.LCH also concurred with both rules.It commented that it is of paramountimportance that: (1) A SEF or DCMseeking access to a DCO must first berequired to meet all regulatoryrequirements; (2) each SEF and DCM



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38See 76 FR 1214, Jan. 7, 2011.39See letter from Robert Pickel, Executive Vice

Chairman, International Swaps and DerivativesAssociation, dated April 8, 2011.

40See Requirements for Processing, Clearing, andTransfer of Customer Positions, 76 FR 13101 (March10, 2011).

41See letter from Craig S. Donohue, ChiefExecutive Officer, CME Group, dated April 11,2011; letter from R. Trabue Bland, Vice Presidentand Assistant General Counsel, ICE, dated April, 11,2011; letter from Iona J. Levine, Group GeneralCounsel 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.

42See 76 FR 45730, Aug. 1, 2011.43See 76 FR 13101, Mar. 10, 2011.

must code to each DCOs applicationprogramming interfaces; and (3) eachSEF and DCM must treat DCOs on anondiscriminatory basis.

ISDA commented that coordinationamong the parties subject to theCommissions new swap jurisdiction iscritical to ensuring that the rulemakingprocess is effective without disrupting

the swap markets and applauds thisproposal. ISDA suggested that anexisting standard managed by ISDA andused between participating companies

be adopted.As noted above, OCC commented that

the phrase for purpose of riskmanagement in proposed 23.506(a)(1) and 37.702(b)(1) createsambiguity because a DCO may haveestablished routing requirements forreasons unrelated to risk managementsuch as increased efficiency ordecreased administrative costs. OCC

believes that a party that submitstransactions to a DCO for clearingshould be required to ensure that it hasthe ability to route the transactions tothe DCO in a manner that meets all ofthe DCOs legitimate requirements, andnot only those that are related to riskmanagement. OCC suggests that theCommission delete the phrase forpurpose of risk management andsubstitute the phrase for clearing.

3. Discussion

Rules, procedures, and operationalsystems, along the lines set forth in therules, currently work well for manyexchange-traded futures. Similar

requirements could be applied acrossmultiple exchanges and clearinghousesfor swaps. The parties would need tohave clearing arrangements in placewith clearing members in advance ofexecution. In cases where more than oneDCO offered clearing services, theparties also would need to specify inadvance where the trade should be sentfor clearing.

The Commission concurs with OCCscomment that a DCO may haverequirements beyond risk management.To the extent that FIA, LCH, and ISDArecommended that the Commission

adopt additional requirements beyondthose set forth in the rule as proposed,the Commission believes it is prematureto adopt the additional requirements atthe present time. However, theCommission will monitor theimplementation of this rule and maypropose amendments in the future.

The Commission is adopting 38.601as proposed. The Commission isadopting 37.702 with the amendmentsuggested by OCC changing forpurposes of risk management to forpurposes of clearing.

C. Clearing Member and ClearingOrganization Acceptance for Clearing

1. Introduction

As noted above, a goal of the Dodd-Frank Act is to reduce risk by increasingthe use of central clearing. Minimizingthe time between trade execution andacceptance into clearing is an important

risk mitigant.This time lag potentially presentscredit risk to the swap counterparties,clearing members, and the DCO becausethe value of a position may changesignificantly between the time ofexecution and the time of novation,thereby allowing financial exposure toaccumulate in the absence of dailymark-to-market. Among the purposes ofclearing are the reduction of risk and theenhancement of financial certainty, andthis time lag diminishes the benefits ofclearing swaps that Congress sought topromote in the Dodd-Frank Act. A delayin clearing is also inconsistent withother proposed regulations concerningproduct eligibility and financialintegrity of transactions insofar as thedelay reduces liquidity and increasesrisk.38

In this rulemaking, the Commission isseeking to expand access to, andstrengthen the financial integrity of, theswap markets subject to Commissionoversight by providing for promptprocessing, submission, and acceptanceof swaps eligible for clearing by DCOs.This requires setting an appropriatetime frame for the processing andsubmission of swaps for clearing, as

well as a time frame for the clearing ofswaps by the DCO.As originally proposed,

39.12(b)(7)(i) required DCOs tocoordinate with DCMs and SEFs tofacilitate prompt and efficientprocessing of trades. In response to acomment, the Commission laterproposed to require prompt, efficient,and accurate processing of trades. 39

Recognizing the key role clearingmembers play in trade processing andsubmission of trades to central clearing,the Commission also proposed parallelprovisions for coordination amongDCOs and clearing members. Proposed 39.12(b)(7)(i)(B) would require DCOsto coordinate with clearing members toestablish systems for prompt processingof trades. Proposed 1.74(a) and23.610(a) would require reciprocalcoordination with DCOs by FCMs, SDs,and MSPs that are clearing members.

As originally proposed, 39.12(b)(7)(ii) required DCOs to accept

immediately upon execution alltransactions executed on a DCM orSEF.40 A number of DCOs and othercommenters expressed concern that thisrequirement could expose DCOs tounwarranted risk because DCOs need to

be able to screen trades for compliancewith applicable clearinghouse rulesrelated to product and credit filters.41

The Commission recognized that whileimmediate acceptance for clearing uponexecution currently occurs in somefutures markets, it might not be feasiblefor all cleared markets at this time. Forexample, where the same clearedproduct is traded on multiple executionvenues, a DCO needs to be able toaggregate the risk of trades coming in toensure that a clearing member orcustomer has not exceeded its creditlimits. Accordingly, the Commissionmodified proposed 39.12(b)(7)(ii) topermit DCOs to screen trades againstapplicable product and credit criteria

before accepting or rejecting them.42

Consistent with principles of openaccess, the proposal would require thatsuch criteria be non-discriminatory withrespect to trading venues and clearingparticipants.

Proposed 1.74(b) would set up aparallel requirement for clearing FCMs;proposed 23.610(b) would set up aparallel requirement for SDs and MSPsthat are clearing members. These rules,again, would apply a performancestandard, not a prescribed method forachieving it.

As originally proposed,

39.12(b)(7)(iii) and 39.12(b)(7)(iv)distinguished between swaps subject tomandatory clearing and swaps notsubject to mandatory clearing.43 Uponreview of the comments, theCommission concluded that thisdistinction was unnecessary with regardto processing time frames. If a DCO listsa product for clearing, it should be ableto process it regardless of whetherclearing is mandatory or voluntary.Accordingly, the Commission modifiedproposed 39.12(b)(7)(iii) to cover alltrades not executed on a DCM or SEF.It would require acceptance or rejection



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44AIMA, AllianceBernstein, Arbor, Barnard,CIEBA, Citadel, DRW, Eris, FHLB, ICI, Javelin,Jeffries, MFA, SDMA, State Street, Spring Trading,Trading Firms, and Vizier.

45See letter from James Cawley, Swaps andDerivatives Market Association, dated April 19,2011.

46Katy Burne, UPDATE: Javelin, CME ClaimRecord Time To Clear Rate Swaps, Dow JonesNewswires, Nasdaq (Dec. 14, 2011; accessed Jan. 3,2012) http://www.nasdaq.com/aspx/stock-market-news-story.aspx?storyid=201112141726dowjonesdjonline000739&title=updatejavelincme-claim-record-time-to-clear-rate-swaps.

by the DCO as quickly after submissionas would be technologically practicableif fully automated systems were used.

Proposed 1.74(b) would set up aparallel requirement for clearing FCMs;proposed 23.610(b) would set up aparallel requirement for SDs and MSPsthat are clearing members. These rules,again, would apply a performance

standard, not a prescribed method forachieving it.

The Commission also recognized thatsome trades on a DCM or SEF may beexecuted non-competitively. Examplesinclude block trades and exchanges offutures for physicals (EFPs). A DCOmay not be notified immediately uponexecution of these trades. Accordingly,the proposal treated these trades in thesame manner as trades that are notexecuted on a DCM or SEF.


Eighteen 44 commenters expressed

support for the timing standard asproposed by the Commission.CME recommended that the standard

be revised to as quickly as would betechnologically practicable if fullyautomated systems and filters were usedor as quickly as possible if automatedsystems or filters are not used.

MGEX requested that the Commissioncodify the preamble text that the newtiming standard would require action ina matter of milliseconds or seconds or,at most, a few minutes, not hours ordays. MGEX also commented thatproposed 39.12(b)(7) should be ageneral acceptance and timing rule, notapplicable for each specific contractlisted to be cleared. MGEX argued thatthe rule only should apply to thoseswaps that a DCO has identified that itcan and will clear, as opposed tovariations of contracts listed for clearingor any contract not previously cleared

by the DCO.Morgan Stanley believes that the

timing standard should be intended toprohibit only those arrangements thatprevent the use of automated systemsthat are available in the market tofacilitate clearing.

LCH suggested that the Commission

modify proposed 39.12(7)(ii) and (iii)by adding the language and for whichsufficient margins have been received

by the derivatives clearing organizationprior to accepting and confirming atrade for clearing.

NYPC requested clarification that incircumstances where a DCOautomatically receives matched trade

data from a DCM or SEF on a locked-in basis, no further systemsdevelopment would be required in orderto satisfy the above-referencedrequirements of proposed regulations1.74(a) and 39.12(b)(7)(i)(B).

Better Markets stated that the timingstandard must be: (1) Provided by theDCO or FCM; (2) capable of receiving

and processing trade data from multiplesources in real time; (3) able to screenagainst standards such as price levelsand block trade sizes as a thresholdmatter; (4) able to decrease or increaseavailable credit real time; and (5)automatic push notification ofacceptance or rejection by the DCO orFCM. Better Markets also commentedthat systems provided by a DCO or FCMmust be open and require no specialcapabilities on the part of the tradeexecution venue, and that once data isinput, the systems must function on afirst-come-first-served basis using a

reliable and common time stampingregime, regardless of affiliation orcontractual relationship between thetrading venue and DCO or FCM. BetterMarkets noted that confirmation ofacceptance or rejection must not differ

between trading venues based onaffiliation or relationship.

SG suggested that the Commissionestablish one or both of the following:(1) Credit limits of customers and FCMsare stored at the DCO and provided toSEFs in real time upon electronicdemand; or (2) an industry-wide utilitythat stores customer and FCM limits andprovides them to DCOs and SEFs in realtime upon electronic demand.

3. Discussion

The Commission continues to believethat acceptance or rejection for clearingin close to real time is crucial both foreffective risk management and for theefficient operation of trading venues.45Rather than prescribe a specific lengthof time, the Commissionis implementing a standard that action

be taken as quickly as would betechnologically practicable if fullyautomated systems were used. Thisstandard would require action in a

matter of milliseconds or seconds or, atmost, a few minutes, not hours or days.The Commission recognizes thatprocessing times may vary by product ormarket.

This requirement is intended to be aperformance standard, not theprescription of a particular method oftrade processing. The Commissionexpects that fully automated systems

will be in place at some DCOs, FCMs,SDs, and MSPs. Others might havesystems with some manual steps. Theuse of manual steps would be permittedso long as the process could operatewithin the same time frame as theautomated systems.

As discussed by numerouscommenters, the proposed standard

approximates real-time acceptancewhile providing flexibility toaccommodate different systems andprocedures. Avoiding a large gap

between trade execution and acceptancefor clearing is crucial to riskmanagement for DCOs, FCMs, andmarket participants.

The Commission notes that the timeframe for acceptance by clearingmembers and DCOs set forth in thissection is stricter than the time framesfor submission by SDs and MSPs setforth in Section III.A., above. Whereexecution is bilateral and clearing is

voluntary, the delay between executionand submission to clearing is, ofnecessity, within the discretion of theparties to some degree. The Commission

believes, however, that prudent riskmanagement dictates that once a tradehas been submitted to a clearingmember or a DCO, the clearing memberor DCO must accept or reject it asquickly as possible.

Assuring prompt acceptance orrejection for clearing also underminesmuch of the stated rationale for theprovisions in the trilateral agreements.In those unusual circumstances in

which trades are rejected, the partieswill know almost immediately and beable to take appropriate steps to mitigaterisk.

The Commission disagrees withCMEs suggested standard of as quicklyas possible. The Commission believesthat this standard would introduce toomuch potential for delay. It couldincrease the very risks that this finalrulemaking is designed to reduce oreliminate.

In support of the final standard, theCommission notes that on December 13,2011, $4.1 billion of trades were

executed on a trading platform andcleared by a DCO within the time framecontemplated by the proposed rules.Specifically, 21 interest rate swaps wereexecuted and cleared with an averagetime of 1.9 seconds and a quickest timeof 1.3 seconds.46

http://www.nasdaq.com/aspx/stock-market-news-story.aspx?storyid=201112141726dowjonesdjonline000739&title=updatejavelincme-claim-record-time-to-clear-rate-swapshttp://www.nasdaq.com/aspx/stock-market-news-story.aspx?storyid=201112141726dowjonesdjonline000739&title=updatejavelincme-claim-record-time-to-clear-rate-swapshttp://www.nasdaq.com/aspx/stock-market-news-story.aspx?storyid=201112141726dowjonesdjonline000739&title=updatejavelincme-claim-record-time-to-clear-rate-swapshttp://www.nasdaq.com/aspx/stock-market-news-story.aspx?storyid=201112141726dowjonesdjonline000739&title=updatejavelincme-claim-record-time-to-clear-rate-swapshttp://www.nasdaq.com/aspx/stock-market-news-story.aspx?storyid=201112141726dowjonesdjonline000739&title=updatejavelincme-claim-record-time-to-clear-rate-swapshttp://www.nasdaq.com/aspx/stock-market-news-story.aspx?storyid=201112141726dowjonesdjonline000739&title=updatejavelincme-claim-record-time-to-clear-rate-swapshttp://www.nasdaq.com/aspx/stock-market-news-story.aspx?storyid=201112141726dowjonesdjonline000739&title=updatejavelincme-claim-record-time-to-clear-rate-swaps


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48Barnard; Futures Industry Association (FIA);SDMA; Better Markets; ICE; CME; Freddie Mac;ISDA; MGEX; MFA; Citadel; FHLB; Jeffries; Arbor;and Javelin.

should be similar to that of the futuresmarkets.

The Commission received nosubstantive comments regardingallocation of uncleared trades.

3. Discussion

For many years in the futures markets,

bunched orders have been executed asa block for immediate acceptance intoclearing and allocated into individualaccounts later in the day. Essentially, astand-by clearing member guaranteesthe trades until they can be allocated.Consequently, there is no need for atwo-hour delay.

The proposed amendments wouldapply the same process to swaps. Byallowing post-trade allocation of

bunched orders, the rule is responsiveto all the comments. By not permittinga two-hour delay the rule is alsoresponsive to the comments of State

Street, MFA, D. E. Shaw, and SDMA,but is contrary to the comments of CMEand BlackRock.

The Commission does not findpersuasive the arguments that clearedswaps should be subject to a standardthat differs in this regard from thestandard for cleared futures. TheCommission believes that a two-hourdelay would create risk rather thanmitigate it. First, the counterparty orcounterparties to the trade would incura delay in acceptance of their side intoclearing because of the happenstance of

being opposite a bunched order. This

result is untenable in fast-movingmarkets. Second, the customers whoseorders were being bunched would alsosuffer the same delay thereby incurringthe same risks.

The futures model has worked wellfor many years. In most instances, theorders are successfully allocated and thestand-by FCM ultimately is not requiredto clear any trades. In those cases wherethere is a misallocation, it is correctedthe next day and the stand-by FCM iscompensated by the account manager.All parties receive the benefits ofimmediate acceptance into clearing.

CME and BlackRock have notdemonstrated why these procedureswould not work for swaps.

The Commission believes that asimilar analysis applies to unclearedswaps. Certainty of allocation by theend of the calendar day that a swap isexecuted will reduce risk for bothcounterparties. The Commissionreceived no comments indicatingotherwise.

The Commission is adopting 1.35(a1)(5)(iv) as proposed.

IV. Clearing Member Risk Management

A. Introduction

CEA Section 3(b) provides that one ofthe purposes of the Act is to ensure thefinancial integrity of all transactionssubject to the Act and to avoid systemicrisk. CEA section 8a(5) authorizes theCommission to promulgate such

regulations that it believes arereasonably necessary to effectuate any ofthe provisions or to accomplish any ofthe purposes of the Act. Riskmanagement systems are critical to theavoidance of systemic risk, as evidenced

by the statutory provisions cited below.CEA section 4s(j)(2) requires each SD

and MSP to have risk managementsystems adequate for managing its

business. CEA section 4s(j)(4) requireseach SD and MSP to have internalsystems and procedures to perform anyof the functions set forth in Section 4s.

CEA section 4d requires FCMs toregister with the Commission. It furtherrequires FCMs to segregate customerfunds. CEA section 4f requires FCMs tomaintain certain levels of capital. CEAsection 4g establishes reporting andrecordkeeping requirements for FCMs.

These provisions of lawandCommission regulations promulgatedpursuant to these provisionscreate aweb of requirements designed to securethe financial integrity of the marketsand the clearing system, to avoidsystemic risk, and to protect customerfunds. Effective risk management bySDs, MSPs, and FCMs is essential toachieving these goals. For example, a

poorly managed position in thecustomer account may cause an FCM to

become undersegregated. A poorlymanaged position in the proprietaryaccount may cause an FCM to fall outof compliance with capitalrequirements.

Even more significantly, a failure ofrisk management can cause an FCM to

become insolvent and default to a DCO.This can disrupt the markets and theclearing system and harm customers.Such failures have been predominatelyattributable to failures in riskmanagement.

Proposed 1.73 set forth riskmanagement requirements that wouldapply to clearing members that areFCMs; proposed 23.609 would applyto clearing members that are SDs orMSPs. These provisions would requirethese clearing members to haveprocedures to limit the financial risksthey incur as a result of clearing tradesand liquid resources to meet theobligations that arise. The proposalrequired each clearing member to:

(1) Establish credit and market risk-based limits based on position size,

order size, margin requirements, orsimilar factors;

(2) Use automated means to screenorders for compliance with the risk-

based limits;(3) Monitor for adherence to the risk-

based limits intra-day and overnight;(4) Conduct stress tests of all positions

in the proprietary account and all

positions in any customer account thatcould pose material risk to the futurescommission merchant at least once perweek;

(5) Evaluate its ability to meet initialmargin requirements at least once perweek;

(6) Evaluate its ability to meetvariation margin requirements in cash atleast once per week;

(7) Evaluate its ability to liquidate thepositions it clears in an orderly manner,and estimate the cost of the liquidationat least once per month; and

(8) Test all lines of credit at least once

per quarter.Each of these items has been observedby Commission staff as an element of anexisting sound risk managementprogram at a DCO or an FCM.

B. Components of the Rule

The Commission received a total of 15comment letters directed specifically atthe proposed risk management rules.48A discussion of the comments receivedin response to each component of therule follows.

1. Establish Credit and Market Limitsand Automated Screening of Orders

a. Summary of CommentsFIA stated that it does not believe that

pre-execution screening of orders isfeasible in all market situations. Forinstance, the FIA noted four situationswherein pre-execution screening isnot possible given current technology.Specifically, FIA does not believe thatpre-execution screening is possible inthe case of floor execution, tradingadvisors using bunched orders, give-up agreements, and traders usingmultiple trading platforms.

The CME also commented thatautomated screening is not feasible in a

floor trading environment. The CMEsuggested that the Commission adoptthe following language: automated orotherwise appropriate means to screenorders for compliance with risk-base-limits.

ISDA made comments consistent withCME and recommended a more flexibleapproach. ISDA noted that the



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49The Dodd-Frank Wall Street Reform andConsumer Protection Act: Title VII, Derivatives,Mark Jickling & Kathleen Ann Ruane, 5 (Aug. 30,2010).

50S. Rep. No. 111176, at 32 (2010) (report of theSenate Committee on Banking, Housing, and UrbanAffairs). 51The report can be found at www.iosco.org.

52See Swap Dealer and Major Swap ParticipantRecordkeeping and Reporting, Duties, and Conflictsof Interest Policies and Procedures; FuturesCommission Merchant and Introducing BrokerConflicts of Interest Policies and Procedures; SwapDealer, Major Swap Participant, and FuturesCommission Merchant Chief Compliance Officer,available at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312b.

regulation may not take into account themanner in which swaps are executed.

b. Discussion

As noted previously, the Dodd-FrankAct requires the increased use of centralclearing. In particular, Section 2(h)establishes procedures for themandatory clearing of certain swaps.

Central clearing will provide morestability to the markets, and increasetransparency for market participants.49As stated in the Committee report of theSenate Committee on Banking, Housing,and Urban Affairs: Increasing the useof central clearinghouses * * * willprovide safeguards for Americantaxpayers and the financial system as awhole.50

The Commission has finalizedextensive risk management standards atthe DCO level. Given the increasedimportance of clearing and the expectedentrance of new products and newparticipants into the clearing system,the Commission believes that enhancingthe safeguards at the clearing memberlevel is necessary as well.

Bringing swaps into clearing willincrease the magnitude of the risksfaced by clearing members. In manycases, it will change the nature of thoserisks as well. Many types of swaps havetheir own unique set of riskcharacteristics. The Commission

believes that the increasedconcentration of risk in the clearingsystem combined with the changingconfiguration of the risk warrantadditional vigilance not only by DCOs

but by clearing members as well.FCMs generally have extensive

experience managing the risk of futures.They generally have less experiencemanaging the risks of swaps. TheCommission believes that it is areasonable precaution to require thatcertain safeguards be in place. It wouldensure that FCMs, who clear on behalfof customers, are subject to standards atleast as stringent as those applicable toSDs and MSPs, who clear only forthemselves. Failure to require SDs,MSPs, and FCMs that are clearingmembers to maintain such safeguards

would frustrate the regulatory regimeestablished in the CEA, as amended bythe Dodd-Frank Act. Accordingly, theCommission believes that applying therisk-management requirements in theproposed rules to SDs, MSPs, and FCMsthat are clearing members are

reasonably necessary to effectuate theprovisions, and to accomplish thepurposes, of the CEA.

The Commission does not intend toprescribe the particular means offulfilling these obligations. As is thecase with DCOs, clearing members willhave flexibility in developingprocedures that meet their needs. For

example, items (1) and (2) could beaddressed through simple numericallimits on order or position size, orthrough more complex margin-basedlimits. Further examples could includeprice limits that would reject orders thatare too far away from the market, orlimits on the number of orders thatcould be placed in a short time.

These proposals are consistent withinternational standards. In August 2010,the International Organization ofSecurities Commissions issued a reportentitled Direct Electronic Access toMarkets. 51 The report set out a number

of principles to guide markets,regulators, and intermediaries. Principle6 states that:

A market should not permit DEA [directelectronic access] unless there are in placeeffective systems and controls reasonablydesigned to enable the management of riskwith regard to fair and orderly tradingincluding, in particular, automated pre-tradecontrols that enable intermediaries toimplement appropriate trading limits.

Principle 7 states that:

Intermediaries (including, as appropriate,clearing firms) should use controls, includingautomated pre-trade controls, which canlimit or prevent a DEA Customer from

placing an order that exceeds a relevantintermediarys existing position or creditlimits.

Over the years, rogue traders havecaused substantial financial damage to

both small and large firms. The size orsophistication of the firm has notprovided comprehensive protection.Traders have found ways to exploit gapsin internal controls. Automatedscreening procedures, such as GlobexCredit Controls, are already in place inmany markets and have proven to beeffective tools for reducing risk.Therefore, the Commission believes that

as proposed, the rule should requireclearing members to use automatedmeans for screening orders executed onautomated trading systems.

In response to the comments, theCommission has determined that, fornon-automated markets such as openoutcry exchanges or voice brokers, therules would permit other forms ofinternal controls. For example, aclearing member cannot use anautomated system to screen the orders

of a floor trader. Proprietary or customerorders executed by open outcry or voice

broker can be screened automatically ifthey are routed automatically. Manyorders, however, continue to be placed

by telephone. It is not practicable at thistime to use automated means to screensuch orders. A clearing member,however, can actively monitor a traders

activities and be in communication ifthe trader approaches a limit. Toincorporate this approach, theCommission is revising 1.73(a)(2)(ii),1.73(a)(2)(iii), and 23.609(a)(2)(ii) usinglanguage suggested by ISDA.Specifically, as amended, these rulesprovide that clearing members mustestablish and maintain systems of riskcontrols reasonably designed to ensurecompliance.

The Commission believes that, asamended, the rules will be responsive tothe comments of FIA, CME, and ISDA.They will continue to emphasize the

key role that order screening can play inmanaging risk while makingaccommodation for certaincircumstances where automatedscreening may not be possible orpracticable at this time.

In response to the comments, theCommission has also determined tomake changes with regard to give-upsand bunched orders. Give-ups are tradeswhere the execution function and theclearing function are performed bydifferent firms. Revised paragraph(2)(iv) requires the clearing firm, which

bears the financial risk of the trade, to

set limits and communicate them to theexecuting firm, which would applythem. This arrangement is consistentwith current practice. The uniform give-up contract contains a provisionallowing a clearing firm to establishlimits on the trades it will accept fromthe executing firm.

To the extent the executing firm is anSD or MSP, and the clearing firm is anaffiliated FCM, the firms will also haveto comply with the conflict of interestrules for SD/MSPs and the conflict ofinterest rules for FCMs.52 Those rulesaddress appropriate partitions betweenthe trading units of an SD/MSP and theclearing units of an affiliated FCM. Forexample, recently-promulgated 23.605(d)(1)(iv) prohibits an SD/MSP

http://www.iosco.org/http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.iosco.org/http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312bhttp://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312b


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from interfering with the setting of risktolerance levels by an affiliated FCM.

As noted above, for bunched orders,typically one firm acts as a stand-byclearing firm for purposes of getting thetrade executed, but before the end of theday, the block is broken up and assignedamong multiple clearing members, eachof whom is acting on behalf of a

particular customer.Revised paragraph (2)(v)(A) requires

the stand-by clearing firm to establishlimits for the block account and screenthe order. Revised paragraph (2)(v)(B)requires each ultimate clearing firm toestablish limits for each of its customersand enter an agreement with theaccount manager under which theaccount manager would screen ordersfor compliance. Revised paragraph(2)(v)(C) requires each ultimate clearingfirm to establish controls to enforce itslimits. The revisions adjust the rule totake into account the more complex

procedures entailed in processingbunched orders. They narrow the scopeof the screening required by variousclearing participants from what wasoriginally proposed.

To the extent the account manager orone of the customers is an SD/MSP andone of the clearing firms is an affiliatedFCM, the firms also will have to complywith the conflict of interest rules for SD/MSPs and the conflict of interest rulesfor FCMs. As noted above, those rulesaddress appropriate partitions betweenthe trading units of an SD/MSP and theclearing units of an affiliated FCM.

2. Stress Testsa. Summary of Comments

Chris Barnard and Better Markets bothrecommended that the Commissionrequire specific stress tests. Barnardrecommended that the Commissionadopt a minimum standard and BetterMarkets recommended an extreme butplausible standard for stress tests. Inaddition, Better Markets believes thatstress test results should be reported tothe Commission and the relevant DCO.FHLB recommended that stress testresults be publicly disclosed. FHLB

believes that public disclosure of stresstest results would allow customers tomitigate risk.

b. Discussion

Stress tests are an essential riskmanagement tool. The purpose inconducting stress tests is to determinethe potential for significant losses in theevent of extreme market events and theability of traders and clearing membersto absorb the losses.

The Commission intentionallyrefrained from setting specific stress

tests levels or a minimum threshold.The Commission believes that clearingmembers are in the best position todesign stress tests based on theirknowledge of markets and the types ofcustomers they carry. In addition, theCommission believes that specifyingcertain stress tests might stifleinnovation or cause firms to use

minimum levels to meet regulatorycompliance rather than implementing avigorous risk management program.This approach is consistent with theapproach recently adopted by theCommission for DCO stress tests. TheCommission intends to monitor theimplementation of this rule todetermine whether clearing membersare routinely conducting stress testsreasonably designed for the types of riskthe clearing members and theircustomers face.

The Commission believes that theconcept of extreme but plausible

conditions is commonly used and wasimplicit in the proposal. TheCommission is adding the phrase to therule text for clarity.

The Commission believes that publicdisclosure of stress test results could bea disincentive to aggressive stresstesting. Moreover, disclosure of resultscould have the effect of improperdisclosure of confidential positioninformation.

The Commission is adopting theprovisions as proposed, withamendments to 1.73(a)(4) and23.609(a)(4) to incorporate the phrase

extreme but plausible marketconditions.

3. Margin Evaluation

a. Summary of Comments

ISDA and FIA believe that therequirement to evaluate initial marginonce per week is unclear. ISDA pointedout that a clearing member generallyknows the amount of initial margin andcollects it promptly.

The Commission received nocomments regarding 1.73(a)(6) and23.609(a)(6) regarding variation margin.

b. DiscussionThe purpose of this provision is to

require clearing firms to evaluate theirability to deal with certaincontingencies on a routine basis. Forexample, a DCO might raise marginrequirements, or option positions might

be exercised, or a customer mightdefault on a margin call. The clearingfirm should make sure that it hasresources available to meet itscontinuing obligations under suchcircumstances.

The Commission is adopting 1.73(a)(5), 1.73(a)(6), 23.609(a)(5),and 23.609(a)(6) as proposed.

4. Estimated Cost of Liquidation


FIA commented that even in normalmarkets, estimating the costs ofliquidating such positions in an orderlymanner will be difficult at best. In timesof market stress, such estimates will beimpossible.

b. Discussion

The Commission recognizes thatestimating the cost of liquidation is attimes difficult. But the inevitableimprecision of any estimate does notjustify abandoning efforts to quantifypotential losses.

The purpose of the calculation is toalert the clearing firm to potential risksthat might otherwise go undetected.This exercise could lead a clearing firm

to decide: (1) To arrange for additionalfinancing to cover a potential loss; or (2)to reduce the positions prior to a periodof market stress. Commission staffperform stress tests of FCM positionsand have alerted FCMs about potentiallosses. Based on Commission staffsexperience in this area, the Commission

believes that this is a topic that has notbeen fully addressed by some clearingmembers in recent years.

In response to commenters, theCommission has decided to modify 1.73(a)(7) to require estimation ofliquidation costs once per quarter,

rather than once per month.Additionally, the Commission is re-numbering 23.609(a)(7) to 23.609(a)(8), and renumbering 23.609(a)(8) to 23.609(a)(7), in orderto follow the parallel structure in 1.73.

The Commission is adopting 1.73(a)(8) and 23.609(a)(7) with themodifications discussed above.

5. Testing Lines of Credit


The CME commented that therequirement to test lines of creditshould only be done on an annual basis

rather than a quarterly basis. The CMEbelieves that quarterly testing is not costefficient. ISDA sought clarification onwhether the test requires an actualdrawing of funds or an assessment ofconditions precedent to drawing.

b. Discussion

The Commission accepts thatquarterly testing might not be costefficient under all circumstances.Nonetheless, the Commissionencourages clearing members to testlines of credit more frequently based on



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53See 76 FR 45730, Aug. 1, 2011.54 Swap Dealer and Major Swap Participant

Recordkeeping and Reporting, Duties, and Conflictsof Interest Policies and Procedures; FuturesCommission Merchant and Introducing BrokerConflicts of Interest Policies and Procedures; SwapDealer, Major Swap Participant, and FuturesCommission Merchant Chief Compliance Officer,available at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312b.

market and credit events. For instance,if a line of credit is in place with a bankthat has recently suffered a credit ratingdowngrade, a test may be appropriate.

The Commission believes that theactual drawing of funds is essential totesting a line of credit. Among otherthings, the test should ensure the abilityof the bank or other institution to movethe funds in a timely fashion and thatthe clearing member can assess itsabili

77 fr 21278 - customer clearing documentation, timing of acceptance for clearing, and clearing...

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