Core Principles and Other Requirements for Swap Execution Facilities

Federal RegisterJan 7, 2011

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 37

RIN Number 3038-AD18

Core Principles and Other Requirements for Swap Execution Facilities

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Notice of Proposed Rulemaking.

SUMMARY:

The Commodity Futures Trading Commission (“Commission” or “CFTC”) is proposing new rules, and guidance and acceptable practices to implement the new statutory provisions enacted by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The proposed rules, guidance, and acceptable practices, which apply to the registration and operation of a new type of regulated entity named a swap execution facility, implement the new statutory framework that, among other things, adds a new Section 5h to the Commodity Exchange Act (“CEA”) concerning the registration and operation of swap execution facilities, and new Section 2(h)(8) to the CEA concerning the listing, trading and execution of swaps on swap execution facilities. The Commission requests comment on all aspects of the proposed rules, guidance and acceptable practices.

DATES:

Comments must be received on or before March 8, 2011.

ADDRESSES:

You may submit comments, identified by RIN number 3038-AD18, 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.

•

Mail:

David A. Stawick, Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.

•

Hand Delivery/Courier:

Same as mail above.

•

Federal eRulemaking Portal: http://www.regulations.gov.

Follow the instructions for submitting comments.

Please submit your comments using only one method.

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 Commission to consider information that may be exempt from disclosure under the Freedom of Information Act (“FOIA”),

a petition for confidential treatment of the exempt information may be submitted according to the established procedures in § 145.9.

5 U.S.C. 552.

17 CFR 145.9.

The Commission reserves the right, but shall have no obligation, to review, prescreen 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 the rulemaking 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 FOIA.

FOR FURTHER INFORMATION CONTACT:

Riva Spear Adriance, Associate Director, 202-418-5494,

radriance@cftc.gov,

or Mauricio Melara, Attorney-Advisor, 202-418-5719,

mmelara@cftc.gov,

Division of Market Oversight, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. Overview

B. The Dodd-Frank Act

II. The Proposed Regulations, Guidance and Acceptable Practices

A. Adoption of New Regulations, Guidance and Acceptable Practices

B. Proposed General Regulations Under Part 37

C. Proposed Regulations, Guidance and Acceptable Practices for Compliance With the Core Principles

III. Effective Date and Transition Period

IV. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

C. Cost-Benefit Analysis

V. Text of the Proposed Regulations, Guidance and Acceptable Practices

I. Background

A. Overview

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).

Title VII of the Dodd-Frank Act

amended the CEA

to establish a comprehensive new regulatory framework for swaps and security-based 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 derivatives products; (3) creating robust 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.

See

Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010). The text of the Dodd-Frank Act may be accessed at

http://www.cftc.gov./LawRegulation/OTCDERIVATIVES/index.htm.

Pursuant to Section 701 of the Dodd-Frank Act, Title VII may be cited as the “Wall Street Transparency and Accountability Act of 2010.”

7 U.S.C. 1

et seq.

The Dodd-Frank Act creates a new type of regulated marketplace: “Swap execution facilities” (“SEFs”),

for which the Dodd-Frank Act establishes a comprehensive regulatory framework, including by: Section 733 (adding new Section 5h to the CEA to provide a regulatory framework of Commission oversight), Section 723(a)(3) (adding new Section 2(h)(8) to the CEA, to require, among other things, that swaps subject to the clearing requirement of Section 2(h)(1) of the CEA be executed either on a designated contract market (“DCM”) or on a SEF, unless no DCM or SEF made the swap “available for trading”),

and Section 733 of the Dodd-Frank Act (adding Section 5h(a)(1), requiring that no person may operate a facility for the trading or processing of swaps unless the facility is registered as a SEF or as a DCM).

This new regulatory framework includes: (i) Registration, operation and compliance requirements for SEFs and (ii) fifteen core principles. Applicants and registered SEFs are required to comply with the core principles as a condition of obtaining and maintaining their registration as a SEF. The definition of swap execution facility is added in Section 721 of the Dodd-Frank Act, amending Section 1a of the CEA. 7 U.S.C. 1a(50).

See

Section 723 of the Dodd-Frank Act.

In enacting the Dodd-Frank Act, Congress directed that rules and regulations required by the provisions of Title VII be promulgated by the later of either 360 days of its enactment or, to the extent that a rulemaking is required by Dodd-Frank, not less than 60 days after the publication of that final rule.

Consistent with Congress' directive, this release proposes amendments to Part 37 of the Commission's regulations to

implement Sections 723(a)(3) and 733 of the Dodd-Frank Act.

See

Section 754 of the Dodd-Frank Act.

See

Section 754 of the Dodd-Frank Act. Please also note that Section 734 of the Dodd-Frank Act deletes the provision of the CEA that provided for Derivatives Transaction Execution Facilities (“DTEFs”), which previously were regulated under Part 37, replacing those provisions with regulations establishing the regulatory requirements for SEFs.

B. The Dodd-Frank Act

Section 723(a)(3) of the Dodd-Frank Act amends Section 2(h) of the CEA, providing that, with respect to transactions involving a swap subject to the clearing requirement of paragraph 2(h)(1), counterparties must execute the transaction on a DCM or a SEF.

This “exchange trading” requirement does not apply if no DCM or SEF “makes the swap available to trade” or if the exceptions to the clearing requirement apply.

See

Section 2(h)(8) of the CEA, as enacted by Section 723(a)(3) of the Dodd-Frank Act. The Dodd-Frank Act also eliminates the swaps exemption under former Section 2(g) of the CEA, supporting the requirement that trading and processing of cleared swaps must occur on a DCM or a SEF as well as expanding the types of products that can be listed and traded on a DCM to include swaps. The Commission is proposing provisions for the trading of swaps on a DCM in a separate rulemaking.

See also

Notice of Proposed Rulemaking Relating to Core Principles and Other Requirements for Designated Contract Markets approved for publication by the Commission at an open meeting on Dec. 1, 2010 and expected to be published shortly in the

Federal Register

(to be codified at 17 CFR part 38) (the “DCM NPRM”). This Notice is available at

http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister120110b.pdf

(last visited on Dec. 8, 2010).

See

Section 2(h)(8)(B) of the CEA, as enacted by Section 723(a)(3) of the Dodd-Frank Act. Newly amended Section 2(h)(7) of the CEA provides for exceptions to the clearing requirement when one of the counterparties to a swap (i) is not a financial entity, (ii) is using the swap to hedge or mitigate commercial risk, and (iii) notifies the Commission how it meets its financial obligations associated with entering into a non-cleared swap.

Section 733 of the Dodd-Frank Act adopts new Section 5h of the CEA, providing that: (i) No person may operate a facility for the trading or processing of swaps, unless the facility is registered as a SEF or as a DCM; (ii) to be registered and maintain registration, a SEF must comply with fifteen enumerated core principles and any requirement that the Commission may impose by rule or regulation; and (iii) the Commission has the authority to prescribe rules governing the regulation of SEFs.

The proposed regulations, guidance and acceptable practices will implement the regulatory obligations that each SEF must meet in order to comply with Section 5h of the CEA both initially upon registration and on an ongoing basis. The Commission requests comments on all aspects of its proposal.

II. The Proposed Regulations, Guidance and Acceptable Practices

A. Adoption of New Regulations, Guidance and Acceptable Practices

The Dodd-Frank Act amended the CEA to provide that, under new Section 5h, the Commission may in its discretion determine by rule or regulation the manner in which DCMs and SEFs comply with the core principles. In consideration of the novel nature of SEFs and also based on its experience in overseeing DCMs' compliance with core principles, the Commission carefully assessed which SEF core principles would benefit from regulations, providing legal certainty and clarity to the marketplace, and which core principles would benefit from guidance or acceptable practices, where flexibility is more appropriate. Based on that evaluation, the Commission is proposing a combination of regulations, guidance and acceptable practices for the oversight and regulation of SEFs.

B. Proposed General Regulations Under Part 37

The Commission is proposing to organize Part 37 to include new subparts A through P. Proposed Subpart A would include general § 37.1 through 37.11.

While in this rulemaking, the Commission is proposing §§ 37.1 through 37.11, it notes that § 37.19, addressing conflicts of interest, was proposed in a separate rulemaking.

Subparts B through P would establish relevant regulations applicable to each of the 15 core principles.

These sections apply both to applicants for registration and registered SEFs, clarify which provisions are applicable to trading on SEFs, provide for SEF registration processes (including processes for the vacation, reinstatement, and transfer of a SEF registration), and provide general requirements regarding: (i) The listing and trading of swaps; (ii) the responsibility, upon request of the Commission, to respond to requests for information and demonstrations of compliance with core principles, and to provide information and certifications upon transfers of equity interest; (iii) the enforceability of a SEF's swap transactions under certain conditions, (iv) limitations on the use of data collected for regulatory purposes, (v) the need for a board of trade that operates a trading facility that has been designated as a DCM by the Commission and also intends to operate a SEF to separately register the entity that will operate as a SEF, (vi) the appropriate execution of swaps based on the type of transaction and order interaction, and (vii) the periodic assessment of the method by which swaps are made available for trading.

75 FR 63732 (October 18, 2010).

Each subpart begins with a regulation containing the language of the core principle.

1. Subpart A—General Provisions

a. Scope—Proposed § 37.1

Proposed § 37.1 provides that Part 37 will apply to entities that are registered SEFs or that are submitting an application for SEF registration under Section 5h of the CEA, and clarifies that Part 37 does not restrict the eligibility of SEFs to operate under the provisions of Parts 38 or 49 of this Chapter.

b. Applicable Provisions—Proposed § 37.2

Proposed § 37.2 lists those Commission regulations that are applicable to SEFs, and provides that SEFs must comply with, in addition to the requirements in Part 37, the proposed Part 43 requirements regarding the real time reporting of swaps and the determination of appropriate block size for swaps, the proposed Part 45 requirements for data elements, recordkeeping and reporting of swap information to swap data repositories (“SDRs”), the proposed Part 46 requirements for business continuity and disaster recovery, the proposed Part 49 requirements regarding SDRs, and the proposed Part 151 position limits requirements.

The Commission notes that because some of the proposed rulemakings are either ongoing or forthcoming, this proposed list of applicable sections under proposed § 37.2 may be subject to further revisions pending the final rules for each respective rulemaking.

c. Requirements for Registration—Proposed § 37.3

i. Application Procedures—Proposed § 37.3(a)

Proposed § 37.3 sets forth the application and approval procedures for registration of new SEFs. The provision would require that all SEF applications, reinstatements of registrations, requests for transfer of registrations, requests for withdrawal of application for registration, and vacation of registrations must be filed electronically with the Secretary of the Commission, in the form and manner as provided by the Commission.

This amendment also would ensure consistency with the process used for filing rule and product submissions under Parts 38, 39 and 40 of the Commission's regulations.

See

17 CFR Parts 38, 39 and 40.

To assist prospective applicants, the Commission proposes to include an application form under Appendix A to Part 37 (“Form SEF”); the proposed form would also be used for any updates or amendments for registration that are not required to be submitted under Part 40 of this Chapter.

Each applicant will be required to provide the Commission with documents and descriptions pertaining to its: (i) Business

organization, (ii) financial resources, (iii) compliance program and (iv) technological capabilities.

The Commission also is requiring tailored application forms for the designation of DCMs and the registration of Designated Clearing Organizations and Swap Data Repositories.

Other than the specific requirements necessitated by the core principles, the majority of information required under the Form SEF consists of information that Commission staff has historically found necessary considering DCM applications. The Commission expects that similar information will be necessary to assess applications for SEF registration. Proposed § 37.3(a)(1) requires that, at a minimum, all applicants must complete the application form and provide the necessary information and documentation in order to initiate the SEF registration review process. The determination when a submission is complete will be at the sole discretion of the Commission. The Commission will review Form SEF and, at the conclusion of its review, by order either: (i) Grant registration; (ii) deny the application for registration; or (iii) grant registration subject to Commission-established conditions.

SEF applicants will be required to provide various documents describing the applicant's legal and financial status. SEF applicants must also submit copies of any applicable rules and regulations (as defined in § 40.1),

disclose any affiliates and a brief description of the nature of the affiliation, and submit copies of any agreements between the SEF and third parties that would assist the applicant in complying with its duties under the CEA.

See

75 FR. 67282, 67292 (November 2, 2010).

Applicants will be required to demonstrate operational capability through documentation, including technical manuals and third party service provider agreements. Proposed § 37.3 also requires that each applicant request and obtain from the Commission a unique, extensible, alphanumeric code for the purpose of identifying the SEF pursuant to the swap recordkeeping and reporting requirements under proposed Part 45.

This requirement stems from the Commission's authority, under Section 728 of the Dodd-Frank Act, to establish standards and requirements related to reporting and recordkeeping for swaps. In particular, the Commission is required to adopt consistent data element standards for “registered entities,” which include SEFs. Proposed Part 45 will set forth the recordkeeping and reporting requirements of each SEF with respect to swap transactions on or through its facility. Proposed § 37.3 codifies the obligation of SEFs to comply with the provisions of proposed Part 45.

See

75 FR 76574 (December 8, 2010).

ii. Procedures for Temporary Grandfather Relief—Proposed § 37.3(b)

Section 754 of the Dodd-Frank Act provides that: “[u]nless otherwise provided in this title, the provisions of this subtitle [Subtitle A—Regulation of Over-the-Counter Swaps Markets] shall take effect on the later of 360 days after the date of enactment of this subtitle [

i.e.,

July 15, 2011], or, to the extent a provision of this subtitle requires a rulemaking, not less than 60 days after publication of the final rule or regulation implementing such provision of this subtitle.”

The Commission anticipates that, upon the effective date of this Part 37, it may receive a large number

of applications for SEF registration from entities that currently provide a marketplace for the listing and trading of swaps. The Commission notes that it would be difficult to carry out and complete an appropriate and comprehensive review of all such applications during the period between publication of the final rulemaking and the effective date of this Part 37. Any consequent delay in the processing of these SEF applications could adversely impact SEF applicants, undermine the efficient implementation of the Dodd-Frank Act, create legal uncertainty for market participants and adversely affect the swaps market.

The Commission notes that although the public estimate regarding the expected number of applications ranges from 30 to 40, certain market participants have noted that the number of SEFs could exceed 100.

Therefore, proposed § 37.3(b) permits the Commission, upon the request of an applicant, to grant temporary grandfather relief to qualifying entities that, due to their operations, will be required to register as a SEF in order to continue operating as of the effective date of the regulations. The proposed temporary grandfather relief would be optional and would enable a qualifying entity to operate without SEF registration on a short-term basis during the pendency of the application review process on the condition that it otherwise operate in conformance with all SEF requirements under the Dodd-Frank Act. This approach is intended to avoid undue market disruption as well as to ensure continuity of the business operations of an existing entity that, at the time that Part 37 becomes effective,

is providing a marketplace for the trading of swaps. The temporary relief would also allow the Commission to implement registration requirements of the Dodd-Frank Act for SEFs while providing the Commission sufficient time to fully review the application of a SEF. Each SEF that qualifies for temporary relief would be subject to Section 5h of the CEA and related regulations during the period in which the Commission is reviewing the SEF's application of registration.

See

Section 754 of the Dodd-Frank Act.

The Commission notes that it previously issued orders providing grandfather relief to exempt commercial markets (“ECMs”) and exempt boards of trade (“EBOTs”), allowing them to continue to operate as EBOTs and ECMs after the effective date of the Dodd-Frank Act (July 15, 2011) (“ECM and EBOT grandfather relief orders”).

The relief under proposed § 37.3(b) would be consistent with the ECM and EBOT grandfather relief orders. In addition, the Commission notes that the grandfather relief under proposed § 37.3(b) would also be available for entities that are currently operating pursuant to another exemption or exclusion provided under the CEA (prior to its amendment by the Dodd-Frank Act) as of the effective date of this Part 37.

See

Orders Regarding the Treatment of Petitions Seeking Grandfather Relief for Exempt Commercial Markets and Exempt Boards of Trade (“ECM and EBOT grandfather relief”). 75 FR 56513 (September 10, 2010). The Commission's Orders set forth various conditions for such grandfather relief, including the filing of a relief petition and a SEF or DCM application with the Commission.

See

CEA Sections 2(d), 2(e), 2(g) and 2(h)(1)-(2).

As a condition for receiving temporary grandfather relief, the applicant must: (1) File a complete application, as required under proposed § 37.3(a),

on the proposed application form, Form SEF, under Appendix A to Part 37; (2) notify the Commission, at the time of its submission of the application, of its interest in operating under the temporary relief; (3) provide transaction data that substantiates that the execution or trading of swaps has occurred and continues to occur on the applicant's trading system or platform at the time the applicant submits the request; and (4) provide a certification that the applicant believes that its operation on a temporary basis will meet the requirements of Part 37 of the CEA, as adopted by the Commission. Since the purpose of the temporary relief is to provide an appropriate process to ensure continuity of the business operations during the pendency of the review of an application, the temporary grandfather relief would expire on the earlier of: (i) The date that the Commission grants or denies registration of the SEF, or (ii) the

date that the Commission rescinds the temporary relief. Additionally, the temporary relief would not be a permanent provision of Part 37. Proposed § 37.3(b) provides for a “sunset” provision so that temporary grandfather relief would terminate 365 days from the effective date of proposed § 37.3(b).

As noted above, the determination of when a submission on Form SEF is complete is at the sole discretion of the Commission.

iii. Procedures for Transfer of Registration—Proposed § 37.3(d)

The Commission is proposing § 37.3(d) to formalize the procedures that a SEF must follow when requesting the transfer of its registration, in anticipation of a corporate event (

e.g.,

a merger, corporate reorganization, or change in corporate domicile) which results in the transfer of all or substantially all of the SEF's assets to another legal entity. Under proposed § 37.3(d), the SEF would submit to the Commission a request for transfer no later than three months prior to the anticipated corporate change, with a limited exception.

The proposed rule would require that where a SEF does not know or could not have reasonably known three months prior to the anticipated change, it shall be required to file the request as soon as it knows of the change.

Proposed § 37.3(d) also would require, as a condition of approval, that the SEF submit a representation that it is in compliance with the CEA, including the SEF core principles, and the Commission's regulations. In addition, the SEF would have to submit various representations by the transferee regarding its duties and obligations.

Proposed § 37.3(d) also provides that the Commission will review any requests for transfer of registration as soon as practicable, and such request will be approved or denied pursuant to a Commission order.

d. Procedures for Listing Products and Implementing Rules—Proposed § 37.4

Proposed § 37.4 conforms to the proposed changes to existing §§ 40.3 (Voluntary submission of new products for Commission review and approval) and 40.5(b) (Voluntary submission of rules for Commission review and approval),

in the Commission's separate rule proposal pertaining to “Provisions Common to Registered Entities.”

Proposed § 40.3 is amended to require additional information to be provided by registered entities that submit new products for the Commission's review and approval. Proposed § 40.5(b) codifies a new standard for the review of new rules or rule amendments as established under the Dodd-Frank Act.

75 FR 67282 (November 2, 2010).

e. Information Relating to Swap Execution Facility Compliance—Proposed § 37.5

Under proposed § 37.5(a), upon request by the Commission, a SEF must file with the Commission certain information related to its business as a SEF, in the form and manner as specified by the Commission. Under proposed § 37.5(b), the Commission may demand that a SEF file a written demonstration regarding its compliance with any specified core principles. The information requested under proposed § 37.5(a) and (b) provides for information requests to entities regarding compliance with the conditions for registration made for any oversight purpose.

In this regard, for example, the Commission may request SEFs to provide information relating to their operations or their practices in connection with its general oversight responsibilities under the CEA, in connection with the Commission's formulation of statements of acceptable practice, or in connection with a particular SEF's compliance with particular core principles or other conditions of its registration.

The Commission believes that on occasion, SEFs will enter into equity interest transfers that result in a change in ownership. In those situations, Commission staff must determine whether the change in ownership will impact adversely the operations of the SEF or the SEF's ability to comply with the core principles and the Commission's regulations. The Commission is proposing § 37.5 to ensure that SEFs remain mindful of their self-regulatory responsibilities when negotiating the terms of significant equity interest transfers, and to improve the Commission staff's ability to undertake a timely and effective due diligence review of the impact, if any, of such transfers.

Proposed § 37.5(c) would require SEFs to file with the Commission a notice of the equity interest transfer of ten percent or more, with certain documents providing information on the transfer, no later than the business day

following the date on which the SEF enters into a firm obligation to transfer the equity interest.

The proposed regulation requires that the SEF keep the Commission apprised of the projected date that the transaction resulting in the equity interest transfer will be consummated, and must provide to the Commission any new agreements or modifications to the original agreement(s) filed pursuant to proposed § 37.5(c). The SEF must notify the Commission of the consummation of the transaction on the day on which it occurs. The proposed regulation will enable staff to consider whether any conditions contained in an equity transfer agreement(s) are inconsistent with the self-regulatory responsibilities of a SEF or with any of the core principles.

“Business day” is defined in Commission § 40.1.

The Commission is proposing a 10 percent threshold because it believes that a change in ownership of such magnitude may have an impact on the operations of the swap execution facility. The Commission believes that such impact may be present even if the change in ownership does not constitute a change in control. For example, if one entity holds a minority 10 percent equity share in the SEF, it may have a more significant voice in the operation of the SEF than five entities each with a minority 2 percent equity share. Given the potential impact that a change in ownership might have on the operations of a SEF, the Commission believes that it is appropriate to require such SEF to certify after such change that it continues to comply with all obligations under the CEA and Commission regulations.

The Commission believes when there is a 10% or greater change in ownership, the SEF itself is the more appropriate entity to provide a certification of its continued compliance with all regulatory obligations. Accordingly, proposed § 37.5(c)(3) would require that if there is a change in ownership,

the SEF must certify, no later than two business days following the date on which the change in ownership occurs, that the SEF meets all of the requirements of Section 5h of the CEA and the provisions of Part 37 of the Commission's regulations.

The Commission's regulations consistently identify a financial or ownership interest of ten percent or more as material and indicative of the ability to influence the activities of an entity or trading in an account.

See, e.g.,

Core Principle 5, Acceptable Practices, and Core Principle 14, Application Guidance, in Appendix B to Part 38 of the Commission's regulations. 17 CFR part 38, Appendix B.

Request for Comment:

The Commission notes that there are differences in the proposed notification requirements for changes in the ownership of SEFs, derivative clearing organizations (“DCOs”), DCMs, and SDRs.

The Commission requests comment on the proposed notification requirements under 37.5(c) and, more specifically, the extent to which there should be uniformity or differentiation in procedures applied to different types of registrants.

See, supra

note 10, DCM NPRM;

also

the Notice of Proposed Rulemaking Relating to Swap Data Repositories, approved for publication by the Commission at an open meeting on November 19, 2010 and expected to be published shortly in the

Federal Register

(to be codified at 17 CFR part 49). This Notice is available at

http://www.cftc.gov/stellent/groups/public/@otherif/documents/ifdocs/federalregister112210d.pdf

(last visited on Dec. 8, 2010); and other appropriate future rulemakings.

f. Enforceability of Executed Swaps—Proposed § 37.6

Proposed § 37.6 is intended to provide legal certainty to market participants transacting in swaps. Under § 37.6(a), a transaction entered into on or pursuant to the rules of a registered SEF will not be void, voidable, subject to rescission or otherwise invalidated or rendered unenforceable as a result of: (1) A violation by the registered SEF of the provisions of Section 5h of the CEA or Part 37; or (2) any Commission proceeding to alter or supplement a rule, term or condition under Section 8a(7) of the CEA, to declare an emergency under Section 8a(9) of the CEA, or any other proceeding the effect of which is to alter, supplement, or require a registered SEF to adopt a specific term or condition, trading rule or procedure, or to take or refrain from taking a specific action.

In other rules proposed by the Commission, a swap confirmation is defined as the consummation (electronically or otherwise) of legally binding documentation (electronic or otherwise) that memorializes the agreement of the counterparties to all of the terms of a swap.

Proposed § 37.6(b) provides that a confirmation must be in writing (whether electronic or otherwise) and must legally supersede any previous agreement (electronically or otherwise). For swaps executed on a SEF, the SEF will provide the counterparties with a definitive written record of the terms of their agreement, which will serve as a confirmation of the swap. The proposed regulation on swap confirmations would require that parties have full written agreement on all terms of a swap at the same time as execution.

See

75 FR 76140 (December 7, 2010); and 75 FR 76574 (December 8, 2010).

g. Prohibited Use of Data Collected for Regulatory Purposes—Proposed § 37.7

In fulfilling their regulatory and compliance obligations, the Commission expects that SEFs will often require market participants to provide proprietary data or personal information. Proposed § 37.7 prohibits a SEF from using information generated by market participants for purposes of meeting regulatory and compliance obligations for marketing products or for other commercial purposes.

The Commission notes that nothing in this regulation prohibits a SEF from sharing such information with another SEF or DCM offering swaps for trading for regulatory purposes.

The Commission notes that, in the recent notice of proposed rulemaking for Business Affiliate Marketing and Disposal of Consumer Information Rules, it proposed rules prohibiting futures commission merchants (“FCMs”) (and other intermediaries) from using certain consumer information received from an affiliate to make a solicitation for marketing purposes. In addition, rules were proposed requiring FCMs to develop a written disposal program to the extent that such FCMs possess consumer information. The underlying policy for these rules is to protect the privacy of customer information. Similarly, Proposed § 37.7 is intended to protect market participants' information provided to a SEF for regulatory purposes from its use to advance the commercial interests of the SEF.

h. Boards of Trade Operating Both a Designated Contract Market and a Swap Execution Facility—Proposed § 37.8

Proposed § 37.8 implements CEA Section 5h(c) by requiring that a board of trade that operates a trading facility that has been designated as a DCM by the Commission and also intends to operate an entity for the execution or trading of swaps: (1) Must separately register such entity as a SEF under Part 37; and (2) may use the same electronic trade execution system for executing swaps that it uses for its DCM operations, provided that, the entity clearly identifies to market participants whether the execution or trading of a swaps is taking place on the DCM or the SEF.

Section 5h(c) of the CEA provides:

IDENTIFICATION OF FACILITY USED TO TRADE SWAPS BY CONTRACT MARKETS.—A board of trade that operates a contract market shall, to the extent that the board of trade also operates a swap execution facility and uses the same electronic trade execution system for listing and executing trades of swaps on or through the contract market and the swap execution facility, identify whether the electronic trading of such swaps is taking place on or through the contract market or the swap execution facility.

i. Permitted Execution Methods—§ 37.9

This rule proposal will provide market participants with the choice of a number of means to access the market and execute trades therein. This flexibility would allow market participants to use requests for quotes, indications of interest, or executable quotes to consummate a trade. It would allow SEFs to use a variety of different trading systems or platforms as long as market participants have the ability to access the market and execute trades as discussed below.

i. SEF Definition

The term ‘swap execution facility’ means a trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by multiple participants in the facility or system, through any means of interstate commerce, including any trading facility, that—(A) Facilitates the execution of swaps between persons; and (B) is not a designated contract market.

CEA Section 1a(50).

Market participants currently use a number of different methods for transacting swaps, including: brokers who facilitate trades over the telephone (commonly referred to as “voice brokers”); hybrid voice and electronic trading systems; fully electronic inter-dealer brokerage systems; single-dealer trading platforms; various versions of “request for quote” platforms (including platforms that allow more than one customer to submit requests for quotes to, and receive responses from, multiple dealers); and order books. The Commission does not believe that all of these methods comply with the statutory definition of a SEF, especially the “multiple participant to multiple participant” requirement thereunder. Specifically, as discussed below, the Commission notes that entities offering the following services do not comply with the statutory definition of a SEF: one-to-one voice services for the execution or trading of swaps (other than for the execution of block trades),

single-dealer platforms, and services that solely provide for the processing of swaps.

As proposed, a block trade is a swap of a large notional or principal amount that is transacted off-exchange, pursuant to the rules of a SEF or DCM, and that is greater than the minimum block trade size set by the SEF or DCM. As proposed, a SEF or DCM must set the minimum block size for a particular swap contract at an amount greater than the appropriate minimum block size for the appropriate category of swap instrument in which such swap contract is categorized.

See

75 FR 76140 (December 7, 2010).

The SEF definition requires at a minimum the existence of a “trading system or platform.” The Commission notes that the terms “trading system” and “platform” are not defined under the Dodd-Frank Act or anywhere in the CEA. Based on the SEF definition under the Dodd-Frank Act, the Commission interprets trading system and platform to include, but not be limited to, the term “trading facility” as defined in CEA Section 1a(51).

In addition, as discussed in detail below, the Commission believes that any other method that allows multiple market participants to have the ability to execute or trade swaps by accepting

bids and offers made by other multiple participants in the facility or system, through any means of interstate commerce, may qualify as an acceptable trade execution method for an entity that wishes to register as a SEF.

See

CEA Section 1a(51). In this context, a trading facility requires “a physical or electronic facility or system in which multiple participants have the ability to execute or trade agreements, contracts, or transactions (i) by accepting bids or offers made by other participants that are open to multiple participants in the facility or system; or (ii) through the interaction of multiple bids or multiple offers within a system with a pre-determined non-discretionary automated trade matching and execution algorithm.”

In order for an entity to meet the definition of a SEF and satisfy the SEF registration requirements, multiple parties must have the “ability to execute or trade swaps by accepting bids and offers made by multiple participants” and such participants must be provided impartial access to the market. The Commission believes that an acceptable SEF platform or system must provide at least a basic functionality to allow market participants the ability to make executable bids or offers and indicative quotes, and to display them to multiple parties, including all other parties participating in the SEF, if the market participants wish to do so. As set forth in proposed § 37.9(b) and discussed below, the Commission proposes that a SEF also must provide market participants with the ability to make a bid, make an offer, hit a bid, or lift an offer, and may provide the ability to request a bid and request an offer. Accordingly, market participants would not have to receive a “request for quote”

from another market participant in order to make a bid or offer or to execute a trade with other market participants. In addition to this basic functionality whereby market participants would have the ability to access all other market participants, a SEF could also provide a multiple-to-multiple request for quote trading system for those market participants that do not wish to display their bids, offers, or requests to all other market participants. A SEF's chosen approach(es) would be described in its registration application, to be evaluated by the Commission during the application process. Once operational, the Commission would be able to empirically evaluate the SEF's treatment of executable bids and offers as compared to responses to requests for quotes to ensure ongoing compliance with the definition of a SEF, the SEF registration requirements, and the core principles.

See infra,

Section II.C.2.i.v for further discussion of “request for quote” systems.

ii. One-to-One Voice and Single-Dealer Platforms

The Commission notes that one-to-one voice services and single-dealer platforms do not satisfy the statutory requirement under CEA Section 1a(50) that “multiple participants have the ability to execute or trade swaps by accepting bids and offers made by multiple participants in the facility or system”. The nature of these types of trading systems or platforms, where transactions are negotiated or consummated via a one-to-one or one-to-many basis, do not provide the ability for participants to conduct multiple-to-multiple execution or trading. The Commission also notes that CEA Sections 5h(f)(2)(A)(ii) and (2)(B)(i) require that SEFs provide market participants with impartial access to their markets, and that SEFs must adopt rules with respect to any limitations they place on access. Entities operating either one-to-one voice services or single-dealer platforms, by definition, limit the provision of liquidity to single dealers or liquidity providers, thus excluding other participants from filling those roles, in non-compliance with the impartial market access requirements applicable to SEFs under the CEA.

iii. Processing of Swaps

In regard to entities that offer, with respect to swaps transactions, processing services exclusively, the Commission notes that Section 5h(a)(1) of the CEA states “[n]o person may operate a facility for the trading or processing of swaps, unless the facility is registered as a [SEF] or as a [DCM] under this section.” In addition, Section 5h(b) states that a registered SEF may “(A) make available for trading any swap, and (B) facilitate trade processing of any swap.” Although these provisions could be read to require the registration of entities that engage in trade processing (but not trade execution) as SEFs, the Commission believes that entities that operate exclusively as swap processors do not meet the SEF definition (and should not be required to register as SEFs) because: (1) They do not provide (as required by the definition) the ability to “execute or trade” a swap; and (2) the definition does not include the term “process.”

iv. Trading Systems or Platforms

When determining what types of trading systems qualify to register as a SEF, the Commission takes into account, in addition to consideration of the SEF definition as discussed above, the core principles applicable to SEFs

as well as the goals provided in Section 733 of the Dodd-Frank Act: (1) Bringing greater pre-trade price transparency to swap transactions; and (2) bringing more swaps trading onto regulated trading systems or platforms.

Therefore, the Commission interprets the SEF registration requirements to necessitate that the trading system or platform: (a) Provide multiple participants with the ability to make bids and offers to other multiple participants or to accept bids or offers made by other multiple participants; (b) promote pre-trade price transparency; (c) ensure that the trading of swaps on the trading system or platform is in accordance with the SEF core principles, the registration requirements and the Commission's regulations; and (d) provide all market participants with impartial access to the SEF's market.

See e.g.,

Sections 5h(f)(2)(A)(ii) and (2)(B)(i) (Core Principle 2, requiring the provision of impartial access).

See also,

proposed § 37.205(b)(1).

As stated in the preceding section, Section 5h(e) of the CEA sets forth Congress' goals with respect to SEFs: The promotion of “the trading of swaps on swap execution facilities” and “pre-trade price transparency in the swaps market.”

The Commission believes that these goals can be achieved for swap transactions that are subject to the CEA execution requirements, are made available for trading, and are not block trades by providing for the execution of such swap transactions on trading systems or platforms that give market participants the option to post both firm and indicative quotes or accept bids and offers that are transparent to the entire market.

See

CEA Section 5h(e).

While currently such systems are often used by traders in order to account for counterparty risk, it is important to note that there is no counterparty risk for swaps that are cleared.

Under proposed § 37.9, applicants and registered SEFs must offer trading services to facilitate the ability of market participants to make executable bids or offers and to display them to multiple parties. Transactions may be executed by providing market participants with a number of execution methods from which to choose, including: (1) “Request for quote” systems that provide market participants the ability to interact with multiple participants but less than the entire market, as described below; (2) systems that allow market participants to display executable bids and offers on a centralized, electronic screen to the entire market; or (3) other systems that comply with the core principles.

Additionally, under the proposal, SEFs must provide a general timing requirement applicable to traders such as brokers who have the ability to execute against a customer's trade or are entering a trade for two customers on opposite sides of the transaction. Under the proposal, a broker would have to provide a minimum pause before entering the second side (whether for its own account or for a second customer), thus “showing” other market participants the terms of a request for quote from its customer, and providing other market participants the opportunity to join in the trade. The Commission proposes to require a minimum pause of 15 seconds between entry of two potentially matching customer-broker swap orders or two potentially matching customer-customer swap orders on SEFs.

(A) Request for Quote Systems

As proposed by the Commission, the steps taken by market participants in order to complete a transaction using an acceptable request for quote system are similar to the steps taken in the marketplace today (

i.e.,

a market participant transmits a request to counterparties for bids or offers and chooses to transact with one of the respondents to the request). However, to ensure that multiple participants have the ability to reach multiple counterparties, the Commission proposes to require SEFs to provide that market participants transmit a request for quote to at least five potential counterparties in the trading system or platform. The Commission notes that, under the proposal, acceptable request for quote systems offered by SEFs could be designed such that requests for quotes are visible to all market participants with access to the trading system or platform, but should permit requesters the option of making a request for quote visible to the entire market. Additionally, the proposal provides that an acceptable request for quote system may allow for a transaction to be consummated if the original request to five potential counterparties receives fewer than five responses.

The proposal also provides that request for quote systems include trading systems or platforms in which multiple market participants view real-time electronic streaming quotes, both firm and indicative, from multiple potential counterparties on a centralized electronic screen, and have the ability to accept a firm streaming quote and complete the transaction or based on an indicative streaming quote, issue a request for quote to no less than five market participants and upon receipt of a responsive quote, have the option to complete the transaction.

See

proposed § 37.9(a)(1)(v).

Under the proposal, SEFs that utilize request for quote systems must also furnish liquidity providers with the ability to post both executable bids or offers and indicative quotes. The terms of any such “resting” executable bids or offers would be displayed to the requester along with any other specific bids or offers included in the responses to its request for quote. Upon receipt of the responses and the appropriate resting bids or offers, the original requester would have the option to execute the transaction. The Commission believes that SEFs that utilize request for quote systems must ensure that any competitive resting bids or offers be taken into account and communicated to the requester along with any bids or offers included with responses to requests for quotes. While the Commission does not believe it appropriate to prescribe a method of integration as part of this rulemaking,

the Commission would expect each SEF to describe its chosen integration mechanism as part of its application.

The Commission believes its proposed approach to the use of request for quote systems by SEFs is consistent with the statute and promotes: (a) The ability of multiple participants to make bids and offers to other multiple participants or to accept bids or offers made by other multiple participants; (b) pre-trade price transparency; (c) the trading of swaps on a regulated trading system or platform in accordance with the registration requirements and the Commission's regulations; and (d) the ability for all market participants to receive impartial access to all other market participants. The Commission further believes that this feature would help encourage price competition within the market.

(B) “By Any Means of Interstate Commerce”

For block trades, swaps not subject to clearing, and bespoke or illiquid swaps, the Commission interprets the statute's language “by any means of interstate commerce” to allow execution methods that may include voice. This method of execution is consistent with the use of voice in the futures markets for executing block trades, where in light of the size of the trades, pre-trade transparency is not required. It is also possible that a SEF might choose to offer to facilitate bilateral trading for those transactions not bound by the CEA's execution requirements and, therefore, the use of voice may be acceptable. The Commission notes that with respect to these types of transactions, market participants may have an interest in choosing their counterparty in light of the credit risk involved. Voice transactions must be entered into some form of electronic affirmation system immediately upon execution.

With regard to swaps available for trading that are not blocks, trading systems or platforms facilitating the execution of such swaps via voice exclusively are not multiple participant to multiple participant and do not provide for pre-trade transparency. While not acceptable as the sole method of execution of swaps required to be traded on a SEF or DCM, the Commission believes voice would be appropriate for a market participant to communicate a message to an employee of the SEF, whether requests for quotes, indications of interest, or firm quotes. For instance, voice-based communications in the proposed SEF context may occur in certain circumstances, such as when an agent: (1) Assists in executing a trade for a client, immediately entering the terms of the trade into the SEF's electronic system; or (2) enters a bid, offer or request for quote immediately into a SEF's electronic multiple-to-multiple trading system or platform. In all cases, the employee of the SEF must promptly provide transparency and comply with audit trail requirements, including by the immediately entering into the trading system or platform any orders or requests for quote that are immediately executable, or, if not, immediately creating an electronic record with the order or request for quote entered into the trading system or platform as soon as practicable. The core principles and these rules would fully apply to such communications including but not limited to the transparency, audit trail, impartial access and standards for requests for quotes.

Request for Comment:

The Commission seeks public comment regarding the trading systems or platforms described in this section. In addition, the Commission asks the public to respond to the specific questions below.

• Does the proposal appropriately implement the statutory directive that a SEF provide multiple participants with the ability to execute or trade swaps by accepting bids and offers made by multiple participants in the facility or system? If not, how should the Commission best carry out the intent of Congress in the registration and oversight of SEFs?

• The Commission interprets the “multiple participant to multiple participant” requirement (in conjunction with the impartial access requirement) as requiring that the facility provide the ability for any market participant to make any bid or offer transparent to the entire market, if the market participant chooses to do so. Should the Commission be explicit as to the means or methods which can be used to fulfill this functionality? If so, in addition to an order book, what other means or models should be included in the final regulations?

• In light of the “multiple participant to multiple participant” requirement, the Commission has proposed that requests for quotes be requested of at least five possible respondents. Is this the appropriate minimum number of respondents that the Commission should require to potentially interact with a request for quote? If not, what is an appropriate minimum number? Some pre-proposal commenters have suggested that market participants should transmit a request for quote to “more than one” market participant. The Commission is interested in receiving public comment on this matter.

• Should the Commission determine that other models of execution satisfy the statutory “multiple participant to multiple participant” requirement as well as the pre-trade price transparency and open access policy objectives under the Dodd-Frank Act?

• Does the proposal properly implement the provision in the SEF definition regarding having the ability to execute or trade swaps “through any means of interstate commerce”?

• In general, does the proposal properly implement the CEA's goal to promote both the trading of swaps on SEFs and pre-trade price transparency? Should there be other characteristics the Commission should consider? If so, what are they?

• What level of pre-trade transparency should be required to promote price discovery, competition and the trading of swaps on SEFs? Should the Commission consider requiring a request for quote method that provides for transparency in the request for quote process in addition to the posting of any resting bids/offers on its trading system or platform? Should all orders and quotes be displayed to all participants or should alternative engagement rules apply on a pre-trade basis?

• Should SEFs be required to communicate executable bids/offers to issuers of requests for quotes? Also, should any such executable bids/offers be provided any priority during the request for quote process? Should market participants have an obligation to consider and/or execute against an executable bid/offer if it is competitive?

• Should SEFs be required to make responses to requests for quotes transparent to all market participants? If so, when should this information be provided to the market? Prior to execution? At the time of execution? Subsequent to execution?

• Would the SEF provisions in the Dodd-Frank Act support a requirement that swaps that meet a certain level of trading activity be limited to trading through order books? If so, what level of trading activity would be the appropriate level at which to mandate trading exclusively on an order book? Should any such analysis be done on a product or asset-class basis?

• Should swap processors be subject to the registration requirements for SEFs?

j. Swaps Made Available for Trading—Proposed § 37.10

The Dodd-Frank Act requires that transactions involving swaps subject to

the clearing requirement be executed on a SEF or DCM.

This trade execution requirement will not apply if (i) the Commission has not made a determination regarding the clearing requirement with respect to the swap,

(ii) an eligible counterparty availed itself of an exception to the clearing requirement and does not wish to transact the swap on a SEF or DCM, or (iii) no DCM or SEF “makes the swap available to trade.”

CEA Section 2(h)(8).

CEA Section 2(h)(1).

CEA Section 2(h)(8).

The Commission proposes to require SEFs to make periodic assessments to determine whether a swap has been made available for trading. To that end, proposed § 37.10 requires each SEF to annually conduct an assessment and provide a report to the Commission regarding the determination that the swaps it offers are made available for trading thereunder. With respect to the determination that swaps are made available to trade, the SEF may consider frequency of transactions and open interest, and any additional factors requested by the Commission.

Request for Comment:

The Commission seeks general public comment regarding the meaning of “made available for trading.” In addition, the Commission asks the public to respond to the specific questions below.

• In addition to the frequency of transactions and open interest, should the Commission request that SEFs consider the number of market participants trading a particular swap? If so, should a minimum number of participants be required, for example, should the swap be traded by more than two participants? More than three?

• Should the Commission request that SEFs consider any other factors or processes to make the determination that swaps are made available for trading?

k. Identification of Non-Cleared Swaps or Swaps Not Made Available To Trade—Proposed § 37.11

The Commission acknowledges that certain market participants may desire to avail themselves of the benefits of trading on SEFs (

e.g.,

automated confirmation of trades, straight-through processing) with respect to trades that are not otherwise required to be executed on a SEF or DCM. In particular, market participants might want to effect swap transactions on SEFs or DCMs regarding swaps that have not been determined to come under the clearing mandate of Section 2(h) of the CEA, transactions that are excepted from the clearing requirements as provided under Section 2(h)(7) of the CEA, and transactions regarding swaps determined to not be available for trading pursuant to Commission § 37.10. Proposed § 37.11 requires that if a SEF determines to provide for trading of swaps that are excepted from the clearing requirements, the SEF must clearly identify to market participants that the particular swap is to be transacted pursuant to one of the applicable exemptions from execution and clearing.

C. Proposed Regulations, Guidance and Acceptable Practices for Compliance With the Core Principles

As noted above, this rulemaking establishes the relevant regulations, guidance and acceptable practices applicable to the 15 core principles. As proposed, the regulations applicable to the 15 core principles are set out in separate subparts to Part 37, Subparts B through P, which includes a codification within each subpart of the statutory language of the respective core principle. The guidance and acceptable practices are set out in Appendix B.

1. Subpart B—Core Principle 1 (Compliance With Core Principles)

Under Core Principle 1, compliance with the core principles, and any other rule or regulation that the Commission may impose under Section 8a(5) of the CEA, is a condition of obtaining and maintaining registration as a SEF.

The Commission proposes to codify the statutory text of Core Principle 1 in proposed § 37.100. SEFs will have reasonable discretion in establishing the manner in which they comply with the core principles.

CEA Section 5h(f)(1)(A).

2. Subpart C—Core Principle 2 (Compliance With Rules)

a. Background

Core Principle 2 requires a SEF to establish and enforce compliance with its rules,

including by: (1) Establishing various rules to deter abuses; and (2) having the capacity to detect, investigate, and enforce such rules.

Similarly, under Core Principle 2, a SEF must establish and enforce rules to provide any eligible contract participant (“ECP”) and any independent software vendor (“ISV”)

with impartial access to the market and to capture information that the SEF may use in establishing whether rule violations have occurred.

Additionally, SEF Core Principle 2 requires a SEF to establish rules governing the operations of the trading platform and provide rules relating to the mandatory clearing requirement under Section 2(h)(8).

The Commission proposes to implement these requirements through §§ 37.200-37.207.

CEA Section 5h(f)(2)(A).

CEA Section 5h(f)(2)(C) requires SEFs to establish rules specifying trading procedures to be used in entering and executing orders traded or posted on the trading platform, including block trades. The sentence annotated by this footnote also captures 2(B).

The Commission notes that examples of independent software vendors include: Smart order routers, trading software companies that develop front-end trading applications, and aggregators of transaction data. Smart order routing generally involves scanning of the market for the best-displayed price and then routing orders to that market for execution. Software that serves as a front-end trading application is typically used by traders to input orders, monitor quotations and view a record of the transactions completed during a trading session. Aggregators of transaction data provide access to news, analytics and execution services. The Commission believes that transparency and trading efficiency would be enhanced as a result of innovations in this field for market services. For instance, certain providers of market services with access to multiple trading systems or platforms could provide consolidated transaction data from such trading systems or platforms to market participants.

CEA Section 5h(f)(2)(B).

CEA Section 2(h)(8) requires counterparties transacting in swaps that are subject to the clearing requirement of Section 2(h) to execute the transaction on a DCM or a SEF, unless no DCM or SEF “makes the swap available to trade” or the swap transaction is subject to the clearing exception under Section 2(h)(7). The sentence annotated by this footnote captures both 2(C) and 2(D).

Although SEFs are a new type of regulated exchange, the Commission notes that the statutory text for SEF Core Principle 2 is largely a compilation of established regulatory principles applicable to DCMs. As a result, proposed §§ 37.200-37.207, implementing SEF Core Principle 2, set forth requirements for establishing and enforcing rules, providing access, conducting trade practice surveillance, and implementing audit trail requirements and disciplinary rules, that are analogous to those found in the proposed regulations for DCM Core Principles 2, 10, and 13. In addition, proposed §§ 37.200-37.207 also address elements of Core Principle 2 that are not implicated by these DCM core principles.

b. Operation of a Swap Execution Facility and Compliance With Rules—Proposed § 37.201

Proposed § 37.201 addresses the requirement to establish and enforce rules. More specifically, the core principle requires that a SEF establish and enforce compliance with its rules.

A SEF is also required to

establish rules governing the operation of the trading platform.

CEA Section 5h(f)(2)(A)(i).

CEA Section 5h(f)(2)(C).

Proposed § 37.201 addresses these elements by requiring SEFs to establish rules governing the members' and market participants' use of their markets, including rules specifying trading procedures for entering and executing orders traded or posted on the trading platform, including block trades. Proposed § 37.201(b) further requires SEFs to establish and impartially enforce compliance with the rules of the SEF, including, but not limited to: (1) The terms and conditions of any swaps traded or processed on or through the SEF; (2) access rules for the SEF; (3) trade practice rules; (4) audit trail requirements; (5) disciplinary rules; and (6) mandatory trading requirements.

c. Access Requirements—Proposed § 37.202

Proposed § 37.202 addresses Core Principle 2's requirement that SEFs provide any ECP and any ISV with impartial access to the market, and that they adopt rules with respect to any limitations they place on access.

In that regard, proposed § 37.202(a) requires a SEF to provide any ECP and any ISV with impartial access to its market(s) and market services (including any indicative quote screens or any similar pricing data displays), which includes establishing criteria that are impartial, transparent, and applied in a fair and nondiscriminatory manner and levying equal fees for participants receiving comparable access to, or services from, the SEF. The purpose of the proposed impartial access requirements is to prevent a SEF's owners or operators from using discriminatory access requirements as a competitive tool against certain participants. Access to a SEF should be determined, for example, on the SEF's impartial evaluation of an applicant's disciplinary history and financial and operational soundness against objective, pre-established criteria. Any participant should be able to demonstrate financial soundness either by showing that it is a clearing member of a DCO that clears products traded on that SEF or by showing that it has clearing arrangements in place with such a clearing member.

CEA Section 5h(f)(2)(A)(ii) and (2)(B)(i).

Proposed § 37.202(b) requires that, prior to granting a participant access to its markets, a SEF must require each member or market participant to consent to its jurisdiction.

Finally, proposed § 37.202(c) requires a SEF to establish and impartially enforce its rules governing any decision to deny, suspend, or permanently bar participants' access to the SEF, including when such decisions are part of a disciplinary or emergency action taken by the SEF.

Consent may be obtained in the form of a written agreement at the time that a member or market participant is granted access to the SEF.

Request for Comment:

The Commission solicits specific public comments regarding the sufficiency of proposed § 37.202.

• In particular, the Commission is interested to know whether additional regulations are necessary to ensure that a SEF can assert jurisdiction over any person or entity executing swaps on the SEF, either for their own account or on behalf of another's account.

• The Commission also requests public comments on proposed §§ 37.202(a) and 37.202(c), which are intended to ensure that similarly situated persons and entities receive equal access to a SEF's trading platform and services, and that similar access and services be charged a similar fee.

• In addition, the Commission wants to know whether the proposed regulations seeking to prohibit a SEF from abusing its authority to deny or suspend access via disciplinary or emergency procedures are sufficient to prohibit discrimination by a SEF against competitors or for inappropriate business reasons.

d. Rule Enforcement Program—Proposed § 37.203

Proposed § 37.203 addresses SEF Core Principle 2's requirement that SEFs establish and enforce trading and trade processing rules that will deter abuses and have the capacity to investigate and enforce those rules.

CEA Section 5h(f)(2)(B).

Proposed regulation 37.203(a) addresses abusive trading practices by requiring SEFs to prohibit specific practices in connection with intermediated and non-intermediated trading activities,

as well as any other manipulative or disruptive trading practices prohibited by the CEA or by the Commission pursuant to Commission regulation.

The prohibited practices include: trading ahead of customer orders, trading against customer orders, accommodation trading, and improper cross-trading. Specific trading practice violations that must be prohibited by all SEFs include: Front-running, wash trading, pre-arranged trading, fraudulent trading, money passes, and any other trading practices that the SEF deems to be abusive. These practices are a compilation of abusive trading practices that DCMs already prohibit, and include trading practices that Congress expressly prohibited in Section 747 of the Dodd-Frank Act. Section 747 of the Dodd-Frank Act amends section 4c(a) of the CEA by adding three disruptive practices, which make it:

Unlawful for any person to engage in any trading, practice, or conduct on or subject to the rules of a registered entity that—

(A) Violates bids or offers;

(B) Demonstrates intentional or reckless disregard for the orderly execution of transactions during the closing period; or

(C) Is of the character of, or is commonly known to the trade as, “spoofing” (bidding or offering with the intent to cancel the bid or offer before execution).

Subsection (b) of the proposed regulation requires that a SEF have arrangements and resources for effective rule enforcement, including the authority to collect information and examine books and records of members and market participants. The Commission believes that SEFs must have appropriate resources to enforce all of its rules, including the ability to perform effective trade practice surveillance. Furthermore, a SEF must have the authority to examine books and records for all market participants. The Commission believes that a SEF can best administer its compliance and rule enforcement obligations by having the ability to reach the books and records of all market participants.

Next, subsection (c) of proposed § 37.203 requires that a SEF maintain sufficient compliance resources to conduct effective and timely audit trail reviews, trade practice surveillance, market surveillance, and real-time monitoring. A SEF must also monitor its staff size annually to ensure that it is appropriate to effectively perform those functions. A SEF's staff size also must be sufficient to address unusual or unanticipated market or trading events while continuing to effectively conduct routine self-regulatory duties. Proposed § 37.203 reflects the Commission's belief that sufficient compliance staff are essential to the effectiveness of a SEF's self-regulatory program.

While requiring sufficient staff, proposed § 37.203(c) does not require that staff size be determined based on a specific formula. Rather, it permits the individual SEF to determine what size staff it needs to effectively perform its self-regulatory responsibilities.

In making this determination, the proposed regulation requires that a SEF take into account specific facts and circumstances (

e.g.,

volume of trading, the number of swaps listed, number of traders,

etc.

), as well as any other factors suggesting the need for increased resources. A factor that may suggest the need for increased compliance resources is a prolonged surge in trading volume or a prolonged period of price volatility.

Proposed § 37.203(d) requires SEFs to maintain an automated trade surveillance system capable of detecting

and investigating potential trade practice violations. At a minimum, a SEF's systems must be capable of generating alerts on at least a trade date plus one day (T+1) basis to help staff focus on potential violations and anomalies found in trade data.

They must also provide compliance staff the ability to sort, query and analyze voluminous amounts of data. In order to detect and prosecute the abusive trading practices enumerated in proposed § 37.203(a), a SEF's automated surveillance system must maintain all trade and order data, including order modifications and cancellations. In addition, a SEF's automated trade surveillance system must provide users with the ability to compute retain, and compare trading statistics; compute profit and loss; and reconstruct the sequence of trading activity. The proposed regulation reflects the Commission's belief that a SEF must have automated surveillance systems that are equivalent to those of a DCM in order to fulfill its trade practice surveillance requirements.

These systems typically differ from those systems used for real-time market monitoring. The requirements for real-time market monitoring can be found in proposed Commission § 37.203(e).

Subsection (e) of proposed § 37.203 requires SEFs to conduct real-time market monitoring of all trading activity on its trading platform, in order to ensure orderly trading and to identify and correct any market or system anomalies. The Commission's proposed regulation requires that any price adjustments or trade cancellations be transparent to the market and subject to clear and fair publicly available standards.

Next, proposed § 37.203(f) requires SEFs to establish procedures for conducting investigations and the requirements for an investigation report. Subsection (f)(1) requires that a SEF have procedures to conduct investigations of possible rule violations and subsection (f)(2) requires that an investigation be completed within a timely manner (generally defined as 12 months after an investigation is opened, absent mitigating circumstances).

Mitigating circumstances may include: the complexity of the investigation, the number of firms or individuals involved as potential wrongdoers, the number of potential violations to be investigated, and the volume of documents and data to be examined and analyzed by compliance staff.

Subsections (f)(3) and (f)(4) of proposed § 37.203 set forth what must be included in an investigation report. Subsection (f)(3) requires that when compliance staff believes there is a reasonable basis for finding a violation, the investigation report must include the potential wrongdoer's disciplinary history. Similarly, subsection (f)(4) requires that an investigation report include the potential wrongdoer's disciplinary history when compliance staff recommends that a warning letter be issued. The Commission believes that prior disciplinary history is critical information that a disciplinary committee should consider when either issuing a warning letter or assessing an appropriate penalty as part of any settlement decision or hearing.

As noted below in the discussion of proposed § 37.206(n), a SEF's disciplinary committee should review a member's complete disciplinary history when determining appropriate sanctions and impose meaningful sanctions on members who repeatedly violate the same or similar rules to discourage recidivist activity.

Subsection (f)(5) of proposed § 37.203 provides that a SEF may authorize its compliance staff to issue a warning letter or to recommend that a disciplinary committee issue a warning letter. However, the proposed regulation prohibits SEFs from issuing more than one warning letter, in lieu of stronger disciplinary action, for the same violation during a rolling 12-month period.

For purposes of this regulation, the Commission does not consider a “reminder letter” or such other similar letter to be any different than a warning letter. While a warning letter may be appropriate for a first-time violation, the Commission does not believe that more than one warning letter in a rolling 12-month period, whether for the same or similar violations is ever appropriate. A policy of issuing repeated warning letters to members and market participants who violate the same or similar rules, rather than issuing meaningful sanctions, reduces the effectiveness of a SEF's rule enforcement program.

Finally, proposed § 37.203(g) requires a SEF to adopt and enforce any additional rules that it believes are necessary to comply with the requirements of proposed § 37.203.

Request for Comment:

The Commission requests public comment on proposed § 37.203.

• In particular, the Commission requests public comment on the abusive trading practices enumerated in subsection 37.203(a). These practices are identical to the abusive trading practices prohibited in DCM trading.

• The Commission also solicits comments regarding the types of abusive trading practices that should be prohibited on a SEF's trading platform, particularly whether SEFs and DCMs are likely to face similar types of trading abuses by market participants, whether additional or different trading practices should be prohibited on a SEF, and whether SEFs should be required to have the same types of trade practice surveillance and real-time market monitoring programs as DCMs.

• Finally, the Commission requests comments on whether the investigatory reports prepared by DCM compliance staff as a prelude to formal disciplinary proceedings, and included in these proposed regulations, are needed within SEFs.

e. Regulatory Services Provided by a Third Party—Proposed § 37.204

Proposed § 37.204 permits a SEF to utilize the services of a registered futures association or another registered entity for assistance in performing certain self-regulatory functions.

However, SEFs remain responsible for the execution of these functions and for compliance with their associated core principles. In this regard, the Commission notes that the Dodd-Frank Act does not confer on SEFs the same right to delegate certain core principle compliance functions as that conferred to DCMs, pursuant to Section 5c(b) of the CEA.

Self-regulatory functions include, for example, trade practice surveillance; market surveillance; real-time market monitoring; investigations of possible rule violations; and disciplinary actions.

The proposed regulation requires that any SEF that contracts with a third-party regulatory service provider ensure that the provider has sufficient capacity and resources to render timely and effective regulatory services. The SEF must also oversee the quality of regulatory services provided on its behalf, and must retain exclusive authority with respect to all substantive decisions made by its regulatory service provider.

The proposed regulation also specifies that any instances where a SEF's actions differ from those recommended by its regulatory provider must be documented and explained in writing.

Such decisions include, but are not limited to, those involving the cancellation of trades, the issuance of disciplinary charges against members or market participants, denials of access to the trading platform, and any decision to open an investigation into a possible rule violation.

Request for Comment:

The Commission requests public comment on proposed § 37.204.

• In particular, the Commission requests comments on the supervisory and decision-making relationship that should exist between a SEF and a third-party regulatory service provider.

• The Commission also seeks public comment on the types of information that SEFs and their regulatory service providers should be required to share with other SEFs and regulatory service providers, in order to conduct effective surveillance of fungible swap products trading on multiple SEFs.

• Finally, because SEFs are not permitted to delegate core principle compliance functions, as are DCMs, are there any additional conditions that the Commission should impose on SEFs' use of third-party regulatory service providers?

f. Audit Trail Requirements—Proposed § 37.205

Proposed § 37.205 addresses SEF Core Principle 2's requirements that a SEF be able to capture information that may be used to determine whether rule violations have occurred.

Proposed § 37.205 requirements are akin to the DCM regulations addressing audit trail requirements.

CEA Section 5h(f)(2)(B)(ii).

For further explanation of the elements of an effective audit trail,

see supra

note 10, DCM NPRM.

Proposed § 37.205 requires that a SEF establish an audit trail, and sets forth the elements of an effective audit trail and the requirements for effective audit trail enforcement.

The Commission believes that these requirements will help to ensure that SEFs can appropriately monitor and investigate any potential customer and market abuse. Additionally, the audit trail data captured by SEFs must be sufficient to reconstruct all transactions promptly, and to provide evidence of any rule violations that may have occurred.

Subsection (a) of the proposed regulation establishes the overarching requirements for SEFs' audit trail programs, while Subsection (b) prescribes the four elements of an acceptable audit trail program and Subsection (c) prescribes the elements of an effective audit trail enforcement program.

Subsection (b)(1) of the proposed regulation requires that a SEF's audit trail include original source documents, defined to include unalterable, sequentially-identified records on which trade execution information is originally recorded, whether manually or electronically. It also requires that customer order records demonstrate the terms of the order, the unique account identifier that relates to the account owner, and the time of the order entry. Subsection (b)(2) of the proposed regulation requires that a SEF's audit trail program include a transaction history database to facilitate rapid access and analysis of all original source documents. Subsection (b)(2) also specifies the trade information that must be included in a transaction history database.

Subsection (b)(3) of the proposed regulation requires that a SEF's audit trail program have electronic analysis capability for all data in its transaction history database and enable the SEF to reconstruct trades in order to identify possible rule violations. Subsection (b)(4) requires that a SEF's audit trail program include the ability to safely store all audit trail data, and to retain it in accordance with the recordkeeping requirements of SEF Core Principle 10 and its associated regulations. Safe storage capability also requires a SEF to protect its audit trail data from unauthorized alteration, accidental erasure or other loss.

For example, mandatory information includes a history of all orders and trades; all data input in the trade matching system for purposes of clearing; the categories of participant for which each trade is executed (

i.e.,

the customer type indicator or “CTI” codes); timing and sequencing data sufficient to reconstruct trading; and identification of each account to which fills are allocated.

Subsection (c) of proposed § 37.205 is organized in two parts. First, subsection (c)(1) requires that a SEF develop an effective audit trail enforcement program, which must, at a minimum, review all members and market participants annually to verify their compliance with all applicable audit trail requirements. Subsection (c)(1) also sets forth minimum review criteria for an electronic trading audit trail that must be carried out by each SEF. Finally, subsection (c)(2) requires that SEFs develop programs to ensure effective enforcement of their audit trail and recordkeeping requirements, including a requirement that SEFs levy meaningful sanctions when deficiencies are found. Sanctions may not include more than one warning letter or other non-financial penalty, in lieu of stronger disciplinary action, for the same violation within a rolling twelve-month period.

Request for Comment:

The Commission seeks public comment on the proposed audit trail and audit trail enforcement requirements for SEFs.

• The Commission seeks specific public comment on whether such requirements should be similar for both SEFs and DCMs.

• Should SEFs be subject to additional requirements beyond the proposed regulations? Are there elements of the proposed regulations that are inappropriate for SEFs?

• For example, is the CTI code system used by DCMs to denote different types of futures participants also necessary for swap transactions on SEFs?

• What specific data points should a SEF's audit trail enforcement program seek to verify?

g. Disciplinary Procedures and Sanctions—Proposed § 37.206

Proposed § 37.206 addresses SEF Core Principle 2's requirement that SEFs establish and enforce participation rules to deter abuse, and have the capacity to investigate and enforce such abuses.

Subsection (a) of the proposed regulation requires that a SEF establish and maintain sufficient enforcement staff and resources to effectively and promptly prosecute possible rule violations within the jurisdiction of the SEF. Subsection (a) also provides that a SEF's enforcement staff may not include members of the SEF or persons whose interests conflict with their enforcement duties. Moreover, a member of the enforcement staff may not operate under the direction or control of any person or persons with trading privileges at the SEF. These provisions seek to ensure the independence of enforcement staff, and help promote disciplinary procedures that are free of potential conflicts of interest.

See

CEA Section 5h(f)(2)(B). In general, the proposed regulations addressing disciplinary procedures for SEFs parallel the disciplinary procedure regulations for DCMs. The proposed regulations pursuant to DCM Core Principle 13 are also similar to the text of the disciplinary procedures in part 8, which the Commission found to be the model for many DCMs' disciplinary programs. 17 CFR 8.01

et seq.

DCMs were exempt from Part 8 pursuant to § 38.2; however, the predecessor DCM Core Principle 13 offered the disciplinary procedures in Part 8 as an example of appropriate disciplinary procedures.

Subsection (b) requires SEFs to establish one or more Review Panels and one or more Hearing Panels (together, “disciplinary panels”). Neither panel may include members of the SEF's compliance staff or any person involved in adjudicating any other stage of the same proceeding.

The proposed regulation provides that a Review Panel must be responsible for determining whether a reasonable basis exists for finding a violation of SEF rules, and for authorizing the issuance of a notice of charges, while a separate Hearing Panel must be responsible for adjudicating the matter and issuing sanctions.

Disciplinary panels must also adhere to the composition requirement of § 40.9(c)(3)(ii), as proposed, which provides that “Each Disciplinary Panel shall include at least one person who would not be disqualified from serving as a Public Director by § 1.3(ccc)(1)(i)-(vi) and (2) of this chapter (a “Public Participant”). Such Public Participant shall chair each Disciplinary Panel. In addition, any registered entity specified in paragraph (c)(3)(i) of this section shall adopt rules that would, at a minimum: (A) Further preclude any group or class of participants from dominating or exercising disproportionate influence on a Disciplinary Panel and (B) Prohibit any member of a Disciplinary Panel from participating in deliberations or voting on any matter in which the member has a financial interest.”

See

75 FR 63752 (October 18, 2010).

The Commission notes that, while proposed § 37.206(b) requires SEFs to empanel distinct bodies to issue charges and to adjudicate charges in a particular matter, SEFs may determine for themselves whether their Review and Hearing Panels are separate standing panels or ad hoc bodies whose members are chosen from a larger “disciplinary committee” to serve in one capacity or

the other for a particular disciplinary matter. The purposes of separate Review and Hearing Panels is to help ensure adjudication of disciplinary matters by separating a decision to issue charges from a hearing on the merits of a matter.

Subsection (c) of the proposed regulation requires a Review Panel to promptly review an investigation report received pursuant to proposed § 37.203(f)(3), and to take action within 30 days of receipt. The Commission believes that prompt disciplinary action provides the best opportunity for witnesses to recall conversations, facts, and other information relevant to the matter, and transmits a clear signal to the market and to market participants that violations of exchange rules will not be tolerated. Subsection (c) also specifies the range of actions which a Review Panel may take upon receiving a completed investigation report. Subsection (d) describes the minimally acceptable contents of any notice of charges (“notice”) issued by a Review Panel. The notice must adequately state the acts, conduct, or practices in which the respondent is alleged to have engaged; state the rule(s) alleged to have been violated; and prescribe the period within which a hearing may be requested. Further, the notice must advise the respondent charged that he or she is entitled, upon request, to a hearing on the charges.

Subsection (e), in turn, specifies a respondent's right to be represented by any counsel or representative of his choosing upon receiving a notice of charges and in all succeeding stages of the disciplinary process. Subsection (f) requires that a respondent must be given a reasonable period of time to file an answer to a charges.

Subsection (g) provides that, if a respondent admits or fails to deny any of the alleged violations a Hearing Panel may find that the violations admitted or not denied have been committed.

Subsection (h) requires that in every instance where a respondent has requested a hearing on a charge that he or she denies, or on a sanction set by the Hearing Panel pursuant to proposed § 37.206(g), the respondent must be given the opportunity for a hearing in accordance with the requirements of proposed § 37.206(j).

The proposed regulations permit a SEF to adopt rules providing that the failure to request a hearing within the time prescribed in the notice, except for good cause, must be deemed a waiver of the right to a hearing and that the failure to answer or deny expressly a charge must be deemed to be an admission of such charge.

Subsection (f) also permits a SEF, through its rules, to require that: (1) The answer must be in writing and include a statement that the respondent admits, denies or does not have and is unable to obtain sufficient information to admit or deny each allegation; (2) failure to file an answer on a timely basis shall be deemed an admission of all allegations in the notice of charges; and (3) failure in an answer to deny expressly a charge shall be deemed to be an admission of such charge.

In addition, if a SEF adopts a rule concerning the admission or failure to deny charges pursuant to Proposed § 37.206(f), then Subsections (g)(1) through (g)(3) of the proposed regulation provide that: (1) The Hearing Panel must impose a sanction for each violation found to have been committed; (2) the SEF must promptly notify the respondent in writing of any sanction to be imposed and advise the respondent that they may request a hearing on such sanction within the period of time stated in the notice; and (3) the rules of the SEF may provide that if the respondent fails to request a hearing within the period of time stated in the notice, then the respondent will be deemed to have accepted the sanction.

Subsection (i) provides the procedures a SEF must follow when it settles a disciplinary case. The provision states that the rules of a SEF may permit a respondent to submit a written offer of settlement any time after an investigation report is completed. The disciplinary panel presiding over the matter may accept the offer of settlement, but may not alter the terms of the offer unless the respondent agrees. Subsection (i) requires a disciplinary panel that accepts a settlement offer to issue a written decision specifying the rule violations it has reason to believe were committed, and any sanction imposed, including any order of restitution where customer harm has been demonstrated. Significantly, proposed § 37.206(i)(3) also provides that if an offer of settlement is accepted without the agreement of a SEF's enforcement staff, the decision must carefully explain the panel's acceptance of the settlement.

Subsection (i) allows a respondent to withdraw his or her offer of settlement at any time before final acceptance by a disciplinary panel. If an offer is withdrawn after submission, or is rejected by a disciplinary panel, the respondent must not be deemed to have made any admissions by reason of the offer of settlement and must not be otherwise prejudiced by having submitted the offer of settlement.

Subsection (j) requires a SEF to adopt rules that provide certain minimum requirements for any hearing conducted pursuant to a notice of charges. In general, Subsections (j)(1)(i) through (j)(1)(vi) require that the SEF: (1) Provide a fair hearing; (2) permit respondents to examine evidence relied on by enforcement staff in presenting the notice of charges; (3) require enforcement and compliance staffs to be parties to the hearing and enforcement staff to present their case on those charges and sanctions that are the subject of the hearing; (4) permit respondents to appear personally at the hearing, to cross-examine and call witnesses and to present evidence; (5) require that persons within its jurisdiction who are called as witnesses participate in the hearing and produce evidence; and (6) transcribe and retain a copy of the hearing. Additionally, subsection (j)(2) specifies that the rules of the SEF may provide that a sanction be summarily imposed upon any person within its jurisdiction whose actions impede the progress of a hearing.

Subsection (k) details the procedures that a Hearing Panel must follow in rendering disciplinary decisions. The provision requires that all decisions include: (1) A notice of charges or a summary of the charges; (2) an answer, if any, or a summary of the answer; (3) a summary of the evidence produced at the hearing or, where appropriate incorporation by reference in the investigation report; (4) a statement of findings and conclusions with respect to each charge, and a careful explanation of the evidentiary and other bases for such findings and conclusions with respect to each charge; (5) an indication of each specific rule which the respondent was found to have violated; and (6) a declaration of any penalty imposed against the respondent, including the basis for such sanctions and the effective date of such sanctions.

Subsection Proposed § 37.206(l) provides the procedures that a SEF must follow in the event that the SEF's rules authorize an appeal of adverse decisions in all or in certain classes of cases.

Notably, the proposed § requires a SEF that permits appeals by disciplinary respondents to also permit appeals by its enforcement staff. This provision reflects the Commission's belief that SEF enforcement staff must have the discretion to appeal disciplinary panel decisions that, for example, do not adequately sanction a respondent's violative conduct. Subsection (m) requires that each SEF establish rules setting forth when a decision rendered under this subsection C will become the final decision of the SEF.

For SEFs that permit appeals, the language in subsections (l)(1) through (l)(4) of proposed § 37.206 generally require the SEF to: (1) Establish an appellate panel that is authorized to hear appeals; (2) ensure that the appellate panel composition is consistent with § 40.9(c)(3)(iii) and not include any members of the SEF's compliance staff, or any person involved in adjudicating any other stage of the same proceeding; (3) except for good cause shown, the appeal or review must be conducted solely on the record before the Hearing Panel, the written exceptions field by the parties, and the oral or written arguments of the parties; and (4) promptly following the appeal or review proceeding, the board of appeals must issue a written decision and provide a copy to the respondent. The Commission notes that a respondent has certain rights of appeal to the Commission under Part 9 of the Commission's regulations.

Subsection (n) requires that every disciplinary sanction imposed by a SEF must be commensurate with the

violations committed and must be clearly sufficient to deter recidivism or similar violations by other market participants. Additionally, the proposed regulation requires that, in the event of demonstrated customer harm, any disciplinary sanction must include full customer restitution. In evaluating appropriate sanctions, the proposed regulation requires the SEF to take into account a respondent's disciplinary history.

Proposed § 37.203(f)(3) also requires that a copy of a member or market participant's disciplinary history be included in the compliance staff's investigation report.

Subsection (o) permits a SEF to adopt a summary fine schedule for violations of rules relating to timely submission of accurate records required for clearing or verifying each day's transactions. The proposed regulation makes clear that a SEF should issue no more than one warning letter in a rolling 12-month period for the same violation before sanctions are imposed. Additionally, the proposed regulation specifies that a summary fine schedule must provide for progressively larger fines for recurring violations. The Commission believes that these provisions will serve to discourage recidivist behavior.

Finally, subsection (p) provides that a SEF may impose an immediate sanction upon a reasonable belief that such action is necessary to protect the best interest of the marketplace. The proposed regulation also provides that any emergency action taken by the SEF must be performed in accordance with certain procedural safeguards.

Request for Comment:

The Commission seeks public comment on proposed § 37.206.

• In particular, comments should address whether SEFs should be subject to the detailed disciplinary procedures proposed herein. The proposed disciplinary procedures emphasize procedural safeguards for respondents, including a clear separation between SEF personnel recommending the issuance of charges, review panels determining whether charges should be issued, and hearing panels adjudicating cases on the merits. Are these disciplinary procedures sufficient for SEFs? Or, should SEFs instead utilize a more streamlined disciplinary process that features, for example, a robust staff summary fine program rather than formal disciplinary hearings.

• Finally, given the significant financial resources of the ECPs conducting swap transactions on SEFs, should Commission regulations provide more detailed guidelines on the appropriate size of any financial penalties levied by SEFs for violative conduct? Should any such guidelines take cognizance of the financial resources of potential respondents?

h. Swaps Subject to Mandatory Clearing—Proposed § 37.207

Proposed § 37.207 mandates that SEFs provide rules that require swap dealers or major swap participants, who trade a swap subject to the mandatory clearing requirement under Section 2(h)(1), to execute the transaction on either a DCM or a SEF. However, swap dealers or major swap participants are not required to execute such transactions if no DCM or SEF makes the swap available to trade.

3. Subpart D—Core Principle 3 (Swaps Not Readily Susceptible to Manipulation)

Under Core Principle 3, Congress required that SEFs offer for trading swaps that are not readily susceptible to manipulation. The Commission notes that the statutory language of Core Principle 3 is substantively identical to the counterpart core principle under Section 5(d)(3) of the CEA as applicable to DCMs. Historically, DCMs complied with the requirements of Section 5(d)(3) by using as guidance the provisions of Guideline No. 1, contained in Appendix A to Part 40. In a separate release, the Commission proposes certain revisions to the former Guideline No. 1, including: (i) Amending the provisions to include swap transactions, (ii) re-titling the guidance as “Demonstration of compliance that a contract is not readily susceptible to manipulation,” and (iii) re-designating the guidance to be included under Appendix C to Part 38.

See, supra

note 10, DCM NPRM.

Accordingly, proposed § 37.301 requires that, applicants and SEFs must provide to the Commission the information required under Appendix C to Part 38 for purposes of demonstrating to the Commission that their swap contracts are not readily susceptible to manipulation.

Under Appendix B to Part 37, the guidance for compliance with Core Principle 3 focuses on the selection and construction of the price index on which the swaps' cash flows are based. If obtained from a private third-party, the company should be independent and reputable. Moreover, the third party should use a sound, well-documented methodology that protects the index from manipulation. If the SEF itself determines the price index, then it should take precautions to safeguard against attempts to artificially influence the index. In this regard, if the price index is based on a survey of cash market sources, then the SEF should maintain a list of such entities which all should be reputable sources with knowledge of the cash market. In addition, the sample of sources polled should be representative of the cash market, and the poll should be conducted at a time when trading in the cash market is active. The cash-settlement survey should include a minimum of four independent entities if such sources do not take positions in the commodity (

e.g.,

if the survey list is comprised exclusively of brokers) or at least eight independent entities if such sources trade for their own accounts (

e.g.,

if the survey list is comprised of dealers or commercial users).

4. Subpart E—Core Principle 4 (Monitoring of Trading and Trade Processing)

Under Core Principle 4, Congress required that SEFs must take an active role in preventing manipulation, price distortion and disruptions of the delivery or cash settlement process. Accordingly, the proposed regulations under Subpart E of Part 37 clarify the related responsibilities for applicants and SEFs to monitor trading activities and prevent market disruptions.

a. General Requirements—Proposed § 37.401

Proposed § 37.401 requires that applicants and SEFs must collect, monitor and evaluate data to detect and prevent manipulative activity. Proposed § 37.401 also requires that applicants and SEFs have the ability to conduct real-time monitoring of trading and comprehensive and accurate trade reconstructions.

As noted above in its discussion of the need for automated tools in connection with Core Principle 2 requirements, the Commission believes that it would be difficult, if not impossible, to monitor for market disruptions in markets with high transaction volume and a large number of trades unless the SEF has installed automated trading alerts to detect many types of potential violations of exchange or Commission rules. Accordingly, the Commission proposes in § 37.401 to require that, where the SEF cannot reasonably demonstrate that its manual processes are effective in detecting and preventing abuses, the SEF must implement automated trading alerts to detect potential problems.

Request for Comment:

The Commission seeks public comment on whether in any rule the Commission may adopt in this matter, SEFs should be required to monitor the extent of high frequency trading, and whether automated trading systems should include the ability to detect and flag high frequency trading anomalies.

b. Additional Requirements for Physical-Delivery Swaps—Proposed § 37.402

For physical delivery swaps, proposed § 37.402 requires that SEFs monitor each swap's terms and conditions as well as take meaningful corrective action to allow market participants to continue to use the market to make sound hedging decisions and for price discovery.

c. Additional Requirements for Cash-Settled Swaps—Proposed § 37.403

Over the past several years, there has been a growth in markets that are linked, for example, where the settlement price of one market is linked to the prices established in another market. As a result, traders may have incentives to disrupt or manipulate prices in the reference market in order to influence the prices in the linked market. The Commission believes that in such situations SEFs must monitor trading in the market to which its swap is linked. Accordingly, proposed § 37.403 requires that, where a swap is settled by reference to the price of an instrument traded in another venue the SEF must either have an information sharing agreement with the other venue or be able to independently determine that positions or trading in the reference instrument are not being manipulated to affect positions or trading in its swap.

d. Ability To Obtain Information—Proposed § 37.404

To ensure that SEFs have the ability to properly assess the potential for price manipulation, price distortions, and the disruption of the delivery or cash-settlement process, proposed § 37.404 provides that SEFs require that traders in their market keep and make available records of their activity in underlying commodities and related derivatives markets and swaps.

e. Risk Controls for Trading—Proposed § 37.405

Proposed § 37.405 requires that a SEF have effective risk controls to reduce the potential risk of market disruptions and ensure orderly market conditions. In the current futures markets, DCMs have implemented a variety of risk controls to avoid market disruptions through restrictions on order entry, including daily price limits, price/quantity bands, and trading pauses. In order to prevent market disruptions due to sudden volatile price movements, proposed § 37.405 requires SEFs to have in place effective risk controls, including but not limited to pauses and/or halts to trading in the event of extraordinary price movements that may result in distorted prices or trigger market disruptions. Such risk controls can, among other things, allow time for participants to analyze the market impact of new information that may have caused a sudden market move, allow new orders to come into a market that has moved dramatically, and allow traders to assess and secure their capital needs in the face of potential margin calls. Moreover, where a swap is linked to, or a substitute for, other swaps on the SEF or other trading venues, including where a swap is based on the level of an equity index, risk controls should be coordinated with those on the similar markets or trading venues, to the extent possible.

The desirability of coordination of various risk controls, for example, “circuit breakers” in equities and their various derivatives including futures and options, recently has been the subject of discussions by regulators and the industry. The Commission believes that pauses and halts are effective risk management tools and must be implemented by SEFs to facilitate orderly markets. These basic risk controls also have proven to be effective and necessary in preventing market disruptions. The Commission recognizes that pauses and halts are only one category of risk controls and that additional controls may be necessary to further reduce the potential for market disruptions. Such controls may include price collars or bands,

maximum order size limits,

stop loss order protections,

kill buttons,

and others.

Price bands would prevent clearly erroneous orders from entering the trading system, including “fat finger” errors, by automatically rejecting orders priced outside of a range of reasonability.

Maximum order size limitations would prevent entry into the trading system of an order that exceeds a maximum quantity established by the SEF.

Stop loss orders would be triggered if the market declines to a level pre-selected by the person entering the order. This mechanism would provide that when the market declines to the trader's pre-selected stop level for such an order, the order would become a limit order executable only down to a price within the range of reasonability permitted by the system, instead of becoming a market order.

Kill buttons would give clearinghouses associated with a SEF the ability to delete open orders and quotes and reject entry of new orders or quotes in instances where a trader breaches its obligations with the clearinghouse.

See

FIA Market Access Risk Management Recommendations, p. 10 (April 2010).

Request for Comment:

The Commission is considering mandating in this rulemaking risk controls that are appropriate and/or necessary. Accordingly, the Commission invites comments on the appropriateness of these and other controls that could supplement trading halts or pauses. The Commission also invites comments on the following additional questions:

• Which risk controls should be mandated and how?

• What types of pauses and halts are necessary and appropriate for particular market conditions?

• What other risk controls are appropriate or necessary to reduce the risk of market disruptions?

f. Trade Reconstruction—Proposed § 37.406

Under Core Principle 4, Congress required that SEFs have the ability to comprehensively and accurately reconstruct all trading on its facility. Proposed § 37.406 sets forth this requirement, including the requirement that audit-trail data and reconstructions be made available to the Commission upon request.

g. Additional Rules Required—Proposed § 37.407

Proposed § 37.407 requires SEFs to adopt and enforce any additional rules that it believes are necessary to comply with the requirements of Subpart E.

5. Subpart F—Core Principle 5 (Ability To Obtain Information)

The proposed regulations under Subpart F require an applicant and a SEF to have the ability and authority, necessary Core Principle 5, to obtain necessary information to perform its obligations.

6. Subpart G—Core Principle 6 (Position Limits or Accountability)

Under Core Principle 6, Congress required that SEFs adopt for each swap, as is necessary and appropriate, position limits or position accountability. In addition, Congress required that, for any contract that is subject to a Federal position limit under CEA Section 4a(a), the SEF shall set its position limits at a level no higher than the position limitation established by the Commission in its Part 151 regulations. Proposed § 37.601 requires that each SEF must comply with the requirements of Part 151 in order to be in compliance with Core Principle 6.

7. Subpart H—Core Principle 7 (Financial Integrity of Transactions)

Proposed § 37.700 sets out the financial integrity requirements for transactions on a SEF, as required under Core Principle 7. Under such core principle, a SEF must establish and enforce rules to ensure the financial integrity of swaps entered on or through the facilities of the SEF, including the clearing and settlement of the swaps. The requirements of proposed § 37.700 depend, in part, on whether the swap is cleared.

The Commission interprets the mandatory clearing requirement in Section 723(a)(3) of the Dodd-Frank Act to mean that a DCO must clear a swap for any DCM or SEF that requests such clearing services, so long as the DCO offers the swap. In addition, a DCO that is clearing particular swaps must also clear the same swaps when listed on DCMs or SEFs, whether affiliated or unaffiliated, on a nondiscriminatory basis.

Under proposed § 37.702(a), a SEF must ensure that all its members meet the definition of “eligible contract participant” under CEA Section 1(a)(18). Under proposed § 37.702(b), for swaps cleared by a DCO, a SEF must ensure that it has the capacity to route transactions to the DCO. With respect to swaps that are not required to be cleared, a SEF must impose additional requirements to ensure the financial integrity of the transaction,

including requiring the transacting member to have entered into a credit arrangement for the transaction, demonstrate an ability to exchange collateral, and have appropriate credit filters in place. The Commission believes that these additional requirements are necessary in light of the fact that uncleared swaps will not have the risk management protections of a DCO.

Separately, if the SEF determines to allow swap transactions that are not cleared, the SEF must have provisions to determine that the swap meets the exemption to the clearing requirement provided under section 2(h)(7) of the CEA, as amended by the Dodd-Frank Act.

The Commission requests comment on whether these standards are appropriate financial integrity safeguards for SEFs. Specifically, the Commission solicits comment regarding how SEF members would demonstrate sufficient credit documentation and ability to exchange collateral.

Request for Comment:

The Commission seeks public comment on the proposed rule, and specifically on the following questions:

• Whether SEFs should provide additional controls to permit FCMs to manage their risks? If so, what specific direct access controls and procedures should SEFs implement?

• Should such controls be mandatory?

8. Subpart I—Core Principle 8 (Emergency Authority)

Under Core Principle 8, a SEF must provide for emergency situations. Based upon its experience with DCMs, and in recognition of the fact that individual SEFs may have different approaches to handling emergency action, proposed § 37.801 refers to the guidance in Appendix B to Part 37 to demonstrate compliance with Core Principle 8.

The guidance reflects the Commission's belief that there should be an increased emphasis on cross-market coordination of emergency actions and SEFs should have alternate lines of communication and approval procedures in order to address emergencies in real time.

The Commission's experience has demonstrated that there are some specific requirements that at a minimum should be followed and these requirements are incorporated under the proposed guidance. Specifically, the SEF should have procedures and guidelines for decision-making and implementation of emergency intervention in the market. The SEF should have the authority to perform various actions, including without limitation: Liquidating or transferring open positions in the market,

suspending or curtailing trading in any swap, and taking such market actions as the Commission may direct. In addition, the guidance notes that SEFs must provide prompt notification and explanation to the Commission of the exercise of emergency authority, and that information on all regulatory actions carried out pursuant to a SEF's emergency authority should be included in a timely submission of a certified rule.

In situations where a swap is traded on more than one platform, emergency action to liquidate or transfer open interest must be directed, or agreed to, by the Commission or Commission staff.

9. Subpart J—Core Principle 9 (Timely Publication of Trading Information)

Under Core Principle 9, Congress required that SEFs make available to the public timely information on price, trading volume, and other trading data on swaps to the extent prescribed by the Commission. Congress also required a SEF to have the capability of electronically capturing trade information for those transactions that occur on the trading system or platform. These matters are addressed in separate releases.

Proposed § 37.901 requires that SEFs comply with the real-time swap reporting and swap reporting and recordkeeping requirements being separately proposed by the Commission.

See, supra

note 10, DCM NPRM; 75 FR 76140 (December 7, 2010); and 75 FR 76574 (December 8, 2010).

Request for Comment:

In order to address all relevant considerations with respect to the reporting requirements of Core Principle 9, the Commission seeks general comments and asks the public to respond to the specific questions below.

• For interest rate swaps, because the term life on an interest rate swap can be one of a large number of possible periods along a yield curve, what would be an appropriate manner to display prices?

• Would prices for interest rate swaps be meaningful or misleading and why?

• If the prices are misleading, what useful information should be displayed at the end of the trading day?

• Please identify any other swap products that have similar price reporting issues and address how the prices for that product should be reported to provide a summary of the trading for that day.

10. Subpart K—Core Principle 10 (Recordkeeping and Reporting)

Core Principle 10 establishes a three-part recordkeeping and reporting requirement applicable to all SEFs, which the Commission proposes to implement through proposed §§ 37.1001-37.1003.

CEA Section 5h(f)(10)(A) requires all SEFs to: Maintain records of all activities relating to the business of each SEF, including a complete audit trail, for a period of at least five years; report to the Commission, in a form and manner acceptable to the Commission, such information as the Commission determines to be necessary or appropriate; and keep records relating to swaps defined in CEA Section 1a(47)(A)(v) open to inspection and examination by the Securities and Exchange Commission. CEA Section 5h(f)(10)(B) requires the Commission to “adopt data collection and reporting requirements for swap execution facilities that are comparable to corresponding requirements for derivatives clearing organizations and swap data repositories.” The Commission's data standards are included in proposed rules in Part 45 of the Commission's regulations.

Proposed § 37.1001 largely codifies the statutory language of Core Principle 10. In addition, it clarifies that investigatory and disciplinary files are included in the records that a SEF must maintain, and requires that a SEF comply with the recordkeeping requirements of § 1.31.

The Commission notes that it has always considered audit trails and investigatory and disciplinary files as a part of the records which a DCM is required to maintain and which the Commission is permitted to request and to examine. In this respect, the proposed regulation merely codifies existing Commission practice.

By incorporating § 1.31, proposed § 37.1001 effectively requires that SEF books and records be readily accessible for the first 2 years of the minimum 5-

year statutory period and be open to inspection by any representatives of the Commission or the United States Department of Justice.

The SEF, at its own expense, must promptly provide either a copy or the original books or records upon request.

Proposed § 37.1001 also effectively incorporates § 1.31(b)'s description of the permissible methods of storing books and records. Consequently, a SEF may store its books and records as prescribed by § 1.31(b)(1)(ii). Among other criteria, § 1.31(b)(1)(ii) defines electronic storage media as “any digital storage medium or system that preserves the records exclusively in a non-rewritable, non-erasable format [and] verifies automatically the quality and accuracy of the storage media recording process * * *.” SEFs must, at all times, have the facilities to immediately produce and be prepared to present legible hard-copy images of such records. Additionally, SEF's must keep only Commission-required records on the media, store a duplicate of the record at a separate location, and organize and maintain an accurate index of all information maintained on both the original and duplicate storage media. SEFs that use electronic storage media are also required to develop and maintain an audit system to track the initial entry of original or duplicate records and any subsequent changes made thereafter. Proposed § 37.1001 also incorporates §§ 1.31(c) and 1.31(d), which expand upon the requirements established by proposed § 37.1001. Section 1.31(c) requires that record-keepers who employ an electronic storage system certify with Commission that the system meets the requirements of an electronic storage media as defined in § 1.31(b)(1)(ii). Section 1.31(d) states that trading cards, documents on which trade information is originally recorded in writing, certain written orders, and paper copies of certain electronically filed forms and reports with original signatures must be retained in hard-copy for the requisite time period. Finally, proposed § 37.1001 also requires that SEFs comply with the recordkeeping requirements applicable to swaps in proposed Part 45.

The statutory regime for SEFs established by the Dodd-Frank Act envisions ongoing Commission oversight of SEFs and their trading activity. Such oversight will resemble, in concept, the oversight already conducted by the Commission with respect to DCMs. Accordingly, proposed § 37.1002 requires that SEFs report to the Commission any information necessary or appropriate for the Commission to perform its oversight duties. The proposed regulation does not articulate specific information that must be provided to the Commission; instead, it establishes the general requirement that SEFs must provide any relevant data requested by the Commission in a form and manner acceptable to the Commission.

The Commission anticipates that the records it will routinely request will include, for example, daily trading records, board of directors' meeting minutes, investigatory and disciplinary files, information regarding resources allocated to compliance functions, and other records used in the Commission's trade practice surveillance program and rule enforcement review program.

Proposed § 37.1003 codifies Core Principle 10's statutory requirement that a SEF keep any records relating to security-based swap agreements defined in Section 1a(47)(A)(v) of the CEA open to inspection and examination by the Securities and Exchange Commission (“SEC”).

CEA Section 5h(f)(10)(A)(iii).

11. Subpart L—Core Principle 11 (Antitrust Considerations)

Core Principle 11 governs the antitrust obligations of SEFs.

This SEF core principle is substantially similar to DCM Core Principle 19.

The Commission believes that the existing guidance applicable to DCM Core Principle 19 remains appropriate. Accordingly, the Commission proposes to codify the statutory text of Core Principle 11 into proposed § 37.1100. Additionally, proposed § 37.1101 refers applicants and SEFs to the guidance in Appendix B to Part 37 for purposes of demonstrating compliance with proposed § 37.1100.

Part 38 contains guidance governing compliance with former Core Principle 18. 17 CFR part 38, App. B.

Prior to the Dodd-Frank Act, the DCM core principle on antitrust considerations was numbered as DCM Core Principle 18.

12. Subpart M—Core Principle 12 (Conflicts of Interest)

Core Principle 12 governs conflicts of interest. Like Core Principle 11, Core Principle 12 is substantially similar to both the DCM and the DCO conflicts of interest core principles, as amended by the Dodd-Frank Act.

As a result, the Commission proposes to handle Core Principle 12 consistent with its handling of those DCM and DCO core principles. This release proposes to codify the statutory text of the core principle in proposed § 37.1200. The applicable regulations implementing this core principle were proposed in a separate release titled “Requirements for Derivatives Clearing Organizations, Designated Contract Markets, and Swap Execution Facilities Regarding the Mitigation of Conflicts of Interest.”

DCM Core Principle 16 and DCO Core Principle P, both as amended by the Dodd-Frank Act.

75 FR 63732 (October 18, 2010).

13. Subpart N—Core Principle 13 (Financial Resources)

Core Principle 13 requires that a SEF have adequate financial resources to discharge its responsibilities. In particular, SEFs must maintain financial resources sufficient to cover operating costs for a period of at least one year, calculated on a rolling basis.

a. General Rule

Under proposed § 37.1301(b), SEFs that also operate as DCOs are also subject to the financial resource requirements for DCOs in proposed § 39.11. Proposed § 37.1301(c) would require that SEFs maintain sufficient financial resources to cover operating costs for at least one year, calculated on a rolling basis—

i.e.,

at all times. The one year period is required under the CEA. The Commission believes that a one-year timeframe would allow a SEF's business to wind down in an orderly fashion and should generally enhance the financial integrity of the markets.

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Some foreign regulatory authorities already have similar requirements for the equivalent entities they regulate. For example, the UK Financial Services Authority's (“FSA”) recognition requirements for UK recognized investment exchanges and UK recognized clearing houses (collectively, “UK recognized bodies”) include the maintenance of financial resources sufficient to ensure that the UK recognized body would be able to complete an orderly closure or transfer of its business without being prevented from doing so by insolvency or lack of available funds. Section 2.3.7 of the FSA Recognition Requirements calls for a UK recognized body to have at all times liquid financial assets amounting to at least six months' operating costs and net capital of at least that amount.

The one-year period also is consistent with established accounting standards, under which an entity's ability to continue as a going concern comes into question if there is evidence that the entity may be unable to continue to meet its obligations in the next 12 months without substantial disposition of assets outside the ordinary course of business, restructuring of debt, externally forced revisions of its operations, or similar actions.

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See

American Institute of Certified Public Accountants Auditing Standards Board Statement of Auditing Standards No. 59, The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern, as amended.

b. Types of Financial Resources

Under proposed § 37.1302, financial resources available to SEFs to satisfy the applicable financial requirements would include the SEF's own capital (assets in excess of liabilities) and any other financial resource deemed acceptable by the Commission. A SEF would be able to request an informal interpretation from CFTC staff on whether or not a particular financial resource would be acceptable.

Request for Comment:

The Commission invites commenters to recommend particular financial resources for inclusion in the final regulation.

c. Computation of Financial Resource Requirement

Proposed § 37.1303 would require that a SEF, at the end of each fiscal quarter, make a reasonable calculation of the financial resources it needs to meet the requirements of proposed

§ 37.1301. In the first instance, the SEF would have reasonable discretion in determining how to make this calculation, the Commission may require changes as appropriate.

d. Valuation of Financial Resources

Proposed § 37.1304 would require that SEFs, no less frequently than quarterly, calculate the current market value of each financial resource used to meet their obligations under these proposed regulations. Additionally, SEFs would have to perform the valuation at other times as appropriate. This provision is designed to address the need to update valuations in circumstances where there may have been material fluctuations in market value that could impact a SEF's ability to meet its obligations under proposed § 37.1301. When valuing a financial resource, a SEF would be required to reduce the value, as appropriate, to reflect any market or credit risk specific to that particular resource,

i.e.,

apply a haircut.

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The Commission would permit each SEF to exercise its discretion in determining the applicable haircuts. However, such haircuts are subject to Commission review and must be acceptable to the Commission.

e. Liquidity of Financial Resources

Proposed § 37.1305 would require that SEFs maintain unencumbered liquid financial assets, such as cash or highly liquid securities, equal to at least six months' operating costs. The Commission believes that having six months' worth of unencumbered liquid financial assets would give a SEF time to liquidate the remaining financial assets it would need to continue operating for the last six months of the required one-year period. If a SEF does not have six months' worth of unencumbered liquid financial assets, it would be allowed to use a committed line of credit or similar facility to satisfy this requirement.

The Commission notes that a committed line of credit or similar facility is not listed in proposed § 37.1302 as a financial resource available to a SEF to satisfy the requirements of proposed § 37.1301. A SEF may only use such resources to meet the liquidity requirements of proposed § 37.1305.

f. Reporting Requirements

Under proposed § 37.1306, at the end of each fiscal quarter, or at any time upon Commission request, SEFs would be required to report to the Commission: (i) The amount of financial resources necessary to meet the requirements set forth in the regulation; and (ii) the value of each financial resource available to meet those requirements. A SEF would also have to provide the Commission with a financial statement, including the balance sheet, income statement, and statement of cash flows, of the SEF or of its parent company, as appropriate.

14. Subpart O—Core Principle 14 (System Safeguards)

Core Principle 14 requires that SEFs: (1) Establish and maintain a program of risk oversight to identify and minimize sources of operational risk through the development of appropriate controls and procedures and the development of automated systems that are reliable, secure, and have adequate scalable capacity; (2) establish and maintain emergency procedures, backup facilities, and a plan for disaster recovery that allow for the timely recovery and resumption of operations; and (3) periodically conduct tests to verify that backup resources are sufficient to ensure continued order processing and trade matching, price reporting, market surveillance, and maintenance of a comprehensive and accurate audit trail. Proposed § 37.1401 would establish system safeguards requirements for all SEFs, pursuant to Core Principle 14.

The proposed rule would require that a SEF's program of risk analysis and oversight address six categories of risk analysis and oversight, including: Information security; business continuity-disaster recovery (“BC-DR”) planning and resources, capacity and performance planning; systems operations; systems development and quality assurance; and physical security and environmental controls.

Because automated systems play a central and critical role in today's electronic financial market environment, oversight of core principle compliance by SEFs with respect to automated systems is an essential part of effective oversight of the trading of swaps. Sophisticated computer systems will be crucial to a SEF's ability to meet its obligations and responsibilities. SEF compliance with generally accepted standards and best practices with respect to the development, operation, reliability, security and capacity of automated systems can reduce the frequency and severity of automated system security breaches or functional failures, thereby augmenting efforts to mitigate systemic risk.

15. Subpart P—Core Principle 15 (Designation of Chief Compliance Officer)

Section 5h(f)(15) of the CEA, as added by Section 733 of the Dodd-Frank Act, creates an internal regulatory framework for all SEFs, with the position of chief compliance officer (“CCO”) serving as a focal point for compliance with the CEA and applicable Commission regulations. The four-part structure of Section 5h(f)(15) requires, first, that every SEF designate an individual to serve as CCO. Second, it enumerates specific duties for CCOs and establishes their responsibilities within a SEF. Third, it requires CCOs to design the procedures establishing the handling, management response, remediation, retesting, and closing of noncompliance issues. Fourth, it outlines the requirements of a mandatory annual report from SEFs to the Commission, which must be prepared and signed by a SEF's CCO. The Commission proposes to implement Section 5h(f)(15) of the CEA through proposed § 37.1501, which further develops the already robust CCO requirements enacted by the Dodd-Frank Act. Section 5h(f)(15) of the CEA and proposed § 37.1501 are summarized below.

The first provision of Section 5h(f)(15)-5h(f)(15)(A)—provides only for the self-explanatory requirement that each SEF designate an individual to serve as its CCO. The second provision of Section 5h(f)(15) offers a detailed description of a CCO's role within a SEF. Specifically, Section 5h(f)(15)(B) includes six enumerated duties incumbent upon all CCOs, and thereby outlines the internal regulatory structure of a SEF as contemplated by the Dodd-Frank Act. The enumerated duties of CCOs include: (1) Reporting directly to the SEF's board of directors or to its senior officer; (2) reviewing an SEF's compliance with the requirements and core principles described in Section 5h; (3) resolving any conflicts of interest that may arise, in consultation with the board of directors or the senior officer of the SEF; (4) establishing and administering any policy or procedure that is required to be established by a SEF pursuant to Section 5h; (5) ensuring compliance with the CEA, including rules prescribed by the Commission pursuant to Section 5h; and (6) establishing procedures for the remediation of noncompliance issues identified by the CCO. The third provision of Section 5h(f)(15) provides that the CCO in establishing and following appropriate procedures shall design such procedures for the handling, management response, remediation, retesting, and closing of noncompliance issues.

Finally, the fourth provision of Section 5h(f)(15)-5h(f)(15)(D)—requires CCOs to prepare and sign annual compliance reports on behalf of their

SEFs. The annual compliance reports must describe a SEF's compliance with the CEA and Commission regulations. They must also describe the policies and procedures of the SEF, including the code of ethics and conflict of interest policies. In addition, the annual compliance reports must include “a certification that, under penalty of law, the report is accurate and complete.” The annual compliance report must be furnished to the Commission as it may prescribe.

Proposed subpart P develops each of these statutory provisions in greater detail and grants CCOs the regulatory authority necessary to fulfill responsibilities in each regard.

a. Definition of Board of Directors—Proposed § 37.1501(a)

Proposed § 37.1501(a) defines “board of directors” as “the board of directors of a swap execution facility or for those swap execution facilities whose organizational structure does not include a board of directors, a body performing a function similar to a board of directors.” The proposed definition reflects the various forms of business associations which a SEF could conceivably take, including forms which do not include a corporate board of directors. It also reflects the flexibility in Section 733 of the Dodd-Frank Act, which refers, for example, to “a body performing a function similar to a board” in discussing the duties of a CCO pursuant to Section 5h(f)(15)(B)(iii) of the CEA.

Request for Comment:

The Commission requests comment on the following:

• Should the Commission develop additional rules around the types of bodies which may perform board-like functions at a SEF, depending on their business form?

• Should the proposed definition of board of directors appropriately address issues related to parent companies, subsidiaries, affiliates, and SEFs located in foreign jurisdictions? Does the proposed rule allow for sufficient flexibility with regard to a SEF's business structure?

b. Designation and Qualifications of Chief Compliance Officer—Proposed § 37.1501(b)

Proposed § 37.1501(b)(1) requires a SEF to establish the position of CCO, designate an individual to serve in that capacity and provide that individual with the authority and resources to develop and enforce policies and procedures necessary to fulfill the duties set forth for CCOs in the Dodd-Frank Act and Commission regulations. In addition, proposed § 37.1501(b)(1) provides that CCOs must have supervisory authority over all staff acting in furtherance of the CCO's statutory and regulatory obligations. In short, proposed § 37.1501(b)(1) establishes CCOs as the focal point of a SEF's regulatory compliance functions.

Proposed § 37.1501(b)(2) details minimum competency standards for CCOs. It requires that CCOs have the background and skills necessary to fulfill the responsibilities of the position, and prohibits anyone who would be disqualified from registration under Sections 8a(2) or 8a(3) of the CEA from serving as a CCO. Although the CCO would not be required to register with the Commission, as the primary individual with responsibility for ensuring a SEF's legal compliance, the Commission believes that CCOs should meet the same standard as those individuals who are required to register, as set forth in the list of statutory disqualifications under Sections 8a(2) and (3) of the CEA. These standards largely consist of a high degree of responsibility and requirements relating to integrity and honesty in financial and business dealings. Section 37.1501(b)(2) also requires that a CCO not serve as general counsel of a SEF. This prohibition reflects the Commission's belief that granting these dual roles to a single individual is incompatible with effective regulation and self-regulation.

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As conceived by the Commission, SEF CCOs have overall responsibility for SEFs' compliance programs. CCOs must be neutral fact-finders, and must be able to act in the interest of effective compliance regardless of the persons, entities, or conduct that may be the subject of investigation. In contrast, an entity's general counsel serves as the legal counsel and defender of a company and seeks to avoid or negate related legal risks. A second basis for the separation of the general counsel and CCO roles is the Commission's determination that an individual acting as CCO should not be in a position to assert attorney-client privilege against the Commission. If a SEF's CCO were also its general counsel, much of the information about its compliance program could potentially be protected from third-party review, including the Commission's, under the shroud of attorney-client privilege. While there may be circumstances where the attorney-client privilege could be asserted by a SEF, the Commission believes that such circumstances do not include the areas of responsibility assigned to CCOs by the CEA or Commission regulations.

Request for Comment:

The Commission is seeking comment on whether additional limitations should be placed on persons who may be designated as a CCO.

• The Commission requests comment on whether the provisions of proposed § 37.1501(b) are sufficient to ensure that a CCO has the authority and resources necessary to fulfill his or her statutory and regulatory obligations.

• The Commission also requests comment regarding the qualifications that should be required of a CCO, and whether the requirements expressed in proposed § 37.1501(b) are sufficient.

• Should there be additional restrictions placed on who is qualified to be designated as a CCO? The Commission requests comment on whether restricting a CCO from serving as the General Counsel or other attorney within the legal department of a SEF would sufficiently address conflict of interest concerns?

c. Appointment, Supervision, and Removal of Chief Compliance Officer—Proposed § 37.1501(c)

Taken together, proposed §§ 37.1501(c)(1), 37.1501(c)(2), and 37.1501(c)(3) provide the supervisory regime applicable to CCOs. Proposed § 37.1501(c) requires that a CCO be appointed by a majority of the SEF's board of directors or senior officer, and that a majority of the board or senior officer be responsible for approving the CCO's compensation. A SEF must notify the Commission within two business days of appointing a new CCO. The proposed regulation also requires the CCO to meet at least annually with the board of directors to discuss the effectiveness of the CCO's administration of the compliance policies adopted by the registrant. The meeting or meetings would create an opportunity for a CCO and the directors to speak freely about any sensitive issues of concern to any of them, including any reservations about the cooperativeness or compliance practices of the registrant's management. The Commission's governance proposals require that each SEF's board of directors include a board-level regulatory oversight committee (“ROC”) consisting exclusively of public directors.

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The Commission believes

that ROCs will help to mitigate potential conflicts of interest within a SEF by introducing an independent perspective to board deliberations.

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The Commission also believes that both CCOs and ROCs will be strengthened in their regulatory work and independence through close cooperation and coordination. Although a CCO is not required to report to his or her ROC, proposed § 37.1501(c)(1) provides that a CCO must meet with the ROC quarterly to discuss matters of mutual concern and share information. These meetings will create an opportunity for a CCO and the ROC to speak freely about potentially sensitive issues, including any reservations by the CCO regarding the SEF's management. They will also facilitate the ROC's oversight responsibilities, and allow the CCO to seek assistance and institutional support from the ROC as necessary.

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Proposed § 37.1501(a) defines board of directors for purposes of subpart P as follows: “the board of directors or board of governors of a swap execution facility, or equivalent governing body of a swap execution facility or of an entity operating a swap execution facility.” The proposed definition reflects the various forms of business associations which a SEF could take, including forms which do not include a corporate board of directors. With respect to boards of directors and ROCs, the Commission notes that in a separately proposed series of regulations governing conflicts of interest within SEFs, DCMs, and DCOs, the Commission proposes a number of governance measures that impact the proposed regulations for CCOs. First, proposed § 40.9(b)(1)(i) requires a SEF's board of directors to be composed of at least 35%, but no less than two, public directors. Second, proposed § 40.9(b)(2) prohibits a SEF from “permit[ing] itself

to be operated by any entity” that does not adhere to the board composition requirements of 40.9(b)(1)(i). Third, proposed § 37.19(b)(3) requires a SEF to have a board-level ROC consisting exclusively of public directors.

105

See

proposed § 37.19(b)(1) for a description of a ROC's role in overseeing the performance of a CCO and effectiveness, efficiency, and independence of a SEF's regulatory and self-regulatory programs.

Finally, proposed § 37.1501(c)(1) also provides that the senior officer of a SEF may assume responsibility for appointing the CCO and approving his or her compensation.

Proposed § 37.1501(c)(2) addresses routine oversight of a SEF's CCO. It allows a SEF with a board of directors to grant oversight authority to either its board or to its senior officer. The proposed regulation is modeled on the terms of Section 5h(f)(15)(B)(i) of the CEA, which requires a CCO to “report directly to the board or to the senior officer of the facility.”

Request for Comment:

The Commission requests comment regarding the appropriate reporting relationship for the CCO of a SEF that has both a senior officer and a board of directors.

• In such cases, should a CCO report to the SEF's board rather than to its senior officer?

• What potential conflicts of interest might arise if a CCO reports to the senior officer rather than to the board, and how might those conflicts be mitigated?

• In addition, the Commission requests comment regarding whether “senior officer” of a SEF should be a defined term, and if so, how the term should be defined.

d. Removal of CCO—Proposed § 37.1501(c)(3)

Proposed § 37.1501(c)(3) requires approval of a majority of an SDR's board of directors to remove a CCO. The Commission believes that these removal provisions will help insulate CCOs and their decision-making from day-to-day commercial pressures that they may otherwise experience. If a SEF does not have a board, the proposed regulation provides that the CCO may be removed by its senior officer. Proposed § 37.1501(c)(3) also requires an SDR to notify the Commission in writing within two business days of the removal or voluntary departure of its CCO by providing a statement describing the circumstances surrounding his or her departure.

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The Commission believes that this provision will help protect CCOs from undue influence or retaliatory termination by the board or the senior officer of the SEF.

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Upon the departure of a CCO, proposed § 37.1501(c)(3) requires a SEF to appoint an interim CCO immediately and a permanent replacement as soon as practicable.

Proposed §§ 37.1501(c)(1) and 37.1501(c)(3) seek to provide a SEF's CCO with a measure of independence from management in the performance of his or her duties, and to ensure that such duties are executed in the most effective and impartial manner possible.

Request for Comment:

The Commission requests comment on any additional measures that should be required to adequately protect CCOs from undue influence in the performance of their duties. The Commission is particularly interested in how it might offer such protection to a CCO who reports to his or her senior officer, either at the SEF's choosing or because the SEF does not have a board of directors. In addition, the Commission also requests comment on whether the provision that would require a majority of a board of directors to remove the CCO is sufficiently specific.

e. Duties of the Chief Compliance Officer—Proposed § 37.1501(d)

Proposed § 37.1501(d) details the duties of a CCO, as well as his or her authority within a SEF. The proposed regulation codifies and expands upon the CCO duties already set forth in Section 5h(f)(15)(B) of the CEA. These duties include overseeing and reviewing compliance with the CEA and Commission regulations, as well as resolving, in consultation with the board of directors or the senior officer, any conflicts of interest that may arise. The proposed regulation also lists a number of potential conflicts that may confront a CCO. The list of conflicts of interest indicates the types of conflicts that the Commission believes a SEF's CCOs should be aware of, but it is not exhaustive.

Proposed § 37.1501(d) also requires that the CCO establish and administer a written code of ethics and policies and procedures designed to prevent violations of the CEA and Commission regulations. Section 37.1501(d) also requires that a CCO establish and administer written policies and procedures, including a “compliance manual,” designed to prevent violations of the CEA and Commission regulations.

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By “compliance manual,” the Commission means a detailed internal handbook explaining to SEF staff the resources and procedures that they are to use in monitoring trading, conducting investigations, documenting their work, and making findings and recommendations to supervisory staff regarding trading in any swap or other conduct by SEF members and market participants that is subject to SEF rules. The Commission believes that such written documentation will serve as a useful guide for the SEF's management and staff. It will also help the Commission evaluate the SEF's compliance and adherence to its own internal standards.

The Commission believes that such written documentation will serve as a useful guide for the SEF's management and staff, as well as for swap participants who will be trading on the SEF. It will also help the Commission to evaluate the SEF's compliance and adherence to its own internal standards. Finally, proposed § 37.1501(d) requires that a CCO establish and follow procedures for the remediation and closing of any noncompliance issues that are identified. To assist the CCO in meeting this responsibility, proposed § 37.1501(b)(1), summarized above, grants a CCO oversight authority over all compliance functions and staff acting in furtherance of those compliance functions. The CCO's authority would also extend to any activities performed by the SEF to verify that other entities are in compliance with applicable laws and regulations, such as the verification of the timeliness of reporting certain swap data, pursuant to proposed § 37.901. The Commission recognizes that the staff that assists a CCO may not be dedicated to the CCO full-time; however, the proposed regulation would ensure that a CCO has authority over any staff and resources while they are acting in furtherance of compliance functions.

Section 37.1501(d), for example, reflects the statutory text of the Dodd-Frank Act by requiring that a CCO review and ensure a SEF's compliance

with the CEA and Commission regulations. It also reflects a CCO's responsibilities with respect to the regulation of members and market participants utilizing a SEF's trading platform. In this regard, Section 37.1501(d)(8) requires that a CCO supervise a SEF's self-regulatory program with respect to trade practice surveillance; market surveillance; real-time market monitoring; compliance with audit trail requirements; enforcement and disciplinary proceedings; and audits, examinations, and other regulatory responsibilities with respect to members and market participants. Similarly, Section 37.1501(d)(9) requires that a CCO supervise the effectiveness and sufficiency of any regulatory services provided to the SEF by a registered futures association or other registered entity in accordance with § 37.204.

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See

proposed § 37.204 (governing a SEF's use of third-party regulatory service providers and its duty to supervise such providers and any services received).

Request for Comment:

The Commission requests comment regarding proposed § 37.1501(d). Comments should address any additional CCO duties which the Commission should include in the proposed regulation. In addition, they should specifically address a CCO's role in managing conflicts of interest within a SEF, the types of conflicts which commenters believe might arise within a SEF, and how and by whom those conflicts should be resolved.

f. Preparation and Submission of Annual Compliance Report—Proposed §§ 37.1501(e) and 37.1501(f)

Section 5h(f)(15)(D) of the CEA requires a CCO to prepare an annual compliance report. As discussed above, the Commission believes that this annual compliance report should give the Commission a complete and accurate picture of a SEF's compliance program. Proposed § 37.1501(e) details the information that must be included in the annual compliance report. The report must include: (i) A description of the SEF's written policies and procedures, code of ethics and conflicts of interest policies; (ii) a detailed review of the SEF compliance with Section 5h of the CEA, including an assessment by the CCO of the effectiveness of the SEF's policies and procedures in ensuring compliance with Section 5h of the CEA and a discussion of areas for improvement; (iii) a description of any material changes to the policies and procedures that were made to these since the last annual compliance report; (iv) a description of the financial, managerial, operational, and staffing resources set aside for the SEF's compliance program, including a description of the SEF's compliance program, describing resources set aside for the SEF's self-regulatory responsibilities. An annual compliance report must also provide: a detailed description and review of the SEF's self-regulatory program, which includes a description of staff associated with self-regulation, a catalogue of investigations and disciplinary actions taken, and a review of the performance of disciplinary committees and panels; (v) a description of any material compliance matters, including instances of

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