# Protection of Cleared Swaps Customer Contracts and Collateral; Conforming Amendments to the Commodity Broker Bankruptcy Provisions > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2012-1033 ## Record - **Collection:** Federal Register - **Document type:** Rule - **Published:** February 7, 2012 - **Citation:** 77 FR 6336 ## Text COMMODITY FUTURES TRADING COMMISSION 17 CFR Parts 22 and 190 RIN Number 3038-AC99 Protection of Cleared Swaps Customer Contracts and Collateral; Conforming Amendments to the Commodity Broker Bankruptcy Provisions AGENCY: Commodity Futures Trading Commission. ACTION: Final rule. SUMMARY: The Commodity Futures Trading Commission (the “Commission”) is adopting final regulations to implement new statutory provisions enacted by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). Specifically, these regulations impose requirements on futures commission merchants (“FCMs”) and derivatives clearing organizations (“DCOs”) regarding the treatment of cleared swaps customer contracts (and related collateral), and make conforming amendments to bankruptcy provisions applicable to commodity brokers under the Commodity Exchange Act (the “CEA”). DATES: The rules will become effective April 9, 2012. All parties must comply with the Part 22 rules by November 8, 2012. All parties must comply with the Part 190 rules by April 9, 2012. Prior to the compliance date for the Part 22 rules, the definition of 190.01(pp) (“Cleared Swap”) shall be limited to transactions where the rules or bylaws of a derivatives clearing organization require that such transactions, along with the money, securities, and other property margining, guaranteeing or securing such transactions, be held in a separate account for Cleared Swaps only. FOR FURTHER INFORMATION CONTACT: Robert B. Wasserman, Chief Counsel, Division of Clearing and Risk (DCR), at 202-418-5092 or rwasserman@cftc.gov; M. Laura Astrada, Associate Chief Counsel, DCR, at 202-418-7622 or lastrada@cftc.gov; Alicia Lewis, Special Counsel, DCR, at 202-418-5862 or alewis@cftc.gov; or Martin White, Assistant General Counsel, Office of the General Counsel, at 202-418-5129 or mwhite@cftc.gov, in each case, at the Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581. SUPPLEMENTARY INFORMATION: Table of Contents I. Background A. Segregation Requirements. B. Overview of the Clearing Process as it Relates to the Segregation Requirements. C. Segregation Alternatives. D. Operation of the Segregation Models in an FCM Bankruptcy. E. Solicitation of Public Input. F. Clarification of the Application of Financial and Segregation Interpretation No. 10 to Cleared Swaps. II. The Final Rules III. Segregation Model for Cleared Swaps Customer Collateral A. Summary of the Comments. B. Discussion of the Comments. IV. Section by Section Analysis: Regulation Part 22 A. Regulation 22.1: Definitions. B. Regulation 22.2—Futures Commission Merchants: Treatment of Cleared Swaps Customer Collateral. C. Regulation 22.3—Derivatives Clearing Organizations: Treatment of Cleared Swaps Customer Collateral. D. Regulation 22.4—Futures Commission Merchants and Derivatives Clearing Organizations: Permitted Depositories. E. Regulation 22.5—Futures Commission Merchants and Derivatives Clearing Organizations: Written Acknowledgment. F. Regulation 22.6—Futures Commission Merchants and Derivatives Clearing Organizations: Naming of Cleared Swaps Customer Accounts. G. Regulation 22.7—Permitted Depositories: Treatment of Cleared Swaps Customer Collateral. H. Regulation 22.8—Situs of Cleared Swaps Customer Accounts. I. Regulation 22.9—Denomination of Cleared Swaps Customer Collateral and Location of Depositories. J. Regulation 22.10—Application of other Regulatory Provisions. K. Regulation 22.11—Information to be Provided Regarding Customers and Their Cleared Swaps. L. Regulation 22.12—Information to be Maintained Regarding Cleared Swaps Customer Collateral. M. Regulation 22.13—Additions to Cleared Swaps Customer Collateral. N. Regulation 22.14—Futures Commission Merchant Failure to Meet a Customer Margin Call in Full. O. Regulation 22.15—Treatment of Cleared Swaps Customer Collateral on an Individual Basis. P. Regulation 22.16—Disclosures to Customers. V. Section by Section Analysis: Amendments to Regulation Part 190 A. Background. B. Definitions. C. Amendments to Regulation 190.02—Operation of the Debtor's Estate Subsequent to the Filing Date and Prior to the Primary Liquidation Date. D. Amendments to Regulation 190.03—Operation of the Debtor's Estate Subsequent to the Primary Liquidation Date. E. Amendments to Regulation 190.04—Operation of the Debtor's Estate—General. F. Amendments to Regulation 190.05—Making and Taking Delivery on Commodity Contracts. G. Amendments to Regulation 190.06—Transfers. H. Amendments to Regulation 190.07—Calculation of Allowed Net Equity. I. Amendments to Regulation 190.09—Member Property. J. Amendments to Regulation 190.10—General. K. Amendments to Appendix A to Part 190—Bankruptcy Forms, Bankruptcy. L. Amendments to Appendix B to Part 190—Special Bankruptcy Distributions. VI. Effective Date VII. Consideration of Costs and Benefits A. Introduction. B. Benefits and Costs of Complete Legal Segregation Model Relative to Futures Model. C. Conclusion. VIII. Related Matters. A. Paperwork Reduction Act. B. Regulatory Flexibility Act. IX. Text of Proposed Rules I. Background A. Segregation Requirements On July 21, 2010, President Obama signed the Dodd-Frank Act. 1 Title VII of the Dodd-Frank Act 2 amended the CEA 3 to establish a comprehensive new regulatory framework for swaps and certain 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; 4 (2) imposing mandatory clearing and trade execution requirements on clearable swap contracts; (3) creating rigorous recordkeeping and real-time reporting regimes; and (4) enhancing the Commission's rulemaking and enforcement authorities with respect to, among others, all registered entities and intermediaries subject to the Commission's oversight. 1 See Dodd-Frank Act, Public Law 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. 2 Pursuant to section 701 of the Dodd-Frank Act, Title VII may be cited as the “Wall Street Transparency and Accountability Act of 2010.” 3 7 U.S.C. 1 et seq. 4 In this release, the terms “swap dealer” and “major swap participant” shall have the meanings set forth in section 721(a) of the Dodd-Frank Act, which added sections 1a(49) and (33) of the CEA. However, as directed by section 721(c) of the Dodd-Frank Act, the Commission is in the process of promulgating rules to further define, among other terms, “swap dealer” and “major swap participant.” See 75 FR 80173, Dec. 21, 2010. Section 724 of the Dodd-Frank Act prescribes the manner in which Cleared Swaps (and related collateral) 5 must be treated prior to and after bankruptcy. Section 724(a) of the Dodd-Frank Act amends section 4d of the CEA to add a new paragraph (f), which imposes the following requirements on an FCM, as well as any depository thereof (including, without limitation, a DCO): 5 Regulation 22.1 defines “Cleared Swap” and “Cleared Swaps Customer Collateral.” 1. The FCM must treat and deal with all collateral (including accruals thereon) deposited by a customer 6 to margin its Cleared Swaps as belonging to such customer; 6 Regulation 22.1 defines “Cleared Swaps Customer.” 2. The FCM must separately account for and may not commingle such collateral with its own property and may not, with certain exceptions, use such collateral to margin the Cleared Swaps of any person other than the customer depositing such collateral; 3. A DCO may not hold or dispose of the collateral that an FCM receives from a customer to margin Cleared Swaps in any manner that would indicate that such collateral belonged to the FCM or any person other than the customer; and 4. The FCM and the DCO may only invest such collateral in enumerated investments. In other words, the FCM and the DCO (i) must hold such customer collateral in an account (or location) that is separate from the property belonging to the FCM or DCO, and (ii) must not use the collateral of one customer to (A) cover the obligations of another customer or (B) the obligations of the FCM or DCO. These basic requirements that Cleared Swaps Customer Collateral be treated as the property of customers and maintained in segregated accounts (or locations) are imposed by the statute and have the force of law regardless of the Commission's particular implementing regulations. Moreover, by the terms of the statute, these requirements would apply even if the Commission promulgated no implementing regulations. Section 724(b) of the Dodd-Frank Act governs bankruptcy treatment of Cleared Swaps by clarifying that Cleared Swaps are “commodity contracts” within the meaning of section 761(4)(F) of the Bankruptcy Code. 7 Therefore, in the event of an FCM or DCO insolvency, Cleared Swaps Customers may invoke the protections of Subchapter IV of Chapter 7 of the Bankruptcy Code (“Subchapter IV”). Such protections include: (i) protected transfers of Cleared Swaps and related collateral; 8 and (ii) if Cleared Swaps are subject to liquidation, preferential distribution of remaining collateral. 9 However, section 766(h) of the Bankruptcy Code (“Section 766(h)”) subjects customers to mutualized risk by requiring that customer property be distributed “ratably to customers on the basis and to the extent of such customers' allowed net equity claims.” This requirement, in turn, limits the Commission's flexibility in designing a model for the protection of customer collateral. 7 11 U.S.C. 761(4)(F). 8 See, e. g., 11 U.S.C. 764. 9 See, e. g., 11 U.S.C. 766(h) and (i). B. Overview of the Clearing Process as It Relates to the Segregation Requirements 1. Central Counterparties/Derivatives Clearing Organizations One of the primary objectives of the Dodd-Frank Act was to promote the central clearing of swaps and to establish the regulatory infrastructure for the clearing of swaps. 10 Clearing is the process by which transactions in derivatives are processed, guaranteed, and settled by a central counterparty, also known as a DCO. In accordance with this overall Congressional purpose, section 724 of the Dodd-Frank Act amends the CEA to provide the statutory foundation for the protection of Cleared Swaps Customer Collateral. 10 See supra n. 1; S. Rep. No. 111-176, at 33 (2010) (“[w]ith appropriate collateral and margin requirements, a central clearing organization can substantially reduce counterparty risk and provide an organized mechanism for clearing transactions”); Process for Review of Swaps for Mandatory Clearing, 76 FR 44464, July 26, 2011 (final rule); Derivatives Clearing Organizations General Provisions and Core Principles, 76 FR 69334, Nov. 8, 2011 (final rule). A DCO has members (“Clearing Members”) who clear derivatives transactions ( e.g., swaps) through the DCO and who are subject to the DCO's rules. Clearing Members may clear transactions on their own behalf ( i.e., “proprietary transactions”) or on behalf of customers ( i.e., “customer transactions”). Clearing members that clear swaps for customers must be registered as futures commission merchants (“FCMs”). 11 11 Section 4d(f)(1) of the CEA, 7 U.S.C. 6d(f)(1). The term “central counterparty” means, conceptually, that the DCO becomes the seller to every buyer, and the buyer to every seller. More specifically, the DCO novates swap transactions initially entered into between various market participants, such as swaps users, dealers, or end users, and cleared either directly (if the market participant is itself a Clearing Member) or indirectly (through an FCM that is a Clearing Member) . The contractual obligations between the original parties (“A” and “B”) 12 are replaced by sets of equivalent obligations: between the Clearing Member FCMs acting for the original parties and the DCO and between the Clearing Member FCMs and their individual customers. Thus, if the original swap agreement would require a certain payment from A to B, as a result of the clearing process this obligation becomes (1) a duty by A's clearing FCM to pay the DCO, (2) a corresponding claim by A's FCM to recompense from A, (3) a duty by the DCO to pay B's clearing FCM, and (4) a corresponding duty by B's FCM to pay B. 12 For purposes of this example, neither A nor B is a Clearing Member. In economic effect, the DCO serves as a guarantor that every Clearing Member party to a cleared swap receives performance according to the terms of the swap, while the clearing FCM serves as a guarantor of its customers' swaps obligations to the DCO. 2. Variation To avoid the accumulation of large obligations, the DCO conducts a variation payment and collection cycle at least once a day, and in the case of many DCOs, twice a day. The DCO will first calculate the gain (and corresponding loss) on each contract through a process known as “marking to market,” using reported market prices where available, or other means (such as surveys of Clearing Members). The DCO will then aggregate and net the gains and losses for each Clearing Member (separately for proprietary and customer accounts), collect from those Clearing Members with net losses, and pay those Clearing Members with net gains. This process is highly time sensitive: The Clearing Member typically has only one or a few hours between the demand for payment and the time payment is due. Similarly, the Clearing Member FCMs will debit the accounts of those customers who have losses on their transactions, and credit the accounts of those customers who have gained. 3. Margin (Collateral) To secure the prompt payment of variation obligations, the DCO will require each Clearing Member to post collateral (often referred to as “margin”) for the transactions it clears (separately for customer positions and proprietary positions). If the Clearing Member does not promptly make a variation payment to the DCO—referred to as a default—the collateral may immediately be liquidated and applied to the obligation. Margin may only be used to meet the default of the Clearing Member posting that margin. While proprietary margin may be used to meet obligations in either the Clearing Member's proprietary account or customer account, the reverse is not true: A Clearing Member's customer margin may not be used to meet a default in the Clearing Member's proprietary account. Similarly, FCMs will—indeed, are required to—collect collateral from each of their customers, based on each customer's portfolio of positions, to secure the prompt payment of the customer's variation obligations. 13 If a customer fails to fulfill an obligation to the FCM arising out of a swap agreement the FCM clears for the customer, the FCM may use some or all of the value of the collateral that customer has posted to meet that obligation—that is the purpose of the collateral. 13 See regulation 39.13(g)(8)(ii) (stating that “[a] derivatives clearing organization shall require its clearing members to collect customer initial margin, as defined in § 1.3 of this chapter, from their customers, for nonhedge positions, at a level that is greater than 100 percent of the derivatives clearing organization's initial margin requirements with respect to each product and swap portfolio.”). 76 FR at 69439. The purpose of this rulemaking is to protect Cleared Swaps Customer Collateral in the event that an FCM defaults to a DCO due to “Fellow-Customer Risk” (as such term is defined in section I(B)(6) herein). However, as section III(B) explores in greater detail, the segregation model selected in this rulemaking provides limited protection from operational and investment risks. The DCO will generally set minimum collateral levels for each type of swap, and will prescribe a “margin methodology” to determine the minimum margin level for portfolios of swaps. The DCO's margin methodology will be designed to estimate the amount of loss a portfolio of swap positions may incur, calculated at a statistical confidence level no less than 99%, over a holding period generally between one and ten days, depending on the time it is estimated to take to liquidate the swaps in the portfolio. 14 The FCM will, in turn, use the same or similar methodology in determining the minimum level of collateral it must collect from each customer. 15 14 See generally, 76 FR 69334. See specifically regulation 39.13(g)(2)(ii) (setting forth a one-day minimum liquidation time for agricultural, energy, and metals swaps, and a five-day minimum liquidation time for all other swaps). 76 FR 69438. 15 The FCM is required to collect a higher level of collateral from its customers than that prescribed for Clearing Members ( see id. ) and may, in its discretion, collect a yet higher level. See regulation 22.13(a)(1). 4. Default Resources As noted above, the margin collateral collected by a DCO is designed to cover most ( e.g., 99%), but not all, potential losses incurred by a Clearing Member. DCOs cover the “tail risk” ( i.e., the risk that a Clearing Member will incur, and default on, a loss in excess of the margin collected) by means of what is sometimes referred to as a default resources package, or “waterfall.” Elements of the waterfall may include a contribution of a specified amount of the DCO's own capital, pre-funded contributions from Clearing Members (a “guaranty fund”), 16 or (to a limited extent), a power by the DCO to assess additional contributions from Clearing Members. Unlike margin, a Clearing Member's contribution to the guaranty fund will generally be usable to meet the default of another Clearing Member. In other words, the guaranty fund is “mutualized.” Elements of the waterfall are applied in an order pre-determined by the DCO's rules. Such rules will often apply the guaranty fund contribution of the defaulter before the DCO's own capital, and the remainder of the guaranty fund ( i.e., the guaranty fund contributions of the non-defaulting Clearing Members) thereafter. 16 See also infra at n. 250. Though seemingly complex, centralized clearing has important advantages in terms of transparency, risk management, netting out of countervailing obligations, and reduced exposure of market participants to each other's credit risk (by effectively substituting the DCO's credit risk). 5. Customer Accounts Generally, a clearing FCM will have two different types of Cleared Swaps Customer Accounts in connection with collateral provided to it by Cleared Swaps Customers. One account is maintained (generally at a bank) by the FCM on behalf of its Cleared Swaps Customers (the “FCM Customer Account”). The FCM Customer Account holds assets provided by customers, or other assets of equivalent value, that are not currently posted with the DCO to support swaps positions cleared by the FCM on behalf of its Cleared Swaps Customers. The other account is maintained by the DCO for the FCM on behalf of the FCM's Cleared Swaps Customers (the “DCO Customer Account”). The DCO Customer Account holds customer assets, or assets of equivalent value, that the FCM has posted to the DCO as collateral for swaps positions that have been established and cleared by the FCM for its Cleared Swaps Customers. The collateral posted by each Cleared Swaps Customer is, however, potentially exposed to risks that do not arise out of the obligations that a Cleared Swaps Customer has directly incurred by assuming his or her swaps position. 17 The most important impact of such risks would occur in the case of an insolvency on the part of the FCM through which the Cleared Swaps Customer clears. As discussed in more detail below, the new CEA section 4d(f), and the Commission's implementing regulations, are designed to provide protection for Cleared Swaps Customer Collateral against certain risks that may arise during an insolvency on the part of the FCM through which the Cleared Swaps Customer clears. 17 Examples of other risks include the possibility of misuse or misallocation of a Cleared Swaps Customer's assets by a dishonest or negligent FCM. 6. Fellow-Customer Risk “Fellow-Customer Risk” is the risk that a DCO would need to access the collateral of non-defaulting Cleared Swaps Customers to cure an FCM default. Fellow-Customer Risk arises in circumstances in which a Cleared Swaps Customer (the “defaulting customer”) of a clearing FCM suffers a (significant) loss in connection with a cleared swap. 18 The loss will result in a call by the DCO for a variation payment from the clearing FCM that carries that Cleared Swaps Customer's Cleared Swaps. 19 The clearing FCM may demand expedited payment from the defaulting Cleared Swaps Customer, but is in any event directly obligated promptly to meet the payment obligation to the DCO. 18 See also supra n. 13. 19 As noted above, the amount the DCO will call for or pay to the FCM in respect of its Cleared Swaps Customers is the net of the gains and losses computed on a customer-by-customer basis. If the loss is great enough, it may exceed the sum of the FCM's available liquid assets, the swaps collateral posted by the Cleared Swaps Customer, and any additional payments immediately available from the Cleared Swaps Customer. In this situation, sometimes called a “double default,” the defaulting Cleared Swaps Customer will have defaulted on its obligation to the clearing FCM which, in turn, will default on its obligation to the DCO. In such circumstances, the FCM will likely have to file for protection in bankruptcy. Meanwhile, the defaulting Cleared Swaps Customer's loss will translate to a gain by one or more other market participants. Notwithstanding the default by the clearing FCM, the DCO, in its capacity as central counterparty, is required to pay out these gains. The DCO will thus be faced with a potentially significant loss. A potential resource for the DCO to apply to this loss in a double default situation is the collateral held in the Cleared Swaps Customer Account maintained by the DCO for the defaulting FCM on behalf of the FCM's Cleared Swaps Customers. Under the current rules applicable to futures clearing, a DCO is permitted to use all of the collateral in the Clearing Member's customer account to meet a loss in that account, without regard to which customer(s) in fact supplied that collateral. Thus, in this case, the non-defaulting customers of the defaulting FCM clearing member would be exposed to loss due to “Fellow-Customer Risk.” C. Segregation Alternatives In implementing new CEA section 4d(f), the Commission considered five alternative segregation models for Cleared Swaps Customer Collateral in the notice of proposed rulemaking issue by the Commission on June 9, 2011 (the “NPRM”). 20 20 See Notice of Proposed Rulemaking on the Protection of Cleared Swaps Customer Contracts and Collateral; Conforming Amendments to the Commodity Broker Bankruptcy Provisions, 76 FR 33818, 33822, June 9, 2011. 1. Legal Segregation With Operational Commingling Model The first alternative explored by the Commission was legal segregation with operational commingling (the “LSOC Model” or “Complete Legal Segregation Model”). Under the LSOC Model, each FCM and DCO would enter (or “segregate”), in its books and records, the Cleared Swaps of each individual customer and relevant collateral. Each FCM and DCO would ensure that such entries are separate from entries indicating (i) FCM or DCO obligations, or (ii) the obligations of non-cleared swaps customers. Operationally, however, each FCM and DCO would be permitted to hold (or “commingle”) the relevant collateral in one account. Each FCM and DCO would ensure that such account is separate from any account holding FCM or DCO property or holding property belonging to non-cleared swaps customers. Prior to the simultaneous default of an FCM and one of its Cleared Swaps Customers (as discussed above, a “double default”), the FCM would ensure that the DCO does not use the collateral of one Cleared Swaps Customer to support the obligations of another customer by making certain that the value of the Cleared Swaps Customer Collateral that the DCO holds equals or exceeds the value of all Cleared Swaps Customer Collateral that it has received to secure the contracts of the FCM's customers. Following a double default, the DCO would be permitted to access the collateral of the defaulting Cleared Swaps Customers, but not the collateral of the non-defaulting Cleared Swaps Customers. Thus while, even under the LSOC Model, Section 766(h) requires the pro rata distribution of customer property, the collateral attributable to the non-defaulting Cleared Swaps Customers would be available to be distributed. 2. Legal Segregation With Recourse Model Second, the Commission contemplated the Legal Segregation with Recourse Model (together with the LSOC Model, the “Legal Segregation Models”). As with the LSOC Model, under the Legal Segregation with Recourse Model, each FCM and DCO would segregate the Cleared Swaps of each individual customer and relevant collateral in its books and records. However, each FCM and DCO would be permitted to commingle the relevant collateral in one account, provided that such account is separate from any proprietary accounts or accounts property belonging to non-cleared swaps customers. Again, as with the LSOC Model, prior to a double default, the FCM would ensure that the DCO does not use the collateral of one Cleared Swaps Customer to support the obligations of another customer by making certain that the value of the Cleared Swaps Collateral that the DCO holds equals or exceeds the value of all Cleared Swaps Collateral that it has received to secure the contracts of the FCM's customers. However, unlike the LSOC Model, following a double default, the Legal Segregation with Recourse Model would not prohibit a DCO from accessing the collateral of the non-defaulting Cleared Swaps Customers, after the DCO applies its own capital to cure the default, as well as the guaranty fund contributions of its non-defaulting FCM members. 3. Physical Segregation Model The Commission also explored the possibility of full physical segregation (the “Physical Segregation Model”) for Cleared Swaps Customer Collateral. The Physical Segregation Model primarily differs from the Legal Segregation Models operationally. In the ordinary course of business ( i.e., prior to a double default), as with the Legal Segregation Models, each FCM and DCO would enter (or “segregate”), in its books and records, the Cleared Swaps of each individual customer and relevant collateral. However, unlike the Legal Segregation Models, each FCM and DCO would maintain separate individual accounts for the relevant collateral. Hence, the FCM would ensure that the DCO does not use the collateral of one Cleared Swaps Customer to support the obligations of another customer by making certain that the DCO does not mistakenly transfer collateral in (i) the account belonging to the former to (ii) the account belonging to the latter. Following a double default, the Physical Segregation Model would lead to the same result as the Complete Legal Segregation Model. Specifically, the DCO would be permitted to access the collateral of the defaulting Cleared Swaps Customers, but not the collateral of the non-defaulting customers. As discussed above, one important limitation on the effectiveness of the Physical Segregation Model is section 766(h) of the Bankruptcy Code, which requires that customer property be distributed ratably. Thus, if because of Physical Segregation, certain Cleared Swaps Customer Collateral was better protected than the property of other Cleared Swaps Customers, it would not be permissible to pay Cleared Swaps Customers in the first group a higher proportion ( i.e., a higher cents-on-the-dollar distribution) of their net equity claims than Cleared Swaps Customers in the second group. Rather, Cleared Swaps Customers in both groups would receive the same proportion of their allowed net equity claims. In other words, in spite of incurring greater cost under the Physical Segregation Model, a Cleared Swaps Customer would essentially receive the same level of protection for its Cleared Swaps Customer Collateral under the Physical Segregation Model as it would under the LSOC Model. 4. Futures Model The Commission also considered replicating the segregation requirement currently applicable to futures (the “Futures Model”). Under this model, DCOs treat each FCM's customer account on an omnibus basis, that is, as belonging to an undifferentiated group of customers. Prior to a double default, the Futures Model shares certain similarities with the Legal Segregation Models. Specifically, each FCM would enter (or “segregate”), in its books and records, the Cleared Swaps of each individual customer and relevant collateral. Each DCO, however, would recognize, in its books and records, the Cleared Swaps that an FCM intermediates on a collective (or “omnibus”) basis. Each FCM and DCO would be permitted to hold (or “commingle”) all Cleared Swaps Customer Collateral in one account. Following a double default, the Futures Model shares certain similarities with the Legal Segregation with Recourse Model. Specifically, the Futures Model would not prohibit a DCO from accessing the collateral of the non-defaulting Cleared Swaps Customers. However, unlike the Legal Segregation with Recourse Model, under the Futures Model the DCO would be permitted to access such collateral before applying its own capital or the guaranty fund contributions of non-defaulting FCM members. 21 21 For a more detailed discussion regarding the operation of the segregation models in an FCM bankruptcy, see section I.D. 5. Optionality Finally, the Commission explored permitting a DCO to choose between (i) the Legal Segregation Models (whether Complete or with Recourse), (ii) the Physical Segregation Model, and (iii) the Futures Model, rather than mandating any particular alternative. D. Operation of the Segregation Models in an FCM Bankruptcy When discussing the issues surrounding an FCM bankruptcy under the Bankruptcy Code, analytically there are several scenarios to consider: (1) The bankruptcy is unrelated to the loss of customer funds, and there is no such loss; (2) The bankruptcy involves shortfalls in customer funds due to operational risks; (3) The bankruptcy involves losses due to customer risk ( i.e., a customer incurs a loss in excess of the FCM's financial ability to cover); or (4) the bankruptcy involves shortfalls in customer funds due to operational risk and losses due to customer risk. 1. Bankruptcy Unrelated to Loss of Customer Funds An FCM bankruptcy that is unrelated to the loss of customer funds may arise because of financial difficulties in the FCM, financial difficulties in the proprietary accounts, or because of the impact of difficulties at a corporate parent or affiliate. Under this scenario, all models share important characteristics: Customer positions and related collateral, whether at a DCO or at the FCM, can be transferred to one or more willing transferee FCMs, or may be liquidated and returned to the trustee. With respect to fostering transfer, however, the Legal Segregation Models (whether Complete or with Recourse) and the Physical Segregation Model do have a significant advantage compared to the Futures Model: In each of them, information about the customers as a whole, and about each individual customer's positions, are transmitted to the DCO every day, an information flow (and store) that is not present in the Futures Model. Thus, each DCO will have important customer information on a customer by customer basis that can be used to facilitate and implement transfers, and is thus less reliant upon the FCM for that information. 2. Bankruptcy With Shortfalls Due to Operational Risks or Investment Risks An FCM bankruptcy with shortfalls due to operational risks would arise because of a shortfall in segregated funds due to, e.g., negligence, theft or other mishap. An FCM may also have shortfalls due to investment risks resulting from extraordinary losses on the set of investments permitted under regulation 1.25 (as included in new regulation 22.2(e)(3)). Under this scenario, all models again share important characteristics: Customer positions and related collateral at a DCO may be delivered to the Trustee, or may transferred by the DCO, but only to the extent of each customer's pro rata share. Under all of the segregation models, to the extent there is a shortfall, each customer will ultimately receive the same cents-on-the-dollar proportion of the value of the customer's account. However, with respect to fostering transfer, the other models again have a significant advantage compared to the Futures Model: In each of them, information about the customers as a whole, and about each individual customer's positions, are transmitted to the DCO every day, an information flow (and store) that is not present in the Futures Model. Thus, each DCO will have important customer information on a customer by customer basis that can be used to facilitate and implement transfers, and accordingly is less reliant upon the FCM for that information. 3. Bankruptcy With Shortfalls Due to Customer Risk An FCM bankruptcy with shortfalls due to customer risk would arise because a customer incurs a loss that exceeds both the customer's collateral and the FCM's ability to pay. Under the Futures Model, the DCO could use the entirety of the FCM's customer account (or as much of it as necessary) to meet the entire loss created by the default. Transfer of customer positions would be difficult, in that the DCO would lack information as to which customers were in default, and which positions belonged to defaulting customers (and, presumably, would not be transferred) and which did not. 22 The DCO would be permitted to liquidate customer positions, a process that might take between one and ten days. 23 Once the loss was crystalized, the DCO would be able to turn over the collateral (less that used to meet the default) to the Trustee for use in the pro rata distribution. 22 See generally, CME Group, Inc. (“CME”) at 14-15 (discussing information deficits at bankrupt FCM). 23 See 76 FR at 69366-68. Under the LSOC Model, the DCO could only use the collateral attributable to defaulting customers (those whose positions suffered losses) to meet the loss. Thus, all collateral attributable to customers whose net positions gained or were “flat” (neither gained nor lost), and much of the collateral attributable to customers whose net positions lost, would be immediately available for transfer. Moreover, the DCO would have information that is no more than one business day old tying customers to portfolios of positions, and the DCO itself would maintain the margining methodology that would tie such portfolios of positions to the collateral requirement associated with such portfolios. Even if the DCO decided to liquidate all customer positions, the collateral of non-defaulting customers would be exposed to less loss than under the Futures Model because the DCO would not have the right to access it. The Physical Segregation Model would work in a manner similar to the LSOC Model. Again, all collateral attributable to customers whose net positions gained or were “flat” (neither gained nor lost), and the remaining collateral attributable to customers whose net positions lost, would be immediately available for transfer. The DCO would have specific information on how much collateral was, in fact, attributable to each customer. However, because of the ratable distribution requirement, any losses that did exist would be shared ratably among all customers. Under the Legal Segregation with Recourse, the DCO could only use the collateral attributable to defaulting customers (those whose positions suffered losses) to meet the loss—at first. It would also use the defaulting clearing member FCM's own contribution to the guaranty fund, its own contribution to the guaranty fund, as well as the contributions of non-defaulting clearing members. However, if those resources were insufficient to cover the default, the DCO would have “recourse” to the collateral of non-defaulting customers. While such recourse is much less likely under the Legal Segregation with Recourse Model than under the Futures Model—because the fellow-customer collateral would not be reached unless the loss was great enough to consume the entire guaranty fund—until the amount of loss from the default was crystalized (through liquidation or transfer), the DCO might be reluctant or unable to release the collateral of non-defaulting customers. Accordingly, while Legal Segregation with Recourse would (in most cases) provide customers superior recovery in a liquidation, it would be much less well-suited to a prompt transfer of positions. E. Solicitation of Public Input The Commission sought public comment on the segregation alternatives mentioned above, and on the advisability of permitting the DCO to choose between alternatives. First, the Commission, through its staff, held extensive external meetings with three segments of stakeholders ( i.e., DCOs, FCMs, and swaps customers). 24 Second, on October 22, 2010, the Commission, through its staff, held a roundtable (the “First Roundtable”). 25 Third, on November 19, 2010, the Commission issued an Advance Notice of Proposed Rulemaking for Protection of Cleared Swaps Customers Before and After Commodity Broker Bankruptcies (the “ANPR”). Fourth, on June 3, 2011, the Commission, through its staff, held a second roundtable (the “Second Roundtable”). 26 Fifth, after careful consideration of the comments the Commission received on the ANPR, the Commission issued the NPRM. 24 A list of external meetings is available at: http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_6_SegBankruptcy/index.htm . 25 The transcript from the First Roundtable (the “First Roundtable Tr.”) is available at: http://www.cftc.gov/ucm/groups/public/@swaps/documents/dfsubmission/dfsubmission6_102210-transcrip.pdf . 26 The transcript from the Second Roundtable (the “Second Roundtable Tr.”) is available at: http://www.cftc.gov/ucm/groups/public/@swaps/documents/dfsubmission/dfsubmission6_060311-transcri.pdf . 1. First Roundtable As the ANPR describes, the First Roundtable revealed that stakeholders had countervailing concerns regarding the alternative segregation models that the Commission set forth. On the one hand, a number of swaps customers argued that the Commission should focus on effectively eliminating Fellow-Customer Risk 27 and Investment Risk. 28 Such swaps customers emphasized that (i) They currently transact in uncleared swaps, (ii) they are able to negotiate for individual segregation at independent third parties for collateral supporting such uncleared swaps, and therefore (iii) they are currently subject to neither Fellow-Customer Risk nor Investment Risk. Such customers found it inappropriate that, under certain alternatives set forth by the Commission, they should be subject to Fellow-Customer Risk and Investment Risk when they transact in Cleared Swaps. 27 As noted in section I.B.1, an FCM functions as a guarantor of customer transactions with a DCO. Section 4d(f) of the CEA prohibits an FCM from using the collateral deposited by one Cleared Swaps Customer to support the swap transactions of another Cleared Swaps Customer. Therefore, if one Cleared Swaps Customer owes money to the FCM ( i.e., the Cleared Swaps Customer has a debit balance), the FCM, acting as guarantor, must deposit its own capital with the DCO to settle obligations attributable to such customer. If the Cleared Swaps Customer defaults to the FCM, and the Cleared Swaps Customer's obligations are so significant that the FCM does not have sufficient capital to meet them, then the FCM would default to the DCO. As discussed in Section I.B.4, the financial resources DCOs maintain to cover Clearing Member defaults with respect to customer positions in excess of collateral provided by the Clearing Member include property of the defaulting Clearing Member ( i.e., collateral deposited to support FCM proprietary transactions and contributions to the DCO guaranty fund). Other elements of such packages may include: (i) The collateral that the FCM deposited to support the transactions of non-defaulting customers; (ii) a portion of the capital of the DCO; and (iii) contributions to the guaranty fund from other DCO Clearing Members. Typically, a DCO would exhaust one element before moving onto the next element. Therefore, the risk that the DCO would use any one element depends on the position of that element in the package. 28 “Investment Risk” is the risk that each Cleared Swaps Customer would share pro rata in any decline in the value of FCM or DCO investments of Cleared Swaps Customer Collateral. Section 4d(f) of the CEA permits an FCM to invest Cleared Swaps Customer Collateral in certain enumerated instruments. The Commission is proposing to expand such instruments to include those referenced in regulation 1.25 (as it may be amended from time to time). Even though (i) such investments are “consistent with the objectives of preserving principal and maintaining liquidity,” and (ii) both the FCM, as well as the DCO, value such investments conservatively (by, e.g., applying haircuts), the value of such investments may decline to less than the value of the collateral originally deposited. See regulation 1.25(b) (as amended in Investment of Customer Funds and Funds Held in an Account for Foreign Futures and Foreign Options Transactions, 76 FR 78776, December 19, 2011). In such a situation, all customers would share in the decline pro rata, even if the invested collateral belonged to certain customers and not others. On the other hand, a number of FCMs and DCOs argued that the benefits of effectively eliminating Fellow-Customer Risk and Investment Risk are outweighed by the costs. With respect to benefits, these FCMs and DCOs noted that the Futures Model has served the futures industry well for many decades. With respect to costs, these FCMs and DCOs described two potential sources. First, FCMs and DCOs stated that, depending on the manner in which the Commission proposes to eliminate or mitigate Fellow-Customer Risk and Investment Risk, they may experience substantial increases to operational costs ( e.g., costs associated with transaction fees, reconciliations, recordkeeping, reporting). Second, and more significantly, FCMs and DCOs stated that they may incur additional risk costs due to proposed financial resources requirements. 29 29 As described below, the term “Risks Costs” refers to the costs associated with the allocation of loss in the event of a default under the Complete Legal Segregation Model relative to the Futures Model. For a more detailed explanation of these costs, see the discussion in section VII.B.2.b., under the heading titled “`Risk Costs' and potential effects on margin levels and DCO guaranty fund levels in response to complete legal segregation.” In addition, some DCOs may have anticipated including collateral from non-defaulting Cleared Swaps Customers as an element in their financial resources packages. If DCOs no longer have access to such collateral, then those DCOs would need to obtain additional financial resources to meet proposed Commission requirements. Both FCMs and DCOs averred that the costs associated with obtaining such additional financial resources may be substantial, and would ultimately be borne by Cleared Swaps Customers. 30 30 75 FR at 75163. For example, one DCO estimated that it would have to increase the amount of collateral that each Cleared Swaps Customer must provide by 60 percent, if it could no longer access the collateral of non-defaulting Cleared Swaps Customers to cure certain defaults. See infra n. 258. 2. ANPR Given the concerns that stakeholders expressed at the First Roundtable, the Commission decided to seek further comment through the ANPR on the potential benefits and costs of (i) The Legal Segregation Models (whether Complete or with Recourse), (ii) the Physical Segregation Model, and (iii) the Futures Model. As the ANPR explicitly stated, “[t]he Commission [was] seeking to achieve two basic goals: Protection of customers and their collateral, and minimization of costs imposed on customers and on the industry as a whole.” 31 In addition, the Commission requested comment on the impact of each model on behavior, as well as whether Congress evinced intent for the Commission to adopt any one or more of these models. 31 Id. As described in the NPRM, the Commission received thirty-one comments from twenty-nine commenters. 32 The comments were generally divided by the nature of the commenter: Most (though not all) of the comments from current or potential Cleared Swaps Customers favored either the Legal Segregation Models (whether Complete or with Recourse) or the Physical Segregation Model, manifesting a willingness to bear the added costs. 33 Most of the FCMs and DCOs favored the Futures Model, though one commenter favored the Complete Legal Segregation Model. 34 Finally, another commenter, in its supplemental comment, opined that the most important factor that the Commission should consider is the extent to which a model fostered the portability 35 of Cleared Swaps belonging to non-defaulting customers. 36 This commenter noted that the Physical Segregation Model and what is now referred to as the Complete Legal Segregation Model were most conducive to that goal. 37 32 All comment letters are available through the Commission's Web site at: http://www.cftc.gov/LawRegulation/FederalRegister/ProposedRules/2010-29836 . 33 See id. 34 See id. 35 The terms “portability,” “port,” and “porting” refer to the ability to reliably transfer the swaps (and related collateral) of a non-defaulting customer from an insolvent FCM to a solvent FCM, without the necessity of liquidating and re-establishing the swaps. 36 See ISDA comment letters on ANPR. 37 See id. After careful consideration of the First Roundtable discussion and the comments received in response to the ANPR, the Commission issued the NPRM on June 9, 2011. 3. Second Roundtable Discussions during the Second Roundtable generally reflected the conflicting concerns expressed by market participants regarding the alternative segregation models set forth by the Commission. Swaps customers continued to state that the Commission should focus on mitigating Fellow-Customer Risk, with some also advocating for the elimination of Investment Risk, while FCMs and DCOs reiterated that the Commission should select the Futures Model as the segregation model for Cleared Swaps Customer Collateral because the Futures Model has served the futures industry well for many decades. Pension funds, and a few investment managers, remained concerned about their potential exposure to Fellow-Customer Risk and Investment Risk and continued to press the Commission to adopt the Physical Segregation Model either outright or on an optional basis. In addition, participants discussed various cost and benefits issues arising in relation to the Futures and the Legal Segregation Models. Specifically, several participants believed that the operational costs would not be significantly different between the Futures Model and the Complete Legal Segregation Model. 38 Moreover, although some participants projected that risk costs would significantly increase if the Commission were to select the Complete Legal Segregation Model, 39 one participant argued that these risk costs would not be incremental risk costs; rather they are risk costs that exist in the Futures Model that would most likely ultimately be borne by customers. 40 Finally, one participant argued that any model that facilitates the ability to port “is superior to one that doesn't” because “the closeout cost in the future's model was the most expensive,” meaning that “closing out a client account and rates could be extremely devastating to the market, and * * * be really significant losses * * * [and] any way [the losses] can be avoided would be beneficial to every participant in the market.” 41 38 See Second Roundtable Tr. at 250, l.2 (In response to whether the Complete Legal Segregation Model would impose operational costs over the Futures Model, Ms. Bregasi stated that “[t]here is no additional cost between LSOC and the futures model;” Mr. Prager stated that “[w]e don't see them incurring other than the start-up costs, the one time that everyone will have to incur to set up, the running cost. We don't see any incremental cost;” and Mr. MacFarlane stated that “I would agree there are no additional operational costs.”). See also, Second Roundtable Tr. at 239, l.8 (Mr. Frankel explaining that operational costs resulting from passing “the client identity and * * * some other multiplier that explains how much excess there is in the seg account for the client * * * [is] a small build.”); Second Roundtable Tr. at 243, l.22 (Mr. Kahn stating that “in terms of the cost, the fact is OTC is a little different than futures because there is a tremendous build that everyone is doing in the case of OTC so if we need to build LSOC which in essence we've done in the LCH European model, there is a cost of that but I can't really define what it is. It's relatively small and not material.”). 39 See Second Roundtable Tr. at 255, l.12 (Mr. Frankel arguing that “Moving to a 99.9 percent confidence of coverage we think will increase margins by about 60 percent [for rates] * * * I think for CDS it could be more than double.”). See also Second Roundtable Tr. at 262, l.2 (Mr. Diplas arguing that “not having the additional pool of funds that are associated with the fellow customers means that we definitely need to actually margin from a CCP perspective, the higher confidence interval. That will differ depending on the asset class we're looking at. Some of them, at least based on the existing pool of trades, it could be manageable like at 60, 70 percent in rates. We'll talk about three to four times the amount that—in credit—and the more we get to instruments with fatter tails the higher the number is going to be. I think that is something that clients need to be cognizant of.”). 40 See, e. g., Second Roundtable Tr. at 257, l.6 (Mr. MacFarlane stating that “what's being said, if our transactions had to be margined on an individual basis it would require that we put up 60 to 70 percent more, which says that then the real risk of that transaction is 75 percent more than what we're collateralizing. So in the event of a default, not by us but by another counterparty potentially, they will be under-collateralized relative to what their individual transaction would require, and then that potentially could work its way back to us.”). 41 See, e. g., Second Roundtable Tr. at 259, l.6 (quoting Mr. Frankel). For a more detailed discussion of cost and benefit considerations, please see discussion below in section VII. 4. NPRM After carefully considering all comments to the ANPR and statements made during the First Roundtable discussion, the Commission proposed in the NPRM the Complete Legal Segregation Model as the segregation model for Cleared Swaps Collateral because the Complete Legal Segregation Model provided the best balance between benefits and costs in order to protect market participants and the public. Nonetheless, due in part to the strong opposing views expressed by market participants, the NPRM made clear that the Commission was still considering whether to adopt, in the alternative, the Legal Segregation with Recourse Model, and was continuing to assess the feasibility of an optional approach and the Futures Model. Commenters to the ANPR generally observed that customers ultimately would bear the costs of implementing whatever segregation model was selected by the Commission. Nonetheless, most (though not all) of the buy-side commenters favored individual protection for Cleared Swaps Customer Collateral. These commenters generally viewed the Complete Legal Segregation Model as the minimum level of protection necessary for Cleared Swaps Customer Collateral. Because it was largely recognized that customers would ultimately bear the costs of implementing the selected segregation model, the Commission believed it appropriate to give weight to the views of market participants who would bear those costs, and found it compelling that most buy-side commenters favored adoption of either the LSOC Model or the Physical Segregation Model. The Commission noted that the Legal Segregation Models and the Physical Segregation Model would provide greater individualized protection to Cleared Swaps Customer Collateral than the Futures Model, and was in accordance with section 4d(f) of the CEA. In addition, the Commission noted that the LSOC Model and the Physical Segregation Model may provide substantial benefits in the form of (i) Decreased Fellow-Customer Risk, (ii) increased likelihood of portability, (iii) decreased systemic risk, and (iv) positive impact on portfolio margining, and asked for comment as to whether and why commenters favor or oppose adoption of the Futures Model. In choosing between the Legal Segregation Models and the Physical Segregation Model, the Commission noted that the operational costs for the Physical Segregation Model would be substantially higher than the operational costs for the Legal Segregation Models (whether Complete or with Recourse). With respect to benefits, the Commission believed that the Physical Segregation Model would provide only incremental advantages over the Complete Legal Segregation Model with respect to the mitigation of Fellow-Customer Risk. In addition, the Commission noted that while the Physical Segregation Model does eliminate Investment Risk, (i) the Commission was in the process of further addressing Investment Risk by proposing amendments to regulation 1.25, and (ii) each FCM and DCO already values investments conservatively. Finally, the Commission observed that the Physical Segregation Model would generally enhance portability to the same extent as the Complete Legal Segregation Model, and therefore would have similar effects on systemic risk. In addition, the Commission stated that the Physical Segregation Model and the Complete Legal Segregation Model would likely enhance portfolio margining to the same extent. Therefore, the Commission chose not to propose the Physical Segregation Model in the NPRM. In choosing between the Complete Legal Segregation Model and the Legal Segregation with Recourse Model, the Commission noted that commenters argued that implementing the former would result in significant Risk Costs, 42 whereas implementing the latter would result in no Risk Costs. In addition, the Commission believes that comments to the ANPR that question the assumptions underlying the upper estimates of Risk Costs for the Complete Legal Segregation Model have raised credible issues regarding the accuracy of those estimates. Nevertheless, the Commission recognized that such assumptions formed an area of divergence between commenters, and therefore asked for additional comment on the Risk Costs for the Complete Legal Segregation Model. The Commission also observed that operational costs for the Complete Legal Segregation Model and the Legal Segregation with Recourse Model were approximately the same. With respect to benefits, the Commission noted that the Complete Legal Segregation Model would (i) Mitigate Fellow-Customer Risk even in extreme FCM defaults, unlike the Legal Segregation with Recourse Model, (ii) enhance portability (and therefore mitigate systemic risk) to a significantly greater extent than the Legal Segregation with Recourse Model, and (iii) have an incremental advantage over the Legal Segregation with Recourse Model with respect to impact on portfolio margining. 43 Consequently, the Commission chose not to propose the Legal Segregation with Recourse Model in the NPRM, but stated that it was still considering this model as an alternative. 42 For a more detailed discussion regarding risk costs, see section VII.B.2.b., infra. 43 See 33818 FR at 33828. F. Clarification of the Application of Financial and Segregation Interpretation No. 10 to Cleared Swaps In response to the Commission's NPRM, clarification was requested 44 regarding the applicability to the cleared swaps market of the Commission's 2005 Amendment to Financial and Segregation Interpretation No. 10 on the Treatment of Funds Deposited in Safekeeping Accounts (“Segregation Interpretation 10-1”). 45 The commenter noted that “[u]ntil 2005, the CFTC permitted the use of third-party custodial accounts for futures margin by pension plans and investment companies registered under the 1940 Act * * *. In 1984, the CFTC issued Financial and Segregation Interpretation No. 10 * * *, permitting the use of third party custodial accounts for the holding of customer property subject to certain conditions ensuring that an FCM would have immediate and unfettered access to customer funds.” 46 However, Segregation Interpretation 10-1 made it clear that, with limited exceptions, FCMs would not be in compliance with the requirements of section 4d(a)(2) of the CEA if they hold customer funds in a third-party custodial account. 44 See Committee on Investment of Employee Benefit Assets (“CIEBA”) December 22, 2011 letter (“CIEBA Supplemental”) at 2. 45 Amendment of Interpretation, 70 FR 24768, May 11, 2005 (Notice) The underlying Financial and Segregation Interpretation No. 10 (“Segregation Interpretation 10”) was issued on May 23, 1984, and can be found at Comm. Fut. L. Rep. (CCH) ¶7120. 46 CIEBA Supplemental at 4. The Commission agrees that Segregation Interpretation 10-1 does not apply to Cleared Swaps. Accordingly, and subject to the conditions described below, Cleared Swaps Customer Collateral may be deposited at a bank in a third-party safekeeping account, in lieu of posting such collateral directly to the FCM, without the FCM being deemed in violation of section 4d(f) of the CEA, and FCMs are permitted to allowed Cleared Swaps Customers to elect to have their Cleared Swaps Customer Collateral held in such accounts. However, if an FCM uses, or allows the use of, a third-party safekeeping account, that FCM must comply with all of the conditions for such accounts set forth in Segregation Interpretation 10 as originally issued in 1984. 47 In addition, as noted in Segregation Interpretation 10, though the use of third-party safekeeping accounts is not prohibited, such collateral constitutes customer property within the meaning of the Bankruptcy Code. As such, positions and collateral held in third-party custodial accounts are subject to the U.S. Bankruptcy Code and applicable provisions in the CEA, which provide for the pro rata share of available customer property. 47 These conditions include limitations regarding the titling and location of the third-party safekeeping account, and requirements concerning the FCM's rights to promptly liquidate positions and access collateral. The commenter also requested that the Commission revise or repeal Segregation Interpretation 10-1 to allow futures and options customers to have their collateral held in third-party safekeeping accounts. 48 However, while the Commission does not believe it would be appropriate to address this request at this time, as it is beyond the scope of this rulemaking, the Commission may address this concern in the future. 48 See CIEBA Supplemental at 12 The Commission also notes that a number of commenters 49 have proposed alternative arrangements that would provide individual protection for collateral belonging to cleared swaps market participants (and, in some cases, futures customers) that are willing and able to bear the associated costs. However, these proposals raise important risk management and cost externality issues, particularly with respect to ensuring that collateral is promptly available to DCOs in the event of a default, ensuring proper capital treatment for the relevant market participants, and protecting all customers. 49 See generally CIEBA August 8, 2011 letter (“CIEBA Original”) at 1-5; Salzman at 1-9; CME at 18; State Street at 2-4. The Commission has directed staff to carefully analyze these proposals with the goal of developing proposed rules that provide additional protection for collateral belonging to market participants. 50 50 The Commission also notes that any market participant may become a clearing member of a DCO, consistent with the DCO's membership eligibility requirements and the CEA and Commission regulations, with all the rights and responsibilities associated therewith. The Commission agrees with the comment that “swap margin is not meant to enhance the swap dealers' bottom line, but to protect the system against counterparty failure,” 51 and remains committed to protecting the market and market participants. 51 See CIEBA Supplemental at 14. II. The Final Rules In determining the scope and content of the final rules, the Commission has taken into account issues raised by commenters, including those issues with respect to the costs and benefits associated with the proposed segregation model for Cleared Swaps Customer Collateral. The Commission received twenty-eight (28) comment letters on the proposed rules, 52 twenty-five (25) of which addressed the issue of which segregation model the Commission should adopt for Cleared Swaps Customer Collateral. Of these twenty-five (25), the strong weight of the commenters rested in favor of individual protection for Cleared Swaps Customer Collateral, with twenty (20) comment letters supporting implementation of the Complete Legal Segregation Model, the Physical Segregation Model or some combination thereof. 53 Four (4) comment letters supported adoption of the current Futures Model, 54 with one (1) comment letter, from the FIA, showing support for both the Complete Legal Segregation Model and the Futures Model. 52 All comment letters are available through the Commission's Web site at: http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1038 . Comments addressing the proposed rules were received from: APG Algemene Pensioen Groep N.V. and the European Federation Retirement Provision (“APG/EFRP”), American Council of Life Insurers (“ACLI”), Association of Institutional Investors (“AII”), Bank of America, N.A., BlackRock, Inc. (“BlackRock”), Chris Barnard, CME, CIEBA, Federal Home Loan Banks (“FHLB”), Fidelity Management & Research Co. (“Fidelity”), Freddie Mac, Futures Industry Association (“FIA”), IntercontinentalExchange, Inc. (“ICE”), Investment Company Institute (“ICI”), International Swaps and Derivatives Association, Inc. (“ISDA”), LCH.Clearnet Group Limited (“LCH”), Managed Funds Association (“MFA”), Natural Gas Exchange, Inc. (“NGX”), Newedge USA, LLC (“Newedge”), Och-Ziff Capital Management Group (“Och-Ziff”), Jerrold E. Salzman, Securities Industry and Financial Markets Association (“SIFMA”), Tudor Investment Corporation (“Tudor”), and Vanguard. Note, CIEBA, Fidelity and the MFA each submitted two comment letters. 53 The following commenters support the Complete Legal Segregation Model outright: ACLI, AII, BlackRock, Mr. Barnard, Freddie Mac, ICI, ISDA, LCH, SIFMA, and Vanguard. APG/EFRP, CIEBA, Fidelity, MFA, Tudor and FHLB support implementation of the Physical Segregation Model. 54 The commenters in favor of adoption of the Futures Model were CME, ICE, Newedge, and Mr. Salzman. After carefully considering all comments, the Commission has selected the Complete Legal Segregation Model as the most appropriate segregation model for Cleared Swaps Customer Collateral under section 4d(f) of the CEA. The Commission believes this model provides the best balance between benefits and costs in order to protect market participants and the public. The Commission has adopted a number of clarifications and corrections suggested in the comment letters. In other cases the final rules are adopted as proposed. The discussion below provides a more detailed analysis of the issues raised by the comment letters. III. Segregation Model for Cleared Swaps Customer Collateral In the NPRM, the Commission proposed the Complete Legal Segregation Model but made clear that, because the costs and benefits associated with the Complete Legal Segregation Model were still being evaluated, the Commission was considering whether to adopt the Legal Segregation with Recourse Model as an alternative, and was continuing to assess the feasibility of the Futures Model and a clearinghouse-by-clearinghouse Optional Approach. Below is a summary of the comments the Commission received regarding the alternative segregation models for Cleared Swaps Customer Collateral. A. Summary of the Comments 1. Complete Legal Segregation Model As mentioned above, the majority of the comment letters supported adoption of the Complete Legal Segregation Model either outright or as a viable alternative to the Physical Segregation Model, with most arguing that the Complete Legal Segregation Model presents the best balance between costs and adequacy of collateral protections, 55 and several calling it a “significant improvement over the” Futures Model. 56 Several commenters also opined that the Complete Legal Segregation Model is supported by the statutory language and purposes of the Dodd-Frank Act. 57 55 See ACLI at 2; AII at 1; BlackRock at 1; Barnard at 2; Fidelity at 2; Freddie Mac at 2; LCH at 1-2; SIFMA at 3; Vanguard at 8. 56 CIEBA at 1; and FHLB at 1. 57 See BlackRock at 3; Fidelity at 5-6; FIA at 3, n. 10; ICI at 2; Mr. Barnard at 1; and SIFMA at 3, n. 7. In addition, many of the comment letters asserted that the Complete Legal Segregation Model largely mitigates Fellow-Customer Risk and enhances the portability of cleared swap positions and associated collateral. 58 One commenter stated that the Complete Legal Segregation Model is “the most cost effective framework to adequately protect the margin customers post to cleared swap transactions” because it effectively mitigates Fellow-Customer Risk, avoids the costs associated with establishing the Physical Segregation Model by allowing margin to be held in an omnibus account, and enhances the portability of cleared swap positions and related margin. 59 Another commenter stated that the Complete Legal Segregation Model “provides the most operationally efficient framework to manage risk on a daily basis or port portfolios especially in periods of stress.” 60 And yet other commenters argued that there has been little substantiation of the “increased costs” that would arise from implementation of the Complete Legal Segregation Model, especially with respect to costs surrounding the reporting requirements associated with maintaining separate legal accounts given that “other regulatory rulemakings that require similar reporting will likely result in many of these incremental operational costs being incurred regardless of which model is chosen.” 61 58 See, e. g., AII at 3 (stating that the Complete Legal Segregation Model effectively eliminates Fellow-Customer Risk, enhances portability of positions and related margin, and largely avoids the costs associated with establishing individually segregated accounts); BlackRock at 2 (arguing that the Complete Legal Segregation Model “eliminates Fellow-Customer Risk and facilitates `immediate' portability of customer positions if required”); CIEBA Original at 5 (acknowledging that the Complete Legal Segregation Model could eliminate Fellow-Customer Risk); FHLB at 3 (agreeing that the Complete Legal Segregation Model greatly reduces Fellow-Customer Risk); ICI at 3 (stating that the Complete Legal Segregation Model mitigates Fellow-Customer Risk); ISDA at 1-2 (agreeing that Complete Legal Segregation Model facilitates post-default portability); MFA at 3-4 (stating that the Complete Legal Segregation Model eliminates Fellow-Customer Risk and enhances the portability of customer positions); Vanguard at 4-6 (arguing that the Complete Legal Segregation Model addresses counterparty risk and Fellow-Customer Risk); and SIFMA at 5 (stating that Complete Legal Segregation Model minimizes Fellow-Customer Risk and facilitates the ability of Cleared Swaps Customers to port their positions to a non-defaulting FCM). 59 AII at 1. 60 BlackRock at 6. 61 Fidelity at 6. See also LCH at 2-3. The Commission has adopted a gross margining requirement. See 76 FR at 69374-76. Several commenters also argued that, in selecting a segregation model for Cleared Swaps Customer Collateral, the Commission should take into account the differences between the risk profiles of futures and over the counter (“OTC”) swaps. 62 62 BlackRock at 2-4; Fidelity at 4; SIFMA at 2; Vanguard at 3-4. Furthermore, commenters argued that, unlike the Futures Model, the Complete Legal Segregation Model would not degrade the collateral protections that currently exist in the OTC swaps market. 63 In addition, one commenter indicated that the Complete Legal Segregation Model is “the model that most closely parallels the protections that [LCH] understand[s] will be required in Europe under the European Commission's proposal for a European Market Infrastructure Regulation (“EMIR”).” 64 63 See Fidelity at 2-4; Freddie Mac at 1; and LCH at 1. See also Tudor at 2 (arguing that the segregation model selected by the Commission should not provide a lesser degree of protection for Cleared Swaps Customer Collateral). 64 LCH at 1. Commenters who did not support adoption of the Complete Legal Segregation Model largely argued that (1) The costs of implementing the Complete Legal Segregation Model outweigh any of the purported benefits of such model; 65 (2) the Complete Legal Segregation Model would, in the view of the commenter, fail to work operationally or legally, 66 and does not take into account the operational complexities of multi-tiered and multi-DCO clearing; 67 (3) individualized segregation potentially introduces systemic costs because it impedes timely market settlements during periods of market stress; 68 (4) since the Futures Model has served the industry well during times of stress in the futures market, it should be the segregation model for Cleared Swaps Customer Collateral; 69 (5) the Complete Legal Segregation Model introduces moral hazard; 70 or (6) the Complete Legal Segregation Model does not provide enough protection of Cleared Swaps Customer Collateral because there is some residual Fellow-Customer Risk, 71 and it does not protect against fraud-related risks, 72 record-keeping/operational risk, and Investment Risks. 73 Moreover, several commenters disagreed with the Commission's interpretation of the statutory language in the Dodd-Frank Act, and argued that the statutory language cited by the Commission does not indicate Congressional intent for individual protection for Cleared Swaps Customer Collateral. 74 65 See, e. g., ICE at 11. 66 See CME at 5 (stating that “the framework established by the [Complete Legal Segregation Model] concept and the proposed regulations will be wholly inadequate to achieve the Commission's desired objectives: Namely, in an FCM default, the preservation of non-defaulting cleared swaps customers' collateral and the ability to port their positions and collateral to another FCM.”). 67 See, e. g., CME at 6-8. See also Mr. Salzman at 7 (stating that “the benefits promised by the proponents of the [Complete Legal Segregation Model] are illusory,” and arguing that the Commission's authority to adopt, and a bankruptcy court's willingness to respect, such model are questionable). 68 See ICE at 3. 69 See, e. g., Newedge at 8; and CME at 23. 70 See, e. g., Newedge at 4-5. 71 See, e. g., CME at 7. 72 Fraud-related risks are risks associated to an FCM's fraudulent activity with respect to the cleared swap margin account. 73 See, e. g., Tudor at 4; CIEBA Original at 1; and FHLB at 3-6 (each advocating for the adoption and implementation, either outright or on an optional basis, of the Physical Segregation Model, though acknowledging that the Complete Legal Segregation Model is preferable to the Futures Model). 74 See CME at 21-22 (arguing that if Congress intended to change the framework for the protection of customer collateral it would have explicitly done so); FIA at 3, n. 10 (agreeing that the complete legal segregation model is permitted by the language of section 4d(f), but arguing that Commission reliance on the differences between sections 4d(a) and 4d(b) are misplaced); and ICE at 5 (arguing that the Commission should not rely on the language in section 4d(f) because there is no legislative history interpreting the statutory language). 2. Physical Segregation Model Comments with respect to the Physical Segregation Model were mixed, with some commenters advocating the adoption of the Physical Segregation Model outright, 75 others advocating for its adoption on an optional basis, 76 and others arguing that the Physical Segregation Model should not be adopted because the increased costs and operational burdens associated with adoption of the Physical Segregation Model outweigh the benefits. 77 75 FHLB at 1; Tudor at 1-2. 76 ACLI at 2; CIEBA at 2; MFA at 2; Mr. Salzman at 8. 77 BlackRock at 6; Vanguard at 6. Two commenters requested that the Commission reconsider adoption of the Physical Segregation Model on the basis that (i) Customer collateral should be individually segregated at both the FCM and the DCO to provide the same level of customer collateral protection that currently exists in the OTC swaps market, (ii) none of the other models are sufficient to fully protect customer collateral from recordkeeping/operational, investment and fraud-related risks, (iii) the Physical Segregation Model facilitates porting more than the other models, and (iv) the commenters would be willing to bear any increased costs associated with the adoption of the Physical Segregation Model. 78 78 See, e.g., ICI at 2 and 9. In addition, though several commenters supported the Complete Legal Segregation Model as the best alternative under consideration, these commenters urged the Commission to develop a framework for the adoption of the Physical Segregation Model because (i) The protections offered by the Physical Segregation Model are greater than those offered by the Complete Legal Segregation Model, (ii) the Physical Segregation Model facilitates porting more than the other models, and (iii) the costs assertions resulting from implementing the Physical Segregation Model have either not been substantiated or are costs that the commenters are willing to bear. 79 79 See, e.g., ACLI at 2; BlackRock at 5. Commenters that opposed adoption of the Physical Segregation Model generally did so on the basis that implementation of the model would give rise to substantial increased costs with little increased benefit, as compared with the Complete Legal Segregation Model. 80 80 See, e.g., AII at 2; ICE at 9; FIA at 6; SIFMA at 4 n. 9; and Vanguard at 6. 3. Futures Model As mentioned above, four comment letters supported adoption of the Futures Model, with one commenter supporting adoption of both the Complete Legal Segregation Model and the Futures Model. CME argued that the Futures Model provides the best balance of costs versus industry risk as a whole and is “the only approach that provides both legal and operational certainty to all parties in the event of an FCM default.” 81 According to CME, the Complete Legal Segregation Model imperfectly protects customer collateral and thus, “the Commission [should] not rush [sic] to implement a `solution' that gives superficial comfort, but may not work either operationally or legally in the event of an actual default.” 82 CME encouraged the Commission to “engage in further study, and establish a review process that includes a representative group of interested parties with expertise in the area, in order to evaluate alternative approaches.” 83 Because the Futures Model has effectively protected customer interests in the futures market, CME recommended that, in the interim, the Commission implement swaps clearing employing the Futures Model. 84 Moreover, CME suggests that the Commission support a new industry effort to, at some point in the future, develop and implement a guaranteed clearing participant relationship that would allow a client, on an optional basis, to have a direct relationship with a DCO, with the client's positions guaranteed by a guaranteeing clearing member of the DCO and the client's Cleared Swaps Customer Collateral held in an outside account by a third party custodian. 81 CME at 23. 82 Id. at 2. 83 Id. 84 See id. at 23. Mr. Salzman supported adoption of the Futures Model with optional full physical segregation of Cleared Swaps Customer Collateral. ICE advocated adoption of the Futures Model, arguing against fundamentally changing a clearinghouse's existing operations, and positing that customers that wish to avoid Fellow-Customer Risk might explore becoming direct clearing participants once they “fully appreciate[e] the substantial costs * * * associated with implementing and maintaining [the Complete Legal Segregation Model].” 85 However, ICE also proposed, as a middle ground, a model that appears to be based on the Futures Model but that provides some protection against Fellow-Customer Risk. ICE explained that its ICE Clear Credit affiliate had adopted a model under which, “customers are exposed to `fellow-customer risk' only with respect to the customer's pro-rata share of the net customer-related margin requirement of its clearing member.” 86 ICE Clear Credit considers “the difference between a customer's gross margin requirement and the customer's net margin requirement” to be “Excess Margin.” 87 ICE stated that a customer's Excess Margin is segregated and held by ICE Clear Credit on a custodial basis and is therefore not exposed to Fellow-Customer Risk. ICE argued that this model would provide some protection against Fellow-Customer Risk but would be more cost-effective than the proposed Complete Legal Segregation Model. In addition, ICE stated that individual segregation should be offered to customers at the option of a DCO, and also advanced the notion that the Commission should “carefully consider and weigh the costs and benefits of potential customer-related OTC clearing models by asset class * * *.” 88 85 ICE at 3. 86 Id. 87 Id. at 3, n. 3. 88 ICE at 1-2. Newedge, which submitted a comment on behalf of itself, DRW Trading Group and nine “Customers,” supported adoption of the Futures Model on the basis that the Futures Model “is the model most consistent with the general purposes of Title VII of Dodd-Frank as well as least likely to add moral hazard to the industry.” 89 Newedge argued that Title VII is about the reduction of systemic risk through the mutualization of risk, and that by mutualizing credit risk the Futures Model promotes the purpose of the Dodd-Frank Act because such mutualization encourages the creation and maintenance of well-capitalized FCMs. In addition, Newedge argued that the loss of customer off-sets would increase moral hazard because it would encourage FCMs to maintain less excess capital. Furthermore, Newedge suggested that, as an alternative to the adoption of the Complete Legal Segregation Model, the Commission should require greater FCM disclosure to allow customers to better assess Fellow-Customer Risk. 90 89 Newedge at 2. 90 Newedge argues that such disclosure be provided in “plain English” on an annual basis, and include the following data: The FCM's total equity, regulatory capital and net worth; The dollar value of the FCM's proprietary margin requirements as a percentage of its segregated and secured customer margin requirements; What number of the FCM's customers comprise an agreed significant percentage of its customer segregated funds; The aggregate notional value of non-hedged, principal OTC transactions into which the FCM has entered; The amount, generic source and purpose of any unsecured and uncommitted short-term funding the FCM is using; The aggregate amount of financing the FCM provides for customer transactions involving illiquid financial products for which it is difficult to obtain timely and accurate prices; The percentage of customer “bad debts” the FCM had during the prior year compared to its year-end segregated and secured customer funds; and A summary of the FCM's current risk practices, controls and procedures. Newedge at 7. See also FHLB at 7, n. 14 (encouraging the Commission, in response to a question in the NPRM regarding additional disclosure of FCM financial information, to make such information publicly available on a real time basis); and MFA at 5 (arguing that “if the Commission mandates the disclosure by FCMs of certain financial information, customers will be in a better position than they are today to evaluate the financial strength of their FCM.”). Comment letters supporting individual protection for customer collateral over the Futures Model generally did so on the basis that the Futures Model (i) does not protect Cleared Swaps Customer Collateral from Fellow-Customer Risk, Investment Risk, operational risk or fraud-related risk, and (ii) does not facilitate the portability of customer positions and associated collateral in the event of an FCM's default. 91 91 See, e.g., AII at 1-2; BlackRock at 2, 7-8; CIEBA Original at 5; FHLB at 6-7; Fidelity at 3; Freddie Mac at 1-2; SIFMA at 5; and Vanguard at 4-5. BlackRock argued that not only does the Futures Model fail to address the core risk differences between futures and OTC swaps, but because of the buffer created by the mutualized risk provided by the customer collateral, the Futures Model may result in less stringent selection and oversight of customers by FCMs. 92 In addition, BlackRock argued that the moral hazard argument advocated by proponents of the Futures Model presumes that futures customers have access to information that allows them to make informed decisions regarding their fellow customers. However, BlackRock stated that access to such information is currently lacking, there are no requirements or incentives for a DCO or FCM to inform a customer when a fellow customer is in a stress or potential default situation and, as a result, customers are forced to rely on DCOs and regulators for protection. 93 92 Blackrock at 8. 93 Id. Freddie Mac argued that by allowing DCOs to access the collateral of non-defaulting customers to cover the losses of defaulting customers, the Futures Model provides a “subsidy to DCOs, FCMs and their riskiest customers at the expense of customers that present less risk[, and] this non-transparent shifting of risk would create moral hazard and inefficient credit decisions.” 94 94 Freddie Mac at 2. Similarly, FHLB argued that DCOs and FCMs should bear all Fellow-Customer Risk as they are in a superior position to conduct analyses of other cleared swap customers. 95 In addition, FHLB indicated that if the Commission adopts the Futures Model as the segregation model for Cleared Swaps Customer Collateral, it would be anomalous for market participants to have the initial margin they post for Cleared Swaps face greater risk than the initial margin they post for uncleared swaps. 96 Moreover, the Futures Model would impede portability because the collateral posted for Cleared Swaps “could be tied up in the omnibus account indefinitely.” 97 95 FHLB at 6-7. 96 FHLB at 7. FHLB also states that market participants have a statutory right to segregate initial margin they post for uncleared swaps with an independent custodian. Id. at 6. 97 FHLB at 7. SIFMA stated that avoiding Fellow-Customer Risk presented by the Futures Model should be the most important objective in selecting a segregation model for Cleared Swaps Customer Collateral and, as such, none of the members of the Asset Management Group supports the Futures Model. 98 In addition, SIFMA argued that the Futures Model does not facilitate portability to the same extent as the Complete Legal Segregation Model and, therefore, is not as effective at reducing systemic risk. 99 98 SIFMA at 3. 99 See SIFMA at 4-6. Vanguard asserted that the Futures Model exposes market participants to Fellow-Customer Risk and because this risk is not a factor in the OTC swaps markets, the magnitude of such risk is not something that a customer could ever assess, especially given the “complete lack of transparency with respect to [an] FCM's other customers and their trading positions.” 100 Furthermore, Vanguard stated that mutualization of customer losses effectively allows “less sophisticated analysis of the risk presented by individual customers and their trading portfolios as such individual risk can ultimately be covered by the overall pool of margin posted by all of the FCM's customers,” with the result that “riskier customers (and trading portfolios) [are] likely to be under margined and safer clients (and trading portfolios) [are] likely to be over margined relative to their actual level of risk presented to the system.” 101 In sum, Vanguard stated that, given the differences between the swaps and futures markets, the Futures Model could expose a Cleared Swaps Customer to significantly greater and potentially unlimited risk. 102 100 Vanguard at 5. 101 Id. 102 Id. 4. Legal Segregation With Recourse Model None of the comment letters received by the Commission appeared to support the Legal Segregation with Recourse Model. Commenters that discussed this model generally stated that the Commission should not adopt the Legal Segregation with Recourse Model because either (1) by failing to mitigate Fellow-Customer Risk, it is substantially inferior to the Complete Legal Segregation Model 103 or (2) it suffers from the same shortcomings as the Complete Legal Segregation Model since it is costly to implement and fails to mitigate investment and operational risks. 104 103 See BlackRock at 7; FHLB at 7; Freddie Mac at 2; FIA at 6-7; MFA at 2; and Vanguard at 4. 104 See, e.g., CME at 16. 5. Optional Approach Though some commenters expressed a desire to have optional full physical segregation of Cleared Swaps Customer Collateral, none of the commenters supported the Optional Approach outlined by the Commission. 105 Under this approach, each DCO would choose the level of customer collateral protection it chooses to offer. 106 The Commission noted that this approach might be reconciled with section 766(h) of the Bankruptcy Code by permitting DCOs to require that FCMs establish separate legal entities, each of which is limited to clearing at DCOs that use only the same customer collateral protection model. 107 105 See, e.g., MFA at 3 n. 11 (stating “[t]he Commission should allow market participants to elect the Physical Segregation Model but only to the extent that it is compatible with the Complete Legal Segregation Model. We are not advocating that the Commission adopt the “Optional Approach” set forth in the Proposing Release, because we believe that approach would be very difficult to implement.”); ACLI at 2 (supporting the option to negotiate and select the Physical Segregation Model); BlackRock at 5 (stating that BlackRock would support an optional approach if the Commission believes such an approach would be prudent, but cautions that optionality may present implementation challenges and result in portability delays); CIEBA Original at 1 (promoting optional individual segregation of Cleared Swaps Customer Collateral); CME at 17-20 (arguing that the Commission should support efforts to establish programs that would permit individuals to physically segregate the collateral associated with their Cleared Swaps positions on an optional basis); and Tudor at 6 (arguing that if the Commission does not adopt the Physical Segregation Model, the Commission should “require DCOs to offer various segregation models to their cleared swaps customers, including full physical segregation.”). 106 See 76 FR at 33825. 107 See 76 FR at 33829. One commenter stated that it is “likely that the benefits of creating such a regulatory structure would be illusory,” 108 while another argued that “[o]ptionality will produce complexity and expense that might be tolerable when the cleared swaps market is well established, but that will be burdensome to a developing market.” 109 In addition, one commenter expressed concern regarding the appropriateness of the Commission adopting a segregation regime “that provides protection to customers based on their ability and willingness to pay.” 110 108 CME at 20. 109 ISDA at 2. 110 FIA at 6. B. Discussion of the Comments After careful analysis of the issues raised by the comment letters with respect to the selection of a segregation model for Cleared Swaps Customer Collateral, the Commission is adopting the Complete Legal Segregation Model. As described above, the majority of market participants supported adoption of either the Complete Legal Segregation Model or the Physical Segregation Model. In addition, while certain technical corrections/clarifications were requested, none of the commenters identified material new information with respect to costs or benefits associated with the adoption of the Complete Legal Segregation Model or any other model under consideration. Some commenters did, however, re-iterate their view that their business model depended upon receiving stronger protection for their Cleared Swaps Customer Collateral than what exists under the Futures Model. These commenters are accustomed to paying for the higher costs implicit in separate accounting in the current bilateral market. On the other hand, CME, ICE, and Mr. Salzman identified a number of issues with the Complete Legal Segregation Model, including a number of limitations on the protection it provides to customers. They did not, however, provide reason to reject the conclusion that the Complete Legal Segregation Model provides substantially greater protection against Fellow-Customer Risk than the Futures Model. CME notes 111 that a portion of the Cleared Swaps Customer Collateral will be held at the FCM, not the DCO, and that this collateral will not be protected by Complete Legal Segregation in the event that an FCM becomes insolvent. This proposition is true 112 but is of little or no relevance to the comparison of Complete Legal Segregation with the Futures Model favored by these commenters. Complete Legal Segregation is intended to protect against Fellow-Customer Risk. As discussed in the NPRM and above, 113 Fellow-Customer Risk is the risk that the collateral of one customer will be used to compensate a DCO for market losses resulting from the swaps of another customer. 114 In other words, Fellow-Customer Risk arises in connection with collateral maintained in an FCM's customer account posted with a DCO because, under the Futures Model, the DCO is potentially entitled to take all of the collateral in this account to cover losses created by the swaps of any customer. However, Cleared Swaps Customer Collateral held at the FCM (or at a location other than at the DCO, such as a bank) is not accessible to the DCO. Thus, such collateral is not subject to Fellow-Customer Risk. 115 While Cleared Swaps Customer Collateral in the customer account at the FCM is available to meet customers' swaps-related obligations to the FCM, the FCM is prohibited by statute from using one customer's Cleared Swaps Customer Collateral as margin or security for another customer's swaps. 116 111 CME at 6. 112 See supra note 13. 113 See supra at Section 1.B.6. 114 76 FR at 33821 n. 21. 115 As explained above, FCMs typically maintain two separate Cleared Swaps Customer Accounts. One is maintained at the DCO and contains collateral required by the DCO to secure current swaps positions. The second is maintained by the FCM itself, typically at a bank, and contains collateral provided to the FCM by customers but not currently posted to the account at the DCO. 116 Section 4d(f)(2)(B) of the CEA, 7 U.S.C. 6d(f)(2)(B). To be sure, Cleared Swaps Customer Collateral is subject to operational risk—the risk that, due to fraud, incompetence, or other mishap, customer funds that are required to be segregated are lost. Operational risk, however, is common to all of the segregation models for Cleared Swaps Customer Collateral, including the Physical Segregation Model. 117 Collateral at the FCM is also subject to a modicum of Investment Risk. But Commission regulation 1.25, upon which regulation 22.2(e)(1) is based, is designed to ensure that customer segregated funds are invested in a manner that minimizes their exposure to credit, liquidity, and market risks both to preserve their availability to customers and DCOs and to enable investments to be quickly converted to cash at a predictable value in order to avoid systemic risk. Towards these ends, regulation 1.25 establishes a general prudential standard by requiring that all permitted investments be “consistent with the objectives of preserving principal and maintaining liquidity.” 118 117 Moreover, as noted above ( see supra section I.D.2), while the LSOC Model does not protect against operational risk any more than the Futures Model, it is superior in that it enhances the ability to transfer collateral after an insolvency caused by operational risk. 118 See regulation 1.25(b). CME also provides a detailed description of how, due to the “the extended operational timeline for derivatives clearing and the netting of payments,” a customer could default on a payment on Tuesday, but the DCO would, due to a countervailing gain by a different customer or customers of the same clearing member, not see such a default until after Wednesday's clearing cycle (payments for which may not be due until Thursday morning). 119 This analysis elides the fact that, pursuant to the calculations required under regulation 22.2(f), an FCM with a customer who incurred a loss in excess of that customer's Cleared Swaps Customer Collateral would, unless and until that customer posted additional collateral, be required to have covered such loss with the FCM's own capital deposited into the Cleared Swaps Customer Account. If, at any moment, such customer loss was not covered by the FCM's own capital, then the FCM would be in violation of its segregation requirements. Pursuant to Commission regulation 1.12(h), 119 CME at 9. [w]henever a person registered as a futures commission merchant knows or should know that the total amount of its funds on deposit in segregated accounts on behalf of customers * * * is less than the total amount of such funds required by the Act and the Commission's rules to be on deposit in segregated * * * accounts on behalf of such customers, the registrant must report such deficiency immediately by telephonic notice * * * to the registrant's designated self-regulatory organization and the principal office of the Commission in Washington, DC * * *. 120 120 Commission regulation 1.12(h) emphasis added. Thus, an FCM whose customer suffers such a loss which is not covered by the FCM's own capital on deposit in the Cleared Swaps Customer Account will certainly know of such deficiency no later than noon the next day (Wednesday in CME's example), when it will be required, pursuant to regulation 22.2(g), to compute its segregated funds requirements and the amount of segregated funds it has on deposit to meet such requirements. Moreover, the Commission believes that an FCM carrying a customer account that suffers losses in excess of that firm's ability to cover “should know” of such losses by the end of that trading day (Tuesday in CME's example). Such notice will permit the Commission to act to notify the relevant clearing organizations and to ensure that prompt action is taken to either bring capital in to enable the FCM to meet its segregated funds requirements or to otherwise act to minimize customer losses. CME implies that a successful porting of customer accounts requires information that is “100% accurate,” 121 and that an FCM is unlikely to meet that standard each day. CME also notes that there may be portfolio changes in customer accounts on the day of default. 122 Moreover, CME notes that a defaulting FCM may have systems that fail. 123 CME notes that in the case of Lehman Brothers, 124 there was a “rushed, confused, uncertain and near-panic atmosphere,” as described in the report of the SIPA Trustee. 125 121 CME at 13. 122 Id. at 12. 123 Id. at 14. 124 The Lehman Brothers FCM was placed into a Securities Investor Protection Corporation liquidation on Friday, September 19, 2008. 125 CME at 14 (citation omitted). Recent experience demonstrates, however, that transfers can occur despite less than perfect information. For example, in the case of the bankruptcy of Lehman Brothers the commodity customer accounts were effectively transferred to Barclays over the weekend of September 20-21, 2008, immediately following the commencement of the liquidation of the firm, 126 and any discrepancies were resolved, despite the difficulties described. Indeed, the key issue will be to identify the collateral attributable to the defaulting customer, as distinguished from the collateral attributable to all other customers, as discrepancies between non-defaulting customers can be resolved either as transferred accounts are reconciled, or through the claims process. 126 This transfer was authorized in the hours immediately following the commencement of Lehman's liquidation, and was implemented in the hours immediately thereafter. Thus, while CME is correct in stating that “the risk of ultimate financial loss to customers due to a fellow-customer default is reduced but certainly not eliminated under CLSM,” 127 the Commission concludes, based on its experience with its rules in general and with FCM bankruptcies in particular, that the probability and probable amount of such loss is far less than CME implies. 127 CME at 15. Moreover, the swift portability of collateral associated with customer positions in the event of an FCM's default remains problematic under the Futures Model where there is a customer default. Furthermore, many of the imperfections of the Complete Legal Segregation Model and the residual Fellow-Customer Risk associated therewith that were highlighted by CME arise from the “last-day risk” that results from the fact that information about each customer's positions is only provided once each day. However, the NPRM made clear in relevant portions of sections 22.11 and 22.12, and the Commission reiterates herein, that information must be provided and calculations must be made at least once a business day. In other words, many of the imperfections discussed by CME are not inherent to the Complete Legal Segregation Model. Rather, each DCO is free to make improvements to that minimum regulatory standard if the DCO finds such improvements to be technologically feasible and economically justifiable. For example, a DCO could require its clearing members to identify the customer associated with each swap as it is cleared, and the DCO could use this information to associate gains and losses more tightly with each customer, thereby minimizing “last-day risk.” The NPRM and this final rule simply set a minimum threshold for daily tracking. With respect to costs associated with evaluating the credit risks of individual customers, CME noted that it calculates, “at the end of each trading day * * * for each FCM's cleared swaps customer account * * * the net position of each customer in the account [and] the net margin requirement for each customer in the account.” 128 Thus, based on CME's description of its current clearing practices, it would appear that CME already undertakes an individualized evaluation of the sufficiency of the collateral posted by each customer of an FCM. 129 In addition, as CME notes, “FCMs are subject to compliance audits that are conducted for each FCM by the DCO serving as its “designated self-regulatory organization.” 130 It would therefore seem that at least some of the costs associated with evaluating the credit risk of individual customers are already being incurred by DCOs. 128 Id. at 9 (emphasis supplied). 129 In addition, during the Second Roundtable, Ms. Taylor of CME stated that with respect to risk management, CME is “set up to do it in the over-the-counter business at the individual customer level.” See Second Roundtable Tr. at168, l. 10. 130 See also Second Roundtable Tr. at 171, l. 18 (Ms. Taylor stating that “on a day-to-day basis we don't see the collateral that's in the account of a customer at an FCM, but we do have transparency into the efficacy of the practices of holding margin and holding it in segregated accounts through the financial supervision and audit functions so that there is ongoing monitoring of that * * *”). With respect to ICE's proposal, the Commission notes that it would provide less Fellow-Customer Risk protection than the Complete Legal Segregation Model. The fact that swap customers seem to overwhelmingly favor at least as much Fellow-Customer Risk protection as afforded to them under the Complete Legal Segregation Model, notwithstanding the potential costs, weighs in favor of the Complete Legal Segregation Model rather than ICE's proposal. With respect to Newedge's suggestion for increased disclosure of FCM information, additional disclosure is often beneficial, and the Commission will consider additional disclosure requirements as a means of enhancing protection for collateral belonging to market participants. However, because of confidentiality concerns, any feasible enhanced disclosure is insufficient for quantifying risk exposure to Fellow-Customer Risk and, thus, insufficient for providing Cleared Swaps Customers with the ability to effectively manage such exposure. 131 Moreover, even if it were practical to provide Cleared Swaps Customers with information sufficient to assess Fellow-Customer Risk, that task is better left to the DCO since (1) DCOs have a concentrated ability to ensure adequate risk mitigation, and (2) having each Cleared Swaps Customer effectively risk-manage each FCM would likely entail duplication with resulting cost. 131 See Second Roundtable at p. 183, 1.12-p. 184, 1.10 (In reference to the disclosure of additional FCM information, Mr. Kahn stating “Barclays does agree and would be willing to show our risk-management procedures and policies, and we do talk to our buy side clients about that * * * [but] if Barclays is providing clearing services for any of the individual firms on the other side of the table, we do not say that, nor would we ever give out any position level information. It is very important to us that in whatever paradigm it's set up and how you evaluate from a risk-management standpoint that the buy side and their trades that they've put on that we are serving remains confidential and does not leak to the market in any side.”); and Second Roundtable at p. 185, 1.6 (Ms. Taylor stating that “when we know when people clear, that's very confidential information and I'm very sympathetic to the fear about fellow customer risk, but I'm also very sympathetic to the fact that none of you would want your information disclosed so that there is a balance on the other side * * *”). See also In re Stotler and Co., 144 B.R. 385, 393 (Bankr.N.D.Ill. 1992) (“[T]he legislative history of 11 U.S.C. 766 emphasizes that the risk of a broker's bankruptcy is not to be borne by the customer * * *.” Individual customers “face a formidable task in researching the relative solvency, reputation, and success of competing FCMs.”). Thus, after careful analysis of the comments, the Commission believes that the Complete Legal Segregation Model provides the most appropriate framework for the protection of Cleared Swaps Customer Collateral at this time. None of the segregation models the Commission considered provides perfect protection for Cleared Swaps Customer Collateral, and the degree of imperfection of any of the models is influenced by “the facts and circumstances” of an FCM default. However, as CME notes, the Complete Legal Segregation Model “would, on its face, lead to greater protection of cleared swaps customer collateral against Fellow-Customer Risk than the Futures Model” 132 and is “more likely to facilitate portability of cleared swaps customer positions than the Futures Model, in the event of an FCM default in its cleared swaps customer account * * *.” 133 Furthermore, the Complete Legal Segregation Model provides the best balance between benefits and costs in order to protect market participants and the public. 132 CME at 16. 133 Id. Finally, while the Complete Legal Segregation Model is a critical step in the efforts to protect customers and their collateral, as noted above, the Commission is actively considering seeking notice and comment on a proposal to allow individual protection of client assets. In addition, the Commission is directing staff to look into the possibility of adopting the Complete Legal Segregation Model for the futures market. The Commission remains committed to protecting market participants. IV. Section by Section Analysis: Regulation Part 22 A. Regulation 22.1: Definitions Proposed regulation 22.1 established definitions for, inter alia, the following terms: “cleared swap,” “cleared swaps customer,” “cleared swaps customer account,” “cleared swaps customer collateral,” “cleared swaps proprietary account,” “clearing member,” 134 “collecting futures commission merchant,” “commingle,” “customer,” “depositing futures commission merchant,” “permitted depository,” 135 and “segregate.” 134 Under the Commission's proposal, the term “clearing member” means “any person that has clearing privileges such that it can process, clear and settle trades through a derivatives clearing organization on behalf of itself or others. The derivatives clearing organization need not be organized as a membership organization.” 135 The Commission proposed to define “permitted depository” as a depository that is a bank located in the United States, a trust company located in the United States, a Collecting Futures Commission Merchant registered with the Commission (but only with respect to a Depositing Futures Commission Merchant providing Cleared Swaps Customer Collateral), or a derivatives clearing organization registered with the Commission. In addition, the FCM or the DCO must hold a written acknowledgment letter from the depository as required by proposed regulation 22.5. 1. “Segregate” and “Commingle” Regulation 22.1 proposed definitions for the terms “segregate” and “commingle” that are intended to codify the common meaning of such terms under the part 1 of the Commission's regulations (the “Part 1 Provisions”). Pursuant to the proposal, to “segregate” two or more items means to keep them in separate accounts and to avoid combining them in the same transfer between accounts. In contrast, “commingle” means to hold two or more items in the same account, or to combine such items in a transfer between accounts. The Commission did not receive comments on these proposed definitions and is, therefore, adopting them as proposed. 2. “Cleared Swap” Regulation 22.1 proposed a definition of the term “Cleared Swap” that (i) excludes, for purposes of Part 22 only, cleared swaps (and related collateral) that, pursuant either to a Commission rule, regulation, or order (including an order under section 4d(a) of the CEA) or to a DCO rule approved in accordance with regulation 39.15(b)(2), 136 are commingled with futures contracts (and related collateral) in a customer account established for the futures contracts, but (ii) includes, for purposes of Part 22 only, futures contracts or foreign futures contracts (and, in each case, related collateral) that, pursuant to either a Commission rule, regulation, or order (including an order under section 4d(f) of the CEA) or to a DCO rule approved in accordance with regulation 39.15(b)(2), 137 are commingled with cleared swaps (and related collateral) in a customer account established for the cleared swaps. The Commission did not receive comments on the proposed definition of “Cleared Swap” and is adopting it as proposed with one change. The Commission finalized regulation 39.15 on October 18, 2011. 138 That final regulation requires a DCO seeking to commingle Cleared Swaps (and related collateral) with futures contracts (and related collateral) in a futures account to petition for a Commission order under section 4d(a) of the CEA. Thus, the final definition of “Cleared Swap” in this rulemaking removes the reference to DCO rule approval procedures relevant to such commingling. 136 Section 4d(a) of the CEA, 7 U.S.C. 6d(a). 137 Section 4d(f) of the CEA, 7 U.S.C. 6d(f). 138 76 FR 69441. 3. “Cleared Swaps Customer” and “Customer” Regulation 22.1 proposed definitions of “Cleared Swaps Customer” and “Customer.” The Commission is adopting the definitions of “Cleared Swaps Customer” and “Customer” essentially as proposed, except that a technical amendment is made to the definition of Cleared Swaps Customer to clarify that a clearing member of a DCO is not a Cleared Swaps Customer with respect to Cleared Swaps cleared on that DCO. 4. “Cleared Swaps Customer Collateral” Proposed regulation 22.1 defined Cleared Swaps Customer Collateral to include (i) money, securities, or other property that an FCM or a DCO receives, from, for, or on behalf of a Cleared Swaps Customer that is intended to or does margin, guarantee, or secure a Cleared Swap 139 or, if the Cleared Swap is in the form or nature of an option, constitutes the settlement value of such option and (ii) “accruals,” which are the money, securities, or other property that an FCM or DCO receives, either directly or indirectly, as incident to or resulting from a Cleared Swap that the FCM intermediates for a Cleared Swaps Customer. The proposed definition explicitly included a Cleared Swap in the form or nature of an option as Cleared Swaps Customer Collateral, but did not explicitly include option premiums as Cleared Swaps Customer Collateral. The proposed definition also explicitly included in “accruals” the money, securities, or other property that a DCO may receive relating to the Cleared Swap that an FCM intermediates for a Cleared Swap Customer. 139 Proposed regulation 22.1 provides that “Cleared Swaps Customer Collateral” includes collateral that an FCM or a DCO receives from, for, or on behalf of a Cleared Swaps Customer that either (i) is actually margining, guaranteeing, or securing a Cleared Swap or (ii) is intended to margin, guarantee, or secure a Cleared Swap. This provision is a clarification of “customer funds” as defined in regulation 1.3, which includes “all money, securities, and property received by a futures commission merchant or by a clearing organization from, for, or on behalf of, customers or option customers * * * to margin, guarantee, or secure futures contracts.” FIA suggested that the Commission confirm that the term Cleared Swaps Customer Collateral includes all assets provided by a Cleared Swaps Customer, including any sums required by an FCM to margin a Cleared Swap, even if that sum is in excess of the amount required by the relevant DCO, as well as collateral “voluntarily” deposited by a Cleared Swaps Customer in a Cleared Swaps Customer Account. 140 In response, the Commission is clarifying that the definition of Cleared Swaps Customer Collateral includes any sums required by an FCM that is intended to, or does, margin a Cleared Swap as well as collateral “voluntarily” deposited by, or on behalf of, a Cleared Swaps Customer in a Cleared Swaps Customer Account. Moreover, in response to this comment, the Commission is adding a new section 22.13(c), which states that collateral posted by a Cleared Swaps Customer in excess of the amount required by a DCO (the “excess collateral”) may be transmitted by the Cleared Swaps Customer's FCM to the DCO if, but only if, (i) the FCM is permitted to do so by DCO rule and (ii) the DCO provides a mechanism by which the FCM can identify the amount of such excess collateral attributable to each Cleared Swaps Customer, and such mechanism is employed effectively to accomplish that goal. 140 See FIA at 7-8. 5. “Cleared Swaps Customer Account” and “Cleared Swaps Proprietary Account” As proposed, regulation 22.1 defined a “Cleared Swaps Customer Account” as (i) an account that an FCM maintains at a Permitted Depository for the Cleared Swaps (and related collateral) of its Cleared Swaps Customers, or (ii) an account that a DCO maintains at a Permitted Depository for collateral related to Cleared Swaps that the FCM members intermediate for their Cleared Swaps Customers. Regulation 22.1 also proposed a definition for “Cleared Swaps Proprietary Account” that is substantially similar to regulation 1.3, which defines “Proprietary Account” for futures contracts. The Commission requested comment on whether the proviso in paragraph (b)(8), which states that “an account owned by any shareholder or member of a cooperative association of producers, within the meaning of section 6a of the Act, which association is registered as an FCM and carries such account on its records, shall be deemed to be a Cleared Swaps Customer Account and not a Cleared Swaps Proprietary Account of such association, unless the shareholder or member is an officer, director, or manager of the association,” remains relevant, particularly with respect to Cleared Swaps. The Commission did not receive comments on these proposed definitions and is, therefore, adopting the definitions of “Cleared Swaps Customer Account” and “Cleared Swaps Proprietary Account” as proposed. 6. “Clearing Member” Regulation 22.1 proposed a definition of “Clearing Member.” The Commission did not receive comments on this proposed definition. Therefore, the Commission is adopting the definition of “Clearing Member” as proposed. 7. “Collecting Futures Commission Merchant” and “Depositing Futures Commission Merchant” Proposed regulation 22.1 defined a “Collecting Futures Commission Merchant” or “Collecting FCM” as one that carries Cleared Swaps on behalf of another FCM and the Cleared Swaps Customers of that other FCM and, as part of doing so, collects Cleared Swaps Customer Collateral. 141 In contrast, a “Depositing Futures Commission Merchant” or “Depositing FCM” was defined as one that carries Cleared Swaps on behalf of its Cleared Swaps Customers through a Collecting FCM, and, as part of doing so, deposits Cleared Swaps Customer Collateral with such Collecting FCM. The Commission did not receive comments on these proposed definitions and is adopting the definitions of “Collecting Futures Commission Merchant” and “Depositing Futures Commission Merchant” as proposed. 141 For the avoidance of doubt, an FCM does not become a Collecting FCM simply by intermediating the proprietary transactions of another FCM. An FCM only becomes a Collecting FCM by intermediating, on behalf of another FCM, Cleared Swaps belonging to Cleared Swaps Customers (and the relevant collateral). 8. “Permitted Depository” Regulation 22.1 proposed a definition of “Permitted Depository.” The Commission did not receive comments on this proposed definition and is, therefore, adopting the definition of “Permitted Depository” as proposed. B. Regulation 22.2—Futures Commission Merchants: Treatment of Cleared Swaps Customer Collateral Regulation 22.2 proposed requirements for an FCM's treatment of Cleared Swaps Customer Collateral, as well as the associated Cleared Swaps. 1. In General Proposed regulation 22.2(a) required an FCM to treat and deal with the Cleared Swaps of Cleared Swaps Customers, as well as associated Cleared Swaps Customer Collateral, as belonging to the Cleared Swaps Customers. The Commission did not receive any comments on regulation 22.2(a) and is therefore adopting regulation 22.2(a) as proposed. 2. Location of Collateral Proposed regulation 22.2(b) required that an FCM segregate all Cleared Swaps Customer Collateral that it receives. Additionally, proposed regulation 22.2(b) required that an FCM adopt one of two methods to hold segregated Cleared Swaps Customer Collateral, which parallel either implicit assumptions or explicit provisions of regulation 1.20(a). The Commission did not receive any comments on regulation 22.2(b) and is therefore adopting regulation 22.2(b) as proposed. 3. Commingling Proposed regulation 22.2(c) permitted an FCM to commingle the Cleared Swaps Customer Collateral of multiple Cleared Swaps Customers, while prohibiting the FCM from commingling Cleared Swaps Customer Collateral with: • FCM property, except as permitted under proposed regulation 22.2(e) (as discussed below); or • “customer funds” (as regulation 1.3 defines such term) for futures contracts or the “foreign futures or foreign options secured amount” (as regulation 1.3 defines such term), except as permitted by a Commission rule, regulation or order (or a derivatives clearing organization rule approved pursuant to regulation 39.15(b)(2)). 142 142 As the discussion on the proposed definition of “Cleared Swaps” highlights, if the Commission adopts a rule or regulation or issues an order pursuant to section 4d(a) of the CEA, or if the Commission approves DCO rules pursuant to regulation 39.15(b)(2) permitting such commingling, the Commission would apply the corresponding provisions and Part 190 to the Cleared Swap (and related collateral) as if the swap constituted a futures contract (and related collateral). In contrast, if the Commission adopts a rule or regulation or issues an order pursuant to section 4d(f) of the CEA, or if the Commission approves DCO rules pursuant to regulation 39.15(b)(2) permitting such commingling, the proposed definition of “Cleared Swap” would operate to apply Part 22 and Part 190 to (i) the futures contract (and related collateral) or (ii) the foreign futures contract (and related collateral) as if such contracts constituted Cleared Swaps (and related collateral). The Commission did not receive any comments on regulation 22.2(c) and is therefore adopting regulation 22.2(c) as proposed. 4. Limitations on Use Proposed regulation 22.2(d) prohibited an FCM from (i) using, or permitting the use of, the Cleared Swaps Customer Collateral of one Cleared Swaps Customer to purchase, margin, or settle the Cleared Swaps, or any other transaction, of a person other than the Cleared Swaps Customer; (ii) using Cleared Swaps Customer Collateral to margin, guarantee, or secure the non-Cleared Swap contracts ( e.g., futures or foreign futures contracts) of the entity constituting the Cleared Swaps Customer; 143 (iii) imposing, or permitting the imposition of, a lien on Cleared Swaps Customer Collateral, including on any FCM residual financial interest therein; and (iv) claiming that any of the [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2012-1033. Public record. Not legal advice.