Core Principles and Other Requirements for Designated Contract Markets

Federal RegisterJun 19, 2012

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 16, and 38

RIN 3038-AD09

Core Principles and Other Requirements for Designated Contract Markets

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Final rule.

SUMMARY:

The Commodity Futures Trading Commission (“Commission” or “CFTC”) is adopting new and amended rules, guidance, and acceptable practices to implement certain statutory provisions enacted by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). The final rules, guidance and acceptable practices, which apply to the designation and operation of contract markets, implement the Dodd-Frank Act's new statutory framework that, among other things, amends section 5 of the Commodity Exchange Act (“the Act” or “CEA”) concerning designation and operation of contract markets, and adds a new CEA section 2(h)(8) to mandate the listing, trading and execution of certain swaps on designated contract markets (“DCMs”).

DATES:

Effective date:

The rules will become effective August 20, 2012.

Compliance date:

The compliance date for contract markets that have obtained designation on, or prior to, the date of publication of this release: Designated contract markets must comply with the rules adopted in this release (except § 38.151(a)) by October 17, 2012; and must comply with § 38.151(a) in accordance with the timeline described in

SUPPLEMENTARY INFORMATION.

FOR FURTHER INFORMATION CONTACT:

Nancy Markowitz, Deputy Director, 202-418-5453,

nmarkowitz@cftc.gov

, Nadia Zakir, Special Counsel, 202-418-5720,

nzakir@cftc.gov

, or Aaron Brodsky, Attorney-Advisor, 202-418-5349,

abrodsky@cftc.gov

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

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. Title VII of the Dodd-Frank Act

B. The Dodd-Frank Act Amendments Applicable to Designated Contract Markets

II. Final Rules

A. Repeal of Designation Criteria

B. Adoption of Rules and Revised Guidance and Acceptable Practices

C. General Regulations (Subpart A)

1. § 38.1-Scope

2. § 38.2-Exempt Provisions

3. § 38.3—Procedures for Designation

4. § 38.4—Procedures for Listing Products and Implementing Designated Contract Market Rules

5. § 38.5—Information Relating to Contract Market Compliance

6. § 38.7—Prohibited Use of Data Collected for Regulatory Purposes

7. § 38.8—Listing of Swaps on a Designated Contract Market

8. § 38.9—Boards of Trade Operating Both a Designated Contract Market and a Swap Execution Facility

9. § 38.10—Reporting of Swaps Traded on a Designated Contract Market

D. Core Principles

1. Subpart B—Designation as Contract Market

2. Subpart C—Compliance With Rules

i. § 38.150—Core Principle 2

ii. § 38.151—Access Requirements

iii. § 38.152—Abusive Trading Practices Prohibited

iv. § 38.153—Capacity to Detect and Investigate Rule Violations

v. § 38.154—Regulatory Services Provided by a Third Party

vi. § 38.155—Compliance Staff and Resources

vii. § 38.156—Automated Trade Surveillance System

viii. § 38.157—Real-Time Market Monitoring

ix. § 38.158—Investigations and Investigation Reports

x. § 38.159—Ability to Obtain Information

xi. § 38.160—Additional Sources for Compliance

3. Subpart D—Contracts Not Readily Subject to Manipulation

4. Subpart E—Prevention of Market Disruption

i. § 38.251—General Requirements

ii. § 38.252—Additional Requirements for Physical-Delivery Contracts

iii. § 38.253—Additional Requirements for Cash-Settled Contracts

iv. § 38.254—Ability to Obtain Information

v. § 38.255—Risk Controls for Trading

vi. § 38.256—Trade Reconstruction

vii. § 38.257—Regulatory Service Provider

viii. § 38.258—Additional Sources for Compliance

5. Subpart F—Position Limitations or Accountability

6. Subpart G—Emergency Authority

7. Subpart H—Availability of General Information

i. § 38.401(a)—General

ii. § 38.401(b)—Accuracy Requirement

iii. § 38.401(c)—Notice of Regulatory Submissions

iv. § 38.401(d)—Rulebook

8. Subpart I—Daily Publication of Trading Information

9. Subpart J—Execution of Transactions

10. Subpart K—Trade Information

i. § 38.551—Audit Trail Required

ii. § 38.552—Elements of an Acceptable Audit Trail Program

iii. § 38.553—Enforcement of Audit Trail Requirements

11. Subpart L—Financial Integrity of Transactions

i. § 38.601—Mandatory Clearing

ii. § 38.602—General Financial Integrity

iii. § 38.603—Protection of Customer Funds

iv. § 38.604—Financial Surveillance

v. § 38.605—Requirements for Financial Surveillance Program

vi. § 38.606—Financial Regulatory Services Provided by a Third Party

vii. § 38.607—Direct Access

12. Subpart M—Protection of Markets and Market Participants

i. § 38.651—Additional Sources for Compliance

13. Subpart N—Disciplinary Procedures

i. § 38.701—Enforcement Staff

ii. § 38.702—Disciplinary Panels

iii. § 38.703—Review of Investigation Report

iv. § 38.704—Notice of Charges

v. § 38.705—Right to Representation

vi. § 38.706—Answer to Charges

vii. § 38.707—Admission or Failure To Deny Charges

viii. § 38.708—Denial of Charges and Right to Hearing

ix. § 38.709—Settlement Offers

x. § 38.710—Hearings

xi. § 38.711—Decisions

xii. § 38.712—Right To Appeal

xiii. § 38.713—Final Decisions

xiv. § 38.714—Disciplinary Sanctions

xv. § 38.715—Summary Fines

xvi. § 38.716—Emergency Disciplinary Actions

14. Subpart O—Dispute Resolution

15. Subpart P—Governance Fitness Standards

16. Subpart Q—Conflicts of Interest

17. Subpart R—Composition of Governing Boards of Contract Markets

18. Subpart S—Recordkeeping

i. § 38.951—Additional Sources for Compliance

19. Subpart T—Antitrust Considerations

20. Subpart U—System Safeguards

i. § 38.1051—General Requirements

21. Subpart V—Financial Resources

i. § 38.1100(a)—Core Principle 21, and § 38.1101(a) and (c)—General Rule and Computation of Financial Resources Requirement

ii. § 38.1101(b)—Types of Financial Resources

iii. § 38.1101(d)—Valuation of Financial Resources

iv. § 38.1101(e)—Liquidity of Financial Resources

v. § 38.1101(f)—Reporting Requirements

22. Subpart W—Diversity of Boards of Directors

23. Subpart X—Securities and Exchange Commission

i. § 38.1200 (Core Principle 23), § 38.1201 (Additional Sources for Compliance), and Guidance in Appendix B.

III. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

C. Cost Benefit Considerations

IV. Text of Final Rules

I. Background

A. Title VII of the Dodd-Frank Act

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street

Reform and Consumer Protection Act.

Title VII of the Dodd-Frank Act

amended the CEA

to establish a comprehensive, new regulatory framework for swaps and security-based swaps. The legislation was enacted to reduce risk, increase transparency, and promote market integrity within the financial system by, among other things: (1) Providing for the registration and comprehensive regulation of swap dealers and major swap participants; (2) imposing clearing and trade execution requirements on standardized derivative products; (3) creating robust recordkeeping and real-time reporting regimes; and (4) enhancing the Commission's rulemaking and enforcement authorities with respect to, among others, all registered entities and intermediaries subject to the Commission's oversight.

See

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

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

7 U.S.C. 1

et seq.

(amended 2010).

B. The Dodd-Frank Act Amendments Applicable to Designated Contract Markets

In this final rulemaking, the Commission is establishing the regulatory obligations that each DCM must meet in order to comply with section 5 of the CEA, as amended by the Dodd-Frank Act, initially upon designation and thereafter on an ongoing basis.

Section 735 of the Dodd-Frank Act amended section 5 of the CEA pertaining to the designation and operation of contract markets, by: (i) Eliminating the eight criteria that must be met for designation as a contract market, contained in former section 5(b) of the CEA; (ii) amending most of the core principles, including incorporating most of the substantive elements of the former designation criteria, and requiring that all DCMs demonstrate compliance with each of the core principles as a condition of obtaining and maintaining designation as a contract market; and (iii) adding five new core principles, including Core Principle 13 (Disciplinary Procedures), Core Principle 20 (System Safeguards), Core Principle 21 (Financial Resources), Core Principle 22 (Diversity of Boards of Directors), and Core Principle 23 (Securities and Exchange Commission).

New Core Principle 13 is verbatim of former Designation Criterion 6.

In addition, section 723(a)(3) of the Dodd-Frank Act added section 2(h)(8) of the CEA to require, among other things, that swaps that are required to be cleared must be executed either on a DCM or on a Swap Execution Facility (“SEF”),

unless no DCM or SEF makes the swap “available to trade.”

Section 5h(a)(1) of the CEA, as amended by the Dodd-Frank Act, also prohibits any person from operating a facility for the trading and processing of swaps unless the facility is registered as a SEF or a DCM. Accordingly, unless otherwise specified in this release, each of the 23 core principles and the final implementing regulations, guidance and acceptable practices, apply to all “contracts” listed on a DCM, which will include swaps, futures and options contracts. The rules adopted in this release also implement relevant provisions related to the trading and execution of swaps on DCMs.

The Commission proposed rules governing the registration and operation of SEFs in a separate, rulemaking titled “Core Principles and Other Requirements for Swap Execution Facilities.” 76 FR 1214, Jan. 7, 2011. The core principles applicable to DCMs pursuant to section 5 of the Act and the core principles applicable to swap execution facilities pursuant to section 5h of the Act include, in a number of instances, similar or identical language. Although the Commission's interpretation of specific language in section 5 of the Act may inform its interpretation of similar or identical language in section 5h of the Act, and vice versa, the Commission may interpret the core principles applicable to each category of registered entity in light of that category's unique market characteristics and regulatory functions and responsibilities.

See

section 723(a) of the Dodd-Frank Act. The Commission separately proposed rules implementing the “made available to trade” mandate.

See

76 FR 77728, Dec. 14, 2011.

On December 22, 2010, the Commission published proposed regulations to implement the statutory provisions of the Dodd-Frank Act relevant to the designation and operation of DCMs (“DCM NPRM”), under part 38 of the Commission's regulations.

75 FR 80572, Dec. 22, 2010 (“DCM NPRM”). The DCM NPRM also proposed revisions to related regulations under parts 1 and 16.

The proposed rulemaking was subject to an initial 60-day comment period, which closed on February 22, 2011. The comment period was subsequently reopened on two separate occasions, each time for an additional 30 days.

The Commission received numerous written comments from members of the public, and Commission staff participated in several meetings with market participants, including representatives of both currently-designated and prospective contract markets.

See

76 FR 14825, Mar. 18, 2011;

see also

76 FR 25274, May 4, 2011.

The Commission received comment letters from numerous parties, including the following: ACM Capital Management; Alice Corporation; Alternative Investment Management Association; American Bankers Association and ABA Securities Association; American Gas Association; Argus Media, Inc. (“Argus”); Better Markets, Inc. (“Better Markets”); BJ D'Milli; BlackRock, Inc. (“BlackRock”); Bloomberg; CBOE Futures Exchanges (“CFE”); CME Group Inc. (“CME”) (CME's comments were submitted on behalf of its four DCMs: the Chicago Mercantile Exchange, Inc., the Board of Trade of the City of Chicago, Inc., the New York Mercantile Exchange, Inc., and the Commodity Exchange, Inc.); Citadel; Committee on Capital Markets Regulation; Committee on Futures and Derivatives Regulation of the New York City Bar Association; DC Energy; The Depository Trust & Clearing Corporation; East Coast Petroleum; ELX Futures, L.P. (“ELX”); Eris Exchange, LLC (“Eris”); Electric Trade Association; FIA/FSR/IIB/IRI/ISDA/SIFMA/US Chamber of Commercial (jointly); Green Exchange LLC (“GreenX”); ICAP; IntercontinentalExchange, Inc. (“ICE”) (ICE's comments were submitted on behalf of its four regulated futures exchanges: ICE Future US, Chicago Climate Futures Exchange, ICE Futures Europe, and ICE Futures Canada); International Swaps and Derivatives Association (“ISDA”); Kansas City Board of Trade (“KCBT”); Markit; MarkitSERV; Minneapolis Grain Exchange, Inc. (“MGEX”); Noble Energy; NYSE Liffe US LLC (“NYSE Liffe”); Nodal Exchange, LLC (“Nodal”); Todd Petzel; OneChicago LLC Futures Exchange (“OCX”); Swaps and Derivatives Market Association; Tradeweb; Trading Technologies International, Inc. (“Trading Technologies”); Wholesale Markets Brokers' Association; Working Group of Commercial Energy Firms (Hunton and Williams); and joint letter from CME, NYSE Liffe, GreenX, Eris Exchange, CBOE Futures Exchange, KCBT and MGEX (“CME Joint Comment Letter”). A number of comment letters solely addressed the implementation phasing for Dodd-Frank rulemakings. Those comments are outside the scope of this rulemaking and are more appropriate to the recent rulemaking pertaining to “Swap Transaction Compliance and Implementation Schedule: Clearing and Trade Execution Requirements under section 2(h) of the CEA.”

See

76 FR 58186, Sep. 20, 2011.

In this notice of final rulemaking, the Commission is adopting many of the proposed rules, guidance, and acceptable practices. However, as a result of the written comments received and dialogue with market participants, the Commission has revised and/or eliminated a number of regulations that were proposed in the DCM NPRM, and in a number of instances, has codified guidance and/or acceptable practices in lieu of the proposed rules.

The Commission also received a number of comments pertaining to the costs and/or benefits of certain proposed regulations. The Commission has undertaken an extensive review of the costs and benefits of the regulations being adopted in this release pursuant to section 15(a) of the CEA,

as is further discussed in the cost benefit consideration section of this final rulemaking. As discussed in that section, the Commission has determined that the final rules appropriately balance the costs and benefits associated with oversight of DCMs pursuant to the

CEA, as amended by the Dodd-Frank Act.

7 U.S.C. 19.

The Commission is hereby adopting final regulations to implement section 5 of the CEA, as well as the requirements of sections 2(h)(8) and 5h(a)(1) of the CEA, as amended by the Dodd-Frank Act, as applicable to DCMs. The final regulations will eliminate the guidance on compliance with the designation criteria for DCMs, implement new and revised regulations for the core principles, and codify certain requirements and practices that have evolved over the years and are commonly accepted in the industry.

The final regulations adopted herein will become effective 60 days after publication in the

Federal Register

. Contract markets that have obtained designation prior to or at the time of the publication of this release must comply with the new and revised rules adopted in this release, except § 38.151(a), within 60 days of the effective date of this release; and must comply with § 38.151(a) in accordance with the timeline described in the discussion of that rule below.

II. Final Rules

A. Repeal of Designation Criteria

Section 735 of the Dodd-Frank Act eliminated the eight DCM designation criteria in former CEA section 5(b), and largely incorporated the substance of those criteria into the core principles. Accordingly, the Commission is eliminating the guidance on compliance with the designation criteria for DCMs contained in appendix A to part 38.

As proposed in the DCM NPRM, appendix A to part 38 will contain the application form for contract market designation.

B. Adoption of Rules and Revised Guidance and Acceptable Practices

To implement section 735 of the Dodd-Frank Act, the Commission proposed a number of new and revised rules, guidance, and acceptable practices to implement the new and revised core principles. As described in the DCM NPRM, the Commission evaluated the preexisting regulatory framework for overseeing DCMs, which consisted largely of guidance and acceptable practices, in order to update those provisions and to determine which core principles would benefit from having new or revised derivative regulations. Based on that review, and in view of the Dodd-Frank Act's amendments to section 5(d)(1) of the CEA,

which specifically provides the Commission with discretion to determine, by rule or regulation, the manner in which boards of trade comply with the core principles, the Commission proposed revised guidance and acceptable practices for some core principles and, for several core principles, proposed to codify rules in lieu of guidance and acceptable practices.

Former Core Principle 1 stated, among other things, that boards of trade “shall have reasonable discretion in establishing the manner in which they comply with the core principles.” This “reasonable discretion” provision underpinned the Commission's use of core principle guidance and acceptable practices. Section 735 of the Dodd-Frank Act amended this provision to include the proviso that “[u]nless otherwise determined by the Commission by rule or regulation * * *,” boards of trade shall have reasonable discretion in establishing the manner in which they comply with the core principles.

See

7 U.S.C. 7(d)(1)(amended 2010).

Guidance provides DCMs and DCM applicants with contextual information regarding the core principles, including important concerns which the Commission believes should be taken into account in complying with specific core principles. In contrast, the acceptable practices are more specific than guidance and provide examples of how DCMs may satisfy particular requirements of the core principles; they do not, however, establish mandatory means of compliance. Acceptable practices are intended to assist DCMs by establishing non-exclusive safe harbors. The safe harbors apply only to compliance with specific aspects of the core principle, and do not protect the contract market with respect to charges of violations of other sections of the CEA or other aspects of the core principle.

Summary of Comments

The Commission received a number of comments generally pertaining to the proposed codification of rules in lieu of guidance and/or acceptable practices. Several commenters contended that the principles-based regime has permitted the U.S. futures markets to prosper and keep pace with rapidly changing technology and market needs, and that a rules-based regime will stifle growth, innovation, and competition.

Others noted that the futures markets' resilience throughout the financial crisis is evidence in support of the effectiveness of a principles-based regime.

Commenters also argued that the prescriptive nature of the rules will result in increased costs for DCMs and for the Commission

and that current industry best practices are subject to change and are only able to evolve through continuous improvement and innovation, which is only possible under a flexible regime.

Several commenters provided comments on the codification of specific rules in lieu of guidance and/or acceptable practices, which are addressed below, in the discussion of the respective rules.

CME Comment Letter at 3-4 (Feb. 22, 2011); Eris Comment Letter at 1-2 (Feb. 22, 2011); GreenX Comment Letter at 1 (Feb. 22, 2011); ICE Comment Letter at 3 (Feb. 22, 2011); KCBT Comment Letter at 1, 9 (Feb. 22, 2011).

CME Comment Letter at 3 (Feb. 22, 2011); ICE Comment Letter at 2 (Feb. 22, 2011); KCBT Comment Letter at 9 (Feb. 22, 2011); Eris Comment Letter at 3 (June 3, 2011).

CME Comment Letter at 3 (Feb. 22, 2011); GreenX Comment Letter at 2 (Feb. 2, 2011); MGEX Comment Letter at 2 (Feb. 22, 2011).

CME Comment Letter at 3 (Feb. 22, 2011); GreenX Comment Letter at 2, 11 (Feb. 22, 2011).

Discussion

This final rulemaking largely adopts the framework of rules, guidance and acceptable practices that was proposed in the DCM NPRM, with certain substantive revisions to the regulations, as described in this release. For several core principles, the Commission is maintaining the rules, guidance and acceptable practices, as proposed, with appropriate revisions arising from the Commission's consideration of comments. In several instances, this final rulemaking converts proposed rules to guidance and/or acceptable practices for various DCM compliance practices.

In determining whether to codify a compliance practice in the form of a rule or guidance/acceptable practice, the Commission was guided by whether the practice consisted of a commonly-accepted industry practice. Where there is a standard industry practice that the Commission has determined to be an acceptable compliance practice, the Commission believes that the promulgation of clear-cut regulations will provide greater legal certainty and transparency to DCMs in determining their compliance obligations, and to market participants in determining their obligations as DCM members, and will facilitate the enforcement of such provisions. Several of the rules adopted in this notice of final rulemaking largely codify practices that are commonly accepted in the industry and are currently being undertaken by most, if not all, DCMs.

In the context of each individual rule, the Commission also was guided by comments that provided a basis for greater flexibility or, in some instances, for greater specificity, in respect to the stated compliance obligation.

In addition, the Commission's determination to codify certain compliance practices as rules, rather than as guidance/acceptable practices, is based on its long experience in regulating DCMs. In numerous instances, the rules codify practices that have evolved from the Division of Market Oversight's (“DMO”) recommendations in the context of Rule Enforcement Reviews (“RERs”).

As noted in the DCM NPRM, the RERs are the cornerstone of the Commission's oversight program,

serving as a key tool for monitoring a DCM's compliance with the core principles, and also as a primary means for identifying industry trends and DCM best practices for self-regulation.

See

DCM NPRM at 80574-75 for a more detailed discussion of RERs.

Some commenters claimed that the Commission's approach was overly prescriptive and inconsistent with the core principle framework.

While maintaining the core principle framework as part of the Dodd-Frank Act, Congress revised DCM Core Principle 1 to specifically provide the Commission with discretion to determine, by rule or regulation, the manner in which boards of trade are to comply with the core principles.

Accordingly, in circumstances where a standard industry practice has developed, the Commission is adopting rules in order to provide greater legal certainty and transparency to DCMs and market participants. In other circumstances, the Commission is maintaining the guidance and acceptable practices framework, particularly where the Commission experienced that a standard compliance approach has not evolved within the industry over the years. In those instances, the final regulations maintain the flexibility for DCMs to determine the specific manner in which they choose to satisfy their compliance obligations.

See e.g.,

CME Comment Letters (Feb. 22, 2011, Apr. 18, 2011, Jun. 3, 2011 and Aug. 3, 2011); MGEX Comment Letter (Jun. 3, 2011); GreenX Comment Letter (Feb. 22, 2011).

7 U.S.C. 7(d)(1)(amended 2010).

Several commenters claimed that the codification of additional rules will increase the Commission's costs of regulating DCMs. The Commission believes that a regulatory framework consisting of a higher proportion of rules, in addition to guidance and acceptable practices, may in fact be less costly to administer, as DCMs will have a clear understanding of what is required in order to demonstrate compliance with the core principles. The costs and benefits of this final rulemaking are described further in the Cost Benefit Consideration discussion of this release.

C. General Regulations (Subpart A)

The regulations in this final rulemaking are codified in a series of subparts under part 38. The general regulations consisting of §§ 38.1 through 38.10

are codified in subpart A, and the regulations applicable to each of the 23 core principles are codified in subparts B through X, respectively.

The DCM NPRM did not propose any revisions to § 38.6 of the Commission's regulations.

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

1. § 38.1—Scope

The Commission proposed non-substantive revisions to § 38.1 that corrected cross-references to other sections of the Commission's regulations. Section 38.1 is adopted as proposed.

2. § 38.2—Applicable Provisions

Proposed § 38.2 specified the Commission regulations that are applicable to DCMs. In addition to revising the heading, the proposed revisions to § 38.2 updated the list of Commission regulations that are applicable to DCMs, including the relevant regulations that have been codified, or are proposed to be codified, upon the Commission's finalization of the relevant rulemakings that culminated upon enactment of the Dodd-Frank Act. These included regulations relating to real-time reporting of swaps and the determination of appropriate block size for swaps under part 43, requirements for swap data recordkeeping and reporting under part 45, designation requirements for swap data repositories under part 49, and position limits under part 150 and/or part 151, as applicable.

Discussion

The Commission is revising § 38.2 to specify the Commission regulations from which DCMs will be exempt. The original intent of § 38.2 was to exempt DCMs from various Commission regulations under Title 17 that were codified prior to the CFMA. Proposed § 38.2 listed the specific regulations with which DCMs were required to comply, with the understanding that the DCM was exempt from those not listed. In this final rulemaking, to add clarity, the Commission is revising the title of the rule to “Exempt Provisions” and is modifying § 38.2 to reflect the list of regulations from which DCMs are exempt. Those regulations include: § 1.35(e)-(j), § 1.39(b), § 1.44, § 1.53, § 1.54, § 1.59(b) and (c), § 1.62, § 1.63(a) and (b) and (d) and(f), § 1.64, § 1.69, part 8, § 100.1, § 155.2, and part 156. While § 38.2 likely will be amended if and when the referenced rules are eliminated from the regulations or modified, this revised approach will eliminate the need for the Commission to continually update § 38.2 when new regulations with which DCMs must comply are codified.

3. § 38.3—Procedures for Designation

§ 38.3(a)—Application Procedures

Among the proposed revisions to § 38.3, which contains the application and designation procedures for DCM applicants, the Commission proposed to eliminate the 90-day expedited review procedures for DCM applications, which currently are codified in § 38.3(a)(2). The proposed modification would result in all DCM applications being subject to the statutory 180-day review procedures provided under section 6(a) of the CEA and § 38.3(a)(1) of the Commission's regulations.

7 U.S.C. 8(a).

As noted above, the Dodd-Frank Act eliminated the standalone DCM designation criteria. Accordingly, the Commission proposed re-designating appendix A to include a new DCM application form (“Form DCM”) that contains comprehensive instructions and a list of necessary information and documentation required to initiate a DCM designation proceeding. All new applicants seeking designation would submit to the Commission a completed form, including the information required in each exhibit.

Form DCM would also be used by applicants amending a pending application and existing DCMs applying for an amendment to their order of designation.

The DCM NPRM also proposed certain revisions to § 38.3 that would require DCM applications and certain related DCM filings to be filed with the Secretary of the Commission in an electronic format, via the Internet, email, or other means of direct electronic submission as approved by the Commission.

The proposed electronic filing requirements would specifically apply to DCM applications, reinstatements, requests for transfer of designations, requests for withdrawal of application for designation, and vacation of designations. As explained in the DCM NPRM, the proposed revisions would make the DCM application filing process consistent with the electronic process used for filing rule and product submissions under parts 39 and 40 of the Commission's regulations.

See

17 CFR parts 39 and 40. In addition to these substantive revisions, many of the proposed revisions to § 38.3 were non-substantive and were intended to clarify the rule.

Summary of Comments

Two commenters discussed the proposed elimination of the 90-day expedited review process for DCM applications in § 38.3(a)(1). Nodal expressed support for the proposed elimination of the 90-day review procedures.

Eris opposed the proposed elimination and commented, among other things, that Form DCM should result in a streamlined and standardized review process and that eliminating the 90-day accelerated review process would place new entities at a competitive disadvantage because it

would delay their time to market, which is critical for new entrants.

Nodal Comment Letter at 5 (Feb. 22, 2011).

Eris Comment Letter at 4 (Feb. 22, 2011).

Discussion

The Commission is adopting proposed § 38.3(a) with one modification.

As described in the DCM NPRM, the Commission proposed eliminating the 90-day accelerated review process based on its experience in processing DCM applications. Specifically, the Commission has found that in the interest of meeting the expedited approval timeline, applicants seeking expedited review often filed incomplete or draft applications without adequate supporting materials. Accordingly, the 90-day review process required the expenditure of significant Commission resources as well as the applicant's resources, and often resulted in placing the DCM designation requests on the 180-day review track. It is the Commission's view that the 180-day review period is a more reasonable timeframe for the review of designation requests and will result in more efficient use of the applicant's and the Commission's resources.

In regards to Eris' specific claim that elimination of the 90-day accelerated review process would place new entities at a competitive disadvantage by delaying their time to market, the Commission notes that eliminating the 90-day review process will not prevent Commission staff from reviewing and/or rendering a determination on a DCM application before the 180-day period ends, particularly in instances where a DCM application is substantially complete, does not raise novel issues, and/or where a DCM applicant timely provides supplemental or follow-up responses or documentation necessary for a designation determination.

Similarly, while the Commission recognizes that Form DCM will provide the added benefit of a more streamlined and standardized procedure for submitting and reviewing DCM applications, such benefits will not necessarily result in an expedited Commission determination. Rather, the completeness of the application and timely response to Commission staff's requests will determine the timeframe within which the Commission reviews a DCM application.

Section 6(a) of the Act provides that “the Commission shall approve or deny an application for designation or registration as a contract market * * * within 180 days of the filing of the application.” 7 U.S.C. 8(a).

To account for potential changes in the Commission's prospective technological capabilities, the Commission is slightly modifying the proposed text of § 38.3(a) to clarify that a board of trade must file Form DCM electronically “in a format and manner specified by the Secretary of the Commission.”

The Commission is also making several minor non-substantive and organizational revisions to Form DCM. Additionally, the Commission is clarifying that the exhibits submitted in connection with Form DCM should include a description of how the applicant meets the definition of “board of trade” (as defined in section 1a(2) of the CEA). Applicants must submit all applicable exhibits simultaneous with the submission of completed Form DCM. Form DCM and all exhibits must be substantially complete prior to submission.

Sec. 38.3(b)—Reinstatement of Dormant Designation

Proposed § 38.3(b) required that a dormant DCM, prior to listing or relisting products for trading, must reinstate its designation under the procedures of paragraphs (a)(1) and (2) of § 38.3. The proposed rule provided that applications for reinstatement of designation may rely upon previously-submitted materials that pertain to, and accurately describe, current conditions. The Commission did not receive any comments on § 38.3(b) and is adopting this provision as proposed.

Sec. 38.3(c)—Delegation of Authority

Proposed § 38.3(c) delegated authority to the Director of the Division of Market Oversight (or such other employees as the Director may designate) to notify an applicant seeking designation in the event that the application is materially incomplete and that the 180-day review period is stayed. The Commission did not receive any comments on § 38.3(c) and is adopting this provision as proposed.

Sec. 38.3(d)—Request for Transfer of Designation

The Commission proposed new § 38.3(d) to formalize the procedures that a DCM must follow when requesting the transfer of its DCM designation and positions comprising open interest, in anticipation of a corporate event (e.g., a merger, corporate reorganization, or change in corporate domicile) which results in the transfer of all or substantially all of the DCM's assets to another legal entity. Proposed § 38.3(d)(2) required a DCM to submit to the Commission a request for transfer of designation no later than three months prior to the anticipated corporate change. If a DCM did not know or could not reasonably have known of the anticipated change three months prior to the change, it was required to immediately file the request as soon as it did know of such change. The proposed rule required, that in either case, the request must include a series of submissions, including, among other things, the underlying agreement that governs the corporate change, a narrative description of the corporate change that includes the reason for the change and its impact on the DCM, a discussion of the transferee's ability to comply with the CEA and the Commission's regulations, the governing documents of the transferee, and a list of contracts, agreements, transactions or swaps for which the DCM requests transfer of open interest.

Proposed § 38.3(d) also required, as a condition of approval, that the DCM submit a representation that it is in compliance with the CEA, including the DCM core principles, and the Commission's regulations. In addition, the proposed rule required a DCM to submit various representations by the transferee, including, but not limited to, a representation that the transferee will assume responsibility for complying with all applicable provisions of the CEA and the Commission's regulations and that none of the proposed rule changes will affect the rights and obligations of any participant to which open positions are transferred.

Summary of Comments

CME contended that the proposed rule is overly prescriptive because it applies a “one-size-fits-all approach” even though the circumstances of each transfer are likely to be unique.

While CME did not oppose the three-month advance notification requirement, it did oppose what it believed to be the broad scope of the additional documentation required to be submitted simultaneously with such notification.

CME stated that the required information is unnecessary and is likely to result in later notification to the Commission.

As an alternative, CME recommended that the Commission tailor the information it requires based on the nature of the requested transfer.

CME Comment Letter at 11 (Feb. 22, 2011).

Id.

CME also contended that if a DCM could not have reasonably known of an anticipated change three months in advance, then it cannot “immediately” file both the request and all of the required submissions once it does know, because preparing the

submissions takes time. CME suggested that the rule be amended to require that the documentation be filed “promptly” as soon as the DCM knows of the change, rather than “immediately.”

Id.

Discussion

In response to CME's contention that each transfer is likely to be unique, and its opposition to some of the documentation required by the rule, the Commission notes that the specific information requirements contained in the proposed rule are necessary to enable the Commission to determine that the transfer is in compliance with the CEA. The required documents, such as the transfer agreement, governing documents, list of contracts to be transferred, and compliance representations, are relevant to the Commission's determination of the DCM's ongoing compliance with the CEA. Such documentation is also relatively standard in transfer transactions. The Commission recognizes, however, that there may be some variations in the form of governance documents or underlying agreements for each transfer. Accordingly, DCMs may provide the substance of the required information in the form available to them.

In response to CME's suggestion that the rule be amended to require that the documentation be filed “promptly” as soon as the DCM knows of the change, rather than “immediately,” the Commission notes that the proposed rule specifically stated that in situations where a DCM could not have reasonably known of an anticipated change three months in advance, the DCM must immediately file the request as soon as it knows of such change, with an explanation as to the timing of the request. The Commission believes that in the context of this rule, use of the term “promptly” rather than “immediately” would not provide a meaningful distinction, as the rule simply requires DCMs to provide the documentation as soon as they know of the change.

As described in connection with § 38.3(a), the Commission is slightly modifying the proposed text to clarify that a DCM must file a request for transfer of designation electronically “in a format and manner specified by the Secretary of the Commission.” The Commission is adopting the remainder of the rule as proposed.

Sec. 38.3(e)—Request for Withdrawal of Application for Designation

Proposed § 38.3(e) specified the procedures that a DCM must follow for withdrawing an application for designation. The Commission did not receive any comments on this provision. The Commission is slightly modifying the proposed text to clarify that an applicant must file a request for withdrawal of application for designation electronically “in a format and manner specified by the Secretary of the Commission.” The Commission is adopting the remainder of the rule as proposed.

Sec. 38.3(f)—Request for Vacation of Designation

Proposed § 38.3(f) specified the procedures that a DCM must follow for vacating its designation. The Commission did not receive any comments on this provision. The Commission is adopting it as proposed, with a slight modification to the proposed text to clarify that a DCM must file a request for vacation of designation electronically “in a format and manner specified by the Secretary of the Commission.”

Sec. 38.3(g)—Requirements for Existing Designated Contract Markets

Proposed § 38.3(g) required that each existing DCM provide the Commission with a signed certification of its compliance with each of the 23 core principles and the Commission's regulations under part 38, within 60 days of the effective date of the publication of the final rules proposed in the DCM NPRM. The failure of any existing DCM to provide such certification would be grounds for revocation of the DCM's designation status. The Commission requested comments on whether the 60 day period is sufficient, and if not, what period of time may be more appropriate, and why.

Summary of Comments

Multiple commenters opposed the proposed 60-day timeframe for existing DCMs to certify compliance with the core principles and associated regulations. Commenters suggested several alternative timeframes, including 90 days,

120 days,

180 days,

12 months,

and 18 months.

KCBT argued that the proposed effective date is unreasonable and would be burdensome for DCMs, and suggested that the Commission work with each DCM to create a reasonable compliance timeframe.

Nodal Comment Letter at 4 (Feb. 22, 2011).

CFE Comment Letter at 6-7 (Feb. 22, 2011).

GreenX Comment Letter at 21 (Feb. 22, 2011).

MGEX Comment Letter at 2 (Feb. 22, 2011), and at 1 (June 3, 2011).

NYSE Liffe Comment Letter at 14 (Feb. 22, 2011).

KCBT Comment Letter at 2 (Feb. 22, 2011).

Commenters stated that a 60-day timeframe would be unreasonable given the expenditure of resources and detailed analysis required as a result of significant changes to existing core principles and the addition of new core principles. GreenX stated that Core Principle 21 (Financial Resources) may require DCMs to obtain new investment or financing arrangements.

KCBT stated that it will take DCMs time to convert programs and processes from current acceptable practices to adherence to what it sees as prescriptive objectives and deadlines.

Nodal, which is currently operating as an exempt commercial market (“ECM”), stated that 60 days is an unnecessarily harsh timeframe for an existing business to transform its operations and demand changes from its support providers.

Finally, NYSE Liffe claimed that even 90 or 120 days would be insufficient because certain proposals, such as Core Principles 2 (Compliance with Rules), 4 (Prevention of Market Disruption), and 20 (System Safeguards), will require the implementation of automated systems that require significant time to implement coding and conduct testing.

NYSE Liffe further claimed that the DCM's management and boards will have to review and approve rule changes before they can be implemented, and that the DCM will also have to negotiate and execute changes to contracts with third-party service providers.

CME disagreed with the assertion that the proposed new regulations simply codify practices that are commonly accepted in the industry, and argued that the rules will necessitate strategic, operational, system, and rule changes.

CME claimed that it would need a minimum of 180 days just to assess the impact of the new regulations and to identify, design, and plan the projects necessary to implement them.

GreenX Comment Letter at 21 (Feb. 22, 2011).

KCBT Comment Letter at 2 (Feb. 22, 2011).

Nodal Comment Letter at 4 (Feb. 22, 2011).

NYSE Liffe Comment Letter at 14 (Feb. 22, 2011).

Id.

CME Comment Letter at 12 (Feb. 22, 2011).

Id.

MGEX stated that a “catch all” certification is of limited value given that DCMs spend “countless hours and dollars” demonstrating that they are in compliance with core principles through RERs and responding to other

Commission inquiries.

MGEX also questioned whether it can conclude with any certainty that it is in compliance with the new and revised core principles and regulations.

MGEX requested that the certification requirement be stricken, or if the requirement is deemed necessary, that the process be limited to providing a signed letter attesting to compliance (and that all application forms and documentation that are required with a formal application should be waived for existing DCMs).

MGEX also requested that current DCMs that are already compliant with the existing core principles should be grandfathered.

MGEX Comment Letter at 2 (Feb. 22, 2011).

Id.

MGEX Comment Letter at 1 (June 3, 2011).

Nodal stated that the proposed rules do not address how a DCM applicant that is operating as an ECM pursuant to a grandfathering order can comply with the DCM requirements, and suggested that the Commission stagger certain compliance timeframes to accommodate entities that are operating pursuant to grandfather relief and that may potentially seek to operate as a DCM.

Nodal Comment Letter at 4 (Feb. 22, 2011).

Discussion

The Commission acknowledges commenters' concerns regarding the 60-day time frame for existing DCMs to certify compliance with the core principles and is eliminating this requirement from the final rules. In addition, the Commission has determined that existing DCMs may need additional time to comply with the rules being adopted in this release, and is therefore allowing DCMs an additional 60 days after the effective date of this release to comply with all of the new and revised final rules, except for § 38.151(a), as described in this release. All DCMs are expected to be in compliance with the final rules by that date. Albeit, the new and revised core principles, as amended by the Dodd-Frank Act, took effect on July 16, 2011, and all DCMs were required to be in compliance with each of the new and revised core principles as of that date. The Commission further notes that all DCMs will continue to be subject to compliance reviews by the Commission, including RERs.

With respect to Nodal's comments regarding the impact of the effective date of the DCM and SEF rules on ECMs, the Commission issued orders whereby entities operating as exempt commercial markets pursuant to section 2(h)(3)-(7) of the CEA, or as exempt boards of trade pursuant to section 5d of the CEA, could receive grandfather relief to continue to operate in accordance with those provisions notwithstanding their deletion from the CEA effective July 15, 2011, by the Dodd-Frank Act.

The continued operation and compliance timeframes for exempt boards of trade and exempt commercial markets are addressed by those orders, and accordingly, are outside the scope of this rulemaking.

See

75 FR 56513, Sept. 16, 2010;

see also

7 U.S.C. 7(d) (core principles apply to board of trade).

108

As defined in section 1a(37) of the CEA, the term “organized exchange” means a trading facility that: (A) Permits trading: (i) By or on behalf of a person that is not an eligible contract participant; or (ii) by persons other than on a principal-to-principal basis; or (B) has adopted (directly or through another nongovernmental entity) rules that: (i) Govern the conduct of participants, other than rules that govern the submission of orders or execution of transactions on the trading facility; and (ii) include disciplinary sanctions other than the exclusion of participants from trading.

109

As defined in section 1a(51) (A) of the CEA, the term “trading facility” means a person or group of persons that constitutes, maintains, or provides a physical or electronic facility or system in which multiple participants have the ability to execute or trade agreements, contracts, or transactions—(i) by accepting bids or offers made by other participants that are open to multiple participants in the facility or system; or (ii) through the interaction of multiple bids or multiple offers within a system with a pre-determined nondiscretionary automated trade matching and execution algorithm.

See

section 1a(51)(B) and (C) for exclusions and special rules application to trading facility.

The Commission has considered Alice Corporation's comments, and notes that while a board of trade that is a single corporate entity may operate both a DCM and a SEF, DCMs and SEFs have separate core principles and requirements, and any entity that operates both must separately meet the statutory and regulatory requirements of each facility. In response to Alice Corporation's further comment that counterparties on a DCM should be able to offer volume-based quotes, it is unclear whether Alice Corporation's comment is being offered in the context of acceptable methods of trading on a DCM's central marketplace or in the context of off-exchange transactions. If the former, the Commission reiterates that the acceptable methods of trading on a DCM's central marketplace are specifically determined under the CEA, which requires at a minimum that DCMs must be “trading facilities,” though even in that context the Commission has accepted trading systems beyond pure price-and-time algorithms. If Alice Corporation's reference to volume-based quotes is some sort of off-exchange trading methodology, the Commission reiterates that its analysis of such a proposal would be conducted under Core Principle 9. The comment does not offer sufficient information to analyze the suggestion at this time.

9. § 38.10—Reporting of Swaps Traded on a Designated Contract Market

Proposed § 38.10 codified the compliance obligations of DCMs with respect to real-time reporting of swap transactions and swap data recordkeeping and reporting obligations, as was required under then-proposed parts 43

110

and 45

111

of the Commission's regulations, respectively.

110

See

“Real Time Public Reporting of Swap Transaction Data,” Proposed Rule, 75 FR 76139, Dec. 7, 2010.

111

See

“Swap Data Recordkeeping and Reporting Requirements,” Proposed Rule, 75 FR 76573, Dec. 8, 2010.

Summary of Comments and Discussion

CME referred the Commission to comments it submitted on February 7, 2011 with respect to proposed rulemakings under part 43 (real-time public reporting of swap transaction data) and part 45 (swap data recordkeeping and reporting requirements).

112

CME Comment Letter at 14 (Feb. 22, 2011).

Rule 38.10 references the reporting requirements contained under parts 43 and 45, but does not contain the substantive obligations associated with the requirements. Accordingly, CME's comments were considered in connection with the final rulemakings under parts 43 and 45.

The Commission is adopting this provision as proposed, with certain clarifications to conform the rule to the regulations under parts 43 and 45. Specifically, proposed § 38.10 required that each DCM, with respect to swaps traded on or through the DCM, report specified swap data to an SDR. The Commission is modifying § 38.10 to clarify that DCMs must maintain and report specified swap data for swaps traded “on or pursuant” to the rules of the DCM. The clarification is consistent with the rulemakings that implement real-time reporting of swap transaction data and swap data recordkeeping and reporting requirements under parts 43 and 45 of the Commission's regulations.

113

75 FR 76140, Dec. 7, 2010; 75 FR 76574, Dec. 8, 2010.

D. Core Principles

As noted above, this release reorganizes part 38 to include subparts A through X. Each of subparts B through X includes relevant regulations applicable to the 23 core principles. This final rulemaking codifies within each subpart the statutory language of the respective core principle.

114

As noted in the DCM NPRM, in two instances the language of the core principle, as codified, was slightly revised to add references to the CEA where

the statutory language simply cited to the CEA section without citing to the statute. These non-substantive edits were made to sections 38.100 and 38.1200.

1. Subpart B—Designation as Contract Market

In the DCM NPRM, the Commission proposed to codify the statutory text of Core Principle 1 in § 38.100.

115

The Commission is adopting § 38.100 as proposed.

115

Section 735 of the Dodd-Frank Act amended Core Principle 1 by adding that compliance with the core principles, and any other rule or regulation that the Commission may impose under section 8a(5) of the CEA, is a necessary condition to obtain and maintain designation as a contract market, and by adding the condition that “unless otherwise determined by the Commission by rule or regulation,” DCMs have reasonable discretion in establishing the manner in which they comply with the core principles. 7 U.S.C. 7(d)(1).

2. Subpart C—Compliance With Rules

Section 5(d)(2) of the CEA, as amended by the Dodd-Frank Act, requires that a DCM establish, monitor, and enforce compliance with its rules, including rules regarding access requirements and the terms and conditions of any contract to be traded on the contract market, and rules prohibiting abusive trade practices.

116

A DCM must also have the capacity to detect and investigate potential rule violations and to sanction any person that violates its rules. In addition, a DCM's rules must provide it with the ability and authority to perform the obligations and responsibilities required under Core Principle 2, including the capacity to carry out such international information sharing agreements that the Commission may require.

116

Section 735 of the Dodd-Frank Act amended section 5 of the CEA to eliminate DCM designation criteria and amends several core principles, including Core Principle 2. Core Principle 2 was amended to include language formerly found in Designation Criterion 8—Ability to Obtain Information, and to specifically require that a DCM have the ability to detect, investigate, and sanction rule violations.

The Commission proposed several rules implementing amended Core Principle 2, as further described below.

i. § 38.150—Core Principle 2

Proposed § 38.150 codified the text of section 5(d)(2) of the CEA.

CME commented that a DCM cannot be expected to carry out international or other informational sharing agreements to which it is not a party, and should not be compelled by regulation to enter into such agreements.

117

KCBT opposed the requirement that a DCM establish rules and enter into informational-sharing agreements, particularly when such agreements contain specific requirements that are unsuitable to a DCM or conditions with which the DCM is unable to comply.

118

117

CME Comment Letter at 15 (Feb. 22, 2011).

118

KCBT Comment Letter at 3 (Feb. 22, 2011).

Discussion

The Commission is adopting § 38.150 as proposed. Section 38.150 simply codifies the statutory language of the core principle. The Commission, therefore, does not have discretion to amend the requirements or obligations imposed by the statute.

119

Section 5(d)(2)(C) of the CEA, as amended by the Dodd-Frank Act, states that “[t]he rules of the contract market shall provide the board of trade with the ability and authority to obtain any necessary information to perform any function described in this subsection, including the capacity to carry out such international information sharing agreements as the Commission may require.” 7 U.S.C. 7(d)(2).

ii. § 38.151—Access Requirements

Sec. 38.151(a)—Jurisdiction

Proposed § 38.151(a) required that prior to granting a member or market participant access to its markets, the DCM must require the member or market participant to consent to its jurisdiction.

Summary of Comments

CFE stated that the term “market participant” used in the proposed rule should be limited to non-members of a DCM that have the ability to enter orders directly into a DCM's trade matching system for execution, and that the term should not include non-members that do not have this ability.

120

CFE further commented that the proposed rule should not apply to customers whose orders pass through a member's system before receipt by a DCM because, according to CFE, in that instance the customer order is being received by the DCM from the member.

121

CFE also asserted that customers that submit orders through a member do not have the privilege of trading on a DCM and thus the proposed rule should not apply to them.

122

120

CFE Comment Letter at 2 (Feb. 22, 2011).

121

Id.

122

Id.

CME recommended that the Commission withdraw the proposed rule.

123

It contended that requiring clearing firms to obtain every customer's consent to the regulatory jurisdiction of each DCM would be costly.

124

Moreover, CME commented that even if such consent were obtained, the proposed rule would be entirely ineffective in achieving the Commission's desired outcome.

125

CME explained that if a non-member who had consented to the exchange's jurisdiction under the proposed rule committed a rule violation and subsequently elected not to cooperate in the investigation or disciplinary process, the exchange's only recourse would be to deny the non-member access and, if appropriate, refer the matter to the Commission.

126

CME further explained that a DCM's enforcement options, and the regulatory outcomes, do not change based on whether or not there is a record of the non-member consenting to jurisdiction, but rather depend on whether the non-member chooses to participate in the DCM's investigative and disciplinary processes.

127

123

CME Comment Letter at 17 (Feb. 22, 2011).

124

Id.

at 16.

125

Id.

126

Id.

127

Id.

ICE contended that the proposed rule should distinguish between direct-access and intermediated market participants.

128

Furthermore, ICE stated that a trader should be specifically subject to the jurisdiction and the disciplinary process of the DCM only when the privilege of trading on a DCM is specifically granted by the DCM.

129

Likewise, KCBT explained that even if a non-member consents to KCBT jurisdiction, but later fails to abide by such consent, KCBT's only recourse would be to revoke such participant's market access.

130

Therefore, KCBT questioned the benefit of implementing the proposed rule.

131

128

ICE Comment Letter at 12-13 (Feb. 22, 2011).

129

Id.

at 15.

130

KCBT Comment Letter at 2 (Feb. 22, 2011).

131

Id.

NYSE Liffe sought clarification regarding the type of market participant covered by the proposed rule.

132

NYSE Liffe requested that the Commission confirm that, unless NYSE Liffe permits market participants direct access to its trading platform, it would not consider a DCM to be “granting” market participants access to its markets, thus necessitating that it require market participants to consent to the DCM's jurisdiction.

133

132

NYSE Liffe Comment Letter at 11 (Feb. 22, 2011).

133

Id.

Discussion

The Commission is adopting § 38.151(a) as proposed. While acknowledging the comments described above, the Commission believes that § 38.151(a) codifies jurisdictional requirements necessary to effectuate the statutory mandate of Core Principle 2 that a board of trade “shall have the capacity to detect, investigate, and apply appropriate sanctions to any person that violates any rule of the

contract market.” In the Commission's view, settled jurisdiction—established by a DCM prior to granting members and market participants access to its markets—is necessary to effectively investigate and sanction persons that violate DCM rules. In particular, a DCM should not be in the position of asking market participants to voluntarily submit to jurisdiction and cooperate in investigatory proceedings after a potential rule violation has been found. Similarly, market participants should be clear that their trading practices are subject to the rules of a DCM, including rules that require cooperation in investigatory and disciplinary processes. For the avoidance of doubt, the Commission notes that the scope of § 38.151(a) is not limited to market participants with direct market access, or limited as otherwise suggested by CFE, ICE and NYSE Liffe. To the contrary, persons whose trades are intermediated, persons who are customers of member firms, and persons whose access to the exchange is granted by or through member firms are within the scope of § 38.151(a).

The Commission notes commenters' suggestion that a DCM's ultimate recourse against non-members who fail to cooperate in investigations or disciplinary proceedings is to deny such non-members access to the exchange and, if appropriate, refer them to the Commission. The Commission confirms that denial of access and referral to the Commission are the appropriate steps for a DCM to take when a market participant fails to cooperate in an investigation or disciplinary proceedings. The Commission expects that DCMs will in fact follow these steps. However, the Commission does not agree that this absolves DCMs from their responsibility to establish jurisdiction over members and market participants as an initial condition of trading. Finally, the Commission recognizes that DCMs may need additional time to secure existing market participants' agreements to jurisdiction. Accordingly, the Commission is granting DCMs up to 180 days following the applicable effective date of the rules being adopted in this release to comply with the requirements of § 38.151(a) with respect to existing members and market participants. Each DCM may determine for itself how it will secure such agreements. For example, a DCM could utilize its clearing firms to secure the agreement. With respect to new members and market participants, DCMs will be subject to § 38.151(a) on the effective date of the rules being adopted in this release.

Sec. 38.151(b)—Impartial Access by Members, Market Participants and Independent Software Vendors

Proposed § 38.151(b) required that a DCM provide its members, market participants and independent software vendors (“ISVs”) with impartial access to its markets and services, including: (1) access criteria that are impartial, transparent, and applied in a non-discriminatory manner, and (2) comparable fee structures for members, market participants and ISVs, receiving equal access to, or services from, the DCM. In regards to the proposed rule's comparable fee structure requirement, the DCM NPRM preamble discussion of proposed § 38.151(b) stated that “[f]ee structures may differ among categories if such fee structures are reasonably related to the cost of providing access or services to a particular category.”

134

See

DCM NPRM at 80579. As an example, the preamble further stated that “if a certain category required greater information technology or administrative expenses on the part of the DCM, then a DCM may recoup those costs in establishing fees for that category or member or market participant.”

Id.

Summary of Comments

Chris Barnard supported this requirement, stating that the only reason for charging different fee structure would relate to differing costs of providing access or service to a particular category.

135

CFE commented that the Commission's application of the requirement to have comparable fee structures is too narrow.

136

CFE stated that it is in a DCM's best interest to set fees at levels that encourage participation on the DCM (rather than to exclude participants) because having greater participation leads to greater contract volume and thus more transaction revenue for the DCM.

137

CFE agreed that a DCM should be able to have fee structures that differ among categories and did not believe that the only permitted differentiation should be based on cost.

138

135

Barnard Comment Letter at 2 (Feb. 22, 2011).

136

CFE Comment Letter at 3 (Feb. 22, 2011).

137

Id.

138

Id.

CME stated that the fee restrictions imposed by the proposed rule exceed the Commission's authority under the Dodd-Frank Act, and questioned the basis for the proposed rule.

139

In particular, CME argued that the agency lacks authority to set or limit fees charged by DCMs.

140

139

CME Comment Letter at 8-9 (Feb. 22, 2011).

140

Id.

ELX stated that exchanges must have some flexibility in implementing fees in order to allow new markets to effectively build a customer base.

141

According to ELX, not all customers “receive the same commission” from their FCM, IB or executing broker, and it is artificial to require exchanges to forego their flexibility in pricing to build a marketplace.

142

ELX further stated that competition should not be rigidly regulated at the exchange level while other regulated entities doing business with customers are permitted to use competitive pricing.

143

141

ELX Comment Letter at 3 (Feb. 22, 2011).

142

Id.

at 4.

143

Id.

ICE noted that the discriminatory conduct prohibited by the proposed rule would be subject to review by the Commission as an “access denial” issue under part 9 of the Commission's regulations.

144

Moreover, ICE asserted that in its view, there has been no pattern of DCMs denying access to their markets that warrants the proposed rule.

145

ICE added that the proposed rule should not require access requirements for traders who do not apply for, and are not granted access to, the trading platform by the DCM.

146

144

ICE Comment Letter at 15 (Feb. 22, 2011).

145

Id.

at 15.

146

Id.

KCBT objected to the Commission's mandate of access and fee equality, stating that the mandate may not take into consideration all aspects of an exchange's varying fee or access structures, including beneficial rate structures for high-volume traders or market maker programs.

147

Consequently, KCBT urged the Commission to withdraw from its attempt to impose fee restrictions on DCMs.

148

147

KCBT Comment Letter at 3 (Feb. 22, 2011).

148

Id.

MGEX stated that in general, it is in the best interest of the DCM to have open and available markets and services.

149

Therefore, MGEX argued that the proposed rule is unnecessary and infringes on the business judgment of the DCM.

150

149

MGEX Comment Letter at 3 (Feb. 22, 2011).

150

Id.

Trading Technologies stated that the Commission should modify its proposed impartial access rules to require that DCM co-location service fees be reasonably related to the cost of providing such services.

151

Trading Technologies Comment Letter at 4 (Jun. 3, 2011). The Commission recently addressed co-location fees in a separate proposed rulemaking for “Co-location/Proximity Hosting Services.”

See

notice of proposed rulemaking, 75 FR 33198, Jun. 11, 2010.

Discussion

The Commission is adopting the rule as proposed, with the modifications and clarifications described below.

The Commission believes that the proposed rule falls within the Commission's authority under the Dodd-Frank Act. As an initial matter, Congress, under the Dodd-Frank Act, expressly authorized the Commission to promulgate rules implementing requirements for DCMs, including access requirements.

152

Moreover, the statutory language of Core Principle 2 expressly requires that DCMs “establish, monitor and enforce compliance with the rules of the contract market, including: (1) Access requirements[.]”

153

Though the CEA does not specify that DCMs provide “impartial” access, the Commission believes that a reasonable reading of the CEA is that it permits rules that would promote impartial access.

152

See

CEA section 5(d)(1)(A)(ii) (Core Principle 1), 7 U.S.C. 7(d)(1).

153

CEA section 5(d)(2)(A)(i) (Core Principle 2), 7 U.S.C. 7(d)(2).

The Commission has considered comments that claimed that the rule is unnecessary, and believes that impartial access rules are necessary in order to prevent the use of discriminatory access requirements as a competitive tool against certain participants. In particular, access to a DCM should be based on the financial and operational soundness of a participant, not on factors that could bar access and result in discriminatory access or act as a barrier to entry. Any participant should be able to demonstrate financial soundness by showing either that it is a clearing member of a DCO that clears products traded on that DCM, or that it has clearing arrangements in place with such a clearing member. Furthermore, granting impartial access to participants that satisfy a DCM's access requirements will likely enhance the DCM's liquidity and the overall transparency of the swaps and futures markets.

In regards to comments pertaining to the proposed rule's treatment of fees, the Commission believes that commenters have misinterpreted the proposed requirement for comparable fee structures for categories of market participants receiving equal access to the DCM. The requirement in proposed § 38.151(b) neither sets nor limits fees charged by DCMs. Rather, it states only that the DCM set non-discriminatory fee classes for those receiving access to the DCM as a way to implement the requirement of impartial access to DCMs. DCMs may establish different categories of market participants, but may not discriminate within a particular category. Accordingly, contrary to CME's comment claiming that the fee restrictions imposed by the proposed rule exceed the Commission's authority under the Dodd-Frank Act, the rule does not set or impose fees on DCMs.

To clarify the DCM NPRM preamble discussion of the proposed rule's fee requirement, and in response to CFE and KCBT's comment that a DCM should be able to differentiate among categories by using factors other than cost, the Commission notes that when a DCM determines its fee structure, it may consider other factors in addition to the cost of providing a member, market participant or ISV with access. The proposed requirement that DCMs have a comparable fee structure for categories of market participants was not designed to be a rigid requirement that fails to take into account legitimate business justifications for offering different fees to different categories of entities seeking access. The Commission recognizes that DCMs may also consider services they receive from members, market participants or ISVs (in addition to costs) when determining their fee structure. Market making is an example of one type of service that could merit a fee discount.

To address comments submitted in connection with proposed § 38.151(a) pertaining to the uncertainty of the term “market participant,” the Commission is replacing the term “market participant” in proposed § 38.151(b) with the phrase “persons with trading privileges.”

The Commission is adopting the remainder of the rule as proposed.

Sec. 38.151(c)—Limitations on Access

Proposed § 38.151(c) required a DCM to establish and impartially enforce rules governing any decision by the DCM to deny, suspend, or permanently bar a member's or market participant's access to the contract market. Any decision by a DCM to deny, suspend, or permanently bar a member's or market participant's access to the DCM must be impartial and applied in a non-discriminatory manner.

Summary of Comments

CFE, ICE, and NYSE Liffe commented on the uncertainty of the term “market participant” as used in paragraphs (a), (b), and (c) of proposed § 38.151.

154

CFE Comment Letter at 2 (Feb. 22, 2011); ICE Comment Letter at 14 (Feb. 22, 2011); NYSE Liffe Comment Letter at 11 (Feb. 22, 2011).

Discussion

To address comments pertaining to the uncertainty of the term “market participant,” the Commission is replacing the term “market participant” in proposed § 38.151(c) with the phrase “persons with trading privileges.”

iii. § 38.152—Abusive Trading Practices Prohibited

As proposed, § 38.152 required a DCM to prohibit the following abusive trading practices: front-running, wash trading, pre-arranged trading, fraudulent trading, money passes, and any other trading practices that the DCM deems to be abusive. Additionally, a DCM permitting intermediation would be required to prohibit additional trading practices, including trading ahead of customer orders, trading against customer orders, accommodation trading, and improper cross-trading. The proposal also required a DCM to prohibit any other manipulative or disruptive trading practices prohibited by the Act or by the Commission pursuant to regulation.

155

Section 747 of the Dodd-Frank Act amended section 4c(a) of the CEA, 7 U.S.C. 6c(a), by adding three disruptive practices which make it: unlawful for any person to engage in any trading, practice, or conduct on or subject to the rules of a registered entity that—

(A) Violate bids or offers;

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

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

Summary of Comments

CME and MGEX stated that the proposed rule is too vague because it does not specifically define the enumerated prohibited trade practices.

156

CME also stated that DCMs should have reasonable discretion to establish rules appropriate to their markets that are consistent with the CEA and that satisfy the core principles.

157

CME additionally commented that prearranged trading, which is identified in the proposed rule as a prohibited trade practice, may be permissible at DCMs that allow for block trading, exchange for related position transactions, and pre-execution communications, subject to specified conditions.

158

156

CME Comment Letter at 17 (Feb. 22, 2011) (CME also argued that the proposed regulation was superfluous given that Core Principle 12 already requires a DCM to establish and enforce rules to protect markets and market participants from abusive practices); MGEX Comment Letter at 3 (Feb. 22, 2011).

157

CME Comment Letter at 17 (Feb. 22, 2011).

158

Id.

at 17-18.

Chris Barnard commented that the proposed rule refers to the prohibition of “any other manipulative or disruptive trading practices prohibited by the Act

or by the Commission,” which is important in order to cover new disruptive practices as they emerge, including spoofing.

159

Better Markets commented that it is unclear whether any of the practices associated with high frequency trading will be prohibited by the Commission.

160

Better Markets recommended that the Commission expand its list of prohibited trade practices to include exploiting a large quantity or block trade, price spraying, rebate harvesting, and layering the market, as all four of those practices involve fraudulent trading.

161

159

Barnard Comment Letter at 3 (May 20, 2011).

160

Better Markets Comment Letter at 5 (Feb. 22, 2011).

161

Id.

at 5-8.

Discussion

The Commission is adopting § 38.152 as proposed, subject to the modification described below.

In response to CME and MGEX's concerns regarding the perceived vagueness of the enumerated trading practices, the Commission notes that the definitions of the respective abusive trading practices are commonly known within the industry. Moreover, the enumerated practices in the proposed rule are commonly prohibited within the industry and are typically already prohibited in DCM rulebooks.

162

Although the Commission believes, as noted by CME, that a DCM should have reasonable discretion to establish rules for their markets, the Commission believes that, at a minimum, a DCM must prohibit the abusive trading practices identified in the rule. Indeed, in the RERs conducted by Commission staff to examine DCMs' core principle compliance, Commission staff has found that it is essential for a DCM to be able to demonstrate the capacity to detect, investigate, and enforce the trading violations prohibited under the rule. Consistent with CME's comments on this issue, the Commission clarifies that in certain limited circumstances, as provided under the CEA and the Commission regulations, pre-arranged trading, including block trading and exchange for related position transactions, are permissible at DCMs. Accordingly, the Commission is amending proposed § 38.152 to clarify that a DCM must prohibit pre-arranged trading except as otherwise permitted in part 38 of this chapter. The Commission confirms that pre-execution communications are permissible if allowed by a DCM's rules that have been certified to or approved by the Commission.

162

See e.g.,

CME Rule 534 (Wash Trades Prohibited), and MGEX Rule 743.00 (Accommodation or Wash Trades Forbidden).

In response to Chris Barnard's comment about the inclusion of “spoofing” as a prohibited trade practice, the Commission notes that section 747 of the Dodd-Frank Act amended section 4c(a) of the CEA and includes spoofing as a disruptive trading practice. In the final rule, DCMs are required to prohibit any other manipulative or disruptive trading practices prohibited by the Act. Additionally, the Commission notes that Better Markets' comments regarding Core Principle 2 and high frequency trading are addressed in the context of Core Principle 4.

iv. § 38.153—Capacity To Detect and Investigate Rule Violations

Proposed § 38.153 required that a DCM have arrangements and resources for effective rule enforcement.

163

This included the authority to collect information and examine books and records of members and market participants. Additionally, the proposed rule required a DCM to have, in addition to appropriate resources for trade practice surveillance programs, appropriate resources to enforce all of its rules.

163

As noted in the DCM NPRM, proposed regulation 38.153 was based on the former application guidance for Core Principle 2.

Summary of Comments

CFE requested that the Commission clarify the term “market participant.”

164

CFE claimed that if the term “market participant” were to be interpreted to apply to all customers and not just those customers with direct electronic access to the DCM, then the rule would greatly expand a DCM's regulatory responsibilities over participants with whom it has no direct relationship or connection.

165

CFE further asserted that the rule would greatly increase costs for the DCM and that it would be very difficult for a DCM to undertake the same examination responsibilities for customers that do not have a direct relationship with the DCM that are applicable to a DCM member.

164

CFE Comment Letter at 2 (Feb. 2, 2011).

165

Id.

CME stated that the proposed rule appears to imply that the entire class of non-member, non-registered market participants will be subject to the panoply of recordkeeping requirements currently applicable only to members, registrants, and direct access clients of CME.

166

Additionally, CME commented that the proposed rule does not detail which books, records and information the DCM must be able to obtain from non-member market participants.

167

166

CME Comment Letter at 18 (Feb. 22, 2011).

167

Id.

Discussion

The Commission is adopting this provision as proposed, subject to the modification described below.

The Commission is cognizant that a broad interpretation of the term “market participant” could significantly increase the regulatory responsibilities for DCMs. As noted above, the use of “market participant” may be interpreted to capture a wider range of persons than the Commission intended. Therefore, in response to the commenters' concerns, the Commission is replacing the term “market participant” with “persons under investigation” in the final rule. Thus, a DCM must have the authority to collect books and records from its members, and from any persons under investigation, for effective enforcement of its rules. The books and records collected by the DCM should encompass all information and documents that are necessary to detect and prosecute rule violations.

v. § 38.154—Regulatory Services Provided by a Third Party

As the Commission stated in the DCM NPRM, the CEA “provides that a DCM may comply with applicable core principles by delegating relevant functions to a registered futures association or another registered entity” (collectively, a “regulatory service provider”).

168

Proposed § 38.154(a) required that a DCM that contracts with a regulatory service provider ensure that its regulatory service provider has sufficient capacity and resources to provide timely and effective regulatory services. The proposed rule also made clear that a DCM “will at all times remain responsible for the performance of any regulatory services received, for compliance with the [DCM's] obligations under the CEA and Commission regulations, and for the regulatory service provider's performance on its behalf.”

169

168

Id.

at 80580.

169

75 FR 80572, 80612, Dec. 22, 2010.

Proposed § 38.154(b) required that a DCM maintain adequate compliance staff to supervise any services performed by a regulatory service provider. The proposed rule also required that the DCM hold regular meetings with its regulatory service provider to discuss current work and other matters of regulatory concern. The DCM must also conduct periodic reviews of the adequacy and

effectiveness of services provided on its behalf.

Proposed § 38.154(c) required a DCM that utilizes a regulatory service provider to retain exclusive authority over certain areas, including the cancellation of trades, issuance of disciplinary charges against members or market participants, and denials of access to the trading platform for disciplinary reasons. While the proposed rule permitted a DCM to retain exclusive authority in other areas of its choosing, it required that the decision to open an investigation into a possible rule violation reside with the regulatory service provider.

Summary of Comments

MGEX, KCBT and CME asserted that the proposed rule was overly burdensome or unnecessary.

170

MGEX expressed general opposition to proposed § 38.154, stating that if a service has been delegated to another registered entity pursuant to a Commission-approved agreement, then this “should be sufficient and no other formal agreement is necessary.”

171

KCBT contended that proposed § 38.154 is overly burdensome and duplicative, particularly when a DCM contracts with a regulatory service provider that is also a DCM required to comply with the same core principles.

172

KCBT noted that it currently is a party to a services agreement with another DCM and that it will be costly and unnecessary to perform periodic reviews and hold regular meetings with this regulatory service provider.

173

170

MGEX Comment Letter at 3 (Feb. 22, 2011); KCBT Comment Letter at 3 (Feb. 22, 2011); CME Comment Letter at 19 (Feb. 22, 2011).

171

MGEX Comment Letter at 3 (Feb. 22, 2011).

172

KCBT Comment Letter at 3 (Feb. 22, 2011).

173

Id.

Similarly, CME contended that the proposed rule was overly prescriptive and suggested that the rules would better serve as guidance and acceptable practices.

174

In particular, CME pointed to the requirements that a DCM conduct periodic reviews of the services provided and hold regular meetings with the regulatory service provider to discuss ongoing investigations, trading patterns, market participants, and any other matters of regulatory concern.

175

CME stated that “[w]hile it may well be that it is constructive for the DCM to hold regular meetings with its service provider and `discuss market participants,' the core principle should stand on its own and the DCM should have the flexibility to determine how best to demonstrate compliance with the core principle.”

176

174

CME Comment Letter at 18-19 (Feb. 22, 2011).

175

Id.

176

CME Comment Letter at 19 (Feb. 22, 2011).

CME further objected to the requirement that exclusive authority to open investigations remain with the regulatory service provider.

177

While it argued that the regulatory service provider “should have the independence to open an investigation at its discretion, [CME] sees no reason why the DCM cannot also direct the regulatory service provider to open an investigation.”

178

Additionally, CME and KCBT both objected to the requirement in proposed § 38.154(c) that all decisions concerning the cancellation of trades remain within the exclusive authority of the DCM.

179

CME and KCBT argued that a DCM may be better served by granting such authority to a regulatory service provider.

180

177

Id.

178

Id.

179

CME Comment Letter at 19 (Feb. 22, 2011); KCBT Comment Letter at 3 (Feb. 22, 2011).

180

Id.

NYSE Liffe expressed support for the idea that a DCM will remain ultimately responsible for meeting its regulatory obligations even when it contracts with a regulatory service provider.

181

However, NYSE Liffe requested clarification regarding what authority must be maintained by a DCM when it uses a third-party regulatory service provider.

182

NYSE Liffe pointed to the requirement in proposed § 38.154(c) that a DCM must retain “exclusive authority” in certain areas and requested further clarification as to the definition of “exclusive authority.”

183

In particular, NYSE Liffe requested guidance as to whether a DCM retains “exclusive authority” if its regulatory service provider prepares and presents an investigation report to a DCM's review panel, or assists DCM staff in presenting the matter, as long as the ultimate decision to bring a disciplinary action remains with the DCM's review panel.

184

Additionally, NYSE Liffe sought guidance as to whether a regulatory service provider would be permitted to “prosecute a disciplinary proceeding * * * so long as the ultimate decision to impose a penalty on a respondent, including a possible denial of access to the trading platform, resides with a hearing panel formed pursuant to the DCM's rules?”

185

181

NYSE Liffe Comment Letter at 9 (Feb. 22, 2011).

182

Id.

183

Id.

184

Id.

185

Id.

at 10.

Discussion

The Commission is adopting § 38.154(a) and (b), as proposed, and is adopting § 38.154(c) with certain modifications.

In the past, the Commission has described acceptable “contracting” and “delegating” arrangements for the performance of core principle functions by third-parties.

186

The Commission proposed § 38.154 to clarify its previous guidance on such arrangements. In particular, the Commission does not draw substantive distinctions between “contracting” and “delegating” arrangements as they pertain to core principle compliance functions. Regardless of the term by which a DCM may refer to its utilization of a third-party, the Commission believes that the same regulatory requirements are applicable for purposes of part 38. For purposes of part 38, the Commission refers to such arrangements as “delegation.” The Commission also notes that DCMs must remain responsible for carrying out any function delegated to a third party, and that DCMs must ensure that the services received will enable the DCM to remain in compliance with the CEA's requirements. The Commission believes that proposed § 38.154 effectively establishes a system for administering regulatory services provided to DCMs by third party regulatory service providers. The Commission is of the view that the rule generally provides an appropriate balance between flexibility and ensuring that a DCM properly oversees the actions of its regulatory service provider to ensure accountability and effective performance.

186

See

66 FR 42256, 42266, Aug. 10, 2001.

The Commission acknowledges comments asserting that the rule is overly burdensome or unnecessary but believes that a DCM that elects to use a regulatory service provider must properly supervise the quality and effectiveness of the regulatory services provided on its behalf. The Commission believes that proper supervision will require that a DCM have complete and timely knowledge of relevant work performed by the DCM's regulatory service provider on its behalf. The Commission also believes that such knowledge can only be acquired through the periodic reviews and regular meetings required under proposed § 38.154.

Additionally, the Commission acknowledges CME and KCBT's comments regarding the cancellation of trades but believes that the potential economic consequences of trade

cancellations on a DCM's members and market participants are such that a DCM should retain exclusive authority over the cancellation of trades.

The Commission has considered CME's comment regarding the importance of allowing a DCM to open investigations into possible rule violations. The Commission believes that a DCM should have the ability to request that its regulatory service provider conduct an investigation on a market participant or to conduct such an investigation on its own. Consequently, the Commission is modifying § 38.154(c) by removing the requirement that the decision to open an investigation into possible rule violations reside exclusively with the regulatory service provider.

Lastly, in response to the request by NYSE Liffe for additional guidance regarding whether certain regulatory decisions must be retained by a DCM, the Commission believes that a DCM would retain “exclusive authority” under § 38.154(c) if it permits a regulatory service provider to present, or assist DCM staff to present, an investigation report or evidence to a disciplinary panel as long as the decisions to bring a disciplinary action and impose a disciplinary penalty on a respondent, including the decision to deny access, remains with the DCM or the DCM's disciplinary bodies.

vi. § 38.155—Compliance Staff and Resources

In proposed § 38.155(a), the Commission required that a DCM establish and maintain sufficient compliance staff and resources to conduct a number of enumerated tasks, such as audit trail reviews, trade practice surveillance, market surveillance, and real time market monitoring. The proposed rule also required that the DCM have sufficient compliance staff to address unusual market or trading events and to conduct and complete any investigations in a timely manner.

In proposed § 38.155(b), the Commission required a DCM to monitor the size and workload of its compliance staff annually to ensure that staff and resources are adequate. In the preamble to the proposed rule, the Commission clarified that it was not proposing that compliance staff size be determined based on a specific formula. Rather, the Commission intended “to leave to the discretion of each individual DCM to determine the size of the staff it needs to effectively perform its self-regulatory responsibilities.”

187

In making this determination, the proposed rule also set forth certain factors that should be considered in determining the appropriate level of compliance resources and staff.

187

DCM NPRM at 80580.

Summary of Comments

NYSE Liffe noted that in proposed § 38.154(b), “a DCM that contracts with a regulatory service provider must still maintain sufficient compliance staff.”

188

NYSE Liffe suggested that § 38.155 take into consideration whether a DCM has contracted with a regulatory service provider in determining the appropriate level of compliance staff and resources.

189

NYSE Liffe also requested that the Commission “make clear that a DCM meets its requirement to have sufficient compliance staff to address unusual market or trading events where its regulatory services provider has sufficient resources for addressing these unusual events.”

190

188

NYSE Liffe Comment Letter at 10 (Feb. 22, 2011).

See also

DCM NPRM at 80612.

189

NYSE Comment Letter at 10 (Feb. 22, 2011).

190

Id.

Chris Barnard requested that the Commission amend § 38.155 to require DCMs to have a chief compliance officer “working within a job description, structures, rules and procedures that act to maintain its independence.”

191

Barnard Comment Letter at 3 (May 20, 2011).

Discussion

The Commission believes that proposed § 38.155 effectively sets forth the requirement that DCMs must establish and maintain sufficient compliance staff to enforce compliance with its rules as required under Core Principle 2, and accordingly, the Commission is adopting § 38.155 as proposed.

The Commission is of the view that having adequate staff to perform a DCM's compliance and enforcement responsibilities is essential to the effectiveness of its self-regulatory programs, including market surveillance, audit trail, trade practice surveillance, and disciplinary programs. The Commission believes (as noted by NYSE Liffe) that the staff of a regulatory service provider may be taken into consideration when determining whether a DCM has sufficient compliance staff. However, the Commission notes that pursuant to § 38.154(b), each DCM must still retain sufficient compliance staff to supervise the quality and effectiveness of any services provided by a regulatory service provider on its behalf.

The Commission acknowledges Chris Barnard's comment that a DCM should be required to designate a chief compliance officer but notes that the Dodd-Frank Act mandates that certain regulated entities, such as SEFs, swap data repositories, and derivatives clearing organizations, designate chief compliance officers. There is no explicit statutory requirement for DCMs. Therefore, the Commission does not believe it is appropriate to require DCMs to appoint a chief compliance officer. However, it is current industry practice for DCMs to designate an individual as chief regulatory officer, and it will be difficult for a DCM to meet the requirements of § 38.155 without a chief regulatory officer or similar individual to supervise its regulatory program, including any services rendered to the DCM by a regulatory service provider.

vii. § 38.156—Automated Trade Surveillance System

Proposed § 38.156 required a DCM to maintain an automated trade surveillance system capable of detecting and investigating potential trade practice violations. The automated trade surveillance would be required to maintain all data reflecting the details of each order entered into the trading system, including order modifications and cancellations, and data reflecting transactions executed on the DCM. The proposed rule required the automated surveillance system to process this data on a trade date plus one day basis (“T+1 basis”). Additionally, according to the rule, the automated trade surveillance system would be required to provide users with the ability to compute, retain and compare trading statistics; compute profit and loss; and reconstruct the sequence of trading activity.

Summary of Comments

CME commented that an exchange does not capture order details, modifications or cancellations for open-outcry orders in an automated manner unless such orders are transmitted to the floor via the exchange's order routing system, or with respect to privately negotiated transactions.

192

CME asserted that it has been unable to design a system that automates the actual investigation of potential trade practice violations, and that it would not be able to do so within 60 days of the final rules taking effect.

193

CME further argued that it is unclear whether the regulation applies to electronic trading or open outcry trading.

194

CME challenged the use of what it deems as “broad and ambiguous” terms to describe

capabilities that a DCM's automated trade surveillance system is required to have, including the capability to detect and flag specific trade execution patterns and anomalies; compute, retain and compare trading statistics; and compute trade gains, losses, and futures-equivalent positions.

195

CME recommended that the Commission reconsider the requirements of this regulation and consider a more flexible, core principles-based approach.

196

192

CME Comment Letter at 20 (Feb. 22, 2011).

193

Id.

194

Id.

195

Id.

196

Id.

MGEX agreed with the proposed requirement that a DCM's automated surveillance system must maintain all trade data and order data on a T+1 basis, but opposed the proposed requirement that a DCM compute, retain and compare trading statistics.

197

MGEX contended that this information is not a trade data item and requested that this requirement be removed from the final rule.

198

197

MGEX Comment Letter at 4 (Feb. 22, 2011).

198

Id.

NYSE Liffe commented that it would take significant time to determine the types of changes to existing automated systems required to implement the proposed rules, including § 38.156, and recommended that the Commission provide existing DCMs with at least 18 months from the effective date of the rule to certify compliance with the final regulations.

199

NYSE Liffe Comment Letter at 14 (Feb. 22, 2011).

Better Markets commented that an automated trade surveillance system, which records orders, modifications of orders, and cancellations, must allow for such data to be time-stamped at intervals consistent with the capabilities of high frequency traders that use the DCM's systems to transact.

200

Better Markets Comment Letter at 9 (Feb. 22, 2011).

Discussion

The Commission is adopting proposed § 38.156, with one modification.

The requirement that an automated trade surveillance system maintain all data reflecting the details of each order entered into the trading system is being moved to § 38.552 (Elements of an acceptable audit trail program). Specifically, the Commission believes that § 38.552(b) is the more logical place in the Commission's rules to address this aspect of a DCM's automated surveillance system because paragraph (b) specifies the requirements for a DCM's audit trail program, including a history of all orders and trades.

In response to CME's comment regarding a system that automates the actual investigation, the Commission notes that CME has misinterpreted the proposed rule, as § 38.156 applies to a DCM's automated surveillance system and not to the actual investigation which the Commission expects would be carried out by a DCM's compliance staff with the assistance of automated surveillance tools. The Commission confirms that the speed and timing of capturing information through an automated trade surveillance system is different for open-outcry than for electronic trading, as CME stated in its comments; this is addressed in the discussion concerning § 38.552.

In regards to CME's comment pertaining to the breadth of the rule, while the Commission acknowledges that computing, retaining, and comparing trading statistics may not specifically be a trade data item, the Commission believes that these analytical tools are a necessary component of an effective trade surveillance system. The Commission notes that timing concerns raised by NYSE Liffe regarding compliance with the final rules are addressed above in the § 38.3 discussion. Additionally, the Commission notes that Better Markets' comments regarding Core Principle 2 and high frequency trading are addressed in the context of Core Principle 4.

viii. § 38.157—Real-Time Market Monitoring

Proposed § 38.157 codified existing practices at DCMs for real-time monitoring of electronic trading, and reflected the growth of electronic trading in the U.S. futures markets, as well as the Commission's experience in designating new contract markets since passage of the CFMA.

201

Proposed § 38.157 required a DCM to conduct real-time market monitoring of all trading activity on its electronic trading platform to ensure orderly trading and identify market or system anomalies. The proposed rule further required a DCM to have the authority to cancel trades and adjust trade prices when necessary, and that any price adjustments or trade cancellations must be transparent to the market and subject to clear, fair and publicly-available standards.

201

See

DCM NPRM at 80581.

Summary of Comments

In its comments, CME reiterated its belief that the proposed rules are overly prescriptive.

202

CME argued that the standards set in the proposed rule are unreasonably high.

203

CME pointed to the requirement that a DCM “conduct real-time market monitoring of all trading activity on its electronic trading platform(s) to ensure orderly trading and identify any market or system anomalies” and argued that it is not clear whether any DCM could comply with these standards.

204

202

CME Comment Letter at 20-21 (Feb. 22, 2011).

203

Id.

204

CME Comment Letter at 20-21 (Feb. 22, 2011) (citing DCM NPRM at 80613, with emphasis added by CME).

Better Markets stated that when conducting real-time market monitoring, DCMs should have the capability to monitor high frequency trading.

205

Better Markets argued that this process should include “monitoring of orders and cancellations, each time-stamped at intervals consistent with the capabilities of [high frequency traders].”

206

205

Better Markets Comment Letter at 9 (Feb. 22, 2011).

206

Id.

Discussion

The Commission is adopting § 38.157, as proposed, subject to the modification described below.

In regard to the CME's comment, the Commission believes that § 38.157, as proposed, enables a DCM to effectively monitor its electronic markets and grants a DCM the flexibility to determine the best way to conduct real-time market monitoring. The Commission also believes that the proposed rule correctly mandates that a DCM conduct real-time market monitoring of all trading activity that occurs on its electronic trading platform(s) in order to detect disorderly trading and market or system anomalies, and take appropriate regulatory action.

The Commission recognizes that real-time market monitoring cannot ensure orderly trading at all times, but it should be able to identify disorderly trading when it occurs. Therefore, the Commission is modifying the first sentence of proposed § 38.157 to remove the requirement to “ensure orderly trading” and instead state that “a designated contract market must conduct real-time market monitoring of all trading activity on its electronic trading platform(s) to identify disorderly trading and any market or system anomalies.” In response to Better Markets' comments, the Commission believes that § 38.157 is sufficient to establish a DCM's obligations with respect to real-time market monitoring of all trading on a DCM's electronic trading platform, including high frequency trading. The Commission will continue to assess the impact of high

frequency trading on the markets regulated by the Commission.

The Commission believes that § 38.157 effectively establishes a DCM's obligations with respect to real-time market monitoring of trading activity on its electronic trading platforms. Accordingly, the Commission is adopting § 38.157 as modified above.

ix. § 38.158—Investigations and Investigation Reports

Sec. 38.158(a)—Procedures

Proposed paragraph (a) of § 38.158 required that a DCM have procedures to conduct investigations of possible rule violations. The proposed rule required that an investigation must be commenced upon Commission staff's request or upon discovery of information by the DCM indicating a possible basis for finding that a violation has occurred or will occur.

Summary of Comments

CME argued that the proposed rule diminishes any discretion on behalf of DCMs to determine the matters that warrant a formal investigation, because at the time of discovery or upon receipt of information, and before a review occurs, there always may be a possible basis that a violation has occurred or will occur.

207

CME agreed that written referrals from the Commission, law enforcement authorities, other regulatory agencies, or other SROs should result in a formal investigation in every instance.

208

However, CME contended that the DCM should have reasonable discretion to determine how it responds to complaints and other referrals, including the discretion to follow-up with a less formal inquiry in certain situations.

209

207

CME Comment Letter at 21 (Feb. 22, 2011).

208

Id.

209

Id.

Discussion

The Commission is adopting § 38.158(a) as proposed, subject to a minor modification. The Commission confirms that in certain circumstances a DCM should have reasonable discretion regarding whether or not to open an investigation, as noted by CME. Consequently, the Commission is revising paragraph (a) of § 38.158 to reflect that an investigation must be commenced upon receipt of a request from Commission staff or upon the discovery or receipt of information by the DCM that indicates a “reasonable basis” for finding that a violation “may have” occurred or will occur.

Sec. 38.158(b)—Timeliness

Proposed § 38.158(b) required that an investigation be completed in a timely manner, which is defined in the proposed rule as 12 months after an investigation is opened, absent mitigating factors. The mitigating factors identified in the proposed rule included the complexity of the investigation, the number of firms or individuals involved as potential wrongdoers, the number of potential violations to be investigated, and the volume of documents and data to be examined by compliance staff.

Summary of Comments

CME expressed general support for the proposed rule, but recommended that the list of possible mitigating circumstances also include the domicile of the subjects and cooperative enforcement matters with the Commission, since the DCM may not have independent control over the pace of the investigation.

210

CME also requested that the Commission make clear that the time period necessary to prosecute an investigation once it is referred for enforcement action is independent of the 12-month period referenced in the regulation.

211

210

Id.

211

Id.

at 22.

Discussion

The Commission is adopting the rule as proposed.

The Commission believes that a 12-month period to complete an investigation is appropriate and timely. Although the Commission believes, as noted by CME, that additional mitigating factors could justifiably contribute to a delay in completing an investigation within a 12-month period the Commission notes that the factors included in the proposed rule were not intended to be an exhaustive list of mitigating circumstances. In the Commission's view, the factors listed in the proposed rule represent some of the more common examples that could delay completing an investigation within the 12-month period. The Commission also confirms that § 38.158 only applies to the investigation phase of a matter.

Sec. 38.158(c)—Investigation Reports When a Reasonable Basis Exists for Finding a Violation

Proposed § 38.158(c) sets forth the elements and information that must be included in an investigation report when there is a reasonable basis for finding a rule violation, including: (i) The reason for the investigation; (ii) a summary of the complaint, if any; (iii) the relevant facts; (iv) compliance staff's analysis and conclusions; (v) a recommendation as to whether disciplinary action should be pursued; and (vi) the member or market participant's disciplinary history.

Summary of Comments

CME commented that rule violations can range from very minor to egregious and not every rule violation merits formal disciplinary action.

212

CME argued that minor transgressions can effectively be addressed by the issuance of a warning letter by CME compliance staff, and that the Commission should amend the rule accordingly to account for this possibility.

213

212

Id.

213

Id.

CME and ICE opposed the requirement that a DCM include a respondent's disciplinary history in the investigative report that is submitted to a review panel.

214

CME commented that a respondent's disciplinary history is not relevant to the consideration of whether that respondent has committed a further violation of the DCM's rules.

215

However, CME noted that an exception would be where the prior disciplinary offense is an element of proof for the rule violations for which compliance staff is asking the review panel to issue charges, such as a violation of a previously issued “cease and desist” order.

216

ICE stated that unless the rule violations that are the subject of the investigative report involve pervasive recordkeeping violations, only substantive violations in the respondent's history would be relevant to the review panel's deliberations.

217

214

CME Comment Letter at 21-22 (Feb. 22, 2011); ICE Comment Letter at 15 (Feb. 22, 2011).

215

CME Comment Letter at 35 (Feb. 22, 2011).

216

Id.

217

ICE Comment Letter at 15 (Feb. 22, 2011).

Discussion

The Commission is adopting the rule as proposed, subject to one modification to address the comments from CME and ICE.

The Commission confirms, as CME noted, that “minor transgressions” can be addressed by a DCM's compliance staff with the issuance of warning letters and this is discussed below in § 38.158(e). However, as further discussed below in §§ 38.158(d) and (e), no more than one warning letter may be issued to the same person or entity found to have committed the same rule violation within a rolling 12-month period.

The Commission also agrees with CME and ICE that a respondent's disciplinary history is not always

relevant to the consideration of whether a respondent has committed a further violation of a DCM's rules. As a result, this requirement is being eliminated from the final rule. The Commission notes, however, that all disciplinary sanctions, including sanctions imposed pursuant to an accepted settlement offer, must take into account the respondent's disciplinary history.

Sec. 38.158(d)—Investigation Reports When No Reasonable Basis Exists for Finding a Violation

Proposed § 38.158(d) sets forth the elements and information that must be included in an investigation report when it has been determined that no reasonable basis exists for finding a rule violation, including: (i) The reason the investigation was initiated; (ii) a summary of the complaint, if any; (iii) the relevant facts; and (iv) compliance staff's analysis and conclusions. The proposed rule also required that if a DCM's compliance staff recommends that a warning letter be issued, the investigation report must also include the potential wrongdoer's disciplinary history.

Summary of Comments

CME recommended that the Commission amend the proposed rule to account for a DCM's ability to close a case administratively and still issue a warning letter without disciplinary committee approval, as the CME Market Regulation Department currently has such authority.

218

CME Comment Letter at 22 (Feb. 22, 2011).

Discussion

The Commission is adopting § 38.158(d) as proposed, subject to one modification.

The Commission is eliminating the provision in paragraph (d) that discussed the concept of warning letters because the Commission does not believe that a DCM would need to limit the number of warning letters that can be issued when a rule violation has not been found. For example, Commission staff has found in its RERs that some DCMs issue warning letters as reminders or for educational purposes. The Commission notes, however, that this modification does not impact the limitation on the number of warning letters that may be issued—by a disciplinary panel or by compliance staff—to the same person for the same violation in a rolling 12-month period when a rule violation is found to have been committed.

Sec. 38.158(e)—Warning Letters

Proposed § 38.158(e) provided that a DCM may authorize its compliance staff to issue a warning letter or to recommend that a disciplinary committee issue a warning letter. The proposed rule also provided that no more than one warning letter for the same potential violation may be issued to the same person or entity during a rolling 12-month period.

Summary of Comments

CME and MGEX opposed the requirement that a DCM may only issue one warning letter to the same person for the same rule violation in a rolling 12-month period.

219

CME stated that the rule is unduly prescriptive and fails to take into consideration important factors that are relevant to a DCM when evaluating potential sanctions in a disciplinary matter.

220

CME stated that the DCM should have discretion to determine the appropriate sanctions in all cases.

221

MGEX contended that the requirement will effectively prohibit a DCM from using warning letters as an educational tool or reminder.

222

According to MGEX, the proposed rule forces DCMs to adopt summary fines and prevents them from pursuing minor infractions, which may lead to additional unintended consequences outside of the purpose of the Dodd-Frank Act.

223

MGEX recommended that the Commission remove this requirement and provide the DCM more flexibility in determining the proper methodology for enforcing rules, regulations, and procedures.

224

219

CME Comment Letter at 22-23 (Feb. 22, 2011); MGEX Comment Letter at 4 (Feb. 22, 2011).

220

CME Comment Letter at 22 (Feb. 22, 2011).

221

Id.

222

MGEX Comment Letter at 4 (Feb. 22, 2011).

223

Id.

224

Id.

Discussion

The Commission is adopting § 38.158(e) with certain modifications, including to convert a portion of the rule to guidance.

The Commission acknowledges the comments from CME and MGEX concerning the issuance of warning letters but believes that in order to ensure that warning letters serve as effective deterrents, and to preserve the value of disciplinary sanctions, the Commission believes that no more than one warning letter may be issued to the same person or entity found to have committed the same rule violation within a rolling 12-month period.

225

As discussed in the DCM NPRM, while a warning letter may be appropriate for a first-time violation, the Commission does not believe that more than one warning letter in a rolling 12-month period for the same violation is ever appropriate.

226

This provision will remain as a rule. A policy of issuing repeated warning letters, rather than issuing meaningful sanctions, to members and market participants who repeatedly violate the same or similar rules denigrates the effectiveness of a DCM's rule enforcement program.

227

Furthermore, the section of the proposed rule governing warning letters is consistent with what Commission staff has advised DCM applicants in the past and with recommendations made in prior RERs.

228

225

For purposes of this rule, the Commission does not consider a “reminder letter” or such other similar letter to be any different than a warning letter.

226

See

DCM NPRM at 80581.

227

See

id.

at 80581.

228

See

1998 Rule Enforcement Review of Kansas City Board of Trade; and Rule Enforcement Review of the Minneapolis Grain Exchange (Aug. 27, 2009).

The Commission notes that the final rule does not include the reference that a warning letter issued in accordance with this section is not a penalty or an indication that a finding of a violation has been made because paragraph (e) only addresses warning letters that are issued for a finding of a violation. Also, the provision requiring a copy of a warning letter issued by compliance staff to be included in the investigation report is being eliminated from the final rule because the Commission has determined that such a requirement is unnecessary.

As noted above, the Commission believes that minor transgressions can be addressed by the issuance of a warning letter by a DCM's compliance staff. Accordingly, in order to provide a DCM with flexibility in this regard, the Commission is moving this provision of the rule to the guidance section of Core Principle 2. The text of the guidance provides that the rules of a DCM may authorize compliance staff to issue a warning letter to a person or entity under investigation or to recommend that a disciplinary panel take such action.

x. § 38.159—Ability To Obtain Information

Proposed § 38.159 required a DCM to have the ability and authority to obtain any necessary information to perform any function required under proposed subpart C (Compliance with rules) of the Commission's regulations. This would include the capacity to carry out any international information sharing agreements required by the

Commission. Proposed § 38.159 also provided “that information sharing agreements can be established with other designated contract markets and swap execution facilities, or the Commission can act in conjunction with a DCM to carry out such information sharing.”

229

DCM NPRM at 80614.

Summary of Comments

CME and KCBT stated that a DCM should not be mandated to carry out international or other informational sharing agreements to which it is not a party and should not be compelled by Commission regulation to enter into agreements, particularly when such agreements contain terms determined by other parties, which conceivably could include terms or conditions unsuitable to a DCM or conditions that a DCM is unable to comply with.

230

CME Comment Letter at 15 (Feb. 22, 2011); KCBT Comment Letter at 3 (Feb. 22, 2012).

Discussion

The Commission is adopting § 38.159 as proposed. In response to CME and KCBT's comments, § 38.159 clarifies and codifies the Core Principle 2 requirement that a DCM have the ability and authority to obtain necessary information to perform its rule enforcement obligations. The core principle specifically requires that the rules of the DCM provide it with the ability and authority to perform any function described in the core principle, including capacity to carry out such international information sharing agreements, as the Commission may require. The rule provides that information sharing agreements can be established with other DCMs or SEFs, or that the Commission can act in conjunction with a DCM to carry out such information sharing.

231

The Commission notes that the language of § 38.159, including the language to which CME objects, is substantially similar to the language of Core Principle 2. The Commission also notes that while the rule requires DCMs to have the capacity to carry out such information sharing agreements, as is required by the statute, the rule does not mandate or prescribe the specific terms of such agreements, and thus, DCMs would have the ability to collaborate on the terms of such agreements. The Commission believes that § 38.159 appropriately implements the requirements of section 5(d)(2)(C) of the CEA and is adopting § 38.159 as proposed.

231

As noted in the DCM NPRM, this proposed language is virtually identical to the language found in the guidance for former Designation Criterion 8.

xi. § 38.160—Additional Rules Required

Proposed § 38.160 required a DCM to adopt and enforce any additional rules that it believes are necessary to comply with the requirements of this subpart C.

The Commission has determined to codify proposed § 38.160 as guidance for Core Principle 2 in appendix B, rather than a rule, in order to provide DCMs with added flexibility in adopting rules that they believe are necessary to comply with this core principle. Consistent with this determination, the Commission is replacing proposed § 38.160 with new § 38.160 (titled “Additional sources for compliance”) that simply permits DCMs to rely upon the guidance in appendix B of this part to demonstrate to the Commission compliance with § 38.150 of this part.

3. Subpart D—Contracts Not Readily Subject To Manipulation

The Dodd-Frank Act did not revise the statutory text of Core Principle 3 (Contracts Not Readily Subject to Manipulation). DCMs historically have complied with the requirements of Core Principle 3 through the guidance provided in Guideline No. 1, which was codified in former appendix A to part 40, which is now superseded by appendix C under part 38 of this final rulemaking. In the DCM NPRM, the Commission proposed to maintain the guidance under former Guideline No. 1 in new appendix C, but with certain proposed revisions, as the central mode of compliance for DCMs under Core Principle 3. In addition to the guidance, the DCM NPRM proposed two rules under Core Principle 3. Proposed § 38.200 codified the statutory language of Core Principle 3, and proposed § 38.201 referred applicants and DCMs to the guidance in appendix C to part 38 for purposes of demonstrating to the Commission their compliance with the requirements of § 38.200.

In the DCM NPRM, the Commission proposed certain revisions to former Guideline No. 1, including: (1) Codifying the provision in appendix C of part 38, and eliminating it from part 40; (2) re-titling the guidance as “Demonstration of Compliance That a Contract is not Readily Susceptible to Manipulation;” and (3) amending and updating the guidance to expand the provision to include swap transactions.

Proposed appendix C to part 38 was intended to act as a source for new and existing DCMs to reference for best practices when developing products to list for trading. The amended guidance provided greater detail to DCMs regarding the relevant considerations in demonstrating compliance with Core Principle 3 when designing a contract and submitting supporting documentation and data to the Commission at the time the DCM submits: (1) The terms and conditions of a new contract under §§ 40.2 or 40.3, or (2) amendments to terms and conditions under §§ 40.5 or 40.6. Specifically, proposed appendix C to part 38 provided guidance regarding: (1) The forms of supporting information a new contract submission should include; (2) how to estimate deliverable supplies; (3) the contract terms and conditions that should be specified for physically delivered contracts; (4) how to demonstrate that a cash-settled contract is reflective of the underlying cash market, is not readily subject to manipulation or distortion, and is based on a cash price series that is reliable, acceptable, publicly available and timely; (5) the contract terms and conditions that should be specified for cash-settled contracts; (6) the requirements for options on futures contracts; (7) the terms and conditions for non-price based futures contracts; and (8) the terms and conditions for swap contracts.

Estimating Deliverable Supply

Summary of Comments

CME commented on the proposed guidance pertaining to estimating deliverable supply in paragraph (b)(1)(i)(A) of proposed appendix C.

232

CME contended that the proposed definition of deliverable supply is restrictive and inconsistent with long-standing industry practice.

233

Specifically, CME objected to the proposed provision that states that “an appropriate estimate of deliverable supply excludes supplies that are committed to some commercial use.”

234

CME stated that DCMs have historically estimated deliverable supplies by including in their calculations all supplies that are stored in the delivery territory or that move through the

delivery territory, including a determination of amounts committed to commercial use.

235

CME asserted that the proposed rulemaking does not identify any problems with continuing to use the current methodology in these markets, and claimed that if the proposed standard is adopted, it will impose additional costs on exchanges and market participants, including requiring exchanges to survey market participants annually with no defined benefit.

236

232

CME Comment Letter at 38 (Feb. 22, 2011). Proposed paragraph (b)(1)(i)(A) of appendix C provided guidance on how to estimate the deliverable supply of a commodity that underlies a futures contract. The estimated deliverable supply should reflect the amount of that commodity that can reasonably be expected to be readily available to long traders to take delivery and short traders to make delivery at the expiration of a futures contract. This information is used by Commission staff when considering a contract's terms and conditions in determining whether a contract is readily susceptible to manipulation. DCM NPRM at 80631.

233

CME Comment Letter at 38 (Feb. 22, 2011).

234

See

proposed paragraph (b)(1)(i)(A), appendix C. DCM NPRM at 80631.

235

CME Comment Letter at 38 (Feb. 22, 2011).

236

Id.

Moreover, CME argued that the requirement that DCMs submit monthly deliverable supply estimates “for at least the most recent five years for which data sources permit” to be used by the Commission to review a DCM's certification or approval request for a new contract or related rule amendment is onerous for DCMs.

237

Instead, CME suggested that the Commission require monthly estimates of deliverable supply for the most recent three years.

238

237

Id.

238

Id.

Discussion

The Commission acknowledges CME's comments regarding the proposed guidance for estimating deliverable supply but notes that a DCM has historically been required to estimate deliverable supplies, which has required that a DCM consult with market participants on a regular basis. In that regard, contrary to CME's claim, the proposed guidance stating that exchanges should survey market participants should not impose additional costs on exchanges. As noted above, Commission staff will continue to work with exchange staff to determine how the deliverable supply for a certain commodity should be estimated. Moreover, the Commission confirms, as noted by CME, that the term “commercial use” may not be appropriate and could cause confusion. Accordingly, the Commission is eliminating the sentence in proposed paragraph (b)(1)(i)(A) that references the term “commercial use,” and is replacing it with the term “long-term agreement.” Specifically, the Commission will clarify in paragraph (b)(1)(i)(A) that an estimate of deliverable supply would not include supply that is committed for long-term agreements (i.e., the amount of supply that would not be available to fulfill the delivery obligations arising from current trading).

The Commission is further clarifying in paragraph (b)(1)(i)(A) of the guidance that an exchange may include all or a portion of the supply that is committed for long-term agreements if it can demonstrate that those supplies are consistently and regularly made available to the spot market for traders to acquire at prevailing economic values. Specifically, the Commission is adding language to paragraph (b)(1)(i)(A) t

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