# Derivatives Clearing Organizations and International Standards > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2013-27849 ## Record - **Collection:** Federal Register - **Document type:** Rule - **Published:** December 2, 2013 - **Citation:** 78 FR 72476 ## Text COMMODITY FUTURES TRADING COMMISSION 17 CFR Parts 39, 140, and 190 RIN 3038-AE06 Derivatives Clearing Organizations and International Standards AGENCY: Commodity Futures Trading Commission. ACTION: Final rule. SUMMARY: The Commodity Futures Trading Commission (“Commission”) is adopting final regulations to establish additional standards for compliance with the derivatives clearing organization (“DCO”) core principles set forth in the Commodity Exchange Act (“CEA”) for systemically important DCOs (“SIDCOs”) and DCOs that elect to opt-in to the SIDCO regulatory requirements (“Subpart C DCOs”). Pursuant to the new regulations, SIDCOs and Subpart C DCOs are required to comply with the requirements applicable to all DCOs, which are set forth in the Commission's DCO regulations on compliance with core principles, to the extent those requirements are not inconsistent with the new requirements set forth herein. The new regulations include provisions concerning: procedural requirements for opting in to the regulatory regime as well as substantive requirements relating to governance, financial resources, system safeguards, special default rules and procedures for uncovered losses or shortfalls, risk management, additional disclosure requirements, efficiency, and recovery and wind-down procedures. These additional requirements are consistent with the Principles for Financial Market Infrastructures (“PFMIs”) published by the Committee on Payment and Settlement Systems and the Board of the International Organization of Securities Commissions (“CPSS-IOSCO”). In addition, the Commission is adopting certain delegation provisions and certain technical clarifications. DATES: This rule is effective December 31, 2013, except for the amendments to 17 CFR 39.31 and 140.94, which are effective December 13, 2013, and the amendments to 190.09, which are effective December 2, 2013. FOR FURTHER INFORMATION CONTACT: Ananda Radhakrishnan, Director, Division of Clearing and Risk (“DCR”), at 202-418-5188 or aradhakrishnan@cftc.gov; Robert B. Wasserman, Chief Counsel, DCR, at 202-418-5092 or rwasserman@cftc.gov; M. Laura Astrada, Associate Chief Counsel, DCR, at 202-418-7622 or lastrada@cftc.gov; Peter A. Kals, Special Counsel, DCR, at 202-418-5466 or pkals@cftc.gov; Jocelyn Partridge, Special Counsel, DCR, at 202-418-5926 or jpartridge@cftc.gov; or Tracey Wingate, Special Counsel, DCR, at 202-418-5319 or twingate@cftc.gov, in each case, at the Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581. SUPPLEMENTARY INFORMATION: Table of Contents I. Background A. Regulatory Framework for Registered DCOs B. Designation of DCOs as Systemically Important under Title VIII of the Dodd-Frank Act C. Existing Standards for SIDCOs D. DCO Core Principles and Regulations for Registered DCOs E. PFMIs F. The Role of the PFMIs in International Banking Standards G. New Regulations Applicable to SIDCOs and Subpart C DCOs II. Discussion of Revised and New Regulations A. Regulation 39.2 (Definitions) B. Regulation 39.30 (Scope) C. Regulation 39.31 (Election to become subject to the provisions of Subpart C) D. Regulation 39.32 (Governance for systemically important derivatives clearing organizations and subpart C derivatives clearing organizations) E. Regulation 39.33 (Financial resources requirements for systemically important derivatives clearing organizations and subpart C derivatives clearing organizations) F. Regulation 39.34 (System safeguards for systemically important derivatives clearing organizations and subpart C derivatives clearing organizations) G. Regulation 39.35 (Default rules and procedures for uncovered credit losses or liquidity shortfalls (recovery) for systemically important derivatives clearing organizations and subpart C derivatives clearing organizations) H. Regulation 39.36 (Risk management for systemically important derivatives clearing organizations and subpart C derivatives clearing organizations) I. Regulation 39.37 (Additional disclosure for systemically important derivatives clearing organizations and subpart C derivatives clearing organizations) J. Regulation 39.38 (Efficiency for systemically important derivatives clearing organizations and subpart C derivatives clearing organizations) K. Regulation 39.39 (Recovery and wind-down for systemically important derivatives clearing organizations and subpart C derivatives clearing organizations) L. Regulation 39.40 (Consistency with the Principles for Financial Market Infrastructures) M. Regulation 39.41 (Special enforcement authority for systemically important derivatives clearing organizations) N. Regulation 39.42 (Advance notice of material risk-related rule changes by systemically important derivatives clearing organizations) O. Regulation 140.94 (Delegation of authority to the Director of the Division of Clearing and Risk) P. Regulation 190.09 (Member property) III. Effective Date A. Congressional Review Act B. Administrative Procedure Act IV. Related Matters A. Paperwork Reduction Act B. Regulatory Flexibility Act C. Consideration of Costs and Benefits I. Background A. Regulatory Framework for Registered DCOs On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). 1 Title VII of the Dodd-Frank Act, entitled the “Wall Street Transparency and Accountability Act of 2010,” 2 amended the Commodity Exchange Act (“CEA” or the “Act”) 3 to establish a comprehensive regulatory framework for over-the-counter (“OTC”) derivatives, including swaps. 1 Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the Dodd-Frank Act may be accessed at http://www.cftc.gov/ucm/groups/public/@swaps/documents/file/hr4173_enrolledbill.pdf. 2 Section 701 of the Dodd-Frank Act. 3 7 U.S.C. 1 et seq. Section 725(c) of the Dodd-Frank Act amended Section 5b(c)(2) of the CEA, which sets forth core principles that a DCO must comply with in order to register and maintain registration with the Commission. In furtherance of the goals of the Dodd-Frank Act to reduce risk, increase transparency, and promote market integrity, the Commission, pursuant to the Commission's enhanced rulemaking authority, 4 adopted regulations establishing standards for compliance with the DCO core principles. 5 4 See Section 725(c)(2)(i) of the Dodd-Frank Act (giving the Commission explicit authority to promulgate rules regarding the core principles pursuant to its rulemaking authority under Section 8a(5) of the CEA, 7 U.S.C. 12a(5)). 5 See Derivatives Clearing Organization General Provisions and Core Principles, 76 FR 69334 (Nov. 8, 2011). These regulations are set forth in Subpart A and Subpart B of part 39 of the Commission's regulations (“Subpart A” and “Subpart B,” respectively). B. Designation of DCOs as Systemically Important under Title VIII of the Dodd-Frank Act Title VIII of the Dodd-Frank Act, entitled “Payment, Clearing, and Settlement Supervision Act of 2010,” 6 was enacted to mitigate systemic risk in the financial system and promote financial stability. 7 Section 804 of the Dodd-Frank Act requires the Financial Stability Oversight Council (“Council”) to designate those financial market utilities (“FMUs”) 8 that the Council determines are, or are likely to become, systemically important. 9 6 Section 801 of the Dodd-Frank Act. 7 Section 802(b) of the Dodd-Frank Act. 8 An FMU includes any person that manages or operates a multilateral system for the purpose of transferring, clearing, or settling payments, securities, or other financial transactions among financial institutions or between financial institutions and the person. Section 803(6)(A) of the Dodd-Frank Act. 9 Section 804(a)(1) of the Dodd-Frank Act. The term “systemically important” means a situation where the failure of or a disruption to the functioning of a financial market utility could create, or increase, the risk of significant liquidity or credit problems spreading among financial institutions or markets and thereby threaten the stability of the financial system of the United States. Section 803(9) of the Dodd-Frank Act. See also Authority to Designate Financial Market Utilities as Systemically Important, 76 FR 44763, 44774 (July 27, 2011) (final rule). In determining whether an FMU is systemically important, the Council uses a detailed two-stage designations process, using certain statutory considerations 10 and other metrics to assess, among other things, “whether possible disruptions [to the functioning of an FMU] are potentially severe, not necessarily in the sense that they themselves might trigger damage to the U.S. economy, but because such disruptions might reduce the ability of financial institutions or markets to perform their normal intermediation functions.” 11 On July 18, 2012, the Council designated eight FMUs as systemically important under Title VIII. 12 Two of these are CFTC-registered DCOs 13 for which the Commission is the Supervisory Agency. 14 10 Under Section 804(a)(2) of the Dodd-Frank Act, in determining whether an FMU is or is likely to become systemically important, the Council must take into consideration the following: (A) The aggregate monetary value of transactions processed by the FMU; (B) the aggregate exposure of an FMU to its counterparties; (C) the relationship, interdependencies, or other interactions of the FMU with other FMUs or payment, clearing or settlement activities; (D) the effect that the failure of or a disruption to the FMU would have on critical markets, financial institutions or the broader financial system; and (E) any other factors the Council deems appropriate. 11 76 FR 44766. 12 See Press Release, Financial Stability Oversight Council, Financial Stability Oversight Council Makes First Designations in Effort to Protect Against Future Financial Crises (July 18, 2012), available at http://www.treasury.gov/press-center/press-releases/Pages/tg1645.aspx. 13 While Chicago Mercantile Exchange, Inc. (“CME Clearing”), ICE Clear Credit LLC (“ICE Clear Credit”), and The Options Clearing Corporation (“OCC”) are the CFTC-registered DCOs that were designated as systemically important by the Council, the CFTC is the Supervisory Agency only for CME Clearing and ICE Clear Credit; the Securities and Exchange Commission (“SEC”) serves as OCC's Supervisory Agency. 14 See Section 803(8)(A) of the Dodd-Frank Act (defining “Supervisory Agency” as the federal agency that has primary jurisdiction over a designated financial market utility under federal banking, securities or commodity futures laws). C. Existing Standards for SIDCOs Section 805 of the Dodd-Frank Act directs the Commission to consider relevant international standards and existing prudential requirements when prescribing risk management standards governing the operations related to payment, clearing, and settlement activities for FMUs that are (1) designated as systemically important by the Council and (2) engaged in activities for which the Commission is the Supervisory Agency. 15 More generally, Section 752 of the Dodd-Frank Act directs the Commission to consult and coordinate with foreign regulatory authorities on the establishment of consistent international standards with respect to the regulation of, among other things, swaps, futures, and options on futures. 16 15 See Section 805(a)(2) of the Dodd-Frank Act. The Commission notes that, under section 805 of the Dodd-Frank Act, the Commission also has the authority to prescribe risk management standards governing the operations related to payment, clearing, and settlement activities for FMUs that are designated as systemically important by the Council and are engaged in activities for which the Commission is the appropriate financial regulator. 16 Section 752(a) of the Dodd-Frank Act, codified at 15 U.S.C. 8325, provides, in relevant part, that in order to promote effective and consistent global regulation of swaps and security based swaps, the CFTC, the SEC, and the prudential regulators (as that term is defined in section 1a(30) of the CEA), as appropriate, shall consult and coordinate with foreign regulatory authorities on the establishment of international standards with respect to the regulation of swaps and swap entities. In addition, section 752(b) of the Dodd-Frank Act states that in order to promote effective and consistent global regulation of contracts of sale of a commodity for future delivery and options on such contracts, the CFTC shall consult and coordinate with foreign regulatory authorities on the establishment of international standards with respect to the regulation of contracts of a sale of a commodity for future delivery and on options on such contracts. In 2013, after careful consideration of the comments on the rules that it had proposed for SIDCOs in 2010 and 2011, 17 and in light of domestic and international market and regulatory developments, the Commission finalized regulations for SIDCOs in a manner consistent with the PFMIs. 18 Most recently, the Commission proposed the regulations for SIDCOs and Subpart C DCOs that are being adopted herein (the “Proposal”). 19 17 See Financial Resources Requirements for Derivatives Clearing Organizations, 75 FR 63113, 63119 (Oct. 14, 2010) (notice of proposed rulemaking) and Risk Management Requirements for Derivatives Clearing Organizations, 76 FR 3697 (Jan. 20, 2011) (notice of proposed rulemaking). 18 Specifically, in that final rulemaking, the Commission amended part 39 by creating a Subpart C and adding regulations that (1) increased the minimum financial resource requirements for SIDCOs, (2) restricted the use of assessments by SIDCOs in meeting such financial resource obligations, (3) enhanced the system safeguards requirements for SIDCOs, and (4) granted the Commission special enforcement authority over SIDCOs pursuant to Section 807 of the Dodd-Frank Act. See Enhanced Risk Management Standards for Systemically Important Derivatives Clearing Organizations, 78 FR 49663 (Aug. 15, 2013) (“SIDCO Final Rule”). 19 Derivatives Clearing Organizations and International Standards, 78 FR 50260 (Aug. 16, 2013) (notice of proposed rulemaking). D. DCO Core Principles and Regulations for Registered DCOs As noted in the Proposal, in order to register and maintain registration status with the Commission, DCOs must comply with all of the DCO core principles set forth in Section 5b(c)(2) of the CEA, as amended by Section 725 of the Dodd-Frank Act, as well as all applicable Commission regulations. The Proposal did, however, identify and discuss those core principles and related Commission regulations that were most relevant to the proposed regulations. Specifically, the Proposal discussed the following DCO core principles and related Commission regulations Core Principle B (Financial Resources) and regulations 39.11 and 39.29; Core Principle D (Risk Management) and regulation 39.13; Core Principle G (Default Rules and Procedures) and regulation 39.16; Core Principle I (System Safeguards) and regulations 39.18 and 39.30; Core Principle L (Public Information) and regulation 39.21; Core Principle O (Governance Fitness Standards); Core Principle P (Conflicts of Interest); and Core Principle Q (Composition of Governing Boards). 20 20 For a summary and description of these core principles and Commission regulations, see 78 FR 50262-50263. E. PFMIs 1. Overview In the SIDCO Final Rule, the Commission determined that, for purposes of meeting its obligation pursuant to Section 805(a)(2)(A) of the Dodd-Frank Act, the PFMIs, which were developed by CPSS-IOSCO over a period of several years, 21 were the international standards most relevant to the risk management of SIDCOs. 22 The PFMIs set out 24 principles which address the risk management and efficiency of a financial market infrastructure's (“FMI”) operations. 23 Assessments of observance with the PFMIs focus also on the “key considerations” set forth for each of the principles. 24 While Subpart A and Subpart B of part 39 of the Commission's regulations incorporate the vast majority of the standards set forth in the PFMIs, 25 the Commission, which is a member of the Board of IOSCO, has an obligation under Section 805(a) of the Dodd-Frank Act to implement regulations relating to risk management that conform with applicable international standards. The PFMIs are such standards and, with this rulemaking, the Commission intends to adopt rules and regulations that are fully consistent with the standards set forth in the PFMIs by the end of 2013. To that end, the Commission has recognized that in certain instances, the standards set forth in the PFMIs may not be fully covered by the requirements set forth in Subpart A and Subpart B of part 39 of the Commission's regulations. Thus, this rulemaking revises Subpart C to address those gaps, specifically with respect to the following PFMI principles: Principle 2 (Governance); Principle 3 (Framework for the comprehensive management of risks); Principle 4 (Credit risk); Principle 6 (Margin); Principle 7 (Liquidity risk); Principle 9 (Money settlements); Principle 14 (Segregation and portability); Principle 15 (General business risk); Principle 16 (Custody and investment risks); Principle 17 (Operational risk); Principle 21 (Efficiency and effectiveness); Principle 22 (Communication procedures and standards); and Principle 23 (Disclosure of rules, key procedures, and market data). 26 21 See Committee on Payment and Settlement Systems and the Technical Committee of the International Organization of Securities Commissions, “Principles for Financial Market Infrastructures,” (April 2012) available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD377.pdf. See also the Financial Stability Board June 2012 Third Progress Report on Implementation, available at http://www.financialstabilityboard.org/publications/r_120615.pdf (Noting publication of the PFMIs as achieving “an important milestone in the global development of a sound basis for central clearing of all standardised OTC derivatives”). 22 In making this determination, the Commission noted that “the adoption and implementation of the PFMIs by numerous foreign jurisdictions highlights the role these principles play in creating a global, unified set of international risk management standards for CCPs.” See 78 FR 49666. 23 See id., ¶ 1.19. 24 See Committee on Payment and Settlement Systems and the Board of the International Organization of Securities Commissions Principles for Financial Market Infrastructures: Disclosure Framework and Assessment Methodology (Dec. 2012) (hereinafter “Disclosure Framework and Assessment Methodology”), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD396.pdf. 25 Indeed, Subpart A and Subpart B were informed by the consultative report for the PFMIs. See generally 76 FR 69334. 26 For a summary and description of these principles, see 78 FR 50263-50266. F. The Role of the PFMIs in International Banking Standards The Commission notes that where a central counterparty (“CCP”) is not prudentially supervised in a jurisdiction that has domestic rules and regulations that are consistent with the standards set forth in the PFMIs, the implementation of certain international banking regulations will have significant cost implications for that CCP and its market participants. In July of 2012, the Basel Committee on Banking Supervision (“BCBS”), 27 the international body that sets standards for the regulation of banks, published the “Capital Requirements for Bank Exposures to Central Counterparties” (“Basel CCP Capital Requirements”), which sets forth interim rules governing the capital charges arising from bank exposures to CCPs related to OTC derivatives, exchange traded derivatives, and securities financing transactions. 28 The Basel CCP Capital Requirements create financial incentives for banks, including their subsidiaries and affiliates, 29 to clear financial derivatives with CCPs that are prudentially supervised in a jurisdiction where the relevant regulator has adopted rules or regulations that are consistent with the standards set forth in the PFMIs. Specifically, the Basel CCP Capital Requirements introduce new capital charges based on counterparty risk for banks conducting financial derivatives transactions through a CCP. 30 These incentives include (1) lower capital charges for exposures arising from derivatives cleared through a qualified CCP (“QCCP”) and (2) significantly higher capital charges for exposures arising from derivatives cleared through non-qualifying CCPs. A QCCP is defined as an entity that (i) is licensed to operate as a CCP, and is permitted by the appropriate regulator to operate as such, and (ii) is prudentially supervised in a jurisdiction where the relevant regulator has established and publicly indicated that it applies to the CCP, on an ongoing basis, domestic rules and regulations that are consistent with the PFMIs. 31 27 The BCBS is comprised of senior representatives of bank supervisory authorities and central banks from around the world including, Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. See Bank for International Settlements, Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems, December 2010 (revised June 2011), available at http://www.bis.org/publ/bcbs189.htm. 28 See “Capital Requirements for Bank Exposures to Central Counterparties” (July 2012), available at www.bis.org/publ/bcbs227.pdf. The Basel CCP Capital Requirements are one component of Basel III, a framework that “is part of a comprehensive set of reform measures developed by the BCBS to strengthen the regulation, supervision and risk management of the international banking sector.” See Bank for International Settlement's Web site for compilation of documents that form the regulatory framework of Basel III, available at http://www.bis.org/bcbs/basel3.htm. 29 “Bank” is defined in accordance with the Basel framework to mean a bank, banking group or other entity ( i.e. bank holding company) whose capital is being measured. See “Basel III: A Global Regulatory Framework,” Definition of Capital, paragraph 51. The term “bank,” as used herein, also includes subsidiaries and affiliates of the banking group or other entity. The Commission notes that a bank may be a client and/or a clearing member of a DCO. 30 See Basel CCP Capital Requirements, Annex 4, Section II, 6(i). See generally 78 FR 50266-50267. 31 See Basel CCP Capital Requirements, Section I, A: General Terms. The failure of a CCP to achieve QCCP status could result in significant costs to its bank customers. As one market participant noted, the “ramifications for failure to achieve QCCP status are onerous for banks' CCP exposures and can result in capital charges on trade exposures that are 10-20 times larger than capital charges for QCCP trade exposures.” 32 The increased capital charges for transactions through non-qualifying CCPs may have significant business and operational implications for U.S. DCOs that operate internationally and are not QCCPs. For instance, banks faced with such higher capital charges may transfer their clearing business away from such DCOs to a QCCP in order to benefit from the preferential capital charges provided by the Basel CCP Capital Requirements. Alternatively, banks may reduce or discontinue their clearing business altogether. Banks may also pass through the higher costs of transacting on a non-qualifying DCO that result from the higher capital charges to their customers. Accordingly, customers using such banks as intermediaries may transfer their business to an intermediary at a QCCP. In short, a DCO's failure to be a QCCP may cause it to face a competitive disadvantage in retaining members and customers. 32 CME at 5, n. 18. G. New Regulations Applicable to SIDCOs and Subpart C DCOs As described in detail in section II below, this final rulemaking includes a new defined term, a Subpart C DCO, to allow registered DCOs that are not SIDCOs to elect to become subject to the provisions in Subpart C of part 39 of the Commission's regulations (“Subpart C”). Further, this rulemaking revises Subpart C so that Subpart C applies to SIDCOs and Subpart C DCOs, and includes new or revised standards for governance, financial resources, system safeguards, default rules and procedures for uncovered losses or shortfalls, risk management, disclosure, efficiency, and recovery and wind-down procedures. These requirements address the remaining gaps between the Commission's regulations and the PFMI standards. Thus, Subpart C, together with the provisions in Subpart A and Subpart B, establish domestic rules and regulations that are consistent with the PFMIs. Because Subparts A, B, and C apply to SIDCOs and Subpart C DCOs on a continuing basis, SIDCOs and Subpart C DCOs should be QCCPs for purposes of the Basel CCP Capital Requirements. 33 33 See QCCP definition supra Section I.F. The Commission received twelve comment letters, nine of which commented on the Proposal. 34 All nine of these letters were generally supportive of the Proposal's goals. Given the importance of obtaining QCCP status for a U.S.-based DCO, the Commission requested comment on additional measures that the Commission should take to help ensure that Subpart C DCOs obtain QCCP status. MGEX responded by asserting that steps should be taken to “ensure that the [Commission's] proposed regulations will be recognized by applicable regulators as being consistent with the PFMIs and that all DCOs subject to those regulations would be considered QCCPs in all relevant jurisdictions.” 35 MGEX also requested that the Commission “coordinate with other regulators” to provide a “uniform framework that recognizes the oversight provided by multiple regulatory jurisdictions so as not to unnecessarily burden DCOs with requirements established by multiple regulatory jurisdictions. 36 As noted in the Proposal, the Commission believes that the Subpart C regulations in combination with the provisions contained in Subpart A and Subpart B would establish domestic rules and regulations that are consistent with the PFMIs. Because SIDCOs and Subpart C DCOs would have the requirements of Subpart A, Subpart B and Subpart C applied to them on a continuing basis, such entities should qualify as QCCPs for purposes of the Basel CCP Capital Requirements. 37 In addition, the Commission notes that it actively coordinates with other domestic and international regulators informally, as required by applicable law (such as through the rulemaking consultation process under Title VIII), and through participation in several working groups and international organizations (such as IOSCO). 38 ISDA, which expressed support for the Commission's goal of implementing regulations for DCOs that are consistent with the PFMIs by the end of 2013, suggested that the Commission issue this rulemaking as an interim final rule “so that market participants will have an opportunity to provide additional substantive comments.” 39 The Commission declines to do so. As is the case with other regulations, part 39 of the Commissions regulations may be reviewed or revised by the Commission as necessary. 34 All comment letters are available through the Commission's Web site at: http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1391. Comments addressing the Proposal were received from the European Commission and the following parties: CME Group Inc. (“CME”); The Futures Industry Association (“FIA”); IntercontinentalExchange, Inc. (“ICE”); International Swaps and Derivatives Association Inc. (“ISDA”); LCH.Clearnet Group Limited (“LCH”); The Minneapolis Grain Exchange (“MGEX”); New York Portfolio Clearing LLC (“NYPC”); and Chris Barnard. 35 MGEX at 6. 36 Id. In addition, ISDA's comment letter addressed the Commission's examination of SIDCOs and Subpart C DCOs. Specifically, ISDA stated that revised Subpart C should specify whether the Commission will evaluate a SIDCO's or Subpart C DCO's compliance with Subpart C as part of its general rule enforcement review program, or whether SIDCOs and Subpart C DCOs will be subject to a more rigorous and more frequent ( e.g., annual) review process. ISDA at 4. This comment does not pertain to any of the proposed regulations and is, therefore, outside the scope of the Proposal. However, the Commission notes that Section 807(a) of the Dodd-Frank Act requires the Commission to examine a SIDCO at least once annually. 37 78 FR 50297. 38 The Commission intends to cooperate with other regulators, both domestically and internationally, to foster efficient and effective communication and consultation so that we may support each other in fulfilling our respective mandates with respect to SIDCOs and Subpart C DCOs. See PFMIs, Responsibility E. 39 ISDA at 1. The following section will address discuss the comments received on specific aspects of the Proposal in connection with explaining each of the amended and new regulations adopted herein. II. Discussion of Revised and New Regulations A. Regulation 39.2 (Definitions) The Commission proposed amending regulation 39.2 by revising one definition and adding six new defined terms. First, the Commission proposed a technical amendment to the definition of “systemically important derivatives clearing organization.” The definition had described a SIDCO as a registered DCO “which has been designated by the [Council] to be systemically important . . .” The proposed definition described a SIDCO as a registered DCO “which is currently designated . . .” Second, the Commission proposed to add a definition for the phrase “activity with a more complex risk profile,” to provide greater clarity as to the types of activities that would trigger a Cover Two financial resources requirement. The Commission proposed to define “activity with a more complex risk profile” to include clearing credit default swaps, credit default futures, and derivatives that reference either credit default swaps or credit default futures, as well as any other activity designated as such by the Commission. The phrase “activity with a more complex risk profile” currently appears in regulation 39.29 (Financial resources requirements), which the Commission proposed to revise and renumber as regulation 39.33. 40 40 See Section II.E., infra. The Commission also proposed to add a definition for the term “subpart C derivatives clearing organization.” The proposed definition would include any registered DCO that is not a SIDCO and that has elected to become subject to Subpart C. Finally, the Commission proposed to add definitions for “depository institution,” “U.S. branch or agency of a foreign banking organization,” and “trust company.” These terms are used in the provisions concerning liquidity set forth in paragraphs (c) and (d) of revised regulation 39.29, which the Proposal renumbered as regulation 39.33. 41 As proposed, a “depository institution” would have the meaning set forth in Section 19(b)(1)(A) of the Federal Reserve Act (12 U.S.C. 461(b)(1)(A)). A “U.S. branch or agency of a foreign banking organization” would mean the U.S. branch or agency of a foreign banking organization as defined in Section 1(b) of the International Banking Act of 1978 (12 U.S.C. 3101). A “trust company” would mean a trust company that is a member of the Federal Reserve System, under Section 1 of the Federal Reserve Act (12 U.S.C. 221), but that does not meet the definition of “depository institution.” 41 See id. The Commission received only one comment on the substance of the proposed definitions. Chris Barnard stated that he approved of the fact that the definition of “activity with a more complex risk profile” includes credit default swaps and other activities designated as such by the Commission under regulation 39.33(a). In addition, the Commission received a comment regarding the wording of a defined term. MGEX expressed concern regarding the title “Subpart C DCO.” Specifically, MGEX stated that the title “itself implies to the public that the [Subpart C] DCO is of significantly lesser status” as compared to a SIDCO. 42 MGEX requested that the Commission instead use the term “Qualified Central Counterparty” in its regulations and to define that term to include any DCO that is held to the standards set forth in Subpart C. The Commission declines to adopt this suggestion. 42 MGEX at 4. SIDCOs and registered DCOs that elect to opt-in to these heightened standards are not identically situated in that a SIDCO is required to comply with the standards set forth in Subpart C because of its importance to the US financial markets. In other words, a Subpart C DCO may rescind its election whereas a SIDCO may not. In addition, there may be circumstances in which the Commission may want to apply a particular regulation only to SIDCOs. For example, regulation 39.41, enacted pursuant to section 807c of the Dodd-Frank Act, grants the Commission special enforcement authority over SIDCOs, but not Subpart C DCOs. Moreover, SIDCOs are required to comply with regulation 40.10, enacted consistent with section 806 of the Dodd-Frank Act, which, among other things, requires them to provide notice to the Commission not less than 60 days in advance of proposed changes to their rules, procedures, or operations that could materially affect the nature or level of risks presented by the systemically important derivatives clearing organization. This requirement is not imposed on Subpart C DCOs. Thus, it is necessary and appropriate for the Commission to retain the ability to differentiate between SIDCOs and other registered DCOs in its regulations. Moreover, as discussed below, MGEX and other commenters have noted that the proposed opt-in structure is important in that it allows registered DCOs that are not SIDCOs to be eligible for QCCP status. Once a Subpart C DCO successfully attains QCCP status, the Commission notes that, in general, its regulations do not prohibit a Subpart C DCO (or a SIDCO) from stating that it is a QCCP in its marketing materials. Indeed, the Commission expects that Subpart C DCOs would market themselves as QCCPs, which is why a Subpart C DCO is prohibited from marketing itself as a QCCP while in the process of rescinding its election. For the reasons stated above, the Commission believes that the proposed revised and new definitions are appropriate and, therefore, is adopting them as proposed. B. Regulation 39.30 (Scope) The Commission proposed expanding regulation 39.28 (and renumbering it regulation 39.30) so that Subpart C would apply to SIDCOs and Subpart C DCOs. As described above, the rules proposed in Subpart C address the gaps between Commission regulations and the standards set forth in the PFMIs. 43 As such, a DCO that is subject to the requirements of Subpart A, Subpart B, and Subpart C should meet the requirements for QCCP status and benefit from the lower capital charges on clearing member banks and bank customers of clearing members for exposures resulting from derivatives cleared through QCCPs. 44 Such a DCO may also be viewed more favorably by potential members or customers of members in that it would be seen to be held to international standards. 43 See also supra Section I.G. 44 See supra Section I.F. The Commission requested comment on the proposed rules. LCH and MGEX argued that the amended and new provisions of Subpart C should pertain to all registered DCOs. LCH asserted that the BCBS capital rules provide significant incentives for a DCO to meet the high standards embodied in the PFMIs or face the real risk that bank clearing members will cease to clear through them and therefore all DCOs should be required to comply with these standards. 45 MGEX argued that the Commission's proposed opt-in regime grants SIDCOs an unfair competitive advantage over other DCOs. 46 MGEX suggested that the Commission consider holding all registered DCOs to these higher standards and to provide an “opt-out” mechanism for those registered DCOs that are not SIDCOs that do not wish to attain QCCP status. 47 In addition, LCH and MGEX requested that, if the Commission elects to finalize the proposed regulations with the opt-in regime, DCOs be permitted to petition the Commission for additional time to comply with all of the Subpart C regulations. 48 45 LCH at 3. 46 MGEX at 2-3. 47 MGEX at 3. 48 LCH at 3-4; MGEX at 4. The Commission has decided to adopt regulation 39.30 as proposed. First, because of the potential benefits resulting from QCCP status, as described above, the Commission believes that a DCO that has not been designated to be systemically important should have the option to elect to become subject to Subpart C. 49 However, the Commission does not believe that a DCO that is not a SIDCO should be required to be held to Subpart C if it does not elect to because of the potential costs associated with compliance with these standards. In addition, and as discussed in more detail below, those DCOs that elect to be held to Subpart C may choose the effective date of their election. Because a Subpart C DCO is not required to comply with the regulations set forth in Subpart C until the specified effective date, a Subpart C DCO has a certain amount of control over the date on which it must comply with the Subpart C regulations. 49 As a technical matter, the Commission proposed to move existing paragraph (c) of renumbered regulation 39.30 (requiring a SIDCO to provide notice to the Commission in advance of any proposed change to its rules, procedures, or operations that could materially affect the nature or level of risks presented by the SIDCO, in accordance with the requirements of regulation 40.10) to proposed new regulation 39.42. Because the other provisions of proposed regulation 39.30 would pertain exclusively to the scope of Subpart C, it would be appropriate for existing paragraph (c) to be codified in a separate regulation. See infra Section II.N. for further detail. Further, the Commission concludes that a SIDCO should be required to comply with revised Subpart C in order to maintain risk management standards that enhance the safety and efficiency of a SIDCO, reduce systemic risks, foster transparency, and support the stability of the broader financial system. 50 In order to support financial stability, a SIDCO must operate in a safe and sound manner. If it fails to measure, monitor, and manage its risks effectively, a SIDCO could pose significant risk to its participants and the financial system more broadly. 51 The Commission shares the stated objectives of the PFMIs, namely to enhance the safety and efficiency of FMIs and, more broadly, reduce systemic risk and foster transparency and financial stability. 52 As discussed in the Proposal, the PFMIs have been adopted and implemented by numerous foreign jurisdictions. 53 The Commission notes that none of the commenters opposed holding all SIDCOs to the Subpart C regulations. The Commission believes that a global, unified set of international risk management standards for systemically important CCPs can help support the stability of the broader financial system. As such, for the reasons described above and in the Proposal, the Commission believes that SIDCOs should be required to comply with all of the requirements set forth in part 39 of the Commission's regulations, including the standards set forth in Subpart C, as revised herein. 50 See SIDCO Final Rule (Discussion of risk management standards). See also Section 805(b) of the Dodd-Frank Act. 51 See supra Section I.E. 52 PFMIs ¶ 1.15. 53 See 78 FR 50260, 50268. C. Regulation 39.31 (Election to become subject to the provisions of Subpart C) As discussed above and in the Proposal, 54 the Basel CCP Capital Requirements impose significantly higher capital charges on banks (including their subsidiaries and affiliates) that clear financial derivatives through CCPs that do not qualify as QCCPs ( i.e., CCPs that are licensed and supervised in a jurisdiction where the relevant regulator applies to the CCP, on an ongoing basis, domestic rules and regulations that are not consistent with the PFMIs). 55 Because such charges could create incentives for banks to migrate their business to CCPs that are QCCPs or to avoid clearing, 56 U.S. DCOs that operate internationally, but are not QCCPs, may face a substantial competitive disadvantage. The Subpart C requirements, as amended herein, address any remaining gaps between the Commission's existing regulations and the PFMI standards. 57 Accordingly, a DCO that is subject to the collective obligations contained in Subpart A, Subpart B and Subpart C should be a QCCP for purposes of the Basel CCP Capital Requirements. 58 54 See discussion of the role of the PFMIs in international banking standards supra Section I.F., 78 FR 50266-9. 55 See Basel CCP Capital Requirements at Section I.A.: General Terms. 56 As noted above, banks alternatively may reduce or discontinue their clearing business or pass through to their customers any higher costs of transacting through a DCO that is not a QCCP. See discussion of the role of the PFMIs in International Banking Standards supra Section I.F; 78 FR 50267, 50269. 57 See discussion of the new regulations applicable to SIDCOs and Subpart C DCOs supra Section I.G. 58 Id. Regulation 39.31, as proposed, would provide a mechanism whereby a DCO that has not been designated by the Council as systemically important may elect to become subject to the provisions of Subpart C ( i.e., may “opt” to become subject to the regulations otherwise applicable only to SIDCOs) and, thereby, attain QCCP status, should the DCO individually determine that the benefits of achieving such status outweigh the costs associated with implementing the Subpart C regulations. The Commission also proposed procedures for withdrawing or rescinding that election. The Commission received five comment letters regarding proposed regulation 39.31. 59 These comments generally supported the adoption of procedures that would provide non-SIDCO DCOs the opportunity to become QCCPs through adherence to an enhanced regulatory regime. 60 LCH, for example, “strongly supported” the adoption of “heightened regulatory standards that would allow both SIDCOs and non-SIDCOs to be QCCPs.” 61 The European Commission similarly stated that central counterparties “that wish to operate under safer standards and compete on the basis of the quality of their risk-management . . . should not be prevented from doing so.” 62 59 Comments on proposed regulation 39.31 were received from the European Commission, FIA, ISDA, LCH and MGEX. 60 See, e.g., European Commission at 1, LCH at 2, MGEX at 1-2. 61 LCH at 1. See also MGEX at 1 (“MGEX applauds the Commission for attempting to establish an avenue by which DCOs not designated as systemically important could qualify for [QCCP] status.”). 62 European Commission at 1. MGX and LCH disagreed, however, with the proposed “opt-in” approach and suggested alternative means for achieving the Commission's objectives. 63 As mentioned above, both LCH and MGEX suggested that the Commission require all currently registered DCOs to be held to the enhanced regulatory requirements proposed to be applicable only to SIDCOs and Subpart C DCOs. 64 LCH asserted that “it is important for all CCPs which clear swaps and other derivatives . . . to adhere to the higher standards.” 65 MGEX claimed that requiring DCOs that have not been designated by the Council as systemically important to “opt-in” to Subpart C compliance is “unnecessarily burdensome and discriminatory” in comparison to the regulatory treatment of SIDCOs. 66 In support of its position, MGEX noted that SIDCOs will be held to the same standards as Subpart C DCOs, but will not be required to submit a Subpart C Election Form, or to otherwise engage in the Subpart C election process in order to become a QCCP. 67 MGEX contended that requiring all currently registered DCOs to be held to the enhanced regulatory regime would negate the need for a Subpart C Election Form and, therefore, would treat all DCOs identically in terms of their registration status and requirements, which would enable DCOs to spend the time that they would otherwise spend on preparing a Subpart C Election Form on ensuring their compliance with the Subpart C regulations. 68 63 See LCH at 2-4, MGEX at 2-6. 64 See LCH at 3, MGEX at 3. 65 LCH at 2. 66 MGEX at 2. 67 Id. 68 MGEX at 3-4. MGEX recognized, however, “a number of potential issues” with universal application of the Subpart C requirements. 69 For example, this proposed alternative, by itself, would not provide flexibility for DCOs that do not wish to be held to the higher standards and could require the Commission to expend “considerable resources to verify compliance for each currently registered DCO shortly after implementation” and to engage in the processes necessary to revoke the Subpart C DCO status of those DCOs that fail to satisfy the proposed regulations. 70 Both MGEX and LCH suggested alternatives. Specifically, these commenters recommended that the Commission replace the proposed “opt-in” regime with a regime under which the Subpart C standards would be applicable to all DCOs, but a DCO would be permitted to “opt-out” of the heightened standards, if it believed that attaining QCCP status was not important for its business. 71 Both entities recommended that the opt-out regime be accompanied by an extension of the compliance deadline 72 for all or some of the substantive proposed Subpart C regulations. 73 Specifically, LCH and MGEX voiced concern that it would be difficult or unlikely for non-SIDCO DCOs to satisfy the Subpart C election and implementation requirements necessary to achieve QCCP status prior to December 31, 2013. 74 LCH specifically stated that additional time is necessary to come into compliance with the regulations “governing financial resources, system safeguards, risk management, and recovery and wind-down plans.” 75 Both MGEX and LCH commented on the particular difficulty of developing a recovery and wind down plan citing, respectively, the “complexity and potential effects the contents of such a plan would have on the operation of a DCO” 76 and the fact that the Commission has not previously proposed any requirements with respect to such plans. 77 69 MGEX at 3. 70 Id. 71 See LCH at 2-4, MGEX at 3-4. 72 The Commission notes that, there is no general “compliance deadline” for non-SIDCO DCOs. While a non-SIDCO that wishes to become a Subpart C DCO must satisfy all of the Subpart C requirements (except the specific obligations for which the DCO is permitted to apply for additional time to comply) at the time it elects to become subject to Subpart C, a DCO is not required to make that election at any particular time or at all, unless it determines that the cost of such compliance is usurped by the benefits it would receive through Subpart C status. 73 LCH at 2-4, MGEX at 3-4. 74 LCH at 2, MGEX at 2. The Basel III Counterparty Credit Risk and Exposures to Central Counterparties-Frequently Asked Questions (“Basel III FAQs”) state that, if a CCP's primary regulator has publicly stated that it is working towards implementing regulations consistent with the PFMIs, then such CCP may be treated as a QCCP until December 31, 2013. After December 31, 2013, the Basel III FAQs state that the CCP's primary regulator must have implemented regulations consistent with the PFMIs and these regulations must be applied to the CCP on an ongoing basis in order for such CCP to be eligible for QCCP status. See Basel III FAQs, Question 5.6, available at: http://www.bis.org/publ/bcbs237.pdf. 75 See LCH at 3, 4. 76 MGEX at 4. 77 See LCH at 3, 4. In support of their requests for additional time to comply with the Subpart C requirements, LCH and MGEX cited the time needed to identify gaps between their current rules and procedures and the Subpart C regulations, to implement any necessary changes to comply with the Subpart C regulations, and to prepare and submit their Subpart C Election Forms. 78 Both entities objected to the amount of time between the publication of the Proposal and the time when compliance will be required in order to qualify for QCCP status by the end of the 2013. 79 78 See LCH at 3, MGEX at 3. 79 See LCH at 4, MGEX at 2. MGEX also objected to the alleged disparate treatment afforded SIDCOs which “have been able to prepare for compliance with the enhanced standards at least since the release of the PFMIs in April 2012.” 80 In addition, LCH asserted that, as proposed, the Commission would be requiring Subpart C DCOs to come into compliance with all aspects of the PFMIS “prior to many non-US CCPs.” 81 LCH suggested that adopting the final regulations, but permitting compliance at a later date, would allow the Commission to adopt the PFMIs prior to the end of 2013 while, at the same time, providing DCOs with an “ability to achieve QCCP status by the end of 2013.” 82 80 MGEX at 2. 81 LCH at 4. In support of this assertion, however, LCH cites to just one aspect of the Subpart C requirements—the recovery and wind-down plans—which may not be required of certain EU CCPs in order to become and maintain QCCP status. Specifically, LCH asserts that “CCPs in the European Union will not be required to provide recovery and wind-down plans to become and remain QCCPs as EMIR, which implements the PFMIs in Europe, does not include such a requirement. EU legislation implementing the recovery and wind resolution aspects of the PMIs is not expected to be proposed by the European Commission until early next year” and “implementation is unlikely before 2016 at the earliest.” Id. LCH also notes that laws in some EU jurisdictions will require CCPs to have recovery plans prior to implementation of EU legislation. LCH at 4, n. 4. As noted below, the Commission will permit SIDCOs and Subpart C DCOs the opportunity to request that the Commission grant the SIDCO or Subpart C DCO an extension of the deadline with respect to recovery and wind-down plans for up to one year. See infra Section II.K. (Regulation 39.39 (Recovery and wind down for systemically important derivatives clearing organizations and subpart C derivatives clearing organizations)). 82 See LCH at 2, 4. LCH claims that requiring a Subpart C DCO to comply with the Subpart C regulations by the end of 2013 would “likely result in Subpart C DCO's not being able to achieve QCCP status prior to that time” and that the failure of a Subpart C DCO to achieve QCCP status would put the Subpart C DCO at a completive disadvantage to non-QCCPs that are “grandfathered” as QCCPs. LCH at 2. As noted below, the Commission believes that permitting Subpart C DCOs a broad-based opportunity to delay compliance with the Subpart C regulations, as suggested by LCH, could put a DCO at greater risk of failing to obtain QCCP status. The Commission continues to believe that non-SIDCO DCOs that are willing and able to satisfy the enhanced regulatory requirements contained in Subpart C, should, when they are able to do so, be afforded the opportunity to attain QCCP status and to reap the benefits that may result from that designation 83 and that the application of Subpart C non-SIDCO DCOs that wish to become subject to regulations that are consistent with the standards set forth in the PFMIs helps promote the international consistency called for in Section 752 of the Dodd-Frank Act. 84 Commenters addressing proposed regulation 39.31 were unanimously supportive of this objective. Accordingly, the Commission has determined to adopt a regulatory framework that permits a DCO that has not been designated as systemically important by the Council to elect to become subject to the heightened standards set forth in Subpart C. 83 See 78 FR 50268-50269. 84 See discussion of existing standards for SIDCOs supra Section I.C. In response to the comments recommending that the” Commission apply the regulatory requirements to all DCOs or employ an “opt-out” regime in lieu of the proposed “opt-out” procedures, the Commission notes that neither commenter advocating such alternatives provided any quantitative data or qualitative analyses of the costs and benefits of its suggested alternatives, particularly as compared to the Commission's Proposal. The Commission believes it would be inappropriate to adopt the proffered alternatives absent such analyses and without sufficient opportunity for the public to review and comment upon them. The Commission also is concerned that an “opt-out” regime would unfairly shift certain costs associated with the Subpart C regulations to those non-SIDCO DCOs that do not intend to avail themselves of the opportunity to become QCCPs. Specifically, regulation 39.31, as proposed and finalized herein, would require only those non-SIDCO DCOs that wish to become subject to the Subpart C regulations (and to attain the benefits of QCCP status) to complete and file a Subpart C Election Form. Non-SIDCO DCOs that do not wish to become subject to the Subpart C regulations (nor to obtain the benefits of QCCP status) are not obligated to take any further action. In contrast, an “opt-out” regime would impose an obligation to file an opt-out application on those DCOs that do not intend to seek the benefit of QCCP status, while removing the Subpart C Election Form obligation from those DCOs that do. In response to commenters' requests for additional time for Subpart C DCOs to comply with the new Subpart C regulations, and as discussed in more detail below, the Commission has determined that it would be appropriate to permit SIDCOs and Subpart C DCOs to request extensions of time to comply with the requirements for system safeguards, default rules and procedures for uncovered credit losses or liquidity, and recovery and wind-down plans contained in regulations 39.34, 39.35 and 39.39, respectively. 85 The Commission is declining, however, to permit requests from a DCO for, or to generally provide, a wholesale extension of time to comply with the new Subpart C regulations. Thus, a DCO seeking to become a Subpart C DCO will otherwise be required to be in compliance with the Subpart C regulations at the time it makes its Subpart C election. The new Subpart C regulations finalized herein seek to provide DCOs that have not been designated by the Council as systemically important the opportunity to qualify as QCCPs. Despite LCH's assertion to the contrary, 86 the Commission is concerned that a broad-based extension of the compliance deadline (in contrast to individually justified extensions with respect to particular requirements) would be more likely to jeopardize the ability of a Subpart C DCO to achieve QCCP status. As noted above, rules and regulations that are consistent with the PFMIs must be implemented by the end of 2013. 87 Moreover, as noted above, a QCCP is defined, in part, as a CCP that is prudentially supervised in a jurisdiction where the relevant regulator applies to the CCP, on an ongoing basis, domestic rules and regulations that are consistent with the PFMIs. 88 85 See infra Section II.F. (Regulation 39.34 (System safeguards for systemically important derivatives clearing organizations and subpart C derivatives clearing organizations)), Section G (Regulation 39.35 (Default rules or procedures for uncovered credit losses or liquidity shortfalls (recovery) for systemically important derivatives clearing organizations and subpart C derivatives clearing organizations)), and Section II.K (Regulation 39.35 (Recovery and wind-down for systemically important derivatives clearing organizations and subpart C derivatives clearing organizations)). 86 Notwithstanding its timing concerns, LCH has indicated that it intends to “take advantage of the Subpart C election process. LCH at 3. 87 See supra n 91. 88 See supra Section I.F. (The Role of the PFMIs in International Banking Standards). The Commission further notes that a non-SIDCO DCO is obligated to comply with the Subpart C regulations only if—and when—the DCO affirmatively elects to become subject to such regulations, based upon its own examination of the benefits (including, but not limited to, the opportunity to attain QCCP status) and burdens thereof. No non-SIDCO DCO is obligated to elect to become a Subpart C DCO and thereby comply with the Subpart C regulations by December 31, 2013 or any other date unless it believes that it is prudent to do so in light of its particular business. The Commission stands ready to review the application of any DCO that is prepared to be held to the Subpart C standards, whether the DCO is prepared to do so on December 31, 2013 or any later date. The Commission also disagrees with commenters' assertions that potential Subpart C DCOs have only recently been advised of the nature of the additional regulations to which they, if they choose, will be subject. The final PFMIs were published in April of 2012. In the same month, the Commission and other domestic financial regulators issued a joint press release explicitly notifying the public of the publication of the final PFMIs. 89 At a minimum, therefore, DCOs have been on notice of the specific requirements of the PFMIs since April 2012. Moreover, the Basel CCP Capital Requirements were published in July of 2012, and as mentioned above, the Basel FAQs, which were published in December of 2012, state that during 2013, if a CCP regulator has not yet implemented the PFMIs but has publicly stated that it is working towards implementing these principles, the CCPs that are regulated by the CCP regulator may be treated as QCCPs. 90 Thus, by December of 2012, DCOs were on notice of the preferential capital treatment that would result from becoming subject to regulations that are consistent with the PFMIs by the end of 2013. 89 Joint Press Release, Board of Governors of the Federal Reserve System, the Commodity Futures Trading Commission and the Securities and Exchange Commission, CPSS-IOSCO Issue Final Report on Principles for Financial Market Infrastructures” (April 16, 2012). 90 Basel III FAQs at 23. In the Final SIDCO Rule the Commission explicitly advised the public of its intention toward implementing regulations that are fully consistent with the PFMIs by the end of 2013. See SIDCO Final Rule at 4966 (“Moreover, the Commission, which is a member of the Board of IOSCO, is working towards implementing rules and regulations that are fully consistent with the PFMIs by the end of 2013”). 1. Regulation 39.31(a)—Eligibility Requirements Regulation 39.31(a), as proposed, set forth the two categories of entities that would be eligible to elect to become subject to the provisions in Subpart C. As proposed: (1) A DCO that is not a SIDCO could request such election using the procedures set forth in proposed regulation 39.31(b) and (2) an entity applying for registration as a DCO pursuant to regulation 39.3 (“DCO Applicant”) could request the election in conjunction with its application for registration (“Registration Application”) using the procedures set forth in proposed regulation 39.31(c). The Commission did not receive any comments specifically addressing proposed regulation 39.31(a). Accordingly, for the reasons cited in the Proposal, 91 the Commission is adopting regulation 39.31(a) as proposed. 91 78 FR 50298. 2. Regulation 39.31(b)—Subpart C Election and Withdrawal Procedures for Registered DCOs Regulation 39.31(b), as proposed, would establish the procedures by which a DCO that is already registered could elect to become subject to the provisions of Subpart C and the procedure by which the DCO could withdraw that election. 92 Comments generally addressing the Proposal to adopt regulations that would permit a DCO to elect to become subject to Subpart C ( i.e., comments on the “opt-in” regime) are discussed above. 93 In addition, the Commission received one comment referencing the Subpart C Election Form. MGEX asserted that the Commission should “waive” the Subpart C Election Form as “it seems overly burdensome and costly for a currently registered DCO to be required to complete an entirely new application which calls for submission of the same or similar information and analysis that the DCO previously provided [in its DCO Application]”. 94 In support of this request, MGEX cites to a statement in the Proposal that the Commission “anticipates considerable overlap between the information and documentation contained in the Registration Application files [sic] by a DCO Applicant and the information and documentation that would be required to be submitted to the Commission as part of the Subpart C Election Form.” 95 This reference is misplaced. The cited statement was made in the portion of the Proposal describing the proposed election and withdrawal procedures for new DCO applicants. 96 The “overlap in information and documentation” to which the Commission was referring is the overlap between the materials that would be submitted by new applicants for DCO registration in their DCO applications and the materials that a newly registered DCO would supply as part of a Subpart C Election Form submitted shortly thereafter. 97 In contrast, the information supplied by a currently registered DCO as part of the Form DCO that was filed when such DCO applied for registration is likely to be stale and would need to be updated. 98 Moreover, the Subpart C Election Form simply calls for the electing DCO to demonstrate its compliance with the requirements of Subpart C, with fairly minimal formatting requirements. The form is intended to provide the Commission, clearing members, and customers (and, significantly, the regulators of such clearing members and customers) with assurance that the electing DCO will be held to and will be required to meet the standards set forth in Subpart C. 99 Thus, the Commission continues to believe that it is necessary and appropriate to require DCOs electing to become subject to Subpart C to submit such information to the Commission. 92 78 FR 50271, 50298-99. 93 See supra Section II.C. (Regulation 39.31 (Election to become subject to the provisions of Subpart C)). 94 MGEX at 5. 95 MGEX at 5 (citing 78 FR 50271). 96 78 FR 50271. 97 This distinction is even more important in the case of a clearing organization, such as MGEX, that was “grandfathered in” to DCO status under the Commodity Futures Modernization Act of 2000 (Pub. L. No. 106-554, 114 Stat. 2763, sec. 112(f) (adding sec. 5a(b) to the CEA) and thus never filed an application for registration as a DCO. 98 See Subpart C Election Form, Exhibit Instructions at no 2, (“If the [DCO] is an Applicant, in its Form DCO, the [DCO] may summarize such information and provide a cross reference to the Exhibit in this Subpart C Election Form that contains the required information” (emphasis added)). 99 See 78 FR 50269. MGEX further asserts that the Subpart C Election Form requirement puts Subpart C DCOs at a risk of “delayed regulatory approval” not borne by SIDCOs, which it claims are “grandfathered in to Subpart C . . . due to their SIDCO status.” 100 MGEX states that to “ensure equal treatment” among all DCOs, any requirements to provide information as part of the Subpart C election process should be imposed upon SIDCOs as well. 101 The Commission notes that SIDCOs, having been designated as systemically important by the Council, are subject to annual examinations under Title VIII and are, therefore, in a different position than DCOs that have not been so designated, but wish to elect to be held to the same international standards in an effort to attain QCCP status. The Commission also notes that SIDCOs, as well as Subpart C DCOs, are required by regulation 39.37, as finalized herein, to complete and publically disclose their responses to the Disclosure Framework. 102 As such, and since SIDCOs are required to be subject to the Subpart C regulations, the Commission does not feel it necessary to require SIDCOs to complete a Subpart C Election Form. In addition, because the Commission declines to require all DCOs to comply with the regulations in Subpart C, the Subpart C Election Form is necessary to provide a mechanism by which a registered DCO may elect to become subject to Subpart C. 100 MGEX at 5. 101 Id. 102 See supra Section II.I. (Regulation 39.37 (Additional disclosure for systemically important derivatives clearing organizations and subpart C derivatives clearing organizations)). In its comments on proposed regulation 39.37, MGEX also asserted that, while requiring the submission of a Quantitative Disclosure Document is “consistent with the PFMIs,” the Commission should delay implementation of this requirement until the Quantitative Disclosure Document is finalized in order to allow DCOs time to review and comment upon it or to otherwise prepare for compliance. 103 The Commission confirms that, as noted in the Subpart C Election Form, as proposed and finalized herein, completion and publication of the Quantitative Information Disclosure will not be required until the criteria for such disclosure has been finalized and published, which has not yet occurred. 103 MGEX at 8-9. Finally, MGEX responded to the Commission's request for comment 104 on whether or not the Commission should add a requirement that the certifications contained in the Subpart C Election Form be made under penalty of perjury. MGEX opposed the addition of this requirement. 105 The Commission notes that such a requirement would be inconsistent with the current Form DCO, which does not include a similar requirement. Therefore, the Commission has decided not to add a perjury certification to the Subpart C Election Form. 104 78 FR 50272. 105 MGEX at 5. Accordingly, after careful review and consideration of the comments, and for the reasons cited above and set forth in the Proposal, 106 the Commission is adopting regulation 39.31(b) as proposed. The Commission has, however, altered the Subpart C Election Form in two respects. 106 78 FR 50268-69. As discussed further below, 107 DCOs that seek to become Subpart C DCOs (as well as SIDCOs) will be permitted to request an extension of up to one year to comply with any of the provisions of regulations 39.34, 39.35, or 39.39 pursuant to those regulations. 108 The Commission has determined that, to the extent that a DCO elects to request any such extensions, it must do so prior to filing the Subpart C Election Form and the General Instructions to the Subpart C Election Form have been modified accordingly. 109 The Commission also has made technical modifications to the certifications contained in the Subpart C Election Form to account for any extensions of time granted pursuant to regulation 39.34(d) and/or 39.39(f). 107 See infra at sections II.F. (Regulation 39.34—System Safeguards), II.G. (Regulation 39.35—Default Rules and Procedures), and II.K. (Regulation 39.39 (Recovery and Wind-Down). 108 Regulation 39.34(d), as finalized herein, provides that the Commission may, upon request, grant a SIDCO or Subpart C DCO an extension of up to one year to comply with any of the provisions of regulation 39.34. Regulation 39.39(f), as finalized herein, similarly provides that a SIDCO or Subpart C DCO, upon request, may be granted an extension of up to one year to comply with the provisions of regulations 39.35 and 39.39. Any such requests made by a DCO seeking to become a Subpart C DCO will become part of that DCO's Subpart C Election Form. 109 The Commission notes that it is not prescribing a particular time period elapse between the filing of applications for compliance extensions and the filing of the Subpart C Election Form. As noted in the Proposal, 110 the Commission emphasizes that, consistent with the certification required to be provided by a DCO as part of its Subpart C Election Form, a DCO, as of the date that its election to become subject to Subpart C becomes effective, would be held to the requirements of Subpart C. As of that date, the DCO would be subject to examination for compliance with Subpart C and to potential enforcement action for non-compliance. This status would continue until such time, if any, that the election is properly vacated as set forth in regulation 39.31(e), as finalized. 111 To the extent that compliance with Subpart C would require the DCO to implement new rules or rule amendments, all such rules or rule amendments must be approved or permitted to take effect prior to the effective date of the DCO's election. 110 78 FR 50269-50270. 111 See infra Section II.C.5. (Regulation 39.31(e)—Rescission). 3. Regulation 39.31(c)—Election and Withdrawal Procedures for DCO Applicants Regulation 39.31(c), as proposed, sets forth procedures through which a DCO Applicant could request to become subject to the provisions of Subpart C at the time the DCO Applicant files its Registration Application. The Commission did not receive any comments specifically addressing proposed regulation 39.31(c). 112 Accordingly, for the reasons cited in the Proposal, 113 the Commission is adopting regulation 39.31(c) as proposed. In the interest of administrative economy, the Commission continues to encourage DCO Applicants to make their election to become subject to Subpart C at the time that their Registration Application is filed. Simultaneous filings would appear to allow Commission resources to be used more efficiently and effectively. 112 See supra Section II.C. (Regulation 39.31 (Election to become Subject to Subpart C) for a discussion of comments regarding the proposed opt-in regime and process generally and the Subpart C Election Form. 113 78 FR 50271. 4. Regulation 39.31(d)—Public Information Regulation 39.31(d), as proposed, would provide that certain portions of the Subpart C Election Form will be considered public documents that may routinely be made available for public inspection. The Commission did not receive any comments with respect to proposed regulation 39.31(d). Accordingly, for the reasons set forth in the Proposal, 114 the Commission is adopting regulation 39.31(d) as proposed. 114 Id. 5. Regulations 39.31(e)—Rescission Regulation 39.31(e), as proposed, would permit a Subpart C DCO to rescind its election to comply with Subpart C by filing a notice of its intent to rescind the election with the Commission. Such rescission would, however, be subject to certain conditions. As proposed, the rescission of a DCO's election to become subject to Subpart C would become effective on the date specified by the Subpart C DCO in its notice of intent to rescind the Subpart C election, except that the rescission could not become effective any earlier than 90 days after the date the notice of intent to rescind is filed with the Commission. The Subpart C DCO would be required to comply with all of the provisions of Subpart C until such rescission is effective and the Commission would retain its authority concerning any activities or events occurring during the time that the DCO maintained its status as a Subpart C DCO. Regulation 39.31(e), as proposed, also would require a Subpart C DCO that files a notice of intent to rescind to (1) provide specified notices to each of its clearing members, and to have rules in place requiring each of its clearing members to provide such notices to each of the clearing member's customers; (2) provide specified notices to the general public; and (3) remove references to its Subpart C DCO (and QCCP) status on its Web site and in other materials that it provides to its clearing members and customers, other market participants, or members of the public. In addition, the employees and representatives of the Subpart C DCO would be prohibited from making any reference to the organization as a Subpart C DCO (or QCCP) on and after the date that the notice of its intent to rescind is filed. The Commission received two comments addressing proposed regulation 39.31(e). ISDA recommended that the Commission modify the proposed regulation to require, as a condition to a Subpart C DCO's rescission of its Subpart C election, “to certify that it has obtained approval from clearing members ( e.g., by member ballot) to rescind the election.” 115 In response to ISDA's suggestion, the Commission believes that this is a matter of corporate governance and the DCO should follow its own policies and procedures with respect to internal decisions regarding rescission. The Commission further notes that existing regulation 39.3(e) does not require a DCO to certify that it has obtained the approval of its clearing members to vacate its DCO registration prior to filing with the Commission a request to do so 116 and, thus, requiring the certification suggested by ISDA would be in tension with existing regulations. Accordingly, the Commission has declined to accept ISDA's recommendation. 115 ISDA at 3-4. 116 17 CFR 39.3(e). FIA recommended that the Commission extend the time period between the date that a DCO files a notice of intent to rescind its election to be subject to Subpart C and the date that such rescission could become effective from 90 days to 180 days. 117 In support of its recommendation, the FIA agreed with the view voiced by the Commission in the Proposal 118 that a delay in the effective date of the rescission is necessary to provide banks and other entities that wish to limit their cleared transactions to clearing solely through a QCCP sufficient time to transfer their business to another Subpart C DCO or a SIDCO. 119 The FIA expressed concern, however, that the 90 day delay is insufficient “to allow a clearing member to make a determination whether to withdraw as a clearing member and, if it elects to do so, notify its customers, find one or more clearing members prepared to accept each customer and allow the new clearing member and each customer to negotiate the terms of their agreement.” 120 The Commission recognizes that the clearing members of a DCO that has filed a notice of intent to rescind its election to become subject to Subpart C may need additional time to determine and to effectuate the actions they may wish to take in light of such filing and believes that a 180 day waiting period until such rescission may become effective is reasonable. Accordingly, the Commission has decided to lengthen the minimum time period between the date a notice of intent to rescind an election to become subject to Subpart C is filed and the date that such rescission may become effective to 180 days. For the reasons cited above and set forth in the Proposal, 121 the Commission is adopting regulation 39.31(e) as proposed in all other respects. 117 FIA at 5. 118 78 FR 50272. 119 FIA at 4. 120 FIA at 4-5. 121 78 FR 50271-72. 6. Regulations 39.31(f)—Loss of SIDCO Designation Regulation 39.31(f), as proposed, would provide that a SIDCO that is registered with the Commission, but whose designation of systemic importance is rescinded by the Council, 122 would immediately be deemed to be a Subpart C DCO. Such Subpart C DCO would be subject to the Subpart C provisions unless and until it elects to rescind its status as a Subpart C DCO. The Commission did not receive any comments on proposed regulation 39.31(f). Accordingly, for the reasons set forth in the Proposal, 123 the Commission is adopting regulation 39.31(f) as proposed. 122 See 12 CFR 1320.13(b) (procedure for the Council to rescind a designation of systemic importance for a systemically important financial market utility). 123 78 FR 50272. 7. Regulation 39.31(g) Regulation 39.31(g), as proposed, provides that all forms and notices required by regulation 39.31 shall be filed electronically with the Secretary of the Commission in the format and manner specified by the Commission. The Commission did not receive any comments on proposed regulation 39.31(g) and, thus, is adopting the regulation as proposed. D. Regulation 39.32 (Governance for systemically important derivatives clearing organizations and subpart C derivatives clearing organizations) The Commission proposed adding regulation 39.32 in order to implement DCO Core Principles O (Governance Fitness Standards), P (Conflicts of Interest), and Q (Composition of Governing Boards) for SIDCOs and Subpart C DCOs in a manner that would be consistent with PFMI Principle 2 (Governance). 124 124 In 2010 and 2011, the Commission proposed regulations concerning the governance of DCOs (the “2010/2011 Proposals”). See Requirements for Derivatives Clearing Organizations, Designated Contract Markets, and Swap Execution Facilities Regarding the Mitigation of Conflicts of Interest, 75 FR 63732 (Oct. 18, 2010); see also Governance Requirements for Derivatives Clearing Organizations, Designated Contract Markets, and Swap Execution Facilities, 76 FR 722 (Jan. 8, 2011). The Commission notes that the regulations contained in the 2010/2011 Proposals are the subject of a separate rulemaking. The Commission is not addressing those regulations in this rulemaking. As discussed above, DCO Core Principle O states that each DCO must establish governance arrangements that are transparent to fulfill public interest requirements and to permit the consideration of the views of owners and participants. 125 DCO Core Principle O also requires each DCO to establish and enforce appropriate fitness standards for (i) directors, (ii) members of any disciplinary committee, (iii) members of the DCO, (iv) any other individual or entity with direct access to the settlement or clearing activities of the DCO, and (v) any party affiliated with any entity mentioned in (i)-(v) above. In addition, DCO Core Principle P requires each DCO to establish and enforce rules to minimize conflicts of interest in the decision making process of the DCO, and DCO Core Principle Q states that each DCO must ensure that the composition of the governing board or committee of the DCO includes market participants. These core principles are substantively similar to PFMI Principle 2, which states that a CCP “should have governance arrangements that are clear and transparent, promote the safety and efficiency of [the CCP], and support the stability of the broader financial system, other relevant public interest considerations, and the objectives of relevant stakeholders.” Additionally, under PFMI Principle 2, a CCP should have procedures for managing conflicts of interest among board members, and board members and managers should be required to have “appropriate skills,” “incentives,” and “experience.” 126 125 See supra Section I.D. 126 PFMIs at Principle 2, K.C. 4-5. As proposed, subsection (a) (General rules) would require a SIDCO or Subpart C DCO to establish governance arrangements that: (1) Are written, clear and transparent, place a high priority on the safety and efficiency of the SIDCO or Subpart C DCO, and explicitly support the stability of the broader financial system and other relevant public interest considerations; (2) ensure that the design, rules, overall strategy, and major decisions of the SIDCO or Subpart C DCO appropriately reflect the legitimate interests of clearing members, customers of clearing members, and other relevant stakeholders; and (3) disclose, to an extent consistent with other statutory and regulatory requirements on confidentiality and disclosure: (i) Major decisions of the board of directors to clearing members, other relevant stakeholders, and to the Commission, and (ii) Major decisions of the board of directors having a broad market impact to the public. 127 127 The provisions concerning transparency describe which information, including the identities of board members, should be disclosed to the public and/or the Commission. As proposed, subsection (b) (Governance arrangements) would require the rules and procedures of a SIDCO or Subpart C DCO to: (1) Describe the SIDCO's or Subpart C DCO's management structure; (2) clearly specify the roles and responsibilities of the board of directors and its committees, including the establishment of a clear and documented risk management framework; (3) clearly specify the roles and responsibilities of management; (4) establish procedures for managing conflicts of interest among board members; and (5) assign responsibility and accountability for risk decisions and for implementing rules concerning default, recovery, and wind-down. As proposed, subsection (c) (Fitness standards for the board of directors and management) would require that board members and managers have the appropriate experience, skills, incentives and integrity; risk management and internal control personnel have sufficient independence, authority, resources and access to the board of directors; and that the board of directors include members who are not executives, officers or employees of the SIDCO or Subpart C DCO or of their affiliates. The Commission requested comment on proposed regulation 39.32 and asked that commenters include a detailed description of any alternatives to proposed regulation 39.32 and estimates of the costs and benefits of such alternatives. LCH commented that a SIDCO or Subpart C DCO should be permitted to petition the Commission for additional time to comply with new regulation 39.32 and with all other substantive regulations contained in this rulemaking. The Commission does not believe that a SIDCO or Subpart C DCO should be permitted to petition for additional time to comply with new regulation 39.32 for the reasons stated above. 128 128 See supra Section II.C. (Regulation 39.31 (Election to become subject to the provisions of Subpart C)). LCH also requested clarification as to which major decisions of the board of directors should be disclosed under new regulation 39.32(a)(3). LCH stated that a board may make a resolution that is not determinative, for example to commence exploratory negotiations for making an acquisition. LCH stated that it did not believe Principle 2 would require it to publish such a decision because Explanatory Note 3.2.18 to Principle 2 states that an FMI need not disclose a major decision where doing so would endanger commercial confidentiality. The Commission agrees with LCH that there is a distinction between exploratory negotiations and a final decision. The Commission also agrees with the suggestion made in Explanatory Note 3.2.18 that it is reasonable for a DCO to focus on disclosing the “outcome” of decisions made by the board rather than decisions that are not determinative. It should also be noted that paragraph (a)(3) does not require a disclosure that would compromise “statutory and regulatory requirements on confidentiality and disclosure.” Similarly, MGEX requested clarification as to: what qualifies as a “major decision” under proposed paragraph (a)(3); which “information” the Commission was referring to in footnote 137 of the Proposal; and whether the disclosure provision of paragraph (a) is intended to be a “reiteration of existing law[s] or regulation[s].” MGEX also suggested that paragraph (a) be amended to include a provision stating that a DCO may withhold disclosing a major decision of the board of directors if disclosing it would “stifle candid board debate or endanger commercial confidentiality.” The Commission agrees with MGEX that regulation 39.32 affords a DCO reasonable discretion in determining which decisions are “major” so as to warrant disclosure under paragraph (a)(3) and which decisions should not be disclosed due to concerns about confidentiality. Moreover, paragraph (a)(3) requires disclosure of “decisions,” rather than the debate preceding them. The Commission concludes that the language of proposed paragraph (a)(3) suffices in these regards. ISDA commented that regulation 39.32 should address decision-making by a SIDCO or Subpart C DCO during a crisis or emergency. Specifically, ISDA suggests that there should be a provision requiring a SIDCO or Subpart C DCO to obtain the views and approval of member representatives ( e.g. through the DCO's risk committee or otherwise) before taking any material action in response to an emergency. The Commission has decided not to include this requested provision because the Commission has decided not to impose requirements beyond those required by Principle 2 as part of this rulemaking. Accordingly, the Commission has decided to finalize regulation 39.32 as proposed. The governance requirements set forth in the proposed regulation were designed to enhance risk management and controls by promoting fitness standards for directors and managers, promoting transparency of governance arrangements, and making sure that the interests of a SIDCO's or Subpart C DCO's clearing members and, where relevant, customers are taken into account. Because of the potential impact that a SIDCO's failure could have on the U.S. financial markets, the Commission believes that that these requirements should be applicable to SIDCOs. Moreover, it would be beneficial to Subpart C DCOs, their members and customers, and the financial system generally, for regulation 39.32 to apply to Subpart C DCOs. E. Regulation 39.33 (Financial resources requirements for systemically important derivatives clearing organizations and subpart C derivatives clearing organizations) In August of 2013, the Commission finalized Regulation 39.29, which sets forth financial resource requirements for SIDCOs in a manner that parallels the financial resources standard in Principle 4 of the PFMIs. 129 The Commission proposed to amend regulation 39.29 to enhance financial resources requirements for SIDCOs and Subpart C DCOs and to achieve consistency with the relevant provisions of the PFMIs, in particular Principle 4 and Principle 7. 129 See SIDCO Final Rule 78 FR 49666. The Commission first proposed to renumber existing regulation 39.29 to 39.33 and to apply the requirements set forth therein to Subpart C DCOs. The Commission further proposed, for purposes of organization, deleting from paragraph (a)(1) the requirement that, where a clearing member controls another clearing member or is under common control with another clearing member, a SIDCO treat affiliated clearing members as a single clearing member (the “Clearing Member Aggregation Requirement”). The Commission proposed to include such language in new paragraph (a)(4) to clarify that the Clearing Member Aggregation Requirement applies when a SIDCO or Subpart C DCO calculates its financial resources requirements under regulation 39.33(a) as well as its liquidity resources requirements under regulation 39.33(c). The Commission also proposed amending paragraph (a) to state that the Commission shall, if it deems appropriate, determine whether a SIDCO or Subpart C DCO is systemically important in multiple jurisdictions. In making this determination, the Commission would, in order to limit such determinations to appropriate cases, review whether another jurisdiction had determined the SIDCO or Subpart C DCO to be systemically important according to a designations process that considers whether the foreseeable effects of a failure or disruption of the derivatives clearing organization could threaten the stability of each relevant jurisdiction's financial system. In addition, the Commission proposed amending paragraph (a) to state that the Commission shall also determine, if it deems appropriate, whether any of the activities of a SIDCO or Subpart C DCO, in addition to clearing credit default swaps, credit default futures, or any derivatives that reference either, has a more complex risk profile and that in making this determination, the Commission may take into consideration characteristics such as non-linear and discrete jump-to-default price changes. 130 The Commission also proposed amending paragraph (b) to clarify that the prohibition on including assessments as a financial resource applies to calculating financial resources needed to cover the default of the largest and, where applicable, second largest clearing member, in extreme but plausible circumstances. 131 130 The Commission's amendment to regulation 140.94(a) delegates the authority to make these determinations to the Director of the Division of Clearing and Risk. 131 The preamble to the SIDCO Final Rule adopting release made clear that paragraph (b) applied to both Cover One and Cover Two, but the Commission has decided to add clarifying language to the regulation text. See generally SIDCO Final Rule. The PFMI Explanatory Notes explain that liquidity risk arises in an FMI (such as a DCO) when settlement obligations are not completed when due as part of its settlement process. Liquidity risk can arise in a number of ways: between an FMI and its participants, between an FMI and other entities (such as the FMI's settlement banks and liquidity providers), or between an FMI's participants. 132 The Commission proposed adding paragraphs (c), (d), and (e) to address the liquidity of SIDCOs' and Subpart C DCOs' financial resources. The liquidity resources discussed in paragraphs (c), (d), and (e) should be sufficient to address the different exposures to liquidity risk applicable to that DCO. 132 See PFMIs, E.N. 3.7.1. Under proposed paragraph (c)(1), a SIDCO or Subpart C DCO would be required to maintain eligible liquidity resources that will enable the SIDCO or Subpart C DCO to meet its intraday, same-day, and multiday settlement obligations, as defined in regulation 39.14(a), with a high degree of confidence under a wide range of stress scenarios, including the default of the member creating the largest liquidity requirements under extreme but plausible circumstances. Under proposed paragraph (c)(2), a SIDCO or Subpart C DCO would be required to maintain liquidity resources that are sufficient to satisfy the obligations required by new paragraph (c)(1) in all relevant currencies for which the SIDCO or Subpart C DCO has settlement obligations to its clearing members. Under proposed paragraph (c)(3), a SIDCO or Subpart C DCO would be limited to using only certain types of liquidity resources to satisfy the minimum liquidity requirement set forth in proposed paragraph (c)(1). 133 Among these “qualifying liquidity resources” are “committed lines of credit,” “committed foreign exchange swaps,” and “committed repurchase agreements.” “Committed” is intended to connote a legally binding contract under which a liquidity provider agrees to provide the relevant liquidity resource without delay or further evaluation of the DCO's creditworthiness, e.g., a line of credit that cannot be withdrawn at the election of the liquidity provider during times of financial stress, or in the event of the default of a member of the SIDCO or Subpart C DCO. 134 133 In determining whether the liquidity resources that are eligible under paragraph (c)(3) are sufficient in amount to meet the obligation specified under paragraph (c)(1) (resources that “enable” the DCO to meet its settlement obligations), it is important to avoid double counting. For example, one may not count both a committed repurchase arrangement and U.S. Treasury Bills that would be used to collateralize that arrangement. 134 Times of financial stress and the event of the default of a member of the DCO are, of course, the times when reliable liquidity arrangements are most needed. Under proposed paragraph (c)(3)(ii), a SIDCO or Subpart C DCO would be required to take appropriate steps to verify that its qualifying liquidity arrangements do not include material adverse change provisions and are enforceable, and will be highly reliable, even in extreme but plausible market conditions. Also consistent with Principle 7, under proposed paragraph (c)(4), if a SIDCO or Subpart C DCO maintains liquid financial resources in addition to those required to satisfy the Cover One requirement, then those resources should be in the form of assets that are likely to be saleable with proceeds available promptly or acceptable as collateral for lines of credit, swaps, or repurchase agreements on an ad hoc basis. In addition, Principle 7 provides and proposed paragraph 39.33(c)(4) requires that a SIDCO or Subpart C DCO should consider maintaining collateral with low credit, liquidity, and market risks that is typically accepted by a central bank of issue for any currency in which it may have settlement obligations, but shall not assume the availability of emergency central bank credit as a part of its liquidity plan. 135 135 It should be noted that the requirement of proposed paragraph (c)(4) that a SIDCO or Subpart C DCO consider maintaining certain types of collateral, like the requirement of proposed paragraph (c)(1)(ii), does not include a requirement as to the decision to be made following such consideration. Pursuant to proposed paragraphs (d)(1)-(2), a SIDCO or Subpart C DCO would be required to monitor its liquidity providers in a manner consistent with Principle 7. Proposed paragraph (d)(1) would define “liquidity provider” to mean any of the following: (i) A depository institution, a U.S. branch or agency of a foreign banking organization, a trust company, or a syndicate of depository institutions, U.S. branches or agencies of foreign banking organizations, or a trust companies providing a line of credit, foreign exchange swap facility or repurchase facility to the SIDCO or Subpart C DCO; and (ii) Any other counterparty relied upon by a SIDCO or Subpart C DCO to meet its minimum liquidity resources requirement under paragraph (c) of this section. In addition, proposed paragraph (d)(4) would require a SIDCO or Subpart C DCO to regularly test its procedures for accessing its liquidity resources. Finally, pursuant to proposed subsection (e) and consistent with Principle 4, a SIDCO or Subpart C DCO would be required to document its supporting rationale for, and have appropriate governance arrangements relating to, the amount of total financial resources it maintains pursuant to regulation 39.33(a) and the amount of total liquidity resources it maintains pursuant to regulation 39.33(c). 136 136 This provision is consistent with PFMI Principle 4, K.C. 4. The Commission requested comment on all aspects of proposed regulation 39.33. ISDA, MGEX and the European Commission each commented on paragraph (a)(1). ISDA requested clarification of the term “credit exposure,” which the Proposal used to replace the term “financial obligation,” which currently appears in regulation 39.29 (renumbered as regulation 39.33 as part of this rulemaking). In response to this comment, the Commission will revert to the term financial obligation. MGEX requested clarification that a Subpart C DCO that is neither systemically important in multiple jurisdictions nor involved in activities with a more complex risk profile would be required to meet only the Cover One financial resources requirement, 137 not the Cover Two requirement. 138 The Commission notes that MGEX understood paragraph (a)(1) correctly, and the Commission believes that the language in paragraph (a)(1) is sufficiently clear. 137 Regulation 39.11 requires DCOs to maintain financial resources sufficient to cover a wide range of potential stress scenarios, which include, but are not limited to, the default of the participant and its affiliates that would potentially cause the largest aggregate financial exposure to the CCP in extreme but plausible market conditions, otherwise known as “Cover One.” 138 The term “Cover Two” refers to the requirement that a DCO maintain financial resources sufficient to enable it to meet its financial obligations to its clearing members notwithstanding a default by the two clearing members creating the largest combined loss (which would include both proprietary and customer accounts) for the SIDCO in extreme but plausible market conditions. The European Commission disagreed with the Commission's decision to require a SIDCO or Subpart C DCO to meet the Cover Two financial resources requirement only if it is systemically important in multiple jurisdictions or is involved in activities with a more complex risk profile. The European Commission suggested that all SIDCOs should be required to comply with the Cover Two requirement for the following reasons. First, any DCO that serves non-US clearing members or non-US trading venues is systemically important. 139 In addition, any DCO that is systemically important in the U.S. is systemically important internationally. 140 Second, requiring certain DCOs to meet the Cover One requirement while requiring other DCOs to meet the Cover Two requirement would be “detrimental to the object of building equal conditions of fair competition” between U.S.-registered DCOs and DCOs registered in other jurisdictions. 141 Third, banking regulators cannot deem various SIDCOs and Subpart C DCOs to all be QCCPs if some are required to meet the Cover One requirement while others are requirement to meet the Cover Two requirement. 142 Fourth, differing financial resources requirements would make the European Commission's equivalence assessment of U.S.-registered DCOs more difficult. 143 Fifth, it would be more prudent from a risk management perspective if the Cover Two requirement applied to all products and not only those “with a more complex risk profile.” 144 139 European Commission at 2. 140 Id. 141 Id. 142 Id. 143 European Commission at 2-3. 144 European Commission at 3. The applicability of the Cover Two requirement in paragraph (a)(1) is consistent with Principle 4 of the PFMIs. Further, while the European Commission raises important points, further work would need to be done to consider the costs versus the benefits of imposing a Cover Two financial resources requirements on all DCOs regardless of whether that DCO was affirmatively found to be systemically important by the Council (or other jurisdictions) and regardless of the types of products that DCO clears. Nonetheless, the Commission notes that the two existing SIDCOs will, in fact, be subject to a Cover Two financial resources requirement. 145 145 As discussed in the final rule on Enhanced Risk Management Standards for Systemically Important Derivatives Clearing Organizations, ICE Clear Credit clears credit default swaps (which is a product with a more complex risk profile) and currently meets a Cover Two requirement. See 78 FR 49670. Further, CME Clearing currently sizes its guaranty fund for interest rate swaps and its guaranty fund for credit default swaps to a Cover Two standard, and is required to meet a Cover Two standard for its base guaranty fund pursuant to regulation 39.29(a) by the end of 2013 because its clears credit default swaps. See 78 FR 49671. Chris Barnard commented that he supported the language of paragraph (a)(3) (determination of whether an activity has a more complex risk profile) and that it will appropriately result in higher financial resources requirements for such activities. Chris Barnard commented further that this should improve the robustness of a DCO's clearing system and help protect the financial system from contagion. 146 146 Chris Barnard at 2. With respect to proposed paragraph (c)(2)(satisfaction of settlement in all relevant currencies), LCH commented that it seeks confirmation that the provision is intended to pertain to “material currencies only, which are indeed the ones [for which a liquidity shortfall would be] likely to disrupt the SIDCO's [or Subpart C DCO's] services and impact financial stability.” 147 147 LCH at 5. There is no support for the implied assertions that a DCO could fail to meet its obligations in certain currencies on time without disrupting its services or impacting financial stability, and that a DCO could forgo arrangements to meet its obligations in certain currencies consistent with Principle 7. Any default by a DCO to meet its obligations on time would be likely to disrupt its services and impact financial stability. Thus, in this context, new paragraph (c)(2) covers those currencies for which the SIDCO or Subpart C DCO has obligations to perform settlements, as defined in § 39.14(a)(1), to its clearing members. The Commission believes that this interpretation is consistent with Principle 7. To be sure, where an FMI's obligations in a particular currency are relatively small, the depth and complexity of the arrangements necessary to establish high reliability is likely proportionately less demanding. In addition, with respect to proposed paragraph (c)(2), CME commented that it clears derivatives that settle in approximately 14 currencies and that it would be difficult to obtain committed credit facilities for currencies other than G-7 currencies. 148 For those other currencies, CME claimed that it would be forced to require a restrictive set of margin policies, including requiring a clearing member to post margin in the same currency as the settlement currency. 149 This, CME argued, would require CME's bank affiliated clearing members to face increased capital charges because it may be difficult for cash collateral in such currencies to receive bankruptcy remote treatment (and, therefore, a smaller capital requirement) unless such cash is posted with a central bank. 150 148 CME at 10. 149 Id. 150 Id. As an initial matter, CME provided no support for the assertion that cash collateral would not be bankruptcy remote in the case of a DCO. To the contrary, section 761(10) of the Bankruptcy Code defines customer property to include both cash and securities, and 761(16) defines member property in terms of customer property. Section 766(i) provides that, in the case of the insolvency of a clearing organization, both customer and member property will be protected. 151 A SIDCO or Subpart C DCO will have discretion to determine the most efficient means of ensuring sufficient liquidity, which may include requiring (or incentivizing) members to post all or a part of their collateral in the settlement currency. 151 11 USC 761(i). With respect to proposed paragraph (c)(3)(i)(E), CME commented that it is inconsistent with Principle 7 to require U.S. Treasury securities, which are held by a SIDCO or Subpart C DCO for purposes of meeting the minimum amount of liquidity resources required under proposed paragraph (c)(1), to be subject to “committed” funding arrangements. 152 CME commented that it interprets Principle 7 to require only “investments” to be subject to “prearranged and highly reliable funding arrangements” and not “highly marketable collateral,” of which U.S. Treasury securities are an example. 153 152 CME at 10. 153 CME at 3-4. CME stated further that the European Securities and Markets Authority (ESMA), the Monetary Authority of Singapore (MAS), and the Reserve Bank of Australia (RBA) have each taken a “more flexible approach” than proposed paragraph (c)(3)(i)(E) in interpreting the qualifying liquid resources provisions of Principle 7. 154 According to CME, these other regulators do not, in some cases, require highly marketable collateral such as U.S. Treasury securities to be subject to committed funding facilities. 155 In addition, CME stated that other regulators do not, in some cases, require highly marketable collateral to be subject to prearranged and highly reliable funding arrangements. 156 154 CME at 4. 155 Id. 156 Id. ISDA commented that it would be neither necessary nor appropriate to require that U.S. Treasuries, used to satisfy the minimum liquid resources requirement, be subject to prearranged and highly reliable funding arrangements. 157 According to ISDA, such a requirement has the potential to exacerbate a liquidity crisis and pass on risk from the DCO to its liquidity providers. 158 157 ISDA at 4. 158 Id. CME further argued that it would be unnecessary to require U.S. Treasury securities to be subject to committed funding arrangements because the U.S. Treasury market is the world's global standard for reliable liquidity and that same-day settlement of U.S. Treasury securities is reliably available in material sizes for a negligible yield concession of 1-2 basis points per annum. 159 CME noted that banks are permitted to classify U.S. Treasury securities as “High Quality Liquid Assets” (HQLA) under the Basel III capital rules. CME also stated that due to their robust liquidity and eligibility to be pledged at the Federal Reserve Bank discount window, U.S. Treasury securities are extremely safe for banks to accept under uncommitted repurchase agreements. 160 159 CME at 7-8. 160 CME at 8. CME also argued that there would be several negative consequences if the Commission required a DCO to arrange for U.S. Treasury securities to be subject to a committed funding arrangement. 161 First, CME stated that this provision would necessitate CME to limit the amount of U.S. Treasury securities a CME-clearing member could deposit to meet initial margin and guaranty fund obligations. 162 To compensate, the clearing members would have to deposit additional cash. CME argued that this would be detrimental to bank affiliated clearing members because the Basel III capital rules may require banks to take higher capital charges for cash collateral than for other types of collateral, including U.S. Treasury securities because cash collateral is not confirmed to be bankruptcy remote. 163 CME also stated that there would be difficulties establishing a committed liquidity facility for U.S. Treasury securities. CME asserted that the banks that are affiliated with CME clearing members are the best sources of such liquidity resources, and such banks may be prevented from participating in a large committed facility because of the risk that they would breach their single counterparty exposure limits under proposed Basel III capital rules. As a result, bank affiliated clearing members may reduce their customer clearing business, which could, in turn, increase costs to customers or prevent customers from taking advantage of the risk mitigating benefits of central clearing. 164 161 CME at 9-12. 162 CME at 10. 163 CME at 9. As noted above, this assertion is unsupported, and is contradicted by Subchapter IV of Chapter 7 of the Bankruptcy Code. 164 CME at 11. Finally, CME suggested that the market for committed liquidity facilities may not be large enough to offer a facility that would enable CME to satisfy the proposed liquidity provisions of regulation 39.33(c). CME also discussed a cost estimate for establishing committed facilities. This cost estimate is addressed in the cost benefit considerations, below. 165 165 CME at 12-13. See also section IV.C., infra. FIA also commented that U.S. Treasury securities should be considered a qualifying liquid resource under paragraph (c)(3), even if they are not subject to funding arrangements in accordance with proposed subparagraph (E)(2). 166 FIA argued that, alternatively, subparagraph (E)(2) should permit a DCO to arrange for U.S. Treasury securities to be subject to uncommitted repurchase agreements. FIA supports CME's comment that U.S. Treasury securities are “high quality liquid assets” under BCBS standards and have remained highly liquid during times of stress. 167 166 FIA at 3-4. 167 Id. However, in appealing to the standards established by other jurisdictions, CME acknowledged that the EMIR Regulatory Technical Standards limit CCPs to “count[ing] `highly marketable financial instruments . . . that the CCP can demonstrate are readily available and convertible into cash on a same day basis using prearranged and highly reliable funding arrangements, including in stressed market conditions.' ” 168 Similarly, CME refers to United Kingdom requirements for a liquidity resource to be qualifying that include that the CCP needs to “ demonstrate its ability to liquidate the resource for same day cash.” 169 The Commission agrees that the obligation of a SIDCO or Subpart C DCO with respect to highly marketable collateral will be to demonstrate that, as stated in subparagraph (E)(2), those assets are, in fact, readily available and convertible into cash pursuant to prearranged and highly reliable funding arrangements, even in extreme but plausible market conditions. 168 CME at 6, quoting European Market Infrastructure Regulation Regulatory Technical Standards, Article 33 (emphasis supplied here). 169 CME at 6 (emphasis supplied). ISDA commented that proposed paragraph (c)(3)(ii), which requires a SIDCO or Subpart C DCO to take steps to verify that the prearranged and highly reliable funding arrangements for U.S. Treasury securities or other sovereign bonds do not include material adverse change provisions, is unnecessary because the PFMIs do not specifically require this. 170 ISDA also noted that credit arrangements generally include such clauses in order to protect the financial institution providing the credit, to protect that institution's shareholders, and to prevent the spread of risk from a DCO to financial institutions. 171 170 ISDA at 4. 171 Id. In light of these comments, the Commission has decided to make minor revisions to the language in 39.33(c)(3)(E)(1) and (E)(2) to more closely align with the language used in key consideration 5 to Principle 7. The purpose of the reference to the material adverse change clauses is to ensure that a SIDCO or Subpart C DCO not rely on a credit or liquidity arrangement that can be declined ( i.e., would not be reliably enforceable) at the very point in time when the DCO would, in fact, need to use the arrangement. In other words, these funding arrangements are intended to ensure that a SIDCO or Subpart C DCO will be able to meet its obligations when they come due even after a default in extreme but plausible conditions. If a funding arrangement includes a provision that there be no material adverse changes as a condition to draw, then such funding arrangement will not in fact serve its intended purpose. By contrast, a representation that there have been no material adverse changes for some period prior to execution of a liquidity arrangement, where the truth of such representation is not a condition to enforceability of the obligation to provide liquidity, would not be a condition that defeats the purpose of the liquidity arrangement. The Commission believes this interpretation is consistent with key consideration 5 of Principle 7, which states in relevant part that “For the purpose of meeting its minimum liquid resource requirement, an FMI's qualifying liquid resources in each currency include . . . highly marketable collateral held in custody and investments that are readily available and convertible into cash with prearranged and highly reliable funding arrangements, even in extreme but plausible market conditions.” Accordingly, the Commission has decided to modify paragraph (c)(3)(ii) to replace the phrase “material adverse change clause” with “material adverse change condition” and to add the “even in extreme but plausible market conditions” language from key consideration 5 to clarify this issue and to ensure consistency with Principle 7 with respect to this point. With respect to proposed paragraph (c)(4), ISDA commented that if a SIDCO or Subpart C DCO maintains financial resources in an amount greater than the Cover One financial resources requirement, then the SIDCO or Subpart C DCO should be required to maintain collateral with a low credit risk to cover such greater amount. 172 ISDA also commented that the phrase “with proceeds available promptly” should be deleted because it does not appear in the PFMIs and is not clearly defined. 173 The Commission notes that the financial resources at issue in this paragraph are in excess of those required by Principle 7 and regulation 39.33(a). Therefore, the Commission believes it is appropriate for attendant requirements to be less stringent than those that apply to required financial resources. In addition, the requirement in paragraph (c)(4) that a SIDCO or Subpart C DCO should consider maintaining collateral with low credit risk for any excess financial resources is consistent with Principle 7. Moreover, the Commission disagrees with ISDA and believe that the concept of “with proceeds available promptly” is covered by, and consistent with, the PFMIs. 172 Id. 173 ISDA at 4-5. In response to the Commission's question as to whether proposed paragraph (d)(4) should specify the frequency with which a SIDCO or Subpart C DCO must test its procedures for accessing liquidity resources, MGEX commented that it believes the proposed language is sufficient. 174 MGEX commented that the proposed language appropriately affords a DCO the discretion to determine the frequency of testing its procedures for accessing liquidity resources. 175 MGEX stated that a DCO is in the best position to determine this frequency and that unnecessary, redundant testing would cause a DCO to incur unnecessary costs. 176 174 MGEX at 7. 175 Id. 176 Id. The Commission has decided to finalize regulation 39.33 as modified above. New paragraphs (c), (d), and (e) are intended to address the gaps between current part 39 requirements and standards set forth in Principle 7. 177 The Commission believes these new provisions are appropriate and will reduce risk for SIDCOs and Subpart C DCOs, their clearing members, and customers of clearing members. In particular, new paragraph (c)(1) will help prevent a SIDCO or Subpart C DCO from defaulting on its obligations to non-defaulting clearing members, which is particularly important for a SIDCO because of the potential impact that the failure of a SIDCO could have on the U.S. financial markets, because maintaining resources that enable the DCO to meet its intraday, same-day, and multiday settlement obligations. New paragraph (c)(2) will require a SIDCO to meet its obligations in each relevant currency in a timely manner. This is important because if a SIDCO has sufficient funds to meet an obligation, but the funds are not in the correct currency, then the SIDCO cannot meet that obligation in a timely manner, which could lead to a disruption of the SIDCO's services. Such disruption could, in turn, have a significant impact on the financial stability of the U.S. economy. 177 Principle 7, K.C. 2 requires a CCP to measure, monitor, and manage liquidity risk effectively. This includes the CCP maintaining sufficient liquid resources in all relevant currencies in order to effect same-day and, where applicable, intraday and multiday settlement of payment obligations in a wide range of potential stress scenarios, including the default of the participant that would create the largest aggregate payment obligations in extreme but plausible market conditions. In addition, Principle 7, K. C. 5 limits a CCP to counting only certain qualifying liquid resources for the purpose of meeting its financial resources requirement. These resources include: cash in the currency of the requisite obligations, held either at the central bank of issue or at a creditworthy commercial bank; committed lines of credit; or high quality, liquid, general obligations of a sovereign nation. In addition, Principle 7, K. C. 4 states that a CCP that is systemically important in multiple jurisdictions or that is involved in activities with a more complex risk profile should consider maintaining sufficient qualifying liquid resources to meet the default of the two participants that would create the largest aggregate payment obligations in such circumstances. Principle 7, K. C. 7 also requires a CCP to monitor its liquidity providers, including clearing members, by undertaking due diligence to confirm that they have sufficient information to understand and manage their liquidity risks and have the capacity to perform as required under their commitments to the CCP. New paragraph (c)(1)(ii) will require a SIDCO or Subpart C DCO that is systemically important in multiple jurisdictions, or that is involved in activities with a more complex risk profile, to consider maintaining certain eligible liquidity resources that, at a minimum, will enable it to meet its intraday, same-day, and multiday settlement obligations, stress scenarios that include a default of the two clearing members creating the largest aggregate liquidity obligation for the DCO in extreme but plausible market conditions. The proposed list of these resources is consistent with those set forth in Principle 7. The financial integrity of a SIDCOs and or Subpart C DCOs might be enhanced if it considers meeting this enhanced standard. The provisions of new paragraph (c)(4) (pertaining to, among other issues, the liquidity of financial resources held in addition to those financial resources required by the Cover One standard) are designed to enhance the financial condition of SIDCOs and Subpart C DCOs and help reinforce stability. 178 178 See generally Financial Stability Oversight Council 2012 Annual Report, Appendix A at 163 (finding that “the contagion effect of a CME failure could impose material financial losses on CME's clearing members and other market participants (such as customers) and could lead to increased liquidity demands and credit problems across financial institutions, especially those that are active in the futures and options markets.”). F. Regulation 39.34 (System safeguards for systemically important derivatives clearing organizations and subpart C derivatives clearing organizations) In August of 2013, the Commission finalized regulation 39.30, which enhanced system safeguards requirements for SIDCOs with respect to business continuity and disaster recovery, and included a two-hour recovery time objective (“RTO”). 179 As discussed in the adopting release, the two-hour RTO is consistent with Principle 17 of the PFMIs and increases the soundness and operating resiliency of the SIDCO, which in turn, increases the overall stability of the U.S. financial markets. 180 The Commission proposed renumbering regulation 39.30 as regulation 39.34 and amending the regulation to cover Subpart C DCOs in addition to SIDCOs. The Commission also made a technical correction to paragraph (b) to make clear that subparagraphs (1), (2), and (3) concern each activity necessary for the daily processing, clearing, and settlement of existing and new contracts. Finally, the Commission proposed amending the regulation to allow the Commission to, upon request, grant newly designated SIDCOs and Subpart C DCOs up to one year to comply with the provisions of regulation 39.34. 181 179 See SIDCO Final Rule 78 FR 49672-49674. 180 Id. 181 In response to comments received, regulation 39.39, as finalized herein, will permit the Commission, upon request, to grant newly designated SIDCOs and Subpart C DCOs up to one year to comply with the provisions of regulation 39.35 and 39.39. To harmonize regulation 39.34 with this revision, the Commission has determined to make a technical correction to proposed regulation 39.34 that replaces the phrase “upon application” with the phrase “upon request.” MGEX commented that it “appreciates the additional time granted for comply [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2013-27849. Public record. Not legal advice.