# Derivatives Clearing Organization General Provisions and Core Principles > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2019-09025 ## Record - **Collection:** Federal Register - **Document type:** Proposed Rule - **Published:** May 16, 2019 - **Citation:** 84 FR 22226 ## Text COMMODITY FUTURES TRADING COMMISSION 17 CFR Parts 1, 39, and 140 RIN 3038-AE66 Derivatives Clearing Organization General Provisions and Core Principles AGENCY: Commodity Futures Trading Commission. ACTION: Notice of proposed rulemaking. SUMMARY: The Commodity Futures Trading Commission (Commission) is proposing amendments to certain regulations applicable to registered derivatives clearing organizations (DCOs). These proposed amendments would, among other things, address certain risk management and reporting obligations, clarify the meaning of certain provisions, simplify processes for registration and reporting, and codify existing staff relief and guidance. In addition, the Commission is proposing technical amendments to certain provisions, including certain delegation provisions, in other parts of its regulations. DATES: Comments must be received by July 15, 2019. ADDRESSES: You may submit comments, identified by “Derivatives Clearing Organization General Provisions and Core Principles” and RIN 3038-AE66, by any of the following methods: • CFTC Comments Portal: https://comments.cftc.gov. Select the “Submit Comments” link for this rulemaking and follow the instructions on the Public Comment Form. • Mail: Send to Christopher Kirkpatrick, Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581. • Hand Delivery/Courier: Follow the same instructions as for Mail, above. Please submit your comments using only one of these methods. To avoid possible delays with mail or in-person deliveries, submissions through the CFTC Comments Portal are encouraged. All comments must be submitted in English, or if not, accompanied by an English translation. Comments will be posted as received to https://comments.cftc.gov. You should submit only information that you wish to make available publicly. If you wish the Commission to consider information that you believe is exempt from disclosure under the Freedom of Information Act (FOIA), a petition for confidential treatment of the exempt information may be submitted according to the procedures established in § 145.9 of the Commission's regulations. 1 1 17 CFR 145.9. Commission regulations referred to herein are found at 17 CFR chapter I (2018), and are accessible on the Commission's website at https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm. The Commission reserves the right, but shall have no obligation, to review, pre-screen, filter, redact, refuse or remove any or all of your submission from https://comments.cftc.gov that it may deem to be inappropriate for publication, such as obscene language. All submissions that have been redacted or removed that contain comments on the merits of the rulemaking will be retained in the public comment file and will be considered as required under the Administrative Procedure Act and other applicable laws, and may be accessible under the FOIA. FOR FURTHER INFORMATION CONTACT: Eileen A. Donovan, Deputy Director, 202-418-5096, edonovan@cftc.gov; Parisa Abadi, Associate Director, 202-418-6620, pabadi@cftc.gov; Eileen R. Chotiner, Senior Compliance Analyst, 202-418-5467, echotiner@cftc.gov; Abigail S. Knauff, Special Counsel, 202-418-5123, aknauff@cftc.gov; Division of Clearing and Risk, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581. SUPPLEMENTARY INFORMATION: Table of Contents I. Background A. Project KISS B. Regulatory Framework for DCOs II. Amendments to Part 1—General Regulations Under the Commodity Exchange Act A. Written Acknowledgment From Depositories—§ 1.20 B. Governance and Conflicts of Interest—§§ 1.59, 1.63, and 1.69 III. Amendments to Part 39—Subpart A—General Provisions Applicable to DCOs A. Definitions—§ 39.2 B. Procedures for Registration—§ 39.3 C. Procedures for Implementing DCO Rules and Clearing New Products IV. Amendments to Part 39—Subpart B—Compliance With Core Principles A. Compliance With Core Principles—§ 39.10 B. Financial Resources—§ 39.11 C. Participant and Product Eligibility—§ 39.12 D. Risk Management—§ 39.13 E. Treatment of Funds—§ 39.15 F. Default Rules and Procedures—§ 39.16 G. Rule Enforcement—§ 39.17 H. Reporting—§ 39.19 I. Public Information—§ 39.21 J. Governance Fitness Standards, Conflicts of Interest, and Composition of Governing Boards—§§ 39.24, 39.25, and 39.26 K. Legal Risk—§ 39.27 L. Fully-Collateralized Positions V. Amendments to Part 39—Subpart C—Provisions Applicable to SIDCOs and DCOs That Elect To Be Subject to the Provisions A. Financial Resources for SIDCOs and Subpart C DCOs—§ 39.33 B. Risk Management for SIDCOs and Subpart C DCOs—§ 39.36 C. Additional Disclosure for SIDCOs and Subpart C DCOs—§ 39.37 D. Corrections to Subpart C Regulations VI. Amendments to Appendix A to Part 39—Form DCO VII. Amendments to Appendix B to Part 39—Subpart C Election Form VIII. Amendments to Part 140—Organization, Functions, and Procedures of the Commission IX. Related Matters A. Regulatory Flexibility Act B. Paperwork Reduction Act C. Cost-Benefit Considerations D. Antitrust Considerations I. Background A. Project KISS The Commission is engaging in an agency-wide review of its rules, regulations, and practices to make them simpler, less burdensome, and less costly, and to make progress on G-20 regulatory reforms. This initiative is called Project KISS, which stands for “Keep It Simple, Stupid.” 2 Consistent with these objectives, the Commission is proposing amendments to regulations applicable to DCOs to, among other things, enhance certain risk management and reporting obligations, clarify the meaning of certain provisions, simplify processes for registration and reporting, and codify existing relief and guidance. 2 See Remarks of Acting Chairman J. Christopher Giancarlo before the 42nd Annual International Futures Industry Conference in Boca Raton, FL, Mar. 15, 2017, available at https://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-20. On February 24, 2017, President Donald J. Trump issued Executive Order 13777: Enforcing the Regulatory Reform Agenda (E.O. 13777). E.O. 13777 directs federal agencies, among other things, to designate a Regulatory Reform Officer and establish a Regulatory Reform Task Force. Although the CFTC, as an independent federal agency, is not bound by E.O. 13777, the Commission is nevertheless engaging in an agency-wide review of its rules, regulations, and practices to make them simpler, less burdensome, and less costly. See Request for Information, 82 FR 23756 (May 24, 2017). B. Regulatory Framework for DCOs Section 5b(c)(2) of the Commodity Exchange Act (CEA) sets forth core principles with which a DCO must comply in order to be registered and to maintain registration as a DCO (DCO Core Principles). 3 In 2011, the Commission adopted regulations in subparts A and B of part 39 to implement the DCO Core Principles. 4 In 2013, the Commission adopted regulations in subpart C of part 39 5 to establish additional standards for compliance with the DCO Core Principles for those DCOs that have been designated as systemically important (SIDCOs) by the Financial Stability Oversight Council in accordance with Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). 6 The subpart C regulations are consistent with the Principles for Financial Market Infrastructures (PFMIs), published by the Committee on Payments and Market Infrastructures (CPMI) and the Technical Committee of the International Organization of Securities Commissions (IOSCO). 7 Other DCOs may elect to opt-in to the subpart C requirements (subpart C DCOs) in order to achieve status as a qualifying central counterparty (QCCP). 8 3 7 U.S.C. 7a-1. 4 See Derivatives Clearing Organization General Provisions and Core Principles, 76 FR 69334 (Nov. 8, 2011) (codified at 17 CFR part 39); Customer Clearing Documentation, Timing of Acceptance for Clearing, and Clearing Member Risk Management, 77 FR 21278 (Apr. 9, 2012) (further amending § 39.12). 5 Derivatives Clearing Organizations and International Standards, 78 FR 72476 (Dec. 2, 2013). 6 See Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010). 7 See CPMI-IOSCO, Principles for Financial Market Infrastructures (Apr. 2012), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD377.pdf. 8 In July 2012, the Basel Committee on Banking Supervision, 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 describes standards for capital charges arising from bank exposures to central counterparties (CCPs) related to over-the-counter derivatives, exchange-traded derivatives, and securities financing transactions. The Basel CCP Capital Requirements create financial incentives for banks, including their subsidiaries and affiliates, 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. These incentives include (1) lower capital charges for exposures arising from derivatives cleared through a 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. The failure of a CCP to achieve QCCP status could result in significant costs to its bank customers. Since the part 39 regulations were adopted, Commission staff has worked with DCOs to address questions regarding interpretation and implementation of the requirements established in the regulations. In light of this, the Commission believes it would be helpful to revise or clarify certain provisions of part 39 and to codify staff relief or guidance granted in the interim. The Commission is also proposing a few new requirements with respect to default procedures and event-specific reporting in response to recent events. The Commission believes these changes will provide greater clarity and transparency for DCOs and DCO applicants and lead to more effective DCO compliance and risk management generally. The Commission has carefully considered the costs and benefits associated with the proposed amendments, and invites commenters to provide data and analysis regarding any aspect of the proposed rulemaking. In addition to the amendments proposed herein, the Commission requests comment for any other aspects of part 39 that commenters believe the Commission should clarify or otherwise amend. II. Amendments to Part 1—General Regulations Under the Commodity Exchange Act A. Written Acknowledgment From Depositories—§ 1.20 Regulation 1.20(d)(1) requires that a futures commission merchant (FCM) obtain a written acknowledgment from each depository with which the FCM deposits futures customer funds. 9 The written acknowledgment must conform to a template letter set forth in appendix A to § 1.20, and the template letter includes certain requirements set forth in § 1.20(d)(3) through (6). Regulation 1.20(d)(1) further provides, however, that an FCM is not required to obtain a written acknowledgment from a DCO that has adopted rules that provide for the segregation of customer funds in accordance with all relevant provisions of the CEA and the Commission's rules and orders thereunder. The Commission is proposing to amend § 1.20(d) to clarify that the requirements listed in § 1.20(d)(3) through (6) do not apply to a DCO, or to an FCM that clears through that DCO, if the DCO has adopted rules that provide for the segregation of customer funds. The proposed changes are not intended to be substantive, but rather to reflect the Commission's intent when § 1.20 was last amended. Nonetheless, the Commission emphasizes that it has ample means of obtaining information regarding accounts held at a DCO under § 1.20 by virtue of its ongoing oversight and supervision of DCOs. The Commission also is proposing to amend § 1.20(d)(7) and (8) to explicitly account for FCMs that deposit customer funds with a DCO and thus are not required to obtain a written acknowledgment letter. 9 Regulation 22.5 applies the written acknowledgment letter requirements of § 1.20(d) to FCMs and DCOs in connection with the holding of cleared swaps customer collateral. B. Governance and Conflicts of Interest—§§ 1.59, 1.63, and 1.69 In the course of adopting the current part 39 regulations, the Commission removed and replaced § 39.2, 10 which had exempted DCOs from all Commission regulations except for those specified therein (the “§ 39.2 exemption”). The Commission noted that the § 39.2 exemption failed to account for regulations applicable to DCOs that were adopted later, such as § 1.49. 11 The Commission further noted that removal of the § 39.2 exemption would subject DCOs only to § 1.49 and three additional regulations: §§ 1.59 (activities of self-regulatory organization employees, governing board members, committee members, and consultants); 1.63 (service on self-regulatory organization governing boards or committees by persons with disciplinary histories); and 1.69 (voting by interested members of self-regulatory organization governing boards and various committees). 12 The Commission explained that these three provisions would be superseded by regulations the Commission had proposed to implement Core Principles O (Governance Arrangements), P (Conflicts of Interest), and Q (Composition of Governing Boards). 13 10 The current § 39.2 sets forth definitions of terms used in part 39. 11 See Risk Management Requirements for Derivatives Clearing Organizations, 76 FR 3698, 3714 (Jan. 20, 2011) (proposed rule). 12 Id. at 3714 & n.77. 13 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) (proposed rule); Governance Requirements for Derivatives Clearing Organizations, Designated Contract Markets, and Swap Execution Facilities; Additional Requirements Regarding the Mitigation of Conflicts of Interest, 76 FR 722 (Jan. 6, 2011) (proposed rule). However, the Commission did not adopt those regulations, and §§ 1.59, 1.63, and 1.69 became applicable to DCOs. The Commission is now proposing to adopt implementing regulations for Core Principles O, P, and Q by moving certain requirements from subpart C, which is applicable to only SIDCOs and subpart C DCOs, to subpart B, which is applicable to all registered DCOs (discussed further below). Therefore, the Commission is proposing to restore DCOs' exemption from §§ 1.59, 1.63, and 1.69 by removing “clearing organization” from the definition of “self-regulatory organization” in each of those regulations. The Commission is also proposing to amend § 1.64 to remove language that makes clear that the provision does not apply to DCOs. The amendments to the other provisions make that language no longer necessary. III. Amendments to Part 39—Subpart A—General Provisions Applicable to DCOs A. Definitions—§ 39.2 Regulation 39.2 sets forth definitions applicable to terms used in part 39 of the Commission's regulations. Since § 39.2 was adopted, the Commission has adopted definitions for some of the same terms that apply in other Commission regulations. Accordingly, the Commission is proposing amendments to § 39.2 in order to maintain consistency with terms defined elsewhere in Commission regulations and to provide clarity with respect to the use of these terms. 1. Business Day Regulation 39.19(b)(3) defines “business day,” but because the definition is contained within § 39.19, it is not clear that it is applicable to uses of the term “business day” elsewhere in part 39. The Commission is therefore proposing to remove § 39.19(b)(3) and include the definition of “business day” in § 39.2. The Commission also is proposing to clarify that the term “Federal holidays” in the “business day” definition refers to the schedule of U.S. federal holidays established under 5 U.S.C. 6103. The Commission is specifying this because some DCOs registered with the Commission are located outside the United States. Finally, the Commission is defining “foreign holiday” as a day on which a DCO and its domestic financial markets are closed for a holiday that is not a Federal holiday in the United States, and adding the term to the list of exceptions to the definition of “business day.” The Commission believes there is no reason to require foreign DCOs to report on a non-trading day. 2. Customer Regulation 39.2 defines “customer,” for purposes of part 39, as a person trading in any commodity named in the definition of “commodity” in section 1a(9) of the CEA or in § 1.3 of the Commission's regulations, or in any swap as defined in section 1a(47) of the CEA or in § 1.3. The definition further distinguishes a customer from the owner or holder of a house account. After § 39.2 was adopted, the Commission amended the definition of “customer” in § 1.3, to mean any person who uses a futures commission merchant, introducing broker, commodity trading advisor, or commodity pool operator as an agent in connection with trading in any commodity interest. The Commission also amended the definition of “commodity interest” in § 1.3 to include any swap as defined in the CEA, by the Commission, or jointly by the Commission and the Securities and Exchange Commission. Because the definition of “customer” in § 1.3 now encompasses the definition in § 39.2, the Commission believes that the definition in § 39.2 is unnecessary and may create uncertainty. Therefore, the Commission is proposing to remove the definition of “customer” in § 39.2, leaving the definition in § 1.3 as the applicable definition for purposes of part 39. 3. Customer Account or Customer Origin Regulation 39.2 defines “customer account or customer origin” as a clearing member account held on behalf of customers that is subject to section 4d(a) or section 4d(f) of the CEA. After § 39.2 was adopted, the Commission adopted the definition of “customer account” in § 1.3 to include both a futures account and a cleared swaps customer account, which are accounts subject to sections 4d(a) and 4d(f) of the CEA, respectively. The Commission believes that having a definition of “customer account or customer origin” in § 39.2 and a definition of “customer account” in § 1.3 may create uncertainty. Because the part 39 regulations use both “customer account” and “customer origin” terms, the Commission is proposing to amend the definition of “customer account or customer origin” in § 39.2 to cross-reference the definition of “customer account” in § 1.3, rather than removing the definition or the term “customer origin.” 4. Enterprise Risk Management The Commission is proposing to define “enterprise risk management” because the term is used in proposed § 39.10(d), which is discussed below. 5. Fully-Collateralized Position The Commission is proposing to define “fully-collateralized position” in conjunction with proposed exceptions from several part 39 regulations for DCOs that clear fully-collateralized positions, as discussed below. 6. Key Personnel The Commission is proposing to add “chief information security officer” to the list of positions identified in the definition of “key personnel” in § 39.2. In the event of a cybersecurity incident, it is critical that Commission staff be able to quickly contact the person at each DCO responsible for responding to the incident to assess the DCO's response as well as to coordinate efforts among DCOs as necessary. B. Procedures for Registration—§ 39.3 1. Application Procedures—§ 39.3(a) The Commission is proposing to make several changes to its procedures for registration as a DCO, set forth in § 39.3. Regulation 39.3(a)(1) refers to “[a]n organization desiring to be registered as a [DCO],” while § 39.3(a)(2) refers to “[a]ny person seeking to register as a [DCO].” To make the language consistent, the Commission is proposing to revise § 39.3(a)(1) and (2) to refer to an “entity seeking to register as a [DCO].” The Commission is proposing additional changes to § 39.3(a)(1) to improve the clarity of the text. Regulation 39.3(a)(2) requires an applicant for DCO registration to submit to the Commission a completed Form DCO, which is provided in appendix A to part 39. 14 Since the adoption of Form DCO, the Commission has identified several areas in which changes to Form DCO are needed. Many of the revisions to the part 39 regulations proposed herein would require corresponding changes to Form DCO. Therefore, the Commission is proposing to revise Form DCO as discussed in Section VI. below. 14 At the time § 39.3(a)(2) was adopted, Form DCO was the only appendix to part 39. Since then, appendices have been added to part 39, and Form DCO is now set forth in appendix A. Therefore, the Commission is proposing to revise § 39.3(a)(2) to reference “Form DCO . . . as provided in appendix A to this part.” Regulation 39.3(a)(3) provides that at any time during the application review process, the Commission may request that the DCO applicant submit supplemental information in order for the Commission to process the application. An applicant is required to “file electronically” such supplemental information with the Secretary of the Commission, in the format and manner specified by the Commission. The Commission is proposing to amend § 39.3(a)(3) to require an applicant to “provide” such supplemental information and to delete the requirement that it be filed with the Secretary of the Commission. By making these changes, yet retaining the requirement that the information be provided in the format and manner specified by the Commission, the Commission and DCO applicants would have greater flexibility. For example, the Commission would be able to permit an applicant to provide requested information through a presentation to Commission staff. Regulation 39.3(a)(5) provides for certain sections of a DCO application to be made public, including the “first page of the Form DCO cover sheet.” The regulation refers to Form DCO as it appears in the print edition of the Code of Federal Regulations. However, the Commission is aware that Form DCO may appear differently in other sources, so the Commission is proposing to amend § 39.3(a)(5) to specify that the “first page of the Form DCO cover sheet (up to and including the General Information section)” will be made public. The Commission is also proposing to revise the provision to include specific references to the Form DCO exhibits that will be made public. Finally, the Commission is proposing to adopt new § 39.3(a)(6), which would permit the Commission to extend the 180-day review period for DCO applications specified in § 39.3(a)(1) for any period of time to which the applicant agrees in writing. This provision would be similar to § 40.5(d)(2), which allows the Commission to extend the review period for rules submitted for Commission review and approval, if the registered entity that submitted the rule agrees in writing. The Commission believes it is important to have the ability to extend the review period for a DCO application so that, in the event that any issues or concerns arise that cannot be resolved in a timely manner, the Commission does not find itself in the position of having to deny the application. 2. Stay of Application Review—§ 39.3(b) Regulation 39.3(b)(2) provides for delegation to the Director of the Division, with the concurrence of the General Counsel, the authority to notify an applicant “seeking designation under section 6(a) of the [CEA]” that the application is materially incomplete and the running of the 180-day period is stayed. By its terms, section 6(a) of the CEA applies only to designation of contract markets. However, under § 39.3(a), the Commission applies the same procedures to DCO applications. Because DCOs are “registered” and not “designated,” the Commission is substituting “registration” for “designation” in § 39.3(b)(2). 3. Amendment of an Order of Registration—§ 39.3(a)(2) Regulation 39.3(a)(2) specifies that any person seeking to register as a DCO, any applicant amending its pending application, and any registered DCO seeking to amend its order of registration must submit to the Commission a completed Form DCO, which must include a cover sheet, all applicable exhibits, and any supplemental materials, including amendments thereto, as provided in appendix A to part 39. The Form DCO instructions correspond to this requirement and currently specify that requests for amending a registration order and any associated exhibits must be submitted via Form DCO. The Commission is proposing to change the requirements regarding a DCO's request to amend an order of registration. First, the Commission proposes to amend § 39.3(a)(2) and Form DCO to eliminate the required use of Form DCO to request an amended order of registration from the Commission. Under current practice, a DCO is permitted to file a request for an amended order with the Commission rather than submitting Form DCO. Commission staff typically will review the request, obtain additional information from the DCO where necessary, and subsequently recommend to the Commission whether to grant or deny the amended order. Given current practice, the Commission believes that an updated Form DCO is not needed to request an amended order of registration. Second, the Commission proposes to amend § 39.3(a)(4) to state that an applicant only needs to file amended exhibits and other information when filing a Form DCO to update a pending application. Consistent with existing Commission practice and the proposal to eliminate the use of Form DCO to request an amended registration order, the Commission is proposing new § 39.3(d) to establish a separate process for such requests. A DCO would be required to provide the Commission with any additional information and documentation necessary to review a request to amend an order of registration. The Commission would issue an amended order if the Commission determines that the DCO would continue to maintain compliance with the Act and the Commission's regulations after such an amendment. Further, the Commission may also issue an amended order of registration subject to conditions. The Commission also proposes to specify that it may decline to issue an amended order based upon a determination that the DCO would not continue to maintain compliance with the Act and the Commission's regulations upon such amendment. 4. Dormant Registration—§ 39.3(d) Regulation 39.3(d) establishes the procedure for a dormant DCO to reinstate its registration before it can begin “listing or relisting” products for clearing. The Commission is proposing to replace “listing or relisting” with “accepting” to more accurately describe a DCO's activities. The Commission also proposes to renumber § 39.3(d) as § 39.3(e). 5. Vacation of Registration—§ 39.3(e) Section 7 of the CEA and § 39.3(e) of the Commission's regulations permit a DCO to request that the Commission vacate its registration. Orders of vacation of registration issued by the Commission have included requirements based on section 7 of the CEA and other Commission regulations that are not specifically listed in § 39.3(e). The Commission is proposing to amend § 39.3(e) to codify these requirements and provide greater transparency to any DCO that is considering vacating its registration. To implement the proposed changes, the Commission is proposing to renumber current § 39.3(e) as § 39.3(f)(1). Section 7 of the CEA requires any registered entity that wishes to have its registration vacated to make a written request to the Commission. Section 7 also requires that the request be made at least 90 days prior to the date on which the registered entity wants the vacation to take effect. The Commission is proposing to adopt § 39.3(f)(1)(i) to specifically require a DCO to state in its request the date it wishes to have its registration vacated and to make the request at least 90 days prior to that date. The Commission is also proposing to adopt § 39.3(f)(1)(ii) to require a DCO to state in its request how it intends to transfer or otherwise unwind all open positions at the DCO. Under the proposed rule, any actions to transfer or unwind positions would be required to reflect the interests of affected clearing members and their customers. The Commission believes this requirement will help ensure that a DCO that plans to voluntarily cease its clearing activity will do so with minimal disruptions to its members and the markets it serves. The Commission is proposing to adopt § 39.3(f)(1)(iii) and (iv) to require a DCO to continue to maintain its books and records after its registration has been vacated for the requisite statutory and regulatory retention periods, and to require a DCO to make all such books and records available for inspection by any representative of the Commission or the United States Department of Justice after its registration has been vacated, as set forth in § 1.31 of the Commission's regulations. The Commission has included this requirement in previous orders of vacation based on § 39.3(f), which states that a vacation of registration “shall not affect any action taken or to be taken by the Commission based upon actions, activities or events occurring during the time that the entity was registered with the Commission.” 15 The Commission is proposing this requirement to further ensure that a DCO does not destroy its books and records in order to hinder or avoid Commission action following the vacation of its registration. 15 To accommodate the proposed changes, the Commission is proposing to include this sentence as part of § 39.3(f)(1). Finally, section 7 of the CEA requires the Commission to “forthwith send a copy” of the notice that was filed with the Commission requesting vacation and the order of vacation to all other registered entities. The Commission is proposing to adopt § 39.3(f)(2) to specify that this requirement will be met by posting the required documents on the Commission's website. This provision was written and amended before the internet expanded to its current form and level of access. 16 The Commission believes that posting the required documents on its website is the most effective and efficient way of providing the required information to all registered entities, as well as the public. 16 The requirement to send a copy of the notice and order was first included in section 7 in 1922. The Grain Futures Act, Public Law 67-331 ch. 369, sec. 7, 42 Stat. 1002 (1922). Section 7 was most recently amended in 2000, to cover all types of registered entities, including DCOs. Commodity Futures Modernization Act of 2000, Public Law 106-554, Title I, sec. 123(a)(17), 114 Stat. 2763 (2000). 6. Request for Transfer of Registration and Open Interest—§ 39.3(f) Regulation 39.3(f) establishes procedures that a DCO must follow to request the transfer of its DCO registration and positions comprising open interest for clearing and settlement, in anticipation of a corporate change. Regulation 39.3(f) also pertains to instances in which a corporate change results in the transfer of all or substantially all of a DCO's assets to another legal entity. Commission staff has found that the requirements of § 39.3(f) have created confusion for DCOs which merely want to convert the DCO from one type of legal entity to another or change the place of domicile for the DCO's legal entity without changing the DCO's operations or transferring the DCO's registration to new ownership. The Commission also recognizes that a transfer of open interest would not necessarily be tied to a corporate change. 17 For example, a DCO may wish to transfer open interest to another DCO that is also a subsidiary of the same parent company, or to another DCO in connection with ceasing its clearing services for a particular product. 17 The Commission notes, however, that a transfer of open interest in this regard would not be in the context of a default, which would typically involve a DCO transferring positions from one FCM to another FCM. To separate the procedures for a request to transfer open interest from those procedures to report a change to the DCO's corporate structure or ownership, the Commission is proposing changes to § 39.3(f), to be renumbered as § 39.3(g), to simplify the requirements for requesting a transfer of open interest and remove references to transfers of registration and requirements regarding corporate changes. Proposed § 39.3(g) would only apply to instances in which a DCO requests to transfer its open interest. Changes to the DCO's ownership would continue to be addressed under § 39.19(c)(4)(viii) (proposed to be renumbered as § 39.19(c)(4)(ix)). Additionally, as discussed further below, the Commission is proposing to require a DCO to report a change to the legal name under which it operates in proposed § 39.19(c)(4)(xi). The Commission is also proposing conforming changes to § 39.19(c)(4)(ix) to remove cross-references to § 39.3(f). Under the proposed amendments to § 39.3(g), a DCO seeking to transfer its open interest would be required to submit rules for Commission approval pursuant to § 40.5, 18 rather than submitting a request for an order at least three months prior to the anticipated transfer. In an effort to simplify the existing requirements, the proposed change would permit the transfer to take effect after a 45-day Commission review period. The 45-day review period would be intended to ensure that clearing members are made aware of the intended transfer and to determine whether the transferee DCO is suitable to take on the transfer 19 and would be able to continue to operate in compliance with the CEA and the Commission's regulations. As part of its submission pursuant to § 40.5, the DCO would be required to include: (1) The underlying agreement that governs the transfer; (2) a description of the transfer, including the reason for the transfer and its impact on the rights and obligations of clearing members and market participants holding positions that comprise the DCO's open interest; (3) a discussion of the transferee's ability to comply with the CEA, including the DCO Core Principles, and the Commission's regulations thereunder; (4) the transferee's rules marked to show changes that would result from acceptance of the transferred positions; (5) a list of products for which the DCO requests transfer of open interest; and (6) a representation by the transferee that it is in and will maintain compliance with the CEA, including the DCO Core Principles, and the Commission's regulations thereunder upon transfer of the open interest. 18 SIDCOs should consider whether the facts and circumstances of the approval sought pursuant to a § 40.5 filing also obligate a SIDCO to file a § 40.10 submission. 19 The Commission notes that, under the existing framework, positions cleared for U.S. customers must be cleared by a registered DCO, while proprietary positions of U.S. persons may be cleared by registered or exempt DCOs. As a result, the Commission would need to ensure that the positions are transferred to an entity that is appropriately registered or exempt from DCO registration. C. Procedures for Implementing DCO Rules and Clearing New Products 1. Request for Approval of Rules—§ 39.4(a) Regulation 39.4(a) specifies that an applicant for registration or a registered DCO may request, pursuant to the procedures set forth in § 40.5, that the Commission approve any or all of its rules prior to their implementation. In practice, the Commission's review of applications for DCO registration includes review of the applicant's rules, which are required to be submitted as Exhibit A-2 to Form DCO. The Commission's issuance of an order of registration as a DCO constitutes an approval of the applicant's rules that were submitted as part of the application. Accordingly, the Commission is proposing to delete the reference in § 39.4(a) to an applicant for registration, as it is unnecessary for an applicant to separately request approval of its rules. 2. Portfolio Margining—§ 39.4(e) Regulation 39.4(e) establishes certain procedural requirements that apply to a DCO seeking approval for a futures account portfolio margining program. Under § 39.4(e), a DCO seeking to provide a portfolio margining program under which securities would be held in a futures account is required to petition the Commission for an order “under section 4d of the [CEA].” To conform terminology to other provisions in part 39 which distinguish between futures accounts subject to section 4d(a) of the CEA and cleared swaps accounts subject to section 4d(f) of the CEA, the Commission is proposing to substitute “section 4d(a)” for “section 4d” in § 39.4(e). IV. Amendments to Part 39—Subpart B—Compliance With Core Principles A. Compliance With Core Principles—§ 39.10 1. Chief Compliance Officer—§ 39.10(c) Regulation 39.10(c)(1)(ii) requires that a DCO's chief compliance officer (CCO) report to the board of directors or the senior officer of the DCO. The Commission recognizes that a legal entity registered as a DCO may engage in substantial activities not related to clearing, in which case it may be more appropriate for the CCO to report to the senior officer responsible for the DCO's clearing activities. For example, traditionally, exchanges have had clearing operations as a component of their overall structure. In some instances, the exchange is the same legal entity as the DCO, and therefore, the senior officer of the entity would not necessarily be focused on the clearing operations. In light of this, the Commission is proposing to amend § 39.10(c)(1)(ii) to permit the CCO to report to the senior officer responsible for the DCO's clearing activities. The Commission also is proposing to amend § 39.10(c)(4)(i) to permit the CCO to submit the annual report (which is discussed below) to the senior officer responsible for the DCO's clearing activities. 20 20 Regulation 39.10(c)(3) also requires the CCO to “provide the annual report to the board of directors or the senior officer.” Because this requirement is set forth in greater detail in § 39.10(c)(4)(i), the Commission is proposing to remove, rather than amend, the language in § 39.10(c)(3). Regulation 39.10(c)(3)(i) requires the CCO to prepare an annual report that contains a description of the DCO's written policies and procedures, including the code of ethics and conflict of interest policies. The Commission is proposing to amend this requirement to allow a DCO to incorporate by reference the parts of its most recent CCO annual report containing such description, to the extent that the DCO's written policies and procedures have not materially changed since they were most recently described in a previously submitted CCO annual report. This is intended to help make the process of preparing the CCO annual report more efficient by not requiring the report to repeat potentially lengthy descriptions of policies and procedures that have already been described in a CCO annual report previously submitted to the Commission. However, to ensure that the descriptions remain current and easily accessible, the Commission is proposing to allow this incorporation by reference only to a CCO annual report submitted to the Commission within the five-year period prior to the date of the CCO annual report containing such incorporation by reference. The Commission believes that this timeframe is appropriate given the record retention requirements of § 39.20. The Commission wishes to stress that this ability to incorporate by reference only applies to descriptions of policies and procedures that have not materially changed and does not apply to the CCO's assessment of their effectiveness or other requirements outside of § 39.10(c)(3)(i). The Commission also is proposing to amend § 39.10(c)(3)(ii)(A), which requires the CCO to prepare an annual report that reviews each “core principle and applicable Commission regulation,” and with respect to each, identifies the compliance policies and procedures that are designed to ensure compliance “with the core principle.” In order to be consistent with the first part of the requirement, the Commission is proposing to change the language of the second part to “with each core principle and applicable regulation.” The Commission is further proposing to amend § 39.10(c)(3)(ii) to clarify that, for SIDCOs and subpart C DCOs, this includes the Commission's regulations in subpart C of part 39. In addition, the Commission is further proposing to require that the compliance policies and procedures be identified “by name, rule number, or other identifier” to clarify that this provision is intended to require the CCO annual report to clearly and specifically identify the policies and procedures intended to comply with each core principle and applicable regulation. Finally, § 39.10(c)(4)(i) requires the CCO to provide the annual report to the board of directors or senior officer of the DCO for review prior to submitting it to the Commission. The Commission is proposing to amend the provision to require that this process be described in the annual report, including providing the date on which the report was submitted to the board of directors or senior officer. The Commission notes that § 39.10(c)(4)(i) already requires the submission of the report to the board of directors or senior officer to be recorded in the board of directors' meeting minutes or otherwise, as evidence of compliance with this requirement. However, the Commission believes that it is reasonable to require similar disclosure in the CCO annual report so that compliance is evident outside the context of an examination of the DCO's board of directors' meeting minutes or other records. The Commission notes that some DCOs already describe this process in the cover letter submitted along with the CCO annual report, but the Commission prefers that this description appear in the annual report itself or in an annex, schedule, or exhibit attached to and included with the annual report. The Commission is also proposing to amend § 39.10(c)(4)(ii) by removing the requirement that the CCO annual report be submitted concurrently with the DCO's fiscal year-end audited financial statement, to be consistent with a proposed change to § 39.19(c)(3)(iv) described below. 2. Enterprise Risk Management—§ 39.10(d) The Commission is proposing to add new § 39.10(d) 21 to specifically provide that a DCO is required to have a program of enterprise risk management, which would be defined in § 39.2 as an enterprise-wide strategic business process intended to identify potential events that may affect the enterprise and to manage the probability or impact of those events on the enterprise as a whole, such that the overall risk remains within the enterprise's risk appetite and provides reasonable assurance that the DCO can continue to achieve its objectives, including compliance with the CEA and Commission regulations. The proposed definition is intended to be applicable to a variety of corporate structures, including stand-alone DCOs, legal entities that are a DCO but also perform other functions (such as a DCM), and corporate groups that consist of a DCO and legally separate but affiliated entities. 22 21 The Commission is proposing to place the requirement for an enterprise risk management program in § 39.10, which codifies Core Principle A (pertaining to compliance with the DCO Core Principles generally), to emphasize the broad application of an enterprise risk management program to a DCO's operations and services. The Commission previously declined to adopt an enterprise risk management requirement applicable to DCOs in a rulemaking pertaining to a specific Core Principle—Core Principle I, “System Safeguards”—because such a requirement “must be addressed in a more comprehensive fashion involving more than the system safeguards context alone, and thus are not appropriate for this rulemaking.” See System Safeguards Testing Requirements for Derivatives Clearing Organizations, 81 FR 64322, 64332 (Sept. 19, 2016). Other Commission regulations codify various specific aspects of risk management. For example, § 39.13 codifies Core Principle D, which focuses on market risk and credit risk; § 39.18 codifies Core Principle I, which addresses system safeguards; and § 39.27 codifies Core Principle R, which addresses legal risk. By including the enterprise risk management requirement in § 39.10, the Commission intends to underscore that a properly designed and managed enterprise risk management program covers all risks. 22 The term “enterprise-wide” is intended to require that the process of identifying, assessing, measuring, monitoring, and managing risk apply to the entire legal entity and its affiliates as a collective whole, with the objective to manage the risks to the DCO. A DCO would satisfy its obligations under paragraph (d)(1) (and paragraphs (d)(2) and (3), as discussed below) if it is part of a corporate group that has in place an enterprise risk management program that includes the DCO within its scope and complies with the requirements of this section. An enterprise risk management program requires an entity to assess all potential risks it faces, including but not limited to systemic, cyber, legal, credit, liquidity, concentration, general business, operational, custody and investment, conduct, financial, reporting, compliance, governance, strategic, and reputational risks. An enterprise risk management program also requires the entity to identify and assess those risks on an enterprise-wide basis, meaning that it must consider whether individual risks across the organization and its affiliates are interrelated and may create a combined exposure to the entity that differs from the sum of the individual risks, and must measure, monitor, and manage such risks accordingly. Additionally, an enterprise risk management program requires an assessment of both the nominal or inherent risk that exists prior to the establishment of any risk mitigation activities ( i.e., controls) as well as the residual risk that remains once such mitigation activities or risk responses are taken into account. Existing Commission regulations already require a DCO to manage its risks. 23 However, the Commission has found that some DCOs lack a formal enterprise risk management program that addresses their risks on an enterprise-wide basis. Therefore, proposed § 39.10(d)(1) and (2) would require a DCO to implement an enterprise risk management program and establish and maintain an enterprise risk management framework. 23 For example, § 39.11(a) requires a DCO to identify and adequately manage its general business risks; § 39.13(a) requires a DCO to ensure that it possesses the ability to manage the risks associated with discharging the responsibilities of the DCO through the use of appropriate tools and procedures; and § 39.13(b) requires a DCO to establish and maintain written policies, procedures, and controls which establish an appropriate risk management framework that, at a minimum, clearly identifies and documents the range of risks to which the DCO is exposed and addresses the monitoring and management of the entirety of those risks. Consistent with § 39.10(b), the Commission does not intend to be overly prescriptive by requiring specific standards and methodologies. A DCO should develop an enterprise risk management program that works best for its specific risk exposures, product types, customer base, market segment, and organizational structure, among other things, as long as the program meets the proposed minimum standards and any other legal and regulatory requirements. Therefore, proposed § 39.10(d)(3) would require a DCO to follow generally accepted standards and industry best practices with respect to the development and ongoing monitoring of its enterprise risk management framework, assessment of the performance of the enterprise risk management program, and the management and mitigation of risk to the DCO. The Commission is mindful that best practices evolve and change over time and does not, therefore, wish to prescribe specific standards in its regulations. 24 24 In the interests of offering guidance to DCOs, however, the Commission notes that standards similar to those developed by the Committee of Sponsoring Organizations of the Treadway Commission or the International Organization for Standardization are currently among those that would reasonably be considered in the development of an enterprise risk management program. Although different standards may use different terminology for the same concept, these standards have some commonalities, such as the statement of risk appetite and the use of a risk register or logs to record any losses or risks above a given threshold. These standards are noted here to assist DCOs in identifying standards that they may wish to adopt or consider in designing and implementing their risk management frameworks; there may be other internationally-recognized standards that may be used in addition to or instead of the standards mentioned above. In the interests of transparency, a DCO should specify the standards or industry best practices it uses as part of its enterprise risk management program. The Commission has observed that some DCOs tend to “silo” responsibility for complying with their statutory and regulatory obligations given the diverse nature of the relevant risks. For example, risk management personnel might be primarily responsible for compliance with Core Principle D, while information technology personnel might be primarily responsible for managing the risks addressed by Core Principle I. To ensure that the enterprise risk management program is managed appropriately, the Commission is proposing § 39.10(d)(4), which would require a DCO to identify as its enterprise risk officer an appropriate individual that exercises the full responsibility and authority to manage the DCO's enterprise risk management function. 25 25 The Commission is proposing to require that the DCO “identify,” rather than “designate,” the enterprise risk officer because, for certain corporate structures, the enterprise risk officer would most appropriately be an officer of a parent or other affiliate of the DCO. As a result, the DCO may not always be the entity that may properly “designate” the enterprise risk officer. The enterprise risk officer would be required to have the authority, independence, resources, expertise, and access to relevant information necessary to fulfil the responsibilities of such position. The Commission believes that the independence of the enterprise risk officer is a critical factor in allowing such officer to operate effectively and has concerns about the potential for senior officers to interfere with the enterprise risk officer's performance of his or her responsibilities. The Commission requests comment regarding whether the enterprise risk officer should be required to report directly to the board of directors of the organization for which the enterprise risk officer is responsible for managing the risks, whether such organization is the DCO or its corporate parent or other affiliate. The Commission also requests comment as to whether a DCO's chief risk officer should be permitted to also serve as its enterprise risk officer. B. Financial Resources—§ 39.11 Regulation 39.11 implements Core Principle B, which requires a DCO to possess financial resources that, at a minimum, exceed the total amount that would enable the DCO to meet its financial obligations to its clearing members notwithstanding a default by the clearing member creating the largest financial exposure for the DCO in extreme but plausible market conditions and to cover its operating costs for a period of one year, as calculated on a rolling basis. The Commission is proposing to revise or clarify several aspects of § 39.11, including revising the language of § 39.11(a) to make it more consistent with Core Principle B. 1. Calculation of Largest Financial Exposure and Stress Tests—§ 39.11(a)(1), (c)(1) and (2). Regulation 39.11(a)(1) requires a DCO to maintain financial resources sufficient to meet its financial obligations to its clearing members notwithstanding a default by the clearing member creating the largest financial exposure for the DCO in extreme but plausible market conditions. Regulation 39.11(c)(1) requires a DCO to perform “stress testing” in order to determine the financial resources required to satisfy § 39.11(a)(1). As an initial matter, the Commission is proposing to change the wording to “stress tests” to use the term defined in § 39.2. This is not intended to change the meaning of § 39.11(c)(1). Although § 39.11(c)(1) grants a DCO reasonable discretion in determining the methodology used to calculate its financial resources requirement, Commission staff has noted inconsistencies in how DCOs treat excess collateral on deposit when conducting stress tests. These inconsistencies lessen the usefulness of the stress tests. Accordingly, the Commission is proposing additional minimum requirements that a DCO would have to follow in determining its exposure in accordance with § 39.11(c)(1). In particular, the Commission is proposing to add § 39.11(c)(2)(i)(A) 26 to require a DCO to calculate its largest financial exposure net of the clearing member's required initial margin amount on deposit. In other words, the DCO may not take into account excess collateral on deposit or initial margin required but not yet received. This would focus a DCO's analysis on the resources that would actually be available to the DCO during times of stress and is consistent with recent guidance issued by CPMI-IOSCO suggesting that when assessing the adequacy of their financial resources, CCPs should take into account only prefunded financial resources and ignore voluntary excess contributions. 27 Consistent with this change, the Commission is proposing to remove § 39.11(b)(1)(i), which permits margin to be used to satisfy the requirements of § 39.11(a)(1), because the required initial margin amount on deposit for the clearing member will be applied before determining the largest financial exposure for the DCO in extreme but plausible market conditions. Therefore, the margin would not be available to also cover the exposure. 26 The Commission is proposing to renumber current § 39.11(c)(2) as § 39.11(c)(3). 27 See CPMI-IOSCO, Resilience of central counterparties: Further guidance on the PFMI (July 2017), Principles 4.2.4, 4.2.5, available at https://www.bis.org/cpmi/publ/d163.pdf. Additionally, the Commission is proposing § 39.11(c)(2)(ii) to require that when stress tests produce losses in both customer and house accounts, a DCO must combine the customer and house stress test losses of each clearing member using the same stress test scenario. Finally, the Commission is proposing several provisions designed to ensure customer funds are treated properly when a DCO is calculating its largest financial exposure. Proposed § 39.11(c)(2)(i)(B) would require a DCO to use customer initial margin only to the extent permitted by parts 1 and 22 of the Commission's regulations. Proposed § 39.11(c)(2)(iii) would clarify that when calculating its largest financial exposure, a DCO may net any gains in the house account with customer losses, if permitted by the DCO's rules; however, a DCO may not net losses in the house account with gains in the customer account. Proposed § 39.11(c)(2)(iv) would further clarify that, with respect to a clearing member's cleared swaps customer account, a DCO may net gains for one customer against losses for another customer only to the extent permitted by the DCO's rules. 2. Assessments—§ 39.11(d)(2) Regulation 39.11(d)(2) sets out certain conditions that apply to a DCO's use of assessments for additional guaranty fund contributions in calculating the financial resources available to meet its obligations under § 39.11(a)(1). Regulation 39.11(d)(2)(iv) provides that the DCO shall only count the value of assessments, after a 30 percent haircut, “to meet up to 20 percent of those obligations.” The Commission has been advised that the phrase “those obligations,” which is a reference to the obligations discussed in the introductory language of § 39.11(d)(2), has created some uncertainty. Therefore, for clarity, the Commission is proposing to replace the phrase “those obligations” with “the total amount required under paragraph (a)(1) of this section.” 3. Liquidity of Financial Resources—§ 39.11(e) Regulation 39.11(e)(1)(ii) requires that the financial resources allocated by a DCO to meet the requirements of § 39.11(a)(1) ( i.e., its default resources) be sufficiently liquid to enable the DCO to fulfill its obligations as a central counterparty during a one-day settlement cycle. Regulation 39.11(e)(1)(ii) further requires that those resources include cash, U.S. Treasury obligations, or high quality, liquid, general obligations of a sovereign nation ( i.e., cash or cash equivalents), in an amount greater than or equal to the average of its clearing members' average pays over the last fiscal quarter. 28 If that amount is less than what a DCO needs to fulfill its obligations during a one-day settlement cycle, § 39.11(e)(1)(iii) permits a DCO to take into account a committed line of credit for the purpose of meeting the remainder of the requirement. 28 The Commission wishes to clarify that the cash, U.S. Treasury obligations, or high quality, liquid, general obligations of a sovereign nation required to be held under § 39.11(e)(1)(ii) do not have to be attributable to the DCO's own capital but can be attributable to any of the acceptable financial resources included in § 39.11(a)(1). The Commission's intention was to require that at least a portion of a DCO's default resources be sufficiently liquid to enable the DCO to complete a one-day settlement cycle and that these liquid resources include a certain amount of cash or cash equivalents. Then, if the cash or cash-equivalent amount was not sufficient to meet the total one-day settlement cycle liquidity requirement, a DCO could use a committed line of credit to make up the difference. 29 Regulation 39.11(b)(1), however, which sets forth the types of financial resources that can be considered as default resources, does not expressly permit the use of a committed line of credit; 30 it does permit the use of “[a]ny other financial resource deemed acceptable by the Commission.” The result is that § 39.11(b)(1) only permits a DCO to use a committed line of credit as part of its default resources if “deemed acceptable by the Commission,” while § 39.11(e)(1)(iii) seems to permit a DCO to use a committed line of credit as part of its default resources up to the amount needed to satisfy the “one-day settlement cycle” liquidity requirement after cash or cash equivalents have been applied. Accordingly, the Commission is proposing § 39.11(e)(3) to clarify that a committed line of credit or similar facility is a permitted default resource up to the amount provided for in § 39.11(e)(1)(ii), provided, however, that it is not counted twice to meet the requirements of § 39.11(e)(1)(ii) and § 39.11(e)(2). 31 The Commission is also proposing clarifying changes to the text of § 39.11(e)(1)(iii) and (e)(2). 29 See Financial Resources Requirements for Derivatives Clearing Organizations, 75 FR 63113, 63116 (Oct. 14, 2010) (proposed rule). 30 In the notice of proposed rulemaking for § 39.11, the Commission noted that a committed line of credit or similar facility is not listed as a financial resource available to a DCO to satisfy the requirements of § 39.11(a)(1) and (2). The Commission further noted that a DCO may use a committed line of credit or similar facility only to meet the liquidity requirements set forth in § 39.11(e)(1) and (2). Id. See also Derivatives Clearing Organization General Provisions and Core Principles, 76 FR at 69350 (affirming this approach). 31 The Commission is proposing to renumber current § 39.11(e)(3) as § 39.11(e)(4). In addition, the Commission is proposing to change references to “daily settlement pay” in § 39.11(e)(1)(ii) to “daily settlement variation pay” in order to clarify that additional calls for initial margin should not be included in the calculation. 4. Reporting Requirements—§ 39.11(f) Regulation 39.11(f) sets forth reporting requirements for DCOs concerning the financial resources they are required to maintain pursuant to § 39.11(a). After § 39.11(f) was adopted, the Commission adopted §§ 39.33(a) and 39.39(d), which set forth financial resources requirements for SIDCOs and subpart C DCOs, and financial resources requirements for the recovery and wind-down plans of SIDCOs and subpart C DCOs, respectively. The Commission is proposing to amend several provisions of § 39.11(f) by adding the words “and §§ 39.33(a) and 39.39(d), if applicable,” to clarify that financial resources reporting by SIDCOs and subpart C DCOs should encompass all financial resources requirements applicable to them under part 39. 5. Financial Statements—§ 39.11(f)(1)(ii) Regulation 39.11(f)(1)(ii) requires a DCO to file with the Commission each fiscal quarter, or at any time upon Commission request, a financial statement, including the balance sheet, income statement, and statement of cash flows, of the DCO or of its parent company. Since § 39.11(f)(1)(ii) was implemented, some DCOs have filed the financial statements of their parent companies. Because some of these DCOs are part of a complex corporate structure, Commission staff has had difficulty determining whether the entity covered by a particular financial statement is the true, direct parent of the relevant DCO, which, in turn, makes it difficult to accurately assess the financial strength of the DCO. Therefore, the Commission is proposing to revise § 39.11(f)(1)(ii) to require that the financial statement provided be that of the DCO and not the parent company. In further regard to § 39.11(f)(1)(ii), the Commission has received many inquiries concerning the accounting standards that apply to the preparation of the DCO's financial statements. Generally, Commission regulations require financial statements to be prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP). 32 Therefore, the Commission would expect DCOs to provide financial statements prepared in accordance with U.S. GAAP. However, the Commission recognizes that DCOs organized outside the United States may prepare their financial statements in accordance with International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB), or pursuant to other country-specific accounting standards. The Commission has permitted commodity pool operators to file commodity pool financial statements prepared in accordance with IFRS if the pool is organized under the laws of a foreign jurisdiction, and certain other conditions are met. 33 32 See, e.g., §§ 1.10(d)(3), 4.22(d), and 38.1101(b)(1). 33 See § 4.22(d)(2). The Commission notes that the Securities and Exchange Commission (SEC) has adopted financial reporting requirements for securities clearing agencies that require U.S. GAAP, but permit the use of IFRS by clearing agencies that are “incorporated or organized under the laws of any foreign country.” 34 The SEC stated in its adopting release that it also recognizes the “advantages of financial statement disclosure that are limited to more widely applied bases of accounting and may offer more utility to market participants, regulators, and other stakeholders of clearing agencies.” 35 Therefore, it limited the different bases of accounting upon which annual audited financial statements may be prepared to IFRS and U.S. GAAP. 36 34 17 CFR 240.17Ad-22(c)(2)(ii). 35 Clearing Agency Standards, 77 FR 66220, 66244 (Nov. 2, 2012) (final rule). 36 See id. The Commission therefore is proposing to revise § 39.11(f)(1)(ii) to clarify that the financial statement must be prepared in accordance with U.S. GAAP for DCOs incorporated or organized under U.S. law, and in accordance with either U.S. GAAP or IFRS issued by the IASB for DCOs incorporated or organized under the laws of any foreign country. In reviewing DCOs' financial statements, Commission staff has noted that assets allocated by the DCO to meet the requirements of § 39.11(a)(1) or (2) often are not identified accordingly. The Commission therefore is proposing in § 39.11(f)(1)(ii) and (f)(2)(i) (discussed below) to require that assets allocated by the DCO for such purpose must be clearly identified on the DCO's balance sheet as held for that purpose. In addition, the Commission is proposing to renumber current § 39.11(f)(2) as § 39.11(f)(1)(iv) and amend it to incorporate the language of current § 39.11(f)(4), which requires a DCO to submit its quarterly financial report no later than 17 business days after the end of the DCO's fiscal quarter or at a later time as permitted by the Commission in its discretion in response to a DCO's request for an extension. 6. Annual Reporting—§ 39.11(f)(2) The Commission is proposing to revise § 39.11(f)(2) to set forth a DCO's annual financial reporting requirements (currently set forth in § 39.19(c)(3)(ii), which would also be revised) in the same way § 39.11(f)(1) sets forth a DCO's quarterly financial reporting requirements (which are cross-referenced in § 39.19(c)(2)). In addition to its audited year-end financial statement, a DCO would be required to submit: (1) A reconciliation, including appropriate explanations, of its balance sheet when material differences exist between it and the balance sheet in the DCO's financial statement for the last quarter of the fiscal year or, if no material differences exist, a statement so indicating, and (2) such further information as may be necessary to make the statements not misleading. Commission staff has encountered situations in which significant discrepancies exist between a DCO's financial statements for the last quarter of its fiscal year and its audited year-end financial statement. There is often a simple explanation for this, e.g., the discrepancies reflect a material change in a given foreign exchange rate. The Commission believes a reconciliation will help explain these discrepancies and will aid its review of the DCO's financial statements. 7. Documentation Requirements—§ 39.11(f)(3) Current § 39.11(f)(3) requires a DCO to provide to the Commission certain documentation related to its quarterly financial reporting. 37 The Commission has determined that requiring this documentation each quarter is unnecessary where there is no change from the prior submission. Therefore, the Commission is proposing to revise § 39.11(f)(3) to clarify that a DCO must send the documentation to the Commission required under current paragraphs (f)(3)(i) and (ii) (proposed to be renumbered as paragraphs (f)(3)(i)(A) and (i)(B)) only upon the DCO's first submission under § 39.11(f)(1) and in the event of any change thereafter. 37 The documentation explains (1) the methodology used to compute financial resources requirements, and (2) the basis for the DCO's determinations regarding valuation and liquidity requirements. The Commission also is proposing to renumber § 39.11(f)(3)(iii), which concerns providing copies of agreements establishing or amending a credit facility, insurance coverage, or other arrangement, as § 39.11(f)(3)(ii), and add language specifying that copies of the agreements should evidence or support the DCO's ability to meet applicable financial resources and liquidity resources requirements. 8. Certification—§ 39.11(f)(4) After § 39.11 was adopted, the Division advised DCOs that the quarterly financial report required under paragraph (f) should be accompanied by a certification as to the accuracy of the report signed by the person responsible for the accuracy and completeness of the report. 38 Such certification is required for submission of annual chief compliance officer reports and Form 1-FR by FCMs, and is also appropriate in these circumstances. 39 The Commission is proposing to amend § 39.11(f)(4) to add this new requirement. 38 Memorandum to All Registered DCOs from Ananda Radhakrishnan, Director, Division of Clearing and Risk, June 7, 2012. 39 See 17 CFR 39.10(c)(4)(ii) (requiring certification of annual reports by chief compliance officers); 17 CFR 1.10(d)(4) (requiring certification of financial reports submitted by FCMs and introducing brokers); see also 17 CFR 4.22(h) (requiring commodity pool operators to certify periodic and annual financial reports); 17 CFR 4.27(e)(1) (requiring commodity pool operators and commodity trading advisors to certify periodic reports). C. Participant and Product Eligibility—§ 39.12 Regulation 39.12 implements Core Principle C, which requires a DCO to establish admission and continuing eligibility standards for its members, as well as standards for determining the eligibility of agreements, contracts, or transactions submitted to the DCO for clearing. Several provisions in § 39.12 require a DCO to “adopt” or “establish” rules. The Commission is proposing to amend those provisions to require a DCO to “have” rules. 40 40 The Commission is also proposing to renumber paragraphs (a)(5)(i)(A) and (B) and (a)(5)(ii) of § 39.12(a)(5) as paragraphs (a)(5)(ii), (iii), and (iv), respectively. Regulation 39.12(b)(2) provides that a DCO shall adopt rules providing that all swaps with the same terms and conditions are economically equivalent within the DCO. The Commission recognizes that some DCOs do not clear swaps and it was not the intention of the Commission to require DCOs that do not clear swaps to adopt the rules required under this provision. Therefore, the Commission is proposing to revise § 39.12(b)(2) so that it explicitly applies only to DCOs that clear swaps. D. Risk Management—§ 39.13 Regulation 39.13 implements Core Principle D, which establishes risk management standards for DCOs. The Commission is proposing to clarify several aspects of § 39.13. 1. Risk Management Framework—§ 39.13(b) Regulation 39.13(b) requires a DCO to establish and maintain written policies, procedures, and controls, approved by its board of directors, which establish an appropriate risk management framework. The introductory heading to this provision states that it is a “[d]ocumentation requirement.” The Commission is proposing to replace “[d]ocumentation requirement” with “[r]isk management framework” and is also proposing to replace the words “establish and maintain” with “have and implement” to make it clear that a DCO is not only required to have a documented risk management framework but to put it into action. 2. Limitation of Exposure to Potential Default Losses—§ 39.13(f) Regulation 39.13(f) requires a DCO to limit its exposure to potential losses from clearing member defaults to “ensure” that the DCO's operations would not be disrupted and non-defaulting clearing members would not be exposed to unanticipated or uncontrollable losses. The Commission recognizes that a DCO cannot ensure protection from that which it cannot anticipate. Therefore, the Commission is proposing to replace “ensure” with “minimize the risk” and make conforming changes to paragraphs (f)(1) and (2) of § 39.13. 3. Margin Requirements—§ 39.13(g) a. Methodology and Coverage—§ 39.13(g)(2) Regulation 39.13(g)(2)(i) requires that a DCO have initial margin requirements that are commensurate with the risks of each product and portfolio, including any unusual characteristics of, or risks associated with, particular products or portfolios. The regulation currently notes that such risks “include[ ] but [are] not limited to jump-to-default risk or similar jump risk.” The Commission is proposing to amend § 39.13(g)(2)(i) to note that such risks also include “concentration of positions.” Recent events, including a significant loss from a default at a central counterparty outside of the Commission's jurisdiction, highlight the importance of addressing those risks. b. Independent Validation—§ 39.13(g)(3) Regulation 39.13(g)(3) requires that a DCO's systems for generating initial margin requirements, including its theoretical models, be reviewed and validated by a qualified and independent party on a regular basis. The provision further provides that the validation may be conducted by independent contractors or employees of the DCO, as long as they are not responsible for the development or operation of the systems and models being tested. The Commission is proposing to amend this provision to specify that “on a regular basis” means annually and to also permit employees of an affiliate of the DCO to conduct the validations. Based on experience since the provision was adopted, the Commission believes an annual validation is sufficient. The Commission also believes it is appropriate to permit employees of an affiliate of the DCO to conduct the validations because, as with independent contractors or employees of the DCO, the main concern is that they not be persons responsible for development or operation of the systems and models being tested. c. Spreads and Portfolio Margins—§ 39.13(g)(4) The Commission is amending § 39.13(g)(4) to substitute the phrase “conceptual basis” for the phrase “theoretical basis” in the discussion of spread margin. This change would not alter the meaning of the rule but would simply make the terminology consistent with that used in the other Commission regulations. 41 41 See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 FR 636, 658 (Jan. 6, 2016). d. Back Tests—§ 39.13(g)(7) The Commission is proposing new § 39.13(g)(7)(iii) to clarify that, in conducting back tests of initial margin requirements, a DCO should compare portfolio losses only to those components of initial margin that capture changes in market risk factors. e. Gross Customer Margin—§ 39.13(g)(8)(i) Regulation 39.13(g)(8)(i) requires a DCO to collect initial margin on a gross basis for each clearing member's customer account(s). After the regulation was adopted, Division staff received several inquiries regarding whether the provision applied to intraday settlements as well as end-of-day settlements. In response, the Division advised DCOs that the provision requires a DCO to collect customer initial margin on a gross basis during any settlement cycle (end-of-day or intraday) in which the DCO collects customer initial margin. The Division also asked DCOs to notify the Division, in writing, of any issues that could prevent a DCO from fully complying with this requirement. 42 42 Memorandum to All Registered DCOs from Ananda Radhakrishnan, Director, Division of Clearing and Risk, July 19, 2012. Although § 39.13(g)(8)(i) does not differentiate between end-of-day and intraday collections of customer initial margin, there are significant operational issues that may affect the ability of clearing members to accurately determine the positions of individual customers on an intraday basis with respect to certain types of transactions ( e.g., transfers, give-ups, and allocations of block orders) and with respect to certain types of market participants ( e.g., locals and high frequency traders). Therefore, intraday gross margin calculations may result in some clearing members being charged too much margin and others being charged too little margin, which could necessitate significant end-of-day adjustments. Regulation 39.13(g)(8)(i) is premised upon the ability of a DCO to accurately determine the initial margin amounts that would be required for each individual customer if each individual customer were a clearing member. Accordingly, the Commission is proposing to amend § 39.13(g)(8)(i) to require a DCO to collect customer initial margin from its clearing members on a gross basis only during its end-of-day settlement cycle, in light of the operational issues that may arise intraday. However, the Commission strongly encourages DCOs to collect customer initial margin from their clearing members on a gross basis during any intraday settlement cycle in which the DCOs collect customer initial margin, if they are able to calculate the margin accurately. The Commission requests comment as to whether this is the correct approach or whether there are other alternatives that would address the collection of intraday gross margin. Currently, § 39.13(g)(8)(i)(B) provides that for purposes of calculating the gross initial margin requirement for clearing members' customer accounts, to the extent not inconsistent with other Commission regulations, a DCO may require its clearing members to report the gross positions of each individual customer to the DCO, or it may permit each clearing member to report the sum of the gross positions of its customers to the DCO. Regulation 39.13(g)(8)(i)(C) further provides that for purposes of paragraph (g)(8), a DCO may rely, and may permit its clearing members to rely, upon the sum of the gross positions reported to the clearing members by each domestic or foreign omnibus account that they carry, without obtaining information identifying the positions of each individual customer underlying such omnibus accounts. In addition, § 39.19(c)(5)(iii) currently requires a DCO to file with the Commission, for each customer origin of each clearing member, the end-of-day gross positions of each beneficial owner, upon Commission request. The Commission believes the ability to analyze positions at the customer level is a crucial element of an effective risk surveillance program. For example, a clearing member account that is composed of 1,000 customers each holding one contract poses substantially less financial risk to the clearing member and to the DCO than a clearing member account composed of one customer holding 1,000 contracts. The ability to identify those customers whose positions create the most risk to a DCO's clearing members would assist the Commission in determining whether adequate measures are in place to address those risks and whether the Commission needs to take proactive steps to see that those risks are mitigated. When the part 39 regulations were adopted, the Commission determined to allow a DCO to permit its clearing members to report the sum of the gross positions of their customers to the DCO without obtaining information identifying the positions of each individual customer underlying such clearing members' omnibus accounts. The Commission also determined not to require routine reporting of end-of-day gross positions of each beneficial owner to the Commission, in part because of concerns about the difficulty that DCOs would have in obtaining this information. 43 Subsequently, however, the Commission adopted § 22.11(c), which requires FCMs to report customer information about swaps to DCOs. 44 Thus, for swaps, DCOs now have data that they did not have fully available to them at the time part 39 was adopted. Moreover, the Commission has established a reporting protocol for this data, which can be used for submitting futures data as well. 43 Derivatives Clearing Organization General Provisions and Core Principles, 76 FR at 69375, 69400. 44 Protection of Cleared Swaps Customer Contracts and Collateral; Conforming Amendments to the Commodity Broker Bankruptcy Provisions, 77 FR 6336, 6376 (Feb. 7, 2012) (codified at 17 CFR 22). To avoid a potential regulatory gap, the Commission is proposing to require a DCO to have rules requiring its clearing members to report customer information about futures (as well as swaps) to DCOs. This will enable DCOs, in turn, to report this information to the Commission, as discussed further below with respect to the proposed amendment to § 39.19(c)(1)(i)(D). Specifically, the proposed amendments to § 39.13(g)(8)(i)(B) would require a DCO to have rules that require its clearing members to provide reports to the DCO each day setting forth end-of-day gross positions of each beneficial owner within each customer origin of the clearing member. 45 45 In this regard, the Commission is also proposing to amend § 39.13(g)(8)(i)(B) by changing “may” to “shall,” deleting “to the extent not inconsistent with other Commission regulations” and “or it may permit each clearing member to report the sum of the gross positions of its customers to the derivatives clearing organization,” deleting paragraph (C), and renumbering paragraphs (D) and (E). f. Customer Initial Margin Requirements—§ 39.13(g)(8)(ii) Regulation 39.13(g)(8)(ii) provides that a DCO must require its clearing members to collect customer initial margin from their customers, “for non-hedge positions, at a level that is greater than 100 percent of the [DCO]'s initial margin requirements with respect to each product and swap portfolio.” Historically, DCMs had set customer initial margin requirements for their FCM members, 46 and the Commission stated that this provision simply shifts the responsibility for establishing customer initial margin requirements from DCMs to DCOs. 47 The Commission also noted its belief that requiring an FCM to collect higher customer initial margin for “non-hedge positions” provides a valuable cushion of readily available customer margin collateral. 48 46 The Commission is proposing to amend § 39.13(g)(8)(ii) and (iii) to clarify that these provisions apply to FCM clearing members only. 47 Derivatives Clearing Organization General Provisions and Core Principles, 76 FR at 69377. 48 Id. at 69378. After § 39.13(g)(8)(ii) was adopted, the Division issued interpretative guidance addressing several aspects of the regulation in response to a request from Chicago Mercantile Exchange, Inc. (CME), a registered DCO. 49 The Commission is proposing to amend § 39.13(g)(8)(ii) in a manner consistent with the interpretative guidance provided in the Division's letter, as discussed further below. 49 CFTC Letter No. 12-08 (Sept. 14, 2012); see also Letter from Lisa Dunsky, Executive Director and Associate General Counsel, Chicago Mercantile Exchange Inc., to Ananda Radhakrishnan, Director, Division of Clearing and Risk (Aug. 29, 2012). In its request, CME asked for clarification as to the meaning of the term “non-hedge positions.” CME explained that DCM requirements for collection of higher customer initial margin had been applied historically on an account, rather than a position, basis. Under existing rules or practices at various DCMs, exchange members, market makers, market professionals, and certain other categories of customers had been subject to the clearing initial margin requirement; i.e., such exchange member accounts were designated as “hedge” or “member,” and by virtue of this designation, received the lower clearing initial margin rate, even though there may have been speculative positions in the accounts. CME also inquired as to the applicability of § 39.13(g)(8)(ii) to non-clearing FCM customer omnibus accounts at clearing FCMs. CME stated that a non-clearing FCM's customer omnibus account may be comprised of both hedge accounts and speculative accounts, and the clearing FCM typically did not know the identity of the underlying customers in a non-clearing FCM's omnibus account. The non-clearing FCM sets customer initial margin requirements based on whether a customer account is designated as “hedge” or “speculative.” Thus, a speculative account included within an omnibus account already would have been assessed the higher customer initial margin requirement by such customer's non-clearing FCM. If the clearing FCM were required to apply the higher customer initial margin rate to the entire customer omnibus account, this would require the non-clearing FCM to either (1) post more collateral with the clearing FCM than the amount actually collected from its hedge customers in the omnibus account, or (2) collect the higher customer initial margin requirement from its hedge customers so that it could post this collateral with the clearing FCM. In its response to CME's request, the Division stated that it interprets § 39.13(g)(8)(ii) “in a manner that preserves the historical customer margining practices applicable to FCMs . . . [noting that] FCMs are expected to continue the practice of collecting customer initial margin at a level higher than the minimum required, if such action is warranted based on the unique risk profile of an individual customer.” The Commission agrees with such interpretation and accordingly, is proposing to revise § 39.13(g)(8)(ii) to permit DCOs to continue the practice of establishing customer initial margin requirements based on the type of customer account and by applying prudential standards that result in FCMs collecting customer initial margin at levels commensurate with the risk presented by each customer account. The Commission therefore proposes to amend § 39.13(g)(8)(ii) by deleting the reference to “non-hedge” positions, changing the reference to “a level that is greater than 100 percent” to “a level that is not less than 100 percent,” clarifying that the customer initial margin level is measured against “clearing” initial margin requirements, and explicitly stating that customer initial margin levels must be “commensurate with the risk presented by each customer account.” The Commission believes that establishing a bright-line test to determine the appropriate percentage by which customer initial margin requirements must exceed clearing initial margin requirements with respect to any particular types of customer accounts is inappropriate because the circumstances for each DCO and the nature of its clearing members and their customers vary. In adopting § 39.13(g)(8)(ii), the Commission noted that the percentage “should be based on the nature and volatility patterns of the particular product or swap portfolio, and the DCO's related evaluation of the potential risks posed by customers in general to their clearing members and, in turn, the potential risks posed by such clearing members in general to the DCO, rather than the creditworthiness of particular customers.” 50 The Commission requests comment as to whether it should add standards or further direction in § 39.13(g)(8)(ii), or provide guidance to further clarify what would be considered “commensurate with the risk presented,” similar to the Commission's statement in the adopting release noted above. 50 Derivatives Clearing Organization General Provisions and Core Principles, 76 FR at 69378. The Commission is proposing to amend the language in § 39.13(g)(8)(ii) that gives the DCO reasonable discretion in determining the percentage by which customer initial margin requirements must exceed the DCO's clearing initial margin requirements with respect to particular products or portfolios, by replacing “the percentage by which” with “whether and by how much.” However, the proposed amendments to § 39.13(g)(8)(ii) would give the Commission the ability to require different customer initial margin levels if the Commission deems the levels insufficient to protect the financial integrity of the DCO or its clearing members. Since the adoption of § 39.13(g)(8)(ii), DCOs have typically added a 10 percent increase to the clearing initial margin requirement to set the higher customer initial margin requirement. The Commission has generally found this to be adequate in ordinary market conditions. g. Haircuts—§ 39.13(g)(12) Regulation 39.13(g)(12) requires a DCO to apply appropriate reductions in value to reflect credit, market, and liquidity risks (haircuts), to the assets that it accepts in satisfaction of initial margin obligations. This provision also requires a DCO to evaluate the appropriateness of the haircuts “on at least a quarterly basis.” Regulation 39.11(d)(1) requires that haircuts be evaluated on a monthly basis for assets that are used to meet the DCO's financial resources obligations set forth in § 39.11(a). The Commission is proposing to amend § 39.13(g)(12) to align it with § 39.11(d)(1) by requiring that DCOs evaluate the appropriateness of the haircuts that they apply to assets accepted in satisfaction of initial margin obligations on a monthly basis. Given that initial margin is held for risk management purposes, and the value of these assets change frequently, the Commission believes it would be more appropriate to assess haircuts more frequently. 4. Other Risk Control Mechanisms—§ 39.13(h) a. Risk Limits—§ 39.13(h)(1) Regulation 39.13(h)(1)(i) requires a DCO to impose risk limits on each clearing member, by house origin and by each customer origin, in order to prevent a clearing member from carrying positions for which the risk exposure exceeds a specified threshold relative to the clearing member's and/or the DCO's financial resources. The Commission is proposing to clarify that such risk limits should also be imposed to address positions that may be difficult to liquidate. This might be the case, for example, in instances where a position in a particular contract or swap is concentrated with a particular member, such that there is reason to doubt whether, in the event that this member defaults, other members would be willing and able to accept, collectively, the entirety of that position or swap. As noted above, in section IV.D.3.a, recent events highlight the importance of imposing risk limits to address positions that may be difficult to liquidate, particularly concentrated positions. b. Clearing Members' Risk Management Policies and Procedures—§ 39.13(h)(5) Regulation 39.13(h)(5)(ii) requires a DCO to, on a periodic basis, review the risk management policies, procedures, and practices of each of its clearing members, which address the risks that such clearing members may pose to the DCO, and to document such reviews. The Commission is proposing to clarify that DCOs should, having conducted such reviews, “take appropriate actions to address concerns identified in such reviews,” and that the documentation of the reviews should include “the basis for determining what action was appropriate to take.” The Commission notes that, where a DCO is required to conduct any type of review under Commission regulations, similar remediation and documentation is expected. Absent such follow-up, the reviews would lack purpose. 5. Cross-Margining Arrangements—§ 39.13(i) A cross-margining arrangement allows a DCO to provide offsets or reductions in required margin between products that it and another DCO (or other clearing organization) clear if the risk of one product is significantly and reliably correlated with the risk of the other product. The Commission approved the first cross-margining arrangement in 1988, and it has approved many such arrangements since. 51 Proposed § 39.13(i) would codify the Commission's existing practices for evaluating cross-margining arrangements. 52 51 The Commission has issued a number of cross-margining program orders, including, but not limited to: A June 1, 1988 order approving a proprietary cross-margining system between the Intermarket Clearing Corporation (ICC) and Options Clearing Corporation (OCC), as expanded by a November 26, 1991 order approving the addition of cross-margining of positions of market professionals in non-proprietary accounts of participating clearing members to the ICC/OCC cross-margining program, 56 FR 61406 (Comm. F. T. Comm'n Dec. 3, 1991), and as further amended by a January 22, 1996 order to incorporate the provisions of appendix B, Framework 1 to the Commission's part 190 Regulations; a September 26, 1989 order approving a proprietary cross-margining system between OCC and CME, as expanded by a November 26, 1991 order approving the addition of cross-margining of positions of market professionals in non-proprietary accounts of participating clearing members to the OCC/CME cross-margining program, 56 FR 61404 (Comm. F. T. Comm'n Dec. 3, 1991); a June 2, 1993 order approving the proposals of CME and ICC to implement a tri-lateral cross-margining program with OCC, as further amended by a January 22, 1996 amended order to reflect the approval of proposed changes to the CME/ICC/OCC cross-margining amendments for proprietary and market professional accounts to incorporate the provisions of appendix B, Framework 1 to the Commission's part 190 Regulations; a November 5, 2004 order approving the establishment of an internal cross-margining program that permits cross-margining of positions of market professionals in internal non-proprietary accounts of OCC clearing members; and a February 29, 2008 order approving the establishment of a non-proprietary cross-margining agreement between the OCC and ICE Clear US, Inc. The Commission has also allowed cross-margining programs into effect without Commission approval including, but not limited to, a proprietary cross-margining program between CME and the London Clearing House (allowed into effect without approval on March 23, 2000). 52 In February 2015, CPMI-IOSCO issued a Level 2 assessment report on implementation of the PFMIs by CCPs and trade repositories in the U.S. (Implementation Report). See CPMI-IOSCO, Implementation monitoring of PFMIs: Level 2 assessment report for central counterparties and trade repositories—United States (Feb. 2015), available at http://www.bis.org/cpmi/publ/d126.pdf. The Implementation Report noted that Commission regulations do not explicitly address cross-margining, and in particular, the risk management requirements necessary where two or more CCPs participate in cross-margining arrangements. The Commission notes that existing DCO Core Principles and regulations regarding risk management, treatment of customer funds, default and settlement procedures, taken as a whole, address cross-margining arrangements. In evaluating cross-margining arrangements, the Commission reviews: (1) The methodology to be used to calculate margin requirements for the positions subject to the cross-margining arrangement; (2) the correlation between the positions, including the stability of the relationship among the eligible products and the potential impact a change in the correlation could have on setting margin requirements; (3) the impact on the settlement process; and (4) the application of default procedures, including any loss-sharing arrangements, pursuant to the proposed arrangement. If only one of the clearing organizations participating in the arrangement is a registered DCO, the Commission looks at additional factors, including the other clearing organization's status with and oversight by other regulator(s). Also, if one of the clearing organizations is organized outside of the United States, the Commission evaluates the bankruptcy treatment in that clearing organization's jurisdiction. Finally, the Commission considers the impact of the cross-margining arrangement, if any, on the DCO's ability to comply with the DCO Core Principles, particularly those concerning financial resources and risk management. The Commission requests comment as to whether there are other factors the Commission should consider and, therefore, other information that it should request. The Commission is proposing to require a DCO to provide the relevant information needed to facilitate its review as part of a rule filing submitted for Commission approval pursuant to § 40.5. The Commission requests comment as to whether this would be the appropriate process or whether a more or less detailed review process is appropriate given the factors and risks involved. E. Treatment of Funds—§ 39.15 Regulation 39.15 implements Core Principle F, which requires a DCO to establish standards and procedures designed to protect its clearing members' funds, hold such funds in a manner that would minimize the risk of loss or delay in the DCO's access, and invest such funds in instruments with minimal credit, market, and liquidity risks. The Commission is proposing to amend certain aspects of § 39.15. 1. Segregation of Customer Funds—§ 39.15(b)(1) Regulation 39.15(b)(1) requires a DCO to comply with the applicable segregation requirements of section 4d of the CEA and Commission regulations thereunder, or any other applicable Commission regulation or order requiring that customer “funds and assets” be segregated, set aside, or held in a separate account. Section 4d of the CEA refers to customer “money, securities and property.” Therefore, the Commission is proposing to amend § 39.15(b) to clarify that “funds and assets” are equivalent to “money, securities, and property” in order to better align the language of the regulation with the language in the statute. 2. Commingling in Cleared Swaps Customer Account—§ 39.15(b)(2)(i) Regulation 39.15(b)(2)(i) requires a DCO to file rules for Commission approval pursuant to § 40.5 in order for the DCO and its clearing members to commingle customer positions in futures, options, and swaps, and any money, securities, or property received to margin, guarantee or secure such positions, in an account subject to the requirements of section 4d(f) of the CEA ( i.e., the cleared swaps customer account). The Commission is proposing to revise § 39.15(b)(2)(i) to clarify that a DCO that wants to commingle foreign futures and foreign options with swaps must meet the same requirements. 3. Commingling in Futures Customer Account—§ 39.15(b)(2)(ii) Regulation 39.15(b)(2)(ii) requires a DCO to file a petition for an order pursuant to section 4d(a) of the CEA in order for the DCO and its clearing members to commingle customer positions in futures, options, and swaps, and any money, securities, or property received to margin, guarantee or secure such positions, in an account subject to the requirements of section 4d(a) of the CEA. The Commission is proposing to revise § 39.15(b)(2)(ii) to clarify that a DCO that wants to commingle foreign futures and foreign options with futures and options must meet the same requirements as a DCO that wants to commingle swaps with futures and options. Further, when § 39.15(b)(2)(ii) was first promulgated, the Commission, in reference to its decision to require an order rather than a rule approval to commingle cleared swaps with futures in a futures account, stated “at this time, it is appropriate to provide these additional procedural protections before exposing futures customers to the risks of swaps that may be commingled in a futures account.” 53 The Commission, however, acknowledged that “as the Commission and the industry gain more experience with cleared swaps, the Commission may revisit this issue in the future.” 54 The Commission now believes that a request for a rule approval that complies with § 40.5 will provide the Commission with sufficient means to determine whether customer funds held in a futures account will be adequately protected if cleared swaps, foreign futures, or foreign options are also held in the account. 53 Derivatives Clearing Organization General Provisions and Core Principles, 76 FR at 69392. 54 Id. Therefore, the Commission is proposing to revise § 39.15(b)(2)(ii) to require a DCO to file rules for Commission approval pursuant to § 40.5 in order for the DCO and its clearing members to commingle swaps, foreign futures, or foreign options with futures and options in an account subject to the requirements of section 4d(a) of the CEA. 4. Commission Action—§ 39.15(b)(2)(iii) Regulation 39.15(b)(2)(iii) provides that the Commission may “grant approval of” a rule submission filed under § 39.15(b)(2)(i) in accordance with § 40.5. The Commission is proposing to replace the words “grant approval of” with “approve” in order to be consistent with the language used in § 40.5(b). Further, the Commission is proposing to amend § 39.15(b)(2)(iii) to reflect the proposed changes to § 39.15(b)(2)(ii). Specifically, the Commission is proposing to eliminate § 39.15(b)(2)(iii)(A) and (B) and include the content of both paragraphs within § 39.15(b)(2)(iii). 5. Transfer of Customer Positions—§ 39.15(d) Regulation 39.15(d) requires a DCO to have rules providing for the prompt transfer of all or a portion of a customer's portfolio of positions and related funds at the same time from the carrying clearing member to another clearing member, without requiring the close-out and re-booking of the positions prior to the requested transfer. Some DCOs have noted that, although a DCO may transfer positions from one clearing member to another, the DCO does not generally transfer funds. The DCO simply adjusts the amount of margin due from, or owed to, each clearing member during the next collection cycle. Moreover, the receiving clearing member may not owe additional funds if it has sufficient excess margin funds on deposit at the DCO. The DCO may only transfer funds if it has already collected variation margin from the transferring clearing member and positions were transferred at the trade price. In addition, any excess margin held by the transferring clearing member would be transferred to the receiving clearing member. Accordingly, the Commission is proposing to amend § 39.15(d) to delete the words “at the same time,” thus requiring the “prompt,” but not necessarily simultaneous, transfer of a customer's positions and related funds. The Commission is further amending the provision to require the transfer of related funds “as necessary,” recognizing that the transfer of customer positions will not always require the transfer of funds. 6. Permitted Investments—§ 39.15(e) Regulation 39.15(e) requires any investment of customer funds or assets by a DCO to comply with § 1.25, as if all such funds and assets comprise customer funds subject to segregation pursuant to section 4d(a) of the CEA and Commission regulations thereunder. At the time § 39.15(e) was adopted, the Commission had not yet adopted regulations concerning cleared swaps customer funds but intended for § 39.15(e) to also apply to those funds. The Commission has since adopted the part 22 regulations and therefore is proposing to amend § 39.15(e) to clarify that the requirement applies to any investment of customer funds or assets, including cleared swaps customer collateral as defined in § 22.1. F. Default Rules and Procedures—§ 39.16 Regulation 39.16 codifies Core Principle G, which requires a DCO to have rules and procedures designed to allow for the efficient, fair, and safe management of events during which a clearing member becomes insolvent or otherwise defaults on its obligations to the DCO. Core Principle G also requires a DCO to clearly state its default procedures, make its default rules publicly available, and ensure that it may take timely action to contain losses and liquidity pressures while continuing to meet its obligations. The Commission is proposing to amend certain aspects of § 39.16. 55 55 The proposed amendments to § 39.16 include replacing “adopt” with “have” where a DCO is required to adopt rules, consistent with the proposed changes to § 39.12 previously discussed. 1. Default Management Plan—§ 39.16(b) Regulation 39.16(b) requires a DCO to have a default management plan and, among other things, test the plan at least on an annual basis. A DCO's default management plan involves its clearing members, so the Commission believes the plan cannot be tested effectively without the clearing members' participation. Accordingly, the Commission is proposing to amend § 39.16(b) to add a requirement that the DCO include clearing members in a test of its default management plan on at least an annual basis. A DCO should ensure that a sufficient portion of its clearing membership participates in such testing and is therefore prepared to support the DCO's default management efforts. 2. Default Procedures—§ 39.16(c) Regulation 39.16(c) requires a DCO to adopt procedures that would permit the DCO to take timely action to contain losses and liquidity pressures and to continue meeting its obligations in the event of a default by one if its clearing members. The Commission is proposing to amend § 39.16(c)(1) to require a DCO to have a default committee that would be convened in the event of a default involving substantial or complex positions to help identify market issues with any action the DCO is considering. The default committee would be required to include clearing members and could include other participants to help the DCO efficiently manage the house or customer positions of the defaulting clearing member. The Commission also is proposing to amend § 39.16(c)(2)(ii) to require that a DCO have default procedures that include immediate public notice on the DCO's website of a declaration of default. The Commission believes it is important to the integrity and stability of the financial markets that clearing members, other CCPs, and the public become aware as soon as possible when a default has occurred. The Commission requests comment, however, as to whether the timing of the announcement would potentially impact the market or the DCO's ability to manage the default. Finally, § 39.16(c)(2)(iii)(C) requires any allocation of a defaulting clearing member's positions to be proportional to the size of the participating or accepting clearing member's positions in the same product class at the DCO. The Commission is proposing to amend this provision to clarify that the DCO shall not require a clearing member to bid for a portion of, or accept an allocation of, the defaulting clearing member's positions that is not proportional to the size of the bidding or accepting clearing member's positions in the same product class at the DCO. This is intended to clarify that a clearing member that wishes to voluntarily bid for or accept more than its proportional share should be allowed to do so, provided that the clearing member has the ability to manage the risk of the new positions. The Commission is proposing to further amend § 39.16(c)(2)(iii)(C) in order to clarify that the provision applies to both auctions and allocations and to provide that the size of the participating or accepting clearing member's positions in the same product class at the DCO should be measured by the clearing initial margin requirement for those positions. The Commission requests comment as to whether the Commission should require DCOs to take into consideration other indicators of active participation in a market, such as open interest, volume, and/or other criteria. G. Rule Enforcement—§ 39.17 Regulation 39.17(a) codifies Core Principle H, which requires a DCO to maintain adequate arrangements and resources for the effective monitoring and enforcement of compliance with its rules and dispute resolution. Core Principle H also requires a DCO to have the authority and ability to discipline, limit, suspend, or terminate the activities of a member or participant if it violates the DCO's rules. Finally, Core Principle H requires a DCO to report its rule enforcement activities and sanctions imposed on members and participants to the Commission. The Commission is proposing to amend § 39.17(a)(1) to clarify the Commission's expectation that DCOs currently do, and will continue to, ensure that both the DCO and its members comply with the DCO's rules. Regulation 39.17(b) permits a DCO's board of directors to delegate its responsibility for compliance with the requirements of § 39.17(a) to the DCO's risk management committee. The Commission recognizes that some DCOs delegate such responsibility to a committee other than the risk management committee. Therefore, the Commission is proposing to amend § 39.17(b) to replace “risk management committee” with “an appropriate committee.” H. Reporting—§ 39.19 Regulation 39.19 implements Core Principle J, which requires that each DCO provide to the Commission all information that the Commission determines to be necessary to conduct oversight of the DCO. In addition to clarifying existing requirements, the Commission is proposing to adopt additional reporting requirements that would allow the Commission to conduct more effective oversight of DCO compliance with the DCO Core Principles and Commission regulations. 1. General—§ 39.19(a) The Commission is proposing to revise the text of § 39.19(a) to match the text of Core Principle J. The proposed revisions are not meant to alter the meaning of the provision. 2. Submission of Reports—§ 39.19(b) Regulation 39.19(b)(1) requires a DCO to submit the information required by the section to be submitted to the Commission electronically and in a format and manner specified by the Commission, unless otherwise specified by the Commission or its designee. The Commission is proposing to delete “[u]nless otherwise specified by the Commission or its designee” and “electronically,” requiring a DCO to submit the information in a format and manner specified by the Commission. This would simplify the text while retaining the flexibility the Commission originally intended. The Commission is proposing new § 39.19(b)(2) to require that when making a submission pursuant to the section, an employee of a DCO must certify that he or she is duly authorized to make such a submission on behalf of the DCO. This provision would codify existing practices with respect to the use of the CFTC Portal for submissions pursuant to § 39.19. Finally, the Commission is proposing to remove existing § 39.19(b)(3) and move the definition of “business day” to § 39.2, as previously discussed. Existing § 39.19(b)(2) would be renumbered as § 39.19(b)(3). 3. Daily Reporting of Information—§ 39.19(c)(1)(i) Regulation 39.19(c)(1)(i) requires a DCO to report to the Commission on a daily basis margin, cash flow, and position information for each clearing member, by house origin and by each customer origin. The Commission is proposing to amend § 39.19(c)(1)(i) to require a DCO to additionally report margin, cash flow, and position information by individual customer account, which is information the DCOs currently provide. The Commission is specifying “individual customer account,” as individual customers may have multiple accounts, which should be reported separately. The Commission is also proposing to have DCOs provide any legal entity identifiers and internally-generated identifiers within each customer origin for each clearing member. The Commission is also proposing to amend § 39.19(c)(1)(i)(D) to specify that, with respect to end-of-day positions, DCOs must report the positions themselves ( i.e., the long and short positions) as well as risk sensitivities and valuation data for these positions. Risk-sensitivities are different measures of the impact of changes in underlying factors on the value of the positions. For example, an interest rate delta describes the theoretical profit or loss (“P&L”) that results from a one basis point increase in a currency's interest rate curve. A delta ladder describes a series of sensitivities for different maturity points (tenors) where each “rung” represents an increasing maturity point or tenor along the zero rate curve term structure. Each value on the rung represents the P&L that the portfolio would experience if the interest rate for that tenor were to increase by one basis point, all else being equal. Thus, if the entire curve were to shift up by one basis point, the portfolio's theoretical P&L would be equal to the sum of all the individual sensitivities. In the context of options, examples of risk sensitivities would be the different Greeks—delta measures an option's price sensitivity relative to changes in the price of the underlying asset, gamma measures the sensitivity of delta in response to price changes in the underlying instrument, vega measures an option's sensitivity to changes in the volatility of the underlying, theta measures the time decay of an option. Valuation data refer to variables and inputs that reflect current market conditions, as well as expectations for the future. In the case of credit default swaps, valuation models rely on for example, risk neutral default probabilities of swaps, forward credit spreads for different maturities. For interest rate swaps, valuation models require discount factors. The Commission intends to implement a range of different methodologies to conduct risk surveillance of cleared derivatives exposures, some involving full revaluation of portfolios and others relying on delta ladders and other risk sensitivities. Collectively, the enhanced information sets will enable Commission staff to run stress tests; identify concentration and risk in currencies and in maturity buckets; perform back testing; validate guaranty funds; and validate variation margin. 4. Daily Reporting on Securities Positions—§ 39.19(c)(1)(ii)(C) Regulation 39.19(c)(1)(i) requires DCOs to submit certain information to the Commission on a daily basis, e.g., initial margin requirements, initial margin on deposit, daily variation margin, other daily cash flows such as option premiums, and end-of day positions. Paragraph (c)(1)(ii)(C) further instructs DCOs to provide the required information for all securities positions that are held in a customer account subject to section 4d of the CEA or are subject to a cross-margining agreement. Paragraph (c)(1)(ii)(C) was added to clarify the applicability of daily reporting requirements to securities positions carried by FCMs that are also registered broker-dealers. Since the adoption of § 39.19(c)(1), the Commission has become aware of a potential ambiguity in the wording of paragraph (c)(1)(ii)(C), which requires the reporting of all securities positions “that are held in a customer account subject to section 4d of the Act or are subject to a cross-margining agreement.” The ambiguity concerns whether the reporting requirement for securities positions subject to a cross-margining agreement applies to customer positions only or to any position subject to a cross-margining agreement, whether house or customer. Reporting of securities positions is designed to capture positions that could have an impact on the risks a DCO must manage. Because risks associated with securities positions subject to a cross-margining agreement would be relevant to the DCO's risk management function and therefore the Commission's risk surveillance program, all such securities positions, whether house or customer, were intended to be included in daily reporting. In order to avoid ambiguity and more precisely articulate the scope of paragraph (c)(1)(ii)(C), the Commission is proposing to insert subordinate paragraph numbering between the clauses in paragraph (c)(1)(ii)(C) which relate to securities positions held in a customer account or subject to a cross-margining agreement. 5. Quarterly Reporting—§ 39.19(c)(2) Regulation 39.19(c)(2) requires a DCO to provide the financial resources report required by § 39.11(f). The Commission adopted § 39.19(c)(2) so that each DCO reporting requirement would be included in § 39.19. The Commission is proposing to revise the text of § 39.19(c)(2) to be more consistent with the text of § 39.11(f); i.e., a DCO would be required to provide to the Commission each fiscal quarter, or at any time upon Commission request, a report of the DCO's financial resources as required by § 39.11(f)(1). 6. Audited Year-End Financial Statements—§ 39.19(c)(3)(ii) Regulation 39.19(c)(3)(ii) requires a DCO to file with the Commission its audited year-end financial statements or, if there are no financial statements available for the DCO, the consolidated audited year-end financial statements of the DCO's parent company. As with the quarterly filing requirements of § 39.11(f)(1)(ii), the purpose of requiring a DCO to submit year-end financial statements is to enable the Commission to assess the financial strength of the DCO. However, if a DCO is part of a large and complex corporate structure and files its parent company's financial statements, it can be difficult for the Commission to assess the financial strength of the DCO itself. Therefore, the Commission is proposing to amend § 39.19(c)(3)(ii) to require the audited year-end financial statements of the DCO. 7. Time of Report—§ 39.19(c)(3)(iv) Regulation 39.19(c)(3)(iv) requires a DCO to submit concurrently to the Commission all reports required by paragraph (c)(3) not more than 90 days after the end of the DCO's fiscal year. The Commission may provide an extension of time only if it determines that a DCO's failure to submit the report in a timely manner “could not be avoided without unreasonable effort or expense.” 56 The Commission is proposing to eliminate this requirement to provide it with the flexibility to grant extensions under additional circumstances when appropriate. 56 The Commission delegated this authority to the Director of the Division of Clearing and Risk under § 140.94(c)(9). Additionally, the Commission is proposing to remove the requirement that reports be submitted concurrently in order to provide DCOs with the flexibility to submit reports required under § 39.19(c)(3) as they are completed. The Commission recognizes that one report may be completed sooner than the other and believes it would benefit the Commission's oversight of the DCO if the Commission could begin reviewing the report as soon as it is ready. 8. Decrease in Financial Resources—§ 39.19(c)(4)(i) The Commission is proposing a technical amendment to § 39.19(c)(4)(i), which concerns reporting of a decrease in a DCO's financial resources. The amendment would add a reference to the financial resources requirements of § 39.33, which applies to SIDCOs and subpart C DCOs. The Commission also is proposing to renumber the subordinate paragraphs for the sake of clarity. 9. Decrease in Liquidity Resources—§ 39.19(c)(4)(ii) The Commission is proposing to adopt new § 39.19(c)(4)(ii), 57 which would require the same reporting for a decrease in liquidity resources as that required by § 39.19(c)(4)(i) for a decrease in overall financial resources. The reporting required in § 39.11(f)(1)(ii) provides the Commission with notice of any change in a DCO's liquidity resources over the course of a fiscal quarter. This new provision would provide the Commission with notice if a DCO has a significant decrease in liquidity resources over a short period of time, which could indicate there is a greater issue of which the Commission should be aware. 57 The Commission is proposing to renumber existing § 39.19(c)(4)(ii) and all subsequent paragraphs of § 39.19(c)(4). 10. Request to Clearing Member To Reduce Positions—§ 39.19(c)(4)(vi) The Commission is proposing to amend current § 39.19(c)(4)(v), proposed to be renumbered as § [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%3A2019-09025. Public record. Not legal advice.