# Derivatives Clearing Organization General Provisions and Core Principles

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/fr%3A2020-01065

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** January 27, 2020
- **Citation:** 85 FR 4800

## 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:

Final rule.

SUMMARY:

The Commodity Futures Trading Commission (Commission) is amending certain regulations applicable to registered derivatives clearing organizations (DCOs). The amendments 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, among other things. In addition, the Commission is adopting technical amendments to certain provisions, including certain delegation provisions, in other parts of its regulations.

DATES:

Effective date:
The effective date for this final rule is February 26, 2020.

Compliance date:
DCOs must comply with the amendments to the rules by January 27, 2021.

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;
Brian Baum, Special Counsel, 202-418-5654,
bbaum@cftc.gov;
August A. Imholtz III, Special Counsel, 202-418-5140,
aimholtz@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; Joe Opron, Special Counsel, 312-596-0653,
jopron@cftc.gov;
Division of Clearing and Risk, Commodity Futures Trading Commission, 525 West Monroe Street, Suite 1100, Chicago, IL 60661.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

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. Fully Collateralized Positions

B. Compliance With Core Principles—§ 39.10

C. Financial Resources—§ 39.11

D. Participant and Product Eligibility—§ 39.12

E. Risk Management—§ 39.13

F. Treatment of Funds—§ 39.15

G. Default Rules and Procedures—§ 39.16

H. Rule Enforcement—§ 39.17

I. Reporting—§ 39.19

J. Public Information—§ 39.21

K. Governance Fitness Standards, Conflicts of Interest, and Composition of Governing Boards—§§ 39.24, 39.25, and 39.26

L. Legal Risk—§ 39.27

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

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. Additional Comments

X. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

C. Cost-Benefit Considerations

D. Antitrust Considerations

I. Background

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),
1

and part 39 of the Commission's regulations implement the DCO Core Principles. Subpart C of part 39 establishes 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).
2

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).
3

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).
4

1
7 U.S.C. 7a-1.

2

See
Dodd-Frank Act, Public Law 111-203, 124 Stat. 1376 (2010).

3

See
CPMI-IOSCO, Principles for Financial Market Infrastructures (Apr. 2012), available at
http://www.iosco.org/library/pubdocs/pdf/IOSCOPD377.pdf.

4
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 May 2019, the Commission proposed certain changes to its part 39 regulations (Proposal)
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in order to enhance certain risk management and reporting obligations, clarify the meaning of certain provisions, simplify processes for registration and reporting, and codify staff relief and guidance granted since the regulations were first adopted. The Commission also proposed a few new requirements with respect to default procedures and event-specific reporting.

5

See
Derivatives Clearing Organization General Provisions and Core Principles, 84 FR 22226 (May 16, 2019).

The Commission invited commenters to provide data and analysis regarding any aspect of the proposed rulemaking and received a total of 14 substantive comment letters in response.
6

After

considering the comments, the Commission is largely adopting the rules as proposed, although there are a number of proposed changes that the Commission has determined to either revise or decline to adopt. The Commission believes that the rules it is adopting herein will provide greater clarity and transparency for DCOs and DCO applicants and lead to more effective DCO compliance and risk management generally.

6
The Commission received comment letters submitted by the following: Chris Barnard; Cboe Futures Exchange, LLC (CBOE); CME Group, Inc.

(CME); Eurex Clearing AG (Eurex); Futures Industry Association (FIA) and International Swaps and Derivatives Association (ISDA); Intercontinental Exchange, Inc. (ICE); LCH Group (LCH); Managed Funds Association (MFA); Minneapolis Grain Exchange, Inc. (MGEX); Nodal Clear, LLC (Nodal); North American Derivatives Exchange, Inc. (Nadex); The Options Clearing Corporation (OCC); Paolo Saguato, of the George Mason University Antonin Scalia Law School; and Securities Industry and Financial Markets Association's Asset Management Group (SIFMA AMG). All comments referred to herein are available on the Commission's website, at
https://comments.cftc.gov/PublicComments/CommentList.aspx?id=2985.

In the discussion below, the Commission highlights topics of particular interest to commenters and discusses comment letters that are representative of the views expressed on those topics. The discussion does not explicitly respond to every comment submitted; rather, it addresses the most significant issues raised by the proposed rulemaking and analyzes those issues in the context of specific comments.

II. Amendments to Part 1—General Regulations Under the Commodity Exchange Act

The Commission is adopting as proposed two amendments in part 1 of its regulations in order to remove inapplicable provisions and to clarify when certain requirements do not apply.

A. Written Acknowledgment From Depositories—§ 1.20

Regulation 1.20(d)(1) requires a futures commission merchant (FCM) to obtain from each depository with which the FCM deposits futures customer funds, a written acknowledgment that meets 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 proposed 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 Commission also proposed 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.

ICE, FIA, and ISDA supported the proposed changes, with FIA and ISDA noting that clarifying the applicability of § 1.20(d)(3) through (6) avoids redundant information-sharing arrangements.

B. Governance and Conflicts of Interest—§§ 1.59, 1.63, and 1.69

In 2011, the Commission removed and replaced § 39.2, which previously had exempted DCOs from all Commission regulations except for those specified therein (§ 39.2 exemption).
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The Commission noted that removal of the § 39.2 exemption would subject DCOs to three existing 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)) that were expected to be superseded by other regulations the Commission had proposed.
8

7

See
Risk Management Requirements for Derivatives Clearing Organizations, 76 FR 3698, 3714 (Jan. 20, 2011) (proposed rule). The current § 39.2 sets forth definitions of terms used in part 39.

8

Id.

However, the Commission did not adopt those superseding regulations, and §§ 1.59, 1.63, and 1.69 became applicable to DCOs with the removal of the § 39.2 exemption. Therefore, the Commission proposed 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 also proposed to amend § 1.64 to remove language that the amendments to the other provisions would render unnecessary. The Commission did not receive any comments on the proposed changes to §§ 1.59, 1.63, 1.64, and 1.69.

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. After § 39.2 was adopted, the Commission adopted definitions for some of the same terms that apply in other Commission regulations. The Commission is adopting changes to five definitions in § 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

The Commission is removing § 39.19(b)(3), which defines “business day,” and moving the definition of “business day” to § 39.2 to make clear that it applies wherever the term is used in part 39. The Commission is also clarifying that the term “Federal holiday” in the “business day” definition refers to the schedule of U.S. federal holidays established under 5 U.S.C. 6103, and adding “any holiday on which a [DCO] and its domestic financial markets are closed” rather than “foreign holiday,” as originally proposed, to the list of exceptions to the definition of “business day.”

The Commission received two comments on the proposed changes to the definition of “business day.” CME suggested substituting “market holiday” for “foreign holiday” in the definition of “business day” to also recognize days that are not Federal holidays when U.S. markets are closed. ICE supported the Commission defining “foreign holiday” and adding the term to the list of exceptions to the definition of “business day,” but also noted potential conflicts between the proposed definition of “business day” in § 39.2 and the definition of “business day” in §§ 1.3 and 39.19(b)(3).

The Commission agrees that any day on which markets are closed should not be considered a business day, and therefore is adopting the proposed definition of “business day” with the substitution of “any holiday on which a [DCO] and its domestic financial markets are closed” for “foreign holiday,” to encompass both foreign and U.S. market holidays.

In proposing to define “business day” in § 39.2, the Commission also proposed to remove the definition in § 39.19(b)(3), to avoid any conflict between those provisions. The Commission is removing the definition of “business day” from § 39.19(b)(3). The Commission recognizes that the definition of “business day” in § 39.2 differs slightly from the definition of “business day” in § 1.3, but notes that the definition in § 39.2 is meant specifically for application to part 39.

2. Customer, and Customer Account or Customer Origin

The Commission is removing the definition of “customer” and modifying the definition of “customer account or customer origin” in § 39.2 because those terms were defined in § 1.3 after § 39.2 was adopted.

ICE commented that, for DCOs organized outside of the United States, references to customer accounts under the proposed definitions do not distinguish appropriately between customer accounts carried by FCM clearing members and customer accounts carried by non-FCM clearing members, which may be subject to segregation and other requirements under non-U.S. law rather than under the CEA. ICE therefore suggested that the Commission clarify the application of the definitions to non-U.S. DCOs. In response to ICE's comment, the Commission notes that “customer” is defined in § 1.3 to mean “any person who uses a [FCM] . . . .”

3. Enterprise Risk Management

The Commission is adopting as proposed the definition of “enterprise risk management” because the term is used in § 39.10(d), which is discussed below. The Commission did not receive any comments on the proposed definition.

4. Fully Collateralized Position

The Commission is adopting the definition of “fully collateralized position” in conjunction with proposed exceptions from several part 39 regulations for DCOs that clear fully collateralized positions, as discussed below. Nadex requested clarification of the meaning of the word “counterparty” in the definition of “fully collateralized,” and suggested replacing the word with “party” because “counterparty” implies that the DCO need only hold sufficient funds to cover the maximum possible loss that the counterparty may sustain, but to be fully collateralized the DCO must hold sufficient funds to cover the maximum possible loss of each party. In response to Nadex's comment, the Commission is including “party,” in addition to “counterparty,” in the definition of “fully collateralized position” to make clear that the definition is intended to include each party to a contract.

5. Key Personnel

The Commission is adding “chief information security officer” (CISO) to the list of positions identified in the definition of “key personnel” in § 39.2. Nadex requested clarification that it is sufficient for a staff member to be assigned the responsibilities of a CISO in addition to other responsibilities of their role. Nadex also requested guidance confirming that the CISO may be employed by the DCO or by an affiliate, and that, with respect to a DCO that is also a designated contract market (DCM), an individual may fulfill the role of CISO for both the DCM and DCO.

The Commission confirms that a DCO staff member may be assigned the responsibilities of a CISO in addition to other responsibilities of their role; the CISO may be employed by the DCO or by an affiliate; and, for a DCO that is also a DCM, an individual may fulfill the role of CISO for both the DCM and DCO.

B. Procedures for Registration—§ 39.3

1. Application Procedures—§ 39.3(a)

The Commission is adopting several changes to its procedures for registration as a DCO generally as proposed. These changes include: Revisions to § 39.3(a)(1) to improve the clarity and consistency of the text; revisions to Form DCO to correspond to other proposed revisions to the part 39 regulations; providing greater flexibility in § 39.3(a)(3) for DCO applicants submitting supplemental information; clarifying references in § 39.3(a)(5) to the portion of the Form DCO cover sheet and other application materials that will be made public; and, in new § 39.3(a)(6), permitting the Commission to extend the 180-day review period for DCO applications for any period of time to which the applicant agrees in writing. The Commission did not receive any comments on these proposed changes.

2. Stay of Application Review—§ 39.3(b)

The Commission is adopting as proposed the change to § 39.3(b)(2) to correct inaccurate language. In § 39.3(b)(2), which is the Commission's delegation of authority to the Director of the Division of Clearing and Risk to stay an application for DCO registration that is materially incomplete, the Commission is adopting a change to replace the inaccurate “designation” with “registration.” The Commission did not receive any comments on this change.

3. Request To Amend an Order of Registration—§ 39.3(a)(2), § 39.(a)(4), and § 39.3(d)

The Commission is adopting as proposed three changes to procedures in § 39.3(a)(2) for a registered DCO requesting an amended order of registration, to reflect current Commission practice. The rule will no longer require use of Form DCO to request an amended order of registration under § 39.3(a)(2), and an applicant will only need to file amended exhibits and other information when filing a Form DCO to update a pending application under § 39.3(a)(4). The Commission also is adopting new § 39.3(d) to establish a separate process for such requests.

ICE supported the proposal to eliminate using Form DCO to request an amended registration order, and stated that it believes the modification to § 39.3(a)(2) will help streamline the process for a DCO to file a request for an amended order.

4. Dormant Registration—§ 39.3(e)

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 adopting as proposed changes to § 39.3(d), renumbered as § 39.3(e), to correct inaccurate language. Specifically, the Commission is adopting an amendment to replace “listing or relisting” with “accepting” to more accurately describe a DCO's activities. The Commission did not receive any comments on these proposed changes.

5. Vacation of Registration—§ 39.3(f)

The Commission is adopting as proposed changes to § 39.3(e), renumbered as § 39.3(f), to codify requirements for a DCO requesting vacation of its registration, and provide greater transparency to any DCO that is considering vacating its registration.
9

The amendments renumber current § 39.3(e) as § 39.3(f)(1) and add provisions under § 39.3(f)(1) regarding procedures for a DCO seeking to vacate its registration. The Commission is also adopting § 39.3(f)(2) to specify that the requirement in section 7 of the CEA that the Commission must “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 will be met by posting the required documents on the Commission's website. The Commission did not receive any comments on the proposed changes.

9
The Commission is also making a technical change to § 39.3(f), to remove the term “registered” from “registered [DCO],” for consistency with other provisions in part 39.

6. Request for Transfer of Registration and Open Interest—§ 39.3(g)

The Commission is adopting changes to § 39.3(f), renumbered as § 39.3(g), to simplify the requirements for a DCO to request a transfer of open interest and to separate the process from the procedures used to report a change to a

DCO's corporate structure or ownership. The Commission proposed changes regarding 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. The changes simplify the requirements for requesting a transfer of open interest and remove references to transfers of registration and requirements regarding corporate changes, so that § 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), renumbered as § 39.19(c)(4)(ix). In light of a comment from ICE discussed below, the Commission is further modifying § 39.3(g) to account for a transfer of foreign futures positions by a DCO to a clearing organization permitted to clear for a registered foreign board of trade pursuant to § 48.7.

Under the amendments to § 39.3(g), a DCO seeking to transfer its open interest will be required to submit rules for Commission approval pursuant to § 40.5,
10

rather than submitting a request for an order at least three months prior to the anticipated transfer. Regulation 39.3(g) also specifies certain information that the DCO would be required to include in its submission pursuant to § 40.5.

10
The Commission reiterates that, as noted in the Proposal, 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.

CME and ICE generally supported the proposed changes to § 39.3(g) regarding requests to transfer open interest. CME noted that a DCO cannot unilaterally transfer to another DCO open interest associated with contracts that are subject to the rules of a DCM, as those transfers must be authorized by the DCM through rule amendment or otherwise. CME referred to procedures under § 38.3(d) for a DCM to transfer open interest associated with contracts listed on a DCM to another DCM, in connection with a change of registration. The Commission agrees that where a DCO is requesting transfer of open interest under § 39.3(g) for contracts listed on a DCM, the DCM also would be subject to applicable Commission regulations, including part 38.

CME and ICE also supported use of the rule approval process under § 40.5 for submission of requests to transfer open interest. ICE suggested that it may be appropriate for a transfer to take effect pursuant to a self-certification under § 40.6 where the transfer does not raise any particular novel issues or concerns. ICE further requested that the Commission clarify that it may, in appropriate circumstances, take action on a transfer request in less than 45 days, both in circumstances that do not raise particular concerns and in exigent or distressed circumstances in which the full period may not be necessary or feasible. The Commission declines to adopt ICE's suggestion to permit a transfer of open interest to be made pursuant to § 40.6 and is adopting the requirement to submit such requests under § 40.5 as proposed. The Commission only has ten business days to review rules submitted pursuant to § 40.6, which the Commission believes is not sufficient time to review rules related to transfers of open interest. The Commission reviews transfers of open interest to ensure that clearing members have sufficient notice of the transfer, because there may be clearing members of the transferring DCO that are not members of the receiving DCO. Such clearing members may need time to become members of the receiving DCO or to close out their positions, and if they are FCMs that clear for customers, to transfer their customers to other FCMs if necessary. The Commission also reviews the transfer plans (typically there is a transition agreement between the DCOs) to make sure that the associated risks will be adequately managed. The Commission confirms, however, that under § 40.5(g), it has the ability to expedite its approval of a request where appropriate.

ICE also suggested clarification of procedures for transfers between a registered DCO and a clearing organization that is not a registered DCO (such as a foreign clearing organization that is either an exempt DCO or otherwise not subject to DCO registration based on its activities). As the Commission noted in the Proposal, under the existing regulatory framework, all futures positions and U.S. customer swap positions must be cleared by a registered DCO, while proprietary swap positions of U.S. persons may be cleared by a registered or exempt DCO.
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However, the proposed rule failed to contemplate a transfer of foreign futures positions by a DCO to a clearing organization permitted to clear for a registered foreign board of trade pursuant to § 48.7. As noted above, the Commission is modifying the final rule to broaden its applicability to account for such a transfer.

11

See
Derivatives Clearing Organization General Provisions and Core Principles, 84 FR at 22230, n. 19.

C. Procedures for Implementing DCO Rules and Clearing New Products

The Commission is adopting two non-substantive changes to its procedures for implementing DCO rules and clearing new products in § 39.4, to remove or correct certain references. The Commission did not receive any comments on the proposed amendments to § 39.4 and is adopting them as proposed.

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 deleting 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 substituting “section 4d(a)” for “section 4d” in § 39.4(e).

IV. Amendments to Part 39—Subpart B—Compliance With Core Principles

A. Fully Collateralized Positions

The Commission is amending certain regulations in part 39 to address fully collateralized positions, which do not pose the full range of risks that the regulations are meant to address. As discussed in the Proposal, fully collateralized positions do not expose DCOs to many of the risks that traditionally margined products do, as

full collateralization prevents a DCO from being exposed to credit risk stemming from the inability of a clearing member or customer of a clearing member to meet a margin call or a call for additional capital.
12

This renders certain provisions of part 39 inapplicable or unnecessary. As a result, the Division of Clearing and Risk has granted relief from certain provisions of part 39 to DCOs that clear fully collateralized positions.
13

The Commission is amending certain regulations consistent with that relief.
14

12

See id.
at 22245.

13

See
CFTC Letter No. 14-04 (Jan. 16, 2014) (granting exemptive relief to Nadex); CFTC Letter No. 17-35 (July 24, 2017) (granting exemptive relief to LedgerX).

14
The Division of Clearing and Risk also issued interpretive guidance to Nadex for other provisions in part 39. CFTC Letter No. 14-05 (Jan. 16, 2014). The interpretive guidance may be relied on by third parties, and is not impacted by this rulemaking.

The amendments are based on an assessment of how the DCO Core Principles and part 39 apply to fully collateralized positions, as well as the relief previously granted to DCOs that clear such positions. The Commission believes the amendments will not negatively impact prudent risk management at any DCO, regardless of the types of products cleared. The amendments to each provision are discussed in this section, whereas specific comments are addressed in conjunction with the discussion of those provisions further below.
15

15
To the extent there were comments on the changes to regulations in part 39 that address DCOs that clear fully collateralized positions, the Commission has addressed these comments throughout. To the extent there were no comments, the Commission is adopting the changes as proposed.

1. Definition of “Fully Collateralized Positions”—§ 39.2

As discussed above, the Commission is adopting a definition of “fully collateralized position” as a contract cleared by a DCO that requires the DCO to hold, at all times, funds in the form of the required payment sufficient to cover the maximum possible loss that a party or counterparty could incur upon liquidation or expiration of the contract.

2. Computation of Financial Resources Requirement—§ 39.11(c)(1)

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)
16

requires a DCO to perform monthly stress testing in order to make a reasonable calculation of the financial resources it would need in the event of such a default. The Commission is amending § 39.11(c)(1)(i) to clarify that a DCO does not have to perform monthly stress tests on fully collateralized positions. For fully collateralized positions, a DCO holds its maximum possible loss on each contract at all times and does not face the risk of a clearing member default. The monthly stress tests required by § 39.11(c)(1)(i) are therefore unnecessary for fully collateralized positions.

16
This paragraph is being renumbered as § 39.11(c)(1)(i) due to revisions discussed elsewhere in this rulemaking.

3. Liquidity of Financial Resources—§ 39.11(e)(1)(ii)

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 during a one-day settlement cycle. The Commission is amending § 39.11(e)(1)(iv) to clarify that DCOs do not need to include fully collateralized positions in the calculation required thereunder. The specific amount of liquid resources a DCO must hold is based on the historical settlement pays of its clearing members. A DCO maintains sufficient liquidity for fully collateralized positions by requiring clearing members to post the full potential loss of a position in the form of the potential obligation. Requiring collateral to be in the form of the potential obligation eliminates the risk that the DCO will not have sufficient liquidity to meet its obligations and the need for daily mark-to-market settlements. Further, if a DCO were to complete the calculation required by § 39.11(e)(1)(ii), the amount would not change from day to day as the DCO operates a fully collateralized model. As a result, the calculation required in § 39.11(e)(1)(ii) is inapplicable to fully collateralized positions.

4. Periodic Reporting of Participant Eligibility—§ 39.12(a)(5)(i) and (a)(5)(i)(B)

Regulation 39.12(a)(5)(i) requires a DCO to require its clearing members to provide the DCO with periodic financial reports that allow the DCO to assess whether participation requirements are being met on an ongoing basis. Regulation 39.12(a)(5)(i)(B)
17

requires a DCO to make these reports available to the Commission at the Commission's request.
18

The Commission is adding new § 39.12(a)(5)(v) to exclude non-FCM clearing members that only clear fully collateralized positions from the financial reporting requirements in § 39.12(a)(5)(i) and (a)(5)(i)(B). The Commission's participant eligibility requirements in § 39.12(a) are intended to ensure that DCO participants maintain sufficient financial resources and operational capacity to meet the obligations arising from clearing at a DCO.
19

Clearing members that only clear fully collateralized positions present no credit or default risk to the DCO because their full potential loss is already held by the DCO. Thus, periodic financial reports from non-FCM clearing members that only clear fully collateralized positions do not provide any risk management benefit to a DCO.

17
This paragraph is being renumbered as § 39.12(a)(5)(iii) due to revisions discussed elsewhere in this rulemaking.

18
Regulation 39.12(a)(5)(i)(B) allows DCOs to either require clearing members to make the reports available to the Commission or to provide the reports to the Commission directly.

19

See
Derivatives Clearing Organization General Provisions and Core Principles, 76 FR 69334, 69352 (Nov. 8, 2011).

5. Large Trader Stress Tests—§ 39.13(h)(3)

Regulation 39.13(h)(3) requires a DCO to conduct stress testing on a daily basis with respect to each large trader who poses significant risk to a clearing member or the DCO, and at least on a weekly basis with respect to each clearing member account, by house origin and by each customer origin. The Commission is adding new § 39.13(h)(3)(iii) to exclude clearing member accounts that hold only fully collateralized positions from the stress testing requirements in § 39.13(h)(3)(i) and (ii). As discussed above, DCOs hold, at all times, the full potential loss of fully collateralized positions cleared by the DCO, and a DCO does not face the risk of default from accounts that only hold fully collateralized positions. As a result, such stress tests would not provide DCOs new information on accounts that only clear fully collateralized positions.

6. Default Rules and Procedures—§ 39.16(e)

Regulation 39.16(a) requires a DCO to have rules and procedures designed to allow for the efficient, fair, and safe management of events during which clearing members become insolvent or otherwise default on their obligations to the DCO. Regulation 39.16(b) and (c)

require, among other things, a DCO to maintain a written default management plan and procedures that would permit the DCO to take timely action to contain losses and liquidity pressures in the event of a default. In response to a request from Nadex,
20

the Commission is adopting new § 39.16(e) to provide that a DCO may satisfy the requirements of paragraphs (a), (b), and (c) of § 39.16 by having rules that permit it to clear only fully collateralized positions. This rule was not included in the Proposal because relief had been provided through a staff interpretative letter, as discussed below, but the Commission believes it is appropriate to include it in the final rule because it is consistent with other exceptions for fully collateralized positions adopted herein.

20

See
discussion
infra
section IV.G.3.

7. Daily Reporting—§ 39.19(c)(1)(i)

Regulation 39.19(c)(1)(i) requires a DCO to submit to the Commission a daily report containing information on initial margin, daily variation margin payments, other daily cash flows, and end-of-day positions. The Commission is amending § 39.19(c)(1)(i) such that the enumerated daily reporting is not required with respect to fully collateralized positions. Because fully collateralized positions do not pose a credit risk to the DCO or other participants, the Commission does not need daily reporting of this information with respect to fully collateralized positions.

B. Compliance With Core Principles—§ 39.10

1. Chief Compliance Officer—§ 39.10(c)

The Commission is adopting several amendments to § 39.10(c) to permit greater flexibility in the reporting requirements applicable to the Chief Compliance Officer (CCO) for DCOs engaged in substantial activities not related to clearing. These amendments are intended to make the process of preparing the CCO's annual report more efficient, to improve clarity and consistency of the regulations, and to require that the CCO's annual report describe the process by which the report is provided to the board of directors or senior officer so that compliance with existing regulations is evident outside the context of an examination of the DCO's board of directors' meeting minutes or other records. Unless stated otherwise below, the Commission did not receive any comments on the proposed amendments to § 39.10(c) and is adopting them as proposed.

The Commission is amending § 39.10(c)(1)(ii) to permit a DCO's CCO to report to the senior officer responsible for the DCO's clearing activities if the DCO engages in substantial activities not related to clearing (for example, if the DCO is also a DCM). The Commission is also amending § 39.10(c)(4)(i) to permit the CCO to submit the annual report to the same individual (or to the board of directors) for internal review. CME supported these proposed amendments, noting that the senior officer responsible for the DCO's clearing activities is most familiar with the day-to-day operations of the DCO and its personnel and is therefore generally best positioned to ensure that the compliance program implemented by the CCO is appropriately designed to ensure compliance with the CEA and Commission regulations.

The Commission is amending § 39.10(c)(3)(i) to permit the CCO's annual report to incorporate by reference the parts of its most recent CCO annual report containing descriptions of the DCO's written policies and procedures, to the extent that such policies and procedures have not materially changed since they were most recently described in a previously submitted CCO annual report submitted within the five-year period prior to the date of the CCO annual report containing such incorporation by reference. CME strongly supported these proposed revisions, noting that they reduce the requirement to provide duplicative information contained in previous reports and thus reduce the administrative burden on both the DCO's compliance staff and Commission staff. CME also commented that the five-year timeframe for re-introducing materially unchanged policies is appropriate.

The Commission is amending § 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,” to change the latter language to “with each core principle and applicable regulation.” The Commission is also amending § 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 regulation now requires that the compliance policies and procedures be identified “by name, rule number, or other identifier.”

The Commission is amending § 39.10(c)(4)(i) to require that the CCO's annual report describe the process by which it was submitted to the board of directors or the senior officer. In response to a comment described below, rather than requiring that the CCO's annual report include the date on which it was submitted to the board of directors or the senior officer, the Commission is further amending § 39.10(c)(4)(i) to require that it be accompanied by a cover letter, notice, or other document that specifies the date of submission. Lastly, the Commission is amending § 39.10(c)(4)(ii) to remove the requirement that the annual report be submitted concurrently with the DCO's fiscal year-end audited financial statement to be consistent with a change to § 39.19(c)(3)(iv) explained below.

CME stated that including within the annual report the date on which the annual report was submitted to the board of directors or the senior officer, per the proposed amendments to § 39.10(c)(4)(i), is problematic because the report would need to be prepared and distributed “well in advance” of a board or committee meeting or other intended date. CME noted that a change of meeting date or agenda could render the date included in the report inaccurate. CME therefore recommended that the CCO's annual report include the intended date of submission, but that a cover sheet be added to the report after the meeting that either confirms that the date within the report is correct or provides an alternative date specifying when the report was actually provided. The Commission agrees that the revisions, as proposed, could cause the report to be inaccurate in the event of a delay or other scheduling change. In light of CME's comments, the Commission is not including in § 39.10(c)(4)(i) the proposed requirement that the CCO's annual report include the date of submission and is replacing it with a requirement that the annual report be accompanied by a cover letter, notice, or other document that specifies the date of submission.

Nadex suggested that the Commission consider conforming the language of the CCO's duties and annual report requirements in § 39.10 with that of § 3.3, which pertains to the CCOs of FCMs, swap dealers, and major swap participants. The Commission is not adopting this change, because recent amendments to § 3.3 were largely intended to more closely harmonize these requirements with corresponding rules of the Securities and Exchange Commission (SEC) for CCOs of security-based swap dealers and major security-

based swap participants, and are not applicable to DCOs. However, the Commission may consider this in a future rulemaking.

2. Enterprise Risk Management—§ 39.10(d)

The Commission is adopting new § 39.10(d), which requires a DCO to have a program of enterprise risk management and 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.

ICE was generally supportive of § 39.10(d) as proposed, and CME agreed with several aspects of the proposal. MGEX recognized the value that an enterprise risk management program provides in ensuring the integrity of DCOs and the financial markets and agreed that a DCO should assess and manage the broad array of risks identified in the Proposal. MGEX requested that the Commission grant a longer time period for compliance to allow DCOs adequate time to implement the program, given the extensive nature of an enterprise risk management program and the work that will be involved in developing such a program. The Commission is giving DCOs one year to comply with the amendments to the regulations.

The Commission did not receive any comments specifically on §§ 39.10(d)(1), (d)(2), or (d)(3), and is finalizing these paragraphs as proposed.

The Commission received several responses to a request for 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. OCC stated that, generally, the enterprise risk officer should report directly to the board of directors, or to an appropriate committee of the board of directors, but also commented that a DCO should have the discretion to determine whether the enterprise risk officer should report directly to the board of directors, a committee of the board, or the senior officer responsible for a DCO's clearing activities. CME commented that the enterprise risk officer should have access to the board of directors and its relevant committees and should provide regular reports to the board or its relevant committees, but did not believe it is necessary for the enterprise risk officer to have a direct administrative reporting relationship to the board or its committees. Nadex stated that the enterprise risk officer should not report to the DCO's board of directors because the purpose of a board of directors is to provide oversight and strategic guidance to the organization, not management of specific individuals within the organization. Nadex suggested that the enterprise risk officer provide reports to the board but could report to the DCO's chief executive officer, chief risk officer, or other appropriate officer of the DCO or a parent company.

In light of the comments, the Commission has concluded that a DCO should have the discretion to determine whether its enterprise risk officer will report directly to the board of directors, to an appropriate committee of the board of directors, or to the senior officer responsible for the DCO's clearing activities. Regardless of the formal reporting relationship, however, the Commission believes that the enterprise risk officer should have access to the board of directors to ensure that the board receives reports and information from the enterprise risk officer. The Commission is therefore finalizing proposed § 39.10(d)(4) with additional language requiring such access.

The Commission also requested comment as to whether a DCO's chief risk officer should be permitted to also serve as its enterprise risk officer, and commenters generally were supportive. Nadex noted that the two positions “do not have conflicting purposes.” OCC noted that a chief risk officer is typically the individual with the greatest authority, independence, resources, expertise, and access to relevant information necessary to fulfill the responsibilities of managing the DCO's enterprise risk management function. CME commented that whether a DCO's chief risk officer should also be permitted to serve as the overall organization's enterprise risk officer depends on the organizational structure related to the DCO and the structure of the broader corporate group, while Nodal stated that a DCO should have “complete discretion” to identify the appropriate person to serve as the enterprise risk officer, including whether that person may also be the DCO's chief risk officer. MGEX noted that, due to existing chief risk officer responsibilities of administering similar risk management programs, the chief risk officer may be the most adept individual to manage an enterprise-wide risk management framework. MGEX further argued that allowing the same person to fill both roles would also prevent fragmenting risk management oversight responsibilities while being less time-consuming and less costly for smaller DCOs, adding that it would be “effectively impossible” for smaller DCOs to have a fully independent employee or officer, thereby furthering the need for flexibility in who can fulfill such role. LCH recommended that the role of the enterprise risk officer be included in the role and responsibilities of the chief risk officer to reduce duplication of responsibilities and benefit from efficiencies that can be derived from combining “these related roles.”

In response to the comments, the Commission believes that a DCO should generally have the discretion to allow the DCO's enterprise risk officer and its chief risk officer to be the same individual and, therefore, is finalizing the regulation as proposed, without adding language prohibiting this practice. However, the Commission notes that § 39.10(d)(4), as finalized, requires the enterprise risk officer to have, among other things, the independence and resources necessary to fulfill the responsibilities of the position. The Commission believes that, for larger, more complex DCOs, it may be challenging to meet this requirement if one individual performs the functions of both roles.

In response to a request for clarification from Nadex, the Commission confirms that the regulations, as finalized, do not require that an individual be assigned the title of “Enterprise Risk Officer.” It is sufficient that the DCO be able to identify the individual assigned the responsibilities of the position and that the other applicable requirements are satisfied.

Lastly, when the Commission adopted the requirement in § 39.13(c) that a DCO have a chief risk officer, it stated that, given the importance of the risk management function and the comprehensive nature of the responsibilities of a DCO's CCO under § 39.10, the Commission expected that a DCO's chief risk officer and its CCO would be two different individuals.
21

Commission staff noted this in a subsequent interpretation regarding the application of certain part 39 requirements to fully collateralized DCOs.
22

However, the Commission recognizes that, due to the limited risk profile of DCOs that clear only fully collateralized positions, it would be possible for a single individual to be both the CCO and the chief risk officer of such a DCO if the individual possesses the qualifications for both roles.

21
76 FR 69334, 69363 (Nov. 8, 2011).

22
CFTC Letter No. 14-05 (Jan. 16, 2014).

C. Financial Resources—§ 39.11

The Commission is adopting various changes to § 39.11 to make the language more closely match that of Core Principle B, address inconsistencies in how DCOs treat excess collateral on deposit when conducting stress tests, ensure that customer funds are properly accounted for when a DCO is calculating its largest financial exposure, require DCOs to provide certain information to aid the Commission's review of their financial statements, and to clarify or conform a number of provisions. Unless stated otherwise below, the Commission did not receive any comments on the proposed amendments to § 39.11 and is adopting them as proposed.

1. Calculation of Largest Financial Exposure and Stress Tests—§ 39.11(a)(1), (b)(1), (c)(1), and (c)(2)

The Commission is revising the language in § 39.11(a) to make it more consistent with Core Principle B.

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. The Commission is deleting § 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.

OCC supported the removal of § 39.11(b)(1)(i), under the assumption that a DCO could also net other margin it requires a clearing member to have on deposit when calculating its largest financial exposure. OCC requested that, if the Commission does not believe that a DCO should net such additional required margin on deposit, the Commission interpret such additional required margin on deposit as “[a]ny other financial resource deemed acceptable by the Commission” under current § 39.11(b)(1)(vi), proposed to be renumbered § 39.11(b)(1)(v).

The Commission is adopting additional minimum requirements that a DCO will have to follow in determining its financial exposure in accordance with § 39.11(c)(1). In particular, the Commission is adding § 39.11(c)(2)(i)(A) to require a DCO to calculate its largest financial exposure net of the clearing member's required initial margin amount on deposit. In response to questions and requests for clarification from OCC, ICE, FIA, and ISDA, the regulation specifies that this required margin includes any add-ons, such as concentration charges and liquidity charges, and only required margin (including add-ons) may be considered. In other words, the DCO is not permitted to take into account excess collateral on deposit. Additionally, the Commission is adopting § 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. New § 39.11(c)(2)(iii) allows a DCO to net gains in the house account with losses in the customer account, if permitted by its rules, but explicitly prohibits a DCO from netting losses in the house account with gains in the customer account. New § 39.11(c)(2)(iv), as modified to address comments, allows a DCO, with respect to a clearing member's cleared swaps customer account, to net customer gains against customer losses only to the extent permitted by the DCO's rules. In light of the comments, the Commission confirms that the purpose of § 39.11(c)(2)(iv) is to confirm that, while all customer positions must be included in calculating largest net exposure, netting between such positions must be done in a manner consistent with what is permitted by the DCO's rules. The Commission is also specifying that the requirements of § 39.11(c) do not apply to fully collateralized positions.

A number of commenters supported proposed § 39.11(c)(2)(i)(A). For example, SIFMA AMG stated that the various proposed revisions to § 39.11(c)(2) would require DCOs to make more prudent assumptions when calculating default fund requirements, improve the process of sizing the financial resources package, and standardize assumptions and enable customers to make apples-to-apples comparisons between DCOs. Mr. Barnard stated that proposed § 39.11(c)(2)(i)(A) would prudently focus a DCO's analysis on the resources that would actually be available to it during times of stress, further enhance the financial soundness of DCOs, and improve protection for market participants and the public. He also noted that the proposal is consistent with the PFMIs, which provide that central counterparties should not use collateral beyond the margin requirement for purposes of calculating their available resources,
23

and should increase efficiencies for industry while more prudently managing financial risk.

23

See
CPMI-IOSCO, Principles for Financial Market Infrastructures (Apr. 2012), available at
http://www.iosco.org/library/pubdocs/pdf/IOSCOPD377.pdf.

2. Assessments—§ 39.11(d)(2)

The Commission is amending § 39.11(d)(2)(iv) by replacing the phrase “those obligations” with “the total amount required under paragraph (a)(1) of this section.” The Commission did not receive any comments on this change.

The Commission did receive other comments on assessments. SIFMA AMG stated that the Commission should not allow DCOs to count unfunded liabilities, such as assessments, towards “cover one” and “cover two” calculations because they are highly likely to be unreliable during times of stress. Similarly, FIA and ISDA requested that the Commission amend § 39.11(d)(2) to prohibit the use of assessments because assessments are unfunded resources. Because the Commission had only proposed the clarifying change to § 39.11(d)(2)(iv) noted above and had not proposed to prohibit assessments entirely, the Commission would need to consider this in a separate proposal.

Lastly, ICE questioned the impact on § 39.11(d)(2)(iv) of the Commission's clarification of how a DCO must calculate its largest financial exposure under § 39.11(a)(1). In response, the Commission is further amending § 39.11(d)(2)(iv) to clarify that the value of the assessments may be determined by using the largest financial exposure in extreme but plausible market conditions prior to netting against required initial margin on deposit.

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. The Commission is adopting an amendment 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. It also is adopting clarifying changes to the text of § 39.11(e)(1)(iii) and (e)(2), and adding § 39.11(e)(1)(iv) to provide that a DCO is not subject to

§ 39.11(e)(1)(ii) for fully collateralized positions.

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. 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. The Commission is adopting new § 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), but that it may not be counted twice to meet the requirements of both § 39.11(e)(1)(ii) and § 39.11(e)(2). FIA and ISDA supported proposed § 39.11(e)(3) because it explicitly states the Commission's intention for a DCO to use a committed line of credit or similar facility under these circumstances.

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 amending 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)

The Commission is amending § 39.11(f)(1)(ii) to require a DCO to file with the Commission each fiscal quarter, or at any time upon Commission request, a financial statement of the DCO, including the balance sheet, income statement, and statement of cash flows. Prior to this amendment, the regulation permitted the DCO to file the financial statement of the DCO or its parent company. Some DCOs that are part of a complex corporate structure file the financial statements of their parent companies, which makes it difficult to accurately assess the financial strength of the DCO.

The amendment to § 39.11(f)(1)(ii) also requires a DCO to prepare its financial statement in accordance with U.S. generally accepted accounting principles (U.S. GAAP), except that a DCO that is incorporated or organized under the laws of any foreign country may prepare its financial statement in accordance with either U.S. GAAP or the International Financial Reporting Standards issued by the International Accounting Standards Board (IFRS).

However, in response to comments, the Commission is not adopting the proposed amendments to § 39.11(f)(1)(ii) and § 39.11(f)(2)(i) that would have required the balance sheet to identify any assets allocated to satisfy the requirements of § 39.11(a)(1) or § 39.11(a)(2) as held for that purpose.

MGEX requested clarification regarding the application of the proposed revisions to § 39.11(f)(1)(ii) on an entity that is a DCO and also has non-DCO operations. MGEX noted that it is both a DCO and a DCM, and its financial statements show revenue and expenses from all sources and activities, not just those pertaining to MGEX's activities as a DCO. The Commission confirms that the revisions are intended to address the case of a DCO that is a separate legal entity from its parent company, in which case the Commission would expect to receive financial statements for the DCO disaggregated from that of its parent. In the case of a DCO with revenue and expenses from non-DCO activity, such as if the same legal entity were also a DCM, the Commission would not require or expect the entity to separate its clearing-related and non-clearing-related financial information in its financial statements.

MGEX further suggested that the proposed revisions to § 39.11(f)(1)(ii) requiring that the financial statement provided be that of the DCO and not the parent company should only apply to DCOs that are part of a complex corporate structure, and not to simple parent/subsidiary structures. MGEX stated that compiling and submitting separate financial statements for a simple parent/subsidiary structure would result in increased expenses while providing no material benefit. The Commission is declining to adopt this suggestion because the Commission believes there is value in understanding the financial condition of a DCO separate from that of its parent company, as separate legal entities should be able to prepare separate financial statements, and because there is no bright line distinguishing between simple and complex corporate structures.

SIFMA AMG suggested that the Commission require DCOs to prepare quarterly and annual reports as required by § 39.11(f) in accordance with U.S. GAAP. Eurex and LCH supported the proposal in § 39.11(f)(1)(ii) to allow non-U.S. DCOs to use either U.S. GAAP or IFRS. LCH also recommended that the CFTC allow non-U.S. DCOs to report in currencies other than the U.S. dollar, stating that this would allow the quarterly reports to align with the reporting currency of the entity's audited year-end financial statements and would simplify the reconciliation process proposed in § 39.11(f)(2). The Commission is declining LCH's suggestion because if a DCO were to report in currencies other than the U.S. dollar, Commission staff would need to convert the currencies to U.S. dollars to properly analyze the reports, which would require staff to make decisions about exchange rates. To the extent that a DCO that does business in a foreign currency must make conversions to U.S. dollars as part of preparing its financial statements, it is more appropriate to permit the DCO to determine the exchange rate it uses as long as the information is presented with sufficient clarity to allow Commission staff to evaluate the reasonableness of the decision.

CME supported the proposal in § 39.11(f)(1)(ii) and § 39.11(f)(2)(i) to identify assets required to meet the resource requirements of § 39.11(a)(1) and (2). However, CME stated that the balance sheet may not be the most appropriate financial statement to identify assets satisfying these requirements. CME noted certain requirements of U.S. GAAP that may preclude a company from including this information on its balance sheet. Eurex noted similar issues for financial statements prepared in accordance with IFRS. Given these concerns, the Commission is not adopting the proposed changes in this regard. However, the Commission encourages DCOs to identify the assets required to meet the resource requirements of § 39.11(a)(1) and (2) to the extent that they can, given applicable accounting standards. The Commission notes that providing such information would facilitate its review of DCOs' financial statements and potentially reduce the burden on DCOs to respond to staff inquiries regarding their financial statements and compliance with § 39.11(a)(1) and (2).

6. Timing of Financial Statements—§ 39.11(f)(1)(iv)

The Commission is amending § 39.11(f)(1)(iv) to incorporate the language of current § 39.11(f)(4), which requires a DCO to submit its quarterly 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).

The amendment does not incorporate changes suggested by commenters, described below, because the reporting dates currently in effect are the same as those for FCMs under the Commission's regulations. The Commission believes that DCOs should be aligned with FCMs rather than DCMs because FCMs, unlike DCMs, hold initial margin and default funds and collect variation margin, which clearly and directly relate to the financial resources available to DCOs. In addition, the timing of the fourth quarter report allows Commission staff to verify the accuracy of a DCO's quarterly financial reports; numerous differences between that report and the year-end report may signal that the DCO has deficient processes and procedures pertaining to preparation of financial statements.

CME recommended that, for the first three quarters of the fiscal year, the due dates for submitting the DCO quarterly financial resource reports be aligned with the due dates for a DCM's submission of financial resource reports pursuant to § 38.1101(f)(4), which requires the reports to be filed no later than 40 calendar days after the end of the DCM's first three fiscal quarters. CME also recommended that the due date to submit a DCO's financial resource report for the fourth quarter of the fiscal year be aligned with the due date for submitting audited year-end financial statements pursuant to current § 39.19(c)(3)(iv) and proposed § 39.11(f)(2)(ii), which is not more than 90 days after the end of the DCO's fiscal year end. CME argued that the proposed requirement in § 39.11(f)(2)(iii)(A) for a DCO to submit a reconciliation where material differences exist between the balance sheet in the audited year-end financial statement with the balance sheet in the DCO's financial statement for the last quarter of the fiscal year, discussed below, would be unnecessary if the Commission harmonized the submission due date for a DCO's financial resources report for the last quarter of the fiscal year with the submission due date for the audited year-end financial statements.

7. Reconciliation—§ 39.11(f)(2)(iii)(A)

The Commission is amending § 39.11(f)(2)(iii)(A) to require a DCO to annually submit a reconciliation, including appropriate explanations, of its balance sheet in the audited year-end financial statement with the balance sheet in the DCO's financial statement for the last quarter of the fiscal year when material differences exist or, if no material differences exist, a statement so indicating. LCH recommended defining “material” as 10 percent of either the (1) six-month liquidity test, or (2) 12-month capital cost-based financial resources test. The Commission believes that DCOs should retain reasonable discretion to define “material” for these purposes and therefore declines to include this suggestion.

8. Documentation Requirements—§ 39.11(f)(3)

Regulation 39.11(f)(3) requires a DCO to provide to the Commission certain documentation related to its quarterly financial reporting.
24

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 revising § 39.11(f)(3) to clarify that a DCO must send the documentation to the Commission required under current subparagraphs (i) and (ii) (proposed to be renumbered as subparagraphs (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.

24
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 renumbering § 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 adding language specifying that copies of the agreements should evidence or support the DCO's ability to meet applicable financial resources and liquidity resources requirements.

9. Certification—§ 39.11(f)(4)

After § 39.11 was adopted, the Division of Clearing and Risk 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.
25

The Commission is codifying the staff guidance by amending § 39.11(f)(4) to require the certification because the Commission believes that requiring the person responsible to certify as to the accuracy of the report encourages that person to review the report more carefully and therefore reduces the likelihood of inaccuracies in the report.

25
Memorandum to All Registered DCOs from Ananda Radhakrishnan, Director, Division of Clearing and Risk, June 7, 2012.

D. 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 amending those provisions to require a DCO to “have” rules.
26

In addition, the Commission is amending § 39.12(b)(2), which requires a DCO to adopt rules providing that all swaps with the same terms and conditions are economically equivalent within the DCO, so that it explicitly applies only to those DCOs that clear swaps.

26
The Commission also proposed to renumber paragraphs (i)(A), (i)(B), and (ii) of § 39.12(a)(5) as paragraphs (ii), (iii), and (iv), respectively.

The Commission did not receive any comments on the proposed changes to § 39.12, and is adopting the changes as proposed.

E. Risk Management—§ 39.13

The Commission is adopting several changes to § 39.13, which sets out risk management requirements for DCOs. Unless stated otherwise below, the Commission did not receive any comments on the proposed amendments to § 39.13 and is adopting them as proposed.

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 replacing “[d]ocumentation requirement” with “[r]isk management framework” and 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 that a DCO, “through margin requirements and other risk control mechanisms, shall limit its exposure to potential losses from defaults by its clearing members 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. Recognizing that a DCO cannot ensure protection from that which it cannot anticipate, the Commission is revising § 39.13(f) to require a DCO to “limit its exposure to potential losses from defaults by clearing members through margin requirements and other risk control mechanisms reasonably designed to ensure that . . . .”

The Commission had proposed to change “to ensure that” to “to minimize the risk that.” However, in this instance, the Commission has decided to adopt language suggested by commenters because the Commission believes that it better articulates the DCO's obligations. ICE supported replacing “ensure” with “minimize the risk” in § 39.13(f) and making conforming changes. However, FIA and ISDA expressed concern that the change, if interpreted to alter a DCO's existing obligations, would increase the potential for non-defaulting clearing members to be exposed to uncapped liability. FIA and ISDA suggested revising the language to instead require a DCO to “limit its exposure to potential losses from defaults by clearing members through margin requirements and other risk control mechanisms
reasonably designed to
ensure that . . . .” In response to a comment from FIA and ISDA, the Commission notes that this change clarifies, but does not alter, a DCO's existing obligations under this provision.

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. The Commission is amending § 39.13(g)(2)(i) to delete the statement in the existing regulation that such risks “includ[e] but are not limited to jump-to-default risk or similar jump risk.” The Commission had proposed to amend the regulation to keep this statement and add a statement that such risks also include “concentration of positions.” However, upon considering comments on the proposal, the Commission is concerned that including and adding to a list of examples of types of risks might be interpreted to mean that a DCO does not have to consider risks not mentioned. The Commission reiterates that a DCO should consider a range of risks, including, for example, jump-to-default risk, concentration risk, correlation risk, and other risks associated with the particular products and portfolios it clears. However, the Commission further notes that DCOs have discretion with respect to how they identify, label, and address such risks; therefore, the Commission is declining to define such terms.

LCH commented in support of the proposed revisions to § 39.13(g)(2)(i). However, although FIA and ISDA agreed that a DCO should consider concentration risk when establishing initial margin requirements, they requested that the Commission define this term in a re-proposed rule. FIA and ISDA further suggested that concentration risk could be defined to include positions that cannot be closed in a two-day period. Alternatively, they suggested that concentration risk could be more broadly defined. FIA and ISDA recommended that initial margin should cover concentration risk over the period that it would take to liquidate a defaulting participant's positions, and that initial margin requirements should consider the concentration risk of open positions relative to product liquidity and percentage of open interest. FIA and ISDA also recommended that a DCO's initial margin requirements evaluate concentration risk at an account level. Finally, FIA and ISDA requested that the Commission require in a re-proposal that a DCO consider other risk factors, such as correlation and pro-cyclicality, when determining its initial margin requirements. However, as explained above, the Commission has determined that including in § 39.13(g)(2)(i) a list of examples of types of risks might be interpreted to mean that a DCO does not have to consider risks not mentioned. Instead, a DCO should consider a range of risks based on the particular products and portfolios it clears, and it has discretion in how it identifies and addresses such 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 adopting proposed amendments to 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, as long as the affiliate's employees are not responsible for the development or operation of the systems and models being tested. In addition, the Commission is further modifying § 39.13(g)(3) to specify that, where no material changes have been made to a DCO's margin model, previous validations can be reviewed and affirmed as part of the annual review process, as recommended by several commenters. The Commission is adopting this change because it agrees with commenters that it is unnecessarily burdensome to require DCOs to revalidate models that have not changed since the previous validation.

ICE expressed support for permitting employees of an affiliate of the DCO to conduct initial margin model validations. LCH also supported the proposed changes to § 39.13(g)(3). Nodal argued that requiring annual validations of a DCO's systems for generation of initial margin requirements, even for theoretical models, is unnecessary because theoretical models do not change from year to year. Nodal added that annual validations would present an undue burden for certain DCOs due to the significant cost and time involved in obtaining an independent validation. Nodal requested that, if the Commission requires annual validations as proposed, it exclude theoretical models from the annual validation requirement to the extent that they have not materially changed since the prior independent validation. CME commented that, in revising § 39.13(g)(3), the Commission should consider the provisions of the Bank Holding Company Supervision Manual, which allows banks to take varying approaches to model validations from year to year.
27

In particular, CME stated that, in some cases where no material changes have occurred, the manual suggests that previous validations could be reviewed and affirmed as part of the annual review process.

27
Board of Governors of the Federal Reserve System, Division of Supervision and Regulation,
Bank Holding Company Supervision Manual—Model Risk Management,
Section 2126.0.5 (Feb. 2019), available at
https://www.federalreserve.gov/publications/files/bhc.pdf.

FIA and ISDA supported the proposal to replace the requirement to review and validate margin models on a “regular basis” with a requirement to do so “on

an annual basis.” They also supported allowing a DCO to exercise discretion concerning the extent of the annual validation process depending, for example, on whether material changes have been made to the margin model since the prior validation, and cited to the Bank Holding Company Supervision Manual as well.

FIA and ISDA also requested that the Commission withdraw the proposal to allow employees of an affiliate of a DCO to conduct an initial margin model validation and instead require in a re-proposed rule that a qualified and independent third party must conduct the initial margin model validation. FIA and ISDA argued that employees who validate an initial margin model used by more than one affiliated DCO may fail to analyze whether a single model is appropriate for different products cleared by different affiliated DCOs. FIA and ISDA further suggested that the Commission re-propose several adjustments to a DCO's initial margin model validation process to increase transparency. The Commission believes it is appropriate to permit a DCO's employees or employees of an affiliate of the DCO to conduct the validations, provided they are not responsible for development or operation of the systems and models being tested. Since § 39.13(g)(3) has been in place, the Commission has not encountered any issues with employees of a DCO conducting the validations; therefore, the Commission believes it is appropriate to permit employees of an affiliate of the DCO to conduct the validations.

c. Spreads and Portfolio Margins—§ 39.13(g)(4)

To be consistent with other Commission regulations, 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. LCH supported the proposed changes.

d. Back Tests—§ 39.13(g)(7)

The Commission is adopting 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.

LCH supported the proposed changes to § 39.13(g)(7)(iii). ICE agreed that portfolio back testing of the statistical performance of the core margin model should be solely based upon market risk factors that can be directly measured and tested. However, ICE commented that, when performing back testing to assess whether the DCO has collected sufficient margin to meet its coverage requirement, the DCO should include all of the margin model's charges and add-ons, “in other words, all of the margin resources available to mitigate the risk of the position (excluding any voluntary excess posted by a clearing member).” In contrast, although SIFMA AMG agreed that clarification is necessary in this regard, it suggested that margin add-ons, which it noted are outside of the model framework, should not be included when back testing a margin model. SIFMA AMG stated that excluding the impact of these and other similar add-ons will reduce the likelihood of misrepresenting the actual margin coverage produced by a DCO's models, as their inclusion may result in margin breaches going undetected. In addition, SIFMA AMG stated that margin add-ons are often calculated at the sole discretion of the DCO and are not readily replicable by market participants. SIFMA AMG further stated that DCOs should disclose these back-testing results at the contract level, rather than the account level, to increase transparency and facilitate enhanced risk monitoring by all market participants.

In response to the comments, the Commission notes that comparing portfolio losses only to components of initial margin that capture changes in market risk factors reduces the likelihood of misrepresenting the actual margin coverage produced by a DCO's models, as the inclusion of other components may result in margin breaches going undetected.

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). The Commission is revising § 39.13(g)(8)(i) to clarify that initial margin must be collected on a gross basis only at the end-of-day settlement cycle.

OCC supported the proposed changes. The Commission also received two comments specific to its statement in the Proposal that, notwithstanding the proposed change to the rule text, a DCO should also collect customer initial margin from its clearing members on a gross basis during any intraday settlement cycle in which the DCO collects customer initial margin if the DCO is able to calculate the margin accurately.
28

LCH stated that it supports the intraday collection of customer initial margin on a gross basis because it supports the risk management function of a DCO. By contrast, FIA and ISDA argued that the Commission should not encourage a DCO to collect gross customer initial margin during an intraday settlement cycle because it would create significant operational problems.

28

See
Derivatives Clearing Organization General Provisions and Core Principles, 84 FR 22236.

In response to the comment from FIA and ISDA, the Commission reiterates that it recommends that a DCO should collect customer initial margin from its clearing members on a gross basis during any intraday settlement cycle in which the DCO collects customer initial margin, but only if it is able to calculate the margin accurately. The Commission further reiterates that it would not expect a DCO to collect customer initial margin on an intraday basis if it would create significant operational problems for the DCO or its clearing members.

Furthermore, the Commission is adopting amendments to § 39.13(g)(8)(i)(B) to 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 individual customer account within each customer origin of the clearing member. The Commission is requiring that the daily reports specify positions of “each individual customer account” instead of “each beneficial owner,” as originally proposed, to be consistent with the information that DCOs must report to the Commission pursuant to § 39.19(c)(1), as discussed below.

OCC commented that the proposed changes to § 39.13(g)(8)(i)(B) would introduce a significant shift in the burden to maintain customer-level records from FCMs and introducing brokers to a DCO. OCC stated that virtually every FCM clears through multiple DCOs, so requiring a DCO to collect and report this customer-level information to the Commission does not in fact allow the Commission to appropriately understand the risks associated with individual customers without further aggregating the data that various DCOs receive from an individual FCM. OCC represented that it and its clearing members would need to make significant operational changes to obtain this information and report it daily, and OCC would need to make corresponding rule changes.

MGEX noted that while FCMs know and have a relationship with their customers, clearing members do not necessarily have such a relationship with the customers of FCMs for which they clear. Therefore, a rule requiring clearing members to report customer level information is impractical, and

attempting to apply this requirement at the FCM level would similarly be problematic, as certain FCMs with omnibus accounts may not have a relationship with the clearing member's DCO.

ICE supported the transparency associated with reporting of additional customer level information, but noted that the Commission should further consider the costs to clearing members and DCOs of developing new operational systems and procedures that the proposal would necessitate, and consider ways to phase in any new requirements to allow for the necessary development of new operational systems and procedures, at both the DCO and clearing member levels. ICE commented that DCOs and market participants should also have the opportunity to consider whether the changes could affect other longstanding practices, such as the treatment by DCOs of the risk in the customer account on a net basis, and encouraged the Commission to work with and consult the industry as a whole to implement any changes to current practices.

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.” Shortly after this provision was first adopted, the Commission became aware that it was being interpreted by DCOs in a way that would have significantly increased margin requirements for customers in a way that the Commission did not intend. This was addressed at the time through an interpretative letter issued by the Division of Clearing and Risk that accurately reflected the Commission's original intent.
29

The Commission is now amending the provision, consistent with the staff interpretation, to permit DCOs to establish 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.

29
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).

The Commission received three comments in support of the proposed changes to § 39.13(g)(8)(ii) and one comment in opposition. OCC supported the proposed changes and stated, in response to a specific request for comment from the Commission, that further clarification on what would be considered “commensurate with the risk presented” is unnecessary. ICE supported the proposed changes to § 39.13(g)(8)(ii) giving DCOs discretion in determining the percentage by which customer initial margin requirements must exceed the DCO's clearing initial margin requirements. CME supported codification of the staff interpretation but was concerned that the proposed changes to § 39.13(g)(8)(ii) would shift the burden of determining the appropriate level of additional customer margin from FCM clearing members to DCOs. As a result, CME requested that § 39.13(g)(8)(ii) be further amended to state that “the [DCO] shall have reasonable discretion in determining clearing initial margin requirements for products or portfolios and whether and by how much customer initial margin requirements for categories of customers determined to have heightened risk profiles by their clearing members must exceed, at a minimum, the [DCO]'s clearing initial margin requirements by a standardized amount.” The Commission is adopting similar revisions, in order to confirm that the changes to § 39.13(g)(8)(ii) are not intended to shift the burden of determining the appropriate level of additional customer margin from clearing members to the DCO.

FIA and ISDA commented that the proposed change to customer initial margin requirements may impose an operationally impractical regime for clearing members to collect initial margin from customers, arguing that the proposed amendments would give DCOs too much discretion and encourage DCOs to apply differing measures to assess additional margin. FIA and ISDA believe that clearing members would benefit from a common approach to additional margin among DCOs. FIA and ISDA recommended that, regardless of whether the Commission adopts the proposed change, it should codify earlier no-action relief which clarifies that the initial margin requirements in § 39.13(g)(8)(ii) do not apply to security futures positions.

With respect to the applicability of § 39.13(g)(8)(ii) to security futures positions, the Commission notes that the interpretative guidance provided in CFTC Letter No. 12-08 is still in effect. The Commission further notes that it has received similar comments in connection with a recently proposed joint rulemaking issued by the Commission and the SEC on this topic, and believes that it is more appropriate to consider whether or not to codify this relief as part of that rulemaking.
30

30
Customer Margin Rules Relating to Security Futures, 84 FR 36434 (July 26, 2019).

g. Haircuts—§ 39.13(g)(12)

Regulation 39.13(g)(12) requires a DCO to apply “haircuts” to the assets that it accepts in satisfaction of initial margin obligations, and to evaluate the appropriateness of the haircuts on at least a quarterly basis. Regulation 39.11(d)(1) requires a DCO to evaluate on a monthly basis its haircuts for assets that are used to meet the DCO's financial resources obligations set forth in § 39.11(a) (
i.e.,
its “cover one” default resources). The Commission is amending § 39.13(g)(12) to align it with § 39.11(d)(1) by requiring that a DCO evaluate the appropriateness of the haircuts that it applies 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 may change frequently, the Commission believes it is appropriate to assess haircuts more frequently.

The Commission received one comment in support of the proposal and one comment in opposition. FIA and ISDA stated that the proposed change is appropriate given the frequent changes in the value of assets held for initial margin. LCH disagreed with the proposed change, stating that, in normal market conditions, haircuts do not significantly change, or may not change at all, from month to month. LCH suggested that haircut reviews continue to be required on a quarterly basis, but that the Commission enhance § 39.13(g)(12) by mandating that DCOs review haircuts more frequently in the event of specific scenarios, such as breach of back testing or high market volatility, which would affect the valuation and liquidity of eligible collateral.

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 proposed to amend the provision to specify that risk limits

should also be imposed to address positions that may be difficult to liquidate.

The Commission has determined not to adopt the proposed changes to § 39.13(h)(1) at this time, but will continue to consider this issue further. The Commission remains concerned about positions that may be difficult to liquidate, particularly concentrated positions. As the Commission mentioned in the Proposal, recent events, including a significant loss from a default at a central counterparty outside of the Commission's jurisdiction, highlight the importance of addressing such positions. However, the Commission believes that DCOs should address difficult-to-liquidate positions using the DCO's margin methodology and consider whether and what other measures may be appropriate.

OCC opposed the proposed change, in favor of addressing difficult-to-liquidate positions through a DCO's margin methodology. OCC argued that margin requirements can more effectively account for the liquidity risk associated with specific positions held by specific clearing members, because margin requirements can be tailored to the risks and particular attributes of each relevant product, portfolio, and market. The margin requirements can then serve as one input a DCO uses in determining the appropriate risk limits. FIA and ISDA noted that the proposed imposition of hard risk limits on positions that may be difficult to liquidate would be a significant departure from current risk management practices for clearing members. FIA and ISDA suggested that the Commission should withdraw the proposed change to § 39.13(h)(1)(i) and consult with DCOs and clearing members about how to best risk-manage positions that are difficult to liquidate. LCH agreed that DCOs should have procedures in place to address clearing members with large positions that may be difficult to liquidate in the event of a default. However, LCH suggested that, rather than setting bright-line limits on the maximum size of such positions, the Commission should require DCOs to have measures in place, such as margin add-ons, to address concentration risk. LCH stated that this would be an appropriate approach because the mitigants against concentration risk of certain positions in any one clearing member would be built into the DCO's risk model. LCH further indicated that setting and maintaining such hard limits may result in market fragmentation or artificial limits that are not risk related and may inadvertently create disincentives to clearing.

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 adopting an amendment to this regulation 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 received one comment in support of the proposal and two comments in opposition. LCH supported the proposed changes regarding clearing member risk management policies and procedures. FIA and ISDA stated that the proposed change that would require a DCO to take appropriate actions to address concerns resulting from a review of a clearing member's risk management policies and procedures is unnecessary. ICE opposed requiring DCOs to supervise or impose changes in the risk management policies of clearing members, and commented that any such requirement would be more appropriate at the designated self-regulatory organization (DSRO) level, rather than the DCO level.

In response to ICE's suggestion that clearing member risk reviews should be conducted by a DSRO, the Commission notes that not all clearing members are subject to the supervision of a DSRO. The Commission disagrees with FIA and ISDA's comment that requiring a DCO to take appropriate actions to address concerns resulting from a review of a clearing member's risk management policies and procedures is unnecessary. As the Commission stated in the Proposal, absent such follow-up, the reviews would lack purpose.

5. Cross-Margining—§ 39.13(i)

The Commission is codifying its existing practices for evaluating cross-margining programs in new § 39.13(i), which requires a DCO that seeks to implement or modify a cross-margining program with one or more other clearing organizations to submit rules for Commission approval pursuant to § 40.5. However, the Commission is not adopting the proposed requirement that a DCO provide, at a minimum, specific information needed to facilitate the Commission's review of the rule filing. Rather, the Commission is requiring that a DCO submit information sufficient for the Commission to understand the risks that would be posed by the program and the means by which the DCO would address and mitigate those risks. The Commission believes that leaving it to the discretion of the DCO to determine what information to provide, yet giving the Commission the ability to request any additional information it may need to conduct its review of a cross-margining program, is appropriate given that cross-margining programs can vary greatly, depending on the products, participants, and clearing organizations involved. The Commission notes, however, there may be instances where a cross-margining program would require approval beyond the § 40.5 submission. For example, a cross-margining program between a registered DCO and a clearing organization that is not registered with the Commission may require relief from section 4d of the CEA for FCM customers to be eligible to participate.

The Commission received one comment in support of the proposal and one comment in opposition. FIA and ISDA supported the proposal, stating that it would increase transparency and improve the ability of clearing members to manage the risks associated with positions subject to cross-margining. They recommended that the Commission consider including in its evaluation the credit and liquidity risk management, settlement, and default management-related principles identified in the PFMIs. In addition, FIA and ISDA suggested that the Commission should require DCOs participating in a cross-margining arrangement to consult with their respective clearing members.

OCC opposed the proposal to require a DCO to provide specific types of information, arguing that it would reduce the Commission's flexibility to determine what types of information are necessary for it to review in specific circumstances. OCC suggested that a DCO should not be required to provide each of the specified types of information when it is requesting the Commission's approval to update an existing cross-margining program, where analyzing factors unrelated to the change for which it is requesting approval would create an unnecessary burden. OCC suggested that instead the Commission should issue guidance on what information it may require in its review of a cross-margining program. OCC further requested that, should the Commission nonetheless choose to require specific types of information in proposed § 39.13(i), the information should only be required when the Commission reviews a new cross-

margining program and not when the Commission reviews changes to an existing cross-margining program. OCC also suggested that DCOs should be able to submit a cross-margining program under either § 40.5 or § 40.6(a), and requested that the Commission only apply the § 40.5 review process to a new cross-margining program.

In response to FIA and ISDA's comment on consulting with clearing members, the Commission notes that § 40.5(a)(8) requires a DCO to provide a brief explanation of any substantive opposing views expressed by its members that were not incorporated into the rule, or a statement that no such opposing views were expressed. The Commission recognizes that § 40.5(a)(8) does not require consultation with clearing members. Because the Commission did not propose this requirement, it cannot adopt it at this time but may consider it in conjunction with a future rulemaking.

The Commission considered OCC's recommendation that a DCO be able to submit cross-margining rules pursuant to § 40.6,
31

but has determined to adopt the requirement to submit such rules under § 40.5 as proposed to give the Commission sufficient time to consider those rules. The Commission confirms, however, that it may expedite the rule approval process under § 40.5(g) where appropriate.

31
The Commission has approved prior cross-margining arrangements pursuant to its rule approval process or by Commission order.
See
Derivatives Clearing Organization General Provisions and Core Principles, 84 FR 22238, n. 51 (discussing prior cross-margining arrangements approved by the Commission). In the discussion in the Proposal of prior cross-margining arrangements approved by the Commission, the Commission referenced certain orders that were amended to incorporate the provisions of Appendix B, Framework 1 to the Commission's part 190 regulations. The Commission notes that Framework 1 would no longer apply in this context, as cross-margining arrangements would be approved pursuant to § 40.5 rather than by Commission order.

F. Treatment of Funds—§ 39.15

The Commission is adopting as proposed amendments to § 39.15, which concerns a DCO's treatment of clearing member and customer funds. Regulation 39.15(b)(2)(ii) is being amended to permit a DCO to file rules for Commission approval pursuant to § 40.5, rather than request a Commission order, to allow the DCO and its clearing members to commingle cleared swaps, foreign futures, or foreign options with futures and options in an account subject to the requirements of section 4d(a) of the CEA (
i.e.,
the futures account). This is consistent with the existing requirements for commingling futures with cleared swaps in the cleared swaps customer account pursuant to § 39.15(b)(2)(i) (which is also being amended to permit foreign futures and foreign options to be held in the account). 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.”
32

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.”
33

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.

32
Derivatives Clearing Organization General Provisions and Core Principles, 76 FR 69392.

33

Id.

The Commission is also amending § 39.15(d) to require the “prompt,” but not necessarily simultaneous, transfer of a customer's positions and related funds from one clearing member to another clearing member “as necessary.” The Commission had proposed this change because, although a DCO may transfer positions from one clearing member to another, the DCO does not generally transfer funds.

ICE generally supported the proposed amendments to § 39.15, including allowing commingling of swaps in a futures account pursuant to rules submitted under § 40.5 rather than pursuant to a separate Commission order under section 4d of the CEA. LCH, FIA, and ISDA supported the proposed amendment to § 39.15(d) to require the prompt, but not necessarily simultaneous, transfer of a customer's positions and related funds. FIA and ISDA noted that clearing members transfer positions before related collateral is transferred under current market practice. LCH noted that proposed § 39.15(d) reflects how funds are transferred, especially where there is third-party involvement and the simultaneous transfer of funds may not be possible.

The Commission did not receive any comments on the proposed technical changes to § 39.15(b)(2)(iii) and (e) and is adopting those changes as proposed.

G. Default Rules and Procedures—§ 39.16

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. The Commission is adopting an amendment to § 39.16(b), as further modified in response to a comment from FIA and ISDA, to require that the DCO include clearing members and participants in a test of its default management plan on at least an annual basis to the extent the plan relies on their participation. The Commission continues to believe, as noted in the Proposal, that a DCO should ensure that a sufficient portion of its clearing membership participates in such testing.

OCC supported the proposed change but stated that a DCO should have broad discretion to determine whether a “sufficient portion” of its clearing membership is participating. OCC noted that the number of clearing members that participate in a default management test is not necessarily indicative of whether a DCO's default management plan has been tested effectively, and that other factors must also be considered.

FIA and ISDA generally supported the proposed change but recommended that the rule refer to clearing members and “participants” so that, if a DCO's rules allow non-clearing members to participate in an auction of a defaulting clearing member's positions, a sufficient portion of such participants should be required to participate in the testing of the DCO's default management plan. FIA and ISDA further suggested that participation in testing should be tied to asset classes so that only clearing members that carry positions, or participants that trade, in a particular asset class are required to participate in tests of a DCO's default management plan for that particular asset class. Lastly, FIA and ISDA recommended that DCOs should be required to coordinate the testing of their respective default management plans so that the requirement to participate in testing of the plan does not place an undue burden on clearing members.

Nodal commented that the requirement to include clearing members in a test of a DCO's default management plan is not necessary for a DCO that does not rely exclusively on clearing member auctions. Nodal requested that the Commission limit the application of the proposed rule, if adopted, to those DCOs that primarily rely on a clearing member auction process in their default management

plans, rather than applying it to all DCOs.

As to FIA and ISDA's suggestion that participation in testing should be tied to asset classes, the Commission believes that this decision is in the DCO's discretion. Lastly, as to FIA and ISDA's recommendation that DCOs should be required to coordinate the testing of their respective default management plans, the Commission encourages DCOs to coordinate the testing of their default management plans to the extent possible to avoid placing an undue burden on clearing members and participants.

2. Default Procedures—§ 39.16(c)

a. Default Committee—§ 39.16(c)(1)

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 of its clearing members. The Commission proposed 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. In light of the strong divergence in the views expressed in the comments received on this proposal, the Commission has determined not to adopt the proposed changes to § 39.16(c)(1) at this time. The Commission wishes to give industry stakeholders some time to come closer to consensus on this issue.

Some comments generally supported the proposal. MFA supported the proposal to allow non-clearing members to participate in a DCO's default committee. MFA noted, however, that the proposal permits but does not require customer participation, and requested that the Commission affirmatively mandate customer involvement. MFA understands that DCOs already have the authority to voluntarily include customers in their default committees, but that they have chosen not to do so.

FIA and ISDA generally supported the proposed requirement that a DCO have a standing default committee. They recommended, however, that, absent exigent circumstances, the default committee convene whenever a material default occurs, not only when a default involving substantial or complex positions occurs. FIA and ISDA also supported the proposed requirement that the default committee include clearing members, but they recommended that clearing members be allowed to voluntarily participate on default management committees.

Mr. Saguato supported the proposal to have clearing member and customer participation on a DCO's default committee. Mr. Saguato suggested that the Commission explore the costs and benefits of further increasing and formalizing the role of clearing members and their customers in the default process, as Mr. Saguato believes clearing members should have a primary role in setting default procedures. Furthermore, SIFMA AMG agreed that DCOs should have a standing committee to address all defaults.

Other comments opposed the proposal. ICE did not believe that requiring the use of a default committee that includes clearing members and other participants is advisable. ICE noted that it is not clear what criteria would be used to determine whether a default scenario is “complex” or “substantial,” or who would make the determination. ICE commented that it is not feasible for these and other considerations to be addressed in a rule, which therefore weighs against mandating the use of a default committee.

MGEX urged the Commission to permit a DCO's pre-existing risk or risk management committee to also serve as the default committee. MGEX indicated that allowing this type of dual-purpose committee would offer smaller entities with less complex product offerings a more immediate and efficient implementation, while avoiding the potential difficulty in finding sufficient clearing member interests to fill two separate committees.

CME commented that the proposal to require a default committee and clearing member participation on that committee risks unnecessarily prolonging and overcomplicating the default management process. CME also stated that a DCO's default management plan should account for the risks from substantial and/or complex portfolios, and these types of portfolios should be addressed in the design and testing phases of a DCO's default management plan and its day-to-day risk management. Lastly, CME noted that providing information on a defaulted clearing member's portfolio to the clearing members on the DCO's default committee, independent of their participation in subsequent liquidation or auction processes, increases the risk of information leakage and disadvantageous pricing.

Nodal commented that requiring a DCO to have a default committee that includes clearing members or other participants is not likely to assist in efficiently managing the positions of the defaulting member; instead, it would add unnecessary complexity to what is already an efficient process. Nodal further stated that having clearing members on a default committee could create the potential for conflicts for any clearing member or participant selected, as well as introduce an element of self-interest or potential gaming within the decision-making of the default procedure and response. Finally, OCC commented that “substantial or complex positions” should not include exchange-traded products.

b. Declaration of Default—§ 39.16(c)(2)(ii)

The Commission is adopting an amendment to § 39.16(c)(2)(ii) to require that a DCO have default procedures that include public notice on the DCO's website of a declaration of default. However, the final rule differs from the proposal in that it does not require “immediate” public notice of a default. Instead, the final rule is silent on the timing of the notice. The Commission believes that a DCO should provide public notice as quickly as possible, taking into account the potential negative impact that it might have on the DCO's ability to manage the default.

The Commission had requested comment as to whether the timing of the announcement would potentially impact the market or the DCO's ability to manage the default. SIFMA AMG agreed with the proposal to require a DCO's default procedures to include immediate public notice on the DCO's website of a declaration of default. CME recommended that the Commission permit DCOs to exercise discretion on the timing of a public notice of a declaration of default where such notification could negatively impact the ability of the DCO to manage the default. CME noted that mandatory immediate public notification runs the risk of causing disadvantageous pricing for liquidation or auctions, which could increase the costs to the DCO of managing the clearing member default, and if losses are incurred, could ultimately increase the risk of mutualizing losses among its clearing members.

Mr. Saguato commented that requiring immediate public notice of a declaration of default is unnecessary and potentially counterproductive to an effective default management process

and should not be adopted as proposed. Mr. Saguato further stated that markets should be notified only at the completion of the default management process, to avoid the risk of spillovers.

OCC suggested that the Commission consider whether “prompt” public notice on the DCO's website would be more appropriate for consistency with the timing of other activities a DCO must perform pursuant to its default management plan and the responsibility of a clearing member to provide the DCO with prompt notice if it becomes insolvent. OCC noted that requiring immediate public notice may result in a DCO notifying the public of a default before the DCO has complete information about the default, which may trigger market panic before the DCO is able to understand the circumstances giving rise to the default and the market impact.

Eurex opposed the requirement to provide immediate public notice, arguing that it could adversely affect the DCO's ability to manage a default and may interfere with the DCO's existing notification practices with respect to porting, for example. Nodal, FIA, and ISDA noted that the timing of an announcement of a default could potentially affect the market and the ability of the DCO, clearing members, and customers to manage the risks and consequences of the default. Therefore, Eurex, Nodal, FIA, and ISDA recommended that the Commission allow a DCO to have flexibility in the manner and timing of these notices. MGEX generally agreed that public notice of a default is vital for promoting the integrity and stability of financial markets, but suggested that the Commission give DCOs discretion with respect to the timing of posting such notice, which would allow the DCO to consider the nature of the default and any circumstances warranting flexibility.

ICE commented that, depending on the facts and circumstances of a default, an immediate announcement could potentially impact the market and the DCO's ability to manage the default. ICE therefore suggested that DCOs should be required to provide public notice of a default “as soon as practicable under the circumstances.”

c. Allocation of Defaulting Clearing Member's Positions—§ 39.16(c)(2)(iii)(C)

Regulation 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 adopting an amendment to this provision to provide 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 amendment is intended to clarify that a clearing member that w

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2020-01065. Public record. Not legal advice.