Conflicts and Affiliations

Federal RegisterAug 6, 2026

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 37, 38, and 39

RIN 3038-AF76

Conflicts and Affiliations

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Notice of proposed rulemaking.

SUMMARY:

The Commodity Futures Trading Commission (“CFTC” or “Commission”) is proposing new rules and amendments to its existing regulations for futures commission merchants (“FCMs”), swap execution facilities (“SEFs”), designated contract markets (“DCMs”), and derivatives clearing organizations (“DCOs”) (the “Proposal”). The Proposal addresses requirements relating to financial oversight of FCMs by self-regulatory organizations (“SROs”) and designated self-regulatory organizations (“DSROs”), as well as disclosure requirements by FCMs regarding affiliate relationships that an FCM has with a SEF, DCM, or DCO. For SEFs, DCMs, and DCOs, the Proposal would also establish requirements, including conflicts of interest rules, to address those registered entities' relationships with certain affiliates, such as FCM affiliates and affiliated principal trading firms. The Proposal includes guidance regarding the implementation of safeguards to protect the impartiality of SEFs, DCMs, and DCOs, including where applicable in their role as SROs or performing SRO functions with respect to certain affiliates. The guidance addresses the sharing of resources including staffing, technology, and office space, and limitations on the sharing of non-public information.

DATES:

Comments must be in writing and received by October 5, 2026.

ADDRESSES:

You may submit comments, identified by “Conflicts and Affiliations” and RIN 3038-AF76, by any of the following methods:

•

Regulations.gov:

Go to

https://www.regulations.gov

and press the “Search” button, then proceed as follows:

1. Under Refine Documents Results—check the box to “Only show documents open for comment”;

2. Under Agency—select “See More” and check the box for “Commodity Futures Trading Commission,” then press the Apply button;

3. Identify this proposal in the list of CFTC documents open for comment, press the “Comment” button to open the submission form, and follow the instructions on the form.

Alternatively, if you are viewing this proposal on

www.federalregister.gov,

click the “Submit A Public Comment” button at the top of the page to open the comment form. Follow the instructions on the form to submit your comment to

Regulations.gov

•

Mail:

Send to Christopher Kirkpatrick, Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581.

•

Hand Delivery/Courier:

Address to—CFTC Comment Submission, Attn: Christopher Kirkpatrick, Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581.

Please submit your comments using only one of these methods. To avoid possible delays with mail or in-person deliveries, submissions through

Regulations.gov

are encouraged.

All comments must be submitted in English, or if not, accompanied by an English translation. Do not include in your comment text or attachments any personal identifying information or business information that you do not want published online. Comments (regardless of submission method) will be published without review for, and without removal of, any personal identifying information or information your business may consider confidential.

If you wish to submit confidential information for the Commission's consideration, please contact the CFTC personnel listed in this Notice under

FOR FURTHER INFORMATION CONTACT

before making any submission. Please also carefully review the Commission's procedures in 17 CFR 145.9 for requesting confidential treatment under the Freedom of Information Act (“FOIA”) of information submitted to the Commission.

The CFTC reserves the right, but shall have no obligation, to review, pre-screen, filter, or redact all or any part of your comment submission. The CFTC also reserves the right, without further notification, to refuse to publish or to remove from public view all or any part of your submission to the extent it contains content inappropriate for publication in a comment file, such as—without limitation—obscene language, threats of violence, solicitations for commercial sales or illegal activity, or obvious spam. If a submission that is refused for or withdrawn from publication because of inappropriate content also contains comments on the merits of this proposal, such submission will be retained in the record for the matter and will be considered as required under the Administrative Procedure Act (“APA”) and other applicable laws, and may be accessible under the FOIA.

Pursuant to the APA at 5 U.S.C. 553(b)(4), a plain language summary of the proposed rule is available at

Regulations.gov

FOR FURTHER INFORMATION CONTACT:

Stephen Andrews, Deputy General Counsel for Regulation,

sdandrews@cftc.gov,

202-418-5000, Office of the General Counsel, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581; Aaron Levine,

alevine@cftc.gov,

646-746-9700, Office of the General Counsel, Commodity Futures Trading Commission, 290 Broadway, New York, NY 10007.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction

A. Background

B. Regulatory Background

C. SEF and DCM Statutory and Regulatory Requirements

D. FCM Statutory and Regulatory Requirements

E. DCO Statutory and Regulatory Requirements

F. Current Affiliated Relationships

II. DCM Obligations—Proposed Amendments to Commission Regulations 1.52, 38.604, and 38.606

A. Proposed Amendments to Commission Regulation 1.52—SRO Surveillance of Financial Requirements for Affiliate FCMs

B. Proposed Amendments to Commission Regulations 38.604 and 38.606—DCM Financial Surveillance of Members and Third-Party Regulatory Service Providers

III. Exchange-Related Conflicts Mitigation

A. Proposed New Commission Regulations 38.852 and 37.1201—Conflicts of Interest Involving an Affiliate Market Participant

B. Proposed New Commission Regulations 38.852(b) and (c)—Prohibition on Affiliate Principal Trading Firms and Conditional Affiliate Market Maker Exception

C. Proposed New Commission Regulation 38.853—Board Composition, Regulatory Oversight Committee, and Disciplinary Panels

IV. DCO-Affiliate Clearing Member—Proposed Amendments to Commission Regulations 39.2, 39.21, and 39.25

A. Background

B. Comments on the Affiliations RFC

C. Identified Concerns

D. Proposed Amendments

E. Statutory Authority

F. Alternatives Considered

G. Request for Comment

V. Public Disclosures by FCMs—Proposed Amendment to Commission Regulation 1.55

A. Background

B. Comments on the Affiliations RFC

C. Proposed Amendments

D. Statutory Authority

E. Alternatives Considered

F. Request for Comment

VI. Compliance Responsibility

VII. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

C. Consideration of Costs and Benefits

D. Antitrust Considerations

E. Executive Orders 12866, 13563, and 14192

List of Subjects

I. Introduction

A. Background

The Commission proposes new rules and amendments to its existing regulations for SEFs, DCMs, DCOs, and FCMs that would further establish requirements and guidance applicable to those entities' relationships with certain affiliated entities. Exchanges, DCOs, and intermediaries are already subject to requirements addressing conflicts of interest, reporting, and disclosure. However, the Commission preliminarily believes that the regulated entities would benefit from new regulations and amendments to increase the detail and specificity of the existing regulations in order to mitigate potential risks particularly given the increasing number of affiliate relationships among market participants.

In 2023, Commission staff published a request for comment in part in response to growing interest among market participants in affiliated structures (the “Affiliations RFC”).

From the comments it received, and through its experience, the Commission has observed applicants for SEF, DCM, and DCO registration or designation and existing registered entities changing the traditional market structure of a separately-owned and independently operated exchange, market participant, and clearinghouse to an “affiliated” market structure in which these distinct entities share common ownership. Some forms of affiliate relationships have a long history, such as those between DCMs and DCOs, while other forms of affiliate relationships, such as those between a DCM and an affiliate market maker, are comparatively new.

See

CFTC Staff of the Divisions of Market Oversight, Clearing and Risk, and Market Participants, “Request for Comment on the Impact of Affiliations on Certain CFTC-Regulated Entities” (Jun. 27, 2023) (“Affiliations RFC”).

The Commission preliminarily believes that this market structure may provide benefits to the derivatives markets and market participants. In this regard, the Commission believes that facilitating market structure innovation and competition, subject to appropriate safeguards, advances the Commission's mission of promoting the integrity, resilience, and vibrancy of the U.S. derivatives markets.

The Commission recognizes, however, that there may be risks as well, including to unaffiliated market participants such as retail customers. One risk that this Proposal seeks to address is conflicts of interest arising in an affiliated market structure. For example, a situation in which an exchange and a market participant (such as a market maker) on that exchange share common ownership presents conflict of interest concerns regarding an exchange's enforcement of its rules for the affiliated participant. Similar concerns arise regarding the oversight and enforcement functions of a clearinghouse that shares common ownership with a clearing member. This Proposal would require registered entities to have procedures in place to mitigate such potential conflicts of interest, including specifically regarding systems, personnel, and office space, and provides guidance regarding appropriate practices in connection with such procedures. This Proposal also would subject DCMs with affiliate principal trading firms to additional requirements, given the heightened conflicts of interest concerns that may arise in that context.

CFTC Mission Statement,

https://www.cftc.gov/About/AboutTheCommission#:~:text=The%20mission%20of%20the%20C.

The financial oversight of FCMs is governed by the longstanding principle of self-regulation, in which DCMs and registered futures associations are responsible, in their capacity as SROs, to adopt financial and related reporting requirements for member FCMs, and to periodically examine FCMs for compliance with such requirements. The Commission also permits two or more SROs to enter into an agreement to assign to one of the SROs (the DSRO) the function of examining member FCMs for compliance with minimum capital and related financial reporting obligations. Given the inherent potential conflict of interest that exists when an SRO or a DSRO surveils their affiliate FCM, the Proposal comprises requirements designed to minimize potential risks resulting from the conflict, including a requirement for an SRO with an affiliate FCM to establish a separate reporting line for staff performing self-regulatory functions and a prohibition against an SRO acting as the DSRO for its affiliate FCM. The Proposal also strengthens the disclosure requirements imposed on FCMs pursuant to Regulation 1.55 with respect to such affiliate relationships. Additionally, the Proposal would allow an FCM to select its DSRO, subject to certain requirements.

In this Proposal, the Commission is drawing on comments from the Commission staff-issued Affiliations RFC, Commission staff's other discussions with market participants (including DCMs, DCOs, FCMs, and market makers), Commission staff's experience in conducting its routine oversight of SEFs, DCMs, and DCOs, including SEF application registration reviews, DCM designation application reviews, SEF and DCM rule enforcement reviews, DCO applications for registration, and regular engagement with SEFs, DCMs, and DCOs. The Commission has also consulted with DCMs and the National Futures Association (“NFA”),

in their role as SROs and DSROs, and reviewed market practices concerning affiliate relationships between DCMs and FCMs.

NFA is currently the only registered futures association.

In developing the Proposal, the Commission has consulted with the Securities and Exchange Commission (“SEC”) and the prudential regulators, pursuant to section 712(a)(1) of the Dodd-Frank Act.

15 U.S.C. 8302 (“Before commencing any rulemaking or issuing an order regarding swaps, swap dealers, major swap participants, swap data repositories, derivatives clearing organizations with regard to swaps, persons associated with a swap dealer or major swap participant, eligible contract participants, or swap execution facilities pursuant to this subtitle, the Commodity Futures Trading Commission shall consult and coordinate to the extent possible with the Securities and Exchange Commission and the prudential regulators for the purposes of assuring regulatory consistency and comparability, to the extent possible.”).

B. Regulatory Background

Section 8a(5) of the Commodity Exchange Act (“CEA” or the “Act”)

authorizes the Commission “to make and promulgate such rules and regulation as, in the judgment of the Commission, are reasonably necessary to effectuate any of the provisions, or to accomplish any of the purposes, of” the CEA. The Commission preliminarily believes that the Proposal is reasonably necessary to accomplish the purposes of section 3(b) of the CEA which states “[i]t is the purpose of this Act to serve the public interests . . . through a system of

effective self-regulation

of trading facilities, clearing systems [and] market participants . . . .”

This

Proposal addresses critical issues that the Commission believes are necessary for effective self-regulation that have been raised because of affiliations between trading facilities and/or clearing systems and participants in those facilities and/or systems. This Proposal sets out rules and guidance for SEFs and DCMs, which are trading facilities, DCOs, which are clearing systems, and FCMs, which are market participants. In each instance, SEFs, DCMs, and DCOs have self-regulatory obligations.

An affiliation between a SEF, DCM, or DCO and an FCM or other market participant raises questions about the (a) quality of oversight of self-regulation, (b) discretionary decision-making by the DCO, DCM, or SEF, and (c) potential conflicts of interest. The Commission has observed increasing numbers of affiliations in “affiliated” corporate structures of SEFs, DCMs, and DCOs, so the Commission believes it is reasonably necessary to issue this Proposal to specifically address these market structures.

7 U.S.C. 12a(5).

7 U.S.C. 5(b) (emphasis added). As noted above, section 8a(5) of the CEA authorizes the Commission to make and promulgate such rules and regulation as in the Commission's judgment are reasonably necessary to effectuate any of the provisions, or to accomplish any of the purposes, of the CEA. The

Commission is of the view that the best interpretation of section 8a(5) of the CEA is that it delegates to the Commission discretionary authority to establish the proposed rules.

See

17 CFR 1.3 (definition of “self-regulatory organization”) and CEA sections 5b(c)(2)(A)-(R), 7 U.S.C. 7a-1(c)(2)(A)-(R) (DCO Core Principles). Also, for purposes of section 1.52 of the CEA, only DCMs and registered futures associations are included in the definition of SRO because only DCMs and registered futures associations are required to adopt minimum capital and financial reporting requirements for their member firms. SEFs, DCMs, and DCOs are all subject to requirements under the Act and the Commission's regulations to supervise the conduct of their members and participants.

In addition, the Commission, pursuant to section 8a(5) of the CEA, is proposing rules applicable to SEFs, DCMs, DCOs, and FCMs, in order to effectuate the relevant Core Principles and/or provisions of the CEA, as appropriate, for each particular entity. For SEFs, the Commission believes that the Proposal is reasonably necessary to effectuate the Core Principles set out in section 5h(f)(2) (impartial access),

section 5h(f)(10) (reporting),

5h(f)(12) (conflicts of interest),

and section 5h(f)(13) (adequate financial, operational, and managerial resources).

CEA 5h(f)(2), 7 U.S.C. 7b-3(f)(2).

CEA 5h(f)(10), 7 U.S.C. 7b-3(f)(10).

CEA 5h(f)(12), 7 U.S.C. 7b-3(f)(12).

CEA 5h(f)(13), 7 U.S.C. 7b-3(f)(13).

For DCMs, the Commission believes that the Proposal is reasonably necessary to effectuate the Core Principles in section 5(d)(2) (access requirements),

section 5(d)(11) (rules to ensure the financial integrity of any FCM and the protection of customer funds),

section 5(d)(12) (promote fair and equitable trading),

section 5d(16) (conflicts of interest),

and section 5(d)(21) (adequate financial, operational and managerial resources).

CEA 5(d)(2), 7 U.S.C. 7(d)(2).

CEA 5(d)(11), 7 U.S.C. 7(d)(11).

CEA 5(d)(12), 7 U.S.C. 7(d)(12).

CEA 5(d)(16), 7 U.S.C. 7(d)(16).

CEA 5(d)(21), 7 U.S.C. 7(d)(21).

For DCOs, the Commission believes that the Proposal is reasonably necessary to effectuate the Core Principles in CEA section 5b(c)(2)(C) (participant and product eligibility),

section 5b(c)(2)(D) (risk management),

section 5b(c)(2)(J) (reporting),

section 5b(c)(2)(L) (public information),

and section 5b(c)(2)(P) (conflicts of interest).

CEA 5b(c)(2)(C), 7 U.S.C. 7a-1(c)(2)(C).

CEA 5b(c)(2)(D), 7 U.S.C. 7a-1(c)(2)(D).

CEA 5b(c)(2)(J), 7 U.S.C. 7a-1(c)(2)(J).

CEA 5b(c)(2)(L), 7 U.S.C. 7a-1(c)(2)(L).

CEA 5b(c)(2)(P), 7 U.S.C. 7a-1(c)(2)(P).

With respect to FCMs, the Proposal includes rules for those FCMs that are affiliated with an exchange or DCO. The Commission believes that these rules are reasonably necessary to effectuate Section 4f(b) (Commission authority to adopt regulations imposing minimum financial requirements).

CEA 4f(b), 7 U.S.C. 6f(b).

Accordingly, the Commission believes that the amendments in this Proposal relating to affiliations of SEFs, DCOs, DCMs, and FCMs are reasonably necessary to implement the purposes and provisions of the CEA. The application of these statutory provisions for each proposed amendment to current Commission regulations is described in detail below.

C. SEF and DCM Statutory and Regulatory Requirements

The Core Principles in parts 37 and 38, and corresponding regulations, are relevant to the proposed regulations in this Proposal. Their applicability is addressed in more detail with respect to each proposed regulation. Below is a summary of relevant Core Principles and regulations.

SEF Core Principle 12 requires a SEF to (a) establish and enforce rules to minimize conflicts of interest in its decision-making process and (b) establish a process for resolving the conflicts of interest.

DCM Core Principle 16 likewise provides that a board of trade shall establish and enforce rules: (a) to minimize conflicts of interest in the decision-making process of the contract market and (b) to establish a process for resolving conflicts of interest described in paragraph (a) of this section.

Commission Regulation 38.851 refers to the guidance and/or Acceptable Practices in appendix B of part 38 to advise on how DCMs may comply with the Core Principle and implementing regulations.

17 CFR 37.1200.

17 CFR 38.850.

The part 38 Guidance to Core Principle 16 provides that the means to address conflicts of interest in the DCM's decision-making should include methods to ascertain the presence of conflicts of interest and to make decisions in the event of such a conflict.

In addition, the DCM should provide for appropriate limitations on the use or disclosure of material non-public information gained through the performance of official duties by board members, committee members, and contract market employees or gained through an ownership interest in the contract market.

See

17 CFR part 38, app. B—Guidance on, and Acceptable Practices in, Compliance with Core Principles, Core Principle 16, sec. (B)(a).

See id.

The Core Principle 16 Acceptable Practices provide additional details to assist DCMs in demonstrating compliance with the Core Principle by outlining specific compliance practices. Among other things, they provide that DCMs “bear special responsibility to regulate effectively, impartially, and with due consideration of the public interest, as provided for in section 3 of the Act.”

The Acceptable Practices also state that DCMs “should be particularly vigilant for such conflicts between and among any of their self-regulatory responsibilities, their commercial interests, and the several interests of their management, members, owners, customers and market participants, other industry participants, and other constituencies.”

Additionally, the Acceptable Practices provide several key provisions relating to board composition, the regulatory oversight committee (“ROC”), and disciplinary panels.

See id.

The Commission's parts 37 and 38 regulations also provide impartial access requirements, which highlight the importance of a SEF's and a DCM's responsibility to treat its market participants fairly. Commission Regulation 37.202 requires that a SEF shall provide any eligible contract participant (“ECP”) and any independent software vendor with impartial access to its market(s) and market services, including any indicative quote screens or any similar

pricing data displays, provided that the facility has: (1) criteria governing such access that are impartial, transparent, and applied in a fair and nondiscriminatory manner; (2) procedures whereby ECPs provide the SEF with written or electronic confirmation of their status as ECPs; and (3) comparable fee structures for ECPs and independent software vendors receiving comparable access to, or services from, the SEF.

17 CFR 37.202.

Similarly, Commission Regulation 38.151 provides that a DCM must provide its members, persons with trading privileges, and independent software vendors with impartial access to its markets and services, including: (1) access criteria that are impartial, transparent, and applied in a non-discriminatory manner; and (2) comparable fee structures for members, persons with trading privileges and independent software vendors receiving equal access to, or services from, the DCM.

17 CFR 38.151.

Parts 37 and 38 of the Commission's regulations also require SEFs and DCMs to maintain adequate financial, operational, and managerial resources. SEF Core Principle 13 (Financial Resources) provides that a SEF shall have adequate financial, operational, and managerial resources to discharge each responsibility of the SEF.

It further provides that the financial resources of a SEF shall be considered to be adequate if the value of the financial resources exceeds the total amount that would enable the SEF to cover the operating costs of the SEF for a one-year period, as calculated on a rolling basis.

DCM Core Principle 21 (Financial Resources) provides similar requirements, requiring that a DCM shall have adequate financial, operational, and managerial resources to discharge each of its responsibilities.

In addition, a DCM's financial resources shall be considered to be adequate if the value of the financial resources exceeds the total amount that would enable the contract market to cover the operating costs of the contract market for a 1-year period, as calculated on a rolling basis.

17 CFR 37.1300(a).

17 CFR 37.1300(b).

17 CFR 38.1100.

17 CFR 38.1100(b).

Finally, pursuant to DCM Core Principle 11 (Financial Integrity of Transactions), DCMs are required to establish and enforce rules to: (a) ensure the financial integrity of transactions entered into on or through the facilities of the contract market and (b) ensure the financial integrity of any FCM or IB.

In this connection, Commission Regulation 38.602 provides that a DCM must provide for the financial integrity of its transactions by establishing and maintaining appropriate minimum financial standards for its members and non-intermediated market participants.

In addition, Commission Regulation 38.604 provides that a DCM must monitor its members' compliance with the DCM's minimum financial standards, and therefore, must routinely receive and promptly review financial and related information from its members, as well as continuously monitor the positions of its members and their customers.

17 CFR 38.600.

17 CFR 38.602.

17 CFR 38.604.

D. FCM Statutory and Regulatory Requirements

One of the chief functions of DCMs and registered futures associations is the financial oversight of their member FCMs. FCMs perform critical functions to facilitate the efficient operation of Commission-regulated exchange-traded derivatives markets.

In addition to trading for their own accounts and carrying the accounts of their affiliates, FCMs act as market intermediaries, standing between customers trading futures and swaps on one side and DCMs and DCOs on the other side. As market intermediaries, FCMs carry customer accounts and hold customer funds to margin futures and cleared swap transactions. Additionally, FCMs fulfill daily settlement obligations on behalf of customers by posting sufficient funds to DCOs to support their customers' futures and swap positions, including paying mark-to-market losses associated with such positions. FCMs are also essential to the efficient operation of Commission-regulated markets in that they guarantee each customer's financial performance for futures and swap positions to DCOs by agreeing to use their own financial resources to cover any shortfall resulting from a customer default.

An FCM is defined in 17 CFR 1.3, in relevant part, as: (i) an entity that is engaged in soliciting or accepting orders for the purchase or sale of any commodity for future delivery or a swap and, in connection with the solicitation and acceptance of such orders, accepts money, securities or property (or extends credit in lieu thereof) to margin, guarantee or secure futures or swaps transactions, or (ii) an entity registered as an FCM.

17 CFR 39.16(c)(2)(vi).

The Act established the critical role performed by FCMs and authorizes the Commission to adopt regulations to help ensure that they maintain the necessary financial resources to properly perform such duties. Section 4f(b) of the CEA authorizes the Commission to adopt regulations imposing minimum capital and financial reporting requirements on FCMs to help ensure that they maintain adequate financial resources to fulfill their obligations.

Under this statutory authorization, the Commission adopted regulations requiring FCMs to, among other requirements, maintain a minimum level of regulatory capital,

segregate customer funds from their own funds in specially designated customer accounts,

and maintain appropriate risk management programs to monitor and manage the risks associated with their activities as FCMs.

FCMs are also required to provide a notice if they experience certain events that could impact their financial condition.

In addition, FCMs are bound by specific public disclosure requirements to promote the protection of customer funds and to minimize the systemic risk posed by certain actions of market participants.

Section 4f(b) of the Act provides, in relevant part, that no person shall be registered as an FCM unless such person meets the minimum financial requirements that the Commission may prescribe by regulation as necessary to insure such person meets its obligations as a registrant, and each person registered as an FCM shall at all times continue to meet such prescribed minimum financial requirements. 7 U.S.C. 6f(b).

17 CFR 1.17.

17 CFR 1.20; 17 CFR 22.2; 17 CFR 30.7.

17 CFR 1.11. FCMs are also subject to a requirement to address certain conflicts of interest within the firm. Specifically, pursuant to section 4d(c) of the Act, the Commission adopted Commission Regulation 1.71, which requires FCMs to adopt and implement written conflicts of interest policies and procedures. 7 U.S.C. 6d(c) and 17 CFR 1.71. Commission Regulation 1.71 focuses on the potential conflicts that could arise between individuals conducting research and analysis, on the one hand, and individuals involved in trading and clearing, on the other hand. The regulation, however, does not more broadly address the sharing of non-public information between FCMs and their affiliates.

Id.; see also Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and Duties Rules; Futures Commission Merchant and Introducing Broker Conflicts of Interest Rules; and Chief Compliance Officer Rules for Swap Dealers, Major Swap Participants, and Futures Commission Merchants,

77 FR 20120 at 20144-20146 (Apr. 3, 2012) and

Implementation of Conflicts of Interest Policies and Procedures by Futures Commission Merchants and Introducing Brokers,

75 FR 70152 (Nov. 17, 2010).

17 CFR 1.12.

17 CFR 1.55.

The financial oversight of FCMs and other market intermediaries is primarily performed by the respective DCMs and registered futures associations

in their role as SROs.

In 2000, Congress

affirmed this regulatory structure of industry self-regulation by amending section 3 of the CEA to state: “It is the purpose of this Act to serve the public interests . . . through a system of effective self-regulation of trading facilities, clearing systems, market participants, and market professionals under the oversight of the Commission.”

Pursuant to such objective, the Act, as further implemented through Commission regulations, requires SROs to adopt financial and related reporting requirements for member FCMs, and to periodically examine FCMs for compliance with such requirements.

NFA's financial requirements for FCMs are available at its website,

www.nfa.futures.org.

Section 3(b) of the Act. Commission Regulation 1.3 defines an SRO as a DCM, a registered futures

association, or a SEF. For purposes of Commission Regulation 1.52, however, SEFs are excluded from the SRO definition. SEFs are not required to adopt minimum capital and financial reporting requirements for their member firms and, as a result, the oversight program required under Commission Regulation 1.52 is not applicable to SEFs. With respect to the SEF's obligation to monitor its members for financial soundness, the obligation extends only to a requirement to ensure that the members continue to qualify as ECPs as defined in section 1a(18) of the Act.

See

78 FR 68506 at 68560.

Commodity Futures Modernization Act of 2000, Sec. 108, Public Law 106-554, 114 Stat. 2763 (2000).

Specifically, section 17(p) of the CEA requires a registered futures association to establish and submit for Commission approval rules imposing minimum capital, segregation, and other financial requirements applicable to its members for which such requirements are imposed by the Commission, which must be at least as stringent as those set by the Act or Commission regulations.

Section 17(p) further provides that a registered futures association must implement a program to audit and enforce compliance by its members with the registered futures association's minimum financial requirements.

CEA 17(p)(2), 7 U.S.C. 21(p)(2).

See Id.

Similarly, section 5(d)(11)(B) of the Act and Commission Regulation 38.600 require, in relevant part, each DCM to implement rules to ensure the financial integrity of any member FCM and the protection of customer funds.

Pursuant to Commission Regulation 38.602, DCMs must further establish and maintain appropriate minimum financial standards for its members.

Additionally, Commission Regulations 38.604 and 38.605 require each DCM to be responsible for the financial surveillance of its FCM members. As discussed above, Commission Regulation 38.604 requires each DCM to monitor the FCM members' compliance with the DCM's minimum financial standards.

To that effect, a DCM must review financial and related information from its FCM members and engage in intra-day surveillance by monitoring the positions of its FCM members and their customers.

In connection with the intra-day surveillance requirement, Commission Regulation 38.604 specifies that each DCM must survey the obligations of each FCM created by its customers' positions and compare such obligations to the financial resources of the FCM.

Pursuant to Commission Regulation 38.604(c), if a DCM, in its professional judgement, determines that the obligations of an FCM member are excessive, the DCM must take appropriate action to protect customer funds, including by contacting the FCM or the FCM's DSRO.

Commission Regulation 38.605 requires a DCM, in its role as an SRO, to comply with the standards of Commission Regulation 1.52 to ensure the financial integrity of its member FCMs by establishing and carrying out a financial surveillance program.

As further discussed below, Commission Regulation 1.52 sets forth the required elements of SRO supervisory programs and permits one or more SROs to establish, subject to Commission approval, a Joint Audit Plan to provide for the SRO supervision of members of more than one SRO.

CEA 5(d)(11)(B), 7 U.S.C. 7(d)(11)(B); 17 CFR 38.600.

17 CFR 38.602.

17 CFR 38.604.

Id.

Specifically, Commission Regulation 38.604 further provides that a DCM must: (a) continually surveil the obligations of each FCM created by the positions of its customers, (b) compare those obligations to the resources of the FCM, and (c) take appropriate steps to use this information to protect customer funds.

17 CFR 38.604(b).

Id. See also Core Principles and Other Requirements for Designated Contract Markets,

77 FR 36612 at 36647 (Jun. 19, 2012).

17 CFR 38.605. A DCM's financial surveillance program must comply with Commission Regulation 1.52, which is discussed below.

17 CFR 1.52.

Pursuant to Commission Regulation 38.606, DCMs may, but are not obligated to, satisfy their financial surveillance responsibilities under Commission Regulations 38.604 and 38.605 by designating a regulatory service provider (“RSP”) to conduct such financial surveillance, provided that the RSP is a registered futures association or a registered entity,

the DCM ensures that the RSP has the capacity and resources to conduct the necessary financial surveillance and, notwithstanding the use of an RSP, the DCM remains responsible for compliance with its financial surveillance obligations.

Pursuant to Commission Regulation 38.606, the appointment of an RSP must be governed by a written agreement that specifically documents the services to be performed as well as the capacity and resources of the RSP with respect to the services performed.

17 CFR 1.3.

17 CFR 38.604 and 38.605. The term “registered entity” is defined in section 1a(40) of the Act and includes DCMs, SEFs, and DCOs. 7 U.S.C. 1a.

17 CFR 38.606.

Consistent with the CEA's purpose of serving the public interest through a system of effective self-regulation, Commission Regulation 1.52 establishes the minimum standards that all SROs must satisfy in conducting FCM financial oversight. Commission Regulation 1.52 directs SROs to adopt rules prescribing minimum financial and related financial reporting requirements for member FCMs that are the same as, or more stringent, than the Commission's requirements.

Commission Regulation 1.52 also requires SROs to establish and operate a supervisory program that includes examination of member FCMs to assess whether such FCMs are in compliance with SRO rules and Commission regulations governing, among other requirements, minimum net capital and related financial requirements, the appropriate segregation of customer funds, and financial reporting requirements.

As part of the supervisory program, an SRO must perform ongoing surveillance of FCMs through, among other actions, review and analysis of financial statements and regulatory notices, and must conduct routine periodic on-site examinations.

17 CFR 1.52(b)(1). NFA's FCM capital and financial reporting requirements are set forth in section 1 of the NFA's Financial Requirements section of its rulebook and may be accessed at NFA's website:

https://www.nfa.futures.org/rulebook/index.aspx.

17 CFR 1.52(c)(1).

17 CFR 1.52(c)(1)(ii) and 17 CFR 1.52(c)(1)(iv)(A).

Commission Regulation 1.52(d) also permits two or more SROs to enter into an agreement to establish a Joint Audit Plan for the purpose of assigning to one of the SROs (the “DSRO”) of the Joint Audit Plan the function of examining member FCMs for compliance with minimum capital and related financial reporting obligations.

The audit plan

must be submitted to the Commission for approval.

Currently all active SROs are members of a Joint Audit Plan that was approved by the Commission on March 18, 2009.

The delegation of primary responsibility for monitoring and examining the financial condition of FCMs that are members of two or more SROs to a DSRO under the Joint Audit Plan allows for a more efficient use of SRO resources, while also reducing burdens that would otherwise be imposed on an FCM from duplicative supervision, including periodic on-site examinations from multiple SROs.

The purpose of delegation of financial surveillance to DSROs is to promote an effective and efficient market through applying financial standards for FCMs that are often members of multiple DCMs. The Commission has previously noted the inefficiencies that may be caused by duplicative financial surveillance amongst different SROs over the same FCM, stating that “it may be advantageous for the contract markets to engage in a joint enforcement or audit program to monitor compliance with such uniform minimum financial and related reporting requirements.”

Futures Commission Merchants Financial and Reporting

Requirements,

41 FR 45705 at 45706 (Oct. 15, 1976). In addition, the Commission, in proposing to authorize the delegation of financial surveillance responsibilities to DSROs, highlighted the efficiencies of such delegation, noting that it would benefit both FCMs and SROs.

Minimum Financial Requirements,

42 FR 39032 at 39037 (Aug. 1, 1977).

17 CFR 1.52(d)(3) and 1.52(h).

The original signatories of the Joint Audit Plan approved on March 18, 2009 are as follows: Board of Trade of the City of Chicago, Inc.; Board of Trade of Kansas City; CBOE Futures Exchange, LLC; Chicago Climate Futures Exchange, L.L.C.; Chicago Mercantile Exchange Inc.; Commodity Exchange, Inc.; ELX Futures, L.P.; HedgeStreet, Inc.; ICE Futures U.S., Inc.; INET Futures Exchange, L.L.C.; Minneapolis Grain Exchange; NASDAQ OMX Futures Exchange; NFA; New York Mercantile Exchange, Inc.; NYSE Liffe US, L.L.C.; and One Chicago, L.L.C. The Joint Audit Plan is available at

https://www.cftc.gov/idc/groups/public/@lrfederalregister/documents/frcomment/08-007b001.pdf.

The current signatories (DCMs, and one registered futures association) are listed on the JAC website, available at:

http://www.jacfutures.com/jac/default.aspx.

See Financial Surveillance Examination Program Requirements for Self-Regulatory Organizations,

84 FR 12882 at 12883 (Apr. 3, 2019).

Both SROs and DSROs are required to maintain adequate levels and independence of examination staff.

In this regard, Commission Regulations 1.52(c) and 1.52(d), which govern SROs and DSROs respectively, contain identical language that requires SROs and DSROs to maintain staff of an adequate size, training, and experience to effectively implement a supervisory program.

In addition, staff “must maintain independent judgment and its actions must not impair its independence nor appear to impair its independence in matters related to the supervisory program.”

This language is consistent with the longstanding guidance to SROs contained in the Financial and Segregation Interpretation No. 4-1 (Advisory Interpretation for Self-Regulatory Organization Surveillance Over Members' Compliance with Minimum Financial, Segregation, Reporting, and Related Recordkeeping Requirements), and Addendums A and B to Financial and Segregation Interpretation No. 4-1, and Financial and Segregation Interpretation No. 4-2 (Risk-Based Auditing), which guided the practices of members of the Joint Audit Committee (“JAC”)

voluntarily operating a Joint Audit Plan that had since been approved by the Commission.

Commission Regulation 1.52 also provides that the members of the JAC must establish, operate and maintain a joint audit program, meeting the requirements specified in Commission Regulation 1.52(d)(2)(ii) (“Joint Audit Program”).

The Joint Audit Program sets forth the policies and procedures to be followed by each DSRO in the conduct of examinations and financial reviews of FCMs.

17 CFR 1.52(c)(1)(i) and 1.52(d)(2)(ii)(C).

Id.

The JAC is a voluntary, cooperative organization comprised of representatives of the financial surveillance staff of DCMs and NFA, formed for the purpose of coordinating the monitoring and examination of common FCM members of such entities.

See Joint Audit Committee Operating Agreement,

73 FR 52832 (Sept. 11, 2008) (requesting comments prior to the Commission's approval of the most recent JAC agreement, which was granted on Mar. 18, 2009).

Commission staff letters are available on the Commission's website,

www.cftc.gov.

17 CFR 1.52(d)(2)(i).

See also Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations,

78 FR 68506 at 68580 (Nov. 14, 2013) and

Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations,

77 FR 67866 at 67892 (Nov. 14, 2012).

E. DCO Statutory and Regulatory Requirements

Section 5b(c)(2) of the CEA sets forth Core Principles with which a DCO must comply to be registered and to maintain registration as a DCO,

and part 39 of the Commission's regulations implements the DCO Core Principles. Under the DCO Core Principles and related Commission regulations, a DCO has extensive responsibilities to manage its risks and supervise the conduct of its members and participants. A DCO's affiliation with a clearing member may raise questions regarding the impartiality with which these responsibilities will be carried out. For example, an affiliation between a clearing member and a DCO may incentivize the DCO to act with partiality in favor of its affiliate when making decisions regarding the treatment of non-public information or the adequacy of applicable financial resources, with possible anti-competitive effects.

CEA 5b(c)(2), 7 U.S.C. 7a-1(c)(2).

Several existing DCO Core Principles and related regulations target potential risks posed by clearing members generally and partially address some of the concerns and risks raised by affiliated relationships in the clearing context. For example, Core Principle C (Participant and Product Eligibility) requires a DCO to: (1) establish appropriate admission and continuing eligibility standards (including sufficient financial resources and operational capacity to meet obligations arising from participation in the DCO) for members of, and participants in, the DCO; (2) establish appropriate standards for determining eligibility of agreements, contracts, or transactions submitted to the DCO for clearing; and (3) establish and implement procedures to verify, on an ongoing basis, compliance with the DCO's participation and membership requirements, which must be objective, be publicly disclosed, and permit fair and open access. Commission Regulation 39.12 implements Core Principle C.

Core Principle D (Risk Management) requires a DCO to, among other things: (1) measure and monitor its credit exposures to each clearing member daily; (2) through margin requirements and other risk control mechanisms, limit its exposure to potential losses from a clearing member default; and (3) require sufficient margin from its clearing members to cover potential exposures in normal market conditions. Commission Regulation 39.13 implements Core Principle D and, among other things, requires that a DCO: (1) have an appropriate risk management framework that, at a minimum, clearly identifies and documents the range of risks to which the DCO is exposed, addresses the monitoring and management of the entirety of those risks, and provides a mechanism for internal audits; (2) measure and monitor its credit exposure to each clearing member on a daily basis; (3) limit its exposure to potential losses from defaults by its clearing members; and (4) have rules that require its clearing members to maintain current written risk management policies and procedures, which address the risks that such clearing members may pose to the DCO.

Furthermore, Core Principle L (Public Information) requires a DCO to provide market participants with sufficient information to enable them to identify and evaluate accurately the risks and costs associated with using the DCO's services, and to publicly disclose, among other items, any information relevant to participation in the DCO's settlement and clearing activities. Commission Regulation 39.21 implements Core Principle L and, among other things, requires a DCO to

make certain information readily available to the general public by posting it on its website. Core Principle N (Antitrust Considerations) requires a DCO to avoid, unless necessary or appropriate to achieve the purposes of the CEA, adopting any rule or taking any action that results in any unreasonable restraint of trade, or imposing any material anticompetitive burden. Commission Regulation 39.23 codifies Core Principle N. Core Principle P (Conflicts of Interest) requires a DCO to establish and enforce rules to minimize conflicts of interest in the decision-making process of the DCO, and establish a process for resolving such conflicts of interest. Commission Regulation 39.25 implements Core Principle P and further requires the DCO to describe procedures for identifying, addressing, and managing conflicts of interest involving members of the board of directors.

F. Current Affiliated Relationships

i. Current SEF and DCM Affiliated Relationships

Certain SEFs and DCMs have affiliated relationships, including with entities that trade or facilitate trades on their own markets. The Commission notes that there are 20 SEFs currently registered with the Commission. Some of these SEFs have affiliated relationships with market participants, such as IBs and CTAs, that execute, introduce, or otherwise facilitate trades on the SEFs. Similarly, there are 27 DCMs currently designated by the Commission. The Commission is aware that certain DCMs have affiliated relationships including with market makers, liquidity providers, FCMs, and IBs that execute, introduce, intermediate, or otherwise facilitate trades on the DCMs.

The Commission acknowledges that some SEFs and DCMs already have publicly available rules and disclosures regarding their affiliate relationships. For example, certain SEFs acknowledge affiliate relationships in their rulebooks. Among other things, some DCM rulebooks provide conditions on affiliate participation, including that the affiliate does not have access to the DCM's material non-public information, that the DCM maintains operational independence from the affiliate, and that the affiliate will not receive preferential treatment. Some DCMs also provide website disclosures that identify the affiliated market participant.

Finally, as discussed above, DCMs have self-regulatory responsibilities with respect to their members. In this regard, while Commission Regulation 1.52 does not expressly prohibit an SRO from acting as a DSRO for its affiliated FCM, to date, no DCM with an affiliate FCM has attempted to act as DSRO for its affiliate FCM. Instead, CME or NFA, the two DSROs under the current Joint Audit Plan, perform the periodic financial surveillance of FCMs that are affiliated with a DCM.

A DCM may, in its capacity as an SRO, delegate primary responsibility for monitoring and examining the financial condition of member FCMs to a DSRO.

ii. Current DCO Affiliated Relationships

The Commission has also observed various affiliated relationships in the clearing context—historically, DCO-exchange affiliations, and more recently, DCO-clearing member affiliations. There are 24 DCOs currently registered with the Commission; approximately 5 of those DCOs have an affiliated clearing member. The Commission notes that the DCOs with affiliated clearing members have implemented a variety of measures to address potential concerns regarding these relationships. For example, certain of these DCOs provide public disclosure of the affiliated relationships and have rules which prohibit access to non-public information by the affiliated clearing member.

iii. Current Affiliated Market Makers

The Commission has more recently observed a growing number of registered entities, including DCMs, that have affiliated market makers trading on the exchange. There are approximately eight DCMs with affiliated market makers. The Commission understands that this market structure is particularly prominent in prediction markets and that the operators of such markets believe that an affiliated market maker can be especially important in the creation and maintenance of new markets. The Commission notes that the exchanges with affiliated market makers have implemented a variety of measures to address potential concerns regarding these relationships. For example, these measures include public disclosure of affiliate relationships, rules to prohibit access to non-public information by the affiliated market maker, and adjustments to the traditional price-time priority execution method on central limit order books.

As the preceding discussion reflects, a number of SEFs, DCMs, and DCOs have voluntarily adopted measures designed to identify and address the potential conflicts of interest associated with affiliated relationships—including public disclosure of affiliations, information barriers limiting affiliate access to material non-public information, and requirements that affiliated participants receive no preferential treatment. The Commission recognizes the value of these measures and preliminarily believes that they have contributed to the integrity of these markets and to the confidence of market participants in their fairness.

At the same time, the Commission preliminarily believes that the existing framework of voluntary practices, however constructive, is uneven. As described above and below, various measures have been adopted to differing degrees and stringency, and they are memorialized in disparate forms. Because each measure is adopted at the discretion of the individual entity, it may be narrowed, modified, or discontinued, and such voluntary undertakings are not uniformly subject to the Commission's examination and enforcement processes. Market participants who transact across multiple registered entities therefore cannot presently rely on a consistent baseline of protections, and the public may find it difficult to identify, compare, or verify the safeguards that apply to any particular affiliated relationship.

The Commission preliminarily believes that establishing a consistent regulatory baseline—one that draws on the sound practices responsible registered entities have already developed—would promote the consistency, clarity, and transparency that voluntary measures alone have not achieved. A codified framework would afford registered entities and market participants predictable expectations; help ensure that comparable conflicts are subject to comparable safeguards regardless of the venue on which they arise; and render those safeguards durable and subject to Commission oversight. The Commission preliminarily believes that such a framework would advance the conflict-of-interest, customer-protection, and market-integrity objectives reflected in the Core Principles applicable to SEFs, DCMs, and DCOs discussed above, and that, by doing so, it would reinforce—rather than displace—the practices registered entities have adopted and the confidence those practices have helped to build. The proposed amendments set forth in the following sections are intended to establish that framework.

II. DCM Obligations—Proposed Amendments to Commission Regulations 1.52, 38.604, and 38.606

A. Proposed Amendments to Commission Regulation 1.52—SRO Surveillance of Financial Requirements for Affiliate FCMs

i. Background

DCMs and registered futures associations play a foundational role in the surveillance of FCM's compliance with Commission and SRO financial requirements. Section 5(d)(11)(B) of the CEA requires each DCM to establish and enforce rules to ensure the financial integrity of any FCM that is a member of the contract market and to ensure the protection of customer funds.

Section 17(p) of the CEA imposes parallel obligations on registered futures associations, requiring NFA—the sole such association—to establish, subject to Commission approval, minimum financial requirements applicable to its FCM members and a program to audit and enforce compliance with those requirements.

CEA 5(d)(11)(B), 7 U.S.C. 7(d)(11)(B).

CEA 17(p), 7 U.S.C. 21(p).

Commission Regulation 1.52 establishes the minimum standards that all SROs must satisfy in carrying out their financial supervisory programs. Commission Regulation 1.52(c) requires each SRO to establish and operate a supervisory program—including written policies and procedures—for examining its member FCMs for compliance with applicable SRO rules and Commission regulations governing minimum net capital, segregation of customer funds, risk management, financial reporting, recordkeeping, and sales-practice requirements.

Commission Regulations 1.52(c)(2)(i) and (d)(2)(ii)(C)(1) further require SROs and DSROs to maintain examination staff of “adequate size, training, and experience” to effectively implement the supervisory program and the Joint Audit Program, respectively, and provide that such staff “must maintain independent judgment” and that their “actions must not impair its independence nor appear to impair its independence in matters related to” those programs.

These existing independence requirements are important, but they do not specifically address the concerns presented when an SRO has an affiliate FCM.

17 CFR 1.52(c)(1).

17 CFR 1.52(c)(2)(i), (d)(2)(ii)(C)(1).

As described above, Commission Regulation 1.52 permits two or more SROs to file with the Commission a plan for delegating to a DSRO, for any FCM that is a member of more than one such SRO, the function of monitoring and examining that FCM for compliance with minimum financial and related reporting requirements.

The SROs participating in such a plan form a JAC which establishes and operates a Commission-approved Joint Audit Program and designates the DSRO responsible for the examination of each FCM.

Under this framework, the assignment of a particular FCM to a particular DSRO is made by the JAC pursuant to the plan; the FCM itself plays no role in selecting its DSRO and is notified of the DSRO to which it has been assigned.

17 CFR 1.52(d)(1).

17 CFR 1.52(d)(2)(i).

See

17 CFR 1.52(i)(2).

There is currently one Joint Audit Program, which has its origins in a Joint Audit Agreement entered into in 1984 by a number of futures exchanges and NFA, under which an FCM that is a member of more than one SRO is assigned a single DSRO primarily responsible for conducting periodic financial examinations, the results of which are shared with the FCM's other SROs.

Although the 1984 Agreement was entered into by NFA and numerous independent futures exchanges, consolidation among the exchanges in the intervening decades has substantially reduced the number of SROs that serve as DSROs.

Today, as a result of the delegations elected by SROs under the Joint Audit Program, CME serves as the DSRO for FCMs that are clearing members of CME, and NFA serves as the DSRO for FCMs that are not CME clearing members.

See

Joint Audit Plan, 49 FR 28906 (July 17, 1984) (approved by Commission letter dated Oct. 10, 1984); 73 FR 52832 (Sept. 11, 2008) (describing the 1984 Agreement and a proposed replacement addressing JAC governance, voting rights, membership criteria, information-sharing arrangements, and DSRO designation criteria); and 78 FR 65806 at 68559 (Nov. 14, 2013) (noting that the Commission approved the Joint Audit Plan on March 18, 2009). The current version of the Joint Audit Agreement, which has been shared with Commission staff and is unchanged in all material respects from the 2009 Joint Audit Agreement, was entered into on September 1, 2017 and is

available at: https://www.cftc.gov/media/11981/JACagreement_2017/download.

The current signatories to the Joint Audit Agreement are listed on the JAC website,

available at: http://www.jacfutures.com/jac/default.aspx.

See

Financial Surveillance Examination Program Requirements for Self-Regulatory Organizations, 84 FR 12882, 12884 & n.22 (Apr. 3, 2019).

In October 2024, NFA approved the FCM application of F&O Financial LLC, an FCM jointly owned by CME and an unaffiliated firm.

Accordingly, CME—which serves as the DSRO for all FCMs that are clearing members of CME—is now affiliated with an FCM, while continuing to serve as the DSRO for FCMs that may compete with that affiliate.

See

Press Release, CME Group,

CME Group Receives Approval to Establish Futures Commission Merchant

(Oct. 29, 2024),

https://www.cmegroup.com/media-room/press-releases/2024/10/29/cme_group_receivesapprovaltoestablishfuturescommissionmerchant.html.

CME delegated the DSRO function of its affiliated FCM to NFA to mitigate the potential conflict of interest associated with acting as DSRO for an affiliated FCM.

Commission Regulation 1.52(b) requires each SRO to adopt rules prescribing minimum financial and related reporting requirements for its member FCMs that are the same as, or more stringent than, the Commission's requirements.

Commission Regulations 1.52(c) and 1.52(d) require an SRO and, where applicable, a DSRO to operate a financial supervisory program that includes routine surveillance through the review and analysis of financial statements and regulatory notices, and periodic on-site examinations of member FCMs.

Both regulations require that examination staff be of adequate size, training, and experience to effectively implement the program, and that such staff “maintain independent judgment” such that the staff's “actions must not impair its independence nor appear to impair its independence in matters related to the supervisory program.”

17 CFR 1.52(b).

17 CFR 1.52(c), (d).

17 CFR 1.52(c)(1)(i), (d)(2)(ii)(C)(1).

Because NFA is the only futures association registered under section 17 of the Act,

and a registered futures association is an SRO for purposes of Commission Regulation 1.52,

every FCM is a member of NFA. NFA does not operate a market, does not trade, and has no affiliate FCMs or other market participants.

Consequently, NFA is, for every FCM, an SRO with no commercial interest in the FCM's trading activity and, but for the current Joint Audit Program and any resource constraints, is available to serve as that FCM's DSRO.

See

7 U.S.C. 21.

See

17 CFR 1.52(a)(2).

See

Letter from Carol Wooding, SVP, General Counsel and Secretary, on behalf of the NFA to Christopher Kirkpatrick, Sec'y, CFTC at 1 (Sept. 26, 2023) (hereinafter “NFA Comment”). The letter is available on the Commission's website.

Commission Regulation 1.52 does not currently address SRO oversight of an affiliate FCM expressly, nor does it prohibit an SRO from acting as DSRO for its own affiliate FCM. To date, however, no DCM with an affiliate FCM has acted as DSRO for that affiliate FCM. Instead, in each such case, the

DCM has voluntarily requested that NFA perform the DSRO function for the affiliate FCM.

See

NFA Comment,

supra

note 96, at 4-5.

ii. Comments on the Affiliations RFC

The Commission received substantial comment on DSRO oversight of FCMs in response to the 2023 Affiliations RFC.

The relevant comments addressed three distinct questions: (1) whether a DCM should be permitted to serve as the DSRO for its own affiliate FCM; (2) whether a DCM with an affiliate FCM should serve as the DSRO for non-affiliate FCMs that may compete with that affiliate; and (3) what information barriers and structural safeguards should apply to a DSRO's oversight of FCMs. The Commission addresses each in turn.

See

Affiliations RFC,

supra

note 1.

A DCM serving as DSRO for its own affiliate FCM.

The Commission received six comment letters related to the conflicts of interest implications for the self-regulatory framework of SROs and DSROs having an affiliate FCM. All six commenters agreed that a DCM should not act as the DSRO for its affiliate FCM.

Letter from Jonathan Marcus, Senior Managing Director and General Counsel, on behalf of CME Group Inc., to Christopher Kirkpatrick, Sec'y, CFTC at 14 (Sept. 20, 2023) (hereinafter “CME Comment”); Letter from Kara Dutta, Assistant General Counsel, on behalf of Intercontinental Exchange, Inc., to Christopher Kirkpatrick, Sec'y, CFTC at 2 (Sept. 28, 2023) (hereinafter “ICE Comment”); Letter from Patrick Sexton, EVP, General Counsel & Corporate Secretary, on behalf of Cboe Global Markets, Inc. to Christopher Kirkpatrick, Sec'y, CFTC at 3 (Sept. 28, 2023) (hereinafter “Cboe Comment”); Letter from Ronald H. Filler, Professor Emeritus, New York Law School, to Office of the Secretary, CFTC at 8 (Nov. 3, 2023) (hereinafter “Filler Comment”);

See

Letter from Allison Lurton, General Counsel & Chief Legal Officer, on behalf of the Futures Industry Association, to Christopher Kirkpatrick, Sec'y, CFTC at 9-10 (Sept. 28, 2023) (hereinafter “FIA Comment”); NFA Comment,

supra

note 96, at 4.

NFA—the DSRO for FCMs that are not CME clearing members under the current Joint Audit Plan—observed that although each DCM with an affiliate FCM has to date voluntarily requested that NFA perform the DSRO function, the Commission should nonetheless amend Commission Regulation 1.52 to ensure that a DCM could not be the DSRO for its affiliate FCM in the future.

100

The Futures Industry Association (“FIA”) and Professor Ronald Filler emphasized the centrality of DSRO examination to FCM financial surveillance and the risk of impartial treatment if a DSRO oversees its own affiliate FCM.

101

The Global Association of Central Counterparties (“CCP Global”) expressed support for the existing Commission Regulation 1.52 framework while emphasizing the importance of explicit rules and procedures to ensure that affiliated FCMs are not afforded preferential treatment relative to non-affiliate FCMs.

102

100

NFA Comment,

supra

note 96, at 4-5.

101

FIA Comment,

supra

note 99, at 9; Filler Comment, at 8.

102

Letter from The Global Association of Central Counterparties at 2-3 (Sept. 28, 2023) (hereinafter “CCP Global Comment”).

A DCM with an affiliate FCM serving as DSRO for non-affiliate FCMs.

Several commenters separately addressed whether a DCM that has an affiliate FCM should be able to serve as the DSRO for

non-affiliate

FCMs—that is, the FCMs that may compete with the DCM's own affiliate. Commenters identified this relationship as raising distinct conflict-of-interest and competition concerns arising from the DSRO's access to the confidential information of the FCMs it examines.

NFA characterized this as an issue that SROs and DSROs “have not previously faced” and explained that a DCM with an affiliate FCM serving as DSRO for its non-affiliate FCM members “may raise conflicts and competitive issues that may be heightened by the DSRO's access to its non-affiliate FCMs' confidential information and a perception that actions taken in overseeing its unaffiliated FCM members benefit its affiliate FCM.”

103

ICE Futures U.S., Inc. (“ICE”) likewise urged the Commission to “consider whether it is appropriate for an entity to be tasked with auditing entities with which it competes” and stated that, at a minimum, robust information barriers should be required “to ensure that information derived from an examination does not flow to the affiliated entity that competes with the firms being audited.”

104

Professor Filler questioned whether a DCM with an affiliate FCM should “even serve as a DSRO . . . for another FCM given the confidential information that each DSRO obtains from the other FCMs” and suggested that “[o]ne possible model would only allow [NFA] . . . to serve as the DSRO for all FCMs, even [CME] clearing member firms, if a DCM becomes affiliated with an FCM.”

105

103

NFA Comment,

supra

note 96, at 4.

104

ICE Comment,

supra

note 99, at 2-3.

105

Filler Comment,

supra

note 99, at 8.

CME recommended that persons affiliated with an FCM not be permitted to participate in or receive reports from the JAC, “which could include sensitive information pertaining to other unaffiliated FCMs.”

106

CME Comment,

supra

note 99, at 14.

Information barriers and structural safeguards.

Commenters were broadly supportive of information barriers and confidentiality safeguards to govern a DSRO's access to and handling of the non-public information of the FCMs it examines. CME, NFA, ICE, and Professor Filler each agreed that appropriate firewalls and information barriers should be in place.

107

NFA emphasized the importance of separate boards of directors, separate key management personnel, information-sharing barriers, and conflicts-of-interest policies.

108

ICE, while supportive of information barriers generally, separately cautioned that information barriers alone “will not mitigate the conflicts of interest” presented by a DSRO's oversight of an affiliate FCM.

109

107

CME Comment,

supra

note 99, at 14-15; NFA Comment,

supra

note 96, at 3; ICE Comment,

supra

note 99 at 3; Filler Comment,

supra

note 99, at 5.

108

NFA Comment,

supra

note 96, at 3.

109

ICE Comment,

supra

note 99, at 2.

Commenters that operate affiliated structures described their existing safeguards. MIAX described its rule providing that its affiliate FCM “will not receive preferential treatment in any respect,” a company-wide information-barrier policy, and a representation that affiliates do not share senior compliance and risk-management personnel, such as the CRO or CCO, or physical office space, although certain functions such as cybersecurity and internal audit may be shared.

110

See

Letter from Thomas F. Gallagher, Chairman and CEO, on behalf of Miami International Holdings, Inc. and Mark G. Bagan, President and CEO, on behalf of Minneapolis Grain Exchange, LLC, to Christopher Kirkpatrick, Sec'y, CFTC at 4-7 (Sept. 26, 2023) (hereinafter “MIAX/MGEX Comment”).

Views supporting the existing framework or a principles-based approach.

CME, ICE, CCP Global, Cboe, and the World Federation of Exchanges (“WFE”) urged the Commission to retain its principles-based regulatory approach and cautioned against prescriptive structural requirements, even while several of them supported particular targeted measures.

111

CME Comment,

supra

note 99, at 1-2, 16-17 (cautioning against “comprehensive and prescriptive rules” while supporting a prohibition on an SRO serving as DSRO for its own affiliate); CCP Global Comment,

supra

note 102, at 2 (the Commission should not “deviate from its principles-based approach”); ICE Comment,

supra

note 99, at 1 (expressing support for “the CFTC's principles-based approach); Cboe Comment,

supra

note 99, at 3; Letter from Charlie Ryder, Regulatory Affairs Manager, on behalf of World Federation of Exchanges, to the CFTC at 3-4 (Sept. 28, 2023) (hereinafter “WFE Comment”).

iii. Identified Concerns

After considering these comments, the Commission has identified four sets of concerns regarding SRO and DSRO oversight of FCMs that the Commission

preliminarily believes the existing Commission Regulation 1.52 framework does not specifically address. The first three concern an SRO's oversight of its own affiliate FCM. The fourth concerns the position of non-affiliate FCMs that are examined by a DSRO whose affiliate FCM competes with them, and the absence of any mechanism by which such an unaffiliated FCM may be subject to examination by an SRO that has no competing commercial interest in its activities.

Impartiality of supervision.

An SRO with an affiliate FCM has a commercial interest in that affiliate's success that does not exist with respect to its other, unaffiliated member FCMs. That commercial interest could affect, or appear to affect, the rigor with which the SRO applies its supervisory program to the affiliate FCM, including the timeliness and intensity of any enforcement response to identified deficiencies. Commission Regulations 1.52(c)(2)(i) and (d)(2)(ii)(C)(1) already require that examination staff maintain independent judgment and avoid actions that “impair . . . or appear to impair” their independence.

112

The Commission preliminarily believes that, in the affiliate FCM context, additional structural safeguards are warranted to give effect to those existing independence requirements.

112

17 CFR 1.52(c)(1)(i), (d)(2)(ii)(C)(1).

Use of non-public information.

Through its supervisory program, an SRO acquires non-public information concerning the financial condition, customer activity, risk profile, and proprietary trading of its member FCMs. Access to, or sharing with an affiliate FCM of, non-public information of non-affiliate member FCMs could afford the affiliate FCM a competitive advantage and could disadvantage non-affiliate member FCMs that compete with the affiliate FCM. Reciprocally, the SRO's access to its affiliate FCM's non-public information—outside of what is necessary for the SRO's regulatory functions—could blur the boundary between regulatory and commercial information flows within the affiliated group.

Reporting lines for examination staff.

SRO examination staff implementing the supervisory program may report to SRO management that also bears commercial responsibility for the affiliated enterprise. Such reporting relationships could undermine, or appear to undermine, the independent judgment that Commission Regulation 1.52 already requires of supervisory staff.

Oversight of non-affiliate FCMs by a DSRO whose affiliate FCM competes with them.

The first three concerns address an SRO's oversight of its own affiliate FCM. A distinct concern arises with respect to the non-affiliate FCMs that a DSRO examines when that DSRO has an affiliate FCM competing in the same markets. In conducting the supervisory program and the on-site examinations required by Commission Regulation 1.52(c) and the Joint Audit Program, a DSRO obtains detailed non-public information—including financial condition, customer activity, positions, and risk profile—concerning each FCM it examines.

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Where the DSRO has an affiliate FCM, the DSRO acquires this information about firms that compete with its affiliate, giving rise to both a competitive concern—that such information could advantage the affiliate FCM—and a concern that the DSRO's oversight decisions affecting non-affiliate FCMs could be perceived as benefiting its affiliate.

113

See

17 CFR 1.52(c)(1), (d)(2)(ii)(C).

The Commission preliminarily believes that, although the information-barrier and separation safeguards proposed herein mitigate this concern by restricting the flow of non-affiliate FCMs' non-public information to an affiliate FCM, those safeguards operate only as constraints on the DSRO. They do not afford a non-affiliate FCM any means of being subject to examination by an SRO that has no commercial interest in the FCM's activities. Because NFA operates no market and has no affiliate FCM, NFA is, for every FCM, such an SRO. The Commission preliminarily believes that affording each FCM the option to elect NFA as its DSRO would provide a direct, registrant-side response to this concern, complementing the constraints imposed on the DSRO by the safeguards described above.

iv. Proposed Amendments

The Commission preliminarily believes that targeted amendments to Commission Regulation 1.52—calibrated to the specific circumstance of an SRO with an affiliate FCM—would address the concerns identified above while preserving the existing framework for SROs and DSROs that do not have an affiliate FCM. Each element of the proposed amendments is discussed below.

Definitions—Proposed Commission Regulations 1.52(a)(3) and (a)(4).

The Commission proposes to add definitions of “affiliate futures commission merchant,” “control,” and “non-public information” to Commission Regulation 1.52(a) in order to effectuate the proposed substantive revisions to Commission Regulation 1.52.

Proposed Commission Regulation 1.52(a)(3) would define “affiliate futures commission merchant” as an FCM (as defined in Commission Regulation 1.3) that directly or indirectly controls, is controlled by, or is under common control with an SRO. The same paragraph would define “control”—including the terms “controlled by” and “under common control with”—to mean the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise. This control formulation tracks well-established usage under the federal securities laws

114

and is intended to capture the range of relationships that give rise to the concerns identified above. The Commission preliminarily believes a control-based definition (rather than a fixed ownership-percentage threshold) is appropriate because the relevant concerns (

i.e.,

commercial alignment, information flow, reporting-line pressure) turn on the ability to direct management and policies rather than on any particular equity stake.

114

See, e.g.,

17 CFR 230.405 (Securities Act); 17 CFR 240.12b-2 (Exchange Act).

Proposed Commission Regulation 1.52(a)(4) would define “non-public information” as information that has not been disseminated in a manner which makes it generally available to the trading public. This formulation reflects the existing concept of non-public information used in Commission guidance and Acceptable Practices

115

and is intended to capture, for example, the categories of financial, operational, customer-position, risk-management, and proprietary-trading information that an SRO acquires through its supervisory program.

115

See, e.g.,

17 CFR part 38, app. B, Core Principle 16(a).

Reporting Lines for Examination Staff—Proposed Commission Regulation 1.52(c)(1)(i)(B).

Proposed Commission Regulation 1.52(c)(1)(i)(B) would require that, if an SRO has an affiliate FCM, the examination staff implementing the supervisory program required by Commission Regulation 1.52(c) report directly to the board of directors or other designated committee or officer responsible for regulatory compliance of the SRO. The proposed regulation would further require that, if examination staff report to an officer

responsible for regulatory compliance of the self-regulatory organization, such officer must, in turn, report directly to the board of directors or other designated committee. The proposal would not displace the existing Commission Regulation 1.52(c)(1)(i) requirement that staff maintain independent judgment. Rather, it would supplement that general independence standard with a specific reporting-line safeguard for the circumstance the Commission has identified as presenting heightened risk to that independence (

i.e.,

the existence of an affiliate relationship). The Commission preliminarily believes that a reporting line that runs to the board (or to a designated committee or officer with regulatory-compliance responsibility) rather than to commercial management, would insulate examination staff from reporting pressures that could affect their independent judgment given the commercial interest at play with respect to an affiliate FCM.

In practice, the Commission preliminarily expects that most DCMs would implement this requirement by having examination staff report directly to its ROC

116

or to a chief regulatory officer (“CRO”) or similar officer who, in turn, reports to the ROC, thus preserving a reporting line insulated from commercial pressures. The Commission requests comment on existing SRO reporting lines and its understanding of how SROs would comply with this proposed regulation.

116

The Acceptable Practices in app. B to part 38 notes that a ROC must consist only of public directors (

i.e.,

those directors that have no material relationship to the DCM that “reasonably could affect the independent judgment or decision-making of the director”).

Mandatory Independent Third-Party SRO—Proposed Commission Regulation 1.52(c)(1)(i)(C).

Proposed Commission Regulation 1.52(c)(1)(i)(C) would require an SRO that has an affiliate FCM to designate an independent third-party SRO to conduct the surveillance of the affiliate FCM otherwise required of the SRO under existing Commission Regulation 1.52(c). The SRO with the affiliate FCM would be required to ensure that the third-party SRO implements a supervisory program that satisfies both Commission Regulation 1.52(c) and the RSP requirements of Commission Regulation 38.606. The SRO would at all times remain responsible for compliance with its obligations under the CEA and the Commission's regulations, and for the third-party SRO's performance on its behalf—consistent with the existing Commission Regulation 38.606 framework for RSP arrangements.

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The Commission requests comment on whether it is appropriate for the designating SRO to be responsible for the third-party's performance on its behalf where such designation is mandatory as opposed to voluntary, as in the Commission Regulation 38.606 circumstance. The Commission also requests comment on the appropriate liability standard for the designating SRO.

117

See

17 CFR 38.606.

This proposal would codify—and extend across the full Commission Regulation 1.52(c) supervisory function—the practice that the Commission understands that DCMs with affiliate FCMs already follow on a voluntary basis. The Commission preliminarily believes that codification is appropriate to ensure the practice continues to make the requirement transparent to FCMs and their customers, and to provide an enforceable regulatory baseline against which the Commission can monitor compliance. The Commission also preliminarily believes that such codification would mitigate the inherent conflicts of interest arising out of an SRO fulfilling its regulatory obligations in the context of its affiliate FCM.

Restrictions on Access to and Sharing of Non-Public Information—Proposed Commission Regulation 1.52(c)(1)(i)(D).

Proposed Commission Regulation § 1.52(c)(1)(i)(D) would impose two related restrictions on an SRO that has an affiliate FCM. First, proposed Commission Regulation 1.52(c)(1)(i)(D)(1) would prohibit an SRO from accessing the non-public information of its affiliate FCM, except as necessary to comply with the SRO's responsibilities and obligations as a DCM under part 38 of the Commission's Regulations. Second, proposed Commission Regulation 1.52(c)(1)(i)(D)(2) would prohibit an SRO from sharing, directly or indirectly, non-public information obtained from its supervisory program of its non-affiliate member FCMs with its affiliate FCM for any purpose, except as necessary to comply with the SRO's responsibilities and obligations as an SRO under Commission Regulation 1.52 or as a DCM under part 38 of the Commission's regulations. The Commission preliminarily believes that an SRO sharing such information with its affiliate FCM would be extremely rare.

The Commission recognizes that a DCM's compliance with its part 38 obligations—including financial surveillance under Commission Regulations 38.604 and 38.605 and the trade-practice surveillance and audit-trail functions associated with DCM Core Principles 2, 4, and 11—necessarily entail receipt and use of information that is non-public as to particular member FCMs, including an affiliate FCM. The part 38 compliance carve-out preserves the SRO's ability to carry out those required functions, while prohibiting the use, access, or sharing of non-public information for any purpose outside those regulatory responsibilities. The “directly or indirectly” language is intended to prevent circumvention by routing non-public information to the affiliate FCM via another affiliated entity. Indirect routing may nevertheless occur—or, at least, appear to occur to market participants. This fact informs the Commission's preliminary view, as outlined below, that market participants should be able to elect a neutral SRO.

Parallel Amendments to the Joint Audit Plan Provisions—Proposed Commission Regulation 1.52(d)(2)(ii)(C)(1).

The Commission proposes parallel amendments to Commission Regulation 1.52(d)(2)(ii)(C)(1), which governs DSROs operating under the Joint Audit Plan.

Proposed Commission Regulation 1.52(d)(2)(ii)(C)(1)(ii)

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would expressly require that a DSRO that has an affiliate FCM may not perform the function of a DSRO for that affiliate FCM. This proposal codifies the practices currently followed under the Joint Audit Plan, under which NFA performs the DSRO function for an FCM affiliated with a DCM. The Commission preliminarily believes that an express prohibition, codified in the Commission's regulations, is preferable to continued reliance on voluntary practice for the reasons described above (

i.e.,

conflict of interest risk mitigation and enhanced market integrity), including that, absent a regulatory prohibition, voluntary practice could change thus allowing a surveillance structure that the Commission preliminarily believes results in unmitigable conflicts of interest. The Commission requests comment on whether this proposed regulation should include a similar liability standard as proposed in proposed Commission Regulation 1.52(c)(2)(i)(B).

118

The text in current Commission Regulation 1.52(d)(2)(C)(1) is proposed to be moved to proposed Commission Regulation 1.52(d)(2)(C)(1)(i) without any changes to the rule text.

Proposed Commission Regulation 1.52(d)(2)(ii)(C)(1)(iii) would, consistent with the proposed regulations

applicable to SROs, require that if a DSRO has an affiliate FCM, the examination staff implementing the DSRO's supervisory program must report directly to the board of directors or other designated committee or officer responsible for regulatory compliance of the DSRO. Further, the proposed regulation would require that, if such examination staff report to an officer responsible for regulatory compliance of the DSRO, such officer must, in turn, report directly to the board of directors or other designated committee. The Commission's reasoning is consistent with that provided above; namely, to insulate examination staff from reporting pressures that could affect their independent judgment given the commercial interest at play with respect to an affiliate FCM.

Proposed Commission Regulation 1.52(d)(2)(ii)(C)(1)(iv) would impose on DSROs the same restrictions on access to and sharing of non-public information that the Commission would impose on SROs more generally, with the same carve-out for compliance with part 38 obligations. The Commission preliminarily believes that uniform treatment is appropriate because the DSRO function under the Joint Audit Plan and the broader supervisory program under Commission Regulation 1.52(c) raises materially similar concerns when an affiliate FCM is involved.

FCM Election of a Registered Futures Association as Designated Self-Regulatory Organization—Proposed Commission Regulation 1.52(d)(2)(i)(A).

The safeguards described above operate as constraints on the SRO and the DSRO. They do not, however, afford a non-affiliate FCM any affirmative means of obtaining examination by an SRO that has no commercial interest in its activities, including by virtue of that SRO having an affiliate FCM. Proposed Commission Regulation 1.52(d)(2)(i)(A) would supply that means.

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It would permit an FCM that is a member of a registered futures association to elect, in writing to the JAC, to have such registered futures association serve as its DSRO.

120

Upon receipt of a valid election, the JAC would designate NFA as that FCM's DSRO and reflect the designation in the Joint Audit Program.

121

In the absence of an election, the JAC would designate the FCM's DSRO under the existing process. The Proposal would provide expressly that an election does not alter the examination standards applicable to the FCM under the Joint Audit Program and does not relieve any SRO of the residual responsibility it retains under Commission Regulations, including Commission Regulations 1.52(d)(1)(ii) and (i)(2).

119

The CEA authorizes a futures association to register with the Commission pursuant to the terms and conditions set out in the Act. CEA sec. 17. The Commission's rules regarding futures associations require a registered futures association to, among other things, demonstrate that it will be able to carry out the purposes of section 17 of the Act. For example, a registered futures association “should be prepared to establish and maintain in accordance with § 1.52 of this chapter, a financial compliance program for those members of the association who are futures commission merchants.” 17 CFR 170.1.

120

The Commission recognizes that there currently is only one registered futures association—NFA—and so this proposed regulation would function to allow FCMs that are NFA members to select NFA as their DSRO. The Commission further recognizes that, while today there is only one JAC, Commission Regulation 1.52(d) allows any two (or more) SROs to form a JAC and there could be more than one in the future. To the extent another JAC consistent with Commission regulations, the Commission preliminarily believes that an FCM subject to such JAC should, likewise, be able to elect a registered futures association its DSRO, to the extent this proposal is adopted as proposed.

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Such DSRO designations are made public on a monthly basis through the Commission's publication of selected FCM financial data.

See

Financial Data for FCMs,

https://www.cftc.gov/MarketReports/financialfcmdata/index.htm.

The Commission preliminarily believes that affording each FCM this option is warranted for three reasons. First, the election provides the option of a neutral examiner available to every FCM. The safeguards described above reduce the risk that a DSRO's relationship to its affiliate FCM affects its oversight of the non-affiliate FCMs it examines, but they leave the non-affiliate FCMs dependent on the efficacy of those constraints. A non-affiliate FCM that prefers examination by an SRO with no commercial stake in its business has, under the current framework, no means of established process to obtain it (absent abstaining from trading on CME). Because NFA operates no market and has no affiliate FCM or other affiliate market participant, NFA is, for every FCM, an SRO without the same sort of commercial interest in the FCM's trading activity. The election would allow any FCM to obtain examination by such an organization directly, rather than relying solely on constraints imposed on its assigned DSRO.

Second, the Commission preliminarily believes that the election option would introduce a measure of market discipline that supplements, but does not supplant, the Commission's oversight of the self-regulatory framework. Under the current structure, an FCM has no ability to decline examination by an assigned DSRO, so an FCM's continued examination by a particular DSRO conveys no information about whether the FCM regards that DSRO's oversight as impartial. By making elections observable, the Proposal would allow the degree to which FCMs elect or decline to elect away from a particular DSRO to serve as an indicator—to the Commission and to other market participants—of confidence in that DSRO's application of the Joint Audit Program. A DSRO that retains Commission Regulation 1.52 authority over the FCMs it examines after acquiring an affiliate FCM would have demonstrated such confidence; a significant pattern of elections away from a DSRO would identify a circumstance likely warranting the Commission's attention. For example, this pattern may indicate a “race to the bottom”—FCMs may elect a DSRO based on the perceived “difficulty” of the DSRO's supervisory program. The Commission emphasizes that the election would not permit any FCM to alter the standards under which it is examined, and that the election supplements rather than replaces the Commission's independent supervisory judgment. The Commission further notes that the notice period and minimum-duration provisions described below are designed so that an election reflects a considered determination rather than transient or strategic switching; the Commission preliminarily believes these features would cause election activity to surface durable, rather than ephemeral, assessments of a DSRO's oversight.

Third, the Commission preliminarily believes that a standing and universally available election option would address the relevant concerns without requiring the Commission or the JAC to make case-by-case determinations and would accommodate future changes in market structure. Conditioning the election on a finding that a particular FCM's DSRO is affiliated with a competitor would require contestable determinations regarding affiliation and competition of the kind that may be difficult to draw. A universal election option available to every FCM requires no such triggering determination. It also would ensure that the option is available automatically as affiliate relationships arise in the future—a consideration of practical importance given both the consolidation of DSROs under the Joint Audit Program over the past four decades and the recent emergence of an affiliate FCM at a DSRO. The Commission recognizes that, for an FCM whose DSRO has no affiliate FCM, the election's practical significance is limited; the universal availability of the election rests on the

administrability and forward-looking considerations described here rather than on a present benefit common to all FCMs.

The Commission recognizes that there may be potential drawbacks to this approach. For example, the Commission understands that existing DSROs, including CME, have experience and resources dedicated to fulfilling their roles as DSROs. In this regard, a DSRO and its staff likely have developed significant familiarity with the particular FCMs that it examines, including historical records and observations that may facilitate future examinations. An election option may disrupt this historical knowledge and expertise. The Commission requests feedback with respect to these observations and how they may affect any final rule.

Membership Predicate—Proposed Commission Regulation 1.52(d)(2)(i)(B).

Proposed Commission Regulation 1.52(d)(2)(i)(B) would confirm that no FCM may be designated to, and the JAC may not designate to an FCM, an SRO of which the FCM is not a member, and that nothing in the election provision requires any SRO other than a registered futures association (

i.e.,

NFA) to serve as the DSRO for an FCM that is not its member. Because NFA membership is a practical prerequisite to FCM registration, every FCM may make a valid election of NFA. The membership predicate ensures that the election provision does not disturb the existing arrangement under which an SRO other than NFA serves as DSRO only for FCMs that are its members; the Proposal would create no right to elect an exchange SRO, and any assignment of an FCM to an SRO other than NFA would continue to occur through the JAC's existing designation process and only as to FCMs that are members of that SRO.

Notice Period and Effective Date of Election—Proposed Commission Regulation 1.52(d)(2)(i)(C).

Proposed Commission Regulation 1.52(d)(2)(i)(C) would provide that an election takes effect on the later of the first day of the next examination cycle under Commission Regulation 1.52(d)(2)(ii)(C)(4) or six months after the JAC's receipt of the election, and that an election does not interrupt or shorten an examination then in progress. The Proposal would further authorize the JAC, where it determines that elections received within a common period would, if given immediate effect, impair a DSRO's ability to maintain examination staff of adequate size, training, and experience as required under Commission Regulation 1.52(d)(2)(ii)(C)(1), to establish a reasonable schedule phasing in the effective dates of such elections, provided that no election is delayed beyond twelve months after its receipt.

The Commission preliminarily believes that a defined notice period, together with the phasing authority, is necessary to ensure that a DSRO receiving elected FCMs has sufficient time to recruit, train, and deploy qualified examination staff, and to prevent a concentration of elections within a short period from compromising examination quality.

Minimum Duration of Election—Proposed Commission Regulation 1.52(d)(2)(i)(D).

Proposed Commission Regulation 1.52(d)(2)(i)(D) would require an FCM, following the effective date of an election, to retain its elected DSRO for not fewer than three complete examination cycles under Commission Regulation 1.52(d)(2)(ii)(C)(4) before electing a different DSRO or revoking its election.

The Commission preliminarily believes a minimum-duration requirement is warranted to prevent repeated switching that would impose recurring transition burdens on DSROs and complicate continuity of examination, and to support the staffing investment that a DSRO must make to absorb electing FCMs. The proposed three-examination-cycle period—corresponding to approximately four and one-half years—reflects the Commission's preliminary judgment as to the period necessary to balance these continuity and staffing interests against an FCM's interest in its ability to revisit its election. In this regard, the Commission preliminarily believes that a shorter period of time would hinder a DSRO's ability to manage its resources effectively, develop expertise and deepen its understanding of the FCMs it examines. The minimum-duration requirement would not affect an FCM's obligations, or any SRO's residual responsibilities, including under Commission Regulations 1.52(d)(1)(ii) and (i)(2). As noted below, the Commission requests comment on the appropriate length of these cycles.

Conforming Amendment to the Member-Notification Provision—Proposed Commission Regulation 1.52(i)(2).

The Commission proposes a conforming amendment to Commission Regulation 1.52(i)(2), which requires a delegating SRO to notify each affected member of the identity of the DSRO to which the member has been assigned. The amendment would provide that this notification includes, where applicable, a registered futures association where the member has elected such registered futures association as its DSRO under proposed Commission Regulation 1.52(d)(2)(i)(A). This conforming change ensures that the existing notification mechanism accurately reflects an elected, rather than solely an assigned, DSRO.

v. Statutory Authority

The Commission proposes the amendments to Commission Regulation 1.52 pursuant to section 8a(5) of the Act, which authorizes the Commission to promulgate such rules and regulations as, in its judgment, are reasonably necessary to effectuate any of the provisions or to accomplish any of the purposes of the Act.

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The Commission's authority to prescribe minimum financial-surveillance standards for SROs, and to establish the framework for delegated financial oversight of FCMs through the Joint Audit Program, is longstanding: Commission Regulation 1.52 has been in effect since 1978, and the Commission last comprehensively revised the Commission Regulation 1.52 framework in 2013.

123

The proposed amendments do not expand the scope of that authority; rather, they calibrate the existing framework to address a specific circumstance—an SRO's oversight of an affiliate FCM, and a DSRO's oversight of non-affiliate FCMs that compete with its affiliate—that the current framework does not address.

122

CEA 8a(5), 7 U.S.C. 12a(5).

123

Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations,

78 FR 68506 (Nov. 14, 2013).

The proposed FCM option to elect a registered futures association as DSRO rests on the same section 8a(5) authority, supplemented by section 17 of the Act, which vests the Commission with oversight authority over registered futures associations,

124

and section 4f(b) of the Act, under which registered futures association membership is a practical prerequisite to FCM registration.

125

The Commission preliminarily believes that section 8a(5)—read together with sections 17 and 4f(b)—and the Commission's existing approval-and-conditioning authority over Joint Audit Plans under § 1.52(d)(1) and (h)—supplies sufficient authority to require a registered futures association, including NFA, to accept an FCM's election in the circumstance addressed by the proposal.

124

CEA 17, 7 U.S.C. 21.

125

CEA 4f(b), 7 U.S.C. 6f(b).

vi. Alternatives Considered

The Commission considered, and requests comment on, several alternative approaches to the issues addressed by the proposed amendments to Commission Regulation 1.52.

1. Reliance on Existing Voluntary Practice

The Commission considered relying on the current voluntary practice—under which NFA performs DSRO functions for FCMs affiliated with DCMs—without codification. The Commission preliminarily concluded that relying on this voluntary practice is untenable, given the increasing number of DCMs with affiliate FCMs and the possibility that such voluntary practice could change. In this regard, the Commission preliminarily determined that codification is preferable to ensure continuity of that voluntary practice, to extend safeguards beyond the DSRO context to the broader Commission Regulation 1.52(c) supervisory function, and to make the requirements transparent to market participants. The Commission requests comment on whether reliance on existing voluntary practice is sufficient.

2. Independent DSRO for All Member FCMs

The Commission considered, as suggested by Professor Filler and reflected in part in NFA's comment, requiring that NFA (or another independent third-party SRO) serve as DSRO for

all

member FCMs of an SRO that has an affiliate FCM—not only for the affiliate FCM itself.

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The rationale for this alternative is that an SRO's access to non-public information of

non-affiliate

FCMs—which may compete with the affiliate FCM—raises competitive concerns even when the SRO does not directly examine the affiliate FCM. The Commission preliminarily declines to take this approach for two reasons. First, the Commission understands that FCM examinations provide valuable information to DSROs that also operate an exchange, and that such information may bear on risk management decisions made by the exchange. In this regard, removing FCM examination authority from such DSROs may result in blind spots that increase systemic risk. Second, the Commission preliminarily concludes that the proposed approach is sufficient to address the relevant competitive concerns while enabling market forces to show revealed preferences. The Commission requests comment on this alternative, including whether the proposed access and sharing restrictions adequately mitigate the competitive concerns that this alternative would address.

126

Filler Comment,

supra

note 99, at 8;

see also

NFA Comment,

supra

note 96, at 4-5.

3. Prescriptive Separation Requirements

The Commission considered prescriptive separation requirements—including physical office separation, technical specifications for information barriers, and dual-hatting prohibitions for senior officers—for SRO personnel involved in the supervisory program of an affiliate FCM. The Commission notes that a DCM with an affiliate FCM would be subject to the Commission's proposed conflicts-of-interest-procedures rule described below, and that the Commission's proposed acceptable practices in implementing such procedures likewise would apply. As described below, the Commission preliminarily believes that a principles-based rule, together with detailed acceptable practices, provides the market with appropriate guidance regarding the Commission's expectations, while allowing for some flexibility in approaches. The Commission, therefore, preliminarily concludes that the targeted requirements in the current proposal—combined with the existing Commission Regulation 1.52 independence-of-staff standards and the aforementioned proposed conflicts procedures rule—are sufficient to address the concerns identified. The Commission requests comment on this preliminary conclusion.

vii. Request for Comment

The Commission requests comment on all aspects of the proposed amendments to Commission Regulation 1.52, including:

(1) Whether the proposed definition of “affiliate futures commission merchant”—and the related “control” formulation—captures the appropriate scope of relationships. Should the definition encompass partial ownership interests that do not rise to the level of “control”? If so, at what threshold or under what criteria?

(2) Whether the proposed definition of “non-public information” is appropriately scoped. Should this concept be expressed in terms of materiality, enumerated categories of information (

e.g.,

customer positions, financial condition, risk-management policies), as proposed, or based on some other criteria?

(3) Whether the Commission should adopt the alternative under which an SRO with an affiliate FCM would be required to designate an independent third-party DSRO for examination of all of its member FCMs, rather than only for the affiliate FCM.

(4) Whether, in circumstances where the Proposal would mandate delegation of SRO or DSRO functions under Commission Regulations 1.52(c) or (d), it is reasonable for the delegating SRO to be responsible and liable for the third-party's performance on its behalf. Should the delegating SRO be subject to a strict liability standard such that any examination failure on the part of the third-party SRO is the responsibility of the delegating SRO, or, alternatively, should the delegating SRO be liable only if it is negligent in its selection of the third-party SRO?

(5) Whether the part 38 carve-out, which would allow an SRO or DSRO to access or share certain non-public information to comply with part 38 obligations, is appropriately scoped, including whether additional specificity is warranted regarding the categories of non-public information access and sharing permitted under the carve-out.

(6) Whether the reporting-line requirements, which would require examination staff to be insulated from commercial pressures, is appropriately calibrated, including whether the Commission should specify the level of the board or committee to which examination staff must report.

(7) Whether the proposed Commission Regulation 1.52 amendments should apply to SRO oversight of affiliated entities other than FCMs (

e.g.,

IBs or market makers).

(8) Whether the Commission should afford FCMs an election of a registered futures association as DSRO at all, and whether the information-access, reporting-line, and prohibition safeguards proposed above—together with the conflicts-of-interest framework proposed elsewhere in this Proposal—would adequately address the concerns regarding a DSRO's oversight of non-affiliate FCMs that compete with its affiliate, without an election option.

(9) Whether the election provision should be limited to a registered futures association, as proposed, or should instead permit an FCM to elect any SRO of which it is a member; and if an open election was permitted, what conditions should apply, including how the membership predicate and examination-standard consistency would be preserved.

(10) Whether the proposed six-month minimum notice period provides an appropriate balance between an electing FCM's interest in a timely transition and a receiving DSRO's need to recruit, train, and deploy qualified examination

staff; and whether a shorter or longer period would be preferable.

(11) Whether the authority of the JAC to phase in clustered elections, subject to the proposed twelve-month outer limit, is appropriately calibrated to protect examination quality and DSRO staffing; whether the outer limit should be shorter or longer; and what criteria the JAC should apply in determining that a phase-in schedule is warranted.

(12) Whether the proposed three-cycle minimum-duration requirement appropriately balances continuity of examination and DSRO staffing stability against an FCM's interest in revisiting its election; and whether a shorter or longer minimum duration would be preferable.

(13) Whether an FCM that has elected a registered futures association should be permitted to revoke its election before the minimum duration elapses in defined circumstances, for example, upon a change in the FCM's clearing membership or upon a material change in the circumstances that prompted the election, and, if so, what circumstances should qualify.

(14) Whether the proposed election option could result in unintended consequences to a DSRO that also operates an exchange including, for example, with respect to risk management activities. For example, could the election option result in a DSRO that loses the ability to examine an FCM as a result of an election revising its DCM or DCO rulebook to require similar examinations to ensure that it receives risk management information regarding its member FCMs, ultimately resulting in duplicative examinations and surveillance?

(15) Whether the proposed election option would have effects on the resources, staffing, or funding of NFA or of any other DSRO that the Commission should consider, including, whether a substantial volume of elections could affect the cost or quality of examinations; and the Commission specifically requests that NFA, CME, and any other SRO, DSRO, FCM, or market participant with relevant information describe the anticipated operational and cost effects of the proposed election option.

(16) The Commission understands that DCOs conduct examinations of their clearing members apart from the obligations imposed by Commission Regulation 1.52. Will the election mechanism result in clearing members becoming subject to duplicative examinations—one by the DCO and one by a registered futures association?

The Commission specifically requests that SROs and DSROs with an affiliate FCM—and any other SRO, DSRO, FCM, or market participant with relevant information—describe:

(17) The arrangements currently in place for the financial surveillance and DSRO oversight of any affiliate FCM, including the identity of the third-party SRO performing those functions and the terms (including cost) of the arrangement.

(18) The reporting lines through which examination staff implementing the Commission Regulation 1.52(c) supervisory program currently report, including the highest organizational level at which that reporting line terminates and the independence of that level from commercial management of the SRO and the affiliate FCM. Whether the reporting-line requirements are consistent with existing reporting structures at SROs and DSROs.

(19) The existing policies, procedures, information barriers, or technological controls governing an SRO's access to non-public information of an affiliate FCM and the SRO's sharing of non-public information obtained from the Commission Regulation 1.52(c) supervisory program with the affiliate FCM, including any exceptions for compliance with part 38 obligations.

(20) The nature and estimated incremental cost of any change to existing arrangements that would be required to comply with the proposed Commission Regulation 1.52 amendments.

(21) Whether the proposed definitions of “affiliate futures commission merchant,” “control,” and “non-public information” would capture relationships or categories of information that differ in any material respect from those addressed by existing arrangements.

B. Proposed Amendments to Commission Regulations 38.604 and 38.606—DCM Financial Surveillance of Members and Third-Party Regulatory Service Providers

i. Background

DCMs bear responsibility for the financial surveillance of their member FCMs under DCM Core Principle 11 (Financial Integrity of Transactions) and Commission Regulations 38.602, 38.604, and 38.605.

127

In particular, Commission Regulation 38.604 requires that a DCM “monitor members' compliance with the [DCM's] minimum financial standards” by, among other things, routinely receiving and promptly reviewing financial and related information from its members, “continuously monitor[ing] the positions of members and their customers,”

128

continually surveying the obligations of each FCM created by the positions of its customers, comparing those obligations to the financial resources of the FCM as appropriate, and taking appropriate steps to use this information to protect customer funds.

129

Commission Regulation 38.605 requires a DCM to comply with the standards of Commission Regulation 1.52 in carrying out this financial surveillance program.

130

127

CEA 5(d)(11), 7 U.S.C. 7(d)(11); 17 CFR 38.602, 38.604, 38.605.

128

17 CFR 38.604.

129

17 CFR 38.604(a)-(c).

130

17 CFR 38.605.

Commission Regulation 38.606 currently permits—but does not require—a DCM to comply with the requirements of Commission Regulations 38.604 and 38.605 through the regulatory services of an RSP.

131

Where a DCM elects to engage an RSP, Commission Regulation 38.606 requires the DCM to ensure that the RSP has the capacity and resources necessary to provide timely and effective regulatory services, including adequate staff and surveillance systems; to enter into a written agreement that specifically documents the services to be performed; and to retain ultimate responsibility for compliance with its obligations under the CEA and the Commission's regulations.

132

131

17 CFR 38.606.

132

Id.

In administering Commission Regulation 38.604, Commission staff has fielded interpretative questions regarding the frequency at which a DCM must monitor positions and survey FCM obligations. The phrases “continuously monitor the positions of members and their customers” and “continually survey the obligations of each [FCM]” in current Commission Regulation 38.604 could be read to require literal real-time monitoring of trading activity. The Commission's intent in adopting those phrases was to direct DCMs to perform risk-based, intra-day assessments of the positions carried by each FCM throughout the trading day—not to impose a continuous real-time monitoring obligation.

133

See Core Principles and Other Requirements for Designated Contract Markets,

77 FR 36612 (June 19, 2012) (adopting Commission Regulation 38.604).

ii. Comments on the Affiliations RFC

The Commission sought comment on whether and how a DCM with an affiliate FCM may carry out its financial surveillance obligations under Commission Regulation 38.604

consistent with its impartiality responsibilities, what mitigants and safeguards might be appropriate, and whether existing regulations are sufficient.

134

Commenters' views fell into three categories:

134

See

Affiliations RFC,

supra

note 1.

Acknowledgment of potential conflicts.

A number of commenters acknowledged that a DCM's financial surveillance of an affiliate FCM presents potential conflict-of-interest concerns. As described above, CME, NFA, ICE, Cboe, FIA, and Professor Filler each indicated that a DCM should not be permitted to act as DSRO for its affiliate FCM.

135

Although these comments are most directly relevant to the proposed Commission Regulation 1.52 amendments described above—which would govern the periodic supervisory and examination program—the underlying concern about partiality in supervision of an affiliated FCM applies as well to the intra-day financial surveillance required by Commission Regulation 38.604.

135

CME Comment,

supra

note 99, at 14; NFA Comment,

supra

note 96, at 4; ICE Comment,

supra

note 99, at 2-3; Cboe Comment,

supra

note 99, at 3; FIA Comment,

supra

note 99, at 9-10; Filler Comment,

supra

note 99, at 8.

Views on mitigants.

Commenters offered a range of views on how potential conflicts in DCM financial surveillance of an affiliate FCM might be mitigated. Several commenters supported information barriers and confidentiality controls. CME, NFA, ICE, and Professor Filler each agreed that appropriate firewalls and information barriers should be in place between a DCM and its affiliate FCM.

136

NFA emphasized the importance of separate boards of directors, separate key management personnel, information-sharing barriers, and conflict-of-interest policies.

137

136

CME Comment,

supra

note 99, at 14-15; NFA Comment,

supra

note 96, at 3; ICE Comment,

supra

note 99, at 3; Filler Comment,

supra

note 99, at 5.

137

NFA Comment,

supra

note 96, at 3.

Other commenters addressed personnel and resource separations in the surveillance context. CME stated that “sufficient separation between DCM or SEF personnel performing surveillance, investigation and enforcement duties and an affiliated intermediary should be implemented and conflicts of interest policies maintained,” but cautioned against “overly prescriptive rules” given the obligations that DCMs already have under the existing Core Principles to enforce rules, treat members impartially, and minimize conflicts of interest in decision-making.

138

MIAX commented that DCM and SEF affiliates should not share senior compliance and risk management personnel—including the CRO and CCO—although certain functional roles, such as cybersecurity, physical security, internal audit, and information security, present no conflicts of interest and may be shared.

139

AEGIS described its existing approach, under which its SEF compliance and surveillance staff are dedicated to the SEF and not shared with any affiliate, and the SEF's staff is segregated into separate physical office space, although certain marketing, treasury, and technology functions are shared with affiliates pursuant to a shared-services agreement.

140

CCP Global emphasized that there should be separation of resources, including key personnel and offices, between affiliated entities.

141

138

CME Comment,

supra

note 99, at 16-17.

139

MIAX/MGEX Comment,

supra

note 110, at 4, 7.

140

Letter from Andrew Furman, Chief Compliance Officer, on behalf of AEGIS SEF, LLC, to CFTC at 3-4 (Sep. 28, 2023) (“AEGIS Comment”).

141

CCP Global Comment,

supra

note 102, at 3.

Views supporting the existing framework.

Several commenters viewed the existing principles-based framework as sufficient to address concerns about a DCM's financial surveillance of an affiliate FCM. Coinbase did not believe that the affiliation between a DCM and an FCM by itself would affect financial surveillance, citing the requirements for the ROC under DCM Core Principle 16 and existing financial-oversight regulations such as Commission Regulation 38.553 applicable to FCMs and NFA.

142

MIAX described its existing internal controls—including a compliance manual that disallows treating affiliates differently than other members and an Audits and Investigations department that reports directly to the CRO, who in turn reports directly to the ROC—as a means of ensuring equal treatment of affiliated and unaffiliated participants.

143

MGEX commented that, so long as an affiliate FCM can demonstrate that it meets the applicable regulatory financial-resources requirements without access to the affiliated entity's funds, affiliation with a DCM should not pose a problem.

144

Cboe did not support new regulations limiting the sharing of personnel or office space and encouraged the Commission to continue a principles-based approach that allows for the flexibility necessary to address particular facts and circumstances rather than developing an entirely new framework.

145

142

Letter from Faryar Shirzad, Chief Policy Officer, and Gregory Compa, Senior Director, Head of Institutional Compliance, on behalf of Coinbase Global, Inc., to CFTC, (Sep. 28, 2023) at 3, 7-8 (“Coinbase Comment”).

143

MIAX/MGEX Comment,

supra

note 110, at 5.

144

Id.

145

Cboe Comment,

supra

note 99, at 3.

The Commission notes that none of the commenters specifically recommended that the Commission mandate use of an RSP under Commission Regulation 38.606 for a DCM's surveillance of its affiliate FCM. Commenters who addressed mitigation generally emphasized information barriers, personnel separations, and other structural safeguards as appropriate means of addressing the potential conflict, rather than mandatory third-party outsourcing of the intra-day financial surveillance function.

iii. Identified Concerns

After considering the comments, the Commission preliminarily believes that a DCM's financial surveillance of an affiliate FCM under Commission Regulation 38.604 presents potential conflicts of interest that warrant attention beyond those addressed by existing regulations.

Specifically, in monitoring the positions of an affiliate FCM, comparing those positions to the FCM's financial resources, and determining the appropriate steps to protect customer funds, a DCM exercises judgment that may be influenced—or appear to be influenced—by its commercial interest in the affiliate FCM. The decision to escalate concerns regarding the affiliate FCM's financial condition (including by contacting the FCM, the FCM's DSRO, or Commission staff under Commission Regulation 38.604(c)) is similarly subject to potential conflict or appearance of a conflict. Although the proposed amendments to Commission Regulation 1.52 described above address the periodic supervisory and examination program that an SRO conducts under Commission Regulation 1.52(c) and the Joint Audit Plan under Commission Regulation 1.52(d), the intra-day financial surveillance required by Commission Regulation 38.604 is distinct as it involves the intraday monitoring of positions and obligations and may require intraday judgment calls about the financial integrity of FCMs and the protection of customer funds that are not present in the Commission Regulation 1.52 context.

Separately, the Commission preliminarily believes that the existing “continuously monitor” and “continually survey” language in Commission Regulation 38.604 would benefit from specifically reflecting the

Commission's intent that the surveillance obligation is risk-based and intra-day, not continuous in a literal real-time sense.

iv. Proposed Amendments

The Commission proposes two sets of amendments to address the concerns identified above.

Clarifying Amendments to Commission Regulation 38.604.

The Commission proposes to amend Commission Regulation 38.604 regarding the frequency of the financial surveillance obligation. As proposed, Commission Regulation 38.604(a) would retain the existing requirement that a DCM monitor its members' compliance with the DCM's minimum financial standards and routinely receive and promptly review financial and related information from its members but would remove the word “continuously” from the requirement to monitor the positions of members and their customers. Instead, proposed Commission Regulation 38.604(a) would require the DCM to (1) monitor the obligations of each FCM created by the positions of its customers “throughout the day”; (2) as appropriate, compare those obligations to the financial resources of the FCM; and (3) take appropriate steps to use this information to protect customer funds.

These amendments are intended to confirm that the surveillance obligation requires intra-day, risk-based monitoring—taking into account factors such as the size of an FCM and its customers' positions, the margin required on open positions, market volatility, the capital levels of an FCM, and the amount of excess segregated funds held by the FCM—rather than literal real-time monitoring of every trade. The Commission preliminarily believes that this clarification codifies existing Commission expectations and market practices and is appropriate independent of the affiliate-FCM context, although it has practical importance for that context as well.

New Conflicts Procedures Requirements—Proposed amendments to Commission Regulation 38.606.

The Commission proposes to amend Commission Regulation 38.606 to add a new paragraph providing that a DCM that has an affiliate FCM (as defined in proposed Commission Regulation 1.52(a)(3)) may comply with the requirements of Commission Regulation 38.604 by designating an independent third-party RSP, and that if such a DCM does not engage an independent third-party RSP, the DCM must have procedures for identifying, addressing, and managing conflicts of interests involving its affiliate FCM that may arise in connection with the DCM's obligations under Commission Regulation 38.604. The amendments would further provide that such procedures must address, at a minimum: (1) applications and systems, such that a DCM's applications and systems are maintained and operated in a manner that prevents the sharing of non-public information with any affiliate FCM; (2) personnel, such that a DCM does not share staff with any affiliate FCM, except with respect to administrative functions; (3) office space, such that a DCM maintains office space for itself that is separate from the office space of any affiliate FCM; (4) documentation, such that a DCM documents all conflicts of interest that arise with respect to an affiliate FCM and how any such conflict of interest is resolved; and (5) disclosures, such that a DCM provides disclosure of the existence of an affiliate FCM in its rulebook and in a clear, prominent, and readily available manner on its website and any other application portal or similar means through which a DCM directly or indirectly connects electronically with its market participants.

This Proposal would not require a DCM with an affiliate FCM to engage an RSP for Commission Regulation 38.604 purposes. The Commission preliminarily believes—in part based on the comments described above—that a principles-based conflicts mitigation requirement, leaving the DCM with the choice between (i) outsourcing Commission regulation 38.604 surveillance to an independent third-party RSP and (ii) implementing procedures to address the conflicts arising from in-house Commission Regulation 38.604 surveillance of an affiliate FCM, would appropriately accommodate the range of arrangements that DCMs may adopt to satisfy DCM Core Principle 11 with respect to affiliated FCMs. This approach is consistent with the principles-based posture recommended by Cboe and is informed by the structural-safeguard recommendations of CME, NFA, MIAX, AEGIS, and CCP Global.

The proposed approach is intended to operate alongside, rather than duplicate, the proposed Commission Regulation 1.52 requirements described above. The proposed Commission Regulation 1.52 changes would require an SRO with an affiliate FCM to designate an independent third-party SRO to conduct the periodic supervisory program and prohibit the SRO from acting as DSRO for the affiliate FCM. The proposed Commission Regulation 38.606 amendment, by contrast, would govern the distinct intra-day financial surveillance function under Commission Regulation 38.604 and would leave the DCM with discretion to determine how best to address the related conflicts.

The Commission also is proposing to amend Appendix B to part 38 to provide DCMs with guidance regarding the Commission's views concerning acceptable practices for conflict-of-interest procedures. The current guidance provided with respect to Core Principle 16 (conflicts of interest) in Appendix B to part 38 notes that DCMs “bear special responsibility to regulate effectively, impartially, and with due consideration of the public interest” and that they “should be particularly vigilant for such conflicts between and among any of their self-regulatory responsibilities, their commercial interests, and the several interests of their management, members, owners, customers and market participants, other industry participants, and other constituencies.”

146

The Appendix provides various acceptable practices to manage conflicts of interest. This proposal would add guidance regarding appropriate separations between a DCM and an affiliate market participant (described below and including an affiliate FCM) as follows:

146

CFR 17 part 38, app. B.

Separate systems.

The guidance would provide that a DCM's applications and systems should be maintained and operated in a manner that prevents the sharing of non-public information with any affiliate FCM, with a carveout to allow such sharing if the DCM shares such non-public information with all of the DCM's market participants or if the information relates only to the affiliate FCM or the affiliate FCM's customers. The guidance would provide further color on appropriate systems separations including that a DCM should: (1) keep logically separate its trading platform, surveillance systems and recordkeeping systems from an affiliate FCM's applications and systems; (2) apply controls across all other applications, information and systems to prevent improper sharing of non-public information with an affiliate FCM; and (3) monitor for instances where an affiliate FCM has gained access to the DCM's applications, information, or systems.

Separate personnel.

The guidance would provide that a DCM should not share staff with an affiliate FCM, with the exception of administrative staff (for example, accounting, human resources

and payroll staff) and technology staff responsible for Core Principle 20 (Systems Safeguards) functions.

Separate office space.

In order to prevent the inappropriate sharing of non-public information, the guidance would provide that a DCM should establish office space for itself that is separate from the office space of any affiliate FCM, and that the separation should include physical barriers and the ability of the DCM to monitor for any instances where an affiliate FCM has gained physical access to the DCM.

The Commission preliminarily believes that this guidance sets out best practices with respect to mitigating conflicts of interest between affiliates. The core of the proposed guidance, together with the proposed rule amendments, recommends physical separations between affiliates' systems, personnel, and offices. The Commission preliminarily believes that such separations will reduce the possibility of affiliates and their personnel from inappropriately sharing non-public information. Furthermore, the Commission preliminarily believes that such separations will provide other market participants with confidence regarding the DCM's ability to manage conflicts.

The Commission requests comment on all aspects of the proposed guidance. The Commission specifically requests comment on whether each aspect of the proposed guidance is adequate or, instead, should be modified or removed, and if the Commission should provide specific guidance with respect to any other aspects of a conflicts of interest program.

v. Statutory Authority

The Commission proposes the amendments to Commission Regulations 38.604 and 38.606 pursuant to section 8a(5) of the Act, which authorizes the Commission to promulgate such rules and regulations as, in its judgment, are reasonably necessary to effectuate any of the provisions or to accomplish any of the purposes of the Act

147

and DCM Core Principles 11 (Financial Integrity of Transactions) and 16 (Conflicts of Interest). Core Principle 11 requires each DCM to establish and enforce rules and procedures for ensuring the financial integrity of transactions entered into on or through the facilities of the contract market and for the protection of customer and member property. Core Principle 16, in turn, requires each DCM to “establish and enforce rules to minimize conflicts of interest in the decision-making process of the contract market and establish a process for resolving [such] conflicts of interest.” Under section 5(d)(1)(B) of the Act, as amended by section 735(b) of the Dodd-Frank Act, a DCM has reasonable discretion in establishing the manner in which it complies with the Core Principles “unless otherwise determined by the Commission by rule or regulation.”

148

That reservation supplies the affirmative authority for the Commission to specify particular means of compliance where a specific circumstance not adequately addressed by the general Core Principle formulation warrants targeted regulation. Section 5c(a)(1) of the Act further authorizes the Commission to issue interpretations of the DCM Core Principles to describe acceptable business practices, on a non-exclusive basis.

149

147

CEA 8a(5), 7 U.S.C. 12a(5).

148

CEA 5(d)(1)(B), 7 U.S.C. 7(d)(1)(B).

149

CEA 5c(a)(1), 7 U.S.C. 7a-2(a)(1)-(2).

The proposed amendments exercise those authorities to address a discrete conflict of interest—a DCM's financial surveillance of an affiliate FCM—that the general Core Principle 11 framework, and the current §§ 38.604 and 38.606 implementing regulations, do not specifically address. The Commission preliminarily believes that the proposed amendments neither displace the DCM's reasonable discretion in complying with the Core Principles nor exceed the Commission's statutory authority under section 8a(5) and section 5(d).

vi. Alternatives Considered

The Commission considered, and requests comment on, two alternatives to the proposed approach.

1. Mandatory Independent Third-Party RSP for Affiliated-FCM Surveillance

The Commission considered requiring a DCM with an affiliate FCM to designate an independent third-party RSP to perform Commission Regulation 38.604 financial surveillance of that affiliate FCM. The Commission preliminarily concluded that the principles-based approach reflected in proposed amendments to Commission Regulation 38.606—combined with the proposed Appendix B guidance—would be sufficient to address the identified concerns at lower cost and is consistent with the principles-based mitigation approach favored by many commenters. The Commission requests comment on whether a mandatory independent third-party RSP requirement for Commission Regulation 38.604 compliance purposes is necessary or appropriate.

2. Prescriptive Separation Requirements in Rule Text

The Commission considered further codifying in rule text the specific separations that the Commission considers appropriate for a DCM that performs Commission Regulation 38.604 surveillance of an affiliate FCM in-house. This approach would give effect to the structural-separation recommendations of certain commenters,

150

but would not accommodate the principles-based flexibility favored by others.

151

The Commission preliminarily concluded that adding Appendix B guidance, rather than new rule text, provides DCMs with appropriate flexibility to design conflicts of interest procedures suited to their specific organizational structures and operational arrangements while providing market participants with information on what the Commission considers to be appropriate conflicts of interest procedures. The Commission requests comment on whether some or all of the Appendix B content should be codified in rule text instead.

150

See, e.g.,

MIAX/MGEX Comment,

supra

note 110, at 4, 7 (no shared senior compliance or risk personnel); AEGIS Comment,

supra

note 140, at 3-4 (separate physical office space); CCP Global Comment,

supra

note 102, at 3 (separation of resources including key personnel and offices); NFA Comment,

supra

note 96, at 3 (separate boards and key management personnel).

151

See, e.g.,

Cboe Comment, supra note 99, at 3; CME Comment,

supra

note 99, at 16-17 (urging the Commission not to implement overly prescriptive rules).

vii. Request for Comment

The Commission requests comment on all aspects of the proposed amendments to Commission Regulations 38.604 and 38.606 including:

(22) Whether the clarifying amendments to Commission Regulation 38.604—including the removal of the word “continuously” and the substitution of “throughout the day”—appropriately capture the Commission's intent regarding the frequency and risk-based nature of the intra-day financial surveillance requirement.

(23) Whether the principles-based approach in proposed Commission Regulation 38.606 is appropriately calibrated, including whether the proposed regulation should specify additional procedural elements that a DCM electing to conduct in-house Commission Regulation 38.604 surveillance of an affiliate FCM must

include in its conflicts of interest procedures.

(24) Whether the Commission should adopt the alternative under which a DCM with an affiliate FCM would be required to designate an independent third-party RSP for Commission Regulation 38.604 surveillance of the affiliate FCM.

(25) Whether the Commission should adopt the alternative under which additional separation requirements would be codified in the rule text.

The Commission also specifically requests that DCMs with an affiliate FCM—and any other DCM, FCM, or market participant with relevant information—describe:

(26) Whether the DCM currently engages an RSP for Commission Regulation 38.604 purposes (including for surveillance of an affiliate FCM); and if so, the identity of the RSP and the terms (including cost) of the arrangement;

(27) Where the DCM conducts Commission Regulation 38.604 surveillance in-house, the policies, procedures, organization separations, and other measures currently in place to address potential conflicts of interest arising from financial surveillance of an affiliate FCM;

(28) The nature and estimated incremental cost of any change to existing arrangements that would be required to comply with Commission Regulation 38.606 as proposed; and

(29) The nature and estimated incremental cost of complying with the mandatory independent third-party RSP alternative described above, including any market-capacity considerations that would arise if additional DCMs were required to engage NFA or another RSP for Commission Regulation 38.604 surveillance of affiliate FCMs.

III. Exchange-Related Conflicts Mitigation

DCM Core Principle 16 and SEF Core Principle 12 each require an exchange to establish and enforce rules to minimize conflicts of interest in its decision-making process.

152

This section of the Proposal addresses conflicts of interest that arise when a DCM or SEF is affiliated with a market participant that directly or indirectly executes, introduces, or otherwise facilitates trades on that exchange. Two distinct kinds of affiliation are at issue, and the distinction between them is central to the regulatory approach the Commission proposes. The first is an affiliation between an exchange and an intermediary—such as an FCM or IB—that acts on behalf of customers. The second is an affiliation between an exchange and a principal trading firm, such as a hedge fund or market maker, that trades for its own account on the exchange. As discussed below, an affiliated intermediary acts as agent for customers, whereas an affiliate principal trading firm trades as principal; every transaction the latter executes against an unaffiliated participant implicates the exchange's own economic interests directly. The Commission preliminarily believes these two affiliations present conflicts that differ in kind and proposes to address them through two distinct mechanisms: a principles-based conflicts-of-interest framework applicable to any affiliate market participant, and, for an affiliate principal trading firm, a more prescriptive set of requirements. This section of the Proposal also addresses conflicts of interest matters related to DCM board composition, ROCs, and disciplinary panels.

152

CEA 5(d)(16), 7 U.S.C. 7(d)(16) (DCM Core Principle 16); CEA 5h(f)(12), 7 U.S.C. 7b-3(f)(12) (SEF Core Principle 12).

A. Proposed New Commission Regulations 38.852 and 37.1201—Conflicts of Interest Involving an Affiliate Market Participant

i. Background

DCM Core Principle 16 directs each DCM to establish and enforce rules to minimize conflicts of interest in its decision-making process and to establish a process for resolving such conflicts of interest.

153

The Commission's guidance and acceptable practices for Core Principle 16 appear in Appendix B to part 38.

154

SEF Core Principle 12 imposes a parallel obligation on each SEF to minimize conflicts of interest in its decision-making process and to establish a process for resolving them.

155

Both Core Principles are principles based: the exchange must minimize conflicts in its decision-making and have a process to resolve them, but the manner in which it does so is left to the exchange's reasonable discretion, subject to the Commission's rules and informed by Commission guidance and acceptable practices.

156

153

CEA 5(d)(16), 7 U.S.C. 7(d)(16) (DCM Core Principle 16).

154

17 CFR part 38, app. B, Core Principle 16. app. B currently does not provide any guidance with respect to compliance with Core Principle 16.

155

CEA 5h(f)(12), 7 U.S.C. 7b-3(f)(12) (SEF Core Principle 12); 17 CFR part 37 2.

156

See

CEA 5(d)(1)(B), 7 U.S.C. 7(d)(1)(B) (DCM reasonable discretion); CEA 5h(f)(1)(B), 7 U.S.C. 7b-3(f)(1)(B) (SEF reasonable discretion).

Neither Core Principle, however, specifically addresses the conflicts of interest that arise when the exchange is affiliated with one of its own market participants. Appendix B to part 38 speaks to conflicts between a DCM's self-regulatory responsibilities and its commercial interests generally, but neither the part 38 regulations nor the part 38 guidance specifically addresses conflicts arising from an exchange's affiliation with an FCM, IB, or principal trading firm participating on its market.

ii. Comments on the Affiliations RFC

The Commission received substantial comment in response to the 2023 Affiliations RFC on conflicts arising from an exchange's affiliation with a market participant.

157

Commenters generally agreed that affiliations between an exchange and a market participant can create conflicts of interest warranting management, but a substantial majority favored addressing those conflicts through a principles-based framework rather than prescriptive structural requirements or an outright prohibition.

157

Affiliations RFC,

supra

note 1.

Views supporting a principles-based framework.

Commenters that operate exchanges with affiliated intermediaries trading on their markets and others urged the Commission to address potential conflicts through a principles-based approach with accompanying guidance rather than prescriptive rules. AEGIS, which operates a SEF affiliated with a CTA and IB that executes transactions on the SEF, described the existing combination of regulations and the registration process as “effective in avoiding conflicts of interest.”

158

The Wholesale Markets Brokers' Association, Americas (“WMBAA”), whose members operate SEFs with affiliated IBs, similarly commented that the matters raised in the RFC “are addressed by current CFTC regulations and current market practices” and cautioned that an “overly prescriptive implementation of the Core Principles” could “dissuade future entrants into the swaps market and reduce competition.”

159

158

AEGIS Comment,

supra

note 140, at 1.

159

Letter from Shawn Bernardo, on behalf of WMBAA, to CFTC at 2 (Sep. 28, 2023) (“WMBAA Comment”).

Cboe, which operates DCMs, a SEF, and DCO, commented that “existing CFTC regulations provide an appropriate, principles-based framework” for evaluating and disclosing the risks associated with intermediary affiliations and urged the Commission to “continue embracing a principles-based approach that allows for necessary flexibility to address

particular facts and circumstances rather than develop an entirely new framework.”

160

Coinbase observed that existing law and regulations already “prohibit DCMs from engaging in anticompetitive behavior and require them to maintain impartial access to their market, enforce their rulebooks consistently across participants, maintain adequate staffing, safeguard confidential information and manage conflicts of interest” and encouraged the Commission to revise existing provisions “only to the extent that” a gap is identified, rather than adopt “overly prescriptive regulations.”

161

CCP Global, while stating that it “does not believe that the CFTC should deviate from its principles-based approach,” suggested it “could be beneficial” for the Commission to provide additional guidance—for example, “an illustrative list of conflicts to be mitigated, managed, and/or disclosed and a list of tools that entities may use to mitigate these conflicts.”

162

CME, while cautioning the Commission “against adopting comprehensive and prescriptive rules” and emphasizing that the existing principles-based approach “has worked well” supported “requiring a marketplace SRO that is affiliate with an FCM (or other CFTC registrant) to adopt and implement rules, policies, and/or procedures to assure that its operations and those of the CFTC registrant are sufficiently separated.”

163

160

Cboe Comment,

supra

note 99, at 2.

161

Coinbase Comment,

supra

note 142, at 2.

162

CCP Global,

supra

note 102, at 2.

163

CME Comment,

supra

note 99, at 1, 4.

Views on specific mitigants and disclosures.

Some commenters described the specific separations, safeguards, and disclosures they viewed as appropriate, and many reported that such measures are already standard market practice. AEGIS described an approach under which staff responsible for compliance and surveillance are “dedicated to the SEF and not shared with any affiliate” and are “segregated into separate physical” office space, with certain marketing, treasury, and technology functions shared with affiliates only pursuant to a CFTC-reviewed shared-services agreement; it also described independent governance through a SEF board and regulatory oversight committee with public directors, the use of a third-party RSP for trade-practice surveillance, and public disclosure of its affiliated broker firm.

164

WMBAA reported that its members' SEFs manage affiliated-intermediary conflicts through “rulebooks, distinct and transparent governance structures and operational policies,” a third-party RSP, and “data separation barriers,” while emphasizing the cost and efficiency benefits of “properly segmented” shared resources.

165

CCP Global emphasized that an affiliate FCM should “neither be afforded preferential treatment, nor be disadvantaged or subject to more restrictive treatment” relative to unaffiliated FCMs, and should be subject to the “same access criteria and rules as non-affiliated” members “in areas including, but not limited to, fees, surveillance, and disciplinary processes”; it further supported “separation of resources, including key personnel, offices, and information systems” and robust information barriers.

166

164

AEGIS Comment,

supra

note 140, at 1.

165

WMBAA Comment,

supra

note 159, at 4-5.

166

CCP Global Comment,

supra

note 102, at 3.

MIAX identified a “well-conceived, thorough, and rigorously enforced” information-barrier policy; a prohibition on affiliates sharing “senior compliance and risk management personnel, such as the Chief Risk Officer, the Chief Compliance Officer, and the Chief Regulatory Officer”; physically and logically separate information-technology systems and separate office space; and a public rule that the affiliate “will not receive preferential treatment in any respect” disclosed on its website.

167

It identified cybersecurity, physical security, internal audit, and information security as functions that may be shared without conflict.

168

CME recommended that an affiliated registrant's operations be “sufficiently separated” from the exchange's and agreed that the exchange should adopt firewalls and internal procedures to prevent the affiliate from accessing confidential information held by exchange staff.

169

167

MIAX/MGEX Comment,

supra

note 110, at 4, 15.

168

Id.

169

CME Comment,

supra

note 99, at 4, 15.

Regarding disclosure, MIAX and AEGIS each described public disclosure of the affiliate relationship as their existing practice, and CCP Global, Cboe, and Coinbase each treated transparency regarding the affiliation as an element of an adequate conflicts framework.

170

MIAX/MGEX Comment,

supra

note 110, at 5 & n.13; AEGIS Comment, supra note 140, at 1; CCP Global Comment,

supra

note 102, at 2-3; Cboe Comment,

supra

note 99, at 2; Coinbase Comment,

supra

note 142, at 2.

Views opposing affiliation.

Public Citizen and Better Markets opposed permitting exchange-affiliate relationships, with Public Citizen taking the view that the conflicts “cannot be successfully mitigated” and that the Commission “must therefore establish rules prohibiting” such affiliations, and Better Markets opposing affiliation structures generally while recommending robust disclosure and conflicts-of-interest requirements if the Commission permits such structures.

171

See

Letter from Tyson Slocum, Energy Program Director, on behalf of Public Citizen, Inc., to the CFTC at 1-2 (Sep. 28, 2023) (hereinafter “Public Citizen Comment”); Letter from Cantrell Dumas, Director of Derivatives Policy, on behalf of Better Markets, Inc., to the CFTC at 1, 4 (Sep. 28, 2023) (hereinafter “Better Markets Comment”).

Views distinguishing agents from principals.

Finally, several commenters distinguished an affiliated intermediary that acts as an agent for customers from an affiliated firm that trades on a proprietary basis on the exchange. CME distinguished between an affiliate FCM that “acts solely on an agency basis” and a trading firm that “trades on a proprietary basis on the DCM,” observing that the latter “raises conflict of interest concerns of a very different type and magnitude.”

172

Cboe questioned whether a DCM or SEF should be permitted to have an affiliated liquidity provider trade on its market.

173

And Coinbase observed that the degree of conflict “varies depending on whether the trader is trading on behalf of others . . . or whether the trader is solely trading for its own profit.”

174

172

CME Comment,

supra

note 99, at 3, 5.

173

Cboe Comment,

supra

note 99, at 3.

174

Coinbase Comment,

supra

note 142, at 7.

iii. Identified Concerns

After considering the comments described above, the Commission preliminarily identifies the following concerns with respect to an exchange's affiliation with a market participant.

First,

an exchange exercises substantial discretion across functions that bear directly on the competitive position of its market participants. That discretion includes market and trade-practice surveillance, investigations and rule enforcement, product listing decisions, and fee and incentive arrangements. Where the exchange is affiliated with a market participant, the structural incentive to exercise that discretion in a manner that favors the affiliate, or that disadvantages the affiliate's competitors, can compromise the exchange's role as a neutral, self-regulatory operator of the market.

Second,

an exchange acquires non-public information about its market participants—including regarding order flow and positions, and, through its surveillance and examination functions, financial and risk information. Affiliation creates the risk that such

information could be shared with, or used to benefit, the exchange's affiliate. As several commenters recognized, robust information barriers between the exchange and its affiliate are a principal safeguard against this risk; unaffiliated participants may be reluctant to provide non-public information to an exchange if they perceive that it could reach a competitor.

Third,

even where an exchange in fact treats it affiliate on an arms-length basis, the Commission believes that the perception of preferential treatment can itself have anti-competitive effects and understands that many market participants share this concern. Unaffiliated participants may conclude that they are systematically disadvantaged in surveillance, enforcement, listing, trading or fee decisions, and may direct activity away from the venue, undermining the integrity of the exchange as a market-neutral operator. It is possible that unaffiliated participants may decide not to trade due to perceived unfairness, which could have a negative impact on liquidity, or that non-affiliate participants may have to trade on certain venues—in some cases due to a lack of viable alternatives—despite these concerns.

The Commission preliminarily believes these concerns warrant Commission action and that the Commission's existing regulations and guidance are not sufficient. At the same time, the Commission is preliminarily persuaded by the substantial body of comment indicating that exchanges with affiliated market participants generally already maintain the kinds of governance separations, information barriers, and disclosures that mitigate these concerns. The Commission's proposed approach, described below, is calibrated accordingly.

175

The mission of the Commodity Futures Trading Commission is to promote the integrity, resilience, and vibrancy of the U.S. derivatives markets through sound regulation.

See

Mission Statement, available at

https://www.cftc.gov/About/AboutTheCommission. See also

Chairman Michael Selig's April 1, 2026 public statement that “regulators must be disciplined enough to administer the minimum effective dose of regulation, otherwise innovation moves elsewhere and our nation suffers the consequences,” available at

https://www.cftc.gov/PressRoom/SpeechesTestimony/seligstatement040126.

iv. Proposed Amendments

The Commission proposes to add a new Commission Regulation 38.852 to part 38 and a parallel new Commission Regulation 37.1201 to part 37, each establishing a principles-based requirement that an exchange with an affiliate market participant maintain procedures to identify, address, and manage the related conflicts of interest, together with conforming acceptable practices in Appendix B to each part.

Definition of “affiliate market participant”

—

Proposed Commission Regulations 38.852(a), 37.1201(a).

Proposed Commission Regulation 38.852(a) would define “affiliate market participant” as any person (including any affiliate FCM or affiliate principal trading firm) that (i) directly or indirectly executes, introduces, or otherwise facilitates trades on or subject to the rules of the DCM, and (ii) directly or indirectly controls, is controlled by, or is under common control with the DCM. Proposed Commission Regulation 37.1201(a) would adopt a parallel definition for SEFs that additionally enumerates an affiliate introducing broker, reflecting the central role of introducing brokers in the SEF market structure. Each definition uses the same “control”-based formulation the Commission proposes to use for the parallel definitions of “affiliate futures commission merchant” and “affiliate clearing member”.

176

See supra

Sec. II.A.iv.a,

infra

Sec. IV.D.

The Commission preliminarily believes that a control-based definition, rather than a fixed ownership-percentage threshold, is appropriate because the relevant conflicts turn on the power to direct management and policies rather than on any particular equity stake, and that consistency across the parallel definitions will promote clarity and ease of compliance for corporate groups with multiple CFTC-registered entities.

177

The Commission solicits comment on the proposed definition.

177

The terms “affiliate” and “affiliated” are consistent with how the Commission has defined such terms elsewhere in its regulations, including Commission Regulations 49.2 and 23.23(a)(1). The Commission also believes that its definition is generally consistent with how SEFs and DCMs have defined the term “affiliate” in their rulebooks. See,

e.g.,

LedgerX LLC (d/b/a MIAX Derivatives Exchange) (defining affiliate as “a Person who, directly or indirectly, controls, is controlled by, or is under common control with another Person”); Kalshi LLC (defining affiliate as, with respect to any Person, any Person who, directly or indirectly, Controls, is Controlled by, or is under common Control with, such other Person”); AEGIS SEF (defining affiliate as “a Person who directly or indirectly, controls, is controlled by, or is under common control with another Person”); BGC SEF (defining Affiliate as any other Person which directly, or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with, such Person.”).

Principles-based conflicts requirement

—

Proposed Commission Regulations 38.852(b), 37.1201(b).

Proposed Commission Regulation 38.852(b)(1) would require that a DCM have procedures for identifying, addressing, and managing conflicts of interest involving an affiliate market participant. The proposed regulation would further require that such procedures address, at a minimum, applications and systems, personnel, office space, documentation of conflicts, and disclosures. Proposed Commission Regulation 37.1201(b) would impose the identical requirement on a SEF. This formulation parallels the requirement the Commission proposes below for DCOs in proposed Commission Regulation 39.25(d) and the existing procedures-based formulation in Commission Regulation 39.25(c).

178

See infra

Sec. IV.D.

The Commission preliminarily believes a principles-based requirement is preferable to prescriptive structural separation rules in this context. Whether an exchange has an affiliate market participant is an objective inquiry, as is whether the exchange maintains procedures to identify, address, and manage the associated conflicts, including with respect to the specifically enumerated categories. The Commission can examine for compliance, and the requirement places the burden on the exchange to design and implement procedures suited to its particular structure and risk profile. This approach is consistent with the principles-based posture favored by most commenters and is informed by the specific safeguards that exchanges with affiliated participants report already maintaining.

Acceptable practices

—

Appendix B to parts 37 and 38.

The Commission proposes to add conforming acceptable practices to Appendix B of both parts 37 and 38, identifying the separations the Commission would consider appropriate for an exchange with an affiliate market participant. This Proposal would add guidance regarding appropriate separations between a DCM or

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