[Federal Register Volume 65, Number 240 (Wednesday, December 13, 2000)]
[Rules and Regulations]
[Pages 78020-78030]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-30269]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 39

RIN 3038-AB57


A New Regulatory Framework for Clearing Organizations

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC) 
is promulgating a new regulatory framework to apply to clearing 
organizations. These regulations for clearing organizations are part of 
an initiative that would also establish a new regulatory framework for 
multilateral transaction execution facilities (MTEF) and market 
intermediaries. The final new framework in its entirety is 
simultaneously announced today in companion releases. The new 
framework, including these regulations are centered on broad, flexible, 
core principles and are designed to ``promote innovation, maintain U.S. 
competitiveness, and at the same time reduce systemic risk and protect 
customers.'' The Commission has fashioned these regulations so that it 
can fairly and efficiently carry out the important duty of overseeing 
clearing organizations in a changing, dynamic industry pursuant to a 
transparent codified framework.

EFFECTIVE DATE: February 12, 2001.

FOR FURTHER INFORMATION CONTACT: Alan L. Seifert, Deputy Director, 
Division of Trading and Markets, or Lois J. Gregory, Special Counsel, 
Division of Trading and Markets, Commodity Futures Trading Commission, 
Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581. 
Telephone (202) 418-5260 or e-mail [email protected], 
[email protected], or [email protected].

SUPPLEMENTARY INFORMATION:  

[[Page 78021]]

I. Background

    On June 22, 2000, the Commission published for comment proposed new 
Part 39, a regulatory framework for the oversight of clearing 
organizations. 65 FR 39027. Part 39 is part of an initiative that would 
also establish a new regulatory framework for MTEFs and market 
intermediaries. The final new framework in its entirety is 
simultaneously announced today in companion releases. The new 
framework, including Part 39, is centered on broad, flexible, core 
principles and is designed to ``promote innovation, maintain U.S. 
competitiveness, and at the same time reduce systemic risk and protect 
customers.'' 65 FR 38986.
    The futures and option markets are undergoing changes in market 
structure and technology. Clearing organizations for these markets 
perform valuable functions by mitigating counterparty risk, 
facilitating the netting and offsetting of contractual obligations, and 
decreasing systemic risk. Clearing organizations should be subject to 
continuing regulatory oversight to ensure that they have sufficient 
financial resources and that they establish and implement prudential 
risk management programs designed to control concentration risks 
associated with centralized clearing.\1\ The Commission has fashioned 
new Part 39 so that it can fairly and efficiently carry out the 
important duty of overseeing clearing organizations in a changing, 
dynamic industry pursuant to a transparent codified framework.
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    \1\ See Over-the-Counter Derivatives Markets and the Commodity 
Exchange Act, Report of the President's Working Group, November 
1999.
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    Part 39 requires that transactions effected on recognized futures 
exchanges (RFEs) under Part 38 and derivatives transaction facilities 
(DTFs) under Part 37 be cleared only by clearing organizations that 
have been recognized by the Commission under Part 39--recognized 
clearing organizations (RCOs). RCOs are also permitted to clear 
transactions that are exempt under Part 35--Exemption of Bilateral 
Agreements and Part 36--Exemption of Transactions on Multilateral 
Transaction Execution Facilities.\2\ In addition, nothing in Part 39 
prohibits an RCO from clearing any other type of instrument such as 
cash or forward delivery contracts.\3\
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    \2\ In addition to RCOs, certain other enumerated entities also 
are authorized to clear transactions exempt under Parts 35 and 36. 
These include a clearing agency or system regulated by the 
Securities and Exchange Commission (SEC), the Federal Reserve, or 
the Comptroller of the Currency, and certain foreign clearing 
organizations.
    \3\ Further, nothing in Part 39 prohibits an entity that clears 
only exempt transactions from applying to the Commission for RCO 
status. An entity may want to apply for recognition as an RCO for 
its own business purposes.
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    Current futures clearing organizations may self-certify and 
automatically qualify as RCOs under Part 39. New entities could apply 
for RCO status by demonstrating that their rules, procedures, and 
operations would be consistent with the 13 broad and flexible core 
principles set forth in Part 39. Appendix A to Part 39 would provide 
guidance to applicant RCOs as to how to make such a demonstration. 
Certain provisions of Part 39 and Appendix A have been modified from 
their proposed versions in light of comments received from participants 
in the industry. These modifications, as discussed herein, provide 
additional clarity and are consistent with the new regulatory 
framework's goal of promoting innovation and maintaining U.S. 
competitiveness, while also reducing systemic risk and protecting 
customers.

II. Overview

    The Commission received comment letters on Part 39 from a number of 
SROs and other interested entities.\4\ Commenters overwhelmingly 
supported the Part 39 requirement that all transactions executed on a 
designated contract market, an RFE, or a DTF, if cleared, be cleared by 
an RCO. Commenters also supported the proposition that nothing in Part 
39 prohibits RCOs from clearing transactions other than those effected 
pursuant to Parts 35-38. Other comments concerned the definition of 
clearing organization, the jurisdiction of the Commission, the 
applicable provisions of the Commodity Exchange Act (Act) and 
regulations, and the guidance in Appendix A to Part 39. In response to 
the comments, the Commission has made changes to the definition of 
clearing organization and changes that clarify the jurisdiction of the 
Commission under Part 39. Other changes to Part 39 limit the 
applicability of sections of the Act and the regulations, and address 
the illustrative purpose of the guidance in Appendix A.
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    \4\ In this and three companion Notices of Final Rulemaking 
which are being published in this edition of the Federal Register, 
comment letters (CL) are referenced by file number, letter number 
and page. These letters are available through the Commission's 
internet web site. Comments filed in response to the notice of 
proposed rulemaking on clearing organizations are contained in file 
No. 23. Comments filed predominantly in response to the notice of 
proposed rulemaking on Parts 36-38, but which also had comments on 
clearing organizations, are contained in file No. 21. Those 
commenting upon Part 39 include: Board of Trade Clearing Corporation 
(BOTCC); California Power Exchange; Chicago Board of Trade; Chicago 
Mercantile Exchange (CME); Federal Reserve Bank of Chicago (FRB of 
Chicago); Financial Markets Lawyers Group; Futures Industry 
Association (FIA); Global TeleExchange; Government Securities 
Clearing Corporation (GSCC); New York Independent System Operator; 
JP Morgan; Kiodex, Inc.; Mercatus Center at George Mason University; 
New York Clearing Corporation (NYCC); New York Mercantile Exchange; 
Options Clearing Corporation (OCC); Oxy Energy Services, Inc.; 
PetroCosm Corporation; Securities Industry Association; and Cleary, 
Gottlieb, Steen & Hamilton, on behalf of a coalition of investment 
banks consisting of Chase Manhattan Bank, Citigroup Inc., Credit 
Suisse First Boston Inc., Goldman Sachs & Co., Merrill Lynch & Co. 
Inc., and Morgan Stanley Dean Witter & Co. (Coalition).
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III. Discussion

A. Purpose

    The Part 39 core principles reflect standards that the Commission 
takes into account in overseeing the clearing of futures and option 
contracts without imposing new regulatory requirements. Certain 
commenters contended that Part 39 as proposed would impose a new 
regulatory framework on entities already successfully regulated, and 
that the Commission had not fully articulated why Part 39 was being 
imposed at this time. See, e.g., CL 21-51 at 11 and CL 23-40 at 2.
    The Commission currently oversees the clearing organizations that 
are associated or affiliated with U.S. futures and option exchanges. As 
a practical matter, the Commission generally has regulated clearing 
organizations in connection with its oversight of contract markets 
which heretofore have had close affiliations with their clearing 
organizations. Among other things, the Commission has reviewed clearing 
organization rules, audited clearing organizations for compliance with 
the Commission's segregation, recordkeeping, and customer funds 
investment rules, monitored the clearing process in times of major 
market moves to identify potential systemic risks, and conducted 
oversight of the liquidation of positions and transfer of customer 
accounts in cases where clearing members encounter financial 
difficulty.
    The Commission's oversight of clearing organizations also has been 
guided by standards not expressly set forth in the Act or the 
Commission's regulations for contract markets. For example, the 
Commission has taken into account, among other standards and 
procedures, the standards set forth in the Bank for International 
Settlements' (BIS) 1993 Lamfalussy Report on multilateral netting 
systems and other BIS reports, the recommendations with respect to 
clearing and settlement of

[[Page 78022]]

securities transactions of the Group of Thirty, and the recommendations 
of the President's Working Group in response to the market break of 
October 1987. Part 39's core principles reflect these various standards 
and existing futures clearing organizations currently meet these 
standards. Thus, Part 39 represents the Commission's intention to put 
into a logical and coherent regulatory form the same principles that 
the Commission now applies to clearing organizations. This approach is 
a natural accompaniment to the new regulatory framework.
    Recently, there has been an increase in the number of new 
electronic markets that do not have their own clearing capacity. This 
trend has resulted in an increase in the opportunity for clearing 
organizations independent of transaction facilities to clear for 
multiple markets, which in turn magnifies the importance of clearing in 
the management of systemic risk. Clearing organizations unaffiliated 
with the transaction facilities for which they clear necessarily will 
have rules, procedures, and practices separate and independent from the 
transaction facilities. Thus, the Commission will oversee the clearing 
function pursuant to a framework separate from, but related to, the 
framework for the oversight of the transaction facilities.

B. Definition of Clearing Organization

    In its final Part 39 rules, the Commission has clarified the 
definition of ``clearing organization'' to mean, with respect to 
transactions executed on a designated contract market or pursuant to 
Parts 35-38, a person that provides credit enhancement to its members 
or participants in connection with netting and/or settling the payments 
and payment obligations of such members or participants, by becoming a 
universal counterparty to such members or participants, or 
otherwise.\5\ Providing credit enhancement in connection with, or as a 
byproduct of, providing settlement services is the critical attribute 
of a clearing organization.
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    \5\ The definition continues to exclude those netting 
arrangements specified in Sec. 35.2 (d)(1) and (d)(2) and an entity 
that is a single counterparty offering to enter into, or entering 
into, bilateral transactions with multiple counterparties.
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    Some of the comments raised concerns about the proposed definition 
in that they stated certain activities should not constitute the 
activity of clearing. See, e.g., BOTCC CL 21-20 at 10. These activities 
include the netting of payment obligations and entitlements and the 
performance of trade processing services such as trade comparison, 
margin calculation, and reporting services.\6\ In response to these 
comments, the revised definition captures only organizations whose 
services enhance the credit of the members or participants that are 
parties to the contracts cleared by the organization.
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    \6\ It also includes, where applicable, the scheduling or 
netting of physical delivery obligations and related bookkeeping 
functions such as those performed by operators of physical delivery 
points for certain energy-related products. See CL 21-56 at 2.
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    One method of credit enhancement is to be the counterparty to every 
cleared transaction. The clearing organization substitutes itself for 
each original counterparty and becomes legally bound to every party to 
a transaction. This is known as legal novation. However, a clearing 
organization can provide credit enhancement in ways other than strict 
legal novation. It can agree with its members and participants that it 
will be legally bound to guarantee payment flows associated with 
transactions in connection with or as a byproduct of the provision of 
netting services, that is, the netting of all payment obligations and 
entitlements. A clearing organization also could provide credit 
enhancement in any legal agreement to guarantee payment flows in 
connection with other settlement services.
    The provision of one or more clearing services absent credit 
enhancement, however, will not, as a general matter, constitute the 
activity of clearing for purposes of Part 39. Therefore, for purposes 
of Part 39, the term ``clearing organization'' does not encompass the 
sole provision of netting services in the absence of any type of credit 
enhancement.

C. Scope of Part 39

    The language of the scope provision, Sec. 39.1, the enforceability 
provision, Sec. 39.5, and the antifraud provision, Sec. 39.6, in their 
final form, all apply to an RCO's clearing of transactions effected 
pursuant to the enumerated parts. The final language of Sec. 39.2 
clarifies:
    (1) what must be cleared by an RCO (any transaction effected on a 
contract market or pursuant to Parts 37 and 38 that is cleared);
    (2) that the clearing of transactions by an RCO is regulated under 
Part 39;
    (3) that transactions effected pursuant to Parts 35 or 36 may be 
cleared by an RCO or by other authorized clearing organizations;\7\
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    \7\ Transactions pursuant to Part 34 are not included in 39.2 or 
otherwise referred to in Part 39 as these instruments have 
consistently been subject to other regulatory schemes, whether under 
the jurisdiction of the SEC as securities, or regulated pursuant to 
federal banking laws as depository instruments.
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    (4) that the clearing of transactions effected pursuant to Parts 35 
or 36 by an RCO is regulated under Part 39;
    (5) that the clearing of transactions effected pursuant to Parts 35 
or 36 by authorized clearing organizations other than an RCO is not 
regulated under Part 39; and
    (6) that transactions not specified in 39.1(a) may also be cleared 
by an RCO.
    The changes to the scope, enforceability and antifraud provisions 
address commenters' concerns that: (1) proposed Part 39 could be 
interpreted to apply the Act and the Commission's regulations to 
transactions outside the appropriate scope of Part 39, such as cash 
products or other products beyond the authority of the Act, see, e.g., 
CME CL 21-51 at 9-10; (2) it may appear as if the Commission is 
attempting to expand its jurisdiction to include any over-the-counter 
transaction that is submitted to an RCO for clearing, id.; (3) the new 
part should clarify that transactions effected pursuant to Parts 35 or 
36 do not become subject to the jurisdiction of the Commission simply 
because they are submitted to a Part 39 clearing organization and that 
clearing does not, by itself, make an exempt transaction subject to the 
Act, see BOTCC CLs 21-6 at 4 and 21-20 at 8; and (4) the effect of 
Sec. 39.6 would not be the assertion of the Commission's enforcement 
authority over otherwise-exempt transactions simply because those 
transactions are submitted to clearing. As proposed, Sec. 39.6 
prohibited fraud in connection with any transaction cleared by an RCO. 
The final section prohibits fraud in connection with the activity of 
clearing. See BOTCC CL 21-6 at 4, FRB of Chicago CL 23-25 at 7 and GSCC 
CL 23-19 at 4.
    As discussed, the final Part 39 rules address these comments. The 
Commission is not hereby asserting jurisdiction over transactions in 
cash and other products not subject to the Act. Commission oversight of 
an RCO under Part 39 addresses the clearing process only and does not 
include regulation or oversight of the transactions or the traders. The 
Commission, however, notes that it must monitor for the potential that 
clearing of cash and other products not subject to the Act could 
adversely affect the viability, risk exposure, and management of the 
entity as an RCO.\8\
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    \8\ An analogy can be drawn to the interest the Commission has 
in assessing risk presented to futures commission merchants (FCMs) 
by their non-futures activities. Thus, for example, the Commission's 
net capital rule has provisions relating to the capital treatment of 
securities and other non-futures inventory held by an FCM in the 
normal course of its business. See Commission Regulation 1.17. See 
also Commission Regulations 1.14 and 1.15 that assess risk to a 
registered FCM from affiliates in its holding company system.

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[[Page 78023]]

D. Treatment as Contract Market

    As proposed, Sec. 39.1(b)(2) provided that an RCO would be deemed 
to be a contract market for purposes of the Act and the regulations, 
but would be exempt from all such provisions except as reserved in 
Sec. 39.5. In its final rules, the Commission has combined the language 
of proposed Sec. 39.1(b)(2) with proposed Sec. 39.5. Section 39.5 now 
provides that an RCO is deemed to be a contract market to the extent it 
clears transactions specified in Sec. 39.1(a) (the scope provision), 
but is exempt from all provisions of the Act and regulations except, as 
applicable, certain enumerated sections of the Act and the Commission's 
regulations which would continue to apply.
    Combining the separate provisions and amending the resulting 
Sec. 39.5 as indicated, limits the purpose for which RCOs are deemed to 
be contract markets and addresses commenters' concern that the 
provision would subject clearing organizations to provisions of the Act 
and the Commission's regulations that do not now apply. See, e.g., 
BOTCC CL 21-6 at 4. Pursuant to the final rule, an RCO is deemed to be 
a contract market only to the extent it clears those transactions 
specified in Sec. 39.1(a). Further, even though an RCO is deemed to be 
a contract market to this limited extent, Sec. 39.5 exempts it from all 
provisions of the Act and regulations, except the sections enumerated, 
and only to the extent those enumerated sections are applicable to the 
activity of clearing Sec. 39.1(a) transactions.
    In reserving the sections of the Act and the regulations enumerated 
in Sec. 39.5, the Commission is not asserting that any of those 
sections or regulations would be applicable to an RCO under any 
particular circumstances. The Commission only seeks, conservatively, to 
reserve those sections of the Act and regulations that may need to be 
applied to an RCO in order to achieve compliance with the core 
principles set forth in Part 39. The reservations in Sec. 39.5 of 
Sections 4b and 4o of the Act and Rule 33.10 will subject RCOs to the 
same standard with respect to fraud and manipulation in connection with 
the clearing of transactions to which clearing organizations are 
currently subject. See FIA CL 23-26 at 5. Reservation of the enumerated 
sections of the Act or regulations, including specifically Section 4i 
of the Act and Rule 1.38(a), will not render RCOs responsible for the 
enforcement of any new or additional regulatory requirements, nor 
increase the liability of clearing organizations under Section 22 of 
the Act. See BOTCC CLs 21-20 at 7 and 21-6 at 4.

E. Competitive Issues

    Commenters strongly agreed with the requirement in Sec. 39.2 that 
all transactions effected on a contract market, RFE, or DTF, if 
cleared, must be cleared by an RCO. For example, the CME expressed its 
agreement with the result that a clearing organization that either is 
governed by another regulator, or has no regulator, is prohibited from 
clearing such products. CL 21-51 at 10. However, many commenters raised 
concerns regarding the effect of Part 39 on the ability of RCOs to 
compete with other types of clearing organizations. The commenters 
stated that allowing clearing organizations other than RCOs, including 
clearing organizations regulated by the SEC, to clear transactions 
effected pursuant to Parts 35 or 36, will give clearing organizations 
other than RCOs the ability to clear the full spectrum of financial 
transactions--cash, securities, options, futures (if traded on an 
exempt MTEF) and other derivatives. They further stated that the SEC, 
however, will not allow an RCO that is not also registered as a 
clearing agency with the SEC to clear transactions in securities. Id. 
Commenters thought the proposal grants an unfair exemption to 
securities clearinghouses, banks, bank affiliates, and foreign 
clearinghouses from the substantive requirements that otherwise would 
apply to RCOs. CLs 21-6 at 5, 21-20 at 5, 23-26 at 7, and 21-36 at 6.
    In authorizing particular clearing organizations in addition to 
RCOs to clear transactions pursuant to Parts 35 and 36, the Commission 
is adopting the unanimous recommendations made in the report of the 
President's Working Group.\9\ The Commission notes that it has made 
revisions elsewhere in its new regulatory framework (i.e., the final 
rules under Parts 35-38) that lessen the impact of these concerns in 
some instances. Under final rules adopted by the Commission in response 
to comments made by the U.S. Department of the Treasury, transactions 
based on U.S. government securities are not eligible for trading on 
exempt MTEFs.\10\ Under part 39, only RCOs can clear transactions 
effected on DTFs or RFEs.
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    \9\ Over-the-Counter Derivatives Markets and the Commodity 
Exchange Act, Report of the President's Working Group, November 
1999. The group, whose members were signatories to the report, 
includes the Secretary of the Treasury, the Chairman of the Board of 
Governors of the Federal Reserve System, the Chairman of the 
Securities and Exchange Commission, and the Chairman of the 
Commodity Futures Trading Commission.
    \10\ Specifically, the Commission has removed the reference to 
exempt securities and indexes thereof previously included in 
proposed Rule 36.2(b)(4) and has amended final Rule 36.2(b)(1) to 
make clear that eligible debt instruments do not include such exempt 
securities.
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F. Application of Core Principles and Appendix A

1. General
    RCO applicants must demonstrate compliance with each of the core 
principles of Part 39 as a condition of recognition. These principles 
will not subject RCOs to any regulatory requirement not now applicable 
to futures clearing organizations under the Commission's current 
oversight. Each of the core principles must be addressed, but the 
guidance in Appendix A to Part 39 is intended only to be illustrative 
of the types of matters an applicant may address in order to 
satisfactorily demonstrate that it meets the core principles.
    The final appendix clarifies the purpose of the guidance in 
response to commenters' concerns regarding the level of specificity in 
Appendix A. Commenters were concerned that the guidance would take on 
the force of law, applicants would have to affirmatively demonstrate 
compliance with each provision, and clearing organizations would be 
subject to far greater regulatory compliance burdens than before. See, 
e.g., FIA CL 23-26 at 4 and BOTCC CL 21-20 at 10. Appendix A expressly 
makes clear that it is neither a checklist of issues that an applicant 
is required to address nor an exclusive list of matters from which an 
applicant can choose applicable components to address. Rather, the 
appendix provides detailed non-binding guidance that applicants can use 
as a tool in demonstrating satisfaction of the core principles.
    In order to become recognized under Part 39, current futures 
clearing organizations need only submit a certification that their 
rules, procedures and operations fulfill the conditions for recognition 
under Part 39.\11\ All of the current futures clearing organizations 
could become recognized in this

[[Page 78024]]

manner. They are not required to address affirmatively any of the 
separate core principles (and none of the suggested guidance in 
Appendix A).
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    \11\ Although Sec. 39.4(a) allows only nondormant entities, as 
defined, to self-certify, the Commission is prepared to accept the 
certification of the Intermarket Clearing Corporation (ICC) under 
this provision. ICC is a wholly-owned subsidiary of the Options 
Clearing Corporation. Commission staff is familiar with ICC's rules 
and operations. ICC has maintained its clearing systems, rules, and 
banking and other arrangements in place and remains fully prepared 
operationally to clear transactions in futures contracts in 
accordance with its rules.
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2. The Core Principles
    The final rules contain changes that address commenters' views 
concerning the wording and applicability of particular core principles. 
Commenters requested that Core Principle 2, which deals with 
participant and product eligibility, be revised to eliminate product 
eligibility criteria for instruments that an RCO will accept for 
clearing. Commenters contended that this requirement was impractical, 
would require an extraordinary degree of prognostication and would best 
be dealt with on a case-by-case basis by an RCO, considering all 
relevant circumstances. BOTCC CL 21-20 at 13. The Commission has 
revised the final core principle and the accompanying appendix guidance 
accordingly.
    Several commenters thought that Core Principle 7 on enforcement 
inappropriately required arrangements and resources for resolution of 
disputes and encouraged the Commission to eliminate it from the 
principle. See, e.g., NYCC CL 23-40 at 4 and GSCC 23-19 at 4. The 
Commission has considered the commenters' concerns that this 
requirement would impose a new and inappropriate burden on RCOs, but 
has determined to retain it in the core principle with the added 
qualification of ``as applicable.'' The Commission does not wish to 
rule out the possible appropriateness of some form of dispute 
resolution at RCOs as the industry continues to evolve. By qualifying 
the item with its applicability, RCO applicants can choose to address 
whether and why they do or do not have a dispute resolution program in 
demonstrating that they will be able to effectively enforce their 
rules.
    The final version of the other core principles contains 
modifications that serve to increase their intended breadth and 
flexibility. For example, Core Principle 1, which deals with financial 
resources, as proposed, required adequate capital resources to fulfill 
its guarantee function without interruption in various market 
conditions. At the suggestion of one of the commenters, the final 
version of Core Principle 1 requires adequate financial resources to 
fulfill its guarantee function without interruption in reasonably 
foreseeable market conditions. See Coalition CL 23-41 at 24. In 
addition, Core Principle 14 concerning competition has been revised. 
The Commission does not want to inadvertently impose duties on an 
applicant that differ in form or degree from the antitrust statutes and 
court decisions construing federal antitrust laws. See BOTCC CL 21-20 
at 13. Thus, final Core Principle 14 simply requires RCOs to operate in 
a manner consistent with the public interest to be protected by the 
antitrust laws. This language comes directly from Section 15 of the Act 
which the Commission has reserved in Sec. 39.5. The requirements of 
Section 15 remain the responsibility of the Commission and the 
Commission intends to apply Section 15 to antitrust issues in the same 
manner as previously applied.
    Core Principle 12 regarding public disclosure of certain operating 
procedures of an RCO was not revised in response to concerns regarding 
confidentiality. An RCO, however, will not be required under this core 
principle to disclose trade secrets.
3. The Guidance in Appendix A
    Commenters also expressed opinions about the applicability and 
wording of particular proposed guidance in Appendix A. Many of these 
concerns are addressed by language in the final appendix that states 
the guidance is only illustrative of the types of matters an applicant 
may address in order to demonstrate that it meets the core principles 
and is not intended to be a mandatory checklist of issues to address. 
If particular guidance does not apply to an RCO applicant, it may 
either not address it or explain why it does not apply. Applicants also 
are strongly encouraged to address relevant matters other than those 
contained in the guidance suggested in the appendix if doing so would 
assist the applicant in demonstrating compliance with a particular core 
principle.
    The Commission has modified certain of the guidance in response to 
commenters' concerns regarding the appropriateness or applicability of 
particular guidance language. In response to comments that the 
Commission does not have the authority to review the setting of levels 
of margin, the Commission revised guidance regarding the determination 
of appropriate margin levels for a cleared contract and the clearing 
member clearing the contract. See, e.g., FIA CL 23-26 at 4. The final 
version of this guidance suggests that an applicant may describe the 
process by which it would determine appropriate margin levels for an 
instrument that it clears and its clearing members. This information is 
highly relevant and could be used by an applicant for RCO status to 
assist in demonstrating that it meets the third core principle 
concerning the ability to manage risks associated with carrying out the 
guarantee function.
    Several comments addressed the appropriateness of the proposed 
guidance under Core Principle 6 concerning default rules and 
procedures. The guidance suggested that applicants describe rules and 
procedures regarding priority of customer accounts over proprietary 
accounts and, where applicable, in the context of other programs such 
as specialized margin reduction programs like cross-margining. 
Commenters argued that given the successful operation of cross-
margining programs, it is inappropriate for the accounts of cross-
margining participants to be subordinated to the accounts of market 
participants not participating in cross-margining programs. OCC CL 23-
23 at 2, 3. The Commission has considered this argument and although it 
recognizes that cross-margining programs have been successful and can 
operate to reduce risks, including risk of participant default, it has 
determined to retain this guidance in the final Appendix A. The 
guidance is appropriate in that it only suggests that an applicant RCO 
that is proposing or contemplating being a party to a margin reduction 
program such as cross-margining address in its application whether and 
why a priority rule would or would not be present in any particular 
margin reduction program. It does not require such a priority rule. 
This information will provide relevant and useful information to the 
Commission in assessing the applicant's overall compliance with all 
aspects of Core Principle 6.
    The Commission modified other guidance under various core 
principles in response to comments received. For example, the final 
guidance under Core Principle 8 dealing with system safeguards suggests 
that an applicant may confirm that system testing and review has been 
performed by a qualified independent professional, and not specifically 
by a member of the Information Systems Audit and Control Association. A 
professional that is a certified member of the Information Systems 
Audit and Control Association experienced in the industry, however, is 
referred to as an example of an acceptable party to carry out such 
testing and review. See CL 21-20 at 10. In addition, the Commission has 
modified the guidance for Core Principle 9 relating to governance to 
note that an RCO, consistent with longstanding Commission policy, may 
not limit liability for violation of the Act or Commission rules, 
fraud, or wanton or willful misconduct. This requirement

[[Page 78025]]

currently applies to designated contract markets.

G. Other Comments

    Certain commenters suggested that the Commission restrict the 
length of time that a proposed RCO rule could be stayed under 
Commission Regulation 1.41. See e.g., CL 21-20 at 12. The Commission 
anticipates that it only will impose a stay of an RCO rule in limited 
and potentially egregious situations. In fact, the Commission would 
only be able to stay a proposed rule incident to disapproval 
proceedings and the stay determination would not be delegable to 
Commission staff. Since a rule only would be stayed incident to a 
disapproval proceeding, the length of any stay would not be 
indeterminate in any event.
    Certain commenters raised questions as to whether bankruptcy 
provisions that are currently applicable to transactions conducted on a 
contract market could also be applicable to all transactions cleared by 
an RCO. See, e.g., CL 21-65 at 23. Part 39 reserves the applicability 
of Part 190 to the activity of clearing Sec. 39.1(a) transactions, if 
applicable. Part 190 in conjunction with the commodity broker 
liquidation provisions of Subchapter IV of Chapter 7, Title 11 of the 
Federal Bankruptcy Code, apply to an insolvency when the insolvent 
party is a ``commodity broker'' (typically an FCM or clearing 
organization that has any futures accounts), as defined under Title 11. 
If an RCO does not have open futures accounts it would not be covered 
by SubChapter IV.

IV. Section 4(c) Findings

    These final rules are being promulgated under Section 4(c) of the 
Act, which grants the Commission broad exemptive authority. Section 
4(c) of the Act provides that, in order to promote responsible economic 
or financial innovation and fair competition, the Commission may by 
rule, regulation or order, exempt any class of agreements, contracts or 
transactions, including any person or class of persons offering, 
entering into, rendering advice or rendering other services with 
respect to, the agreement, contract, or transaction, from the contract 
market designation requirement of Section 4(a) of the Act, or any other 
provision of the Act other than Section 2(a)(1)(B), if the Commission 
determines that the exemption would be consistent with the public 
interest. Furthermore, Section 4(c)(2) of the Act provides that the 
Commission may not grant an exemption from the contract market 
designation requirement of Section 4(a) of the Act unless the 
Commission also finds that: (i) the contract market designation 
requirement should not be applied to the agreement, contract, or 
transaction for which the exemption is requested and the exemption 
would be consistent with the public interest and the purposes of the 
Act; (ii) the exempted transaction will be entered into solely between 
``appropriate persons''; and (iii) the agreement, contract, or 
transaction in questions will not have a material adverse effect on the 
ability of the Commission or any contract market to discharge its 
regulatory or self-regulatory duties under the Act.
    As explained above, Part 39 is part of a new regulatory framework. 
The new framework is intended to promote innovation and competition in 
the trading of derivatives and to permit the markets the flexibility to 
respond to technological and structural changes. Specifically, Part 39 
replaces Commission regulation of clearing organizations through the 
current more formal designation and regulation of contract markets. It 
provides for a streamlined procedure for clearing organizations to 
obtain recognition by meeting broad, non-prescriptive core principles. 
It permits recognized clearing organizations the flexibility to clear 
regulated, exempt, and unregulated transactions. It also authorizes 
clearing organizations regulated by other regulatory bodies to clear 
certain transactions. The core principle approach set forth in Part 39 
strikes an appropriate balance between applying necessary regulatory 
protections to the critical market functions of clearing and 
facilitating the development of varied clearing mechanisms and 
structures. Accordingly, the Commission believes that Part 39 is 
consistent with the public interest, is consistent with the purposes of 
the Act, will be applicable only to appropriate persons, and would have 
no adverse effect on the regulatory or self-regulatory responsibilities 
imposed by the Act.

V. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA), 5 U.S.C. 601 et seq., 
requires that agencies, in promulgating rules, consider the impact of 
those regulations on small entities. The rules adopted herein would 
affect certain clearing organizations. The Commission has stated that 
it is appropriate to evaluate within the context of a particular rule 
whether some or all of affected entities should be considered small 
entities and, if so, to analyze the economic impact on them of any 
rule. In this regard, the rules being adopted herein would not require 
any current futures clearing organization to change any aspect of its 
operation or take any action other than to submit a certification. The 
rules being adopted replace regulation of clearing organizations 
through the formal designation and regulation of contract markets with 
a streamlined procedure for clearing organizations, regardless of size, 
to obtain recognition by meeting broad, non-prescriptive core 
principles. Accordingly, the Chairman, on behalf of the Commission, 
hereby certifies, pursuant to 5 U.S.C. 605(b), that the action taken 
herein will not have a significant economic impact on a substantial 
number of small entities. In this regard, the Commission notes that it 
did not receive any comments regarding the RFA implications of Part 39.

B. Paperwork Reduction Act

    Part 39 contains information collection requirements. As required 
by the Paperwork Reduction Act of 1995, 44 U.S.C. 3501 et seq., the 
Commission submitted a copy of this part to the Office of Management 
and Budget (OMB) for its review. See 44 U.S.C. Sec. 3507(d). No 
comments were received in response to the Commission's invitation in 
the proposing release to comment on any potential paperwork burden 
associated with this regulation.

List of Subjects in 17 CFR Part 39

    Clearing, Clearing Organizations, Commodity Futures, Consumer 
Protection.

    In consideration of the foregoing, and pursuant to the authority 
contained in Sections 2, 6(c), 7a, and 12a(5) of the U.S.C., the 
Commission hereby amends Chapter I of Title 17 of the Code of Federal 
Regulations by adding part 39 to read as follows:

PART 39--RECOGNIZED CLEARING ORGANIZATIONS

Sec.
39.1  Scope and definitions.
39.2  Permitted clearing.
39.3  Conditions for recognition as a recognized clearing 
organization.
39.4  Procedures for recognition.
39.5  Enforceability.
39.6  Fraud in connection with the clearing of transactions by a 
recognized clearing organization.
Appendix A to Part 39--Application Guidance

    Authority: 7 U.S.C. 2, 6(c), 6d(2), 6g, 7a, 12a(5).

[[Page 78026]]

Sec. 39.1  Scope and definitions.

    (a) Scope. The provisions of this part 39 apply to a recognized 
clearing organization that clears transactions effected on or through a 
designated contract market, a recognized futures exchange under part 38 
of this chapter, a derivatives transaction facility under part 37 of 
this chapter, an exempt multilateral transaction execution facility 
under part 36 of this chapter, and to exempt bilateral transactions 
under part 35 of this chapter.
    (b) Definitions. For purposes of this part:
    (1) Clearing organization means a person that provides a credit 
enhancement function with respect to transactions executed on a 
designated contract market or pursuant to Parts 35 through 38 of this 
chapter in connection with netting and/or settling the payments and 
payment obligations of such members or participants, by becoming a 
universal counterparty to such members or participants, or otherwise; 
but does not include those netting arrangements specified in 
Sec. 35.2(d)(1) and (d)(2), nor does it include an entity that is a 
single counterparty offering to enter into, or entering into bilateral 
transactions with multiple counterparties.
    (2) Recognized clearing organization means a clearing organization 
that has been recognized by the Commission under Sec. 39.3.


Sec. 39.2  Permitted clearing.

    (a) Any transaction effected on a designated contract market, 
recognized futures exchange, or derivatives transaction facility, if 
cleared, shall be cleared by a recognized clearing organization. The 
clearing of transactions by a recognized clearing organization shall be 
governed by the provisions of this part.
    (b) A transaction effected pursuant to part 35 or part 36 of this 
chapter, if cleared, shall meet the requirements of Sec. 35.2(c) or 
Sec. 36.2(c) of this chapter, as applicable, if the transaction is 
cleared by one of the following authorized clearing organizations:
    (1) A recognized clearing organization;
    (2) A securities clearing agency subject to the supervisory 
jurisdiction of the Securities and Exchange Commission;
    (3) A clearing system organized as a bank, bank subsidiary, 
affiliate of a bank, or Edge Act corporation established under the 
Federal Reserve Act authorized to engage in international banking or 
financial activities, and subject to the jurisdiction of the Federal 
Reserve or Comptroller of the Currency; or
    (4) A foreign clearing organization that demonstrates to the 
Commission that it:
    (i) Is subject to home country regulation and oversight comparable 
to the standards set forth by the Commission for recognition of 
clearing organizations under this part; and
    (ii) Is a party to and abides by appropriate and adequate 
information-sharing arrangements.
    (c) The clearing of transactions effected pursuant to part 35 or 
part 36 of this chapter by a recognized clearing organization shall be 
governed by the provisions of this part. The provisions of this part 
shall not apply to the clearing of transactions effected pursuant to 
part 35 or part 36 by an authorized clearing organization other than a 
recognized clearing organization.
    (d) Nothing in this part prohibits clearing by a recognized 
clearing organization of transactions not specified in Sec. 39.1(a).


Sec. 39.3  Conditions for recognition as a recognized clearing 
organization.

    To be recognized by the Commission under this part 39 as a 
recognized clearing organization, an entity:
    (a) Need not be affiliated with a designated contract market or 
recognized futures exchange under part 38 of this chapter, derivatives 
transaction facility under part 37 of this chapter, or exempt 
multilateral transaction execution facility under part 36 of this 
chapter;
    (b) Must have rules and procedures relating to its governance and 
to the operation of its clearing function; and
    (c) Must initially, and on a continuing basis, meet and adhere to 
the following core principles:
    (1) Financial resources: Have adequate financial resources to 
fulfill its guarantee function without interruption in reasonably 
foreseeable market conditions.
    (2) Participant eligibility: Have appropriate admission and 
continuing eligibility standards for members or participants of the 
organization.
    (3) Risk management: Have the ability to manage the risks 
associated with carrying out its guarantee function through the use of 
tools and procedures appropriate under the circumstances.
    (4) Settlement procedures: Have the ability to complete settlements 
on a timely basis under varying circumstances, to maintain an adequate 
record of the flow of funds associated with the transactions it clears, 
and, to the extent applicable, to comply with the terms and conditions 
of any netting or offset arrangements with other clearing 
organizations.
    (5) Treatment of member and participant funds: Have adequate 
procedures designed to protect the safety of member and participant, 
and as applicable, customer funds held by the clearing organization.
    (6) Default rules and procedures: Have rules and procedures 
designed to allow for the effective and fair management of events when 
members or participants become insolvent or otherwise default on their 
obligations to the clearing organization.
    (7) Rule enforcement: Have arrangements and resources for the 
effective monitoring and enforcement of compliance with its rules and, 
as applicable, for resolution of disputes.
    (8) System safeguards: Have a program of testing, oversight, and 
risk analysis to ensure that its automated systems function properly 
and have adequate capacity, security, emergency, and disaster recovery 
procedures.
    (9) Governance: Have appropriate fitness standards for owners or 
operators with greater than ten percent interest or an affiliate of 
such an owner, and for members of the governing board, and a means to 
address conflicts of interest in making decisions.
    (10) Reporting: Provide all information requested by the Commission 
for it to conduct its oversight function of the clearing organization's 
activities.
    (11) Recordkeeping: Keep full books and records of all activities 
relating to its business as a recognized clearing organization in a 
form and manner acceptable to the Commission for a period of five 
years, during the first two of which the books and records are readily 
available, and which shall be open to inspection by any representative 
of the Commission or the U.S. Department of Justice.
    (12) Public information: Publicly disclose information concerning 
the rules and operating procedures governing its clearing and 
settlement systems, including default procedures.
    (13) Information sharing: Participate in domestic and international 
information-sharing agreements as appropriate and use information 
obtained from such agreements in carrying out the clearing 
organization's risk management program.
    (14) Competition: Operate in a manner consistent with the public 
interest to be protected by the antitrust laws.


Sec. 39.4  Procedures for recognition.

    (a) Recognition by certification. A clearing organization that 
cleared for at least one nondormant contract market

[[Page 78027]]

within the meaning of Sec. 5.3 of this chapter on February 12, 2001, 
will be recognized by the Commission as a recognized clearing 
organization upon receipt by the Commission at its Washington, DC, 
headquarters of a copy of the clearing organization's current rules and 
a certification by the clearing organization that it meets the 
conditions for recognition under this part.
    (b) Recognition by application. A clearing organization shall be 
recognized by the Commission as a recognized clearing organization 
sixty days after receipt by the Commission of an application for 
recognition unless notified otherwise during that period, if:
    (1) The application demonstrates that the applicant satisfies the 
conditions for recognition under this part;
    (2) The submission is labeled as being submitted pursuant to this 
part;
    (3) The submission includes a copy of the applicant's rules and, to 
the extent that compliance with the conditions of recognition is not 
self-evident, a brief explanation of how the rules satisfy each of the 
conditions for recognition under Sec. 39.3;
    (4) The applicant does not amend or supplement the application for 
recognition, except as requested by the Commission or for correction of 
typographical errors, renumbering or other nonsubstantive revisions, 
during that period; and
    (5) The applicant has not instructed the Commission in writing 
during the review period to review the application pursuant to 
procedures under section 6 of the Act.
    (6) Appendix A to this part is guidance to applicants concerning 
how the core principles set forth in this paragraph (b) could be 
satisfied.
    (c) Termination of part 39 review. During the sixty-day period for 
review pursuant to paragraph (b) of this section, the Commission shall 
notify the applicant seeking recognition that the Commission is 
terminating review under this section and will review the proposal 
under the procedures of section 6 of the Act, if it appears that the 
application fails to meet the conditions for recognition under this 
part. This termination notification will state the nature of the issues 
raised and the specific condition of recognition that the application 
appears to violate, is contrary to, or fails to meet. Within ten days 
of receipt of this termination notification, the applicant seeking 
recognition may request that the Commission render a decision whether 
to recognize the clearing organization or to institute a proceeding to 
disapprove the proposed submission under procedures specified in 
section 6 of the Act by notifying the Commission that the applicant 
seeking recognition views its submission as complete and final as 
submitted.
    (d) Delegation of authority. (1) The Commission hereby delegates to 
the Director of the Division of Trading and Markets or the Director's 
delegatee, with the concurrence of the General Counsel or the General 
Counsel's delegatee, authority to notify an entity seeking recognition 
under paragraph (b) of this section that review under those procedures 
is being terminated.
    (2) The Director of the Division of Trading and Markets may submit 
to the Commission for its consideration any matter which has been 
delegated in this paragraph.
    (3) Nothing in the paragraph prohibits the Commission, at its 
election, from exercising the authority delegated in paragraph (d)(1) 
of this section.
    (e) Request for Commission approval of rules. (1) An applicant for 
recognition as a recognized clearing organization may request that the 
Commission approve any or all of its rules and subsequent amendments 
thereto, at the time of recognition or thereafter, under section 
5a(a)(12) of the Act and Sec. 1.41 of this chapter. The recognized 
clearing organization may label such rules as having been approved by 
the Commission.
    (2) Rules of a recognized clearing organization that have not been 
submitted pursuant to paragraph (a) or (b)(3) of this section shall be 
submitted to the Commission pursuant to Sec. 1.41 of this chapter.
    (3) An applicant seeking recognition as a recognized clearing 
organization may request that the Commission consider under the 
provisions of section 15 of the Act any of the entity's rules or 
policies at the time of recognition or thereafter.
    (f) Request for withdrawal of recognition. A recognized clearing 
organization may withdraw from Commission recognition by filing with 
the Commission at its Washington, DC headquarters such a request. 
Withdrawal from recognition shall not affect any action taken or to be 
taken by the Commission based upon actions, activities, or events 
occurring during the time that the clearing organization was recognized 
by the Commission.


Sec. 39.5  Enforceability.

    To the extent it clears transactions specified in Sec. 39.1(a), a 
recognized clearing organization shall be deemed to be a contract 
market for purposes of the Act and the Commission rules thereunder; 
provided, however, a recognized clearing organization shall be exempt 
from all provisions of the Act and Commission regulations except, as 
applicable, sections 1a, 2(a)(1), 4, 4b, 4c, 4d, 4g, 4i, 4o, 5(6), 
5(7), 5a(a)(1), 5a(a)(2), 5a(a)(8), 5a(a)(9), the rule disapproval 
procedures of section 5a(a)(12), 5a(a)(16), 5a(a)(17), 6(a), 6(c) to 
the extent it prohibits manipulation of the market price of any 
commodity in interstate commerce or for future delivery on or subject 
to the rules of any contract market, 8a(7), 8a(9), 8c(a), 8c(b), 8c(c), 
8c(d), 9(a), 9(f), 14, 15, 20 and 22 of the Act and Secs. 1.3, 1.20, 
1.24, 1.25, 1.26, 1.27, 1.29, 1.31, 1.36, 1.38, 1.41, parts 15 through 
21, Sec. 33.10, this part 39, and part 190 of this chapter, which 
continue to apply.


Sec. 39.6  Fraud in connection with the clearing of transactions by a 
recognized clearing organization.

    It shall be unlawful for any person, directly or indirectly, in or 
in connection with the clearing of any transaction specified in 
Sec. 39.1(a) by a recognized clearing organization:
    (a) To cheat or defraud or attempt to cheat or defraud any other 
person;
    (b) Willfully to make or cause to be made to any other person any 
false report or statement thereof or cause to be entered for any person 
any false record thereof; or
    (c) Willfully to deceive or attempt to deceive any other person by 
any means whatsoever.

Appendix A to Part 39--Application Guidance

    This appendix provides guidance to applicants for recognition as 
recognized clearing organizations in connection with satisfying each 
of the core principles of Sec. 39.4. This appendix is only 
illustrative of the types of matters an applicant may address, as 
applicable, in order to demonstrate satisfactorily that it meets the 
core principles and is not intended to be a mandatory checklist of 
issues to address.

Core Principle 1--Financial Resources. Have adequate financial 
resources to fulfill its guarantee function without interruption in 
reasonably foreseeable market conditions.

    In addressing core principle 1, applicants may describe or 
otherwise document:
    1. The amount of resources dedicated to supporting the clearing 
function:
    a. The amount of resources available to the clearing 
organization and the sufficiency of those resources to assure that 
no break in clearing operations would occur in a variety of market 
conditions; and
    b. The level of member/participant default such resources could 
support as demonstrated through use of hypothetical default 
scenarios that explain assumptions and variables factored into the 
illustrations.
    2. The nature of resources dedicated to supporting the clearing 
function:
    a. The type of the resources, including their liquidity, and how 
they could be

[[Page 78028]]

accessed and applied by the clearing organization promptly; and
    b. Any legal or operational impediments or conditions to access.

Core Principle 2--Participant Eligibility. Have appropriate admission 
and continuing eligibility standards for members or participants of the 
organization.

    In addressing core principle 2, applicants may describe or 
otherwise document:
    1. Member/participant admission criteria:
    a. How admission standards for its clearing members would 
contribute to the soundness and integrity of operations; and
    b. Matters such as whether these criteria would be in the form 
of organization rules that apply to all clearing members, whether 
different levels of membership would relate to different levels of 
net worth, income, and creditworthiness of members, and whether 
margin levels, position limits and other controls would vary in 
accordance with these levels.
    2. Member/participant continuing eligibility criteria:
    a. A program for monitoring the financial status of its members; 
and
    b. Whether and how the clearing organization would be able to 
change continuing eligibility criteria in accordance with changes in 
a member's financial status.
    3. The clearing function for each instrument the organization 
undertakes to clear.

Core Principle 3--Risk Management. Have the ability to manage the risks 
associated with carrying out its guarantee function through the use of 
tools and procedures appropriate under the circumstances.

    In addressing core principle 3, applicants may describe or 
otherwise document:
    1. Use of risk analysis tools and procedures:
    a. How the adequacy of the overall level of financial resources 
would be tested on an ongoing periodic basis in a variety of market 
conditions; and
    b. How the organization would use specific risk management tools 
such as stress testing and value at risk calculations.
    2. Use of collateral:
    a. How appropriate forms and levels of collateral would be 
established and collected;
    b. How amounts would be adequate to secure prudentially 
obligations arising from clearing transactions and performing as a 
central counterparty;
    c. The process for determining appropriate margin levels for an 
instrument cleared and for clearing members;
    d. The appropriateness of required or allowed forms of margin 
given the liquidity and related requirements of the clearing 
organization;
    e. How the clearing organization would value open positions and 
collateral assets; and
    f. The proposed margin collection schedule and how it would 
relate to changes in the value of market positions and collateral 
values.
    3. Use of credit limits: If and how systems would be implemented 
that would prevent members and other market participants from 
exceeding credit limits.
    4. Use of cross-margin programs: How collateral assets subject 
to cross-margining programs would provide, where applicable, for 
clear, fair, and efficient loss-sharing arrangements in the event of 
a program participant default.

Core Principle 4--Settlement Procedures. Have the ability to complete 
settlements on a timely basis under varying circumstances, to maintain 
an adequate record of the flow of funds associated with the 
transactions it clears, and, to the extent applicable, to comply with 
the terms and conditions of any netting or offset arrangements with 
other clearing organizations.

    In addressing core principle 4, applicants may describe or 
otherwise document:
    1. Settlement timeframe:
    a. Procedures for completing settlements on a timely basis 
during times of normal operating conditions; and
    b. Procedures for completing settlements on a timely basis in 
varying market circumstances including during a period when a 
significant participant or member has defaulted.
    2. Recordkeeping:
    a. The nature and quality of the information collected 
concerning the flow of funds involved in clearing and settlement; 
and
    b. How such information would be recorded, maintained and 
accessed.
    3. Interfaces with other clearing organizations: How compliance 
with the terms and conditions of netting or offset arrangements with 
other clearing organizations would be met, including, among others, 
common banking or common clearing programs.

Core Principle 5--Treatment of Member and Participant Funds. Have 
adequate procedures designed to protect the safety of member and 
participant, and as applicable, customer funds held by the clearing 
organization.

    In addressing core principle 5, applicants may describe or 
otherwise document:
    1. Safe custody:
    a. The safekeeping of funds, whether in accounts, in 
depositories, or with custodians, and how it would meet industry 
standards of safety;
    b. Any written terms regarding the legal status of the funds and 
the specific conditions or prerequisites for movement of the funds; 
and
    c. The extent to which the deposit of funds in accounts in 
depositories or with custodians would limit concentration of risk.
    2. Segregation between customer and proprietary funds: 
Requirements or restrictions regarding commingling customer with 
proprietary funds, obligating customer funds for any purpose other 
than to purchase, clear, and settle the products the clearing 
organization is clearing, or which are subject to cross-margin or 
similar agreements, and any other aspects of customer fund 
segregation.
    3. Investment standards: How customer funds would be invested 
consistent with high standards of safety and associated 
recordkeeping regarding the details of such investments.

Core Principle 6--Default Rules and Procedures. Have rules and 
procedures designed to allow for the effective and fair management of 
events when members or participants become insolvent or otherwise 
default on their obligations to the clearing organization.

    In addressing core principle 6, applicants may describe or 
otherwise document:
    1. Definition of default:
    a. The definition of default and how it would be established and 
enforced; and
    b. How the applicant would address failure to meet margin 
requirements, the insolvent financial condition of a member or 
participant, failure to comply with certain rules, failure to 
maintain eligibility standards, actions taken by other regulatory 
bodies, or other events.
    2. Remedial action: The authority pursuant to which, and how, 
the clearing organization may take appropriate action in the event 
of the default of a member which may include, among other things, 
closing out positions, replacing positions, set-off, and applying 
margin.
    3. Process to address shortfalls: Procedures for the prompt 
application of clearing organization and/or member financial 
resources to address monetary shortfalls resulting from a default.
    4. Customer priority rule: Rules and procedures regarding 
priority of customer accounts over proprietary accounts of 
defaulting members or participants and, where applicable, in the 
context of specialized margin reduction programs such as cross-
margining or trading links with other exchanges.

Core Principle 7--Rule Enforcement. Have arrangements and resources for 
the effective monitoring and enforcement of compliance with its rules 
and, as applicable, for resolution of disputes.

    In addressing core principle 7, applicants may describe or 
otherwise document:
    1. Surveillance: Arrangements and resources for the effective 
monitoring of compliance with rules relating to clearing practices 
and financial surveillance.
    2. Enforcement: Arrangements and resources for effective 
enforcement of rules and authority and ability to discipline and 
limit or suspend a member's or participant's activities pursuant to 
clear and fair standards.
    3. Dispute resolution: Where applicable, arrangements and 
resources for resolution of disputes between customers and members, 
and between members.

Core Principle 8--System Safeguards. Have a program of testing, 
oversight and risk analysis to ensure that its automated systems 
function properly and have adequate capacity, security, emergency, and 
disaster recovery procedures.

    In addressing core principle 8, applicants may describe or 
otherwise document:
    1. Oversight/risk analysis program:
    a. Whether a program addresses appropriate principles for the 
oversight of automated systems to ensure that its clearing systems 
function properly and have adequate capacity and security;

[[Page 78029]]

    b. Emergency procedures and a plan for disaster recovery; and
    c. Periodic testing of back-up facilities and ability to provide 
timely processing, clearing, and settlement of transactions.
    2. Appropriate periodic objective system reviews/testing:
    a. Any program for the periodic objective testing and review of 
the system, including tests conducted and results; and
    b. Confirmation that such testing and review would be performed 
or assessed by a qualified independent professional. A professional 
that is a certified member of the Information Systems Audit and 
Control Association experienced in the industry is an example of an 
acceptable party to carry out such testing and review.

Core Principle 9--Governance. Have appropriate fitness standards for 
owners or operators with greater than ten percent interest or an 
affiliate of such an owner, and for members of the governing board, and 
a means to address conflicts of interest in making decisions.

    In addressing core principle 9, applicants may describe or 
otherwise document:
    1. Standards for fitness for clearing organization owners, 
operators, affiliates of owners or operators, and members of the 
governing board based on disqualification standards under section 
8a(2) of the Act and a history of serious disciplinary offenses, 
such as those which would be disqualifying under Sec. 1.63 of this 
chapter.
    2. Collection and verification of information supporting 
compliance with standards: Verification information could be 
registration information or certification of fitness or affidavit of 
fitness by outside counsel based on other verified information.
    3. Methods to ascertain presence of conflicts of interest and 
methods of making decisions in that event.
    4. A recognized clearing organization may not limit its 
liability or the liability of any of its officers, directors, 
employees, licensors, contractors and/or affiliates where such 
liability arises from such person's violation of the Act or 
Commission rules, fraud, or wanton or willful misconduct.

Core Principle 10--Reporting. Provide all information requested by the 
Commission for it to conduct its oversight function of the clearing 
organization's activities.

    In addressing core principle 10, applicants may describe or 
otherwise document:
    1. Information necessary for the Commission to perform its 
oversight activities of the recognized clearing organization's 
activities:
    a. Information available to or generated by the clearing 
organization that will be made available to the Commission, upon 
request and/or as appropriate, to enable the Commission to perform 
properly its oversight function, including counterparties and their 
positions, stress test results, internal governance, legal 
proceedings, and other clearing activities;
    b. The types of information which are not believed to be 
necessary to provide to the Commission and why; and
    c. The information the organization intends to make routinely 
available to members/participants or the general public.
    2. Provision of information:
    a. The manner in which all relevant information will be provided 
to the Commission whether by electronic or other means; and
    b. The manner in which any information will be made available to 
members/participants and/or the general public.

Core Principle 11--Recordkeeping. Keep full books and records of all 
activities relating to its business as a recognized clearing 
organization in a form and manner acceptable to the Commission for a 
period of five years, during the first two of which the books and 
records are readily available, and which shall be open to inspection by 
any representative of the Commission or the U.S. Department of Justice.

    In addressing core principle 11, applicants may describe or 
otherwise document:
    1. Maintenance of records related to the function of a clearing 
organization in a form and manner acceptable to the Commission:
    a. The different activities related to the function of the 
clearing organization for which the organization intends to keep 
books or records; and
    b. Any activity related to the function of a clearing 
organization for which the organization does not intend to keep 
books or records and why this is not viewed as necessary.
    2. How the entity would satisfy the requirements of Sec. 1.31 of 
this chapter including:
    a. What ``full'' or ``complete'' would encompass with respect to 
each type of book or record that would be maintained;
    b. How books or records would be compiled and maintained with 
respect to each type of activity for which such books or records 
would be kept;
    c. Confirmation that books and records would be open to 
inspection by any representative of the Commission or of the U.S. 
Department of Justice;
    d. How long books and records would be readily available and how 
they would be made readily available during the first two years; and
    e. How long books and records would be maintained (and 
confirmation that, in any event, they would be maintained for at 
least five years).

Core Principle 12--Public Information. Publicly disclose information 
concerning the rules and operating procedures governing its clearing 
and settlement systems, including default procedures.

    In addressing core principle 12, applicants may describe or 
otherwise document:
    Disclosure of information regarding rules and operating 
procedures governing clearing and settlement systems:
    a. Which rules and operating procedures governing clearing and 
settlement systems should be disclosed to the public, to whom they 
would be disclosed, and how they would be disclosed;
    b. What other information would be available regarding the 
operation, purpose and effect of rules;
    c. How member/participants may become familiar with such 
procedures before participating in operations; and
    d. How member/participants will be informed of their specific 
rights and obligations preceding a default and upon a default, and 
of the specific rights, options and obligations of the clearing 
organization preceding and upon the participant's default.

Core Principle 13--Information Sharing. Participate in domestic and 
international information-sharing agreements as appropriate, and use 
information obtained from such agreements in carrying out the clearing 
organization's risk management program.

    In addressing core principle 13, applicants may describe or 
otherwise document:
    1. Applicable appropriate domestic and international 
information-sharing agreements and arrangements including the 
different types of domestic and international information-sharing 
arrangements, both formal and informal, which the clearing 
organization views as appropriate and applicable to its operations.
    2. Using information obtained from information-sharing 
arrangements in carrying out risk management and surveillance 
programs:
    a. How information obtained from any information-sharing 
arrangements would be used to further the objectives of the clearing 
organization's risk management program and any of its surveillance 
programs including financial surveillance and continuing eligibility 
of its members/participants;
    b. How accurate information is expected to be obtained and the 
mechanisms or procedures which would make timely use and application 
of all information; and
    c. The types of information expected to be shared and how that 
information would be shared.

Core Principle 14--Competition. Operate in a manner consistent with the 
public interest to be protected by the antitrust laws.

    Pursuant to Core Principle 14, an entity seeking recognition as 
a recognized clearing organization may request the Commission 
consider under the provisions of section 15 of the Act any of the 
entity's rules or policies at the time of application for 
recognition or thereafter. The Commission intends to apply section 
15 of the Act to its consideration of issues under this core 
principle in a manner consistent with that previously applied to 
contract markets.

    Issued in Washington, D.C., this 21st day of November, 2000, by 
the Commission.
Jean A. Webb,
Secretary of the Commission.

[This statement will not appear in the Code of Federal Regulations.]

Concurrence of Commissioner Thomas J. Erickson Regarding Final 
Rules for a New Regulatory Framework for Clearing Organizations

    I concur with the adoption of the final rules relating to 
clearing organizations. Increasingly, clearing is being de-coupled 
from the exchange. More electronic

[[Page 78030]]

exchanges are choosing to contract with new or existing clearing 
organizations for this aspect of traditional exchange activity. From 
what the Commission heard at the public hearing on the proposed 
framework, this trend is expected to continue and accelerate. 
Accordingly, this proposal represents a first step toward providing 
clearing organizations with the flexibility they will need to adapt 
to this new environment.
    Nevertheless, I am sympathetic to the concerns of domestic 
clearing organizations regarding competition, jurisdiction and 
scope. Specifically, the final rule's treatment of securities 
clearinghouses, banks, bank affiliates, and foreign clearinghouses 
with regard to the requirements of Part 39 would appear to subject 
futures clearinghouses to a significant competitive disadvantage. 
The Commission's final rules justify this approach with little more 
than the observation that it is consistent with the ``unanimous 
recommendations of the President's Working Group.'' \1\ Much more 
needs to be done so that one segment of the industry is not 
disproportionately affected and unfairly hamstrung by these 
regulations. Therefore, while I support the final rules to the 
extent they represent the Commission's willingness to meet the 
evolving marketplace with innovative approaches, I do so with the 
caveat that Part 39 will clearly need the Commission's full 
attention in order to ensure that the Commission is not picking 
winners and losers. At a minimum, since these reforms follow so 
closely the recommendations of the President's Working Group, I hope 
that the members of the PWG will respond swiftly to today's action 
by making parallel changes to their own regulatory schemes 
implementing the PWG's recommendations.
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    \1\ See Final Rules for a New Regulatory Framework for Clearing 
Organizations, p.12.

    Date: November 20, 2000.
Thomas J. Erickson,
Commissioner.
[FR Doc. 00-30269 Filed 12-12-00; 8:45 am]
BILLING CODE 6351-01-P