[Federal Register Volume 66, Number 168 (Wednesday, August 29, 2001)]
[Rules and Regulations]
[Pages 45604-45613]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-21670]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 39

RIN 3038-AB66


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 final rules to implement provisions of the 
Commodity Futures Modernization Act of 2000 governing derivatives 
clearing organizations. The rules apply to derivatives clearing 
organizations that are required to be registered, or which voluntarily 
apply to register, with the Commission.

EFFECTIVE DATE: October 29, 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]. or 
[email protected].

[[Page 45605]]


SUPPLEMENTARY INFORMATION:

I. Background

    On May 14, 2001, the Commission published for comment proposed part 
39 of its regulations to implement Section 5b of the Commodity Exchange 
Act (``Act''), as added by the Commodity Futures Modernization Act of 
2000 (``CFMA''),\1\ governing derivatives clearing organizations.\2\ 
Section 5b(a) requires that contracts of sale of a commodity for future 
delivery, options on such contracts, and options on a commodity be 
cleared only by a derivatives clearing organization (``DCO'') 
registered with the Commission,\3\ unless the contracts or options are 
in: (i) commodities excluded under the Act, (ii) commodities exempted 
under the Act, or (iii) security futures products cleared by a 
securities clearing agency. With the exception of security futures 
products, which may be cleared by a securities clearing agency,\4\ 
contracts traded on a designated contract market, if cleared, must be 
cleared by a DCO.\5\ Agreements, contracts and transactions in excluded 
or exempted commodities that are traded on a derivatives transaction 
execution facility, if cleared, may be cleared through clearing 
organizations other than DCOs.\6\ However, a clearing organization that 
clears these contracts may voluntarily apply, pursuant to section 5b(b) 
of the Act, to register with the Commission as a DCO. A DCO may clear 
other contracts, agreements, or transactions, including, but not 
limited to, certain over-the-counter (``OTC'') derivative instruments 
referenced in section 5b(b) of the Act, and others, such as 
transactions in spot and forward contracts.
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    \1\ See Appendix E of Pub.L. 106-554, 114 Stat. 2763 (2000).
    \2\ 66 FR 24308.
    \3\ For purposes of this release, use of the term ``derivatives 
clearing organization'' means a DCO registered, deemed to be 
registered, or required to be registered, with the Commission 
pursuant to section 5b of the Act.
    \4\ Security futures products traded on a national securities 
exchange that is notice-registered with the CFTC as a designated 
contract market must be cleared by a securities clearing agency 
registered under the Securities Exchange Act of 1934. Securities 
Exchange Act section 17A(b)(1). Security futures products traded on 
a contract market that is notice-registered with the SEC may be 
cleared by either a DCO or a securities clearing agency. See section 
5b of the Act.
    \5\ However, the Commission will consider requests for other 
types of clearing arrangements pursuant to its exemptive authority 
under section 4(c) of the Act.
    \6\ This includes excluded or exempted contracts traded on a 
derivatives transaction execution facility pursuant to any of the 
sub-provisions of section 5a of the Act.
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    To be registered as a DCO, an applicant must demonstrate that it 
complies with fourteen core principles set forth in the CFMA. Part 39 
stipulates the form and provides guidance for what should be included 
in applications for DCO registration, and sets forth procedures for 
processing such applications. It also addresses ongoing compliance by 
DCOs with the core principles and other provisions of the Act and 
regulations, the enforceability of contracts cleared on DCOs, and 
fraud. Part 39 does not apply to the execution of transactions cleared 
by DCOs; its provisions apply only to the clearing of transactions by 
DCOs.
    The Commission received three comment letters on proposed part 
39.\7\ Although the Commission has made various changes in response to 
the comments as discussed below, the final rules do not differ 
significantly from those that were proposed.
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    \7\ Comment letters (CL) were received from the Board of Trade 
Clearing Corporation (``BOTCC''), the Chicago Mercantile Exchange 
(``CME''), and the International Swaps and Derivatives Association 
(``ISDA'').
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II. Final Part 39

A. Application and Approval Procedures

    As did the proposed rule, final rule 39.1 provides that part 39 
applies to any DCO that is registered, is required to be registered, or 
which voluntarily applies to be registered with the Commission. The 
Commission agrees with comments suggesting that grandfathered DCOs also 
be specifically included in this scope provision and has accordingly 
amended it to include DCOs that are ``deemed to be registered,'' which 
is the language used in the CFMA to refer to grandfathered DCOs.\8\ 
Thus, the final part 39 rules apply to any DCO, as defined under 
section 1a(9) of the Act,\9\ which is registered or deemed to be 
registered with the Commission, is required to become so registered, or 
which voluntarily seeks to become so registered. Final rule 39.3 
provides that an organization meeting all requirements is ``deemed 
registered'' sixty days after receipt of an application unless notified 
otherwise.\10\
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    \8\ Section 5b(d) provides that a DCO ``shall be deemed to be 
registered'' if it acts as the clearing organization for a board of 
trade that was designated as a contract market prior to the date of 
enactment of the CFMA. See BOTCC CL at 2.
    \9\ As noted in the proposing release, an organization need not 
perform a direct credit enhancement function in order to be a DCO 
under the Act. See section 1a(9)(ii) (providing that the term DCO 
includes entities that provide for the settlement or netting of 
agreements, contracts, or transactions executed by participants in 
the DCO). Accordingly, and in response to BOTCC's request for 
clarification, the term ``clear'' (and all forms of the verb) is 
meant to include these other services. See BOTCC CL at 6. An 
organization that intends to provide settlement or other clearing-
type services without accompanying credit enhancement must still 
demonstrate compliance with all section 5b core principles to obtain 
unconditional registration as a DCO. The Commission may grant DCO 
registration with conditions when and as appropriate.
    \10\ The Act does not include an express time limit for 
Commission consideration of applications to become registered DCOs.
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    Rule 39.3 also sets forth the requirements for registration. As 
proposed, the rule required that an applicant meet the definition of a 
DCO provided by section 1a(9) of the Act, which in turn, requires that 
the entity perform certain functions. As noted by BOTCC, however, an 
applicant that has not been grandfathered pursuant to section 5b(d) of 
the Act will not have performed the activities envisioned by that 
definition. The Commission has modified the rule, therefore, to state 
that an applicant need only represent that it will operate in 
accordance with the definition of a DCO contained in section 1a(9) of 
the Act.\11\
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    \11\ An applicant's representation of how it will operate refers 
to the information the applicant must include in its application 
describing the operations and functions the applicant will undertake 
as a registered DCO.
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    Other requirements of rule 39.3 include submission by an applicant 
of its rules and a demonstration that the applicant is able to satisfy 
the core principles of the Act to the extent that its ability to do so 
is not self evident from the applicant's rules. As proposed, rule 39.3 
also would have required applicants to submit ``any'' agreements with 
third parties that would enable the applicant to comply with the core 
principles and descriptions of ``any'' system test procedures, tests 
conducted or test results. BOTCC commented that ``[t]hese materials can 
be voluminous. More importantly, these materials frequently will 
contain trade secrets of the submitting party or be subject to detailed 
confidentiality procedures established by third-party system providers 
and other vendors.'' \12\ BOTCC therefore recommended that the rule 
``be amended to require an applicant only to submit such information as 
is necessary to demonstrate the applicant's compliance with core 
principles.'' \13\ The Commission has modified the rule to clarify that 
the agreements and descriptions of system tests referred to in rule 
39.3 that must be submitted are those that will enable the applicant to 
comply, or demonstrate the applicant's ability to comply, with the core 
principles.\14\
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    \12\ BOTCC CL at 3.
    \13\ Id.
    \14\ This information is essential to the Commission's oversight 
of DCOs. However, trade secrets and other proprietary information 
may be entitled to protection under the Freedom of Information Act. 
See rule 39.3(a)(7). As has been the case in the past, the staff is 
prepared to work with applicants to arrange reasonable 
accommodations to address concerns about the relevance of 
disclosures or the volume of submissions.

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[[Page 45606]]

    If an applicant does not meet the registration requirements, 
Commission staff will inform the applicant of the shortcomings and 
notify it that review is being terminated under part 39 and will 
continue under section 6 of the Act. Within ten days of being notified, 
the applicant may ask the Commission either to register it or to 
commence registration denial proceedings. An applicant also may 
withdraw its application.
    An applicant may request that the Commission approve any of its 
rules pursuant to the procedures and timeframes for approval provided 
by rule 40.5. An applicant may request approval of one or more of its 
rules at the time it makes its initial application, or thereafter. 
Under section 5b(c)(3) of the Act, an applicant also may request that 
the Commission issue an order concerning whether a rule or practice of 
the applicant is the least anticompetitive means of achieving the 
objectives, purposes, and policies of the Act. In considering any 
requests for such orders, the Commission will review the analysis 
submitted by the applicant with respect to the rule or practice in 
question and will apply section 15(b) of the Act in a manner consistent 
with its previous application of section 15 to contract markets.

B. Existing Derivatives Clearing Organizations

    Section 5b(d) of the Act provides that existing DCOs shall be 
deemed to be registered with the Commission to the extent that the DCO 
clears agreements, contracts, or transactions for a board of trade that 
had been designated by the Commission as a contract market for such 
agreements, contracts, or transactions prior to enactment of the CFMA. 
In response to comments, the Commission clarifies that clearing 
organizations that are grandfathered under this provision need not 
apply to the Commission to clear new contracts that were not cleared 
before the date of enactment of the CFMA.\15\
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    \15\ See CME CL at 1. They would, however, be required under 
section 5c(c) of the Act to provide certification that the clearing 
of the new contract(s) complies with the Act and the Commission's 
regulations. Self-certification procedures for products are provided 
under rule 40.2.
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C. Derivatives Clearing Organizations

1. Exemption
    As proposed, rule 39.2 provided that a DCO and the clearing of 
transactions on a DCO would be exempt from all Commission regulations 
except for those contained in proposed parts 39 and 40,\16\ and certain 
select regulations relating to, for example, the segregation of 
customer funds and recordkeeping.\17\ In response to comments noting 
that only subsection (b) of Commission regulation 1.38 is relevant to 
the activities of DCOs, the Commission has amended proposed rule 39.2 
to reserve only that subsection.\18\ The Commission also has amended 
proposed rule 39.2 to delete reservation of the option anti-fraud 
provisions in Commission regulation 33.10, because part 39 contains its 
own anti-fraud rule, which applies to the activity of clearing option 
contracts otherwise covered by regulation 33.10.\19\ Parts 15 through 
18 of the Commission's regulations continue to be reserved in final 
rule 39.2 to the extent they are applicable. These provisions are 
reserved in connection with the Commission's authority to make special 
calls pursuant to rule 39.5(d).\20\
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    \16\ Part 40 of the regulations, which contains provisions 
common to contract markets, derivatives transactions execution 
facilities and DCOs, was adopted by the Commission on August 1, 
2000. See 66 FR 42256 (August 10, 2001).
    \17\ This included Commission Regulation 1.31, which was updated 
and amended by the Commission in 1999 to provide broad, flexible 
performance standards for recordkeeping. It is substantially similar 
to the recordkeeping requirements maintained by the Securities and 
Exchange Commission. Notwithstanding the basic non-mandatory nature 
of the guidance provided in the appendix to part 39, the Commission 
clarifies that, with respect to Core Principle K, a DCO's 
recordkeeping must satisfy the performance standards in Regulation 
1.31 in order to demonstrate compliance with the core principle, 
because that rule has been reserved.
    \18\ See BOTCC CL at 2.
    \19\ Id.
    \20\ Id. See generally the discussion regarding information 
needed by the Commission to fulfill its oversight function under 
section II. C. 3., infra.
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    Final rule 39.2 continues to provide that the reserved regulations 
apply to DCOs as though they were set forth in part 39 and included 
specific reference to DCOs. The Commission agrees with BOTCC's 
suggestion that this drafting convention be extended so that references 
in the regulations to the terms ``clearinghouse'' and ``clearing 
organization'' shall be deemed to mean a ``derivatives clearing 
organization,'' and has modified rule 39.2 accordingly.\21\
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    \21\ BOTCC CL at 2.
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2. Rules
    Rule 39.4 provides that a DCO may request that the Commission 
approve any of its rules either prior to or after implementation of the 
rule(s).\22\ Such requests will be processed under the applicable 
procedures of part 40. As provided by part 40 and rule 39.4, any new or 
amended rule not voluntarily submitted to the Commission for approval 
must be submitted with a certification that the new rule or amendment 
complies with the Act. Also as provided by part 40 and added in final 
rule 39.4, a DCO that accepts for clearing a new product that is not 
traded on a designated contract market or a registered derivatives 
transaction execution facility must submit to the Commission any rules 
establishing the terms and conditions of the product that make it 
acceptable for clearing with a certification that the clearing of the 
product and the rules and terms and conditions comply with the Act and 
the rules thereunder. A DCO also may request, at any time, that the 
Commission issue an order concerning whether any of its rules or 
practices is the least anticompetitive means of achieving the 
objectives, purposes, and policies of the Act. As with such requests 
accompanying applications, the Commission will review the analysis 
submitted with respect to the rule or practice in question and will 
apply section 15(b) of the Act in a manner consistent with its previous 
application of section 15 to contract markets.
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    \22\ The Act limits a registered entity seeking approval to 
request approval only ``prior'' to implementation. The Commission is 
using its section 4(c) exemptive authority with respect to this 
provision to provide DCOs with greater procedural flexibility.
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3. Information
    Rule 39.5 allows the Commission to request certain information from 
DCOs in order to carry out its oversight function. For example, rule 
39.5(b) allows the Commission to ask a DCO to submit, in writing, 
information deemed necessary to demonstrate that the DCO is operating 
in compliance with one or more of the core principles. Such a request 
is an informal method of resolving compliance issues and is intended to 
be a preferable alternative to the more formal procedures of section 
5c(d) of the Act. As proposed in rule 39.3(e), the Commission has 
delegated the authority to request information under 39.5(b) to 
specified staff. This delegation is consistent with the delegation of 
authority in rule 37.8(d) regarding information relating to 
transactions on derivatives transaction execution facilities and in 
rule 40.7(a)(1) regarding product and rule amendments and supplements. 
The authority under rule 39.5(b) is an important complement to the 
streamlined and reduced requirements of the CFMA. In response to 
concerns expressed by CME, the

[[Page 45607]]

Commission affirms its intent that rule 39.5 be used only when there is 
a reasonable basis upon which to request information about the ongoing 
compliance by a DCO with one or more core principles.\23\
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    \23\ See CME CL at 2-3. In order to perform properly its 
oversight function with respect to the core principles, such a 
request may include information related to the DCO's broader 
business as a clearing organization in addition to its business as a 
registered DCO, because the ability to fulfill the latter function 
may potentially be affected by the former. See BOTCC CL at 5.
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    Rule 39.5(c) requires that large trader information be provided to 
the Commission by futures commission merchants, clearing members, and 
foreign brokers. In response to comments, the Commission does not 
believe it is necessary to expand this list to include foreign traders 
or participants in a DCO, as in each instance, the report would be 
filed through an entity included on the list. Rule 39.5(d) authorizes 
the Commission to make special calls for information concerning 
customer accounts from futures commission merchants, clearing members, 
or foreign brokers. Commission staff will limit special calls as needed 
to carry out the Commission's oversight function with respect to DCOs 
and their operations.
4. Enforceability
    As proposed, rule 39.6 provided that a contract or transaction 
cleared pursuant to the rules of a DCO shall not be void, voidable, 
subject to rescission, or otherwise invalidated or rendered 
unenforceable as a result of a violation by the DCO of the provisions 
of section 5b of the Act or part 39, or as a result of any Commission 
proceeding to alter, supplement, or require the DCO to adopt a specific 
rule or procedure, or refrain from taking a specific action. In its 
comment letter, ISDA stated that the reference to contracts or 
transactions ``cleared pursuant to the rules'' may create ambiguity and 
uncertainty in that it does not clearly cover contracts or transactions 
cleared by non-registered DCOs. ISDA suggested clarifying the 
applicability of the enforceability provision by substituting the words 
``submitted to a derivatives clearing organization for clearance'' for 
``cleared pursuant to the rules.'' The Commission has considered ISDA's 
comment and has amended final rule 39.6 in this manner to clarify the 
rule's applicability to DCOs that are required to register, as well as 
those that are already registered, with the Commission. The Commission 
believes this clarification is appropriate in that enforceability of 
contracts extends not only to DCOs properly registered with the 
Commission, but to those that should be, but are not, registered with 
the Commission and consequently are in violation of Section 5b(a) of 
the Act.
    The Commission's substitution of the words ``submitted to a 
derivatives clearing organization for clearance'' in final rule 39.6 
also addresses BOTCC's suggestion that the Commission clarify that the 
enforceability provision applies to cleared transactions and to those 
submitted for clearing, but for which the clearing process was delayed 
or interrupted.\24\ In addition, in response to BOTCC comments, the 
Commission has modified proposed rule 39.6 to apply to violations of 
any of the provisions of the Act or of the Commission's regulations, 
rather than to violations of section 5b of the Act or part 39 of the 
regulations only.\25\
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    \24\ See BOTCC CL at 6, n.9. BOTCC notes that this distinction 
could be important in circumstances where the insolvency of a 
clearing member or DCO participant interferes with normal clearing 
processes.
    \25\ See BOTCC CL at 6.
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5. Anti-fraud
    As proposed, rule 39.7 prohibited fraudulent actions by persons 
``in or in connection with'' the clearing of transactions on a DCO. 
Both CME and ISDA commented that the proposed rule could be interpreted 
to apply to fraud with respect to aspects of a transaction cleared by a 
DCO other than the activity of clearing. ISDA asserted that the rule 
should be narrowly construed to mean fraud specific to the clearing 
function and not in connection with the solicitation or execution of a 
transaction merely because the transaction is also cleared.\26\ CME 
stated that the rule could be read to apply to the execution of 
transactions cleared by a DCO even if the transaction would otherwise 
be outside the Commission's jurisdiction.\27\ CME argued that 
participants in derivatives markets unregulated by the CFTC will 
arrange to have such transactions cleared by non-DCO clearing 
organizations if there appears to be any chance that rule 39.7 could 
subject their transactions to CFTC jurisdiction.\28\
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    \26\ See ISDA CL at 3-4.
    \27\ See CME CL at 1-2.
    \28\ See CME CL at 2.
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    In response to these comments, the Commission reaffirms that 
transactions that are outside the CFTC's jurisdiction do not become 
subject to its jurisdiction simply because they are cleared by a DCO. 
Thus, rule 39.7 does not govern, cover, or relate to the solicitation 
or execution of transactions. This is consistent with rule 39.6, which 
provides that a violation of any Commission regulation, which would 
include rule 39.7, does not affect the enforceability of transactions 
submitted for clearance on a DCO, and with the CFMA's separate 
treatment of clearing from the transaction facilities for which 
transactions are cleared.
    BOTCC also requested confirmation that proof of scienter is needed 
for violations of rule 39.7.\29\ The Commission confirms that 
violations of the anti-fraud provision do require proof of 
scienter.\30\
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    \29\ See BOTCC CL at 6.
    \30\ This is consistent with other anti-fraud provisions such as 
Section 4(b) of the Act, Commission regulation 30.9 (concerning 
fraud involving foreign futures contracts) and Commission regulation 
33.10 (concerning fraud in connection with domestic exchange-traded 
option transactions). The Commission has held that Regulations 30.9 
and 33.10 require proof of scienter. See, e.g., In Re Staryk [1996-
1998 Transfer Binder] Comm. Fut. L. Rep. (CCH) para. 27,206 at 
45,810 (CFTC Dec. 18, 1997). The Commission also removed the words 
``other'' and ``thereof'' twice each from rule 39.7. These words do 
not serve a useful purpose in the rule and their removal does not 
change the meaning or application of the rule, but does make it 
consistent with rule 1.1 recently adopted by the Commission. See 66 
FR 42256 (August 10, 2001). Rule 1.1 concerns fraud in or in 
connection with transactions in foreign currency subject to the Act.
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D. Application Guidance and Compliance With Core Principles

    In order to become registered, an applicant must demonstrate the 
ability to comply with the core principles for DCOs set forth in 
Section 5b of the Act. In order to remain registered, a DCO must 
continue to comply with the core principles. An applicant or DCO has 
reasonable discretion in establishing the manner in which it 
demonstrates its ability to comply with the core principles or its 
ongoing compliance. Appendix A to part 39 provides guidance that 
applicants and DCOs can use to demonstrate initial ability to comply 
and continuing compliance with the core principles. The guidance 
illustrates the manner in which a clearing organization may meet a core 
principle and is not intended to be a mandatory checklist.
    The proposed guidance for Core Principle B--Financial Resources--
addressed the ``amount'' of resources dedicated to supporting the 
clearing function. As proposed, this guidance referred to the amount of 
resources available and their sufficiency to assure that no break in 
clearing operations will occur in a variety of market conditions. In 
response to comments, point 1 of the guidance has been modified to 
refer to the ``level'' rather than the ``amount'' of resources and 
assurance that no ``material adverse'' break in clearing

[[Page 45608]]

operations will occur.\31\ Point 2 continues to refer to the ``nature'' 
of the resources. The Commission recognizes that it may be difficult to 
quantify resource allocations. Thus, in the final guidance it suggests 
that applicants or DCOs may provide information describing the level 
and nature of resources available to support the clearing function, 
rather than the specific or exact amount of resources available at any 
one time. In addition, the Commission recognizes that certain temporary 
breakdowns that do not materially affect the clearing function do and 
will occur. The Commission notes that the guidance relevant to this 
issue addresses the allocation of sufficient resources to prevent 
breakdowns of a serious and fundamental nature that would materially, 
adversely affect an applicant's or DCO's ability to fulfill its basic 
clearing services.\32\ Furthermore, reference in the guidance to a 
credit enhancement function is not intended to imply a requirement that 
a DCO provide that function.\33\
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    \31\ See BOTCC CL at 7.
    \32\ See BOTCC CL at 7.
    \33\ See ISDA CL at 4; see also footnote 9, supra.
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    Point 2 of the proposed guidance under Core Principle B--Financial 
Resources--addressed the updating and reporting of certain financial 
information. With respect to public disclosure, this guidance has been 
amended so as to apply only ``when appropriate.'' Information is not 
expected to be made publicly available if it is not appropriate to do 
so, as in the case of certain confidential and proprietary financial 
and commercial information.\34\ The proposed guidance on Core Principle 
L--Public Information--also referred to public disclosure and concerned 
rules and operating procedures governing clearing and settlement 
systems. This guidance has not been altered from its proposed form and 
is consistent with guidance regarding public disclosure of similar 
material by contract markets or applicants therefor.\35\
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    \34\See BOTCC CL at 7.
    \35\See the application guidance for designation criterion 7 of 
section 5(b) of the Act and the guidance on, and acceptable 
practices for, complying with core principles 7 and 10 of section 
5(d) of the Act; see also BOTCC CL at 7.
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    As proposed, point 3 of the guidance for Core Principle C--
Participant and Product Eligibility--suggested that an applicant or DCO 
describe how it would establish criteria for the transactions it will 
clear, and point 2 of the guidance for Core Principle D--Risk 
Management--suggested providing a description of how appropriate forms 
and levels of collateral would be established and collected. In 
response to comments, these points have been reworded to clarify that 
the information suggested as relevant to demonstrating compliance 
relates to the different factors the applicant or DCO will consider in 
carrying out its responsibilities, rather than its internal 
procedures.\36\ In addition, the words ``where applicable'' have been 
added to subpart (b) of point 2 of the guidance for Core Principle D, 
referring to sufficient resources to perform the central counterparty 
function, in recognition of the fact that the definition of DCO does 
not require the performance of a direct credit enhancement 
function.\37\
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    \36\See BOTCC CL at 8.
    \37\ See footnote 9 and text accompanying footnote 33.
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    Point 1 of the guidance under Core Principle G--Default Rules and 
Procedures--has been revised to suggest more clearly that relevant 
information includes how the applicant or DCO defines default, what 
steps would be taken in the event of a default, and steps that would be 
taken in situations related to, but which may not constitute, 
default.\38\ Point 5 of the guidance for Core Principle G concerning 
default rules and procedures suggests that applicants or DCOs address 
rules and procedures regarding priority of customer accounts over 
proprietary accounts of defaulting members/participants. In response to 
comments, the Commission clarifies that this is not meant, and should 
not be interpreted, to imply that customer priority procedures are a 
necessary element in the structure of all DCOs.\39\ Rules and 
procedures regarding priority of customer accounts are only relevant 
with respect to a DCO that directly or indirectly clears contracts for 
one or more accounts that are customer accounts in the particular 
market for which it is clearing, while also clearing non-customer or 
proprietary accounts.
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    \38\ See BOTCC CL at 8.
    \39\ See ISDA CL at 4-5.
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    Point 2 of the proposed guidance for Core Principle I--System 
Safeguards--suggested that applicants or DCOs provide confirmation that 
system testing and review will be performed or assessed by a qualified 
independent professional. In response to comments, the Commission has 
clarified that a qualified independent professional need not 
necessarily be external to the organization to be considered 
independent.\40\ An internal reviewer may qualify as independent if he/
she is independent of the activities being audited and is 
organizationally able to render an objective assessment.
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    \40\ See BOTCC CL at 8.
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III. Section 4(c) Findings

    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, either unconditionally or on 
stated terms or conditions, from any of the requirements of any 
provision of the Act (except certain provisions governing a group or 
index of securities and security futures products). As relevant here, 
when granting an exemption pursuant to section 4(c), the Commission 
must find that the exemption would be consistent with the public 
interest.
    The Commission is using its section 4(c) exemptive authority here 
to provide registered entities with greater procedural flexibility than 
is contained in the Act. Pursuant to rule 39.4, a DCO may request that 
the Commission approve its rules or rule amendments prior to their 
implementation, or any time thereafter, notwithstanding the Act's 
limitation on registered entities seeking approval to do so only prior 
to implementation.\41\ The Commission believes this exercise of 
exemptive authority should provide DCOs with greater procedural 
flexibility. Accordingly, the Commission finds under section 4(c) of 
the Act that the exemption is consistent with the public interest. The 
Commission also notes that it will consider, under its section 4(c) 
exemptive authority, requests by designated contract markets to use the 
clearing services of organizations other than DCOs registered with the 
Commission.
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    \41\ See section 5c(c)(2) of the Act.
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IV. Consideration of Costs and Benefits

    Section 15 of the Act, as amended by section 119 of the CFMA, 
requires the Commission to consider the costs and benefits of its 
action before promulgating a new regulation under the Act. The 
Commission has applied the cost-benefit provisions of section 15 in 
this rulemaking and understands that, by its terms, section 15 as 
amended does not require the Commission to quantify the costs and 
benefits of a new regulation or to determine whether the benefits of 
the proposed regulation outweigh its costs. Rather, section 15 simply 
requires the Commission to ``consider the costs and benefits'' of its 
action.
    The amended section 15 further specifies that costs and benefits 
shall be

[[Page 45609]]

evaluated in light of five broad areas of market and public concern: 
protection of market participants and the public; efficiency, 
competitiveness, and financial integrity of futures markets; price 
discovery; sound risk management practices; and other public interest 
considerations. Accordingly, the Commission may, in its discretion, 
give greater weight to any one of the five enumerated areas of concern 
and may in its discretion determine that, notwithstanding its costs, a 
particular rule is necessary or appropriate to protect the public 
interest or to effectuate any of the provisions or to accomplish any of 
the purposes of the Act.
    Part 39 is part of a package of related rule provisions 
implementing the CFMA. The Commission has considered the costs and 
benefits of part 39 and the costs and benefits of the related rule 
provisions. Significantly, part 39 limits the period of time for 
Commission review of DCO applications to 60 days, thereby providing the 
important benefit of an expedited review, even though the Act does not 
specify any time limit for review of DCO applications. Part 39 also 
provides the benefit of substantial, additional, non-binding guidance 
to DCO applicants and DCOs as to how they may comply with the statutory 
core principles. The rules impose reporting, recordkeeping and other 
informational requirements on DCOs only when they are mandated by, 
carry out, or are fully consistent with, the new provisions of the CFMA 
concerning DCOs.
    The Commission has considered the costs and benefits of this rule 
package in light of the specific areas of concern identified in the 
CFMA. The rules impose limited costs on DCOs in requiring them to 
gather, compile, and submit certain information that the Commission 
needs in order to oversee their clearing functions and to enforce their 
compliance with the Act. The rules will not increase costs related to 
market competitiveness and will not affect the price discovery function 
of markets. The Commission believes that the anti-fraud provision of 
part 39 benefits market participants and the public interest by 
deterring illegal behavior and that the enforceability provision of 
part 39 benefits the public interest by furthering legal certainty.
    After considering these factors, the Commission has determined to 
promulgate part 39. The Commission notes that it did not receive any 
comments in response to the discussion regarding the costs and benefits 
of part 39 included in the proposal. Moreover, insofar as the comments 
received raised any matters that might be deemed to relate to the costs 
and benefits of part 39, the Commission has addressed them in the 
foregoing discussion and through modifications to the original 
proposal.

V. Implementation Issues; No-action

    In light of Congress's intent to implement the changes of the CFMA 
without delay, the Commission determined when it proposed these rules 
that it would not bring any enforcement action against any person who 
complied with the proposed rules during the transition period between 
the effective date of the amendments to the Act (generally December 21, 
2000) and the adoption of final implementing regulations. 66 FR at 
24310. At that time, the Commission also advised persons relying on 
that no-action position that they would be required to bring their 
conduct into compliance with the final rules to the extent that the 
final rules differed from the proposed rules. Id.
    The rules being adopted today will become effective October 29, 
2001. To the extent that the final rules differ from the proposed 
rules, persons relying on the no-action position of the proposed rules 
will be required to bring their conduct into compliance with the final 
rules in order to continue to rely on the no-action. Furthermore, the 
Commission will not bring any enforcement action against any person who 
complies with the final rules during the period between their adoption 
and effective date.

VI. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601-612, 
requires that agencies, in promulgating rules, consider the impact of 
those regulations on small entities. The rules adopted herein would 
affect DCOs. The Commission has previously established certain 
definitions of ``small entities'' to be used by the Commission in 
evaluating the impact of its rules on such entities in accordance with 
the RFA.\42\ In its previous determinations, the Commission has 
concluded that contract markets are not small entities for purposes of 
the RFA.\43\ DCOs clear contracts executed on contract markets and 
other trading facilities. For reasons similar to those applicable to 
contract markets, DCOs, as defined in the CFMA, should not be 
considered small entities. In this regard, the Commission notes that it 
did not receive any comments regarding the RFA implications of part 39. 
Accordingly, the Commission does not expect the rules, as adopted 
herein, to have a significant economic impact on a substantial number 
of small entities. Therefore, the Acting Chairman, on behalf of the 
Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that the 
promulgated rules will not have a significant economic impact on a 
substantial number of small entities.
---------------------------------------------------------------------------

    \42\ 47 FR 18618 (April 30, 1982).
    \43\ 47 FR 18618, 18619 (discussing contract markets).
---------------------------------------------------------------------------

B. Paperwork Reduction Act

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

List of Subjects in 17 CFR Part 39

    Commodity futures, Consumer protection.

    In consideration of the foregoing, and pursuant to the authority 
contained in section 7b of title 7 of the U.S.C., as added by the 
Commodity Futures Modernization Act of 2000, Appendix E of Pub. L. 106-
554, 114 Stat. 2763 (2000), 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--DERIVATIVES CLEARING ORGANIZATIONS

Sec.
39.1  Scope.
39.2  Exemption.
39.3  Procedures for registration.
39.4  Procedures for implementing derivatives clearing organization 
rules and clearing certain new products.
39.5  Information relating to derivatives clearing organization 
operations.
39.6  Enforceability.
39.7  Fraud in connection with the clearing of transactions on a 
derivatives clearing organization.

Appendix A to Part 39--Application Guidance and Compliance With Core 
Principles

    Authority: 7 U.S.C. 7b as added by the Commodity Futures 
Modernization Act of 2000, Appendix E of Pub. L. 106-554, 114 Stat. 
2763 (2000).


Sec. 39.1  Scope.

    The provisions of this part apply to any derivatives clearing 
organization as defined under section 1a(9) of the Act which is 
registered or deemed to be registered with the Commission as a

[[Page 45610]]

derivatives clearing organization, is required to register as such with 
the Commission pursuant to section 5b(a) of the Act, or which 
voluntarily applies to register as such with the Commission pursuant to 
section 5b(b) or otherwise.


Sec. 39.2  Exemption.

    A derivatives clearing organization and the clearing of agreements, 
contracts and transactions on a derivatives clearing organization are 
exempt from all Commission regulations except for the requirements of 
this part 39 and Secs. 1.3, 1.12(f)(1), 1.20, 1.24, 1.25, 1.26, 1.27, 
1.29, 1.31, 1.36, 1.38(b), part 40 and part 190 of this chapter, and as 
applicable to the agreement, contract or transaction cleared, parts 15 
through 18 of this chapter. The foregoing reserved regulations are 
applicable to a derivatives clearing organization and its activities as 
though they were set forth in this section and included specific 
reference to derivatives clearing organizations. Any reference to the 
term ``clearinghouse'' or ``clearing organization'' contained in the 
regulations shall be deemed to refer to a derivatives clearing 
organization.


Sec. 39.3  Procedures for registration.

    (a) Registration by application. An organization shall be deemed to 
be registered as a derivatives clearing organization sixty days after 
receipt by the Commission of an application for registration as a 
derivatives clearing organization unless notified otherwise during that 
period, or, as determined by Commission order, registered upon 
conditions, if:
    (1) The application is labeled as being submitted pursuant to this 
part 39;
    (2) The applicant represents that it will operate in accordance 
with the definition of derivatives clearing organization contained in 
section 1a(9) of the Act;
    (3) The application includes a copy of the applicant's rules;
    (4) To the extent it is not self evident from the applicant's 
rules, the application demonstrates how the applicant is able to 
satisfy each of the core principles specified in section 5b(c)(2) of 
the Act;
    (5) The applicant submits agreements entered into or to be entered 
into between or among the applicant, its operator or its participants, 
and descriptions of system test procedures, tests conducted or test 
results, that will enable the applicant to comply, or demonstrate the 
applicant's ability to comply, with the core principles specified in 
section 5b(c)(2) of the Act;
    (6) The applicant does not amend or supplement the application 
except as requested by the Commission or for correction of 
typographical errors, renumbering or other nonsubstantive revisions, 
during that period;
    (7) The applicant identifies with particularity information in the 
application that will be subject to a request for confidential 
treatment and supports that request for confidential treatment with 
reasonable justification; and
    (8) The applicant has not instructed the Commission in writing 
during the review period to review the application pursuant to the time 
provisions of and procedures under section 6 of the Act.
    (b) Termination of part 39 review. If, during the sixty-day period 
for review provided by paragraph (a) of this section, it appears that 
the application's form or substance fails to meet the requirements of 
this part, the Commission shall notify the applicant seeking 
registration that the Commission is terminating review under this 
section and will review the proposal under the time period and 
procedures of section 6 of the Act. This termination notification will 
state the nature of the issues raised and the specific condition of 
registration that the applicant would violate, appears to violate, or 
the violation of which cannot be ascertained from the application. 
Within ten days of receipt of this termination notification, the 
applicant seeking registration may request that the Commission render a 
decision whether to register the applicant or to institute a proceeding 
to deny the proposed application under procedures specified in section 
6 of the Act by notifying the Commission that the applicant views its 
submission as complete and final as submitted.
    (c) Withdrawal of application for registration. An applicant for 
registration may withdraw its application by filing with the Commission 
such a request. Withdrawal of an application for registration shall not 
affect any action taken or to be taken by the Commission based upon 
actions, activities, or events occurring during the time that the 
application for registration was pending with the Commission.
    (d) Guidance for applicants and registrants. Appendix A to this 
part provides guidance to applicants and registrants on how the core 
principles specified in section 5b(c)(2) of the Act may be satisfied.
    (e) Delegation of authority. (1) The Commission hereby delegates, 
until it orders otherwise, to the Director of the Division of Trading 
and Markets or the Director's delegatees, with the concurrence of the 
General Counsel or the General Counsel's delegatees, the authority to 
exercise the functions under paragraphs (a) and (b) of this section and 
under Sec. 39.5.
    (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 this paragraph prohibits the Commission, at its 
election, from exercising the authority delegated in paragraph (e)(1) 
of this section.


Sec. 39.4  Procedures for implementing derivatives clearing 
organization rules and clearing certain new products.

    (a) Request for approval of rules. An applicant for registration, 
or a registered derivatives clearing organization, may request, 
pursuant to the procedures of Sec. 40.5 of this chapter, that the 
Commission approve any or all of its rules and subsequent amendments 
thereto, including operational rules, prior to their implementation or, 
notwithstanding the provisions of section 5c(c)(2) of the Act, at any 
time thereafter, under the procedures of Sec. 40.5 of this chapter. A 
derivatives clearing organization may label as, ``Approved by the 
Commission,'' only those rules that have been so approved.
    (b) Self-certification of rules. Proposed new or amended rules of a 
derivatives clearing organization not voluntarily submitted for prior 
Commission approval pursuant to paragraph (a) of this section must be 
submitted to the Commission with a certification that the proposed new 
rule or rule amendment complies with the Act and rules thereunder 
pursuant to the procedures of Sec. 40.6 of this chapter.
    (c) Acceptance of certain new products for clearing. A derivatives 
clearing organization that accepts for clearing a new product that is 
not traded on a designated contract market or a registered derivatives 
transaction execution facility must submit to the Commission any rules 
establishing the terms and conditions of the product that make it 
acceptable for clearing with a certification that the clearing of the 
product and the rules and terms and conditions comply with the Act and 
the rules thereunder pursuant to the procedures of Sec. 40.2 of this 
chapter.
    (d) Orders regarding competition. An applicant or a registered 
derivatives clearing organization may request that the Commission issue 
an order concerning whether a rule or practice of the organization is 
the least anticompetitive means of achieving the objectives, purposes, 
and policies of the Act.

[[Page 45611]]

Sec. 39.5  Information relating to derivatives clearing organization 
operations.

    (a) Upon request by the Commission, a derivatives clearing 
organization shall file with the Commission such information related to 
its business as a clearing organization, including information relating 
to trade and clearing details, in the form and manner and within the 
time as specified by the Commission in the request.
    (b) Upon request by the Commission, a derivatives clearing 
organization shall file with the Commission a written demonstration, 
containing such supporting data, information and documents, in the form 
and manner and within such time as the Commission may specify that the 
derivatives clearing organization is in compliance with one or more 
core principles as specified in the request.
    (c) Information regarding transactions by large traders cleared by 
a derivatives clearing organization shall be filed with the Commission, 
in a form and manner acceptable to the Commission, by futures 
commission merchants, clearing members, foreign brokers or registered 
entities other than a derivatives clearing organization, as applicable. 
Provided, however, that if no such person or entity is required to file 
large trader information with the Commission, such information must be 
filed with the Commission by a derivatives clearing organization.
    (d) Upon special call by the Commission, each futures commission 
merchant, clearing member or foreign broker shall provide information 
to the Commission concerning customer accounts or related positions 
cleared on a derivatives clearing organization or other multilateral 
clearing organization in the form and manner and within the time 
specified by the Commission in the special call.


Sec. 39.6  Enforceability.

    An agreement, contract or transaction submitted to a derivatives 
clearing organization for clearance shall not be void, voidable, 
subject to rescission, or otherwise invalidated or rendered 
unenforceable as a result of:
    (a) A violation by the derivatives clearing organization of the 
provisions of the Act or of Commission regulations; or
    (b) Any Commission proceeding to alter or supplement a rule under 
section 8a(7) of the Act, to declare an emergency under section 8a(9) 
of the Act, or any other proceeding the effect of which is to alter, 
supplement, or require a derivatives clearing organization to adopt a 
specific rule or procedure, or to take or refrain from taking a 
specific action.


Sec. 39.7  Fraud in connection with the clearing of transactions on a 
derivatives clearing organization.

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

Appendix A to Part 39--Application Guidance and Compliance With Core 
Principles

    This appendix provides guidance concerning the core principles 
with which applicants must demonstrate the ability to comply and 
with which registered derivatives clearing organizations must 
continue to comply to be granted and to maintain registration as a 
derivatives clearing organization under section 5b of the Act and 
Sec. 39.3 and Sec. 39.5 of the Commission's regulations. The 
guidance follows each core principle and can be used to demonstrate 
core principle compliance under Sec. 39.3(a)(iv) and Sec. 39.5(d). 
The guidance for each core principle is illustrative only of the 
types of matters a clearing organization may address, as applicable, 
and is not intended to be a mandatory checklist. Addressing the 
criteria set forth in this appendix would help the Commission in its 
consideration of whether the clearing organization is in compliance 
with the core principles. To the extent that compliance with, or 
satisfaction of, a core principle is not self-explanatory from the 
face of a clearing organization's rules, an application pursuant to 
Sec. 39.3 or a submission pursuant to Sec. 39.5 should include an 
explanation or other form of documentation demonstrating that the 
clearing organization is able to or does comply with the core 
principles.
    Core Principle A: IN GENERAL--To be registered and to maintain 
registration as a derivatives clearing organization, an applicant 
shall demonstrate to the Commission that the applicant complies with 
the core principles specified in this paragraph. The applicant shall 
have reasonable discretion in establishing the manner in which it 
complies with the core principles.
    An entity preparing to submit to the Commission an application 
to operate as a derivatives clearing organization is encouraged to 
contact Commission staff for guidance and assistance in preparing 
its application. Applicants may submit a draft application for 
review prior to the submission of an actual application without 
triggering the application review procedures of Sec. 39.3 of the 
Commission's regulations. The Commission also may require a 
derivatives clearing organization to demonstrate to the Commission 
that it is operating in compliance with one or more core principles.
    Core Principle B: FINANCIAL RESOURCES--The applicant shall 
demonstrate that the applicant has adequate financial, operational, 
and managerial resources to discharge the responsibilities of a 
derivatives clearing organization.
    In addressing Core Principle B, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    1. The resources dedicated to supporting the clearing function:
    a. The level of resources available to the clearing organization 
and the sufficiency of those resources to assure that no material 
adverse break in clearing operations will 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 accessed and applied by the clearing organization 
promptly;
    b. How financial and other material information will be updated 
and reported to members, the public, if and when appropriate, and to 
the Commission on an ongoing basis; and
    c. Any legal or operational impediments or conditions to access.
    Core Principle C: PARTICIPANT AND PRODUCT ELIGIBILITY--The 
applicant shall establish (i) appropriate admission and continuing 
eligibility standards (including appropriate minimum financial 
requirements) for members of and participants in the organization; 
and (ii) appropriate standards for determining eligibility of 
agreements, contracts, or transactions submitted to the applicant.
    In addressing Core Principle C, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    1. Member/participant admission criteria:
    a. How admission standards for its clearing members/participants 
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/
participants, whether different levels of membership/participation 
would relate to different levels of net worth, income, and 
creditworthiness of members/participants, 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/
participants; and
    b. Whether and how the clearing organization would be able to 
change continuing eligibility criteria in accordance

[[Page 45612]]

with changes in a member's/participant's financial status.
    3. Criteria for instruments acceptable for clearing:
    a. The criteria, and the factors considered in establishing the 
criteria, for the types of agreements, contracts, or transactions it 
will clear; and
    b. How those criteria take into account the different risks 
inherent in clearing different agreements, contracts, or 
transactions and how they affect maintenance of assets to support 
the guarantee function in varying risk environments.
    4. The clearing function for each instrument the organization 
undertakes to clear.
    Core Principle D: RISK MANAGEMENT--The applicant shall have the 
ability to manage the risks associated with discharging the 
responsibilities of a derivatives clearing organization through the 
use of appropriate tools and procedures.
    In addressing Core Principle D, applicants and registered 
derivatives clearing organizations 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;
    b. How the organization would use specific risk management tools 
such as stress testing and value at risk calculations; and
    c. What contingency plans the applicant has for managing extreme 
market events.
    2. Use of collateral:
    a. What 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, where 
applicable, performing as a central counterparty;
    c. The factors considered in determining appropriate margin 
levels for an instrument cleared and for clearing members/
participants;
    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 systems would be implemented that would prevent members/
participants and other market participants from exceeding credit 
limits and how they would operate.
    Core Principle E: SETTLEMENT PROCEDURES--The applicant shall 
have the ability to (i) complete settlements on a timely basis under 
varying circumstances; (ii) maintain an adequate record of the flow 
of funds associated with each transaction that the applicant clears; 
and (iii) comply with the terms and conditions of any permitted 
netting or offset arrangements with other clearing organizations.
    In addressing Core Principle E, applicants and registered 
derivatives clearing organizations 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 one or 
more significant members/participants have 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 F: TREATMENT OF FUNDS--The applicant shall have 
standards and procedures designed to protect and ensure the safety 
of member and participant funds.
    In addressing Core Principle F, applicants and registered 
derivatives clearing organizations 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 
funds with proprietary funds, obligating customer funds for any 
purpose other than to purchase, clear, and settle the products the 
clearing organization is clearing, or procedures regarding customer 
funds which are subject to cross-margin or similar agreements, and 
any other aspects of customer fund segregation.
    3. Investment standards:
    a. How customer funds would be invested consistent with high 
standards of safety; and
    b. How the organization will gather and keep associated records 
and data regarding the details of such investments.
    Core Principle G: DEFAULT RULES AND PROCEDURES--The applicant 
shall have rules and procedures designed to allow for efficient, 
fair, and safe management of events when members or participants 
become insolvent or otherwise default on their obligations to the 
derivatives clearing organization.
    In addressing Core Principle G, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    1. Definition of default:
    a. The events that will constitute member or participant 
default;
    b. What action the organization would take upon a default and 
how the organization would otherwise enforce the definition of 
default; and
    c. How the organization would address situations related to but 
which may not constitute an event of default, such as 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/participant 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/participant financial resources to address monetary 
shortfalls resulting from a default.
    4. Use of cross-margin programs:
    How cross-margining programs would provide for clear, fair, and 
efficient means of covering losses in the event of a program 
participant default.
    5. Customer priority rule:
    Rules and procedures regarding priority of customer accounts 
over proprietary accounts of defaulting members/participants and, 
where applicable, in the context of specialized margin reduction 
programs such as cross-margining or trading links with other 
exchanges.
    Core Principle H: RULE ENFORCEMENT--The applicant shall (i) 
maintain adequate arrangements and resources for the effective 
monitoring and enforcement of compliance with rules of the applicant 
and for resolution of disputes; and (ii) have the authority and 
ability to discipline, limit, suspend, or terminate a member's or 
participant's activities for violations of rules of the applicant.
    In addressing Core Principle H, applicants and registered 
derivatives clearing organizations 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 the effective enforcement of 
rules and authority and ability to discipline and limit or suspend a 
member's/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/participants, and between 
members/participants.
    Core Principle I: SYSTEM SAFEGUARDS--The applicant shall 
demonstrate that the applicant (i) has established and will maintain 
a program of oversight and risk analysis to ensure that the 
automated systems of the applicant function properly and have 
adequate capacity and security;

[[Page 45613]]

and (ii) has established and will maintain emergency procedures and 
a plan for disaster recovery, and will periodically test backup 
facilities sufficient to ensure daily processing, clearing, and 
settlement of transactions.
    In addressing Core Principle I, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    1. Oversight/risk analysis program:
    a. Whether a program addresses appropriate principles and 
procedures for the oversight of automated systems to ensure that its 
clearing systems function properly and have adequate capacity and 
security. The Commission believes that the guidelines issued by the 
International Organization of Securities Commissions (IOSCO) in 1990 
and adopted by the Commission on November 21, 1990 (55 FR 48670), as 
supplemented in October 2000, are appropriate guidelines for an 
automated clearing system to apply.
    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.
    Core Principle J: REPORTING--The applicant shall provide to the 
Commission all information necessary for the Commission to conduct 
the oversight function of the applicant with respect to the 
activities of the derivatives clearing organization.
    In addressing Core Principle J, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    1. Information available to or generated by the clearing 
organization that will be made routinely available to the 
Commission, upon request and/or as appropriate, to enable the 
Commission to perform properly its oversight function, including 
information regarding counterparties and their positions, stress 
test results, internal governance, legal proceedings, and other 
clearing activities;
    2. Information the clearing organization will make available to 
the Commission on a non-routine basis and the circumstances which 
would trigger such action;
    3. The information the organization intends to make routinely 
available to members/participants and/or the general public; and
    4. Provision of information:
    a. The manner in which all relevant routine or non-routine 
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 K: RECORDKEEPING--The applicant shall maintain 
records of all activities related to the business of the applicant 
as a derivatives clearing organization in a form and manner 
acceptable to the Commission for a period of 5 years.
    In addressing Core Principle K, applicants and registered 
derivatives clearing organizations may describe or otherwise 
document:
    1. The different activities related to the entity as a clearing 
organization for which it must maintain records; and
    2. How the entity would satisfy the performance standards of 
Commission regulation 1.31 (17 CFR 1.31), reserved in this part 39 
and applicable to derivatives clearing organizations, including:
    a. What ``full'' or ``complete'' would encompass with respect to 
each type of book or record that would be maintained;
    b. The form and manner in which 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 L: PUBLIC INFORMATION--The applicant shall make 
information concerning the rules and operating procedures governing 
the clearing and settlement systems (including default procedures) 
available to market participants.
    In addressing Core Principle L, applicants and registered 
derivatives clearing organizations 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 the clearing organization's rules;
    c. How members/participants may become familiar with such 
procedures before participating in operations; and
    d. How members/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 member's/participant's default.
    Core Principle M: INFORMATION SHARING--The applicant shall (i) 
enter into and abide by the terms of all appropriate and applicable 
domestic and international information-sharing agreements; and (ii) 
use relevant information obtained from the agreements in carrying 
out the clearing organization's risk management program.
    In addressing Core Principle M, applicants and registered 
derivatives clearing organizations 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. How information obtained from information-sharing 
arrangements would be used to carry 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 N: ANTITRUST CONSIDERATIONS--Unless appropriate 
to achieve the purposes of this Act, the derivatives clearing 
organization shall avoid (i) adopting any rule or taking any action 
that results in any unreasonable restraint of trade; or (ii) 
imposing any material anticompetitive burden on trading on the 
contract market.
    Pursuant to section 5b(c)(3) of the Act, a registered 
derivatives clearing organization or an entity seeking registration 
as a derivatives clearing organization may request that the 
Commission issue an order concerning whether a rule or practice of 
the organization is the least anticompetitive means of achieving the 
objectives, purposes, and policies of the Act. The Commission 
intends to apply section 15(b) 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, DC on August 22, 2001, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 01-21670 Filed 8-28-01; 8:45 am]
BILLING CODE 6351-01-P