[Federal Register Volume 75, Number 200 (Monday, October 18, 2010)]
[Proposed Rules]
[Pages 63732-63753]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-26220]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 37, 38, 39, and 40

RIN 3038-AD01


Requirements for Derivatives Clearing Organizations, Designated 
Contract Markets, and Swap Execution Facilities Regarding the 
Mitigation of Conflicts of Interest

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (the ``Commission'') 
hereby proposes rules to implement new statutory provisions enacted by 
Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection 
Act (the ``Dodd-Frank Act''). Specifically, the proposed rules 
contained herein impose new requirements on derivatives clearing 
organizations (``DCOs''), designated contract markets (``DCMs''), and 
swap execution facilities (``SEFs'') with respect to mitigation of 
conflicts of interest.

DATES: Submit comments on or before November 17, 2010.

ADDRESSES: You may submit comments, identified by RIN number, by any of 
the following methods:
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     Agency Web Site: http://www.cftc.gov. Follow the 
instructions for submitting comments on the Web site.
     E-mail: [email protected].
     Fax: 202-418-5521.
     Mail: David A. Stawick, Secretary of the Commission, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street, NW., Washington, DC 20581.
     Hand Delivery/Courier: Same as mail above.

FOR FURTHER INFORMATION CONTACT: Nancy Liao Schnabel, Special Counsel, 
Division of Clearing and Intermediary Oversight (DCIO), at 202-418-5344 
or [email protected]; Lois Gregory, Assistant Deputy Director for 
Market Review, the Division of Market Oversight (DMO), at 202-418-5569 
or [email protected]; Andrea Musalem, Special Counsel, DCIO, at 202-
418-5167 or [email protected]; Jordan O'Regan, Attorney-Advisor, DCIO, 
at 202-418-5984 or [email protected]; Cody Alvarez, Attorney-Advisor, 
DMO, at 202-418-5404 or [email protected]; Dana Brown, Law Clerk, DMO, 
at 202-418-5093 or [email protected]; Jolanta Sterbenz, Counsel, Office 
of the General Counsel, at 202-418-6639 or [email protected]; David 
Reiffen, Senior Economist, Office of the Chief Economist, at 202-418-
5602 or [email protected]; or Alicia Lewis, Attorney-Advisor, DCIO, at 
202-418-5862 or [email protected]; in each case, also at the Commodity 
Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, 
NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

I. Background

    On July 21, 2010, President Obama signed the Dodd-Frank Act.\1\ 
Title VII of the Dodd-Frank Act \2\ amended the Commodity Exchange Act 
(``CEA'') \3\ to establish a comprehensive new regulatory framework for 
swaps and certain security-based swaps. The legislation was enacted to 
reduce risk, increase transparency, and promote market integrity within 
the financial system by, among other things: (i) Providing for the 
registration and comprehensive regulation of swap dealers and major 
swap participants; \4\ (ii) imposing mandatory clearing and trade 
execution requirements on clearable swap contracts; (iii) creating 
robust recordkeeping and real-time reporting regimes; and (iv) 
enhancing the rulemaking and enforcement authorities of the Commission 
with respect to, among others, all registered entities and 
intermediaries subject to the oversight of the Commission.
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    \1\ See Dodd-Frank Act, Pub. L. 111-203, 124 Stat. 1376 (2010). 
The text of the Dodd-Frank Act may be accessed at http://www.cftc.gov./LawRegulation/OTCDERIVATIVES/index.htm.
    \2\ Pursuant to Section 701 of the Dodd-Frank Act, Title VII may 
be cited as the ``Wall Street Transparency and Accountability Act of 
2010.''
    \3\ 7 U.S.C. 1 et seq.
    \4\ In this release, the terms ``swap dealer'' and ``major swap 
participant'' shall have the meanings set forth in Section 721(a) of 
the Dodd-Frank Act, which added Sections 1a(49) and (33) of the CEA. 
However, Section 721(c) of the Dodd-Frank Act directs the Commission 
to promulgate rules to further define, among other terms, ``swap 
dealer'' and ``major swap participant.'' The Commission is in the 
process of this rulemaking. See, e.g., http://www.cftc.gov/LawRegulation/OTCDerivatives/OTC_2_Definitions.html. The 
Commission anticipates that such rulemaking will be completed by the 
statutory deadline of July 15, 2011.
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    In order to ensure the proper implementation of the comprehensive 
new regulatory framework, especially with respect to (ii) above, the 
Dodd-Frank Act requires \5\ the Commission to promulgate rules to 
mitigate conflicts of interest in the operation of certain DCOs, DCMs, 
and SEFs. First, Section 726(a) of the Dodd-Frank Act specifically 
empowers the Commission to adopt ``numerical limits * * * on control'' 
or ``voting rights'' that enumerated entities \6\ may hold with respect 
to such DCOs, DCMs, and SEFs. Second, Section 726(b) of the Dodd-Frank 
Act directs the Commission to determine the manner in which its rules 
may be deemed necessary or

[[Page 63733]]

appropriate to improve the governance of certain DCOs, DCMs, or SEFs or 
to mitigate systemic risk, promote competition, or mitigate conflicts 
of interest in connection with the interaction between swap dealers and 
major swap participants, on the one hand, and such DCOs, DCMs, and 
SEFs. Finally, Section 726(c) of the Dodd-Frank Act directs the 
Commission to consider the manner in which its rules address conflicts 
of interest in the abovementioned interaction arising from equity 
ownership, voting structure, or other governance arrangements of the 
relevant DCOs, DCMs, and SEFs. The Commission must complete a 
rulemaking under Section 726 of the Dodd-Frank Act within 180 days 
after enactment--i.e., by January 14, 2011.\7\
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    \5\ See the following colloquy between Representative Stephen 
Lynch and Representative Barney Frank on the language that became 
Section 726 of the Dodd-Frank Act:
    Madam Speaker, for the purpose of a colloquy, I would like to 
engage with the chairman of the committee and the drafter of this 
legislation. I congratulate him on the great work he has done on 
this reform bill.
    Mr. Chairman, I want to call your attention to sections 726 and 
765 of the bill. These two provisions require the CFTC and the SEC 
to conduct rulemakings to eliminate the conflicts of interest 
arising from the control of clearing and trading facilities by 
entities such as swap dealers and major swap participants.
    This problem arises because, right now, 95 percent of all of the 
clearinghouses in this country are owned by just five banks. So, 
while we are relying on the clearinghouses to reduce systemic risk, 
we have the banks now owning the clearinghouses.
    The question I have is regarding the intent of the conferees in 
retaining subsection B of these provisions. It could be loosely 
construed to leave it up to the agencies whether or not to adopt 
rules.
    Mr. Chairman, do you agree that my reading of sections 726 and 
765 affirmatively require these agencies to adopt strong conflict of 
interest rules on control and governance of clearing and trading 
facilities?
    Mr. FRANK of Massachusetts. If the gentleman would yield to me, 
he has been a leader in this important area, and he is a careful 
lawyer and understands that just saving a principle isn't enough. 
You've got to make sure it is carried out. Dealing with a conflict 
of interest that he has been a leader in identifying is essential if 
this is going to work. So I completely agree with him. Yes, we mean 
both of those subsections, and it is a mandatory rulemaking.
    I will say to my neighbor from Massachusetts that we will be 
monitoring this carefully. They can expect oversight hearings 
because, yes, this is definitely a mandate to them to adopt rules to 
deal with what would be a blatant conflict of interest in the 
efficacy rules, and we intend to follow that closely.
    156 Cong. Rec. H5217 (2010).
    \6\ The ``enumerated entities'' include: (i) Bank holding 
companies with over $50,000,000,000 in total consolidated assets; 
(ii) a nonbank financial company supervised by the Board of 
Governors of the Federal Reserve System; (iii) an affiliate of (i) 
or (ii); (iv) a swap dealer; (v) a major swap participant; or (vi) 
an associated person of (iv) or (v).
    \7\ In adopting rules to implement Section 726 of the Dodd-Frank 
Act, the Commission is also implementing Section 725(d) of the Dodd-
Frank Act. The latter states: ``[t]he Commodity Futures Trading 
Commission shall adopt rules mitigating conflicts of interest in 
connection with the conduct of business by a swap dealer or a major 
swap participant with a derivatives clearing organization, board of 
trade, or a swap execution facility that clears or trades swaps in 
which the swap dealer or major swap participant has a material debt 
or material equity investment.''
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    In carrying out Section 726 of the Dodd-Frank Act,\8\ the 
Commission identifies in Section II below the following potential 
conflicts of interest:
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    \8\ Although the Commission is proposing the rules contained 
herein to specifically carry out Section 726 of the Dodd-Frank Act 
(as well as Section 725(d) of the Dodd-Frank Act), the Commission 
notes that it has additional authority to propose such rules under 
Sections 735(b), 735(c), and 733 of the Dodd-Frank Act. See infra 
note 17 for a more extensive description of Sections 735(b), 735(c), 
and 733 of the Dodd-Frank Act.
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     Conflicts of interest that a DCO may confront when 
determining (i) whether a swap contract is capable of being cleared, 
(ii) the minimum criteria that an entity must meet in order to become a 
swap clearing member, and (iii) whether a particular entity satisfies 
such criteria; \9\ and
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    \9\ The Commission requests comment as to whether DCOs, like 
DCMs and SEFs, have (or potentially may have) other conflicts of 
interest that implicate the balance between advancement of 
commercial interests and fulfillment of self-regulatory 
responsibilities.
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     Conflicts of interest that a DCM or SEF may confront in 
balancing advancement of commercial interests and fulfillment of self-
regulatory responsibilities.

The Commission proposes in Section III below (i) structural governance 
requirements and (ii) limits on the ownership of voting equity and the 
exercise of voting power, and describes, in each case, the manner in 
which such proposals may mitigate conflicts of interest in the 
operation of a DCO, DCM, or SEF.\10\
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    \10\ Commission regulations (the ``Regulations'') referred to 
herein are found at 17 CFR Ch. 1.
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    In general, the proposed rules include strengthened versions of the 
acceptable practices that the Commission previously adopted for the DCM 
core principle on conflicts of interest.\11\ The proposed rules impose 
structural governance requirements and limits on the ownership of 
voting equity and the exercise of voting power. They impose specific 
composition requirements on DCO, DCM, or SEF Boards of Directors and 
require each DCO, DCM, or SEF to have a nominating committee and one or 
more disciplinary panels. Each DCO must have a risk management 
committee and each DCM or SEF must have a regulatory oversight 
committee and a membership or participation committee, subject to 
specific composition requirements.
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    \11\ See, generally, ``Conflicts of Interest in Self-Regulation 
and Self-Regulatory Organizations,'' 74 FR 18982 (April 27, 2009) 
(which defined ``public director''); 72 FR 6936 (Feb. 14, 2007) 
(which adopted final acceptable practices for the DCM core 
principle) (the ``DCM Conflicts of Interest Release''); 71 FR 38740 
(July 7, 2006) (which proposed acceptable practices for the DCM core 
principle).
    Currently, DCM core principle 15 addresses conflicts of 
interest. See 7 U.S.C. 7(d)(15). The Dodd-Frank Act has redesignated 
DCM core principle 15 as DCM core principle 16, but has left the 
actual language of the principle substantively unchanged.
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    The proposed rules limit DCM or SEF members (and related persons) 
from beneficially owning more than twenty (20) percent of any class of 
voting equity in the registered entity or from directly or indirectly 
voting an interest exceeding twenty (20) percent of the voting power of 
any class of equity interest in the registered entity. With respect to 
a DCO only, the proposed rules require a DCO to choose one of two 
alternative limits on the ownership of voting equity or the exercise of 
voting power. Under the first alternative, no individual member may 
beneficially own more than twenty (20) percent of any class of voting 
equity in the DCO or directly or indirectly vote an interest exceeding 
twenty (20) percent of the voting power of any class of equity interest 
in the DCO. In addition, the enumerated entities, whether or not they 
are DCO members, may not collectively own on a beneficial basis more 
than forty (40) percent of any class of voting equity in a DCO, or 
directly or indirectly vote an interest exceeding forty (40) percent of 
the voting power of any class of equity interest in the DCO.
    Under the second alternative, no DCO member or enumerated entity, 
regardless of whether it is a DCO member, may own more than five (5) 
percent of any class of voting equity in the DCO or directly or 
indirectly vote an interest exceeding five (5) percent of the voting 
power of any class of equity interest in the DCO.
    Notwithstanding the foregoing, the proposed rules recognize that 
circumstances may exist where neither alternative would be appropriate 
for a DCO. Consequently, the proposed rules provide a procedure for the 
DCO to apply for, and the Commission to grant, a waiver of the limits 
specified in the first and second alternative.
    The proposed rules reflect consultation with staff of the following 
agencies: (i) The Securities and Exchange Commission (the ``SEC''); 
\12\ (ii) the Board of Governors of the Federal Reserve, (iii) the 
Office of the Comptroller of the Currency; (iv) the Federal Deposit 
Insurance Corporation; and (v) the Treasury Department. Staff from each 
of these agencies has provided verbal and/or written comments, and the 
proposed rules incorporate elements of the comments provided. The 
proposed rules have been further informed by (i) the joint roundtable 
that Commission and SEC staff conducted on August 20, 2010 (the 
``Roundtable'') \13\ and (ii) public comments posted to the Web site of 
the Commission.\14\ Finally, mindful of the importance of international 
harmonization,\15\ the proposed rules incorporate certain elements of: 
(i) The Proposal for a Regulation of the European Parliament and of the 
Council on OTC Derivatives, Central Counterparties, and Trade 
Depositories (the ``European Commission Proposal''); \16\ and (ii) the 
latest draft of the Principles for Financial Market Infrastructures, 
which would ultimately be reviewed by the Committee on Payment and 
Settlement Systems of the Bank for International Settlements and the 
Technical Committee of the

[[Page 63734]]

International Organization of Securities Commissions.
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    \12\ Section 765 of the Dodd-Frank Act requires the SEC to 
promulgate rules to mitigate conflicts of interest in the operation 
of (i) a clearing agency that clears security-based swaps, (ii) a 
security-based swap execution facility, or (iii) a national 
securities exchange that posts or makes available for trading 
security-based swaps.
    \13\ The transcript from the roundtable (the ``Roundtable Tr.'') 
is available at: http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/derivative9sub082010.pdf.
    \14\ Such comments are available at: http://www.cftc.gov/LawRegulation/DoddFrankAct/OTC_9_DCOGovernance.html.
    \15\ Currently, the Commission regulates certain entities based 
outside of the United States (e.g., LCH.Clearnet Limited and ICE 
Clear Europe Limited (``ICE Clear Europe''), each of which is based 
in the United Kingdom).
    \16\ COM(2010) 484/5.
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    The Commission anticipates conducting at least one other rulemaking 
that may impose requirements on DCOs, DCMs, and SEFs with respect to 
governance and mitigation of conflicts of interest.\17\ The Commission 
expects to finish such rulemaking by the statutory deadline of July 15, 
2011.
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    \17\ Such rulemaking would implement Sections 735(b) and 725(c) 
of the Dodd-Frank Act, which amends Sections 5(d) and 5b(c) of the 
CEA to add new core principles, or to supplement existing core 
principles, regarding the governance of DCMs and DCOs, and the 
mitigation of conflicts of interest in the operation of such 
entities. Such core principles would apply to all DCMs and DCOs, 
regardless of whether they clear or list swap contracts or only 
commodity futures or options. Such rulemaking would also implement 
Section 733 of the Dodd-Frank Act, which inserts new Section 5h of 
the CEA to create a registration category for SEFs, and to impose 
core principles that include the mitigation of conflicts of 
interest. The Commission is considering the proposals set forth 
below, among others, with respect to the second rulemaking: (1) 
Requiring each DCO, DCM, or SEF to have a regulatory program to (i) 
identify, on an ongoing basis, existing and potential conflicts of 
interest, and (ii) to make decisions in the event of such conflict; 
(2) mandating that each DCO, DCM, or SEF (i) prescribe limits on use 
of non-public information, and (ii) afford transparency with respect 
to governance arrangements; (3) requiring each DCO, DCM, or SEF to 
report to the Commission whenever (i) the Board of Directors rejects 
a recommendation or supersedes an action of the DCM or SEF 
Regulatory Oversight Committee, DCM or SEF Membership or 
Participation Committee, or DCO Risk Management Committee, as 
applicable, or (ii) the DCO Risk Management Committee rejects or 
supersedes an action of the DCO Risk Management Subcommittee, if 
applicable; (4) mandating minimum governance fitness standards for 
DCO and DCM members and participants; and (5) prescribing minimum 
standards regarding (i) DCM consideration of market participant 
views and (ii) the diversity of DCM Board of Directors, if the DCM 
is publicly-listed.
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    The Commission requests comment on all aspects of this release.

II. Conflicts of Interest

    As mentioned above, Title VII of the Dodd-Frank Act amended the CEA 
to establish a comprehensive new framework for swaps and security-based 
swaps. This framework imposes mandatory clearing and trade execution 
requirements with respect to clearable swap contracts. Some market 
participants, investor advocates, and academics have expressed a 
concern that the enumerated entities have economic incentives to 
minimize the number of swap contracts subject to mandatory clearing and 
trading. They contend that control of a DCO by the enumerated entities, 
whether through ownership or otherwise, constitutes the primary means 
for keeping swap contracts out of the mandatory clearing requirement, 
and therefore also out of the trading requirement. The Commission 
addresses these arguments below. The Commission also examines the 
contention that sustained competition between DCMs or SEFs with respect 
to the same swap contracts may exacerbate certain structural conflicts 
of interest, as the DCM Conflicts of Interest Release defines such 
term.\18\
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    \18\ According to the DCM Conflicts of Interest Release, ``[t]he 
presence of potentially conflicting demands within a single entity--
regulatory authority coupled with commercial incentives to misuse 
such authority--constitutes the new structural conflict of interest 
addressed by the acceptable practices adopted herein.'' 72 FR at 
6937.
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a. DCOs

    In general, in the commodity futures and options markets, the DCM 
decides which contracts to list, whereas the DCO manages the risk of 
guaranteeing such contracts. Clearing members exercise significant 
control over the manner in which a DCO manages risk, whether the 
members own the DCO or not.\19\ Based on Commission experience, such 
control has generally permitted the DCO to serve the purposes of the 
CEA, especially with respect to ``ensur[ing] the financial integrity of 
all transactions subject to [the CEA] and the avoidance of systemic 
risk.'' \20\ Clearing members contribute substantial financial 
resources to the DCO default or guarantee fund. If a clearing member 
defaults, and the DCO holds insufficient performance bond from such 
member to cover its losses, then the DCO would access the default or 
guarantee fund. Thus, the DCO spreads its losses across all clearing 
members. This mechanism creates an incentive for each clearing member 
to ensure that (i) other clearing members meet certain financial 
requirements and (ii) the DCO adopt a conservative approach towards 
risk management, especially in determining whether a particular 
contract would be acceptable for clearing.
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    \19\ The CME Group, Inc. (the ``CME Group''), a publicly-listed 
corporation, wholly owns the Chicago Mercantile Exchange, Inc. 
(``CME''). However, CME Clearing House, a division of CME, has a 
Risk Committee that is composed of: (i) Two members of the CME Board 
of Directors; (ii) five clearing member representatives; and (iii) 
two additional individuals, one of whom cannot be a clearing member 
representative. See CME Rule 403.A, available at: http://www.cmegroup.com/rulebook/CME/I/4/03.html.
    \20\ See Section 3(b) of the CEA, 7 U.S.C. 5(b).
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    This same mechanism also creates a disincentive for clearing 
members to act collectively (i) to exclude other entities from becoming 
clearing members or (ii) to bar a DCO from accepting new commodity 
futures or options contracts. After all, each new clearing member must 
contribute to the default or guarantee fund. Such contribution would 
result in a pro rata decrease in the potential exposure of each other 
clearing member to a default. Moreover, clearing members generally had 
little incentive to prevent the DCO from accepting a particular 
contract, absent a risk-based objection. In fact, the more different 
types of contracts that a DCO accepts, the more the intermediation 
services that such clearing member offers would likely be in demand.
    The regulated market structure that the Dodd-Frank Act contemplates 
for swap contracts is, in many ways, the mirror image of the market 
structure for commodity futures and option contracts. Currently, most 
swap contracts are privately negotiated between two parties, and are 
generally not cleared.\21\ Section 723 of the Dodd-Frank Act requires: 
(i) Swap contracts meeting certain criteria to be cleared with a DCO; 
and (ii) such contracts to be executed on a DCM or SEF (unless no DCM 
or SEF lists such contracts). Therefore, a DCO has unprecedented 
influence over the manner in which a swap contract can be executed.
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    \21\ See, e.g., Darrel Duffie, Ada Li, Theo Lubke, ``Policy 
Perspectives on OTC Derivatives Market Infrastructure,'' Federal 
Reserve Bank of New York Staff Report No. 424, dated January 2010, 
as revised March 2010 (the ``FRBNY Staff Report''). According to 
Section II of the FRBNY Staff Report, ``[a]n over-the-counter trade 
is privately negotiated between the buyer and seller.'' According to 
Section VII(A)(i) of the FRBNY Staff Report, ``[o]nly some types of 
OTC derivatives are now cleared. These include, for example, certain 
actively traded credit derivatives, some common forms of interest-
rate swaps, and some energy derivatives. Of these `eligible' types 
of OTC derivatives, those for which clearing has been set up, not 
all positions are actually cleared; the decision of which positions 
to clear has to this point been left to the discretion of market 
participants.''
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    Certain market participants and academics believe that Section 723 
of the Dodd-Frank Act does not introduce any new incentives for 
clearing members to act collectively (i) to exclude other entities from 
becoming clearing members or (ii) to bar a DCO from accepting new 
contracts. First, they argue that clearing does not make a bilateral 
swap contract less profitable.\22\ Second, they contend that, because 
clearing does not impact the profitability of a bilateral swap 
contract, swap clearing members that are

[[Page 63735]]

enumerated entities have specific, risk-based justifications for (i) 
setting membership criteria that exclude certain entities \23\ and (ii) 
determining that certain swap contracts cannot be cleared.\24\ Third, 
they assert that such swap clearing members must have the right to 
cause the DCO to act on such justifications, since ultimately, the 
capital of such clearing members (i.e., their contributions to the 
default or guarantee fund) may be accessed if a fellow clearing member 
defaults.\25\
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    \22\ See, e.g., Comments from James Hill, Managing Director and 
Global Credit Derivatives Officer, Morgan Stanley, representing the 
Securities Industry and Financial Markets Association (``Hill'') 
(``I think there's a bit of a misconception that somehow clearing 
makes trades less profitable. That's clearly not the case. In fact, 
I think most of the large systemically important participants in 
this market prefer clearing. And I think that's not just a 
statement; there is significant anecdotal evidence to support that 
perhaps the most important of which is LCH''), Roundtable Tr. at 21-
22.
    \23\ See, e.g., Comments from Hill (``as a general rule, the 
clearing member needs to be able to absorb losses, a default by 
another clearing member, number one; and, number two, they need to 
be able to absorb the economic transaction risk in the portfolio of 
a defaulting member * * * And so the way these clearinghouses set up 
their risk, you know, their admission or their membership criteria, 
is both of those things. So, A, they have to have a capital base 
sufficient to absorb losses and add in more capital to the 
clearinghouse if a member defaults. And B, they have to be able to 
in a situation where a clearing member has defaulted, which is 
probably the time of most economic stress, you know, in the economy, 
be able to take down the economic transaction risk of the swaps that 
were otherwise, the defaulting member was otherwise a party to, 
those trades need to be allocated among the surviving clearing 
members * * * And so the way these clearinghouses developed their 
criteria is they look at both of those prongs and they set 
thresholds to make sure that the members who are admitted can do 
those things. Because, remember, if you admit a member who can't do 
both of those things, then what happens is the clearinghouse will 
have insufficient capital in a situation where a member has 
defaulted, which is the time of the highest economic stress''), 
Roundtable Tr. at 28 to 29.
    \24\ See, e.g., Comments from Hill (``In evaluating what trades 
should be cleared, there's a balance that needs to be struck between 
the goal of increasing clearing, obviously, but, B, you don't want 
to put trades in the clearinghouse that can't be appropriately risk-
managed. So if you put trades in the clearinghouse that are illiquid 
and can't be valued properly, what will happen is when a clearing 
member defaults, there will be insufficient collateral with respect 
to that trade because it wasn't properly valued in the 
clearinghouse, and the surviving clearing members will be stressed 
from an economic perspective in taking positions the value of which 
cannot be readily ascertained. So it's critical that only trades 
that can be appropriately risk-managed be put into the 
clearinghouse. And I think what you'll see is that most of the 
clearinghouses look to their clearing members to help them valuate 
which trades are appropriate from a clearing perspective, and that 
is completely consistent with the economic incentives because the 
clearing members are the ones who have the overwhelming 
preponderance of the capital in the clearinghouse. So it's their 
capital that's at risk. They should certainly have a say in helping 
the clearinghouse evaluate which trades are acceptable for clearing 
and which trades are too risky or can't be valued, or are too 
illiquid or not standardized and, therefore, shouldn't be 
cleared''), Roundtable Tr. at 43 to 45.
    \25\ Id. See, also, e.g., Comments from Lee Olesky, Chief 
Executive Officer and Co-Founder, TradeWeb (``Olesky'') (``And I 
second Mr. Hill's comments. I think that it's very important that 
the people who bear the risk and supply the capital should have a 
substantial voice in how that risk gets managed, and that includes 
what contracts are accepted for clearing''), Roundtable Tr. at 46.
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    Others do not agree. They maintain that certain enumerated entities 
are active in the over-the-counter swap markets \26\ and that they earn 
significant revenues from this line of business.\27\ Such entities may 
experience substantial decreases in revenues if swap contracts were 
required to be (i) cleared with a DCO and (ii) executed on a DCM or 
SEF.\28\ Therefore, some contend that such entities may have an 
incentive to represent that certain swap contracts do not meet the 
mandatory clearing criteria under Section 723 of the Dodd-Frank 
Act.\29\ Such swap contracts would also not be subject to the trading 
requirement under Section 723 of the Dodd-Frank Act.
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    \26\ For example, according to the Office of the Comptroller of 
the Currency (``OCC''), as of the second quarter of 2009, U.S. 
commercial banks held derivatives with $203.5 trillion in notional 
value. Of that $203.5 trillion, the top five commercial banks held 
approximately $197 trillion. The top five commercial banks were: (i) 
JPMorgan Chase Bank N.A.; (ii) Goldman Sachs Bank USA; (iii) Bank of 
America N.A.; (iv) Citibank N.A.; and (v) Wells Fargo Bank N.A. The 
sixth commercial bank, holding approximately $3 trillion, was HSBC 
Bank USA N.A. See OCC's Quarterly Report on Bank Trading and 
Derivatives Activities, Second Quarter 2009.
    \27\ Id. (stating that ``U.S. commercial banks reported revenues 
of $5.2 billion trading cash and derivative instruments in the 
second quarter of 2009, compared to a record $9.8 billion in the 
first quarter'').
    \28\ According to Section VI of the FRBNY Staff Report, ``[e]ven 
after an OTC derivatives product has achieved relatively active 
trading, and would be suitable for exchange trading, dealers have an 
incentive to maintain the wider bid-ask spreads that they can obtain 
in the OTC market relative to the spreads that might apply to the 
same product on an exchange, where buyers and sellers can more 
directly compete for the same trade. Further, exchanges are more 
likely to match ultimate buyers to sellers, reducing the fraction of 
trades intermediated by dealers. Thus, from the viewpoint of their 
profits, dealers may prefer to reduce the migration of derivatives 
trading from the OTC market to central exchanges.''
    \29\ See, e.g., Comments of Heather Slavkin, Senior Legal and 
Policy Advisor, Office of Investment, AFL-CIO (``Slavkin'') (``If 
there's an interest among the people who own the clearinghouse, or a 
conflict of interest that would create incentives for them to also 
favor, you know, [not] allowing certain types of swaps to clear 
because they may be more profitable for the institution generally if 
they remain over the counter, then that can create perverse 
incentives to maintain the OTC, nontransparent, systemically risky 
markets when the goal needs to be to prevent those conflicts of 
interest to ensure that anything that can be cleared does, in fact, 
clear''), Roundtable Tr. at 21; Comments of Darrell Duffie, Dean 
Witter Distinguished Professor of Finance at the Graduate School of 
Business, Stanford University (``Duffie'') (``We talked earlier 
about how the members of the clearinghouse should determine what 
gets traded, and we also have conflicts of interest arising from the 
incentives of the dealers to profit from bid versus ask on products 
that are not traded on swap execution facilities. So the interaction 
effect here is effectively if one gets cleared as one gets traded on 
a swap execution facility, then we want to be very careful that the 
members of a central clearing counterparty that determine what gets 
cleared and, therefore, have control over what gets traded on swap 
execution facilities are the members that have, you know, the right 
social incentives to create competition''); Comments of Michael 
Greenberger, Professor, University of Maryland School of Law 
(``Greenberger'') (``If you have one clearinghouse dominated by the 
major swaps dealers, they have several conflicting incentives. One 
is, I reject the idea that somehow they do not want to keep a large 
and vibrant over-the-counter market. We're told that clearing is 
very profitable. If it was that profitable, where were these people 
when we were aggressively arguing for mandatory clearing and 
exchange trading? They were on the opposite side of that. The 
transaction fees and the spreads still make an unregulated market 
very, very profitable, probably more profitable than the profits 
that would derive from clearing. So, if you have the swaps dealers 
in control of a clearing facility, they have that incentive''), 
Roundtable Tr. at 111.
---------------------------------------------------------------------------

    Although Section 723 of the Dodd-Frank Act grants the Commission 
ultimate authority to determine whether a swap contract must be cleared 
with a DCO, it also anticipates that the Commission would consider the 
risk assessment of DCOs. Currently, DCOs that clear large volumes of 
swap contracts tend to have swap clearing members that consist 
exclusively of enumerated entities.\30\ Therefore, some argue that the 
risk assessment of such DCOs may be compromised.\31\

[[Page 63736]]

Moreover, some contend that the swap clearing members of such DCOs may 
exclude non-enumerated entities from becoming clearing members, because 
non-enumerated entities may influence risk assessments of DCOs in favor 
of clearing more swap contracts.\32\ Some market participants maintain 
that such practices may have systemic implications.\33\
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    \30\ For example, as of July 2, 2010, ICE Clear Europe cleared 
approximately $3.3 trillion in European credit default swap 
(``CDS'') indices and an additional $501 billion in European CDS 
single-name instruments. See ``ICE Surpasses $10 Trillion Milestone 
in Global CDS Clearing,'' available at: 
http:[sol][sol]ir.theice.com/releasedetail.cfm?ReleaseID=485527.
    As of September 20, 2010, all CDS clearing members of ICE Clear 
Europe are banks, bank holding companies, or affiliates thereof. 
Such members are: (i) Banc of America N.A.; (ii) Barclays Bank PLC; 
(iii) BNP Paribas; (iv) Citigroup Global Markets Limited; (v) Credit 
Suisse International; (vi) Deutsche Bank AG; (vii) Goldman Sachs 
International; (viii) HSBC Bank PLC; (ix) JPMorgan Chase Bank, N.A.; 
(x) Morgan Stanley Capital Services, Inc.; (xi) Nomura International 
PLC; (xii) Soci[eacute]t[eacute] G[eacute]n[eacute]rale; (xiii) The 
Royal Bank of Scotland PLC; (xiv) UBS AG, London Branch; and (xv) 
UniCredit Bank AG. See ICE Clear Europe, Clearing Members, available 
at: https:[sol][sol]www.theice.com/publicdocs/clear_europe/ICE_
Clear_Europe_Clearing_Member_List.pdf, and the release updating 
such list, available at https:[sol][sol]www.theice.com/publicdocs/
clear_europe/circulars/C10080.pdf.
    ICE Trust U.S. LLC (``ICE Trust''), an affiliate of ICE Clear 
Europe, cleared approximately $6 billion in North American CDS 
indices and $272 billion in North American single-name indices. The 
CDS clearing members of ICE Clear Europe and ICE Trust generally 
overlap (counting affiliated entities), except that Merrill Lynch 
International is a clearing member of ICE Trust and 
Soci[eacute]t[eacute] G[eacute]n[eacute]rale and UniCredit Bank AG 
are not. See ICE Trust, Participant List, available at: 
https:[sol][sol]www.theice.com/publicdocs/ice_trust/ICE_Trust_
Participant_List.pdf. ICE Trust is currently not a DCO.
    \31\ See note 29 above. See, also, Comments from Slavkin (``I 
think that there's the risk that anything that could be made to 
appear to be something that is a bilateral * * * contract, you could 
have the spurious customization issues, if there's the opportunity 
to get additional profits within the big dealer banks, and those 
same dealer banks are running and controlling the clearinghouses, 
then, you know, the potential for spurious customization becomes a 
real issue and becomes a possibility''), Roundtable Tr. at 40.
    In addition to noting that the enumerated entities may have 
incentives to influence DCO risk assessments in favor of considering 
fewer contracts to be suitable for mandatory clearing, certain 
academics have observed that, for those contracts that nonetheless 
are cleared, the enumerated entities may have incentives to lower 
risk management standards. See, e.g., Comments from Greenberger (``* 
* * yes, certain products will be cleared because they are 
profitable and [the enumerated entities] may over calculate and be 
over enthused about clearing things that are too risky''), 
Roundtable Tr. at 112. For example, the enumerated entities may not 
accurately calculate the amount of performance bond and/or guarantee 
or default fund contributions necessary to clear a particular swap 
contract.
    \32\ See, e.g., Comments from Jason Kastner, Vice Chairman, 
Swaps and Derivatives Markets (``Kastner'') (``Let me give you a 
specific example. One of the members of this SDMA currently clears 
13 percent of the business at a large exchange in Chicago. That 
large, independent FCM is clearly qualified to become a swap 
clearing member. But because of various conflicts of interest, the 
risk committee of said exchange is precluding that firm, which is 
clearly qualified and has the capital, from becoming a swap clearing 
member * * * this goes back to the governance point and transparency 
about who's making that decision and why, because a lot of times 
what happens is people will swallow themselves in the cloak of risk 
management or financial stability or whatever really to make an 
anti-competitive stand. In other words, you can never say that you 
don't want to let somebody in. But you could probably find an excuse 
or a reason in the interest of systematic--you know, systemic 
stability and the rest of it to put an asterisk on the application 
or just delay it for awhile''), Roundtable Tr. at 90-91.
    See, also, infra note 67 on the potential non-availability of 
arrangements whereby a non-clearing futures commission merchant may 
present a customer trade to a swap clearing member for clearing with 
a DCO.
    \33\ In Lessening Systemic Risk: Removing Final Hurdles to 
Clearing OTC Derivatives, the Swaps and Derivatives Market 
Association states: ``[r]estricted access leads to reduced clearing 
which leads to systemic risk.''
---------------------------------------------------------------------------

    The framers of the Dodd-Frank Act observe that the clearing of swap 
contracts constitutes a key means for managing systemic risk, because 
clearing removes the type of interconnectedness between financial 
institutions that contributed to the financial crisis resulting from 
the failure and bankruptcy of firms such as Bear Stearns, Lehman 
Brothers, and AIG.\34\ Therefore, it is important to mitigate potential 
conflicts of interest that may prevent clearable swap contracts from 
becoming subject to mandatory clearing. At the same time, the 
Commission recognizes that the safety and soundness of a DCO should not 
be compromised. A DCO must not only have the ability to appropriately 
manage the risk associated with each and every contract that it 
guarantees, it must be able to decline accepting contracts for clearing 
if they pose unacceptable risks. In addition, DCO members must have 
input in setting membership criteria, because they bear the risk of 
loss in the event of member default. Nevertheless, the Commission does 
not believe that (i) subjecting more swap contracts to mandatory 
clearing is incompatible with (ii) DCO safety and soundness.\35\ 
Rather, the Commission intends to ensure, through the proposed rules 
below, that a DCO takes action to achieve both (i) and (ii), and that 
the private, competitive interests of certain DCO members do not 
capture DCO risk assessments.
---------------------------------------------------------------------------

    \34\ See, e.g., the letter from Senators Christopher Dodd and 
Blanche Lincoln, respective chairs of the Senate Banking and 
Agriculture Committee, to Representatives Barney Frank and Collin 
Peterson, respective chairs of the House Financial Services and 
Agriculture Committees, dated June 30, 2010 (stating that ``Congress 
determined that clearing is at the heart of reform--bringing 
transactions and counterparties into a robust, conservative and 
transparent risk management framework'').
    \35\ Certain Roundtable participants agree. See Comments from 
Duffie (``I don't think there's a conflict between the incentives 
for competition, increasing competition in this market on the one 
hand and the incentives for improving financial stability on the 
other, or I don't think there's a problem between those two. You can 
* * * have both. The incentives to watch for on competition are that 
we've got enough access by multiple market * * * participants, and 
that the oligopolistic nature of the market is, to some extent, 
watched carefully by regulators''), Roundtable Tr. at 104.
---------------------------------------------------------------------------

b. DCMs and SEFs

    The main function of a DCM, as well as a SEF, is to provide a 
facility for: (i) The discovery of prices; and (ii) the execution of 
transactions. However, in order to obtain and maintain a license to 
perform such a function, each DCM and SEF must fulfill self-regulatory 
obligations under the CEA and the Dodd-Frank Act.\36\ Therefore, 
although each DCM or SEF \37\ is a commercial enterprise, the fact that 
each entity has self-regulatory obligations means that each entity ``is 
not simply a corporation, but a corporation charged with the public 
trust.'' \38\ Section 3(b) of the CEA confers on the Commission the 
responsibility for ensuring that each DCM or SEF appropriately 
prioritizes its self-regulatory obligations. Such obligations include 
appropriately implementing the comprehensive new framework that the 
Dodd-Frank Act sets forth, as well as meeting existing requirements 
under the CEA.
---------------------------------------------------------------------------

    \36\ Section 3(a) of the CEA defines the ``national public 
interest'' that transactions in commodity futures and options and 
swaps serve. It states, ``[t]he transactions subject to this Act are 
entered into regularly in interstate and international commerce and 
are affected with a national public interest by providing a means 
for managing and assuming price risks, discovering prices, or 
disseminating pricing information through trading in liquid, fair 
and financially secure trading facilities.'' 7 U.S.C. 5(a). The 
importance of transactions in commodity futures and options, as well 
as swaps, forms the basis for Commission regulation of DCMs and 
SEFs.
    Section 3(b) of the CEA describes the system of regulation that 
Congress has directed the Commission to implement to achieve the 
abovementioned purposes. It states: ``[i]t is the purpose of this 
chapter to serve the public interests * * * through a system of 
effective self-regulation of trading facilities, clearing systems, 
market participants and market professionals under the oversight of 
the Commission.'' 7 U.S.C. 5(a). The Commission has interpreted the 
``self-regulation'' referenced in Section 3(b) of the CEA as 
encompassing both (i) the registered entity ensuring that members 
meet applicable statutory requirements, and (ii) the registered 
entity having systems to ensure that it continues to meet applicable 
statutory requirements. For example, as the Commission previously 
stated in the DCM Conflicts of Interest Release, ``Core Principle 15 
requires DCMs to maintain systems to minimize structural conflicts 
of interest inherent in self-regulation, as well as individual 
conflicts of interest faced by particular persons. The acceptable 
practices are rationally related to the purposes of Core Principle 
15.'' 72 FR at 6937, 6940.
    \37\ As mentioned above, the SEF is a new registration category 
that the Dodd-Frank Act created. Therefore, the Commission has never 
opined as to whether a SEF is a ``self-regulatory organization'' 
within the meaning of Regulation 1.3(ee). However, a SEF has self-
regulatory obligations under the Dodd-Frank Act, as the Commission 
has interpreted such obligations in the DCM Conflicts of Interest 
Release. For example, to the extent that a SEF determines that it 
must impose requirements on members in order to comport with a core 
principle (e.g., with respect to position limits), a SEF must 
monitor member compliance with such requirement, and must have the 
authority and ability to enforce such requirement. See Section 
5h(f)(2)(A) of the CEA, as added by Section 733 of the Dodd-Frank 
Act.
    \38\ Preamble to proposed acceptable practices on ``Conflicts of 
Interest in Self-Regulation and Self-Regulatory Organizations,'' 71 
FR 38740, 38741 (July 7, 2006).
---------------------------------------------------------------------------

    As the DCM Conflicts of Interest Release notes, increased 
competition may exacerbate conflicts of interest, causing a DCM to (i) 
prioritize commercial interests over self-regulatory responsibilities; 
\39\ and (ii) restrict access or impose burdens on access in a 
discriminatory manner.\40\

[[Page 63737]]

The Dodd-Frank Act attempts to create conditions favorable to sustained 
competition between DCMs and SEFs with respect to the same swap 
contract. For example, the Dodd-Frank Act contemplates that either a 
DCM or a SEF may list swap contracts.\41\ It also contemplates that 
multiple DCMs or SEFs may list the same swap contract, and that such 
swap contracts may be offset at the same DCO.\42\ Also, in requiring 
certain swap contracts to be listed on a DCM or SEF,\43\ the Dodd-Frank 
Act may encourage competition between standardized swap contracts and 
commodity futures and options.\44\
---------------------------------------------------------------------------

    \39\ See, generally, the DCM Conflicts of Interest Release.
    \40\ See, infra note 67 for a specific example of DCM or SEF 
restrictions or burdens on access. Also, clauses (i) and (ii) are 
not mutually exclusive. As the DCM Conflicts of Interest Release 
notes, ``[s]elf-regulation's traditional conflict--that members will 
fail to police their peers with sufficient zeal--has been joined by 
the possibility that competing DCMs could abuse their regulatory 
authority to gain competitive advantage or to satisfy commercial 
imperatives.'' 72 FR at 6938. In its Concept Release Concerning 
Self-Regulation, the SEC identified one method that national 
securities exchanges have used to gain a competitive advantage: 
``abus[ing] SRO status by overregulating members that operate 
markets that compete with the SROs.'' Release No. 34-50700 (Nov. 18, 
2004), 69 FR 71256 (Dec. 8, 2004).
    Also, similar to the incentives that the enumerated entities may 
have with respect to the mandatory clearing requirement, if the 
enumerated entities control a DCM or SEF, they may cause such DCM or 
SEF to not list a swap contract for trading, if it would be more 
profitable to keep such contract bilaterally negotiated. However, 
the Commission notes that nothing would prevent another DCM or SEF 
from listing such contract, and that Section 723 of the Dodd-Frank 
Act would require that a DCO clearing such contract provide non-
discriminatory access to such DCM or SEF.
    \41\ See Section 2(h)(8) of the CEA, as added by Section 723 of 
the Dodd-Frank Act.
    \42\ See Section 2(h)(1)(B) of the CEA, as added by Section 733 
of the Dodd-Frank Act. Whereas DCMs have competed in the past, and 
are currently competing, to list commodity futures and options 
contracts with the same economic terms and conditions, such 
contracts have not been, and currently are not, fungible. In other 
words, such contracts cannot be offset in the same DCO.
    \43\ See Section 2(h)(8) of the CEA, as added by Section 723 of 
the Dodd-Frank Act.
    \44\ For example, two DCMs (i.e., the NASDAQ OMX Futures 
Exchange and CME), as well as one exempt board of trade (i.e., Eris 
Exchange), offer interest rate futures products. Currently, interest 
rate swap contracts constitute a large percentage of the bilateral 
swaps market. See, e.g., OCC's Quarterly Report on Bank Trading and 
Derivatives Activities, First Quarter 2010, Executive Summary, 
available at: http:[sol][sol]www.occ.treas.gov/ftp/release/2010-
71a.pdf. (stating that ``[d]erivative contracts remain concentrated 
in interest rate products, which comprise 84% of total derivative 
notional values'').
---------------------------------------------------------------------------

    Such sustained competition, if it occurs,\45\ would constitute an 
increase to the competition that most DCMs currently face with respect 
to commodity futures and options. As described below, the Commission 
intends to ensure through the proposed rules that each DCM or SEF 
implements appropriate systems to manage such conflicts.
---------------------------------------------------------------------------

    \45\ As discussed above, whether such competition occurs depends 
in part on the manner in which Section 723 of the Dodd-Frank Act is 
implemented.
---------------------------------------------------------------------------

c. Questions on Conflicts of Interest

    The Commission seeks comment on the questions set forth below on 
potential conflicts of interest.
     Has the release correctly identified the conflicts of 
interest that a DCO, DCM, or SEF may confront?
     Has the release accurately specified the possible effects 
of such conflicts of interest on DCO, DCM, or SEF operations? What are 
other possible effects?
     What other conflicts of interest may exist? What are the 
effects of such conflicts?

III. Mitigation of Conflicts of Interest

    To mitigate, on a prophylactic basis, the conflicts of interest 
identified above, the Commission sets forth below proposed (i) 
structural governance requirements and (ii) limits on the ownership of 
voting equity and the exercise of voting power. As explained in greater 
detail below, the Commission views (ii) as a method of enhancing (i), 
in that (ii) limits the influence that certain shareholders may exert 
over the DCO, DCM, or SEF Board of Directors. The Commission believes 
that such influence may affect, among other things, the independent 
perspective of public directors. The Commission does not believe that 
stricter structural governance requirements (e.g., a higher percentage 
of public directors) justify more lenient limits on the ownership of 
voting equity and the exercise of voting power, or vice versa. However, 
the Commission requests comment on the proper relationship between such 
requirements and limits. The Commission also requests comment on 
whether both (i) structural governance requirements and (ii) limits on 
the ownership of voting equity and the exercise of voting power are 
necessary or appropriate to mitigate the conflicts of interest 
described in Section II, or whether one or the other (or neither) would 
be effective.
    In applying such requirements and limits, the Commission does not 
propose to distinguish between DCMs and SEFs listing swap contracts. As 
mentioned above, such DCMs and SEFs may experience sustained 
competition with respect to the same swap contract, and therefore would 
face the same pressures on self-regulation. Additionally, the 
Commission does not propose to distinguish between (i) DCMs listing 
swap contracts and (ii) DCMs listing only commodity futures and 
options. As mentioned above, clearable swap contracts may share 
sufficiently similar characteristics with certain commodity futures and 
options as to compete with respect to execution. Therefore, a DCM 
listing only commodity futures and options may face competition from a 
SEF with fewer self-regulatory requirements, in the same manner as a 
DCM listing swap contracts. Given that the same conflicts of interest 
\46\ may concern both types of DCM, it would appear that the same (i) 
structural governance requirements and (ii) limits on the ownership of 
voting equity and the exercise of voting power should apply.
---------------------------------------------------------------------------

    \46\ Namely, (i) prioritizing commercial interests over self-
regulatory responsibilities and (ii) restricting access or imposing 
burdens on access in a discriminatory manner, in each case, because 
of increased competition.
---------------------------------------------------------------------------

    In addition, the Commission does not propose to distinguish between 
(i) DCOs clearing swap contracts and (ii) DCOs clearing only commodity 
futures and options. Certain standardized swap contracts have 
sufficiently similar risk profiles to commodity futures and options 
that the Commission has, on occasion, permitted such products to be 
commingled and margined within the segregated customer account under 
Section 4d of the CEA.\47\ If the Commission applied differential (i) 
structural governance requirements and (ii) limits on the ownership of 
voting equity and the exercise of voting power, the Commission risks 
creating an incentive for regulatory arbitrage between the two types of 
DCO.
---------------------------------------------------------------------------

    \47\ 7 U.S.C. 6d.
---------------------------------------------------------------------------

    The Commission requests comment on holding the two types of (i) 
DCMs and (ii) DCOs to the same requirements regarding the mitigation of 
conflicts of interest. The Commission also requests comment on holding 
DCMs and SEFs listing swap contracts to the same requirements. The 
Commission is specifically interested in the costs and benefits of its 
approach.

a. Structural Governance Requirements

i. Independence
    In general, the structural governance requirements mitigate 
conflicts of interest at a DCO, DCM, or SEF by introducing a 
perspective independent of competitive, commercial, or industry 
considerations to the deliberations of governing bodies (i.e., the 
Board of Directors and committees). Such independent perspective would 
more likely encompass regulatory considerations, and to accord such 
considerations proper weight. Such independent perspective also would 
more likely contemplate the manner in which a decision might affect all 
constituencies, as opposed to concentrating on the manner in which a 
decision affects the interests of one constituency.\48\
---------------------------------------------------------------------------

    \48\ See, e.g., the DCM Conflicts of Interest Release (stating 
that ``the public interest will be furthered if the boards and 
executive committees of all DCMs are at least 35% public. Such 
boards and committees will gain an independent perspective that is 
best provided by directors with no current industry ties or other 
relationships which may pose a conflict of interest. These public 
directors, representing over one-third of their boards, will 
approach their responsibilities without the conflicting demands 
faced by industry insiders. They will be free to consider both the 
needs of the DCM and of its regulatory mission, and may best 
appreciate the manner in which vigorous, impartial, and effective 
self-regulation will serve the interests of the DCM and the public 
at large. Furthermore, boards of directors that are at least 35% 
public will help to promote widespread confidence in the integrity 
of U.S. futures markets and self-regulation''). 72 FR 6946.

---------------------------------------------------------------------------

[[Page 63738]]

    In the DCM Conflicts of Interest Release, the Commission emphasized 
the importance of independent decision-makers in protecting DCM self-
regulatory functions from DCM commercial interests and that of its 
constituencies. However, the Commission notes that participants in the 
Roundtable raised the possibility that conflicts of interest may also 
be mitigated by providing for fair representation of all constituencies 
in the governance of a DCO, DCM, or SEF.\49\ Theoretically, all 
constituencies would act in their own commercial, competitive, or 
industry interests, but no one interest would dominate. The Commission 
specifically requests comment regarding whether fair representation 
would be preferable to, or would complement, director independence in 
mitigating the DCO, DCM, and SEF conflicts of interest described in 
Section II. The Commission would particularly welcome factual examples. 
The Commission also requests comment on how the proposed structural 
governance requirements should change if the Commission adopts a fair 
representation standard as either an alternative to, or a complement 
of, rules emphasizing an independent perspective.
---------------------------------------------------------------------------

    \49\ See, e.g., Comment from Hal Scott, Nomura Professor of 
International Financial Systems and Director of Program on 
International Financial Systems, Harvard Law School (``Scott'') 
(``When I spoke, I was saying I opposed ownership restrictions, I 
was not talking about voting restrictions which I think is a 
different issue, and the way I would put it is not a voting 
restriction. I would turn it around to a duty of fair 
representation, which the SEC is quite familiar with, and is applied 
to their regulated entities which ensures that the users, more 
broadly defined of the exchange. And maybe if you translated this 
into the clearinghouse, the users, but not necessarily the members 
of the clearinghouse, would have representation in terms of 
governance * * * Independent directors, to me, are most needed with 
public companies as under SOX when there was a broad duty to 
shareholders. But I think what's needed in this context is more the 
expert, and we heard before that it's very important that people 
that know what they're doing have input into those, and clearly 
major users of these clearinghouses, that is customers who clear 
through a member. Major hedge funds, for instance, have a lot of 
expertise, okay, in these areas, they're big traders * * *''), 
Roundtable Tr. at 130-131; Richard Prager, Managing Director, Global 
Head of Fixed Income Trading, Blackrock (``as the [sole] fiduciary 
on this panel * * * we would be in support of a very inclusive 
participation and governance with teeth''), Roundtable Tr. at 131-
132; Lynn Martin, Chief Operating Officer, NYSE Liffe U.S. (``You 
may be aware that NYSE Euronext's U.S. Future Exchange--NYSE Life 
U.S., is a semi-neutralized structure whereby we balance the views 
of both the independence criteria as required by core principle 15 
in the CFTC-DCM requirements, as well as the views of NYSE Euronext 
and our external investor firms' views, such that no one board 
action may be enacted based on the views of any one of those 
constituents * * * So, it's our belief that a more balanced board 
structure, a more balanced governance structure, is the proper way 
to handle or potentially mitigate conflicts of interest''), 
Roundtable Tr. at 121.
---------------------------------------------------------------------------

ii. Board Requirements
1. Composition
    As the DCM Conflicts of Interest Release states, ``the governing 
board * * * is [the] ultimate decision maker and therefore the logical 
place to begin to address conflicts.'' \50\ The Commission proposes (i) 
maintaining the requirement that DCM Boards of Directors be composed of 
at least 35 percent ``public directors'' \51\ and (ii) extending this 
requirement to SEF and DCO Boards of Directors. In the DCM Conflicts of 
Interest Release, the Commission stated that the 35 percent requirement 
struck an appropriate balance between (i) the need to minimize 
conflicts of interest in DCM decision-making processes with (ii) the 
need for expertise and efficiency in such processes. Such rationale 
would appear to apply to SEF and DCO Boards of Directors as well.\52\
---------------------------------------------------------------------------

    \50\ 72 FR at 6940.
    \51\ See Section III(a)(iv) of this release for more detail 
regarding the definition of ``public director.''
    The Commission notes that such percentage harmonizes with 
Article 25(2) of the European Commission Proposal, which requires a 
central counterparty (``CCP'') to have ``a board of which at least 
one third, but no less than two, of its members are independent.''
    \52\ 72 FR at 6946.
---------------------------------------------------------------------------

    In addition to the 35 percent composition requirement, the 
Commission proposes specifying that DCO, DCM, and SEF Boards of 
Directors may not have less than two public directors. Such a 
requirement is also contained in the European Commission Proposal.\53\ 
As the Commission has observed that most DCO and DCM Boards of 
Directors contain more than three members, the Commission does not 
believe that such a requirement imposes additional burden. However, the 
Commission welcomes comment on this proposal.
---------------------------------------------------------------------------

    \53\ See Article 25(2) of the European Commission Proposal.
---------------------------------------------------------------------------

    In order to prevent evasion of the abovementioned composition 
requirements through corporate structuring or internal reorganization, 
the Commission proposes extending the composition requirements to any 
committee of the Board of Directors that may exercise delegated 
authority with respect to the management of a DCO, DCM, or SEF. 
Further, the Commission proposes prohibiting a DCO, DCM, or SEF from 
permitting itself to be operated \54\ by another entity, unless such 
entity agrees to comport with such requirements in the same manner as 
the DCO, DCM, or SEF.
---------------------------------------------------------------------------

    \54\ The proposed rule defines ``operate'' as ``the direct 
exercise of control (including through the exercise of veto power) 
over the day-to-day business operations of'' a DCO, DCM, or SEF ``by 
the sole or majority shareholder of such registered entity, either 
through the ownership of voting equity, by contract, or otherwise. 
The term `operate' shall not prohibit an entity, acting as the sole 
or majority shareholder of such registered entity, from exercising 
its rights as a shareholder under any contract, agreement, or other 
legal obligation.''
---------------------------------------------------------------------------

    The Commission would like to clarify that it does not intend to 
extend the abovementioned composition requirements to an entity that 
does not exert active and recurrent control over the operations of a 
DCO, DCM, or SEF. Consequently, the Commission proposes to deem an 
entity to ``operate'' a DCO, DCM, or SEF only if it engages in ``the 
direct exercise of control (including through the exercise of veto 
power) over the day-to-day business operations'' of the registered 
entity.
    In addition to the abovementioned composition requirements, the 
Commission proposes prohibiting a DCO, DCM, or SEF from permitting 
itself to be operated by an entity unless such entity agrees to subject 
(i) its officers, directors, employees, and agents to Commission 
authority, and (ii) its books and records to Commission inspection and 
copying. The Commission believes that such proposals are necessary to 
ensure effective audits of DCO, DCM, or SEF operations, given the 
corporate structure of the DCO, DCM, or SEF.
2. Questions on Composition
    The Commission seeks comment on the questions set forth below on 
DCO, DCM, and SEF Boards of Directors composition requirements:
     Would such composition requirements be equally valid in 
mitigating conflicts of interest concerning a privately-held DCO, DCM, 
and SEF, as opposed to a publicly-held DCO, DCM, and SEF?
     As mentioned above, would providing for fair 
representation on DCO, DCM, or SEF Boards of Directors be preferable 
to, or complementary to, mandating specific percentages of

[[Page 63739]]

public directors? Also, if the main purpose of the 35 percent 
composition requirement is to introduce an independent perspective into 
DCO, DCM, and SEF governance, would requiring one or two public 
directors be sufficient, regardless of the size of the DCO, DCM, or SEF 
Board of Directors?
     As mentioned above, the Commission is seeking to mitigate 
potential conflicts of interest that may influence a DCO regarding (i) 
whether a swap contract is capable of being cleared, (ii) the minimum 
criteria that an entity must meet in order to become a swap clearing 
member, and (iii) whether a particular entity satisfies such criteria. 
Because the DCO Board of Directors would make ultimate decisions 
implicating (i), (ii), and (iii), is the 35 percent composition 
requirement sufficient to ensure that the private, competitive 
interests of certain DCO members do not capture DCO risk assessments 
with respect to both products and membership? Or should the Commission 
increase the required percentage of public directors to 51 percent? Or 
is there a number less than 51 percent but greater than 35 percent that 
would be more appropriate?
     As described above, the Dodd-Frank Act envisions (i) a DCM 
competing with a SEF to list the same swap contract, and (ii) a DCM 
listing a commodity futures or options contract that competes with a 
swap contract listed on a SEF. In both cases, a DCM would be competing 
against an entity with lesser self-regulatory obligations. Such 
competition may place increased stress on the manner in which the DCM 
aims to satisfy its self-regulatory responsibilities. In light of such 
stress, is the 35 percent composition requirement still sufficient to 
protect the DCM self-regulatory function?
     As referenced above, the Dodd-Frank Act anticipates that a 
SEF would face a more competitive environment at inception than a DCM 
currently listing commodity futures and options. As the DCM Conflicts 
of Interest Release notes, increased competition may be detrimental to 
self-regulation. Therefore, is the 35 percent composition requirement 
appropriate to ensure that a SEF discharges its self-regulatory 
functions in the first instance?
3. Substantive Requirements
    In addition to the abovementioned composition requirements, the 
Commission proposes the substantive requirements set forth below, which 
aim to enhance the accountability of the DCO, DCM, or SEF Board of 
Directors to the Commission regarding the manner in which such Board of 
Directors causes the DCO, DCM, or SEF to discharge all statutory, 
regulatory, or self-regulatory responsibilities under the Dodd-Frank 
Act and the existing CEA.
     The roles and responsibilities of a DCO, DCM, or SEF Board 
of Directors must be clearly articulated, especially in respect of the 
manner in which such Board of Directors ensures that the DCO, DCM, or 
SEF complies with all statutory, regulatory, and self-regulatory 
responsibilities under the Dodd-Frank Act and the existing CEA.
     A DCO, DCM, or SEF Board of Directors shall review its 
performance and that of its individual members annually. It should 
consider periodically using external faciliators for such reviews.
     A DCO, DCM, or SEF must have procedures to remove a member 
from the Board of Directors, where the conduct of such member is likely 
to be prejudicial to the sound and prudent management of the DCO, DCM, 
or SEF.
    Because of the highly specialized nature of DCO, DCM, or SEF 
operation, the Commission proposes requiring that each member of a DCO, 
DCM, or SEF Board of Directors have sufficient expertise, where 
applicable, in financial services, risk management, and clearing 
services. Roundtable participants generally agreed that a DCO, DCM, or 
SEF Board of Directors must have sufficient expertise.\55\
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    \55\ See, e.g., Comments from Slavkin (``I think having real 
experts on the boards of directors is a very important issue. We all 
saw situations in the last several years where there were boards 
that were two-thirds independent and made really stupid decisions 
about risk management. So, we need to make sure that there are 
people on those boards of directors that really understand the risks 
that exist within a clearinghouse and are prepared to perceive 
potential risks that may arise in the system down the road and 
address them. So they also need to have the personalities to stand 
up to a board of directors that may be entrenched and have their own 
interests that may differ from those that are in the best interests 
of the systemic stability''), Roundtable Tr. at 77; Comments from 
Johnathan Short, Senior Vice President, General Counsel and 
Corporate Secretary, the IntercontinentalExchange, Inc. (``I mean, 
she's right, but I just want to point out that there really is a 
tension there, because some of the people who are best qualified to 
assess risk in a given market are the people that some parts of 
the--you know, of the market are complaining about is controlling 
clearinghouses and controlling key infrastructure''), Roundtable Tr. 
at 78; Comments from William H. Navin, Executive Vice President and 
General Counsel, Options Clearing Corporation (``I would second 
those remarks. Our experience has been that we've benefited greatly 
from the expertise of industry directors, and I think it would be 
throwing the baby out with the bathwater if substantial restrictions 
on industry governance were to be enacted''), Roundtable Tr. at 78; 
Comments from Greenberger (``I do agree with what has been said, 
that you need experts on the board. What I disagree with is that all 
expertise comes from five swaps dealers or it all comes from people 
who work for banks. There are academics, former regulators, and, you 
know, other participants in the market who have talked today about 
their need for open and fair access. I think that kind of diversity 
on the board is important''), Roundtable Tr. at 164.
---------------------------------------------------------------------------

    To ensure that members of a DCO, DCM, or SEF Board of Directors are 
not incented to accord undue consideration to the commercial interests 
of a DCO, DCM, or SEF in relation to regulatory interests, the 
Commission proposes to prohibit linking the compensation of public 
directors and other non-executive members of the Board of Directors to 
the business performance of the DCO, DCM, or SEF.
    The abovementioned substantive requirements are in accord with 
certain provisions in the European Commission Proposal.\56\
---------------------------------------------------------------------------

    \56\ See Article 25 of the European Commission Proposal.
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4. Questions on Substantive Requirements
    The Commission seeks comment on the questions set forth below on 
the substantive requirements applicable to a DCO, DCM, or SEF Board of 
Directors:
     What substantive requirements, other than those identified 
above, should the Commission consider imposing on a DCO, DCM, or SEF 
Board of Directors to mitigate the potential conflicts of interest 
described in Section II, as well as any potential conflicts of interest 
not specified herein? For example, should the Commission consider any 
additional requirements related to (i) the fiduciary duties that a DCO, 
DCM, or SEF Board of Directors may owe or (ii) policies or charters 
that the DCO, DCM, or SEF Board of Directors may adopt?
iii. Committees
1. Requirements for Each DCO, DCM, and SEF
a. Nominating Committee
    As stated above, the structural governance requirements contained 
herein focus on mitigating conflicts of interest through introducing a 
perspective independent of competitive, commercial, or industry 
considerations to the deliberations of DCO, DCM, and SEF governing 
bodies. Public director composition requirements are not, in and of 
themselves, sufficient to ensure the representation of such independent 
perspective. The Commission also must protect the integrity of the 
process by which the DCO, DCM, or SEF selects public directors.\57\
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    \57\ See, e.g., Comments from Rick McVey, Chief Executive 
Officer, MarketAxess (``McVey'') (``I personally think that one of 
the most important areas to focus on is the governance and 
nominating committee. How do people get on these boards? And if 
there is a requirement that that process be independent I think you 
would get both qualified people that are going to look after the 
best interest of the company, and you would get better independence 
on these boards''), Roundtable Tr. at 150.

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[[Page 63740]]

    To this end, the Commission proposes requiring each DCO, DCM, or 
SEF to have a Nominating Committee. The role of the Nominating 
Committee would be to: (i) Identify individuals qualified to serve on 
the Board of Directors, consistent with the criteria that the Board of 
Directors require and any composition requirement that the Commission 
promulgates; and (ii) administer a process for the nomination of 
individuals to the Board of Directors. The Commission proposes that (i) 
public directors comprise at least 51 percent of the Nominating 
Committee, and (ii) a public director chair the Nominating Committee.
b. Disciplinary Panels
    As stated above, each DCM and SEF must fulfill self-regulatory 
obligations under the CEA and the Dodd-Frank Act. Also, each DCO has 
certain self-regulatory obligations.\58\ The Commission proposes 
requiring each DCO, DCM, or SEF to have one or more disciplinary 
panels.\59\ The role of such disciplinary panels would be to conduct 
hearings, render decisions, and impose sanctions with respect to 
disciplinary matters.
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    \58\ For example, to the extent that a DCO determines that it 
must impose requirements on members in order to comport with a core 
principle or other regulatory requirement (e.g., limits on ownership 
and voting power), a DCO must monitor member compliance with such 
requirement, and must have the authority and ability to enforce such 
requirement. See Section 5b(c)(2)(H) of the CEA, as added by Section 
725(c) of the Dodd-Frank Act.
    \59\ The Commission understands that DCOs currently may not have 
disciplinary panels, but that the Risk Management Committee of a DCO 
may perform the functions of such panel. Therefore, consistent with 
current practice, the Commission proposes to permit the DCO Board of 
Directors to delegate to the Risk Management Committee the 
performance of such functions. If the Board of Directors so 
delegates, (i) the DCO would no longer need to maintain a 
disciplinary panel, but (ii) the composition requirements applicable 
to a disciplinary panel would be extended to any committee (or 
similar body) to which a decision of the Risk Management Committee 
may be appealed.
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    The Commission believes that it is imperative for each DCO, DCM, or 
SEF to exercise its disciplinary authority in an impartial manner. In 
the DCM Conflicts of Interest Release, the Commission acknowledged the 
value of fair representation in maintaining such impartiality.\60\ To 
ensure that fair representation results in impartiality, the Commission 
proposes (i) maintaining the requirement that each DCM adopt rules that 
would preclude any group or class of participants from dominating or 
exercising disproportionate influence on the disciplinary panel, and 
(ii) extending such requirement to each DCO or SEF. The Commission also 
proposes mandating that each DCO, DCM, or SEF adopt rules that would 
prohibit any member of a disciplinary panel from participating in 
deliberations or voting on any matter in which the member knowingly has 
a financial interest.
---------------------------------------------------------------------------

    \60\ See 72 FR at 6952 (stating that ``fair disciplinary 
procedures, with minimal conflicts of interest, require disciplinary 
bodies that represent a diversity of perspectives and 
experiences'').
---------------------------------------------------------------------------

    In the DCM Conflicts of Interest Release, the Commission also 
acknowledged the importance of an independent perspective.\61\ The 
Commission proposes retaining and strengthening the role that such 
perspective plays in DCO, DCM, or SEF disciplinary processes. First, 
the Commission proposes (i) maintaining the requirement that each DCM 
disciplinary panel include at least one ``public participant,'' \62\ 
and (ii) extending such requirement to each DCO or SEF disciplinary 
panel. Second, the Commission proposes requiring that the chair of each 
disciplinary panel be a public participant.
---------------------------------------------------------------------------

    \61\ Id. (stating that ``[t]he presence of at least one public 
person on disciplinary bodies * * * provides an outside voice and 
helps to ensure that the public's interests are represented and 
protected. This approach is consistent with the Commission's overall 
objective of ensuring an appropriate level of public representation 
at every level of DCM decision making, while simultaneously 
calibrating the required number of public persons to the nature and 
responsibility of the decision-making body in question'').
    \62\ Id. at 6957. In the proposed rules, a ``Public 
Participant'' is defined as an entity that meets the bright-line 
materiality tests in the definition of ``Public Director.''
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2. Requirements for Each DCO Only
a. Risk Management Committee (and Subcommittee)
    The central purpose of a DCO is to guarantee the performance of 
each derivatives contract that it clears. In order to fulfill such 
guarantee, each DCO must appropriately manage the risks associated with 
such contract. In general, a DCO convokes a committee to oversee risk 
management. The Commission proposes to require each DCO to have a Risk 
Management Committee.
    Swap contracts, as well as commodity futures and options, are 
complex instruments. Managing the risks of such instruments requires 
expertise. In general, clearing members constitute the main source of 
such expertise, as they (i) routinely execute trades in such 
instruments and (ii) have experience in managing risks posed by 
customer trades. Because of the lack of a centralized market for swap 
contracts, swap clearing members also perform the function of (i) 
pricing a swap contract and (ii) participating in an auction to 
liquidate the swap contract in the event of member default.
    However, as discussed above, swap clearing members at DCOs that 
currently clear large volumes of swap contracts are exclusively 
enumerated entities. Some have argued that the enumerated entities have 
an incentive to influence DCO risk assessments regarding (i) whether a 
swap contract is capable of being cleared, (ii) the appropriate 
membership criteria for a swap clearing member, and (iii) whether a 
particular entity meets such criteria. Therefore, the Commission must 
carefully consider the composition of the Risk Management Committee, in 
order to achieve (i) the increased clearing of swap contracts that the 
Dodd-Frank Act contemplates without compromising (ii) DCO safety and 
soundness.
    The Commission proposes a three-pronged approach to mitigating the 
potential conflict of interest identified above, while still ensuring 
that the Risk Management Committee retains sufficient expertise. First, 
the Commission proposes requiring that 35 percent of the Risk 
Management Committee be composed of public directors, with sufficient 
expertise in, among other things, clearing services.\63\ Second, the 
Commission proposes requiring that 10 percent of the Risk Management 
Committee be composed of customers of clearing members, who also 
routinely execute swap contracts (as well as commodity futures and 
options) and who have experience in using pricing models for such 
contracts (if only to ensure that they receive a fair price from the 
enumerated entities).\64\ Because customers benefit from a wider pool 
of swap clearing members and greater competition between such members, 
customers have an incentive to ensure that the membership criteria of a 
DCO are risk-based, and do not reflect the private, competitive 
interests of the enumerated entities. Third, the Commission proposes to 
permit a DCO Risk Management Committee to delegate to a subcommittee 
(the ``Risk

[[Page 63741]]

Management Subcommittee'') the responsibility to: (i) Determine the 
standards and requirements for initial and continuing clearing 
membership eligibility; (ii) approve or deny (or review approvals or 
denials of) clearing membership applications; and (iii) determine 
products eligible for clearing. If the Risk Management Committee 
effects such a delegation, then it would free itself of the composition 
requirements. The decisions of the Risk Management Subcommittee would 
be subject to review by the Risk Management Committee. Therefore, if 
the Risk Management Committee determines that a particular decision by 
the Risk Management Subcommittee is overly risky, then the Risk 
Management Committee may overrule that decision.\65\
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    \63\ See Comments from Greenberger, supra note 55, regarding the 
availability of such public directors.
    \64\ See, generally, supra note 55.
    Because customers do not contribute to the DCO default fund, 
customers may have less capital at stake than clearing members if a 
DCO improperly measures risk. Therefore, the Commission believes 
that 10 percent representation would ensure that customers have 
adequate voice on the DCO Risk Management Committee, without 
adversely impacting the risk assessments of such committee.
    \65\ The Commission is contemplating requiring the DCO to report 
to the Commission whenever the Risk Management Committee overrules 
the Risk Management Subcommittee, or whenever the Board of Directors 
overrules the Risk Management Committee. If the Commission decides 
to propose such requirement, it would be included in the second 
rulemaking that the Commission contemplates finishing on governance 
and mitigation of conflicts of interest. See supra note 17.
---------------------------------------------------------------------------

    In order to prevent evasion of the above-mentioned composition 
requirements through internal reorganization, the Commission proposes 
to prohibit:
     A decision of the Risk Management Subcommittee from being 
subject to the approval of, or otherwise restricted or limited by, a 
body other than the DCO Board of Directors or the DCO Risk Management 
Committee, including, without limitation, any advisory committee; and
     Certain decisions of the Risk Management Committee \66\ 
from being subject to the approval of, or otherwise restricted or 
limited by, a body other than the DCO Board of Directors, including, 
without limitation, any advisory committee.
---------------------------------------------------------------------------

    \66\ I.e., any decision pertaining to (i) whether a swap 
contract is capable of being cleared, (ii) the appropriate 
membership criteria for a swap clearing member, and (iii) whether a 
particular entity meets such criteria.
---------------------------------------------------------------------------

    The Commission requests comment on its three-pronged approach, 
including any alternatives to such approach. The Commission also 
requests comment on (i) the specific percentages set forth above, and 
(ii) the prohibitions on certain bodies approving of, or otherwise 
restricting or limiting, the decisions of the Risk Management Committee 
(or Risk Management Subcommittee, as applicable).
3. Requirements for Each DCM or SEF Only
a. Membership or Participation Committee
    As mentioned above, increased competition may exacerbate conflicts 
of interest, causing a DCM or SEF to (i) prioritize commercial 
interests over self-regulatory responsibilities; and (ii) restrict 
access or impose burdens on access in a discriminatory manner. 
Roundtable participants identified a specific example of (ii), where 
swap clearing members may seek to limit access to SEF execution and 
pricing to customers executing through such members.\67\ The rationale 
of such example would apply to a DCM as well. To protect decisions 
regarding access from DCM or SEF commercial interests, or the interests 
of the enumerated entities, the Commission proposes requiring a DCM or 
SEF to have a Membership or Participation Committee, composed of 
thirty-five percent public directors.\68\ Such committee would have the 
responsibility to: (i) Determine the standards and requirements for 
initial and continuing membership or participation eligibility; (ii) 
review appeals of staff denials of membership or participation 
applications; and (iii) approve rules that would result in different 
categories or classes of members or participants receiving disparate 
access. The Commission proposes prohibiting the Membership or 
Participation Committee from upholding any staff denial if the relevant 
application meets the standards and requirements that such committee 
sets forth. Further, the Commission proposes prohibiting the Membership 
or Participation Committee from restricting access or imposing burdens 
on access in a discriminatory manner, within each category or class of 
members or participants or between similarly situated categories or 
classes of members or participants. Nothing in this preamble is meant 
to prohibit the Commission from issuing substantive proposals regarding 
access to a DCM or SEF in any subsequent proposed rulemaking.
---------------------------------------------------------------------------

    \67\ See, e.g., Comments from Kastner (``I'll take the ball for 
a second with the SEFs. The same principles that apply to DCOs in 
terms of open access--also if you carefully apply to SEFs, anybody 
who is able to get a clearing account at a qualified swap clearing 
member or FCM to use the, you know, futures analog, anybody that 
wants to trade on a SEF, the SEF should not have any barriers to 
entry.''), Roundtable Tr. at 52, (``The point is if you have a firm 
who is doing customer business and wants to engage in an interest 
rate swap with an end user who is not a clearing member, that they 
should be able to execute that trade with the end user and then give 
up to a clearing member.''), Roundtable Tr. at 84; Comments from 
William DeLeon, Executive Vice President, Global Head of Portfolio 
Risk Management, PIMCO (``You know, that concept of using a SEF, I 
think it should be free and open access * * *. The issue is that 
there needs to be a guarantee that when you access a SEF, that when 
you do a trade, that there is someone who is guarantee that that is 
a good trade. So whether that means that there's a market maker * * 
* or if that means that there's a DCM or an FCM or someone who's 
going to guarantee that they're going to stand behind * * * unknown 
clients * * * ''), Roundtable Tr. at 56.
    \68\ The Commission acknowledges that a DCM may have already 
assigned the functions of a Membership or Participation Committee to 
other governing bodies. Therefore, the proposed rules permit the DCM 
Board of Directors to delegate the performance of the functions of 
the Membership or Participation Committee to one or more other 
committees, provided that each such committee meets the applicable 
composition requirements. If the Board of Directors chooses to so 
delegate, the registered swap execution facility would no longer 
need to maintain a Membership or Participation Committee.
---------------------------------------------------------------------------

b. Regulatory Oversight Committee
    In the DCM Conflicts of Interest Release, the Commission emphasized 
the importance of a DCM Regulatory Oversight Committee (``ROC''):

    Properly functioning ROCs should be robust oversight bodies 
capable of firmly representing the interests of vigorous, impartial, 
and effective self-regulation. ROCs should also represent the 
interests and needs of regulatory officers and staff; the resource 
needs of regulatory functions; and the independence of regulatory 
decisions. In this manner, ROCs will insulate DCM self-regulatory 
functions, decisions, and personnel from improper influence, both 
internal and external.\69\

    \69\ See 72 FR 6950, 6951.

    The Commission also underscored the importance of the DCM ROC being 
---------------------------------------------------------------------------
composed of 100 percent public directors:

    The Commission strongly believes that new structural conflicts 
of interest within self-regulation require an appropriate response 
within DCMs. The Commission further believes that ROCs, consisting 
exclusively of public directors, are a vital element of any such 
response * * *. ROCs make no direct commercial decisions, and 
therefore, have no need for industry directors as members. The 
public directors serving on ROCs are a buffer between self-
regulation and those who could bring improper influence to bear upon 
it.\70\
---------------------------------------------------------------------------

    \70\ Id. at 6951.

    The Commission proposes (i) maintaining the requirement that DCMs 
have a ROC composed of only public directors, and (ii) extending such 
requirement to SEFs, which also have self-regulatory obligations. 
However, the Commission recognizes that SEFs--but not DCMs--must have a 
chief compliance officer (i) to monitor SEF adherence to statutory, 
regulatory, and

[[Page 63742]]

self-regulatory requirements and (ii) to resolve conflicts of interest 
that may impede such adherence. The chief compliance officer must 
report to the SEF Board of Directors (or similar governing body) or the 
senior SEF officer.\71\ Since the Dodd-Frank Act charges the SEF Board 
of Directors (or similar governing body) or the senior SEF officer with 
the responsibility for overseeing the chief compliance officer 
(including with respect to the resolution of conflicts of interest), 
the Commission requests comment on whether requiring a SEF to also have 
a ROC is necessary.
---------------------------------------------------------------------------

    \71\ See Section 5h(f)(15) of the CEA, as added by Section 733 
of the Dodd-Frank Act.
---------------------------------------------------------------------------

iv. Definition of Public Director
    The proposed rules include a definition of ``public director'' that 
makes several modifications to the definition of ``public director'' 
that the Commission adopted in 2009.\72\ Such modifications bring 
several aspects of the definition in line with the definition of 
``independent director'' that the SEC proposed in 2004.\73\ Since the 
Commission is currently, or will in the future, be regulating some of 
the same entities as the SEC,\74\ the modifications to the definition 
of ``public director'' are intended to allow for greater harmonization 
with the SEC and currently accepted practices.\75\
---------------------------------------------------------------------------

    \72\ See, generally, 74 FR 18982 (April 27, 2009).
    \73\ See 69 FR 71127 (December 8, 2004) (the ``SEC 2004 
Release'').
    \74\ E.g., the Options Clearing Corporation, or a SEF that lists 
both CDS indices and single-name CDS contracts.
    \75\ See, e.g., the listing standards of NYSE Euronext or NASDAQ 
OMX.
---------------------------------------------------------------------------

    First, the proposed rules include a new bright-line test that 
prohibits any director that is an officer of another entity, which 
entity has a compensation committee, on which any officer of the 
registered entity serves, from being a public director. This test is a 
part of the independence tests of most listing standards and prevents a 
public director from having a financial relationship that would likely 
impair his independence. In light of the obvious conflicts that could 
arise as a result of such a financial relationship, the Commission 
proposes that this additional bright-line test be included in the 
definition of ``public director.''
    Second, the proposed rules would preclude directors that are 
employees of members of DCOs, DCMs, and SEFs from being public 
directors. The proposed rules would also preclude a director, or an 
entity with which the director is an employee, from being a public 
director if certain payments are made to such director. In 2009, the 
Commission moved the evaluation of employment relationships from the 
bright-line test to an analysis under the overarching materiality 
standard. The Commission is re-evaluating such move in light of current 
concerns regarding further protecting regulatory functions from 
directors that are conflicted due to industry ties. The Commission 
notes that CBOE Futures Exchange, LLC (``CFE'') submitted a comment 
letter to this effect in 2009. In particular, CFE expressed concern 
that, as a result of the removal of employment relationships from the 
bright-line tests, all required public directors could be member 
employees.\76\ At the time, the Commission felt that such a situation 
would be incompatible with the overarching materiality test, even if 
such prohibition against employment was not included in the bright-line 
test. The Commission seeks comments regarding the re-insertion of 
employment relationships in the bright-line tests.
---------------------------------------------------------------------------

    \76\ CFE Comment Letter at 2.
---------------------------------------------------------------------------

    Third, the proposed ``public director'' definition includes an 
expanded definition of ``immediate family'' that includes certain 
family members, whether by blood, marriage or adoption, and also 
includes any person residing in the home of the director or his 
immediate family. Such change attempts to harmonize the ``public 
director'' definition with the SEC 2004 Release and currently accepted 
practices.
    Finally, the Commission notes that the proposed rules retain the 
one-year look-back period. The Commission seeks comment as to whether 
such period should be increased, given (i) current concerns regarding 
further protecting regulatory functions from directors that are 
conflicted due to industry ties, and (ii) the goal of achieving harmony 
with the SEC and currently accepted practices.
v. Questions on Committees and the Definition of Public Director
    In addition to any questions that the Commission may have posed 
above, the Commission seeks comment on the following questions 
regarding DCO, DCM, or SEF committees, and the attendant composition 
requirements, as well as the definition of public director:
     Is each of the committees or panels specified above 
necessary or appropriate for the mitigation of the conflicts of 
interest described in Section II, or of any conflict of interest not 
identified herein? If so, are the composition requirements applicable 
to such committees necessary or appropriate to effect such mitigation?
     What other ways should the Commission consider defining 
``public director''? Are there other circumstances that the Commission 
should include in the bright-line materiality tests? Are there 
circumstances that the Commission should remove from such tests?

b. Ownership and Voting Limits

    As mentioned above, the structural governance requirements mitigate 
DCO, DCM, or SEF conflicts of interest by introducing a perspective 
independent of competitive, commercial, or industry considerations to 
the deliberations of governing bodies. The Commission believes that 
limits on ownership of voting equity and the exercise of voting rights 
would enhance the structural governance requirements.\77\ In general, 
individuals are compensated for service on the Board of Directors (and 
the committees thereof). Voting shareholders elect, directly or 
indirectly, members of the Board of Directors. Such members serve as 
fiduciaries to all shareholders under state law. Therefore, to ensure 
that DCO, DCM, or SEF public directors maintain their independent 
perspective (rather than solely representing the competitive, 
commercial, or industry considerations of shareholders), the Commission 
believes that limits on ownership of voting equity and the exercise of 
voting rights are necessary.\78\
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    \77\ The Commission proposes not to limit non-voting equity. In 
general, a shareholder would have direct influence over a DCO, DCM, 
or SEF Board of Directors only if the shareholder has the ability to 
exercise voting rights with respect to, e.g., election, 
compensation, or removal of directors. However, the Commission notes 
that certain Roundtable participants disagree. See, e.g., Comments 
from Slavkin (``I actually disagree with what the gentleman from JP 
Morgan said when he said that he doesn't think that having an 
economic stake without having a voting interest is a concern. I 
think most of us can imagine a situation where someone owns 5 
percent of our company and asks us to do something. I don't think it 
matters if that person gets to vote for the board of directors, that 
person has real influence regardless of whether it's formal 
influence, there is going to be influence over the decision making, 
there's going to be influence over the strategy and innovation and 
the trajectory of the institution in general, so I do think we need 
to look at ownership restrictions related to voting interests as 
well as related to economic interests even when they're not tied to 
actual voting shares''), Roundtable Tr. at 153. The Commission 
requests comment on whether limits on non-voting equity would be 
appropriate to the mitigation of conflicts of interest.
    \78\ Certain Roundtable Participants agree. See, e.g., Comments 
from Slavkin (``What I'm hearing from the people who support 
governance as opposed to real caps on ownership is an argument in 
favor of the status quo, and I think that when Congressman Brown--
I'm sorry, when Congressman Lynch proposed this amendment that was 
passed in the House legislation, and when Senator Brown proposed, 
you know, the Lynch Light version that was passed by the entire 
Congress, their intention was to create real change in recognition 
of the fact that the current system is broken. It doesn't work. 
That's why we're all sitting around this table today. Governance is 
a valuable tool, it's not the only tool, and I think it's our 
responsibility to try to examine other options and I think that the 
ownership cap is a real valuable tool that can be used to mitigate 
the problems that exist in the current system''), Roundtable Tr. at 
124 to 125.
    The European Commission Proposal explicitly rejects ownership 
limitations. See Section 4.3.4 of the European Commission Proposal 
(stating that structural governance requirements ``are considered 
more effective in addressing any potential conflicts of interest 
that may limit the capacity of CCPs to clear, than any other form of 
regulation which may have undesirable consequence on market 
structures (e.g., limitation of ownership, which would need to 
extend also to so-called vertical structures in which exchanges own 
a CCP)'').
    However, the European Commission Proposal explicitly preserves 
the power of the regulator to refuse authorization of a CCP ``where, 
it is not satisfied as to the suitability of the shareholders or 
members that have qualifying holdings in the CCP, taking into 
account the need to ensure the sound and prudent management of a 
CCP.'' See Article 28(2) of the European Commission Proposal. 
Further, the European Commission Proposal permits the regulator to 
terminate authorization of a CCP where ``shareholders or members, 
whether direct or indirect, * * * exercise an influence which is 
likely to be prejudicial to the sound and prudent management of the 
CCP.'' See Article 28(1) and (4) of the European Commission 
Proposal.
    The Commission requests comment as to whether a reservation of 
power similar to that contained in the European Commission Proposal 
would complement the limits on ownership of voting equity and the 
exercise of voting power described above.

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[[Page 63743]]

i. DCOs
    According to the DCM Conflicts of Interest Release, ``[t]oday's 
DCMs * * * are vibrant commercial enterprises competing globally in an 
industry whose ownership structures, business models, trading 
practices, and products are evolving rapidly.'' \79\ The same 
evolution, and the diversity in ownership structures that it engenders, 
may be observed in DCOs. Therefore, in acknowledgement of the different 
DCO ownership structures that currently or may in the future exist, the 
Commission proposes that a DCO choose between one of two alternative 
limitations on ownership of voting equity and the exercise of voting 
rights. However, the Commission recognizes that circumstances may exist 
where neither alternative may be appropriate. Consequently, the 
Commission also proposes a waiver procedure.
---------------------------------------------------------------------------

    \79\ 72 FR at 6938.
---------------------------------------------------------------------------

1. First Alternative
    For the first alternative, the Commission proposes a combination of 
a single-member limitation and an aggregate limitation (the ``First 
Alternative'').
a. Single-Member Limitation
    First, the Commission proposes requiring a 20 percent limitation on 
the voting equity that any single member (and related persons) \80\ may 
own.\81\ Economic research suggests that holding 20 percent voting 
equity of an entity may be sufficient for exerting control over an 
entity,\82\ especially if that entity has otherwise diffuse 
ownership.\83\
---------------------------------------------------------------------------

    \80\ The Commission requests comment on whether the definitions 
of ``related person'' in the proposed rules are under or over-
inclusive.
    \81\ Ruben Lee, The Governance of Financial Infrastructure, 
Oxford Finance Group, at 256 (January 2010) (stating that 
``[m]andatory ownership constraints may prevent a single firm from 
exercising undue influence over a market institution that is also an 
SRO'').
    \82\ See, generally, e.g., Bae, K-H., J-K and J-M Kang (2002). 
``Tunneling or value added? Evidence from mergers by Korean business 
groups'', Journal of Finance 57, pp. 2695-2740; Barclay, M. and C. 
Holderness (1989) ``Private benefits from control of public 
corporations'', Journal of Financial Economics 25, pp. 371-395; 
Barclay, M. and C. Holderness (1991) ``Negotiated block trades and 
corporate control'', Journal of Finance 46, pp. 861-878; Barclay, M. 
and C. Holderness and D. Sheehan (2001) ``The block pricing 
puzzle'', Working Paper; Cheung,Y-L, P.R. Rao and A. Stouraitis 
(2006) ``Tunneling, propping, and expropriation: evidence from 
connected party transactions in Hong Kong'', Journal of Financial 
Economics 82, pp. 343-386; Claessens, S., S. Djankov, L.H.P. Lang 
(2000) ``The separation of ownership and control in East Asian 
corporations'', Journal of Financial Economics 58, pp. 81-112; Dyck, 
A and L. Zingales (2004) ``Private benefits of control: An 
international comparison'', Journal of Finance 59, pp. 537-600; 
Faccio, M., L.H.P Lang, and L. Young (2001) ``Dividends and 
expropriation'', American Economic Review 91, 54-78; and Morck, R., 
D. Wolfenzon, and B. Yeung (2005) ``Corporate governance, economic 
entrenchment, and growth'', Journal of Economic Literature, 43, pp. 
655-72.
    The 20 percent limitation also accords with the proposals in the 
SEC 2004 Release. See 69 FR at 71143-44.
    \83\ As mentioned above, CME, for example, is wholly-owned by 
CME Group. However, CME Group is a publicly-listed company with 
diffuse ownership.
---------------------------------------------------------------------------

    As described above, based on Commission experience, control of a 
DCO by members collectively has generally permitted the DCO to serve 
the purposes of the CEA. However, such description does not necessarily 
hold true if, for example, the DCO has demutualized but one member 
retains sufficient voting ownership to dominate the DCO.\84\ Such 
domination may result in the DCO relaxing risk management standards 
with respect to that member, but imposing more stringent standards on 
others.
---------------------------------------------------------------------------

    \84\ Comments from Greenberger (``if we want governance with 
teeth, governance with teeth will have ownership limitations. You 
can talk about fair representation, board governance, the fact of 
the matter is, and I think this will bear its way out in the 
comments to you, that does not protect fair and open access * * 
*''), Roundtable Tr. 135.
---------------------------------------------------------------------------

    Given the increased importance of the DCO in managing systemic 
risk, the Commission believes that limiting the amount of voting equity 
that any one member may own is appropriate to ensure impartiality in 
risk assessment, especially in a DCO with otherwise diffuse ownership. 
To prevent evasion of the 20 percent limitation, the Commission 
proposes requiring an identical limit on voting rights; and if the DCO 
is a subsidiary, extending the limitation to the shareholders of its 
direct or indirect parent. If any parent is publicly-listed, then that 
parent would have to comply with shareholder voting requirements 
promulgated by the SEC or the exchange on which the parent is listed.
b. Aggregate Limitation
    Further, the Commission proposes a 40 percent limitation on the 
voting equity that the enumerated entities (and their related persons) 
may own in the aggregate, regardless of whether such entities are DCO 
members.\85\ As mentioned above, some market participants, investor 
advocates, and academics have argued that the enumerated entities may 
have commercial incentives to influence DCO risk assessments regarding 
(i) whether a swap contract is capable of being cleared, (ii) the 
appropriate membership criteria for a swap clearing member, and (iii) 
whether a particular entity meets such criteria. The enumerated 
entities may directly influence such assessments through participation 
on the Risk Management Committee as clearing members, or indirectly 
influence such assessments as voting shareholders. In general, the 
Commission believes that the enumerated entities would attempt to 
influence such assessments as voting shareholders only if the DCO has a 
mutualized structure with concentrated ownership.\86\ In such a 
structure, the percentage necessary for control would be higher than 
the abovementioned 20 percent, which is sufficient for a diffuse 
ownership structure.
---------------------------------------------------------------------------

    \85\ Cf. The Lynch Amendment, which prohibited certain 
``restricted owners'' from collectively acquiring more than 20 
percent of the voting equity in a DCO.
    \86\ See, generally, Barclay, M. and C. Holderness (1989) 
``Private benefits from control of public corporations'', Journal of 
Financial Economics 25, pp. 371-395. The premise of this paper is 
that (i) buyers of equity blocks in a publicly-traded corporation 
appear, on average, to pay a premium above market price, and (ii) 
such premium reflects the value to the buyer of being able to 
influence the decisions of the corporation in a way that is 
privately profitable, but not profitable to other shareholders. In 
general, the Commission believes that, if a DCO has diffuse 
ownership, the outlay that an enumerated entity would need to make 
to influence DCO risk assessments as a voting shareholder would 
likely exceed the outlay necessary to obtain the same amount of 
influence through other means.
---------------------------------------------------------------------------

    In counterweight to the commercial incentives that the enumerated 
entities may have to influence DCO risk assessments regarding (i), 
(ii), and (iii)

[[Page 63744]]

above, the Commission acknowledges that the enumerated entities have 
the capital and expertise necessary to manage the risks of clearing 
swap contracts.\87\ Therefore, the Commission believes that a 40 
percent aggregate limitation is appropriate, assuming that the DCO has 
a mutualized structure with concentrated ownership, because it permits 
the enumerated entities to influence, directly or indirectly, but not 
control, DCO risk assessments.
---------------------------------------------------------------------------

    \87\ See, e.g., Comments from Jeremy Barnum, Managing Director, 
J.P. Morgan (``Barnum'') (``So, on the question of--on the question 
of ownership of clearinghouses and expertise and the Lynch 
amendment, the--it is very appealing in principle to imagine that 
these systemically important financial players into which we are 
putting much more risk, could somehow be entirely free of the 
nefarious influence of the evil dealers who contributed to the 
crisis to quote Mr. Greenberger. But, unfortunately, they are, in 
fact, the market participants who need to use the clearinghouses''), 
Roundtable Tr. at 115; Comments from Olesky (``I think it's really 
important to recognize--for all of us to recognize--that market 
participants really engender many market facilities. And in my 
experience in the investment of capital and the knowledge about a 
particular space has led directly to innovations and advances both 
with Tradeweb and another company I was with, BrokerTech; exchanges; 
clearing corps. If you go back in history, those are the folks that 
have the capital to support this innovation and the knowledge and 
experience to move it forward. And while it's easy to sort of be 
critical of that group, I think it's also important not to cut off 
that flow of capital into innovative organizations that are really 
groups of market participants that are investing in these types of 
mechanisms * * * Tradeweb was started in 1997 with the internet with 
a group of banks. We had four banks initially. Then we sold 100 
percent of the company in 2004 and we weren't owned by any banks for 
4 years. Then we had another investment back in, and we had a 
minority stake by some banks. I think we really have to separate out 
the ownership argument from the governance argument, because it's 
critical to be able to access that capital for entrepreneurs and for 
innovators when they're trying to build these mechanisms''), 
Roundtable Tr. at 60 to 61.
---------------------------------------------------------------------------

    In conjunction with the 40 percent aggregate limitation, the 
Commission proposes requiring a majority vote for the passage of any 
shareholder resolution; and if the DCO is a subsidiary, extending the 
aggregate limitation and the requirement for a majority vote to the 
shareholders of its direct or indirect parent. If any parent is 
publicly-listed, then that parent would have to comply with shareholder 
voting requirements promulgated by the SEC or the exchange on which the 
parent is listed.
2. Second Alternative
    For the second alternative, the Commission proposes a 5 percent 
limitation on the voting equity that any DCO member or enumerated 
entity (whether or not such entity is a DCO member), and the related 
persons thereof in each case, may own (the ``Second Alternative''). 
Such a limitation effectively ensures that neither a DCO member nor an 
enumerated entity would have sufficient power, in a concentrated or 
diffuse ownership structure, to exert undue influence, as a voting 
shareholder, over DCO operations (including with respect to risk 
assessments regarding (i), (ii), and (iii) above). Certain Roundtable 
participants favor a similar approach.\88\
---------------------------------------------------------------------------

    \88\ See, e.g., Comments of Roger Liddell, Chief Executive 
Officer, LCH.Clearnet Group (``Liddell'') (``To go back to the 
question, I think with established organizations, then I think the 
concept of some combination of ownership limits and voting caps 
actually does make sense. For example, in the [LCH] clearinghouse, 
we've got a 5 percent voting cap and have done for many years. And 
the reason for that was to take away any incentive for anyone to 
build up a stake greater than that so that we would be highly 
unlikely to ever have less than 20 shareholders. That works well for 
us''), Roundtable Tr. at 118 to 119.
---------------------------------------------------------------------------

    To prevent evasion of the 5 percent limitation, the Commission 
proposes requiring an identical limit on voting rights; and if the DCO 
is a subsidiary, extending the limitation to the shareholders of its 
direct or indirect parent. If any parent is publicly-listed, then that 
parent would have to comply with shareholder voting requirements 
promulgated by the SEC or the exchange on which the parent is listed.
3. Waiver
    As mentioned above, the Commission believes that there may be 
circumstances where the imposition of rigid limitations on ownership or 
voting rights may not be appropriate for certain DCO ownership 
structures. To provide flexibility, a DCO may request that the 
Commission waive individual and/or aggregate ownership or voting rights 
limitations by any entity for a reasonable period of time.
    The Commission may grant the requested waiver if it determines that 
ownership or voting rights limitations are not necessary or appropriate 
to:
     Improve the governance of the DCO;
     Mitigate systemic risk;
     Promote competition;
     Mitigate conflicts of interest in connection with a swap 
dealer's or major swap participant's conduct of business with the DCO 
with respect to fair and open access and participation and product 
eligibility; and
     Otherwise accomplish the purposes of the Act.
    The Commission may, at any time, revoke the waiver. Upon such 
revocation, or at the expiration of the waiver period, any such DCO 
shall require divestiture of any relevant entity's ownership or voting 
rights percentages to an individual and/or aggregate level that is 
consistent with the First or Second Alternative, or such other level 
that the Commission deems appropriate based on the foregoing factors as 
set forth in Section 726(b) of the Dodd-Frank Act.
4. Questions on the First and Second Alternatives and the Waiver
    The Commission seeks comment on the questions set forth below on 
the First and Second Alternatives, as well as the Waiver:
a. First and Second Alternatives
     Are the First and Second Alternatives effective for 
mitigating, on a prophylactic basis, conflicts of interest arising from 
the control that (i) one member may exert as a dominant voting 
shareholder of a DCO and (ii) the enumerated entities may collectively 
exert as voting shareholders of a DCO (specifically with respect to the 
DCO risk assessments referenced above)? What methods, other than the 
First and Second Alternatives, should the Commission consider to 
mitigate such conflicts of interest? What are the advantages and 
disadvantages of such methods?
     Under what circumstances would the First and Second 
Alternatives not be appropriate for a DCO? For example, should the 
First and Second Alternatives apply equally to established DCOs and 
start-up DCOs? \89\
---------------------------------------------------------------------------

    \89\ See, e.g., Comments from Olesky, supra note 87; Comments 
from Liddell (``However, to pick upon the point that Lee Olesky made 
before, I think you have to be a little bit careful in how you treat 
entrepreneurials or starter ventures because most of the successful 
starter ventures have started with a relatively small number of 
banks sharing an interest in creating something which then becomes a 
lot bigger''), Roundtable Tr. at 119.
---------------------------------------------------------------------------

     Are the percentages that the Commission specifies in the 
First and Second Alternatives effective for mitigating conflicts of 
interest arising from the control that (i) one member may exert as a 
dominant voting shareholder of a DCO and (ii) the enumerated entities 
may collectively exert as voting shareholders of a DCO? If not, what 
alternative percentages should the Commission consider to achieve such 
mitigation?
     Would the First and Second Alternatives be effective to 
mitigate any potential conflicts of interest not discussed herein? If 
not, then what other equity ownership and voting limits should the 
Commission consider?
     Should the limits in the First and Second Alternatives 
only apply to clearing members, and not enumerated entities that are 
not clearing members? Should the limits in the First and Second 
Alternatives apply only to

[[Page 63745]]

DCOs, and not to their parent companies?
b. Waiver
     The Commission seeks comment on (i) the circumstances 
which may require an alternative ownership structure for a DCO, (ii) 
the types of alternative ownership structures of DCOs that may require 
flexibility in setting ownership or voting rights levels consistent 
with achieving the goal of Section 726 of the Dodd-Frank Act to 
mitigate conflicts of interest, and (iii) the appropriate means to 
provide such flexibility to the Commission during the DCO application 
process if such an organization were to adopt an alternative structure.
ii. DCMs or SEFs
    The Commission proposes a 20 percent limitation on the voting 
equity that any single member (and related persons) may own in a DCM or 
SEF. As mentioned above, economic research suggests that holding 20 
percent voting equity of an entity would be sufficient for control, 
especially if such entity has otherwise diffuse ownership. Such a 
limitation would prevent any one member of a DCM or SEF from dominating 
the decision-making process. The Commission also proposes an identical 
limitation on voting rights; and if the DCM or SEF is a subsidiary, 
extending the limitation to the shareholders of its direct or indirect 
parent. If any parent is publicly-listed, then that parent would have 
to comply with shareholder voting requirements promulgated by the SEC 
or the exchange on which the parent is listed.
    The Commission, however, does not propose imposing a limitation on 
the voting equity that the enumerated entities may own in the 
aggregate. As mentioned above, the Dodd-Frank Act specifically attempts 
to encourage sustained competition between multiple DCMs and SEFs over 
listing the same swap contract. Based on comments from Roundtable 
participants, the enumerated entities would be the most likely source 
of funding for a new DCM or SEF.\90\ In this instance, the Commission 
believes that the benefits of sustained competition between new DCMs 
and SEFs outweigh the incremental benefit of better governance through 
limitations on the aggregate influence of the enumerated entities.\91\
---------------------------------------------------------------------------

    \90\ See, e.g., Comments of McVey (``I think when it comes to 
ownership we have to realize that we are embarking on a major 
transformation of OTC markets and all of these entities are going to 
need capital to provide the market efficiencies that we're all 
seeking to achieve. And rightly or wrongly, historically a 
tremendous amount of the capital for clearing, e-trading, data and 
affirmation hubs, has come from the dealer community, and I think it 
would be very dangerous to cut off an important source of capital 
that can lead to some of the market improvements that we're all 
seeking to achieve''), Roundtable Tr. at 121 to 122.
    \91\ See, generally, Comments of Barnum (``The traditional 
vertically integrated exchange model for futures works beautifully 
in a whole range of respects for those products from the perspective 
of liquidity and systemic risk, but it has a couple problems. It 
is--it does seem to create some natural monopoly properties. You can 
debate whether they're severe enough to warrant action or not and 
that's one of the kinds of tensions that needs to be balanced. In 
addition, they work very well for the types of products that 
naturally attract liquidity on exchanges. The whole premise of this 
is that we're pushing a whole new set of products with different 
liquidity characteristics into central counterparties. That means 
that you cannot apply exactly the same framework. There are new 
challenges that are being introduced. They create tensions. And 
those tensions need to be looked at rationally in a continuum 
framework that balances different social goods against each 
other''), Roundtable Tr. at 116 to 117.
---------------------------------------------------------------------------

1. Questions on DCM or SEF Limits on Ownership and Voting Power
    The Commission seeks comment on the questions set forth below on 
the DCM or SEF limits on ownership and voting power:
     Are the single-member limits on ownership and voting power 
effective for mitigating, on a prophylactic basis, the conflicts of 
interest that Section II identifies? What methods, other than such 
limits, should the Commission consider to mitigate such conflicts of 
interest? What are the advantages and disadvantages of such methods?
     Should the Commission also consider instituting a waiver 
procedure for DCMs and SEFs with respect to the single-member 
limitation?
     Should the single-member limitation be extended to the 
parent company of a DCM or SEF?

IV. Effectiveness and Transition Period

    As noted above, the Commission is contemplating rulemakings on 
further defining certain entities implicated by the proposed rules 
(e.g., swap dealers, major swap participants, and swap execution 
facilities). The Commission anticipates that such rulemakings would be 
completed by the statutory deadline of July 15, 2011. Therefore, the 
Commission is proposing a staggered effective date for the final rules 
on mitigation of conflicts of interest. Any portion of the final rules 
implicating entities subject to further definition would not become 
effective until sixty (60) days after July 15, 2011. Portions of the 
final rules not involving such entities would become effective sixty 
(60) days after the Federal Register publication of the final rules.
    Although the Commission proposes that the final rules become 
effective within the time periods specified above, consistent with the 
DCM Conflicts of Interest Release, the Commission will permit each 
existing DCO, DCM, and SEF to phase-in implementation of the final 
rules over two (2) years or two regularly-scheduled Board of Directors 
elections. The Commission expects, however, all new DCO, DCM, and SEF 
applicants to fully comply with the final rules.
    The Commission requests comment on the (i) timing of effectiveness 
for the final rules, and (ii) the length of the phase-in implementation 
period. The Commission further requests comment on whether new DCO, 
DCM, and SEF applicants should have to demonstrate compliance with the 
final rules to receive registration.

V. Numbering

    As the proposed rules constitute amendments or additions to 
Regulation Parts 1, 37, 38, 39, and 40, the Commission anticipates that 
the numbering of such proposed rules will change upon completion of 
other rulemakings concerning such parts.

VI. Related Matters

a. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') requires that agencies, in 
proposing rules, consider the impact of those rules on ``small 
entities.'' \92\ The term ``small entity'' has the same meaning as the 
term ``small business'' under the RFA \93\ and the term ``small 
business'' generally has the same meaning as the term ``small business 
concern'' under section 3 of the Small Business Act.\94\
---------------------------------------------------------------------------

    \92\ 5 U.S.C. 601 et seq.
    \93\ 5 U.S.C. 601(6).
    \94\ A ``small business concern'' is generally defined as one 
which is independently owned and operated and which is not dominant 
in its field of operation. 15 U.S.C. 632.
---------------------------------------------------------------------------

    The proposed rules detailed in this release would only affect DCOs, 
DCMs, and SEFs. The Commission has previously determined that DCOs \95\ 
and DCMs \96\ are not ``small entities'' for purposes of the RFA. In 
contrast, SEFs constitute a new category of registrant that the Dodd-
Frank Act created. Accordingly, the Commission has not addressed the 
question of whether SEFs are, in fact, ``small entities'' for purposes 
of the RFA.
---------------------------------------------------------------------------

    \95\ 66 FR 45604, 45609 (August 29, 2001).
    \96\ 47 FR 18618, 18619 (April 30, 1982).
---------------------------------------------------------------------------

    The Dodd-Frank Act defines a SEF to mean a trading system or 
platform in which multiple participants have the

[[Page 63746]]

ability to execute or trade swaps by accepting bids and offers made by 
multiple participants in the facility or system, through any means of 
interstate commerce, including any trading facility that facilitates 
the execution of swaps between persons and is not a designated contract 
market.\97\ The Commission is hereby proposing that SEFs not be 
considered to be ``small entities'' for essentially the same reasons 
that DCMs and DCOs have previously been determined not to be small 
entities. These reasons include the fact that the Commission designates 
a contract market or registers a derivatives clearing organization only 
when it meets specific criteria including expenditure of sufficient 
resources to establish and maintain adequate self-regulatory programs. 
Likewise, the Commission will register an entity as a SEF only after it 
has met specific criteria including the expenditure of sufficient 
resources to establish and maintain an adequate self-regulatory 
program.\98\ Accordingly, the Commission does not expect the rules, as 
proposed herein, to have a significant impact on a substantial number 
of small entities. Therefore, the Chairman, on behalf of the 
Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that the 
proposed amendments will not have a significant economic impact on a 
substantial number of small entities. The Commission invites the public 
to comment on whether SEFs covered by these rules should be considered 
small entities for purposes of the RFA.
---------------------------------------------------------------------------

    \97\ See Section 721 of the Dodd-Frank Act. The Commission 
anticipates proposing regulations that would further specify those 
entities that must register as a SEF. The Commission does not 
believe that such proposals would alter its determination that a SEF 
is not a ``small entity'' for purposes of the RFA.
    \98\ See Core Principle 2 applicable to SEFs under Section 733 
of the Dodd-Frank Act.
---------------------------------------------------------------------------

b. Paperwork Reduction Act

    The Paperwork Reduction Act (``PRA'') \99\ imposes certain 
requirements on Federal agencies in connection with their conducting or 
sponsoring any collection of information as defined by the PRA. The 
proposed rules do not require a new collection of information on the 
part of any entities that would be subject to the proposed rules. 
Accordingly, for purposes of the PRA, the Commission certifies that the 
proposed rules, if promulgated in final form, would not impose any new 
reporting or recordkeeping requirements.
---------------------------------------------------------------------------

    \99\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

c. Cost-Benefit Analysis

    Section 15(a) of the CEA \100\ requires that the Commission, before 
promulgating a regulation or issuing an order, to consider the costs 
and benefits of its action. By its terms, Section 15(a) of the CEA does 
not require the Commission to quantify the costs and benefits of a new 
regulation or to determine whether the benefits of the regulation 
outweigh its costs. Rather, Section 15(a) of the CEA simply requires 
the Commission to ``consider the costs and benefits'' of its action.
---------------------------------------------------------------------------

    \100\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------

    Section 15(a) of the CEA further specifies that costs and benefits 
shall be evaluated in light of the following considerations: (1) 
Protection of market participants and the public; (2) efficiency and 
competition; (3) financial integrity of the futures markets and price 
discovery; (4) sound risk management practices; and (5) other public 
interest considerations. Accordingly, the Commission could, in its 
discretion, give greater weight to any one of the five considerations 
and could determine that, notwithstanding its costs, a particular 
regulation was 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.
    The Commission has evaluated the costs and benefits of the proposed 
rules, in light of the specific provisions of Section 15(a) of the CEA, 
as follows:
    1. Protection of market participants and the public. The proposed 
rules concern governance and conflicts of interest and seek to improve 
governance arrangements to prevent conflicts of interest that if not 
addressed, would serve the interests of one group of constituents over 
other groups, including other market participants and the public. The 
proposed rules require governance arrangements that allow the 
registered entities to better serve the public interest.
    2. Efficiency and competition. The proposed rules provide for the 
identification and mitigation of conflicts of interest, which improves 
efficiency in decision-making and increases fair access to clearing and 
markets which improves competition.
    3. Financial integrity of futures markets and price discovery. The 
proposed rules facilitate transparency in governance which, in turn, 
facilitates transparency in matters governed including increased fair 
access to clearing and trading which, in turn, facilitates price 
discovery. This decreases risk which, in turn, increases financial 
integrity.
    4. Sound risk management practices. The proposed rules provide for 
participation in decision-making by those who share in the risk 
presented by the operation of the registered entity. The governance 
arrangements provided by the proposed rules provide for a balance among 
different interests (including the public interest) so that risks 
presented by one group's interests will not dominate decision-making in 
the organization. This balance should prevent excess risk associated 
with any one group's interests from affecting operations.
    5. Other public interest considerations. The proposed rules provide 
for governance arrangements for DCOs, DCMs, and SEFs, as well as 
methods of mitigating the presence of conflicts of interest, that 
should, for the reasons, cited above, operate in the best interests of 
the public.
    Accordingly, after considering the five factors enumerated above, 
the Commission has determined to propose the regulations set forth 
below. The Commission invites public comment on its evaluation of the 
costs and benefits of the proposed rules. Specifically, commenters are 
invited to submit data quantifying the costs and benefits of the 
proposed rules with their comment letters.

VII. Text of Proposed Rules

List of Subjects

17 CFR Part 1

    Definitions, Directors, Committees.

17 CFR Part 37

    Swap execution facility, Conflict of Interest, Membership, Access, 
Voting, Ownership.

17 CFR Part 38

    Designated contract markets, Conflict of interest, Membership, 
Access, Voting, Ownership.

17 CFR Part 39

    Registered clearing organization, Conflict of interest, Membership, 
Access, Voting, Ownership.

17 CFR Part 40

    Governance, Directors, Committees, Conflict of interest.

    For the reasons stated in this release, the Commission hereby 
amends 17 CFR parts 1, 37, 38, 39, and 40 as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

    1. Revise the authority citation for part 1 to read as follows:


[[Page 63747]]


    Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f, 
6h, 6i, 6j, 6k, 6l, 6m, 6n, 60, 6p, 7, 7a, 7b, 8, 9, 12, 12c, 13a, 
13a-1, 16, 16a, 19, 21, 23, and 24 and Sec. 726, Pub. L. 111-203, 
124 Stat. 1376.

    2. Section 1.3 is amended by adding paragraphs (zz) through (aaa) 
to read as follows:


Sec.  1.3  Definitions

    (zz) Board of Directors. This term means the Board of Directors or 
Board of Governors of a company or organization, or equivalent 
governing body.
    (aaa) Disciplinary Panel. This term shall be as defined in Sec.  
40.9(c)(3)(i).
    (bbb) Executive Committee. This term shall mean a committee of the 
Board of Directors that may exercise the authority delegated to it by 
the Board of Directors with respect to the management of the company or 
organization.
    (ccc) Public Director. This term means a member of the Board of 
Directors (each, a ``director'') of a registered derivatives clearing 
organization (as defined in Section 1a(15) of the Act), a board of 
trade designated as a contract market pursuant to Section 5 of the Act, 
or a registered swap execution facility (as defined in Section 1a(50) 
of the Act), as applicable, who has been found, by the Board of 
Directors of the registered entity, on the record, to have no material 
relationship with such registered entity. The Board of Directors must 
make such finding upon the nomination or appointment of the director 
and as often as necessary in light of all circumstances relevant to 
such director, but in no case less than annually.
    (1) For purposes of this definition, a ``material relationship'' is 
one that reasonably could affect the independent judgment or decision-
making of the director. In making the finding specified in paragraph 
(ccc) of this section, the Board of Directors need not consider 
previous service as a director of the registered entity to constitute a 
``material relationship.'' Circumstances in which a director shall be 
considered to have a ``material relationship'' with the registered 
entity include, but are not limited to, the following:
    (i) Such director is an officer or an employee of the registered 
entity, or an officer or an employee of its affiliate. In this context, 
``affiliate'' includes parents or subsidiaries of the registered entity 
or entities that share a common parent with the registered entity;
    (ii) Such director is a member of the registered entity, or a 
director, an officer, or an employee of a member. In this context, 
``member'' is defined according to Section 1a(34) of the Act and any 
regulation promulgated thereunder, including, without limitation, 
Sec. Sec.  1.3(c) and (q) of this chapter and any successor provisions;
    (iii) Such director is an officer of another entity, which entity 
has a compensation committee (or similar body) on which any officer of 
the registered entity serves;
    (iv) Such director, or an entity with which the director is a 
partner, an officer, an employee, or a director, receives more than 
$100,000 in combined annual payments for legal, accounting, or 
consulting services from the registered entity, any affiliate thereof 
(as defined in paragraph (ccc)(1)(i) of this section), any member of 
the registered entity (as defined in paragraph (ccc)(1)(ii) of this 
section), or any affiliate of such member. Compensation for services as 
a director of the registered entity or as a director of an affiliate 
thereof does not count toward the $100,000 payment limit, nor does 
deferred compensation for services rendered prior to becoming a 
director of the registered entity, so long as such compensation is in 
no way contingent, conditioned, or revocable; or
    (v) Notwithstanding paragraph (ccc)(1)(iv) of this section, in the 
case of a public director that is a member of the Regulatory Oversight 
Committee, the Risk Management Committee (or any subcommittee thereof), 
or the Membership or Participation Committee (or any committee serving 
a similar function), such director (other than in the capacity of a 
member of such committee, any other committee, or the Board of 
Directors, in each case, of the registered entity), accepts, directly 
or indirectly, any consulting, advisory, or other compensatory fee from 
the registered entity, any affiliate thereof (as defined in paragraph 
(ccc)(1)(i) of this section), any member of the registered entity (as 
defined in paragraph (ccc)(1)(ii) of this section), or any affiliate of 
such member, other than deferred compensation for service rendered 
prior to becoming a member of the Regulatory Oversight Committee, the 
Risk Management Committee (or any subcommittee thereof), or the 
Membership or Participation Committee (or any committee serving a 
similar function), provided that such compensation is in no way 
contingent, conditioned, or revocable.
    (vi) Any of the relationships set forth in paragraphs (ccc)(1)(i) 
through (ccc)(1)(v) of this section apply to the ``immediate family'' 
of such director, i.e., spouse, parents, children, and siblings, in 
each case, whether by blood, marriage, or adoption, or any person 
residing in the home of the director or that of his or her ``immediate 
family.''
    (2) All of the disqualifying circumstances described in paragraph 
(ccc)(1)(i) through (ccc)(1)(v) of this section shall be subject to a 
one-year look back.
    (3) A public director of any registered entity specified in 
paragraph (ccc) of this section may also serve as a public director of 
an affiliate of the registered entity (as defined in paragraph 
(ccc)(1)(i) of this section) if he or she otherwise meets the 
requirements in paragraph (ccc)(1)(i) through (ccc)(1)(v) of this 
section.
    (ddd) Membership or Participation Committee. This term shall be as 
defined in Sec.  37.19(c)(1)(i), with respect to a registered swap 
execution facility, and Sec.  38.851(c)(1)(i), with respect to a 
designated contract market.
    (eee) Nominating Committee. This term shall be as defined in Sec.  
40.9(c)(1)(i).
    (fff) Regulatory Oversight Committee. This term shall be as defined 
in Sec.  37.19(b)(1), with respect to a registered swap execution 
facility, and Sec.  38.851(b)(1), with respect to a designated contract 
market.
    (ggg) Risk Management Committee. This term shall be as defined in 
Sec.  39.13(g)(1).

PART 37--SWAP EXECUTION FACILITIES

    3. Revise the authority citation for part 37 to read as follows:

    Authority: Sec. 726, Pub. L. 111-203, 124 Stat. 1376.

    4. Revise the heading to Part 37 to read as set forth above.
    5. Add Sec.  37.19 to read as follows:


Sec.  37.19  Conflicts of Interest.

    (a) General. The swap execution facility shall:
    (1) Establish and enforce rules to minimize conflicts of interest 
in its decision-making process; and
    (2) Establish a process for resolving the conflicts of interest. 
Nothing in this section shall supersede any requirement applicable to 
the registered swap execution facility under Sec.  40.9 of this 
chapter.
    (b) Regulatory Oversight Committee.
    (1) General. A registered swap execution facility shall have a 
regulatory oversight committee (the ``Regulatory Oversight 
Committee''), which shall:
    (i) Monitor the regulatory program of the registered entity for 
sufficiency, effectiveness, and independence;
    (ii) Oversee all facets of the regulatory program, including:
    (A) Trade practice and market surveillance; audits, examinations, 
and

[[Page 63748]]

other regulatory responsibilities with respect to members (including 
ensuring compliance with, if applicable, financial integrity, financial 
reporting, sales practice, recordkeeping, and other requirements); and 
the conduct of investigations;
    (B) Reviewing the size and allocation of the regulatory budget and 
resources, and the number, hiring, termination, and compensation of 
regulatory personnel;
    (C) Reviewing the performance of the Chief Compliance Officer (as 
referenced in Section 5h(f)(15) of the Act) and making recommendations 
with respect to such performance to the Board of Directors;
    (D) Recommending changes that would ensure fair, vigorous, and 
effective regulation; and
    (E) Reviewing all regulatory proposals prior to implementation and 
advising the Board of Directors as to whether and how such changes may 
impact regulation.
    (2) Reporting. The Regulatory Oversight Committee shall report to 
the Board of Directors of the registered swap execution facility.
    (3) Composition. The Regulatory Oversight Committee shall be 
composed entirely of Public Directors.
    (4) Delegation. The Regulatory Oversight Committee shall oversee 
the regulatory program of the registered swap execution facility on 
behalf of the Board of Directors. The Board of Directors shall delegate 
sufficient authority, dedicate sufficient resources, and allow 
sufficient time for the Regulatory Oversight Committee to fulfill its 
mandate.
    (c) Membership or Participation.
    (1) Committee.
    (i) General. A registered swap execution facility shall have a 
membership or participation committee (the ``Membership or 
Participation Committee''), which shall, at a minimum, perform the 
following functions:
    (A) Determine the standards and requirements for initial and 
continuing membership or participation eligibility;
    (B) Review appeals of staff denials of membership or participation 
applications; and
    (C) Approve rules that would result in different categories or 
classes of members or participants receiving disparate access to the 
registered swap execution facility.
    (ii) Reporting. The Membership or Participation Committee shall 
report to the Board of Directors of the registered swap execution 
facility.
    (iii) Composition. The Membership or Participation Committee shall 
be composed of thirty-five percent Public Directors.
    (iv) Delegation. The Board of Directors may choose to delegate the 
performance of the functions of the Membership or Participation 
Committee to one or more other committees, provided that each such 
committee meets the composition requirements set forth in paragraph 
(c)(1)(iii) of this section. If the Board of Directors chooses to so 
delegate, the registered swap execution facility would no longer need 
to maintain a Membership or Participation Committee.
    (2) Access.
    (i) In reviewing appeals of staff denials of membership or 
participation applications, the Membership or Participation Committee 
(or entity performing the functions of such committee) shall not uphold 
any staff denial if the relevant application meets the standards and 
requirements that such committee sets forth.
    (ii) The Membership or Participation Committee (or entity 
performing the functions of such committee) shall not, and shall not 
permit the registered swap execution facility to, restrict access or 
impose burdens on access in a discriminatory manner, within each 
category or class of members or participants or between similarly-
situated categories or classes of members or participants.
    (d) Limits on Voting Equity Ownership and the Exercise of Voting 
Power.
    (1) Definitions. For purposes of this Sec.  37.19(d):
    (i) Related Persons means, with respect to any member of a 
registered swap execution facility:
    (A) Any person that, directly or indirectly, is a parent or 
subsidiary of, or shares a common parent with, such member;
    (B) Any partner, director, officer, or other employee of such 
member;
    (C) Any immediate family member of such member, or any immediate 
family member of such member's spouse, in each case, who has the same 
home as such member; or
    (D) Any immediate family member of the persons enumerated in 
paragraph (d)(1)(i)(B) of this section, or any immediate family member 
of such person's spouse, in each case, who has the same home as such 
person.
    (2) Limits. A registered swap execution facility shall not permit 
any member, together with any Related Persons of such member, to:
    (i) Beneficially own, directly or indirectly, more than twenty 
percent of any class of equity interest of the registered swap 
execution facility entitled to vote; or
    (ii) Directly or indirectly vote, cause the vote of, give any 
consent or proxy with respect to the voting of, or enter into any 
shareholder agreement regarding the voting of, any interest in the 
registered swap execution facility that exceeds twenty percent of the 
voting power of any class of equity interest of the registered swap 
execution facility.
    (3) Parent Companies. If the registered swap execution facility is 
a subsidiary, paragraph (d)(2) of this section shall apply to its 
parent, whether direct or indirect, in the same manner as it applies to 
the registered swap execution facility. If any parent is publicly-
listed on a domestic exchange, then such parent must follow the voting 
requirements promulgated by the Securities and Exchange Commission or 
the entity on which such parent is listed.
    (4) Remediation. A registered swap execution facility must have 
rules addressing the manner in which it would remediate any breach of 
the limits set forth in paragraph (d)(2) of this section. Such rules 
must specify, at a minimum:
    (i) The manner in which the registered swap execution facility 
would redeem any equity interest that a member or a Related Person 
purchased in excess of the limits set forth in paragraph (d)(2) of this 
section;
    (ii) The manner in which the registered swap execution facility 
would disregard any votes cast in excess of such limits; and
    (iii) The manner in which the registered swap execution facility 
would cause any breach of such limits to be reported to the Chief 
Compliance Officer (as referenced in Section 5h(f)(15) of the Act).

PART 38--DESIGNATED CONTRACT MARKETS

    6. Revise the authority citation for part 38 to read as follows:

    Authority:  7 U.S.C. 2, 5, 6, 6c, 7, 7a-2 and 12a and Sec. 726, 
Pub. L. 111-203, 124 Stat. 1376.

    7. Section 38.1 is amended by adding a new sentence to the end of 
the section to read as follows:


Sec.  38.1  Scope.

    * * * Nothing in this Part 38 shall apply to a board of trade 
designated as a contract market pursuant to Section 5f of the Act.
    8. Add Sec.  38.851 to read as follows:


Sec.  38.851  Conflicts of interest.

    (a) General. A designated contract market shall establish and 
enforce rules

[[Page 63749]]

to minimize conflicts of interest in its decision-making process and 
establish a process for resolving any conflicts of interest. Nothing in 
this section shall supersede any requirement applicable to the 
designated contract market under Sec.  40.9 of this chapter.
    (b) Regulatory Oversight Committee.
    (1) General. A designated contract market shall have a regulatory 
oversight committee (``Regulatory Oversight Committee''), which shall:
    (i) Monitor the regulatory program of the registered entity for 
sufficiency, effectiveness, and independence;
    (ii) Oversee all facets of the regulatory program, including:
    (A) Trade practice and market surveillance; audits, examinations, 
and other regulatory responsibilities with respect to members 
(including ensuring compliance with, if applicable, financial 
integrity, financial reporting, sales practice, recordkeeping, and 
other requirements); and the conduct of investigations;
    (B) Reviewing the size and allocation of the regulatory budget and 
resources, and the number, hiring, termination, and compensation of 
regulatory personnel;
    (C) Supervising the chief regulatory officer of the designated 
contract market, who will report directly to the Regulatory Oversight 
Committee;
    (D) Recommending changes that would ensure fair, vigorous, and 
effective regulation; and
    (E) Reviewing all regulatory proposals prior to implementation and 
advising the Board of Directors as to whether and how such changes may 
impact regulation.
    (2) Reporting. The Regulatory Oversight Committee shall report to 
the Board of Directors of the designated contract market.
    (3) Composition. The Regulatory Oversight Committee shall be 
composed entirely of Public Directors.
    (4) Delegation. The Regulatory Oversight Committee shall oversee 
the regulatory program of the designated contract market on behalf of 
the Board of Directors. The Board of Directors shall delegate 
sufficient authority, dedicate sufficient resources, and allow 
sufficient time for the Regulatory Oversight Committee to fulfill its 
mandate.
    (c) Membership or Participation.
    (1) Committee.
    (i) General. A designated contract market shall have a membership 
or participation committee (``Membership or Participation Committee''), 
which shall, at a minimum, perform the following functions:
    (A) Determine the standards and requirements for initial and 
continuing membership or participation eligibility;
    (B) Review appeals of staff denials of membership or participation 
applications; and
    (C) Approve rules that would result in different categories or 
classes of members or participants receiving disparate access to the 
designated contract market.
    (ii) Reporting. The Membership or Participation Committee shall 
report to the Board of Directors of the designated contract market.
    (iii) Composition. The Membership or Participation Committee shall 
be composed of thirty-five percent Public Directors.
    (iv) Delegation. The Board of Directors may choose to delegate the 
performance of the functions of the Membership or Participation 
Committee to one or more other committees, provided that each such 
committee meets the composition requirements set forth in paragraph 
(c)(1)(iii) of this section. If the Board of Directors chooses to so 
delegate, the registered swap execution facility would no longer need 
to maintain a Membership or Participation Committee.
    (2) Access.
    (i) In reviewing appeals of staff denials of membership or 
participation applications, the Membership or Participation Committee 
(or entity performing the functions of such committee) shall not uphold 
any staff denial if the relevant application meets the standards and 
requirements that such committee sets forth.
    (ii) The Membership or Participation Committee (or entity 
performing the functions of such committee) shall not, and shall not 
permit the registered swap execution facility to, restrict access or 
impose burdens on access in a discriminatory manner, within each 
category or class of members or participants or between similarly-
situated categories or classes of members or participants.
    (d) Limits on Voting Equity Ownership and the Exercise of Voting 
Power.
    (1) Definitions. For purposes of this Sec.  38.851(d):
    (i) Related Persons means, with respect to any member of a 
designated contract market:
    (A) Any person that, directly or indirectly, is a parent or 
subsidiary of, or shares a common parent with, such member;
    (B) Any partner, director, officer, or other employee of such 
member;
    (C) Any immediate family member of such member, or any immediate 
family member of such member's spouse, in each case, who has the same 
home as such member; or
    (D) Any immediate family member of the persons enumerated in 
paragraph (d)(1)(i)(B) of this section, or any immediate family member 
of such person's spouse, in each case, who has the same home as such 
person.
    (2) Limits. A designated contract market shall not permit any 
member, together with any Related Persons of such member, to:
    (i) Beneficially own, directly or indirectly, more than twenty 
percent of any class of equity interest of the designated contract 
market entitled to vote; or
    (ii) Directly or indirectly vote, cause the vote of, give any 
consent or proxy with respect to the voting of, or enter into any 
shareholder agreement regarding the voting of, any interest in the 
designated contract market that exceeds twenty percent of the voting 
power of any class of equity interest of the designated contract 
market.
    (3) Parent Companies. If the designated contract market is a 
subsidiary, paragraph (d)(2) of this section shall apply to its parent, 
whether direct or indirect, in the same manner as it applies to the 
designated contract market. If any parent is publicly-listed on a 
domestic exchange, then such parent must follow the voting requirements 
promulgated by the Securities and Exchange Commission or the entity on 
which such parent is listed.
    (4) Remediation. A designated contract market must have rules 
addressing the manner in which it would remediate any breach of the 
limits set forth in paragraph (d)(2) of this section. Such rules must 
specify, at a minimum:
    (i) The manner in which the designated contract market would redeem 
any equity interest that a member or a Related Person purchased in 
excess of the limits set forth in paragraph (d)(2) of this section;
    (ii) The manner in which the designated contract market would 
disregard any votes cast in excess of such limits; and
    (iii) The manner in which the designated contract market would 
cause any breach of such limits to be reported to the chief regulatory 
officer.

PART 39--DERIVATIVES CLEARING ORGANIZATIONS

    9. Revise the authority citation for part 39 read as follows:

    Authority: 7 U.S.C. 7b and Sec. 726, Pub. L. 111-203, 124 Stat. 
1376.

    10. Add Sec.  39.13 to read as follows:

[[Page 63750]]

Sec.  39.13  Risk Management.

    (a) through (g) [Reserved]
    (g) Risk Management Committee.
    (1) General. A derivatives clearing organization shall have a risk 
management committee (the ``Risk Management Committee''), which shall, 
at a minimum, perform the following functions:
    (i) Advise the Board of Directors on significant changes to the 
derivatives clearing organization's risk model and default procedures;
    (ii) Determine the standards and requirements for initial and 
continuing clearing membership eligibility;
    (iii) Approve or deny (or review approvals or denials of) clearing 
membership applications;
    (iv) Determine products eligible for clearing; and
    (v) Review the performance of the Chief Compliance Officer (as 
referenced in Section 5b(i) of the Act) and make recommendations with 
respect to such performance to the Board of Directors.
    (2) Reporting. The Risk Management Committee shall report to the 
Board of Directors of the derivatives clearing organization.
    (3) Composition.
    (i) The Risk Management Committee shall be composed of at least 
thirty-five percent Public Directors of a derivatives clearing 
organization and at least ten percent representatives of customers. In 
this context, a ``customer'' means any customer of a clearing member, 
including, without limitation:
    (A) Any ``customer'' or ``commodity customer'' within the meaning 
of Sec.  1.3(k) of this chapter;
    (B) Any ``foreign futures or foreign options customer'' within the 
meaning of Sec.  30.1(c) of this chapter; and
    (C) Any customer entering into a cleared swap (as defined in 
Section 1a(7) of the Act).
    (ii) The remaining members of such Risk Management Committee (or 
subcommittee thereof as described in paragraph (g)(5) of this section) 
may be, in the discretion of the derivatives clearing organization, 
representatives of clearing members. No such member shall be an 
employee of the derivatives clearing organization.
    (iii) The Chairman of the Risk Management Committee (or 
subcommittee thereof as described in paragraph (g)(5) of this section) 
shall be a Public Director.
    (4) Meetings. The Risk Management Committee shall hold regular 
meetings. The Committee may invite employees of the derivatives 
clearing organization to attend its meetings in a non-voting capacity.
    (5) Delegation. The Risk Management Committee may delegate, in 
writing, the performance of the functions enumerated in paragraph 
(g)(1)(ii) to (iv) of this section to a subcommittee, provided that 
such subcommittee meets the composition requirements set forth in 
paragraph (g)(3) of this section. If the Risk Management Committee 
chooses to so delegate, then it would no longer be subject to such 
composition requirements.
    (6) Discretion.
    (i) No decision of a subcommittee with delegated authority under 
paragraph (g)(5) of this section, pertaining to the functions 
enumerated in paragraph (g)(1)(ii) to (iv) of this section, may be 
subject to the approval of, or otherwise restricted or limited by, a 
body other than the Board of Directors or the Risk Management Committee 
of the derivatives clearing organization, including, without 
limitation, any advisory committee.
    (ii) No decision of the Risk Management Committee pertaining to the 
functions enumerated in paragraph (g)(1)(ii) to (iv) of this section, 
may be subject to the approval of, or otherwise restricted or limited 
by, a body other than the Board of Directors of the derivatives 
clearing organization, including, without limitation, any advisory 
committee.
    11. Add Sec.  39.25 to read as follows:


Sec.  39.25  Conflicts of interest.

    (a) General. (1) A derivatives clearing organization shall 
establish and enforce rules to minimize conflicts of interest in its 
decision-making process and establish a process for resolving any 
conflicts of interest.
    (2) Governance arrangements for derivatives clearing organizations 
should be clear and transparent and be designed to promote the safety 
and efficiency of the derivatives clearing organization, to support the 
stability of the broader financial system and other relevant public 
interest considerations, and to support the objectives of relevant 
stakeholders.
    (3) Nothing in this section shall supersede any requirement 
applicable to the derivatives clearing organization under Sec.  40.9 of 
this chapter.
    (b) Limits on Voting Equity Ownership and the Exercise of Voting 
Power.
    (1) Definitions. For purposes of this Sec.  39.25(b):
    (i) Affiliate means any person that, directly or indirectly, 
controls, is controlled by, or is under common control with, another 
person.
    (ii) Enumerated Entities means:
    (A) A bank holding company (as defined in Section 2 of the Bank 
Holding Company Act of 1956 (12 U.S.C. 1841)) with total consolidated 
assets of $50,000,000,000 or more,
    (B) A nonbank financial company (as defined in Section 102 of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act) supervised 
by the Board of Governors of the Federal Reserve System,
    (C) An Affiliate of such bank holding company or nonbank financial 
company,
    (D) A swap dealer (as defined in Section 1a(49) of the Act and any 
regulations promulgated thereunder),
    (E) A major swap participant (as defined in Section 1a(33) of the 
Act and any regulations promulgated thereunder), and
    (F) An associated person of a swap dealer or major swap participant 
(as defined in Section 1a(3) of the Act and any regulations promulgated 
thereunder).
    (iii) Related Persons means, with respect to any person:
    (A) An Affiliate of such person;
    (B) Any partner, director, officer, or other employee of such 
person;
    (C) Any immediate family member of such person, or any immediate 
family member of such person's spouse, in each case, who has the same 
home as such person; or
    (D) Any immediate family member of the persons enumerated in 
paragraph (b)(1)(iii)(B) of this section, or any immediate family 
member of such person's spouse, in each case, who has the same home as 
such person.
    (2) Limits. A derivatives clearing organization shall choose to 
comport with either paragraph (b)(2)(i) or (b)(2)(ii) of this section:
    (i)(A) The derivatives clearing organization shall not permit any 
member, together with any Related Persons of such member, to:
    (1) Beneficially own, directly or indirectly, more than twenty 
percent of any class of equity interest of the derivatives clearing 
organization entitled to vote; or
    (2) Directly or indirectly vote, cause the vote of, give any 
consent or proxy with respect to the voting of, or enter into any 
shareholder agreement regarding the voting of, any interest in the 
derivatives clearing organization that exceeds twenty percent of the 
voting power of any class of equity interest of the derivatives 
clearing organization.
    (B) Additionally, a derivatives clearing organization shall not 
permit the Enumerated Entities (whether or not they are clearing 
members), together with any Related Persons of such Enumerated 
Entities, to collectively:
    (1) Own, on a beneficial basis, directly or indirectly, more than 
forty percent of

[[Page 63751]]

any class of equity interest of the derivatives clearing organization 
entitled to vote; or
    (2) Directly or indirectly vote, cause the vote of, give any 
consent or proxy with respect to the voting of, or enter into any 
shareholder agreement regarding the voting of, any interest in the 
derivatives clearing organization that exceeds forty percent of the 
voting power of any class of equity interest of the derivatives 
clearing organization.
    (C) The derivatives clearing organization shall ensure that no 
resolution or similar measure on which the Enumerated Entities are 
entitled to vote shall be passed by less than a majority of all 
outstanding equity interests similarly entitled to vote.
    (ii) The derivatives clearing organization shall not permit any 
member or any Enumerated Entity (whether or not such entity is a 
member), together with any Related Persons in each case thereof, to:
    (A) Beneficially own, directly or indirectly, more than five 
percent of any class of equity interest of the derivatives clearing 
organization entitled to vote; or
    (B) Directly or indirectly vote, cause the vote of, give any 
consent or proxy with respect to the voting of, or enter into any 
shareholder agreement regarding the voting of, any interest in the 
derivatives clearing organization that exceeds five percent of the 
voting power of any class of equity interest of the derivatives 
clearing organization.
    (3) Waiver.
    (i) A derivatives clearing organization may request that the 
Commission waive the requirements set forth in paragraph (b)(2) of this 
section.
    (ii)(A) The Commission may grant a waiver for a period of time that 
it deems reasonable if, upon a showing by a derivatives clearing 
organization, the Commission determines that, with respect to the 
derivatives clearing organization, the requirements set forth in 
paragraph (b)(2) of this section are not necessary or appropriate to:
    (1) Improve the governance of the derivatives clearing 
organization;
    (2) Mitigate systemic risk;
    (3) Promote competition;
    (4) Mitigate conflicts of interest in connection with a swap dealer 
or major swap participant's conduct of business with the derivatives 
clearing organization, including with respect to Section 2(h)(1)(B) and 
Section 5b(c)(2)(c) of the Act; and
    (5) Otherwise accomplish the purposes of the Act.
    (B) The Commission may, at any time, revoke the waiver upon its own 
motion. Upon such revocation, or at the expiration of the waiver 
period, the derivatives clearing organization shall require all equity 
holders to comport, through divestiture or other means, with the 
requirements set forth in paragraph (b)(2) of this section.
    (4) Parent Companies. If the derivatives clearing organization is a 
subsidiary, paragraph (b)(2) of this section shall apply to its parent, 
whether direct or indirect, in the same manner as it applies to the 
derivatives clearing organization. If any parent is publicly listed on 
a domestic exchange, then such parent must follow the voting 
requirements promulgated by the Securities and Exchange Commission or 
the entity on which such parent is listed.
    (5) Remediation. A derivatives clearing organization must have 
rules addressing the manner in which it would remediate any breach of 
the limits set forth in paragraph (b)(2) of this section. Such rules 
must specify, at a minimum:
    (i) The manner in which the derivatives clearing organization would 
redeem any equity interest that a member, the Enumerated Entities, or a 
Related Person in each case thereof, purchased in excess of the limits 
set forth in paragraph (b)(2) of this section;
    (ii) The manner in which the derivatives clearing organization 
would disregard any votes cast in excess of such limits; and
    (iii) The manner in which the derivatives clearing organization 
would cause any breach of such limits to be reported to the Chief 
Compliance Officer (as referenced in Section 5b(i) of the Act).

PART 40--PROVISIONS COMMON TO REGISTERED ENTITIES

    1. Revise the authority citation for part 40 to read as follows:

    Authority: 7 U.S.C. 1a, 2, 5, 6, 7, 7a, 8, and 12a, and Sec. 
726, Pub. L. 111-203, 124 Stat. 1376.
    2. Add Sec.  40.9 to read as follows:


Sec.  40.9  Governance.

    (a) General. (1) Nothing in this section shall apply to a board of 
trade designated as a contract market pursuant to Section 5f of the 
Act.
    (2) Capitalized terms not defined herein shall have the meanings 
assigned to them in Sec.  1.3 of this chapter.
    (3) Nothing in this section shall supersede any requirement 
applicable to the registered entity under Parts 37, 38, or 39 of this 
chapter.
    (b) The Board of Directors.
    (1) General.
    (i) The Board of Directors of a registered derivatives clearing 
organization, a designated contract market, or a registered swap 
execution facility shall be composed of at least thirty-five percent, 
but no less than two, Public Directors.
    (ii) The roles and responsibilities of such Board of Directors must 
be clearly articulated, especially in respect of the manner in which 
the Board of Directors ensures that a registered entity referenced in 
paragraph (b)(1)(i) of this section complies with all statutory, 
regulatory, and self-regulatory responsibilities under the Act and the 
regulations promulgated thereunder.
    (2) Parent Companies.
    (i) For purposes of paragraph (b)(2) of this section, ``operate'' 
shall mean the direct exercise of control (including through the 
exercise of veto power) over the day-to-day business operations of a 
registered entity specified in paragraph (b)(1)(i) of this section by 
the sole or majority shareholder of such registered entity, whether 
through the ownership of voting equity, by contract, or otherwise. The 
term ``operate'' shall not prohibit an entity, acting as the sole or 
majority shareholder of such registered entity, from exercising its 
rights as a shareholder under any contract, agreement, or other legal 
obligation.
    (ii) A registered entity specified in paragraph (b)(1)(i) of this 
section shall not permit itself to be operated by any entity unless 
such entity agrees that:
    (A) Paragraph (b)(1) of this section shall apply to such entity in 
the same manner as it applies to the registered entity;
    (B) The officers, directors, employees, and agents of such entity 
shall be deemed to be the officers, directors, employees, and agents of 
the registered entity, and shall thereby be subject to the authority of 
the Commission pursuant to the Act and the regulations promulgated 
thereunder; and
    (C) Any books and records of such entity relating to such operation 
shall be deemed to be the books and records of the registered entity 
for purposes of the Act and the regulations promulgated thereunder. 
Such books and records shall be subject at all times to inspection and 
copying by the Commission, regardless of whether such books and records 
contain confidential information, as long as such entity operates the 
registered entity.
    (3) Expertise. The members of the Board of Directors, including 
Public Directors, of each registered entity specified in paragraph 
(b)(1)(i) of this section, shall be of sufficiently good repute and, 
where applicable, have sufficient expertise in financial services, risk 
management, and clearing services.

[[Page 63752]]

    (4) Compensation. The compensation of the Public Directors and 
other non-executive members of the Board of Directors of a registered 
entity specified in paragraph (b)(1)(i) of this section shall not be 
linked to the business performance of such registered entity.
    (5) Annual Self-Review. The Board of Directors of a registered 
entity specified in paragraph (b)(1)(i) of this section shall review 
its performance and that of its individual members annually. It should 
consider periodically using external facilitators for such reviews.
    (6) Board Member Removal. A registered entity specified in 
paragraph (b)(1)(i) of this section shall have procedures to remove a 
member from the Board of Directors, where the conduct of such member is 
likely to be prejudicial to the sound and prudent management of the 
registered entity.
    (c) Committees and Panels.
    (1) Nominating Committee.
    (i) General. Each registered derivatives clearing organization, 
designated contract market, or registered swap execution facility must 
have a nominating committee (``Nominating Committee''), which shall, at 
a minimum:
    (A) identify individuals qualified to serve on the Board of 
Directors, consistent with criteria approved by the Board of Directors, 
and with the composition requirements set forth in this section; and
    (B) Administer a process for the nomination of individuals to the 
Board of Directors.
    (ii) Reporting. The Nominating Committee shall report to the Board 
of Directors of the registered entity.
    (iii) Composition. The Nominating Committee shall be composed of at 
least fifty-one percent Public Directors. The chair of the Nominating 
Committee shall be a Public Director.
    (2) Executive Committee. Any Executive Committee of a registered 
derivatives clearing organization, designated contract market, or 
registered swap execution facility shall be composed of at least 
thirty-five percent, but no less than two, Public Directors.
    (3) Disciplinary Panels.
    (i) General. Each registered derivatives clearing organization, 
designated contract market, or registered swap execution facility must 
have one or more disciplinary panels (each, a ``Disciplinary Panel''), 
each of which shall be responsible for conducting hearings, rendering 
decisions, and imposing sanctions with respect to disciplinary matters.
    (ii) Composition. Each Disciplinary Panel shall include at least 
one person who would not be disqualified from serving as a Public 
Director by Sec.  1.3(ccc)(1)(i)-(vi) and (2) of this chapter (a 
``Public Participant''). Such Public Participant shall chair each 
Disciplinary Panel. In addition, any registered entity specified in 
paragraph (c)(3)(i) of this section shall adopt rules that would, at a 
minimum:
    (A) Further preclude any group or class of participants from 
dominating or exercising disproportionate influence on a Disciplinary 
Panel and
    (B) Prohibit any member of a Disciplinary Panel from participating 
in deliberations or voting on any matter in which the member has a 
financial interest.
    (iii) Appeals. If the rules of the registered entity provide that 
the decision of a Disciplinary Panel may be appealed to another 
committee of the Board of Directors (or similar body), then such 
committee must also include at least one Public Participant, and such 
Public Participant must chair the committee.
    (iv) Exception. Notwithstanding the foregoing, paragraphs 
(c)(3)(ii) through (c)(3)(iii) of this section do not apply to a 
Disciplinary Panel convened for cases solely involving decorum or 
attire.
    (v) Delegation. With respect to a registered derivatives clearing 
organization, the Board of Directors may delegate to the Risk 
Management Committee the performance of the functions of the 
Disciplinary Panel. If the Board of Directors so delegates:
    (A) The registered derivatives clearing organization need no longer 
maintain a Disciplinary Panel, but
    (B) Paragraph (c)(3)(iii) of this section would still apply to any 
committee (or similar body) to which a decision of the Risk Management 
Committee may be appealed.

    Issued in Washington, DC, on October 1, 2010, by the Commission.
David A. Stawick,
Secretary of the Commission.

Concurring Statement of Commissioner Scott D. O'Malia

October 1, 2010 Public Meeting

    I concur in the Commission's proposal of rules pursuant to 
Section 726 of the Dodd-Frank Act (the ``Act''). However, I have a 
number of concerns associated with the prescriptiveness of the 
proposed conflict of interest rules. I believe, given the goals of 
the Act, it is appropriate to consider more flexible ownership 
structures and voting rights levels as well as the availability of 
waivers for derivatives clearing organizations (``DCOs'').

Ownership and Voting Limits on DCOs

    A main goal of the Act is to mitigate systemic risk in the U.S. 
financial system by imposing a mandatory clearing requirement on 
swaps. Additionally, the business of clearing is serious and 
financially complex. I am concerned that the proposed rules may not 
properly consider the effect on mitigation of systemic risk, 
competition, and capital formation in the DCO space, or afford the 
Commission with the necessary flexibility to achieve those outcomes. 
Given that the Commission has yet to consider any new DCO 
applications under the Act, it is extremely unwise to conduct an 
experiment with the ownership structure of DCOs.
    Second, a stated goal of the Act was to provide all market 
participants with fair, open, and non-discriminatory access to DCOs. 
To achieve that end, Congress included Open Access and Participant 
and Product Eligibility provisions in the Act.\101\ Each provision 
addresses and attempts to eliminate the potential for clearing 
entities to use ownership control to obstruct market participants 
from gaining access to a DCO. Rather than utilizing the limited and 
inflexible ownership caps in the proposed rules, I believe that the 
open access and eligibility provisions will be more effective in 
achieving the Act's goals of fair, open, and non-discriminatory 
access to DCOs.
---------------------------------------------------------------------------

    \101\ Section 2(h)(1)(B) and Section 5b(c)(2)(c) of the Act.
---------------------------------------------------------------------------

    Third, an overarching goal of the Act is the international 
harmonization of financial regulation. I believe that it's 
especially important for the Commission to harmonize its rules with 
those of foreign regulators in order to prevent regulatory 
arbitrage. With that said, the European Commission released 
(September 15, 2010) a proposal on financial reform which does not 
place individual or aggregate ownership limits on DCOs under 
European Union jurisdiction.
    For the aforementioned reasons, I am in favor of a more flexible 
approach to limitations on DCO ownership and voting rights, 
including the availability of a full waiver for individual and 
aggregate ownership or voting limits on swap dealers or major swap 
participants that hold or desire to hold debt or equity positions in 
DCOs.

Public Directors

    I fully support the Commission's decision to require a 
registered entity to have its board of directors and certain other 
committees composed of thirty-five percent (35%) public directors. 
This standard is consistent with the Commission's previous core 
principle 15 for designated contract markets (``DCMs''). The 
Commission thoroughly vetted this percentage with the public in a 
recent rulemaking and it concluded that having a board of directors 
for DCMs composed of thirty-five percent (35%) public directors was 
neither overly burdensome nor cost prohibitive. Today's proposed 
rulemaking also raises the question as to whether it is desirable to 
expand the existing rule from thirty-five percent (35%) up to fifty-
one percent (51%) for DCMs, DCOs, and swap execution facilities. I 
am interested to know how this proposal would enhance the governance 
of the existing board structures of certain registered entities, and 
more specifically, how it would expand the clearing and risk 
management expertise of a DCO.

[[Page 63753]]

    I strongly encourage the public to closely analyze the language 
of each proposed rule and to provide the Commission with 
constructive and detailed comments on each of them. In particular, I 
am interested to know (i) what effect the Commission's proposed 
rules on voting and ownership limitations will have on competition, 
raising capital, and managing risk, and (ii) whether or not the open 
access and eligibility provisions in Sections 2(h)(1)(B) and 
5b(c)(2)(c) of the Act would be a more effective method for the 
Commission to expand access to clearing, rather than placing limits 
on the voting and ownership of DCOs.

Proposed Requirements for Derivatives Clearing Organizations, 
Designated Contract Markets, and Swap Execution Facilities Regarding 
the Mitigation of Conflicts of Interest

Commissioner Jill E. Sommers, Dissenting

    The Commission is voting today on a proposal to implement two 
sections of the Dodd-Frank Act regarding the governance of CFTC 
regulated trading venues and clearinghouses that trade or clear 
swaps and how to mitigate conflicts of interest that may arise in 
connection with ownership interests that certain entities may have 
in these registrants. Specifically, Section 725(d) of the Act 
directs the Commission to:
    Adopt rules mitigating conflicts of interest in connection with 
the conduct of business by a swap dealer or a major swap participant 
with at [DCO], [DCM], or a [SEF] that clears or trades swaps in 
which the swap dealer or major swap participant has a material debt 
or material equity investment.
    Section 726 of the Act provides that the Commission shall adopt 
rules which ``may'' include numerical limits on the degree of 
control or voting rights that certain enumerated entities may 
possess with respect to DCOs, DCMs and SEFs if the Commission 
determines, after a review:
    That such rules are necessary or appropriate to improve the 
governance of, or to mitigate systemic risk, promote competition, or 
mitigate conflicts of interest in connection with a swap dealer or 
major swap participant's conduct of business with, a [DCO], [DCM], 
or [SEF] that clears or posts swaps or makes swaps available for 
trading and in which such swap dealer or major swap participant has 
a material debt or equity investment.
    I recognize that these provisions direct the Commission to adopt 
strong governance rules to mitigate conflicts of interest in 
connection with the interaction between swap dealers and major swap 
participants and DCOs, DCMs and SEFs in which they have a material 
debt or equity investment. In my opinion, however, the voting equity 
restrictions being proposed are not necessary or appropriate to 
mitigate the perceived conflicts and in fact, may do more harm than 
good to the emerging marketplace for trading and clearing swaps.
    In 2009, after more than two years of study, the Commission 
finalized acceptable practices to provide a safe harbor for 
complying with Core Principle 15 for DCMs dealing with conflicts of 
interest. I support making those acceptable practices mandatory for 
DCMs, DCOs and SEFs, as augmented by some of the additional 
provisions being proposed today, such as the Risk Management 
Committee for DCOs. I believe that strong governance rules, coupled 
with the Commission's ultimate authority to determine which swaps 
must be cleared, under Section 723 of Dodd-Frank, is sufficient to 
ensure that swaps that should be listed for trading and cleared will 
be listed for trading and cleared.
    I have grave concerns that the proposed limitations on voting 
equity, especially those proposed for enumerated entities in the 
aggregate with respect to DCOs, may stifle competition by preventing 
new DCMs, DCOs and SEFs that trade or clear swaps from being formed. 
The Commission recognizes in the preamble to the proposal that the 
enumerated entities will be the most likely source of funding for 
new DCMs and SEFs and thus chose not to propose the aggregate limits 
for trading venues. I believe the same logic applies with even 
greater force for DCOs. I am equally concerned that a number of 
recent entrants into the swaps trading and clearing space will 
potentially be required to disband their operations if they are 
unable to attract the required amount of non-voting equity within 
the two-year/two board election cycles proposed. I also note that 
the European Commission explicitly rejected ownership limitations in 
its proposal for regulating OTC derivatives announced September 15th 
because such limitations may have negative consequences for market 
structures. I agree. And I hope that we will be mindful of global 
consistency as we move forward. The marketplace for trading and 
clearing swaps is in its infancy. I strongly believe that the 
limitations the Commission is proposing will have the effect of 
inhibiting emerging competition rather than promoting it. I 
therefore cannot support today's proposal.

[FR Doc. 2010-26220 Filed 10-15-10; 8:45 am]
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