[Federal Register Volume 85, Number 215 (Thursday, November 5, 2020)]
[Notices]
[Pages 70657-70666]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-24612]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-90276; File No. S7-13-12]


Proposed Order Granting Conditional Exemptions Under the 
Securities Exchange Act of 1934 in Connection With the Portfolio 
Margining of Swaps and Security-Based Swaps That Are Credit Default 
Swaps

October 28, 2020.
AGENCY: Securities and Exchange Commission (``SEC'' or ``Commission'')

ACTION: Notice of proposed exemptive order; request for comment.

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SUMMARY: The Commission is proposing to grant exemptive relief, subject 
to certain conditions, from compliance with certain provisions of the 
Securities Exchange Act of 1934 in connection with a program to 
portfolio margin cleared swaps customer and affiliate positions in 
cleared credit default swaps that are swaps and security-based swaps in 
a segregated account established and maintained in accordance with 
Section 4d(f) of the Commodity Exchange Act (in the case of a cleared 
swaps customer) or a cleared swaps proprietary account (in the case of 
an affiliate). This proposed exemptive relief would supersede and 
replace the Commission's Order Granting Conditional Exemptions under 
the Securities Exchange Act of 1934 in Connection with Portfolio 
Margining of Swaps and Security-based Swaps issued in December 2012.

DATES: Comments must be received on or before December 7, 2020.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (http://www.sec.gov/rules/other.shtml); or
     Send an email to [email protected]. Please include 
File Number S7-13-12 on the subject line.

Paper Comments

     Send paper comments to Secretary, Securities and Exchange 
Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number S7-13-12. This file number 
should be included on the subject line if email is used. To help us 
process and review your comments more efficiently, please use only one 
method. The Commission will post all comments on the Commission's 
internet website (http://www.sec/gov/rules/other.shtml). Comments are 
also available for website viewing and printing in the Commission's 
Public Reference Room, 100 F Street, NE, Washington DC 20549, on 
official business days between the hours of 10:00 a.m. and 3:00 p.m.
    All comments received will be posted without change. Persons 
submitting comments are cautioned that the Commission does not redact 
or edit personal identifying information from comment submissions. 
Commenters should submit only information that they wish to make 
available publicly.

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate 
Director, at (202) 551-5525; Thomas K. McGowan, Associate Director, at 
(202) 551-5521; Randall W. Roy, Deputy Associate Director, at (202) 
551-5522;

[[Page 70658]]

Raymond Lombardo, Assistant Director, at 202-551-5755; or Sheila Dombal 
Swartz, Senior Special Counsel, at (202) 551-5545, Division of Trading 
and Markets, Securities and Exchange Commission, 100 F Street NE, 
Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION:

I. Introduction

    The Commission is proposing to issue an order granting conditional 
exemptive relief to SEC-registered clearing agencies also registered 
with the Commodity Futures Trading Commission (``CFTC'') as derivative 
clearing organizations (``clearing agency/DCOs'') and SEC-registered 
broker-dealers also registered with the CFTC as futures commission 
merchants (``BD/FCMs''). The proposed order would exempt these entities 
from compliance with certain provisions of the Securities Exchange Act 
of 1934 (``Exchange Act'') in connection with a program to portfolio 
margin cleared swaps customer and affiliate positions in cleared 
security-based swaps and swaps that are credit default swaps (``CDS'') 
in a segregated account established and maintained in accordance with 
Section 4d(f) of the Commodity Exchange Act (``CEA'') in the case of a 
cleared swaps customer (``CFTC cleared swaps customer account'') or a 
cleared swaps proprietary account in the case of an affiliate (``CFTC 
cleared swaps proprietary account'') (each a ``CFTC cleared swaps 
account''), and to calculate margin requirements on a portfolio 
basis.\1\
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    \1\ The text of the proposed order is set forth in an appendix 
to this release and cited herein as the ``Proposed Order.''
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    The proposed order would supersede and replace the Commission's 
December 2012 order providing similar relief (``2012 Order''), and 
modify certain of its conditions, as discussed in more detail below.\2\ 
In particular, it would eliminate conditions (a)(1) and (a)(2) in the 
2012 Order pertaining to the exemptions for clearing agency/DCOs.\3\ 
The requirements to adhere to these conditions are triggered on the 
compliance date for the final capital, margin, and segregation 
requirements for SBSDs: October 6, 2021. The Commission is seeking 
comment at this time on whether these and other conditions in the 2012 
Order should be modified to provide time to consider comments and, if 
appropriate, issue a new order in advance of conditions (a)(1) and 
(a)(2) in the 2012 Order being triggered.
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    \2\ Order Granting Conditional Exemptions under the Securities 
Exchange Act of 1934 in Connection with Portfolio Margining of Swaps 
and Security-based Swaps, Exchange Act Release No. 68433 (Dec. 12, 
2012) 77 FR 75211 (Dec. 19, 2012).
    \3\ See 2012 Order, 77 FR at 75219-20.
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    Conditions (a)(1) and (a)(2) in the 2012 Order are intended to 
provide an option for security-based swap customers to portfolio margin 
cleared security-based swaps and swaps that are CDS (``cleared CDS'') 
in a security-based swap account in accordance with Section 3E of the 
Exchange Act (``SEC SBS account'') as an alternative to a CFTC cleared 
swaps account.\4\ The proposed order also would modify the conditions 
in paragraphs (b)(1)(ii) and (2)(ii) requiring subordination agreements 
to provide greater clarity that the scope of the subordination does not 
extend to the claims of general creditors. In addition, the proposed 
order would eliminate condition (b)(3) in the 2012 Order, which 
requires approval of a BD/FCM's margin methodology by the Commission or 
Commission staff. Instead, as a condition of the proposed order, a BD/
FCM would need to have an internal risk management program that has 
been approved in advance by the Commission or the Commission staff. 
Further, as a condition of the proposed order, the internal risk 
management program would need to have certain standards drawn from the 
letters the staff of the Division of Trading and Markets (``Division 
staff'') issued to BD/FCMs to approve their margin methodologies.\5\ 
These staff letters would be withdrawn and the proposed order would 
provide that any BD/FCM that received a staff letter approving its 
margin methodology prior to the issuance of the order would be deemed 
to have an approved internal risk management program for the purposes 
of the proposed order.
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    \4\ The Commission has adopted capital, margin, and segregation 
requirements under the Exchange Act for security-based swaps dealers 
(``SBSDs''). See Capital, Margin, and Segregation Requirements for 
Security-Based Swap Dealers and Major Security-Based Swap 
Participants and Capital and Segregation Requirements for Broker-
Dealers, Exchange Act Release No. 86175 (June 21, 2019), 84 FR 
43872, 43956-57 (Aug. 22, 2019) (``Capital, Margin, and Segregation 
Adopting Release'').
    \5\ The staff letters are available at https://www.sec.gov/rules/exorders/exordersarchive/exorders2012.shtml.
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II. Background

A. 2012 Order

    On December 14, 2012, in response to a request from ICE Clear 
Credit LLC,\6\ the Commission issued the 2012 Order to provide relief 
so that clearing agency/DCOs and BD/FCMs could offer customers 
portfolio margining of cleared CDS in a CFTC cleared swaps account 
(``CDS portfolio margin program'').\7\ The 2012 Order exempts a 
clearing agency/DCO from Sections 3E(b), 3E(d) and 3E(e) of the 
Exchange Act and any rules thereunder, solely to perform the functions 
of a clearing agency/DCO under the CDS portfolio margin program, 
subject to five conditions.\8\ It further exempts a BD/FCM from 
Sections 3E(b), 3E(d), 3E(e), and 15(c)(3) of the Exchange Act, and 
Rule 15c3-3, as well as from any requirement to treat an affiliate (as 
defined in association with the ``cleared swaps proprietary account'' 
definition in CFTC Rule 22.1) as a customer for purposes of Rules 8c-1 
and 15c2-1, subject to six conditions.\9\ The conditions applicable to 
clearing agency/DCOs and BD/FCMs are designed to: (1) Protect money, 
securities, and property of security-based swap customers; (2) address 
certain differences in the statutory requirements of the Exchange Act 
and the CEA; and (3) promote appropriate risk management and 
disclosure.\10\ The 2012 Order also sought comment on all aspects of 
the exemptions it provided.\11\
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    \6\ ICE Clear Credit formally petitioned the Commission to grant 
exemptive relief from the application of Section 15(c)(3) of the 
Exchange Act, Rule 15c3-3 and, related rules under the Exchange Act. 
See Letter from Michael M. Phillip, Partner, Winston & Strawn LLP 
(Nov. 7, 2011) (the petition 4-641 and comments received on the 
petition are available at https://www.sec.gov/rules/petitions.shtml).
    \7\ The CFTC also issued a companion exemptive order on January 
13, 2013 permitting ICE Clear Credit and its BD/FCM clearing members 
to provide for the portfolio margining of cleared swaps and 
security-based swaps that are CDS. See CFTC, Order, Treatment of 
Funds Held in Connection with Clearing by ICE Clear Credit of Credit 
Default Swaps (Jan. 13, 2013)(``2013 CFTC Portfolio Margin Order''), 
available at https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/icecreditclearorder011413.pdf. See 
also CFTC, Order, Treatment of Funds Held in Connection with 
Clearing by ICE Clear Europe of Credit Default Swaps (Apr. 9, 2013), 
available at https://www.cftc.gov/sites/default/files/stellent/groups/public/@requestsandactions/documents/ifdocs/icecleareurope4dfcds040913.pdf.
    \8\ See Capital, Margin, and Segregation Adopting Release, 84 FR 
at 43954; Cross-Border Application of Certain Security-Based Swap 
Requirements, Exchange Act Release No. 87780 (Dec. 18, 2019), 85 FR 
6270 (Feb. 4, 2020).
    \9\ See 2012 Order, 77 FR at 75213-14 (discussing these sections 
of the Exchange Act and the rules), 75216-19 (discussing the 
conditions), and 75220-21 (setting forth the conditions). See also 
Order Extending Temporary Exemptions from Exchange Act Section 8 and 
Exchange Act Rules 8c-1, 10b-16, 15a-1, 15c2-1 and 15c2-5 in 
Connection with the Revision of the Definition of ``Security'' to 
Encompass Security-Based Swaps, Exchange Act Release No. 87943 (Jan. 
10, 2020), 85 FR 2763 (Jan. 16, 2020) (providing a temporary 
exemption from certain rules including Rules 8c-1 and 15c-1 in 
connection with the revision of the Exchange Act definition of 
``security'' to encompass security-based swaps until Nov. 5, 2020).
    \10\ See 2012 Order, 77 FR at 75214.
    \11\ 77 FR at 75219. Letters responding to this request for 
comment are available at https://www.sec.gov/comments/s7-13-12/s71312.shtml.

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[[Page 70659]]

B. Division Staff Letters

    On March 8, 2013, the Division staff issued temporary conditional 
approval letters to seven BD/FCMs pursuant to condition (b)(3) in the 
2012 Order \12\ permitting them to participate in the CDS portfolio 
margin program, subject to certain conditions (the ``March 8, 2013 
letters'').\13\ The conditions included a requirement to collect 
initial margin based on a multiplier of the clearing agency/DCO margin 
requirement or to take a 100% capital charge for the difference.
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    \12\ See Proposed Order, ] (b)(3) (providing that BD/FCM must 
require minimum margin levels with respect to any customer 
transaction in a program to commingle and portfolio margin CDS at 
least equal to the amount determined using a margin methodology 
established and maintained by the BD/FCM that has been approved by 
the Commission or the Commission staff).
    \13\ The March 8, 2013 letters and other staff letters to the 
BD/FCMs discussed below are available at: https://www.sec.gov/rules/exorders/exordersarchive/exorders2012.shtml. The temporary staff 
letters were responsive to a comment raising concerns about the 
first CFTC compliance date for mandatory swaps clearing (March 13, 
2013). See Letter from Stuart J. Kaswell, Executive Vice President & 
Managing Director, Managed Funds Association (Feb. 11, 2013) (``MFA 
2/11/13 Letter'') (comment to the 2012 Order), available at https://www.sec.gov/comments/s7-13-12/s71312.shtml.
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    On June 7, 2013, the Division staff issued updated temporary 
conditional letters to the seven BD/FCMs that received the March 8, 
2013 letters, and to one additional BD/FCM, setting forth revised 
conditions for participation in the CDS portfolio margin program (``the 
June 7, 2013 letters''). The June 7, 2013 letters required the BD/FCMs 
to implement a required margin regime and establish minimum risk 
management standards by December 7, 2013. On December 6, 2013, the 
Division staff issued letters to the BD/FCMs extending the December 7, 
2013 date to January 31, 2014. On January 31, 2014, the Division staff 
issued letters to the eight BD/FCMs permanently approving their margin 
methodologies, subject to the conditions in the June 7, 2013 letters 
(``January 31, 2014 letters''). Subsequent to the issuance of the 
January 31, 2014 letters, the Division staff approved the margin 
methodologies of two additional BD/FCMs, subject to the conditions in 
the June 7, 2013 letters.\14\
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    \14\ The Division staff also issued an additional letter 
relating to the transfer of a CDS portfolio margin program using the 
same internal risk model and same internal risk management system 
from one broker-dealer affiliate to another. The June 7, 2013 
letters and subsequent staff letters are collectively referred to 
below as the ``BD/FCM staff letters.''
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III. Discussion of Proposed Relief

    Since the issuance of the 2012 Order, the SEC staff has monitored 
the operations of the BD/FCMs participating in the CDS portfolio margin 
program as well as the market for cleared CDS. The Commission believes 
it may be appropriate to issue a new portfolio margin order with 
modified conditions in light of: (1) The experience gained from this 
monitoring; and (2) comment letters addressing portfolio margining 
received in response to the 2012 Order and in the context of the SEC's 
recently finalized rulemaking adopting capital, margin and segregation 
requirements for security-based swap dealers (``SBSDs'').\15\ A 
modified order also may be appropriate because the CFTC has initiated 
the mandatory clearing of certain swaps, including broad-based index 
CDS.\16\ The following discussion describes the conditions of the 
proposed order--many of which would be largely consistent with 
conditions in the 2012 Order. Proposed modifications to the conditions 
in the 2012 Order are noted and discussed.
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    \15\ The comment letters received with respect to this 
rulemaking are available at https://www.sec.gov/comments/s7-08-12/s70812.shtml.
    \16\ See, e.g., CFTC Announces that Mandatory Clearing Begins 
Today, CFTC Press Release No. 6529-13 (Mar. 11, 2013) (announcing 
that swap dealers, major swap participants and private funds active 
in the swaps market are required to begin clearing certain index 
CDS); CFTC Announces that Mandatory Clearing for Category 2 Entities 
Begins Today, CFTC Press Release No. 6607-13 (June 13, 2013) 
(announcing the second phase of required clearing for certain CDS 
and interest rate swaps).
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A. Conditions for Clearing Agency/DCOs

1. Elimination of Conditions Relating to Expanding the CDS Portfolio 
Margin Program to Securities Accounts
    The conditions in paragraphs (a)(1) and (a)(2) of the 2012 Order 
are intended to provide customers the option to portfolio margin 
cleared CDS in an SEC SBS account once the SEC's margin and segregation 
rules for SBSDs are in place.\17\ In particular, paragraph (a)(1) 
requires that the clearing agency/DCO, by the later of six months after 
the adoption date of the final margin and segregation rules for 
security-based swaps or the compliance date of such rules, to take all 
necessary action within its control to obtain any relief needed to 
permit its BD/FCM clearing members to maintain customer money, 
securities, and property received by the BD/FCM to margin, guarantee, 
or secure customer positions in cleared CDS in an SEC SBS account for 
the purpose of the CDS portfolio margin program. Paragraph (a)(2) 
requires the clearing agency/DCO, within the same timeframe, to take 
all necessary action within its control, to establish rules and 
operational practices to permit its BD/FCM clearing members to maintain 
customer money, securities, and property received by the BD/FCM to 
margin, guarantee, or secure customer positions in cleared CDS in an 
SEC SBS account for the purpose of the CDS portfolio margin program. 
Thus, the requirements to adhere to conditions in paragraphs (a)(1) and 
(2) of the 2012 Order are triggered on the compliance date for the 
final capital, margin, and segregation requirements for SBSDs: October 
6, 2021.
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    \17\ See 2012 Order, 77 FR at 75215-16 (discussing the 
conditions) and 75219-20 (setting forth the conditions).
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    In the 2012 Order, the Commission stated that it was important to 
ultimately provide market participants with the ability to select an 
account structure to manage their individual risks by taking into 
account the different regulatory provisions that may apply to different 
account types and any costs incurred.\18\ Market participants have been 
clearing CDS under the CDS portfolio margin program since the initial 
BD/FCM staff letters were issued in 2013. The CDS portfolio margining 
program has allowed greater efficiencies in clearing, allowing the 
offset of positions and the ability to margin cleared CDS in a single 
account. Portfolio margining facilitates margin requirements that 
better reflect the overall risks presented by a CDS portfolio, which 
may result in decreased margin costs. Because of these greater 
efficiencies and potential cost reductions available under the current 
CDS portfolio margin program in a CFTC cleared swaps account, market 
participants have not expressed a desire to portfolio margin cleared 
CDS in an SEC SBS account. This lack of market interest in a securities 
account alternative also is consistent with: (1) The comments of ICE 
Clear Credit in 2011 that it received no indication in its discussions 
with market participants that they desired a securities account option 
with respect to its petition for rulemaking to portfolio margin cleared 
CDS; and (2) the Division staff's experience in monitoring the CDS 
portfolio margin program.\19\
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    \18\ See 2012 Order, 77 FR at 75216.
    \19\ See Letter from Christopher S. Edmonds, President, ICE 
Clear Credit LLC (Dec. 22, 2011) (``ICE Letter'') (comment to the 
ICE Clear Credit petition for rulemaking 4-641 (Nov. 7, 2011)), 
available at https://www.sec.gov/comments/4-641/4-641.shtml.
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    While portfolio margining cleared CDS in an SEC SBS account also 
would provide greater efficiencies and cost reductions, given the 
success of the current CDS portfolio margin program

[[Page 70660]]

and the lack of market interest in a securities account alternative, 
the Commission preliminarily believes that it may be appropriate to 
eliminate these conditions. Removing them would avoid potentially 
unnecessary costs \20\ to clearing agency/DCOs to implement systems and 
processes to accommodate SEC SBS accounts that may never be utilized. 
Moreover, their removal would not prohibit a clearing agency/DCO from 
offering an SEC SBS account option in the future, if market conditions 
change and the demand arises, subject to applicable regulatory 
approvals and relief.
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    \20\ These costs may involve changes to trade processing systems 
(to designate account type), risk management processes (to capture 
and relate positions and margin held in multiple account types), and 
to treasury and banking processes, systems, and accounts. See, e.g., 
ICE Letter.
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2. Proposed Conditions
    The three clearing agency/DCO conditions in the proposed order are 
largely consistent with the conditions in paragraphs (a)(3), (4), and 
(5) of the 2012 Order, respectively.\21\ The first condition would 
require the clearing agency/DCO to obtain any other relief needed to 
permit a BD/FCM to maintain cleared swaps customer or affiliate money, 
securities, and property received to margin, guarantee, or secure 
cleared swaps customer or affiliate positions in cleared CDS in a CFTC 
cleared swaps customer account or a CFTC cleared swaps proprietary 
account, respectively, for the purpose of clearing such cleared swaps 
customer or affiliate positions under the CDS portfolio margin 
program.\22\ This condition is designed to help ensure that the 
exemption would apply only in circumstances where the regulatory 
framework under the CEA and the CFTC's rules is applicable.
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    \21\ See 2012 Order, 77 FR at 75216 (discussing the conditions) 
and 75220 (setting forth the conditions); Proposed Order, ]] (a)(1), 
(2), and (3). The Commission made some technical changes to the DCO/
clearing agency conditions in the proposed order to account for the 
elimination of conditions (a)(1) and (2) from the 2012 Order. These 
proposed changes include re-numbering the remaining clearing agency/
DCO conditions and moving the definition of ``BD/FCM'' from 
condition (a)(1) in the 2012 Order (which would be eliminated) to 
condition (a)(1) in the proposed order (which parallels condition 
(a)(3) in the 2012 Order). Finally, the Commission is proposing to 
replace the term ``shall'' in two places with the term ``will'' and 
``must,'' respectively.
    \22\ See Proposed Order, ] (a)(1). The proposed order also would 
eliminate use of the generic term ``customer'' in the 2012 Order and 
instead use the more specific terms ``cleared swaps customer,'' 
``affiliate,'' ``security-based swap customer,'' and ``securities 
customer''. In addition, the proposed order would add specific 
language to clarify that cleared CDS positions of cleared swaps 
customers are held in CFTC cleared swaps customer accounts and 
affiliate positions are held in CFTC cleared swaps proprietary 
accounts. These proposed changes reflect the different treatment 
each type of person and account would receive under the CEA and 
rules thereunder, and applicable bankruptcy laws.
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    The second clearing agency/DCO condition would require the 
organization to have appropriate rules and operational practices to 
permit a BD/FCM to maintain cleared swaps customer or affiliate money, 
securities, and property received to margin, guarantee, or secure 
cleared swaps customer or affiliate positions in cleared CDS in a CFTC 
cleared swaps customer account or a cleared swaps proprietary account, 
respectively, for the purpose of clearing such cleared swaps customer 
or affiliate positions under the CDS portfolio margin program.\23\ This 
condition also is designed to help ensure the exemption would apply 
only in circumstances where the regulatory framework under the CEA and 
the CFTC's rules is applicable. The third clearing agency/DCO condition 
would require the organization to have rules mandating that each 
cleared swaps customer and affiliate of the BD/FCM participating in the 
CDS portfolio margin program must be an ``eligible contract 
participant'' as defined in Section 1a(18) of the CEA.\24\ Given that 
Congress determined it is appropriate to include these limitations in 
the Dodd-Frank Act with respect to eligible contract participants, the 
Commission preliminarily believes it is appropriate to limit the 
exemptions in this proposed order to cleared CDS entered into with 
eligible contract participants.\25\
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    \23\ See Proposed Order, ] (a)(2). See also supra note 22.
    \24\ See Proposed Order, ] (a)(3). The 2012 order provided that 
each ``customer'' must be an eligible contract participant. 77 FR 
75220. See also supra note 22.
    \25\ The Dodd-Frank Act limits the swaps and security-based 
swaps transactions that may be entered into by parties that are not 
eligible contract participants. For example, under Section 6(l) of 
the Exchange Act, only an eligible contract participant may enter 
into security-based swaps that are not effected on a national 
securities exchange. 15 U.S.C. 78f(l). In addition, security-based 
swaps that are not registered pursuant to the Securities Act of 1933 
(``Securities Act'') can only be sold to eligible contract 
participants. 15 U.S.C. 77e(e). Section 5(e) of the Securities Act 
specifically provides that it shall be unlawful to for any person, 
directly or indirectly, to make use of any means or instruments of 
transportation or communication in interstate commerce or of the 
mails to offer to sell, offer to buy or purchase or sell a security-
based swap to any person who is not an eligible contract 
participant, unless the transaction is registered under the 
Securities Act. Id.
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B. Conditions for BD/FCMs

    The first, second, fourth, fifth, and sixth BD/FCM conditions in 
the proposed order are largely consistent with the conditions in 
paragraphs (b)(1), (2), (4), (5) and (6) of the 2012 Order, 
respectively.\26\ The first BD/FCM condition would consist of two 
requirements and apply with respect to transactions involving persons 
that are not affiliates of the BD/FCM (i.e., cleared swaps 
customers).\27\ Under the first requirement, the BD/FCM would need to 
maintain cleared swaps customer money, securities, and property 
received to margin, guarantee or secure cleared swaps customer 
positions consisting of cleared CDS in a CFTC cleared swaps customer 
account established and maintained for the purpose of the CDS portfolio 
margin program.\28\ This condition is designed to help ensure that--in 
the absence of the security-based swap and securities customer 
protections afforded by the securities laws--collateral in the account 
is subject to the protections afforded by an alternative regulatory 
scheme (i.e., the CEA and the CFTC's rules). The intent is to avoid 
having the assets in the account fall into a regulatory gap in which 
neither the federal securities laws nor the federal commodity futures 
laws apply. The condition also is designed to limit the relief to 
accounts that are established and maintained specifically for the 
purpose of the CDS portfolio margin program.
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    \26\ See 2012 Order, 77 FR at 75216-19 (discussing the 
conditions) and 75220-21 (setting forth the conditions); Proposed 
Order, ]] (b)(1), (2), (4), (5), and (6). The Commission made some 
technical and stylistic changes to these conditions, including 
replacing the term ``shall'' with ``must'' and capitalizing the 
first letter in each of the conditions (and their subparagraphs). 
Finally, the Commission inserted the phrase ``Section 8 of the 
Exchange Act and'' before ``Exchange Act Rules 8c-1 and 15c2-1'' in 
paragraph (b) of the proposed order to be consistent with the other 
rule references in the order, which refer to the relevant statute. 
See Proposed Order, ] (b).
    \27\ See Proposed Order, ] (b)(1).
    \28\ See Proposed Order, ] (b)(1)(i). See also supra note 22 
(discussing proposed change from the use of the generic term 
``customer'' in the 2012 Order to ``cleared swaps customer'' in the 
proposed order).
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    Under the second requirement, the BD/FCM would need to enter into a 
non-conforming subordination agreement with each non-affiliated cleared 
swaps customer that covers the customer's money, securities, or 
property held in a segregated account.\29\ The non-conforming 
subordination agreement would need to contain: (1) A specific 
acknowledgment by the cleared swaps customer that such money, 
securities or property will not receive customer treatment under the 
Exchange Act or Securities Investor Protection Act of 1970 (``SIPA'') 
or be treated as ``customer property'' as defined in 11 U.S.C. 741 in a 
liquidation of the BD/

[[Page 70661]]

FCM (``stockbroker liquidation''), and that such money, securities or 
property will be subject to any applicable protections under Subchapter 
IV of Chapter 7 of Title 11 of the United States Code and rules and 
regulations thereunder (``commodity broker liquidation provisions''); 
and (2) an affirmation by the cleared swaps customer that claims to 
``customer property'' as defined in SIPA or 11 U.S.C. 741 against the 
BD/FCM will be subordinated to the claims of securities customers and 
security-based swap customers.
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    \29\ See condition (b)(1)(ii) of 2012 Order.
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    The 2012 Order required an affirmation by the customer that all of 
its claims with respect to such money, securities, or property against 
the BD/FCM will be subordinated to the claims of other securities 
customers and security-based swap customers not participating in the 
CDS portfolio margin program.\30\ To better clarify that the cleared 
swaps customer is not subordinating claims to general creditors, the 
Commission is proposing to modify condition (b)(1)(ii) of the 2012 
Order, as stated above, to provide that the cleared swaps customer must 
affirm that claims to ``customer property'' as defined in SIPA or the 
stockbroker liquidation provisions against the BD/FCM will be 
subordinated to the claims of securities customers and security-based 
swap customers. This modification is designed to more narrowly tailor 
the subordination to the portion of the debtor BD/FCM's estate that 
comprises ``customer property'' under SIPA and the stockbroker 
liquidation schemes.\31\
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    \30\ See 2012 Order, 77 FR at 75220.
    \31\ See supra note 22.
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    This proposed condition is designed to remove portfolio margin 
cleared swaps customers from the definitions of ``customer'' under Rule 
15c3-3, SIPA, and the stockbroker liquidation provisions with respect 
to securities or cash held in CFTC cleared swaps accounts that 
otherwise would be subject to the segregation requirements of Rule 
15c3-3 and the bankruptcy protections afforded by SIPA and the 
stockbroker liquidation provisions. The objective is to avoid a 
situation where the portfolio margin cleared swaps customers would be 
entitled to a ratable share of ``customer property'' and other 
protections afforded by SIPA or the stockbroker liquidation provisions 
even though their assets were held in CFTC cleared swaps customer 
accounts that were not subject to the segregation requirements of Rule 
15c3-3. Assets held in a CFTC cleared swaps customer account would 
instead be afforded the protections of the rules of the CFTC governing 
the treatment of customer margin held by BD/FCMS and DCOs as well as 
the protections of the CEA and commodity broker liquidation provisions. 
The proposed condition is not intended to undermine these protections.
    The proposed condition also is not intended to require portfolio 
margin cleared swaps customers to subordinate their claims, in the 
event that their claims as cleared swaps customers are not fully 
satisfied by the distribution of assets held in CFTC cleared swaps 
customer accounts, to assets that may be included in the debtor's 
general estate. In summary, this condition, along with the proposed 
disclosure conditions discussed below, is intended to help ensure that 
cleared swaps customers clearly understand that any security-based swap 
or securities customer protection treatment otherwise available with 
respect to securities transactions under the Exchange Act, SIPA, or the 
stockbroker liquidation provisions will not be available for cleared 
CDS held in a CFTC cleared swaps customer account.
    The second BD/FCM condition in the proposed order would apply with 
respect to transactions involving affiliates of the BD/FCM and would 
consist of three requirements.\32\ Under the first requirement, the BD/
FCM would need to maintain money, securities, and property of 
affiliates received to margin, guarantee, or secure positions 
consisting of cleared CDS in a ``cleared swaps proprietary account'' as 
defined in CFTC Rule 22.1 for the purpose of clearing such positions 
under the CDS portfolio margin program.\33\ The purpose of this 
requirement is that under the CFTC regulatory framework certain 
affiliates are not treated as cleared swaps customers and their assets 
are held in proprietary accounts as distinct from CFTC cleared swaps 
customer accounts.\34\
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    \32\ See Proposed Order, ] (b)(2).
    \33\ See Proposed Order, ] (b)(2)(i).
    \34\ See 17 CFR 22.1. The Commission preliminarily believes that 
this condition is appropriate because affiliates of a BD/FCM that 
are not otherwise excluded from the definition of ``customer'' in 
Exchange Act Rules 8c-1 and 15c2-1 are customers whose securities 
positions cannot be commingled with the broker-dealer's own 
proprietary securities positions and therefore could not be held in 
a cleared swaps account.
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    Under the second requirement, the BD/FCM would need to enter into a 
non-conforming subordination agreement with an affiliate.\35\ The non-
conforming subordination agreement would need to contain: (1) A 
specific acknowledgment by the affiliate that such money, securities or 
property will not receive customer treatment under the Exchange Act or 
SIPA or be treated as customer property in a stockbroker liquidation of 
the BD/FCM, and that such money, securities or property will be held in 
a proprietary account in accordance with the CFTC requirements and will 
be subject to any applicable protections under the commodity broker 
liquidation provisions; and (2) an affirmation by the affiliate that 
claims to ``customer property'' as defined in SIPA or 11 U.S.C. 741 
against the BD/FCM will be subordinated to the claims of securities 
customers and security-based swap customers.
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    \35\ See Proposed Order, ] (b)(2)(ii).
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    For the reasons discussed above, the Commission is proposing to 
modify the text of the affirmation by an affiliate from the 2012 Order 
to more narrowly tailor the subordination to the portion of the debtor 
BD/FCM's estate that comprises ``customer property'' under SIPA and the 
stockbroker liquidation schemes.\36\ This requirement is designed to 
help ensure that affiliates clearly understand that any customer 
protection treatment otherwise available with respect to securities 
transactions under the Exchange Act, SIPA, or the stockbroker 
liquidation provisions will not be available and the account would be 
treated as a proprietary account (and not a CFTC cleared swaps customer 
account) under the CEA. Consistent with the proposed condition above 
with respect to cleared swaps customers that are not affiliates, this 
condition is intended to remove affiliates from the definitions of 
``customer'' under Rule 15c3-3, SIPA, and the stockbroker liquidation 
provisions with respect to securities or cash held in cleared swaps 
proprietary accounts that otherwise would be subject to the segregation 
requirements of Rule 15c3-3 and the bankruptcy protections afforded by 
SIPA and the stockbroker liquidation provisions.
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    \36\ See Proposed Order, ] (b)(2)(ii). The 2012 Order required 
an affirmation by the affiliate that all of its claims with respect 
to such money, securities, or property against the BD/FCM will be 
subordinated to the claims of other securities customers and 
security-based swap customers not operating under a program to 
commingle and portfolio margin CDS. 77 FR at 75220. See also supra 
note 22. The modification would require the affiliate to affirm that 
that all of its claims to ``customer property'' as defined in SIPA 
or 11 U.S.C. 741 against the BD/FCM will be subordinated to the 
claims of securities customers and security-based swap customers.
---------------------------------------------------------------------------

    Under the third requirement, the BD/FCM would need to obtain from 
the affiliate an opinion of counsel that the affiliate is legally 
authorized to subordinate all of its claims against the

[[Page 70662]]

BD/FCM to those of securities customers and security-based swap 
customers.\37\ This condition is designed to help ensure that 
affiliates of the BD/FCM do not place any assets in the proprietary 
account that the affiliate is not legally authorized to subordinate.
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    \37\ See Proposed Order, ] (b)(2)(iii). The 2012 Order required 
that the BD/FCM obtain from the affiliate an opinion of counsel that 
the affiliate is legally authorized to subordinate all of its claims 
against the BD/FCM to those of customers. 77 FR at 75220. See also 
supra note 22.
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    The condition in paragraph (b)(3) of the 2012 Order provides that 
the BD/FCM must require minimum margin levels with respect to any 
customer transaction in the CDS portfolio margin program at least equal 
to the amount determined using a margin methodology established and 
maintained by the BD/FCM that has been approved by the Commission or 
the Commission staff.\38\ A commenter responding to the issuance of the 
2012 Order supported the requirement for a BD/FCM to assess the credit 
risk of counterparties based on the BD/FCM's own risk management 
standards, but argued that requiring a unique margin model beyond the 
BD/FCM's own credit risk assessment is unwarranted.\39\ This commenter 
also stated that this condition ``deters'' efficiency, capital 
formation, and competition.\40\ Another commenter responding to the 
issuance of the 2012 Order argued that the condition undermines a 
fundamental benefit of central clearing: the ability of market 
participants to rely on clearing agency/DCO margin requirements.\41\ 
This commenter believes that this condition reduces transparency and 
the ability to anticipate and verify margin calls, and that it 
discourages entities from entering the cleared CDS market.\42\
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    \38\ See condition (b)(3) of 2012 Order.
    \39\ See Letter from Stuart J. Kaswell, Executive Vice President 
& Managing Director, General Counsel, Managed Funds Association; 
Carl B. Wilkerson, Vice President & Chief Counsel, Securities & 
Litigation, American Council of Life Insurers; and 
Ji[rcaron][iacute] Krol, Director of Government and Regulatory 
Affairs, Alternative Investment Management Association (Dec. 27, 
2013) (``MFA/ACLI/AIMA 12/27/2013 Letter'') (comment to the 2012 
Order), available at https://www.sec.gov/comments/s7-13-12/s71312.shtml; see also Letter from Stuart J. Kaswell, Executive Vice 
President & Managing Director, General Counsel, Managed Funds 
Association; Carl B. Wilkerson, Vice President & Chief Counsel, 
Securities & Litigation, American Council of Life Insurers; and 
Ji[rcaron][iacute] Krol, Director of Government and Regulatory 
Affairs, Alternative Investment Management Association (May 10, 
2013) (comment to the 2012 Order), available at https://www.sec.gov/comments/s7-13-12/s71312.shtml.
    \40\ MFA/ACLI/AIMA 12/27/2013 Letter.
    \41\ See Letter from Adam C. Cooper, Senior Managing Director 
and Chief Legal Officer, Citadel LLC (Feb. 2, 2016) (``Citadel 2/2/
16 Letter'') (comment to the 2012 Order), available at https://www.sec.gov/comments/s7-13-12/s71312.shtml.
    \42\ Citadel 2/2/16 Letter; Letter from Laura Harper Powell, 
Associate General Counsel, Managed Funds Association, and Adam 
Jacobs-Dean, Managing Director, Global Head of Markets Regulation, 
Alternative Investment Management Association (Nov. 19, 2018) 
(comment to the Commission's capital, margin, and segregation 
rulemaking for SBSDs), available at https://www.sec.gov/comments/s7-08-12/s70812.shtml.
---------------------------------------------------------------------------

    In the context of the SEC's capital, margin and segregation 
rulemaking for SBSDs, another commenter expressed concern that the 
conditions in the 2012 Order have proven too restrictive to support a 
robust market for cleared CDS.\43\ More specifically, this commenter 
recommended that both the CFTC and SEC recognize a harmonized portfolio 
margin approach for cleared CDS that defers to the clearing agency/DCO 
margin methodologies.\44\ Finally, a commenter expressed concern that 
the margin requirements imposed by the Commission have delayed 
voluntary buy-side clearing of single-name CDS, with resulting adverse 
effects on trading volume and liquidity.\45\
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    \43\ See Letter from Walt L. Lukken, President and Chief 
Executive Office, Futures Industry Association (Nov. 29, 2018) 
(``FIA 11/29/18 Letter'') (comment to the Commission's capital, 
margin, and segregation rulemaking for SBSDs), available at https://www.sec.gov/comments/s7-08-12/s70812.shtml.
    \44\ Letter from Walt L. Lukken, President and Chief Executive 
Office, Futures Industry Association (Nov. 19, 2018) (comment to the 
Commission's capital, margin, and segregation rulemaking for SBSDs), 
available at https://www.sec.gov/comments/s7-08-12/s70812.shtml; FIA 
11/29/18 Letter.
    \45\ See Letter from Stuart J. Kaswell, Executive Vice President 
& Managing Director, General Counsel, Managed Funds Association (May 
18, 2017) (comment to the Commission's capital, margin, and 
segregation rulemaking for SBSDs), available at https://www.sec.gov/comments/s7-08-12/s70812.shtml.
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    The vast majority of the BD/FCM clearing members of ICE Clear 
Credit have obtained approval of their margin methodologies from 
Commission staff.\46\ Furthermore, each BD/FCM that has received 
approval of its margin methodology already had existing margin models 
in place prior to applying to the Commission. Therefore, the firms 
needed to make some adjustments to their models in order to meet the 
minimum qualitative and quantitative standards set forth in the BD/FCM 
staff letters, but did not need to develop new margin models. To date, 
all BD/FCMs that have submitted applications to Commission staff to 
approve their internal margin methodologies have received approval.
---------------------------------------------------------------------------

    \46\ See ICC membership, available at https://www.theice.com/clear-credit/participants. Based on Division staff experience in 
monitoring the CDS portfolio margin program, the vast majority of 
positions are being cleared through ICE Clear Credit, and to a 
lesser extent, ICE Clear Europe.
---------------------------------------------------------------------------

    The Commission preliminarily believes that it would not be prudent 
for a BD/FCM to simply defer to the margin methodology of the clearing 
agency/DCO in terms of measuring and managing the risk of cleared CDS 
in a portfolio margin account, as requested by commenters. Prudent 
firms establish and maintain integrated internal risk management 
programs that include management policies and procedures designed to 
help ensure an awareness of, and accountability for, the risks taken 
throughout the firm and to develop tools to address those risks. For 
example, there may be idiosyncratic risk factors with respect to a 
cleared swaps customer, an affiliate, or the BD/FCM's financial 
condition that are not covered by the margin methodology of the 
clearing agency/DCO.
    At the same time, the Commission also preliminarily believes that 
it can promote the prudent operation of the BD/FCMs through a process 
of approving their internal risk management programs (rather than their 
internal margin methodologies), as discussed below. This may increase 
transparency for market participants in terms of being able to 
anticipate margin requirements generated by their cleared CDS 
portfolios, as the clearing agency/DCO margin methodology will generate 
the regulatory margin requirement across all the BD/FCMs.\47\ 
Accordingly, the Commission is proposing to modify the condition in 
paragraph (b)(3) of the 2012 Order to eliminate the requirement that 
the Commission or Commission staff approve the BD/FCM's margin 
methodology. Instead, the proposed order would require the BD/FCM to 
adopt an internal risk management program that is reasonably designed 
to identify, measure, and manage the risks arising from its 
participation in the CDS portfolio margin program that has been 
approved in advance by the Commission or the Commission staff and that 
meets the standards described below (``internal risk management 
program'').\48\
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    \47\ Nothing in the proposed order would preclude a BD/FCM from 
setting higher ``house'' margin requirements for some or all of its 
customers. See 17 CFR 39.13(g)(8).
    \48\ See Proposed Order, ] (b)(3). The proposed order would 
contain a provision finding that the BD/FCMs that have received 
previous approval of their internal margin methodology from the 
Division staff would be deemed to have approved internal risk 
management programs for purposes of paragraph (b)(3) of the proposed 
order. These BD/FCMs would no longer be required to have minimum 
margin levels with respect to any customer transaction in a CDS 
portfolio margin program at least equal to the amount determined 
using a margin methodology approved by the Commission or the 
Commission staff, as required by the 2012 Order. They would instead 
comply the internal risk management program standards under 
condition (b)(3) of the proposed order.

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[[Page 70663]]

    An internal risk management program would facilitate the 
identification, measurement, and management of a broader range of risks 
than those covered by the clearing agency/DCO margin methodology and, 
consequently, help ensure that the BD/FCMs operate in a prudent manner 
with respect to the CDS portfolio margin program. Further, an internal 
risk management program entails a more comprehensive set of measures to 
mitigate risk than a margin methodology.\49\ Consequently, based on the 
Commission staff's experience gained in monitoring the CDS portfolio 
margin program, approving a firm's internal risk management program 
(rather than its internal margin methodology) may foster a more robust 
approach to managing risk by BD/FCMs. This approach to managing risk 
also will promote consistency with the Commission's final capital, 
margin, and segregation rules for SBSDs, which require such firms to be 
subject to a risk management rule, as well as with the regulatory 
approach adopted by the CFTC with respect to the portfolio margining of 
cleared CDS.\50\ The proposed requirement to have an internal risk 
management program also is a condition in the BD/FCM staff letters and 
all the firms operating under the 2012 Order have implemented such 
programs.
---------------------------------------------------------------------------

    \49\ See, e.g., 17 CFR 240.15c3-1e(d)(1) (``The VaR model used 
to calculate market and credit risk for a position must be 
integrated into the daily internal risk management system of the 
broker or dealer[.]'').
    \50\ See Capital, Margin, and Segregation Adopting Release, 84 
FR at 43905 (``The Commission proposed that nonbank SBSDs be 
required to comply with Rule 15c3-4 to promote the establishment of 
effective risk management control systems by these firms.''); and 
2013 CFTC Portfolio Margin Order (requiring participants to ``take 
appropriate measures to identify, measure, and monitor financial 
risk associated with carrying the Security-Based CDS in a cleared 
swaps account and implement risk management procedures to address 
those financial risks'').
---------------------------------------------------------------------------

    The requirement that a BD/FCM independently measure risk by 
developing and using its own internal model is not designed to impose a 
margin collection requirement (or capital charge) or diminish the role 
of the clearing agency/DCO margin methodology. Rather, it is intended 
to require the BD/FCM to independently measure the potential future 
credit risk to cleared swaps customers and affiliates participating in 
the CDS portfolio margin program under a different stress scenario in 
order to better understand risks and address them as the firm deems 
appropriate (e.g., through risk limits, threshold triggers, house 
margin, heightened monitoring, or other controls).
    Under this proposed condition, a BD/FCM seeking approval of its 
internal risk management program would need to submit sufficient 
information for the Commission or Commission staff to be able to make a 
determination whether its program meets the proposed standards 
described below.\51\ In reviewing this information, the Commission or 
the Commission staff would be guided by these standards. If a BD/FCM's 
internal risk management program is approved for purposes of this 
proposed order, the program would be subject to ongoing supervision and 
monitoring by the Commission.\52\
---------------------------------------------------------------------------

    \51\ See generally 17 CFR 240.15c3-1e(a)(1). A BD/FCM would only 
need to submit information to the extent it is relevant to the 
portfolio margining of cleared CDS. The BD/FCM may seek confidential 
treatment for information submitted as part of such application.
    \52\ See Proposed Order, ] (c)(1)(ii)(D).
---------------------------------------------------------------------------

    The first standard for the internal risk management program is that 
the BD/FCM would need to calculate a future credit exposure for each 
cleared swaps customer and affiliate (sometimes each a 
``counterparty'') using a proprietary methodology that meets specified 
minimum quantitative and qualitative model standards (``internal risk 
model'').\53\ The quantitative standards would be that the internal 
risk model:
---------------------------------------------------------------------------

    \53\ See Proposed Order, ] (c)(1).
---------------------------------------------------------------------------

     Estimates a potential future exposure over a minimum 10-
day horizon and 99% confidence level and captures all material risk 
factors, including but not limited to general movements in credit 
spread term structure, basis risk between index and single name 
positions, and interest rate risk;
     Includes a concentration/liquidity requirement; and
     Includes a jump-to-default requirement for the sale of CDS 
protection equal to the largest loss of a single name exposure assuming 
a conservative recovery rate that may not exceed 40%.
    The qualitative standards would require that:
     The internal risk model must be adequately documented and 
the model documentation must provide a description of the model 
assumptions, data inputs, parameters, and methodologies employed to 
measure risk;
     The internal risk model must be subject to an annual model 
review by a model group that is independent of the business function;
     The internal risk model must be subject to at least 
quarterly backtesting by counterparty or account; and
     The BD/FCM must provide written notice to the Commission 
or Commission staff prior to implementing any material change to its 
internal risk model.
    These quantitative and qualitative requirements generally are 
consistent with the quantitative and qualitative requirements for 
internal risk models under Appendix E to Rule 15c3-1 and under new Rule 
18a-1. These rules permit certain broker-dealers and SBSDs, 
respectively, to compute capital charges using internal models.\54\ For 
example, the standards in the proposed order generally would require 
that the model cover a 10-day horizon, 99% confidence level, and 
material risks, and that the BD/FCM backtest the model and subject it 
to review.\55\
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    \54\ See 17 CFR 240.15c3-1e and 18a-1; and Capital, Margin, and 
Segregation Adopting Release.
    \55\ See 17 CFR 15c3-1e(d).
---------------------------------------------------------------------------

    The second standard for the internal risk management program is 
that it would need to have the following minimum risk management system 
standards:
     The BD/FCM would need standards to measure and manage risk 
exposure arising from counterparties' CDS portfolios that are 
independent of any central counterparty margin methodology;
     The BD/FCM would need to have an internal credit risk 
rating model that assesses the credit risk of each individual 
counterparty;
     The BD/FCM's monitoring of credit risk would need to 
include the prudent setting of an exposure limit for each individual 
counterparty, and the exposure limit would need to be reviewed if the 
counterparty's credit risk profile changes and at least quarterly;
     The BD/FCM would need to have the ability to limit or 
reduce the exposure to a counterparty through the collection of 
additional margin;
     The BD/FCM would need to have documented procedures to 
value positions conservatively in view of current market prices and the 
amount that might be realized upon liquidation; and
     The BD/FCM would need to have well-defined procedures and 
systems in place for the daily collection and payment of initial and 
variation margin.\56\
---------------------------------------------------------------------------

    \56\ See Proposed Order, ] (c)(2).
---------------------------------------------------------------------------

    This proposed standards requirement is a condition in the BD/FCM 
staff letters. These proposed risk

[[Page 70664]]

management standards are designed to require a BD/FCM to take prudent 
measures to protect the firm from losses that can result from failing 
to account for and control risk with respect to its CDS portfolio 
margin program. Requiring a BD/FCM to incorporate these proposed 
standards is designed to promote the establishment of effective 
internal risk management programs to address the risks of portfolio 
margining cleared CDS.
    The third standard for the internal risk management program is that 
the BD/FCM would need to report to the Commission and FINRA staffs on a 
monthly basis within 5 business days after month end or as otherwise 
requested details of its top 25 counterparties' portfolios as measured 
by net credit exposure as well as the top 25 counterparties' portfolios 
as measured by gross notional amount.\57\ This proposed requirement is 
a condition in the BD/FCM staff letters. Based on Commission staff's 
experience with the BD/FCM staff letter requirements, the Commission 
preliminarily believes that it would be appropriate to require this 
monthly reporting as it will assist Commission staff in monitoring the 
risk to the BD/FCM arising from its portfolio margining of cleared CDS. 
Understanding the magnitude of this risk will assist the Commission 
staff in evaluating the appropriateness of a given firm's internal risk 
management program in terms of its procedures and controls to mitigate 
risk.
---------------------------------------------------------------------------

    \57\ See Proposed Order, ] (c)(3).
---------------------------------------------------------------------------

    The proposed order would not include other conditions in the BD/FCM 
staff letters, including the capital concentration charge. Based on 
Commission staff experience monitoring the BD/FCMs participating in the 
CDS portfolio margin program, the Commission preliminarily believes 
that the capital concentration charge and other conditions in the BD/
FCM staff letters may not be necessary in light of the requirement to 
have a reasonably designed internal risk management program. A 
reasonably designed internal risk management program will provide a BD/
FCM the tools to better understand the risks that arise from its 
portfolio margining of cleared CDS and address them as the firm deems 
appropriate (e.g., through risk limits, threshold triggers, house 
margin, heightened monitoring, or other controls). Therefore, the 
Commission is proposing not to incorporate these conditions into the 
proposed order.
    The fourth BD/FCM condition in the proposed order would require 
that the BD/FCM be in compliance with applicable laws and regulations 
relating to risk management, capital, and liquidity, and be in 
compliance with applicable clearing agency/DCO rules and CFTC 
requirements (including margin, segregation, and related books and 
records provisions) with respect to CFTC cleared swaps customer 
accounts and cleared swaps proprietary accounts subject to the CDS 
portfolio margin program.\58\ The purpose of this condition is to help 
ensure that the exemption is available only when the BD/FCM is in 
compliance with applicable regulatory requirements. The fifth BD/FCM 
condition in the proposed order would require that each cleared swaps 
customer and affiliate of the BD/FCM participating in the CDS portfolio 
margin program be an ``eligible contract participant.'' \59\ As with 
the third condition in the proposed order for clearing agency/DCOs, the 
Commission preliminarily believes it would be appropriate to limit the 
availability of this exemption to eligible contract participants. 
Eligible contract participants should have the expertise or resources 
to effectively determine the risks associated with engaging in these 
types of transactions.
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    \58\ See Proposed Order, ] (b)(4). See also supra note 22.
    \59\ See Proposed Order, ] (b)(5). The 2012 Order requires that 
each customer of the BD/FCM participating in a program to commingle 
and portfolio margin CDS be an ``eligible contract participant'' as 
defined in Section 1a(18) of the CEA. 77 FR at 75220. See also supra 
note 22.
---------------------------------------------------------------------------

    The sixth BD/FCM condition in the proposed order would require 
that, before receiving any money, securities, or property of a cleared 
swaps customer or affiliate to margin, guarantee, or secure positions 
consisting of cleared CDS, the BD/FCM would need to furnish to the 
cleared swaps customer or affiliate a disclosure document containing: 
(1) A statement indicating that the cleared swaps customer's or 
affiliate's money, securities, and property will be held in a CFTC 
cleared swaps account, and that the cleared swaps customer or affiliate 
has elected to seek protections under the commodity broker liquidation 
provisions with respect to such money, securities, and property; and 
(2) a statement that the broker-dealer segregation requirements of 
Sections 15(c)(3) and 3E of the Exchange Act and the rules thereunder, 
and any customer protections under SIPA and the stockbroker liquidation 
provisions, will not apply to such cleared swaps customer or affiliate 
money, securities, and property.\60\ The disclosure document would need 
to be provided to the cleared swaps customer or affiliate at or prior 
to the time that the cleared swaps customer or affiliate opens the CFTC 
cleared swaps account and, in all cases, prior to the BD/FCM receiving 
any money, securities or property into the CFTC cleared swaps account 
of the cleared swaps customer or affiliate. This condition is designed 
to provide market participants that elect to participate in the CDS 
portfolio margin program with important disclosures regarding the legal 
framework that will govern their transactions.
---------------------------------------------------------------------------

    \60\ See Proposed Order, ] (b)(6). See also supra note 22.
---------------------------------------------------------------------------

    Accordingly, pursuant to its authority under Sections 3E(c)(2) \61\ 
and 36 \62\ of the Exchange Act, the Commission preliminarily believes 
that the proposed order, under the terms and conditions described 
above, would be necessary or appropriate in the public interest and 
consistent with the protection of investors.
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    \61\ 15 U.S.C. 78c-5(c)(2). Section 3E(c)(2) of the Exchange Act 
provides that the Commission may, notwithstanding Section 3E(b) of 
the Exchange Act, by rule, regulation, or order prescribe terms and 
conditions under which any money, securities, or property of a 
customer with respect to cleared security-based swaps may be 
commingled and deposited with any other money, securities, or 
property received by the broker-dealer or SBSD and required by the 
Commission to be separately accounted for and treated and dealt with 
as belonging to the security-based swap customer of the broker-
dealer or SBSD.
    \62\ 15 U.S.C. 78mm. Section 36 of the Exchange Act authorizes 
the Commission to conditionally or unconditionally exempt, by rule, 
regulation, or order any person, security, or transaction (or any 
class or classes of persons, securities, or transactions) from any 
provision of the Exchange Act or any rule or regulation thereunder, 
to the extent such exemption is necessary or appropriate in the 
public interest, and is consistent with the protection of investors.
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IV. Request for Comments

    The Commission is seeking comment on all aspects of the proposed 
exemption. In particular, the Commission requests comment on the 
following questions. When responding to the request for comment, please 
explain your reasoning.
    1. Should any of the proposed exemptions or conditions be 
eliminated or modified?
    2. Are there other or different conditions that should apply to the 
proposed exemption?
    3. Are there any specific written disclosures to cleared swaps 
customers or affiliates that a BD/FCM should be required to provide in 
addition to those that are a condition to the proposed exemption?
    4. At what stage during the account opening process does the 
cleared swaps

[[Page 70665]]

customer or affiliate enter into a non-conforming subordination 
agreement as required by the 2012 Order? Is it before, at the same 
time, or after the cleared swaps customer or affiliate receives the 
required written disclosures from the BD/FCM? Should the proposed 
condition related to the written disclosure document be modified to 
require that the BD/FCM furnish it to the cleared swaps customer or 
affiliate before the customer enters into the non-conforming 
subordination agreement with the BD/FCM (and before the BD/FCM receives 
any money, securities, or property to margin the CDS positions)?
    5. Does the proposed modified text required in the non-conforming 
subordination agreements achieve the objectives of: (1) Removing 
portfolio margin cleared swaps customers and affiliates from the 
definitions of ``customer'' under Rule 15c3-3, SIPA, and the 
stockbroker liquidation provisions with respect to securities or cash 
held in CFTC cleared swaps accounts; (2) not undermining the 
protections afforded to the portfolio margin cleared swaps customers 
and affiliates under the rules of the CFTC, the CEA, and commodity 
broker liquidation provisions; and (3) not requiring portfolio margin 
cleared swaps customers or affiliates to subordinate their claims, in 
the event that their cleared swaps customer or affiliate claims are not 
fully satisfied by the distribution of assets held in their CFTC 
cleared swaps accounts, to assets that may be included in the debtor's 
general estate? Is there alternative language that would better achieve 
these objectives? Does the text in the 2012 Order achieve these 
objectives? If this modification or some other modification were made 
to the order, would it require BD/FCMs to amend all their existing 
agreements with cleared swaps customers and affiliates participating in 
the portfolio margin program? If so, would this be a significant 
burden?
    6. Should clearing agencies/DCOs be required to provide market 
participants with the ability to select an SEC SBS account as an 
alternative to a CFTC cleared swaps account?
    7. Have market participants expressed an interest in portfolio 
margining cleared CDS in an SEC SBS account? If so, how has this 
interest changed since 2012?
    8. Would there be interest by BD/FCMs in offering market 
participants the option to portfolio margin cleared CDS in an SEC SBS 
account after the October 6, 2021 compliance date for the SEC's final 
capital, margin, and segregation rules for security-based swaps, when 
the customer protection framework for security-based swaps is in place?
    9. If there was no regulatory requirement to provide market 
participants with the ability to select an SEC SBS account as an 
alternative to a CFTC cleared swaps account, would clearing agencies/
DCOs be incentivized to offer such an alternative in the future, if 
market conditions changed and demand rose for an SEC SBS account 
alternative?
    10. Are the proposed standards for the BD/FCM's internal risk 
management program appropriate?
    11. Is it appropriate for the proposed order to deem a BD/FCM to 
have an internal risk management program that has been approved by the 
Commission or the Commission staff as required by paragraph (b)(3) of 
the proposed order if it has received prior approval of its margin 
methodology?
    12. Would the proposed exemption have a competitive impact--either 
positive or negative--on market participants in the context of CDS 
clearing? What would be the potential benefits and costs of the 
proposed exemption? Would the proposed modifications to the 2012 Order 
impact investor protection? If so, what would those impacts be?

    By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.

Appendix--Text of Proposed Order

    It is hereby ordered that any broker-dealer also registered as a 
futures commission merchant that has received approval of its margin 
methodology by the Commission or Commission staff prior to the date 
of this order is deemed to have an internal risk management program 
that has been approved by the Commission or the Commission staff as 
required by paragraph (b)(3) of this order.
    It is hereby further ordered, pursuant to Section 3E(c)(2) and 
Section 36 of the Securities Exchange Act of 1934 (``Exchange 
Act''), that the following exemptions from Exchange Act requirements 
will apply:
    (a) Exemption for dually-registered clearing agencies/
derivatives clearing organizations.
    A clearing agency registered pursuant to Section 17A of the 
Exchange Act and registered as a derivatives clearing organization 
pursuant to Section 5b of the CEA (a ``clearing agency/DCO'') will 
be exempt from Sections 3E(b), (d), and (e) of the Exchange Act and 
any rules thereunder, solely to perform the functions of a clearing 
agency for credit default swaps (``CDS'') under a program to 
commingle and portfolio margin cleared CDS for cleared swaps 
customer and affiliate positions, subject to the following 
conditions:
    (1) The clearing agency/DCO has obtained any other relief needed 
to permit its clearing members that are registered under Section 
15(b) of the Exchange Act (other than paragraph (11) thereof) and 
also registered as a futures commission merchant pursuant to Section 
4f(a)(1) of the CEA (a ``BD/FCM'') (at the BD/FCM's election), to 
maintain cleared swaps customer or affiliate money, securities, and 
property received by the BD/FCM to margin, guarantee, or secure 
cleared swaps customer or affiliate positions in cleared CDS, which 
include both swaps and security-based swaps, in a segregated account 
established and maintained in accordance with Section 4d(f) of the 
CEA and rules thereunder (in the case of a cleared swaps customer) 
or a cleared swaps proprietary account (in the case of an affiliate) 
for the purpose of clearing (as a clearing member of the clearing 
agency/DCO) such cleared swaps customer or affiliate positions under 
a program to commingle and portfolio margin CDS.
    (2) The clearing agency/DCO has appropriate rules and 
operational practices to permit a BD/FCM that is a clearing member 
(at the BD/FCM's election) to maintain cleared swaps customer or 
affiliate money, securities, and property received by the BD/FCM to 
margin, guarantee, or secure cleared swaps customer or affiliate 
positions in cleared CDS, which include both swaps and security-
based swaps, in a segregated account established and maintained in 
accordance with Section 4d(f) of the CEA and rules thereunder (in 
the case of a cleared swaps customer) or a cleared swaps proprietary 
account (in the case of an affiliate) for the purpose of clearing 
(as a clearing member of the clearing agency/DCO) such cleared swaps 
customer or affiliate positions under a program to commingle and 
portfolio margin CDS.
    (3) The rules of the clearing agency/DCO require that each 
cleared swaps customer and affiliate of the BD/FCM participating in 
a program to commingle and portfolio margin CDS must be an 
``eligible contract participant'' as defined in Section 1a(18) of 
the CEA.
    (b) Exemption for certain BD/FCMs that elect to offer a program 
to commingle and portfolio margin cleared swaps customer and 
affiliate positions in cleared CDS. Solely to perform the functions 
of a BD/FCM for cleared CDS, with respect to any cleared swaps 
customer or affiliate money, securities, and property received by 
the BD/FCM to margin, guarantee, or secure cleared swaps customer or 
affiliate positions in security-based swaps included in a segregated 
account established and maintained in accordance with Section 4d(f) 
of the CEA and rules thereunder (in the case of a cleared swaps 
customer) or a cleared swaps proprietary account (in the case of an 
affiliate) under a program to commingle and portfolio margin cleared 
swaps customer or affiliate positions in CDS, a BD/FCM will be 
exempt from Exchange Act Sections 3E(b), (d), and (e), and Section 
15(c)(3) and Rule 15c3-3 thereunder and any requirement to treat an 
affiliate (as defined in association with the definition of 
``cleared swaps proprietary account'' pursuant to CFTC Rule 22.1) as 
a customer for purposes of Section 8 of the Exchange Act and 
Exchange Act Rules 8c-1 and 15c2-1 thereunder, subject to the 
following conditions:

[[Page 70666]]

    (1) With respect to cleared swaps customers that are not 
affiliates of the BD/FCM,
    (i) The BD/FCM must maintain cleared swaps customer money, 
securities, and property received to margin, guarantee or secure 
cleared swaps customer positions consisting of cleared CDS, which 
include both swaps and security-based swaps, in a segregated account 
established and maintained in accordance with Section 4d(f) of the 
CEA and rules thereunder for the purpose of clearing (as a clearing 
member or through a clearing member of a clearing agency/DCO 
operating pursuant to the exemption in paragraph (a) above) such 
cleared swaps customer positions under a program to commingle and 
portfolio margin CDS; and
    (ii) The BD/FCM must enter into a non-conforming subordination 
agreement with each cleared swaps customer. The agreement must 
contain a specific acknowledgment by the cleared swaps customer that 
such money, securities or property will not receive customer 
treatment under the Exchange Act or SIPA or be treated as ``customer 
property'' as defined in 11 U.S.C. 741 in a liquidation of the BD/
FCM and that such money, securities or property will be subject to 
any applicable protections under Subchapter IV of Chapter 7 of Title 
11 of the United States Code and rules and regulations thereunder; 
as well as an affirmation by the cleared swaps customer that claims 
to ``customer property'' as defined in SIPA or 11 U.S.C. 741 against 
the BD/FCM will be subordinated to the claims of securities 
customers and security-based swap customers.
    (2) With respect to affiliates of the BD/FCM,
    (i) The BD/FCM maintains money, securities, and property of 
affiliates received to margin, guarantee, or secure positions 
consisting of cleared CDS, which include both swaps and security-
based swaps, in a cleared swaps proprietary account for the purpose 
of clearing (as a clearing member of a clearing agency/DCO operating 
pursuant to the exemption in paragraph (a) above) such positions 
under a program to commingle and portfolio margin CDS;
    (ii) The BD/FCM enters into a non-conforming subordination 
agreement with each affiliate. The agreement must contain a specific 
acknowledgment by the affiliate that such money, securities or 
property will not receive customer treatment under the Exchange Act 
or SIPA or be treated as ``customer property'' as defined in 11 
U.S.C. 741 in a liquidation of the BD/FCM, and that such money, 
securities or property will be held in a proprietary account in 
accordance with the CFTC requirements and will be subject to any 
applicable protections under Subchapter IV of Chapter 7 of Title 11 
of the United States Code and rules and regulations thereunder; as 
well as an affirmation by the affiliate that claims to ``customer 
property'' as defined in SIPA or 11 U.S.C. 741 against the BD/FCM 
will be subordinated to the claims of securities customers and 
security-based swap customers; and
    (iii) The BD/FCM obtains from the affiliate an opinion of 
counsel that the affiliate is legally authorized to subordinate all 
of its claims against the BD/FCM to those of securities customers 
and security-based swap customers.
    (3) The BD/FCM has adopted an internal risk management program 
that is reasonably designed to identify, measure, and manage the 
risks arising from its program to allow cleared swaps customers and 
affiliates to commingle and portfolio margin CDS that has been 
approved in advance by the Commission or the Commission staff and 
meets the standards in section (c) below.
    (4) The BD/FCM must be in compliance with applicable laws and 
regulations relating to risk management, capital, and liquidity, and 
must be in compliance with applicable clearing agency/DCO rules and 
CFTC requirements (including segregation and related books and 
records provisions) for accounts established and maintained in 
accordance with Section 4d(f) of the CEA and rules thereunder (in 
the case of cleared swaps customers) and for cleared swaps 
proprietary accounts (in the case of affiliates), and subject to a 
program to commingle and portfolio margin CDS.
    (5) Each cleared swaps customer and affiliate of the BD/FCM 
participating in a program to commingle and portfolio margin CDS is 
an ``eligible contract participant'' as defined in Section 1a(18) of 
the CEA.
    (6) Before receiving any money, securities, or property of a 
cleared swaps customer or affiliate to margin, guarantee, or secure 
positions consisting of cleared CDS, which include both swaps and 
security-based swaps, under a program to commingle and portfolio 
margin CDS, the BD/FCM must furnish to the cleared swaps customer or 
affiliate a disclosure document containing the following 
information:
    (i) A statement indicating that the cleared swaps customer's or 
affiliate's money, securities, and property will be held in an 
account maintained in accordance with the segregation requirements 
of Section 4d(f) of the CEA (in the case of a cleared swaps 
customer) or a cleared swaps proprietary account (in the case of an 
affiliate), and that the cleared swaps customer or affiliate has 
elected to seek protections under Subchapter IV of Chapter 7 of 
Title 11 of the United States Code and the rules and regulations 
thereunder with respect to such money, securities, and property; and
    (ii) A statement that the broker-dealer segregation requirements 
of Section 15(c)(3) and Section 3E of the Exchange Act and the rules 
thereunder, and any customer protections under SIPA and the 
stockbroker liquidation provisions, will not apply to such cleared 
swaps customer or affiliate money, securities, and property.
    (c) Standards for internal risk management program. The internal 
risk management program required pursuant to condition (b)(3) of 
this order must have the following standards in place:
    (1) Internal Risk Model. The BD/FCM must calculate a future 
credit exposure for each cleared swaps customer and affiliate (each 
a ``counterparty'') using its own proprietary methodology 
(``internal risk model'') subject to the following minimum 
quantitative and qualitative model standards:
    (i) Quantitative Requirements. (A) The internal risk model must 
estimate a potential future exposure over a minimum 10-day horizon 
and 99% confidence level and capture all material risk factors, 
including but not limited to general movements in credit spread term 
structure, basis risk between index and single name positions, and 
interest rate risk;
    (B) The internal risk model must include a concentration/
liquidity requirement; and
    (C) The internal risk model must include a jump-to-default 
requirement for the sale of CDS protection equal to the largest loss 
of a single name exposure assuming a conservative recovery rate that 
may not exceed 40%.
    (ii) Qualitative Requirements. (A) The internal risk model must 
be adequately documented and the documentation must provide a 
description of the model assumptions, data inputs, parameters, and 
methodologies employed to measure risk;
    (B) The internal risk model must be subject to an annual model 
review by a model group that is independent of the business 
function;
    (C) The internal risk model must be subject to at least 
quarterly backtesting by counterparty or account; and
    (D) The BD/FCM must provide written notice to the Commission or 
Commission staff prior to implementing any material change to its 
internal risk model.
    (2) Minimum Risk Management System Standards. (A) The BD/FCM 
must maintain risk management system standards to measure and manage 
risk exposure arising from counterparties' CDS portfolios that are 
independent of any central counterparty margin methodology;
    (B) The BD/FCM must have an internal credit risk rating model 
that assesses the credit risk of each individual counterparty;
    (C) The BD/FCM's monitoring of credit risk must include the 
prudent setting of an exposure limit for each individual 
counterparty and the exposure limit must be reviewed if the 
counterparty's credit risk profile changes and at least quarterly;
    (D) The BD/FCM must have the ability to limit or reduce the 
exposure to a counterparty through the collection of additional 
margin;
    (E) The BD/FCM must have documented procedures to value 
positions conservatively in view of current market prices and the 
amount that might be realized upon liquidation; and
    (F) The BD/FCM must have well-defined procedures and systems in 
place for the daily collection and payment of initial and variation 
margin.
    (3) Monthly Reporting. The BD/FCM must report to the Commission 
and FINRA staffs on a monthly basis within 5 business days after 
month end or as otherwise requested details of its top 25 
counterparties' portfolios as measured by net credit exposure as 
well as the top 25 counterparties' portfolios as measured by gross 
notional amount.

[FR Doc. 2020-24612 Filed 11-4-20; 8:45 am]
BILLING CODE 8011-01-P