Process for Review of Swaps for Mandatory Clearing

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Notice of proposed rulemaking.

SUMMARY:

The Commodity Futures Trading Commission (Commission or CFTC) is proposing rules to implement new statutory provisions enacted by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act. These proposed rules apply to the review of swaps by the Commission to determine whether the swaps are required to be cleared.

DATES:

Submit comments on or before January 3, 2011.

ADDRESSES:

You may submit comments, identified by RIN number, by any of the following methods:

• Agency Web Site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments through the Web site.
• 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.
• Federal eRulemaking Portal: http://www.regulations.gov. Follow the instructions for submitting comments.

All comments must be submitted in English, or if not, accompanied by an English translation. Comments will be posted as received to http://www.cftc.gov. You should submit only information that you wish to make available publicly. If you wish the Commission to consider information that may be exempt from disclosure under the Freedom of Information Act, a petition for confidential treatment of the exempt information may be submitted according to the established procedures in CFTC Regulation 145.9.

FOR FURTHER INFORMATION CONTACT:

Eileen A. Donovan, Special Counsel, 202-418-5096, edonovan@cftc.gov, Division of Clearing and Intermediary Oversight, 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 Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Title VII of the Dodd-Frank Act amended the Commodity Exchange Act (CEA) to establish a comprehensive new regulatory framework for swaps and security-based swaps. The legislation was enacted to reduce risk, increase transparency, and promote market integrity within the financial system by, among other things: (1) Providing for the registration and comprehensive regulation of swap dealers and major swap participants; (2) imposing clearing and trade execution requirements on standardized derivative products; (3) creating rigorous recordkeeping and real-time reporting regimes; and (4) enhancing the Commission's rulemaking and enforcement authorities with respect to, among others, all registered entities and intermediaries subject to the Commission's oversight.

Section 723(a)(3) of the Dodd-Frank Act amends the CEA to provide that “it shall be unlawful for any person to engage in a swap unless that person submits such swap for clearing to a derivatives clearing organization [(DCO)] that is registered under [the CEA] or a [DCO] that is exempt from registration under [the CEA] if the swap is required to be cleared.” Section 723(a)(3) requires the Commission to adopt rules for the review of a swap, or group, category, type, or class of swaps (collectively, “swaps”) to make a determination as to whether the swaps should be required to be cleared.

In addition, Section 745(b) of the Dodd-Frank Act amends the CEA to direct the Commission to prescribe criteria, conditions, or rules under which the Commission will determine the initial eligibility or the continuing qualification of a DCO to clear swaps.

Accordingly, the Commission is proposing to adopt Regulation 39.5 to implement procedures for determining the eligibility of a DCO to clear swaps that it plans to accept for clearing; for DCOs submitting swaps to the Commission for review; for Commission-initiated reviews of swaps; and for staying a clearing requirement while the clearing of a swap is reviewed.

The Commission requests comment on all aspects of the proposed rules, as well as comment on the specific provisions and issues highlighted in the discussion below.

II. Proposed Regulations

A. Eligibility of a DCO To Clear Swaps

The Dodd-Frank Act requires the Commission to determine, upon request or its own motion, the initial eligibility or continuing qualification of a DCO to clear a swap that it plans to accept for clearing, under criteria, conditions, or rules determined by the Commission. Such criteria, conditions, or rules must consider the financial integrity of the DCO and any other factors that the Commission determines to be appropriate.

Under proposed Regulation 39.5(a), a DCO would be presumed eligible to accept for clearing any swap that is within a group, category, type, or class of swaps that the DCO already clears. However, such a presumption would be subject to Commission review, and if the Commission determines that the swap is not within a group, category, type, or class of swaps that the DCO already clears, the DCO would be required to request a determination by the Commission of its eligibility to clear the swap. A DCO that plans to accept for clearing any swap that is not within a group, category, type, or class of swaps that the DCO already clears also would be required to make such a request.

To receive a determination of eligibility to clear a swap, a DCO would have to file a written request with the Commission that addresses its ability to maintain compliance with the core principles for DCOs set out in Section 5b(c)(2) of the CEA if it accepts the swap for clearing, specifically: (1) The sufficiency of its financial resources; and (2) its ability to manage the risks associated with clearing the swap, especially if the Commission determines that the swap is required to be cleared.

B. Submission of Swaps to the Commission for Review

The Dodd-Frank Act requires a DCO that plans to accept a swap (or group, category, type, or class of swaps) for clearing to submit the swap to the Commission for review. Proposed Regulation 39.5(b) sets out the process for DCOs to follow, including what information a DCO must include in its submission to assist the Commission in its review.

First, the submission would have to include a statement that the DCO is eligible to clear the swap and, if the Commission determines that the swap is required to be cleared, the DCO would be able to maintain compliance with Section 5b(c)(2) of the CEA. This provision is intended to satisfy the Dodd-Frank Act requirement that a swap submission be consistent with Section 5b(c)(2). Regulation 39.5(b)(1) would require a DCO submitting a swap to be eligible to clear the swap under Regulation 39.5(a) and, as noted above, a DCO that seeks to be considered eligible to clear a swap must demonstrate its ability to maintain compliance with the core principles in Section 5b(c)(2). Therefore, a DCO submitting a swap under Regulation 39.5(b) would have already demonstrated pursuant to Regulation 39.5(a) its ability to comply with Section 5b(c)(2). Accordingly, the Commission believes it is appropriate to require only a statement to that effect in the swap submission itself.

A DCO would also have to provide a statement that includes, but is not limited to, information that would assist the Commission in the quantitative and qualitative assessment of five specific factors that the Dodd-Frank Act requires the Commission to take into account when reviewing a swap submission, and additional information that the Commission believes is needed for an effective review of the swap submission. The proposed regulation would require the DCO to provide specific information relating to product specifications; participant eligibility standards; pricing sources, models, and procedures; risk management procedures; measures of market liquidity and trading activity; the effect of a clearing requirement on the market for the swap; applicable rules, manuals, policies, or procedures; and terms and trading conventions on which the swap is currently traded.

Finally, the swap submission would have to include a description of the manner in which the DCO has provided notice of the submission to its members and a summary of any opposition to the submission expressed by members. The Dodd-Frank Act requires a DCO to provide notice of the submission to its members in a manner to be determined by the Commission. The Commission recognizes that a DCO typically has established procedures for providing notice to its members and believes it is appropriate to allow the DCO to provide notice of a swap submission in the same manner. The submission to the Commission also would have to include a summary of any opposition expressed by members, which means that a DCO would be expected to notify members before it makes its submission to the Commission. The Commission invites comment on whether the regulation should prescribe a specific manner in which a DCO must provide notice to its members, and whether the regulation should prescribe a specific period of time between the notice to members and the submission to the Commission to allow time for members to make their views on the submission known.

Upon receiving a DCO's submission, the Commission would begin its 90-day review by posting the submission on the Commission Web site for a 30-day public comment period, as required by the Dodd-Frank Act. The Commission invites comment regarding the appropriateness and sufficiency of providing notice of the submission on the Commission Web site as compared to publishing notice of the submission in the Federal Register. The review would not begin until the submission was complete, as determined solely in the discretion of the Commission. Due to the relatively brief 90-day review period prescribed by the Dodd-Frank Act, the Commission must be certain before it begins a review that it has the information it needs to reach an appropriate determination.

The proposed regulation encourages a DCO to submit swaps to the Commission, to the extent reasonable and practicable to do so, by group, category, type, or class of swaps. The Commission believes this will make the review process more efficient. The Commission would be able to consolidate multiple submissions from one DCO or subdivide a DCO's submission for review as appropriate.

The Commission would review the submission and make a determination as to whether the swap will be required to be cleared not later than 90 days after receiving the submission, unless the submitting DCO agreed to an extension. In making a determination that the swap must be cleared, the Commission would impose terms and conditions on the requirement as appropriate.

C. Commission-Initiated Reviews of Swaps

The Dodd-Frank Act requires the Commission on an ongoing basis to review swaps that have not been accepted for clearing by a DCO to make a determination as to whether the swaps should be required to be cleared. Under proposed Regulation 39.5(c), the Commission would use information obtained pursuant to Commission regulations from swap data repositories, swap dealers, and major swap participants, and any other available information, in undertaking such reviews.

If no DCO has accepted for clearing a particular swap, group, category, type, or class of swaps that the Commission finds would otherwise be subject to a clearing requirement, the Commission would, as required by the Dodd-Frank Act, investigate the relevant facts and circumstances and, within 30 days of the completion of its investigation, issue a public report containing the results of the investigation. The Commission would take such actions as it determines to be necessary and in the public interest, which may include establishing margin or capital requirements for parties to the swap, group, category, type, or class of swaps.

D. Stay of Clearing Requirement

After making a determination that a swap (or group, category, type, or class of swaps) is required to be cleared, the Commission, on application of a counterparty to a swap or on its own initiative, may stay the clearing requirement until it completes a review of the terms of the swap and the clearing arrangement. Proposed Regulation 39.5(d)(2) sets out the process for a counterparty to a swap to apply for a stay of the clearing requirement.

A counterparty to a swap that wants to apply for a stay of the clearing requirement for that swap would be required to submit a written request to the Secretary of the Commission that includes information that would assist the Commission in its review, including: The identity and contact information of the counterparty to the swap; the terms of the swap subject to the clearing requirement; the name of the DCO that clears the swap; a description of the clearing arrangement; and a statement explaining why the swap should not be subject to a clearing requirement.

The Commission also would be able to obtain additional information to assist it in its review from the DCO that clears the swap. The Commission would complete its review not later than 90 days after issuance of the stay, unless the DCO that clears the swap agrees to an extension.

Upon completion of its review, the Commission could determine, subject to any terms and conditions as the Commission determines to be appropriate, that the swap must be cleared, or that the clearing requirement will not apply but clearing may continue on a non-mandatory basis.

III. Technical Amendments

The Commission is proposing to amend Regulation 140.94 to delegate authority to the Director of the Division of Clearing and Intermediary Oversight to consolidate or subdivide swap submissions as appropriate for review under proposed Regulation 39.5(b)(2) and to request information from a derivatives clearing organization in connection with the stay of a clearing requirement under proposed Regulation 39.5(d)(3).

IV. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA) requires that agencies consider whether the rules they propose will have a significant economic impact on a substantial number of small entities and, if so, provide a regulatory flexibility analysis respecting the impact. The rules proposed by the Commission shall affect only DCOs. The Commission has previously established certain definitions of “small entities” to be used by the Commission in evaluating the impact of its regulations on small entities in accordance with the RFA. The Commission has previously determined that DCOs are not small entities for the purpose of the RFA. Accordingly, the Chairman, on behalf of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that the proposed rules will not have a significant economic impact on a substantial number of small entities.

B. Paperwork Reduction Act

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid control number. OMB has not yet assigned a control number to the new collection. The Paperwork Reduction Act of 1995 (PRA) imposes certain requirements on Federal agencies (including the Commission) in connection with their conducting or sponsoring any collection of information as defined by the PRA. This proposed rulemaking would result in new collection of information requirements within the meaning of the PRA. The Commission therefore is submitting this proposal to the Office of Management and Budget (OMB) for review. If adopted, responses to this collection of information would be mandatory. The Commission will protect proprietary information according to the Freedom of Information Act and 17 CFR Part 145, “Commission Records and Information.” In addition, section 8(a)(1) of the CEA strictly prohibits the Commission, unless specifically authorized by the CEA, from making public “data and information that would separately disclose the business transactions or market positions of any person and trade secrets or names of customers.” The Commission is also required to protect certain information contained in a government system of records according to the Privacy Act of 1974, 5 U.S.C. 552a.

1. Information Provided by Reporting Entities/Persons

The proposed regulations require each respondent to file information with the Commission on an occasional basis, which would result in one annual response per respondent. Commission staff estimates that each respondent would expend 40 hours to prepare each filing required under the proposed regulations, which was estimated based on the Commission's prior experience with DCOs and their preparation of filings for the Commission's review. Commission staff estimates that it would receive filings from up to 12 respondents annually, which assumes that each DCO would make an average of one filing per year. Accordingly the burden in terms of hours would in the aggregate be 40 hours annually per respondent and 480 hours annually for all respondents.

Commission staff estimates that each respondent could expend up to $4000 annually, based on an hourly wage rate of $100, to comply with the proposed regulations. This would result in an aggregated cost of $48,000 per annum (12 respondents x $4000). The Commission invites public comment on the accuracy of its estimate regarding the collection requirements that would result from the proposed regulations.

2. Information Collection Comments

The Commission invites the public and other federal agencies to comment on any aspect of the reporting and recordkeeping burdens discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments in order to: (i) Evaluate whether the proposed collection of information is necessary for the proper performance of the functions of the Commission, including whether the information will have practical utility; (ii) evaluate the accuracy of the Commission's estimate of the burden of the proposed collection of information; (iii) determine whether there are ways to enhance the quality, utility, and clarity of the information to be collected; and (iv) minimize the burden of the collection of information on those who are to respond, including through the use of automated collection techniques or other forms of information technology.

Comments may be submitted directly to the Office of Information and Regulatory Affairs, by fax at (202) 395-6566 or by e-mail at OIRAsubmissions@omb.eop.gov. Please provide the Commission with a copy of submitted comments so that all comments can be summarized and addressed in the final rule preamble. Refer to the Addresses section of this notice of proposed rulemaking for comment submission instructions to the Commission. A copy of the supporting statements for the collections of information discussed above may be obtained by visiting RegInfo.gov. OMB is required to make a decision concerning the collection of information between 30 and 60 days after publication of this document in the Federal Register. Therefore, a comment is best assured of having its full effect if OMB receives it within 30 days of publication.

C. Cost-Benefit Analysis

Section 15(a) of the CEA requires the Commission to consider the costs and benefits of its actions before issuing a rulemaking under the CEA. By its terms, Section 15(a) does not require the Commission to quantify the costs and benefits of a rule or to determine whether the benefits of the rulemaking outweigh its costs; rather, it requires that the Commission “consider” the costs and benefits of its actions. Section 15(a) further specifies that the costs and benefits shall be evaluated in light of five broad areas of market and public concern: (1) Protection of market participants and the public; (2) efficiency, competitiveness, and financial integrity of futures markets; (3) price discovery; (4) sound risk management practices; and (5) other public interest considerations. The Commission may in its discretion give greater weight to any one of the five enumerated areas and could in its discretion determine that, notwithstanding its costs, a particular rule is necessary or appropriate to protect the public interest or to effectuate any of the provisions or accomplish any of the purposes of the CEA.

Summary of proposed requirements. The proposed rule would implement processes for determining the eligibility of a DCO to clear swaps that it wishes to accept for clearing; for DCOs submitting swaps to the Commission for review; for Commission-initiated reviews of swaps; and for staying a clearing requirement while the clearing of a swap is reviewed.

Costs. With respect to costs, the Commission has determined that the rule results in minimal costs. The rule only requires DCOs and swap counterparties to provide sufficient information for the Commission to carry out its responsibilities under the Dodd-Frank Act in an efficient manner. The rule itself does not require the clearing of any swap, so the Commission did not consider the potential costs of mandatory clearing in its analysis.

Benefits. With respect to benefits, the Commission has determined that the rule will benefit the public by making information publicly available and by providing opportunity for comment. The rule also takes into account the risk management practices of a DCO in making a determination on the DCO's eligibility to clear swaps. The rule itself does not require the clearing of any swap, so the Commission did not consider the potential benefits of mandatory clearing in its analysis.

Public Comment. The Commission invites public comment on its cost-benefit considerations. Commenters are also invited to submit any data or other information that they may have quantifying or qualifying the costs and benefits of the proposal with their comment letters.

List of Subjects

17 CFR Part 39

• Business and industry
• Commodity futures
• Reporting and recordkeeping requirements

17 CFR Part 140

• Authority delegations (Government agencies)
• Conflict of interests
• Organization and functions (Government agencies)

For the reasons stated in the preamble, the Commission proposes to amend 17 CFR parts 39 and 140 as follows:

PART 39—DERIVATIVES CLEARING ORGANIZATIONS

1. The authority citation for part 39 is revised to read as follows:

Authority: 7 U.S.C. 7a-1 as amended by Pub. L. 111-203, 124 Stat. 1376.

2. Redesignate §§ 39.5 through 39.7 as §§ 39.6 through 39.8 and add new § 39.5 to read as follows:

PART 140—ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION

3. The authority citation for part 140 continues to read as follows:

Authority: 7 U.S.C. 2 and 12a.

4. In § 140.94, revise paragraph (a)(5) and add new paragraphs (a)(6) and (a)(7) to read as follows:

Note:

The following attachment will not appear in the Code of Federal Regulations:

Statement of Chairman Gary Gensler Process for Review of Swaps for Mandatory Clearing October 26, 2010

I support the proposed rulemaking to establish a process for the review and designation of swaps for mandatory clearing. One of the primary goals of the Dodd-Frank Act was to lower risk by requiring standardized swaps to be centrally cleared. The process set out in the proposed rule is consistent with the Congressional requirement that derivatives clearing organizations (DCOs) be eligible to clear the swaps and that before a swap becomes subject to mandatory clearing the public get to provide input on the contract or class of contracts. Though we have until July to finalize this rulemaking, it is my hope that we can finish by April. This would allow us to begin reviewing the contracts that are already being cleared by DCOs and under Dodd-Frank have already been deemed submitted to the Commission for consideration.