[Federal Register Volume 75, Number 245 (Wednesday, December 22, 2010)]
[Proposed Rules]
[Pages 80572-80636]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-31458]
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Part II
Commodity Futures Trading Commission
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17 CFR Parts 1, 16, and 38
Core Principles and Other Requirements for Designated Contract Markets;
Proposed Rule
Federal Register / Vol. 75 , No. 245 / Wednesday, December 22, 2010 /
Proposed Rules
[[Page 80572]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 16, and 38
RIN 3038-AD09
Core Principles and Other Requirements for Designated Contract
Markets
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is proposing new rules and amended guidance and acceptable
practices to implement the new statutory provisions enacted by Title
VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act
(``Dodd-Frank Act''). The proposed rules, guidance and acceptable
practices, which apply to the designation and operation of contract
markets, implement the Dodd-Frank Act's new statutory framework that,
among other things, amends Section 5 of the Commodity Exchange Act
(``CEA'') concerning designation and operation of contract markets, and
adds a new CEA Section 2(h)(8) to include the listing, trading and
execution of swaps on designated contract markets. The Commission
requests comment on all aspects of the proposed rules, guidance and
acceptable practices.
DATES: Comments must be received on or before February 22, 2011.
ADDRESSES: You may submit comments, identified by RIN number 3038-AD09,
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.
Please submit your comments using only one method.
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 you believe is exempt from disclosure under the
Freedom of Information Act, a petition for confidential treatment of
the exempt information may be submitted according to the procedures
established in Sec. 145.9 of the Commission's regulations, 17 CFR
145.9.
The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from www.cftc.gov that it may deem to be inappropriate for
publication, such as obscene language. All submissions that have been
redacted or removed that contain comments on the merits of the
rulemaking will be retained in the public comment file and will be
considered as required under the Administrative Procedure Act and other
applicable laws, and may be accessible under the Freedom of Information
Act.
FOR FURTHER INFORMATION CONTACT: Nancy Markowitz, Assistant Deputy
Director, 202-418-5453, [email protected], or Nadia Zakir, Attorney-
Advisor, 202-418-5720, [email protected], Division of Market Oversight,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Overview
B. The Current Statutory Framework
C. The Dodd-Frank Act Amendments
II. The Proposed Rules
A. Proposed Repeal of Appendix A to Part 38
B. Adoption of New Regulations and Revised Guidance and
Acceptable Practices
C. Proposed Amendments to General Regulations Under Part 38 (New
Subpart A)
1. Proposed Sec. 38.1--Scope
2. Proposed Sec. 38.2--Applicable Provisions
3. Proposed Sec. 38.3--Procedures for Designation
4. Proposed Sec. 38.4--Procedures for Listing Products and
Implementing Designated Contract Market Rules
5. Proposed Sec. 38.5--Information Relating to Contract Market
Compliance
6. Proposed Sec. 38.7--Prohibited Use of Data Collected for
Regulatory Purposes
7. Proposed Sec. 38.8--Listing of Swaps on a Designated
Contract Market
8. Proposed Sec. 38.9--Designated Contract Markets Operating as
Swap Execution Facilities
9. Proposed Sec. 38.10--Reporting of Swaps Traded on a
Designated Contract Market
D. Proposed New Regulations and Revised Guidance and Acceptable
Practices for Compliance With Core Principles
1. Subpart B--Designation as Contract Market
2. Subpart C--Compliance With Rules
i. Proposed Sec. 38.151--Access Requirements
ii. Proposed Sec. 38.152--Abusive Trading Practices Prohibited
iii. Proposed Sec. 38.153--Capacity To Detect and Investigate
Rule Violations
iv. Proposed Sec. 38.154--Regulatory Services Provided by a
Third Party
v. Proposed Sec. 38.155--Compliance Staff and Resources
vi. Proposed Sec. 38.156--Automated Trade Surveillance System
vii. Proposed Sec. 38.157--Real-Time Market Monitoring
viii. Proposed Sec. 38.158--Investigations and Investigation
Reports
ix. Proposed Sec. 38.159--Ability To Obtain Information
x. Proposed Sec. 38.160--Additional Rules Required
3. Subpart D-Contracts Not Readily Susceptible to Manipulation
4. Subpart E-Prevention of Market Disruption
i. Proposed Sec. 38.251--General Requirements
ii. Proposed Sec. 38.252--Additional Requirements for Physical
Delivery Contracts
iii. Proposed Sec. 38.253--Additional Requirements for Cash-
Settled Contracts
iv. Proposed Sec. 38.254--Ability to Obtain Information
v. Proposed Sec. 38.255--Risk Controls for Trading
vi. Proposed Sec. 38.256--Trade Reconstruction
vii. Proposed Sec. 38.257--Regulatory Service Provider
viii. Proposed Sec. 38.258--Additonal Rules Required
5. Subpart F--Position Limitations or Accountability
6. Subpart G--Emergency Authority
7. Subpart H--Availability of General Information
i. Proposed Sec. 38.401(a)--General
ii. Proposed Sec. 38.401(b)--Accuracy Requirement
iii. Proposed Sec. 38.401(c)--Notice of Regulatory Submissions
iv. Proposed Sec. 38.401(d)--Rulebook
8. Subpart I--Daily Publication of Trading Information
9. Subpart J--Execution of Transactions
i. Proposed Sec. 38.501--General Requirements
ii. Proposed Sec. 38.502--Minimum Centralized Market Trading
Requirement
a. Minimum Centralized Market Trading Percentage Requirement
b. Centralized Market Trading Percentage Calculation
c. Mandatory Delisting
d. Treatment of Contracts Listed as of the Effective Date of
this Section
e. Exemptions
iii. Proposed Sec. 38.501--Block Trades on Futures Contracts
iv. Proposed Sec. 38.504--Block Trades on Swap Contracts
v. Proposed Sec. 38.505--Exchange of Derivatives For Related
Positions
vi. Proposed Sec. 38.506--Office Trades and Transfer Trades
10. Subpart K--Trade Information
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i. Proposed Sec. 38.551--Audit Trail Required
ii. Proposed Sec. 38.552--Elements of an Acceptable Audit Trail
Program
iii. Proposed Sec. 38.553--Enforcement of Audit Trail
Requirements
11. Subpart L--Financial Integrity of Transactions
12. Subpart M--Protection of Market Participants
13. Subpart N--Disciplinary Procedures
i. Proposed Sec. 38.701--Enforcement Staff
ii. Proposed Sec. 38.702--Disciplinary Panels
iii. Proposed Sec. 38.703--Review of Investigation Report
iv. Proposed Sec. 38.704--Notice of Charges
v. Proposed Sec. 38.705--Right to Representation
vi. Proposed Sec. 38.706--Answer to Charges
vii. Proposed Sec. 38.707--Admission or Failure to Deny Charges
viii. Proposed Sec. 38.708--Denial of Charges and Right to
Hearing
ix. Proposed Sec. 38.709--Settlement Offers
x. Proposed Sec. 38.710--Hearings
xi. Proposed Sec. 38.711--Decisions
xii. Proposed Sec. 38.712--Right to Appeal
xiii. Proposed Sec. 38.13--Final Decisions
xiv. Proposed Sec. 38.714--Disciplinary Sanctions
xv. Proposed Sec. 38.715--Summary of Fines for Violations of
Rules Regarding Timely Submission of Records, Decorum or Other
Similar Activities
xvi. Proposed Sec. 38.716--Emergency Disciplinary Actions
14. Subpart O--Dispute Resolution
15. Subpart P--Governance Fitness Standards
16. Subpart Q--Conflicts of Interest
17. Subpart R--Composition of Governing Boards of Contract
Markets
18. Subpart S--Recordkeeping
19. Subpart T--Antitrust Considerations
20. Subpart U--System Safeguards
21. Subpart V--Financial Resources
i. Proposed Sec. 38.1101(a)--General Requirements
ii. Proposed Sec. 38.1101(b)--Types of Financial Resources
iii. Proposed Sec. 38.1101(c)--Computation of Financial
Resource Requirement
iv. Proposed Sec. 38.1101(d)--Valuation of Financial Resources
v. Proposed Sec. 38.1101(e)--Liquidity of Financial Resources
vi. Proposed Sec. 38.1101(f)--Reporting Requirements
22. Subpart W--Diversity of Boards of Directors
23. Subpart X--Securities and Exchange Commission
III. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
1. Additional Information Provided by Designated Contract
Markets
2. Information Collection Comments
C. Cost Benefit Analysis
IV. Text of Proposed Rules
I. Background
A. Overview
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street
Reform and Consumer Protection Act \1\ Title VII of the Dodd-Frank Act
\2\ amended the CEA \3\ 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 robust 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.
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\1\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010) (``Dodd-Frank Act'').
The text of the Dodd-Frank Act may be accessed at http://www.cftc.gov/ucm/groups/public/@swaps/documents/file/hr4173_enrolledbill.pdf.
\2\ Pursuant to Section 701 of the Dodd-Frank Act, Title VII may
be cited as the ``Wall Street Transparency and Accountability Act of
2010.''
\3\ 7 U.S.C. 1 et seq. (amended 2010).
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Section 735 of the Dodd-Frank Act amended Section 5 of the CEA
pertaining to the designation and operation of contract markets, by:
(i) Eliminating the stand-alone designation criteria contained in
former Section 5(b) of the CEA; (ii) revising the existing core
principles, including incorporating therein most of the substantive
elements of the former designation criteria; and (iii) adding five new
core principles, thereby requiring applicants and designated contract
markets (``DCMs'') to comply with a total of 23 core principles as a
condition of obtaining and maintaining designation as a contract
market.
In addition, Section 723(a)(3) of the Dodd-Frank Act added Section
2(h)(8) of the CEA to require, among other things, that execution of
swaps subject to the clearing requirement of Section 2(h)(1) of the CEA
must occur either on a DCM or on a new type of regulated facility
called a Swap Execution Facility (``SEF'').\4\ Also, Section 733 of the
Dodd-Frank Act added Section 5h(a)(1), requiring that no person may
operate a facility for the trading or processing of swaps unless the
facility is registered as a SEF or as a DCM. Accordingly, the rules
proposed in this release also implement provisions related to the
processing, trading and execution of swaps on DCMs.
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\4\ The Commission will be proposing rules governing the
registration and operation of SEFs in a separate, forthcoming
rulemaking. See CFTC Web site for additional information on the
``SEF Registration Requirements and Core Principle Rulemaking,
Interpretation & Guidance'' rulemaking, at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_13_SEFRules/index.htm
(last visited Dec. 14, 2010).
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In enacting the Dodd-Frank Act, Congress directed that rules and
regulations required by the provisions of Title VII take effect the
later of 360 days after enactment of the bill or to the extent that a
rulemaking is required by the Dodd-Frank Act, not less than 60 days
after the publication of that final rule.\5\ Consistent with Congress'
directive, this release proposes amendments to parts 38, 16 and 1 of
the Commission's regulations to implement Section 5 of the CEA, as well
as the requirements of Sections 2(h)(8) and 5h(a)(1) of the CEA, as
amended by the Dodd-Frank Act, as applicable to DCMs.
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\5\ See Section 754 of the Dodd-Frank Act.
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B. The Current Statutory Framework
Section 5 of the CEA governs the designation and operation of
DCMs.\6\ DCMs were first established under the Commodity Futures
Modernization Act of 2000 (``CFMA'') \7\ as one of two forms of
Commission-regulated markets for the trading of contracts for sale of a
commodity for future delivery or commodity options.\8\
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\6\ 7 U.S.C. 7; see also, Section 5 of the CEA, as amended by
the Dodd-Frank Act.
\7\ Commodity Futures Modernization Act of 2000, Public Law 106-
554, 114 Stat. 2763 (2000) (``CFMA'').
\8\ The CFMA established two tiers of regulated markets--
designated contract markets and registered derivatives transaction
execution facilities (``DTEFs''). In addition, the CFMA provided for
two markets exempt from regulation, exempt boards of trade
(``EBOTs'') and exempt commercial markets (``ECMs''). A description
of the categories, requirements and functions of each of these
markets as first established under the CFMA is provided in the
Commission's notice of proposed rulemaking and final rulemaking
implementing the CFMA. See A New Regulatory Framework for Trading
Facilities, Intermediaries and Clearing Organizations, Notice of
Proposed Rulemaking, 66 FR 14,262, March 9, 2001; Final Rulemaking,
66 FR 42,256, Aug. 10, 2001. In addition, a new type of regulated
market was created under the CFTC Reauthorization Act of 2008
(``Farm Bill''), Incorporated as Title XIII of the Food,
Conservation and Energy Act of 2008, Public Law 110-246, 122 Stat.
1651 (June 18, 2008). Under the Farm Bill, the Commission was
required to determine and make public its determination whether a
particular agreement, contract or transaction executed or traded on
an ECM serves a significant price discovery function (``SPDC'').
Once a contract was identified as a SPDC, the ECM on which the
contract was traded was required to demonstrate to the Commission
that the ECM had a regulatory system in place that satisfied the
requirements of the core principles under current Section 2(h)(7) of
the current CEA and the applicable provisions of Sec. 36.3 of the
Commission's regulations. Section 723 of the Dodd-Frank Act repealed
the ECM SPDC provisions.
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The CEA, as amended by the CFMA, requires a DCM applicant to
demonstrate that it satisfies each of
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eight designation criteria as a condition of obtaining designation as a
contract market.\9\ In addition, each applicant is required to
demonstrate its ability to comply with 18 core principles at the time
of application, and on an ongoing basis after designation.\10\
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\9\ The eight designation criteria under current Section 5(b) of
the CEA are titled the following: (1) In General; (2) Prevention of
Market Manipulation; (3) Fair and Equitable Trading; (4) Trade
Execution Facility; (5) Financial Integrity of Transactions; (6)
Disciplinary Procedures; (7) Public Access; and (8) Ability to
Obtain Information.
\10\ 7 U.S.C. 7(d). The Commission also undertakes due diligence
reviews of each contract market's compliance with the core
principles during rule and product certification reviews and
periodic examinations of DCMs' compliance with the core principles
under Rule Enforcement Reviews (``RERs'').
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C. The Dodd-Frank Act Amendments Applicable to Designated Contract
Markets
Section 735 of the Dodd-Frank Act amends Section 5 of the CEA by:
(i) Eliminating the eight criteria for designation as a contract
market; (ii) amending many of the core principles, including
incorporating most of the substantive requirements of the current
designation criteria, and requiring that all DCMs demonstrate
compliance with each of the core principles as a condition of obtaining
and maintaining designation as a contract market; and (iii) adding five
new core principles, specifically Core Principle 13 (Disciplinary
Procedures), Core Principle 20 (System Safeguards), Core Principle 21
(Financial Resources), Core Principle 22 (Diversity of Boards of
Directors), and Core Principle 23 (Securities and Exchange
Commission).\11\
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\11\ New Core Principle 13 is verbatim of current Designation
Criterion 6.
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As noted above, the Dodd-Frank Act also specifically requires under
Section 2(h)(8) of the CEA, as amended,\12\ that execution of swaps
that are required to be cleared must occur on either a DCM or a SEF,
except where no DCM or SEF makes the swap available for trading.\13\
Accordingly, unless otherwise specified in this release, each of the 23
core principles and the proposed regulations, guidance and acceptable
practices, apply to all ``contracts'' listed on a DCM, which will
include swaps, futures and options contracts.
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\12\ See Section 723 of the Dodd-Frank Act.
\13\ Section 5h(a)(1) of the CEA, as amended by Dodd-Frank Act,
also prohibits any person from operating a facility for the trading
and processing of swaps unless the facility is registered as a SEF
or DCM.
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In sum, the new and revised regulations, guidance and acceptable
practices proposed in this release will implement the regulatory
obligations that each DCM must meet in order to comply with Section 5
of the CEA, as amended by the Dodd-Frank Act, initially upon
designation and thereafter on an ongoing basis. The Commission requests
comments on all aspects of the proposed rules, guidance and acceptable
practices.
II. The Proposed Rules
A. Proposed Repeal of Appendix A to Part 38
Section 735 of the Dodd-Frank Act eliminates the criteria for
designation as a contract market in current CEA Section 5(b), creates a
new core principle from one of the criterion, and incorporates most of
the substance of the remaining designation criteria into the core
principles. Because the designation criteria are eliminated under the
Dodd-Frank Act, the Commission proposes to eliminate the guidance on
compliance with the designation criteria for DCMs contained in Appendix
A to part 38. As noted below, this release further proposes to
redesignate Appendix A as the application form for contract market
designation.
B. Adoption of New Regulations and Revised Guidance and Acceptable
Practices
In implementing the provisions of the CFMA, the Commission adopted
a regulatory framework for part 38 of its regulations that consisted
largely of general application guidance and acceptable practices
consistent with the CFMA's principles-based regime.\14\ The Dodd-Frank
Act amends Section 5(d)(1)(B) of the CEA generally to provide that the
Commission, in its discretion, may determine by rule or regulation the
manner in which boards of trade comply with the core principles.\15\
Accordingly, the Commission undertook a comprehensive evaluation of its
existing regulations, guidance and acceptable practices associated with
each of the core principles in order to update those provisions and to
determine which core principles would benefit from new or revised
regulations and new or revised guidance or acceptable practices. Based
on that review, the Commission is proposing both new and revised
regulations and revised guidance and acceptable practices for some core
principles, as set forth in this release.
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\14\ Guidance provides DCMs and DCM applicants with contextual
information regarding the core principles, including important
concerns which the Commission believes must be taken into account in
complying with specific core principles. In contrast, the acceptable
practices are more specific than guidance and provide examples of
how DCMs may satisfy particular requirements of the core principles;
they do not, however, establish mandatory means of compliance.
Acceptable practices are intended to assist DCMs by establishing
non-exclusive safe harbors. The safe harbors apply only to
compliance with specific aspects of the core principle, and do not
protect the contract market with respect to charges of violations of
other sections of the CEA or other aspects of the core principle.
\15\ Current Core Principle 1 states, among other things, that
boards of trade ``shall have reasonable discretion in establishing
the manner in which they comply with the core principles.'' This
``reasonable discretion'' provision underpins the Commission's use
of core principle guidance and acceptable practices. Section 735 of
the Dodd-Frank Act amends this provision to include the proviso that
``[u]nless otherwise determined by the Commission by rule or
regulation * * *,'' boards of trade shall have reasonable discretion
in establishing the manner in which they comply with the core
principles. See Section 735(b) of the Dodd-Frank Act, amending
Section 5(d)(1)(B) of the CEA.
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The proposed new regulations codify certain requirements and
practices that are commonly accepted in the industry and have been
found, based on the Commission's administrative experience in
overseeing the futures markets since passage of the CFMA, to represent
the best practice means of complying with the core principles.\16\
Indeed, some of these requirements are the off-shoot of the Rule
Enforcement Reviews (``RERs'') periodically carried out by Commission
staff.
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\16\ The Commission's oversight of DCMs' compliance with the
core principles includes the evaluation of applications for contract
market designation, periodic RERs of DCMs' compliance with various
statutory requirements, and the review of rule and product
certifications implicating all aspects of the core principles.
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The RERs are the cornerstone of the Commission's oversight program,
serving as a key tool for monitoring a DCM's compliance with the core
principles, and also as a primary means for identifying industry trends
and DCM best practices for self-regulation. Essentially, RER findings
and recommendations communicate to the industry what Commission staff
believes are best practices for compliance and such recommendations
typically are then adopted industry-wide as the standard form of
compliance.
The RERs, which are conducted periodically at all DCMs, typically
examine DCMs' compliance with specific core principles relating to
audit trail, trade practice surveillance, market surveillance,
disciplinary programs, and dispute resolution.\17\ Commission staff's
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findings and any recommendations for improvement are included in a
report that is presented to the Commission, and the Commission votes on
whether to accept the report. The RER report is publicly released and
published on the Commission's Web site and also sent to the DCM.
Although a DCM may not fully agree with the Commission staff's
findings, responses from DCMs, which are required within 30 days,
almost always explain how the DCM intends to implement staff's
recommendations, if any. Because RER reports are public,
recommendations for one DCM invariably lead to all DCMs that suffer
from the same identified shortfall taking timely corrective action.
Such corrective action usually includes modifying compliance procedures
and/or adopting or modifying existing rules.
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\17\ Staff typically review a one-year target period and,
depending on the core principles covered, thoroughly examine a DCM's
audit trail reviews, trade practice and market surveillance
investigations, investigation logs, hedge exemptions, surveillance
systems, compliance manuals, summary fine schedules, disciplinary
files, settlement agreements, and arbitration files. Staff also
conducts on-the-record interviews with DCM compliance officials.
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The Commission believes that the promulgation of clear-cut and
definite requirements or practices in those instances where a standard
industry practice has developed would provide greater legal certainty
to the industry in demonstrating compliance with the CEA. Accordingly,
in certain circumstances, the Commission is proposing to replace the
general application guidance and acceptable practices in part 38 with
regulations that codify the relevant practices and requirements for
those core principles. For some of the new core principles, the
Commission also is proposing regulations that represent the best
practice for complying with the core principle. For several core
principles, the Commission is proposing to maintain the guidance and
acceptable practices, albeit with proposed revisions that reflect
developments in the industry since the passage of the CFMA, and the
Commission's considerable experience since the passage of the CFMA with
matters involving compliance with the core principles by a broad range
of DCMs.
C. Proposed Amendments to General Regulations Under Part 38 (New
Subpart A)
The Commission is proposing to reorganize part 38 to include new
subparts A through X. Proposed subpart A would include the general
regulation Sec. Sec. 38.1 through 38.10,\18\ applicable both to DCM
applicants and to existing DCMs. Subparts B through X would each
include relevant regulations applicable to each core principle.\19\
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\18\ This release does not propose any revisions to Sec. 38.6
of the Commission's regulations.
\19\ Each of these subparts begins with a regulation containing
the language of the core principle.
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1. Proposed Sec. 38.1--Scope
The proposed revisions to Sec. 38.1 are non-substantive as they
simply eliminate cross-references to other sections of the Commission's
regulations that are no longer applicable, and add references to
sections, most of them new, that are now applicable.
2. Proposed Sec. 38.2--Applicable Provisions
Section 38.2 sets forth the Commission regulations that DCMs must
comply with in addition to those in part 38. The proposed revisions to
Sec. 38.2 include a change to the title of the section to more
accurately describe the regulation, and further updates the list of
Commission regulations that are applicable to DCMs based on the new
provisions under the Dodd-Frank Act, including the proposed provisions
relating to real time reporting of swaps and the determination of
appropriate block size for swaps which will be proposed under part 43,
requirements for data element, recordkeeping and reporting of swap
information to swap data repositories which will be proposed under part
45, business continuity and disaster recovery which will be proposed
under part 46, designation requirements for swap data repositories
which will be proposed under part 49, and position limits which will be
proposed under part 151.\20\
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\20\ The Commission notes that because some of the proposed
rulemakings are either ongoing or forthcoming, this proposed list of
reserved sections under Sec. 38.2 may be subject to further
revisions pending the final rules for each respective rulemaking.
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3. Proposed Sec. 38.3--Procedures for Designation
Current Sec. 38.3 sets forth the application and approval
procedures for new DCM applications.\21\ The Commission is proposing in
Sec. 38.3 that all DCM applications, reinstatements, requests for
transfer of designations, requests for withdrawal of application for
designation, and vacation of designations be filed with the Secretary
of the Commission in an electronic format, via the Internet, e-mail, or
other means of direct electronic submission as approved by the
Commission.\22\
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\21\ In addition to these substantive revisions, many of the
proposed revisions to Sec. 38.3 are non-substantive and are
intended to clarify the rule.
\22\ This amendment also would ensure consistency with the
electronic process used for filing rule and product submissions
under parts 39 and 40 of the Commission's regulations. See 17 CFR
parts 39 and 40.
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The Commission also is proposing to eliminate the expedited
approval procedures for DCM applications, such that the timing of such
reviews will be governed only by the 180-day statutory review period
and procedures specified in Section 6(a) of the CEA.\23\ Based upon its
experience since 2001, the Commission has determined that the 90-day
accelerated review process is inefficient and impracticable.
Specifically, the Commission has found that applicants seeking
expedited review often file incomplete or draft applications, without
adequate supporting materials, in the interest of meeting the expedited
approval timeline. This, in turn, has required Commission staff to
expend significant amounts of time reviewing incomplete or draft
applications, necessitating numerous follow-up conversations with
applicants, usually resulting in removal of applications from the
expedited review timeline. The Commission believes that by requiring
all applications to be reviewed within the 180-day review period,
applicants will have sufficient time to submit complete applications
for review, and to respond to Commission staff requests for additional
information, resulting in a more efficient review process.\24\
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\23\ 7 U.S.C. 8(a); see also, Section 6(a) of the CEA, as
amended by the Dodd-Frank Act.
\24\ This proposal also is consistent with the Commission's
proposal to eliminate the 90-day expedited review procedures for
derivatives clearing organization applications under part 39 in a
separate rulemaking.
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To provide an applicant with more certainty of the types of
information that are required to support its DCM application, the
Commission proposes to redesignate Appendix A to part 38 \25\ to
include a new application form with comprehensive instructions to guide
DCM applicants and a specified lists of documents and information that
must be provided as exhibits.\26\ Other than the specific requirements
necessitated by the revised and newly added core principles, the
majority of information required under the form application consists of
information that historically has been required by the Commission staff
in its reviews of DCM applications under the Commission's regulations.
Accordingly, proposed Sec. 38.3(a)(1) requires that, at a minimum, all
applicants must complete the application form and provide the necessary
information and documentation, in accordance with the associated
instructions, in order to
[[Page 80576]]
initiate the 180-day designation review process.
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\25\ Appendix A currently contains the stand alone designation
criteria now eliminated under the Dodd-Frank Act.
\26\ The Commission also is requiring tailored application forms
for the registration of Designated Clearing Organizations, Swap
Execution Facilities and Swap Data Repositories.
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The Commission is proposing new Sec. 38.3(d) to formalize the
procedures that a DCM must follow when requesting the transfer of its
DCM designation and positions comprising open interest, in anticipation
of a corporate event (e.g., a merger, corporate reorganization, or
change in corporate domicile) which results in the transfer of all or
substantially all of the DCM's assets to another legal entity. Under
proposed Sec. 38.3(d)(2), the DCM would submit to the Commission a
request for transfer no later than three months prior to the
anticipated corporate change, with a limited exception.\27\ The request
shall include: (1) The underlying agreement that governs the corporate
change; (2) a narrative description of the corporate change, including
the reason for the change and its impact on the DCM, including its
governance and operations, and its impact on the rights and obligations
of market participants holding the open positions; (3) a discussion of
the transferee's ability to comply with the CEA, including the core
principles applicable to DCMs, and the Commission's regulations
thereunder; (4) the governing documents of the transferee, including
but not limited to, articles of incorporation, bylaws, operating
agreements and/or partnership agreements, as applicable; (5) the
transferee's rules marked to show changes from the current rules of the
DCM; and (6) a list of contracts, agreements, transactions or swaps for
which the DCM requests transfer of open interest.
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\27\ The proposed rule would require that where a DCM does not
know or could not have reasonably known three months prior to the
anticipated change, it shall be required to file the request as soon
as it knows of the change.
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Proposed Sec. 38.3(d) also would require, as a condition of
approval, that the DCM submit a representation that it is in compliance
with the CEA, including the DCM core principles, and the Commission's
regulations. In addition, the DCM would have to submit various
representations by the transferee, including but not limited to: (1)
That the transferee will assume responsibility for complying with all
applicable provisions of the CEA and the Commission's regulations
promulgated thereunder, including part 38 and Appendices thereto; (2)
that the transferee will assume, maintain and enforce all rules
implementing and complying with these core principles, including the
adoption of the transferor's rulebook; (3) upon the transfer, all open
interest in all contracts listed on the transferor will be transferred
to and represent equivalent open interest in all such contracts listed
on the transferee, (4) that none of the proposed rule changes will
affect the rights and obligations of any participant with open
positions transferred to it; and (5) it will notify market participants
of any changes to the rulebook and of the transfer.
Proposed Sec. 38.3(d) also provides that the Commission will
review any requests for transfer of designation and open interest as
soon as practicable, and such request will be approved or denied
pursuant to a Commission order.
Proposed Sec. 38.3(g) \28\ is a new rule that is intended to
ensure that all DCMs designated before the effective date of the rules
proposed in this part 38 are in compliance with both the five new core
principles and the revised core principles. As noted above, the Dodd-
Frank Act significantly changes some of the compliance obligations of
DCMs under current Section 5 of the CEA by amending the majority of the
existing core principles and adding five new core principles.\29\ All
DCMs, including existing DCMs, must comply with the requirements of
Section 5 of the CEA, as amended, as well as the applicable
requirements under the Commission's regulations, including this
release, upon their effective date. Accordingly, in proposed Sec.
38.3(g), the Commission would require that each existing DCM provide
the Commission with a signed certification of its compliance with each
of the 23 core principles and the Commission's regulations under part
38 as amended in this release, within 60 days of the effective date of
the publication of the final rules proposed in this release. The
failure of any existing DCM to provide such certification shall be
grounds for revocation of the DCM's designation status. While the
Commission believes that 60 days is a sufficient period of time for
DCMs to have rules and procedures in place to ensure compliance with
the core principles and the rules proposed in this release, the
Commission requests comments on whether the 60 day period is
sufficient, and if not, what period of time may be more appropriate and
why.
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\28\ In addition, proposed Sec. Sec. 38.3(e) and 38.3(f)
restate existing requirements with certain non-substantive,
clarifying changes.
\29\ Compare 7 U.S.C. 7(d) with section 5(d) of the CEA, as
amended by the Dodd-Frank Act.
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4. Proposed Sec. 38.4--Procedures for Listing Products and
Implementing Designated Contract Market Rules
The proposed amendments to Sec. 38.4 are largely intended to
conform this rule to the proposed changes to existing Sec. Sec. 40.3
(Voluntary submission of new products for Commission review and
approval) and 40.5(b) (Voluntary submission of rules for Commission
review and approval).\30\ The proposed amendments to those rules are
made in the separate release pertaining to ``Provisions Common to
Registered Entities.'' \31\
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\30\ Proposed Sec. 40.3 is amended to require additional
information to be provided by registered entities submitting new
products for the Commission's review and approval. Proposed Sec.
40.5(b) codifies a new standard for the review of new rules or rule
amendments as established under the Dodd-Frank Act.
\31\ 75 FR 67482, Nov. 2, 2010.
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5. Proposed Sec. 38.5--Information Relating to Contract Market
Compliance
On occasion, DCMs enter into equity interest transfers that result
in a change in ownership. In those situations, Commission staff must
determine whether the change in ownership will impact adversely the
operations of the DCM or the DCM's ability to comply with the core
principles and the Commission's regulations. The Commission is
proposing to amend Sec. 38.5 to ensure that DCMs remain mindful of
their self-regulatory responsibilities when negotiating the terms of
significant equity interest transfers, and to improve the Commission
staff's ability to undertake a timely and effective due diligence
review of the impact, if any, of such transfers.
In this regard, proposed Sec. 38.5(c) would require DCMs to file
with the Commission a notice of the equity interest transfer of ten
percent or more, no later than the business day, as defined in Sec.
40.1, following the date on which the DCM enters into a firm obligation
to transfer the equity interest.\32\ The notification must include and
be accompanied by: (i) Any relevant agreement(s), including preliminary
agreements; (ii) any associated changes to relevant corporate
documents; (iii) a chart outlining any new ownership or corporate or
organizational structure;
[[Page 80577]]
(iv) a brief description of the purpose and any impact of the equity
interest transfer; and (v) a representation from the DCM that it meets
all of the requirements of Section 5(d) of the Act and Commission
regulations adopted thereunder. The proposed rule requires that the DCM
keep the Commission apprised of the projected date that the transaction
resulting in the equity interest transfer will be consummated, and must
provide to the Commission any new agreements or modifications to the
original agreement(s) filed pursuant to Sec. 38.5(c). The DCM must
notify the Commission of the consummation of the transaction on the day
in which it occurs. The proposed rule will enable staff to consider
whether any conditions contained in an equity transfer agreement(s) are
inconsistent with the self-regulatory responsibilities of a DCM or with
any of the core principles.\33\
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\32\ The Commission is proposing a 10 percent threshold because
it believes that a change in ownership of such magnitude may have an
impact on the operations of the DCM. The Commission believes that
such impact may be present even if the change in ownership does not
constitute a change in control. For example, if one entity holds a
minority 10 percent equity share in the DCM, it may have a more
significant voice in the operation of the DCM than five entities
each with a minority 2 percent equity share. Given the potential
impact that a change in ownership might have on the operations of a
DCM, the Commission believes that it is appropriate to require such
DCM to certify after such change that it continues to comply with
all obligations under the CEA and Commission regulations.
\33\ The Commission also maintains the existing provisions of
Sec. 38.5 that allow the Commission at any time to request a DCM to
file a written demonstration with the Commission that it is in
compliance with one or more of the core principles.
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Section 38.5(d) currently requires that upon a change in ownership,
an acquirer of an existing DCM must certify that the exchange meets all
of the requirements of the current Sections 5(b) and 5(d) of the Act,
and the provisions of part 38 of the Commission's regulations. The
Commission believes when there is a 10% or greater change in ownership,
the DCM itself is the more appropriate entity to provide a
certification of its continued compliance with all regulatory
obligations. Accordingly, proposed Sec. 38.5(c)(3) \34\ would require
that if there is a change in ownership \35\ the DCM must certify, no
later than two business days following the date on which the change in
ownership occurs, that the DCM meets all of the requirements of Section
5(d) of the CEA, as amended by the Dodd-Frank Act, and the provisions
of part 38 of the Commission's regulations. The proposed rule also
requires that the DCM include as part of its certification whether any
aspects of the DCM's operations will change as a result of the change
in ownership, and if so, the DCM must provide a description of the
changes. Finally, proposed Sec. 38.5(c) provides that the
certification may rely on, and be supported by, prior materials and
information submitted as part of an application for designation or a
required product or rule filing or new filings if necessary to update
its previous filings.
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\34\ The Commission is proposing to redesignate Sec. 38.5(d) as
Sec. 38.5(c).
\35\ The Commission's regulations consistently identify a
financial or ownership interest of ten percent or more as material
and indicative of the ability to influence the activities of an
entity or trading in an account. See, e.g., Core Principle 5,
Acceptable Practices, and Core Principle 14, Application Guidance,
in appendix B to part 38 of the Commission's regulations. 17 CFR
part 38, appendix B.
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6. Proposed Sec. 38.7 \36\--Prohibited Use of Data Collected for
Regulatory Purposes
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\36\ Current Sec. 38.6 (Enforceability) remains unchanged.
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To fulfill their regulatory and compliance obligations, DCMs often
require market participants to provide proprietary data or personal
information. Proposed Sec. 38.7 would prohibit DCMs from using such
information for business or marketing purposes.\37\ The Commission
notes that nothing in this provision should be viewed as prohibiting a
DCM from sharing such information with another DCM or SEF for
regulatory purposes, where necessary.
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\37\ The Commission notes that in the recent notice of proposed
rulemaking for Business Affiliate Marketing and Disposal of Consumer
Information Rules, 75 FR 66018-01, Oct. 27, 2010 (to be codified at
17 CFR part 163) rules are proposed prohibiting FCMs (and other
intermediaries) from using certain consumer information received
from an affiliate to make a solicitation for marketing purposes. In
addition, rules were proposed requiring FCMs to develop a written
disposal program to the extent that such FCMs possess consumer
information. The underlying policy for these rules is to protect the
privacy of customer information. Similarly, this proposed rule is
intended to protect market participant's information provided to a
DCM for regulatory purposes from its use to advance the commercial
interests of the DCM.
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7. Proposed Sec. 38.8--Listing of Swaps on a Designated Contract
Market
The Dodd-Frank Act permits existing DCMs to list, trade and execute
swaps, provided that the DCMs do so in a manner that complies with the
provisions of the CEA, as amended by the Dodd-Frank Act, and part 38,
as amended. Proposed Sec. 38.8(a) requires a DCM to notify the
Commission, prior to or upon listing its first swap contract, of the
manner in which it will fulfill each of the requirements under amended
CEA and part 38 with respect to the listing, trading, execution and
reporting of swap transactions.
Proposed Sec. 38.8(b) requires a DCM to request and obtain from
the Commission a unique, extensible, alphanumeric code for the purpose
of identifying the DCM before it lists swaps. A DCM will do so pursuant
to the swap recordkeeping and reporting requirements under proposed
part 45 of the Commission's regulations. This requirement stems from
the Commission's authority, under Section 728 of the Dodd-Frank Act, to
establish standards and requirements related to reporting and
recordkeeping for swaps.\38\ In particular, the Commission is required
to adopt consistent data element standards for ``registered entities,''
which includes DCMs. part 45, which is being proposed in the separate
Commission release ``Data Recordkeeping and Reporting Requirements,''
will set forth the recordkeeping and reporting requirements for DCMs
with respect to swaps.\39\ Proposed Sec. 38.8(b) codifies the
obligations of DCMs to comply with the provisions of proposed part 45.
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\38\ See Section 21 of the CEA, as amended by the Dodd-Frank
Act.
\39\ See ``Swap Data Recordkeeping and Reporting Requirements,''
Proposed Rule, 75 FR 76574 (Dec. 8, 2010).
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8. Proposed Sec. 38.9--Boards of Trade Operating Both a Designated
Contract Market and a Swap Execution Facility
As noted above, the Dodd-Frank Act created a new regulated entity,
the SEF, for the listing, trading and processing of swaps. The
registration and compliance requirements for SEFs will be proposed in
redesignated part 37, in a forthcoming release.\40\ Under the Dodd-
Frank Act, a DCM may list and trade swaps pursuant to its designation
as a contract market. In addition, a board of trade that operates a DCM
also may operate a SEF, provided that the board of trade separately
registers as a SEF and complies with the applicable SEF core principles
and any Commission regulations thereunder. Proposed Sec. 38.9 codifies
the requirement that a board of trade that operates a DCM and that
intends to operate a SEF must separately register pursuant to the SEF
registration requirements and, on an ongoing basis, must separately
comply with the SEF rules and core principles under Section 5h of the
CEA, as amended by the Dodd-Frank Act, and part 37 of the Commission's
regulations.
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\40\ See CFTC Web site for additional information on the ``SEF
Registration Requirements and Core Principle Rulemaking,
Interpretation & Guidance,'' at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_13_SEFRules/index.htm (last visited
Dec. 14, 2010).
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Moreover, section 5h(c) of the CEA, as amended by the Dodd-Frank
Act, provides that any board of trade that is a DCM and intends to
operate as an independent SEF may use the same electronic trade
execution system for listing and executing swaps, provided that the
board of trade makes it clear to market participants whether the
electronic trading of such swaps is taking place on or through the DCM
or the SEF.\41\ Proposed Sec. 38.9(b) codifies this statutory
requirement.
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\41\ Section 5h(c) of the CEA, as amended by the Dodd-Frank Act,
provides:
IDENTIFICATION OF FACILITY USED TO TRADE SWAPS BY CONTRACT
MARKETS.--A board of trade that operates a contract market shall, to
the extent that the board of trade also operates a swap execution
facility and uses the same electronic trade execution system for
listing and executing trades of swaps on or through the contract
market and the swap execution facility, identify whether the
electronic trading of such swaps is taking place on or through the
contract market or the swap execution facility.
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[[Page 80578]]
9. Proposed Sec. 38.10--Reporting of Swaps Traded on a Designated
Contract Market
Section 727 of the Dodd-Frank Act directs the Commission to adopt
rules providing for the public availability of swap transaction and
pricing data in real-time.\42\ To the extent that they make swaps
available for trading and execution either on a SEF or a DCM, DCMs will
have real-time public reporting obligations pursuant to the Dodd-Frank
Act and, therefore, must comply with the applicable provisions
governing real time reporting. The Commission is proposing regulations
applicable to the real time swap reporting obligations of certain
entities under a separate release.\43\ The real time reporting
regulations are proposed to be codified under part 43 of the
Commission's regulations. In addition to the real time reporting
obligations, the proposed rule also requires DCMs to comply with the
swap reporting and recordkeeping requirements that are being proposed
by the Commission in a separate release, and are proposed to be
codified under part 45 of the Commission's regulations. Accordingly,
proposed Sec. 38.10 would codify the compliance obligations of DCMs
with respect to real time reporting of swap transactions and swap data
recordkeeping and reporting obligations, as may be required under
proposed parts 43 and 45 of the Commission's regulations, respectively.
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\42\ See Sections 2(a)(13)-(14) of the CEA, as amended by the
Dodd-Frank Act.
\43\ See ``Real Time Public Reporting of Swap Transaction
Data,'' Proposed Rule, 75 FR 76140 (Dec. 7, 2010).
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D. Proposed New Regulations and Revised Guidance and Acceptable
Practices For Compliance With the Core Principles
As noted above, this release proposes to reorganize part 38 to
include subparts A through X. As proposed, each of subparts B through X
will include relevant regulations applicable to the 23 core principles.
In addition to the proposed new regulations, the Commission proposes to
codify within each subpart the statutory language of the respective
core principle.\44\
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\44\ In two instances, the language of the core principle, as
codified, was slightly revised to add references to the CEA where
the statutory language simply cited to the CEA section without
citing to the statute. These non-substantive edits were made to
Sec. Sec. 38.100 and 38.1200.
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1. Subpart B--Designation as Contract Market
The Dodd-Frank Act amends Core Principle 1 to make clear that
compliance with the core principles, and any other rule or regulation
that the Commission may impose under Section 8a(5) of the CEA, is a
necessary condition to obtain and maintain designation as a contract
market.\45\ Amended Core Principle 1 provides that unless otherwise
determined by the Commission by rule or regulation, DCMs will continue
to have reasonable discretion in establishing the manner in which they
comply with the core principles. The Commission proposes to codify the
statutory text of Core Principle 1 in proposed Sec. 38.100.
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\45\ 7 U.S.C. 7; see also Section 5(d)(1) of the CEA, as amended
by the Dodd-Frank Act.
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2. Subpart C--Compliance With Rules
Core Principle 2, as amended by the Dodd-Frank Act, requires that a
DCM establish, monitor, and enforce its rules, including rules relating
to access requirements, rules regarding the terms and conditions of any
contract to be traded on the contract market, and rules prohibiting
abusive trading practices. A DCM also must have the capacity to detect
and investigate potential rule violations, and to sanction any person
that violates its rules.\46\ In addition, a DCM's rules must provide it
with the ability and authority to perform the obligations and
responsibilities required under Core Principle 2, including the
capacity to carry-out such international information sharing agreements
that the Commission may require. Proposed Sec. 38.150 implements these
requirements.
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\46\ As noted above, Section 735 of the Dodd-Frank Act amends
Section 5 of the CEA to eliminate DCM designation criteria and
amends several core principles, including Core Principle 2. Core
Principle 2 was amended to include language formerly found in
Designation Criterion 8--Ability to Obtain Information, and to
specifically require that a DCM have the ability to detect,
investigate, and sanction rule violations.
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For the most part, the Commission is codifying: (1) Language found
in the guidance and acceptable practices for Core Principle 2 and
former designation criterion 8; (2) existing DCM compliance practices
that the Commission believes constitute best practices; and (3)
recommendations made over the past several years by the Commission in
rule enforcement reviews.\47\ In addition, the Commission is proposing
some practices and requirements that are new for DCMs. The Commission
also looked to and incorporated into the proposed rules for Core
Principle 2 certain concepts that are currently contained in part 8 of
its regulations-- Exchange Procedures for Disciplinary, Summary, and
Membership Denial Actions. In this regard, the Commission notes that
most DCMs' compliance and enforcement practices relating to Core
Principle 2 obligations historically have been consistent with the
rules contained in part 8.\48\ Each of the proposed rules under subpart
C is discussed below.
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\47\ Commission staff conducts periodic RERs of all DCMs. RERs
examine DCM compliance with specific core principles over a one-year
target period. Commission staff's analyses, conclusions and
recommendations regarding any identified deficiencies are included
in a publicly available written report.
\48\ Section 38.2 of the Commission's regulations exempts DCMs
from all Commission rules not specifically reserved. The part 8
rules were not reserved.
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i. Proposed Sec. 38.151--Access Requirements
Proposed Sec. 38.151 is an example of a rule in which the
Commission proposes a new requirement for DCMs.\49\ Proposed Sec.
38.151(a) requires that prior to granting a member or market
participant access to its markets, the DCM must require the member or
market participant to consent to its jurisdiction. The growth of
electronic trading in the futures industry and the transformation of
futures exchanges from traditional membership organizations to
demutualized for-profit entities has changed how individuals and firms
access the markets and execute trades. When open outcry dominated
trading, orders were typically called in to a desk on the trading floor
and members on the floor executed trades. Today, on most DCMs, one does
not need to be a ``member'' to enter an order on an electronic trading
system. Rather, clearing members can provide their customers with
access to a DCM's electronic trading system and customers can enter
their own orders. Depending on the type of access granted by the
clearing member, the customer's order either will go through the
clearing member's system for risk management before hitting the DCM's
electronic trading system or directly go into the DCM's trading system.
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\49\ Generally, Sec. 38.151 is being proposed pursuant to the
Commission's general rulemaking authority under Section 8a(5) of the
CEA (providing the authority to ``promulgate such rules * * *
reasonably necessary * * * to accomplish any of the purposes of''
the CEA), and Section 3 of the CEA (providing that the purposes of
the Act include the promotion of ``fair competition among boards of
trade, other markets and market participants''). 7 U.S.C. 5, 12a(5).
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DCMs generally require through rule and/or clearing firm connection
[[Page 80579]]
agreements that prior to a clearing member granting a customer access
to the DCM's electronic trading system, the clearing member secure its
customer's agreement to abide by, and be subject to, the DCM's rules.
Nevertheless, DCMs do not view themselves as having the jurisdiction
needed to compel these market participants to participate in the
investigation and disciplinary process. Although DCMs have the option
of requiring a clearing firm to bar a customer from accessing the DCM
if the DCM believes that the customer committed a rule violation, most
DCMs will first request that the customer submit to its jurisdiction
and participate in the investigation and disciplinary process before
exercising this option.
Trading on a DCM is a privilege that is subject to conditions and
entails certain responsibilities. The Commission believes that if a
participant is granted the privilege of trading on a DCM, the
participant should not only be required to abide by the DCM's rules,
but the participant also must consent to the DCM's jurisdiction and
participate in both the investigatory and disciplinary process. The
Commission recognizes that this requirement will require clearing firms
to amend their existing customer agreements to secure customers'
agreements to submit to a DCM's jurisdiction. Accordingly, although
DCMs would be required to implement proposed Sec. 38.151(a) either by
rule and/or modification of connection agreements by the effective date
of the final rule, the proposed rule permits DCMs to allow their
clearing firms up to 180 days to secure the necessary modifications to
existing customer agreements.
Proposed Sec. 38.151(b) requires that a DCM provide its members,
market participants and ISVs with impartial access to its markets and
services. This includes: 1) access criteria that are impartial,
transparent, and applied in a non-discriminatory manner, and 2)
comparable fee structures for members, market participants and
independent software vendors (``ISV''),\50\ receiving equal access to,
or services from the DCM. The purpose of the proposed impartial access
requirements is to prevent DCMs from using discriminatory access
requirements as a competitive tool against certain participants. Access
to a DCM should be based on the financial and operational soundness of
a participant, rather than discriminatory or other improper
motives.\51\ Any participant should be able to demonstrate financial
soundness either by showing that it is a clearing member of a DCO that
clears products traded on that DCM or by showing that it has clearing
arrangements in place with such a clearing member. Furthermore,
granting impartial access to participants that satisfy a DCM's access
requirements may enhance the DCM's liquidity and the overall
transparency of the swaps and futures markets.
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\50\ The Commission notes that examples of independent software
vendors include: smart order routers, trading software companies
that develop front-end trading applications, and aggregators of
transaction data. Smart order routing generally involves scanning of
the market for the best-displayed price and then routing orders to
that market for execution. Software that serves as a front-end
trading application is typically used by traders to input orders,
monitor quotations and view a record of the transactions completed
during a trading session. Aggregators of transaction data provide
access to news, analytics and execution services. The Commission
believes that transparency and trading efficiency would be enhanced
as a result of innovations in this field for market services. For
instance, certain providers of market services with access to
multiple trading systems or platforms could provide consolidated
transaction data from such trading systems or platforms to market
participants.
\51\ The Commission believes that the requirement to provide
impartial access requires DCMs to avoid the creation of exclusive
membership standards that focus on high net worth. Therefore, any
participant should be able to demonstrate financial soundness either
by showing that it is a clearing member of a DCO that clears
products traded on that DCM or by showing that it has clearing
arrangements in place with such a clearing member.
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A DCM can satisfy the requirement that membership and participation
criteria are impartial, transparent, and non-discriminatory by
establishing clear and impartial guidelines and procedures for granting
access to its facilities and publishing such guidelines and procedures
on its Web site. Such requirements may establish different categories
of market participants, but may not discriminate within a particular
category. Fee structures may differ among categories if such fee
structures are reasonably related to the cost of providing access or
services to a particular category. For example, if a certain category
requires greater information technology or administrative expenses on
the part of the DCM, then a DCM may recoup those costs in establishing
fees for that category of member or market participant.
Proposed Sec. 38.151(c) (Limitations on Access) requires a DCM to
establish and impartially enforce rules governing any decision by the
DCM to deny, suspend, or permanently bar a member's or market
participant's access to the contract market. While paragraph (b) of
proposed Sec. 38.151 requires impartiality in a DCM's decision to
grant access, paragraph (c) addresses the converse situation where a
DCM wishes to deny access, or to revoke the access of members or market
participants who already possess it. Proposed Sec. 38.151(c) gives
specific examples of when such situations might arise, including DCM
disciplinary proceedings or emergency actions. As with decisions to
grant access, any decision by a DCM to deny, suspend, or permanently
bar a member's or market participant's access to the DCM must be
impartial and applied in a non-discriminatory manner.
ii. Proposed Sec. 38.152--Abusive Trading Practices Prohibited
Proposed Sec. 38.152 requires that a DCM prohibit enumerated
abusive trading practices. The listed practices are a compilation of
abusive trading practices that DCMs already prohibit. A DCM permitting
intermediation must prohibit specific trading practices, including
trading ahead of customer orders, trading against customer orders,
accommodation trading, and improper cross-trading. Specific trading
practices that must be prohibited by all DCMs include front-running,
wash trading, pre-arranged trading, fraudulent trading, money passes
and any other trading practices that the DCM deems to be abusive. In
addition, a DCM also must prohibit any other manipulative or disruptive
trading practices prohibited by the CEA or by the Commission pursuant
to Commission regulation.\52\
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\52\ Section 747 of the Dodd-Frank Act amends Section 4c(a) of
the CEA by adding three disruptive practices which make it: unlawful
for any person to engage in any trading, practice, or conduct on or
subject to the rules of a registered entity that-
(A) Violates bids or offers;
(B) Demonstrates intentional or reckless disregard for the
orderly execution of transactions during the closing period; or
(C) Is, is of the character of, or is commonly known to the
trade as, `spoofing' (bidding or offering with the intent to cancel
the bid or offer before execution).
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iii. Proposed Sec. 38.153--Capacity To Detect and Investigate Rule
Violations
Proposed Sec. 38.153 is based on the current application guidance
for Core Principle 2.\53\ The proposed rule requires that a DCM have
arrangements and resources for effective rule enforcement. This
includes the authority to collect information and examine books and
records of members and market participants.\54\ By its terms, Core
Principle 2 requires a DCM to have, in addition to appropriate
resources for trade practice surveillance
[[Page 80580]]
programs, appropriate resources to enforce all of its rules.
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\53\ 17 CFR part 38, App. B, Core Principle 2, Application
Guidance at ] 1.
\54\ The language in the current application guidance requires
that a DCM ``have arrangements and resources for effective trade
practice surveillance programs[.]'' Id.
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The proposed rule also requires a DCM to have the authority to
examine books and records for all market participants rather than
limiting that authority to ``non-intermediated market participants'' as
such authority was limited in the former application guidance. A DCM
can best administer its compliance and rule enforcement obligations if
it has the ability to reach the books and records of all market
participants, rather than a subset of market participants.
iv. Proposed Sec. 38.154--Regulatory Services Provided by a Third
Party
The CEA provides that a DCM may comply with applicable core
principles by delegating relevant functions to a registered futures
association or another registered entity.\55\ The Commission also has
described acceptable ``contracting'' arrangements for the performance
of core principle functions by third-parties.\56\ In this context, the
term ``contracting'' implies a lesser transference of authority to the
third-party than does ``delegating.'' In all cases, however, the
Commission has specified, as required under the CEA,\57\ that DCMs
remain responsible for carrying out any function delegated or
contracted to a third party and that DCMs must ensure that the services
received will enable them to remain in compliance with the CEA's
requirements.
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\55\ 7 U.S.C. 7a-2(b); see also, section 5c(b)(1) of the CEA, as
amended by the Dodd-Frank Act.
\56\ See 66 FR 42256, 42266, Aug. 10, 2001.
\57\ See 7 U.S.C. 7a-2(b)(2); see also, Section 5c(b)(2) of the
CEA, as amended by the Dodd-Frank Act.
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In recent years, the Commission has gained much experience in
administering the delegation and contracting regime for regulatory
services. Many DCMs, especially those that were designated after
passage of the CFMA, employ third-party regulatory service providers to
meet one or more core principle obligations. In administering this
regime, the Commission has found that DCM applicants have questions as
to the manner and degree to which their staffs must remain involved in
regulatory decisions when they utilize third-party providers.
Accordingly, the Commission is proposing new Sec. 38.154 to supplement
its previous guidance on delegation and contracting arrangements to
clarify its expectations in this regard. The proposed rule is equally
applicable to delegations and contracting, and to arrangements DCMs
have with regulatory service providers that are registered futures
associations or other registered entities. For purposes of proposed
Sec. 38.154, the applicable self-regulatory functions include: trade
practice surveillance; market surveillance; real-time market
monitoring; investigations of possible rule violations; and
disciplinary actions.
The proposed rule requires that DCMs utilizing third-party
regulatory service providers must ensure that their providers have
sufficient capacity and resources to render timely and effective
regulatory services. The DCM also must oversee the quality of the
contracted regulatory services and must retain exclusive authority with
respect to certain regulatory decisions. These regulatory decisions
include cancellation of trades, the issuance of disciplinary charges
against members or market participants, and denials of access to the
trading platform for disciplinary reasons. Conversely, the proposed
rule also specifies that a decision to open an investigation of a
possible rule violation must be made solely by a regulatory service
provider, and all instances where a DCM's actions differ from those
recommended by its regulatory provider must be documented and explained
in writing.
v. Proposed Sec. 38.155--Compliance Staff and Resources
As noted above, Core Principle 2 requires that a DCM enforce
compliance with its rules and have the capacity to detect, investigate,
and sanction violations. Having adequate staff to perform a DCM's
compliance and enforcement responsibilities is essential to the
effectiveness of its self-regulatory programs, including market
surveillance, audit trail, trade practice surveillance, and
disciplinary programs.
A DCM's ability to enforce speculative limits, monitor for
manipulation, complete timely investigations, conduct annual open
outcry and electronic audit trail reviews, as well as perform other
regulatory duties, is compromised if a DCM does not have sufficient
staff. Thus, examining the size and experience of a DCM's compliance
staff is a critical component of RERs carried out by Commission staff.
In several RERs, staff has recommended, and the Commission has
accepted, findings that DCMs: (1) increase their compliance staff
levels, and (2) monitor the size of their staffs and increase the
number of staff appropriately as trading volume increases, new
responsibilities are assigned to compliance staff, or internal reviews
demonstrate that work is not completed in an effective or timely
manner.\58\
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\58\ See Rule Enforcement Review of the Minneapolis Grain
Exchange (Aug. 27, 2009); Rule Enforcement Review of ICE Futures
U.S. (Feb. 2, 2010); and Rule Enforcement Review of the Chicago
Board of Trade and the Chicago Mercantile Exchange (Sep. 13, 2010).
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Those recommendations have formed the basis for proposed Sec.
38.155. The proposed rule requires that a DCM maintain sufficient
compliance resources to conduct effective audit trail reviews, trade
practice surveillance, market surveillance, and real-time monitoring.
It also requires that a DCM monitor its staff size annually to ensure
that it is appropriate to effectively perform those functions. Staff
size also must be sufficient to address market or trading events and to
complete investigations in a timely manner.
The Commission is not proposing that staff size be determined based
on a specific formula. Rather, the Commission proposes to leave to the
discretion of each individual DCM to determine the size of the staff it
needs to effectively perform its self-regulatory responsibilities. In
making this determination, the proposed rule requires that a DCM take
into account specific facts and circumstances (e.g., volume, the number
of new contracts, etc.), as well as any other factors suggesting the
need for increased resources. Factors that may suggest the need for
increased compliance resources are a prolonged surge in trading volume
or a prolonged period of price volatility. A DCM must have sufficient
staff to address unusual or unanticipated events while continuing to
effectively conduct its routine self-regulatory duties.
vi. Proposed Sec. 38.156--Automated Trade Surveillance System
All currently active DCMs, or their third-party service providers,
maintain automated surveillance systems to conduct trade practice
surveillance. These systems vary in degree of sophistication, but
typically generate alerts on a trade date plus one day (T+1) basis to
help staff focus on potential violations and anomalies found in trade
data.\59\ They also provide a DCM's compliance staff the ability to
sort and query voluminous amounts of data. In performing their
surveillance responsibilities, DCMs engage in various analyses to
profile trading activity and conduct investigations to detect and
prosecute possible trading abuses. These functions all require the
collection of order and trade data and the ability to
[[Page 80581]]
process that data in various ways for analysis.
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\59\ These systems typically differ from those systems used for
real-time market monitoring. The requirements for real-time market
monitoring can be found in proposed Sec. 38.157.
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Proposed Sec. 38.156 reflects the substantial growth in U.S.
futures trading volume since the CFMA was adopted in 2000. The
approximate trading volume for U.S. futures exchanges (including
futures and options on futures) was 596 million contracts in 2000, 2
billion contracts in 2005, and 3.2 billion contracts in 2010. In view
of this growth in volume, combined with new participants in the
markets, such as high frequency traders, it is critical that DCMs have
automated tools that, at a minimum, have the capability to generate
alerts, profile trading activity, and sort and query data to conduct
trade practice surveillance. The Commission has found, in performing
its oversight responsibility of monitoring the markets to ensure market
integrity and customer protection, that effectively monitoring this
large amount of volume requires automated tools.\60\ A DCM's automated
surveillance system must have specific characteristics for it to be
able to detect and prosecute the abusive trading practices enumerated
in proposed Sec. 38.152. A DCM's automated surveillance system must
maintain all trade and order data, including order modifications and
cancellations. The system must process this data on a T+1 basis. In
addition, a DCM's automated trade surveillance system must provide
users with the ability to compute, retain and compare trading
statistics; compute profit and loss; and reconstruct the sequence of
trading activity.
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\60\ In this regard, the Commission is in the midst of modifying
its own automated surveillance systems for both trade practice
surveillance and market surveillance.
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vii. Proposed Sec. 38.157--Real-time Market Monitoring
Proposed Sec. 38.157 codifies existing practices at DCMs for real-
time monitoring of electronic trading. The practices codified in
proposed Sec. 38.157 reflect the growth of electronic trading in the
U.S. futures markets, as well as the Commission's experience in
designating new contract markets since passage of the CFMA. All DCMs
that were designated post-CFMA trade exclusively on electronic trading
platforms.
The purpose of real-time monitoring of electronic trading is to
ensure orderly trading and to identify and correct any market or system
anomalies promptly. The proposed rule requires that any DCM price
adjustment or trade cancellation process be clear and transparent to
the market and subject to clear, fair and publicly-available standards.
viii. Proposed Sec. 38.158--Investigations and Investigation Reports
Proposed Sec. 38.158 is largely a compilation of requirements
found in Sec. Sec. 8.06 and 8.07 of the Commission's regulations, with
some modifications. Paragraph (a) of the proposed rule requires that a
DCM have procedures to conduct investigations of possible rule
violations. Paragraph (b) requires that an investigation be completed
within a timely manner. A timely manner is defined to be 12 months
after an investigation is opened, absent mitigating circumstances. This
differs from Sec. 8.06(b) of the Commission's regulations, which
provides that an investigation be ``completed within four months,
unless significant reasons exist to extend it beyond such period.'' In
its experience in conducting RERs, the Commission has found that while
simple, straight-forward investigations typically are completed in less
than four months, many DCM investigations involve fact patterns
requiring more in-depth and sophisticated analysis. Depending on the
complexity of a matter, an investigation frequently may take between
four and 12 months to complete.
While it is not typical for an investigation to take longer than
one year to complete, certain circumstances may justify an
investigation taking longer than one year. These include the complexity
of the investigation, the number of firms or individuals involved, the
number of potential violations, the amount of trade data requiring
analysis and, in some instances, the amount of video recordings to be
reviewed and analyzed.\61\
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\61\ See Rule Enforcement Review of ICE Futures U.S. (Feb. 2,
2010), and Rule Enforcement Review of the Chicago Board of Trade and
the Chicago Mercantile Exchange (Sep. 13, 2010). Some exchanges,
such as CBOT and CME, have video cameras on their open outcry
trading floors.
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Paragraphs (c) and (d) of proposed Sec. 38.158 set forth the
elements and information that must be included in an investigation
report when there is or there is not a reasonable basis for finding a
rule violation. While the proposed language is similar to Sec. Sec.
8.07(a) and (b) of the Commission's regulations, there are two notable
differences.
First, proposed Sec. 38.158(c) requires that when DCM compliance
staff believes there is a reasonable basis for finding a violation, the
investigation report must include the potential wrongdoer's
disciplinary history. Second, proposed Sec. 38.158(d) requires that if
a DCM's compliance staff recommends that a warning letter be issued,
the investigation report must also include the potential wrongdoer's
disciplinary history.\62\ Requiring disclosure of a member's or market
participant's prior disciplinary history in the above-described
circumstances is consistent with recommendations made in RERs.\63\ The
Commission believes that prior disciplinary history is critical
information that a disciplinary committee should consider when either
issuing a warning letter or assessing an appropriate penalty as part of
any settlement decision or hearing.\64\ In practice, when a DCM's
compliance department believes there is a reasonable basis to find a
violation, the investigation report is forwarded to a disciplinary
committee for action. Therefore, the Commission believes that the
investigation report is the most logical place to include disciplinary
history.
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\62\ In some instances, even though there is not sufficient
evidence to recommend disciplinary action, a DCM's compliance staff
may believe that a rule violation occurred.
\63\ See 2000 Rule Enforcement Review of the New York Mercantile
Exchange.
\64\ As noted below in the discussion of proposed Sec.
38.158(c), a DCM's disciplinary committee should review a member's
complete disciplinary history when determining appropriate sanctions
and impose meaningful sanctions on members who repeatedly violate
the same or similar rules to discourage recidivist activity.
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Proposed Sec. 38.158(e) provides that a DCM may authorize its
compliance staff to issue a warning letter or to recommend that a
disciplinary committee issue a warning letter. The proposed rule is
substantively identical to Commission Sec. 8.07(c), except that it
prohibits a DCM from issuing more than one warning letter for the same
violation during a rolling 12-month period. Currently, many DCMs use
summary fine programs to enforce their audit trail rules. Typically,
such programs allow compliance staff to issue summary fines for trade
timing, order ticket and trading card violations. Such summary fine
schemes generally start with a warning letter for the first offense.
While a warning letter may be appropriate for a first-time violation,
the Commission does not believe that more than one warning letter in a
rolling 12-month period for the same or similar violation is ever
appropriate. A policy of issuing repeated warning letters, rather than
issuing meaningful sanctions, to members and market participants who
repeatedly violate the same or similar rules denigrates the
effectiveness of a
[[Page 80582]]
DCM's rule enforcement program.\65\ The proposed rule is consistent
with what Commission staff has advised DCM applicants and
recommendations made in RERs.\66\
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\65\ For purposes of this rule, the Commission does not consider
a ``reminder letter'' or such other similar letter to be any
different than a warning letter.
\66\ See 1998 Rule Enforcement Review of Kansas City Board of
Trade; and, Rule Enforcement Review of the Minneapolis Grain
Exchange (Aug. 27, 2009).
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ix. Proposed Sec. 38.159--Ability To Obtain Information
Proposed Sec. 38.159 expands on the Core Principle 2 requirement
that a DCM have the ability and authority to obtain necessary
information to perform its rule enforcement obligations, including the
capacity to carry out any international information sharing agreements
required by the Commission. The proposed rule provides that information
sharing agreements can be established with other DCMs or SEFs, or that
the Commission can act in conjunction with a DCM to carry out such
information sharing. This language is virtually identical to the
language found in the guidance for former Designation Criterion 8.\67\
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\67\ 17 CFR Part 38, App. A, Designation Criterion 8, Guidance.
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x. Proposed Sec. 38.160--Additional Rules Required
Proposed Sec. 38.160 requires a DCM to adopt and enforce any
additional rules that it believes are necessary to comply with the
requirements of this subpart C.
3. Subpart D--Contracts Not Readily Subject to Manipulation
The Dodd-Frank Act did not make any amendments to current Core
Principle 3--Contracts Not Readily Subject to Manipulation.
Historically, DCMs complied with the requirements of Core Principle 3
by using as guidance the provisions of Guideline No. 1, contained in
Appendix A to part 40. The Commission proposes certain revisions to the
former Guideline No. 1, including: (1) Amending the provision to
include swap transactions, (2) re-titling the guidance as
``Demonstration of compliance that a contract is not readily
susceptible to manipulation,'' and (3) redesignating the provision as
Appendix C of part 38. Proposed Sec. 38.201 refers applicants and DCMs
to the guidance in Appendix C to part 38 for purposes of demonstrating
to the Commission their compliance with the requirements of Sec.
38.200. Proposed guidance under Appendix C to part 38 would replace
Guideline No. 1 under Appendix A to part 40.
The amended guidance provides greater detail to DCMs regarding the
relevant considerations in demonstrating compliance with Core Principle
3 when designing a contract and submitting supporting documentation and
data to the Commission at the time the DCM submits: (1) The terms and
conditions of a new contract under Sec. Sec. 40.2 or 40.3, or (2)
amendments to terms and conditions under Sec. Sec. 40.5 or 40.6.
In general, the guidance provides that the settlement or delivery
procedures adopted by a DCM for a futures contract should reflect the
underlying cash market. The objective is to ensure that a given futures
contract is not readily susceptible to manipulation and that it will
provide a reliable pricing basis and promote cash/futures price
convergence. Accordingly, the terms and conditions should conform to
prevailing commercial practices and provide for adequate deliverable
supply.
For cash-settled contracts, the cash-settlement procedure should be
based on a reliable price reference series that accurately reflects the
underlying market value, is not readily susceptible to manipulation,
and is commonly used by industry/market participants as a price
reference. Therefore, the calculation methodology of the price
reference series, if applicable, must be submitted as supporting
documentation. In that regard, for a price reference series that is
based on an index or survey of prices or rates, this would include the
index or survey methodology used to determine the level of the index
used as the price reference. Furthermore, the views and opinions of
prospective market users of the contracts should be given considerable
weight in the contract design process. The more accurately a listed
contract's terms and conditions reflect the underlying cash market in
that commodity, the more likely the contract will perform the intended
risk management and/or price discovery functions. Finally, a DCM should
ensure that the terms and conditions of listed contracts remain
consistent with the guidance set forth herein. These concepts are set
forth in the guidance in Appendix C to part 38.
The guidance in Appendix C to part 38 is comprised of best
practices that were developed over the past three decades by the
Commission and other market regulators in their review of product
submissions. The Commission first adopted a Guideline for product
submissions on November 3, 1982 \68\ and since then has modified it
from time to time. Furthermore, the Commission's Guideline served as
the basis for ``Guidance on Standards of Best Practice for the Design
and/or Review of Commodity Contracts,'' endorsed by the International
Organization of Securities Commissioners (``IOSCO'') in its Tokyo
Communiqu[eacute] (October 1997).\69\ The Guidance recognizes that the
proper design of the terms and conditions of contracts reduces the
susceptibility of such contracts to market abuses, including
manipulation, and enhances the economic utility of such contracts to
commercial users. Accordingly, the Guidance for designing futures
contracts focuses on such issues as a contract's economic utility
(i.e., a contract should meet risk management needs of potential users
and/or promote price discovery of the underlying commodity), the
contract's correlation with the cash market (i.e., the contract terms
and conditions generally should reflect the operation of the underlying
cash market and avoid impediments to delivery), a contract's settlement
and delivery reliability (i.e., the settlement and delivery procedures
should reflect the underlying cash market and promote price
convergence), the contract's responsiveness to the views of potential
market users, and the contract's transparency (i.e., the contract's
terms and conditions, as well as relevant information concerning
delivery and pricing, should be readily available to market authorities
and to market users).
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\68\ See 47 FR 49832, 49838, Nov. 3, 1982.
\69\ See Tokyo Commodity Futures Markets Regulators' Conference
(October, 1997), http://www.cftc.gov/ucm/groups/public/@internationalaffairs/documents/file/oia_tokyorpt.pdf (last visited
Oct. 25, 2010).
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Appendix C to part 38 is intended to act as a source for new and
existing DCMs to reference for best practices when developing new
products to list for trading. Specifically, Appendix C to part 38
provides guidance regarding: (1) The forms of supporting information a
new contract submission should include; (2) how to estimate deliverable
supplies; (3) the contract terms and conditions that should be
specified for physically delivered contracts; (4) how to demonstrate
that a cash-settled contract is reflective of the underlying cash
market, is not readily subject to manipulation or distortion, and is
based on a cash price series that is reliable, acceptable, publicly
available and timely; (5) the contract terms and conditions that should
be specified for cash-settled contracts; (6) the requirements for
options on futures contracts; (7) the terms and conditions for non-
price based futures contracts; and (8) the terms and conditions for
[[Page 80583]]
swap contracts. Currently, DCMs generally conduct market research in a
manner discussed in Appendix C.
4. Subpart E--Prevention of Market Disruption
The Dodd-Frank Act amended current Core Principle 4 by: (i)
Changing the title of the core principle from ``Monitoring of Trading''
to ``Prevention of Market Disruptions;'' and (ii) specifying the
methods and procedures DCMs must employ in discharging their
obligations under Core Principle 4. The amendments to Core Principle 4
emphasize that DCMs must take an active role, not only in monitoring
trading activities within their markets, but in preventing market
disruptions. Accordingly, the proposed rules under subpart E of part 38
codify the relevant provisions of the current Application Guidance and
Acceptable Practices for Core Principle 4 in current Appendix B to part
38, and include new requirements that clarify and strengthen a DCM's
responsibilities under the amended core principle.
i. Proposed Sec. 38.251--General Requirements
As noted above, the Dodd-Frank Act amended Section 5(d)(4) of the
CEA by adding new language to Core Principle 4 to require DCMs to
conduct real-time monitoring of trading and to have the ability to
comprehensively and accurately reconstruct trading.\70\ Accordingly,
proposed Sec. 38.251 (General Requirements) would require that the DCM
have the ability to conduct real-time monitoring of trading and
comprehensive and accurate trade reconstructions. Intra-day trade
monitoring must include the capacity to detect abnormal price
movements, unusual trading volumes, impairments to market liquidity,
and position-limit violations.
---------------------------------------------------------------------------
\70\ See Section 735 of the Dodd-Frank Act.
---------------------------------------------------------------------------
As noted above in its discussion of the need for automated tools in
connection with Core Principle 2 requirements, the Commission believes
that it would be difficult, if not impossible, to monitor for market
disruptions in contract markets with high transaction volume and a
large number of trades unless the DCM has installed automated trading
alerts to detect many types of potential violations of exchange or
Commission rules. Accordingly, the Commission proposes in Sec. 38.251
to require that, where the DCM cannot reasonably demonstrate that its
manual processes are effective in detecting and preventing abuses, the
DCM must implement automated trading alerts to detect potential
problems.
We invite comment on whether in any rule the Commission may adopt
in this matter DCMs should be required to monitor the extent of high
frequency trading, and whether automated trading systems should include
the ability to detect and flag high frequency trading anomalies.
ii. Proposed Sec. 38.252--Additional Requirements for Physical
Delivery Contracts
The Commission has observed a number of physically-delivered
futures contracts where the convergence of the futures price and the
cash market price of the underlying commodity have been
problematic.\71\ Price convergence refers to the process whereby the
price of a physically-delivered futures contract converges to the spot
price of the underlying commodity, as the futures contract nears
expiration (a cash-settled contract, by definition, converges to the
underlying price series at expiration). The hedging effectiveness of a
physically-delivered futures contract depends in part upon the extent
to which the futures price reliably converges to the comparable cash
market price, or to a predictable differential to the comparable cash
market price. The delivery mechanism for physically-delivered futures
contracts is the critical link that drives price convergence. To the
extent that delivery of a commodity at futures expiration occurs and
the delivered commodity is merchandised in the physical marketing
channel, arbitrage should ensure that the price of the futures contract
converges to the price of the commodity in the physical marketing
channel. Impediments to futures delivery, or the delivery of an
instrument that permits a long futures position holder to defer moving
the physical commodity into normal marketing channels, may weaken the
crucial link between cash markets and the futures market, resulting in
a lack of reliable price convergence.\72\
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\71\ The Commission notes that the lack of convergence and its
adverse impact on the ability to effectively hedge in some
agricultural futures markets has been the subject of several
meetings of the Commission's Agricultural Advisory Committee. Where
there is a lack of convergence, this has resulted in extremely weak
bases, i.e., cash prices well below equivalent futures prices,
disadvantaging short hedgers and resulting in abnormally large
quantities of futures deliveries that diverted grain from normal
commercial channels and tied up warehouse space. The lack of
convergence likely sends the wrong price discovery signals to the
market. See, Materials from Meeting of the CFTC's Agricultural
Advisory Committee (AAC) (October 29, 2009), http://www.cftc.gov/About/CFTCCommittees/AgriculturalAdvisory/aac_102909agenda.html;
see also, the AAC Subcommittee on Convergence in Agricultural
Commodity Markets Report and Recommendations (October 29, 2009),
http://www.cftc.gov/ucm/groups/public/@aboutcftc/documents/file/reportofthesubcommitteeonconve.pdf.
\72\ For example, specifying a shipping certificate with an
indefinite life as the futures delivery instrument that permits a
long futures position holder to avoid taking delivery in the
physical marketing channel, which, in certain circumstances, may
result in weak or erratic convergence between the futures price and
the cash price.
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Therefore, for physical delivery contracts, proposed Sec. 38.252
specifically requires that, among other things, DCMs must monitor each
contract's terms and conditions as to whether there is convergence of
the futures price to the cash price of the underlying commodity and
take meaningful corrective action, including to address conditions that
interfere with convergence, or if appropriate, change contract terms
and conditions, when lack of convergence impacts the ability to use the
markets for making hedging decisions and for price discovery.
The Commission requests comments on what other factors, in addition
to the delivery mechanism, a DCM should be required to consider in
determining whether convergence is occurring.
iii. Proposed Sec. 38.253--Additional Requirements for Cash-Settled
Contracts
Over the past several years, there has been a growth in markets
that are linked, for example, where the settlement price of one market
is linked to the prices established in another market. As a result,
traders may have incentives to disrupt or manipulate prices in the
reference market in order to influence the prices in the linked market.
Accordingly, proposed Sec. 38.253 would require that, where a DCM
contract is settled by reference to the price of a contract or
instrument traded in another venue, including a price or index derived
from prices on another exchange, the DCM must have rules that require
the traders on the DCM's market to provide the DCM with their positions
in the reference market as the traders' contracts approach settlement.
In the alternative, Sec. 38.253 provides that the DCM may have an
information sharing agreement with the other venue or designated
contract market.
iv. Proposed Sec. 38.254--Ability To Obtain Information
The current acceptable practice for Core Principle 4 provides that
DCMs, at a minimum, should have routine access to the positions and
trading of their market participants. To ensure that the DCM has the
ability to properly assess
[[Page 80584]]
the potential for price manipulation, price distortions, and the
disruption of the delivery or cash-settlement process, proposed Sec.
38.254 provides that each DCM require that traders in their market keep
records, including records of their activity in the underlying
commodity and related derivative markets and contracts, and make such
records available, upon request, to the designated contract market. The
Commission's own market surveillance staff, which has similar authority
to obtain information from large traders (under Sec. 18.05 for futures
and options and proposed Sec. 20.6 for swaps), has found that access
to such information is vital to an effective surveillance program.
v. Proposed Sec. 38.255--Risk Controls for Trading
Proposed Sec. 38.255 requires that a DCM have effective risk
controls to reduce the potential risk of market disruptions and ensure
orderly market conditions. In the current futures markets, DCMs have
implemented a variety of risk controls to avoid market disruptions
through restrictions on order entry, including daily price limits,
price/quantity bands, and trading pauses. Most commonly used by DCMs
for futures contracts in physical commodities (outside of the spot
month) and futures contracts in broad-based equity indexes (in
coordination with circuit breakers on national security exchanges) are
daily price limits, which restrict the total price movement allowed on
any given trading day, calculated as a limit above and below the prior
day's futures settlement price.\73\ Under daily price limits, futures
can continue to trade within the limit up/down prices, but no trading
can take place above or below the daily price limit. Some DCMs also
have rules for the automatic expansion of the daily price limit after
consecutive days of limit bid/offer prices. Some electronic trading
platforms also have ``reasonability tests'' and/or ``price bands'' for
order entry, which do not allow an order to enter the trade matching
system if it is outside a predetermined price range or is of a
particularly large size.\74\ Finally, some trading platforms use
trading pauses to halt trading for a short period of time during
certain market conditions. Trading pauses are used,\75\ most commonly,
for trading in equity index products.
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\73\ Option contracts on futures may have different daily price
limits than the underlying futures.
\74\ For example, the GLOBEX electronic trading system for the
NYMEX crude oil futures contract generally will not accept an order
75 points above or below the last traded price nor will it accept an
order for a quantity larger than 999 contracts.
\75\ The NYMEX Henry Hub Natural Gas (NG) futures has a 5 minute
pause in trading when a daily price limit--up or down--is hit, then
trading resumes at a higher limit. However, this provision does not
apply during the last 60 minutes of regular trading hours. See NYMEX
rule 220.08.
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The CME's GLOBEX system also has a risk control, commonly referred
to as ``stop logic functionality,'' that implements a pause of a few
seconds in the order matching system to protect against cascading stop
orders--the domino effect of one stop order triggering others. The stop
logic functionality pauses trading when the last transaction price
would have triggered a series of stop loss orders that, if executed,
would cause the market to trade outside of predefined values, which
typically consist of values that are the same as the ``no bust'' range
\76\ established for a market.
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\76\ Under most exchanges' trade cancellation rules, trades
considered to have been executed in error may be cancelled. Where
the trade is within the ``no bust range'' for the specified futures
contract, which range is determined by the exchange under its rules,
the exchange will allow the trade to stand.
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In order to prevent market disruptions due to sudden volatile price
movements, proposed Sec. 38.255 requires DCMs to have in place
effective risk controls, including but not limited to pauses and/or
halts to trading in the event of extraordinary price movements that may
result in distorted prices or trigger market disruptions. Risk controls
such as trading pauses and halts can, among other things, allow time
for participants to analyze the market impact of new information that
may have caused a sudden market move, allow new orders to come into a
market that has moved dramatically, and allow traders to assess and
secure their capital needs in the face of potential margin calls.
Moreover, where a contract market can be a proxy or substitute for
similar markets on the DCM or on other trading venues, including where
a contract is based on the price of an equity security or the level of
an equity index, risk controls should be coordinated with those on the
similar markets or trading venues, to the extent possible. The
desirability of coordination of various risk controls, for example,
``circuit breakers'' in equities and their various derivatives
including futures and options, recently has been the subject of
discussions by regulators and the industry.
The Commission believes that pauses and halts are effective risk
management tools and must be implemented by DCMs to facilitate orderly
markets. These basic risk controls also have proven to be effective and
necessary in preventing market disruptions. The Commission requests
comments on what types of pauses and halts are necessary and
appropriate for particular market conditions. The Commission recognizes
that pauses and halts are only one category of risk controls and that
additional controls may be necessary to further reduce the potential
for market disruptions. Such controls may include price collars or
bands,\77\ maximum order size limits,\78\ stop loss order
protections,\79\ kill button,\80\ and others. The Commission is
considering mandating in this rulemaking risk controls that are
appropriate and/or necessary. Accordingly, the Commission invites
comments on the appropriateness of these and other controls that could
supplement trading halts or pauses. The Commission also invites
comments on the following additional questions:
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\77\ Price bands would prevent clearly erroneous orders from
entering the trading system, including ``fat finger'' errors, by
automatically rejecting orders priced outside of a range of
reasonability.
\78\ Maximum order size limitations prevent entry into the
trading system of an order that exceeds a maximum quantity
established by the DCM.
\79\ Stop loss orders would be triggered if the market declines
to a level pre-selected by the person entering the order. This
mechanism would provide that when the market declines to the
trader's pre-selected stop level for such an order, the order would
become a limit order executable only down to a price within the
range of reasonability permitted by the system, instead of becoming
a market order.
\80\ The kill button gives clearinghouses associated with the
DCM the ability to delete open orders and quotes and reject entry of
new orders or quotes in instances where a trader breaches its
obligations with the clearinghouse. FIA Market Access Risk
Management Recommendations, p. 10 (April 2010).
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What other DCM risk controls are appropriate or necessary
to reduce the risk of market disruptions?
Which risk controls should be mandated and how?
vi. Proposed Sec. 38.256--Trade Reconstruction
The Dodd-Frank Act added language to Core Principle 4 that
designated contract markets must have the ability to comprehensively
and accurately reconstruct all trading on its trading facility. These
audit-trail data and reconstructions must also be made available to the
Commission in a form, manner, and time as determined by the Commission.
Proposed Sec. 38.256 codifies these requirements.
vii. Proposed Sec. 38.257--Regulatory Service Provider
Proposed Sec. 38.257 provides that a designated contract market
must comply with the regulations in this section
[[Page 80585]]
through a dedicated regulatory department, or by delegation of that
function to a regulatory service provider, over which the designated
market has supervisory authority.
viii. Proposed Sec. 38.258--Additional Rules Required
Proposed Sec. 38.258 requires a DCM to adopt and enforce any
additional rules that it believes are necessary to comply with the
requirements of subpart E.
5. Subpart F--Position Limitations or Accountability
Core Principle 5 under Section 5(d)(5) requires that DCMs adopt for
each contract, as is necessary and appropriate, position limitations or
position accountability. The Dodd-Frank Act amended Core Principle 5 by
adding that for any contract that is subject to a position limitation
established by the Commission pursuant to Section 4a(a) of the CEA, the
DCM shall set the position limitation of the board of trade at a level
not higher than the position limitation established by the Commission.
The Federal position limits established by the Commission currently are
codified in part 150. In a separate release, as required by the Dodd-
Frank Act, the Commission will consider replacing part 150 (Limits on
Positions) with new part 151 (Limits on Positions) to establish Federal
position limits for certain exempt and agricultural commodities that
currently are not subject to Federal position limits.\81\ In that
release, the Commission will propose to require that exchanges adopt
their own position limits for all commodities (whether such commodities
are subject to Federal limits or not), with an alternative of adopting
position accountability rules in lieu of position limits for contracts
in major currencies and certain excluded commodities. Proposed Sec.
38.301 requires that each DCM must comply with the requirements of part
151 that the Commission adopts in order to be in compliance with Core
Principle 5.
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\81\ See CFTC Web site for additional information on the
Position Limits rulemaking, at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_26_PosLimits/index.htm (last visited
Dec. 14, 2010).
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6. Subpart G--Emergency Authority
The Dodd-Frank Act made minor, non-substantive changes to Core
Principle 6 under Section 5(d)(6) of the CEA. Based upon its
experience, and in recognition of the fact that DCMs may have different
procedures and guidelines for taking emergency action, the Commission
believes that it is appropriate to maintain an expanded version of the
existing guidance and add an acceptable practice under its regulations
for purposes of complying with this core principle. As a result, the
Commission proposes to retain most of the former Application Guidance
found in Appendix B to part 38 of the Commission's regulations, with
some revisions and additions. Proposed Sec. 38.351 refers applicants
and DCMs to the guidance and acceptable practices in Appendix B to part
38 for purposes of demonstrating to the Commission their compliance
with the requirements of subpart G. Specifically, a DCM is required to
have rules providing it with the authority to intervene as necessary to
maintain fair and orderly trading and to prevent or address
manipulation or disruptive trading practices, whether the need for
intervention arises exclusively from the DCM's own market or as part of
a coordinated, cross-market intervention. The increased tendency for
similar, if not identical, contracts to be traded on more than one
venue, that in the future may include a SEF, demonstrates the
importance of coordinated interventions. Accordingly, the Commission
believes that there should be an increased emphasis on cross-market
coordination of emergency actions. The guidance also provides that the
DCM rules should include procedures and guidelines to avoid conflicts
of interest in accordance with new provisions proposed in Sec. 40.9
and to include alternate lines of communication and approval procedures
in order to be able to address, in real time, emergencies that may
arise. This latter provision is a result of the expansion of electronic
markets and the speed of order execution. As a result of fast-paced
trading systems, there is a need for DCMs to be able to react quickly
to market events and intervene without delay. Thus, the proposed
guidance acknowledges this trend with this provision. The proposed
guidance also clarifies that the DCM must also have rules that allow it
to take such market actions as may be directed by the Commission.
The Commission's experience and industry practice have demonstrated
that there are some specific best practices that should be followed,
and these best practices are incorporated in an acceptable practice.
Specifically, the DCM should have procedures and guidelines for
decision-making and implementation of emergency intervention in the
market. The DCM should have the authority to liquidate or transfer open
positions in the market,\82\ suspend or curtail trading in any
contract, require market participants in any contract to meet special
margin requirements and allow it to take such market actions as the
Commission may direct.
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\82\ In situations where a swap is traded on more than one
platform, emergency action to liquidate or transfer open interest
must be directed, or agreed to, by the Commission or Commission
staff.
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7. Subpart H--Availability of General Information
Core Principle 7 requires that DCMs make available to the public
accurate information concerning the contract market's rules and
regulations, contracts and operations. The Dodd-Frank Act amended Core
Principle 7 by adding a provision requiring the board of trade to make
public the rules and specifications describing the operation of the
DCM's electronic matching platform or trade execution facility.\83\
Since passage of the CFMA, the types of information and the various
practices for providing information have become standardized across the
industry as DCMs have adopted practices that comply with the current
guidance and acceptable practices for Core Principle 7. Accordingly,
proposed Sec. 38.401 in subpart H codifies these practices. In
addition, the Commission proposes several additional provisions to
ensure that pertinent information is available to the Commission,
market participants and the public, as described below.
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\83\ This requirement, while new to the text of Core Principle
7, was previously required as part of former Designation Criteria 4.
---------------------------------------------------------------------------
i. Proposed Sec. 38.401(a)--General
Proposed Sec. 38.401(a) requires DCMs to have in place procedures,
arrangements and resources for disclosing to market authorities, market
participants and the public accurate and relevant information
pertaining to: (i) Contract terms and conditions, (ii) rules and
regulations applicable to the trading mechanism, and (iii) rules and
specifications pertaining to the operation of the electronic matching
platform or trade execution facility. Among other types of information,
DCMs must ensure that market authorities, market participants and the
public have available all material information pertaining to new
product listings, new or amended governance, trading and product rules,
or other changes to information previously disclosed by the DCM, within
the time period prescribed in proposed Sec. 38.401. As described in
Sec. 38.401(a) of the regulation, DCMs must provide the required
information to market
[[Page 80586]]
participants and the public by posting such information on their Web
site, as set forth in proposed Sec. 38.401(c).
ii. Proposed Sec. 38.401(b)--Accuracy Requirement
Proposed Sec. 38.401(b) requires that each DCM have procedures in
place to ensure that any information or communication with the
Commission is accurate and complete, and further that no false or
misleading information is submitted and that no material information is
omitted. Similarly, each DCM must have procedures in place to ensure
the accuracy and completeness of any information made available to
market participants and the public, including information that is made
available on its Web site.
iii. Proposed Sec. 38.401(c)--Notice of Regulatory Submissions
The Commission historically has required DCMs to update their
rulebooks upon the effectiveness of a rule amendment, product listing
or rule certification that has been filed with the Commission. While
proposed Sec. 38.401(c) maintains the general requirement for posting
rules in the DCM rulebook upon their effectiveness, the Commission
believes that market participants and the public would benefit from
notifications of proposed rule amendments, product listing (or de-
listings) and rule certifications in advance of their taking
effect.\84\ Accordingly, proposed Sec. 38.401(c) requires each DCM to
post on its Web site all rule filings and submissions that it makes to
the Secretary of the Commission. This information should be posted on
the DCM's Web site on the same day that such information is transmitted
to the Commission. Where applicable, the DCM Web site should make clear
that the posted submissions are pending before the Commission. For
example, a DCM's Web site may contain a separate Web page for
``regulatory filings'' or ``rule certifications'' for posting
submissions or certifications pertaining to new product listings, new
rules, rule amendments or changes to previously-disclosed information.
This requirement will provide market participants with advance notice
of rule amendments and certifications, consistent with the goal of Core
Principle 7 to make pertinent information available to market
participants and the public. This posting requirement is in addition to
the obligation of DCMs to update their Rulebooks upon the effectiveness
of a rule submission or certification.
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\84\ This is especially relevant when the Commission determines
to stay the certification of a DCM submission, as provided by the
Dodd-Frank Act, for a 90-day review period, thereby triggering a
public comment period.
---------------------------------------------------------------------------
To the extent that a DCM requests confidential treatment of certain
information filed or submitted to the Commission, the proposed rule
requires the DCM to post the public portions of the filing or
submission.
iv. Proposed Sec. 38.401(d)--Rulebook
As noted above, consistent with the current acceptable practices
for Core Principle 7, all DCMs must post and routinely update their
rulebooks, which appear on their Web sites. Currently, each DCM updates
its rulebook the day that a new product is listed or a new or amended
rule takes effect. The vast majority of DCM Web sites also are readily
accessible to the public and the information is available by visitors
to the Web site without requiring registration, log-in, or user name or
password. Proposed Sec. 38.401(d) merely codifies these existing
practices.\85\
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\85\ As noted above, the requirement to maintain an accurate and
updated rulebook does not relieve DCMs of their obligations under
paragraph (c) to post on their Web sites all rule filings and
submissions submitted to the Commission.
---------------------------------------------------------------------------
8. Subpart I--Daily Publication of Trading Information
Core Principle 8 requires that DCMs make available to the public
accurate information on settlement prices, volume, open interest, and
opening and closing ranges for actively traded contracts on the
contract market. The Dodd-Frank Act did not amend Core Principle 8.
Accordingly, in proposed Sec. 38.451, the Commission reiterates the
current acceptable practice that requires mandatory compliance with
Sec. 16.01, ``Trading volume, open contracts, prices and critical
dates.''
However, in order to conform to the Dodd-Frank Act, certain changes
were made to Sec. 16.01 regarding the information a reporting market
will record and publish on futures and options contracts, and on swap
and swaption contracts.
Specifically, the Commission proposes to amend Sec. 16.01(d) to
require reporting markets to report information in paragraphs (a)(1)
through (6) of Sec. 16.01. Prior to the enactment of the Dodd-Frank
Act, reporting markets were required only to report separately the
following information enumerated in paragraphs (a)(1) through (5) of
current Sec. 16.01 for futures and options: The option delta, where
delta system is used, total gross open contracts, excluding from
futures those contracts against which notices have been stopped; for
futures, open contracts against which delivery notices have been
stopped on that business day; the total volume of trading, excluding
transfer trades or office trades; and the total volume of futures
exchanged for commodities or for derivatives positions that are
included in the total volume of trading.
The Commission proposes to require reporting markets to also report
to the Commission the information found in paragraph (a)(6) that is
``the total volume of block trades that are included in the total
volume of trading.'' Previously such information was only required to
be reported to the public but not separately to the Commission. The
Commission believes that having block trade volumes reported separately
to it would be useful, particularly in analyzing whether a contract
market is in compliance with Core Principle 9 (Execution of
Transactions). Because reporting markets currently are required to make
block trade volumes available to the public, it should not be an
unreasonable burden for the reporting market to submit that information
separately to the Commission.
Under the Dodd-Frank Act, DCMs are able to list and trade swaps.
Accordingly, amendments to part 16 specify the type of information that
DCMs or SEFs must publish daily regarding the swaps contracts traded.
Specifically, DCMs and SEFs would be required to publish for their
swaps contracts all the information included in proposed Sec. 16.01
(a) (1) through (6) for each trading day for each swap, class of swaps,
swaption or class of swaptions as appropriate. For swap contracts that
are standard-sized contracts (i.e., contracts that have a set contract
size for all contracts), volume and open interest for swaps and
swaptions shall be reported in terms of number of contracts traded,
just as futures contracts currently are reported. For swap contracts
that are non-standard-sized contracts (i.e., contracts whose contract
size can vary for each transaction) the volume and open interest should
be reported in terms of total notional value traded for that trading
day. In addition, Sec. 16.01(b) is amended to require each DCM or SEF
to publish for each trading day, by commodity and contract month or by
tenor of the swap, the opening price, high price, low price and
settlement price of the swap or swaption contract. The Commission is
seeking comments on end-of-day price reporting for swaps. Specifically,
the Commission seeks comments on the following issues:
For interest rate swaps, because the tenor on an interest
rate swap can be one of thousands of possible periods, what would be an
appropriate manner
[[Page 80587]]
to display end-of-day prices for each interest rate swap?
Would certain end-of-day swap price reporting be more
meaningful than others? If so, which methods of price reporting would
be more meaningful and why?
Would certain end-of-day swap price reporting be
misleading? If so, which methods of price reporting would be misleading
and why?
9. Subpart J--Execution of Transactions
The Dodd-Frank Act amended Core Principle 9 to require, among other
things, that a board of trade must provide a competitive, open and
efficient market and mechanism for executing transactions ``that
protects the price discovery process of trading in the centralized
market of the board of trade.\86\ The amended core principle also
provides that off exchange transactions are permitted for bona fide
business purposes if authorized by the board of trade's rules.\87\
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\86\ 7 U.S.C. 7; see also Section 5(d)(9) of the CEA, as amended
by the Dodd-Frank Act.
\87\ This language was taken from former Designation Criterion
3.
---------------------------------------------------------------------------
In assessing a DCM's initial and ongoing compliance with Core
Principle 9, the Commission currently considers several criteria,
including, among others, the methodology and mechanisms of the DCM's
trading system to ensure fair and orderly trading and the rules the DCM
may have for permissible transactions executed off the centralized
market. In so doing, the Commission has looked at Sec. 1.38 of the
Commission's regulations, which sets forth a requirement that all
purchases and sales of a commodity for future delivery or a commodity
option on or subject to the rules of a DCM should be executed by open
and competitive methods. There is an exception to this ``open and
competitive'' requirement if the transaction is in compliance with the
rules of the DCM that specifically provide for the non-competitive
execution of such transactions.\88\ In addition, the current guidance
for Core Principle 9 provides that a competitive, open and efficient
market and mechanism for execution of transactions includes: (1) The
DCM's methodology for entering orders and executing transactions; (2)
that appropriate objective testing and review of automated systems
should occur initially and periodically to ensure proper system
functioning, adequate capacity and security; and (3) that a DCM that
determines to allow block trades should ensure that such trades do not
operate in a manner that compromises the integrity of prices or price
discovery in the relevant market.\89\
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\88\ The Commission notes that the CFMA, which was enacted after
promulgation of Sec. 1.38, modified Section 3 of the current CEA to
require that transactions subject to the CEA provide ``a means for
managing and assuming price risks, discovering prices, or
disseminating pricing information through trading in liquid, fair
and financially secure trading facilities.'' The CFMA also
specifically listed some of the types of transactions that could be
executed off the centralized market, including exchange of futures
for swaps, and allowing a futures commission merchant, acting as
principal or agent, to enter into or confirm the execution of a
contract for the purchase or sale of a commodity for future delivery
if the contract is reported, recorded, or cleared in accordance with
the rules of a contract market or derivatives clearing organization.
7 U.S.C. 7(b)(3).
\89\ The current acceptable practice for Core Principle 9
identifies an example of the type of party that would be an
acceptable party to carry out the testing and review of an
electronic trading system. The Commission notes that under its
proposed rulemaking, all rules relating to the type of testing and
review required for trading systems would be set forth under new
Core Principle 20, System Safeguards, discussed infra at Section
II.D.20.
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In light of the Dodd-Frank Act amendments to Core Principle 9 and
the Commission's experience in implementing Core Principle 9 since
enactment of the CFMA, the Commission proposes to adopt certain
regulations in subpart J of the Commission's regulations to establish
requirements that a DCM must meet in order to comply with amended Core
Principle 9. Specifically, new regulations are proposed to clarify the
amended core principle's mandate requiring the protection of the price
discovery function of trading on a DCM's centralized market. Other
regulations codify practices that have become standard and adopted over
the years by the industry. In addition, the Commission re-proposes
certain guidance and acceptable practices that were published by the
Commission in the September 2008 Notice of Proposed Rulemaking
pertaining to ``Execution of Transactions: Regulation 1.38 and Guidance
on Core Principle 9'' \90\ (hereafter ``2008 Core Principle 9 Proposed
Rulemaking'') for purposes of informing DCMs of how they may comply
with certain other aspects of amended Core Principle 9.\91\
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\90\ 73 FR 54097, Sep. 18, 2008. That proposed rulemaking was a
re-proposal of some rules, guidance and acceptable practices
pertaining to Regulation 1.38 and Core Principle 9, initially
proposed on July 1, 2004. See 69 FR 39880, July 1, 2004. There were
no final rulemakings to either of these proposals.
\91\ In 2009, before those proposed rules were finalized,
Congress initiated the legislative process that culminated in the
Dodd-Frank Act. Accordingly, a number of the proposed rules
contained in this release consist of regulations that were initially
proposed in the 2008 Core Principle 9 Proposed Rulemaking, with
relevant updates.
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In short, the Commission proposes to adopt the following
regulations, guidance and acceptable practices for Core Principle 9, as
amended by the Dodd-Frank Act:
New Sec. 38.501 proposes to codify in part 38 the
requirements that are currently contained in Sec. 1.38 of the
Commission's regulations, with amendments that were initially proposed
in the 2008 Core Principle 9 Proposed Rulemaking along with relevant
updates. Section 1.38 of the Commission's regulations would be
eliminated.
New Sec. 38.502 addresses the specific requirements
associated with protecting the price discovery function of trading on a
DCM's centralized market as now specifically imposed by the Dodd-Frank
Act. The proposed rule imposes: (i) Minimum requirements for trading on
the centralized market for contracts listed on DCMs, (ii) mandatory
delisting of contracts if the requirements of trading are not met,
(iii) specified procedures for treatment of contracts existing prior to
the effective date of this section, and (iv) limited exemptions for
certain contracts that the Commission, upon a petition of the DCM,
permits to remain listed under specified circumstances.
New Sec. Sec. 38.503 and 38.504 propose to codify certain
requirements for block trades for futures and swaps and Sec. 38.505
addresses other off-exchange transactions. These provisions codify
practices that Commission staff has previously required and that have
become industry practices. In particular, these proposed rules set
forth block trade requirements for futures contracts and options,
including who may enter into block trade transactions, conditions for
block trades between affiliated parties, aggregation, recordkeeping and
reporting procedures. In addition, in proposed Sec. 38.505, the
Commission proposes to adopt rules for off-exchange transactions that
involve exchange of derivatives for related position, specifically
describing what constitutes a bona fide trade and reporting
requirements for such trades. Proposed Sec. 38.504 addresses certain
block trading requirements specifically for swaps traded on the DCM,
and proposed Sec. 38.506 addresses transfer and office trades.
A new acceptable practice would provide a safe harbor
methodology for DCMs to follow in determining the minimum size of block
transactions for individual contracts. The acceptable practice also
would provide a safe harbor relating to the manner of pricing block
trades. By proposing this acceptable practice the Commission
[[Page 80588]]
recognizes the need for flexibility as the appropriate minimum size and
pricing of block trades vary among contracts and across DCMs.
i. Proposed Sec. 38.501--General Requirements
Current Sec. 1.38 of the Commission's regulations requires,
subject to certain exceptions, ``that all purchases and sales of a
commodity for future delivery, and of any commodity option, on or
subject to the rules of a DCM shall be executed openly and
competitively by open outcry or posting of bids and offers or by other
equally open and competitive methods * * * provided, however, that this
requirement shall not apply to transactions that are executed
noncompetitively in accordance with written rules of the contract
market * * *'' \92\ The 2008 Core Principle 9 Proposed Rulemaking
proposed certain revisions to Sec. 1.38. Specifically, in addition to
simplifying the language, the 2008 Core Principle 9 Proposed Rulemaking
proposed to update the language of Sec. 1.38 to more accurately
identify the types of transactions that may be executed off a contract
market's centralized market under the rules of a DCM.\93\ The 2008 Core
Principle 9 Proposed Rulemaking also would make it clear that under
Sec. 1.38, DCMs may self-certify (not just seek approval for) rules or
rule amendments related to transactions off the centralized
marketplace. Both of these changes were proposed to the language of
regulation Sec. 1.38 to incorporate updates made to the CEA in 2000 by
the CFMA.
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\92\ 17 CFR 1.38 (2009).
\93\ The proposed language for Sec. 1.38(b)(1) identified
``transfer trades, office trades, block trades, inter-exchange
spread transactions, or trades involving the exchange of futures for
commodities or for derivatives positions, if transacted in
accordance with written rules of a contract market that provide for
execution away from the centralized market and that have been
certified to or approved by the Commission.'' This release proposes
updates to this list.
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As noted above, the existing provisions of current Sec. 1.38 will
be incorporated in proposed Sec. 38.501, including previously proposed
amendments, with some updates. These updates include language that adds
to the types of transactions that may be executed off of a DCM's
centralized market. In addition, the proposed rule replaces the term
``exchange of futures for commodities or for derivatives positions''
with the term ``exchange of derivatives for a related position.'' This
term is more descriptive of the panoply of off-exchange transactions
currently offered by DCMs, including exchange for physicals, exchange
for swaps, exchange for risk or exchange of futures for futures. This
term also will encompass other types of off-exchange transactions, not
limited to futures. Finally, because swaps may now be traded on DCMs,
the proposed rule will reference swaps.
ii. Proposed Sec. 38.502--Minimum Centralized Market Trading
Requirement
As noted, the Dodd-Frank Act amended Core Principle 9 to
specifically require that in the execution of transactions, ``the price
discovery function of trading in the centralized market'' must be
protected.\94\ The amended core principle recognizes that trading in
the centralized market provides a price discovery function, and
specifically requires that the execution of transactions be in a manner
that protects that price discovery process.
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\94\ 7 U.S.C. 7; see also section 5(d)(9) of the CEA, as amended
by the Dodd-Frank Act.
---------------------------------------------------------------------------
The Commission notes that, under the current regulatory landscape,
some DCMs have listed contracts for the purpose of providing a clearing
solution for privately negotiated bi-lateral swap trades or trades made
on exempt commercial markets. The DCMs accept these trades as futures
contracts by converting them, through their block trade or exchange-
for-swaps (or other exchange of derivatives for a related position)
rules, to economically equivalent futures contracts in order for them
to be cleared by their derivatives clearing organization. The vast
majority of those contracts are not executed openly or competitively on
the centralized market, but rather are effected away from the DCM's
centralized market.\95\ Despite the lack of trading on the centralized
market these contracts still manage to achieve open interest over
sustained periods of time.
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\95\ Under current CEA section 4d(a)(2), funds supporting
customer trades executed on a designated contract market must be
segregated from other funds, including proprietary funds, of a
future commission merchant (``FCM'') or clearinghouse. Customers
often desire to comingle funds in this segregated account primarily
to take advantage of lower margins due to off-setting positions.
Current CEA section 4d(a)(2) provides a venue for achieving this by
allowing the Commission to issue orders exempting an FCM or
clearinghouse from the segregation requirement in appropriate
situations. The DCM must go through the process of petitioning the
Commission for an exemption, and providing the necessary information
and data for the Commission to make a decision. The Commission's
process for issuing Section 4d orders necessarily entails careful
and measured review, and accordingly, can be time-intensive. The
Commission believes that rather than seeking 4d orders for off-
exchange products, certain DCMs have resorted to listing those
products as futures despite their unlikely prospects for central
marketplace trading, to achieve the same results as the Section 4d
process to the possible detriment of the centralized market. See
also, section 4d(a)(2) of the CEA, as amended by the Dodd-Frank Act.
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A DCM that trades contracts that have a disproportionate percentage
of their trading volume attributable to off-exchange activity and
little or no open and competitive, centralized market trading would not
appear to be in compliance with amended Core Principle 9. Specifically,
where all or most transactions in a DCM contract are executed off the
centralized market, there is no price discovery taking place on the DCM
such that the protection of the price discovery process of trading in
the centralized market is not satisfied.
The Commission notes that, while amended Core Principle 9
recognizes the primacy of trading on the centralized market for price
discovery, it does not bar off exchange transactions. Congress
reaffirmed that the rules of the DCM may authorize bona fide off-
exchange transactions. Thus, in implementing the provisions of the
Dodd-Frank Act, the Commission seeks to protect the price discovery
process of trading on the DCM's centralized market while permitting
DCMs to authorize off-exchange transactions where necessary and
appropriate for bona fide business purposes. Accordingly, the
Commission's proposal provides for permissible off-exchange
transactions, but only to the extent that such transactions do not
compromise the price discovery process of trading in the centralized
market. If off-exchange transactions become the exclusive or
predominant method of establishing or offsetting positions in a
particular market, the price discovery process in the centralized
market will be jeopardized.
a. Minimum Centralized Market Trading Percentage Requirement
The Commission believes that a significant amount of trading in any
contract listed on a DCM must occur on the centralized market in order
to meet the requirements of Core Principle 9. The Commission believes
that setting a minimum percentage of trading that must take place on
the centralized market is an appropriate method of implementing this
provision in order to provide clarity and legal certainty to DCMs.
Accordingly, the Commission is proposing to establish a minimum on-
exchange trading threshold of 85 percent.
In considering the minimum threshold of trading on the centralized
market, the Commission reviewed data regarding the amount of off-
exchange transactions in 570 listed DCM
[[Page 80589]]
contracts.\96\ Those contracts represented actively traded futures
products on eight DCMs and included a wide cross-section of products
with open interest. The data illustrated that the trading volume in the
570 contracts could be grouped into two main categories.\97\ In one
category, involving 410 of the contracts, mostly involving energy,
forex and weather contracts, almost all or all of the trading over a
three month period occurred off-exchange. As noted above, the
Commission believes that the price discovery process in the centralized
market is jeopardized where off-exchange transactions become the
exclusive or predominant method of establishing or offsetting positions
in a particular market. Since there was no centralized market trading
in those contracts, the Commission did not consider these 410 contracts
in its analysis of the appropriate minimum centralized market trading
requirement. In the second largest category, involving 128 contracts
from all asset classes which included contracts with large and small
open interest, the average amount of off-exchange trading over the
three-month period ranged from 0% to 15%. The Commission believes that
this second category of contracts, where there was actual centralized
market trading to observe, provides a reasonable basis for establishing
a minimum centralized market trading requirement. Accordingly, from
this second category the Commission took the upper range of the maximum
average amount of off-exchange trading, and proposes that a maximum of
15% of total trading volume of a contract would be an allowable amount
of off-exchange trading in order to protect the price discovery process
of trading on the centralized market.
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\96\ Commission staff collected data on the amount of off-
exchange trading that took place over the three month period from
May 2010 through July 2010, for 570 contracts listed on eight
designated contract markets (CME, CBOT, NYMEX, COMEX, ICEUS, One
Chicago, Kansas City Board of Trade and the Minneapolis Grain
Exchange) and covering 10 asset classes (agricultural, alternative
markets (i.e., environmental products), currency, energy, financial,
index, interest rates, metal, real estate and weather). In
collecting data, Commission staff attempted to sample a cross-
section of trading data from the eight DCMs. The data collected
represents samples of: (i) Active contracts in the main asset
classes (financials, energy, agricultural, index, currency, weather,
real estate, and metals); (ii) particular contracts that
historically have not traded on the centralized market (i.e.,
certain energy contracts, currency); (iii) commodities that as a
group trade differently from other commodities (i.e., cocoa,
coffee); (iv) commodities that are prominent on certain exchanges
(i.e., wheat on the Kansas City Board of Trade and the Minneapolis
Grain Exchange), (v) ``softs'' and (vi) other products on ICE
Futures U.S. Commission staff began collecting data in early August
2010 for the period May 2010 through July 2010. This time period was
chosen because it represented the most current and straightforward
data available at the time Commission staff began collecting data.
\97\ A third category, consisting of a small number of contracts
with trading volume between 15-60%, is discussed further below.
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The Commission believes that requiring at least 85% of a contract's
volume to be traded on the centralized market will balance the goal of
protecting the price discovery process of trading in the centralized
market, with the goal of allowing off-exchange transactions for bona
fide business purposes. The Commission invites comments on the minimum
centralized market trading percentage requirement proposed herein. In
particular, the Commission requests that commenters providing
alternative percentage requirements or alternative approaches also
provide data that supports any alternative percentage or other
approach.
b. Centralized Market Trading Percentage Calculation
In order to determine the percentage of on and off exchange trading
in a contract, DCMs must measure the average percentage of trading in
each contract over a sufficient period of time. Indeed, the data
collected by the Commission indicates that for those contracts that
have significant trading on the centralized market, the amount of off-
exchange trading varies from day to day. The Commission proposes that a
reasonable time period over which to measure and determine a contract's
on-exchange trading volume is 12 months.
Thus, for new contracts listed after the effective date of the
minimum centralized market trading percentage requirement in 38.502(a),
the Commission proposes that DCMs determine the amount of on-exchange
trading in each contract at the conclusion of the 12 month period
following the contract's initial listing on the exchange, and again on
every 12 month anniversary going forward. The designated contract
market must calculate the centralized market trading percentage for
each listed contract within thirty days following the conclusion of the
12 month anniversary of each contract's listing. The Commission notes
that in order to be in compliance with Core Principle 9, the DCM has
the burden of reviewing the on and off-exchange trading for each of its
contracts over the relevant period to determine whether it is subject
to delisting. The Commission notes that as part of its oversight, it
also will be reviewing trading data of contracts. For contracts and
contract months listed prior to the effective date of Sec. 38.502(a),
the Commission proposes that the DCM must initially calculate the
centralized market trading percentage in each of its contracts within
thirty days of the effective date of this minimum centralized market
trading rule. The initial calculation for each existing contract must
be based on the trading volume in the contract during the 12 month
period immediately preceding the effective date of this rule.\98\
Thereafter, the DCM must calculate the centralized market trading
percentage in each such contract within thirty days of the 12 month
anniversary of the initial calculation.
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\98\ As noted in the discussion under subpart J of this release,
if a contract has been listed for less than a 12 month period, the
Commission proposes that a DCM may seek an exemption as to that
contract(s) and obtain a maximum of 12 additional months to
calculate its centralized market trading for that contract(s).
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c. Mandatory Delisting
As noted above, the minimum centralized market trading requirement
would permit DCMs to list only those contracts that have a minimum
average over a 12 month period of 85% trading on the centralized
market. Accordingly, subject to the relief provided for existing
contracts and the other limited exemptions noted in paragraphs (d) and
(e) of proposed Sec. 38.502 below, proposed Sec. 38.502(c) requires
that for those contracts that do not meet the minimum centralized
market trading percentage requirement, the DCM has the following
options, which it must effectuate within ninety days of the centralized
market trading percentage calculation: (i) If the DCM operates a SEF,
it can delist the swap contract from the DCM and transfer open swap
positions to the SEF; (ii) the DCM can transfer the swap contract(s) to
another SEF that accepts the contract; or (iii) the DCM can trade the
contract on the DCM for liquidation purposes only.
The Commission notes that contracts that may be required to be
delisted have a potential alternative venue as Congress created, in the
Dodd-Frank Act, the SEF,\99\ a new trading facility for the trading,
processing and execution of swaps.\100\ Among other requirements,
[[Page 80590]]
the Dodd-Frank Act requires SEFs to facilitate the clearing and
settlement of swaps.\101\ Accordingly, parties seeking clearing and
segregated account status for swaps may achieve these objectives on a
SEF.\102\ The Commission invites comments as to these proposals.
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\99\ The SEF Core Principles, under Section 5h of the CEA, as
amended by the Dodd-Frank Act, do not include a counterpart to the
DCM Core Principle 9 requirement to protect the ``price discovery
process of trading in the centralized market of the board of
trade.''
\100\ The Commission notes that based upon a letter sent to
Chairman Gensler from the Wholesale Markets Brokers' Association
(``WMBA''), the Commission understands that many of the participants
that currently facilitate the privately negotiated contracts that
are listed, but not traded, on a designated contract market intend
to establish SEFs, confirming that this is an appropriate
alternative forum for such contracts. The Commission, however, takes
notice of the fact that the WMBA also proposes a much broader
reading of Core Principle 9 contending, among other things, that the
requirements of Core Principle 9 apply only to transactions that are
traded on a DCM and not to transactions, such as exchanges of
futures for swaps, that are submitted in compliance with DCM rules;
that the Commission should consider other execution models that are
competitive open and efficient; that compliance with Core Principle
9 does not require that all trades submitted to a DCM be executed on
the DCM's proprietary electronic trading network; and that Core
Principle 9 should not be applied in the same way to futures, which
may be traded by retail investors, as it may be applied to OTC
products that are only eligible to be traded by Eligible Contract
Participants. Letter to Chairman Gary Gensler from WMBA dated
September 10, 2010.
\101\ CEA Section 5h(f)(7), as amended by the Dodd-Frank Act. In
addition, this requirement accommodates the creation of Cleared
Swaps Customer Collateral account with bankruptcy protection.
Additionally, the Commission may permit the netting of futures and
swaps within such account. See CEA Section 4d(f)(3)(B), as amended
by the Dodd-Frank Act.
\102\ The Commission notes that swaps cleared through an FCM and
associated collateral are protected in bankruptcy as commodity
contracts. See section 724(b) of the Dodd Frank Act (to be codified
at 11 U.S.C. 761(4)(F)). Moreover, to achieve benefits of portfolio
margining, a designated contract market may still petition for an
order pursuant to section 4d(a)(2) of the CEA to permit such swap
transactions to be commingled in the segregated customer account for
exchange traded transactions, or an order pursuant to CEA section
4d(f)(3)(B) to permit related exchange traded futures transactions
to be commingled in the segregated customer account for swaps.
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d. Treatment of Contracts Listed as of the Effective Date of This
Section
Proposed Sec. 38.502(d) provides relief from the provisions of
Sec. 38.502(c) for contracts listed on a DCM as of the effective date
of this section. The Commission understands that many contracts and
contract months listed on a DCM before the effective date of the
proposed rule may not meet the proposed minimum centralized market
trading percentage requirement and, therefore, would be subject to
mandatory delisting upon the effective date of the rules in this
section (``affected contracts''). The Commission also notes that
delisting a large number of these affected contracts within a short
period of time may be difficult and result in potential financial
consequences. Accordingly, the Commission proposes a transition process
for the affected contracts to be liquidated in a fair and orderly
manner. Specifically, the Commission proposes in Sec. 38.502(d) that
affected contracts that do not meet the minimum centralized market
trading requirement may continue to be listed on the DCM until all open
positions in such contracts and contract months are closed or
liquidated. Trading in such contracts will be allowed but only to close
or liquidate a position.\103\
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\103\ It is possible that a trader may not desire to close out a
position. Since the position is carried at the clearing house, a
trader may instead decide to keep the position in the clearing house
until expiration. Traders with existing positions as of the
effective date of the rules in this section will be permitted to
maintain these positions in the respective margin account.
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In essence then, after the effective date of the proposed rules in
this section, affected contracts that are listed before the effective
date of this rule and that do not meet the minimum centralized market
trading requirement will not be required to delist or liquidate within
90 days as required by the proposed rule. Instead, all affected
contracts will be allowed to continue to be listed, and either traded
on the DCM for liquidation purposes only, through offsetting trades, or
held until settlement at contract expiration. These affected contracts
would, therefore, either close out at contract expiration or when open
interest in the contract reaches zero. For any affected contracts that
may not have been listed and traded for a full 12 month period on the
effective date of the proposed rule, proposed Sec. 38.502(e) proposes
additional relief, as described below.
The Commission points out that with respect to this transition
period, trades in the affected contracts must comply with the
provisions of Section 2(h)(8) of the CEA, as amended by the Dodd-Frank
Act, once effective. Thus, while a DCM will be allowed to continue to
list and trade in its existing contracts for purposes of liquidating
respective futures positions, upon the effective date of amended CEA
Section 2(h)(8), the closing out of that position with an associated
swaps position must be accomplished in compliance with the requirements
of amended CEA Section 2(h)(8). To that end, such swaps positions can
only be executed on a SEF or DCM, or with a bilateral off-exchange
trade either as a block trade, or where the trade is exempt from the
provisions of amended CEA Section 2(h)(8) because one party to the
trade includes an end user.\104\
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\104\ See generally, section 2(h) of the CEA, as amended by the
Dodd-Frank Act.
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The Commission invites comments on its proposal and also invites
alternative proposals on how to address those DCM contracts listed
prior to the effective date of these rules.
e. Exemption Upon Petition
As noted above, the data collected by the Commission illustrates a
category of contracts that experienced an average off-exchange trading
volume greater than 15% but less than 100% over the three month period.
The Commission recognizes that there are contracts that may experience
off-exchange trading averages that are above the proposed 15% maximum
off-exchange trading and that circumstances surrounding those contracts
may warrant an exemption from the minimum centralized market trading
percentage requirement. For example, there may be situations where a
newly-listed contract initially may have little on-exchange trading,
and may fail to meet the minimum centralized market trading requirement
for the initial 12 month period despite experiencing a steady increase
in trading volume over time. In those situations, it may be appropriate
to provide the DCM with an opportunity to petition for an exemption to
this requirement for a maximum of a 12 month period. Proposed Sec.
38.502(e)(1) reflects such an exemption.
In order to promote legitimate petitions, the proposed rule
specifically provides that the DCM must demonstrate in its petition
that such contract has achieved an average of at least 50% trading
volume on the centralized market over the preceding 12 month period,
and also must make an adequate showing that the contract, if granted
the exception, is likely to attain the minimum trading requirement
within the following 12 month period. The Commission also recognizes
that some affected contracts that are listed as of the effective date
of the proposed rule may not have been listed and traded for a full 12
month period at such time, potentially requiring the DCM to calculate
the contract's on-exchange trading based on some shorter period of
time. In those situations, the Commission believes it is only fair to
allow such contracts additional time, if desired, to determine whether
the minimum centralized market trading percentage requirement is met.
As such, the Commission proposes in Sec. 38.502(e)(2) to allow a DCM
in this situation to petition the Commission to exempt a contract from
the requirements of proposed Sec. 38.502(d) for a maximum period of 12
months. Under proposed Sec. 38.502(e)(3) petitions seeking an
exemption from the mandatory delisting requirement in Sec. 38.502(c)
must be submitted to the Commission within thirty-five days of the 12
month anniversary of the listing of such contract, or for affected
contracts
[[Page 80591]]
seeking an exemption because they have been listed for less than 12
months, thirty-five days after the effective date of this section. The
filing of a petition shall toll the mandatory delisting requirement
until such time that a decision is made. The Commission invites
comments on all aspects of this proposed rule.
We specifically request comment on how the proposals related to the
requirement that 85 percent or greater of volume of a contract must be
traded on the DCM's centralized market will affect the ability of
market participants to take advantage of efficiencies like portfolio
margining for swaps and futures positions. We also request comment on
any negative consequences this proposal may have on the trading of
swaps and related transactions like exchange of futures for swaps? The
Commission also is requesting comments on whether any other exemptions
should be considered for contracts that do not meet the minimum
centralized market trading percentage threshold of on-exchange trading
volume but nevertheless appear to serve a price discovery function, and
what factors should be considered in making the exemption
determination. For example, would it be acceptable for a contract
market to provide evidence of the frequency to which cash market bids,
offers or transactions in a commodity are directly based on, or are
determined by referencing the prices generated by trading the subject
contract on the designated contract market? Finally, the Commission
also requests comments, with supporting information, on whether the
Commission should consider any other exemptions from proposed Sec.
38.502.
iii. Proposed Sec. 38.503--Block Trades on Futures Contracts
As noted above, in addition to updates to Sec. 1.38, the 2008 Core
Principle 9 Proposed Rulemaking \105\ proposed revised guidance and
acceptable practices relating to block transactions for futures and
options. The Commission proposes to codify some of the provisions in
the guidance and acceptable practices relating to block trading that
are, to a large degree, already current industry practice. The
Commission believes that codifying these block trading requirements
will result in greater regulatory certainty and consistency for DCMs.
As discussed below, the Commission proposes, however, to maintain
guidance and acceptable practices with respect to a DCM's determination
of block sizes and block pricing for futures contracts, as it is
expected that the determination of block sizes and pricing will evolve
as both the industry and the Commission continue to gain experience in
this area.
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\105\ The Commission first proposed amendments to section 1.38
and guidance with respect to Core Principle 9 in July 2004. See 69
FR 39,880, Jul. 1, 2004.
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Consistent with the requirements set forth in current Sec. 1.38
and amended Core Principle 9, proposed Sec. 38.503(a) would require
that a board of trade that permits block trade transactions on futures
contracts must have rules governing such transactions. As proposed in
the 2008 Core Principle 9 Proposed Rulemaking, this regulation will
require that the rules limit block trades to large transactions and
impose minimum size requirements. The proposed rule also states that
the block trade size must be certified or approved by the Commission.
The Commission recognizes that the minimum size thresholds for
block trades in a contract may change over time due to changes in sizes
of trades in the centralized market and the market's volume and
liquidity. Accordingly, proposed Sec. 38.503(b) proposes that block
trade size must be reviewed on an annual basis. Any necessary
adjustments must be made to new and existing contracts.
Proposed Sec. 38.503(c) codifies the 2008 Core Principle 9
Proposed Rulemaking proposal to limit block trade parties for futures,
options and swaps to eligible contract participants (``ECPs'') as that
term is defined in Section 1a(18) of the CEA, as amended by the Dodd-
Frank Act. However, the rule makes clear that commodity trading
advisors acting in an asset managerial capacity and investment advisors
that have over $25 million in assets under management, including
foreign persons performing equivalent roles, are allowed to carry out
block trades for non-ECP customers. The proposed rule also prohibits
any person from conducting a block trade on behalf of a customer,
unless the person receives instruction or prior consent to do so from
the customer.\106\
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\106\ All of these requirements mirror block trade rules
previously approved by the Commission. The Commission approved block
trade rules of the Cantor Financial Futures Exchange, Inc. on
February 11, 2000; the Commission also approved Chicago Mercantile
Exchange block trade rules on May 19, 2000.
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Proposed Sec. 38.503(d) codifies the concepts in the 2008 Core
Principle 9 Proposed Rulemaking with respect to affiliated parties for
futures, options on futures and options on commodities. The proposed
rule defines an ``affiliated party,'' for purposes of block trades on
futures, as a party that directly or indirectly through one or more
persons, controls, is controlled by, or is under common control with
another party. As noted in the 2008 Core Principle 9 Proposed
Rulemaking, appropriate safeguards are important for block trades
between affiliated parties, because transactions between two closely
related parties are more susceptible to abuse, such as setting
unreasonable prices, artificially boosting volume, money passing, or
wash trading. This is because it is possible that two related parties
are not motivated by their own separate interests, but by the interests
of a person or entity that may control both of the parties. Thus, under
proposed Sec. 38.502(d)(3), block trades can take place between
affiliated parties under the following conditions: (i) The block trade
prices must be based on a competitive market price, either by falling
within the contemporaneous bid/ask spread on the centralized market or
calculated based on a contemporaneous market price in a related cash
market; (ii) each party must have a separate and independent bona fide
business purpose for engaging in the trades; and (iii) each party's
decision to enter into the block trade must be made by a separate and
independent decision-maker. As noted in the 2008 Core Principle 9
Proposed Rulemaking, the Commission believes that the proposed rules
for block trades between affiliated parties strike an appropriate
balance between allowing such trades and ensuring that each party is
acting independently when it agrees to enter into such a transaction.
Proposed Sec. 38.503(e) codifies the practices proposed in the
2008 Core Principle 9 Proposed Rulemaking relating to aggregation of
orders. The proposed rule prohibits aggregation of orders for different
trading accounts in order to satisfy the minimum block size
requirement, except if done by a commodity trading advisor acting in an
asset manager capacity or an investment advisor who has $25 million in
total assets under management.
Proposed Sec. 38.503(f) and (g) set forth the requirements for
recordkeeping and reporting of block trades for futures and options. As
to recordkeeping, proposed Sec. 38.502(f) reflects the provisions
contained in Sec. 1.38(b) with certain updates. Thus, as is the
current requirement, persons handling, executing, clearing, or carrying
transactions off the centralized market must follow the rules of the
DCM, including providing the appropriate identification of such
transactions to the DCM. In addition, the proposed rule codifies the
concept initially proposed in the 2008 Core Principle 9 Proposed
Rulemaking that the DCM must have rules for keeping appropriate
records.
[[Page 80592]]
Proposed Sec. 38.503(f) requires that parties to, and members
facilitating, block trades keep accurate block trade records that
comply with Core Principles 10 and 18 and the associated
regulations.\107\ The proposed rule also requires that block trade
orders and records must be accessible to the DCM, the Commission or the
Department of Justice, upon request.
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\107\ An acceptable practice under this regulation is set forth
in proposed appendix B of part 38 and provides that records kept in
accordance with the requirements of FASB Statement No. 133
(``Accounting for Derivative Instruments and Hedging Activities''),
as amended by FASB Statement No. 161 (``Disclosures About Derivative
Instruments and Hedging Activities--An amendment of FASB Statement
No. 133'') are acceptable records.
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Proposed Sec. 38.503(g) reflects a revised approach from the 2008
Core Principle 9 Proposed Rulemaking pertaining to the reporting of
block trades. While the 2008 Core Principle 9 Proposed Rulemaking
proposed that block trades be reported to the contract market within a
reasonable time, proposed Sec. 38.503(g) codifies the practice already
enforced by a great majority of DCMs by requiring that DCMs have up to
5 \108\ minutes to report block trades.\109\ The Commission believes
that this is an appropriate amount of time for reporting block trades
and balances the goals of providing transparency while enabling market
participants involved in block trades with time to hedge risks
associated with such trades. The Commission seeks comments as to
whether this is an appropriate time period or whether and why another
time period is more appropriate.
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\108\ The Commission notes that for a few contracts with lower
liquidity, such as weather and housing, CME allows for a 15 minute
reporting time.
\109\ See 73 FR 54,097, at note 18, Sep. 18, 2008 (noting CBOT
Rule 331.05(d), CMD Rule 526(F); NYMEX Rule 6.21C).
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In addition, proposed Sec. 38.503(g) requires DCMs to publicize
the details on block trades immediately upon the receipt of the
transaction report, and to publicize daily the total quantity of the
block trades that are included in the total volume of trading under the
procedures set forth in Sec. 16.01.
Proposed Sec. 38.503(h) refers applicants and DCMs to the guidance
in Appendix B to part 38 for purposes of determining block size and
pricing determinations. As noted above, the Commission is proposing
amended guidance and acceptable practices in Appendix B of part 38
pertaining to block size and block pricing. The Commission believes
that a one-size fits all approach to determining block size and pricing
is inappropriate for block trades as it is expected, as noted above,
that the determination of block sizes and pricing will evolve as both
the industry and the Commission continue to gain experience in this
area. Accordingly, the Commission is re-proposing, with some changes,
the acceptable practices that were proposed in the 2008 Core Principle
9 Proposed Rulemaking regarding establishing an acceptable minimum
block size.
The 2008 Core Principle 9 Proposed Rulemaking proposed replacing an
earlier-proposed numerical test with the concept that, in establishing
requirements for minimum block size, it was more appropriate to utilize
a procedural approach that takes into consideration the purposes for
allowing blocks and the trading in the particular contract. The 2008
Core Principle 9 Proposed Rulemaking explained that one of the bases
for permitting block trades to be transacted off the centralized market
is that prices attendant to the execution of large transactions on the
centralized market may diverge from prevailing market prices that
reflect supply and demand of the commodity. This is because the
centralized market may not provide sufficient liquidity to execute
large transactions without additional costs that may reflect the cost
of executing the trade. Consequently, reporting these prices as
conventional market trades would be misleading to the public. As
explained in the 2008 Core Principle 9 Proposed Rulemaking, another
basis for allowing block trades is that such trades facilitate hedging
by providing a means for commercial firms to transact large orders
without the need for significant price concessions, and resulting price
uncertainty for parties to the transaction that would occur if
transacted on the centralized market. Finally, a procedural approach is
more appropriate because the size of a typical trade varies between
contracts, and is dependent on the liquidity in the centralized market
and other commercial factors.
Given these reasons, the Commission previously proposed a standard
whereby the minimum block trade sizes should be larger than the size at
which a single buy or sell order is customarily able to be filled in
its entirety at a single price in that contract's centralized market,
and exchanges should determine a fixed minimum number of contracts
needed to meet this threshold. The Commission is re-proposing this
acceptable practice with some modifications. Specifically, the
Commission proposes that block trade sizes should be a number larger
than the size at which a single buy or sell order is customarily able
to be filled in its entirety without incurring a substantial price
concession. The Commission believes this is a more appropriate
threshold because in less liquid markets even a small number of trades
could have a slight movement on price and would not present an accurate
picture of the market.
In the 2008 Core Principle 9 Proposed Rulemaking, the Commission
also proposed, as part of the acceptable practice, certain factors that
the DCM could consider in determining the appropriate minimum block
size. These factors included the market's volume, liquidity and depth,
a review of typical trade sizes and/order sizes and any input it may
receive from floor brokers, floor traders and/or market users
regarding, for example, what size order is generally too large to fill
without major price concessions. The Commission believes that these
factors are likely to lead to an appropriate block size and thus
proposes them as acceptable practices in this release. In addition, the
Commission is proposing that DCMs also take into account, as an
additional factor, the block sizes on comparable swap products. This
additional factor is necessary and appropriate in light of the
inclusion of swap trading and execution on DCMs and SEFs, and the
corresponding swap block rules discussed below.
The Commission proposes similar acceptable practices for
determining the acceptable minimum size for block trades in new futures
contracts and options. However, because a new contract will not have
any trading history, the Commission proposes that the acceptable
minimum block trade size in such contracts is the trade size that the
DCM reasonably anticipates will not be able to be filled in its
entirety in the contract's centralized market, without major price
concessions. In determining an acceptable block size, the DCM should
consider centralized market data in a related futures contract, the
same contract traded on another exchange, or trading activity in the
underlying cash market. For the reasons discussed above, the DCM should
also consider, as an additional factor, the block sizes on comparable
swap products.
The Commission also re-proposes in this release the acceptable
practices proposed in the 2008 Core Principle 9 Proposed Rulemaking
relating to the pricing of blocks. The proposed acceptable practice
requires that block trades between non-affiliated parties must be at a
fair and reasonable price. The proposed acceptable practices set forth
the factors that could be considered by DCMs in determining what is
fair and reasonable, including:
[[Page 80593]]
(1) The size of the block, (2) the price and size of other block trades
in any relevant markets at the applicable time, and (3) the
circumstances of the market or the parties to the block trade. The
proposed acceptable practice states that relevant markets include the
DCM itself, the underlying cash markets and/or related futures or
option markets. As noted in the proposed acceptable practices, if the
contract market rule requiring a fair and reasonable price includes the
circumstances of the parties or of the market, a block trade
participant can execute a block transaction at a price that is away
from the market provided that the participant retains documentation to
demonstrate that the price was indeed fair and reasonable under the
participant's or market's particular circumstances. In addition, the
proposed acceptable practices note that block trades between affiliated
parties are subject to the pricing requirements in Sec. 38.503(d).
iv. Proposed Sec. 38.504--Block Trades on Swap Contracts
The Dodd-Frank Act amended the CEA to expand the list of products
that may be traded on a DCM to include swaps, in addition to futures
and options contracts. The Commission recognizes that there exists
certain inherent differences between futures and options, on the one
hand, and swaps on the other, which may necessitate that DCMs apply
different rules to these products. While the Commission generally
believes that the same block trade rules should apply to futures,
options and swaps listed and traded on the DCM, the Commission proposes
that characteristics of swaps do warrant a different approach for
purposes of determining minimum block size. In addition, the Dodd-Frank
Act provides specific statutory requirements for reporting of swap
block transactions. The rules governing each of these requirements are
currently being addressed in a forthcoming Commission release titled
``Real Time Reporting,'' which is proposing rules that will be codified
in part 43 of the Commission's regulations.\110\ Accordingly, DCMs must
comply with the provisions of proposed part 43 for purposes of setting
the minimum size of swap block trades, and for reporting swap block
trades. Proposed Sec. 38.504 provides that DCMs must have rules that
require compliance with these rules for swaps traded on their markets.
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\110\ See supra note 43.
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v. Proposed Sec. 38.505--Exchange of Derivatives for Related Position
In the 2008 Core Principle 9 Proposed Rulemaking, the Commission
proposed acceptable practices relating to exchange of futures for
related position transactions. The acceptable practices proposed in
that rulemaking were based on previous publications by the Commission,
including the 1987 EFP Report prepared by the Commission's then-
Division of Trading and Markets and the Commission's 1998 EFP Concept
Release.\111\ Proposed Sec. 38.505 codifies the practices that the
Commission historically has required from DCMs with respect to these
types of transactions.
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\111\ See Division of Trading and Markets, Report on Exchanges
of Futures for Physicals (1987) (the ``1987 EFP Report'');
Regulation of Non-Competitive Transactions Executed on or Subject to
the Rules of a Contract Market, 63 FR 3708, Jan. 26, 1998 (the
``1998 EFP Concept Release'').
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As an initial matter, proposed Sec. 38.505 (a) revises the
nomenclature for referring to transactions that have been referred to
in the past as ``exchange of futures for commodities or derivatives
positions,'' to refer to all such transactions under the umbrella term
``exchange of derivatives for related position'' (``EDRP''). The
Commission believes that this is a more accurate and descriptive term
as it will include transactions not limited to futures, such as swaps.
Proposed Sec. 38.505(a) codifies the requirements and characteristics
of a bona fide EDRP and is based on Commission standards that have
developed over the years. Specifically, the proposed rule sets forth
the elements of a bona fide EDRP to include separate but integrally
related transactions, price correlation and quantitative equivalence of
the two legs, an actual transfer of ownership of the commodity or
derivatives position and both legs transacted between the same two
parties.
As to pricing of these transactions, proposed Sec. 38.505
maintains the methodology set forth in the acceptable practices
proposed in the 2008 Core Principle 9 Proposed Rulemaking.\112\
Accordingly, the proposed rule provides that the price differential
between the two legs should reflect commercial realities, and at least
one leg of the transaction should be priced at the prevailing market
price.
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\112\ The Commission is codifying the EDRP pricing methodology
based on its experience over the past years in determining the
reasonability of EDRP pricing.
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Further, proposed Sec. 38.505(b) codifies the requirements
applicable to bona fide transitory exchange of derivatives for related
position transactions. A transitory exchange of derivatives for a
related position transaction involves both an EDRP and an off-setting
transaction to one of the legs of that transaction. As codified in
Sec. 38.504(b), the proposed rule will permit parties to an EDRP to
engage in a separate transaction that offsets a leg of the EDRP if the
offsetting transaction results in an actual transfer of ownership and
demonstrates other indicia of being a bona fide transaction, and the
offsetting transaction is able to stand on its own as a commercially
appropriate transaction; that is, there must be no obligation on either
party that the offsetting transaction will require the execution of a
related EDRP, or vice versa.
Proposed Sec. 38.505(c) prohibits DCMs from permitting a
contingent exchange of derivative for a related position transaction
where the exchange of derivative for the related position is contingent
upon an offsetting transaction.
In the 2008 Core Principle 9 Proposed Rulemaking, the Commission
proposed that EDRP transactions be reported to the DCM within a
reasonable time. Given the continuous changes and advancements in
electronic trading over the years, the Commission believes that such
trades also should be reported in a five minute time period, as is
proposed for block trades. Thus, proposed Sec. 38.505(d) requires that
such trades be reported to the market within five minutes of
consummation. The Commission invites comments on this proposal and, in
particular, if and why any other time period should be allowed.
Proposed Sec. 38.505(e) codifies the acceptable practice proposed
in the 2008 Core Principle 9 Proposed Rulemaking requiring the DCM to
follow procedures set forth in current section 16.01 to publicize daily
the total quantity of exchange for derivatives for related position.
vi. Proposed Sec. 38.506--Office Trades and Transfer Trades
In the 2008 Core Principle 9 Proposed Rulemaking, the Commission
noted that transfer trades and office trades move existing positions
between accounts and are bookkeeping in nature. Such transactions,
therefore, do not affect the price discovery process of the centralized
market because they do not establish or offset positions. The
Commission will not require these transactions to follow the
publication requirements under Sec. 16.01 as required for blocks and
EDRPs. Instead, proposed Sec. 38.506 requires that records of such
[[Page 80594]]
transactions be kept in accordance with the recordkeeping regulation
Sec. 1.31.
10. Subpart K--Trade Information
Section 5(d)(10) of the CEA, as amended by the Dodd-Frank Act,
requires DCMs to capture, verify, and retain detailed trade information
(i.e., audit trail data) for all transactions in their markets. Amended
Core Principle 10--Trade Information is almost identical to the
requirements contained in the current Core Principle 10. Both the
amended and current Core Principle 10 require DCMs to maintain rules
and procedures that provide for the recording and safe storage of all
identifying trade information in a manner that enables the DCM to
assist in the prevention of customer and market abuses and provide
evidence of any rule violations. Because the amended core principle has
almost identical statutory text, the Commission interprets amended Core
Principle 10 as imposing the same substantive content as its
predecessor.\113\
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\113\ The Commission previously expressed the regulatory
requirements of former Core Principle 10 through its application
guidance for that core principle. See 17 CFR part 38, App. B,
Application Guidance and Acceptable Practices for Core Principle 10.
It also provided additional insight regarding the core principle
through detailed acceptable practices that all DCMs could use to
demonstrate compliance with former Core Principle 10. The acceptable
practices explained that ``the goal of an audit trail is to detect
and deter customer and market abuse.'' Id. at (b)(1). It also
outlined the elements of an effective audit trail. Those elements
included original source documents, which help to establish the
accuracy and authenticity of an audit trail. They also included a
transaction history database and electronic analysis capability,
which allow a DCM to more easily access and review audit trail data
to identify possible trading abuses and rule violations. Finally,
the acceptable practices pointed to a DCM's safe storage capability,
emphasizing that audit trail data must be stored in a manner that
protects it from unauthorized alteration, accidental erasure, or
other loss.
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The application guidance and acceptable practices for current Core
Principle 10 provide the basis of the Commission's proposed audit trail
regulations in proposed subpart K, particularly proposed Sec. Sec.
38.551 (Audit Trail Required) and 38.552 (Elements of an Acceptable
Audit Trail Program), summarized below. In addition, the proposed rules
update the guidance and acceptable practices in that the proposed
regulations address audit trail requirements for electronic trading.
The Commission notes that the proposed rules for electronic trading
audit trails are substantially similar to the long-standing
requirements for open-outcry trading. However, because those
requirements reflected a time when electronic trading accounted for
less than 10 percent of U.S. futures volume, they did not explicitly
address electronic trading.\114\
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\114\ This figure is based on fiscal year 2000, as reported in
the Commission's FY 2009 Performance and Accountability Report, p.
14.
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The proposed rules also draw on recent RERs analyzing DCMs'
compliance with former Core Principle 10. In the context of RERs, staff
has made a number of findings and recommendations regarding DCMs' audit
trail enforcement programs, including recommendations regarding more
frequent audit trail reviews and larger sanctions for audit trail
violations. Staff also has directed DCMs to develop audit trail
programs for electronic trading that are comparable in rigor and scope
to their audit trail programs for open-outcry trading.\115\ These
findings and recommendations, including those with respect to
electronic trading audit trails, are reflected in proposed Sec.
38.553, also summarized below.
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\115\ See Rule Enforcement Review of the Minneapolis Grain
Exchange (August 27, 2009), and Rule Enforcement Review of ICE
Futures U.S. (Feb. 2, 2010).
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Whether applicable to open-outcry or to electronic trading, the
proposed rules in subpart K seek to ensure that DCMs capture, verify,
and retain sufficient order and trade-related information for DCM staff
to detect possible trading violations and other market and customer
abuses. They also require DCMs to possess specific resources and
capabilities with respect to their audit trails. These include the
ability to promptly reconstruct all transactions and the ability to
track customer orders from the time of receipt through fill,
allocation, or any other disposition. The proposed rules also require a
DCM's audit trail program to collect original source documents, to
build a transaction history database, and to develop an electronic
analysis capability with respect to all trade information in that
database. DCMs also must possess a safe storage capability with respect
to their audit trail data. Finally, they must develop meaningful
enforcement programs to ensure member and market participant compliance
with all applicable audit trail requirements. In each respect, the
Commission's proposed rules are consistent with its long-standing
requirements and expectations regarding reliable, complete, and
effective audit trails. The specific requirements of the proposed rules
implementing amended Core Principle 10 are summarized below.
i. Proposed Sec. 38.551--Audit Trail Required
Proposed Sec. 38.551 is based on the application guidance and
acceptable practices for former Core Principle 10.\116\ It establishes
the overarching requirements for DCMs' audit trail programs to ensure
that DCMs can appropriately monitor and investigate any potential
customer and market abuse. Proposed Sec. 38.551 provides that the
audit trail data captured by DCMs must be sufficient to reconstruct all
transactions within a reasonable period of time, and to provide
evidence of any rule violations that may have occurred. The proposed
rule also provides that audit trails must be sufficient to track
customer orders from the time of receipt through fill, allocation, or
other disposition. Audit trail data must include both order and trade
information. Proposed Sec. 38.551 applies equally to open-outcry and
electronic trading.
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\116\ 17 CFR Part 38, App. B, Core Principle 10, Application
Guidance and Acceptable Practices.
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ii. Proposed Sec. 38.552--Elements of an Acceptable Audit Trail
Program
Proposed Sec. 38.552 prescribes the four elements of an acceptable
audit trail program. These elements are necessary to ensure that a DCM
can capture and retain sufficient trade-related information, can
reconstruct trading promptly, and has the necessary tools to detect and
deter potential customer and market abuses through its audit trail.
First, proposed Sec. 38.552(a) requires that a DCM's audit trail
include original source documents, defined to include unalterable,
sequentially-identified records on which trade execution information is
originally recorded, whether manually or electronically. It also
requires that customer order records demonstrate the terms of the
order, the account identifier that relates to the account owner, and
the time of the order entry. Finally, proposed Sec. 38.552(a) requires
that, for open-outcry trades, the time of report of order of execution
must also be captured in the audit trail.
Second, proposed Sec. 38.552(b) requires that a DCM's audit trail
program must include a transaction history database. A transaction
history database facilitates rapid access and analysis of all original
source documents, thereby aiding DCMs in monitoring for customer and
market abuses. Proposed Sec. 38.552(b) also specifies the trade
information that must be included in a transaction history database.
Mandatory information includes a history of all orders and trades; all
data input in the trade
[[Page 80595]]
matching system for clearing; the categories of participants for which
trades are executed (i.e., customer type indicator or ``CTI'' codes);
timing and sequencing data sufficient to reconstruct trading; and
identification of each account to which fills are allocated.
Third, proposed Sec. 38.552(c) requires that a DCM's audit trail
program have electronic analysis capability for all data in its
transaction history database. This requirement helps ensure effective
use of audit trail data by requiring appropriate tools to use in
conjunction with a DCM's transaction history database. Proposed Sec.
38.552(c) also provides that a DCM's electronic analysis capability
must allow it to reconstruct trades in order to identify possible rule
violations.
Finally, proposed Sec. 38.552(d) requires that a DCM's audit trail
program include the ability to safely store all audit trail data, and
to retain it in accordance with the recordkeeping requirements of DCM
Core Principle 18 and the associated regulations under part 38. Safe
storage capability enables a DCM to properly preserve and protect the
audit trail data so that it is readily available for the DCM to use in
any future investigation or inquiry into possible violations of DCM
rules. Safe storage capability requires a DCM to protect its audit
trail data from unauthorized alteration, accidental erasure or other
loss.
iii. Proposed Sec. 38.553--Enforcement of Audit Trail Requirements
Proposed Sec. 38.553 prescribes the elements of an effective audit
trail enforcement program. The proposed rule is organized in two parts.
First, proposed Sec. 38.553(a) requires a DCM to develop an effective
audit trail enforcement program. An effective enforcement program must,
at a minimum, review all members and market participants annually to
verify their compliance with all applicable audit trail requirements.
Proposed Sec. 38.553(a) is further divided into two paragraphs.
Paragraph (a)(2) of proposed Sec. 38.553 establishes minimum review
criteria for open-outcry trading. It requires that DCMs conduct annual
reviews of all members and market participants to verify their
compliance with their trade timing, order ticket and trading card
requirements. Similarly, paragraph (a)(1) sets forth minimum review
criteria for an electronic trading audit trail. It requires annual
examinations by DCMs of randomly selected samples of front-end audit
trail data from order routing systems to ensure the presence and
accuracy of required audit trail data. In addition, paragraph (a)(1)
requires that DCMs: Review the processes used by members and market
participants to assign and maintain exchange user identifications;
review usage patterns of the user identifications; and review account
numbers and Customer Trading Identification codes in trade records to
test for accuracy and improper usage. The Commission notes that,
compared to the corresponding requirements for open-outcry trading,
audit trail and audit trail enforcement requirements for electronic
trading are still evolving, and that the Commission's expectations in
this area, pursuant to amended Core Principle 10, are likely to evolve
as well.
Second, proposed Sec. 38.553(b) requires DCMs to develop programs
to ensure effective enforcement of their audit trail and recordkeeping
requirements. It applies equally to both open-outcry and electronic
trading. Proposed Sec. 38.553(b) requires DCMs' enforcement programs
to identify members and market participants that routinely fail to
comply with the requirements of Core Principle 10. DCMs also must levy
meaningful sanctions when deficiencies are found. Sanctions may not
include more than one warning letter or other non-financial penalty for
the same violation within a rolling twelve-month period.
11. Subpart L--Financial Integrity of Transactions
Core Principle 11, as amended by the Dodd-Frank Act, retains the
provisions of current Core Principle 11.\117\ This core principle
requires that a DCM establish and enforce rules and procedures for
ensuring the financial integrity of transactions entered into, on or
through the facilities of the contract market, including the clearing
and settlement of the transactions with a DCO. Amended Core Principle
11 also requires that a DCM establish and enforce rules to ensure: (i)
The financial integrity of any futures commission merchant (``FCM'')
and introducing broker (``IB''); and (ii) the protection of customer
funds. Because textually the language is almost the same, the
Commission is interpreting the provisions as it has in the past.
Proposed Sec. Sec. 38.600 through 38.607, largely codify language
found in the existing application guidance for current Core Principle
11 and former Designation Criterion 5.\118\ However, based upon its
past experience, the Commission is proposing some new practices and
requirements for DCMs in implementing amended Core Principle 11.
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\117\ There were no substantive changes to the amended Core
Principle 11 from the current one. The amended core principle reads
as follows: The board of trade shall establish and enforce--(A)
rules and procedures for ensuring the financial integrity of
transactions entered into on or through the facilities of the
contract market (including the clearance and settlement of the
transactions with a derivatives clearing organization); and (B)
rules to ensure: (i) The financial integrity of any (I) futures
commission merchant, and (II) introducing broker; and (ii) the
protection of customer funds.
\118\ Former Designation Criterion 5 stated that ``the board of
trade shall establish and enforce rules and procedures for ensuring
the financial integrity of transactions entered into by or through
the facilities of the contract market, including the clearance and
settlement of the transactions with a derivatives clearing
organization.'' 17 CFR part 38, App. A.
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Proposed Sec. 38.601 would require that all transactions executed
on or through a DCM, other than transactions in security futures
products, be cleared through a Commission-registered DCO. This proposed
rule codifies current practice, as well as the requirements of amended
Core Principle 11 to mandate clearing. The Commission interprets the
mandatory clearing requirement in Section 723(a)(3) of the Dodd-Frank
Act \119\ to mean that a DCO must clear a swap for any DCM or SEF that
requests such clearing services, so long as the DCO offers the swap for
clearing. In addition, a DCO that is clearing particular swaps must
also clear the same swaps when listed on DCMs or SEFs, whether
affiliated or unaffiliated, on a nondiscriminatory basis.
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\119\ Among other things, section 723(a)(3) of the Dodd-Frank
Act adds a new section 2(h)(1) to the CEA that provides that: (i)
All swaps that are required to be cleared be cleared by a
Commission-registered DCO; and (ii) a DCO must have open access
rules, including rules providing for the non-discriminatory clearing
of a swap executed bilaterally on or through the rules of an
unaffiliated DCM or SEF.
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Proposed Sec. Sec. 38.602 and 38.603 provide that DCMs must adopt
rules establishing minimum financial standards for both member FCMs and
IBs and non-intermediated market participants, as well as rules for the
protection of customer funds, including the segregation of customer and
proprietary funds, the custody of customer funds, the investment
standards for customer funds, intermediary default procedures and
related recordkeeping. Proposed Sec. 38.604 requires that a DCM must
routinely receive and promptly review financial and related information
from its members and conduct ongoing financial surveillance of the risk
created by the positions the customers of an FCM take on the DCM. To
meet this requirement, the DCM must have rules pertaining to minimum
financial standards of intermediaries that include, among other things,
rules prescribing minimum capital requirements for
[[Page 80596]]
member FCMs and IBs.\120\ Rules or procedures pertaining to protection
of customer funds must include, among other things, that each DCM must
continually survey the obligations of each FCM created by the positions
of its customers, and, as appropriate, compare those obligations to the
financial resources of the FCM. The DCM should use this information to
protect customer funds by, for example, taking appropriate steps to
verify that its member FCMs have sufficient capital to continue to
guarantee the positions of each customer. If the obligations of a
member FCM appear excessive as compared to the capital of such FCM, a
DCM should take appropriate action, including contacting the FCM or the
FCM's designated self-regulatory organization.
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\120\ An FCM that is a clearing member will also have additional
obligations to the DCO as a result of its clearing membership.
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Proposed Sec. 38.605 requires DCMs as self-regulatory
organizations (``SRO'') to comply with the standards of amended Sec.
1.52 to ensure the financial integrity of intermediaries by
establishing and carrying out an SRO program for the examination and
financial supervision of intermediaries. Section 1.52, as proposed to
be amended in this release, sets forth the required elements of SRO
supervisory programs and permits one or more SROs to establish, subject
to Commission approval, a joint audit plan to provide for the SRO
supervision of members of more than one SRO. Proposed amendments to
Sec. 1.52 include references to existing guidance to SROs contained in
the Division of Trading and Markets Financial and Segregation
Interpretations 4-1 and 4-2, which currently guide the practices of
members of the Joint Audit Committee operating a joint audit plan that
has been approved by the Commission.\121\
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\121\ See 73 FR 52832, Sept. 11, 2008 (requesting comments prior
to the Commission's approval of the most recent Joint Audit
Committee agreement, which approval was granted March 18, 2009).
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Proposed Sec. 38.606 would provide that DCMs may satisfy their
financial surveillance responsibilities under proposed Sec. Sec.
38.604 and 38.605 by outsourcing such responsibilities to a registered
futures association or other regulated entity. Proposed Sec. 38.606
would provide that a DCM must ensure that the regulatory service
provider has the capacity and resources to conduct the necessary
financial surveillance, and would further provide that the DCM remains
responsible for compliance with its financial surveillance obligations
notwithstanding the use of a regulatory service provider.
As noted above, amended Core Principle 11 provides that a DCM must
establish and enforce rules to, among other things, ensure both the
financial integrity of any FCM, and the protection of customer funds.
With an increasing number of DCMs permitting the customers of an FCM to
transmit orders directly to the DCM in real time, the ability of an FCM
to control and monitor its level of risk may become compromised. In
this automated trading environment, the only controls that effectively
can enforce limitations on risk are automated controls.\122\ Proposed
Sec. 38.607 would require a DCM that allows customers direct access to
its contract market to implement certain direct access controls and
procedures in order to provide member FCMs with tools to manage their
financial risk. The proposed rule contemplates that an FCM would
continue to have primary responsibility for overall risk management,
but that the DCM would be required to establish an automated risk
management system permitting an FCM to set appropriate risk limits for
each customer with direct access to the contract market. As an SRO, the
DCM would be responsible for implementing and enforcing rules requiring
the FCM to use the provided controls and procedures appropriately. The
specific type of pre-trade controls implemented by a DCM shall be a
matter for determination by the DCM, its member FCMs, and the DCM's
DCO. This proposed rule requiring direct access controls and procedures
where direct access is permitted is consistent with current
international guidance.\123\ The Commission requests comments on the
proposed rule, and specifically on the following questions:
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\122\ International Organization of Security Commissions
[IOSCO], Final Report of the IOSCO Technical Committee, Principles
for Direct Electronic Access to Markets, at 4, IOSCO Doc. FR08/10
(August 12, 2010).
\123\ Id.
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Whether DCMs should provide additional controls to permit
FCMs to manage their risks? If so, what specific direct access controls
and procedures should DCMs implement?
Should such controls be mandatory?
12. Subpart M--Protection of Markets and Market Participants
Section 735 of the Dodd-Frank Act amends Core Principle 12. Current
Core Principle 12 states that the board of trade shall establish and
enforce rules to protect market participants from abusive practices
committed by any party acting as an agent for the participants. The
amended Core Principle 12 requires that the DCM establish and enforce
rules to protect markets and market participants from abusive practices
committed by any party, including abusive practices committed by a
party acting as an agent for a participant, and promote fair and
equitable trading on the contract market. The current guidance for this
core principle \124\ provides that a DCM should have methods and
resources appropriate to the nature of the trading system and the
structure of the market to detect trade practice and market abuses, and
to prohibit, detect and discipline intermediary behavior that is
abusive, fraudulent, noncompetitive or unfair, in connection with the
execution of trades.
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\124\ The current guidance for Core Principle 12 provides that
``a designated contract market should have rules prohibiting conduct
by intermediaries that is fraudulent, noncompetitive, unfair, or an
abusive practice in connection with the execution of trades and a
program to detect and discipline such behavior. The contract market
should have methods and resources appropriate to the nature of the
trading system and the structure of the market to detect trade
practice abuses.'' 17 CFR part 38, App. B.
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The Commission believes that compliance with this core principle
requires the DCM to implement trade practice and market surveillance
programs and provide a competitive, open and efficient market and
mechanism for executing transactions in accordance with other core
principles and the regulations thereunder. To provide clarity and
certainty of these requirements, the Commission proposes Sec. 38.651
that specifically states compliance requirements, including the core
principles that must be followed. Specifically, a trade practice
surveillance program should be conducted in accordance with Core
Principle 2 and the associated regulations in subpart C of this part
38, which would require, among other things, that a DCM prohibit
certain enumerated abusive and disruptive trading practices, have
arrangements and resources for effective rule enforcement and enforce
compliance with its rules and have the capacity to detect, investigate,
and sanction violations.
A market surveillance program should include monitoring the market
to prevent manipulation, price distortion and disruptions of daily
trading and the physical delivery or cash-settlement process. A market
surveillance program should be conducted in accordance with Core
Principle 4 and the associated regulations in subpart E of this part 38
that would require, among other things, that the DCM demonstrate the
capability of conducting real-time monitoring of trading and
comprehensive and accurate
[[Page 80597]]
trade reconstructions and require that traders in their markets keep
records, including their activity in the underlying commodity and
related derivative markets. Effectively monitoring the market would
require sufficient, well trained market surveillance staff and, where
appropriate, automated tools to assist in the monitoring of the market
for, among other things, potential market disruptions. Such automated
tools should be capable of providing automated trading alerts to detect
many types of potential violations of exchange or Commission rules.
Finally, in order to promote fair and equitable trading, the DCM
must establish and enforce trading rules with adequate specificity to
include, among other things, providing to market participants, on a
fair, equitable and timely basis, information regarding prices, bids
and offers. The DCM should provide a competitive, open and efficient
market and mechanism for executing transactions in accordance with Core
Principle 9 and the associated regulations in subpart J of this part 38
that, among other things, recognizes that trading in the centralized
market provides a price discovery function and would specifically
require that the execution of transactions be in a manner that protects
that price discovery process.
13. Subpart N--Disciplinary Procedures
Section 735 of the Dodd-Frank Act amends the disciplinary procedure
requirements applicable to DCMs in two significant ways. First, Section
735(a) eliminates all DCM designation criteria, including Designation
Criterion 6 (Disciplinary Procedures).\125\ Second, Section 735(b)
creates a new Core Principle 13 (Disciplinary Procedures) that is
devoted exclusively to exchange disciplinary proceedings, and that
captures disciplinary concepts inherent in both Designation Criterion 6
and in current DCM Core Principle 2 (Compliance with Rules).\126\ The
rules proposed under subpart N implement new Core Principle 13.\127\
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\125\ See Sec. 735(a) of the Dodd-Frank Act.
\126\ Compare current CEA Sec. 5(b)(6) and Sec. 5(d)(2) with
CEA Sec. 5(d)(13) as amended by the Dodd-Frank Act.
\127\ Prior to the passage of the Dodd-Frank Act, the standards
for DCMs' disciplinary practices were found in Designation Criterion
6 and the statutory language, guidance, and acceptable practices for
former Core Principle 2. Designation Criterion 6 required that a DCM
establish and enforce disciplinary procedures that authorized it to
discipline, suspend, or expel members or market participants that
violated the rules of the DCM, or similar methods for performing the
same functions, including delegation of the functions to third
parties. Paragraph (a)(2) of the application guidance for former
Core Principle 2 required DCMs to have the ``arrangements,
resources, and authority [necessary] for effective rule
enforcement,'' and the ``authority and ability to discipline and
limit, or suspend the activities of a member or market participant
pursuant to clear and fair standards.'' 17 CFR part 38, App. B,
Application Guidance for Core Principle 2 at (a)(2). In addition,
paragraph (b)(4) of the former core principle's acceptable practices
required any DCM that wished to take advantage of the acceptable
practice's safe harbor to have ``prompt and effective disciplinary
action for any violation * * * found to have been committed.'' 17
CFR part 38, App. B, Acceptable Practices for Core Principle 2 at
(b)(4). Paragraph (b)(4) also referenced part 8 of the Commission's
regulations as an example that DCMs could follow to comply with Core
Principle 2. 17 CFR 8.01 et seq. In its experience, the Commission
has found that many DCMs' disciplinary programs do in fact model the
disciplinary structures and processes in part 8. While the
acceptable practices for former Core Principle 2 offered the
disciplinary procedures in part 8 as an example of appropriate
disciplinary procedures, DCMs were exempt from part 8 pursuant to
Sec. 38.2. The disciplinary procedures proposed herein do not re-
subject DCMs to part 8, but rather propose new disciplinary
procedures for inclusion in part 38.
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The proposed rules in subpart N are consistent with current
disciplinary practices at most DCMs. They reflect disciplinary concepts
formerly found in Designation Criterion 6 and the guidance and
acceptable practices for former Core Principle 2. The proposed rules
also are similar to the text of the disciplinary procedures in part 8
of the Commission's regulations.\128\ In general, the Commission's
proposed rules seek to ensure a fair, prompt, and effective
disciplinary program. They require meaningful sanctions against persons
and entities that violate DCM rules. The proposed rules also provide
numerous procedural safeguards to ensure fairness for all respondents
in disciplinary actions. Finally, they require full customer
restitution in any disciplinary matter where customer harm is
demonstrated.
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\128\ See supra note 47.
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In those cases where the proposed rules place new requirements on
DCMs with respect to their disciplinary procedures, such requirements
are derived from findings and recommendations made by Commission staff
through its RERs. Proposed Sec. 38.701 (Enforcement Staff), for
example, requires a DCM to have sufficient staff and resources to
effectively and promptly prosecute possible violations of exchange
rules. It also requires a DCM to monitor the size and workload of its
enforcement staff annually, and to increase its enforcement resources
and staff as appropriate. The text of proposed rule 38.701 mirrors that
of proposed rule 38.155, which requires DCMs to retain sufficient
compliance staff and resources to comply with new DCM Core Principle
2--Compliance with Rules.\129\
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\129\ See Rule Enforcement Review of the Minneapolis Grain
Exchange (Aug. 27, 2009), Rule Enforcement Review of ICE Futures
U.S. (Feb. 2, 2010), and Rule Enforcement Review of the Chicago
Board of Trade and the Chicago Mercantile Exchange (Sep. 13, 2010)
for findings and recommendations pertaining to the adequate staff
size of DCM compliance departments.
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Other proposed requirements in subpart N that are based on findings
and recommendations in recent RERs include a requirement that
disciplinary panels improve their written documentation in disciplinary
decisions and settlements.\130\ These heightened documentation
requirements appear in proposed Sec. 38.703 (Review of Investigation
Report), proposed Sec. 38.709 (Settlement Offers), and proposed Sec.
38.711 (Decisions), all of which require that the facts and analysis
supporting disciplinary settlements and decisions be explained
carefully and in writing by the relevant disciplinary panel. The
Commission believes that improved written documentation, as required by
the proposed rules, will yield a number of significant benefits.
Disciplinary panels will be required to focus their analysis more
carefully in order to articulate the rationale for their decisions. DCM
enforcement staff will gain a better understanding of the evidentiary
expectations to which different disciplinary panels adhere. DCM
enforcement staff and respondents will both have an improved record to
base any appeals they may wish to file. Finally, improved written
documentation of the facts and analysis supporting settlements and
disciplinary decisions will help facilitate subsequent review of DCMs'
disciplinary programs by the Commission.
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\130\ See Rule Enforcement Review of the New York Mercantile
Exchange (Sep. 16, 2004) and Rule Enforcement Review of the Chicago
Board of Trade and the Chicago Mercantile Exchange (Sep. 13, 2010).
The structure of disciplinary panels is discussed in the context of
proposed Sec. 38.702, below.
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Proposed Sec. 38.714 (Disciplinary Sanctions), further provides
that all disciplinary penalties imposed by a DCM or its disciplinary
panels must be commensurate with the violations committed, and be
sufficient to deter recidivist activity. This proposed rule reflects
DMO staff's concerns with respect to the adequacy of disciplinary
sanctions in cases it has examined through its RER process.\131\
Finally, proposed Sec. 38.715 (Summary Fines for Violations of Rules
Regarding Timely
[[Page 80598]]
Submission of Records, Decorum, or Other Similar Activities) makes
clear that a DCM should issue no more than one warning letter in a
rolling 12-month period before sanctions are imposed, again reflecting
DMO staff's concerns with respect to the adequacy of sanctions imposed.
Proposed subpart N is divided into a total of 16 rules, each of which
is described in detail below.
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\131\ See Rule Enforcement Review of the New York Mercantile
Exchange (Sep. 16, 2004); Rule Enforcement Review of the Kansas City
Board of Trade (June 16, 2006); and Rule Enforcement Review of the
Minneapolis Grain Exchange (Aug. 27, 2009).
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i. Proposed Sec. 38.701--Enforcement Staff
Proposed Sec. 38.701 requires that a DCM establish and maintain
sufficient enforcement staff and resources to effectively and promptly
prosecute possible rule violations within the jurisdiction of the
contract market. A DCM must also monitor the size and workload of its
enforcement staff annually and increase its resources and staff as
appropriate. The Commission recognizes that at some DCMs, compliance
staff also serves as enforcement staff. That is, they both investigate
cases and present them before disciplinary panels. These proposed rules
are not intended to prohibit that practice.
The Commission believes that adequate staff and resources are
essential to the effective performance of a DCM's disciplinary program.
As noted previously, this is reflected in DMO staff's findings and
recommendations in recent RERs, in which DMO staff recommended that
DCMs increase their compliance staff levels and monitor the size of
their staff and increase the number of staff appropriately as trading
volume increases, new responsibilities are assigned to compliance
staff, or internal reviews demonstrate that work is not completed in an
effective or timely manner.
Proposed Sec. 38.701 also provides that a DCM's enforcement staff
may not include members of the exchange or persons whose interests
conflict with their enforcement duties. Moreover, a member of the
enforcement staff may not operate under the direction or control of any
person or persons with trading privileges at the contract market. These
provisions seek to ensure the independence of enforcement staff, and
help promote disciplinary procedures that are free of potential
conflicts of interest.
ii. Proposed Sec. 38.702--Disciplinary Panels
Proposed Sec. 38.702 requires a DCM to establish one or more
Review Panels and one or more Hearing Panels (together, ``disciplinary
panels'') to fulfill its obligations under this section. The
composition of both panels must meet the composition requirements of
proposed Sec. 40.9(c)(3)(ii)\132\ and may not include any members of
the DCM's compliance staff, or any person involved in adjudicating any
other stage of the same proceeding. Paragraph (b) of the proposed rule
provides that a Review Panel must be responsible for determining
whether a reasonable basis exists for finding a violation of contract
market rules, and for authorizing the issuance of a notice of charges
against persons alleged to have violated exchange rules. If a notice of
charges is issued, then Paragraph (c) of the proposed rule helps to
ensure an impartial hearing by requiring a separate Hearing Panel to
adjudicate the matter and issue sanctions. The Commission notes that,
while proposed Sec. 38.702 requires DCMs to empanel distinct bodies to
issue charges and to adjudicate charges in a particular matter, DCMs
may determine for themselves whether their Review and Hearing Panels
are separate standing panels or ad hoc bodies whose members are chosen
from a larger ``disciplinary committee'' to serve in one capacity or
the other for a particular disciplinary matter.
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\132\ Section 40.9(c)(3)(ii), as proposed in the separate
release titled Requirements for Derivatives Clearing Organizations,
Designated Contract Markets, and Swap Execution Facilities Regarding
the Mitigation of Conflicts of Interest, provides that ``Each
Disciplinary Panel shall include at least one person who would not
be disqualified from serving as a Public Director by Sec.
1.3(ccc)(1)(i)-(vi) and (2) of this chapter (a ``Public
Participant''). Such Public Participant shall chair each
Disciplinary Panel. In addition, any registered entity specified in
paragraph (c)(3)(i) of this section shall adopt rules that would, at
a minimum: (A) Further preclude any group or class of participants
from dominating or exercising disproportionate influence on a
Disciplinary Panel and (B) Prohibit any member of a Disciplinary
Panel from participating in deliberations or voting on any matter in
which the member has a financial interest.'' See 75 FR 63732, Oct.
18, 2010.
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iii. Proposed Sec. 38.703--Review of Investigation Report
Proposed Sec. 38.703 requires a Review Panel to promptly review an
investigation report received pursuant to proposed Sec. 38.158(c). In
addition, a Review Panel must take action on any investigation report
received within 30 days of such receipt. The Commission believes that
prompt action by all disciplinary panels is necessary for an effective
disciplinary program. Among other considerations, prompt disciplinary
action provides the best opportunity for witnesses to recall
conversations, facts, and other information relevant to the matter. In
addition, prompt and effective disciplinary action provides a clear
signal to the market and to market participants that violations of
exchange rules will not be tolerated by the DCM.
After receipt of the investigation report, if a Review Panel
determines that additional investigation or evidence is needed, it must
promptly direct the compliance staff to conduct further investigation.
In the alternative, if a Review Panel determines that no reasonable
basis exists for finding a violation, or that prosecution is
unwarranted, it may direct that no further action be taken. This
determination must include a written statement setting forth the facts
and analysis supporting the decision. Finally, if a Review Panel
determines that a reasonable basis exists for finding a violation and
adjudication is warranted, it must direct that the person or entity
alleged to have committed the violation be served with a notice of
charges.
iv. Proposed Sec. 38.704--Notice of Charges
Proposed Sec. 38.704 describes the minimally acceptable contents
of a notice of charges (``notice'') issued by a Review Panel. The
notice must adequately state the acts, conduct, or practices in which
the respondent is alleged to have engaged; state the rule, or rules,
alleged to have been violated; and prescribe the period within which a
hearing on the charges may be requested. Further, the notice must also
advise the respondent charged that he is entitled, upon request, to a
hearing on the charges. Pursuant to paragraphs (a) and (b) of the
proposed rule, the DCM may adopt rules providing that (1) the failure
to request a hearing within the time prescribed in the notice, except
for good cause, may be deemed a waiver of the right to a hearing; and
(2) the failure to answer or deny expressly a charge may be deemed to
be an admission of such charge.
v. Proposed Sec. 38.705--Right to Representation
Proposed Sec. 38.705 requires that, upon being served with a
notice of charges, a respondent must have the right to be represented
by counsel or any other representative of his choosing in all
succeeding stages of the disciplinary process. Together with proposed
Sec. Sec. 38.704 (requiring an adequate notice of charges to the
respondent), 38.708 (conferring the right to hearing), and 38.710
(hearing procedures), 38.705 is one of the primary proposed rules in
subpart N that helps ensure basic fairness for respondents in
disciplinary proceedings.
[[Page 80599]]
vi. Proposed Sec. 38.706--Answer to Charges
Proposed Sec. 38.706 provides that a respondent must be given a
reasonable period of time to file an answer to a charge. In general,
paragraphs (a) through (c) of the proposed rule provide that the rules
of the DCM may require that: (1) The answer must be in writing and
include a statement that the respondent admits, denies or does not have
and is unable to obtain sufficient information to admit or deny each
allegation; (2) failure to file an answer on a timely basis shall be
deemed an admission of all allegations in the notice of charges; and
(3) failure in an answer to deny expressly a charge shall be deemed to
be an admission of such charge.
vii. Proposed Sec. 38.707--Admission or Failure to Deny Charges
Proposed Sec. 38.707 provides that, if a respondent admits or
fails to deny any of the violations alleged in a notice of charges,
then a Hearing Panel may find that the violations admitted or not
denied have in fact been committed. If a DCM adopts a rule concerning
the admission or failure to deny charges, then Sections (a) through (c)
of the proposed rule provide that: (1) The Hearing Panel must impose a
sanction for each violation found to have been committed; (2) the DCM
must promptly notify the respondent in writing of any sanction to be
imposed and advise the respondent that they may request a hearing on
such sanction within the period of time stated in the notice; and (3)
the rules of the DCM may provide that if the respondent fails to
request a hearing within the period of time stated in the notice, then
the respondent will be deemed to have accepted the sanction.
viii. Proposed Sec. 38.708--Denial of Charges and Right to Hearing
Proposed Sec. 38.708 provides that in every instance where a
respondent has requested a hearing on a charge that he or she denies,
or on a sanction set by the Hearing Panel pursuant to proposed Sec.
38.707, the respondent must be given the opportunity for a hearing in
accordance with the requirements of proposed Sec. 38.710. The DCM's
rules may provide that, except for good cause, the hearing must be
concerned only with those charges denied or sanctions set by the
Hearing Panel under proposed Sec. 38.707 for which a hearing has been
requested.
ix. Proposed Sec. 38.709--Settlement Offers
Proposed Sec. 38.709 provides the procedures a DCM must follow if
it permits the use of settlements to resolve disciplinary cases.
Section (a) of the proposed rule states that the rules of a DCM may
permit a respondent to submit a written offer of settlement any time
after an investigation report is completed. The disciplinary panel
presiding over the matter may accept the offer of settlement, but may
not alter the terms of the offer unless the respondent agrees. In
addition, Section (b) of the proposed rule provides that the rules of
the DCM may allow a disciplinary panel to permit the respondent to
accept a sanction without admitting or denying the rule violations upon
which the sanction is based.
Section (c) of proposed Sec. 38.709 states that a disciplinary
panel accepting a settlement offer must issue a written decision
specifying the rule violations it has reason to believe were committed,
and any sanction imposed, including any order of restitution where
customer harm has been demonstrated. Importantly, Section (c) also
provides that if an offer of settlement is accepted without the
agreement of a DCM's enforcement staff, the decision must carefully
explain the disciplinary panel's acceptance of the settlement. Finally,
Section (d) of proposed Sec. 38.709 allows a respondent to withdraw
his or her offer of settlement at any time before final acceptance by a
disciplinary panel. If an offer is withdrawn after submission, or is
rejected by a disciplinary panel, the respondent must not be deemed to
have made any admissions by reason of the offer of settlement and must
not be otherwise prejudiced by having submitted the offer of
settlement.
x. Proposed Sec. 38.710--Hearings
Proposed Sec. 38.710 requires a DCM to adopt rules that provide
certain minimum requirements for any hearing conducted pursuant to a
notice of charges. In general, Sections (a)(1) through (a)(7) of the
proposed rule require the following requirements: (1) A fair hearing;
(2) authority for a respondent to examine evidence relied on by
enforcement staff in presenting the charges contained in the notice of
charges; (3) the DCM's enforcement and compliance staffs must be
parties to the hearing and the enforcement staff must present its case
on those charges and sanctions that are the subject of the hearing; (4)
the respondent must be entitled to appear personally at the hearing,
have the authority to cross-examine persons appearing as witnesses at
the hearing, and call witnesses and present evidence as may be relevant
to the charges; (5) the DCM must require persons within its
jurisdiction who are called as witnesses to participate in the hearing
and produce evidence; (6) a copy of the hearing must be made and become
a record of the proceeding if the respondent has requested a hearing;
and (7) the rules of the DCM may provide that the cost of transcribing
the record must be borne by a respondent who requests a transcript.
Additionally, proposed paragraph (b) specifies that the rules of the
DCM may provide that a sanction be summarily imposed upon any person
within its jurisdiction whose actions impede the progress of a hearing.
xi. Proposed Sec. 38.711--Decisions
Proposed Sec. 38.711 details the procedures that a Hearing Panel
must follow in rendering disciplinary decisions. The proposed rule
requires that all decisions include: (1) A notice of charges or a
summary of the charges; (2) the answer, if any, or a summary of the
answer; (3) a summary of the evidence produced at the hearing or, where
appropriate incorporation by reference in the investigation report; (4)
a statement of findings and conclusions with respect to each charge,
and a careful explanation of the evidentiary and other basis for such
findings and conclusions with respect to each charge; (5) an indication
of each specific rule with which the respondent was found to have
violated; and (6) a declaration of any penalty imposed against the
respondent, including the basis for such sanctions and the effective
date of such sanctions.
xii. Proposed Sec. 38.712--Right to Appeal
Proposed Sec. 38.712 provides the procedures that a DCM must
follow in the event that the DCM's rules authorize an appeal of adverse
decisions in all or in certain classes of cases. Notably, the proposed
rule requires a DCM that permits appeals by disciplinary respondents to
also permit appeals by its enforcement staff. This provision reflects
the Commission's belief that DCM enforcement staff must have the
discretion to appeal disciplinary panel decisions that, for example, do
not adequately sanction a respondent's violative conduct.
For DCMs that permit appeals, the language in paragraphs (a)
through (d) of proposed Sec. 38.712 generally requires the DCM to: (1)
Establish an appellate panel that is authorized to hear appeals; (2)
ensure that the appellate panel composition is consistent with
[[Page 80600]]
Sec. 40.9(c)(iv) of the Commission's regulations and does not include
any members of the DCM's compliance staff, or any person involved in
adjudicating any other stage of the same proceeding; (3) except for
good cause shown, conduct the appeal or review solely on the record
before the Hearing Panel, the written exceptions filed by the parties,
and the oral or written arguments of the parties; and (4) issue a
written decision of the board of appeals and provide a copy to the
respondent promptly following the appeal or review proceeding.
xiii. Proposed Sec. 38.713--Final Decisions
Proposed Sec. 38.713 requires that each DCM establish rules
setting forth when a decision rendered under this subpart N will become
the final decision of the DCM.
xiv. Proposed Sec. 38.714--Disciplinary Sanctions
Proposed Sec. 38.714 requires that every disciplinary sanction
imposed by a DCM must be commensurate with the violations committed and
must be clearly sufficient to deter recidivism or similar violations by
other market participants. Additionally, the proposed rule requires
that, in the event of demonstrated customer harm, any disciplinary
sanction must include full customer restitution. In evaluating
appropriate sanctions, the proposed rule requires the DCM to take into
account a respondent's disciplinary history.\133\
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\133\ Proposed Sec. 38.158(c), which is being proposed as part
of this release with respect to Core Principle 2, requires that a
copy of a member or market participant's disciplinary history be
included in the compliance staff's investigation report.
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xv. Proposed Sec. 38.715--Summary Fines for Violations of Rules
Regarding Timely Submission of Records, Decorum, or Other Similar
Activities
Proposed Sec. 38.715 permits a DCM to adopt a summary fine
schedule for violations of rules relating to timely submission of
accurate records required for clearing or verifying each day's
transactions, decorum, attire, or other similar activities. A DCM may
authorize its compliance staff to summarily impose minor sanctions
against persons within the DCM's jurisdiction for violating such rules.
The proposed rule makes clear that a DCM should issue no more than one
warning letter in a rolling 12-month period for the same violation
before sanctions are imposed. Additionally, the proposed rule specifies
that a summary fine schedule must provide for progressively larger
fines for recurring violations.
xvi. Proposed Sec. 38.716--Emergency Disciplinary Actions
Proposed Sec. 38.716 provides that a DCM may impose a sanction,
including a suspension, or take other summary action against a person
or entity subject to its jurisdiction upon a reasonable belief that
such immediate action is necessary to protect the best interest of the
marketplace. The proposed rule also provides that any emergency action
taken by the DCM must be in accordance with certain procedural
safeguards that protect the respondent, including the right to be
served with notice before the action is taken or otherwise at the
earliest possible opportunity after action has been taken; the right to
be represented by legal counsel in any proceeding subsequent to the
emergency disciplinary action; the right to a hearing as soon as
reasonably practical; and the right to receive a written decision on
the summary action taken by the DCM.
14. Subpart O--Dispute Resolution
Under the Dodd-Frank Act current Core Principle 13 is not
substantively changed but it is renumbered as Core Principle 14. This
core principle governs the obligations of DCMs to implement and enforce
a dispute resolution program for their market participants and market
intermediaries.\134\ Currently, compliance with the core principle is
guided by application guidance and acceptable practices in Appendix B
of part 38. Based upon the Commission's experience over the last 10
years, this guidance has been successful in enabling DCMs to structure
the appropriate dispute resolution program for themselves. Accordingly,
the Commission proposes to maintain the guidance and acceptable
practices, adding only clarifying changes that do not revise the
substantive obligations of DCMs with respect to this core principle.
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\134\ 17 CFR part 38, App. B.
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15. Subpart P--Governance Fitness Standards
The Dodd-Frank Act redesignated former current Core Principle 14 as
Core Principle 15. The language of this core principle remains
unchanged and requires the DCM to establish and enforce appropriate
fitness standards for directors, members of any disciplinary committee,
members of the contract market, and any other persons with direct
access to the facility (including any parties affiliated with any of
the persons described in this core principle). This release proposes to
codify the statutory text of the core principle in proposed Sec.
38.800. The applicable regulations implementing this core principle
will be proposed in a forthcoming rulemaking, expected to be completed
by the statutory deadline of July 15, 2011.\135\
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\135\ See CFTC Web site for additional information on the
``Governance Requirements for Derivatives Clearing Organizations,
Designated Contract Markets, and Swap Execution Facilities,
Additional Requirements Regarding the Mitigation of Conflicts of
Interest,'' at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_9_DCOGovernance/index.htm (last visited Dec. 14,
2010).
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16. Subpart Q--Conflicts of Interest
The Dodd-Frank Act redesignated current Core Principle 15
(Conflicts of Interest) as Core Principle 16. However, in all other
respects, Dodd-Frank did not substantively amend the core principle.
This release proposes to codify the statutory text of the core
principle in proposed Sec. 38.850. The applicable regulations
implementing this core principle were proposed in a separate release
titled ``Requirements for Derivatives Clearing Organizations,
Designated Contract Markets, and Swap Execution Facilities Regarding
the Mitigation of Conflicts of Interest.'' \136\
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\136\ 75 FR 63732, Oct. 18, 2010.
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17. Subpart R--Composition of Governing Boards of Contract Markets
The Dodd-Frank Act redesignated the former Core Principle 16
(Composition of Governing Boards of Mutually Owned Contract Markets) as
Core Principle 17. In addition, current Core Principle 16 was amended
by: (i) Changing the title of the core principle to ``Composition of
Governing Boards of Contract Markets''; and (ii) revising the scope of
the core principle such that it now requires the governance
arrangements of all DCMs to be designed to permit the consideration of
the views of market participants.\137\ This release proposes to codify
the statutory text of the core principle in proposed Sec. 38.900. The
applicable regulations implementing this core principle will be
proposed in a forthcoming rulemaking, which is expected to be completed
by the statutory deadline of July 15, 2011.\138\
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\137\ Former Core Principle 16, which applied only to mutually
owned DCMs, required such DCMs to ensure that the composition of
their governing boards included market participants.
\138\ See supra note 131.
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18. Subpart S--Recordkeeping
The Dodd-Frank Act designated current Core Principle 17
(Recordkeeping) as Core Principle 18. In almost all respects, Dodd-
Frank did not substantively amend the Core Principle. Under current
Core Principle 17, DCMs
[[Page 80601]]
are required to maintain records of all activities related to their
business as DCMs, in a form and manner acceptable to the Commission,
``for a period of 5 years.'' \139\ The Commission adopted acceptable
practices for this core principle by stating that DCMs could comply
with the core principle by complying with Sec. 1.31 of the
Commission's regulations (``Sec. 1.31''). Section 1.31 establishes
recordkeeping requirements for all books and records required to be
kept under the CEA, whether by a DCM or otherwise and requires that
books and records be kept ``for a period of 5 years.'' \140\ The
Commission proposes to maintain compliance with Sec. 1.31 as a primary
component of compliance with this core principle, and proposes to
incorporate the requirements in Sec. 1.31 into proposed Sec. 38.951.
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\139\ See 7 U.S.C. 7(d)(17).
\140\ 17 CFR 1.31(a)(1).
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One notable change in the amended core principle is that while
current Core Principle 17 requires that records be retained for 5
years, the amended Core Principle (18) now requires that records be
retained for ``at least 5 years.'' \141\ Accordingly, proposed Sec.
38.951 permits the Commission to extend DCMs' recordkeeping
requirements beyond the five years otherwise required of all entities
by Sec. 1.31, should it elect to do so. Thus, by its terms, the
proposed rule requires DCMs to ``maintain records of all activities
relating to the business of the contract market, in a form and manner
acceptable to the Commission, for a period of at least 5 years.'' In
addition, DCMs must ``maintain such records, including trade records
and investigatory and disciplinary files, in accordance with the
requirements of Sec. 1.31 [of the Commission's regulations].''
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\141\ Compare 7 USC 7(d)(17) with Section 5(d)(18) of the CEA as
amended by the Dodd-Frank Act (emphasis added).
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By incorporating Sec. 1.31, and more specifically, by
incorporating Sec. 1.31(a), proposed Sec. 38.951 effectively requires
that DCMs' books and records be readily accessible for the first two
years of the minimum five-year statutory period and be open to
inspection by any representatives of the Commission or the United
States Department of Justice. The DCM, at its own expense, must
promptly provide either a copy or the original book or record upon
request.
Proposed Sec. 38.951 also effectively incorporates current Sec.
1.31(b)'s description of the permissible methods of storing books and
records. Consequently, a DCM may store its books and records on either
micrographic media, such as microfilm or microfiche or any similar
medium, or electronic storage media as defined by Sec.
1.31(b)(1)(ii).\142\ DCMs must, at all times, have the facilities to
immediately produce the micrographic media or electronic storage media
images and be prepared to present legible hard-copy images of such
records. Additionally, DCM's must keep only Commission-required records
on the media, store a duplicate of the record at a separate location,
and organize and maintain an accurate index of all information
maintained on both the original and duplicate storage media. DCMs that
use electronic storage media are also required to develop and maintain
an audit system to track the initial entry of original or duplicate
records and any subsequent changes made thereafter.
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\142\ Among other criteria, Sec. 1.31(b)(1)(ii) defines
electronic storage media as ``any digital storage medium or system
that preserves the records exclusively in a non-rewritable, non-
erasable format [and] verifies automatically the quality and
accuracy of the storage media recording process * * *.''
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Finally, proposed Sec. 38.951 also incorporates Sec. Sec. 1.31(c)
and 1.31(d). Section 1.31(c) of the Commission's regulations requires
record-keepers who employ an electronic storage system to certify with
the Commission that the system meets the requirements of an electronic
storage media as defined in Sec. 1.31(b)(1)(ii). Section 1.31(d)
states that trading cards, documents on which trade information is
originally recorded in writing, certain written orders, and paper
copies of certain electronically filed forms and reports with original
signatures must be retained in hard-copy for the requisite time period.
The proposed rule also requires a DCM to comply with the requirements
of proposed Sec. 45.1--``Swap Recordkeeping Requirements''--if
applicable to the DCM.
19. Subpart T--Antitrust Considerations
Current Core Principle 18 governs the antitrust obligations of
DCMs.\143\ The Dodd-Frank Act renumbered this core principle as Core
Principle 19, but in all other respects the statutory text of the core
principle is the same. The Commission believes that the existing
guidance to this Core Principle remains appropriate. Accordingly, other
than to codify the statutory text of Core Principle 19 into the
proposed Sec. 38.1000, the Commission at this time is not proposing
any amendments to the relevant guidance under part 38.
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\143\ Part 38 contains guidance governing compliance with Core
Principle 18. 17 CFR part 38, App. B.
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Proposed Sec. 38.1001 refers applicants and DCMs to the guidance
in Appendix B to part 38 for purposes of demonstrating to the
Commission their compliance with the requirements of proposed Sec.
38.1000.20.
20. Subpart U--System Safeguards
Proposed Sec. 38.1051 establishes system safeguards requirements
for all DCMs, pursuant to new Core Principle 20 added under the Dodd-
Frank Act. Core Principle 20, codified in Sec. 38.1050 requires DCMs
to: (1) Establish and maintain a program of risk oversight to identify
and minimize sources of operational risk through the development of
appropriate controls and procedures and the development of automated
systems that are reliable, secure, and have adequate scalable capacity;
(2) establish and maintain emergency procedures, backup facilities, and
a plan for disaster recovery that allow for the timely recovery and
resumption of operations and the fulfillment of the responsibilities
and obligations of the DCM; and (3) periodically conduct tests to
verify that backup resources are sufficient to ensure continued order
processing and trade matching, price reporting, market surveillance,
and maintenance of a comprehensive and accurate audit trail. The rules
proposed under subpart U implement these requirements.
Because automated systems play a central and critical role in
today's electronic financial market environment, oversight of core
principle compliance by DCMs with respect to automated systems is an
essential part of effective oversight of both futures and swaps
markets. Sophisticated computer systems are crucial to a DCM's ability
to meet its obligations and responsibilities. Safeguarding the
reliability, security, and capacity of such systems is also essential
to mitigation of systemic risk for the nation's financial sector as a
whole. This is particularly true in light of the fact that the over-
the-counter swaps market is estimated to have in excess of $600
trillion in outstanding contracts, roughly 40 times the gross domestic
product of the United States.\144\ The ability of DCMs to recover and
resume trading promptly in the event of a disruption of their
operations is highly important to the U.S. economy. Ensuring the
resilience of the automated systems of DCMs is a vitally important
[[Page 80602]]
part of the Commission's mission, and will be crucial to the robust and
transparent systemic risk management framework established by the Dodd-
Frank Act. DCM compliance with generally accepted standards and best
practices with respect to the development, operation, reliability,
security and capacity of automated systems can reduce the frequency and
severity of automated system security breaches or functional failures,
thereby augmenting efforts to mitigate systemic risk. Notice to the
Commission concerning systems malfunctions, systems security incidents,
or any events leading to the activation of a DCM's business continuity-
disaster recovery (``BC-DR'') plan will assist the Commission's
oversight and its ability to assess systemic risk levels. It would
present unacceptable risks to the U.S. financial system if futures and
swaps markets that comprise critical components of the world financial
system were to become unavailable for an extended period of time for
any reason, and adequate system safeguards are crucial to mitigation of
such risks.
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\144\ These figures derived from Bank for International
Settlements, BIS Quarterly Review, June 2010, Page A121, Table 19 at
http://www.bis.org/statistics/otcder/dt1920a.pdf.; see also, Bureau
of Economic Analysis news release, BEA 10-47, issued September 30,
2010 at http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm.
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Based on the aforementioned, the rules proposed under Sec. 38.1051
would require a DCM's program of risk analysis and oversight to address
five categories of risk analysis and oversight, including information
security; BC-DR planning and resources, capacity and performance
planning; systems operations; systems development and quality
assurance; and physical security and environmental controls. The
proposed rules specifically would require each DCM to maintain a BC-DR
plan and BC-DR resources sufficient to enable resumption of trading and
of all of the responsibilities and obligations of the DCM during the
next business day following any disruption of its operations, either
through sufficient infrastructure and personnel resources of its own or
through sufficient contractual arrangements with other DCMs or disaster
recovery service providers. The proposed rules also would require each
DCM to notify Commission staff of various system security-related
events; to provide relevant documents to the Commission; and to conduct
regular, periodic, objective testing and review of its automated
systems. Moreover, the proposed rules would require each DCM, to the
extent practicable, to coordinate its BC-DR plan with those of the
members and market participants upon whom it depends to provide
liquidity, to initiate coordinated testing of such plans, and to take
into account in its own BC-DR plan, the BC-DR plans of relevant
telecommunications, power, water, and other essential service
providers.
21. Subpart V--Financial Resources
The Dodd-Frank Act added new Core Principle 21. This core principle
requires that a DCM must have adequate financial resources to discharge
its responsibilities. The new core principle also requires that boards
of trade must maintain financial resources sufficient to cover
operating costs for a period of at least one year, calculated on a
rolling basis.
The Commission notes that a DCM is the first entity in the trading
process to ensure that trading occurs in a liquid, fair, and
financially secure trading facility. For instance, a DCM must have,
among other things, adequate trade practice and market surveillance,
disciplinary, recordkeeping, and alternate dispute resolution programs
in place in order to comply with the relevant core principles. In order
to fulfill these responsibilities, a DCM must have appropriate minimum
financial resources on hand and on an ongoing basis to sustain
operations for a reasonable period of time. Furthermore, DCMs must have
sufficient resources at any given time to allow them, if necessary, to
close out trading in a manner not disruptive to the market.
Proposed Sec. 38.1101 sets out financial resource requirements for
DCMs, to implement new Core Principle 21. Under proposed Sec. 38.1101,
DCMs that also operate as DCOs are also subject to the financial
resource requirements for DCOs in proposed Sec. 39.11.\145\
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\145\ Commission regulation Sec. 39.11 establishes requirements
that a DCO will have to meet in order to comply with DCO Core
Principle B (Financial Resources), as amended by the Dodd-Frank Act.
Amended Core Principle B requires a DCO to possess financial
resources that, at a minimum, exceed the total amount that would
enable the DCO to meet its financial obligations to its clearing
members notwithstanding a default by the clearing member creating
the largest financial exposure for the DCO in extreme but plausible
conditions; and enable the DCO to cover its operating costs for a
period of 1 year, as calculated on a rolling basis. See 75 FR 63113,
Oct. 14, 2010.
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i. Proposed Sec. 38.1101 (a)--General Requirements
Proposed Sec. 38.1100 recites the language of Core Principle 21,
as set forth in Section 5(d)(21) of the CEA, as amended by the Dodd-
Frank Act. Proposed Sec. 38.1101(a)(1) and (3) would require DCMs to
maintain sufficient financial resources to cover operating costs for at
least one year, calculated on a rolling basis--i.e., at all times. The
DCM must have sufficient financial resources to cover operating costs
for at least one year from any particular point in time. The one year
period is required under the amended core principle, and the Commission
considers one year an appropriate timeframe given the potential need to
allow contracts to expire and to allow the DCM's business to wind down
in an orderly fashion. The Commission believes that this requirement
will provide a clear baseline for financial resources, thus enhancing
the financial integrity of the markets.\146\
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\146\ Some foreign regulatory authorities already have similar
requirements for the equivalent entities they regulate. For example,
the UK Financial Services Authority's (``FSA'') recognition
requirements for UK recognized investment exchanges and UK
recognized clearing houses (collectively, ``UK recognized bodies'')
include the maintenance of financial resources sufficient to ensure
that the UK recognized body would be able to complete an orderly
closure or transfer of its business without being prevented from
doing so by insolvency or lack of available funds. Section 2.3.7 of
the FSA Recognition Requirements calls for a UK recognized body to
have at all times liquid financial assets amounting to at least six
months' operating costs and net capital of at least that amount.
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The one-year period also is consistent with established accounting
standards, under which an entity's ability to continue as a going
concern comes into question if there is evidence that the entity may be
unable to continue to meet its obligations in the next 12 months
without substantial disposition of assets outside the ordinary course
of business, restructuring of debt, externally forced revisions of its
operations, or similar actions.\147\
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\147\ See American Institute of Certified Public Accountants
Auditing Standards Board Statement of Auditing Standards No. 59, The
Auditor's Consideration of an Entity's Ability to Continue as a
Going Concern, as amended.
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ii. Proposed Sec. 38. 1101(b)--Types of Financial Resources
Under proposed Sec. 38.1101(b), financial resources available to
DCMs to satisfy the applicable financial requirements would include the
DCM's own capital (assets in excess of liabilities) and any other
financial resource deemed acceptable by the Commission. A DCM would be
able to request an informal interpretation from Commission staff on
whether a particular financial resource would be acceptable to the
Commission. The Commission invites commenters to recommend particular
financial resources for inclusion in the final regulation.
iii. Proposed Sec. 38.1101(c)--Computation of Financial Resource
Requirement
Proposed Sec. 38.1101(c) would require a DCM at the end of each
fiscal quarter to make a reasonable calculation of the financial
resources it needs to meet the
[[Page 80603]]
requirements of proposed Sec. 38.1101(b). In the first instance, the
DCM would have reasonable discretion in determining a methodology it
uses to make the calculation. However, the Commission may review the
methodology and require changes as appropriate.
iv. Proposed Sec. 38.1101(d)--Valuation of Financial Resources
Proposed Sec. 38.1101(d) would require DCMs, no less frequently
than at the end of each fiscal quarter, to calculate the current market
value of each financial resource used to meet their obligations under
these proposed rules. Additionally, the DCMs would be required to
perform the valuation at other times as appropriate. This provision is
designed to address the need to update valuations in circumstances
where there may have been material fluctuations in market value that
could impact a DCM's ability to meet its obligations on a rolling basis
as required by proposed Sec. 38.1101(a). When valuing a financial
resource, a DCM would be required to reduce the value, as appropriate,
to reflect any market or credit risk specific to that particular
resource, i.e., apply a haircut.\148\ The Commission would permit each
DCM to exercise its discretion in determining the applicable haircuts.
However, such haircuts are subject to Commission review and must be
acceptable to the Commission.
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\148\ A ``haircut'' is a deduction taken from the value of an
asset to reserve for potential future adverse price movements in
such asset.
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v. Proposed Sec. 38.1101(e)--Liquidity of Financial Resources
Proposed Sec. 38.1101(e) would require DCMs to maintain
unencumbered liquid financial assets, such as cash or highly liquid
securities, equal to at least six months' operating costs. The
Commission believes that having six months' worth of unencumbered
liquid financial assets would give a DCM time to liquidate the
remaining financial assets it would need to continue operating for the
last six months of the required one-year period. If a DCM does not have
six months' worth of unencumbered liquid financial assets, it would be
allowed to use a committed line of credit or similar facility to
satisfy this requirement.
The Commission notes that a committed line of credit or similar
facility is not listed in proposed Sec. 38.1101(b) as a financial
resource available to a DCM to satisfy the requirements of proposed
Sec. 38.1101(a). A DCM may only use a committed line of credit or
similar facility to meet the liquidity requirements set forth in
proposed Sec. 38.1101(e).
vi. Proposed Sec. 38.1101(f)--Reporting Requirements
Under proposed Sec. 38.1101(f), at the end of each fiscal quarter,
or at any time upon Commission request, DCMs would be required to
report to the Commission: (i) the amount of financial resources
necessary to meet the requirements set forth in the regulation; and
(ii) the value of each financial resource available to meet those
requirements. A DCM would also have to provide the Commission with a
financial statement, including the balance sheet, income statement, and
statement of cash flows, of the DCM or of its parent company (if the
DCM does not have an independent financial statement and the parent
company's financial statement is prepared on a consolidated basis).
Proposed Sec. 38.1101(f) requires a DCM to provide the Commission
with sufficient documentation that explains the methodology it used to
calculate its financial requirements and the basis for its
determinations regarding valuation and liquidity. The DCM also must
provide copies of any agreements establishing or amending a credit
facility, insurance coverage, or any similar arrangement that evidences
or otherwise supports its conclusions. The sufficiency of the
documentation would be determined by the Commission in its sole
discretion. The DCM would have 17 business days \149\ from the end of
the fiscal quarter to file the report, but would also be able to
request an extension of time from the Commission.
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\149\ This filing deadline is consistent with the deadline
imposed on FCMs for the filing of monthly financial reports. See 17
CFR 1.10(b).
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The Commission invites comments on all these proposed rules
relating to requirements for financial resources for DCMs.
22. Subpart W--Diversity of Boards of Directors
The Dodd-Frank Act added new Core Principle 22, requiring that
publicly traded DCMs must endeavor to recruit individuals to serve on
their board of directors from among a broad and culturally diverse pool
of qualified candidates. This release proposes to codify the statutory
text of the core principle in proposed Sec. 38.1150. This core
principle will be addressed in a forthcoming release that is expected
to be completed by the statutory deadline of July 15, 2011.
23. Subpart X--Securities and Exchange Commission
The Dodd-Frank Act added new Core Principle 23, requiring that DCMs
keep any records relating to swaps defined in CEA Section 1a(47)(A)(v),
as amended by the Dodd-Frank Act, open to inspection and examination by
the Securities and Exchange Commission (``SEC'').\150\ Consistent with
the text of this core principle, the Commission proposes guidance under
part 38 that provides that each DCM should have arrangements and
resources for collecting and maintaining accurate records pertaining to
any swap agreements defined in section 1a(47)(A)(v) of the amended CEA.
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\150\ 7 U.S.C. 7; see also Section 5(d)(23) of the CEA, as
amended by the Dodd-Frank Act.
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Proposed Sec. 38.1201 refers applicants and DCMs to the guidance
in Appendix B to part 38 for purposes of demonstrating to the
Commission their compliance with the requirements of Proposed Sec.
38.1200, which codifies the text of the core principle.
III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') \151\ requires Federal
agencies, in promulgating rules, to consider the impact of those rules
on small entities. The rules adopted herein will affect designated
contract markets. The Commission has previously established certain
definitions of ``small entities'' to be used by the Commission in
evaluating the impact of its rules on small entities in accordance with
the RFA.\152\ The Commission previously determined that designated
contract markets are not small entities for the purpose of the
RFA.\153\ Therefore, the Chairman, on behalf of the Commission,
pursuant to 5 U.S.C. 605(b) certifies that the proposed rules will not
have a significant economic impact on a substantial number of small
entities.
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\151\ 5 U.S.C. 601 et seq.
\152\ 47 FR 18618-21, Apr. 30, 1982.
\153\ Id.
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B. Paperwork Reduction Act
This proposed rulemaking contains information collection
requirements. The Paperwork Reduction Act (PRA) \154\ imposes certain
requirements on Federal agencies in connection with their conducting or
sponsoring any collection of information as defined by the PRA. 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. The Commission is
[[Page 80604]]
proposing to amend Collection 3038-0052 to allow for an increase in
response hours for the proposed rulemaking amending part 38, which
captures associated proposed amendments to rules 1.52 and 16.01, as
required under the Dodd-Frank Act.\155\ The Commission therefore is
submitting this proposal to the Office of Management and Budget (OMB)
for its review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.
The title for this collection is ``Part 38--Designated Contract
Markets'' (OMB Control number 3038-0052). Responses to this collection
of information would be mandatory. The Commission will protect
proprietary information according to the Freedom of Information Act
(FOIA) 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 Act, 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.'' \156\ The Commission is also required to protect
certain information contained in a government system of records
according to the Privacy Act of 1974.\157\
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\154\ 44 U.S.C. 3501 et seq.
\155\ Dodd Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, 124 Stat. 1376 (2010).
\156\ 7 U.S.C. 12.
\157\ 5 U.S.C. 552a.
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1. Additional Information Provided by Designated Contract Markets
The proposed rules require each respondent to file information with
the Commission. For instance, contract markets must file applications
and supporting documents and information with the Commission for
designation pursuant to Commission rule 38.3. Designated contract
markets must either request approval or certify rules and products with
the Commission pursuant to Commission rule 38.4. Designated contract
markets must disclose information related to prices, volume, open
interest and certain trading information pursuant to Core Principle 8
(Daily Publication of Trading Information).\158\
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\158\ See Section 735(b) of the Dodd-Frank Act.
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Commission staff previously estimated 300 hours average response
time from each respondent for this collection of information for
designation and compliance purposes pursuant to part 38. Based on its
experience with administering registered entities' submission
requirements since implementation of the Commodity Futures
Modernization Act of 2000,\159\ Commission staff believes that the
response time for designation and compliance would generally increase
by 10% with the implementation of swaps trading on designated contract
markets pursuant to Section 723(a)(3) of the Dodd-Frank Act and the
addition of new core principles with which designated contract markets
must comply. Commission staff estimates that it would receive filings
from 17 respondents.\160\ Accordingly, the additional burden in terms
of hours would be 30 additional hours per respondent and 510 additional
hours annually for all respondents for designation and compliance.
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\159\ Public Law 106-554, 114 Stat. 2763 (2000).
\160\ The number of designated contract markets increased from
13 to 17 since the last amendment to Collection 3038-0052.
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In addition to the general increase noted above, pursuant to the
proposed rulemaking, respondents are subject to new Core Principle 21
(Financial Resources) that requires the respondent to have adequate
financial, operational and managerial resources.\161\ In order to
demonstrate compliance with Core Principle 21, each respondent will
need to file specific reports to the Commission on a quarterly basis,
which would result in four quarterly responses per respondent per year.
Commission staff estimates that each respondent would expend 10 hours
to prepare each filing required under the proposed regulations. As
noted above, Commission staff estimates that it would receive filings
from 17 respondents. Accordingly, the additional burden in terms of
hours would be 40 additional hours annually per respondent and 680
additional hours annually for all respondents to comply with Core
Principle 21.
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\161\ See section 735(b) of the Dodd-Frank Act.
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Commission staff estimates that respondents could expend up to an
additional $3,640 annually based on an hourly wage rate of $52 (30
hours + 40 hours x $52) to comply with the proposed rules. This would
result in an aggregated additional cost of $61,880 per annum (17
respondents x $3,640).
OMB Control Number 3038-005.
Estimated Number of Respondents: 17.
Quarterly Responses by Each Respondent: 4.
Total Quarterly Responses by Each Respondent: 68.
Estimated Additional Average Hours per Response: 70.
Aggregate Annual Hourly Reporting Burden: 1190.
2. Information Collection Comments
Copies of the submission from the Commission to OMB are available
by visiting RegInfo.gov. The Commission will consider public comments
on this proposed collection of information in:
(1) Evaluating whether the proposed collection of information is
necessary for the proper performance of the functions of the
Commission, including whether the information will have a practical
use;
(2) Evaluating the accuracy of the estimated burden of the proposed
collection of information, including the degree to which the
methodology and the assumptions that the Commission employed were
valid;
(3) Enhancing the quality, utility, and clarity of the information
proposed to be collected; and
(4) Minimizing the burden of the proposed information collection
requirements on designated clearing organizations, designated contract
markets, and swap execution facilities, including through the use of
appropriate automated, electronic, mechanical, or other technological
information collection techniques, e.g., permitting electronic
submission of responses.
Organizations and individuals desiring to submit comments on the
proposed information collection requirements should contact the Office
of Information and Regulatory Affairs, Office of Management and Budget,
by fax at (202) 395-6566 or by e-mail at [email protected].
Please provide the Commission with a copy of submitted comments so that
they may be summarized and addressed in the final rulemaking. Refer to
the Addresses section of this notice of proposed rulemaking for comment
submission instructions to the Commission.
OMB is required to make a decision concerning the proposed
information collection requirements between 30 and 60 days after
publication of this Release in the Federal Register. Therefore, a
comment to OMB is best assured of receiving full consideration if OMB
receives it within 30 days of publication of this Release. Nothing in
the foregoing affects the deadline enumerated above for public comment
to the Commission on the proposed rules.
C. Cost Benefit Analysis
Section 15(a) of the CEA \162\ requires that the Commission
consider the costs and benefits of its actions before issuing a
regulation under the Act. By its terms, Section 15(a) does not require
the Commission to quantify the costs and
[[Page 80605]]
benefits of a new rule or determine whether the benefits of the
rulemaking outweigh its costs; rather, Section 15(a) requires the
Commission to ``consider'' the costs and benefits of its actions.
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\162\ 7 U.S.C. 19(a).
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Section 15(a) of the CEA further specifies that 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. Accordingly, the Commission
could, in its discretion, give greater weight to any one of the five
considerations and could, in its discretion, determine that,
notwithstanding its costs, a particular rule was necessary or
appropriate to protect the public interest or to effectuate any of the
provisions or to accomplish any of the purposes of the CEA.
Summary of Proposed Requirements
The proposed rulemaking would change the criteria applicants for
designation as a contract market must meet by: (1) Eliminating all of
the existing eight designation criteria and incorporating those
criteria into various DCM core principles; (2) revising, in some
instances, the wording of the 18 pre-existing DCM core principles; and
(3) adding five additional DCM core principles. In addition to revising
the DCM core principles, the Dodd-Frank Act requires that the trading
or processing of clearable swaps must occur only on a registered DCM or
SEF.\163\ This rulemaking will implement, in part 38 of the
Commission's regulations, these amended provisions of the Act relevant
to DCMs. Specific provisions include a proposal to replace guidance and
acceptable practices associated with certain core principles with
regulations. The Commission also is proposing several procedural
changes for new applications for designation as a contract market,
including the elimination of the expedited approval procedures and the
creation of a DCM application form. Under the proposal, the timing of
reviews of designation applications would be governed only by the 180-
day statutory review period.
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\163\ See section 723 of Dodd-Frank Act.
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Costs
As highlighted by recent events in the global credit markets,
transacting of swaps in unregulated, over-the-counter markets does not
contribute to the goal of stability in the broader financial markets.
The public would continue to be at risk to such financial instability
if certain derivatives were allowed to trade over the counter rather
than on regulated exchanges. Designated contract markets that determine
to list swaps for trading will be subject to core principles for
trading of swaps just as they are for futures contracts. If swaps were
allowed to continue to be transacted bilaterally, rather than on the
centralized market of a DCM, price discovery and transparency in the
swaps markets would continue to be inhibited.
Under the proposed rulemaking, designated contract markets will be
required to comply with five additional core principles for trading
futures and option contracts. Moreover, designated contract markets
that determine to list standardized swaps for trading will be required
to comply with the same core principles as for trading futures
contracts. These procedures are mandatory pursuant to the Dodd-Frank
Act and any additional costs associated with these procedures are
required by the implementation of the Dodd-Frank Act. The Commission is
also proposing to replace guidance and acceptable practices associated
with certain core principles with regulations. While these new
regulations generally codify existing industry practice, bringing their
procedures into full compliance with these new regulations may impose
some costs on DCMs.
Regarding new applications for designation as a contract market,
the Commission is proposing several procedural changes, including the
elimination of the expedited approval procedures, such that the timing
of such reviews would be governed only by the 180-day statutory review
period. This may impose costs on DCM applicants that may have to wait
longer for designation than under current procedures. However, in light
of the difficulties in submitting a complete application under the
expedited procedures, few DCMs have been eligible for designation under
the expedited procedures, so these costs should be limited.
Benefits
The Commission believes that the benefits of the rulemaking are
significant. The proposed regulations provide for the transacting of
swaps on DCMs. DCMs will compete with swap execution facilities to list
new standardized swaps contracts, while certain customized swaps will
continue to transact bilaterally. This competition will benefit the
marketplace. Providing market participants with the ability to trade
standardized swaps openly and competitively additionally will provide
market participants with enhanced price transparency resulting in
greater protection of market participants and the public.
The proposed regulations also require DCMs that determine to list
swaps for trading will have to coordinate with DCOs so that the swaps
may be listed swaps for clearing. This will subject the swaps to the
DCO's risk management and margining procedures, which addresses the
consideration of sound risk management practices and will add to the
financial integrity of the swaps markets.
The proposed regulations eliminate all of the existing eight
designation criteria and incorporate those criteria into various
existing DCM core principles. The proposed regulations additionally
implement five new core principles, specifically Core Principle 13
(Disciplinary Procedures), Core Principle 20 (System Safeguards), Core
Principle 21 (Financial Resources), Core Principle 22 (Diversity of
Boards of Directors), and Core Principle 23 (Securities and Exchange
Commission). The proposed rules also modify existing core principles.
For example, newly amended Core Principle 9 (Execution of Transactions)
requires the board of trade to provide a competitive, open and
efficient market and mechanism for executing transactions that protects
the price discovery process of trading in the centralized market. These
changes will benefit the public by further enhancing the transparency
and integrity of futures and options markets as well as swap markets on
DCMs.
Further, the Commission proposes to replace guidance and acceptable
practices associated with certain core principles with regulations.
This will have the benefit to DCMs and the public of providing greater
regulatory certainty. Finally the changes to the procedures for
applying for contract market designation will benefit new applicants by
improving the workability and efficiency of the application process.
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.
[[Page 80606]]
IV. Text of Proposed Rules
List of Subjects
17 CFR Part 1
Commodity futures, Designated contract markets, Minimum financial
requirements for intermediaries, Reporting and recordkeeping
requirements.
17 CFR Part 16
Commodity futures, Reporting and Recordkeeping requirements.
17 CFR Part 38
Block transaction, Commodity futures, Designated contract markets,
Reporting and Recordkeeping requirements, Transactions off the
centralized market.
For the reasons stated in the preamble, and under the authority of
7 U.S.C. 1, et seq., the Commodity Futures Trading Commission proposes
to amend 17 CFR parts 1, 16 and 38 as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
1. Revise the authority citation for part 1 to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f,, 6g,
6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a-2, 7b, 8, 9, 12, 12a, 12c,
13a, 13a-1, 16, 19, 21, 23 and 24, as amended by Pub. L. No. 111-
203, 124 Stat 1376.
Sec. 1.38 [Removed and Reserved]
2. Remove and reserve Sec. 1.38.
3. Revise Sec. 1.52 to read as follows:
Sec. 1.52 Self-regulatory organization adoption and surveillance of
minimum financial requirements.
(a) Each self-regulatory organization must adopt rules prescribing
minimum financial and related reporting requirements for members who
are registered futures commission merchants, registered retail foreign
exchange dealers, or registered introducing brokers. The self-
regulatory minimum financial and related reporting requirements must be
the same as, or more stringent than, the requirements contained in
Sec. Sec. 1.10 and 1.17 of this chapter, for futures commission
merchants and introducing brokers, and Sec. Sec. 5.7 and 5.12 of this
chapter for retail foreign exchange dealers; Provided, however, a self-
regulatory organization may permit its member registrants that are
registered with the Securities and Exchange Commission as securities
brokers or dealers to file (in accordance with Sec. 1.10(h) of this
chapter) a copy of their Financial and Operational Combined Uniform
Single Report under the Securities Exchange Act of 1934, Part II, Part
IIA, or Part II CSE, in lieu of Form 1-FR. The definition of adjusted
net capital must be the same as that prescribed in Sec. 1.17(c) of
this chapter for futures commission merchants and introducing brokers,
and Sec. 5.7(b)(2) of this chapter for futures commission merchants
offering or engaging in retail forex transactions and for retail
foreign exchange dealers.
(b) Each self-regulatory organization must establish and operate a
supervisory program for the purpose of assessing whether each member
registrant is in compliance with the applicable self-regulatory
organization and Commission rules and regulations governing minimum net
capital and related financial requirements, the obligation to segregate
customer funds, financial reporting requirements, recordkeeping
requirements, and sales practice and other compliance requirements. The
supervisory program also must address the following elements:
(1) Adequate levels and independence of audit staff. A self-
regulatory organization must maintain staff of an adequate size,
training, and experience to effectively implement a supervisory
program. Staff of the self-regulatory organization, including officers,
directors and supervising committee members, must maintain independent
judgment and its actions must not impair its independence nor appear to
impair its independence in matters related to the supervisory program.
The self-regulatory organization must provide annual ethics training to
all staff with responsibilities for the supervisory program.
(2) Ongoing surveillance. A self-regulatory organization's ongoing
surveillance of member registrants must include the review and analysis
of financial reports and regulatory notices filed by member registrants
with the designated self-regulatory organization.
(3) High-risk firms. A self-regulatory organization's supervisory
program must include procedures for identifying member registrants that
are determined to pose a high degree of potential financial risk,
including the potential risk of loss of customer funds. High-risk
member registrants must include firms experiencing financial or
operational difficulties, failing to meet segregation or net capital
requirements, failing to maintain current books and records, or
experiencing material inadequacies in internal controls. Enhanced
monitoring for high risk firms should include, as appropriate, daily
review of net capital, segregation, and secured calculations, to assess
compliance with self-regulatory and Commission requirements.
(4) On-site examinations. (i) A self-regulatory organization must
conduct routine periodic on-site examinations of member registrants.
Member futures commission merchants and retail foreign exchange dealers
must be subject to on-site examinations no less frequently than once
every eighteen months. A self-regulatory organization may establish a
risk-based method of establishing the scope of each on-site
examination, provided however, that the scope of each on-site
examination of a futures commission merchant or retail foreign exchange
dealer must include an assessment of whether the registrant is in
compliance with applicable Commission and self-regulatory organization
minimum capital and customer fund protection requirements,
recordkeeping, and reporting requirements.
(ii) A self-regulatory organization must establish the frequency of
on-site examinations of member introducing brokers that do not operate
pursuant to guarantee agreements with futures commission merchants or
retail foreign exchange dealers using a risk-based approach, provided
however, that each introducing broker is subject to an on-site
examination no less frequently than once every three years.
(iii) A self-regulatory organization must conduct on-site
examinations of member registrants in accordance with uniform audit
programs and procedures that have been submitted to the Commission.
(5) Adequate documentation. A self-regulatory organization must
adequately document all aspects of the operation of the supervisory
program, including the conduct of risk-based scope setting and the
risk-based surveillance of high-risk member registrants, and the
imposition of remedial and punitive action(s) for material violations.
(c) Any two or more self-regulatory organizations may file with the
Commission a plan for delegating to a designated self-regulatory
organization, for any registered futures commission merchant, retail
foreign exchange dealer, or introducing broker that is a member of more
than one such self-regulatory organization, the responsibility of:
(1) Monitoring and auditing for compliance with the minimum
financial and related reporting requirements adopted by such self-
regulatory organizations and the Commission in accordance with
paragraphs (a) and (b) of this section; and
[[Page 80607]]
(2) Receiving the financial reports necessitated by such minimum
financial and related reporting requirements.
(d) Any plan filed under this section may contain provisions for
the allocation of expenses reasonably incurred by the designated self-
regulatory organization among the self-regulatory organizations
participating in such a plan.
(e) A plan's designated self-regulatory organization must report
to:
(1) That plan's other self-regulatory organizations any violation
of such other self-regulatory organizations' rules and regulations for
which the responsibility to monitor, audit or examine has been
delegated to such designated self-regulatory organization under this
section; and
(2) The Commission any violation of a self-regulatory
organization's rules and regulations or any violation of the
Commission's regulations for which the responsibility to monitor, audit
or examine has been delegated to such designated self-regulatory
organization under this section.
(f) The self-regulatory organizations may, among themselves,
establish programs to provide access to any necessary financial or
related information.
(g) After appropriate notice and opportunity for comment, the
Commission may, by written notice, approve such a plan, or any part of
the plan, if it finds that the plan, or any part of it:
(1) Is necessary or appropriate to serve the public interest;
(2) Is for the protection and in the interest of customers or
option customers;
(3) Reduces multiple monitoring and multiple auditing for
compliance with the minimum financial rules of the self-regulatory
organizations submitting the plan of any futures commission merchant,
retail foreign exchange dealer, or introducing broker that is a member
of more than one self-regulatory organization;
(4) Reduces multiple reporting of the financial information
necessitated by such minimum financial and related reporting
requirements by any futures commission merchant, retail foreign
exchange dealer, or introducing broker that is a member of more than
one self-regulatory organization;
(5) Fosters cooperation and coordination among the self-regulatory
organizations; and
(6) Does not hinder the development of a registered futures
association under Section 17 of the Act.
(h) After the Commission has approved a plan, or part thereof,
under Sec. 1.52(g), a self-regulatory organization relieved of
responsibility must notify each of its members that are subject to such
a plan:
(1) Of the limited nature of its responsibility for such a member's
compliance with its minimum financial and related reporting
requirements; and
(2) Of the identity of the designated self-regulatory organization
that has been delegated responsibility for such a member.
(i) The Commission may at any time, after appropriate notice and
opportunity for hearing, withdraw its approval of any plan, or part
thereof, established under this section, if such plan, or part thereof,
ceases to adequately effectuate the purposes of Section 4f(b) of the
Act or of this section.
(j) Whenever a registered futures commission merchant, a registered
retail foreign exchange dealer, or a registered introducing broker
holding membership in a self-regulatory organization ceases to be a
member in good standing of that self-regulatory organization, such
self-regulatory organization must, on the same day that event takes
place, give electronic notice of that event to the Commission at its
Washington, DC, headquarters and send a copy of that notification to
such futures commission merchant, retail foreign exchange dealer, or
introducing broker.
(k) Nothing in this section shall preclude the Commission from
examining any futures commission merchant, retail foreign exchange
dealer, or introducing broker for compliance with the minimum financial
and related reporting requirements to which such futures commission
merchant, retail foreign exchange dealer, or introducing broker is
subject.
(l) In the event a plan is not filed and/or approved for each
registered futures commission merchant, retail foreign exchange dealer,
or introducing broker that is a member of more than one self-regulatory
organization, the Commission may design and, after notice and
opportunity for comment, approve a plan for those futures commission
merchants, retail foreign exchange dealers, or introducing brokers that
are not the subject of an approved plan (under paragraph (g) of this
section), delegating to a designated self-regulatory organization the
responsibilities described in paragraph (c) of this section.
PART 16--REPORTS BY CONTRACT MARKETS AND SWAP EXECUTION FACILITIES
4. The authority citation for part 16 is revised to read as
follows:
Authority: 7 U.S.C. 2, 6a, 6c, 6g, 6i, and 7, and 7b-3, as
amended by Pub. L. 111-203, 124 Stat. 1376.
5. The heading for part 16 is revised to read as set forth above.
6. Revise Sec. 16.01 to read as follows:
Sec. 16.01 Publication of market data on futures, swaps and options
thereon: Trading volume, open contracts, prices, and critical dates.
(a) Trading volume and open contracts. (1) Each reporting market,
as defined in part 15 of this chapter, must record for each business
day the following information separately:
(i) For futures, by commodity and by futures expiration date;
(ii) For options by underlying futures contracts for options on
futures contracts or by underlying physical for options on physicals,
and by put, by call, by expiration date and by strike price;
(iii) For swaps or class of swaps, by product type and by term life
of the swap; and
(iv) For swaptions or class of swaptions, by underlying swap
contracts for options on swap contracts or by underlying physical for
swaptions on physicals, and by put, by call, by expiration date and by
strike price.
(2) Volume for swaps and swaptions shall be reported in terms of
contracts for standard-sized contracts (i.e., contracts with a set
contract size for all contracts) or in terms of notional value for non-
standard-sized contracts (i.e., contracts whose contract size is not
set and can vary for each transaction):
(i) The option delta, where a delta system is used;
(ii) The total gross open contracts for futures, excluding those
contracts against which delivery notices have been stopped;
(iii) For futures products that specify delivery, open contracts
against which delivery notices have been issued on that business day;
(iv) The total volume of trading, excluding transfer trades or
office trades;
(v) The total volume of futures/options/swaps/swaptions exchanged
for commodities or for derivatives positions that are included in the
total volume of trading; and
(vi) The total volume of block trades included in the total volume
of trading.
(b) Prices. (1) Each reporting market must record the following
information separately:
(i) For futures, by commodity and by futures expiration,
(ii) For options, by underlying futures contracts for options on
futures contracts or by underlying physical for
[[Page 80608]]
options on physicals, and by put, by call, by expiration date and by
strike price,
(iii) For swaps, by product type and contract month or term life of
the swap, and
(iv) For swaptions or class of swaptions, by underlying swap
contracts for options on swap contracts or by underlying physical for
swaptions on physicals, and by put, by call, by expiration date and by
strike price.
(2) Each reporting market must record for the trading session and
for the opening and closing periods of trading as determined by each
reporting market:
(i) The opening and closing prices of each futures, option, swap or
swaption.
(ii) The price that is used for settlement purposes, if different
from the closing price.
(iii) The lowest price of a sale or offer, whichever is lower, and
the highest price of a sale or bid, whichever is higher, that the
reporting market reasonably determines accurately reflects market
conditions. Bids and offers vacated or withdrawn shall not be used in
making this determination. A bid is vacated if followed by a higher bid
or price and an offer is vacated if followed by a lower offer or price.
(3) If there are no transactions, bids, or offers during the
opening or closing periods, the reporting market may record as
appropriate:
(i) The first price (in lieu of opening price data) or the last
price (in lieu of closing price data) occurring during the trading
session, clearly indicating that such prices are the first and last
prices; or
(ii) Nominal opening or nominal closing prices that the reporting
market reasonably determines to accurately reflect market conditions,
clearly indicating that such prices are nominal.
(4) Additional information. Each reporting market must record the
following information with respect to transactions in commodity
futures, commodity options, swaps or swaptions on that reporting
market:
(i) The method used by the reporting market in determining nominal
prices and settlement prices; and
(ii) If discretion is used by the reporting market in determining
the opening and/or closing ranges or the settlement prices, an
explanation that certain discretion may be employed by the reporting
market and a description of the manner in which that discretion may be
employed. Discretionary authority must be noted explicitly in each case
in which it is applied (for example, by use of an asterisk or
footnote).
(c) Critical dates. Each reporting market must report to the
Commission, for each futures contract, the first notice date and the
last trading date, and for each option contract, the expiration date in
accordance with paragraph (d) of this section.
(d) Form, manner and time of filing reports. Unless otherwise
approved by the Commission or its designee, reporting markets must
submit to the Commission the information specified in paragraphs
(a)(2), (b), and (c) of this section as follows:
(1) Using the format, coding structure and electronic data
transmission procedures approved in writing by the Commission or its
designee; provided however, that the information must be made available
to the Commission or its designee in hard copy upon request;
(2) When each such form of the data is first available, but not
later than 7 a.m. on the business day following the day to which the
information pertains for the delta factor and settlement price and not
later than 12 p.m. for the remainder of the information. Unless
otherwise specified by the Commission or its designee, the stated time
is U.S. eastern standard time for information concerning markets
located in that time zone, and U.S. central time for information
concerning all other markets; and
(3) For information on reports to the Commission for swap or
swaption contracts, refer to part 20 of this chapter.
(e) Publication of recorded information. (1) Reporting markets must
make the information in paragraph (a) of this section readily available
to the news media and the general public without charge, in a format
that readily enables the consideration of such data, no later than the
business day following the day to which the information pertains. The
information in paragraphs (a)(2)(iv) through (vi) of this section shall
be made readily available in a format that presents the information
together.
(2) Reporting markets must make the information in paragraphs
(b)(2) and (3) of this section readily available to the news media and
the general public, and the information in paragraph (b)(4)(ii) of this
section readily available to the general public, in a format that
readily enables the consideration of such data, no later than the
business day following the day to which the information pertains.
Information in paragraph (b)(4)(i) of this section must be made
available in the registered entity's rulebook, which is publicly
accessible on its Web site.
PART 38--DESIGNATED CONTRACT MARKETS
7. Revise the authority citation for part 38 to read as follows:
Authority: 7 U.S.C. 2, 4c,. 6, 6a, 6d, 6e, 6f, 6g, 6i, 6j, 6k,
6l, 6m, 6n, 7, 7a-2, 7b, 7b-1, 7b-3, 8, 9, 15, and 21 as amended by
Pub. L. 111-203, 124 Stat. 1376.
8. Designate existing Sec. Sec. 38.1 through 38.6 as subpart A
under the following subpart heading:
Subpart A--General Provisions
* * * * *
Sec. 38.1 [Amended]
9. Amend Sec. 38.1 by removing the reference ``Parts 36 or 37 of
this chapter'' and adding in its place the reference ``parts 37 or 49
of this chapter''.
10. Revise Sec. 38.2 to read as follows:
Sec. 38.2 Applicable provisions.
A designated contract market, the contract market's operator and
transactions traded on or through a designated contract market under
Section 5 of the Act shall comply with the requirements of this part
38, Sec. Sec. 1.3, 1.12(e), 1.31, 1.37(c)-(d), 1.52, 1.59(d), 1.60,
1.63(c), 1.67, 33.10, part 9, parts 15 through 21, part 40, part 41,
part 43, part 45, part 46, part 49, part 151, and part 190 of this
chapter, including any related definitions and cross-referenced
sections.
11. Revise Sec. 38.3 to read as follows:
Sec. 38.3 Procedures for designation.
(a) Application procedures. (1) A board of trade seeking
designation as a contract market must file electronically Application
Form DCM provided in Appendix A of this part, with the Secretary of the
Commission at its Washington, DC headquarters at [email protected]
and the Division of Market Oversight at [email protected]. The
Commission will review the application for designation as a contract
market pursuant to the 180-day timeframe and procedures specified in
Section 6(a) of the Act. The Commission shall approve or deny the
application or, if deemed appropriate, designate the applicant as a
contract market subject to conditions.
(2) The application must include information sufficient to
demonstrate compliance with the core principles specified in Section
5(d) of the Act. Application Form DCM consists of instructions, general
questions and a list of Exhibits (documents, information and evidence)
required by the Commission in order to determine whether an applicant
is able to comply with the core principles. An application will not
[[Page 80609]]
be considered to be materially complete unless the applicant has
submitted, at a minimum, the Exhibits as required in Application Form
DCM. If the application is not materially complete, the Commission
shall notify the applicant that the application will not be deemed to
have been submitted for purposes of the 180-day review period set forth
in paragraph (a)(1) of this section.
(3) The applicant must identify with particularity any information
in the application that will be subject to a request for confidential
treatment pursuant to Sec. 145.9 of this chapter.
(4) Section 40.8 of this chapter sets forth those sections of the
application that will be made publicly available, notwithstanding a
request for confidential treatment pursuant to Sec. 145.9 of this
chapter.
(5) If any information contained in the application or in any
Exhibit is or becomes inaccurate for any reason, an amendment to the
application or a submission filed under part 40 of this chapter must be
filed promptly correcting such information.
(b) Reinstatement of dormant designation. Before listing or
relisting products for trading, a dormant designated contract market as
defined in Sec. 40.1 of this chapter must reinstate its designation
under the procedures of paragraphs (a)(1) and (a)(2) of this section;
provided, however, that an application for reinstatement may rely upon
previously submitted materials that still pertain to, and accurately
describe, current conditions.
(c) Delegation of authority. (1) The Commission hereby delegates,
until it orders otherwise, to the Director of the Division of Market
Oversight or such other employee or employees as the Director may
designate from time to time, upon consultation with the General Counsel
or the General Counsel's delegate, authority to notify the applicant
seeking designation under Section 6(a) of the Act that the application
is materially incomplete and the running of the 180-day period is
stayed.
(2) The Director may submit to the Commission for its consideration
any matter that has been delegated in this paragraph.
(3) Nothing in this paragraph prohibits the Commission, at its
election, from exercising the authority delegated in paragraph (c)(1)
of this section.
(d) Request for transfer of designation. (1) Request for transfer
of designation, listed contracts and open interest. A designated
contract market that wants to request the transfer of its designation
from its current legal entity to a new legal entity, as a result of a
corporate reorganization or otherwise, must file a request with the
Commission for approval to transfer the designation, listed contracts
and positions comprising all associated open interest. Such request
must be filed electronically with the Secretary of the Commission at
its Washington, DC headquarters at [email protected] and the
Division of Market Oversight at [email protected].
(2) Timing of submission. The request must be filed no later than
three months prior to the anticipated corporate change; provided that
the designated contract market may file a request with the Commission
later than three months prior to the anticipated change if the
designated contract market does not know and reasonably could not have
known of the anticipated change three months prior to the anticipated
change. In such event, the designated contract market shall be required
to immediately file the request with the Commission as soon as it knows
of such change with an explanation as to the timing of the request.
(3) Required information. The request shall include the following:
(i) The underlying agreement that governs the corporate change.
(ii) A narrative description of the corporate change, including the
reason for the change and its impact on the designated contract market,
including its governance, and operations, and its impact on the rights
and obligations of market participants holding the open interest
positions.
(iii) A discussion of the transferee's ability to comply with the
Act, including the core principles applicable to designated contract
markets, and the Commission's regulations thereunder.
(iv) The governing documents of the transferee including, but not
limited to, articles of incorporation and bylaws.
(v) The transferee's rules marked to show changes from the current
rules of the designated contract market.
(vi) A list of contracts, agreements, transactions or swaps for
which the designated contract market requests transfer of open
interest.
(vii) A representation by the transferee that it:
(A) Will be the surviving corporation and successor-in-interest to
the transferor designated contract market and will retain and assume,
without limitation, all the assets and liabilities of the transferor;
(B) Will assume responsibility for complying with all applicable
provisions of the Act and the Commission's regulations thereunder,
including part 38 and Appendices thereto;
(C) Will assume, maintain and enforce all rules implementing and
complying with these core principles, including the adoption of the
transferor's rulebook, as amended in the request, and that any such
amendments will be submitted to the Commission pursuant to Section
5c(c) of the Act and part 40 of the Commission's regulations; and
(D) Will comply with all self-regulatory responsibilities except if
otherwise indicated in the request, and will maintain and enforce all
self-regulatory programs.
(viii) A representation by the transferee that upon the transfer:
(A) All open interest in all contracts listed on the transferor
will be transferred to and represent equivalent open interest in all
such contracts listed on the transferee;
(B) It will assume responsibility for and maintain compliance with
product core principles for all contracts previously listed for trading
through the transferor, whether by certification or approval; and
(C) That none of the proposed rule changes will affect the rights
and obligations of any participant with open positions transferred to
it and that the proposed rule changes do not modify the manner in which
such contracts are settled or cleared.
(ix) A representation by the transferee that market participants
will be notified of all changes to the transferor's rulebook prior to
the transfer and will be further notified of the concurrent transfer of
the contract market designation and the related transfer of all listed
contracts and all associated open interest, to the transferee upon
Commission approval and issuance of an order permitting this transfer.
(4) Commission determination. The Commission will review a request
as soon as practicable and such request will be approved or denied
pursuant to a Commission order and based on the Commission's
determination as to the transferee's ability to continue to operate the
designated contract market in compliance with the Act and the
Commission's regulations thereunder.
(e) Request for withdrawal of application for designation. An
applicant for designation may withdraw its application submitted
pursuant to paragraphs (a)(1) and (a)(2) of this section by filing such
a request with the Commission at its Washington, DC headquarters.
Withdrawal of an application for designation shall not affect any
action taken or to be taken by the Commission based upon actions,
activities or events occurring during the
[[Page 80610]]
time that the application for designation was pending with the
Commission.
(f) Request for vacation of designation. A designated contract
market may vacate its designation under Section 7 of the Act by filing
electronically such a request with the Commission at its Washington, DC
headquarters. Vacation of designation shall not affect any action taken
or to be taken by the Commission based upon actions, activities or
events occurring during the time that the facility was designated by
the Commission.
(g) Requirements for existing designated contract markets. A board
of trade that is designated as a contract market as of [EFFECTIVE DATE
OF FINAL RULE], will be considered to be a designated contract market
under this section, provided that such existing designated contract
market certifies to the Commission in writing that it is in compliance
with each of the designated contract market core principles and
associated regulations in this part, within 60 days of [EFFECTIVE DATE
OF FINAL RULE].
12. In Sec. 38.4, revise paragraphs (a) and (b) to read as
follows:
Sec. 38.4 Procedures for listing products and implementing designated
contract market rules.
(a) Request for Commission approval of rules and products. (1) An
applicant for designation, or a designated contract market, may request
that the Commission approve under Section 5c(c) of the Act, any or all
of its rules and contract terms and conditions, and subsequent
amendments thereto, prior to their implementation or, notwithstanding
the provisions of Section 5c(c)(2) of the Act, at anytime thereafter,
under the procedures of Sec. Sec. 40.3 or 40.5 of this chapter, as
applicable. A designated contract market may label a future, swap or
options product in its rules as ``Listed for trading pursuant to
Commission approval,'' if the future, swap or options product and its
terms or conditions have been approved by the Commission, and it may
label as ``Approved by the Commission'' only those rules that have been
so approved.
(2) Notwithstanding the timeline under Sec. Sec. 40.3(c) and
40.5(c) of this chapter, the operating rules and terms and conditions
of futures, swaps and option products that have been submitted for
Commission approval at the same time as an application for contract
market designation or an application under Sec. 38.3(b) of this part
to reinstate the designation of a dormant designated contract market,
as defined in Sec. 40.1 of this chapter, or while one of the foregoing
is pending, will be deemed approved by the Commission no earlier than
when the facility is deemed to be designated or reinstated.
(b) Self-certification of rules and products. Rules of a designated
contract market and subsequent amendments thereto, including both
operational rules and the terms or conditions of futures, swaps and
option products listed for trading on the facility, not voluntarily
submitted for prior Commission approval pursuant to paragraph (a) of
this section must be submitted to the Commission with a certification
that the rule, rule amendment or futures, swap or options product
complies with the Act or rules thereunder pursuant to the procedures of
Sec. 40.6 of this chapter, as applicable. Provided, however, any rule
or rule amendment that would, for a delivery month having open
interest, materially change a term or condition of a swap or a contract
for future delivery in an agricultural commodity enumerated in Section
1a(9) of the Act, or of an option on such contract or commodity, must
be submitted to the Commission prior to its implementation for review
and approval under Sec. 40.4 of this chapter.
* * * * *
13. Revise Sec. 38.5 to read as follows:
Sec. 38.5 Information relating to contract market compliance.
(a) Requests for information. Upon request by the Commission, a
designated contract market must file with the Commission such
information related to its business as a designated contract market,
including information relating to data entry and trade details, in the
form and manner, and within the time specified by the Commission in its
request.
(b) Demonstration of compliance. Upon request by the Commission, a
designated contract market must file with the Commission a written
demonstration, containing such supporting data, information and
documents, in the form and manner and within such time as the
Commission may specify, that the designated contract market is in
compliance with one or more core principles as specified in the
request, or that is requested by the Commission to satisfy its
obligations under the Act.
(c) Equity interest transfers. (1) Equity transfer notification.
Upon entering into any agreement(s) that could result in an equity
interest transfer of ten percent or more in the contract market, the
designated contract market must file a notification of the equity
interest transfer with the Secretary of the Commission at its
Washington, DC headquarters at [email protected] and the Division of
Market Oversight at [email protected], no later than the business
day, as defined in Sec. 40.1 of this chapter, following the date on
which the designated contract market enters into a firm obligation to
transfer the equity interest.
(2) Required information. (i) The notification must include and be
accompanied by:
(A) Any relevant agreement(s), including any preliminary
agreements;
(B) Any associated changes to relevant corporate documents;
(C) A chart outlining any new ownership or corporate or
organizational structure;
(D) A brief description of the purpose and any impact of the equity
interest transfer; and
(E) A representation from the designated contract market that it
meets all of the requirements of Section 5(d) of the Act and Commission
regulations adopted thereunder.
(ii) The designated contract market must keep the Commission
apprised of the projected date that the transaction resulting in the
equity interest transfer will be consummated, and must provide to the
Commission any new agreements or modifications to the original
agreement(s) filed pursuant to this section. The designated contract
market must notify the Commission of the consummation of the
transaction on the day in which it occurs.
(3) Certification. (i) Upon a transfer of an equity interest of ten
percent or more in a designated contract market, the designated
contract market must file with the Secretary of the Commission at its
Washington, DC headquarters, at [email protected], and the Division
of Market Oversight, at [email protected], a certification that
the designated contract market meets all of the requirements of Section
5(d) of the Act and Commission regulations adopted thereunder, no later
than two business days, as defined in Sec. 40.1 of this chapter,
following the date on which the equity interest transfer of ten percent
or more was consummated. Such certification must state whether changes
to any aspects of the designated contract market's operations were made
as a result of such change in ownership, and include a description of
any such change(s).
(ii) The certification required under this paragraph may rely on
and be supported by reference to an application for designation or
prior filings made pursuant to a product or rule submission
requirement, along with any necessary new filings, including new
filings that provide any and all material
[[Page 80611]]
updates of prior submissions. The DCM shall also amend any information
that is no longer accurate on Form DCM consistent with the procedures
set forth in Sec. 38.3 of this part.
(d) Delegation of authority. The Commission hereby delegates, until
it orders otherwise, the authority set forth in paragraph (b) of this
section to the Director of the Division of Market Oversight or such
other employee or employees as the Director may designate from time to
time. The Director may submit to the Commission for its consideration
any matter that has been delegated in this paragraph. Nothing in this
paragraph prohibits the Commission, at its election, from exercising
the authority delegated in this paragraph.
14. Add Sec. 38.7 to subpart A to read as follows:
Sec. 38.7 Prohibited use of data collected for regulatory purposes.
A designated contract market may not use for business or marketing
purposes any proprietary data or personal information it collects or
receives, from or on behalf of any person, for the purpose of
fulfilling its regulatory obligations; provided however, that a
designated contract market, where necessary, may share such information
with one or more designated contract markets, or swap execution
facilities registered with the Commission, for regulatory purposes.
15. Add Sec. 38.8 to subpart A to read as follows:
Sec. 38.8 Listing of swaps on a designated contract market.
(a) A designated contract market that lists for the first time a
swap contract for trading on its contract market must, either prior to
or at the time of such listing, file with the Commission a written
demonstration detailing how the designated contract market is
addressing its self-regulatory obligations and is fulfilling its
statutory and regulatory obligations with respect to swap transactions.
(b) Prior to listing swaps for trading on or through a designated
contract market, each designated contract market must request from the
Commission a unique, extensible, alphanumeric code for the purpose of
identifying the designated contract market pursuant to part 45 of this
chapter.
16. Add Sec. 38.9 to subpart A to read as follows:
Sec. 38.9 Boards of trade operating both a designated contract market
and a swap execution facility.
(a) A board of trade that operates a designated contract market and
that intends to also operate a swap execution facility must separately
register, pursuant to the swap execution facility registration
requirements set forth in part 37 of this chapter, and on an ongoing
basis, comply with the core principles under Section 5h of the Act, and
the swap execution facility rules under part 37 of this chapter.
(b) A board of trade that operates both a designated contract
market and a swap execution facility, and that uses the same electronic
trade execution system for executing and trading swaps that it uses in
its capacity as a designated contract market must clearly identify to
market participants for each swap whether the execution or trading of
such swap is taking place on the designated contract market or on the
swap execution facility.
17. Add Sec. 38.10 to subpart A to read as follows:
Sec. 38.10 Reporting of swaps traded on a designated contract market.
With respect to swaps traded on or through a designated contract
market, each designated contract market must report specified swap data
as provided under parts 43 and 45 of this chapter.
18. Add subparts B through X to read as follows:
Subpart B--Designation as Contract Market
Sec.
38.100 Core Principle 1.
Subpart C--Compliance With Rules
38.150 Core Principle 2.
38.151 Access requirements.
38.152 Abusive trading practices prohibited.
38.153 Capacity to detect and investigate rule violations.
38.154 Regulatory services provided by a third party.
38.155 Compliance staff and resources.
38.156 Automated trade surveillance system.
38.157 Real-time market monitoring.
38.158 Investigations and investigation reports.
38.159 Ability to obtain information.
38.160 Additional rules required.
Subpart D--Contracts Not Readily Susceptible to Manipulation
38.200 Core Principle 3.
38.201 Additional sources for compliance.
Subpart E--Prevention of Market Disruption
38.250 Core Principle 4.
38.251 General requirements.
38.252 Additional requirements for physical delivery markets.
38.253 Additional requirements for cash-settled markets.
38.254 Ability to obtain information.
38.255 Risk controls for trading.
38.256 Trade reconstruction.
38.257 Regulatory service provider.
38.258 Additional rules required.
Subpart F--Position Limitations or Accountability
38.300 Core Principle 5.
38.301 Position limitations and accountability.
Subpart G--Emergency Authority
38.350 Core Principle 6.
38.351 Additional sources for compliance.
Subpart H--Availability of General Information
38.400 Core Principle 7.
38.401 General requirements.
Subpart I--Daily Publication of Trading Information
38.450 Core Principle 8.
38.451 Reporting of trade information.
Subpart J--Execution of Transactions
38.500 Core Principle 9.
38.501 General requirements.
38.502 Minimum centralized trading requirement.
38.503 Blocks trades on futures contracts.
38.504 Block trades on swap contracts.
38.505 Exchange of derivatives for related position.
38.506 Office trades and transfer trades.
Subpart K--Trade Information
38.550 Core Principle 10.
38.551 Audit trail required.
38.552 Elements of an acceptable audit trail program.
38.553 Enforcement of audit trail requirements.
Subpart L--Financial Integrity of Transactions
38.600 Core Principle 11.
38.601 Mandatory clearing.
38.602 General financial integrity.
38.603 Protection of customer funds.
38.604 Financial surveillance.
38.605 Requirements for financial surveillance program.
38.606 Financial regulatory services provided by a third party.
38.607 Direct access.
Subpart M--Protection of Markets and Market Participants
38.650 Core Principle 12.
38.651 Additional sources for compliance.
Subpart N--Disciplinary Procedures
38.700 Core Principle 13.
38.701 Enforcement staff.
38.702 Disciplinary panels.
38.703 Review of investigation report.
38.704 Notice of charges.
38.705 Right to representation.
38.706 Answer to charges.
38.707 Admission or failure to deny charges.
38.708 Denial of charges and right to hearing.
38.709 Settlement offers.
38.710 Hearings.
38.711 Decisions.
38.712 Right to appeal.
38.713 Final decisions.
38.714 Disciplinary sanctions.
38.715 Summary fines for violations of rules regarding timely
submission of
[[Page 80612]]
records, decorum, or other similar activities.
38.716 Emergency disciplinary actions.
Subpart O--Dispute Resolution
38.750 Core Principle 14.
38.751 Additional sources for compliance.
Subpart P--Governance Fitness Standards
38.800 Core Principle 15.
Subpart Q--Conflicts of Interest
38.850 Core Principle 16.
Subpart R--Composition of Governing Boards of Contract Markets
38.900 Core Principle 17.
Subpart S--Recordkeeping
38.950 Core Principle 18.
38.951 Additional sources for compliance.
Subpart T--Antitrust Considerations
38.1000 Core Principle 19.
38.1001 Additional sources for compliance.
Subpart U--System Safeguards
38.1050 Core Principle 20.
38.1051 General requirements.
Subpart V--Financial Resources
38.1100 Core Principle 21.
38.1101 General requirements.
Subpart W--Diversity of Boards of Directors
38.1150 Core Principle 22.
Subpart X--Securities and Exchange Commission
38.1200 Core Principle 23.
38.1201 Additional sources for compliance.
Subpart B--Designation as Contract Market
Sec. 38.100 Core Principle 1.
(a) In general. To be designated, and maintain a designation, as a
contract market, a board of trade shall comply with:
(1) Any core principle described in Section 5(d) of the Act, and
(2) Any requirement that the Commission may impose by rule or
regulation pursuant to Section 8a(5) of the Act.
(b) Reasonable discretion of the contract market. Unless otherwise
determined by the Commission by rule or regulation, a board of trade
described in paragraph (a) of this section shall have reasonable
discretion in establishing the manner in which the board of trade
complies with the core principles described in this subsection.
Subpart C--Compliance With Rules
Sec. 38.150 Core Principle 2.
(a) In general. The board of trade shall establish, monitor, and
enforce compliance with the rules of the contract market, including:
(1) Access requirements;
(2) The terms and conditions of any contracts to be traded on the
contract market; and
(3) Rules prohibiting abusive trade practices on the contract
market.
(b) Capacity of contract market. The board of trade shall have the
capacity to detect, investigate, and apply appropriate sanctions to any
person that violates any rule of the contract market.
(c) Requirement of rules. The rules of the contract market shall
provide the board of trade with the ability and authority to obtain any
necessary information to perform any function described in this
section, including the capacity to carry out such international
information-sharing agreements, as the Commission may require.
Sec. 38.151 Access requirements.
(a) Jurisdiction. Prior to granting any member or market
participant access to its markets, a designated contract market must
require that the member or market participant consent to its
jurisdiction.
(b) Impartial access by members, market participants and
independent software vendors. A designated contract market must provide
its members, market participants and independent software vendors with
impartial access to its markets and services, including:
(1) Access criteria that are impartial, transparent, and applied in
a non-discriminatory manner; and
(2) Comparable fee structures for members, market participants and
independent software vendors receiving equal access to, or services
from, the designated contract market.
(c) Limitations on access. A designated contract market must
establish and impartially enforce rules governing denials, suspensions,
and revocations of a member's and market participant's access
privileges to the designated contract market, including when such
actions are part of a disciplinary or emergency action by the
designated contract market.
Sec. 38.152 Abusive trading practices prohibited.
A designated contract market must prohibit abusive trading
practices on its markets by members and market participants. Designated
contract markets that permit intermediation must prohibit customer-
related abuses including, but not limited to, trading ahead of customer
orders, trading against customer orders, accommodation trading, and
improper cross trading. Specific trading practices that must be
prohibited by all designated contract markets include front-running,
wash trading, pre-arranged trading, fraudulent trading, money passes,
and any other trading practices that a designated contract market deems
to be abusive. In addition, a designated contract market also must
prohibit any other manipulative or disruptive trading practices
prohibited by the Act or by the Commission pursuant to Commission
regulation.
Sec. 38.153 Capacity to detect and investigate rule violations.
A designated contract market must have arrangements and resources
for effective enforcement of its rules. Such arrangements must include
the authority to collect information and documents on both a routine
and non-routine basis, including the authority to examine books and
records kept by the designated contract market's members and by market
participants. A designated contract market's arrangements and resources
must also facilitate the direct supervision of the market and the
analysis of data collected to determine whether a rule violation
occurred.
Sec. 38.154 Regulatory services provided by a third party.
(a) Use of third-party provider permitted. A designated contract
market may choose to contract with a registered futures association or
another registered entity, as such terms are defined under the CEA,
(collectively, ``regulatory service provider''), for the provision of
services to assist in complying with the core principles, as approved
by the Commission. Any designated contract market that chooses to
contract with a regulatory service provider must ensure that its
regulatory service provider has the capacity and resources necessary to
provide timely and effective regulatory services, including adequate
staff and automated surveillance systems. A designated contract market
will at all times remain responsible for the performance of any
regulatory services received, for compliance with the designated
contract market's obligations under the CEA and Commission regulations,
and for the regulatory service provider's performance on its behalf.
(b) Duty to supervise third party. A designated contract market
that elects to utilize a regulatory service provider must retain
sufficient compliance staff to supervise the quality and effectiveness
of the services provided on its behalf. Compliance staff of the
designated contract market must hold regular meetings with the
regulatory service provider to discuss ongoing investigations, trading
patterns, market participants, and any other matters of
[[Page 80613]]
regulatory concern. A designated contract market also must conduct
periodic reviews of the adequacy and effectiveness of services provided
on its behalf. Such reviews must be documented carefully and made
available to the Commission upon request.
(c) Regulatory decisions required from the designated contract
market. A designated contract market that elects to utilize a
regulatory service provider must retain exclusive authority in
decisions involving the cancellation of trades, the issuance of
disciplinary charges against members or market participants, and
denials of access to the trading platform for disciplinary reasons. A
designated contract market may also retain exclusive authority in other
areas of its choosing; provided however, that the decision to open an
investigation into a possible rule violation must always reside
exclusively with the regulatory service provider. A designated contract
market must document any instances where its actions differ from those
recommended by its regulatory service provider, including the reasons
for the course of action recommended by the regulatory service provider
and the reasons why the designated contract market chose a different
course of action.
Sec. 38.155 Compliance staff and resources.
(a) Sufficient compliance staff. A designated contract market must
establish and maintain sufficient compliance department resources and
staff to ensure that it can conduct effective audit trail reviews,
trade practice surveillance, market surveillance, and real-time market
monitoring. The designated contract market's compliance staff must also
be sufficient to address unusual market or trading events as they
arise, and to conduct and complete investigations in a timely manner,
as set forth in Sec. 38.158(b) of this part.
(b) Ongoing monitoring of compliance staff resources. A designated
contract market must monitor the size and workload of its compliance
staff annually, and ensure that its compliance resources and staff are
at appropriate levels. In determining the appropriate level of
compliance resources and staff, the designated contract market should
consider projected trading volume increases, the number of new products
or contracts projected to be listed for trading, any new
responsibilities expected to be assigned to compliance staff, the
results of any internal review demonstrating that work is not completed
in an effective or timely manner, and any other factors suggesting the
need for increased resources and staff.
Sec. 38.156 Automated trade surveillance system.
A designated contract market must maintain an automated trade
surveillance system capable of detecting and investigating potential
trade practice violations. Such system must maintain all data
reflecting the details of each order entered into the trading system,
including all order modifications and cancellations and maintain all
data reflecting transactions executed on the designated contract
market. The automated system must load and process daily orders and
trades no later than 24 hours after the completion of the trading day.
In addition, the automated trade surveillance system must have the
capability to detect and flag specific trade execution patterns and
trade anomalies; compute, retain, and compare trading statistics;
compute trade gains, losses, and futures-equivalent positions;
reconstruct the sequence of market activity; perform market analyses;
and support system users to perform in-depth analyses and ad hoc
queries of trade-related data.
Sec. 38.157 Real-time market monitoring.
A designated contract market must conduct real-time market
monitoring of all trading activity on its electronic trading
platform(s) to ensure orderly trading and identify any market or system
anomalies. A designated contract market must have the authority to
adjust trade prices or cancel trades when necessary to mitigate market
disrupting events caused by malfunctions in its electronic trading
platform(s) or errors in orders submitted by members and market
participants. Any trade price adjustments or trade cancellations must
be transparent to the market and subject to standards that are clear,
fair, and publicly available.
Sec. 38.158 Investigations and investigation reports.
(a) Procedures. A designated contract market must establish and
maintain procedures that require its compliance staff to conduct
investigations of possible rule violations. An investigation must be
commenced upon the receipt of a request from Commission staff or upon
the discovery or receipt of information by the designated contract
market that, in the judgment of its compliance staff, indicates a
possible basis for finding that a violation has occurred or will occur.
(b) Timeliness. Each compliance staff investigation must be
completed in a timely manner. Absent mitigating factors, a timely
manner is no later than 12 months after the date that an investigation
is opened. Mitigating factors that may reasonably justify an
investigation taking longer than 12 months to complete include the
complexity of the investigation, the number of firms or individuals
involved as potential wrongdoers, the number of potential violations to
be investigated, and the volume of documents and data to be examined
and analyzed by compliance staff.
(c) Investigation reports when a reasonable basis exists for
finding a violation. Compliance staff must submit a written
investigation report for disciplinary action in every instance in which
compliance staff determines from surveillance or from an investigation
that a reasonable basis exists for finding a rule violation. The
investigation report must include the reason the investigation was
initiated; a summary of the complaint, if any; the relevant facts;
compliance staff's analysis and conclusions; and a recommendation as to
whether disciplinary action should be pursued. The report must also
include the member or market participant's disciplinary history at the
designated contract market.
(d) Investigation reports when no reasonable basis exists for
finding a violation. If after conducting an investigation, compliance
staff determines that no reasonable basis exists for finding a
violation, it must prepare a written report including the reason the
investigation was initiated; a summary of the complaint, if any; the
relevant facts; compliance staff's analysis and conclusions; and if
applicable, any recommendation that a disciplinary committee issue a
warning letter in accordance with paragraph (e) of this section. If
compliance staff recommends that a warning letter be issued to a member
or market participant pursuant to paragraph (e) of this section, the
investigation report must include a copy of the letter as well as the
member or market participant's disciplinary history at the designated
contract market.
(e) Warning letters. In addition to the action required to be taken
under paragraphs (c) and (d) of this section, the rules of a designated
contract market may authorize compliance staff to issue a warning
letter to a person or entity under investigation or to recommend that a
disciplinary committee take such an action. A warning letter issued in
accordance with this section is not a penalty or an indication that a
finding
[[Page 80614]]
of a violation has been made. A copy of a warning letter issued by
compliance staff must be included in the investigation report required
by paragraphs (c) and (d) of this section. No more than one warning
letter for the same potential violation may be issued to the same
person or entity during a rolling 12-month period.
Sec. 38.159 Ability to obtain information.
A designated contract market must have the ability and authority to
obtain any necessary information to perform any function required under
this subpart C of the Commission's regulations, including the capacity
to carry out international information-sharing agreements as the
Commission may require. Appropriate information-sharing agreements can
be established with other designated contract markets and swap
execution facilities, or the Commission can act in conjunction with the
designated contract market to carry out such information sharing.
Sec. 38.160 Additional rules required.
A designated contract market must adopt and enforce any additional
rules that it believes are necessary to comply with the requirements of
this subpart C.
Subpart D--Contracts Not Readily Subject to Manipulation
Sec. 38.200 Core Principle 3.
The board of trade shall list on the contract market only contracts
that are not readily susceptible to manipulation.
Sec. 38.201 Additional sources for compliance.
Applicants and designated contract markets may refer to the
guidance in appendix C of this part to demonstrate to the Commission
compliance with the requirements of Sec. 38.200 of this part.
Subpart E--Prevention of Market Disruption
Sec. 38.250 Core Principle 4.
The board of trade shall have the capacity and responsibility to
prevent manipulation, price distortion, and disruptions of the delivery
or cash-settlement process through market surveillance, compliance, and
enforcement practices and procedures, including:
(a) Methods for conducting real-time monitoring of trading; and
(b) Comprehensive and accurate trade reconstructions.
Sec. 38.251 General requirements.
A designated contract market must:
(a) Collect and evaluate data on individual traders' market
activity on an ongoing basis in order to detect and prevent
manipulation, price distortions and, where possible, disruptions of the
delivery or cash-settlement process;
(b) Monitor and evaluate general market data in order to detect and
prevent manipulative activity that would result in the failure of the
market price to reflect the normal forces of supply and demand;
(c) Have the capacity to conduct real-time monitoring of trading
and comprehensive and accurate trade reconstructions. The monitoring of
intraday trading must include the capacity to detect abnormal price
movements, unusual trading volumes, impairments to market liquidity,
and position-limit violations; and
(d) Have either manual processes or automated alerts that are
effective in detecting and preventing trading abuses.
Sec. 38.252 Additional requirements for physical delivery contracts.
(a) For physical delivery contracts, the designated contract market
must:
(1) Monitor a contract's terms and conditions as to whether there
is convergence between the contract price and the price of the
underlying commodity;
(2) Monitor that the deliverable supply is adequate so that the
contract will not be susceptible to price manipulation or distortion;
(3) Assess whether the deliverable commodity reasonably can be
expected to be available to short traders and salable by long traders
at its market value in normal cash marketing channels; and
(4) When available, monitor data related to the size and ownership
of deliverable supplies.
(b) The designated contract market must continually monitor the
appropriateness of the contract's terms and conditions, including the
delivery instrument, the delivery locations and location differentials,
and the commodity characteristics and related differentials. The
designated contract market must address conditions that are interfering
with convergence or causing price distortions or market disruptions,
including, when appropriate, changes to contract terms.
Sec. 38.253 Additional requirements for cash-settled contracts.
(a) For cash-settled contracts, the designated contract market must
monitor:
(1) The availability and pricing of the commodity making up the
index to which the contract will be settled; and
(2) The continued appropriateness of the methodology for deriving
the index. Designated contract markets must promptly amend any
methodologies that result, or are likely to result, in manipulation,
price distortions, or market disruptions, or must impose new
methodologies to resolve the threat of disruptions or distortions.
(b) If a contract listed on a designated contract market is settled
by reference to the price of a contract or commodity traded in another
venue, including a price or index derived from prices on another
designated contract market, the designated contract market must have
rules that require traders on the DCM market to provide the DCM with
their positions in the reference markets as the traders' contracts
approach settlement. In the alternative, the DCM may have an
information sharing agreement with the other venue or designated
contract market.
Sec. 38.254 Ability to obtain information.
(a) The designated contract market must have rules that require
traders in its contracts to keep records of their trading, including
records of their activity in the underlying commodity and related
derivatives markets and make such records available, upon request, to
the designated contract market.
(b) A designated contract market with customers trading through
intermediaries must either use a comprehensive large-trader reporting
system (LTRS) or be able to demonstrate that it can obtain position
data from other sources in order to conduct an effective surveillance
program.
Sec. 38.255 Risk controls for trading.
The designated contract market must establish and maintain risk
control mechanisms to reduce the potential risk of market disruptions,
including but not limited to market restrictions that pause or halt
trading in market conditions prescribed by the designated contract
market. If a contract is linked to, or a substitute for, other
contracts on the designated contract market or on other trading venues,
such risk controls must, to the extent practicable, be coordinated with
any similar controls placed on those other contracts. If a contract is
based on the price of an equity security or the level of an equity
index, such risk controls must, to the extent practicable, be
coordinated with any similar controls placed on national security
exchanges.
Sec. 38.256 Trade reconstruction.
The designated contract market must have the ability to
comprehensively and accurately reconstruct all trading on its trading
facility. All audit-trail data and reconstructions must be made
available
[[Page 80615]]
to the Commission in a form, manner, and time as determined by the
Commission.
Sec. 38.257 Regulatory service provider.
A designated contract market must comply with the regulations in
this subpart through a dedicated regulatory department, or by
delegation of that function to a registered futures association or a
registered entity (collectively, ``regulatory service provider''), as
such terms are defined under the Act and over which the designated
contract market has supervisory authority.
Sec. 38.258 Additional rules required.
A designated contract market must adopt and enforce any additional
rules that it believes are necessary to comply with the requirements of
subpart E of this part.
Subpart F--Position Limitations or Accountability
Sec. 38.300 Core Principle 5.
To reduce the potential threat of market manipulation or congestion
(especially during trading in the delivery month), the board of trade
shall adopt for each contract of the board of trade, as is necessary
and appropriate, position limitations or position accountability for
speculators. For any contract that is subject to a position limitation
established by the Commission pursuant to Section 4a(a), the board of
trade shall set the position limitation of the board of trade at a
level not higher than the position limitation established by the
Commission.
Sec. 38.301 Position limitations and accountability.
A designated contract market must meet the requirements of part 151
of this chapter.
Subpart G--Emergency Authority
Sec. 38.350 Core Principle 6.
The board of trade, in consultation or cooperation with the
Commission, shall adopt rules to provide for the exercise of emergency
authority, as is necessary and appropriate, including the authority:
(a) To liquidate or transfer open positions in any contract;
(b) To suspend or curtail trading in any contract; and
(c) To require market participants in any contract to meet special
margin requirements.
Sec. 38.351 Additional sources for compliance.
Applicants and designated contract markets may refer to the
guidance and/or acceptable practices in Appendix B of this part to
demonstrate to the Commission compliance with the requirements of Sec.
38.350.
Subpart H--Availability of General Information
Sec. 38.400 Core Principle 7.
The board of trade shall make available to market authorities,
market participants, and the public accurate information concerning:
(a) The terms and conditions of the contracts of the contract
market; and
(b)(1) The rules, regulations and mechanisms for executing
transactions on or through the facilities of the contract market, and
(2) The rules and specifications describing the operation of the
contract market's:
(i) Electronic matching platform, or
(ii) Trade execution facility.
Sec. 38.401 General requirements.
(a) General. (1) A designated contract market must have procedures,
arrangements and resources for disclosing to the Commission, market
participants and the public accurate information pertaining to:
(i) Contract terms and conditions;
(ii) Rules and regulations pertaining to the trading mechanisms;
and
(iii) Rules and specifications pertaining to operation of the
electronic matching platform or trade execution facility.
(2) Through such procedures, arrangements and resources, the
designated contract market must ensure public dissemination of
information pertaining to new product listings, new rules, rule
amendments or other changes to previously disclosed information, in
accordance with the timeline provided in paragraph (c) of this section.
(3) A designated contract market shall meet the requirements of
this paragraph (a), by placing the information on the designated
contract market's Web site within the time prescribed in paragraph (c)
of this section.
(b) Accuracy Requirement. A designated contract market must provide
accurate and complete information and not omit material information
with respect to any communication with the Commission, and any
information required to be transmitted or made available to market
participants and the public, including on its Web site or otherwise.
(c) Notice of Regulatory Submissions. (1) A designated contract
market, in making available on its Web site information pertaining to
new product listings, new rules, rule amendments or other changes to
previously-disclosed information, must place such information on its
Web site simultaneous with the filing of such information with the
Secretary of the Commission. Satisfaction of the requirements of this
paragraph (c) shall be in addition to the requirements of paragraph (d)
of this section.
(2) To the extent that a designated contract market requests
confidential treatment of any information filed with the Secretary of
the Commission, the designated contract market must post on its Web
site the public version of such filing or submission.
(d) Rulebook. A designated contract market must ensure that the
rulebook posted on its Web site is accurate, complete, current and
readily accessible to the public. A designated contract market must
publish or post in its rulebook all new or amended rules, both
substantive and non-substantive, on the date of implementation of such
new or amended rule, the day a new product is listed, or the day any
changes to previously disclosed information take effect. Satisfaction
of the requirements of this paragraph (d) is in addition to the
requirements of paragraph (c) of this section.
Subpart I--Daily Publication of Trading Information
Sec. 38.450 Core Principle 8.
The board of trade shall make public daily information on
settlement prices, volume, open interest, and opening and closing
ranges for actively traded contracts on the contract market.
Sec. 38.451 Reporting of trade information.
A designated contract market must meet the reporting requirements
set forth in part 16 of this chapter.
Subpart J--Execution of Transactions
Sec. 38.500 Core Principle 9.
The board of trade shall provide a competitive, open, and efficient
market and mechanism for executing transactions that protects the price
discovery process of trading in the centralized market of the board of
trade. The rules of the board of trade may authorize, for bona fide
business purposes:
(a) Transfer trades or office trades;
(b) An exchange of:
(1) Futures in connection with a cash commodity transaction;
(2) Futures for cash commodities; or
(3) Futures for swaps; or
(c) A futures commission merchant, acting as principal or agent, to
enter into or confirm the execution of a contract for the purchase or
sale of a commodity
[[Page 80616]]
for future delivery if the contract is reported, recorded, or cleared
in accordance with the rules of the contract market or a derivatives
clearing organization.
Sec. 38.501 General requirements.
(a) Transactions on the centralized market; requirements. All
purchases and sales of any commodity for future delivery, and any
commodity option or swap, on or subject to the rules of a designated
contract market, must be executed openly and competitively by open
outcry, posting of bids and offers, or other equally open and
competitive methods, in a place or through an electronic system
provided by the designated contract market, during the hours prescribed
by the designated contract market for trading in such commodity,
commodity option or swap.
(b) Transactions off the centralized market; requirements.
Notwithstanding paragraph (a) of this section, transactions may be
executed off of a designated contract market's centralized market,
including transfer trades, office trades, block trades, or trades
involving the exchange of derivatives for related positions, if
transacted in accordance with the written rules of the designated
contract market that provide for execution of transactions off the
centralized market and that have been certified to or approved by the
Commission. Every person handling, executing, clearing, or carrying the
trades, transactions or positions described in this paragraph shall
comply with the rules of the appropriate designated contract market,
including to identify and mark by appropriate symbol or designation all
such transactions or contracts and all orders, records and memoranda
pertaining thereto.
Sec. 38.502 Minimum centralized market trading requirement.
(a) Minimum centralized market trading percentage requirement. No
designated contract market may continue to list a contract for trading
unless an average of 85% or greater of the total volume of such
contract is traded on the designated contract market's centralized
market, as calculated over a 12 month period as specified in paragraph
(b) of this section.
(b) Centralized market trading percentage calculation. (1)
Contracts listed after the effective date of this section. For each new
contract listed after the effective date of Sec. 38.502, the
designated contract market must determine the percentage of the total
volume, in all contract months combined, that is attributable to
centralized market trading for a 12 month period commencing one year
following the date of the contract's initial listing on the designated
contract market, and on each 12 month anniversary of the contract's
listing thereafter. The designated contract market must calculate the
centralized market trading percentage for each listed contract within
thirty days following the conclusion of the 12 month anniversary of
each contract's listing.
(2) Contracts listed as of the effective date of this section. For
contracts and contract months listed as of the effective date of Sec.
38.502, the designated contract market initially must complete the
centralized market trading percentage calculation in each such contract
within thirty days of the effective date of this Sec. 38.502
(``Initial Calculation'').
(3) Initial Calculation. The Initial Calculation for each such
existing contract must be based on:
(i) The trading volume in such contract during the 12 month period
immediately preceding the effective date of this section; or
(ii) If contract has been listed less than 12 months, the trading
volume in such contract during the time period in which the contract
was initially listed on the designated contract market.
(4) Anniversary Calculation. Thereafter, the designated contract
market must calculate and file with the Commission the centralized
market trading percentage in each such contract within thirty days of
the 12 month anniversary of the Initial Calculation.
(c) Mandatory delisting. Except as otherwise provided in paragraph
(d) of this section, as to any contract that does not meet the minimum
centralized market trading percentage requirement of paragraph (a) of
this section, within ninety days of the centralized market trading
percentage calculation, the designated contract market must:
(1) Delist the contract from the designated contract market and
transfer open positions in the contract to a SEF that it operates;
(2) Delist the contract from the designated contract market and
transfer all open positions in the contract to another SEF that will
accept the contract; or
(3) Liquidate the contract.
(d) Treatment of contracts listed as of the effective date of this
section. Contracts and contract months that are listed on a designated
contract market as of the effective date of Sec. 38.502 and that do
not meet the requirements of paragraph (a) of this section, as
calculated in accordance with paragraph (b) of this section, may
continue to be listed on the designated contract market until all open
positions in such contracts and contract months are liquidated. Trading
in such contracts is allowed for liquidation purposes only.
(e) Exemptions upon petition. (1) A designated contract market may
petition the Commission to exempt a contract from the requirements of
paragraphs (c) or (d) of this section, for a maximum period of 12
months, or such other time as determined by the Commission.
(2) The designated contract market must demonstrate in its petition
that:
(i) (A) Such contract achieved an average of at least 50% trading
volume on the centralized market over the preceding 12 month period,
and
(B) The contract is likely to attain the minimum centralized market
trading percentage requirement within the following 12 month period; or
(ii) As of the effective date of this section, such contract has
been listed for less than 12 months.
(3) Petitions seeking an exemption from the mandatory delisting
requirement must be submitted to the Commission within thirty-five days
of the 12 month anniversary of the listing of such contract, or for
contracts listed less than 12 months, thirty-five days after the
effective date of this section, as applicable.
(4) The filing of a petition for a mandatory delisting exemption
shall toll the mandatory delisting requirement set forth in paragraph
(c) of this section until such time that a decision is made on the
petition.
Sec. 38.503 Block trades on futures contracts.
(a) Block trade rules. A designated contract market that permits
block trade transactions on futures contracts must have rules that
limit such block trades to large transactions, and impose minimum size
requirements on such transactions that are appropriate for each listed
contract subject to a block trading provision. The block trade size for
each listed contract must be certified to or approved by the
Commission.
(b) Block size review. A designated contract market must review the
minimum size thresholds for all block trades on futures contracts on an
annual basis to ensure that the minimum size remains appropriate for
each contract, and in accordance with the provisions of this section
38.503.
(c) Eligible block trade participants. Block trading must be
limited to Eligible Contract Participants, as that term is defined in
Section 1a(18) of the Act, except that the designated contract market
may allow a commodity trading advisor acting in an asset managerial
[[Page 80617]]
capacity and registered pursuant to Section 4n of the Act, or a
principal thereof, including any investment advisor who satisfies the
criteria of Sec. 4.7(a)(2)(v) of this chapter, or a foreign person
performing a similar role or function and subject as such to foreign
regulation, to transact block trades for customers who are not Eligible
Contract Participants, if such commodity trading advisor, investment
advisor or foreign person has more than $25,000,000 in total assets
under management. A person may transact a block trade on behalf of a
customer only when such person has received an instruction or prior
consent to do so from the customer.
(d) Affiliated parties. (1) Block trades between affiliated parties
are permitted under the circumstances provided in paragraph (d)(3) of
this section.
(2) For purposes of block trades, an affiliated party is a party
that directly or indirectly through one or more persons, controls, is
controlled by, or is under common control with another party.
(3) Block trades between affiliated parties are permitted if:
(i) Priced on a competitive market price, either by falling within
the contemporaneous bid-ask spread on the centralized market or
calculated based on a contemporaneous market price in a related cash
market;
(ii) Each party has a separate and independent legal bona fide
business purpose for engaging in the trades; and
(iii) Each party's decision to enter into the block trade is made
by a separate and independent decision-maker.
(e) Aggregation. Except as otherwise stated in this paragraph (e),
the aggregation of orders for different accounts in order to satisfy
the minimum block size requirement is prohibited. Aggregation is
permissible if done by a commodity trading advisor acting in an asset
managerial capacity and registered pursuant to Section 4n of the Act,
or a principal thereof, including any investment advisor who satisfies
the criteria of Sec. 4.7(a)(2)(v) of this chapter, or a foreign person
performing a similar role or function and subject as such to foreign
regulation, if such commodity trading advisor, investment advisor or
foreign person has more than $25,000,000 in total assets under
management.
(f) Recordkeeping. Parties to, and members facilitating, a block
trade must keep accurate block trade records that comply with Sections
5(d)(10) and 5(d)(18) of the Act and the associated Commission
regulations in subparts K and S of this part. Block trade orders must
be recorded by the member and time-stamped with both the time the order
was received and the time the order was reported to the designated
contract market, and must indicate if the block trades are between
affiliated parties. When requested by the designated contract market,
the Commission or the Department of Justice, parties to, and members
facilitating, a block trade must provide records to document that the
block trade is executed in conformance with the board of trade's rules.
(g) Reporting. (1) Each block trade must be reported to the
designated contract market within five minutes after its execution.
(2) The designated contract market must publicize the details of
each block trade immediately upon receipt of the transaction report,
and must publicize daily the total quantity of block trades that are
included in the total volume of trading under the procedures set forth
in Sec. 16.01 of this chapter.
(h) Block size determinations; pricing of block trades. Applicants
and designated contract markets may refer to the guidance and
acceptable practices in appendix B of this part to demonstrate to the
Commission compliance with the requirements for block size
determinations and pricing of block trades.
Sec. 38.504 Block trades on swap contracts.
A designated contract market must have rules requiring that block
trades involving swaps comply with the requirements set forth in part
43 of this chapter.
Sec. 38.505 Exchange of derivatives for related position.
(a) (1) A designated contract market may permit bona fide exchange
of derivatives for related positions transactions.
(2) (i) A bona fide exchange of derivatives for related positions
transaction must include:
(A) Separate but integrally related transactions involving the same
or a related commodity;
(B) Price correlation and quantitative equivalence of the
derivative and related position legs; and
(C) A buyer of a derivative who is the seller of the corresponding
related position, and a seller of a derivative who is the buyer of the
corresponding related position.
(ii) The transaction must result in an actual transfer of ownership
of the related position and occur between parties with different
beneficial owners or under separate control.
(iii) The price differential between the futures leg and the
commodities leg or derivatives position should reflect commercial
realities, and at least one leg of the transaction should be priced at
the prevailing market price.
(b) A designated contract market may permit parties to an exchange
of derivatives for related position transaction to engage in a separate
transaction that offsets a leg of the exchange of derivatives for a
related position if:
(1) The offsetting transaction results in an actual transfer of
ownership and demonstrates other indicia of being a bona fide
transaction as set forth in paragraph (a) of this section; and
(2) The offsetting transaction must be able to stand on its own as
a commercially appropriate transaction, with no obligation on either
party that the offsetting transaction be dependent upon the execution
of the exchange of derivatives for related position transaction, or
that the exchange of derivatives for a related position transaction be
dependent upon the execution of the offsetting transaction.
(c) An exchange of derivatives for a related position transaction
must be bona fide such that the exchange of derivatives for the related
position is not contingent upon an offsetting transaction.
(d) An exchange of derivatives for a related position transaction
must be reported to the designated contract market within five minutes
after its execution.
(e) A designated contract market must make public, on a daily
basis, the total quantity of exchanges of derivatives for a related
position transactions that are included in the total volume of trading
under the procedures set forth in Sec. 16.01 of this chapter.
Sec. 38.506 Office trades and transfer trades.
A designated contract market must keep records of office trades and
transfer trades under the procedures set forth in Sec. 1.31 of this
chapter.
Subpart K--Trade Information
Sec. 38.550 Core Principle 10.
The board of trade shall maintain rules and procedures to provide
for the recording and safe storage of all identifying trade information
in a manner that enables the contract market to use the information:
(a) To assist in the prevention of customer and market abuses; and
(b) To provide evidence of any violations of the rules of the
contract market.
Sec. 38.551 Audit trail required.
A designated contract market must capture and retain all audit
trail data
[[Page 80618]]
necessary to detect, investigate, and prevent customer and market
abuses. Such data must be sufficient to reconstruct all transactions
within a reasonable period of time and to provide evidence of any
violations of the rules of the designated contract market. An
acceptable audit trail must also permit the designated contract market
to track a customer order from the time of receipt through fill,
allocation, or other disposition, and must include both order and trade
data.
Sec. 38.552 Elements of an acceptable audit trail program.
(a) Original source documents. A designated contract market's audit
trail must include original source documents. Original source documents
include unalterable, sequentially identified records on which trade
execution information is originally recorded, whether recorded manually
or electronically. Records for customer orders (whether filled,
unfilled or cancelled, each of which shall be retained or
electronically captured) must reflect the terms of the order, an
account identifier that relates back to the account(s) owner(s), and
the time of order entry. For open-outcry trades, the time of report of
execution of the order shall also be captured.
(b) Transaction history database. A designated contract market's
audit trail program must include an electronic transaction history
database. An adequate transaction history database includes a history
of all orders and trades, and also includes:
(1) All data that are input into the trade entry or matching system
for the transaction to match and clear;
(2) The categories of participants for which such trades are
executed, including whether the person executing a trade was executing
it for his/her own account or an account for which he/she has
discretion, his/her clearing member's house account, the account of
another member, including market participants present on the floor, or
the account of any other customer;
(3) Timing and sequencing data adequate to reconstruct trading; and
(4) Identification of each account to which fills are allocated.
(c) Electronic analysis capability. A designated contract market's
audit trail program must include electronic analysis capability with
respect to all audit trail data in the transaction history database. An
adequate electronic analysis capability must permit the sorting and
presentation of data in the transaction history database so as to
reconstruct trading and identify possible trading violations with
respect to both customer and market abuse.
(d) Safe storage capability. A designated contract market's audit
trail program must include the capability to safely store all audit
trail data retained in its transaction history database. Such safe
storage capability must include the capability to store all data in the
database in a manner that protects it from unauthorized alteration, as
well as from accidental erasure or other loss. Data must be retained in
accordance with the recordkeeping requirements of Core Principle 18 and
the associated regulations in subpart S of this part.
Sec. 38.553 Enforcement of audit trail requirements.
(a) Annual audit trail and recordkeeping reviews. A designated
contract market must enforce its audit trail and recordkeeping
requirements through at least annual reviews of all members and market
participants to verify their compliance with the contract market's
audit trail and recordkeeping requirements. Such reviews must include,
but are not limited to, the following:
(1) For electronic trading, audit trail and recordkeeping reviews
must include reviews of randomly selected samples of front-end audit
trail data for order routing systems; a review of the process by which
user identifications are assigned and user identification records are
maintained; a review of usage patterns associated with user
identifications to monitor for violations of user identification rules;
and reviews of account numbers and customer type indicator codes in
trade records to test for accuracy and improper use.
(2) For open outcry trading, audit trail and recordkeeping reviews
must include reviews of members' and market participants' compliance
with the designated contract market's trade timing, order ticket, and
trading card requirements.
(b) Enforcement program required. A designated contract market must
establish a program for effective enforcement of its audit trail and
recordkeeping requirements for both electronic and open-outcry trading,
as applicable. An effective program must identify members and market
participants that have failed to maintain high levels of compliance
with such requirements, and levy meaningful sanctions when deficiencies
are found. Sanctions must be sufficient to deter recidivist behavior,
and may not include more than one warning letter for the same violation
within a rolling twelve month period.
Subpart L--Financial Integrity of Transactions
Sec. 38.600 Core Principle 11.
The board of trade shall establish and enforce:
(a) Rules and procedures for ensuring the financial integrity of
transactions entered into on or through the facilities of the contract
market (including the clearance and settlement of the transactions with
a derivatives clearing organization); and
(b) Rules to ensure:
(1) The financial integrity of any:
(i) Futures commission merchant, and
(ii) Introducing broker; and
(2) The protection of customer funds.
Sec. 38.601 Mandatory clearing.
Transactions executed on or through the designated contract market,
other than transactions in security futures products, must be cleared
through a Commission-registered derivatives clearing organization, in
accordance with the provisions of part 39 of this chapter.
Sec. 38.602 General financial integrity.
A designated contract market must provide for the financial
integrity of its transactions by establishing and maintaining
appropriate minimum financial standards for its members and non-
intermediated market participants.
Sec. 38.603 Protection of customer funds.
A designated contract market must have rules concerning the
protection of customer funds. These rules shall address appropriate
minimum financial standards for intermediaries, the segregation of
customer and proprietary funds, the custody of customer funds, the
investment standards for customer funds, intermediary default
procedures and related recordkeeping. A designated contract market must
review the default rules and procedures of the derivatives clearing
organization that clears for such designated contract market to wind
down operations, transfer customers, or otherwise protect customers in
the event of a default of a clearing member or the derivatives clearing
organization.
Sec. 38.604 Financial surveillance.
A designated contract market must monitor members' compliance with
the designated contract market's minimum financial standards and,
therefore, must routinely receive and promptly review financial and
related information from its members, as well as continuously monitor
the positions of members and their customers. A designated contract
market must have rules that prescribe minimum capital requirements for
member futures commission merchants
[[Page 80619]]
and introducing brokers. A designated contract market must:
(a) Continually survey the obligations of each futures commission
merchant created by the positions of its customers;
(b) As appropriate, compare those obligations to the financial
resources of the futures commission merchant; and
(c) Take appropriate steps to use this information to protect
customer funds.
Sec. 38.605 Requirements for financial surveillance program.
A designated contract market's financial surveillance program for
futures commission merchants, retail foreign exchange dealers, and
introducing brokers must comply with the requirements of Sec. 1.52 of
this chapter to assess the compliance of such entities with applicable
contract market rules and Commission regulations.
Sec. 38.606 Financial regulatory services provided by a third party.
A designated contract market may comply with the requirements of
Sec. 38.604 (Financial Surveillance) and Sec. 38.605 (Requirements
for Financial Surveillance Program) of this part through the regulatory
services of a registered futures association or a registered entity
(collectively, ``regulatory service provider''), as such terms are
defined under the Act. A designated contract market must ensure that
its regulatory service provider has the capacity and resources
necessary to provide timely and effective regulatory services,
including adequate staff and appropriate surveillance systems. A
designated contract market will at all times remain responsible for
compliance with its obligations under the Act and Commission
regulations, and for the regulatory service provider's performance on
its behalf. Regulatory services must be provided under a written
agreement with a regulatory services provider that shall specifically
document the services to be performed as well as the capacity and
resources of the regulatory service provider with respect to the
services to be performed.
Sec. 38.607 Direct access.
A designated contract market that permits direct electronic access
by customers (i.e., allowing customers of futures commission merchants
to enter orders directly into a designated contract market's trade
matching system for execution) must have in place effective systems and
controls reasonably designed to enable the FCM's management of
financial risk, such as automated pre-trade controls that enable member
futures commission merchants to implement appropriate financial risk
limits. A designated contract market must implement and enforce rules
requiring the member futures commission merchants to use the provided
systems and controls.
Subpart M--Protection of Markets and Market Participants
Sec. 38.650 Core Principle 12.
The board of trade shall establish and enforce rules:
(a) To protect markets and market participants from abusive
practices committed by any party, including abusive practices committed
by a party acting as an agent for a participant; and
(b) To promote fair and equitable trading on the contract market.
Sec. 38.651 Additional sources for compliance.
A designated contract market must have and enforce rules that are
designed to promote fair and equitable trading and to protect the
market and market participants from abusive practices including
fraudulent, noncompetitive or unfair actions, committed by any party.
The designated contract market must have methods and resources
appropriate to the nature of the trading system and the structure of
the market to detect trade practice and market abuses and to discipline
such behavior, in accordance with Core Principles 2 and 4, and the
associated regulations in subparts C and E of this part, respectively.
The designated contract market also must provide a competitive, open
and efficient market and mechanism for executing transactions in
accordance with Core Principle 9 and the associated regulations under
subpart J of this part.
Subpart N--Disciplinary Procedures
Sec. 38.700 Core Principle 13.
The board of trade shall establish and enforce disciplinary
procedures that authorize the board of trade to discipline, suspend, or
expel members or market participants that violate the rules of the
board of trade, or similar methods for performing the same functions,
including delegation of the functions to third parties.
Sec. 38.701 Enforcement staff.
A designated contract market must establish and maintain sufficient
enforcement staff and resources to effectively and promptly prosecute
possible rule violations within the disciplinary jurisdiction of the
contract market. A designated contract market must also monitor the
size and workload of its enforcement staff annually, and ensure that
its enforcement resources and staff are at appropriate levels. The
enforcement staff may not include either members of the designated
contract market or persons whose interests conflict with their
enforcement duties. A member of the enforcement staff may not operate
under the direction or control of any person or persons with trading
privileges at the contract market. A designated contract market's
enforcement staff may operate as part of the designated contract
market's compliance department.
Sec. 38.702 Disciplinary panels.
(a) Disciplinary panels required. A designated contract market must
establish one or more Review Panels and one or more Hearing Panels
(collectively, ``disciplinary panels'') that are authorized to fulfill
their obligations under the rules of this subpart. Disciplinary panels
must meet the composition requirements of Sec. 40.9(c)(3)(ii) of this
chapter, and must not include any members of the designated contract
market's compliance staff, or any person involved in adjudicating any
other stage of the same proceeding.
(b) Review panels. A designated contract market's Review Panel(s)
must be responsible for determining whether a reasonable basis exists
for finding a violation of contract market rules, and for authorizing
the issuance of notices of charges against persons alleged to have
committed violations if the Review Panel believes that the matter
should be adjudicated.
(c) Hearing Panels. A designated contract market's Hearing Panel(s)
must be responsible for adjudicating disciplinary cases pursuant to a
notice of charges authorized by a Review Panel, and must also be
responsible for such other duties as are specified in this subpart.
Sec. 38.703 Review of investigation report.
Promptly after receiving a completed investigation report pursuant
to Sec. 38.158(c) of this part, a Review Panel must promptly review
the report and, within 30 days of such receipt, must take one of the
following actions:
(a) If the Review Panel determines that additional investigation or
evidence is needed, it must promptly direct the compliance staff to
conduct further investigation.
(b) If the Review Panel determines that no reasonable basis exists
for finding a violation or that prosecution is otherwise unwarranted,
it may direct that no further action be taken. Such determination must
be in writing, and must include a written statement setting
[[Page 80620]]
forth the facts and analysis supporting the decision.
(c) If the Review Panel determines that a reasonable basis exists
for finding a violation and adjudication is warranted, it must direct
that the person or entity alleged to have committed the violation be
served with a notice of charges and must proceed in accordance with the
rules of this section.
Sec. 38.704 Notice of charges.
A notice of charges must adequately state the acts, conduct, or
practices in which the respondent is alleged to have engaged; state the
rule, or rules, alleged to have been violated (or about to be
violated); and prescribe the period within which a hearing on the
charges may be requested. The notice must also advise the respondent
charged that he is entitled, upon request, to a hearing on the charges;
and if the rules of the designated contract market so provide:
(a) That failure to request a hearing within the period prescribed
in the notice, except for good cause, may be deemed a waiver of the
right to a hearing; and
(b) That failure to answer or to deny expressly a charge may be
deemed to be an admission of such charge.
Sec. 38.705 Right to representation.
Upon being served with a notice of charges, a respondent must have
the right to be represented by legal counsel or any other
representative of its choosing in all succeeding stages of the
disciplinary process.
Sec. 38.706 Answer to charges.
A respondent must be given a reasonable period of time to file an
answer to a notice of charges. The rules of a designated contract
market may require that:
(a) The answer must be in writing and include a statement that the
respondent admits, denies, or does not have and is unable to obtain
sufficient information to admit or deny each allegation. A statement of
a lack of sufficient information shall have the effect of a denial of
an allegation;
(b) Failure to file an answer on a timely basis shall be deemed an
admission of all allegations contained in the notice of charges; and
(c) Failure in an answer to deny expressly a charge shall be deemed
to be an admission of such charge.
Sec. 38.707 Admission or failure to deny charges.
The rules of a designated contract market may provide that if a
respondent admits or fails to deny any of the charges a Hearing Panel
may find that the violations alleged in the notice of charges for which
the respondent admitted or failed to deny any of the charges have been
committed. If the designated contract market's rules so provide, then:
(a) The Hearing Panel must impose a sanction for each violation
found to have been committed;
(b) The Hearing Panel must promptly notify the respondent in
writing of any sanction to be imposed pursuant to paragraph (a) of this
section and shall advise the respondent that it may request a hearing
on such sanction within the period of time, which shall be stated in
the notice;
(c) The rules of a designated contract market may provide that if a
respondent fails to request a hearing within the period of time stated
in the notice, the respondent will be deemed to have accepted the
sanction.
Sec. 38.708 Denial of charges and right to hearing.
In every instance where a respondent has requested a hearing on a
charge that is denied, or on a sanction set by the Hearing Panel
pursuant to Sec. 38.707 of this part, the respondent must be given an
opportunity for a hearing in accordance with the requirements of Sec.
38.710 of this part. The designated contract market's rules may provide
that, except for good cause, the hearing must be concerned only with
those charges denied and/or sanctions set by the Hearing Panel under
Sec. 38.707 of this part for which a hearing has been requested.
Sec. 38.709 Settlement offers.
(a) The rules of a designated contract market may permit a
respondent to submit a written offer of settlement at any time after
the investigation report is completed. The disciplinary panel presiding
over the matter may accept the offer of settlement, but may not alter
the terms of a settlement offer unless the respondent agrees.
(b) The rules of a designated contract market may provide that, in
its discretion, a disciplinary panel may permit the respondent to
accept a sanction without either admitting or denying the rule
violations upon which the sanction is based.
(c) If an offer of settlement is accepted, the panel accepting the
offer must issue a written decision specifying the rule violations it
has reason to believe were committed, including the basis or reasons
for the panel's conclusions, and any sanction to be imposed, which must
include full customer restitution where customer harm is demonstrated.
If an offer of settlement is accepted without the agreement of the
enforcement staff, the decision must adequately support the Hearing
Panel's acceptance of the settlement. Where applicable, the decision
must also include a statement that the respondent has accepted the
sanctions imposed without either admitting or denying the rule
violations.
(d) The respondent may withdraw his or her offer of settlement at
any time before final acceptance by a panel. If an offer is withdrawn
after submission, or is rejected by a disciplinary panel, the
respondent must not be deemed to have made any admissions by reason of
the offer of settlement and must not be otherwise prejudiced by having
submitted the offer of settlement.
Sec. 38.710 Hearings.
(a) A designated contract market must adopt rules that provide for
the following minimum requirements for any hearing conducted pursuant
to a notice of charges:
(1) The hearing must be fair, must be conducted before members of
the Hearing Panel, and must be promptly convened after reasonable
notice to the respondent. The formal rules of evidence need not apply;
nevertheless, the procedures for the hearing may not be so informal as
to deny a fair hearing. No member of the Hearing Panel for the matter
may have a financial, personal, or other direct interest in the matter
under consideration.
(2) In advance of the hearing, the respondent must be entitled to
examine all books, documents, or other evidence in the possession or
under the control of the designated contract market that are to be
relied upon by the enforcement staff in presenting the charges
contained in the notice of charges or which are relevant to those
charges.
(3) The designated contract market's enforcement and compliance
staffs must be parties to the hearing, and the enforcement staff must
present their case on those charges and sanctions that are the subject
of the hearing.
(4) The respondent must be entitled to appear personally at the
hearing, must be entitled to cross-examine any persons appearing as
witnesses at the hearing, and must be entitled to call witnesses and to
present such evidence as may be relevant to the charges.
(5) The designated contract market must require persons within its
jurisdiction who are called as witnesses to participate in the hearing
and to produce evidence. It must make reasonable efforts to secure the
presence of all other persons called as witnesses whose testimony would
be relevant.
(6) If the respondent has requested a hearing, a copy of the
hearing must be
[[Page 80621]]
made and must become a part of the record of the proceeding. The record
must be one that is capable of being accurately transcribed; however,
it need not be transcribed unless the transcript is requested by
Commission staff or the respondent, the decision is appealed pursuant
to Sec. 38.712 of this part, or is reviewed by the Commission pursuant
to Section 8c of the Act or part 9 of this chapter. In all other
instances a summary record of a hearing is permitted.
(7) The rules of a designated contract market may provide that the
cost of transcribing the record of the hearing must be borne by a
respondent who requests the transcript, appeals the decision pursuant
to Sec. 38.712 of this part, or whose application for Commission
review of the disciplinary action has been granted. In all other
instances, the cost of transcribing the record must be borne by the
designated contract market.
(b) The rules of a designated contract market may provide that a
sanction may be summarily imposed upon any person within its
jurisdiction whose actions impede the progress of a hearing.
Sec. 38.711 Decisions.
Promptly following a hearing conducted in accordance with Sec.
38.710 of this part, the Hearing Panel must render a written decision
based upon the weight of the evidence contained in the record of the
proceeding and must provide a copy to the respondent.
The decision must include:
(a) The notice of charges or a summary of the charges;
(b) The answer, if any, or a summary of the answer;
(c) A summary of the evidence produced at the hearing or, where
appropriate, incorporation by reference of the investigation report;
(d) A statement of findings and conclusions with respect to each
charge, and a complete explanation of the evidentiary and other basis
for such findings and conclusions with respect to each charge;
(e) An indication of each specific rule that the respondent was
found to have violated; and
(f) A declaration of all sanctions imposed against the respondent,
including the basis for such sanctions and the effective date of such
sanctions.
Sec. 38.712 Right to appeal.
The rules of a designated contract market may permit the parties to
a proceeding to appeal promptly an adverse decision of the Hearing
Panel in all or in certain classes of cases. Such rules may require a
party's notice of appeal to be in writing and to specify the findings,
conclusions, or sanctions to which objection are taken. If the rules of
a designated contract market permit appeals, then both the respondent
and the enforcement staff must have the opportunity to appeal and the
designated contract must provide for the following:
(a) The designated contract market must establish an appellate
panel that must be authorized to hear appeals of respondents. In
addition, the rules of a designated contract market may provide that
the appellate panel may, on its own initiative, order review of a
decision by the Hearing Panel within a reasonable period of time after
the decision has been rendered.
(b) The composition of the appellate panel must be consistent with
Sec. 40.9(c)(iv) of this chapter, and must not include any members of
the designated contract market's compliance staff, or any person
involved in adjudicating any other stage of the same proceeding. The
rules of a designated contract market must provide for the appeal
proceeding to be conducted before all of the members of the board of
appeals or a panel thereof.
(c) Except for good cause shown, the appeal or review must be
conducted solely on the record before the Hearing Panel, the written
exceptions filed by the parties, and the oral or written arguments of
the parties.
(d) Promptly following the appeal or review proceeding, the board
of appeals must issue a written decision and must provide a copy to the
respondent. The decision issued by the board of appeal must adhere to
all the requirements of Sec. 38.711 of this part, to the extent that a
different conclusion is reached from that issued by the Hearing Panel.
Sec. 38.713 Final decisions.
Each designated contract market must establish rules setting forth
when a decision rendered pursuant to this section will become the final
decision of such designated contract market.
Sec. 38.714 Disciplinary sanctions.
All disciplinary sanctions imposed by a designated contract market
or its disciplinary panels must be commensurate with the violations
committed and must be clearly sufficient to deter recidivism or similar
violations by other market participants. All disciplinary sanctions
must take into account the respondent's disciplinary history. In the
event of demonstrated customer harm, any disciplinary sanction must
also include full customer restitution.
Sec. 38.715 Summary fines for violations of rules regarding timely
submission of records, decorum, or other similar activities.
A designated contract market may adopt a summary fine schedule for
violations of rules relating to the timely submission of accurate
records required for clearing or verifying each day's transactions,
decorum, attire, or other similar activities. A designated contract
market may permit its compliance staff, or a designated panel of
contract market officials, to summarily impose minor sanctions against
persons within the designated contract market's jurisdiction for
violating such rules. A designated contract market's summary fine
schedule may allow for warning letters to be issued for first-time
violations or violators, provided that no more than one warning letter
may be issued per rolling 12-month period for the same violation. If
adopted, a summary fine schedule must provide for progressively larger
fines for recurring violations.
Sec. 38.716 Emergency disciplinary actions.
(a) A designated contract market may impose a sanction, including
suspension, or take other summary action against a person or entity
subject to its jurisdiction upon a reasonable belief that such
immediate action is necessary to protect the best interest of the
marketplace.
(b) Any emergency disciplinary action must be taken in accordance
with a designated contract market's procedures that provide for the
following:
(1) If practicable, a respondent must be served with a notice
before the action is taken, or otherwise at the earliest possible
opportunity. The notice must state the action, briefly state the
reasons for the action, and state the effective time and date, and the
duration of the action.
(2) The respondent must have the right to be represented by legal
counsel or any other representative of its choosing in all proceedings
subsequent to the emergency action taken. The respondent must be given
the opportunity for a hearing as soon as reasonably practicable and the
hearing must be conducted before the Hearing Panel pursuant to the
requirements of Sec. 38.710 of this part.
(3) Promptly following the hearing provided for in this rule, the
designated contract market must render a written decision based upon
the weight of the evidence contained in the record of the proceeding
and must provide a copy to the respondent. The decision must include a
description of the summary action taken; the reasons for the
[[Page 80622]]
summary action; a summary of the evidence produced at the hearing; a
statement of findings and conclusions; a determination that the summary
action should be affirmed, modified, or reversed; and a declaration of
any action to be taken pursuant to the determination, and the effective
date and duration of such action.
Subpart O--Dispute Resolution
Sec. 38.750 Core Principle 14.
The board of trade shall establish and enforce rules regarding, and
provide facilities for alternative dispute resolution as appropriate
for, market participants and any market intermediaries.
Sec. 38.751 Additional sources for compliance.
Applicants and designated contract markets may refer to the
guidance and acceptable practices in Appendix B of this part to
demonstrate to the Commission compliance with the requirements of Sec.
38.750 of this part.
Subpart P--Governance Fitness Standards
Sec. 38.800 Core Principle 15.
The board of trade shall establish and enforce appropriate fitness
standards for directors, members of any disciplinary committee, members
of the contract market, and any other person with direct access to the
facility (including any party affiliated with any person described in
this paragraph).
Subpart Q--Conflicts of Interest
Sec. 38.850 Core Principle 16.
The board of trade shall establish and enforce rules:
(a) To minimize conflicts of interest in the decision-making
process of the contract market; and
(b) To establish a process for resolving conflicts of interest
described in paragraph (a) of this section.
Subpart R--Composition of Governing Boards of Contract Markets
Sec. 38.900 Core Principle 17.
The governance arrangements of the board of trade shall be designed
to permit consideration of the views of market participants.
Subpart S--Recordkeeping
Sec. 38.950 Core Principle 18.
The board of trade shall maintain records of all activities
relating to the business of the contract market:
(a) In a form and manner that is acceptable to the Commission; and
(b) For a period of at least 5 years.
Sec. 38.951 Additional sources for compliance.
A designated contract market must maintain such records, including
trade records and investigatory and disciplinary files, in accordance
with the requirements of Sec. 1.31 of this chapter, and in accordance
with Sec. 45.1 of this chapter, if applicable.
Subpart T--Antitrust Considerations
Sec. 38.1000 Core Principle 19.
Unless necessary or appropriate to achieve the purposes of this
Act, the board of trade shall not:
(a) Adopt any rule or taking any action that results in any
unreasonable restraint of trade; or
(b) Impose any material anticompetitive burden on trading on the
contract market.
Sec. 38.1001 Additional sources for compliance.
Applicants and designated contract markets may refer to the
guidance and acceptable practices in appendix B of this part to
demonstrate to the Commission compliance with the requirements of Sec.
38.1000 of this part.
Subpart U--System Safeguards
Sec. 38.1050 Core Principle 20.
Each designated contract market shall:
(a) Establish and maintain a program of risk analysis and oversight
to identify and minimize sources of operational risk, through the
development of appropriate controls and procedures, and the development
of automated systems, that are reliable, secure, and have adequate
scalable capacity;
(b) Establish and maintain emergency procedures, backup facilities,
and a plan for disaster recovery that allow for the timely recovery and
resumption of operations and the fulfillment of the responsibilities
and obligations of the board of trade; and
(c) Periodically conduct tests to verify that backup resources are
sufficient to ensure continued order processing and trade matching,
transmission of matched orders to a designated clearing organization
for clearing, price reporting, market surveillance, and maintenance of
a comprehensive and accurate audit trail.
Sec. 38.1051 General requirements.
(a) A designated contract market's program of risk analysis and
oversight with respect to its operations and automated systems must
address each of the following categories of risk analysis and
oversight:
(1) Information security;
(2) Business continuity-disaster recovery planning and resources;
(3) Capacity and performance planning;
(4) Systems operations;
(5) Systems development and quality assurance; and
(6) Physical security and environmental controls.
(b) In addressing the categories of risk analysis and oversight
required under paragraph (a) of this section, a designated contract
market should follow generally accepted standards and best practices
with respect to the development, operation, reliability, security, and
capacity of automated systems.
(c) A designated contract market must maintain a business
continuity-disaster recovery plan and business continuity-disaster
recovery resources, emergency procedures, and backup facilities
sufficient to enable timely recovery and resumption of its operations
and resumption of its ongoing fulfillment of its responsibilities and
obligations as a designated contract market following any disruption of
its operations. Such responsibilities and obligations include, without
limitation, order processing and trade matching; transmission of
matched orders to a designated clearing organization for clearing;
price reporting; market surveillance; and maintenance of a
comprehensive audit trail. The designated contract market's business
continuity-disaster recovery plan and resources generally should enable
resumption of trading and clearing of the designated contract market's
products during the next business day following the disruption.
Designated contract markets determined by the Commission to be critical
financial markets are subject to more stringent requirements in this
regard, set forth in Sec. 40.9 of this chapter. Electronic trading is
an acceptable backup for open outcry trading in the event of a
disruption.
(d) A designated contract market that is not determined by the
Commission to be a critical financial market satisfies the requirement
to be able to resume trading and clearing during the next business day
following a disruption by maintaining either:
(1) Infrastructure and personnel resources of its own that are
sufficient to ensure timely recovery and resumption of its operations
and resumption of its ongoing fulfillment of its responsibilities and
obligations as a designated contract market following any disruption of
its operations; or
(2) Contractual arrangements with other designated contract markets
or
[[Page 80623]]
disaster recovery service providers, as appropriate, that are
sufficient to ensure continued trading and clearing of the designated
contract market's products, and ongoing fulfillment of all of the
designated contract market's responsibilities and obligations with
respect to those products, in the event that a disruption renders the
designated contract market temporarily or permanently unable to satisfy
this requirement on its own behalf.
(e) A designated contract market must notify Commission staff
promptly of all:
(1) Electronic trading halts and systems malfunctions;
(2) Cyber security incidents or targeted threats that actually or
potentially jeopardize automated system operation, reliability,
security, or capacity; and
(3) Any activation of the designated contract market's business
continuity-disaster recovery plan.
(f) A designated contract market must give Commission staff timely
advance notice of all:
(1) Planned changes to automated systems that may impact the
reliability, security, or adequate scalable capacity of such systems;
and
(2) Planned changes to the designated contract market's program of
risk analysis and oversight.
(g) A designated contract market must provide to the Commission
upon request current copies of its business continuity-disaster
recovery plan and other emergency procedures, its assessments of its
operational risks, and other documents requested by Commission staff
for the purpose of maintaining a current profile of the designated
contract market's automated systems.
(h) A designated contract market must conduct regular, periodic,
objective testing and review of its automated systems to ensure that
they are reliable, secure, and have adequate scalable capacity. It must
also conduct regular, periodic testing and review of its business
continuity-disaster recovery capabilities. Both types of testing should
be conducted by qualified, independent professionals. Such qualified
independent professionals may be independent contractors or employees
of the designated contract market, but should not be persons
responsible for development or operation of the systems or capabilities
being tested. Pursuant to Core Principle 18 (Recordkeeping) and
Sec. Sec. 38.950 and 38.951 of this part, the designated contract
market must keep records of all such tests, and make all test results
available to the Commission upon request.
(i) To the extent practicable, a designated contract market should:
(1) Coordinate its business continuity-disaster recovery plan with
those of the members and other market participants upon whom it depends
to provide liquidity, in a manner adequate to enable effective
resumption of activity in its markets following a disruption causing
activation of the designated contract market's business continuity-
disaster recovery plan;
(2) Initiate and coordinate periodic, synchronized testing of its
business continuity-disaster recovery plan and the business continuity-
disaster recovery plans of the members and other market participants
upon whom it depends to provide liquidity; and
(3) Ensure that its business continuity-disaster recovery plan
takes into account the business continuity-disaster recovery plans of
its telecommunications, power, water, and other essential service
providers.
(j) Part 46 of this chapter governs the obligations of those
registered entities that the Commission has determined to be critical
financial markets, with respect to maintenance and geographic dispersal
of disaster recovery resources sufficient to meet a same-day recovery
time objective in the event of a wide-scale disruption. Section 40.9 of
this chapter establishes the requirements for core principle compliance
in that respect.
Subpart V--Financial Resources
Sec. 38.1100 Core Principle 21.
(a) In General. The board of trade shall have adequate financial,
operational, and managerial resources to discharge each responsibility
of the board of trade.
(b) Determination of Adequacy. The financial resources of the board
of trade shall be considered to be adequate if the value of the
financial resources exceeds the total amount that would enable the
contract market to cover the operating costs of the contract market for
a 1-year period, as calculated on a rolling basis.
Sec. 38.1101 General requirements.
(a) General rule. (1) A designated contract market must maintain
financial resources sufficient to enable it to perform its functions in
compliance with the core principles set forth in Section 5 of the Act
and regulations thereunder.
(2) An entity that operates as both a designated contract market
and a derivatives clearing organization also shall comply with the
financial resource requirements of Sec. 39.11 of this chapter.
(3) Financial resources shall be considered sufficient if their
value is at least equal to a total amount that would enable the
designated contract market, or applicant for designation as such, to
cover its operating costs for a period of at least one year, calculated
on a rolling basis.
(b) Types of financial resources. Financial resources available to
satisfy the requirements of paragraph (a) of this section may include:
(1) The designated contract market's own capital; and
(2) Any other financial resource deemed acceptable by the
Commission.
(c) Computation of financial resource requirement. A designated
contract market must, on a quarterly basis, based upon its fiscal year,
make a reasonable calculation of its projected operating costs over a
12-month period in order to determine the amount needed to meet the
requirements of paragraph (a) of this section. The designated contract
market shall have reasonable discretion in determining the methodology
used to compute such projected operating costs. The Commission may
review the methodology and require changes as appropriate.
(d) Valuation of financial resources. At appropriate intervals, but
not less than quarterly, a designated contract market must compute the
current market value of each financial resource used to meet its
obligations under paragraph (a) of this section. Reductions in value to
reflect market and credit risk (``haircuts'') must be applied as
appropriate.
(e) Liquidity of financial resources. The financial resources
allocated by the designated contract market to meet the requirements of
paragraph (a) of this section must include unencumbered, liquid
financial assets (i.e., cash and/or highly liquid securities) equal to
at least six months' operating costs. If any portion of such financial
resources is not sufficiently liquid, the designated contract market
may take into account a committed line of credit or similar facility
for the purpose of meeting this requirement.
(f) Reporting requirements. (1) Each fiscal quarter, or at any time
upon Commission request, a designated contract market must:
(i) Report to the Commission:
(A) The amount of financial resources necessary to meet the
requirements of paragraph (a) of this section; and
(B) The value of each financial resource available, computed in
accordance with the requirements of paragraph (d) of this section; and
(ii) Provide the Commission with a financial statement, including
the balance sheet, income statement, and statement of cash flows of the
[[Page 80624]]
designated contract market or of its parent company.
(2) The calculations required by this paragraph shall be made as of
the last business day of the designated contract market's fiscal
quarter.
(3) The designated contract market must provide the Commission
with:
(i) Sufficient documentation explaining the methodology used to
compute its financial requirements under paragraph (a) of this section,
(ii) Sufficient documentation explaining the basis for its
determinations regarding the valuation and liquidity requirements set
forth in paragraphs (d) and (e) of this section, and
(iii) Copies of any agreements establishing or amending a credit
facility, insurance coverage, or other arrangement evidencing or
otherwise supporting the designated contract market's conclusions.
(4) The report shall be filed not later than 17 business days after
the end of the designated contract market's fiscal quarter, or at such
later time as the Commission may permit, in its discretion, upon
request by the designated contract market.
Subpart W--Diversity of Board of Directors
Sec. 38.1150 Core Principle 22.
The board of trade, if a publicly traded company, shall endeavor to
recruit individuals to serve on the board of directors and the other
decision-making bodies (as determined by the Commission) of the board
of trade from among, and to have the composition of the bodies reflect,
a broad and culturally diverse pool of qualified candidates.
Subpart X--Securities and Exchange Commission
Sec. 38.1200 Core Principle 23.
The board of trade shall keep any such records relating to swaps
defined in Section 1a(47)(A)(v) of the Act open to inspection and
examination by the Securities and Exchange Commission.
Sec. 38.1201 Additional sources for compliance.
Applicants and designated contract markets may refer to the
guidance and/or acceptable practices in Appendix B of this part to
demonstrate to the Commission compliance with the requirements of Sec.
38.1200 of this part.
19. Revise appendix A to part 38 to read as follows:
Appendix A--Form DCM[GPO: Follow lit]
COMMODITY FUTURES TRADING COMMISSION
FORM DCM
CONTRACT MARKET
APPLICATION OR AMENDMENT TO APPLICATION FOR DESIGNATION
DESIGNATION INSTRUCTIONS
Intentional misstatements or material omissions of fact may
constitute Federal criminal violations (7 U.S.C. 13 and 18 U.S.C.
1001) or grounds for disqualification from designation.
DEFINITIONS
Unless the context requires otherwise, all terms used in the
Form DCM have the same meaning as in the Commodity Exchange Act, as
amended (``CEA'' or ``Act''), and in the General Rules and
Regulations of the Commodity Futures Trading Commission
(``Commission'') thereunder.
GENERAL INSTRUCTIONS
1. Application Form DCM and Exhibits thereto are to be filed
with the Commission by applicants for designation as a contract
market, or by a designated contract market amending such
designation, pursuant to Section 5 of the CEA and the Commission's
regulations thereunder. Applicants may prepare their own Form DCM
but must follow the format prescribed herein. Upon the filing of an
application for designation in accordance with the instructions
provided herein, the Commission will publish notice of the filing
and afford interested persons an opportunity to submit written data,
views and arguments concerning such application. No application for
designation shall be effective unless the Commission, by order,
grants such designation.
2. Individuals' names, except the executing signature in Item
10, shall be given in full (Last Name, First Name, and Middle Name).
3. Signatures on all copies of the Form DCM filed with the
Commission can be executed electronically. If the Form DCM is filed
by a limited liability company, it must be signed in the name of the
limited liability company by a member duly authorized to sign on the
limited liability company's behalf; if filed by a partnership, it
shall be signed in the name of the partnership by a general partner
duly authorized; if filed by an unincorporated organization or
association which is not a partnership, it shall be signed in the
name of such organization or association by the managing agent--
i.e., a duly authorized person who directs or manages or who
participates in the directing or managing of its affairs; if filed
by a corporation, it shall be signed in the name of the corporation
by a principal officer duly authorized.
4. If Form DCM is being filed as an application for designation,
all applicable items must be answered in full. If any item is not
applicable, indicate by ``none,'' ``not applicable,'' or ``N/A'' as
appropriate.
5. For the purposes of this Form DCM, the term ``Applicant''
shall include any applicant for designation as a contract market or
any designated contract market that is amending Form DCM.
6. Under Section 5 of the CEA and the Commission's regulations
thereunder, the Commission is authorized to solicit the information
required to be supplied by this Form DCM from Applicants seeking
designation as a contract market and from a designated contract
market. Disclosure of the information specified on this Form DCM is
mandatory prior to the start of processing of an application for
designation as a contract market. The information provided with this
Form DCM will be used for the principal purpose of determining
whether the Commission should grant or deny designation to an
Applicant. The Commission further may determine that other and
additional information is required from the Applicant in order to
process its application. Except in cases where confidential
treatment is requested by the Applicant and granted by the
Commission, pursuant to the Freedom of Information Act and the rules
of the Commission thereunder, information supplied on this Form DCM
will be included routinely in the public files of the Commission and
will be available for inspection by any interested person. A Form
DCM which is not prepared and executed in compliance with applicable
requirements and instructions may be returned as not acceptable for
filing. Acceptance of this Form DCM, however, shall not constitute a
finding that the Form DCM has been filed as required or that the
information submitted is true, current or complete.
UPDATING INFORMATION ON THE FORM DCM
1. Part 38 of the Commission's regulations requires that if any
information contained in this application, or any supplement or
amendment thereto, is or becomes inaccurate for any reason, an
amendment to Form DCM, or a submission under part 40 of the
Commission's regulations, in either case correcting such information
must be filed promptly with the Commission.
2. Designated Contract Markets filing Form DCM as an amendment
need file only the facing page, the signature page (Item 10), and
any pages on which an answer is being amended, together with any
exhibits that are being amended. The submission of an amendment
represents that the remaining items and exhibits remain true,
current and complete as previously filed.
WHERE TO FILE
The Application Form DCM and appropriate exhibits must be filed
electronically with the Secretary of the Commission at its
Washington DC headquarters at [email protected] and the Division
of Market Oversight at [email protected].
BILLING CODE 6351-01-P
[[Page 80625]]
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BILLING CODE 6351-01-C
EXHIBITS INSTRUCTIONS
The following exhibits must be filed with the Commission by
Applicants seeking designation as a contract market, or by a
designated contract market amending its designation, pursuant to
Section 5 of the CEA and the Commission's regulations thereunder.
The exhibits should be labeled according to the items specified in
this Form DCM. If any exhibit is not applicable, please specify the
exhibit letter and indicate by ``none,'' ``not applicable,'' or ``N/
A'' as appropriate.
EXHIBITS--BUSINESS ORGANIZATION
1. Attach as Exhibit A, the name of any person(s) who owns ten
percent (10%) or more of the Applicant's stock or who, either
directly or indirectly, through agreement or otherwise, in any other
manner, may control or direct the management or policies of
Applicant.
Provide as part of Exhibit A the full name and address of each
such person and attach a copy of the agreement or, if there is none
written, describe the agreement or basis upon which such person
exercises or may exercise such control or direction.
2. Attach as Exhibit B, a list of the present officers,
directors, governors (and, in the case of an Applicant that is not a
corporation, the members of all standing committees grouped by
committee), or persons performing functions similar to any of the
foregoing, of the designated contract market or of any entity that
performs the regulatory activities of the Applicant, indicating for
each:
a. Name
b. Title
c. Dates of commencement and termination of present term of
office or position
d. Length of time each present officer, director, or governor
has held the same office or position
e. Brief account of the business experience of each officer and
director over the last five (5) years
f. Any other business affiliations in the derivatives and
securities industry
g. For directors, list any committees on which they serve and
any compensation received by virtue of their directorship
h. A description of:
(1) Any order of the Commission with respect to such person
pursuant to Section 5e of the CEA;
(2) Any conviction or injunction against such person within the
past ten (10) years;
(3) Any disciplinary actions with respect to such person within
the last five (5) years;
(4) Any disqualification under Sections 8b and 8d of the CEA;
(5) Any disciplinary action under Section 8c of the CEA; and
(6) Any violation pursuant to Section 9 of the CEA.
3. Attach as Exhibit C, a narrative that sets forth the fitness
standards for the Board of Directors and its composition including
the number and percentage of public directors.
4. Attach as Exhibit D, a narrative or graphic description of
the organizational structure of the Applicant. Include a list of all
affiliates of the Applicant and indicate the general nature of the
affiliation. Note: If the designated contract market activities of
the Applicant are or will be conducted primarily by a division,
subdivision, or other separate entity within the Applicant,
corporation or organization, describe the relationship of such
entity within the overall organizational structure and attach as
Exhibit D a description only as it applies to the division,
subdivision or separate entity, as applicable. Additionally, provide
any relevant jurisdictional information, including any and all
jurisdictions in which you or any affiliated entity are doing
business, and registration status, including pending applications
(e.g., country, regulator, registration category, date of
registration). Provide the address for legal service of process for
each jurisdiction, which cannot be a post office box.
5. Attach as Exhibit E, a description of the personnel
qualifications for each category of professional employees employed
by the Applicant or the division, subdivision, or other separate
entity within the Applicant as described in Item 4.
6. Attach as Exhibit F, an analysis of staffing requirements
necessary to carry out operations of the Applicant as a designated
contract market and the name and qualifications of each key staff
person.
7. Attach as Exhibit G, a copy of the constitution, articles of
incorporation, formation or association with all amendments thereto,
partnership or limited liability agreements, and existing by-laws,
operating agreement, rules or instruments corresponding thereto, of
the Applicant. Include any additional governance fitness information
not included in Exhibit C. Provide a certificate of good standing
dated
[[Page 80628]]
within one week of the date of the Form DCM.
8. Attach as Exhibit H, a brief description of any pending legal
proceeding(s), other than ordinary and routine litigation incidental
to the business, to which the Applicant or any of its affiliates is
a party or to which any of its or their property is the subject.
Include the name of the court or agency where the proceeding(s) are
pending, the date(s) instituted, the principal parties involved, a
description of the factual basis alleged to underlie the
proceeding(s), and the relief sought. Include similar information as
to any proceeding(s) known to be contemplated by the governmental
agencies.
EXHIBITS--FINANCIAL INFORMATION
9. Attach as Exhibit I:
a. (i) Balance sheet, (ii) Statement of income and expenses,
(iii) Statement of cash flows, and (iv) Statement of sources and
application of revenues and all notes or schedules thereto, as of
the most recent fiscal year of the Applicant, or of its parent
company, if applicable. If a balance sheet and any statements
certified by an independent public accountant are available, such
balance sheet and statement(s) should be submitted as Exhibit I.
b. Provide a narrative of how the value of the financial
resources of the Applicant is at least equal to a total amount that
would enable the Applicant to cover its operating costs for a period
of at least one year, calculated on a rolling basis, and whether
such financial resources include unencumbered, liquid financial
assets (i.e. cash and/or highly liquid securities) equal to at least
six months' operating costs.
c. Attach copies of any agreements establishing or amending a
credit facility, insurance coverage, or other arrangement evidencing
or otherwise supporting the Applicant's conclusions regarding the
liquidity of its financial assets.
d. Representations regarding sources and estimates for future
ongoing operational resources.
10. Attach as Exhibit J, a balance sheet and an income and
expense statement for each affiliate of the designated contract
market that also engages in designated contract market activities as
of the end of the most recent fiscal year of each such affiliate,
and each affiliate of the designated contract market that engages in
swap execution facility activities.
11. Attach as Exhibit K, the following:
a. A complete list of all dues, fees and other charges imposed,
or to be imposed, by or on behalf of Applicant for its designated
contract market services that are provided on an exclusive basis and
identify the service or services provided for each such due, fee, or
other charge.
b. A description of the basis and methods used in determining
the level and structure of the dues, fees and other charges listed
in paragraph (a.) of this item.
c. If the Applicant differentiates, or proposes to
differentiate, among its customers, or classes of customers in the
amount of any dues, fees, or other charges imposed for the same or
similar exclusive services, so state and indicate the amount of each
differential. In addition, identify and describe any differences in
the cost of providing such services, and any other factors, that
account for such differentiations.
EXHIBITS--COMPLIANCE
12. Attach as Exhibit L, a narrative and supporting documents
that may be provided under other Exhibits herein, that describe the
manner in which the Applicant is able to comply with each core
principle. The Applicant should include an explanation, and any
other forms of documentation the Applicant thinks will be helpful to
its explanation, demonstrating how the designated contract market
will be able to comply with each core principle. To the extent that
the application raises issues that are novel, or for which
compliance with a core principle is not self-evident, include an
explanation of how that item and the application satisfy the core
principles.
13. Attach as Exhibit M, a copy of the Applicant's rules (as
defined in Sec. 40.1 of the Commission's regulations) and any
technical manuals, other guides or instructions for users of, or
participants in, the market, including minimum financial standards
for members or market participants. Include rules citing applicable
Federal position limits and aggregation standards in part 151 of the
Commission's regulations and any exchange set position limit rules.
Include rules on publication of daily trading information with
regards to the requirements of part 16 of the Commission's
regulations. The Applicant should include an explanation, and other
forms of documentation the Applicant thinks will be helpful to its
explanation, demonstrating how the designated contract market will
be able to comply with each core principle and how its rules,
technical manuals, other guides or instructions for users of, or
participants in, the market, or minimum financial standards for
members of market participants as provided in this Exhibit M help
support the designated contract market's compliance with the core
principles.
14. Attach as Exhibit N, executed or executable copies of any
agreements or contracts entered into or to be entered into by the
Applicant, including third party regulatory service provider or
member or user agreements that enable or empower the Applicant to
comply with applicable core principles. Identify: (1) The services
that will be provided; and (2) The core principles addressed by such
agreement.
15. Attach as Exhibit O, a copy of any compliance manual and any
other documents that describe with specificity, the manner in which
the Applicant will conduct trade practice, market and financial
surveillance.
16. Attach as Exhibit P, a description of the Applicant's
disciplinary and enforcement protocols, tools, and procedures and
the arrangements for alternative dispute resolution.
17. Attach as Exhibit Q, a description of the Applicant's trade
matching algorithm and examples of how that algorithm works in
various trading scenarios involving various types of orders.
18. Attach as Exhibit R, a list of rules prohibiting specific
trade practice violations.
19. Attach as Exhibit S, a discussion of how trading data will
be maintained by the designated contract market.
20. Attach as Exhibit T, a list of the name of the clearing
organization(s) that will be clearing the Applicant's trades, and a
representation that clearing members of that organization will be
guaranteeing such trades.
21. Attach as Exhibit U, any information (described with
particularity) included in the application that will be subject to a
request for confidential treatment pursuant to Sec. 145.9 of the
Commission's regulations.
EXHIBITS--OPERATIONAL CAPABILITY
22. Attach as Exhibit V, information responsive to the
Technology Questionnaire (hyperlink to Web site). This questionnaire
focuses on information pertaining to the Applicant's program of risk
analysis and oversight. Main topic areas include: information
security; business continuity-disaster recovery (``BC-DR'') planning
and resources; capacity and performance planning; systems
operations; systems development and quality assurance; and physical
security and environmental controls.
20. Revise Appendix B to part 38 to read as follows:
Appendix B to Part 38--Guidance on, and Acceptable Practices in,
Compliance With Core Principles
1. This appendix provides guidance on complying with core
principles, both initially and on an ongoing basis, to obtain and
maintain designation under Section 5(d) of the Act and this part 38.
Where provided, guidance is set forth in paragraph (a) following the
relevant heading and can be used to demonstrate to the Commission
compliance with the selected requirements of a core principle, under
Sec. Sec. 38.3 and 38.5 of this part. The guidance for the core
principle is illustrative only of the types of matters a designated
contract market may address, as applicable, and is not intended to
be used as a mandatory checklist. Addressing the issues set forth in
this appendix would help the Commission in its consideration of
whether the designated contract market is in compliance with the
selected requirements of a core principle; provided however, that
the guidance is not intended to diminish or replace, in any event,
the obligations and requirements of applicants and designated
contract markets to comply with the regulations provided under this
part.
2. Where provided, acceptable practices meeting selected
requirements of core principles are set forth in paragraph (b)
following guidance. Designated contract markets that follow specific
practices outlined in the acceptable practices for a core principle
in this appendix will meet the selected requirements of the
applicable core principle; provided however, that the acceptable
practice is not intended to diminish or replace, in any event, the
obligations and requirements of applicants and designated contract
markets to comply with the regulations provided under this part 38.
The acceptable practices are for
[[Page 80629]]
illustrative purposes only and do not state the exclusive means for
satisfying a core principle.
Core Principle 1 of section 5(d) of the Act: DESIGNATION AS
CONTRACT MARKET.--(A) IN GENERAL--To be designated, and maintain a
designation, as a contract market, a board of trade shall comply
with--
(i) any core principle described in this subsection; and
(ii) any requirement that the Commission may impose by rule or
regulation pursuant to section 8a(5).
(B) REASONABLE DISCRETION OF CONTRACT MARKET--Unless otherwise
determined by the Commission by rule or regulation, a board of trade
described in subparagraph (A) shall have reasonable discretion in
establishing the manner in which the board of trade complies with
the core principles described in this subsection.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 2 of section 5(d) of the Act: COMPLIANCE WITH
RULES--(A) IN GENERAL.--The board of trade shall establish, monitor,
and enforce compliance with the rules of the contract market,
including--
(i) access requirements;
(ii) the terms and conditions of any contracts to be traded on
the contract market; and
(iii) rules prohibiting abusive trade practices on the contract
market.
(B) CAPACITY OF CONTRACT MARKET.--The board of trade shall have
the capacity to detect, investigate, and apply appropriate sanctions
to any person that violates any rule of the contract market.
(C) REQUIREMENT OF RULES.--The rules of the contract market
shall provide the board of trade with the ability and authority to
obtain any necessary information to perform any function described
in this subsection, including the capacity to carry out such
international information-sharing agreements as the Commission may
require.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 3 of section 5(d) of the Act: CONTRACTS NOT
READILY SUBJECT TO MANIPULATION--The board of trade shall list on
the contract market only contracts that are not readily susceptible
to manipulation.
(a) Guidance. (1) Designated contract markets may list new
products for trading by self-certification under Sec. 40.2 of this
chapter or may submit products for Commission approval under Sec.
40.3 of this chapter.
(2) Guidance in appendix C to this part may be used as guidance
in meeting this core principle for both new products listings and
existing listed contracts.
(b) Acceptable Practices. [Reserved.]
Core Principle 4 of section 5(d) of the Act: PREVENTION OF
MARKET DISRUPTION.--The board of trade shall have the capacity and
responsibility to prevent manipulation, price distortion, and
disruptions of the delivery or cash-settlement process through
market surveillance, compliance, and enforcement practices and
procedures, including--
(A) methods for conducting real-time monitoring of trading; and
(B) comprehensive and accurate trade reconstructions.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 5 of section 5(d) of the Act: POSITION
LIMITATIONS OR ACCOUNTABILITY--(A) IN GENERAL.--To reduce the
potential threat of market manipulation or congestion (especially
during trading in the delivery month), the board of trade shall
adopt for each contract of the board of trade, as is necessary and
appropriate, position limitations or position accountability for
speculators.
(B) MAXIMUM ALLOWABLE POSITION LIMITATION.--For any contract
that is subject to a position limitation established by the
Commission pursuant to section 4a(a), the board of trade shall set
the position limitation of the board of trade at a level not higher
than the position limitation established by the Commission.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 6 of section 5(d) of the Act: EMERGENCY
AUTHORITY--The board of trade, in consultation or cooperation with
the Commission, shall adopt rules to provide for the exercise of
emergency authority, as is necessary and appropriate, including the
authority--
(A) to liquidate or transfer open positions in any contract;
(B) to suspend or curtail trading in any contract; and
(C) to require market participants in any contract to meet
special margin requirements.
(a) Guidance. In consultation and cooperation with the
Commission, a designated contract market should have the authority
to intervene as necessary to maintain markets with fair and orderly
trading and to prevent or address manipulation or disruptive trading
practices, whether the need for intervention arises exclusively from
the DCM's market or as part of a coordinated, cross-market
intervention. DCM rules should include procedures and guidelines to
avoid conflicts of interest in accordance with the provisions of
Sec. 40.9 of this chapter, and include alternate lines of
communication and approval procedures to address emergencies
associated with real time events. To address perceived market
threats, the designated contract market should have rules that allow
it to take certain actions in the event of an emergency, as defined
in Sec. 40.1(h) of this chapter, including: imposing or modifying
position limits, price limits, and intraday market restrictions;
imposing special margin requirements; ordering the liquidation or
transfer of open positions in any contract; ordering the fixing of a
settlement price; extending or shortening the expiration date or the
trading hours; suspending or curtailing trading in any contract;
transferring customer contracts and the margin or altering any
contract's settlement terms or conditions; and, where applicable,
providing for the carrying out of such actions through its
agreements with its third-party provider of clearing or regulatory
services. In situations where a swap is traded on more than one
platform, emergency action to liquidate or transfer open interest
must be as directed, or agreed to, by the Commission or the
Commission's staff. The Commission should be notified promptly of
the DCM's exercise of emergency action, explaining how conflicts of
interest were minimized, including the extent to which the DCM
considered the effect of its emergency action on the underlying
markets and on markets that are linked or referenced to the contract
market and similar markets on other trading venues. Information on
all regulatory actions carried out pursuant to a DCM's emergency
authority should be included in a timely submission of a certified
rule pursuant to part 40 of this chapter.
(b) Acceptable Practices. A designated contract market must have
procedures and guidelines for decision-making and implementation of
emergency intervention in the market. At a minimum, the DCM must
have the authority to liquidate or transfer open positions in the
market, suspend or curtail trading in any contract, and require
market participants in any contract to meet special margin
requirements. In situations where a swap is traded on more than one
platform, emergency action to liquidate or transfer open interest
must be directed, or agreed to, by the Commission or the
Commission's staff. The DCM must promptly notify the Commission of
the exercise of its emergency authority, documenting its decision-
making process, including how conflicts of interest were minimized,
and the reasons for using its emergency authority. The DCM must also
have rules that allow it to take such market actions as may be
directed by the Commission.
Core Principle 7 of section 5(d) of the Act: AVAILABILITY OF
GENERAL INFORMATION.--The board of trade shall make available to
market authorities, market participants, and the public accurate
information concerning--
(A) the terms and conditions of the contracts of the contract
market; and
(B)(i) the rules, regulations, and mechanisms for executing
transactions on or through the facilities of the contract market;
and
(ii) the rules and specifications describing the operation of
the contract market's--
(I) electronic matching platform; or
(II) trade execution facility.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 8 of section 5(d) of the Act: DAILY PUBLICATION
OF TRADING INFORMATION.--The board of trade shall make public daily
information on settlement prices, volume, open interest, and opening
and closing ranges for actively traded contracts on the contract
market.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 9 of section 5(d) of the Act: EXECUTION OF
TRANSACTIONS.--``(A) IN GENERAL.--The board of trade shall provide a
competitive, open, and efficient market and mechanism for executing
transactions that protects the price discovery process of trading in
the centralized market of the board of trade.
(B) RULES.--The rules of the board of trade may authorize, for
bona fide business purposes--
[[Page 80630]]
(i) transfer trades or office trades;
(ii) an exchange of--
(I) futures in connection with a cash commodity transaction;
(II) futures for cash commodities; or
(III) futures for swaps; or
(iii) a futures commission merchant, acting as principal or
agent, to enter into or confirm the execution of a contract for the
purchase or sale of a commodity for future delivery if the contract
is reported, recorded, or cleared in accordance with the rules of
the contract market or a derivatives clearing organization.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. (1) Block size determination for
existing contracts. For any futures contract that has been trading
for one calendar quarter or longer, the acceptable minimum block
trade size should be a number larger than the size at which a single
buy or sell order is customarily able to be filled in its entirety
in that product's centralized market without incurring a substantial
price concession. In specifying the minimum block, the designated
contract market should consider, and the Commission will review,
data related to factors including: the trading volume, open
interest, liquidity and depth of the order book, typical trade and
order sizes in the market, any input the designated contract market
receives from brokers, floor traders and/or market users related to
these factors, and the block sizes on comparable swap products.
(2) Block size determination for new contracts. For any futures
contract that has been listed for trading for less than one calendar
quarter, an acceptable minimum block trade size should be a number
equal to the size of a trade that the exchange reasonably
anticipates will not be able to be filled in its entirety in that
product's centralized market without incurring a substantial price
concession. In reviewing the block size for these products, the
designated contract market should consider, and the Commission will
review: centralized market data in a related futures contract, the
same contract traded on another exchange, trading activity in the
underlying cash market, and the block sizes on comparable swap
products. For both existing and new contracts, the designated
contract market may consider other relevant factors, but must
present those factors to the Commission when it certifies or seeks
approval of the block trade size.
(3) Pricing of block trades. (i) Block trades must be at a price
that is fair and reasonable. In determining whether a block trade
price is fair and reasonable, the DCM should consider: (A) the size
of the block; (B) the price and size of other block trades in any
relevant markets at the applicable time; and/or (C) the circumstance
of the market or the parties to the block trade. Relevant markets
include the designated contract market itself, the underlying cash
markets, and/or related futures or options markets. (ii) Block
trades between affiliated parties are subject to the pricing
requirements set forth in Sec. 38.503(d) of this part.
(4) Recordkeeping for block trades. Records kept in accordance
with the requirements of FASB Statement No. 133 (``Accounting for
Derivative Instruments and Hedging Activities''), as amended by FASB
Statement No. 161 (``Disclosures about Derivative Instruments and
Hedging Activities--an amendment of FASB Statement No. 133'') are
acceptable records.
Core Principle 10 of section 5(d) of the Act: TRADE
INFORMATION.--The board of trade shall maintain rules and procedures
to provide for the recording and safe storage of all identifying
trade information in a manner that enables the contract market to
use the information--
(A) to assist in the prevention of customer and market abuses;
and
(B) to provide evidence of any violations of the rules of the
contract market.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 11 of section 5(d) of the Act: FINANCIAL
INTEGRITY OF TRANSACTIONS.--The board of trade shall establish and
enforce--
(A) rules and procedures for ensuring the financial integrity of
transactions entered into on or through the facilities of the
contract market (including the clearance and settlement of the
transactions with a derivatives clearing organization); and
(B) rules to ensure--
(i) the financial integrity of any--
(I) futures commission merchant; and
(II) introducing broker; and
(ii) the protection of customer funds.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 12 of section 5(d) of the Act: PROTECTION OF
MARKETS AND MARKET PARTICIPANTS-- The board of trade shall establish
and enforce rules--
(A) to protect markets and market participants from abusive
practices committed by any party, including abusive practices
committed by a party acting as an agent for a participant; and
(B) to promote fair and equitable trading on the contract
market.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 13 of section 5(d) of the Act: DISCIPLINARY
PROCEDURES.--The board of trade shall establish and enforce
disciplinary procedures that authorize the board of trade to
discipline, suspend, or expel members or market participants that
violate the rules of the board of trade, or similar methods for
performing the same functions, including delegation of the functions
to third parties.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 14 of section 5(d) of the Act: DISPUTE
RESOLUTION.--The board of trade shall establish and enforce rules
regarding, and provide facilities for alternative dispute resolution
as appropriate for, market participants and any market
intermediaries.
(a) Guidance. A designated contract market should provide
customer dispute resolution procedures that are: appropriate to the
nature of the market; fair and equitable; and available on a
voluntary basis, either directly or through another self-regulatory
organization, to customers that are non-eligible contract
participants.
(b) Acceptable Practices.
(1) Fair and equitable procedure. Every contract market shall
provide customer dispute resolution procedures that are fair and
equitable. An acceptable customer dispute resolution mechanism
would:
(i) Provide the customer with an opportunity to have his or her
claim decided by an objective and impartial decision-maker;
(ii) Provide each party with the right to be represented by
counsel at the commencement of the procedure, at the party's own
expense;
(iii) Provide each party with adequate notice of the claims
presented against such party, an opportunity to be heard on all
claims, defenses and permitted counterclaims, and an opportunity for
a prompt hearing;
(iv) Authorize prompt, written, final settlement awards that are
not subject to appeal within the designated contract market; and
(v) Notify the parties of the fees and costs that may be
assessed.
(2) Voluntary Procedures. The use of dispute settlement
procedures shall be voluntary for customers other than eligible
contract participants as defined in section 1a(18) of the Act, and
may permit counterclaims as provided in Sec. 166.5 of this chapter.
(3) Member-to-Member Procedures. If the designated contract
market also provides procedures for the resolution of disputes that
do not involve customers (i.e., member-to-member disputes), the
procedures for resolving such disputes must be independent of and
shall not interfere with or delay the resolution of customers'
claims or grievances.
(4) Delegation. A designated contract market may delegate to
another self-regulatory organization or to a registered futures
association its responsibility to provide for customer dispute
resolution mechanisms, provided, however, that in the event of such
delegation, the designated contract market shall in all respects
treat any decision issued by such other organization or association
with respect to such dispute as if the decision were its own,
including providing for the appropriate enforcement of any award
issued against a delinquent member.
Core Principle 15 of section 5(d) of the Act: GOVERNANCE FITNESS
STANDARDS.--The board of trade shall establish and enforce
appropriate fitness standards for directors, members of any
disciplinary committee, members of the contract market, and any
other person with direct access to the facility (including any party
affiliated with any person described in this paragraph).
(a) Guidance. [Reserved.]
(b) Applicable Practices. [Reserved.]
Core Principle 16 of section 5(d) of the Act: CONFLICTS OF
INTEREST.--The board of trade shall establish and enforce rules--
(A) to minimize conflicts of interest in the decision making
process of the contract market; and
(B) to establish a process for resolving conflicts of interest
described in subparagraph (A).
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 17 of section 5(d) of the Act: COMPOSITION OF
GOVERNING BOARDS OF CONTRACT MARKETS.--The governance arrangements
of the board of
[[Page 80631]]
trade shall be designed to permit consideration of the views of
market participants.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 18 of section 5(d) of the Act: RECORDKEEPING.--
The board of trade shall maintain records of all activities relating
to the business of the contract market--
(A) in a form and manner that is acceptable to the Commission;
and
(B) for a period of at least 5 years.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 19 of section 5(d) of the Act: ANTITRUST
CONSIDERATIONS.--Unless necessary or appropriate to achieve the
purposes of this Act, the board of trade shall not--
(A) adopt any rule or taking any action that results in any
unreasonable restraint of trade; or
(B) impose any material anticompetitive burden on trading on the
contract market.
(a) Guidance. An entity seeking designation as a contract market
may request that the Commission consider under the provisions of
section 15(b) of the Act, any of the entity's rules, including
trading protocols or policies, and including both operational rules
and the terms or conditions of products listed for trading, at the
time of designation or thereafter. The Commission intends to apply
section 15(b) of the Act to its consideration of issues under this
core principle in a manner consistent with that previously applied
to contract markets.
(b) Acceptable Practices. [Reserved.]
Core Principle 20 of section 5(d) of the Act: SYSTEM
SAFEGUARDS.--The board of trade shall--
(A) establish and maintain a program of risk analysis and
oversight to identify and minimize sources of operational risk,
through the development of appropriate controls and procedures, and
the development of automated systems, that are reliable, secure, and
have adequate scalable capacity;
(B) establish and maintain emergency procedures, backup
facilities, and a plan for disaster recovery that allow for the
timely recovery and resumption of operations and the fulfillment of
the responsibilities and obligations of the board of trade; and
(C) periodically conduct tests to verify that backup resources
are sufficient to ensure continued order processing and trade
matching, price reporting, market surveillance, and maintenance of a
comprehensive and accurate audit trail.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 21 of section 5(d) of the Act: FINANCIAL
RESOURCES.--
(A) IN GENERAL.--The board of trade shall have adequate
financial, operational, and managerial resources to discharge each
responsibility of the board of trade.
(B) DETERMINATION OF ADEQUACY.--The financial resources of the
board of trade shall be considered to be adequate if the value of
the financial resources exceeds the total amount that would enable
the contract market to cover the operating costs of the contract
market for a 1-year period, as calculated on a rolling basis.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 22 of section 5(d) of the Act: DIVERSITY OF BOARD
OF DIRECTORS.--The board of trade, if a publicly traded company,
shall endeavor to recruit individuals to serve on the board of
directors and the other decision-making bodies (as determined by the
Commission) of the board of trade from among, and to have the
composition of the bodies reflect, a broad and culturally diverse
pool of qualified candidates.
(a) Guidance. [Reserved.]
(b) Acceptable Practices. [Reserved.]
Core Principle 23 of section 5(d) of the Act: SECURITIES AND
EXCHANGE COMMISSION.--The board of trade shall keep any such records
relating to swaps defined in section 1a(47)(A)(v) open to inspection
and examination by the Securities and Exchange Commission.
(a) Guidance. A designated contract market should have
arrangements and resources for collecting and maintaining accurate
records pertaining to any swaps agreements defined in section
1a(47)(A)(v) of the Act.
(b) Acceptable Practices. [Reserved.]
21. Add appendix C to part 38 to read as follows:
Appendix C--Demonstration of Compliance That a Contract is not Readily
Susceptible to Manipulation
(a) Futures Contracts--General Information. When a designated
contract market certifies or submits for approval contract terms and
conditions for a new futures contract, that submission must include
the following information:
(1) A narrative describing the contract, including data and
information to support the contract's terms and conditions, as set
by the designated contract market. When designing a futures
contract, the designated contract market should conduct market
research so that the contract design meets the risk management needs
of prospective users and promotes price discovery of the underlying
commodity. The designated contract market should consult with market
users to obtain their views and opinions during the contract design
process to ensure the contract's term and conditions reflect the
underlying cash market and that the futures contract will perform
the intended risk management and/or price discovery functions. A
designated contract market should provide a statement indicating
that it took such steps to ensure the usefulness of the submitted
contract.
(2) A detailed cash market description for physical and cash-
settled contracts should be included. Such descriptions must be
based on government and/or other publically-available data whenever
possible and be formulated for both the national and regional/local
market relevant to the underlying commodity. For tangible
commodities, the cash market descriptions for the relevant market
(i.e., national and regional/local) must incorporate at least five
full years of data that may include, among other factors,
production, consumption, stocks, imports, exports, and prices. Each
of those cash market variables must be fully defined and the data
sources must be fully specified and documented to permit Commission
staff to replicate the estimates of deliverable supply (defined in
paragraph (b)(1)(A) of this appendix C). Whenever possible, the
Commission requests that monthly or daily prices (depending on the
contract) underlying the cash settlement index be submitted for the
most recent five full calendar years and for as many of the current
year's months for which data are available. For contracts that are
cash settled to an index, the index's methodology must be provided
along with supporting information showing how the index is
reflective of the underlying cash market, is not readily subject to
manipulation or distortion, and is based on a cash price series that
is reliable, acceptable, publicly available and timely (defined in
paragraphs (c)(2) and (c)(3) of this appendix C). The Commission
recognizes that the data necessary for accurate and cogent cash
market analyses for an underlying commodity vary with the nature of
the underlying commodity. The Commission may require that the
designated contract market submit a detailed report on commodity
definitions and uses.
(b) Futures Contracts Settled by Physical Delivery. (1) For
listed contracts that are settled by physical delivery, the terms
and conditions of the contract should conform to the most common
commercial practices and conditions in the cash market for the
commodity underlying the futures contract. The terms and conditions
should be designed to avoid any impediments to the delivery of the
commodity so as to promote convergence between the price of the
futures contract and the cash market value of the commodity at the
expiration of a futures contract.
(i) Estimating Deliverable Supplies.
(A) General definition. The specified terms and conditions,
considered as a whole, must result in a ``deliverable supply'' that
is sufficient to ensure that the contract is not susceptible to
price manipulation or distortion. In general, the term ``deliverable
supply'' means the quantity of the commodity meeting the contract's
delivery specifications that reasonably can be expected to be
readily available to short traders and salable by long traders at
its market value in normal cash marketing channels at the contract's
delivery points during the specified delivery period, barring
abnormal movement in interstate commerce. Typically, deliverable
supply reflects the quantity of the commodity that potentially could
be made available for sale on a spot basis at current prices at the
contract's delivery points. For a non-financial physical-delivery
commodity contract, this estimate might represent product which is
in storage at the delivery point(s) specified in the futures
contract or can be moved economically into or through such points
consistent with the delivery procedures set forth in the contract
and which is available for sale on a spot basis within the marketing
channels that normally are tributary to the delivery point(s).
Furthermore, an appropriate estimate of deliverable supply excludes
commodity supplies that are committed to some commercial use. The
size of commodity supplies that are committed to
[[Page 80632]]
some commercial use may be estimated by consulting with market
participants. An adequate measure of deliverable supply would be an
amount of the commodity that would meet the normal or expected range
of delivery demand without causing futures prices to become
distorted relative to cash market prices. Given the availability of
acceptable data, deliverable supply should be estimated on a monthly
basis for at least the most recent five years for which data are
available. To the extent possible and that data resources permit,
deliverable supply estimates should be constructed such that the
data reflect, as close as possible, the market defined by the
contract's terms and conditions, and should be formulated, whenever
possible, with government or publically available data. All
deliverable supply estimates must be fully defined, have all
underlying assumptions explicitly stated, and have documentation of
all data/information sources in order to permit estimate replication
by Commission staff.
(B) Accounting for variations in deliverable supplies. To assure
the availability of adequate deliverable supplies and acceptable
levels of commercial risk management utility, contract terms and
conditions should account for variations in the patterns of
production, consumption and supply over a period of years of
sufficient length to assess adequately the potential range of
deliverable supplies. This assessment also should consider
seasonality, growth, and market concentration in the production/
consumption of the underlying cash commodity. Deliverable supply
implications of seasonal effects are more straightforwardly
delineated when deliverable supply estimates are calculated on a
monthly basis and when such monthly estimates are provided for at
least the most recent five years for which data resources permit. In
addition, consideration should be given to the relative roles of
producers, merchants, and consumers in the production, distribution,
and consumption of the cash commodity and whether the underlying
commodity exhibits a domestic or international export focus. Careful
consideration also should be given to the quality of the cash
commodity and to the movement or flow of the cash commodity in
normal commercial channels and whether there exist external factors
or regulatory controls that could affect the price or supply of the
cash commodity.
(C) Calculation of deliverable supplies. Designated contract
markets should derive a quantitative estimate of the deliverable
supplies for the delivery period specified in the proposed contract.
For commodities with seasonal supply or demand characteristics, the
deliverable supply analysis should include that period when
potential supplies typically are at their lowest levels. The
estimate should be based on statistical data, when reasonably
available, covering a period of time that is representative of the
underlying commodity's actual patterns of production, patterns of
consumption, and patterns of seasonal effects (if relevant). Often,
such a relevant time period should include at least five years of
monthly deliverable supply estimates permitted by available data
resources. Deliverable supply estimates should also exclude the
amount of the commodity that would not be otherwise deliverable on
the futures contract. For example, deliverable supplies should
exclude quantities that at current price levels are not economically
obtainable or deliverable or were previously dedicated under
contract for commercial use.
(2) Contract Terms and Conditions Requirements for Futures
Contracts Settled by Physical Delivery.
(i) For physical delivery contracts, an acceptable specification
of terms and conditions would include, but may not be limited to,
rules that address, as appropriate, the following criteria and
comply with the associated standards:
(A) Quality Standards: The terms and conditions of a commodity
contract should describe or define all of the economically
significant characteristics or attributes of the commodity
underlying the contract. In particular, the quality standards should
be described or defined so that such standards reflect those used in
transactions in the commodity in normal cash marketing channels.
Documentation establishing that the quality standards of the
contract's underlying commodity comply with those accepted/
established by the industry, by Government regulations, and/or by
relevant laws should also be submitted. For any particular commodity
contract, the specific attributes that must be enumerated depend
upon the individual characteristics of the underlying commodity.
These may include, for example, the following items: grade, quality,
purity, weight, class, origin, growth, issuer, originator, maturity
window, coupon rate, source, hours of trading, etc. If the terms of
the contract provide for the delivery of multiple qualities of a
specific attribute of the commodity having different cash market
values, then a ``par'' quality should be specified with price
differentials applicable to the ``non-par'' qualities that reflect
discounts or premiums commonly observed or expected to occur in the
cash market for that commodity.
(B) Delivery Points and Facilities: Delivery point/area
specifications should provide for futures delivery at a single
location or at multiple locations where the underlying cash
commodity is normally transacted or stored and where there exists a
viable cash market(s). If multiple delivery points are specified and
the value of the commodity differs between these locations, contract
terms should include price differentials that reflect usual
differences in value between the different delivery locations. If
the price relationships among the delivery points are unstable and a
designated contract market chooses to adopt fixed locational price
differentials, such differentials should fall within the range of
commonly observed or expected commercial price differences. In this
regard, any price differentials must be supported with cash price
data for the delivery location(s). The terms and conditions of the
contracts also should specify, as appropriate, any conditions the
delivery facilities and/or delivery facility operators must meet in
order to be eligible for delivery. Specification of any requirements
for delivery facilities also should consider the extent to which
ownership of such facilities is concentrated and whether the level
of concentration would be susceptible to manipulation of the futures
contract's prices. Commodity contracts also should specify
appropriately detailed delivery procedures that describe the
responsibilities of deliverers, receivers and any required third
parties in carrying out the delivery process. Such responsibilities
could include allocation between buyer and seller of all associated
costs such as load-out, document preparation, sampling, grading,
weighing, storage, taxes, duties, fees, drayage, stevedoring,
demurrage, dispatch, etc. Required accreditation for third-parties
also should be detailed. These procedures should seek to minimize or
eliminate any impediments to making or taking delivery by both
deliverers and takers of delivery to help ensure convergence of cash
and futures at the expiration of a futures delivery month.
(C) Delivery Period and Last Trading Day: An acceptable
specification of the delivery period would allow for sufficient time
for deliverers to acquire the deliverable commodity and make it
available for delivery, considering any restrictions or requirements
imposed by the designated contract market. Specification of the last
trading day for expiring contracts should consider whether adequate
time remains after the last trading day to allow for delivery on the
contract.
(D) Contract Size and Trading Unit: An acceptable specification
of the delivery unit and/or trading unit would be a contract size
that is consistent with customary transactions, transportation or
storage amounts in the cash market (e.g., the contract size may be
reflective of the amount of the commodity that represents a
pipeline, truckload or railcar shipment). For purposes of increasing
market liquidity, a designated contract market may elect to specify
a contract size that is smaller than the typical commercial
transaction size, storage unit or transportation size. In such
cases, the commodity contract should include procedures that allow
futures traders to easily take or make delivery on such a contract
with a smaller size, or, alternatively, the designated contract
market may adopt special provisions requiring that delivery be made
only in multiple contracts to accommodate reselling the commodity in
the cash market. If the latter provision is adopted, contract terms
should be adopted to minimize the potential for default in the
delivery process by ensuring that all contracts remaining open at
the close of trading in expiring delivery months can be combined to
meet the required delivery unit size. Generally, contract sizes and
trading units must be determined after a careful analysis of
relevant cash market trading practices, conditions and deliverable
supply estimates, so as to ensure that the underlying market
commodity market and available supply sources are able to support
the contract sizes and trading units at all times.
(E) Delivery Pack: The term ``delivery pack'' refers to the
packaging standards (e.g., product may be delivered in burlap or
polyethylene bags stacked on wooden
[[Page 80633]]
pallets) or non-quality related standards regarding the composition
of commodity within a delivery unit (e.g., product must all be
imported from the same country or origin). An acceptable
specification of the delivery pack or composition of a contract's
delivery unit should reflect, to the extent possible, specifications
commonly applied to the commodity traded or transacted in the cash
market.
(F) Delivery Instrument: An acceptable specification of the
delivery instrument (e.g., warehouse receipt, depository certificate
or receipt, shipping certificate, bill of lading, in-line transfer,
book transfer of securities, etc.) would provide for its conversion
into the cash commodity at a commercially-reasonable cost.
Transportation terms (e.g., FOB, CIF, freight prepaid to
destination) as well as any limits on storage or certificate daily
premium fees should be specified. These terms should reflect cash
market practices and the customary provision for allocating delivery
costs between buyer and seller.
(G) Inspection Provisions: Any inspection/certification
procedures for verifying compliance with quality requirements or any
other related delivery requirements (e.g., discounts relating to the
age of the commodity, etc.) should be specified in the contract
rules. An acceptable specification of inspection procedures would
include the establishment of formal procedures that are consistent
with procedures used in the cash market. To the extent that formal
inspection procedures are not used in the cash market, an acceptable
specification would contain provisions that assure accuracy in
assessing the commodity, that are available at a low cost, that do
not pose an obstacle to delivery on the contract and that are
performed by a reputable, disinterested third party or by qualified
designated contract market employees. Inspection terms also should
detail which party pays for the service, particularly in light of
the possibility of varying inspection results.
(H) Delivery (Trading) Months: Delivery months should be
established based on the risk management needs of commercial
entities as well as the availability of deliverable supplies in the
specified months.
(I) Minimum Price Fluctuation (Minimum Tick): The minimum price
increment (tick) should be set at a level that is equal to, or less
than, the minimum price increment commonly observed in cash market
transactions for the underlying commodity. Specifying a futures'
minimum tick that is greater than the minimum price increment in the
cash market can undermine the risk management utility of the futures
contract by preventing hedgers from efficiently establishing and
liquidating futures positions that are used to hedge anticipated
cash market transactions or cash market positions.
(J) Maximum Price Fluctuation Limits: Designated contract
markets may adopt price limits to: (1) Reduce or constrain price
movements in a trading day that may not be reflective of true market
conditions but might be caused by traders overreacting to news; (2)
Allow additional time for the collection of margins in times of
large price movements; and (3) Provide a ``cooling-off'' period for
futures market participants to respond to bona fide changes in
market supply and demand fundamentals that would lead to large cash
and futures price changes. If price limit provisions are adopted,
the limits should be set at levels that are not overly restrictive
in relation to price movements in the cash market for the commodity
underlying the futures contract.
(K) Speculative Limits: Specific information regarding the
establishment of speculative position limits are set forth in part
151 of the Commission's regulations.
(L) Reportable Levels: Refer to Sec. 15.03 of the Commission's
regulations.
(M) Trading Hours: Should be set by the designated contract
market to delineate each trading day.
(c) Futures Contracts Settled by Cash Settlement. (1) Cash
settlement is a method of settling certain futures or option
contracts whereby, at contract expiration, the contract is settled
by cash payment in lieu of physical delivery of the commodity or
instrument underlying the contract. An acceptable specification of
the cash settlement price for commodity futures and option contracts
would include rules that fully describe the essential economic
characteristics of the underlying commodity (e.g., grade, quality,
weight, class, growth, issuer, maturity, source, rating, description
of the underlying index and index's calculation methodology, etc.),
as well as how the final settlement price is calculated. In
addition, the rules should clearly specify the trading months and
hours of trading, the last trading day, contract size, minimum price
change (tick size) and any limitations on price movements (e.g.,
price limits or trading halts).
(2) Cash settled contracts may be susceptible to manipulation or
price distortion. In evaluating the susceptibility of a cash-settled
contract to manipulation, a designated contract market must consider
the size and liquidity of the cash market that underlies the listed
contract. In particular, situations susceptible to manipulation
include those in which the volume of cash market transactions and/or
the number of participants contacted in determining the cash-
settlement price are very low. Cash-settled contracts may create an
incentive to manipulate or artificially influence the data from
which the cash-settlement price is derived or to exert undue
influence on the cash-settlement price's computation in order to
profit on a futures position in that commodity. The utility of a
cash-settled contract for risk management and price discovery would
be significantly impaired if the cash settlement price is not a
reliable or robust indicator of the value of the underlying
commodity or instrument. Accordingly, careful consideration should
be given to the potential for manipulation or distortion of the cash
settlement price, as well as the reliability of that price as an
indicator of cash market values. Appropriate consideration also
should be given to the commercial acceptability, public
availability, and timeliness of the price series that is used to
calculate the cash settlement price. Documentation demonstrating
that the settlement price index is a reliable indicator of market
values and conditions and is commonly used as a reference index by
industry/market agents should be provided. Such documentation may
take on various forms, including carefully documented interview
results with knowledgeable agents.
(3) Where an independent, private-sector third party calculates
the cash settlement price series, a designated contract market must
consider the need for a licensing agreement that will ensure the
designated contract market's rights to the use of the price series
to settle the listed contract.
(i) Where an independent, private-sector third party calculates
the cash settlement price series, the designated contract market
should verify that the third party utilizes business practices that
minimize the opportunity or incentive to manipulate the cash-
settlement price series. Such safeguards may include lock-downs,
prohibitions against derivatives trading by employees, or public
dissemination of the names of sources and the price quotes they
provide. Because a cash-settled contract may create an incentive to
manipulate or artificially influence the underlying market from
which the cash-settlement price is derived or to exert undue
influence on the cash-settlement computation in order to profit on a
futures position in that commodity, a designated contract market
should, whenever practicable, enter into an information-sharing
agreement with the third-party provider which would enable the
designated contract market to better detect and prevent manipulative
behavior.
(ii) Where a designated contract market itself generates the
cash settlement price series, the designated contract market should
establish calculation procedures that safeguard against potential
attempts to artificially influence the price. For example, if the
cash settlement price is derived by the designated contract market
based on a survey of cash market sources, the designated contract
market should maintain a list of such entities which all should be
reputable sources with knowledge of the cash market. In addition,
the sample of sources polled should be representative of the cash
market, and the poll should be conducted at a time when trading in
the cash market is active. The cash-settlement survey should include
a minimum of four independent entities if such sources do not take
positions in the commodity (e.g., if the survey list is comprised
exclusively of brokers) or at least eight independent entities if
such sources trade for their own accounts (e.g., if the survey list
is comprised of dealers or merchants).
(iii) The cash-settlement calculation should involve
computational procedures that eliminate or reduce the impact of
potentially unrepresentative data.
(iv) The cash settlement price should be an accurate and
reliable indicator of prices in the underlying cash market. The cash
settlement price also should be acceptable to commercial users of
the commodity contract. The registered entity should fully document
that the settlement price is accurate, reliable, highly regarded by
industry/market agents, and fully reflects the economic and
commercial conditions of the relevant designated contract market.
[[Page 80634]]
(v) To the extent possible, the cash settlement price should be
based on cash price series that are publicly available and available
on a timely basis for purposes of calculating the cash settlement
price at the expiration of a commodity contract. A designated
contract market should make the final cash settlement price and any
other supporting information that is appropriate for release to the
public, available to the public when cash settlement is accomplished
by the derivatives clearing organization. If the cash settlement
price is based on cash prices that are obtained from non-public
sources (e.g., cash market surveys conducted by the designated
contract market or by third parties on behalf of the designated
contract market), a designated contract market should make available
to the public as soon as possible after a contract month's
expiration the final cash settlement price as well as any other
supporting information that is appropriate or feasible to make
available to the public.
(4) Contract Terms and Conditions Requirements for Futures
Contracts Settled by Cash Settlement
(i) An acceptable specification of the terms and conditions of a
cash-settled commodity contract will also set forth the trading
months, last trading day, contract size, minimum price change (tick
size) and daily price limits, if any.
(A) Commodity Characteristics: The terms and conditions of a
commodity contract should describe the commodity underlying the
contract.
(B) Contract Size and Trading Unit: An acceptable specification
of the trading unit would be a contract size that is consistent with
customary transactions in the cash market. A designated contract
market may opt to set the contract size smaller than that of
standard cash market transactions.
(C) Cash Settlement Procedure: The cash settlement price should
be reliable, acceptable, publicly available, and reported in a
timely manner as described in paragraphs (c)(3)(iv) and (c)(3)(v) of
this appendix C.
(D) Pricing Basis and Minimum Price Fluctuation (Minimum Tick):
The minimum price increment (tick) should be set a level that is
equal to, or less than, the minimum price increment commonly
observed in cash market transactions for the underlying commodity.
Specifying a futures' minimum tick that is greater than the minimum
price increment in the cash market can undermine the risk management
utility of the futures contract by preventing hedgers from
efficiently establishing and liquidating futures positions that are
used to hedge anticipated cash market transactions or cash market
positions.
(E) Maximum Price Fluctuation Limits: Designated contract
markets may adopt price limits to: (1) Reduce or constrain price
movements in a trading day that may not be reflective of true market
conditions but might be caused by traders overreacting to news; (2)
Allow additional time for the collection of margins in times of
large price movements; and (3) Provide a ``cooling-off'' period for
futures market participants to respond to bona fide changes in
market supply and demand fundamentals that would lead to large cash
and futures price changes. If price-limit provisions are adopted,
the limits should be set at levels that are not overly restrictive
in relation to price movements in the cash market for the commodity
underlying the futures contract. For broad-based stock index futures
contracts, rules should be adopted that coordinate with New York
Stock Exchange (``NYSE'') declared Circuit Breaker Trading Halts and
would recommence trading in the futures contract only after trading
in the majority of the stocks underlying the index has recommenced.
(F) Last Trading Day: Specification of the last trading day for
expiring contracts should be established such that it occurs before
publication of the underlying third-party price index or
determination of the final settlement price. If the designated
contract market chooses to allow trading to occur through the
determination of the final settlement price, then the designated
contract market should show that futures trading would not distort
the final settlement price calculation.
(G) Trading Months: Trading months should be established based
on the risk management needs of commercial entities as well as the
availability of price and other data needed to calculate the cash
settlement price in the specified months. Specification of the last
trading day should take into consideration whether the volume of
transactions underlying the cash settlement price would be unduly
limited by occurrence of holidays or traditional holiday periods in
the cash market. Moreover, a contract should not be listed past the
date for which the designated contract market has access to use a
proprietary price index for cash settlement.
(H) Speculative Limits: Specific rules and policies for
speculative position limits are set forth in the part 151 of the
Commission's regulations.
(I) Reportable Levels: Refer to Sec. 15.03 of the Commission's
regulations.
(J) Trading Hours: Should be set by the designated contract
market to delineate each trading day.
(d) Options on a Futures Contract. (1) The Commission's
experience with the oversight of trading in futures option contracts
indicates that most of the terms and conditions associated with such
trading do not raise any regulatory concerns or issues. The
Commission has found that the following terms do not affect an
option contract's susceptible to manipulation or its utility for
risk management. Thus, the Commission believes that, in most cases,
any specification of the following terms would be acceptable; the
only requirement is that such terms be specified in an automatic and
objective manner in the option contract's rules:
[cir] Exercise method;
[cir] Exercise procedure (if positions in the underlying futures
contract are established via book entry);
[cir] Strike price listing provisions, including provisions for
listing strike prices on a discretionary basis;
[cir] Strike price intervals;
[cir] Automatic exercise provisions;
[cir] Contract size (unless not set equal to the size of the
underlying futures contract); and
[cir] Option minimum tick should be equal to or smaller than
that of the underlying futures contract.
(2) Option Expiration & Last Trading Day. For options on futures
contracts, specification of expiration dates should consider the
relationship of the option expiration date to the delivery period
for the underlying futures contract. In particular, an assessment
should be made of liquidity in the underlying futures market to
assure that any futures contracts acquired through exercise can be
liquidated without adversely affecting the orderly liquidation of
futures positions or increasing the underlying futures contract's
susceptibility to manipulation. When the underlying futures contract
exhibits a very low trading activity during an expiring delivery
month's final trading days or has a greater risk of price
manipulation than other contracts, the last trading day and
expiration day of the option should occur prior to the delivery
period or the settlement date of the underlying future. For example,
the last trading day and option expiration day might appropriately
be established prior to first delivery notice day for option
contracts with underlying futures contracts that have very limited
deliverable supplies. Similarly, if the futures contract underlying
an option contract is cash settled using cash prices from a very
limited number of underlying cash market transactions, the last
trading and option expiration days for the option contract might
appropriately be established prior to the last trading day for the
futures contract.
(3) Speculative Limits. In cases where the terms of an
underlying futures contract specify a spot-month speculative
position limit and the option contract expires during, or at the
close of, the futures contract's delivery period, the option
contract should include a spot-month speculative position limit
provision that requires traders to combine their futures and option
position and be subject to the limit established for the futures
contract. Specific rules and policies for speculative position
limits are set forth in part 151 of the Commission's regulations.
(4) Options on Physicals Contracts.
(i) Under the Commission's regulations, the term ``option on
physicals'' refers to option contracts that do not provide for
exercise into an underlying futures contract. Upon exercise, options
on physicals can be settled via physical delivery of the underlying
commodity or by a cash payment. Thus, options on physicals raise
many of the same issues associated with trading in futures contracts
regarding adequacy of deliverable supplies or acceptability of the
cash settlement price series. In this regard, an option that is cash
settled based on the settlement price of a futures contract would be
considered an ``option on physicals'' and the futures settlement
price would be considered the cash price series.
(ii) In view of the above, acceptable practices for the terms
and conditions of options on physicals contracts include, as
appropriate, those practices set forth above for physical-delivery
or cash-settled futures contracts plus the practices set forth for
options on futures contracts.
(e) Security Futures Products. (1) The listing of security
futures products are
[[Page 80635]]
governed by the special requirements of part 41 of the Commission's
regulations. A designated contract market should follow the
appropriate guidance regarding physically delivered security futures
products that are settled through physical delivery or cash
settlement.
(f) Non-Price Based Futures Contracts. (1) Non-price based
contracts are typically construed as binary options, but also may be
designed to function similar to traditional futures or option
contracts.
(2) Where the contract is settled to a third party cash-
settlement series, the designated contract market should consider
the nature and sources of the data comprising the cash-settlement
calculation, the computational procedures, and the mechanisms in
place to ensure the accuracy and reliability of the index value. The
evaluation also considers the extent to which the third party has,
or will adopt, safeguards against unauthorized or premature release
of the index value itself or any key data used in deriving the index
value.
(3) The designated contract market should follow the guidance in
paragraph (c)(4) (Contract Terms and Conditions Requirements for
Futures Contracts Settled by Cash Settlement) of this appendix C to
meet compliance.
(g) Swap Contracts. (1) In general, swap contracts are an
agreement to exchange a series of cash flows over a period of time
based on reference price indices. When listing a swap for trading, a
swap execution facility or designated contract market must determine
that the reference price indices used for its contracts are not
readily susceptible to manipulation. Accordingly, careful
consideration should be given to the potential for manipulation or
distortion of the cash settlement price, as well as the reliability
of that price as an indicator of cash market values. Appropriate
consideration also should be given to the commercial acceptability,
public availability, and timeliness of the price series that is used
to calculate the cash settlement price. Documentation demonstrating
that the settlement price index is a reliable indicator of market
values and conditions and is highly regarded by industry/market
agents should be provided. Such documentation may take on various
forms, including carefully documented interviews with principal
market trading agents, pricing experts, marketing agents, etc.
Appropriate consideration also should be given to the commercial
acceptability, public availability, and timeliness of the price
series that is used to calculate the cash flows of the swap.
(i) Where an independent, private-sector third party calculates
the referenced price index, the designated contract market should
verify that the third party utilizes business practices that
minimize the opportunity or incentive to manipulate the cash-
settlement price series. Such safeguards may include lock-downs,
prohibitions against derivatives trading by employees, or public
dissemination of the names of sources and the price quotes they
provide. Because a cash-settled contract may create an incentive to
manipulate or artificially influence the underlying market from
which the cash-settlement price is derived or to exert undue
influence on the cash-settlement computation in order to profit on a
futures position in that commodity, a designated contract market
should, whenever practicable, enter into an information-sharing
agreement with the third-party provider which would enable the
designated contract market to better detect and prevent manipulative
behavior.
(ii) Where a designated contract market itself generates the
cash settlement price series, the designated contract market should
establish calculation procedures that safeguard against potential
attempts to artificially influence the price. For example, if the
cash settlement price is derived by the designated contract market
based on a survey of cash market sources, the designated contract
market should maintain a list of such entities which all should be
reputable sources with knowledge of the cash market. In addition,
the sample of sources polled should be representative of the cash
market, and the poll should be conducted at a time when trading in
the cash market is active. The cash-settlement survey should include
a minimum of four independent entities if such sources do not take
positions in the commodity (e.g., if the survey list is comprised
exclusively of brokers) or eight independent entities if such
sources trade for their own accounts (e.g., if the survey list is
comprised of dealers or merchants).
(iii) The cash-settlement calculation should involve appropriate
computational procedures that eliminate or reduce the impact of
potentially unrepresentative data.
(2) Speculative Limits: Specific rules and policies for
speculative position limits are set forth in part 151 of the
Commission's regulations.
(3) Intraday Market Restrictions: Designated contract markets or
swap execution facilities must have in place intraday market
restrictions that pause or halt trading in the event of
extraordinary price moves that may result in distorted prices. Such
restrictions need to be coordinated with other markets that may be a
proxy or a substitute for the contracts traded on their facility.
For example, coordination with NYSE rule 80.B Circuit Breaker
Trading Halts. The designated contract market or swap execution
facility must adopt rules to specifically address who is authorized
to declare an emergency; how the designated contract market or swap
execution facility will notify the Commission of its decision that
an emergency exists; how it will address conflicts of interest in
the exercise of emergency authority; and how it will coordinate
trading halts with markets that trade the underlying price reference
index or product.
(4) Settlement Method. The designated contract market or swap
execution facility should follow the guidance in paragraph (c)(4)
(Contract Terms and Conditions Requirements for Futures Contracts
Settled by Cash Settlement) of this appendix C to meet compliance,
or paragraph (b)(2) (Contract Terms and Conditions Requirements for
Futures Contracts Settled by Physical Delivery) of this appendix C,
as appropriate.
By the Commission.
Dated: December 1, 2010.
David A. Stawick,
Secretary.
Appendices to Core Principles and Other Requirements for Designated
Contract Markets--Commission Voting Summary and Statements of
Commissioners
Note: The following appendices will not appear in the Code of
Federal Regulations
Appendix 1--Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Dunn and
Chilton voted in the affirmative; Commissioners Sommers and O'Malia
voted in the negative.
Appendix 2--Statements of Commissioners
Statement of Chairman Gary Gensler
I support the proposed rulemaking to update our rules and
guidance with regard to designated contract markets (DCMs). The
Dodd-Frank Act updated the statutory language for core principles
for contract markets, increasing the number to 23 and modifying
existing core principles. Thus, it is important to update our rules
and guidance to reflect those changes. Further, the Dodd-Frank Act
allows DCMs to--for the first time--offer swaps in addition to
futures and commodity options, and this proposal addresses that
broader scope. I believe it is also important to update the rules
and guidance for DCMs in light of the fact that we will be
promulgating rules and guidance for swap execution facilities, and
many of the core principles are similar. This rule will help to
promote transparency and market integrity.
Dissent of Commissioner Jill E. Sommers and Commissioner Scott D.
O'Malia
We respectfully dissent from the action taken today by the
Commission to issue proposed regulations relating to ``Core
Principle and Other Requirements for Designated Contract Markets''
(DCMs). While we each dissent for a number of reasons, we join in
writing to express our disagreement with the Commission's narrow
interpretation of Core Principle 9--Execution of Transactions, and
request comment on the implications of such a narrow interpretation
of Core Principle 9 for markets and market participants.
In relevant part, Core Principle 9 states: ``The board of trade
shall provide a competitive, open, and efficient market and
mechanism for executing transactions that protects the price
discovery process of trading in the centralized market of the board
of trade.'' Core Principle 9 does not say that every contract listed
for trading on the board of trade must trade in the centralized
market. Nor does it require that every contract listed for trading
serve a price discovery function. Rather, it requires a mechanism
for protecting the price discovery function for those contracts that
do trade in the centralized market. With these proposed regulations,
the Commission is interpreting
[[Page 80636]]
Core Principle 9 in a way that does not comport with the plain
language of the statute.
Over the past decade, a long list of non-standardized, illiquid
contracts in the energy sphere have been executed off-exchange and
cleared on-exchange through the exchange of futures for swaps (EFS)
mechanism. The availability of clearing for these contracts added a
level of safety, soundness and transparency to the marketplace that
did not exist before. If the Commission had not permitted these
contracts to be listed for clearing through the EFS process it is
highly doubtful that the level of clearing that exists today for
these contracts would have been achieved, and highly likely that
this activity would have remained opaque to market participants and
regulators. Congress was aware of this specialized marketplace when
it amended Core Principle 9. If Congress had intended to outlaw this
activity it could have done so by explicitly requiring all DCM
contracts to trade in the centralized market. It did not do so. In
fact, Core Principle 9 explicitly allows boards of trade to
authorize certain types of contracts that have traditionally been
traded off the centralized market, including EFS.
Finally, the full ramifications of the Commission's overly-
restrictive reading of Core Principle 9 are not yet known, but are
likely to be of great consequence to many market participants.
Clearing helps mitigate risk, and the movement of illiquid contracts
into a cleared environment was a positive development for our
markets and market participants. Clearing contracts listed on a DCM
also permits market participants to take advantage of certain
efficiencies, like portfolio margining. Now, hundreds of contracts
that are listed for trading on DCMs and cleared likely will no
longer enjoy that status. The assumption appears to be that these
contracts will simply be listed for trading on a swap execution
facility (SEF) and cleared, without any disruption to markets or
market participants. We are not willing to make such a bold
assumption, especially when the Commission has not yet proposed
regulations relating to listing and trading requirements for SEFs.
We would have preferred that the proposed regulations preserve
the functioning of this specialized marketplace; a marketplace that
has not adversely affected price discovery for any contract
currently traded in the centralized market.
[FR Doc. 2010-31458 Filed 12-21-10; 8:45 am]
BILLING CODE 6351-01-P