[Federal Register Volume 76, Number 5 (Friday, January 7, 2011)]
[Proposed Rules]
[Pages 1214-1259]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-32358]
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Part II
Commodity Futures Trading Commission
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17 CFR Part 37
Core Principles and Other Requirements for Swap Execution Facilities;
Proposed Rule
Federal Register / Vol. 76 , No. 5 / Friday, January 7, 2011 /
Proposed Rules
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 37
RIN Number 3038-AD18
Core Principles and Other Requirements for Swap Execution
Facilities
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 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. The proposed
rules, guidance, and acceptable practices, which apply to the
registration and operation of a new type of regulated entity named a
swap execution facility, implement the new statutory framework that,
among other things, adds a new Section 5h to the Commodity Exchange Act
(``CEA'') concerning the registration and operation of swap execution
facilities, and new Section 2(h)(8) to the CEA concerning the listing,
trading and execution of swaps on swap execution facilities. The
Commission requests comment on all aspects of the proposed rules,
guidance and acceptable practices.
DATES: Comments must be received on or before March 8, 2011.
ADDRESSES: You may submit comments, identified by RIN number 3038-AD18,
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 may be exempt from disclosure under the Freedom of
Information Act (``FOIA''),\1\ a petition for confidential treatment of
the exempt information may be submitted according to the established
procedures in Sec. 145.9.\2\
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\1\ 5 U.S.C. 552.
\2\ 17 CFR 145.9.
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The Commission reserves the right, but shall have no obligation, to
review, prescreen filter, redact, refuse, or remove any or all of your
submission from http://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
FOIA.
FOR FURTHER INFORMATION CONTACT: Riva Spear Adriance, Associate
Director, 202-418-5494, [email protected], or Mauricio Melara,
Attorney-Advisor, 202-418-5719, [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 Dodd-Frank Act
II. The Proposed Regulations, Guidance and Acceptable Practices
A. Adoption of New Regulations, Guidance and Acceptable
Practices
B. Proposed General Regulations Under Part 37
C. Proposed Regulations, Guidance and Acceptable Practices for
Compliance With the Core Principles
III. Effective Date and Transition Period
IV. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Cost-Benefit Analysis
V. Text of the Proposed Regulations, Guidance and Acceptable
Practices
I. Background
A. Overview
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street
Reform and Consumer Protection Act (``Dodd-Frank Act'').\3\ Title VII
of the Dodd-Frank Act \4\ amended the CEA \5\ 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
derivatives 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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\3\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Pub. L. 111-203, 124 Stat. 1376 (2010). The text of the Dodd-
Frank Act may be accessed at http://www.cftc.gov./LawRegulation/
OTCDERIVATIVES/index.htm.
\4\ Pursuant to Section 701 of the Dodd-Frank Act, Title VII may
be cited as the ``Wall Street Transparency and Accountability Act of
2010.''
\5\ 7 U.S.C. 1 et seq.
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The Dodd-Frank Act creates a new type of regulated marketplace:
``Swap execution facilities'' (``SEFs''),\6\ for which the Dodd-Frank
Act establishes a comprehensive regulatory framework, including by:
Section 733 (adding new Section 5h to the CEA to provide a regulatory
framework of Commission oversight), Section 723(a)(3) (adding new
Section 2(h)(8) to the CEA, to require, among other things, that swaps
subject to the clearing requirement of Section 2(h)(1) of the CEA be
executed either on a designated contract market (``DCM'') or on a SEF,
unless no DCM or SEF made the swap ``available for trading''),\7\ and
Section 733 of the Dodd-Frank Act (adding 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).
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\6\ This new regulatory framework includes: (i) Registration,
operation and compliance requirements for SEFs and (ii) fifteen core
principles. Applicants and registered SEFs are required to comply
with the core principles as a condition of obtaining and maintaining
their registration as a SEF. The definition of swap execution
facility is added in Section 721 of the Dodd-Frank Act, amending
Section 1a of the CEA. 7 U.S.C. 1a(50).
\7\ See Section 723 of the Dodd-Frank Act.
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In enacting the Dodd-Frank Act, Congress directed that rules and
regulations required by the provisions of Title VII be promulgated by
the later of either 360 days of its enactment or, to the extent that a
rulemaking is required by Dodd-Frank, not less than 60 days after the
publication of that final rule.\8\ Consistent with Congress' directive,
this release proposes amendments to Part 37 of the Commission's
regulations to
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implement Sections 723(a)(3) and 733 of the Dodd-Frank Act.\9\
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\8\ See Section 754 of the Dodd-Frank Act.
\9\ See Section 754 of the Dodd-Frank Act. Please also note that
Section 734 of the Dodd-Frank Act deletes the provision of the CEA
that provided for Derivatives Transaction Execution Facilities
(``DTEFs''), which previously were regulated under Part 37,
replacing those provisions with regulations establishing the
regulatory requirements for SEFs.
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B. The Dodd-Frank Act
Section 723(a)(3) of the Dodd-Frank Act amends Section 2(h) of the
CEA, providing that, with respect to transactions involving a swap
subject to the clearing requirement of paragraph 2(h)(1),
counterparties must execute the transaction on a DCM or a SEF.\10\ This
``exchange trading'' requirement does not apply if no DCM or SEF
``makes the swap available to trade'' or if the exceptions to the
clearing requirement apply.\11\
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\10\ See Section 2(h)(8) of the CEA, as enacted by Section
723(a)(3) of the Dodd-Frank Act. The Dodd-Frank Act also eliminates
the swaps exemption under former Section 2(g) of the CEA, supporting
the requirement that trading and processing of cleared swaps must
occur on a DCM or a SEF as well as expanding the types of products
that can be listed and traded on a DCM to include swaps. The
Commission is proposing provisions for the trading of swaps on a DCM
in a separate rulemaking. See also Notice of Proposed Rulemaking
Relating to Core Principles and Other Requirements for Designated
Contract Markets approved for publication by the Commission at an
open meeting on Dec. 1, 2010 and expected to be published shortly in
the Federal Register (to be codified at 17 CFR part 38) (the ``DCM
NPRM''). This Notice is available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister120110b.pdf (last
visited on Dec. 8, 2010).
\11\ See Section 2(h)(8)(B) of the CEA, as enacted by Section
723(a)(3) of the Dodd-Frank Act. Newly amended Section 2(h)(7) of
the CEA provides for exceptions to the clearing requirement when one
of the counterparties to a swap (i) is not a financial entity, (ii)
is using the swap to hedge or mitigate commercial risk, and (iii)
notifies the Commission how it meets its financial obligations
associated with entering into a non-cleared swap.
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Section 733 of the Dodd-Frank Act adopts new Section 5h of the CEA,
providing that: (i) 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; (ii) to be registered and maintain registration, a SEF must comply
with fifteen enumerated core principles and any requirement that the
Commission may impose by rule or regulation; and (iii) the Commission
has the authority to prescribe rules governing the regulation of SEFs.
The proposed regulations, guidance and acceptable practices will
implement the regulatory obligations that each SEF must meet in order
to comply with Section 5h of the CEA both initially upon registration
and on an ongoing basis. The Commission requests comments on all
aspects of its proposal.
II. The Proposed Regulations, Guidance and Acceptable Practices
A. Adoption of New Regulations, Guidance and Acceptable Practices
The Dodd-Frank Act amended the CEA to provide that, under new
Section 5h, the Commission may in its discretion determine by rule or
regulation the manner in which DCMs and SEFs comply with the core
principles. In consideration of the novel nature of SEFs and also based
on its experience in overseeing DCMs' compliance with core principles,
the Commission carefully assessed which SEF core principles would
benefit from regulations, providing legal certainty and clarity to the
marketplace, and which core principles would benefit from guidance or
acceptable practices, where flexibility is more appropriate. Based on
that evaluation, the Commission is proposing a combination of
regulations, guidance and acceptable practices for the oversight and
regulation of SEFs.
B. Proposed General Regulations Under Part 37
The Commission is proposing to organize Part 37 to include new
subparts A through P. Proposed Subpart A would include general Sec.
37.1 through 37.11.\12\ While in this rulemaking, the Commission is
proposing Sec. Sec. 37.1 through 37.11, it notes that Sec. 37.19,
addressing conflicts of interest, was proposed in a separate
rulemaking.\13\ Subparts B through P would establish relevant
regulations applicable to each of the 15 core principles.\14\
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\12\ These sections apply both to applicants for registration
and registered SEFs, clarify which provisions are applicable to
trading on SEFs, provide for SEF registration processes (including
processes for the vacation, reinstatement, and transfer of a SEF
registration), and provide general requirements regarding: (i) The
listing and trading of swaps; (ii) the responsibility, upon request
of the Commission, to respond to requests for information and
demonstrations of compliance with core principles, and to provide
information and certifications upon transfers of equity interest;
(iii) the enforceability of a SEF's swap transactions under certain
conditions, (iv) limitations on the use of data collected for
regulatory purposes, (v) the need for a board of trade that operates
a trading facility that has been designated as a DCM by the
Commission and also intends to operate a SEF to separately register
the entity that will operate as a SEF, (vi) the appropriate
execution of swaps based on the type of transaction and order
interaction, and (vii) the periodic assessment of the method by
which swaps are made available for trading.
\13\ 75 FR 63732 (October 18, 2010).
\14\ Each subpart begins with a regulation containing the
language of the core principle.
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1. Subpart A--General Provisions
a. Scope--Proposed Sec. 37.1
Proposed Sec. 37.1 provides that Part 37 will apply to entities
that are registered SEFs or that are submitting an application for SEF
registration under Section 5h of the CEA, and clarifies that Part 37
does not restrict the eligibility of SEFs to operate under the
provisions of Parts 38 or 49 of this Chapter.
b. Applicable Provisions--Proposed Sec. 37.2
Proposed Sec. 37.2 lists those Commission regulations that are
applicable to SEFs, and provides that SEFs must comply with, in
addition to the requirements in Part 37, the proposed Part 43
requirements regarding the real time reporting of swaps and the
determination of appropriate block size for swaps, the proposed Part 45
requirements for data elements, recordkeeping and reporting of swap
information to swap data repositories (``SDRs''), the proposed Part 46
requirements for business continuity and disaster recovery, the
proposed Part 49 requirements regarding SDRs, and the proposed Part 151
position limits requirements.\15\
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\15\ The Commission notes that because some of the proposed
rulemakings are either ongoing or forthcoming, this proposed list of
applicable sections under proposed Sec. 37.2 may be subject to
further revisions pending the final rules for each respective
rulemaking.
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c. Requirements for Registration--Proposed Sec. 37.3
i. Application Procedures--Proposed Sec. 37.3(a)
Proposed Sec. 37.3 sets forth the application and approval
procedures for registration of new SEFs. The provision would require
that all SEF applications, reinstatements of registrations, requests
for transfer of registrations, requests for withdrawal of application
for registration, and vacation of registrations must be filed
electronically with the Secretary of the Commission, in the form and
manner as provided by the Commission.\16\
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\16\ This amendment also would ensure consistency with the
process used for filing rule and product submissions under Parts 38,
39 and 40 of the Commission's regulations. See 17 CFR Parts 38, 39
and 40.
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To assist prospective applicants, the Commission proposes to
include an application form under Appendix A to Part 37 (``Form SEF'');
the proposed form would also be used for any updates or amendments for
registration that are not required to be submitted under Part 40 of
this Chapter.\17\ Each applicant will be required to provide the
Commission with documents and descriptions pertaining to its: (i)
Business
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organization, (ii) financial resources, (iii) compliance program and
(iv) technological capabilities.
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\17\ The Commission also is requiring tailored application forms
for the designation of DCMs and the registration of Designated
Clearing Organizations and Swap Data Repositories.
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Other than the specific requirements necessitated by the core
principles, the majority of information required under the Form SEF
consists of information that Commission staff has historically found
necessary considering DCM applications. The Commission expects that
similar information will be necessary to assess applications for SEF
registration. Proposed Sec. 37.3(a)(1) requires that, at a minimum,
all applicants must complete the application form and provide the
necessary information and documentation in order to initiate the SEF
registration review process. The determination when a submission is
complete will be at the sole discretion of the Commission. The
Commission will review Form SEF and, at the conclusion of its review,
by order either: (i) Grant registration; (ii) deny the application for
registration; or (iii) grant registration subject to Commission-
established conditions.
SEF applicants will be required to provide various documents
describing the applicant's legal and financial status. SEF applicants
must also submit copies of any applicable rules and regulations (as
defined in Sec. 40.1),\18\ disclose any affiliates and a brief
description of the nature of the affiliation, and submit copies of any
agreements between the SEF and third parties that would assist the
applicant in complying with its duties under the CEA.
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\18\ See 75 FR. 67282, 67292 (November 2, 2010).
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Applicants will be required to demonstrate operational capability
through documentation, including technical manuals and third party
service provider agreements. Proposed Sec. 37.3 also requires that
each applicant request and obtain from the Commission a unique,
extensible, alphanumeric code for the purpose of identifying the SEF
pursuant to the swap recordkeeping and reporting requirements under
proposed Part 45.\19\
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\19\ 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. In
particular, the Commission is required to adopt consistent data
element standards for ``registered entities,'' which include SEFs.
Proposed Part 45 will set forth the recordkeeping and reporting
requirements of each SEF with respect to swap transactions on or
through its facility. Proposed Sec. 37.3 codifies the obligation of
SEFs to comply with the provisions of proposed Part 45. See 75 FR
76574 (December 8, 2010).
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ii. Procedures for Temporary Grandfather Relief--Proposed Sec. 37.3(b)
Section 754 of the Dodd-Frank Act provides that: ``[u]nless
otherwise provided in this title, the provisions of this subtitle
[Subtitle A--Regulation of Over-the-Counter Swaps Markets] shall take
effect on the later of 360 days after the date of enactment of this
subtitle [i.e., July 15, 2011], or, to the extent a provision of this
subtitle requires a rulemaking, not less than 60 days after publication
of the final rule or regulation implementing such provision of this
subtitle.''
The Commission anticipates that, upon the effective date of this
Part 37, it may receive a large number \20\ of applications for SEF
registration from entities that currently provide a marketplace for the
listing and trading of swaps. The Commission notes that it would be
difficult to carry out and complete an appropriate and comprehensive
review of all such applications during the period between publication
of the final rulemaking and the effective date of this Part 37. Any
consequent delay in the processing of these SEF applications could
adversely impact SEF applicants, undermine the efficient implementation
of the Dodd-Frank Act, create legal uncertainty for market participants
and adversely affect the swaps market.
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\20\ The Commission notes that although the public estimate
regarding the expected number of applications ranges from 30 to 40,
certain market participants have noted that the number of SEFs could
exceed 100.
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Therefore, proposed Sec. 37.3(b) permits the Commission, upon the
request of an applicant, to grant temporary grandfather relief to
qualifying entities that, due to their operations, will be required to
register as a SEF in order to continue operating as of the effective
date of the regulations. The proposed temporary grandfather relief
would be optional and would enable a qualifying entity to operate
without SEF registration on a short-term basis during the pendency of
the application review process on the condition that it otherwise
operate in conformance with all SEF requirements under the Dodd-Frank
Act. This approach is intended to avoid undue market disruption as well
as to ensure continuity of the business operations of an existing
entity that, at the time that Part 37 becomes effective,\21\ is
providing a marketplace for the trading of swaps. The temporary relief
would also allow the Commission to implement registration requirements
of the Dodd-Frank Act for SEFs while providing the Commission
sufficient time to fully review the application of a SEF. Each SEF that
qualifies for temporary relief would be subject to Section 5h of the
CEA and related regulations during the period in which the Commission
is reviewing the SEF's application of registration.
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\21\ See Section 754 of the Dodd-Frank Act.
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The Commission notes that it previously issued orders providing
grandfather relief to exempt commercial markets (``ECMs'') and exempt
boards of trade (``EBOTs''), allowing them to continue to operate as
EBOTs and ECMs after the effective date of the Dodd-Frank Act (July 15,
2011) (``ECM and EBOT grandfather relief orders'').\22\ The relief
under proposed Sec. 37.3(b) would be consistent with the ECM and EBOT
grandfather relief orders. In addition, the Commission notes that the
grandfather relief under proposed Sec. 37.3(b) would also be available
for entities that are currently operating pursuant to another exemption
or exclusion provided under the CEA (prior to its amendment by the
Dodd-Frank Act) as of the effective date of this Part 37.\23\
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\22\ See Orders Regarding the Treatment of Petitions Seeking
Grandfather Relief for Exempt Commercial Markets and Exempt Boards
of Trade (``ECM and EBOT grandfather relief''). 75 FR 56513
(September 10, 2010). The Commission's Orders set forth various
conditions for such grandfather relief, including the filing of a
relief petition and a SEF or DCM application with the Commission.
\23\ See CEA Sections 2(d), 2(e), 2(g) and 2(h)(1)-(2).
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As a condition for receiving temporary grandfather relief, the
applicant must: (1) File a complete application, as required under
proposed Sec. 37.3(a),\24\ on the proposed application form, Form SEF,
under Appendix A to Part 37; (2) notify the Commission, at the time of
its submission of the application, of its interest in operating under
the temporary relief; (3) provide transaction data that substantiates
that the execution or trading of swaps has occurred and continues to
occur on the applicant's trading system or platform at the time the
applicant submits the request; and (4) provide a certification that the
applicant believes that its operation on a temporary basis will meet
the requirements of Part 37 of the CEA, as adopted by the Commission.
Since the purpose of the temporary relief is to provide an appropriate
process to ensure continuity of the business operations during the
pendency of the review of an application, the temporary grandfather
relief would expire on the earlier of: (i) The date that the Commission
grants or denies registration of the SEF, or (ii) the
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date that the Commission rescinds the temporary relief. Additionally,
the temporary relief would not be a permanent provision of Part 37.
Proposed Sec. 37.3(b) provides for a ``sunset'' provision so that
temporary grandfather relief would terminate 365 days from the
effective date of proposed Sec. 37.3(b).
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\24\ As noted above, the determination of when a submission on
Form SEF is complete is at the sole discretion of the Commission.
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iii. Procedures for Transfer of Registration--Proposed Sec. 37.3(d)
The Commission is proposing Sec. 37.3(d) to formalize the
procedures that a SEF must follow when requesting the transfer of its
registration, 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 SEF's assets
to another legal entity. Under proposed Sec. 37.3(d), the SEF would
submit to the Commission a request for transfer no later than three
months prior to the anticipated corporate change, with a limited
exception.\25\
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\25\ The proposed rule would require that where a SEF 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. 37.3(d) also would require, as a condition of
approval, that the SEF submit a representation that it is in compliance
with the CEA, including the SEF core principles, and the Commission's
regulations. In addition, the SEF would have to submit various
representations by the transferee regarding its duties and obligations.
Proposed Sec. 37.3(d) also provides that the Commission will
review any requests for transfer of registration as soon as
practicable, and such request will be approved or denied pursuant to a
Commission order.
d. Procedures for Listing Products and Implementing Rules--Proposed
Sec. 37.4
Proposed Sec. 37.4 conforms 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),\26\ in the Commission's separate rule
proposal pertaining to ``Provisions Common to Registered Entities.''
\27\
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\26\ Proposed Sec. 40.3 is amended to require additional
information to be provided by registered entities that submit 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.
\27\ 75 FR 67282 (November 2, 2010).
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e. Information Relating to Swap Execution Facility Compliance--Proposed
Sec. 37.5
Under proposed Sec. 37.5(a), upon request by the Commission, a SEF
must file with the Commission certain information related to its
business as a SEF, in the form and manner as specified by the
Commission. Under proposed Sec. 37.5(b), the Commission may demand
that a SEF file a written demonstration regarding its compliance with
any specified core principles. The information requested under proposed
Sec. 37.5(a) and (b) provides for information requests to entities
regarding compliance with the conditions for registration made for any
oversight purpose.\28\
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\28\ In this regard, for example, the Commission may request
SEFs to provide information relating to their operations or their
practices in connection with its general oversight responsibilities
under the CEA, in connection with the Commission's formulation of
statements of acceptable practice, or in connection with a
particular SEF's compliance with particular core principles or other
conditions of its registration.
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The Commission believes that on occasion, SEFs will 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 SEF or the SEF's
ability to comply with the core principles and the Commission's
regulations. The Commission is proposing Sec. 37.5 to ensure that SEFs
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.
Proposed Sec. 37.5(c) would require SEFs to file with the
Commission a notice of the equity interest transfer of ten percent or
more, with certain documents providing information on the transfer, no
later than the business day \29\ following the date on which the SEF
enters into a firm obligation to transfer the equity interest.\30\ The
proposed regulation requires that the SEF 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 proposed Sec. 37.5(c). The SEF must
notify the Commission of the consummation of the transaction on the day
on which it occurs. The proposed regulation will enable staff to
consider whether any conditions contained in an equity transfer
agreement(s) are inconsistent with the self-regulatory responsibilities
of a SEF or with any of the core principles.
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\29\ ``Business day'' is defined in Commission Sec. 40.1.
\30\ 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 swap execution facility. 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 SEF, it may have a more significant voice in the operation of
the SEF 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 SEF, the Commission believes that it is
appropriate to require such SEF to certify after such change that it
continues to comply with all obligations under the CEA and
Commission regulations.
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The Commission believes when there is a 10% or greater change in
ownership, the SEF itself is the more appropriate entity to provide a
certification of its continued compliance with all regulatory
obligations. Accordingly, proposed Sec. 37.5(c)(3) would require that
if there is a change in ownership,\31\ the SEF must certify, no later
than two business days following the date on which the change in
ownership occurs, that the SEF meets all of the requirements of Section
5h of the CEA and the provisions of Part 37 of the Commission's
regulations.
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\31\ 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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Request for Comment:
The Commission notes that there are differences in the proposed
notification requirements for changes in the ownership of SEFs,
derivative clearing organizations (``DCOs''), DCMs, and SDRs.\32\ The
Commission requests comment on the proposed notification requirements
under 37.5(c) and, more specifically, the extent to which there should
be uniformity or differentiation in procedures applied to different
types of registrants.
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\32\ See, supra note 10, DCM NPRM; also the Notice of Proposed
Rulemaking Relating to Swap Data Repositories, approved for
publication by the Commission at an open meeting on November 19,
2010 and expected to be published shortly in the Federal Register
(to be codified at 17 CFR part 49). This Notice is available at
http://www.cftc.gov/stellent/groups/public/@otherif/documents/ifdocs/federalregister112210d.pdf (last visited on Dec. 8, 2010);
and other appropriate future rulemakings.
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[[Page 1218]]
f. Enforceability of Executed Swaps--Proposed Sec. 37.6
Proposed Sec. 37.6 is intended to provide legal certainty to
market participants transacting in swaps. Under Sec. 37.6(a), a
transaction entered into on or pursuant to the rules of a registered
SEF will not be void, voidable, subject to rescission or otherwise
invalidated or rendered unenforceable as a result of: (1) A violation
by the registered SEF of the provisions of Section 5h of the CEA or
Part 37; or (2) any Commission proceeding to alter or supplement a
rule, term or condition under Section 8a(7) of the CEA, to declare an
emergency under Section 8a(9) of the CEA, or any other proceeding the
effect of which is to alter, supplement, or require a registered SEF to
adopt a specific term or condition, trading rule or procedure, or to
take or refrain from taking a specific action.
In other rules proposed by the Commission, a swap confirmation is
defined as the consummation (electronically or otherwise) of legally
binding documentation (electronic or otherwise) that memorializes the
agreement of the counterparties to all of the terms of a swap.\33\
Proposed Sec. 37.6(b) provides that a confirmation must be in writing
(whether electronic or otherwise) and must legally supersede any
previous agreement (electronically or otherwise). For swaps executed on
a SEF, the SEF will provide the counterparties with a definitive
written record of the terms of their agreement, which will serve as a
confirmation of the swap. The proposed regulation on swap confirmations
would require that parties have full written agreement on all terms of
a swap at the same time as execution.
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\33\ See 75 FR 76140 (December 7, 2010); and 75 FR 76574
(December 8, 2010).
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g. Prohibited Use of Data Collected for Regulatory Purposes--Proposed
Sec. 37.7
In fulfilling their regulatory and compliance obligations, the
Commission expects that SEFs will often require market participants to
provide proprietary data or personal information. Proposed Sec. 37.7
prohibits a SEF from using information generated by market participants
for purposes of meeting regulatory and compliance obligations for
marketing products or for other commercial purposes.\34\ The Commission
notes that nothing in this regulation prohibits a SEF from sharing such
information with another SEF or DCM offering swaps for trading for
regulatory purposes.
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\34\ The Commission notes that, in the recent notice of proposed
rulemaking for Business Affiliate Marketing and Disposal of Consumer
Information Rules, it proposed rules prohibiting futures commission
merchants (``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, Proposed Sec. 37.7 is intended to protect
market participants' information provided to a SEF for regulatory
purposes from its use to advance the commercial interests of the
SEF.
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h. Boards of Trade Operating Both a Designated Contract Market and a
Swap Execution Facility--Proposed Sec. 37.8
Proposed Sec. 37.8 implements CEA Section 5h(c) by requiring that
a board of trade that operates a trading facility that has been
designated as a DCM by the Commission and also intends to operate an
entity for the execution or trading of swaps: (1) Must separately
register such entity as a SEF under Part 37; and (2) may use the same
electronic trade execution system for executing swaps that it uses for
its DCM operations, provided that, the entity clearly identifies to
market participants whether the execution or trading of a swaps is
taking place on the DCM or the SEF.\35\
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\35\ Section 5h(c) of the CEA 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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i. Permitted Execution Methods--Sec. 37.9
This rule proposal will provide market participants with the choice
of a number of means to access the market and execute trades therein.
This flexibility would allow market participants to use requests for
quotes, indications of interest, or executable quotes to consummate a
trade. It would allow SEFs to use a variety of different trading
systems or platforms as long as market participants have the ability to
access the market and execute trades as discussed below.
i. SEF Definition
The term `swap execution facility' means a trading system or
platform in which multiple participants have the ability to execute or
trade swaps by accepting bids and offers made by multiple participants
in the facility or system, through any means of interstate commerce,
including any trading facility, that--(A) Facilitates the execution of
swaps between persons; and (B) is not a designated contract market.\36\
---------------------------------------------------------------------------
\36\ CEA Section 1a(50).
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Market participants currently use a number of different methods for
transacting swaps, including: brokers who facilitate trades over the
telephone (commonly referred to as ``voice brokers''); hybrid voice and
electronic trading systems; fully electronic inter-dealer brokerage
systems; single-dealer trading platforms; various versions of ``request
for quote'' platforms (including platforms that allow more than one
customer to submit requests for quotes to, and receive responses from,
multiple dealers); and order books. The Commission does not believe
that all of these methods comply with the statutory definition of a
SEF, especially the ``multiple participant to multiple participant''
requirement thereunder. Specifically, as discussed below, the
Commission notes that entities offering the following services do not
comply with the statutory definition of a SEF: one-to-one voice
services for the execution or trading of swaps (other than for the
execution of block trades),\37\ single-dealer platforms, and services
that solely provide for the processing of swaps.
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\37\ As proposed, a block trade is a swap of a large notional or
principal amount that is transacted off-exchange, pursuant to the
rules of a SEF or DCM, and that is greater than the minimum block
trade size set by the SEF or DCM. As proposed, a SEF or DCM must set
the minimum block size for a particular swap contract at an amount
greater than the appropriate minimum block size for the appropriate
category of swap instrument in which such swap contract is
categorized. See 75 FR 76140 (December 7, 2010).
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The SEF definition requires at a minimum the existence of a
``trading system or platform.'' The Commission notes that the terms
``trading system'' and ``platform'' are not defined under the Dodd-
Frank Act or anywhere in the CEA. Based on the SEF definition under the
Dodd-Frank Act, the Commission interprets trading system and platform
to include, but not be limited to, the term ``trading facility'' as
defined in CEA Section 1a(51).\38\ In addition, as discussed in detail
below, the Commission believes that any other method that allows
multiple market participants to have the ability to execute or trade
swaps by accepting
[[Page 1219]]
bids and offers made by other multiple participants in the facility or
system, through any means of interstate commerce, may qualify as an
acceptable trade execution method for an entity that wishes to register
as a SEF.
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\38\ See CEA Section 1a(51). In this context, a trading facility
requires ``a physical or electronic facility or system in which
multiple participants have the ability to execute or trade
agreements, contracts, or transactions (i) by accepting bids or
offers made by other participants that are open to multiple
participants in the facility or system; or (ii) through the
interaction of multiple bids or multiple offers within a system with
a pre-determined non-discretionary automated trade matching and
execution algorithm.''
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In order for an entity to meet the definition of a SEF and satisfy
the SEF registration requirements, multiple parties must have the
``ability to execute or trade swaps by accepting bids and offers made
by multiple participants'' and such participants must be provided
impartial access to the market. The Commission believes that an
acceptable SEF platform or system must provide at least a basic
functionality to allow market participants the ability to make
executable bids or offers and indicative quotes, and to display them to
multiple parties, including all other parties participating in the SEF,
if the market participants wish to do so. As set forth in proposed
Sec. 37.9(b) and discussed below, the Commission proposes that a SEF
also must provide market participants with the ability to make a bid,
make an offer, hit a bid, or lift an offer, and may provide the ability
to request a bid and request an offer. Accordingly, market participants
would not have to receive a ``request for quote'' \39\ from another
market participant in order to make a bid or offer or to execute a
trade with other market participants. In addition to this basic
functionality whereby market participants would have the ability to
access all other market participants, a SEF could also provide a
multiple-to-multiple request for quote trading system for those market
participants that do not wish to display their bids, offers, or
requests to all other market participants. A SEF's chosen approach(es)
would be described in its registration application, to be evaluated by
the Commission during the application process. Once operational, the
Commission would be able to empirically evaluate the SEF's treatment of
executable bids and offers as compared to responses to requests for
quotes to ensure ongoing compliance with the definition of a SEF, the
SEF registration requirements, and the core principles.
---------------------------------------------------------------------------
\39\ See infra, Section II.C.2.i.v for further discussion of
``request for quote'' systems.
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ii. One-to-One Voice and Single-Dealer Platforms
The Commission notes that one-to-one voice services and single-
dealer platforms do not satisfy the statutory requirement under CEA
Section 1a(50) that ``multiple participants have the ability to execute
or trade swaps by accepting bids and offers made by multiple
participants in the facility or system''. The nature of these types of
trading systems or platforms, where transactions are negotiated or
consummated via a one-to-one or one-to-many basis, do not provide the
ability for participants to conduct multiple-to-multiple execution or
trading. The Commission also notes that CEA Sections 5h(f)(2)(A)(ii)
and (2)(B)(i) require that SEFs provide market participants with
impartial access to their markets, and that SEFs must adopt rules with
respect to any limitations they place on access. Entities operating
either one-to-one voice services or single-dealer platforms, by
definition, limit the provision of liquidity to single dealers or
liquidity providers, thus excluding other participants from filling
those roles, in non-compliance with the impartial market access
requirements applicable to SEFs under the CEA.
iii. Processing of Swaps
In regard to entities that offer, with respect to swaps
transactions, processing services exclusively, the Commission notes
that Section 5h(a)(1) of the CEA states ``[n]o person may operate a
facility for the trading or processing of swaps, unless the facility is
registered as a [SEF] or as a [DCM] under this section.'' In addition,
Section 5h(b) states that a registered SEF may ``(A) make available for
trading any swap, and (B) facilitate trade processing of any swap.''
Although these provisions could be read to require the registration of
entities that engage in trade processing (but not trade execution) as
SEFs, the Commission believes that entities that operate exclusively as
swap processors do not meet the SEF definition (and should not be
required to register as SEFs) because: (1) They do not provide (as
required by the definition) the ability to ``execute or trade'' a swap;
and (2) the definition does not include the term ``process.''
iv. Trading Systems or Platforms
When determining what types of trading systems qualify to register
as a SEF, the Commission takes into account, in addition to
consideration of the SEF definition as discussed above, the core
principles applicable to SEFs \40\ as well as the goals provided in
Section 733 of the Dodd-Frank Act: (1) Bringing greater pre-trade price
transparency to swap transactions; and (2) bringing more swaps trading
onto regulated trading systems or platforms.\41\ Therefore, the
Commission interprets the SEF registration requirements to necessitate
that the trading system or platform: (a) Provide multiple participants
with the ability to make bids and offers to other multiple participants
or to accept bids or offers made by other multiple participants; (b)
promote pre-trade price transparency; (c) ensure that the trading of
swaps on the trading system or platform is in accordance with the SEF
core principles, the registration requirements and the Commission's
regulations; and (d) provide all market participants with impartial
access to the SEF's market.
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\40\ See e.g., Sections 5h(f)(2)(A)(ii) and (2)(B)(i) (Core
Principle 2, requiring the provision of impartial access). See also
infra, Section II.C.2.a. (discussing the provision of impartial
access under to Core Principle 2).
\41\ See CEA Section 5h(e) (Stating twin goals regarding the
promotion of ``the trading of swaps on swap execution facilities''
and ``pre-trade price transparency in the swaps market'').
---------------------------------------------------------------------------
The Commission believes that, to register as a SEF or to maintain
registration, an applicant or SEF must provide market participants with
the ability to make executable quotes on either side of a swap
transaction and to take the opposite side of a trade from participants
who seek to enter into transactions on such contract. The ``multiple
participant to multiple participant'' requirement, when read in
conjunction with the impartial access requirement (i.e., the Core
Principle 2 requirement that the SEF must ``provide market participants
with impartial access to the market'') requires that each SEF provide
any market participant with the ability to make any bid or offer
transparent to all other market participants of the SEF. In addition,
the ``ability to execute or trade'' statutory provision means that the
SEF must provide market participants with the ability to post both firm
and indicative quotes on a centralized screen such that they can be
executed or traded against by other multiple market participants. Under
the proposal, it is a market participant's prerogative to make a bid or
offer available to all other market participants in the trading system
or platform without an invitation to join an auction process. Willing
counterparties should have the ability to execute swap trades by
accepting such bids or offers. The Commission believes there could be a
number of ways for a SEF to provide this functionality, including but
not limited to having an order book.
Additionally, SEFs must make indicative quote functionalities
available, such that market participants could provide non-executable
quotes or indicative quotes through the SEF that are visible and
accessible to all other market participants. Such functionalities could
include electronic,
[[Page 1220]]
streaming indicative quotes, or other methods for providing market
participants with indicative quotes. Indicative quotes provide
additional information about pricing and help inform market
participants as they consider hedging and investment strategies, as
well as when considering whether and how to execute a trade (either
through a request for quote or through an existing executable quote).
The Commission believes that indicative quotes are consistent with the
statute's goal of achieving pre-trade price transparency.
The Commission believes that SEFs can utilize various trading
systems and platforms that provide market participants with the ability
to post executable bids or offers for display to multiple potential
counterparties. A trading system or platform that provides this minimum
multiple-to-multiple functionality, as described above, also may
include other functionalities that provide multiple participants with
the ability to access multiple market participants, but not necessarily
the entire market if the participant so chooses. These may include
certain request for quote systems, as described below, or other systems
that meet the SEF definition and comply with the core principles.\42\
Hence, although at times a market participant may desire to interact
with a limited number of market participants (i.e., fewer than the
entire market) and are permitted to do so under the proposal, market
participants that desire to access the entire market must be provided
with the ability to do so as well.
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\42\ As previously noted, one-to-one voice systems and single-
dealer platforms do not satisfy the listed factors.
---------------------------------------------------------------------------
v. Execution Methods
Proposed Sec. 37.9 will allow market participants to have the
choice of a number of means to access and execute within a SEF's
marketplace. There would not be any requirements for pre-trade
transparency for: (1) Blocks; (2) trades subject to the end user
exceptions; or (3) contracts which are not ``made available for
trading.'' Thus the requirements for pre-trade transparency (e.g.,
posting both firm and indicative quotes on a centralized electronic
screen accessible to all market participants) \43\ for trades executed
on a SEF would only relate in the context of transactions in swaps
which are: (1) Subject to the mandatory clearing requirement; (2)
``made available for trading'' on a SEF; and (3) too small to be a
block trade under part 45. For these three types of transactions, SEFs
could permit their market participants to trade via requests for
quotes, indications of interest, or executable quotes.
---------------------------------------------------------------------------
\43\ See also, proposed Sec. 37.205(b)(1).
---------------------------------------------------------------------------
As stated in the preceding section, Section 5h(e) of the CEA sets
forth Congress' goals with respect to SEFs: The promotion of ``the
trading of swaps on swap execution facilities'' and ``pre-trade price
transparency in the swaps market.'' \44\ The Commission believes that
these goals can be achieved for swap transactions that are subject to
the CEA execution requirements, are made available for trading, and are
not block trades by providing for the execution of such swap
transactions on trading systems or platforms that give market
participants the option to post both firm and indicative quotes or
accept bids and offers that are transparent to the entire market.\45\
---------------------------------------------------------------------------
\44\ See CEA Section 5h(e).
\45\ While currently such systems are often used by traders in
order to account for counterparty risk, it is important to note that
there is no counterparty risk for swaps that are cleared.
---------------------------------------------------------------------------
Under proposed Sec. 37.9, applicants and registered SEFs must
offer trading services to facilitate the ability of market participants
to make executable bids or offers and to display them to multiple
parties. Transactions may be executed by providing market participants
with a number of execution methods from which to choose, including: (1)
``Request for quote'' systems that provide market participants the
ability to interact with multiple participants but less than the entire
market, as described below; (2) systems that allow market participants
to display executable bids and offers on a centralized, electronic
screen to the entire market; or (3) other systems that comply with the
core principles.
Additionally, under the proposal, SEFs must provide a general
timing requirement applicable to traders such as brokers who have the
ability to execute against a customer's trade or are entering a trade
for two customers on opposite sides of the transaction. Under the
proposal, a broker would have to provide a minimum pause before
entering the second side (whether for its own account or for a second
customer), thus ``showing'' other market participants the terms of a
request for quote from its customer, and providing other market
participants the opportunity to join in the trade. The Commission
proposes to require a minimum pause of 15 seconds between entry of two
potentially matching customer-broker swap orders or two potentially
matching customer-customer swap orders on SEFs.
(A) Request for Quote Systems
As proposed by the Commission, the steps taken by market
participants in order to complete a transaction using an acceptable
request for quote system are similar to the steps taken in the
marketplace today (i.e., a market participant transmits a request to
counterparties for bids or offers and chooses to transact with one of
the respondents to the request). However, to ensure that multiple
participants have the ability to reach multiple counterparties, the
Commission proposes to require SEFs to provide that market participants
transmit a request for quote to at least five potential counterparties
in the trading system or platform. The Commission notes that, under the
proposal, acceptable request for quote systems offered by SEFs could be
designed such that requests for quotes are visible to all market
participants with access to the trading system or platform, but should
permit requesters the option of making a request for quote visible to
the entire market. Additionally, the proposal provides that an
acceptable request for quote system may allow for a transaction to be
consummated if the original request to five potential counterparties
receives fewer than five responses.\46\
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\46\ The proposal also provides that request for quote systems
include trading systems or platforms in which multiple market
participants view real-time electronic streaming quotes, both firm
and indicative, from multiple potential counterparties on a
centralized electronic screen, and have the ability to accept a firm
streaming quote and complete the transaction or based on an
indicative streaming quote, issue a request for quote to no less
than five market participants and upon receipt of a responsive
quote, have the option to complete the transaction. See proposed
Sec. 37.9(a)(1)(v).
---------------------------------------------------------------------------
Under the proposal, SEFs that utilize request for quote systems
must also furnish liquidity providers with the ability to post both
executable bids or offers and indicative quotes. The terms of any such
``resting'' executable bids or offers would be displayed to the
requester along with any other specific bids or offers included in the
responses to its request for quote. Upon receipt of the responses and
the appropriate resting bids or offers, the original requester would
have the option to execute the transaction. The Commission believes
that SEFs that utilize request for quote systems must ensure that any
competitive resting bids or offers be taken into account and
communicated to the requester along with any bids or offers included
with responses to requests for quotes. While the Commission does not
believe it appropriate to prescribe a method of integration as part of
this rulemaking,
[[Page 1221]]
the Commission would expect each SEF to describe its chosen integration
mechanism as part of its application.
The Commission believes its proposed approach to the use of request
for quote systems by SEFs is consistent with the statute and promotes:
(a) The ability of multiple participants to make bids and offers to
other multiple participants or to accept bids or offers made by other
multiple participants; (b) pre-trade price transparency; (c) the
trading of swaps on a regulated trading system or platform in
accordance with the registration requirements and the Commission's
regulations; and (d) the ability for all market participants to receive
impartial access to all other market participants. The Commission
further believes that this feature would help encourage price
competition within the market.
(B) ``By Any Means of Interstate Commerce''
For block trades, swaps not subject to clearing, and bespoke or
illiquid swaps, the Commission interprets the statute's language ``by
any means of interstate commerce'' to allow execution methods that may
include voice. This method of execution is consistent with the use of
voice in the futures markets for executing block trades, where in light
of the size of the trades, pre-trade transparency is not required. It
is also possible that a SEF might choose to offer to facilitate
bilateral trading for those transactions not bound by the CEA's
execution requirements and, therefore, the use of voice may be
acceptable. The Commission notes that with respect to these types of
transactions, market participants may have an interest in choosing
their counterparty in light of the credit risk involved. Voice
transactions must be entered into some form of electronic affirmation
system immediately upon execution.
With regard to swaps available for trading that are not blocks,
trading systems or platforms facilitating the execution of such swaps
via voice exclusively are not multiple participant to multiple
participant and do not provide for pre-trade transparency. While not
acceptable as the sole method of execution of swaps required to be
traded on a SEF or DCM, the Commission believes voice would be
appropriate for a market participant to communicate a message to an
employee of the SEF, whether requests for quotes, indications of
interest, or firm quotes. For instance, voice-based communications in
the proposed SEF context may occur in certain circumstances, such as
when an agent: (1) Assists in executing a trade for a client,
immediately entering the terms of the trade into the SEF's electronic
system; or (2) enters a bid, offer or request for quote immediately
into a SEF's electronic multiple-to-multiple trading system or
platform. In all cases, the employee of the SEF must promptly provide
transparency and comply with audit trail requirements, including by the
immediately entering into the trading system or platform any orders or
requests for quote that are immediately executable, or, if not,
immediately creating an electronic record with the order or request for
quote entered into the trading system or platform as soon as
practicable. The core principles and these rules would fully apply to
such communications including but not limited to the transparency,
audit trail, impartial access and standards for requests for quotes.
Request for Comment:
The Commission seeks public comment regarding the trading systems
or platforms described in this section. In addition, the Commission
asks the public to respond to the specific questions below.
Does the proposal appropriately implement the statutory
directive that a SEF provide multiple participants with the ability to
execute or trade swaps by accepting bids and offers made by multiple
participants in the facility or system? If not, how should the
Commission best carry out the intent of Congress in the registration
and oversight of SEFs?
The Commission interprets the ``multiple participant to
multiple participant'' requirement (in conjunction with the impartial
access requirement) as requiring that the facility provide the ability
for any market participant to make any bid or offer transparent to the
entire market, if the market participant chooses to do so. Should the
Commission be explicit as to the means or methods which can be used to
fulfill this functionality? If so, in addition to an order book, what
other means or models should be included in the final regulations?
In light of the ``multiple participant to multiple
participant'' requirement, the Commission has proposed that requests
for quotes be requested of at least five possible respondents. Is this
the appropriate minimum number of respondents that the Commission
should require to potentially interact with a request for quote? If
not, what is an appropriate minimum number? Some pre-proposal
commenters have suggested that market participants should transmit a
request for quote to ``more than one'' market participant. The
Commission is interested in receiving public comment on this matter.
Should the Commission determine that other models of
execution satisfy the statutory ``multiple participant to multiple
participant'' requirement as well as the pre-trade price transparency
and open access policy objectives under the Dodd-Frank Act?
Does the proposal properly implement the provision in the
SEF definition regarding having the ability to execute or trade swaps
``through any means of interstate commerce''?
In general, does the proposal properly implement the CEA's
goal to promote both the trading of swaps on SEFs and pre-trade price
transparency? Should there be other characteristics the Commission
should consider? If so, what are they?
What level of pre-trade transparency should be required to
promote price discovery, competition and the trading of swaps on SEFs?
Should the Commission consider requiring a request for quote method
that provides for transparency in the request for quote process in
addition to the posting of any resting bids/offers on its trading
system or platform? Should all orders and quotes be displayed to all
participants or should alternative engagement rules apply on a pre-
trade basis?
Should SEFs be required to communicate executable bids/
offers to issuers of requests for quotes? Also, should any such
executable bids/offers be provided any priority during the request for
quote process? Should market participants have an obligation to
consider and/or execute against an executable bid/offer if it is
competitive?
Should SEFs be required to make responses to requests for
quotes transparent to all market participants? If so, when should this
information be provided to the market? Prior to execution? At the time
of execution? Subsequent to execution?
Would the SEF provisions in the Dodd-Frank Act support a
requirement that swaps that meet a certain level of trading activity be
limited to trading through order books? If so, what level of trading
activity would be the appropriate level at which to mandate trading
exclusively on an order book? Should any such analysis be done on a
product or asset-class basis?
Should swap processors be subject to the registration
requirements for SEFs?
j. Swaps Made Available for Trading--Proposed Sec. 37.10
The Dodd-Frank Act requires that transactions involving swaps
subject to
[[Page 1222]]
the clearing requirement be executed on a SEF or DCM.\47\ This trade
execution requirement will not apply if (i) the Commission has not made
a determination regarding the clearing requirement with respect to the
swap,\48\ (ii) an eligible counterparty availed itself of an exception
to the clearing requirement and does not wish to transact the swap on a
SEF or DCM, or (iii) no DCM or SEF ``makes the swap available to
trade.'' \49\
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\47\ CEA Section 2(h)(8).
\48\ CEA Section 2(h)(1).
\49\ CEA Section 2(h)(8).
---------------------------------------------------------------------------
The Commission proposes to require SEFs to make periodic
assessments to determine whether a swap has been made available for
trading. To that end, proposed Sec. 37.10 requires each SEF to
annually conduct an assessment and provide a report to the Commission
regarding the determination that the swaps it offers are made available
for trading thereunder. With respect to the determination that swaps
are made available to trade, the SEF may consider frequency of
transactions and open interest, and any additional factors requested by
the Commission.
Request for Comment:
The Commission seeks general public comment regarding the meaning
of ``made available for trading.'' In addition, the Commission asks the
public to respond to the specific questions below.
In addition to the frequency of transactions and open
interest, should the Commission request that SEFs consider the number
of market participants trading a particular swap? If so, should a
minimum number of participants be required, for example, should the
swap be traded by more than two participants? More than three?
Should the Commission request that SEFs consider any other
factors or processes to make the determination that swaps are made
available for trading?
k. Identification of Non-Cleared Swaps or Swaps Not Made Available To
Trade--Proposed Sec. 37.11
The Commission acknowledges that certain market participants may
desire to avail themselves of the benefits of trading on SEFs (e.g.,
automated confirmation of trades, straight-through processing) with
respect to trades that are not otherwise required to be executed on a
SEF or DCM. In particular, market participants might want to effect
swap transactions on SEFs or DCMs regarding swaps that have not been
determined to come under the clearing mandate of Section 2(h) of the
CEA, transactions that are excepted from the clearing requirements as
provided under Section 2(h)(7) of the CEA, and transactions regarding
swaps determined to not be available for trading pursuant to Commission
Sec. 37.10. Proposed Sec. 37.11 requires that if a SEF determines to
provide for trading of swaps that are excepted from the clearing
requirements, the SEF must clearly identify to market participants that
the particular swap is to be transacted pursuant to one of the
applicable exemptions from execution and clearing.
C. Proposed Regulations, Guidance and Acceptable Practices for
Compliance With the Core Principles
As noted above, this rulemaking establishes the relevant
regulations, guidance and acceptable practices applicable to the 15
core principles. As proposed, the regulations applicable to the 15 core
principles are set out in separate subparts to Part 37, Subparts B
through P, which includes a codification within each subpart of the
statutory language of the respective core principle. The guidance and
acceptable practices are set out in Appendix B.
1. Subpart B--Core Principle 1 (Compliance With Core Principles)
Under Core Principle 1, 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 condition of obtaining and maintaining
registration as a SEF.\50\ The Commission proposes to codify the
statutory text of Core Principle 1 in proposed Sec. 37.100. SEFs will
have reasonable discretion in establishing the manner in which they
comply with the core principles.
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\50\ CEA Section 5h(f)(1)(A).
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2. Subpart C--Core Principle 2 (Compliance With Rules)
a. Background
Core Principle 2 requires a SEF to establish and enforce compliance
with its rules,\51\ including by: (1) Establishing various rules to
deter abuses; and (2) having the capacity to detect, investigate, and
enforce such rules.\52\ Similarly, under Core Principle 2, a SEF must
establish and enforce rules to provide any eligible contract
participant (``ECP'') and any independent software vendor (``ISV'')
\53\ with impartial access to the market and to capture information
that the SEF may use in establishing whether rule violations have
occurred.\54\ Additionally, SEF Core Principle 2 requires a SEF to
establish rules governing the operations of the trading platform and
provide rules relating to the mandatory clearing requirement under
Section 2(h)(8).\55\The Commission proposes to implement these
requirements through Sec. Sec. 37.200-37.207.
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\51\ CEA Section 5h(f)(2)(A).
\52\ CEA Section 5h(f)(2)(C) requires SEFs to establish rules
specifying trading procedures to be used in entering and executing
orders traded or posted on the trading platform, including block
trades. The sentence annotated by this footnote also captures 2(B).
\53\ 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.
\54\ CEA Section 5h(f)(2)(B).
\55\ CEA Section 2(h)(8) requires counterparties transacting in
swaps that are subject to the clearing requirement of Section 2(h)
to execute the transaction on a DCM or a SEF, unless no DCM or SEF
``makes the swap available to trade'' or the swap transaction is
subject to the clearing exception under Section 2(h)(7). The
sentence annotated by this footnote captures both 2(C) and 2(D).
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Although SEFs are a new type of regulated exchange, the Commission
notes that the statutory text for SEF Core Principle 2 is largely a
compilation of established regulatory principles applicable to DCMs. As
a result, proposed Sec. Sec. 37.200-37.207, implementing SEF Core
Principle 2, set forth requirements for establishing and enforcing
rules, providing access, conducting trade practice surveillance, and
implementing audit trail requirements and disciplinary rules, that are
analogous to those found in the proposed regulations for DCM Core
Principles 2, 10, and 13. In addition, proposed Sec. Sec. 37.200-
37.207 also address elements of Core Principle 2 that are not
implicated by these DCM core principles.
b. Operation of a Swap Execution Facility and Compliance With Rules--
Proposed Sec. 37.201
Proposed Sec. 37.201 addresses the requirement to establish and
enforce rules. More specifically, the core principle requires that a
SEF establish and enforce compliance with its rules.\56\A SEF is also
required to
[[Page 1223]]
establish rules governing the operation of the trading platform.\57\
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\56\ CEA Section 5h(f)(2)(A)(i).
\57\ CEA Section 5h(f)(2)(C).
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Proposed Sec. 37.201 addresses these elements by requiring SEFs to
establish rules governing the members' and market participants' use of
their markets, including rules specifying trading procedures for
entering and executing orders traded or posted on the trading platform,
including block trades. Proposed Sec. 37.201(b) further requires SEFs
to establish and impartially enforce compliance with the rules of the
SEF, including, but not limited to: (1) The terms and conditions of any
swaps traded or processed on or through the SEF; (2) access rules for
the SEF; (3) trade practice rules; (4) audit trail requirements; (5)
disciplinary rules; and (6) mandatory trading requirements.
c. Access Requirements--Proposed Sec. 37.202
Proposed Sec. 37.202 addresses Core Principle 2's requirement that
SEFs provide any ECP and any ISV with impartial access to the market,
and that they adopt rules with respect to any limitations they place on
access.\58\ In that regard, proposed Sec. 37.202(a) requires a SEF to
provide any ECP and any ISV with impartial access to its market(s) and
market services (including any indicative quote screens or any similar
pricing data displays), which includes establishing criteria that are
impartial, transparent, and applied in a fair and nondiscriminatory
manner and levying equal fees for participants receiving comparable
access to, or services from, the SEF. The purpose of the proposed
impartial access requirements is to prevent a SEF's owners or operators
from using discriminatory access requirements as a competitive tool
against certain participants. Access to a SEF should be determined, for
example, on the SEF's impartial evaluation of an applicant's
disciplinary history and financial and operational soundness against
objective, pre-established criteria. 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 SEF or by showing
that it has clearing arrangements in place with such a clearing member.
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\58\ CEA Section 5h(f)(2)(A)(ii) and (2)(B)(i).
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Proposed Sec. 37.202(b) requires that, prior to granting a
participant access to its markets, a SEF must require each member or
market participant to consent to its jurisdiction.\59\ Finally,
proposed Sec. 37.202(c) requires a SEF to establish and impartially
enforce its rules governing any decision to deny, suspend, or
permanently bar participants' access to the SEF, including when such
decisions are part of a disciplinary or emergency action taken by the
SEF.
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\59\ Consent may be obtained in the form of a written agreement
at the time that a member or market participant is granted access to
the SEF.
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Request for Comment:
The Commission solicits specific public comments regarding the
sufficiency of proposed Sec. 37.202.
In particular, the Commission is interested to know
whether additional regulations are necessary to ensure that a SEF can
assert jurisdiction over any person or entity executing swaps on the
SEF, either for their own account or on behalf of another's account.
The Commission also requests public comments on proposed
Sec. Sec. 37.202(a) and 37.202(c), which are intended to ensure that
similarly situated persons and entities receive equal access to a SEF's
trading platform and services, and that similar access and services be
charged a similar fee.
In addition, the Commission wants to know whether the
proposed regulations seeking to prohibit a SEF from abusing its
authority to deny or suspend access via disciplinary or emergency
procedures are sufficient to prohibit discrimination by a SEF against
competitors or for inappropriate business reasons.
d. Rule Enforcement Program--Proposed Sec. 37.203
Proposed Sec. 37.203 addresses SEF Core Principle 2's requirement
that SEFs establish and enforce trading and trade processing rules that
will deter abuses and have the capacity to investigate and enforce
those rules.\60\
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\60\ CEA Section 5h(f)(2)(B).
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Proposed regulation 37.203(a) addresses abusive trading practices
by requiring SEFs to prohibit specific practices in connection with
intermediated and non-intermediated trading activities,\61\ as well as
any other manipulative or disruptive trading practices prohibited by
the CEA or by the Commission pursuant to Commission regulation.
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\61\ The prohibited practices include: trading ahead of customer
orders, trading against customer orders, accommodation trading, and
improper cross-trading. Specific trading practice violations that
must be prohibited by all SEFs include: Front-running, wash trading,
pre-arranged trading, fraudulent trading, money passes, and any
other trading practices that the SEF deems to be abusive. These
practices are a compilation of abusive trading practices that DCMs
already prohibit, and include trading practices that Congress
expressly prohibited in Section 747 of the Dodd-Frank Act. 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 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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Subsection (b) of the proposed regulation requires that a SEF have
arrangements and resources for effective rule enforcement, including
the authority to collect information and examine books and records of
members and market participants. The Commission believes that SEFs must
have appropriate resources to enforce all of its rules, including the
ability to perform effective trade practice surveillance. Furthermore,
a SEF must have the authority to examine books and records for all
market participants. The Commission believes that a SEF can best
administer its compliance and rule enforcement obligations by having
the ability to reach the books and records of all market participants.
Next, subsection (c) of proposed Sec. 37.203 requires that a SEF
maintain sufficient compliance resources to conduct effective and
timely audit trail reviews, trade practice surveillance, market
surveillance, and real-time monitoring. A SEF must also monitor its
staff size annually to ensure that it is appropriate to effectively
perform those functions. A SEF's staff size also must be sufficient to
address unusual or unanticipated market or trading events while
continuing to effectively conduct routine self-regulatory duties.
Proposed Sec. 37.203 reflects the Commission's belief that sufficient
compliance staff are essential to the effectiveness of a SEF's self-
regulatory program.
While requiring sufficient staff, proposed Sec. 37.203(c) does not
require that staff size be determined based on a specific formula.
Rather, it permits the individual SEF to determine what size staff it
needs to effectively perform its self-regulatory responsibilities.\62\
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\62\ In making this determination, the proposed regulation
requires that a SEF take into account specific facts and
circumstances (e.g., volume of trading, the number of swaps listed,
number of traders, etc.), as well as any other factors suggesting
the need for increased resources. A factor that may suggest the need
for increased compliance resources is a prolonged surge in trading
volume or a prolonged period of price volatility.
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Proposed Sec. 37.203(d) requires SEFs to maintain an automated
trade surveillance system capable of detecting
[[Page 1224]]
and investigating potential trade practice violations. At a minimum, a
SEF's systems must be capable of generating alerts on at least a trade
date plus one day (T+1) basis to help staff focus on potential
violations and anomalies found in trade data.\63\ They must also
provide compliance staff the ability to sort, query and analyze
voluminous amounts of data. In order to detect and prosecute the
abusive trading practices enumerated in proposed Sec. 37.203(a), a
SEF's automated surveillance system must maintain all trade and order
data, including order modifications and cancellations. In addition, a
SEF'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. The
proposed regulation reflects the Commission's belief that a SEF must
have automated surveillance systems that are equivalent to those of a
DCM in order to fulfill its trade practice surveillance requirements.
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\63\ 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 Commission Sec. 37.203(e).
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Subsection (e) of proposed Sec. 37.203 requires SEFs to conduct
real-time market monitoring of all trading activity on its trading
platform, in order to ensure orderly trading and to identify and
correct any market or system anomalies. The Commission's proposed
regulation requires that any price adjustments or trade cancellations
be transparent to the market and subject to clear and fair publicly
available standards.
Next, proposed Sec. 37.203(f) requires SEFs to establish
procedures for conducting investigations and the requirements for an
investigation report. Subsection (f)(1) requires that a SEF have
procedures to conduct investigations of possible rule violations and
subsection (f)(2) requires that an investigation be completed within a
timely manner (generally defined as 12 months after an investigation is
opened, absent mitigating circumstances).\64\
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\64\ Mitigating circumstances may 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.
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Subsections (f)(3) and (f)(4) of proposed Sec. 37.203 set forth
what must be included in an investigation report. Subsection (f)(3)
requires that when compliance staff believes there is a reasonable
basis for finding a violation, the investigation report must include
the potential wrongdoer's disciplinary history. Similarly, subsection
(f)(4) requires that an investigation report include the potential
wrongdoer's disciplinary history when compliance staff recommends that
a warning letter be issued. 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.\65\
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\65\ As noted below in the discussion of proposed Sec.
37.206(n), a SEF'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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Subsection (f)(5) of proposed Sec. 37.203 provides that a SEF may
authorize its compliance staff to issue a warning letter or to
recommend that a disciplinary committee issue a warning letter.
However, the proposed regulation prohibits SEFs from issuing more than
one warning letter, in lieu of stronger disciplinary action, for the
same violation during a rolling 12-month period.\66\
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\66\ For purposes of this regulation, the Commission does not
consider a ``reminder letter'' or such other similar letter to be
any different than a warning letter. 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, whether for the same or similar violations is ever
appropriate. A policy of issuing repeated warning letters to members
and market participants who violate the same or similar rules,
rather than issuing meaningful sanctions, reduces the effectiveness
of a SEF's rule enforcement program.
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Finally, proposed Sec. 37.203(g) requires a SEF to adopt and
enforce any additional rules that it believes are necessary to comply
with the requirements of proposed Sec. 37.203.
Request for Comment:
The Commission requests public comment on proposed Sec. 37.203.
In particular, the Commission requests public comment on
the abusive trading practices enumerated in subsection 37.203(a). These
practices are identical to the abusive trading practices prohibited in
DCM trading.
The Commission also solicits comments regarding the types
of abusive trading practices that should be prohibited on a SEF's
trading platform, particularly whether SEFs and DCMs are likely to face
similar types of trading abuses by market participants, whether
additional or different trading practices should be prohibited on a
SEF, and whether SEFs should be required to have the same types of
trade practice surveillance and real-time market monitoring programs as
DCMs.
Finally, the Commission requests comments on whether the
investigatory reports prepared by DCM compliance staff as a prelude to
formal disciplinary proceedings, and included in these proposed
regulations, are needed within SEFs.
e. Regulatory Services Provided by a Third Party--Proposed Sec. 37.204
Proposed Sec. 37.204 permits a SEF to utilize the services of a
registered futures association or another registered entity for
assistance in performing certain self-regulatory functions.\67\
However, SEFs remain responsible for the execution of these functions
and for compliance with their associated core principles. In this
regard, the Commission notes that the Dodd-Frank Act does not confer on
SEFs the same right to delegate certain core principle compliance
functions as that conferred to DCMs, pursuant to Section 5c(b) of the
CEA.
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\67\ Self-regulatory functions include, for example, trade
practice surveillance; market surveillance; real-time market
monitoring; investigations of possible rule violations; and
disciplinary actions.
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The proposed regulation requires that any SEF that contracts with a
third-party regulatory service provider ensure that the provider has
sufficient capacity and resources to render timely and effective
regulatory services. The SEF must also oversee the quality of
regulatory services provided on its behalf, and must retain exclusive
authority with respect to all substantive decisions made by its
regulatory service provider.\68\ The proposed regulation also specifies
that any instances where a SEF's actions differ from those recommended
by its regulatory provider must be documented and explained in writing.
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\68\ Such decisions include, but are not limited to, those
involving the cancellation of trades, the issuance of disciplinary
charges against members or market participants, denials of access to
the trading platform, and any decision to open an investigation into
a possible rule violation.
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Request for Comment:
The Commission requests public comment on proposed Sec. 37.204.
In particular, the Commission requests comments on the
supervisory and decision-making relationship that should exist between
a SEF and a third-party regulatory service provider.
The Commission also seeks public comment on the types of
information that SEFs and their regulatory service providers should be
required to share with other SEFs and regulatory service providers, in
order to conduct effective surveillance of fungible swap products
trading on multiple SEFs.
[[Page 1225]]
Finally, because SEFs are not permitted to delegate core
principle compliance functions, as are DCMs, are there any additional
conditions that the Commission should impose on SEFs' use of third-
party regulatory service providers?
f. Audit Trail Requirements--Proposed Sec. 37.205
Proposed Sec. 37.205 addresses SEF Core Principle 2's requirements
that a SEF be able to capture information that may be used to determine
whether rule violations have occurred.\69\ Proposed Sec. 37.205
requirements are akin to the DCM regulations addressing audit trail
requirements.\70\
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\69\ CEA Section 5h(f)(2)(B)(ii).
\70\ For further explanation of the elements of an effective
audit trail, see supra note 10, DCM NPRM.
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Proposed Sec. 37.205 requires that a SEF establish an audit trail,
and sets forth the elements of an effective audit trail and the
requirements for effective audit trail enforcement.\71\ The Commission
believes that these requirements will help to ensure that SEFs can
appropriately monitor and investigate any potential customer and market
abuse. Additionally, the audit trail data captured by SEFs must be
sufficient to reconstruct all transactions promptly, and to provide
evidence of any rule violations that may have occurred.
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\71\ Subsection (a) of the proposed regulation establishes the
overarching requirements for SEFs' audit trail programs, while
Subsection (b) prescribes the four elements of an acceptable audit
trail program and Subsection (c) prescribes the elements of an
effective audit trail enforcement program.
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Subsection (b)(1) of the proposed regulation requires that a SEF'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 unique account identifier that relates to the account
owner, and the time of the order entry. Subsection (b)(2) of the
proposed regulation requires that a SEF's audit trail program include a
transaction history database to facilitate rapid access and analysis of
all original source documents. Subsection (b)(2) also specifies the
trade information that must be included in a transaction history
database.\72\ Subsection (b)(3) of the proposed regulation requires
that a SEF's audit trail program have electronic analysis capability
for all data in its transaction history database and enable the SEF to
reconstruct trades in order to identify possible rule violations.
Subsection (b)(4) requires that a SEF'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 SEF Core Principle 10
and its associated regulations. Safe storage capability also requires a
SEF to protect its audit trail data from unauthorized alteration,
accidental erasure or other loss.
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\72\ For example, mandatory information includes a history of
all orders and trades; all data input in the trade matching system
for purposes of clearing; the categories of participant for which
each trade is executed (i.e., the customer type indicator or ``CTI''
codes); timing and sequencing data sufficient to reconstruct
trading; and identification of each account to which fills are
allocated.
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Subsection (c) of proposed Sec. 37.205 is organized in two parts.
First, subsection (c)(1) requires that a SEF develop an effective audit
trail enforcement program, which must, at a minimum, review all members
and market participants annually to verify their compliance with all
applicable audit trail requirements. Subsection (c)(1) also sets forth
minimum review criteria for an electronic trading audit trail that must
be carried out by each SEF. Finally, subsection (c)(2) requires that
SEFs develop programs to ensure effective enforcement of their audit
trail and recordkeeping requirements, including a requirement that SEFs
levy meaningful sanctions when deficiencies are found. Sanctions may
not include more than one warning letter or other non-financial
penalty, in lieu of stronger disciplinary action, for the same
violation within a rolling twelve-month period.
Request for Comment:
The Commission seeks public comment on the proposed audit trail and
audit trail enforcement requirements for SEFs.
The Commission seeks specific public comment on whether
such requirements should be similar for both SEFs and DCMs.
Should SEFs be subject to additional requirements beyond
the proposed regulations? Are there elements of the proposed
regulations that are inappropriate for SEFs?
For example, is the CTI code system used by DCMs to denote
different types of futures participants also necessary for swap
transactions on SEFs?
What specific data points should a SEF's audit trail
enforcement program seek to verify?
g. Disciplinary Procedures and Sanctions--Proposed Sec. 37.206
Proposed Sec. 37.206 addresses SEF Core Principle 2's requirement
that SEFs establish and enforce participation rules to deter abuse, and
have the capacity to investigate and enforce such abuses.\73\
Subsection (a) of the proposed regulation requires that a SEF establish
and maintain sufficient enforcement staff and resources to effectively
and promptly prosecute possible rule violations within the jurisdiction
of the SEF. Subsection (a) also provides that a SEF's enforcement staff
may not include members of the SEF 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 SEF. These provisions seek to
ensure the independence of enforcement staff, and help promote
disciplinary procedures that are free of potential conflicts of
interest.
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\73\ See CEA Section 5h(f)(2)(B). In general, the proposed
regulations addressing disciplinary procedures for SEFs parallel the
disciplinary procedure regulations for DCMs. The proposed
regulations pursuant to DCM Core Principle 13 are also similar to
the text of the disciplinary procedures in part 8, which the
Commission found to be the model for many DCMs' disciplinary
programs. 17 CFR 8.01 et seq. DCMs were exempt from Part 8 pursuant
to Sec. 38.2; however, the predecessor DCM Core Principle 13
offered the disciplinary procedures in Part 8 as an example of
appropriate disciplinary procedures.
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Subsection (b) requires SEFs to establish one or more Review Panels
and one or more Hearing Panels (together, ``disciplinary panels'').
Neither panel may include members of the SEF's compliance staff or any
person involved in adjudicating any other stage of the same
proceeding.\74\ The proposed regulation provides that a Review Panel
must be responsible for determining whether a reasonable basis exists
for finding a violation of SEF rules, and for authorizing the issuance
of a notice of charges, while a separate Hearing Panel must be
responsible for adjudicating the matter and issuing sanctions.\75\
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\74\ Disciplinary panels must also adhere to the composition
requirement of Sec. 40.9(c)(3)(ii), as proposed, which 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 63752
(October 18, 2010).
\75\ The Commission notes that, while proposed Sec. 37.206(b)
requires SEFs to empanel distinct bodies to issue charges and to
adjudicate charges in a particular matter, SEFs 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. The purposes of separate
Review and Hearing Panels is to help ensure adjudication of
disciplinary matters by separating a decision to issue charges from
a hearing on the merits of a matter.
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[[Page 1226]]
Subsection (c) of the proposed regulation requires a Review Panel
to promptly review an investigation report received pursuant to
proposed Sec. 37.203(f)(3), and to take action within 30 days of
receipt. The Commission believes that prompt disciplinary action
provides the best opportunity for witnesses to recall conversations,
facts, and other information relevant to the matter, and transmits a
clear signal to the market and to market participants that violations
of exchange rules will not be tolerated. Subsection (c) also specifies
the range of actions which a Review Panel may take upon receiving a
completed investigation report. Subsection (d) describes the minimally
acceptable contents of any 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(s) alleged to have been violated; and prescribe the period within
which a hearing may be requested. Further, the notice must advise the
respondent charged that he or she is entitled, upon request, to a
hearing on the charges.\76\ Subsection (e), in turn, specifies a
respondent's right to be represented by any counsel or representative
of his choosing upon receiving a notice of charges and in all
succeeding stages of the disciplinary process. Subsection (f) requires
that a respondent must be given a reasonable period of time to file an
answer to a charges.\77\ Subsection (g) provides that, if a respondent
admits or fails to deny any of the alleged violations a Hearing Panel
may find that the violations admitted or not denied have been
committed.\78\ Subsection (h) requires 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.
37.206(g), the respondent must be given the opportunity for a hearing
in accordance with the requirements of proposed Sec. 37.206(j).
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\76\ The proposed regulations permit a SEF to adopt rules
providing that the failure to request a hearing within the time
prescribed in the notice, except for good cause, must be deemed a
waiver of the right to a hearing and that the failure to answer or
deny expressly a charge must be deemed to be an admission of such
charge.
\77\ Subsection (f) also permits a SEF, through its rules, to
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.
\78\ In addition, if a SEF adopts a rule concerning the
admission or failure to deny charges pursuant to Proposed Sec.
37.206(f), then Subsections (g)(1) through (g)(3) of the proposed
regulation provide that: (1) The Hearing Panel must impose a
sanction for each violation found to have been committed; (2) the
SEF 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 SEF 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.
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Subsection (i) provides the procedures a SEF must follow when it
settles a disciplinary case. The provision states that the rules of a
SEF 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.
Subsection (i) requires a disciplinary panel that accepts a settlement
offer to 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.
Significantly, proposed Sec. 37.206(i)(3) also provides that if an
offer of settlement is accepted without the agreement of a SEF's
enforcement staff, the decision must carefully explain the panel's
acceptance of the settlement.\79\
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\79\ Subsection (i) 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.
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Subsection (j) requires a SEF to adopt rules that provide certain
minimum requirements for any hearing conducted pursuant to a notice of
charges. In general, Subsections (j)(1)(i) through (j)(1)(vi) require
that the SEF: (1) Provide a fair hearing; (2) permit respondents to
examine evidence relied on by enforcement staff in presenting the
notice of charges; (3) require enforcement and compliance staffs to be
parties to the hearing and enforcement staff to present their case on
those charges and sanctions that are the subject of the hearing; (4)
permit respondents to appear personally at the hearing, to cross-
examine and call witnesses and to present evidence; (5) require that
persons within its jurisdiction who are called as witnesses participate
in the hearing and produce evidence; and (6) transcribe and retain a
copy of the hearing. Additionally, subsection (j)(2) specifies that the
rules of the SEF may provide that a sanction be summarily imposed upon
any person within its jurisdiction whose actions impede the progress of
a hearing.
Subsection (k) details the procedures that a Hearing Panel must
follow in rendering disciplinary decisions. The provision requires that
all decisions include: (1) A notice of charges or a summary of the
charges; (2) an 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 bases for such findings and
conclusions with respect to each charge; (5) an indication of each
specific rule 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.
Subsection Proposed Sec. 37.206(l) provides the procedures that a
SEF must follow in the event that the SEF's rules authorize an appeal
of adverse decisions in all or in certain classes of cases.\80\
Notably, the proposed Sec. requires a SEF that permits appeals by
disciplinary respondents to also permit appeals by its enforcement
staff. This provision reflects the Commission's belief that SEF
enforcement staff must have the discretion to appeal disciplinary panel
decisions that, for example, do not adequately sanction a respondent's
violative conduct. Subsection (m) requires that each SEF establish
rules setting forth when a decision rendered under this subsection C
will become the final decision of the SEF.
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\80\ For SEFs that permit appeals, the language in subsections
(l)(1) through (l)(4) of proposed Sec. 37.206 generally require the
SEF to: (1) Establish an appellate panel that is authorized to hear
appeals; (2) ensure that the appellate panel composition is
consistent with Sec. 40.9(c)(3)(iii) and not include any members of
the SEF's compliance staff, or any person involved in adjudicating
any other stage of the same proceeding; (3) except for good cause
shown, the appeal or review must be conducted solely on the record
before the Hearing Panel, the written exceptions field by the
parties, and the oral or written arguments of the parties; and (4)
promptly following the appeal or review proceeding, the board of
appeals must issue a written decision and provide a copy to the
respondent. The Commission notes that a respondent has certain
rights of appeal to the Commission under Part 9 of the Commission's
regulations.
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Subsection (n) requires that every disciplinary sanction imposed by
a SEF must be commensurate with the
[[Page 1227]]
violations committed and must be clearly sufficient to deter recidivism
or similar violations by other market participants. Additionally, the
proposed regulation requires that, in the event of demonstrated
customer harm, any disciplinary sanction must include full customer
restitution. In evaluating appropriate sanctions, the proposed
regulation requires the SEF to take into account a respondent's
disciplinary history.\81\
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\81\ Proposed Sec. 37.203(f)(3) also 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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Subsection (o) permits a SEF 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. The
proposed regulation makes clear that a SEF 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 regulation
specifies that a summary fine schedule must provide for progressively
larger fines for recurring violations. The Commission believes that
these provisions will serve to discourage recidivist behavior.
Finally, subsection (p) provides that a SEF may impose an immediate
sanction upon a reasonable belief that such action is necessary to
protect the best interest of the marketplace. The proposed regulation
also provides that any emergency action taken by the SEF must be
performed in accordance with certain procedural safeguards.
Request for Comment:
The Commission seeks public comment on proposed Sec. 37.206.
In particular, comments should address whether SEFs should
be subject to the detailed disciplinary procedures proposed herein. The
proposed disciplinary procedures emphasize procedural safeguards for
respondents, including a clear separation between SEF personnel
recommending the issuance of charges, review panels determining whether
charges should be issued, and hearing panels adjudicating cases on the
merits. Are these disciplinary procedures sufficient for SEFs? Or,
should SEFs instead utilize a more streamlined disciplinary process
that features, for example, a robust staff summary fine program rather
than formal disciplinary hearings.
Finally, given the significant financial resources of the
ECPs conducting swap transactions on SEFs, should Commission
regulations provide more detailed guidelines on the appropriate size of
any financial penalties levied by SEFs for violative conduct? Should
any such guidelines take cognizance of the financial resources of
potential respondents?
h. Swaps Subject to Mandatory Clearing--Proposed Sec. 37.207
Proposed Sec. 37.207 mandates that SEFs provide rules that require
swap dealers or major swap participants, who trade a swap subject to
the mandatory clearing requirement under Section 2(h)(1), to execute
the transaction on either a DCM or a SEF. However, swap dealers or
major swap participants are not required to execute such transactions
if no DCM or SEF makes the swap available to trade.
3. Subpart D--Core Principle 3 (Swaps Not Readily Susceptible to
Manipulation)
Under Core Principle 3, Congress required that SEFs offer for
trading swaps that are not readily susceptible to manipulation. The
Commission notes that the statutory language of Core Principle 3 is
substantively identical to the counterpart core principle under Section
5(d)(3) of the CEA as applicable to DCMs. Historically, DCMs complied
with the requirements of Section 5(d)(3) by using as guidance the
provisions of Guideline No. 1, contained in Appendix A to Part 40. In a
separate release, the Commission proposes certain revisions to the
former Guideline No. 1, including: (i) Amending the provisions to
include swap transactions, (ii) re-titling the guidance as
``Demonstration of compliance that a contract is not readily
susceptible to manipulation,'' and (iii) re-designating the guidance to
be included under Appendix C to Part 38.\82\
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\82\ See, supra note 10, DCM NPRM.
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Accordingly, proposed Sec. 37.301 requires that, applicants and
SEFs must provide to the Commission the information required under
Appendix C to Part 38 for purposes of demonstrating to the Commission
that their swap contracts are not readily susceptible to manipulation.
Under Appendix B to Part 37, the guidance for compliance with Core
Principle 3 focuses on the selection and construction of the price
index on which the swaps' cash flows are based. If obtained from a
private third-party, the company should be independent and reputable.
Moreover, the third party should use a sound, well-documented
methodology that protects the index from manipulation. If the SEF
itself determines the price index, then it should take precautions to
safeguard against attempts to artificially influence the index. In this
regard, if the price index is based on a survey of cash market sources,
then the SEF 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 commercial users).
4. Subpart E--Core Principle 4 (Monitoring of Trading and Trade
Processing)
Under Core Principle 4, Congress required that SEFs must take an
active role in preventing manipulation, price distortion and
disruptions of the delivery or cash settlement process. Accordingly,
the proposed regulations under Subpart E of Part 37 clarify the related
responsibilities for applicants and SEFs to monitor trading activities
and prevent market disruptions.
a. General Requirements--Proposed Sec. 37.401
Proposed Sec. 37.401 requires that applicants and SEFs must
collect, monitor and evaluate data to detect and prevent manipulative
activity. Proposed Sec. 37.401 also requires that applicants and SEFs
have the ability to conduct real-time monitoring of trading and
comprehensive and accurate trade reconstructions.
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 markets with high transaction volume and a large number
of trades unless the SEF has installed automated trading alerts to
detect many types of potential violations of exchange or Commission
rules. Accordingly, the Commission proposes in Sec. 37.401 to require
that, where the SEF cannot reasonably demonstrate that its manual
processes are effective in detecting and preventing abuses, the SEF
must implement automated trading alerts to detect potential problems.
[[Page 1228]]
Request for Comment:
The Commission seeks public comment on whether in any rule the
Commission may adopt in this matter, SEFs 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.
b. Additional Requirements for Physical-Delivery Swaps--Proposed Sec.
37.402
For physical delivery swaps, proposed Sec. 37.402 requires that
SEFs monitor each swap's terms and conditions as well as take
meaningful corrective action to allow market participants to continue
to use the market to make sound hedging decisions and for price
discovery.
c. Additional Requirements for Cash-Settled Swaps--Proposed Sec.
37.403
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.
The Commission believes that in such situations SEFs must monitor
trading in the market to which its swap is linked. Accordingly,
proposed Sec. 37.403 requires that, where a swap is settled by
reference to the price of an instrument traded in another venue the SEF
must either have an information sharing agreement with the other venue
or be able to independently determine that positions or trading in the
reference instrument are not being manipulated to affect positions or
trading in its swap.
d. Ability To Obtain Information--Proposed Sec. 37.404
To ensure that SEFs have the ability to properly assess the
potential for price manipulation, price distortions, and the disruption
of the delivery or cash-settlement process, proposed Sec. 37.404
provides that SEFs require that traders in their market keep and make
available records of their activity in underlying commodities and
related derivatives markets and swaps.
e. Risk Controls for Trading--Proposed Sec. 37.405
Proposed Sec. 37.405 requires that a SEF 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. In order to prevent market
disruptions due to sudden volatile price movements, proposed Sec.
37.405 requires SEFs 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. Such risk controls 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 swap is linked to, or a
substitute for, other swaps on the SEF or other trading venues,
including where a swap is based on 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 SEFs to facilitate orderly markets. These basic risk
controls also have proven to be effective and necessary in preventing
market disruptions. 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,\83\ maximum order size
limits,\84\ stop loss order protections,\85\ kill buttons,\86\ and
others.
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\83\ 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.
\84\ Maximum order size limitations would prevent entry into the
trading system of an order that exceeds a maximum quantity
established by the SEF.
\85\ 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.
\86\ Kill buttons would give clearinghouses associated with a
SEF 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. See FIA Market Access Risk
Management Recommendations, p. 10 (April 2010).
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Request for Comment:
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:
Which risk controls should be mandated and how?
What types of pauses and halts are necessary and
appropriate for particular market conditions?
What other risk controls are appropriate or necessary to
reduce the risk of market disruptions?
f. Trade Reconstruction--Proposed Sec. 37.406
Under Core Principle 4, Congress required that SEFs have the
ability to comprehensively and accurately reconstruct all trading on
its facility. Proposed Sec. 37.406 sets forth this requirement,
including the requirement that audit-trail data and reconstructions be
made available to the Commission upon request.
g. Additional Rules Required--Proposed Sec. 37.407
Proposed Sec. 37.407 requires SEFs to adopt and enforce any
additional rules that it believes are necessary to comply with the
requirements of Subpart E.
5. Subpart F--Core Principle 5 (Ability To Obtain Information)
The proposed regulations under Subpart F require an applicant and a
SEF to have the ability and authority, necessary Core Principle 5, to
obtain necessary information to perform its obligations.
6. Subpart G--Core Principle 6 (Position Limits or Accountability)
Under Core Principle 6, Congress required that SEFs adopt for each
swap, as is necessary and appropriate, position limits or position
accountability. In addition, Congress required that, for any contract
that is subject to a Federal position limit under CEA Section 4a(a),
the SEF shall set its position limits at a level no higher than the
position limitation established by the Commission in its Part 151
regulations. Proposed Sec. 37.601 requires that each SEF must comply
with the requirements of Part 151 in order to be in compliance with
Core Principle 6.
[[Page 1229]]
7. Subpart H--Core Principle 7 (Financial Integrity of Transactions)
Proposed Sec. 37.700 sets out the financial integrity requirements
for transactions on a SEF, as required under Core Principle 7. Under
such core principle, a SEF must establish and enforce rules to ensure
the financial integrity of swaps entered on or through the facilities
of the SEF, including the clearing and settlement of the swaps. The
requirements of proposed Sec. 37.700 depend, in part, on whether the
swap is cleared.\87\
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\87\ The Commission interprets the mandatory clearing
requirement in Section 723(a)(3) of the Dodd-Frank Act 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. 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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Under proposed Sec. 37.702(a), a SEF must ensure that all its
members meet the definition of ``eligible contract participant'' under
CEA Section 1(a)(18). Under proposed Sec. 37.702(b), for swaps cleared
by a DCO, a SEF must ensure that it has the capacity to route
transactions to the DCO. With respect to swaps that are not required to
be cleared, a SEF must impose additional requirements to ensure the
financial integrity of the transaction,\88\ including requiring the
transacting member to have entered into a credit arrangement for the
transaction, demonstrate an ability to exchange collateral, and have
appropriate credit filters in place. The Commission believes that these
additional requirements are necessary in light of the fact that
uncleared swaps will not have the risk management protections of a DCO.
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\88\ Separately, if the SEF determines to allow swap
transactions that are not cleared, the SEF must have provisions to
determine that the swap meets the exemption to the clearing
requirement provided under section 2(h)(7) of the CEA, as amended by
the Dodd-Frank Act.
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The Commission requests comment on whether these standards are
appropriate financial integrity safeguards for SEFs. Specifically, the
Commission solicits comment regarding how SEF members would demonstrate
sufficient credit documentation and ability to exchange collateral.
Request for Comment:
The Commission seeks public comment on the proposed rule, and
specifically on the following questions:
Whether SEFs should provide additional controls to permit
FCMs to manage their risks? If so, what specific direct access controls
and procedures should SEFs implement?
Should such controls be mandatory?
8. Subpart I--Core Principle 8 (Emergency Authority)
Under Core Principle 8, a SEF must provide for emergency
situations. Based upon its experience with DCMs, and in recognition of
the fact that individual SEFs may have different approaches to handling
emergency action, proposed Sec. 37.801 refers to the guidance in
Appendix B to Part 37 to demonstrate compliance with Core Principle 8.
The guidance reflects the Commission's belief that there should be
an increased emphasis on cross-market coordination of emergency actions
and SEFs should have alternate lines of communication and approval
procedures in order to address emergencies in real time.
The Commission's experience has demonstrated that there are some
specific requirements that at a minimum should be followed and these
requirements are incorporated under the proposed guidance.
Specifically, the SEF should have procedures and guidelines for
decision-making and implementation of emergency intervention in the
market. The SEF should have the authority to perform various actions,
including without limitation: Liquidating or transferring open
positions in the market,\89\ suspending or curtailing trading in any
swap, and taking such market actions as the Commission may direct. In
addition, the guidance notes that SEFs must provide prompt notification
and explanation to the Commission of the exercise of emergency
authority, and that information on all regulatory actions carried out
pursuant to a SEF's emergency authority should be included in a timely
submission of a certified rule.
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\89\ 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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9. Subpart J--Core Principle 9 (Timely Publication of Trading
Information)
Under Core Principle 9, Congress required that SEFs make available
to the public timely information on price, trading volume, and other
trading data on swaps to the extent prescribed by the Commission.
Congress also required a SEF to have the capability of electronically
capturing trade information for those transactions that occur on the
trading system or platform. These matters are addressed in separate
releases.\90\ Proposed Sec. 37.901 requires that SEFs comply with the
real-time swap reporting and swap reporting and recordkeeping
requirements being separately proposed by the Commission.
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\90\ See, supra note 10, DCM NPRM; 75 FR 76140 (December 7,
2010); and 75 FR 76574 (December 8, 2010).
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Request for Comment:
In order to address all relevant considerations with respect to the
reporting requirements of Core Principle 9, the Commission seeks
general comments and asks the public to respond to the specific
questions below.
For interest rate swaps, because the term life on an
interest rate swap can be one of a large number of possible periods
along a yield curve, what would be an appropriate manner to display
prices?
Would prices for interest rate swaps be meaningful or
misleading and why?
If the prices are misleading, what useful information
should be displayed at the end of the trading day?
Please identify any other swap products that have similar
price reporting issues and address how the prices for that product
should be reported to provide a summary of the trading for that day.
10. Subpart K--Core Principle 10 (Recordkeeping and Reporting)
Core Principle 10 establishes a three-part recordkeeping and
reporting requirement applicable to all SEFs, which the Commission
proposes to implement through proposed Sec. Sec. 37.1001-37.1003.\91\
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\91\ CEA Section 5h(f)(10)(A) requires all SEFs to: Maintain
records of all activities relating to the business of each SEF,
including a complete audit trail, for a period of at least five
years; report to the Commission, in a form and manner acceptable to
the Commission, such information as the Commission determines to be
necessary or appropriate; and keep records relating to swaps defined
in CEA Section 1a(47)(A)(v) open to inspection and examination by
the Securities and Exchange Commission. CEA Section 5h(f)(10)(B)
requires the Commission to ``adopt data collection and reporting
requirements for swap execution facilities that are comparable to
corresponding requirements for derivatives clearing organizations
and swap data repositories.'' The Commission's data standards are
included in proposed rules in Part 45 of the Commission's
regulations.
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Proposed Sec. 37.1001 largely codifies the statutory language of
Core Principle 10. In addition, it clarifies that investigatory and
disciplinary files are included in the records that a SEF must
maintain, and requires that a SEF comply with the recordkeeping
requirements of Sec. 1.31.\92\
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\92\ The Commission notes that it has always considered audit
trails and investigatory and disciplinary files as a part of the
records which a DCM is required to maintain and which the Commission
is permitted to request and to examine. In this respect, the
proposed regulation merely codifies existing Commission practice.
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By incorporating Sec. 1.31, proposed Sec. 37.1001 effectively
requires that SEF books and records be readily accessible for the first
2 years of the minimum 5-
[[Page 1230]]
year statutory period and be open to inspection by any representatives
of the Commission or the United States Department of Justice.\93\ The
SEF, at its own expense, must promptly provide either a copy or the
original books or records upon request.
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\93\ Proposed Sec. 37.1001 also effectively incorporates Sec.
1.31(b)'s description of the permissible methods of storing books
and records. Consequently, a SEF may store its books and records as
prescribed by Sec. 1.31(b)(1)(ii). 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 * * *.''
SEFs must, at all times, have the facilities to immediately produce
and be prepared to present legible hard-copy images of such records.
Additionally, SEF'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. SEFs
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.
Proposed Sec. 37.1001 also incorporates Sec. Sec. 1.31(c) and
1.31(d), which expand upon the requirements established by proposed
Sec. 37.1001. Section 1.31(c) requires that record-keepers who
employ an electronic storage system certify with 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. Finally,
proposed Sec. 37.1001 also requires that SEFs comply with the
recordkeeping requirements applicable to swaps in proposed Part 45.
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The statutory regime for SEFs established by the Dodd-Frank Act
envisions ongoing Commission oversight of SEFs and their trading
activity. Such oversight will resemble, in concept, the oversight
already conducted by the Commission with respect to DCMs. Accordingly,
proposed Sec. 37.1002 requires that SEFs report to the Commission any
information necessary or appropriate for the Commission to perform its
oversight duties. The proposed regulation does not articulate specific
information that must be provided to the Commission; instead, it
establishes the general requirement that SEFs must provide any relevant
data requested by the Commission in a form and manner acceptable to the
Commission.\94\
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\94\ The Commission anticipates that the records it will
routinely request will include, for example, daily trading records,
board of directors' meeting minutes, investigatory and disciplinary
files, information regarding resources allocated to compliance
functions, and other records used in the Commission's trade practice
surveillance program and rule enforcement review program.
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Proposed Sec. 37.1003 codifies Core Principle 10's statutory
requirement that a SEF keep any records relating to security-based swap
agreements defined in Section 1a(47)(A)(v) of the CEA open to
inspection and examination by the Securities and Exchange Commission
(``SEC'').\95\
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\95\ CEA Section 5h(f)(10)(A)(iii).
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11. Subpart L--Core Principle 11 (Antitrust Considerations)
Core Principle 11 governs the antitrust obligations of SEFs.\96\
This SEF core principle is substantially similar to DCM Core Principle
19.\97\ The Commission believes that the existing guidance applicable
to DCM Core Principle 19 remains appropriate. Accordingly, the
Commission proposes to codify the statutory text of Core Principle 11
into proposed Sec. 37.1100. Additionally, proposed Sec. 37.1101
refers applicants and SEFs to the guidance in Appendix B to Part 37 for
purposes of demonstrating compliance with proposed Sec. 37.1100.
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\96\ Part 38 contains guidance governing compliance with former
Core Principle 18. 17 CFR part 38, App. B.
\97\ Prior to the Dodd-Frank Act, the DCM core principle on
antitrust considerations was numbered as DCM Core Principle 18.
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12. Subpart M--Core Principle 12 (Conflicts of Interest)
Core Principle 12 governs conflicts of interest. Like Core
Principle 11, Core Principle 12 is substantially similar to both the
DCM and the DCO conflicts of interest core principles, as amended by
the Dodd-Frank Act.\98\ As a result, the Commission proposes to handle
Core Principle 12 consistent with its handling of those DCM and DCO
core principles. This release proposes to codify the statutory text of
the core principle in proposed Sec. 37.1200. 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.'' \99\
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\98\ DCM Core Principle 16 and DCO Core Principle P, both as
amended by the Dodd-Frank Act.
\99\ 75 FR 63732 (October 18, 2010).
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13. Subpart N--Core Principle 13 (Financial Resources)
Core Principle 13 requires that a SEF have adequate financial
resources to discharge its responsibilities. In particular, SEFs must
maintain financial resources sufficient to cover operating costs for a
period of at least one year, calculated on a rolling basis.
a. General Rule
Under proposed Sec. 37.1301(b), SEFs that also operate as DCOs are
also subject to the financial resource requirements for DCOs in
proposed Sec. 39.11. Proposed Sec. 37.1301(c) would require that SEFs
maintain sufficient financial resources to cover operating costs for at
least one year, calculated on a rolling basis--i.e., at all times. The
one year period is required under the CEA. The Commission believes that
a one-year timeframe would allow a SEF's business to wind down in an
orderly fashion and should generally enhance the financial integrity of
the markets.\100\
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\100\ 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.\101\
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\101\ 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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b. Types of Financial Resources
Under proposed Sec. 37.1302, financial resources available to SEFs
to satisfy the applicable financial requirements would include the
SEF's own capital (assets in excess of liabilities) and any other
financial resource deemed acceptable by the Commission. A SEF would be
able to request an informal interpretation from CFTC staff on whether
or not a particular financial resource would be acceptable.
Request for Comment:
The Commission invites commenters to recommend particular financial
resources for inclusion in the final regulation.
c. Computation of Financial Resource Requirement
Proposed Sec. 37.1303 would require that a SEF, at the end of each
fiscal quarter, make a reasonable calculation of the financial
resources it needs to meet the requirements of proposed
[[Page 1231]]
Sec. 37.1301. In the first instance, the SEF would have reasonable
discretion in determining how to make this calculation, the Commission
may require changes as appropriate.
d. Valuation of Financial Resources
Proposed Sec. 37.1304 would require that SEFs, no less frequently
than quarterly, calculate the current market value of each financial
resource used to meet their obligations under these proposed
regulations. Additionally, SEFs would have 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 SEF's ability
to meet its obligations under proposed Sec. 37.1301. When valuing a
financial resource, a SEF 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.\102\
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\102\ The Commission would permit each SEF 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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e. Liquidity of Financial Resources
Proposed Sec. 37.1305 would require that SEFs 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 SEF 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 SEF 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. 37.1302 as a financial
resource available to a SEF to satisfy the requirements of proposed
Sec. 37.1301. A SEF may only use such resources to meet the liquidity
requirements of proposed Sec. 37.1305.
f. Reporting Requirements
Under proposed Sec. 37.1306, at the end of each fiscal quarter, or
at any time upon Commission request, SEFs 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 SEF
would also have to provide the Commission with a financial statement,
including the balance sheet, income statement, and statement of cash
flows, of the SEF or of its parent company, as appropriate.
14. Subpart O--Core Principle 14 (System Safeguards)
Core Principle 14 requires that SEFs: (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 (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. Proposed Sec. 37.1401 would
establish system safeguards requirements for all SEFs, pursuant to Core
Principle 14.
The proposed rule would require that a SEF's program of risk
analysis and oversight address six categories of risk analysis and
oversight, including: 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.
Because automated systems play a central and critical role in
today's electronic financial market environment, oversight of core
principle compliance by SEFs with respect to automated systems is an
essential part of effective oversight of the trading of swaps.
Sophisticated computer systems will be crucial to a SEF's ability to
meet its obligations and responsibilities. SEF 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.
15. Subpart P--Core Principle 15 (Designation of Chief Compliance
Officer)
Section 5h(f)(15) of the CEA, as added by Section 733 of the Dodd-
Frank Act, creates an internal regulatory framework for all SEFs, with
the position of chief compliance officer (``CCO'') serving as a focal
point for compliance with the CEA and applicable Commission
regulations. The four-part structure of Section 5h(f)(15) requires,
first, that every SEF designate an individual to serve as CCO. Second,
it enumerates specific duties for CCOs and establishes their
responsibilities within a SEF. Third, it requires CCOs to design the
procedures establishing the handling, management response, remediation,
retesting, and closing of noncompliance issues. Fourth, it outlines the
requirements of a mandatory annual report from SEFs to the Commission,
which must be prepared and signed by a SEF's CCO. The Commission
proposes to implement Section 5h(f)(15) of the CEA through proposed
Sec. 37.1501, which further develops the already robust CCO
requirements enacted by the Dodd-Frank Act. Section 5h(f)(15) of the
CEA and proposed Sec. 37.1501 are summarized below.
The first provision of Section 5h(f)(15)-5h(f)(15)(A)--provides
only for the self-explanatory requirement that each SEF designate an
individual to serve as its CCO. The second provision of Section
5h(f)(15) offers a detailed description of a CCO's role within a SEF.
Specifically, Section 5h(f)(15)(B) includes six enumerated duties
incumbent upon all CCOs, and thereby outlines the internal regulatory
structure of a SEF as contemplated by the Dodd-Frank Act. The
enumerated duties of CCOs include: (1) Reporting directly to the SEF's
board of directors or to its senior officer; (2) reviewing an SEF's
compliance with the requirements and core principles described in
Section 5h; (3) resolving any conflicts of interest that may arise, in
consultation with the board of directors or the senior officer of the
SEF; (4) establishing and administering any policy or procedure that is
required to be established by a SEF pursuant to Section 5h; (5)
ensuring compliance with the CEA, including rules prescribed by the
Commission pursuant to Section 5h; and (6) establishing procedures for
the remediation of noncompliance issues identified by the CCO. The
third provision of Section 5h(f)(15) provides that the CCO in
establishing and following appropriate procedures shall design such
procedures for the handling, management response, remediation,
retesting, and closing of noncompliance issues.
Finally, the fourth provision of Section 5h(f)(15)-5h(f)(15)(D)--
requires CCOs to prepare and sign annual compliance reports on behalf
of their
[[Page 1232]]
SEFs. The annual compliance reports must describe a SEF's compliance
with the CEA and Commission regulations. They must also describe the
policies and procedures of the SEF, including the code of ethics and
conflict of interest policies. In addition, the annual compliance
reports must include ``a certification that, under penalty of law, the
report is accurate and complete.'' The annual compliance report must be
furnished to the Commission as it may prescribe.
Proposed subpart P develops each of these statutory provisions in
greater detail and grants CCOs the regulatory authority necessary to
fulfill responsibilities in each regard.
a. Definition of Board of Directors--Proposed Sec. 37.1501(a)
Proposed Sec. 37.1501(a) defines ``board of directors'' as ``the
board of directors of a swap execution facility or for those swap
execution facilities whose organizational structure does not include a
board of directors, a body performing a function similar to a board of
directors.'' The proposed definition reflects the various forms of
business associations which a SEF could conceivably take, including
forms which do not include a corporate board of directors. It also
reflects the flexibility in Section 733 of the Dodd-Frank Act, which
refers, for example, to ``a body performing a function similar to a
board'' in discussing the duties of a CCO pursuant to Section
5h(f)(15)(B)(iii) of the CEA.
Request for Comment:
The Commission requests comment on the following:
Should the Commission develop additional rules around the
types of bodies which may perform board-like functions at a SEF,
depending on their business form?
Should the proposed definition of board of directors
appropriately address issues related to parent companies, subsidiaries,
affiliates, and SEFs located in foreign jurisdictions? Does the
proposed rule allow for sufficient flexibility with regard to a SEF's
business structure?
b. Designation and Qualifications of Chief Compliance Officer--Proposed
Sec. 37.1501(b)
Proposed Sec. 37.1501(b)(1) requires a SEF to establish the
position of CCO, designate an individual to serve in that capacity and
provide that individual with the authority and resources to develop and
enforce policies and procedures necessary to fulfill the duties set
forth for CCOs in the Dodd-Frank Act and Commission regulations. In
addition, proposed Sec. 37.1501(b)(1) provides that CCOs must have
supervisory authority over all staff acting in furtherance of the CCO's
statutory and regulatory obligations. In short, proposed Sec.
37.1501(b)(1) establishes CCOs as the focal point of a SEF's regulatory
compliance functions.
Proposed Sec. 37.1501(b)(2) details minimum competency standards
for CCOs. It requires that CCOs have the background and skills
necessary to fulfill the responsibilities of the position, and
prohibits anyone who would be disqualified from registration under
Sections 8a(2) or 8a(3) of the CEA from serving as a CCO. Although the
CCO would not be required to register with the Commission, as the
primary individual with responsibility for ensuring a SEF's legal
compliance, the Commission believes that CCOs should meet the same
standard as those individuals who are required to register, as set
forth in the list of statutory disqualifications under Sections 8a(2)
and (3) of the CEA. These standards largely consist of a high degree of
responsibility and requirements relating to integrity and honesty in
financial and business dealings. Section 37.1501(b)(2) also requires
that a CCO not serve as general counsel of a SEF. This prohibition
reflects the Commission's belief that granting these dual roles to a
single individual is incompatible with effective regulation and self-
regulation.\103\
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\103\ As conceived by the Commission, SEF CCOs have overall
responsibility for SEFs' compliance programs. CCOs must be neutral
fact-finders, and must be able to act in the interest of effective
compliance regardless of the persons, entities, or conduct that may
be the subject of investigation. In contrast, an entity's general
counsel serves as the legal counsel and defender of a company and
seeks to avoid or negate related legal risks. A second basis for the
separation of the general counsel and CCO roles is the Commission's
determination that an individual acting as CCO should not be in a
position to assert attorney-client privilege against the Commission.
If a SEF's CCO were also its general counsel, much of the
information about its compliance program could potentially be
protected from third-party review, including the Commission's, under
the shroud of attorney-client privilege. While there may be
circumstances where the attorney-client privilege could be asserted
by a SEF, the Commission believes that such circumstances do not
include the areas of responsibility assigned to CCOs by the CEA or
Commission regulations.
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Request for Comment:
The Commission is seeking comment on whether additional limitations
should be placed on persons who may be designated as a CCO.
The Commission requests comment on whether the provisions
of proposed Sec. 37.1501(b) are sufficient to ensure that a CCO has
the authority and resources necessary to fulfill his or her statutory
and regulatory obligations.
The Commission also requests comment regarding the
qualifications that should be required of a CCO, and whether the
requirements expressed in proposed Sec. 37.1501(b) are sufficient.
Should there be additional restrictions placed on who is
qualified to be designated as a CCO? The Commission requests comment on
whether restricting a CCO from serving as the General Counsel or other
attorney within the legal department of a SEF would sufficiently
address conflict of interest concerns?
c. Appointment, Supervision, and Removal of Chief Compliance Officer--
Proposed Sec. 37.1501(c)
Taken together, proposed Sec. Sec. 37.1501(c)(1), 37.1501(c)(2),
and 37.1501(c)(3) provide the supervisory regime applicable to CCOs.
Proposed Sec. 37.1501(c) requires that a CCO be appointed by a
majority of the SEF's board of directors or senior officer, and that a
majority of the board or senior officer be responsible for approving
the CCO's compensation. A SEF must notify the Commission within two
business days of appointing a new CCO. The proposed regulation also
requires the CCO to meet at least annually with the board of directors
to discuss the effectiveness of the CCO's administration of the
compliance policies adopted by the registrant. The meeting or meetings
would create an opportunity for a CCO and the directors to speak freely
about any sensitive issues of concern to any of them, including any
reservations about the cooperativeness or compliance practices of the
registrant's management. The Commission's governance proposals require
that each SEF's board of directors include a board-level regulatory
oversight committee (``ROC'') consisting exclusively of public
directors.\104\ The Commission believes
[[Page 1233]]
that ROCs will help to mitigate potential conflicts of interest within
a SEF by introducing an independent perspective to board
deliberations.\105\ The Commission also believes that both CCOs and
ROCs will be strengthened in their regulatory work and independence
through close cooperation and coordination. Although a CCO is not
required to report to his or her ROC, proposed Sec. 37.1501(c)(1)
provides that a CCO must meet with the ROC quarterly to discuss matters
of mutual concern and share information. These meetings will create an
opportunity for a CCO and the ROC to speak freely about potentially
sensitive issues, including any reservations by the CCO regarding the
SEF's management. They will also facilitate the ROC's oversight
responsibilities, and allow the CCO to seek assistance and
institutional support from the ROC as necessary.
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\104\ Proposed Sec. 37.1501(a) defines board of directors for
purposes of subpart P as follows: ``the board of directors or board
of governors of a swap execution facility, or equivalent governing
body of a swap execution facility or of an entity operating a swap
execution facility.'' The proposed definition reflects the various
forms of business associations which a SEF could take, including
forms which do not include a corporate board of directors. With
respect to boards of directors and ROCs, the Commission notes that
in a separately proposed series of regulations governing conflicts
of interest within SEFs, DCMs, and DCOs, the Commission proposes a
number of governance measures that impact the proposed regulations
for CCOs. First, proposed Sec. 40.9(b)(1)(i) requires a SEF's board
of directors to be composed of at least 35%, but no less than two,
public directors. Second, proposed Sec. 40.9(b)(2) prohibits a SEF
from ``permit[ing] itself to be operated by any entity'' that does
not adhere to the board composition requirements of 40.9(b)(1)(i).
Third, proposed Sec. 37.19(b)(3) requires a SEF to have a board-
level ROC consisting exclusively of public directors.
\105\ See proposed Sec. 37.19(b)(1) for a description of a
ROC's role in overseeing the performance of a CCO and effectiveness,
efficiency, and independence of a SEF's regulatory and self-
regulatory programs.
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Finally, proposed Sec. 37.1501(c)(1) also provides that the senior
officer of a SEF may assume responsibility for appointing the CCO and
approving his or her compensation.
Proposed Sec. 37.1501(c)(2) addresses routine oversight of a SEF's
CCO. It allows a SEF with a board of directors to grant oversight
authority to either its board or to its senior officer. The proposed
regulation is modeled on the terms of Section 5h(f)(15)(B)(i) of the
CEA, which requires a CCO to ``report directly to the board or to the
senior officer of the facility.''
Request for Comment:
The Commission requests comment regarding the appropriate reporting
relationship for the CCO of a SEF that has both a senior officer and a
board of directors.
In such cases, should a CCO report to the SEF's board
rather than to its senior officer?
What potential conflicts of interest might arise if a CCO
reports to the senior officer rather than to the board, and how might
those conflicts be mitigated?
In addition, the Commission requests comment regarding
whether ``senior officer'' of a SEF should be a defined term, and if
so, how the term should be defined.
d. Removal of CCO--Proposed Sec. 37.1501(c)(3)
Proposed Sec. 37.1501(c)(3) requires approval of a majority of an
SDR's board of directors to remove a CCO. The Commission believes that
these removal provisions will help insulate CCOs and their decision-
making from day-to-day commercial pressures that they may otherwise
experience. If a SEF does not have a board, the proposed regulation
provides that the CCO may be removed by its senior officer. Proposed
Sec. 37.1501(c)(3) also requires an SDR to notify the Commission in
writing within two business days of the removal or voluntary departure
of its CCO by providing a statement describing the circumstances
surrounding his or her departure.\106\ The Commission believes that
this provision will help protect CCOs from undue influence or
retaliatory termination by the board or the senior officer of the SEF.
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\106\ Upon the departure of a CCO, proposed Sec. 37.1501(c)(3)
requires a SEF to appoint an interim CCO immediately and a permanent
replacement as soon as practicable.
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Proposed Sec. Sec. 37.1501(c)(1) and 37.1501(c)(3) seek to provide
a SEF's CCO with a measure of independence from management in the
performance of his or her duties, and to ensure that such duties are
executed in the most effective and impartial manner possible.
Request for Comment:
The Commission requests comment on any additional measures that
should be required to adequately protect CCOs from undue influence in
the performance of their duties. The Commission is particularly
interested in how it might offer such protection to a CCO who reports
to his or her senior officer, either at the SEF's choosing or because
the SEF does not have a board of directors. In addition, the Commission
also requests comment on whether the provision that would require a
majority of a board of directors to remove the CCO is sufficiently
specific.
e. Duties of the Chief Compliance Officer--Proposed Sec. 37.1501(d)
Proposed Sec. 37.1501(d) details the duties of a CCO, as well as
his or her authority within a SEF. The proposed regulation codifies and
expands upon the CCO duties already set forth in Section 5h(f)(15)(B)
of the CEA. These duties include overseeing and reviewing compliance
with the CEA and Commission regulations, as well as resolving, in
consultation with the board of directors or the senior officer, any
conflicts of interest that may arise. The proposed regulation also
lists a number of potential conflicts that may confront a CCO. The list
of conflicts of interest indicates the types of conflicts that the
Commission believes a SEF's CCOs should be aware of, but it is not
exhaustive.
Proposed Sec. 37.1501(d) also requires that the CCO establish and
administer a written code of ethics and policies and procedures
designed to prevent violations of the CEA and Commission regulations.
Section 37.1501(d) also requires that a CCO establish and administer
written policies and procedures, including a ``compliance manual,''
designed to prevent violations of the CEA and Commission
regulations.\107\
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\107\ By ``compliance manual,'' the Commission means a detailed
internal handbook explaining to SEF staff the resources and
procedures that they are to use in monitoring trading, conducting
investigations, documenting their work, and making findings and
recommendations to supervisory staff regarding trading in any swap
or other conduct by SEF members and market participants that is
subject to SEF rules. The Commission believes that such written
documentation will serve as a useful guide for the SEF's management
and staff. It will also help the Commission evaluate the SEF's
compliance and adherence to its own internal standards.
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The Commission believes that such written documentation will serve
as a useful guide for the SEF's management and staff, as well as for
swap participants who will be trading on the SEF. It will also help the
Commission to evaluate the SEF's compliance and adherence to its own
internal standards. Finally, proposed Sec. 37.1501(d) requires that a
CCO establish and follow procedures for the remediation and closing of
any noncompliance issues that are identified. To assist the CCO in
meeting this responsibility, proposed Sec. 37.1501(b)(1), summarized
above, grants a CCO oversight authority over all compliance functions
and staff acting in furtherance of those compliance functions. The
CCO's authority would also extend to any activities performed by the
SEF to verify that other entities are in compliance with applicable
laws and regulations, such as the verification of the timeliness of
reporting certain swap data, pursuant to proposed Sec. 37.901. The
Commission recognizes that the staff that assists a CCO may not be
dedicated to the CCO full-time; however, the proposed regulation would
ensure that a CCO has authority over any staff and resources while they
are acting in furtherance of compliance functions.
Section 37.1501(d), for example, reflects the statutory text of the
Dodd-Frank Act by requiring that a CCO review and ensure a SEF's
compliance
[[Page 1234]]
with the CEA and Commission regulations. It also reflects a CCO's
responsibilities with respect to the regulation of members and market
participants utilizing a SEF's trading platform. In this regard,
Section 37.1501(d)(8) requires that a CCO supervise a SEF's self-
regulatory program with respect to trade practice surveillance; market
surveillance; real-time market monitoring; compliance with audit trail
requirements; enforcement and disciplinary proceedings; and audits,
examinations, and other regulatory responsibilities with respect to
members and market participants. Similarly, Section 37.1501(d)(9)
requires that a CCO supervise the effectiveness and sufficiency of any
regulatory services provided to the SEF by a registered futures
association or other registered entity in accordance with Sec.
37.204.\108\
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\108\ See proposed Sec. 37.204 (governing a SEF's use of third-
party regulatory service providers and its duty to supervise such
providers and any services received).
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Request for Comment:
The Commission requests comment regarding proposed Sec.
37.1501(d). Comments should address any additional CCO duties which the
Commission should include in the proposed regulation. In addition, they
should specifically address a CCO's role in managing conflicts of
interest within a SEF, the types of conflicts which commenters believe
might arise within a SEF, and how and by whom those conflicts should be
resolved.
f. Preparation and Submission of Annual Compliance Report--Proposed
Sec. Sec. 37.1501(e) and 37.1501(f)
Section 5h(f)(15)(D) of the CEA requires a CCO to prepare an annual
compliance report. As discussed above, the Commission believes that
this annual compliance report should give the Commission a complete and
accurate picture of a SEF's compliance program. Proposed Sec.
37.1501(e) details the information that must be included in the annual
compliance report. The report must include: (i) A description of the
SEF's written policies and procedures, code of ethics and conflicts of
interest policies; (ii) a detailed review of the SEF compliance with
Section 5h of the CEA, including an assessment by the CCO of the
effectiveness of the SEF's policies and procedures in ensuring
compliance with Section 5h of the CEA and a discussion of areas for
improvement; (iii) a description of any material changes to the
policies and procedures that were made to these since the last annual
compliance report; (iv) a description of the financial, managerial,
operational, and staffing resources set aside for the SEF's compliance
program, including a description of the SEF's compliance program,
describing resources set aside for the SEF's self-regulatory
responsibilities. An annual compliance report must also provide: a
detailed description and review of the SEF's self-regulatory program,
which includes a description of staff associated with self-regulation,
a catalogue of investigations and disciplinary actions taken, and a
review of the performance of disciplinary committees and panels; (v) a
description of any material compliance matters, including instances of
noncompliance, that were identified in the year prior to the filing of
the report; and (vi) any objections to the annual compliance report by
the board or senior officer of the SEF. In addition to the above
information, proposed Sec. 37.1501(e) also requires the annual report
to include a certification by the CCO that, under penalty of law, the
compliance report is accurate and complete.
Proposed Sec. 37.1501(f)(1) sets forth the procedures for the
review of the annual compliance report by the board of directors of the
SEF or senior officer, prior to submission to the Commission. While the
board or senior officer has a chance to review the annual compliance
report before submission, the report is not subject to their approval.
Proposed Sec. 37.1501(f)(1) explicitly prohibits the board or senior
officer from forcing the CCO to make any material changes to the
report. The purpose of this review is to permit the members of the
board or the senior officer to provide the Commission with any
objections they might have to the report. The Commission believes that
the prohibition against the board and senior officer making changes to
the annual compliance report will allow the CCO to make a complete and
accurate assessment of the SEF's compliance program.
Proposed Sec. 37.1501(f)(2) describes the process for submission
of the report to the Commission. The proposed regulation requires that
the annual compliance report be electronically provided to the
Commission not more than 60 days after the end of the calendar year. If
a CCO determines that an annual compliance report filed with the
Commission has a material error or if material non-compliance is
identified after filing, proposed Sec. 37.1501(f)(3) would require a
SEF to promptly file an amended report. This amended report must also
include the certification by the CCO as to the accuracy and
completeness made in the initial submission of the report. If a CCO is
unable to file an annual compliance report within 60 days of the end of
the calendar year, proposed Sec. 37.1501(f)(4) would permit a CCO to
request the Commission to grant an extension of time to file its
compliance report based on substantial undue hardship. Extensions for
the filing deadline would be granted at the discretion of the
Commission. Additionally, to protect the trade secrets of the SEF and
the security of the data held by the SEF, the proposed regulation
requires that annual compliance reports filed pursuant to Sec. 37.1501
be treated as exempt from mandatory public disclosure for purposes of
FOIA and the Sunshine Act and parts 145 and 147 of Commission
regulations.
Request for Comment:
The Commission requests comment on its proposed regulations
regarding the preparation and submission of a SEF's annual compliance
report.
Should the annual compliance report contain additional
content beyond what is proposed in Sec. 37.1501(e)? Are additional
provisions necessary to ensure that a SEF's board of directors cannot
adversely influence the content of an annual compliance report as
drafted by the CCO?
In the alternative, are additional provisions necessary to
ensure that individual directors or other SEF employees have an
adequate opportunity to register any concerns or objections they might
have to the contents of an annual compliance report?
The Commission also requests comment relating to insulating a SEF's
CCO from undue influence or coercion.
Should the Commission adopt a regulation that prohibits an
officer, director or employee of the SEF or related person to coerce,
manipulate, mislead, or fraudulently influence the CCO in performing
his or her duties?
Is it necessary to adopt regulations to address potential
conflicts between and among a SEF's compliance, commercial, and
ownership interests?
If so, what should such regulations entail, and what
specific conflicts of interest should they address?
g. Recordkeeping--Proposed Sec. 37.1501(g)
Proposed Sec. 37.1501(g) details SEFs' recordkeeping requirements
for records relating to a CCO's areas of responsibility. This proposed
regulation requires a SEF to maintain: (i) A copy of its written
policies and procedures,
[[Page 1235]]
including its code of ethics and conflicts of interest policies; (ii)
copies of all materials created in furtherance of the chief compliance
officer's self-regulatory duties, including records of any
investigations or disciplinary actions taken by the SEF; (iii) copies
of all materials, including written reports provided to the board of
directors in connection with review of the annual report, as well as
the board minutes or other similar written records, that record the
submission of the annual compliance report to an SEF's board of
directors or its senior officer; and (iv) any other records relevant to
an SEF's annual report. The records required to be maintained pursuant
to this section are designed to provide Commission staff with a basis
to determine whether a SEF has complied with the CEA and applicable
Commission regulations. The Commission also wants to preserve its
ability to reconstruct why certain information was included or excluded
in an annual report, in the event that such reconstruction becomes
necessary under a future audit or investigation.
The SEF would be required to maintain these records in accordance
with Sec. 1.31 of the Commission's regulations. Following Sec. 1.31,
all records must be kept for a period of five years.
Request for Comment:
The Commission requests comment regarding whether the requirements
of proposed Sec. 37.1501(g) are sufficient to create a complete and
easily auditable record of a board of directors' or senior officer's
review of an annual compliance report to ensure that the report, as
drafted by the CCO, was not altered.
III. Effective Date and Transition Period
The statutory deadline for final regulations is July 15, 2011.
Final regulations may become effective sixty (60) days after their
publication in the Federal Register, but no earlier than July 15, 2011.
The Commission is proposing that the effective date for the proposed
regulations be 90 days after publication of final regulations in the
Federal Register. The Commission believes that the effective date would
be appropriate to allow potential SEFs and market participants time to
adapt to the new regulatory regime for the trading of swaps in an
efficient and orderly manner. In addition, the Commission believes that
this would give any entities then operating a marketplace for the
execution or trading of swaps adequate time to submit a SEF application
and meet the conditions to receive relief under the grandfather
provisions.
Request for Comment:
The Commission requests comment on whether the proposed effective
date is appropriate and, if not, the Commission further requests
comment on possible alternative effective dates and the basis for any
such alternative dates.
IV. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') \109\ requires Federal
agencies, in promulgating regulations, to consider the impact of those
regulations on small businesses. The regulations adopted herein will
affect SEFs. The Commission has previously established certain
definitions of ``small entities'' to be used by the Commission in
evaluating the impact of its regulations on small entities in
accordance with the RFA.\110\ In its previous determinations, the
Commission has concluded that DCMs, derivatives transaction execution
facilities (``DTEFs''), ECMs, EBOTs and DCOs are not small entities for
the purpose of the RFA.\111\
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\109\ 5 U.S.C. 601 et seq.
\110\ 47 FR 18618-21 (Apr. 30, 1982).
\111\ 47 FR 18618, 18619 (April 30, 1982) discussing contract
markets; 66 FR 42256, 42268 (August 10, 2001) discussing derivatives
transaction execution facilities, exempt commercial markets and
exempt boards of trade; and 66 FR 45604, 45609 (August 29, 2001)
discussing DCOs.
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While SEFs are new entities to be regulated by the Commission
pursuant to the Dodd-Frank Act,\112\ in a recent rulemaking
proposal,\113\ the Commission proposed that SEFs should not be
considered as small entities for the purpose of the RFA. The Dodd-Frank
Act defines a SEF to mean ``a trading system or platform in which
multiple participants have the ability to execute or trade swaps by
accepting bids and offers made by multiple participants in the facility
or system, through any means of interstate commerce, including any
trading facility, that--(A) facilitates the execution of swaps between
persons; and (B) is not a designated contract market.'' \114\ In its
recent rulemaking, the Commission proposed that SEFs not be considered
to be ``small entities'' for essentially the same reasons that DCMs and
DCOs have previously been determined not to be small entities. These
reasons include the fact that the Commission designates a DCM or
registers a DCO only when it meets specific criteria including
expenditure of sufficient resources to establish and maintain adequate
self-regulatory programs. Likewise, the Commission will register an
entity as a SEF only after it has met specific criteria including the
expenditure of sufficient resources to establish and maintain an
adequate self-regulatory program. In addition, once registered, a SEF
will be required to comply with the additional requirements set forth
in the final form of this proposed Part 37 rulemaking. In addition, the
Commission proposes that SEFs should not be considered small entities
based on, among other things, the central role SEFs will play in the
national regulatory scheme overseeing the trading of swaps. Not only
will SEFs play a vital role in the national economy, but they will be
subject to Commission oversight with statutory duties to enforce the
regulations adopted by their own governing bodies.
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\112\ Dodd Frank Wall Street Reform and Consumer Protection Act,
Pub. L. 111-203, 124 Stat. 1376 (2010).
\113\ 75 FR 63745-46 (October 18, 2010).
\114\ See CEA Section 1a(50). The Commission anticipates
proposing regulations that would further specify those entities that
must register as a SEF. The Commission does not believe that such
proposals would alter its determination that a SEF is not a ``small
entity'' for purposes of the RFA.
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Accordingly, the Commission does not expect the regulations, as
proposed herein, to have a significant economic impact on a substantial
number of small entities. Therefore, the Chairman, on behalf of the
Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that the
proposed regulations will not have a significant economic impact on a
substantial number of small entities. The Commission invites the public
to comment on whether SEFs covered by these rules should be considered
small entities for purposes of the RFA.
B. Paperwork Reduction Act
The Paperwork Reduction Act (``PRA'') \115\ 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. This proposed rulemaking will result in new
collection of information requirements within the meaning of the PRA.
The Commission therefore is submitting this proposal to the Office of
Management and Budget (OMB) for review in accordance with 44 U.S.C.
3507(d) and 5 CFR 1320.11. The title for this collection of information
is ``Part 37--Swap Execution Facilities'' (OMB control number 3038-
NEW). If adopted, responses to this collection of information would be
mandatory. The Commission will protect proprietary
[[Page 1236]]
information according to the Freedom of Information Act and 17 CFR part
145, ``Commission Records and Information.'' In addition, section
8(a)(1) of the CEA strictly prohibits the Commission, unless
specifically authorized by the CEA, from making public ``data and
information that would separately disclose the business transactions or
market positions of any person and trade secrets or names of
customers.'' \116\ The Commission is also required to protect certain
information contained in a government system of records according to
the Privacy Act of 1974.\117\
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\115\ 44 U.S.C. 3501 et seq.
\116\ 7 U.S.C. 12(a)(1).
\117\ 5 U.S.C. 552a.
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1. Collection of Information--Regulations Relating to Part 37, Swap
Execution Facilities
The proposed regulations require each respondent to file
information with the Commission. For instance, SEFs must file
applications with the Commission for registration pursuant to Sec.
37.3. SEFs must either request approval with, or certify to, the
Commission rules and products, pursuant to Sec. 37.4. SEFs must
disclose information related to prices, trading volume, and other
trading data on swaps pursuant to Core Principle 9 (Timely Publication
of Trading Information).
Commission staff has previously estimated hourly burdens for DCMs
and DTEFs pursuant to the Commodity Futures Modernization Act of 2000
(``CFMA'').\118\ More recently, Commission staff estimated hourly
burdens for ECMs with significant price discovery contracts
(``SPDCs''). While the Commission has no way of knowing the exact
hourly burden upon a registered entity prior to implementation of the
regulations governing that registered entity, staff believes the
estimated burden for a SEF would be within the range of previously
estimated hours of burden for the above registered entities. Those
hourly burdens are noted below:
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\118\ Appendix E of Public Law 106-554, 114 Stat. 2763 (2000).
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Initial estimate of DCM's annual burden \119\: 300 hours per DCM.
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\119\ 66 FR 38992 (June 22, 2000).
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Estimate of DCM's annual burden as of 2006 \120\: 370 hours per
DCM.
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\120\ 71 FR 38748 (July 7, 2006).
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Current estimate of DCM's annual burden \121\: 440 hours per DCM.
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\121\ See, supra note 10, DCM NPRM.
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Initial estimate of DTEF's annual burden \122\: 200 hours per DTEF.
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\122\ 65 FR 38993 (June 22, 2000).
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Initial estimate of ECM's with SPDCs annual burden \123\: 233 hours
per ECM.
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\123\ 73 FR 75901 (December 12, 2008).
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Based on the proposed regulations, Commission staff believes that a
SEF will have more reporting responsibilities than an ECM with a SPDC
and a DTEF, but fewer reporting hours than a DCM (as most recently
calculated).\124\ Based on its experience with administering registered
entities' submission requirements since implementation of the CFMA,
Commission staff estimates an annual reporting burden for SEFs to be an
average of the above noted estimates for DCMs, DTEFs and ECMs with
SPDCs.
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\124\ ECMs with SPDCs are subject to 9 core principles, DTEFs
are subject to 9 core principles, DCMs are currently subject to 18
core principles, (but will be subject to 23 core principles upon
finalization of the Part 38 regulations implementing the Dodd-Frank
Act). SEFs will be subject to 15 core principles upon finalization
of the regulations to implement the Dodd-Frank Act.
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Staff estimates that each respondent would, on average, have an
annual burden of 308 hours of reporting time. Staff estimates that 30-
40 SEFs will register with the Commission as a result of the Dodd-Frank
Act.\125\ Accordingly, the burden in terms of hours would in the
aggregate be 308 hours annually per respondent and 10,780 hours
annually for all respondents.
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\125\ For hourly reporting requirements, an average of 35 SEFs
was used for calculation purposes.
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Commission staff estimates that respondents could expend up to
$16,016 annually based on an hourly rate of $52 to comply with the
proposed regulations. This would result in an aggregated cost of
$560,560 per annum (35 respondents x $16,016).
Estimated Number of respondents: 35.
Annual Responses by each respondent: 1.
Total annual responses: 35.
Quarterly responses by each respondent: 4.
Total quarterly responses: 140.
Estimated average hours per response: 308.
Aggregate annual reporting burden: 10,780.
2. Information Collection Comments
Copies of the supporting statements for the collections of
information from the Commission to OMB are available by visiting
RegInfo.gov. Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission will
consider public comments on the proposed information requirements in
order to:
(1) Evaluate whether the proposed collections of information are
necessary for the proper performance of the functions of the
Commission, including whether the information will have a practical
use;
(2) Evaluate the accuracy of the estimated burden of the
proposed information collection requirements, including the degree
to which the methodology and the assumptions that the Commission
employed were valid;
(3) Enhance the quality, utility, and clarity of the information
proposed to be collected; and
(4) Minimize the burden of the proposed information collection
requirements on DCOs, DCMs, and SEFs, 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 address 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 regulations.
C. Cost-Benefit Analysis
Section 15(a) of the CEA \126\ requires that the Commission
consider the costs and benefits of its actions before issuing a
regulation under the CEA. By its terms, Section 15(a) does not require
the Commission to quantify the costs and 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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\126\ 7 U.S.C. 19(a).
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Section 15(a) 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,
[[Page 1237]]
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 provide, pursuant to the Dodd-Frank
Act, for the trading or processing of swaps on a registered SEF subject
to 15 core principles. This rulemaking will implement, in Part 37 of
the Commission's regulations, these provisions of the CEA. The proposal
includes regulations as well as guidance and acceptable practices to
implement these core principles. In general, the proposed regulations
implementing core principles for SEFs are consistent with the existing
or proposed regulations for similar or identical core principles
applicable to DCMs.
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. SEFs that determine to register with the
Commission in order to provide for the transacting of swaps will be
subject to core principles for transacting of swaps. If swaps were
allowed to continue to be transacted bilaterally, rather than on the
regulated market of a SEF, price discovery and transparency in the
swaps markets would continue to be inhibited. 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.
Benefits
The Commission believes that the benefits of the rulemaking are
significant. The proposed regulations provide for the transacting of
swaps on SEFs. SEFs will compete with DCMs that make certain swaps
available for trading, while certain swaps will continue to transact
bilaterally. This competition will benefit the marketplace. Providing
market participants with the ability to trade certain swaps openly and
competitively on a SEF complying with all of the SEF core principles as
well as on DCMs complying with DCM core principles will provide market
participants with additional choices and will enhance price
transparency resulting in protection of market participants and the
public. The proposed regulations will necessitate that SEFs that
determine to make certain swaps available for trading will have to
coordinate with DCOs in order to effect clearing and thus be subject to
the DCO's risk management and margining procedures.
Request for 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.
V. Text of the Proposed Regulations, Guidance and Acceptable Practices
List of Subjects in 17 CFR Part 37
Swaps, Swap execution facilities, Registration application,
Registered entities, Reporting and recordkeeping requirements.
In light of the foregoing, and pursuant to authority in the CEA,
and, in particular, Sections 3, 5, 5c(c), 8a(5) and 21 of the CEA, the
Commission hereby proposes to revise part 37 of Title 17 of the Code of
Federal Regulations to read as follows:
PART 37--SWAP EXECUTION FACILITIES
Subpart A--General Provisions
Sec.
37.1 Scope.
37.2 Applicable provisions.
37.3 Requirements for registration.
37.4 Procedures for listing products and implementing rules.
37.5 Information relating to swap execution facility compliance.
37.6 Enforceability.
37.7 Prohibited use of data collected for regulatory purposes.
37.8 Boards of trade operating both a designated contract market and
a swap execution facility.
37.9 Permitted execution methods.
37.10 Assessments regarding transactional tiers or platform and
swaps made available for trading.
37.11 Identification of non-cleared swaps or swaps not made
available to trade.
Subpart B--Compliance with Core Principles
Sec.
37.100 Core Principle 1--Compliance with core principles.
Subpart C--Compliance with Rules
Sec.
37.200 Core Principle 2--Compliance with rules.
37.201 Operation of swap execution facility and compliance with
rules.
37.202 Access requirements.
37.203 Rule enforcement program.
37.204 Regulatory services provided by a third party.
37.205 Audit trail requirements.
37.206 Disciplinary procedures and sanctions.
37.207 Swaps subject to mandatory clearing.
Subpart D--Swaps Not Readily Susceptible to Manipulation
Sec.
37.300 Core Principle 3--Swaps not readily susceptible to
manipulation.
37.301 General requirement.
Subpart E--Monitoring of Trading and Trade Processing
Sec.
37.400 Core Principle 4--Monitoring of trading and trade processing.
37.401 General requirements.
37.402 Additional requirements for physical-delivery swaps.
37.403 Additional requirements for cash-settled swaps.
37.404 Ability to obtain information.
37.405 Risk controls for trading.
37.406 Trade reconstruction.
37.407 Additional rules required.
Subpart F--Ability to Obtain Information
Sec.
37.500 Core Principle 5--Ability to obtain information.
37.501 Establish and enforce rules.
37.502 Collection of information.
37.503 Provide information to the commission.
37.504 Information-sharing agreements.
Subpart G--Position Limits or Accountability
Sec.
37.600 Core Principle 6--Position limits or accountability.
37.601 Position limits or accountability.
Subpart H--Financial Integrity of Transactions
Sec.
37.700 Core Principle 7--Financial integrity of transactions.
37.701 Mandatory clearing.
37.702 General financial integrity.
37.703 Monitoring for financial soundness.
Subpart I--Emergency Authority
Sec.
37.800 Core Principle 8--Emergency authority.
37.801 Additional sources for compliance.
Subpart J--Timely Publication of Trading Information
Sec.
37.900 Core Principle 9--Timely publication of trading information.
37.901 General requirement.
37.902 Capacity of swap execution facility.
Subpart K--Recordkeeping and Reporting
Sec.
37.1000 Core Principle 10--Recordkeeping and reporting.
[[Page 1238]]
37.1001 Recordkeeping required.
37.1002 Reporting to the commission required.
37.1003 Inspection and examination by the Securities and Exchange
Commission.
Subpart L--Antitrust Considerations
Sec.
37.1100 Core Principle 11--Antitrust considerations.
37.1101 Additional sources for compliance.
Subpart M--Conflicts of Interest
Sec.
37.1200 Core Principle 12--Conflicts of interest.
Subpart N--Financial Resources
Sec.
37.1300 Core Principle 13--Financial resources.
37.1301 General requirements.
37.1302 Types of financial resources.
37.1303 Computation of financial resource requirement.
37.1304 Valuation of financial resources.
37.1305 Liquidity of financial resources.
37.1306 Reporting requirements.
Subpart O--System Safeguards
Sec.
37.1400 Core Principle 14--System safeguards.
37.1401 Requirements.
Subpart P--Designation of Chief Compliance Officer
Sec.
37.1500 Core Principle 15--Designation of Chief Compliance Officer.
37.1501 Chief Compliance Officer.
Appendix A to Part 37--Form SEF
Appendix B to Part 37--Guidance on, and Acceptable Practices in,
Compliance with Core Principles
Authority: 7 U.S.C. 1a, 2, 5, 6, 6c, 7, 7a-2, 7b-3 and 12a, as
amended by Titles VII and VIII of the Dodd-Frank Wall Street Reform
and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).
Subpart A--General Provisions
Sec. 37.1 Scope.
The provisions of this part 37 shall apply to every swap execution
facility that is registered, has been registered or is applying to
become registered as a swap execution facility under Section 5h of the
Act. Provided, however, nothing in this provision affects the
eligibility of swap execution facilities to operate under the
provisions of Parts 38 or 49 of this Chapter.
Sec. 37.2 Applicable provisions.
A swap execution facility, the swap execution facility's operator
and transactions traded on or through a swap execution facility under
Section 5h of the Act shall comply with the requirements of this part
37, and 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.
Sec. 37.3 Requirements for registration.
(a) Application procedures. (1) An applicant seeking registration
as a swap execution facility must file electronically an application
for registration with the Secretary of the Commission, in the form and
manner as provided by the Commission. The Commission shall approve or
deny the application or, if deemed appropriate, register the applicant
as a swap execution facility subject to conditions.
(2) The application must include information sufficient to
demonstrate compliance with the core principles specified in Section 5h
of the Act. The Application Form SEF consists of instructions, general
questions and a list of Exhibits (documents, information and evidence)
the Commission requires in order to be able to determine whether an
applicant is able to comply with the core principles. An application
will not be considered to be materially complete unless the applicant
has submitted, at a minimum, the Exhibits as required in Application
Form SEF. 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 Commission's review.
(3) An applicant seeking registration must request from the
Commission a unique, extensible, alphanumeric code for the purpose of
identifying the swap execution facility pursuant to Part 45 of this
chapter.
(4) An applicant seeking registration 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.
(5) 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.
(6) If any information contained in the application or 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.
(7) 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 registration that
the application is materially incomplete and the review is stayed. 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.
(b) Temporary Grandfather Relief from Registration. Concurrent with
the completion of the application procedures under paragraph (a) of
this section, an applicant may submit a notice requesting that the
Commission grant the applicant temporary grandfather relief from the
registration requirement, allowing it to continue operating during the
pendency of the application process.
(1) The Commission may grant such request for temporary grandfather
relief from the registration requirement if the applicant has:
(i) Satisfied all the requirements under paragraph (a) of this
section,
(ii) Provided transaction data that substantiates that the
execution or trading of swaps has occurred and continues to occur on
the applicant's trading system or platform at the time the applicant
submits the request, and
(iii) Provided a certification that the applicant believes that
when it operates under temporary grandfather relief it will meet the
requirements of this Part 37.
(2) The temporary grandfather relief for a swap execution facility
shall expire on the earlier of:
(i) The date that the Commission grants or denies registration of
the swap execution facility; or
(ii) The date that the Commission rescinds the temporary
grandfather relief provided to the swap execution facility.
(3) The grant of temporary grandfather relief from the registration
requirement by the Commission does not affect the right of the
Commission to grant or deny permanent registration as provided under
paragraph (a)(1) of this section. This paragraph shall terminate 365
days from the effectiveness of this regulation.
(c) Reinstatement of dormant registration. Before making any swaps
available for trading, a dormant swap execution facility as defined in
Sec. 40.1 of this Chapter must reinstate its registration under the
procedures of paragraph (a) of this section; provided, however, that an
application for reinstatement may rely upon previously submitted
materials that still pertain to,
[[Page 1239]]
and accurately describe, current conditions.
(d) Request for transfer of registration. (1) Request for transfer
of registration. A swap execution facility that wants to request the
transfer of its registration 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
registration. 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 swap execution facility may file a request with the Commission
later than three months prior to the anticipated change if the swap
execution facility does not know and reasonably could not have known of
the anticipated change three months prior to the anticipated change. In
such event, the swap execution facility 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 swap execution facility,
including its governance, and operations, and its impact on the rights
and obligations of market participants;
(iii) A discussion of the transferee's ability to comply with the
Act, including the core principles applicable to swap execution
facilities, 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 swap execution facility;
(vi) A representation by the transferee that it:
(A) Will be the surviving corporation and successor-in-interest to
the transferor swap execution facility 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 promulgated
thereunder, including Part 37 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.
(vii) A representation by the transferee that upon the transfer:
(A) It will assume responsibility for and maintain compliance with
product core principles for all swaps previously made available for
trading through the transferor, whether by certification or approval;
and
(B) That none of the proposed rule changes will affect the rights
and obligations of any participant.
(viii) 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 registration 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
swap execution facility in compliance with the Act and the Commission's
regulations thereunder.
(e) Request for withdrawal of application for registration. An
applicant for registration may withdraw its application submitted
pursuant to paragraph (a) of this section by filing such a request with
the Commission at its Washington, DC headquarters. Withdrawal of an
application for registration shall not affect any action taken or to be
taken by the Commission based upon actions, activities or events
occurring during the time that the application for registration was
pending with the Commission.
(f) Request for vacation of registration. A swap execution facility
may vacate its registration under Section 7 of the Act by filing
electronically such a request with the Commission at its Washington, DC
headquarters. Vacation of registration shall not affect any action
taken or to be taken by the Commission based upon actions, activities
or events occurring during the time that the swap execution facility
was registered by the Commission.
Sec. 37.4 Procedures for Listing Products and Implementing Rules.
(a) Request for Commission approval of rules and products. (1) An
applicant for designation, or a swap execution facility, 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 swap execution facility should label a swap in its rules
as ``Listed for trading pursuant to Commission approval,'' if the swap
and its terms or conditions have been submitted to the Commission for
approval, 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(b) and
40.5(b) of this Chapter, the operating rules and terms and conditions
of swaps submitted for Commission approval that have been submitted at
the same time as an application for swap execution facility
registration or an application under Sec. 37.3(c) to reinstate the
registration of a dormant swap execution facility 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 swap
execution facility is deemed to be registered or reinstated.
(b) Self-certification of rules and products. Rules of a swap
execution facility and subsequent amendments thereto, including both
the operational rules and the terms or conditions of swaps listed for
trading on the facility, not voluntarily submitted for prior Commission
approval pursuant to paragraph (a) of this regulation, must be
submitted to the Commission with a certification that the rule or rule
amendment of the swap complies with the Act or rules thereunder
pursuant to the procedures of Sec. 40.2 or Sec. 40.6 of this Chapter,
as applicable.
(c) Section 15 consideration. An applicant for registration, or a
registered swap execution facility, may request that the Commission
consider under the provisions of Section 15(b) of the Act any of the
swap execution facility's rules or policies, including both the
operational rules and the terms or conditions of swaps listed for
trading.
[[Page 1240]]
Sec. 37.5 Information Relating to Swap Execution Facility Compliance.
(a) Requests for information. Upon request by the Commission, a
swap execution facility must file with the Commission such information
related to its business as a swap execution facility, including
information relating to data entry and trade details, in the form and
manner and within the time as specified by the Commission in its
request.
(b) Demonstration of compliance. Upon request by the Commission, a
swap execution facility 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 swap execution facility 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 swap execution
facility, the swap execution facility 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 swap execution facility enters into a firm obligation to
transfer the equity interest.
(2) Required information. The notification must include and be
accompanied by: Any relevant agreement(s), including any preliminary
agreements; any associated changes to relevant corporate documents; a
chart outlining any new ownership or corporate or organizational
structure; a brief description of the purpose and any impact of the
equity interest transfer; and a representation from the swap execution
facility that it meets all of the requirements of Section 5h of the Act
and Commission regulations adopted thereunder. The swap execution
facility 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 swap execution facility must notify the Commission of the
consummation of the transaction on the day on which it occurs.
(3) Certification. (i) Upon a transfer of an equity interest of ten
percent or more in a swap execution facility, the swap execution
facility 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 swap execution facility meets all of the requirements of Section 5h
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 of ten percent or more was
acquired. Such certification must state whether changes to any aspects
of the swap execution facility'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 paragraph (c)(3) of this
section may rely on and be supported by reference to an application for
registration 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 updates of prior
submissions.
(d) Delegation of authority. The Commission hereby delegates, until
it orders otherwise, the authority set forth in paragraph (b) of this
regulation 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.
Sec. 37.6 Enforceability.
(a) A transaction entered into on or pursuant to the rules of a
registered swap execution facility shall not be void, voidable, subject
to rescission or otherwise invalidated or rendered unenforceable as a
result of:
(1) A violation by the registered swap execution facility of the
provisions of Section 5h of the Act or this part 37; or
(2) Any Commission proceeding to alter or supplement a rule, term
or condition under Section 8a(7) of the Act, to declare an emergency
under Section 8a(9) of the Act, or any other proceeding the effect of
which is to alter, supplement, or require a registered swap execution
facility to adopt a specific term or condition, trading rule or
procedure or to take or refrain from taking a specific action.
(b) A transaction entered into on or pursuant to the rules of a
registered swap execution facility shall include written documentation
that memorializes all of the terms of the transaction and legally
supersedes any previous agreement. The confirmation of all terms of the
transaction shall take place at the same time as execution.
Sec. 37.7 Prohibited use of data collected for regulatory purposes.
A swap execution facility 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 swap
execution facility, where necessary, may share such information with
one or more swap execution facilities, or designated contract markets
registered with the Commission, for regulatory purposes.
Sec. 37.8 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
intends to also operate a swap execution facility must separately
register the swap execution facility, pursuant to the swap execution
facility registration requirements set forth in this Part 37, and on an
ongoing basis, comply with the core principles under Section 5h of the
Act, and the regulations under this part 37.
(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 for
executing and trading swaps on the designated contract market must
clearly identify to market participants for each swap whether the
execution or trading of such swaps is taking place on the designated
contract market or on the swap execution facility.
Sec. 37.9 Permitted execution methods.
(a) Definitions. (1) As used in this part 37:
(i) Order Book means:
(A) An electronic trading facility, as that term is defined in
section 1a(16) of the Act;
(B) A trading facility, as that term is defined in section 1a(51)
of the Act;
(C) A trading system or platform in which all market participants
in the trading system or platform can enter multiple bids and offers,
observe bids and offers entered by other market participants, and
choose to transact on such bids and offers; or
[[Page 1241]]
(D) Any such other trading system or platform as may be determined
by the Commission.
(ii) Request for Quote System means:
(A) A trading system or platform in which a market participant must
transmit a request for a quote to buy or sell a specific instrument to
no less than five market participants in the trading system or
platform, to which all such market participants may respond. Any bids
or offers resting on the trading system or platform pertaining to the
same instrument must be taken into account and communicated to the
requester along with the responsive quotes; or
(B) A trading system or platform in which multiple market
participants can both:
(1) View real-time electronic streaming quotes, both firm and
indicative, from multiple potential counterparties on a centralized
electronic screen; and
(2) Have the option to complete a transaction by:
(i) Accepting a firm streaming quote, or
(ii) Transmitting a request for quote to no less than five market
participants, based upon an indicative streaming quote, taking into
account any resting bids or offers that have been communicated to the
requester along with any responsive quotes; or
(C) Any such other trading system or platform as may be determined
by the Commission.
(iii) Voice-Based System means a trading system or platform in
which a market participant executes or trades a Permitted Transaction
using a telephonic line or other voice-based service.
(iv) Required Transactions means transactions that are subject to
the execution requirements under this Act and are made available for
trading pursuant to Sec. 37.10, and are not block trades.
(v) Permitted Transactions means transactions that meet any of
these requirements:
(A) Are block trades;
(B) Are not swaps subject to the Act's clearing and execution
requirements, or
(C) Are illiquid or bespoke swaps.
(b) Required Transactions. (1) Required Transactions may be
executed on an Order Book or a Request for Quote System.
(2) An applicant seeking registration as a swap execution facility
must, at a minimum, offer trading services to facilitate Required
Transactions by providing market participants with the ability to post
both firm and indicative quotes on a centralized electronic screen
accessible to all market participants who have access to the swap
execution facility.
(3) Swap execution facilities must require that traders who have
the ability to execute against a customer's order or to execute two
customers against each other be subject to a 15 second timing delay
between the entry of those two orders, such that one side of the
potential transaction is disclosed and made available to other market
participants before the second side of the potential transaction
(whether for the trader's own account or for a second customer), is
submitted for execution.
(4) The Commission may, in its discretion, determine to require the
swap execution facility to provide its participants a different trading
method for a particular swap.
(c) Permitted Transactions. (1) Permitted Transactions may be
executed by an Order Book, Request for Quote System, a Voice-Based
System, or any such other system for trading as may be permitted by the
Commission.
(2) A registered swap execution facility may submit a request to
the Commission to offer trading services to facilitate Permitted
Transactions. When submitting such request, the swap execution facility
must certify its compliance with Sec. 37.11.
Sec. 37.10 Swaps made available for trading.
(a) A swap execution facility must conduct an annual review (or at
the Commission's request) of whether the swap execution facility has
made a swap available for trading.
(b) When conducting reviews and assessments regarding whether the
swap execution facility has made a swap available for trading, a swap
execution facility may consider:
(1) The frequency of transactions in this or similar swaps;
(2) The open interest in this or similar swaps; and
(3) Any other factor requested by the Commission.
(c)(1) If at least one swap execution facility has made the same or
an economically equivalent swap available for trading, all swap
execution facilities are required to treat the swap as made available
for trading.
(2) After conducting its review and assessment of whether a swap is
made available for trading, the swap execution facility must provide
electronically to the Commission a report of its assessment not more
than 30 days after completion of the assessment.
Sec. 37.11 Identification of non-cleared swaps or swaps not made
available to trade.
(a) A swap execution facility may allow:
(1) The execution and trading of swaps that have not been
determined to be subject to the clearing mandate under Section 2(h) of
the Act;
(2) Transactions subject to an exception from the clearing mandate
provided under Section 2(h)(7) of the Act; or
(3) The execution and trading of swaps that have not been made
available for trading pursuant to Sec. 37.10.
(b) A swap execution facility that chooses to offer to facilitate
bilateral trading for swaps detailed in paragraph (a) of this section
must clearly identify to market participants that the particular swap
is to be executed bilaterally between the parties pursuant to one of
the applicable exemption from execution and clearing.
Subpart B--Compliance With Core Principles
Sec. 37.100 Core Principle 1--Compliance with Core Principles.
(a) In general. To be registered, and maintain registration, as a
swap execution facility, the swap execution facility shall comply
with--
(1) All core principles described in Section 5h 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 a Swap Execution Facility. Unless
otherwise determined by the Commission by rule or regulation, a swap
execution facility described in paragraph (a) of this section shall
have reasonable discretion in establishing the manner in which the swap
execution facility complies with the core principles described in
Section 5h of the Act.
Subpart C--Compliance With Rules
Sec. 37.200 Core Principle 2--Compliance with rules.
A swap execution facility shall:
(a) Establish and enforce compliance with any rule of the swap
execution facility, including the terms and conditions of the swaps
traded or processed on or through the swap execution facility and any
limitation on access to the swap execution facility;
(b) Establish and enforce trading, trade processing, and
participation rules that will deter abuses and have the capacity to
detect, investigate, and enforce those rules, including means to
provide market participants with impartial access to the market and to
capture information that may be used in establishing whether rule
violations have occurred;
[[Page 1242]]
(c) Establish rules governing the operation of the facility,
including rules specifying trading procedures to be used in entering
and executing orders traded or posted on the facility, including block
trades; and
(d) Provide by its rules that, when a swap dealer or major swap
participant enters into or facilitates a swap that is subject to the
mandatory clearing requirement of Section 2(h), the swap dealer or
major swap participant shall be responsible for compliance with the
mandatory trading requirement under Section 2(h)(8) of the Act.
Sec. 37.201 Operation of swap execution facility and compliance with
rules.
(a) A swap execution facility must establish rules governing the
operation of the swap execution facility, including, but not limited
to, rules specifying trading procedures to be followed by members and
market participants when entering and executing orders traded or posted
on the swap execution facility, including block trades, as defined in
part 45 of this chapter, if offered.
(b) A swap execution facility must establish and impartially
enforce compliance with the rules of the swap execution facility,
including, but not limited to--
(1) The terms and conditions of any swaps traded or processed on or
through the swap execution facility;
(2) Access to the swap execution facility;
(3) Trade practice rules;
(4) Audit trail requirements;
(5) Disciplinary rules; and
(6) Mandatory clearing requirements.
Sec. 37.202 Access requirements.
(a) Impartial access by members and market participants. A swap
execution facility shall provide any eligible contract participant and
any independent software vendor with impartial access to its market(s)
and market services (including any indicative quote screens or any
similar pricing data displays), providing--
(1) Criteria that are impartial, transparent, and applied in a fair
and nondiscriminatory manner;
(2) A process by which participants provide the swap execution
facility with written or electronic confirmation of their status as
eligible contract participants, as defined by the Act and Commission
regulations, prior to being granted access to the swap execution
facility; and
(3) Comparable fees for participants receiving comparable access
to, or services from, a swap execution facility.
(b) Jurisdiction. Prior to granting any eligible contract
participant access to its facilities, a swap execution facility must
require that the eligible contract participant consents to its
jurisdiction.
(c) Limitations on access. A swap execution facility must establish
and impartially enforce rules governing any decision to allow, deny,
suspend, or permanently bar participants' access to the swap execution
facility, including such decisions when made as part of a disciplinary
or emergency action taken by the swap execution facility.
Sec. 37.203 Rule enforcement program.
A swap execution facility must establish and enforce trading, trade
processing, and participation rules that will deter abuses and it must
have the capacity to detect, investigate and enforce those rules.
(a) Abusive Trading Practices Prohibited. A swap execution facility
must prohibit abusive trading practices on its markets by members and
market participants. Specific trading practices that must be prohibited
by all swap execution facilities include front-running, wash trading,
pre-arranged trading, fraudulent trading, money passes and any other
trading practices that a swap execution facility deems to be abusive.
In addition, a swap execution facility also must prohibit any other
manipulative or disruptive trading practices prohibited by the Act or
by the Commission pursuant to Commission regulation. Swap execution
facilities 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.
(b) Capacity to Detect and Investigate Rule Violations. A swap
execution facility 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
swap execution facility's members and by market participants. A swap
execution facility'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 has occurred.
(c) Compliance Staff and Resources. (1) Sufficient compliance
staff. A swap execution facility 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 swap execution
facility'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. 37.203(f).
(2) Ongoing monitoring of compliance staff resources. A swap
execution facility must monitor the size and workload of its compliance
staff on a continuous basis and, on at least an annual basis, formally
evaluate the need to increase its compliance resources and staff. In
determining the appropriate level of compliance resources and staff,
the swap execution facility should consider trading volume increases,
the number of new products or swaps listed for trading, any new
responsibilities assigned to compliance staff, the results of any
internal review demonstrating that work is not completed in an
effective or timely manner, the recommendation of any Commission rule
enforcement review or evaluation of the swap execution facility and any
other factors suggesting the need for increased resources and staff.
(d) Automated Trade Surveillance System. A swap execution facility
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 or platform, including all order
modifications and cancellations, and maintain all data reflecting
transactions executed on the swap execution facility. 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 enable system users to
perform in-depth analyses and ad hoc queries of trade-related data.
(e) Real-time Market Monitoring. A swap execution facility 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 swap execution facility 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
[[Page 1243]]
adjustments or trade cancellations must be transparent to the market
and subject to standards that are clear, fair, and publicly available.
(f) Investigations and Investigation Reports. (1) Procedures. A
swap execution facility 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 (such as data produced by automated surveillance systems)
by the swap execution facility that, in the judgment of its compliance
staff, indicates a possible basis for finding that a violation has
occurred or will occur.
(2) 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.
(3) 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
swap execution facility, including copies of warning letters.
(4) 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 Sec. 37.203(f)(5). If compliance
staff recommends that a warning letter be issued to a member or market
participant pursuant to Sec. 37.203(f)(5), the investigation report
must include a copy of the letter as well as the member or market
participant's disciplinary history at the swap execution facility,
including copies of warning letters.
(5) Warning letters. In addition to the action required to be taken
under Sec. Sec. 37.203(f)(3) and 37.203(f)(4), the rules of a swap
execution facility 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 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 Sec. Sec. 37.203(f)(3) and 37.203(f)(4). 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.
(g) Additional Rules Required. A swap execution facility must adopt
and enforce any additional rules that it believes are necessary to
comply with the requirements of Sec. 37.203.
Sec. 37.204 Regulatory services provided by a third party.
(a) Use of third-party provider permitted. A swap execution
facility may choose to contract with a registered futures association
or another registered entity, as such terms are defined under the Act,
(collectively, ``regulatory service provider''), for the provision of
services to assist in complying with the core principles, as approved
by the Commission. Any swap execution facility 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 swap execution facility will at all
times remain responsible for the performance of any regulatory services
received, for compliance with the swap execution facility's obligations
under the Act and Commission regulations, and for the regulatory
service provider's performance on its behalf.
(b) Duty to supervise third party. A swap execution facility that
elects to use the service of a regulatory service provider must retain
sufficient compliance staff to supervise the quality and effectiveness
of the regulatory services provided on its behalf. Compliance staff of
the swap execution facility must hold regular meetings with the
regulatory service provider to discuss ongoing investigations, trading
patterns, market participants, and any other matters of regulatory
concern. A swap execution facility must also 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 swap execution facility.
A swap execution facility that elects to use the service of a
regulatory service provider must retain exclusive authority in all
substantive decisions made by its regulatory service provider,
including but not limited to decisions involving the cancellation of
trades, the issuance of disciplinary charges against members or market
participants, denials of access to the trading platform for
disciplinary reasons, and any decision to open an investigation into a
possible rule violation. A swap execution facility must document any
instances where its actions differ from those recommended by its
regulatory service provider.
Sec. 37.205 Audit trail.
A swap execution facility must establish procedures to capture and
retain information that may be used in establishing whether rule
violations have occurred.
(a) Audit Trail Required. A swap execution facility must capture
and retain all audit trail data 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 swap execution
facility. An acceptable audit trail must also permit the swap execution
facility to track a customer order from the time of receipt through
fill, allocation, or other disposition, and must include both order and
trade data.
(b) Elements of an Acceptable Audit Trail Program. (1) Original
source documents. A swap execution facility'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, a unique account
identifier that relates
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back to the account(s) owner(s) and the time of order entry. Swap
execution facilities that permit intermediation must require that all
orders or requests for quotes received by phone that are executable be
immediately entered into the trading system or platform. If an order or
request for quote cannot be immediately entered into the trading system
or platform, an electronic record that includes the account identifier
that relates to the account owner, time of receipt, and terms of the
order or request for quote must immediately be created, and the order
or request for quote must be entered into the trading system or
platform as soon as practicable.
(2) Transaction history database. A swap execution facility'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:
(i) All data that are input into the trade entry or matching system
for the transaction to match and clear;
(ii) The categories of participant for which each trade is
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 or the account of any other customer;
(iii) Timing and sequencing data adequate to reconstruct trading;
and
(iv) Identification of each account to which fills are allocated.
(3) Electronic analysis capability. A swap execution facility'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.
(4) Safe storage capability. A swap execution facility'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 10 for
swap execution facilities and the associated regulations in subpart K
of this part 37.
(c) Enforcement of Audit Trail Requirements. (1) Annual audit trail
and recordkeeping reviews. A swap execution facility 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 swap execution facility's audit trail and
recordkeeping requirements. Such reviews must include, but are not
limited to, 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) Enforcement program required. A swap execution facility must
establish a program for effective enforcement of its audit trail and
recordkeeping requirements. 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.
Sec. 37.206 Disciplinary procedures and sanctions.
A swap execution facility must establish trading, trade processing,
and participation rules that will deter abuses and have the capacity to
enforce such rules through prompt and effective disciplinary action.
(a) Enforcement staff. A swap execution facility must establish and
maintain sufficient enforcement staff and resources to effectively and
promptly prosecute possible rule violations within the disciplinary
jurisdiction of the swap execution facility. A swap execution facility
must also monitor the size and workload of its enforcement staff
annually, and increase its enforcement resources and staff as
appropriate. The enforcement staff may not include either members of
the swap execution facility 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 swap execution facility. A swap execution
facility's enforcement staff may operate as part of the swap execution
facility's compliance department.
(b) Disciplinary panels. (1) Disciplinary panels required. A swap
execution facility 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), and must not include any members of the swap
execution facility's compliance staff, or any person involved in
adjudicating any other stage of the same proceeding.
(2) Review panels. A swap execution facility's Review Panel(s) must
be responsible for determining whether a reasonable basis exists for
finding a violation of swap execution facility 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.
(3) Hearing Panels. A swap execution facility'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.
(c) Review of investigation report. Promptly after receiving a
completed investigation report pursuant to Sec. 37.203(f)(3), a Review
Panel must promptly review the report and, within 30 days of such
receipt, must take one of the following actions:
(1) If the Review Panel determines that additional investigation or
evidence is needed, it must promptly direct the compliance staff to
conduct further investigation.
(2) 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 forth the
facts and analysis supporting the decision.
(3) 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.
(d) 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);
[[Page 1245]]
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 swap execution facility so provide:
(1) The 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
(2) The failure to answer or to deny expressly a charge may be
deemed to be an admission of such charge.
(e) 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.
(f) 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
swap execution facility 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. A statement of
a lack of sufficient information shall have the effect of a denial of
an allegation;
(2) Failure to file an answer on a timely basis shall be deemed an
admission of all allegations contained 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.
(g) Admission or failure to deny charges. The rules of a swap
execution facility 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 swap
execution facility's rules so provide, then:
(1) The Hearing Panel must impose a sanction for each violation
found to have been committed;
(2) The Hearing Panel must promptly notify the respondent in
writing of any sanction to be imposed pursuant to Sec. 37.206(g)(1)
and advise the respondent that it may request a hearing on such
sanction within a specified period of time;
(3) The rules of a swap execution facility may provide that if a
respondent fails to request a hearing within the period of time
specified in the notice, the respondent will be deemed to have accepted
the sanction.
(h) 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 Section 37.206(g), the
respondent must be given an opportunity for a hearing in accordance
with the requirements of Sec. 37.206(j). The swap execution facility'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. 37.206(g) for which a hearing has been
requested.
(i) Settlement offers. (1) The rules of a swap execution facility
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.
(2) The rules of a swap execution facility 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.
(3) 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.
(4) 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.
(j) Hearings. (1) A swap execution facility must adopt rules that
provide for the following minimum requirements for any hearing
conducted pursuant to a notice of charges:
(i) 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.
(ii) 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 swap execution facility that are to be relied
upon by the enforcement staff in presenting the charges contained in
the notice of charges or that are relevant to those charges.
(iii) The swap execution facility'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.
(iv) 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.
(v) The swap execution facility must require that persons within
its jurisdiction who are called as witnesses participate in the hearing
and produce evidence. It must make reasonable efforts to secure the
presence of all other persons called as witnesses whose testimony would
be relevant.
(vi) If the respondent has requested a hearing, a copy of the
hearing must be 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. 37.206(l), 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.
(vii) The rules of a swap execution facility 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. 37.206(l), 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 swap execution
facility.
(2) The rules of a swap execution facility may provide that a
sanction may be summarily imposed upon any person within its
jurisdiction whose actions impede the progress of a hearing.
[[Page 1246]]
(k) Decisions. Promptly following a hearing conducted in accordance
with Sec. 37.206(j), 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:
(1) The 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 of the investigation report;
(4) 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;
(5) An indication of each specific rule that the respondent was
found to have violated;
(6) A declaration of all sanctions imposed against the respondent,
including the basis for such sanctions and the effective date of such
sanctions.
(l) Right to appeal. The rules of a swap execution facility 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 swap execution facility permit appeals,
then both the respondent and the enforcement staff must have the
opportunity to appeal and the swap execution facility must provide for
the following:
(1) The swap execution facility must establish an appellate panel
that must be authorized to hear appeals of respondents. In addition,
the rules of a swap execution facility 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.
(2) The composition of the appellate panel must be consistent with
Sec. 40.9(c)(iv), and must not include any members of the swap
execution facility's compliance staff, or any person involved in
adjudicating any other stage of the same proceeding. The rules of a
swap execution facility must provide for the appeal proceeding to be
conducted before all of the members of the board of appeals or a panel
thereof.
(3) 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.
(4) 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 appeals must adhere to
all the requirement of Sec. 37.206(k), to the extent that a different
conclusion is reached from that issued by the Hearing Panel.
(m) Final decisions. Each swap execution facility must establish
rules setting forth when a decision rendered pursuant to this section
will become the final decision of such swap execution facility.
(n) Disciplinary sanctions. All disciplinary sanctions imposed by a
swap execution facility 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.
(o) Summary fines for violations of rules regarding timely
submission of records. A swap execution facility 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. A swap execution facility may permit its compliance
staff, or a designated panel of swap execution facility officials, to
summarily impose minor sanctions against persons within the swap
execution facility's jurisdiction for violating such rules. A swap
execution facility'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.
(p) Emergency disciplinary actions. (1) A swap execution facility
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.
(2) Any emergency disciplinary action must be taken in accordance
with a swap execution facility's procedures that provide for the
following:
(i) 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.
(ii) 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. 37.206(j).
(iii) Promptly following the hearing provided for in this rule, the
swap execution facility 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 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.
Sec. 37.207 Swaps subject to mandatory clearing.
A swap execution facility shall provide by its rules that when a
swap dealer or major swap participant enters into or facilitates a swap
transaction that is subject to the mandatory clearing requirement of
Section 2(h) of the Act, the swap dealer or major swap participant
shall be responsible for compliance with the mandatory trading
requirement under Section 2(h)(8).
Subpart D--Swaps Not Readily Susceptible to Manipulation
Sec. 37.300 Core Principle 3--Swaps not readily susceptible to
manipulation.
The swap execution facility shall permit trading only in swaps that
are not readily susceptible to manipulation.
Sec. 37.301 General requirement.
(a) To demonstrate to the Commission compliance with the
requirements of Sec. 37.300, a swap execution facility must submit new
swap contracts in advance to the Commission pursuant to part 40 of this
chapter, either by:
(1) Requesting prior approval from the Commission; or
(2) Self-certification for new product submissions.
[[Page 1247]]
(b) Furthermore, the swap execution facility must provide evidence
that the swap complies with Core Principle 3 by providing the
applicable information as set forth in appendix C to part 38--
Demonstration of Compliance that a contract is not readily susceptible
to manipulation.
Subpart E--Monitoring of Trading and Trade Processing
Sec. 37.400 Core Principle 4--Monitoring of trading and trade
processing.
The swap execution facility shall:
(a) Establish and enforce rules or terms and conditions defining,
or specifications detailing:
(1) Trading procedures to be used in entering and executing orders
traded on or through the facilities of the swap execution facility; and
(2) Procedures for trade processing of swaps on or through the
facilities of the swap execution facility; and
(b) Monitor trading in swaps to prevent manipulation, price
distortion, and disruptions of the delivery or cash settlement process
through surveillance, compliance, and disciplinary practices and
procedures, including methods for conducting real-time monitoring of
trading and comprehensive and accurate trade reconstructions.
Sec. 37.401 General requirements.
A swap execution facility 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 reconstruction. 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. 37.402 Additional requirements for physical-delivery swaps.
(a) For physical-delivery swaps, the swap execution facility must:
(1) Monitor a swap's terms and conditions;
(2) Monitor that the deliverable supply is adequate so that the
swap will not be conducive to price manipulation or distortion;
(3) Assess whether the deliverable commodity reasonably can be
expected to be available to traders responsible for making the delivery
and salable or usable by traders receiving delivery 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 swap execution facility must continually monitor the
appropriateness of the swap's terms and conditions, including the
delivery instrument, the delivery locations and location differentials,
and the commodity characteristics and related differentials. The swap
execution facility must act promptly to address the conditions that are
causing price distortions or market disruptions, including, when
appropriate, changes to contract terms.
Sec. 37.403 Additional requirements for cash-settled swaps.
(a) For cash-settled swaps, the swap execution facility must
monitor:
(1) The availability and pricing of the commodity making up the
index to which the swap will be settled; and
(2) The continued appropriateness of the methodology for deriving
the index. For those swap execution facilities that compute their own
indices, they 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 swap listed on a swap execution facility is settled by
reference to the price of a swap traded in another venue, including a
price or index derived from prices on another swap execution facility,
the swap execution facility must have an information sharing agreement
with the other venue or swap execution facility. In lieu of an
information sharing agreement, the swap execution facility must have
the capacity to assess whether positions or trading in the swap or
commodity to which its swap is cash-settled are being manipulated in
order to affect prices on its market.
Sec. 37.404 Ability to obtain information.
(a) The swap execution facility must have rules that require
traders in its swaps 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 swap execution facility and the Commission.
(b) A swap execution facility 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. 37.405 Risk controls for trading.
The swap execution facility 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 swap execution facility.
If a swap is linked to, or a substitute for, other swaps on the swap
execution facility or on other trading venues, such risk controls must,
to the extent practicable, be coordinated with any similar controls
placed on those other swaps. If a swap is based on 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. 37.406 Trade reconstruction.
The swap execution facility 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 to the Commission in a form, manner, and time as determined
by the Commission.
Sec. 37.407 Additional rules required.
A swap execution facility 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--Ability To Obtain Information
Sec. 37.500 Core Principle 5--Ability To Obtain Information.
The swap execution facility shall:
(a) Establish and enforce rules that will allow the facility to
obtain any necessary information to perform any of the functions
described in this section;
(b) Provide the information to the Commission on request; and
(c) Have the capacity to carry out such international information-
sharing agreements as the Commission may require.
Sec. 37.501 Establish and enforce rules.
A swap execution facility must establish and enforce rules that
will allow the swap execution facility to have the ability and
authority to obtain sufficient information to allow it to fully perform
its operational, risk
[[Page 1248]]
management, governance, and regulatory functions and any requirements
under this part 37, including the capacity to carry out international
information-sharing agreements as the Commission may require.
Sec. 37.502 Collection of information.
A swap execution facility must have rules that allow it to collect
information on a routine basis, allow for the collection of non-routine
data from its participants, and allow for its examination of books and
records kept by the traders on its facility.
Sec. 37.503 Provide information to the Commission.
A swap execution facility shall provide information in its
possession to the Commission upon request, in a form and manner that
the Commission approves.
Sec. 37.504 Information-sharing agreements.
A swap execution facility shall share information with other
regulatory organizations, data repositories, and reporting services as
required by the Commission or as otherwise necessary and appropriate to
fulfill its self-regulatory and reporting responsibilities. Appropriate
information-sharing agreements can be established with such entities or
the Commission can act in conjunction with the swap execution facility
to carry out such Information Sharing.
Subpart G--Position Limits or Accountability
Sec. 37.600 Core Principle 6--Position limits or accountability.
(a) In general. To reduce the potential threat of market
manipulation or congestion, especially during trading in the delivery
month, a swap execution facility that is a trading facility shall adopt
for each of the contracts of the facility, as is necessary and
appropriate, position limitations or position accountability for
speculators.
(b) Position limits. For any contract that is subject to a position
limitation established by the Commission pursuant to Section 4a(a) of
the Act, the swap execution facility shall:
(1) Set its position limitation at a level no higher than the
Commission limitation; and
(2) Monitor positions established on or through the swap execution
facility for compliance with the limit set by the Commission and the
limit, if any, set by the swap execution facility.
Sec. 37.601 Position limits or accountability.
(a) To reduce the potential threat of market manipulation or
congestion, especially during trading in the delivery month, a swap
execution facility that is a trading facility shall adopt for each of
the contracts on the facility, as is necessary and appropriate,
position limitations or position accountability for speculators.
(b) For any contract that is subject to a position limitation
established by the Commission pursuant to Section 4a(a), the swap
execution facility shall:
(1) Set its position limitation at a level no higher than the
Commission limitation;
(2) Monitor positions established on or through the swap execution
facility for compliance with the limit set by the Commission and the
limit, if any, set by the swap execution facility.
(c) The swap execution facility must establish the position limits
in accordance with the requirements set forth in part 151.
Subpart H--Financial Integrity of Transactions
Sec. 37.700 Core Principle 7--Financial integrity of transactions.
The swap execution facility shall establish and enforce rules and
procedures for ensuring the financial integrity of swaps entered on or
through the facilities of the swap execution facility, including the
clearance and settlement of the swaps pursuant to Section 2(h)(1) of
the Act.
Sec. 37.701 Mandatory clearing.
Transactions executed on or through the swap execution facility
must be cleared through a Commission-registered derivatives clearing
organization unless:
(a) The transaction is exempted from clearing under Section 2(h)(7)
of the Act; or
(b) The Commission has not determined that the clearing requirement
under Section 2(h)(1) is applicable.
Sec. 37.702 General financial integrity.
A swap execution facility must provide for the financial integrity
of its transactions:
(a) By establishing minimum financial standards for its members,
which shall, at a minimum, require that members qualify as an eligible
contract participant as defined in Section 1a (18) of the Act;
(b) For transactions cleared by a derivatives clearing
organization, by ensuring that the swap execution facility has the
capacity to route transactions to the derivative clearing organization
in a manner acceptable to the derivatives clearing organization for
purposes of ongoing risk management;
(c) For transactions not cleared by a derivatives clearing
organization, by requiring members to demonstrate that they:
(1) Have entered into credit arrangement documentation for the
transaction;
(2) Have the ability to exchange collateral; and
(3) Meet any credit filters that may be adopted by the swap
execution facility; and
(d) By implementing any additional safeguards as may be required by
Commission regulations.
Sec. 37.703 Monitoring for financial soundness.
A swap execution facility must monitor members' compliance with the
swap execution facility's minimum financial standards and, therefore,
must routinely receive and promptly review financial and related
information from its members.
Subpart I--Emergency Authority
Sec. 37.800 Core Principle 8--Emergency authority.
The swap execution facility shall adopt rules to provide for the
exercise of emergency authority, in consultation or cooperation with
the Commission, as is necessary and appropriate, including the
authority to liquidate or transfer open positions in any swap or to
suspend or curtail trading in a swap.
Sec. 37.801 Additional sources for compliance.
Applicants and swap execution facilities may refer to the guidance
and/or acceptable practices in appendix B to part 37 to demonstrate to
the Commission compliance with the requirements of Sec. 37.800.
Subpart J--Timely Publication of Trading Information
Sec. 37.900 Core Principle 9--Timely publication of trading
information.
(a) In general. The swap execution facility shall make public
timely information on price, trading volume, and other trading data on
swaps to the extent prescribed by the Commission.
(b) Capacity of swap execution facility. The swap execution
facility shall be required to have the capacity to electronically
capture and transmit trade information with respect to transactions
executed on the facility.
[[Page 1249]]
Sec. 37.901 General requirement.
With respect to swaps traded on or through a swap execution
facility, each swap execution facility must:
(a) Report specified swap data as provided under part 43 and part
45 of this Chapter; and
(b) Meet the requirements of part 16 of this chapter.
Sec. 37.902 Capacity of swap execution facility.
The swap execution facility must have the capacity to
electronically capture trade information with respect to transactions
executed on the facility.
Subpart K--Recordkeeping and Reporting
Sec. 37.1000 Core Principle 10--Recordkeeping and reporting.
(a) In general. A swap execution facility shall:
(1) Maintain records of all activities relating to the business of
the facility, including a complete audit trail, in a form and manner
acceptable to the Commission for a period of 5 years;
(2) Report to the Commission, in a form and manner acceptable to
the Commission, such information as the Commission determines to be
necessary or appropriate for the Commission to perform the duties of
the Commission under the Act; and
(3) 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.
(b) Requirements. The Commission shall adopt data collection and
reporting requirements for swap execution facilities that are
comparable to corresponding requirements for derivatives clearing
organizations and swap data repositories.
Sec. 37.1001 Recordkeeping required.
A swap execution facility must maintain records of all activities
relating to the business of the facility, in a form and manner
acceptable to the Commission, for a period of at least 5 years. A swap
execution facility must maintain such records, including a complete
audit trail for all swaps executed on or subject to the rules of the
swap execution facility, investigatory files, and disciplinary files,
in accordance with the requirements of Sec. 1.31 and part 45 of this
chapter.
Sec. 37.1002 Reporting to the commission required.
A swap execution facility must report to the Commission, in a form
and manner acceptable to the Commission, such information as the
Commission determines to be necessary or appropriate for the Commission
to perform its duties under the Act.
Sec. 37.1003 Inspection and examination by the Securities and
Exchange Commission.
A swap execution facility must 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.
Subpart L--Antitrust Considerations
Sec. 37.1100 Core Principle 11--Antitrust considerations.
Unless necessary or appropriate to achieve the purposes of this
Act, the swap execution facility shall not:
(a) Adopt any rules or take any actions that result in any
unreasonable restraint of trade; or
(b) Impose any material anticompetitive burden on trading or
clearing.
Sec. 37.1101 Additional sources for compliance.
Applicants and swap execution facilities may refer to the guidance
and/or acceptable practices in appendix B to part 37 to demonstrate to
the Commission compliance with the requirements of Sec. 37.1100.
Subpart M--Conflicts of Interest
Sec. 37.1200 Core Principle 12--Conflicts of interest.
The swap execution facility shall:
(a) Establish and enforce rules to minimize conflicts of interest
in its decision-making process; and
(b) Establish a process for resolving the conflicts of interest.
Subpart N--Financial Resources
Sec. 37.1300 Core Principle 13--Financial resources.
(a) In general. The swap execution facility shall have adequate
financial, operational, and managerial resources to discharge each
responsibility of the swap execution facility.
(b) Determination of resource adequacy. The financial resources of
a swap execution facility shall be considered to be adequate if the
value of the financial resources exceeds the total amount that would
enable the swap execution facility to cover the operating costs of the
swap execution facility for a one-year period, as calculated on a
rolling basis.
Sec. 37.1301 General requirements.
(a) A swap execution facility shall maintain financial resources
sufficient to enable it to perform its functions in compliance with the
core principles set forth in Section 5h of the Act.
(b) An entity that operates as both a swap execution facility and a
derivatives clearing organization also shall comply with the financial
resource requirements of Sec. 39.11.
(c) Financial resources shall be considered sufficient if their
value is at least equal to a total amount that would enable the swap
execution facility, or applicant for designation as such, to cover its
operating costs for a period of at least one year, calculated on a
rolling basis.
Sec. 37.1302 Types of financial resources.
Financial resources available to satisfy the requirements of Sec.
37.1301 may include:
(a) The swap execution facility's own capital; and
(b) Any other financial resource deemed acceptable by the
Commission.
Sec. 37.1303 Computation of financial resource requirement.
A swap execution facility shall, on a quarterly basis, based upon
its fiscal year, make a reasonable calculation of its projected
operating costs over a twelve-month period in order to determine the
amount needed to meet the requirements of Sec. 37.1301. The swap
execution facility 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.
Sec. 37.1304 Valuation of financial resources.
At appropriate intervals, but not less than quarterly, a swap
execution facility shall compute the current market value of each
financial resource used to meet its obligations under Sec. 37.701.
Reductions in value to reflect market and credit risk (haircuts) shall
be applied as appropriate.
Sec. 37.1305 Liquidity of financial resources.
The financial resources allocated by the swap execution facility to
meet the requirements of Sec. 37.1301 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 swap execution
facility may take into account a committed line of credit or similar
facility for the purpose of meeting this requirement.
Sec. 37.1306 Reporting requirements.
(a) Each fiscal quarter, or at any time upon Commission request, a
swap execution facility shall:
[[Page 1250]]
(1) Report to the Commission:
(i) The amount of financial resources necessary to meet the
requirements of Sec. 37.1301; and
(ii) The value of each financial resource available, computed in
accordance with the requirements of Sec. 37.1304;
(2) Provide the Commission with a financial statement, including
the balance sheet, income statement, and statement of cash flows of the
swap execution facility or of its parent company;
(b) The calculations required by this Sec. 37.1306 shall be made
as of the last business day of the swap execution facility's fiscal
quarter.
(c) The swap execution facility shall provide the Commission with:
(1) Sufficient documentation explaining the methodology used to
compute its financial requirements under Sec. 37.1301;
(2) Sufficient documentation explaining the basis for its
determinations regarding the valuation and liquidity requirements set
forth in Sec. Sec. 37.1304 and 37.1305; and
(3) Copies of any agreements establishing or amending a credit
facility, insurance coverage, or other arrangement evidencing or
otherwise supporting the swap execution facility's conclusions.
(d) The report required by this Sec. 37.1306 shall be filed not
later than 17 business days after the end of the swap execution
facility's fiscal quarter, or at such later time as the Commission may
permit, in its discretion, upon request by the swap execution facility.
Subpart O--System Safeguards
Sec. 37.1400 Core Principle 14--System safeguards.
The swap execution facility 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 automated
systems, that:
(1) Are reliable and secure; and
(2) Have adequate scalable capacity;
(b) Establish and maintain emergency procedures, backup facilities,
and a plan for disaster recovery that allow for:
(1) The timely recovery and resumption of operations; and
(2) The fulfillment of the responsibilities and obligations of the
swap execution facility; and
(c) Periodically conduct tests to verify that the backup resources
of the swap execution facility are sufficient to ensure continued:
(1) Order processing and trade matching;
(2) Price reporting;
(3) Market surveillance; and
(4) Maintenance of a comprehensive and accurate audit trail.
Sec. 37.1401 Requirements.
(a) Each swap execution facility shall:
(1) 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;
(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 swap execution facility; and
(3) 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.
(b) A swap execution facility'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 (``BC-DR'') planning and
resources;
(3) Capacity and performance planning;
(4) Systems operations;
(5) Systems development and quality assurance; and
(6) Physical security and environmental controls.
(c) In addressing the categories of risk analysis and oversight
required under paragraph (b) of this section, a swap execution facility
should follow generally accepted standards and best practices with
respect to the development, operation, reliability, security, and
capacity of automated systems.
(d) A swap execution facility must maintain a BC-DR plan and BC-DR
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
swap execution facility 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, where appropriate;
price reporting; market surveillance; and maintenance of a
comprehensive audit trail. The swap execution facility's BC-DR plan and
resources generally should enable resumption of trading and clearing of
swaps executed on the swap execution facility during the next business
day following the disruption. Swap execution facilities determined by
the Commission to be critical financial markets are subject to more
stringent requirements in this regard, set forth in Section 40.9 of the
Commission's regulations.
(e) A swap execution facility 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 swap execution facility following any disruption of
its operations; or
(2) Contractual arrangements with other swap execution facilities
or disaster recovery service providers, as appropriate, that are
sufficient to ensure continued trading and clearing of swaps executed
on the swap execution facility, and ongoing fulfillment of all of the
swap execution facility's responsibilities and obligations with respect
to such swaps, in the event that a disruption renders the swap
execution facility temporarily or permanently unable to satisfy this
requirement on its own behalf.
(f) A swap execution facility 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 swap execution facility's BC-DR plan.
(g) A swap execution facility 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 swap execution facility's program of
risk analysis and oversight.
[[Page 1251]]
(h) A swap execution facility must provide to the Commission upon
request current copies of its BC-DR 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 swap execution facility's automated systems.
(i) A swap execution facility 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 BC-DR
capabilities. Both types of testing should be conducted by qualified,
independent professionals. Such qualified independent professionals may
be independent contractors or employees of the swap execution facility,
but should not be persons responsible for development or operation of
the systems or capabilities being tested. Pursuant to Core Principle 10
under Section 5h of the Act (Recordkeeping and Reporting), and
Sec. Sec. 37.1000 through 37.1003, the swap execution facility must
keep records of all such tests, and make all test results available to
the Commission upon request.
(j) To the extent practicable, a swap execution facility should:
(1) Coordinate its BC-DR plan with those of the 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 swap execution facility's BC-DR
plan;
(2) Initiate and coordinate periodic, synchronized testing of its
BC-DR plan and the BC-DR plans of the market participants upon whom it
depends to provide liquidity; and
(3) Ensure that its BC-DR plan takes into account the BC-DR plans
of its telecommunications, power, water, and other essential service
providers.
(k) 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
establishes the requirements for core principle compliance in that
respect.
Subpart P--Designation of Chief Compliance Officer
Sec. 37.1500 Core Principle 15--Designation of Chief Compliance
Officer.
(a) In general. Each swap execution facility shall designate an
individual to serve as a chief compliance officer.
(b) Duties. The chief compliance officer shall:
(1) Report directly to the board or to the senior officer of the
facility;
(2) Review compliance with the core principles in this subsection;
(3) In consultation with the board of the facility, a body
performing a function similar to that of a board, or the senior officer
of the facility, resolve any conflicts of interest that may arise;
(4) Be responsible for establishing and administering the policies
and procedures required to be established pursuant to this section;
(5) Ensure compliance with the Act and the rules and regulations
issued under the Act, including rules prescribed by the Commission
pursuant to this section; and
(6) Establish procedures for the remediation of noncompliance
issues found during compliance office reviews, look backs, internal or
external audit findings, self-reported errors, or through validated
complaints.
(c) Requirements for procedures. In establishing procedures under
paragraph (b)(6) of this section, the chief compliance officer shall
design the procedures to establish the handling, management response,
remediation, retesting, and closing of noncompliance issues.
(d) Annual reports. (1) In general. In accordance with rules
prescribed by the Commission, the chief compliance officer shall
annually prepare and sign a report that contains a description of:
(i) The compliance of the swap execution facility with the Act; and
(ii) The policies and procedures, including the code of ethics and
conflict of interest policies, of the swap execution facility.
(2) Requirements. The chief compliance officer shall:
(i) Submit each report described in clause (1) with the appropriate
financial report of the swap execution facility that is required to be
submitted to the Commission pursuant to this section; and
(ii) Include in the report a certification that, under penalty of
law, the report is accurate and complete.
Sec. 37.1501 Chief Compliance Officer.
(a) Definition of Board of Directors. For purposes of this part 37,
the term ``board of directors'' means the board of directors of a
registered swap execution facility, or for those swap execution
facilities whose organizational structure does not include a board of
directors, a body performing a function similar to a board of
directors.
(b) Designation and qualifications of chief compliance officer.
(1) Chief Compliance Officer Required. Each registered swap
execution facility shall establish the position of chief compliance
officer, and designate an individual to serve in that capacity.
(i) The position of chief compliance officer shall carry with it
the authority and resources to develop and enforce policies and
procedures necessary to fulfill the duties set forth for chief
compliance officers in the Act and Commission regulations.
(ii) The chief compliance officer shall have supervisory authority
over all staff acting in furtherance of the chief compliance officer's
statutory, regulatory, and self-regulatory obligations.
(2) Qualifications of Chief Compliance Officer. The individual
designated to serve as chief compliance officer shall have the
background and skills appropriate for fulfilling the responsibilities
of the position.
(i) No individual disqualified from registration pursuant to
Sections 8a(2) or 8a(3) of the Act may serve as a chief compliance
officer.
(ii) The chief compliance officer may not be a member of the swap
execution facility's legal department and may not serve as its general
counsel.
(c) Appointment, Supervision, and Removal of Chief Compliance
Officer. (1) Appointment and Compensation of Chief Compliance Officer
Determined by Board of Directors. A registered swap execution
facility's chief compliance officer shall be appointed by its board of
directors. The board of directors must also approve the compensation of
the chief compliance officer and shall meet with the chief compliance
officer at least annually. The chief compliance officer shall also meet
with the regulatory oversight committee, as defined in Sec. 37.19(b),
at least quarterly. The chief compliance officer shall provide any
information regarding the swap execution facility's regulatory program
that is requested by the board of directors or the regulatory oversight
committee. The appointment of the chief compliance officer and approval
of the chief compliance officer's compensation shall require the
approval of a majority of the board of directors. The senior officer of
the swap execution facility may fulfill these responsibilities. A swap
execution facility shall notify
[[Page 1252]]
the Commission of the appointment of a new chief compliance officer
within two business days of such appointment.
(2) Supervision of Chief Compliance Officer. A swap execution
facility's chief compliance officer shall report directly to the board
of directors or to the senior officer of the swap execution facility,
at the swap execution facility's discretion.
(3) Removal of Chief Compliance Officer by Board of Directors.
Removal of a registered swap execution facility's chief compliance
officer shall require the approval of a majority of the swap execution
facility's board of directors. If the swap execution facility does not
have a board of directors, then the chief compliance officer may be
removed by the senior officer of the swap execution facility. The swap
execution facility shall notify the Commission and explain the reasons
for the departure within two business days. The swap execution facility
shall immediately appoint an interim chief compliance officer, and
shall appoint a permanent chief compliance officer as soon as
reasonably practicable. The swap execution facility shall notify the
Commission within two business days of appointing any new chief
compliance officer, whether interim or permanent.
(d) Duties of Chief Compliance Officer. The chief compliance
officer's duties shall include, but are not limited to, the following:
(1) Overseeing and reviewing the swap execution facility's
compliance with Section 5h of the Act and any related rules adopted by
the Commission;
(2) In consultation with the board of directors, a body performing
a function similar to the board, or the senior officer of the swap
execution facility, resolving any conflicts of interest that may arise:
(i) Conflicts between business considerations and compliance
requirements;
(ii) Conflicts between business considerations and the requirement
that the registered swap execution facility provide fair, open, and
impartial access as set forth in Sec. 37.202 of this part; and;
(iii) Conflicts between a registered swap execution facility's
management and members of the board of directors;
(3) Establishing and administering written policies and procedures
reasonably designed to prevent violation of the Act and any rules
adopted by the Commission;
(4) Ensuring compliance with the Act and Commission regulations
relating to agreements, contracts, or transactions, and with Commission
regulations under Section 5h of the Act;
(5) Establishing procedures for the remediation of noncompliance
issues identified by the chief compliance officer through a compliance
office review, look-back, internal or external audit finding, self-
reported error, or validated complaint;
(6) Establishing and following appropriate procedures for the
handling, management response, remediation, retesting, and closing of
noncompliance issues;
(7) Establishing a compliance manual designed to promote compliance
with the applicable laws, rules, and regulations and administering a
written code of ethics designed to prevent ethical violations and to
promote honesty and ethical conduct;
(8) Supervising the swap execution facility's self-regulatory
program with respect to trade practice surveillance; market
surveillance; real-time market monitoring; compliance with audit trail
requirements; enforcement and disciplinary proceedings; audits,
examinations, and other regulatory responsibilities with respect to
members and market participants (including ensuring compliance with, if
applicable, financial integrity, financial reporting, sales practice,
recordkeeping, and other requirements); and
(9) Supervising the effectiveness and sufficiency of any regulatory
services provided to the swap execution facility by a registered
futures association or other registered entity in accordance with Sec.
37.204.
(e) Annual Compliance Report Prepared by Chief Compliance Officer.
The chief compliance officer shall, not less than annually, prepare an
annual compliance report, that at a minimum, contains the following
information covering the time period since the date on which the swap
execution facility became registered with the Commission or since the
end of the period covered by a previously filed annual compliance
report, as applicable:
(1) A description of the registered swap execution facility's
written policies and procedures, including the code of ethics and
conflict of interest policies;
(2) A review of applicable Commission regulations and each
subsection and core principle of Section 5h of the Act, that, with
respect to each:
(i) Identifies the policies and procedures that ensure compliance
with each subsection and the core principle, including each duty
specified in Section 5h(f)(15)(B);
(ii) Provides a self-assessment as to the effectiveness of these
policies and procedures; and
(iii) Discusses areas for improvement, and recommends potential or
prospective changes or improvements to its compliance program and
resources;
(3) A list of any material changes to compliance policies and
procedures since the last annual compliance report;
(4) A description of the financial, managerial, and operational
resources set aside for compliance with respect to the Act and
Commission regulations, including a description of the registered swap
execution facility's self-regulatory program's staffing and structure,
a catalogue of investigations and disciplinary actions taken since the
last annual compliance report, and a review of the performance of
disciplinary committees and panels;
(5) A description of any material compliance matters, including
noncompliance issues identified through a compliance office review,
look-back, internal or external audit finding, self-reported error, or
validated complaint, and explains how they were resolved;
(6) Any objections to the annual compliance report by those persons
who have oversight responsibility for the chief compliance officer; and
(7) A certification by the chief compliance officer that, to the
best of his or her knowledge and reasonable belief, and under penalty
of law, the annual compliance report is accurate and complete.
(f) Submission of Annual Compliance Report by Chief Compliance
Officer to the Commission.
(1) Prior to submission of the annual compliance report to the
Commission, the chief compliance officer shall provide the annual
compliance report to the board of the registered swap execution
facility for its review. If the swap execution facility does not have a
board, then the annual compliance report shall be provided to the
senior officer for their review. Members of the board and the senior
officer may not require the chief compliance officer to make any
changes to the report. Submission of the report to the board or the
senior officer, and any subsequent discussion of the report, shall be
recorded in board minutes or similar written record, as evidence of
compliance with this requirement.
(2) The annual compliance report shall be provided electronically
to the Commission not more than 60 days after the end of the registered
swap execution facility's fiscal year.
(3) Promptly upon discovery of any material error or omission made
in a previously filed compliance report, the chief compliance officer
shall file an amendment with the Commission to
[[Page 1253]]
correct any material error or omission. An amendment shall contain the
oath or certification required under paragraph (e)(7) of this section.
(4) A registered swap execution facility may request the Commission
for an extension of time to file its compliance report based on
substantial, undue hardship. Extensions for the filing deadline may be
granted at the discretion of the Commission.
(5) Annual compliance reports filed pursuant to this section will
be treated as exempt from mandatory public disclosure for purposes of
the Freedom of Information Act and the Government in the Sunshine Act
and parts 145 and 147 of this chapter, but will be available for
official use by any official or employee of the United States and any
State, by any self-regulatory organization of which the person filing
the report is a member, and by any other person to whom the Commission
believes disclosure is in the public interest.
(g) Recordkeeping. (1) The registered swap execution facility must
maintain:
(i) A copy of the written policies and procedures, including the
code of ethics and conflicts of interest policies adopted in
furtherance of compliance with the Act and Commission regulations;
(ii) Copies of all materials created in furtherance of the chief
compliance officer's duties listed in paragraphs (d)(6) and (d)(7) of
this section, including records of any investigations or disciplinary
actions taken by the swap execution facility;
(iii) Copies of all materials, including written reports provided
to the board of directors or senior officer in connection with the
review of the annual compliance report under paragraph (f)(1) of this
section and the board minutes or similar written record of such review,
that record the submission of the annual compliance report to the board
of directors or senior officer; and
(iv) Any records relevant to the registered swap execution
facility's annual compliance report, including, but not limited to,
work papers and other documents that form the basis of the report, and
memoranda, correspondence, other documents, and records that are (A)
created, sent or received in connection with the annual compliance
report and (B) contain conclusions, opinions, analyses, or financial
data related to the annual compliance report.
(2) The registered swap execution facility shall maintain records
in accordance with Sec. 1.31 and part 45 of this chapter.
Appendix A to Part 37--Form SEF
COMMODITY FUTURES TRADING COMMISSION
FORM SEF
SWAP EXECUTION FACILITY
APPLICATION OR AMENDMENT TO APPLICATION FOR REGISTRATION
REGISTRATION INSTRUCTIONS
Intentional misstatements or omissions of material fact may
constitute federal criminal violations (7 U.S.C. Sec. 13 and 18 U.S.C.
Sec. 1001) or grounds for disqualification from registration.
DEFINITIONS
Unless the context requires otherwise, all terms used in the Form
SEF have the same meaning as in the Commodity Exchange Act, as amended
(``Act''), and in the General Rules and Regulations of the Commodity
Futures Trading Commission (``Commission'') thereunder.
GENERAL INSTRUCTIONS
1. Form SEF and Exhibits thereto are to be filed with the
Commission by applicants for registration as a swap execution facility,
or by a swap execution facility amending such registration, pursuant to
Section 5h of the Act and the Commission's regulations thereunder.
Applicants may prepare their own Form SEF but must follow the format
prescribed herein. Upon the filing of an application for registration
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 registration shall be effective unless
the Commission, by order, grants such registration.
2. For the purposes of this Form, the term ``Applicant'' shall
include any applicant for registration as a swap execution facility or
any registered swap execution facility that is seeking an amendment to
its order of registration.
3. Individuals' names, except the executing signature in Item 11,
shall be given in full (Last Name, First Name, Middle Name).
4. Signatures on all copies of the Form SEF filed with the
Commission can be executed electronically. If the Form SEF 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.
5. If Form SEF is being filed as an application for registration,
all applicable items must be answered in full. If any item is not
applicable, indicate by ``none,'' ``not applicable,'' or ``N/A'' as
appropriate.
6. For the purposes of this Form SEF, the term ``Applicant'' shall
include any applicant for registration as a swap execution facility or
any swap execution facility that is amending Form SEF.
7. Under Section 5h of the Act and the Commission's regulations
thereunder, the Commission is authorized to solicit the information
required to be supplied by this Form SEF from any Applicant seeking
registration as a swap execution facility and from any registered swap
execution facility. Disclosure of the information specified on this
Form SEF is mandatory prior to the start of the processing of an
application for registration as a swap execution facility. The
information provided with this Form SEF will be used for the principal
purpose of determining whether the Commission should grant or deny
registration 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 SEF will be
included routinely in the public files of the Commission and will be
available for inspection by any interested person. A Form SEF 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 SEF, however, shall not constitute a finding
that the Form SEF has been filed as required or that the information
submitted is true, current or complete.
UPDATING INFORMATION ON THE FORM SEF
1. Part 37 of the Commission's regulations requires that if any
[[Page 1254]]
information contained in this application, or any supplement or
amendment thereto, is or becomes inaccurate for any reason, an
amendment to Form SEF, or a submission under Part 40, in either case
correcting such information must be filed promptly with the Commission.
2. Swap execution facilities filing Form SEF 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 SEF and appropriate exhibits must be filed
electronically with the Secretary of the Commission in the form and
manner as provided by the Commission.
COMMODITY FUTURES TRADING COMMISSION
FORM SEF
SWAP EXECUTION FACILITY
APPLICATION OR AMENDMENT TO APPLICATION FOR REGISTRATION
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Exact name of Applicant as specified in charter
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Address of principal executive offices
[ballot] If this is an APPLICATION for registration, complete in
full and check here
[ballot] If this is an AMENDMENT to an application, or to an
existing registration, list all items that are amended and check here
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GENERAL INFORMATION
1. Name under which business of the swap execution facility will be
conducted, if different than name specified on facing sheet:
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2. If name of swap execution facility is hereby amended, state
previous swap execution facility name:
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3. Mailing address, if different than address specified on facing
sheet:
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Number and Street
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City, State, Zip Code
3(a). Additional contact information:
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Fax
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Phone
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Website
4. List of principal office(s) and address(es) where swap execution
facility activities are/will be conducted:
Office
Address
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BUSINESS ORGANIZATION
5. Applicant is a:
[ballot] Corporation
[ballot] Partnership
[ballot] Limited Liability Company
[ballot] Other form of organization (specify)
6. If Applicant is a corporation:
a. Date of incorporation:
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b. State of incorporation:
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7. If Applicant is a partnership:
a. Date of filing of partnership articles:
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b. State in which filed:
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8. If Applicant is a limited liability company:
a. Date of filing of Articles of Organization/Certificate of
Formation:
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b. State in which filed:
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9. Applicant agrees and consents that the notice of any proceeding
before the Commission in connection with its application for
registration as a swap execution facility may be given by sending such
notice by certified mail or confirmed telegram to the officer specified
or person named below at the address given.
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Name of person (if Applicant is a corporation, limited liability
company or partnership, title of officer)
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Name of Applicant
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Number and Street
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City State Zip Code
SIGNATURES
10. The Applicant has duly caused this application or amendment to
be signed on its behalf by the undersigned, hereunto duly authorized,
this ---- day of ----------------, 20----. The Applicant and the
undersigned represent hereby that all information contained herein is
true, current and complete. It is understood that all required items
and Exhibits are considered integral parts of this Form SEF and that
the submission of any amendment represents that all unamended items and
Exhibits remain true, current, and complete as previously filed.
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Name of Applicant
-----------------------------------------------------------------------
Manual signature of Member, General Partner, Managing Agent, or
Principal Agent
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Title
EXHIBITS INSTRUCTIONS
The following exhibits must be filed with the Commission by
Applicants seeking registration as a swap execution facility, or by a
registered swap execution facility amending its registration, pursuant
to Section 5h of the Act and the Commission's regulations thereunder.
The exhibits should be labeled according to the items specified in this
Form SEF. If any exhibit is not applicable, please specify the exhibit
letter and indicate by ``none,'' ``not applicable,'' or ``N/A'' as
appropriate.
If the applicant is a newly formed enterprise and does not have the
financial statements required pursuant to Items 9 and 10 (Exhibits I
and J) of this form, the applicant should provide pro forma financial
statements for the most recent six months or since inception, whichever
is less.
EXHIBITS--BUSINESS ORGANIZATION
1. Attach as Exhibit A, the name of any person(s) who own(s) 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
swap execution facility or of any entity that performs the regulatory
activities of the Applicant, indicating for each:
a. Name
b. Title
[[Page 1255]]
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 Act;
(2) Any conviction or injunction against such person within the
past ten (10) years;
(3) Any disciplinary action with respect to such person within the
last five (5) years;
(4) Any disqualification under Sections 8b and 8d of the Act;
(5) Any disciplinary action under Section 8c of the Act; and
(6) Any violation pursuant to Section 9 of the Act.
3. Attach as Exhibit C, a narrative that sets forth the fitness
standards for the Board of Directors and its composition including the
number or 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 swap execution facility 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 swap execution
facility 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
within one week of the date of the Form SEF.
8. Attach as Exhibit H, a brief description of any material 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, and 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, that balance sheet and statement
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 swap execution facility that also
engages in swap execution facility activities as of the end of the most
recent fiscal year of each such affiliate, and each affiliate of the
swap execution facility that engages in designated contract market
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 swap execution
facility 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 swap execution facility 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
[[Page 1256]]
aggregation standards in Part 151 of the Commission's regulations and
any facility 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 any other forms of documentation the Applicant thinks
will be helpful to its explanation, demonstrating how the swap
execution facility 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 or market participants provided in this Exhibit M
help support the swap execution facility'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 a 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, as applicable, an explanation regarding:
a. For trading systems or platforms that enable market participants
to engage in transactions through an order book:
(1) How the trading system or platform provides all orders and
trades in an electronic form, and the timeliness in which the trading
system or platform does so;
(2) How all market participants have the ability to immediately see
and have the ability to transact on all bids and offers through the
applicant's electronic automated trade-matching system or platform; and
(3) The trade matching algorithm and examples of how that algorithm
works in various trading scenarios involving various types of orders.
b. For trading systems or platforms that enable market participants
to engage in transactions on request for quote systems:
(1) How a market participant transmits a request for a quote to buy
or sell a specific instrument to no less than five market participants
in the trading system or platform, to which all such market
participants may respond.
(2) How resting bids or offers may be taken into account.
c. For trading systems or platforms that enable market participants
to engage in transactions via voice:
(1) How the terms of voice-based transactions are entered into the
electronic trading system or platform.
d. How the timing delay described under Sec. 37.9 is incorporated
into the trading system or platform.
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 swap execution facility.
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 (link). The Technology 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 planning and resources; capacity and
performance planning; systems operations; systems development and
quality assurance; and physical security and environmental controls.
Appendix B to Part 37--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 maintain
registration under Section 5h of the Act and this Part 37. 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. 37.3 and 37.5 of this Part 37. The guidance for the core
principle is illustrative only of the types of matters a swap
execution facility 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 swap execution facility 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 swap execution
facilities to comply with the regulations provided under this Part
37.
2. Where provided, acceptable practices meeting selected
requirements of core principles are set forth in paragraph (b)
following the guidance. Swap execution facilities 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 swap execution
facilities to comply with the regulations provided under this Part
37. The acceptable practices are for illustrative purposes only and
do not state the exclusive means for satisfying a core principle.
Core Principle 1 of Section 5h of the Act--Compliance With Core
Principles
(A) In general. To be registered, and maintain registration, as
a swap execution facility, the swap execution facility shall comply
with--(i) all core principles described in Section 5h of the Act;
and (ii) any requirement that the Commission may impose by rule or
regulation pursuant to Section 8a(5) of the Act.
(B) Reasonable Discretion of Swap Execution Facility. Unless
otherwise determined by the Commission by rule or regulation, a swap
execution facility described in paragraph (a) shall have reasonable
discretion in establishing the manner in which the swap execution
facility complies with the core principles described in Section 5h
of the Act.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 2 of Section 5h of the Act--Compliance With Rules
A swap execution facility shall:
(A) Establish and enforce compliance with any rule of the swap
execution facility, including the terms and conditions of the swaps
traded or processed on or through the swap execution facility and
any limitation on access to the swap execution facility;
(B) Establish and enforce trading, trade processing, and
participation rules that will deter abuses and have the capacity to
detect, investigate, and enforce those rules, including means to
provide market participants with impartial access to the market and
to capture information that may be used in establishing whether rule
violations have occurred;
(C) Establish rules governing the operation of the facility,
including rules specifying trading procedures to be used in entering
and executing orders traded or posted on the facility, including
block trades; and
(D) Provide by its rules that, when a swap dealer or major swap
participant enters into or facilitates a swap that is subject to the
[[Page 1257]]
mandatory clearing requirement of Section 2(h), the swap dealer or
major swap participant shall be responsible for compliance with the
mandatory trading requirement under Section 2(h)(8) of the Act.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 3 of Section 5h of the Act--Swaps Not Readily
Susceptible to Manipulation
The swap execution facility shall permit trading only in swaps
that are not readily susceptible to manipulation.
(a) Guidance.
(1) In general, a swap contract is an agreement to exchange a
series of cash flows over a period of time based on some reference
price, which could be a single price, such as an absolute level or a
differential, or a price index calculated based on multiple
observations. Moreover, such a reference price may be reported by
the swap execution facility itself or by an independent third party.
When listing a swap for trading, a swap execution facility must
ensure a swap's compliance with Core Principle 3, paying special
attention to the reference price used to determine the cash flow
exchanges. Specifically, Core Principle 3 requires that the
reference price used by a swap not be readily susceptible to
manipulation. As a result, when identifying a reference price, a
swap execution facility should either: (i) Calculate its own
reference price using suitable and well-established acceptable
methods or (ii) carefully select a reliable third-party index.
(2) The importance of the reference price's suitability for a
given swap is similar to that of the final settlement price for a
cash-settled futures. If the final settlement price is manipulated,
then the swap contract does not serve its intended price discovery
and risk management functions. Similarly, inappropriate reference
prices cause the cash flows between the buyer and seller to differ
from the proper amounts, thus benefitting one party and
disadvantaging the other. Thus, careful consideration should be
given to the potential for manipulation or distortion of the
reference price.
(3) For swaps that are settled by physical delivery or by cash
settlement refer to guidance in Appendix C to Part 38--Demonstration
of Compliance that a contract is not readily susceptible to
manipulation, Section b(2) and Section c(5), respectively.
(b) Acceptable Practices. [Reserved]
Core Principle 4 of Section 5h of the Act--Monitoring of Trading and
Trade Processing
The swap execution facility shall:
(A) Establish and enforce rules or terms and conditions
defining, or specifications detailing:
(1) Trading procedures to be used in entering and executing
orders traded on or through the facilities of the swap execution
facility; and
(2) Procedures for trade processing of swaps on or through the
facilities of the swap execution facility; and
(B) Monitor trading in swaps to prevent manipulation, price
distortion, and disruptions of the delivery or cash settlement
process through surveillance, compliance, and disciplinary practices
and procedures, including methods for conducting real-time
monitoring of trading and comprehensive and accurate trade
reconstructions.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 5 of Section 5h of the Act--Ability To Obtain
Information
The swap execution facility shall:
(A) Establish and enforce rules that will allow the facility to
obtain any necessary information to perform any of the functions
described in this section;
(B) Provide the information to the Commission on request; and
(C) Have the capacity to carry out such international
information-sharing agreements as the Commission may require.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 6 of Section 5h of the Act--Position Limits or
Accountability
(A) In general. To reduce the potential threat of market
manipulation or congestion, especially during trading in the
delivery month, a swap execution facility that is a trading facility
shall adopt for each of the contracts of the facility, as is
necessary and appropriate, position limitations or position
accountability for speculators.
(B) Position limits. For any contract that is subject to a
position limitation established by the Commission pursuant to
Section 4a(a) of the Act, the swap execution facility shall:
(1) Set its position limitation at a level no higher than the
Commission limitation; and
(2) Monitor positions established on or through the swap
execution facility for compliance with the limit set by the
Commission and the limit, if any, set by the swap execution
facility.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 7 of Section 5h of the Act--Financial Integrity of
Transactions
The swap execution facility shall establish and enforce rules
and procedures for ensuring the financial integrity of swaps entered
on or through the facilities of the swap execution facility,
including the clearance and settlement of the swaps pursuant to
Section 2(h)(1) of the Act.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 8 of Section 5h of the Act--Emergency Authority
The swap execution facility shall adopt rules to provide for the
exercise of emergency authority, in consultation or cooperation with
the Commission, as is necessary and appropriate, including the
authority to liquidate or transfer open positions in any swap or to
suspend or curtail trading in a swap.
(a) Guidance. In consultation and cooperation with the
Commission, a swap execution facility 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 swap execution facility's market or as part of a coordinated,
cross-market intervention. Swap execution facility rules should
include procedures and guidelines for decision making and
implementation of emergency intervention that avoid conflicts of
interest in accordance with the provisions of 17 CFR 40.11, and
include alternate lines of communication and approval procedures to
address emergencies associated with real time events. To address
perceived market threats, the swap execution facility should have
rules that allow it to take emergency actions, including imposing or
modifying position limits, imposing or modifying price limits,
imposing or modifying 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, or, if 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 swap execution facility should also have
rules that allow it to take market actions as may be directed by the
Commission. The Commission should be notified promptly of the swap
execution facility's exercise of emergency action, explaining its
decision-making process, the reasons for using its emergency
authority, and how conflicts of interest were minimized, including
the extent to which the swap execution facility considered the
effect of its emergency action on the underlying markets and on
markets that are linked or referenced to the contracts traded on its
facility, including similar markets on other trading venues.
Information on all regulatory actions carried out pursuant to a swap
execution facility's emergency authority should be included in a
timely submission of a certified rule pursuant to Part 40 of this
Chapter.
(b) Acceptable Practices. [Reserved]
Core Principle 9 of Section 5h of the Act--Timely Publication of
Trading Information
(A) In general. The swap execution facility shall make public
timely information on price, trading volume, and other trading data
on swaps to the extent prescribed by the Commission.
(B) Capacity of swap execution facility. The swap execution
facility shall be required to have the capacity to electronically
capture and transmit trade information with respect to transactions
executed on the facility.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 10 of Section 5h of the Act--Recordkeeping and Reporting
(A) In general. A swap execution facility shall:
(1) Maintain records of all activities relating to the business
of the facility,
[[Page 1258]]
including a complete audit trail, in a form and manner acceptable to
the Commission for a period of 5 years;
(2) Report to the Commission, in a form and manner acceptable to
the Commission, such information as the Commission determines to be
necessary or appropriate for the Commission to perform the duties of
the Commission under the Act; and
(3) 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.
(B) Requirements. The Commission shall adopt data collection and
reporting requirements for swap execution facilities that are
comparable to corresponding requirements for derivatives clearing
organizations and swap data repositories.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 11 of Section 5h of the Act--Antitrust Considerations
Unless necessary or appropriate to achieve the purposes of this
Act, the swap execution facility shall not:
(A) Adopt any rules or take any actions that result in any
unreasonable restraint of trade; or
(B) Impose any material anticompetitive burden on trading or
clearing.
(a) Guidance. An entity seeking registration as a swap execution
facility 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 registration 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 12 of Section 5h of the Act--Conflicts of Interest
The swap execution facility shall:
(A) Establish and enforce rules to minimize conflicts of
interest in its decision-making process; and
(B) Establish a process for resolving the conflicts of interest.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 13 of Section 5h of the Act--Financial Resources
(A) In general. The swap execution facility shall have adequate
financial, operational, and managerial resources to discharge each
responsibility of the swap execution facility.
(B) Determination of resource adequacy. The financial resources
of a swap execution facility shall be considered to be adequate if
the value of the financial resources exceeds the total amount that
would enable the swap execution facility to cover the operating
costs of the swap execution facility for a one-year period, as
calculated on a rolling basis.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 14 of Section 5h of the Act--System Safeguards
The swap execution facility 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
automated systems, that:
(1) Are reliable and secure; and
(2) Have adequate scalable capacity;
(B) Establish and maintain emergency procedures, backup
facilities, and a plan for disaster recovery that allow for:
(1) The timely recovery and resumption of operations; and
(2) The fulfillment of the responsibilities and obligations of
the swap execution facility; and
(C) Periodically conduct tests to verify that the backup
resources of the swap execution facility are sufficient to ensure
continued:
(1) Order processing and trade matching;
(2) Price reporting;
(3) Market surveillance; and
(4) Maintenance of a comprehensive and accurate audit trail.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Core Principle 15 of Section 5h of the Act--Designation of Chief
Compliance Officer
(A) In general. Each swap execution facility shall designate an
individual to serve as a chief compliance officer.
(B) Duties. The chief compliance officer shall:
(1) Report directly to the board or to the senior officer of the
facility;
(2) Review compliance with the core principles in this
subsection;
(3) In consultation with the board of the facility, a body
performing a function similar to that of a board, or the senior
officer of the facility, resolve any conflicts of interest that may
arise;
(4) Be responsible for establishing and administering the
policies and procedures required to be established pursuant to this
section;
(5) Ensure compliance with the Act and the rules and regulations
issued under the Act, including rules prescribed by the Commission
pursuant to this section; and
(6) Establish procedures for the remediation of noncompliance
issues found during compliance office reviews, look backs, internal
or external audit findings, self-reported errors, or through
validated complaints.
(C) Requirements for procedures. In establishing procedures
under paragraph (b)(6), the chief compliance officer shall design
the procedures to establish the handling, management response,
remediation, retesting, and closing of noncompliance issues.
(D) Annual reports.
(1) In general. In accordance with rules prescribed by the
Commission, the chief compliance officer shall annually prepare and
sign a report that contains a description of:
(i) The compliance of the swap execution facility with the Act;
and
(ii) The policies and procedures, including the code of ethics
and conflict of interest policies, of the swap execution facility.
(2) Requirements. The chief compliance officer shall:
(i) Submit each report described in clause (1) with the
appropriate financial report of the swap execution facility that is
required to be submitted to the Commission pursuant to this section;
and
(ii) Include in the report a certification that, under penalty
of law, the report is accurate and complete.
(a) Guidance. [Reserved]
(b) Acceptable Practices. [Reserved]
Dated: December 16, 2010.
By the Commission.
David A. Stawick,
Secretary.
Appendices to Core Principles and Other Requirements for Swap Execution
Facilities--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, Chilton
and O'Malia voted in the affirmative; Commissioner Sommers voted in
the negative.
Appendix 2--Statement of Chairman Gary Gensler
I support the proposed rulemaking to fulfill Congress's mandate
to have rules and core principles requirements for swap execution
facilities (SEFs). The proposed rule also fulfills Congress's
mandate to promote transparency through the trading of swaps on
SEFS.
The proposed rule will provide for all market participants an
ability to execute or trade with other market participants. It will
afford market participants with the ability to make firm bids or
offers to all other market participants. It also will allow them to
make indications of interest--or what is often referred to as
``indicative quotes''--to other participants. Furthermore, it will
allow participants to request quotes from other market participants.
These methods will provide hedgers, investors and Main Street
businesses both the flexibility to execute and trade by a number of
methods, but also the benefits of transparency and more market
competition. I believe that transparency and competition in markets
is consistent with Congress mandated in the definition of a swap
execution facility, whereby all market participants can communicate
with all market participants such that everybody gets the benefit of
a competitive and transparent price discovery process.
The proposal does allow participants, though, to do request for
quotes, whereby they would reach out to a minimum number of other
market participants for quotes. It also allows that, for block
transactions, swap transactions involving non-financial end-users,
swaps that are not ``made available for trading'' and bilateral
transactions, market
[[Page 1259]]
participants can get the benefits of the swap execution facilities'
greater transparency or, if they wish, would still be allowed to
execute by voice or other means of trading.
To fulfill Congress's mandate that, the rule requires SEFs to
provide impartial access to market participants for trading on the
platform or system.
The proposed rule also would require SEFs to--on a yearly
basis--state which contracts are deemed ``available for trading,''
based on factors including trading activity and open interest. The
rule, if finalized, goes into effect in January 2012. This will give
the markets time to adapt, allow SEFs to tell the market what
contracts are available for trading.
Appendix 3--Statement of Commissioner Sommers
I disagree with several aspects of the Swap Execution Facility
(SEF) proposal the Commission is issuing today and seek public
comment on alternative language for Section 37.9, Permitted
Execution Methods.
Dodd-Frank defines a SEF as a ``trading system or platform in
which multiple participants have the ability to execute or trade
swaps by accepting bids and offers made by multiple participants in
the facility or system, through any means of interstate commerce,
including any trading facility.'' As I have pointed out in my public
speaking engagements over the past few months, the term ``trading
facility'' is defined in the Commodity Exchange Act (Act), but the
terms ``trading system'' and ``platform'' are not. By introducing
these new, undefined terms into the Act, and by specifying that SEFs
should facilitate the trading of swaps through any means of
interstate commerce, I believe Congress intended a broad model for
executing swaps on SEFs, both cleared, uncleared, liquid or bespoke.
The goals identified by Dodd-Frank for registering SEFs are ``to
promote the trading of swaps on swap execution facilities and to
promote pre-trade price transparency in the swaps market.'' In my
view, the best way to achieve these twin goals is to adopt a model
that provides the maximum amount of flexibility as to the method of
trading. Unfortunately, this proposal does not do that.
Section 37.9, which governs the types of execution methods that
SEFs may offer, is a key provision of this proposed regulation.
While it permits alternative methods of execution, such as the
trading facility model and the request for quote model, it also
requires that to be registered as a SEF an applicant must, at a
minimum, provide market participants ``with the ability to post both
firm and indicative quotes on a centralized electronic screen
accessible to all market participants who have access to the swap
execution facility.'' In my view this provision is not mandated by
Dodd-Frank and may limit competition by shutting out applicants who
wish to offer request for quote services without this functionality.
I believe this interpretation of the statute, and other requirements
within this section, are far too restrictive.
As a result of my concerns, we worked throughout the past week
to include alternative language for Section 37.9 in the proposal. I
believe this alternative language complies with Dodd-Frank and would
promote both pre-trade price transparency and the trading of swaps
on SEFs. Including the alternative would have given the public an
opportunity to comment, in accordance with the Administrative
Procedure Act, on both the alternative language and the language
contained in the proposed rule. I am deeply disappointed that
despite a commitment to a transparent process in promulgating the
Dodd-Frank rules, the alternative language is not in the proposal
today and we are not giving the public the opportunity to comment on
it. That alternative language is set forth below.
Sec. 37.9 Permitted Execution Methods.
(a) Definitions.
(1) As used in this Part 37:
(i) Order Book System means:
(A) An electronic trading facility, as that term is defined in
section 1a(16) of the Act;
(B) A trading facility, as that term is defined in section 1a(51)
of the Act;
(C) A trading system or platform in which all market participants
in the trading system or platform can enter multiple bids and offers,
observe bids and offers entered by other market participants, and
choose to transact on such bids and offers; or
(D) Any such other trading system or platform as may be determined
by the Commission.
(ii) Request for Quote System means:
(A) A trading system or platform in which a market participant
transmits a request for a quote to buy or sell a specific instrument to
all other market participants in the trading system or platform to
which all market participants may respond;
(B) A trading system or platform in which a market participant
transmits a request for a quote to buy or sell a specific instrument to
more than one potential counterparty. Upon receipt of responsive quotes
from any of the potential counterparties, the original requester may
accept a responsive quote and complete a transaction with any one of
the responsive counterparties;
(C) A trading system or platform in which multiple market
participants can both (i) view real-time electronic streaming quotes,
both firm or indicative, from multiple potential counterparties on a
centralized screen; and (ii) have the option to complete a transaction
by (A) accepting a firm streaming quote, or (B) transmitting a request
for a quote to more than one market participant, based upon an
indicative streaming quote, taking into account any resting bids or
offers that have been communicated to the requester along with any
responsive quotes; or
(D) Any such other trading system or platform as may be determined
by the Commission.
(iii) Voice-Based System means:
(A) A trading system or platform in which a market participant
executes or trades a swap using a telephonic line or other voice-based
service.
(2) Swaps subject the clearing requirements under the Act that are
made available for trading pursuant to Sec. 37.10 may be executed or
traded on an Order Book System, a Request for Quote System, or any such
other trading system or platform as may be determined by the
Commission.
(3) Swaps not subject to the clearing requirements under the Act
may be executed or traded on an Order Book System, a Request for Quote
System, a Voice-Based System, or any such other trading system or
platform as may be determined by the Commission.
(4) A swap execution facility can be an Order Book System, a
Request for Quote System, or any such other trading system or platform
as may be determined by the Commission, or any combination of the
aforementioned systems.
[FR Doc. 2010-32358 Filed 1-6-11; 8:45 am]
BILLING CODE 6351-01-P