CFTC Open Meeting Report

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					                                CFTC Open Meeting Report
Introduction

The U.S. Commodity Futures Trading Commission (“CFTC” or “Commission”) held an open
meeting on July 19, 2011 to discuss the issuance of (1) proposed rules on Customer clearing
documentation and timing of acceptance for clearing; (2) final rules on clearing member risk
management; (3) final rules on the process for review of swaps for mandatory clearing; (4) final rules
on part 40, provisions common to registered entities; and (5) final rules removing reference to or
reliance on credit ratings in commission regulations.

According to Chairman Gensler, it is anticipated that the Commission will take up final rules on the
Whistleblower provisions and swap data repository (“SDR”) registration at the next open meeting,
scheduled for August 4, 2011. The Chairman estimated that final rules on entity definitions are
likely to be addressed in either September or October of this year, while product definitions will not
be taken up until November. In addition, during the meeting Chairman Gensler and Commissioner
O’Malia were inclined to hold a roundtable to discuss issues related to the proposed rulemaking on
customer documentation. Commissioner Chilton did not participate in this open meeting, and his
votes were cast by proxy.

Item 1: Proposed Rule on Customer Clearing Documentation, Timing of Acceptance for
Clearing
Presenters: John Lawton, Division of Clearing and Intermediary Oversight; Chris Cummings, Division
of Clearing and Intermediary Oversight; and Ananda Radhakrishnan, Division of Clearing and
Intermediary Oversight

The Commission approved by a vote of 3-to-2 (Commissioners Sommers and O’Malia voting “No”)
the issuance of proposed rules on customer clearing documentation and time of acceptance for
clearing. The proposed regulations would prevent certain Commission registrants (FCMs, swap
dealers, and major swap participants) from entering into an arrangement with their customers that
would disclose the identity of a customer’s original executing counterparty. The proposed rule
would also prevent these Commission registrants from (1) limiting the number of counterparties
with whom a customer may enter into a trade; (2) restricting the size of the position a customer may
take with any individual counterparty, apart from an overall credit limit for all positions held by the
customer; (3) impairing a customer’s access to execution of a trade on terms that have a reasonable
relationship to the best terms available; and (4) preventing compliance with specified time frames for
acceptance of trades into clearing. The proposed regulations will require a clearing member, or the
derivatives clearing organization (“DCO”) acting on its behalf, to accept or reject each trade
submitted for clearing as quickly as would be technologically practicable if fully automated systems
were used. The proposed rules will accommodate trade processing with manual steps provided that
the process could operate within the same time frame as automated systems. The proposal also
permits DCOs to screen trades against applicable product and credit criteria before accepting or
rejecting them, provided that such criteria do not discriminate with respect to trading venues and
clearing participants.

Discussion

Commissioners’ Views: Chairman Gensler supported the proposed rulemaking, asserting that it
promoted access to central clearing, and that it was beneficial for asset managers and pension funds.
He added that the proposed rule clarifies and re-proposes certain aspects of the earlier proposal on
straight through processing. In contrast, Commissioner Dunn expressed reservations about the
proposal, stating he did not know if we would support the rule in its current form as a final rule, but
was willing to vote for releasing the proposal to facilitate public comment on the issue.
Commissioner O’Malia was also critical of the rule, and believed that it was best left to the industry
to work out documentation issues.

Futures v. Swaps: Chairman Gensler asked staff to elaborate how customer documentation
standards differed for swap transactions and futures transactions. Staff explained that the futures
markets differ in that there are no counterparty customer risks as there are with swap transactions.
According to staff, this rule addresses this issue by effectively limiting the number of counterparties
and the speed of trade processing in the context of swap transactions.

Swap Execution Facilities: Commission staff explained the proposed rule would apply mainly to
transactions executed on swap execution facilities (SEFs) or bilateral transactions. Commissioner
O’Malia noted that the proposal provides that a customer’s identity be protected when conducting
swap transactions. He asked whether a FCM acting as an introducing broker for a customer would
be required to disclose that customer’s identity when transacting on a SEF that operates a request-
for-quote (RFQ) model on a disclosed customer basis. Staff responded that the customer’s identity
would still be protected in such a situation.

Annex Agreements: In explaining the anticipated application of the proposed rule, Commission staff
articulated that the rule is crafted to address potential issues related to “annex agreements” rather
than the master execution agreements that they supplement.
Item 2: Final Rule on Clearing Member Risk Management
Presenters: John Lawton, Division of Clearing and Intermediary Oversight; Chris Cummings, Division
of Clearing and Intermediary Oversight; and Ananda Radhakrishnan, Division of Clearing and
Intermediary Oversight

The Commission approved by a vote of 3-to-2 (Commissioners Sommers and O’Malia voting “No”)
the issuance of a final rule on clearing member risk management requirements. The proposed
regulations require each swap dealer, major swap participant (“MSP”), and futures commission
merchant (“FCM”) that are clearing members to establish credit and market risk-based limits based
on position size, order size, margin requirements, or similar factors. In addition, the proposed
regulations require the use of automated means to screen orders for compliance with the risk-based
limits. These entities are required to conduct stress tests of all positions in the proprietary account
and all positions in any customer account, on a weekly basis. Furthermore, the proposed regulations
will require a swap dealer, MSP, and FCM that is a clearing member to evaluate its ability to liquidate
positions it clears in an orderly manner, and estimate the cost of the liquidation at least once per
month. Finally, these entities must test all lines of credit at least once per quarter under the
proposed regulations.

Discussion

Electronic Trading & SEFs: According to Chairman Gensler, over the coming years, the swaps
market will evolve towards electronic trading, including increased high frequency trading in swaps.
He noted that SEFs will facilitate this migration towards electronic trading. The Chairman added
that it is important that market participants trading on a SEF know that their counterparty is backed
by a FCM.

Current Practices: According to Commission staff, several DCMs and DCOs already have practices
in place satisfying these new risk management requirements. These rules will be enforced through a
combination of Commission supervision and self-regulation on the part of FCMs and DCOs, who
will be motivated to monitor activity for their own self-preservation. Furthermore, these rules will
allow for an individualistic approach to risk management practices, as opposed to a one-size-fits-all
approach, as the amount of risk varies across firms.

Technology Advisory Committee: Commissioner O’Malia was critical of the rulemaking team for
not consulting the Technology Advisory Committee (“TAC”) on this rule. He added that several of
these rules are being done in an ad-hoc manner, but they need to ensure that this rule regime
ultimately works across the markets.

FCM Transparency: The Commissioners also discussed the concerns voiced by market participants
(Newedge in particular) about the transparency of FCMs, and whether this rule provides the
necessary means for market participants to evaluate a clearing firm’s customer exposure and asset
concentration. According to staff, these rules will provide a “general idea” as to certain risk
exposures a FCM might have.

Item 3: Final Rule on Review of Swaps for Mandatory Clearing
Presenters: Eileen Donovan, Division of Clearing and Intermediary Oversight; John Lawton, Division
of Clearing and Intermediary Oversight; and Ananda Radhakrishnan, Division of Clearing and
Intermediary Oversight

The Commission approved by unanimous vote the issuance of a final rule on the review of swaps
for mandatory clearing. Under the final rule, a DCO will be presumed eligible to accept for clearing
any swap that is within a group, category, type, or class of swaps that the DCO already clears. A
DCO that plans to accept for clearing any swap that is not within a group, category, type, or class of
swaps that the DCO already clears will be required to request a determination by the Commission of
its eligibility to clear the swap. To receive a determination of eligibility to clear a swap, a DCO will
have to file a written request with the Commission that addresses its ability to maintain compliance
with the DCO core principles if it accepts the swap for clearing, specifically: 1) the sufficiency of its
financial resources; and 2) its ability to manage the risks associated with clearing the swap, especially
if the Commission determines that the swap is required to be cleared. In submitting swaps for
review, the DCO must provide a statement that includes information that will assist in the
assessment of five specific factors set forth in the Dodd-Frank Act and provide specific information
relating to the instrument and entities transacting in that product. The rule also provides for a
Commission review process for swaps that no DCO has accepted for clearing, but would otherwise
be subject to a clearing requirement.

Discussion

Required Personnel: According to Commission staff, it will take more than twenty staff members to
effectively carry out the review process, and it will fall primarily on the CFTC’s Chicago surveillance
group to carry out these efforts.

SDRs: The Commission expects to rely on SDRs to provide a substantial amount of the data needed
to make a determination as to whether a swap should be subject to the mandatory clearing
requirement.

Swap Definition: Commissioner O’Malia asked what will be the definition of “swap” used by the
clearing firms submitting these instruments for review, since final rules on product definitions are
still several months away. Staff responded that firms can submit any instrument that the
Commission has deemed a swap for review. However, once effective, these designations will be
subject to the finalized definition of “swap,” and the treatment of such instruments will be provided
in the final rule.

Item 4: Final Rules on Part 40, Provisions Common to Registered Entities
Presenters: Bella Rozenberg, Division of Market Oversight; Rick Shilts, Office of General Counsel;
Riva Spear Adriance, Division of Market Oversight; Jon Deboard, Division of Clearing and
Intermediary Oversight; and Tom Smith, Chief Accountant

The Commission approved by a unanimous vote the issuance of final rules on provisions common
to entities, commonly known as “Part 40.” The final rules apply to newly registered entities, such as
SEFs and SDRs, and implement a new statutory framework for certification and approval
procedures for new products, new rules and rule amendments submitted to the Commission by
registered entities. The following new timeline applies to self-certified submissions of new rules and
rule amendments (and, notably, does not apply to self-certified new products):

   A new rule or rule amendment will become effective 10 business days after the certified rule or
    rule amendment is received by the Commission, and the proposal requires registered entities to
    certify that copies of their rule submissions are posted on their websites at the time of the filing.

   The Commission may stay the initial review period for 90 additional days if the Commission
    determines that the new rule or rule amendment presents novel or complex issues, is certified
    with an inadequate explanation, or is potentially inconsistent with the CEA or the Commission’s
    regulations.
   The Commission must provide a 30-day public comment period, within the 90-day review
    period. The Commission will provide notice by posting the notice and the rule submission on
    the Commission’s website.

   The new timeline for the Commission’s review of rule certifications takes effect on July 16,
    2011.

The final rules require a systemically important derivatives clearing organization (SIDCO) to provide
the Commission with a 60-day advance notice of any proposed change to its rules or procedures that
could materially affect the nature or level of risks presented by the SIDCO. Further, these rules
prohibit the listing, trading, or clearing of products that involve terrorism, assassination, war,
gaming, or an activity that is unlawful under any State or Federal Law. In addition, the final rules
prohibit the listing, trading, or clearing of a product involving similar activities and that the
Commission determines, in a future rulemaking, to be contrary to the public interest.

Discussion

Future Application of Rule: Commissioner Dunn expressed deep reservations about the
Commission’s new authority to prohibit certain products under this rule, and hoped that in the
future, the Commission uses deep restraint in utilizing its authority. However, he recognized that
the rule is required by statute, as Chairman Gensler also noted. In addition, Chairman Gensler
stressed that this rule was not a return to the Commission review of contracts, as had previously
taken place in the 1980’s.

SIDCOs: Commission staff explained that under the final rule, SIDCOs will only be subject to one
regulator, either the SEC or CFTC as warranted. However, this issue will be addressed further in
the final rules on DCOs.

Item 5: Final Rule on Removal of Credit Ratings from Commission Regulations
Presenter: Ward Griffen, Office of General Counsel

The Commission approved by a unanimous vote the issuance of a final rule removing credit ratings
from Commission regulations. The final rule removes certain credit ratings references and
substitutes them with alternative standards. First, under regulation 1.49 (“General Regulations
Under the Commodity Exchange Act, Denomination of Customer Funds and Location of
Depositories, Qualifications for Depositories”), the Commission has removed the clause in this
regulation that previously allowed the placement of customer funds in a foreign depository based on
the depository’s issuance of highly-rated commercial paper or long term debt instruments. As an
alternative, the Commission will rely solely on the standard that customer funds be placed only in a
foreign depository that has in excess of $1 billion of regulatory capital. Next, under regulation 4.24,
(“Commodity Pool Operators and Commodity Trading Advisors: General Disclosures Required,
Investment Program and Use of Proceeds”), the Commission has removed the reference to
“investment rating” in this regulation and has substituted it with the phrase “credit-worthiness.”

Discussion
Discussion on this final rule was limited. However, in response to a question posed by
Commissioner O’Malia, staff noted that this rule is not necessarily consistent with the approach
taken by other international regulatory authorities.

				
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