The rulemaking proposed by the agency would further implement the statutory core principles for derivative clearing organizations called for under the Dodd-Frank Act.
The CFTC has approved a proposed rule to amend certain regulations that apply to derivatives clearing organizations (DCOs) consistent with the agency’s Project KISS initiative. The CFTC’s notice of proposed rulemaking (NPRM) seeks to further clarify and codify the requirements that apply to DCOs under Part 39 of the CFTC’s regulations. Part 39 implements the statutory core principles for DCOs. Project KISS, which was introduced in May 2017, aims to adopt appropriate changes and simplify agency rules, regulations, and practices to make them less burdensome, less costly, and more transparent to all market participants.
In 2011 and 2013, the CFTC adopted Part 39 of the CFTC Regulations as part of its implementation of the Dodd-Frank Act’s core principles for DCOs. Since those rules were adopted Commission staff has worked with DCOs regarding questions concerning the interpretation and implementation of these regulations, and has issued related relief or guidance.
Proposed rule reflects the Commission’s experience and addresses recent events. Based on its experience in implementing these regulations and subsequent developments, the CFTC staff has drafted and provided further explanation with regard to the proposed rule. The proposed rule is also intended to streamline processes for registration and reporting. Additionally, the proposed rule includes some new requirements with respect to default procedures and reporting in response to more recent events, such as the launch of bitcoin futures contracts and the Nasdaq Clearing default. Given the perceived benefits set forth in the notice of proposed rulemaking, Chairman Giancarlo and Commissioner Berkovitz both issued statements supporting proposal.
Codification and clarification. The NPRM includes a number of amendments that clarify, further define, or provide more explicit direction to market participants as follows.
- Regulations 39.24, 39.25, and 39.26 establish governance requirements for DCOs to better ensure that DCOs are well managed. These amendments provide greater certainty and uniform rules, and are important not only for fairness and consistency, but also to improve risk management across the clearing space.
- Regulation 39.16 would improve requirements around member default management and explicitly require DCOs to have a default committee that must include clearing members. The recent member default at NASDAQ Clearing reinforces the importance of default management mechanisms and information sharing when a default occurs.
- A clear requirement for initial margin to cover concentration risk; a requirement for DCO personnel to certify certain reports; and several new reporting requirements around settlement bank arrangements, depositories, and liquidity funding arrangements.
Other issues warranting further comment and consideration. The NPRM includes proposed amendments that, as Commissioner Berkovitz has noted, might be beneficial but may also present additional issues for the CFTC to consider in developing its final rule. These include the following.
- Changes to regulation 39.13(g)(8) regarding calculation of initial margin and excess margin, that attempt to incorporate in the regulation, and to clarify, staff guidance. Getting initial margin calculations right has been critical to providing sufficient resources to cover variation margin shortfalls that may occur when resolving a member’s default.
- Regulation 39.13(i) provides explicit procedures and requirements for filing DCO rules to implement a cross-margining program with other clearing organizations. While establishing explicit procedures in regulations for evaluating such arrangements would facilitate consistent, objective reviews by the CFTC, multi-entity cross-margining might cross borders and involve multiple regulatory regimes of different regulators. This could create additional layers of legal, operational, and financial risk that would be difficult to evaluate.
- Regulation 40.5 would establish a mechanism for the CFTC’s review of certain DCO rule sets including: (1) a request to transfer a DCO’s open interest, (2) cross-margining programs among different clearing organizations – including across borders and for entities subject to different regulators, and (3) commingling of futures, options, and swaps positions in a section 4d(a) futures account. These rule reviews could involve consideration of novel issues with regard to customer protections, potential risks to FCMs, and market integrity.
The CFTC is seeking comments on the proposal. The comment period will end 60 days after the proposal’s publication in the Federal Register. All comments will be posted on CFTC’s website.
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