Proposed Order Granting Conditional Exemptions Under the Securities Exchange Act of 1934 in Connection With the Portfolio Margining of Swaps and Security-Based Swaps That Are Credit Default Swaps, 70657-70666 [2020-24612]
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Federal Register / Vol. 85, No. 215 / Thursday, November 5, 2020 / Notices
(Public Representative). Section II also
establishes comment deadline(s)
pertaining to each request.
The public portions of the Postal
Service’s request(s) can be accessed via
the Commission’s website (https://
www.prc.gov). Non-public portions of
the Postal Service’s request(s), if any,
can be accessed through compliance
with the requirements of 39 CFR
3011.301.1
The Commission invites comments on
whether the Postal Service’s request(s)
in the captioned docket(s) are consistent
with the policies of title 39. For
request(s) that the Postal Service states
concern market dominant product(s),
applicable statutory and regulatory
requirements include 39 U.S.C. 3622, 39
U.S.C. 3642, 39 CFR part 3030, and 39
CFR part 3040, subpart B. For request(s)
that the Postal Service states concern
competitive product(s), applicable
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include 39 U.S.C. 3632, 39 U.S.C. 3633,
39 U.S.C. 3642, 39 CFR part 3035, and
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deadline(s) for each request appear in
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II. Docketed Proceeding(s)
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CP2021–25; Filing Title: USPS Request
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Acceptance Date: October 30, 2020;
Filing Authority: 39 U.S.C. 3642, 39 CFR
3040.130 through 3040.135, and 39 CFR
3035.105; Public Representative:
Jennaca D. Upperman; Comments Due:
November 9, 2020.
This Notice will be published in the
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Erica A. Barker,
Secretary.
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For further information; please contact
Vanessa A. Countryman from the Office
of the Secretary at (202) 551–5400.
Dated: November 3, 2020.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2020–24772 Filed 11–3–20; 4:15 pm]
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[FR Doc. 2020–24583 Filed 11–4–20; 8:45 am]
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SECURITIES AND EXCHANGE
COMMISSION
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–90276; File No. S7–13–12]
Sunshine Act Meetings
10 a.m. on Tuesday,
November 10, 2020.
PLACE: The meeting will be held via
remote means and/or at the
Commission’s headquarters, 100 F
Street NE, Washington, DC 20549.
STATUS: This meeting will be closed to
the public.
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TIME AND DATE:
1 See Docket No. RM2018–3, Order Adopting
Final Rules Relating to Non-Public Information,
June 27, 2018, Attachment A at 19–22 (Order No.
4679).
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Proposed Order Granting Conditional
Exemptions Under the Securities
Exchange Act of 1934 in Connection
With the Portfolio Margining of Swaps
and Security-Based Swaps That Are
Credit Default Swaps
October 28, 2020.
Securities and Exchange
Commission (‘‘SEC’’ or ‘‘Commission’’)
ACTION: Notice of proposed exemptive
order; request for comment.
AGENCY:
The Commission is proposing
to grant exemptive relief, subject to
certain conditions, from compliance
SUMMARY:
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70657
with certain provisions of the Securities
Exchange Act of 1934 in connection
with a program to portfolio margin
cleared swaps customer and affiliate
positions in cleared credit default swaps
that are swaps and security-based swaps
in a segregated account established and
maintained in accordance with Section
4d(f) of the Commodity Exchange Act
(in the case of a cleared swaps
customer) or a cleared swaps
proprietary account (in the case of an
affiliate). This proposed exemptive
relief would supersede and replace the
Commission’s Order Granting
Conditional Exemptions under the
Securities Exchange Act of 1934 in
Connection with Portfolio Margining of
Swaps and Security-based Swaps issued
in December 2012.
DATES: Comments must be received on
or before December 7, 2020.
ADDRESSES: Comments may be
submitted by any of the following
methods:
Electronic Comments
• Use the Commission’s internet
comment form (https://www.sec.gov/
rules/other.shtml); or
• Send an email to rule-comments@
sec.gov. Please include File Number S7–
13–12 on the subject line.
Paper Comments
• Send paper comments to Secretary,
Securities and Exchange Commission,
100 F Street NE, Washington, DC
20549–1090.
All submissions should refer to File
Number S7–13–12. This file number
should be included on the subject line
if email is used. To help us process and
review your comments more efficiently,
please use only one method. The
Commission will post all comments on
the Commission’s internet website
(https://www.sec/gov/rules/other.shtml).
Comments are also available for website
viewing and printing in the
Commission’s Public Reference Room,
100 F Street, NE, Washington DC 20549,
on official business days between the
hours of 10:00 a.m. and 3:00 p.m.
All comments received will be posted
without change. Persons submitting
comments are cautioned that the
Commission does not redact or edit
personal identifying information from
comment submissions. Commenters
should submit only information that
they wish to make available publicly.
FOR FURTHER INFORMATION CONTACT:
Michael A. Macchiaroli, Associate
Director, at (202) 551–5525; Thomas K.
McGowan, Associate Director, at (202)
551–5521; Randall W. Roy, Deputy
Associate Director, at (202) 551–5522;
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Federal Register / Vol. 85, No. 215 / Thursday, November 5, 2020 / Notices
Raymond Lombardo, Assistant Director,
at 202–551–5755; or Sheila Dombal
Swartz, Senior Special Counsel, at (202)
551–5545, Division of Trading and
Markets, Securities and Exchange
Commission, 100 F Street NE,
Washington, DC 20549–7010.
SUPPLEMENTARY INFORMATION:
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I. Introduction
The Commission is proposing to issue
an order granting conditional exemptive
relief to SEC-registered clearing agencies
also registered with the Commodity
Futures Trading Commission (‘‘CFTC’’)
as derivative clearing organizations
(‘‘clearing agency/DCOs’’) and SECregistered broker-dealers also registered
with the CFTC as futures commission
merchants (‘‘BD/FCMs’’). The proposed
order would exempt these entities from
compliance with certain provisions of
the Securities Exchange Act of 1934
(‘‘Exchange Act’’) in connection with a
program to portfolio margin cleared
swaps customer and affiliate positions
in cleared security-based swaps and
swaps that are credit default swaps
(‘‘CDS’’) in a segregated account
established and maintained in
accordance with Section 4d(f) of the
Commodity Exchange Act (‘‘CEA’’) in
the case of a cleared swaps customer
(‘‘CFTC cleared swaps customer
account’’) or a cleared swaps proprietary
account in the case of an affiliate
(‘‘CFTC cleared swaps proprietary
account’’) (each a ‘‘CFTC cleared swaps
account’’), and to calculate margin
requirements on a portfolio basis.1
The proposed order would supersede
and replace the Commission’s December
2012 order providing similar relief
(‘‘2012 Order’’), and modify certain of
its conditions, as discussed in more
detail below.2 In particular, it would
eliminate conditions (a)(1) and (a)(2) in
the 2012 Order pertaining to the
exemptions for clearing agency/DCOs.3
The requirements to adhere to these
conditions are triggered on the
compliance date for the final capital,
margin, and segregation requirements
for SBSDs: October 6, 2021. The
Commission is seeking comment at this
time on whether these and other
conditions in the 2012 Order should be
modified to provide time to consider
comments and, if appropriate, issue a
new order in advance of conditions
1 The text of the proposed order is set forth in an
appendix to this release and cited herein as the
‘‘Proposed Order.’’
2 Order Granting Conditional Exemptions under
the Securities Exchange Act of 1934 in Connection
with Portfolio Margining of Swaps and Securitybased Swaps, Exchange Act Release No. 68433
(Dec. 12, 2012) 77 FR 75211 (Dec. 19, 2012).
3 See 2012 Order, 77 FR at 75219–20.
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(a)(1) and (a)(2) in the 2012 Order being
triggered.
Conditions (a)(1) and (a)(2) in the
2012 Order are intended to provide an
option for security-based swap
customers to portfolio margin cleared
security-based swaps and swaps that are
CDS (‘‘cleared CDS’’) in a security-based
swap account in accordance with
Section 3E of the Exchange Act (‘‘SEC
SBS account’’) as an alternative to a
CFTC cleared swaps account.4 The
proposed order also would modify the
conditions in paragraphs (b)(1)(ii) and
(2)(ii) requiring subordination
agreements to provide greater clarity
that the scope of the subordination does
not extend to the claims of general
creditors. In addition, the proposed
order would eliminate condition (b)(3)
in the 2012 Order, which requires
approval of a BD/FCM’s margin
methodology by the Commission or
Commission staff. Instead, as a
condition of the proposed order, a BD/
FCM would need to have an internal
risk management program that has been
approved in advance by the
Commission or the Commission staff.
Further, as a condition of the proposed
order, the internal risk management
program would need to have certain
standards drawn from the letters the
staff of the Division of Trading and
Markets (‘‘Division staff’’) issued to BD/
FCMs to approve their margin
methodologies.5 These staff letters
would be withdrawn and the proposed
order would provide that any BD/FCM
that received a staff letter approving its
margin methodology prior to the
issuance of the order would be deemed
to have an approved internal risk
management program for the purposes
of the proposed order.
II. Background
A. 2012 Order
On December 14, 2012, in response to
a request from ICE Clear Credit LLC,6
4 The Commission has adopted capital, margin,
and segregation requirements under the Exchange
Act for security-based swaps dealers (‘‘SBSDs’’). See
Capital, Margin, and Segregation Requirements for
Security-Based Swap Dealers and Major SecurityBased Swap Participants and Capital and
Segregation Requirements for Broker-Dealers,
Exchange Act Release No. 86175 (June 21, 2019), 84
FR 43872, 43956–57 (Aug. 22, 2019) (‘‘Capital,
Margin, and Segregation Adopting Release’’).
5 The staff letters are available at https://
www.sec.gov/rules/exorders/exordersarchive/
exorders2012.shtml.
6 ICE Clear Credit formally petitioned the
Commission to grant exemptive relief from the
application of Section 15(c)(3) of the Exchange Act,
Rule 15c3–3 and, related rules under the Exchange
Act. See Letter from Michael M. Phillip, Partner,
Winston & Strawn LLP (Nov. 7, 2011) (the petition
4–641 and comments received on the petition are
available at https://www.sec.gov/rules/
petitions.shtml).
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the Commission issued the 2012 Order
to provide relief so that clearing agency/
DCOs and BD/FCMs could offer
customers portfolio margining of cleared
CDS in a CFTC cleared swaps account
(‘‘CDS portfolio margin program’’).7 The
2012 Order exempts a clearing agency/
DCO from Sections 3E(b), 3E(d) and
3E(e) of the Exchange Act and any rules
thereunder, solely to perform the
functions of a clearing agency/DCO
under the CDS portfolio margin
program, subject to five conditions.8 It
further exempts a BD/FCM from
Sections 3E(b), 3E(d), 3E(e), and 15(c)(3)
of the Exchange Act, and Rule 15c3–3,
as well as from any requirement to treat
an affiliate (as defined in association
with the ‘‘cleared swaps proprietary
account’’ definition in CFTC Rule 22.1)
as a customer for purposes of Rules 8c–
1 and 15c2–1, subject to six conditions.9
The conditions applicable to clearing
agency/DCOs and BD/FCMs are
designed to: (1) Protect money,
securities, and property of securitybased swap customers; (2) address
certain differences in the statutory
requirements of the Exchange Act and
the CEA; and (3) promote appropriate
risk management and disclosure.10 The
2012 Order also sought comment on all
aspects of the exemptions it provided.11
7 The CFTC also issued a companion exemptive
order on January 13, 2013 permitting ICE Clear
Credit and its BD/FCM clearing members to provide
for the portfolio margining of cleared swaps and
security-based swaps that are CDS. See CFTC,
Order, Treatment of Funds Held in Connection with
Clearing by ICE Clear Credit of Credit Default
Swaps (Jan. 13, 2013)(‘‘2013 CFTC Portfolio Margin
Order’’), available at https://www.cftc.gov/sites/
default/files/idc/groups/public/@newsroom/
documents/file/icecreditclearorder011413.pdf. See
also CFTC, Order, Treatment of Funds Held in
Connection with Clearing by ICE Clear Europe of
Credit Default Swaps (Apr. 9, 2013), available at
https://www.cftc.gov/sites/default/files/stellent/
groups/public/@requestsandactions/documents/
ifdocs/icecleareurope4dfcds040913.pdf.
8 See Capital, Margin, and Segregation Adopting
Release, 84 FR at 43954; Cross-Border Application
of Certain Security-Based Swap Requirements,
Exchange Act Release No. 87780 (Dec. 18, 2019), 85
FR 6270 (Feb. 4, 2020).
9 See 2012 Order, 77 FR at 75213–14 (discussing
these sections of the Exchange Act and the rules),
75216–19 (discussing the conditions), and 75220–
21 (setting forth the conditions). See also Order
Extending Temporary Exemptions from Exchange
Act Section 8 and Exchange Act Rules 8c-1, 10b16, 15a-1, 15c2–1 and 15c2–5 in Connection with
the Revision of the Definition of ‘‘Security’’ to
Encompass Security-Based Swaps, Exchange Act
Release No. 87943 (Jan. 10, 2020), 85 FR 2763 (Jan.
16, 2020) (providing a temporary exemption from
certain rules including Rules 8c-1 and 15c-1 in
connection with the revision of the Exchange Act
definition of ‘‘security’’ to encompass securitybased swaps until Nov. 5, 2020).
10 See 2012 Order, 77 FR at 75214.
11 77 FR at 75219. Letters responding to this
request for comment are available at https://
www.sec.gov/comments/s7-13-12/s71312.shtml.
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B. Division Staff Letters
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On March 8, 2013, the Division staff
issued temporary conditional approval
letters to seven BD/FCMs pursuant to
condition (b)(3) in the 2012 Order 12
permitting them to participate in the
CDS portfolio margin program, subject
to certain conditions (the ‘‘March 8,
2013 letters’’).13 The conditions
included a requirement to collect initial
margin based on a multiplier of the
clearing agency/DCO margin
requirement or to take a 100% capital
charge for the difference.
On June 7, 2013, the Division staff
issued updated temporary conditional
letters to the seven BD/FCMs that
received the March 8, 2013 letters, and
to one additional BD/FCM, setting forth
revised conditions for participation in
the CDS portfolio margin program (‘‘the
June 7, 2013 letters’’). The June 7, 2013
letters required the BD/FCMs to
implement a required margin regime
and establish minimum risk
management standards by December 7,
2013. On December 6, 2013, the
Division staff issued letters to the BD/
FCMs extending the December 7, 2013
date to January 31, 2014. On January 31,
2014, the Division staff issued letters to
the eight BD/FCMs permanently
approving their margin methodologies,
subject to the conditions in the June 7,
2013 letters (‘‘January 31, 2014 letters’’).
Subsequent to the issuance of the
January 31, 2014 letters, the Division
staff approved the margin
methodologies of two additional BD/
FCMs, subject to the conditions in the
June 7, 2013 letters.14
12 See Proposed Order, ¶ (b)(3) (providing that
BD/FCM must require minimum margin levels with
respect to any customer transaction in a program to
commingle and portfolio margin CDS at least equal
to the amount determined using a margin
methodology established and maintained by the
BD/FCM that has been approved by the
Commission or the Commission staff).
13 The March 8, 2013 letters and other staff letters
to the BD/FCMs discussed below are available at:
https://www.sec.gov/rules/exorders/
exordersarchive/exorders2012.shtml. The
temporary staff letters were responsive to a
comment raising concerns about the first CFTC
compliance date for mandatory swaps clearing
(March 13, 2013). See Letter from Stuart J. Kaswell,
Executive Vice President & Managing Director,
Managed Funds Association (Feb. 11, 2013) (‘‘MFA
2/11/13 Letter’’) (comment to the 2012 Order),
available at https://www.sec.gov/comments/s7-1312/s71312.shtml.
14 The Division staff also issued an additional
letter relating to the transfer of a CDS portfolio
margin program using the same internal risk model
and same internal risk management system from
one broker-dealer affiliate to another. The June 7,
2013 letters and subsequent staff letters are
collectively referred to below as the ‘‘BD/FCM staff
letters.’’
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III. Discussion of Proposed Relief
Since the issuance of the 2012 Order,
the SEC staff has monitored the
operations of the BD/FCMs participating
in the CDS portfolio margin program as
well as the market for cleared CDS. The
Commission believes it may be
appropriate to issue a new portfolio
margin order with modified conditions
in light of: (1) The experience gained
from this monitoring; and (2) comment
letters addressing portfolio margining
received in response to the 2012 Order
and in the context of the SEC’s recently
finalized rulemaking adopting capital,
margin and segregation requirements for
security-based swap dealers
(‘‘SBSDs’’).15 A modified order also may
be appropriate because the CFTC has
initiated the mandatory clearing of
certain swaps, including broad-based
index CDS.16 The following discussion
describes the conditions of the proposed
order—many of which would be largely
consistent with conditions in the 2012
Order. Proposed modifications to the
conditions in the 2012 Order are noted
and discussed.
(a)(2) requires the clearing agency/DCO,
within the same timeframe, to take all
necessary action within its control, to
establish rules and operational practices
to permit its BD/FCM clearing members
to maintain customer money, securities,
and property received by the BD/FCM to
margin, guarantee, or secure customer
positions in cleared CDS in an SEC SBS
account for the purpose of the CDS
portfolio margin program. Thus, the
requirements to adhere to conditions in
paragraphs (a)(1) and (2) of the 2012
Order are triggered on the compliance
date for the final capital, margin, and
segregation requirements for SBSDs:
October 6, 2021.
In the 2012 Order, the Commission
stated that it was important to
ultimately provide market participants
with the ability to select an account
structure to manage their individual
risks by taking into account the different
regulatory provisions that may apply to
different account types and any costs
incurred.18 Market participants have
been clearing CDS under the CDS
portfolio margin program since the
initial BD/FCM staff letters were issued
A. Conditions for Clearing Agency/DCOs in 2013. The CDS portfolio margining
1. Elimination of Conditions Relating to program has allowed greater efficiencies
in clearing, allowing the offset of
Expanding the CDS Portfolio Margin
positions and the ability to margin
Program to Securities Accounts
cleared CDS in a single account.
The conditions in paragraphs (a)(1)
Portfolio margining facilitates margin
and (a)(2) of the 2012 Order are
requirements that better reflect the
intended to provide customers the
overall risks presented by a CDS
option to portfolio margin cleared CDS
portfolio, which may result in decreased
in an SEC SBS account once the SEC’s
margin costs. Because of these greater
margin and segregation rules for SBSDs
efficiencies and potential cost
are in place.17 In particular, paragraph
reductions available under the current
(a)(1) requires that the clearing agency/
CDS portfolio margin program in a
DCO, by the later of six months after the CFTC cleared swaps account, market
adoption date of the final margin and
participants have not expressed a desire
segregation rules for security-based
to portfolio margin cleared CDS in an
swaps or the compliance date of such
SEC SBS account. This lack of market
rules, to take all necessary action within interest in a securities account
its control to obtain any relief needed to alternative also is consistent with: (1)
permit its BD/FCM clearing members to The comments of ICE Clear Credit in
maintain customer money, securities,
2011 that it received no indication in its
and property received by the BD/FCM to discussions with market participants
margin, guarantee, or secure customer
that they desired a securities account
positions in cleared CDS in an SEC SBS option with respect to its petition for
account for the purpose of the CDS
rulemaking to portfolio margin cleared
portfolio margin program. Paragraph
CDS; and (2) the Division staff’s
experience in monitoring the CDS
15 The comment letters received with respect to
portfolio margin program.19
this rulemaking are available at https://
While portfolio margining cleared
www.sec.gov/comments/s7-08-12/s70812.shtml.
16 See, e.g., CFTC Announces that Mandatory
CDS in an SEC SBS account also would
Clearing Begins Today, CFTC Press Release No.
provide greater efficiencies and cost
6529–13 (Mar. 11, 2013) (announcing that swap
reductions, given the success of the
dealers, major swap participants and private funds
current CDS portfolio margin program
active in the swaps market are required to begin
clearing certain index CDS); CFTC Announces that
Mandatory Clearing for Category 2 Entities Begins
Today, CFTC Press Release No. 6607–13 (June 13,
2013) (announcing the second phase of required
clearing for certain CDS and interest rate swaps).
17 See 2012 Order, 77 FR at 75215–16 (discussing
the conditions) and 75219–20 (setting forth the
conditions).
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18 See
2012 Order, 77 FR at 75216.
Letter from Christopher S. Edmonds,
President, ICE Clear Credit LLC (Dec. 22, 2011)
(‘‘ICE Letter’’) (comment to the ICE Clear Credit
petition for rulemaking 4–641 (Nov. 7, 2011)),
available at https://www.sec.gov/comments/4-641/
4-641.shtml.
19 See
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and the lack of market interest in a
securities account alternative, the
Commission preliminarily believes that
it may be appropriate to eliminate these
conditions. Removing them would
avoid potentially unnecessary costs 20 to
clearing agency/DCOs to implement
systems and processes to accommodate
SEC SBS accounts that may never be
utilized. Moreover, their removal would
not prohibit a clearing agency/DCO from
offering an SEC SBS account option in
the future, if market conditions change
and the demand arises, subject to
applicable regulatory approvals and
relief.
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2. Proposed Conditions
The three clearing agency/DCO
conditions in the proposed order are
largely consistent with the conditions in
paragraphs (a)(3), (4), and (5) of the 2012
Order, respectively.21 The first
condition would require the clearing
agency/DCO to obtain any other relief
needed to permit a BD/FCM to maintain
cleared swaps customer or affiliate
money, securities, and property
received to margin, guarantee, or secure
cleared swaps customer or affiliate
positions in cleared CDS in a CFTC
cleared swaps customer account or a
CFTC cleared swaps proprietary
account, respectively, for the purpose of
clearing such cleared swaps customer or
affiliate positions under the CDS
portfolio margin program.22 This
condition is designed to help ensure
20 These costs may involve changes to trade
processing systems (to designate account type), risk
management processes (to capture and relate
positions and margin held in multiple account
types), and to treasury and banking processes,
systems, and accounts. See, e.g., ICE Letter.
21 See 2012 Order, 77 FR at 75216 (discussing the
conditions) and 75220 (setting forth the conditions);
Proposed Order, ¶¶ (a)(1), (2), and (3). The
Commission made some technical changes to the
DCO/clearing agency conditions in the proposed
order to account for the elimination of conditions
(a)(1) and (2) from the 2012 Order. These proposed
changes include re-numbering the remaining
clearing agency/DCO conditions and moving the
definition of ‘‘BD/FCM’’ from condition (a)(1) in the
2012 Order (which would be eliminated) to
condition (a)(1) in the proposed order (which
parallels condition (a)(3) in the 2012 Order).
Finally, the Commission is proposing to replace the
term ‘‘shall’’ in two places with the term ‘‘will’’ and
‘‘must,’’ respectively.
22 See Proposed Order, ¶ (a)(1). The proposed
order also would eliminate use of the generic term
‘‘customer’’ in the 2012 Order and instead use the
more specific terms ‘‘cleared swaps customer,’’
‘‘affiliate,’’ ‘‘security-based swap customer,’’ and
‘‘securities customer’’. In addition, the proposed
order would add specific language to clarify that
cleared CDS positions of cleared swaps customers
are held in CFTC cleared swaps customer accounts
and affiliate positions are held in CFTC cleared
swaps proprietary accounts. These proposed
changes reflect the different treatment each type of
person and account would receive under the CEA
and rules thereunder, and applicable bankruptcy
laws.
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that the exemption would apply only in
circumstances where the regulatory
framework under the CEA and the
CFTC’s rules is applicable.
The second clearing agency/DCO
condition would require the
organization to have appropriate rules
and operational practices to permit a
BD/FCM to maintain cleared swaps
customer or affiliate money, securities,
and property received to margin,
guarantee, or secure cleared swaps
customer or affiliate positions in cleared
CDS in a CFTC cleared swaps customer
account or a cleared swaps proprietary
account, respectively, for the purpose of
clearing such cleared swaps customer or
affiliate positions under the CDS
portfolio margin program.23 This
condition also is designed to help
ensure the exemption would apply only
in circumstances where the regulatory
framework under the CEA and the
CFTC’s rules is applicable. The third
clearing agency/DCO condition would
require the organization to have rules
mandating that each cleared swaps
customer and affiliate of the BD/FCM
participating in the CDS portfolio
margin program must be an ‘‘eligible
contract participant’’ as defined in
Section 1a(18) of the CEA.24 Given that
Congress determined it is appropriate to
include these limitations in the DoddFrank Act with respect to eligible
contract participants, the Commission
preliminarily believes it is appropriate
to limit the exemptions in this proposed
order to cleared CDS entered into with
eligible contract participants.25
B. Conditions for BD/FCMs
The first, second, fourth, fifth, and
sixth BD/FCM conditions in the
proposed order are largely consistent
with the conditions in paragraphs (b)(1),
(2), (4), (5) and (6) of the 2012 Order,
23 See Proposed Order, ¶ (a)(2). See also supra
note 22.
24 See Proposed Order, ¶ (a)(3). The 2012 order
provided that each ‘‘customer’’ must be an eligible
contract participant. 77 FR 75220. See also supra
note 22.
25 The Dodd-Frank Act limits the swaps and
security-based swaps transactions that may be
entered into by parties that are not eligible contract
participants. For example, under Section 6(l) of the
Exchange Act, only an eligible contract participant
may enter into security-based swaps that are not
effected on a national securities exchange. 15 U.S.C.
78f(l). In addition, security-based swaps that are not
registered pursuant to the Securities Act of 1933
(‘‘Securities Act’’) can only be sold to eligible
contract participants. 15 U.S.C. 77e(e). Section 5(e)
of the Securities Act specifically provides that it
shall be unlawful to for any person, directly or
indirectly, to make use of any means or instruments
of transportation or communication in interstate
commerce or of the mails to offer to sell, offer to
buy or purchase or sell a security-based swap to any
person who is not an eligible contract participant,
unless the transaction is registered under the
Securities Act. Id.
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respectively.26 The first BD/FCM
condition would consist of two
requirements and apply with respect to
transactions involving persons that are
not affiliates of the BD/FCM (i.e.,
cleared swaps customers).27 Under the
first requirement, the BD/FCM would
need to maintain cleared swaps
customer money, securities, and
property received to margin, guarantee
or secure cleared swaps customer
positions consisting of cleared CDS in a
CFTC cleared swaps customer account
established and maintained for the
purpose of the CDS portfolio margin
program.28 This condition is designed to
help ensure that—in the absence of the
security-based swap and securities
customer protections afforded by the
securities laws—collateral in the
account is subject to the protections
afforded by an alternative regulatory
scheme (i.e., the CEA and the CFTC’s
rules). The intent is to avoid having the
assets in the account fall into a
regulatory gap in which neither the
federal securities laws nor the federal
commodity futures laws apply. The
condition also is designed to limit the
relief to accounts that are established
and maintained specifically for the
purpose of the CDS portfolio margin
program.
Under the second requirement, the
BD/FCM would need to enter into a
non-conforming subordination
agreement with each non-affiliated
cleared swaps customer that covers the
customer’s money, securities, or
property held in a segregated account.29
The non-conforming subordination
agreement would need to contain: (1) A
specific acknowledgment by the cleared
swaps customer that such money,
securities or property will not receive
customer treatment under the Exchange
Act or Securities Investor Protection Act
of 1970 (‘‘SIPA’’) or be treated as
‘‘customer property’’ as defined in 11
U.S.C. 741 in a liquidation of the BD/
26 See 2012 Order, 77 FR at 75216–19 (discussing
the conditions) and 75220–21 (setting forth the
conditions); Proposed Order, ¶¶ (b)(1), (2), (4), (5),
and (6). The Commission made some technical and
stylistic changes to these conditions, including
replacing the term ‘‘shall’’ with ‘‘must’’ and
capitalizing the first letter in each of the conditions
(and their subparagraphs). Finally, the Commission
inserted the phrase ‘‘Section 8 of the Exchange Act
and’’ before ‘‘Exchange Act Rules 8c–1 and 15c2–
1’’ in paragraph (b) of the proposed order to be
consistent with the other rule references in the
order, which refer to the relevant statute. See
Proposed Order, ¶ (b).
27 See Proposed Order, ¶ (b)(1).
28 See Proposed Order, ¶ (b)(1)(i). See also supra
note 22 (discussing proposed change from the use
of the generic term ‘‘customer’’ in the 2012 Order
to ‘‘cleared swaps customer’’ in the proposed
order).
29 See condition (b)(1)(ii) of 2012 Order.
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FCM (‘‘stockbroker liquidation’’), and
that such money, securities or property
will be subject to any applicable
protections under Subchapter IV of
Chapter 7 of Title 11 of the United
States Code and rules and regulations
thereunder (‘‘commodity broker
liquidation provisions’’); and (2) an
affirmation by the cleared swaps
customer that claims to ‘‘customer
property’’ as defined in SIPA or 11
U.S.C. 741 against the BD/FCM will be
subordinated to the claims of securities
customers and security-based swap
customers.
The 2012 Order required an
affirmation by the customer that all of
its claims with respect to such money,
securities, or property against the BD/
FCM will be subordinated to the claims
of other securities customers and
security-based swap customers not
participating in the CDS portfolio
margin program.30 To better clarify that
the cleared swaps customer is not
subordinating claims to general
creditors, the Commission is proposing
to modify condition (b)(1)(ii) of the 2012
Order, as stated above, to provide that
the cleared swaps customer must affirm
that claims to ‘‘customer property’’ as
defined in SIPA or the stockbroker
liquidation provisions against the BD/
FCM will be subordinated to the claims
of securities customers and securitybased swap customers. This
modification is designed to more
narrowly tailor the subordination to the
portion of the debtor BD/FCM’s estate
that comprises ‘‘customer property’’
under SIPA and the stockbroker
liquidation schemes.31
This proposed condition is designed
to remove portfolio margin cleared
swaps customers from the definitions of
‘‘customer’’ under Rule 15c3–3, SIPA,
and the stockbroker liquidation
provisions with respect to securities or
cash held in CFTC cleared swaps
accounts that otherwise would be
subject to the segregation requirements
of Rule 15c3–3 and the bankruptcy
protections afforded by SIPA and the
stockbroker liquidation provisions. The
objective is to avoid a situation where
the portfolio margin cleared swaps
customers would be entitled to a ratable
share of ‘‘customer property’’ and other
protections afforded by SIPA or the
stockbroker liquidation provisions even
though their assets were held in CFTC
cleared swaps customer accounts that
were not subject to the segregation
requirements of Rule 15c3–3. Assets
held in a CFTC cleared swaps customer
account would instead be afforded the
30 See
31 See
2012 Order, 77 FR at 75220.
supra note 22.
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protections of the rules of the CFTC
governing the treatment of customer
margin held by BD/FCMS and DCOs as
well as the protections of the CEA and
commodity broker liquidation
provisions. The proposed condition is
not intended to undermine these
protections.
The proposed condition also is not
intended to require portfolio margin
cleared swaps customers to subordinate
their claims, in the event that their
claims as cleared swaps customers are
not fully satisfied by the distribution of
assets held in CFTC cleared swaps
customer accounts, to assets that may be
included in the debtor’s general estate.
In summary, this condition, along with
the proposed disclosure conditions
discussed below, is intended to help
ensure that cleared swaps customers
clearly understand that any securitybased swap or securities customer
protection treatment otherwise available
with respect to securities transactions
under the Exchange Act, SIPA, or the
stockbroker liquidation provisions will
not be available for cleared CDS held in
a CFTC cleared swaps customer
account.
The second BD/FCM condition in the
proposed order would apply with
respect to transactions involving
affiliates of the BD/FCM and would
consist of three requirements.32 Under
the first requirement, the BD/FCM
would need to maintain money,
securities, and property of affiliates
received to margin, guarantee, or secure
positions consisting of cleared CDS in a
‘‘cleared swaps proprietary account’’ as
defined in CFTC Rule 22.1 for the
purpose of clearing such positions
under the CDS portfolio margin
program.33 The purpose of this
requirement is that under the CFTC
regulatory framework certain affiliates
are not treated as cleared swaps
customers and their assets are held in
proprietary accounts as distinct from
CFTC cleared swaps customer
accounts.34
Under the second requirement, the
BD/FCM would need to enter into a
non-conforming subordination
agreement with an affiliate.35 The nonconforming subordination agreement
would need to contain: (1) A specific
32 See
Proposed Order, ¶ (b)(2).
Proposed Order, ¶ (b)(2)(i).
34 See 17 CFR 22.1. The Commission
preliminarily believes that this condition is
appropriate because affiliates of a BD/FCM that are
not otherwise excluded from the definition of
‘‘customer’’ in Exchange Act Rules 8c–1 and 15c2–
1 are customers whose securities positions cannot
be commingled with the broker-dealer’s own
proprietary securities positions and therefore could
not be held in a cleared swaps account.
35 See Proposed Order, ¶ (b)(2)(ii).
33 See
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acknowledgment by the affiliate that
such money, securities or property will
not receive customer treatment under
the Exchange Act or SIPA or be treated
as customer property in a stockbroker
liquidation of the BD/FCM, and that
such money, securities or property will
be held in a proprietary account in
accordance with the CFTC requirements
and will be subject to any applicable
protections under the commodity broker
liquidation provisions; and (2) an
affirmation by the affiliate that claims to
‘‘customer property’’ as defined in SIPA
or 11 U.S.C. 741 against the BD/FCM
will be subordinated to the claims of
securities customers and security-based
swap customers.
For the reasons discussed above, the
Commission is proposing to modify the
text of the affirmation by an affiliate
from the 2012 Order to more narrowly
tailor the subordination to the portion of
the debtor BD/FCM’s estate that
comprises ‘‘customer property’’ under
SIPA and the stockbroker liquidation
schemes.36 This requirement is
designed to help ensure that affiliates
clearly understand that any customer
protection treatment otherwise available
with respect to securities transactions
under the Exchange Act, SIPA, or the
stockbroker liquidation provisions will
not be available and the account would
be treated as a proprietary account (and
not a CFTC cleared swaps customer
account) under the CEA. Consistent
with the proposed condition above with
respect to cleared swaps customers that
are not affiliates, this condition is
intended to remove affiliates from the
definitions of ‘‘customer’’ under Rule
15c3–3, SIPA, and the stockbroker
liquidation provisions with respect to
securities or cash held in cleared swaps
proprietary accounts that otherwise
would be subject to the segregation
requirements of Rule 15c3–3 and the
bankruptcy protections afforded by
SIPA and the stockbroker liquidation
provisions.
Under the third requirement, the BD/
FCM would need to obtain from the
affiliate an opinion of counsel that the
affiliate is legally authorized to
subordinate all of its claims against the
36 See Proposed Order, ¶ (b)(2)(ii). The 2012
Order required an affirmation by the affiliate that
all of its claims with respect to such money,
securities, or property against the BD/FCM will be
subordinated to the claims of other securities
customers and security-based swap customers not
operating under a program to commingle and
portfolio margin CDS. 77 FR at 75220. See also
supra note 22. The modification would require the
affiliate to affirm that that all of its claims to
‘‘customer property’’ as defined in SIPA or 11
U.S.C. 741 against the BD/FCM will be
subordinated to the claims of securities customers
and security-based swap customers.
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BD/FCM to those of securities customers
and security-based swap customers.37
This condition is designed to help
ensure that affiliates of the BD/FCM do
not place any assets in the proprietary
account that the affiliate is not legally
authorized to subordinate.
The condition in paragraph (b)(3) of
the 2012 Order provides that the BD/
FCM must require minimum margin
levels with respect to any customer
transaction in the CDS portfolio margin
program at least equal to the amount
determined using a margin methodology
established and maintained by the BD/
FCM that has been approved by the
Commission or the Commission staff.38
A commenter responding to the
issuance of the 2012 Order supported
the requirement for a BD/FCM to assess
the credit risk of counterparties based
on the BD/FCM’s own risk management
standards, but argued that requiring a
unique margin model beyond the BD/
FCM’s own credit risk assessment is
unwarranted.39 This commenter also
stated that this condition ‘‘deters’’
efficiency, capital formation, and
competition.40 Another commenter
responding to the issuance of the 2012
Order argued that the condition
undermines a fundamental benefit of
central clearing: the ability of market
participants to rely on clearing agency/
DCO margin requirements.41 This
commenter believes that this condition
reduces transparency and the ability to
anticipate and verify margin calls, and
37 See Proposed Order, ¶ (b)(2)(iii). The 2012
Order required that the BD/FCM obtain from the
affiliate an opinion of counsel that the affiliate is
legally authorized to subordinate all of its claims
against the BD/FCM to those of customers. 77 FR
at 75220. See also supra note 22.
38 See condition (b)(3) of 2012 Order.
39 See Letter from Stuart J. Kaswell, Executive
Vice President & Managing Director, General
Counsel, Managed Funds Association; Carl B.
Wilkerson, Vice President & Chief Counsel,
Securities & Litigation, American Council of Life
Insurers; and Jirˇı´ Krol, Director of Government and
Regulatory Affairs, Alternative Investment
Management Association (Dec. 27, 2013) (‘‘MFA/
ACLI/AIMA 12/27/2013 Letter’’) (comment to the
2012 Order), available at https://www.sec.gov/
comments/s7-13-12/s71312.shtml; see also Letter
from Stuart J. Kaswell, Executive Vice President &
Managing Director, General Counsel, Managed
Funds Association; Carl B. Wilkerson, Vice
President & Chief Counsel, Securities & Litigation,
American Council of Life Insurers; and Jirˇı´ Krol,
Director of Government and Regulatory Affairs,
Alternative Investment Management Association
(May 10, 2013) (comment to the 2012 Order),
available at https://www.sec.gov/comments/s7-1312/s71312.shtml.
40 MFA/ACLI/AIMA 12/27/2013 Letter.
41 See Letter from Adam C. Cooper, Senior
Managing Director and Chief Legal Officer, Citadel
LLC (Feb. 2, 2016) (‘‘Citadel 2/2/16 Letter’’)
(comment to the 2012 Order), available at https://
www.sec.gov/comments/s7-13-12/s71312.shtml.
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that it discourages entities from entering
the cleared CDS market.42
In the context of the SEC’s capital,
margin and segregation rulemaking for
SBSDs, another commenter expressed
concern that the conditions in the 2012
Order have proven too restrictive to
support a robust market for cleared
CDS.43 More specifically, this
commenter recommended that both the
CFTC and SEC recognize a harmonized
portfolio margin approach for cleared
CDS that defers to the clearing agency/
DCO margin methodologies.44 Finally, a
commenter expressed concern that the
margin requirements imposed by the
Commission have delayed voluntary
buy-side clearing of single-name CDS,
with resulting adverse effects on trading
volume and liquidity.45
The vast majority of the BD/FCM
clearing members of ICE Clear Credit
have obtained approval of their margin
methodologies from Commission staff.46
Furthermore, each BD/FCM that has
received approval of its margin
methodology already had existing
margin models in place prior to
applying to the Commission. Therefore,
the firms needed to make some
adjustments to their models in order to
meet the minimum qualitative and
quantitative standards set forth in the
BD/FCM staff letters, but did not need
to develop new margin models. To date,
all BD/FCMs that have submitted
applications to Commission staff to
42 Citadel 2/2/16 Letter; Letter from Laura Harper
Powell, Associate General Counsel, Managed Funds
Association, and Adam Jacobs-Dean, Managing
Director, Global Head of Markets Regulation,
Alternative Investment Management Association
(Nov. 19, 2018) (comment to the Commission’s
capital, margin, and segregation rulemaking for
SBSDs), available at https://www.sec.gov/
comments/s7-08-12/s70812.shtml.
43 See Letter from Walt L. Lukken, President and
Chief Executive Office, Futures Industry
Association (Nov. 29, 2018) (‘‘FIA 11/29/18 Letter’’)
(comment to the Commission’s capital, margin, and
segregation rulemaking for SBSDs), available at
https://www.sec.gov/comments/s7-08-12/
s70812.shtml.
44 Letter from Walt L. Lukken, President and
Chief Executive Office, Futures Industry
Association (Nov. 19, 2018) (comment to the
Commission’s capital, margin, and segregation
rulemaking for SBSDs), available at https://
www.sec.gov/comments/s7-08-12/s70812.shtml; FIA
11/29/18 Letter.
45 See Letter from Stuart J. Kaswell, Executive
Vice President & Managing Director, General
Counsel, Managed Funds Association (May 18,
2017) (comment to the Commission’s capital,
margin, and segregation rulemaking for SBSDs),
available at https://www.sec.gov/comments/s7-0812/s70812.shtml.
46 See ICC membership, available at https://
www.theice.com/clear-credit/participants. Based on
Division staff experience in monitoring the CDS
portfolio margin program, the vast majority of
positions are being cleared through ICE Clear
Credit, and to a lesser extent, ICE Clear Europe.
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approve their internal margin
methodologies have received approval.
The Commission preliminarily
believes that it would not be prudent for
a BD/FCM to simply defer to the margin
methodology of the clearing agency/
DCO in terms of measuring and
managing the risk of cleared CDS in a
portfolio margin account, as requested
by commenters. Prudent firms establish
and maintain integrated internal risk
management programs that include
management policies and procedures
designed to help ensure an awareness
of, and accountability for, the risks
taken throughout the firm and to
develop tools to address those risks. For
example, there may be idiosyncratic risk
factors with respect to a cleared swaps
customer, an affiliate, or the BD/FCM’s
financial condition that are not covered
by the margin methodology of the
clearing agency/DCO.
At the same time, the Commission
also preliminarily believes that it can
promote the prudent operation of the
BD/FCMs through a process of
approving their internal risk
management programs (rather than their
internal margin methodologies), as
discussed below. This may increase
transparency for market participants in
terms of being able to anticipate margin
requirements generated by their cleared
CDS portfolios, as the clearing agency/
DCO margin methodology will generate
the regulatory margin requirement
across all the BD/FCMs.47 Accordingly,
the Commission is proposing to modify
the condition in paragraph (b)(3) of the
2012 Order to eliminate the requirement
that the Commission or Commission
staff approve the BD/FCM’s margin
methodology. Instead, the proposed
order would require the BD/FCM to
adopt an internal risk management
program that is reasonably designed to
identify, measure, and manage the risks
arising from its participation in the CDS
portfolio margin program that has been
approved in advance by the
Commission or the Commission staff
and that meets the standards described
below (‘‘internal risk management
program’’).48
47 Nothing in the proposed order would preclude
a BD/FCM from setting higher ‘‘house’’ margin
requirements for some or all of its customers. See
17 CFR 39.13(g)(8).
48 See Proposed Order, ¶ (b)(3). The proposed
order would contain a provision finding that the
BD/FCMs that have received previous approval of
their internal margin methodology from the
Division staff would be deemed to have approved
internal risk management programs for purposes of
paragraph (b)(3) of the proposed order. These BD/
FCMs would no longer be required to have
minimum margin levels with respect to any
customer transaction in a CDS portfolio margin
program at least equal to the amount determined
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An internal risk management program
would facilitate the identification,
measurement, and management of a
broader range of risks than those
covered by the clearing agency/DCO
margin methodology and, consequently,
help ensure that the BD/FCMs operate
in a prudent manner with respect to the
CDS portfolio margin program. Further,
an internal risk management program
entails a more comprehensive set of
measures to mitigate risk than a margin
methodology.49 Consequently, based on
the Commission staff’s experience
gained in monitoring the CDS portfolio
margin program, approving a firm’s
internal risk management program
(rather than its internal margin
methodology) may foster a more robust
approach to managing risk by BD/FCMs.
This approach to managing risk also
will promote consistency with the
Commission’s final capital, margin, and
segregation rules for SBSDs, which
require such firms to be subject to a risk
management rule, as well as with the
regulatory approach adopted by the
CFTC with respect to the portfolio
margining of cleared CDS.50 The
proposed requirement to have an
internal risk management program also
is a condition in the BD/FCM staff
letters and all the firms operating under
the 2012 Order have implemented such
programs.
The requirement that a BD/FCM
independently measure risk by
developing and using its own internal
model is not designed to impose a
margin collection requirement (or
capital charge) or diminish the role of
the clearing agency/DCO margin
methodology. Rather, it is intended to
require the BD/FCM to independently
measure the potential future credit risk
to cleared swaps customers and
affiliates participating in the CDS
portfolio margin program under a
different stress scenario in order to
better understand risks and address
them as the firm deems appropriate
using a margin methodology approved by the
Commission or the Commission staff, as required by
the 2012 Order. They would instead comply the
internal risk management program standards under
condition (b)(3) of the proposed order.
49 See, e.g., 17 CFR 240.15c3–1e(d)(1) (‘‘The VaR
model used to calculate market and credit risk for
a position must be integrated into the daily internal
risk management system of the broker or dealer[.]’’).
50 See Capital, Margin, and Segregation Adopting
Release, 84 FR at 43905 (‘‘The Commission
proposed that nonbank SBSDs be required to
comply with Rule 15c3–4 to promote the
establishment of effective risk management control
systems by these firms.’’); and 2013 CFTC Portfolio
Margin Order (requiring participants to ‘‘take
appropriate measures to identify, measure, and
monitor financial risk associated with carrying the
Security-Based CDS in a cleared swaps account and
implement risk management procedures to address
those financial risks’’).
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(e.g., through risk limits, threshold
triggers, house margin, heightened
monitoring, or other controls).
Under this proposed condition, a BD/
FCM seeking approval of its internal
risk management program would need
to submit sufficient information for the
Commission or Commission staff to be
able to make a determination whether
its program meets the proposed
standards described below.51 In
reviewing this information, the
Commission or the Commission staff
would be guided by these standards. If
a BD/FCM’s internal risk management
program is approved for purposes of this
proposed order, the program would be
subject to ongoing supervision and
monitoring by the Commission.52
The first standard for the internal risk
management program is that the BD/
FCM would need to calculate a future
credit exposure for each cleared swaps
customer and affiliate (sometimes each
a ‘‘counterparty’’) using a proprietary
methodology that meets specified
minimum quantitative and qualitative
model standards (‘‘internal risk
model’’).53 The quantitative standards
would be that the internal risk model:
• Estimates a potential future
exposure over a minimum 10-day
horizon and 99% confidence level and
captures all material risk factors,
including but not limited to general
movements in credit spread term
structure, basis risk between index and
single name positions, and interest rate
risk;
• Includes a concentration/liquidity
requirement; and
• Includes a jump-to-default
requirement for the sale of CDS
protection equal to the largest loss of a
single name exposure assuming a
conservative recovery rate that may not
exceed 40%.
The qualitative standards would
require that:
• The internal risk model must be
adequately documented and the model
documentation must provide a
description of the model assumptions,
data inputs, parameters, and
methodologies employed to measure
risk;
• The internal risk model must be
subject to an annual model review by a
model group that is independent of the
business function;
51 See generally 17 CFR 240.15c3–1e(a)(1). A BD/
FCM would only need to submit information to the
extent it is relevant to the portfolio margining of
cleared CDS. The BD/FCM may seek confidential
treatment for information submitted as part of such
application.
52 See Proposed Order, ¶ (c)(1)(ii)(D).
53 See Proposed Order, ¶ (c)(1).
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• The internal risk model must be
subject to at least quarterly backtesting
by counterparty or account; and
• The BD/FCM must provide written
notice to the Commission or
Commission staff prior to implementing
any material change to its internal risk
model.
These quantitative and qualitative
requirements generally are consistent
with the quantitative and qualitative
requirements for internal risk models
under Appendix E to Rule 15c3–1 and
under new Rule 18a–1. These rules
permit certain broker-dealers and
SBSDs, respectively, to compute capital
charges using internal models.54 For
example, the standards in the proposed
order generally would require that the
model cover a 10-day horizon, 99%
confidence level, and material risks, and
that the BD/FCM backtest the model and
subject it to review.55
The second standard for the internal
risk management program is that it
would need to have the following
minimum risk management system
standards:
• The BD/FCM would need standards
to measure and manage risk exposure
arising from counterparties’ CDS
portfolios that are independent of any
central counterparty margin
methodology;
• The BD/FCM would need to have
an internal credit risk rating model that
assesses the credit risk of each
individual counterparty;
• The BD/FCM’s monitoring of credit
risk would need to include the prudent
setting of an exposure limit for each
individual counterparty, and the
exposure limit would need to be
reviewed if the counterparty’s credit
risk profile changes and at least
quarterly;
• The BD/FCM would need to have
the ability to limit or reduce the
exposure to a counterparty through the
collection of additional margin;
• The BD/FCM would need to have
documented procedures to value
positions conservatively in view of
current market prices and the amount
that might be realized upon liquidation;
and
• The BD/FCM would need to have
well-defined procedures and systems in
place for the daily collection and
payment of initial and variation
margin.56
This proposed standards requirement
is a condition in the BD/FCM staff
letters. These proposed risk
54 See 17 CFR 240.15c3–1e and 18a–1; and
Capital, Margin, and Segregation Adopting Release.
55 See 17 CFR 15c3–1e(d).
56 See Proposed Order, ¶ (c)(2).
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management standards are designed to
require a BD/FCM to take prudent
measures to protect the firm from losses
that can result from failing to account
for and control risk with respect to its
CDS portfolio margin program.
Requiring a BD/FCM to incorporate
these proposed standards is designed to
promote the establishment of effective
internal risk management programs to
address the risks of portfolio margining
cleared CDS.
The third standard for the internal
risk management program is that the
BD/FCM would need to report to the
Commission and FINRA staffs on a
monthly basis within 5 business days
after month end or as otherwise
requested details of its top 25
counterparties’ portfolios as measured
by net credit exposure as well as the top
25 counterparties’ portfolios as
measured by gross notional amount.57
This proposed requirement is a
condition in the BD/FCM staff letters.
Based on Commission staff’s experience
with the BD/FCM staff letter
requirements, the Commission
preliminarily believes that it would be
appropriate to require this monthly
reporting as it will assist Commission
staff in monitoring the risk to the BD/
FCM arising from its portfolio margining
of cleared CDS. Understanding the
magnitude of this risk will assist the
Commission staff in evaluating the
appropriateness of a given firm’s
internal risk management program in
terms of its procedures and controls to
mitigate risk.
The proposed order would not
include other conditions in the BD/FCM
staff letters, including the capital
concentration charge. Based on
Commission staff experience monitoring
the BD/FCMs participating in the CDS
portfolio margin program, the
Commission preliminarily believes that
the capital concentration charge and
other conditions in the BD/FCM staff
letters may not be necessary in light of
the requirement to have a reasonably
designed internal risk management
program. A reasonably designed internal
risk management program will provide
a BD/FCM the tools to better understand
the risks that arise from its portfolio
margining of cleared CDS and address
them as the firm deems appropriate
(e.g., through risk limits, threshold
triggers, house margin, heightened
monitoring, or other controls).
Therefore, the Commission is proposing
not to incorporate these conditions into
the proposed order.
The fourth BD/FCM condition in the
proposed order would require that the
57 See
Proposed Order, ¶ (c)(3).
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BD/FCM be in compliance with
applicable laws and regulations relating
to risk management, capital, and
liquidity, and be in compliance with
applicable clearing agency/DCO rules
and CFTC requirements (including
margin, segregation, and related books
and records provisions) with respect to
CFTC cleared swaps customer accounts
and cleared swaps proprietary accounts
subject to the CDS portfolio margin
program.58 The purpose of this
condition is to help ensure that the
exemption is available only when the
BD/FCM is in compliance with
applicable regulatory requirements. The
fifth BD/FCM condition in the proposed
order would require that each cleared
swaps customer and affiliate of the BD/
FCM participating in the CDS portfolio
margin program be an ‘‘eligible contract
participant.’’ 59 As with the third
condition in the proposed order for
clearing agency/DCOs, the Commission
preliminarily believes it would be
appropriate to limit the availability of
this exemption to eligible contract
participants. Eligible contract
participants should have the expertise
or resources to effectively determine the
risks associated with engaging in these
types of transactions.
The sixth BD/FCM condition in the
proposed order would require that,
before receiving any money, securities,
or property of a cleared swaps customer
or affiliate to margin, guarantee, or
secure positions consisting of cleared
CDS, the BD/FCM would need to
furnish to the cleared swaps customer or
affiliate a disclosure document
containing: (1) A statement indicating
that the cleared swaps customer’s or
affiliate’s money, securities, and
property will be held in a CFTC cleared
swaps account, and that the cleared
swaps customer or affiliate has elected
to seek protections under the
commodity broker liquidation
provisions with respect to such money,
securities, and property; and (2) a
statement that the broker-dealer
segregation requirements of Sections
15(c)(3) and 3E of the Exchange Act and
the rules thereunder, and any customer
protections under SIPA and the
stockbroker liquidation provisions, will
not apply to such cleared swaps
customer or affiliate money, securities,
58 See Proposed Order, ¶ (b)(4). See also supra
note 22.
59 See Proposed Order, ¶ (b)(5). The 2012 Order
requires that each customer of the BD/FCM
participating in a program to commingle and
portfolio margin CDS be an ‘‘eligible contract
participant’’ as defined in Section 1a(18) of the
CEA. 77 FR at 75220. See also supra note 22.
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and property.60 The disclosure
document would need to be provided to
the cleared swaps customer or affiliate
at or prior to the time that the cleared
swaps customer or affiliate opens the
CFTC cleared swaps account and, in all
cases, prior to the BD/FCM receiving
any money, securities or property into
the CFTC cleared swaps account of the
cleared swaps customer or affiliate. This
condition is designed to provide market
participants that elect to participate in
the CDS portfolio margin program with
important disclosures regarding the
legal framework that will govern their
transactions.
Accordingly, pursuant to its authority
under Sections 3E(c)(2) 61 and 36 62 of
the Exchange Act, the Commission
preliminarily believes that the proposed
order, under the terms and conditions
described above, would be necessary or
appropriate in the public interest and
consistent with the protection of
investors.
IV. Request for Comments
The Commission is seeking comment
on all aspects of the proposed
exemption. In particular, the
Commission requests comment on the
following questions. When responding
to the request for comment, please
explain your reasoning.
1. Should any of the proposed
exemptions or conditions be eliminated
or modified?
2. Are there other or different
conditions that should apply to the
proposed exemption?
3. Are there any specific written
disclosures to cleared swaps customers
or affiliates that a BD/FCM should be
required to provide in addition to those
that are a condition to the proposed
exemption?
4. At what stage during the account
opening process does the cleared swaps
60 See Proposed Order, ¶ (b)(6). See also supra
note 22.
61 15 U.S.C. 78c-5(c)(2). Section 3E(c)(2) of the
Exchange Act provides that the Commission may,
notwithstanding Section 3E(b) of the Exchange Act,
by rule, regulation, or order prescribe terms and
conditions under which any money, securities, or
property of a customer with respect to cleared
security-based swaps may be commingled and
deposited with any other money, securities, or
property received by the broker-dealer or SBSD and
required by the Commission to be separately
accounted for and treated and dealt with as
belonging to the security-based swap customer of
the broker-dealer or SBSD.
62 15 U.S.C. 78mm. Section 36 of the Exchange
Act authorizes the Commission to conditionally or
unconditionally exempt, by rule, regulation, or
order any person, security, or transaction (or any
class or classes of persons, securities, or
transactions) from any provision of the Exchange
Act or any rule or regulation thereunder, to the
extent such exemption is necessary or appropriate
in the public interest, and is consistent with the
protection of investors.
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customer or affiliate enter into a nonconforming subordination agreement as
required by the 2012 Order? Is it before,
at the same time, or after the cleared
swaps customer or affiliate receives the
required written disclosures from the
BD/FCM? Should the proposed
condition related to the written
disclosure document be modified to
require that the BD/FCM furnish it to
the cleared swaps customer or affiliate
before the customer enters into the nonconforming subordination agreement
with the BD/FCM (and before the BD/
FCM receives any money, securities, or
property to margin the CDS positions)?
5. Does the proposed modified text
required in the non-conforming
subordination agreements achieve the
objectives of: (1) Removing portfolio
margin cleared swaps customers and
affiliates from the definitions of
‘‘customer’’ under Rule 15c3–3, SIPA,
and the stockbroker liquidation
provisions with respect to securities or
cash held in CFTC cleared swaps
accounts; (2) not undermining the
protections afforded to the portfolio
margin cleared swaps customers and
affiliates under the rules of the CFTC,
the CEA, and commodity broker
liquidation provisions; and (3) not
requiring portfolio margin cleared
swaps customers or affiliates to
subordinate their claims, in the event
that their cleared swaps customer or
affiliate claims are not fully satisfied by
the distribution of assets held in their
CFTC cleared swaps accounts, to assets
that may be included in the debtor’s
general estate? Is there alternative
language that would better achieve these
objectives? Does the text in the 2012
Order achieve these objectives? If this
modification or some other modification
were made to the order, would it require
BD/FCMs to amend all their existing
agreements with cleared swaps
customers and affiliates participating in
the portfolio margin program? If so,
would this be a significant burden?
6. Should clearing agencies/DCOs be
required to provide market participants
with the ability to select an SEC SBS
account as an alternative to a CFTC
cleared swaps account?
7. Have market participants expressed
an interest in portfolio margining
cleared CDS in an SEC SBS account? If
so, how has this interest changed since
2012?
8. Would there be interest by BD/
FCMs in offering market participants the
option to portfolio margin cleared CDS
in an SEC SBS account after the October
6, 2021 compliance date for the SEC’s
final capital, margin, and segregation
rules for security-based swaps, when the
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customer protection framework for
security-based swaps is in place?
9. If there was no regulatory
requirement to provide market
participants with the ability to select an
SEC SBS account as an alternative to a
CFTC cleared swaps account, would
clearing agencies/DCOs be incentivized
to offer such an alternative in the future,
if market conditions changed and
demand rose for an SEC SBS account
alternative?
10. Are the proposed standards for the
BD/FCM’s internal risk management
program appropriate?
11. Is it appropriate for the proposed
order to deem a BD/FCM to have an
internal risk management program that
has been approved by the Commission
or the Commission staff as required by
paragraph (b)(3) of the proposed order if
it has received prior approval of its
margin methodology?
12. Would the proposed exemption
have a competitive impact—either
positive or negative—on market
participants in the context of CDS
clearing? What would be the potential
benefits and costs of the proposed
exemption? Would the proposed
modifications to the 2012 Order impact
investor protection? If so, what would
those impacts be?
By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
Appendix—Text of Proposed Order
It is hereby ordered that any broker-dealer
also registered as a futures commission
merchant that has received approval of its
margin methodology by the Commission or
Commission staff prior to the date of this
order is deemed to have an internal risk
management program that has been approved
by the Commission or the Commission staff
as required by paragraph (b)(3) of this order.
It is hereby further ordered, pursuant to
Section 3E(c)(2) and Section 36 of the
Securities Exchange Act of 1934 (‘‘Exchange
Act’’), that the following exemptions from
Exchange Act requirements will apply:
(a) Exemption for dually-registered clearing
agencies/derivatives clearing organizations.
A clearing agency registered pursuant to
Section 17A of the Exchange Act and
registered as a derivatives clearing
organization pursuant to Section 5b of the
CEA (a ‘‘clearing agency/DCO’’) will be
exempt from Sections 3E(b), (d), and (e) of
the Exchange Act and any rules thereunder,
solely to perform the functions of a clearing
agency for credit default swaps (‘‘CDS’’)
under a program to commingle and portfolio
margin cleared CDS for cleared swaps
customer and affiliate positions, subject to
the following conditions:
(1) The clearing agency/DCO has obtained
any other relief needed to permit its clearing
members that are registered under Section
15(b) of the Exchange Act (other than
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70665
paragraph (11) thereof) and also registered as
a futures commission merchant pursuant to
Section 4f(a)(1) of the CEA (a ‘‘BD/FCM’’) (at
the BD/FCM’s election), to maintain cleared
swaps customer or affiliate money, securities,
and property received by the BD/FCM to
margin, guarantee, or secure cleared swaps
customer or affiliate positions in cleared
CDS, which include both swaps and securitybased swaps, in a segregated account
established and maintained in accordance
with Section 4d(f) of the CEA and rules
thereunder (in the case of a cleared swaps
customer) or a cleared swaps proprietary
account (in the case of an affiliate) for the
purpose of clearing (as a clearing member of
the clearing agency/DCO) such cleared swaps
customer or affiliate positions under a
program to commingle and portfolio margin
CDS.
(2) The clearing agency/DCO has
appropriate rules and operational practices to
permit a BD/FCM that is a clearing member
(at the BD/FCM’s election) to maintain
cleared swaps customer or affiliate money,
securities, and property received by the BD/
FCM to margin, guarantee, or secure cleared
swaps customer or affiliate positions in
cleared CDS, which include both swaps and
security-based swaps, in a segregated account
established and maintained in accordance
with Section 4d(f) of the CEA and rules
thereunder (in the case of a cleared swaps
customer) or a cleared swaps proprietary
account (in the case of an affiliate) for the
purpose of clearing (as a clearing member of
the clearing agency/DCO) such cleared swaps
customer or affiliate positions under a
program to commingle and portfolio margin
CDS.
(3) The rules of the clearing agency/DCO
require that each cleared swaps customer and
affiliate of the BD/FCM participating in a
program to commingle and portfolio margin
CDS must be an ‘‘eligible contract
participant’’ as defined in Section 1a(18) of
the CEA.
(b) Exemption for certain BD/FCMs that
elect to offer a program to commingle and
portfolio margin cleared swaps customer and
affiliate positions in cleared CDS. Solely to
perform the functions of a BD/FCM for
cleared CDS, with respect to any cleared
swaps customer or affiliate money, securities,
and property received by the BD/FCM to
margin, guarantee, or secure cleared swaps
customer or affiliate positions in securitybased swaps included in a segregated
account established and maintained in
accordance with Section 4d(f) of the CEA and
rules thereunder (in the case of a cleared
swaps customer) or a cleared swaps
proprietary account (in the case of an
affiliate) under a program to commingle and
portfolio margin cleared swaps customer or
affiliate positions in CDS, a BD/FCM will be
exempt from Exchange Act Sections 3E(b),
(d), and (e), and Section 15(c)(3) and Rule
15c3–3 thereunder and any requirement to
treat an affiliate (as defined in association
with the definition of ‘‘cleared swaps
proprietary account’’ pursuant to CFTC Rule
22.1) as a customer for purposes of Section
8 of the Exchange Act and Exchange Act
Rules 8c-1 and 15c2–1 thereunder, subject to
the following conditions:
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(1) With respect to cleared swaps
customers that are not affiliates of the BD/
FCM,
(i) The BD/FCM must maintain cleared
swaps customer money, securities, and
property received to margin, guarantee or
secure cleared swaps customer positions
consisting of cleared CDS, which include
both swaps and security-based swaps, in a
segregated account established and
maintained in accordance with Section 4d(f)
of the CEA and rules thereunder for the
purpose of clearing (as a clearing member or
through a clearing member of a clearing
agency/DCO operating pursuant to the
exemption in paragraph (a) above) such
cleared swaps customer positions under a
program to commingle and portfolio margin
CDS; and
(ii) The BD/FCM must enter into a nonconforming subordination agreement with
each cleared swaps customer. The agreement
must contain a specific acknowledgment by
the cleared swaps customer that such money,
securities or property will not receive
customer treatment under the Exchange Act
or SIPA or be treated as ‘‘customer property’’
as defined in 11 U.S.C. 741 in a liquidation
of the BD/FCM and that such money,
securities or property will be subject to any
applicable protections under Subchapter IV
of Chapter 7 of Title 11 of the United States
Code and rules and regulations thereunder;
as well as an affirmation by the cleared
swaps customer that claims to ‘‘customer
property’’ as defined in SIPA or 11 U.S.C.
741 against the BD/FCM will be subordinated
to the claims of securities customers and
security-based swap customers.
(2) With respect to affiliates of the BD/
FCM,
(i) The BD/FCM maintains money,
securities, and property of affiliates received
to margin, guarantee, or secure positions
consisting of cleared CDS, which include
both swaps and security-based swaps, in a
cleared swaps proprietary account for the
purpose of clearing (as a clearing member of
a clearing agency/DCO operating pursuant to
the exemption in paragraph (a) above) such
positions under a program to commingle and
portfolio margin CDS;
(ii) The BD/FCM enters into a nonconforming subordination agreement with
each affiliate. The agreement must contain a
specific acknowledgment by the affiliate that
such money, securities or property will not
receive customer treatment under the
Exchange Act or SIPA or be treated as
‘‘customer property’’ as defined in 11 U.S.C.
741 in a liquidation of the BD/FCM, and that
such money, securities or property will be
held in a proprietary account in accordance
with the CFTC requirements and will be
subject to any applicable protections under
Subchapter IV of Chapter 7 of Title 11 of the
United States Code and rules and regulations
thereunder; as well as an affirmation by the
affiliate that claims to ‘‘customer property’’
as defined in SIPA or 11 U.S.C. 741 against
the BD/FCM will be subordinated to the
claims of securities customers and securitybased swap customers; and
(iii) The BD/FCM obtains from the affiliate
an opinion of counsel that the affiliate is
legally authorized to subordinate all of its
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claims against the BD/FCM to those of
securities customers and security-based swap
customers.
(3) The BD/FCM has adopted an internal
risk management program that is reasonably
designed to identify, measure, and manage
the risks arising from its program to allow
cleared swaps customers and affiliates to
commingle and portfolio margin CDS that
has been approved in advance by the
Commission or the Commission staff and
meets the standards in section (c) below.
(4) The BD/FCM must be in compliance
with applicable laws and regulations relating
to risk management, capital, and liquidity,
and must be in compliance with applicable
clearing agency/DCO rules and CFTC
requirements (including segregation and
related books and records provisions) for
accounts established and maintained in
accordance with Section 4d(f) of the CEA and
rules thereunder (in the case of cleared swaps
customers) and for cleared swaps proprietary
accounts (in the case of affiliates), and
subject to a program to commingle and
portfolio margin CDS.
(5) Each cleared swaps customer and
affiliate of the BD/FCM participating in a
program to commingle and portfolio margin
CDS is an ‘‘eligible contract participant’’ as
defined in Section 1a(18) of the CEA.
(6) Before receiving any money, securities,
or property of a cleared swaps customer or
affiliate to margin, guarantee, or secure
positions consisting of cleared CDS, which
include both swaps and security-based
swaps, under a program to commingle and
portfolio margin CDS, the BD/FCM must
furnish to the cleared swaps customer or
affiliate a disclosure document containing
the following information:
(i) A statement indicating that the cleared
swaps customer’s or affiliate’s money,
securities, and property will be held in an
account maintained in accordance with the
segregation requirements of Section 4d(f) of
the CEA (in the case of a cleared swaps
customer) or a cleared swaps proprietary
account (in the case of an affiliate), and that
the cleared swaps customer or affiliate has
elected to seek protections under Subchapter
IV of Chapter 7 of Title 11 of the United
States Code and the rules and regulations
thereunder with respect to such money,
securities, and property; and
(ii) A statement that the broker-dealer
segregation requirements of Section 15(c)(3)
and Section 3E of the Exchange Act and the
rules thereunder, and any customer
protections under SIPA and the stockbroker
liquidation provisions, will not apply to such
cleared swaps customer or affiliate money,
securities, and property.
(c) Standards for internal risk management
program. The internal risk management
program required pursuant to condition (b)(3)
of this order must have the following
standards in place:
(1) Internal Risk Model. The BD/FCM must
calculate a future credit exposure for each
cleared swaps customer and affiliate (each a
‘‘counterparty’’) using its own proprietary
methodology (‘‘internal risk model’’) subject
to the following minimum quantitative and
qualitative model standards:
(i) Quantitative Requirements. (A) The
internal risk model must estimate a potential
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future exposure over a minimum 10-day
horizon and 99% confidence level and
capture all material risk factors, including
but not limited to general movements in
credit spread term structure, basis risk
between index and single name positions,
and interest rate risk;
(B) The internal risk model must include
a concentration/liquidity requirement; and
(C) The internal risk model must include
a jump-to-default requirement for the sale of
CDS protection equal to the largest loss of a
single name exposure assuming a
conservative recovery rate that may not
exceed 40%.
(ii) Qualitative Requirements. (A) The
internal risk model must be adequately
documented and the documentation must
provide a description of the model
assumptions, data inputs, parameters, and
methodologies employed to measure risk;
(B) The internal risk model must be subject
to an annual model review by a model group
that is independent of the business function;
(C) The internal risk model must be subject
to at least quarterly backtesting by
counterparty or account; and
(D) The BD/FCM must provide written
notice to the Commission or Commission
staff prior to implementing any material
change to its internal risk model.
(2) Minimum Risk Management System
Standards. (A) The BD/FCM must maintain
risk management system standards to
measure and manage risk exposure arising
from counterparties’ CDS portfolios that are
independent of any central counterparty
margin methodology;
(B) The BD/FCM must have an internal
credit risk rating model that assesses the
credit risk of each individual counterparty;
(C) The BD/FCM’s monitoring of credit risk
must include the prudent setting of an
exposure limit for each individual
counterparty and the exposure limit must be
reviewed if the counterparty’s credit risk
profile changes and at least quarterly;
(D) The BD/FCM must have the ability to
limit or reduce the exposure to a
counterparty through the collection of
additional margin;
(E) The BD/FCM must have documented
procedures to value positions conservatively
in view of current market prices and the
amount that might be realized upon
liquidation; and
(F) The BD/FCM must have well-defined
procedures and systems in place for the daily
collection and payment of initial and
variation margin.
(3) Monthly Reporting. The BD/FCM must
report to the Commission and FINRA staffs
on a monthly basis within 5 business days
after month end or as otherwise requested
details of its top 25 counterparties’ portfolios
as measured by net credit exposure as well
as the top 25 counterparties’ portfolios as
measured by gross notional amount.
[FR Doc. 2020–24612 Filed 11–4–20; 8:45 am]
BILLING CODE 8011–01–P
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]]>Agencies
[Federal Register Volume 85, Number 215 (Thursday, November 5, 2020)]
[Notices]
[Pages 70657-70666]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-24612]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-90276; File No. S7-13-12]
Proposed Order Granting Conditional Exemptions Under the
Securities Exchange Act of 1934 in Connection With the Portfolio
Margining of Swaps and Security-Based Swaps That Are Credit Default
Swaps
October 28, 2020.
AGENCY: Securities and Exchange Commission (``SEC'' or ``Commission'')
ACTION: Notice of proposed exemptive order; request for comment.
-----------------------------------------------------------------------
SUMMARY: The Commission is proposing to grant exemptive relief, subject
to certain conditions, from compliance with certain provisions of the
Securities Exchange Act of 1934 in connection with a program to
portfolio margin cleared swaps customer and affiliate positions in
cleared credit default swaps that are swaps and security-based swaps in
a segregated account established and maintained in accordance with
Section 4d(f) of the Commodity Exchange Act (in the case of a cleared
swaps customer) or a cleared swaps proprietary account (in the case of
an affiliate). This proposed exemptive relief would supersede and
replace the Commission's Order Granting Conditional Exemptions under
the Securities Exchange Act of 1934 in Connection with Portfolio
Margining of Swaps and Security-based Swaps issued in December 2012.
DATES: Comments must be received on or before December 7, 2020.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's internet comment form (https://www.sec.gov/rules/other.shtml); or
Send an email to [email protected]. Please include
File Number S7-13-12 on the subject line.
Paper Comments
Send paper comments to Secretary, Securities and Exchange
Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number S7-13-12. This file number
should be included on the subject line if email is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
internet website (https://www.sec/gov/rules/other.shtml). Comments are
also available for website viewing and printing in the Commission's
Public Reference Room, 100 F Street, NE, Washington DC 20549, on
official business days between the hours of 10:00 a.m. and 3:00 p.m.
All comments received will be posted without change. Persons
submitting comments are cautioned that the Commission does not redact
or edit personal identifying information from comment submissions.
Commenters should submit only information that they wish to make
available publicly.
FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate
Director, at (202) 551-5525; Thomas K. McGowan, Associate Director, at
(202) 551-5521; Randall W. Roy, Deputy Associate Director, at (202)
551-5522;
[[Page 70658]]
Raymond Lombardo, Assistant Director, at 202-551-5755; or Sheila Dombal
Swartz, Senior Special Counsel, at (202) 551-5545, Division of Trading
and Markets, Securities and Exchange Commission, 100 F Street NE,
Washington, DC 20549-7010.
SUPPLEMENTARY INFORMATION:
I. Introduction
The Commission is proposing to issue an order granting conditional
exemptive relief to SEC-registered clearing agencies also registered
with the Commodity Futures Trading Commission (``CFTC'') as derivative
clearing organizations (``clearing agency/DCOs'') and SEC-registered
broker-dealers also registered with the CFTC as futures commission
merchants (``BD/FCMs''). The proposed order would exempt these entities
from compliance with certain provisions of the Securities Exchange Act
of 1934 (``Exchange Act'') in connection with a program to portfolio
margin cleared swaps customer and affiliate positions in cleared
security-based swaps and swaps that are credit default swaps (``CDS'')
in a segregated account established and maintained in accordance with
Section 4d(f) of the Commodity Exchange Act (``CEA'') in the case of a
cleared swaps customer (``CFTC cleared swaps customer account'') or a
cleared swaps proprietary account in the case of an affiliate (``CFTC
cleared swaps proprietary account'') (each a ``CFTC cleared swaps
account''), and to calculate margin requirements on a portfolio
basis.\1\
---------------------------------------------------------------------------
\1\ The text of the proposed order is set forth in an appendix
to this release and cited herein as the ``Proposed Order.''
---------------------------------------------------------------------------
The proposed order would supersede and replace the Commission's
December 2012 order providing similar relief (``2012 Order''), and
modify certain of its conditions, as discussed in more detail below.\2\
In particular, it would eliminate conditions (a)(1) and (a)(2) in the
2012 Order pertaining to the exemptions for clearing agency/DCOs.\3\
The requirements to adhere to these conditions are triggered on the
compliance date for the final capital, margin, and segregation
requirements for SBSDs: October 6, 2021. The Commission is seeking
comment at this time on whether these and other conditions in the 2012
Order should be modified to provide time to consider comments and, if
appropriate, issue a new order in advance of conditions (a)(1) and
(a)(2) in the 2012 Order being triggered.
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\2\ Order Granting Conditional Exemptions under the Securities
Exchange Act of 1934 in Connection with Portfolio Margining of Swaps
and Security-based Swaps, Exchange Act Release No. 68433 (Dec. 12,
2012) 77 FR 75211 (Dec. 19, 2012).
\3\ See 2012 Order, 77 FR at 75219-20.
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Conditions (a)(1) and (a)(2) in the 2012 Order are intended to
provide an option for security-based swap customers to portfolio margin
cleared security-based swaps and swaps that are CDS (``cleared CDS'')
in a security-based swap account in accordance with Section 3E of the
Exchange Act (``SEC SBS account'') as an alternative to a CFTC cleared
swaps account.\4\ The proposed order also would modify the conditions
in paragraphs (b)(1)(ii) and (2)(ii) requiring subordination agreements
to provide greater clarity that the scope of the subordination does not
extend to the claims of general creditors. In addition, the proposed
order would eliminate condition (b)(3) in the 2012 Order, which
requires approval of a BD/FCM's margin methodology by the Commission or
Commission staff. Instead, as a condition of the proposed order, a BD/
FCM would need to have an internal risk management program that has
been approved in advance by the Commission or the Commission staff.
Further, as a condition of the proposed order, the internal risk
management program would need to have certain standards drawn from the
letters the staff of the Division of Trading and Markets (``Division
staff'') issued to BD/FCMs to approve their margin methodologies.\5\
These staff letters would be withdrawn and the proposed order would
provide that any BD/FCM that received a staff letter approving its
margin methodology prior to the issuance of the order would be deemed
to have an approved internal risk management program for the purposes
of the proposed order.
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\4\ The Commission has adopted capital, margin, and segregation
requirements under the Exchange Act for security-based swaps dealers
(``SBSDs''). See Capital, Margin, and Segregation Requirements for
Security-Based Swap Dealers and Major Security-Based Swap
Participants and Capital and Segregation Requirements for Broker-
Dealers, Exchange Act Release No. 86175 (June 21, 2019), 84 FR
43872, 43956-57 (Aug. 22, 2019) (``Capital, Margin, and Segregation
Adopting Release'').
\5\ The staff letters are available at https://www.sec.gov/rules/exorders/exordersarchive/exorders2012.shtml.
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II. Background
A. 2012 Order
On December 14, 2012, in response to a request from ICE Clear
Credit LLC,\6\ the Commission issued the 2012 Order to provide relief
so that clearing agency/DCOs and BD/FCMs could offer customers
portfolio margining of cleared CDS in a CFTC cleared swaps account
(``CDS portfolio margin program'').\7\ The 2012 Order exempts a
clearing agency/DCO from Sections 3E(b), 3E(d) and 3E(e) of the
Exchange Act and any rules thereunder, solely to perform the functions
of a clearing agency/DCO under the CDS portfolio margin program,
subject to five conditions.\8\ It further exempts a BD/FCM from
Sections 3E(b), 3E(d), 3E(e), and 15(c)(3) of the Exchange Act, and
Rule 15c3-3, as well as from any requirement to treat an affiliate (as
defined in association with the ``cleared swaps proprietary account''
definition in CFTC Rule 22.1) as a customer for purposes of Rules 8c-1
and 15c2-1, subject to six conditions.\9\ The conditions applicable to
clearing agency/DCOs and BD/FCMs are designed to: (1) Protect money,
securities, and property of security-based swap customers; (2) address
certain differences in the statutory requirements of the Exchange Act
and the CEA; and (3) promote appropriate risk management and
disclosure.\10\ The 2012 Order also sought comment on all aspects of
the exemptions it provided.\11\
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\6\ ICE Clear Credit formally petitioned the Commission to grant
exemptive relief from the application of Section 15(c)(3) of the
Exchange Act, Rule 15c3-3 and, related rules under the Exchange Act.
See Letter from Michael M. Phillip, Partner, Winston & Strawn LLP
(Nov. 7, 2011) (the petition 4-641 and comments received on the
petition are available at https://www.sec.gov/rules/petitions.shtml).
\7\ The CFTC also issued a companion exemptive order on January
13, 2013 permitting ICE Clear Credit and its BD/FCM clearing members
to provide for the portfolio margining of cleared swaps and
security-based swaps that are CDS. See CFTC, Order, Treatment of
Funds Held in Connection with Clearing by ICE Clear Credit of Credit
Default Swaps (Jan. 13, 2013)(``2013 CFTC Portfolio Margin Order''),
available at https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/icecreditclearorder011413.pdf. See
also CFTC, Order, Treatment of Funds Held in Connection with
Clearing by ICE Clear Europe of Credit Default Swaps (Apr. 9, 2013),
available at https://www.cftc.gov/sites/default/files/stellent/groups/public/@requestsandactions/documents/ifdocs/icecleareurope4dfcds040913.pdf.
\8\ See Capital, Margin, and Segregation Adopting Release, 84 FR
at 43954; Cross-Border Application of Certain Security-Based Swap
Requirements, Exchange Act Release No. 87780 (Dec. 18, 2019), 85 FR
6270 (Feb. 4, 2020).
\9\ See 2012 Order, 77 FR at 75213-14 (discussing these sections
of the Exchange Act and the rules), 75216-19 (discussing the
conditions), and 75220-21 (setting forth the conditions). See also
Order Extending Temporary Exemptions from Exchange Act Section 8 and
Exchange Act Rules 8c-1, 10b-16, 15a-1, 15c2-1 and 15c2-5 in
Connection with the Revision of the Definition of ``Security'' to
Encompass Security-Based Swaps, Exchange Act Release No. 87943 (Jan.
10, 2020), 85 FR 2763 (Jan. 16, 2020) (providing a temporary
exemption from certain rules including Rules 8c-1 and 15c-1 in
connection with the revision of the Exchange Act definition of
``security'' to encompass security-based swaps until Nov. 5, 2020).
\10\ See 2012 Order, 77 FR at 75214.
\11\ 77 FR at 75219. Letters responding to this request for
comment are available at https://www.sec.gov/comments/s7-13-12/s71312.shtml.
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[[Page 70659]]
B. Division Staff Letters
On March 8, 2013, the Division staff issued temporary conditional
approval letters to seven BD/FCMs pursuant to condition (b)(3) in the
2012 Order \12\ permitting them to participate in the CDS portfolio
margin program, subject to certain conditions (the ``March 8, 2013
letters'').\13\ The conditions included a requirement to collect
initial margin based on a multiplier of the clearing agency/DCO margin
requirement or to take a 100% capital charge for the difference.
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\12\ See Proposed Order, ] (b)(3) (providing that BD/FCM must
require minimum margin levels with respect to any customer
transaction in a program to commingle and portfolio margin CDS at
least equal to the amount determined using a margin methodology
established and maintained by the BD/FCM that has been approved by
the Commission or the Commission staff).
\13\ The March 8, 2013 letters and other staff letters to the
BD/FCMs discussed below are available at: https://www.sec.gov/rules/exorders/exordersarchive/exorders2012.shtml. The temporary staff
letters were responsive to a comment raising concerns about the
first CFTC compliance date for mandatory swaps clearing (March 13,
2013). See Letter from Stuart J. Kaswell, Executive Vice President &
Managing Director, Managed Funds Association (Feb. 11, 2013) (``MFA
2/11/13 Letter'') (comment to the 2012 Order), available at https://www.sec.gov/comments/s7-13-12/s71312.shtml.
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On June 7, 2013, the Division staff issued updated temporary
conditional letters to the seven BD/FCMs that received the March 8,
2013 letters, and to one additional BD/FCM, setting forth revised
conditions for participation in the CDS portfolio margin program (``the
June 7, 2013 letters''). The June 7, 2013 letters required the BD/FCMs
to implement a required margin regime and establish minimum risk
management standards by December 7, 2013. On December 6, 2013, the
Division staff issued letters to the BD/FCMs extending the December 7,
2013 date to January 31, 2014. On January 31, 2014, the Division staff
issued letters to the eight BD/FCMs permanently approving their margin
methodologies, subject to the conditions in the June 7, 2013 letters
(``January 31, 2014 letters''). Subsequent to the issuance of the
January 31, 2014 letters, the Division staff approved the margin
methodologies of two additional BD/FCMs, subject to the conditions in
the June 7, 2013 letters.\14\
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\14\ The Division staff also issued an additional letter
relating to the transfer of a CDS portfolio margin program using the
same internal risk model and same internal risk management system
from one broker-dealer affiliate to another. The June 7, 2013
letters and subsequent staff letters are collectively referred to
below as the ``BD/FCM staff letters.''
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III. Discussion of Proposed Relief
Since the issuance of the 2012 Order, the SEC staff has monitored
the operations of the BD/FCMs participating in the CDS portfolio margin
program as well as the market for cleared CDS. The Commission believes
it may be appropriate to issue a new portfolio margin order with
modified conditions in light of: (1) The experience gained from this
monitoring; and (2) comment letters addressing portfolio margining
received in response to the 2012 Order and in the context of the SEC's
recently finalized rulemaking adopting capital, margin and segregation
requirements for security-based swap dealers (``SBSDs'').\15\ A
modified order also may be appropriate because the CFTC has initiated
the mandatory clearing of certain swaps, including broad-based index
CDS.\16\ The following discussion describes the conditions of the
proposed order--many of which would be largely consistent with
conditions in the 2012 Order. Proposed modifications to the conditions
in the 2012 Order are noted and discussed.
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\15\ The comment letters received with respect to this
rulemaking are available at https://www.sec.gov/comments/s7-08-12/s70812.shtml.
\16\ See, e.g., CFTC Announces that Mandatory Clearing Begins
Today, CFTC Press Release No. 6529-13 (Mar. 11, 2013) (announcing
that swap dealers, major swap participants and private funds active
in the swaps market are required to begin clearing certain index
CDS); CFTC Announces that Mandatory Clearing for Category 2 Entities
Begins Today, CFTC Press Release No. 6607-13 (June 13, 2013)
(announcing the second phase of required clearing for certain CDS
and interest rate swaps).
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A. Conditions for Clearing Agency/DCOs
1. Elimination of Conditions Relating to Expanding the CDS Portfolio
Margin Program to Securities Accounts
The conditions in paragraphs (a)(1) and (a)(2) of the 2012 Order
are intended to provide customers the option to portfolio margin
cleared CDS in an SEC SBS account once the SEC's margin and segregation
rules for SBSDs are in place.\17\ In particular, paragraph (a)(1)
requires that the clearing agency/DCO, by the later of six months after
the adoption date of the final margin and segregation rules for
security-based swaps or the compliance date of such rules, to take all
necessary action within its control to obtain any relief needed to
permit its BD/FCM clearing members to maintain customer money,
securities, and property received by the BD/FCM to margin, guarantee,
or secure customer positions in cleared CDS in an SEC SBS account for
the purpose of the CDS portfolio margin program. Paragraph (a)(2)
requires the clearing agency/DCO, within the same timeframe, to take
all necessary action within its control, to establish rules and
operational practices to permit its BD/FCM clearing members to maintain
customer money, securities, and property received by the BD/FCM to
margin, guarantee, or secure customer positions in cleared CDS in an
SEC SBS account for the purpose of the CDS portfolio margin program.
Thus, the requirements to adhere to conditions in paragraphs (a)(1) and
(2) of the 2012 Order are triggered on the compliance date for the
final capital, margin, and segregation requirements for SBSDs: October
6, 2021.
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\17\ See 2012 Order, 77 FR at 75215-16 (discussing the
conditions) and 75219-20 (setting forth the conditions).
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In the 2012 Order, the Commission stated that it was important to
ultimately provide market participants with the ability to select an
account structure to manage their individual risks by taking into
account the different regulatory provisions that may apply to different
account types and any costs incurred.\18\ Market participants have been
clearing CDS under the CDS portfolio margin program since the initial
BD/FCM staff letters were issued in 2013. The CDS portfolio margining
program has allowed greater efficiencies in clearing, allowing the
offset of positions and the ability to margin cleared CDS in a single
account. Portfolio margining facilitates margin requirements that
better reflect the overall risks presented by a CDS portfolio, which
may result in decreased margin costs. Because of these greater
efficiencies and potential cost reductions available under the current
CDS portfolio margin program in a CFTC cleared swaps account, market
participants have not expressed a desire to portfolio margin cleared
CDS in an SEC SBS account. This lack of market interest in a securities
account alternative also is consistent with: (1) The comments of ICE
Clear Credit in 2011 that it received no indication in its discussions
with market participants that they desired a securities account option
with respect to its petition for rulemaking to portfolio margin cleared
CDS; and (2) the Division staff's experience in monitoring the CDS
portfolio margin program.\19\
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\18\ See 2012 Order, 77 FR at 75216.
\19\ See Letter from Christopher S. Edmonds, President, ICE
Clear Credit LLC (Dec. 22, 2011) (``ICE Letter'') (comment to the
ICE Clear Credit petition for rulemaking 4-641 (Nov. 7, 2011)),
available at https://www.sec.gov/comments/4-641/4-641.shtml.
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While portfolio margining cleared CDS in an SEC SBS account also
would provide greater efficiencies and cost reductions, given the
success of the current CDS portfolio margin program
[[Page 70660]]
and the lack of market interest in a securities account alternative,
the Commission preliminarily believes that it may be appropriate to
eliminate these conditions. Removing them would avoid potentially
unnecessary costs \20\ to clearing agency/DCOs to implement systems and
processes to accommodate SEC SBS accounts that may never be utilized.
Moreover, their removal would not prohibit a clearing agency/DCO from
offering an SEC SBS account option in the future, if market conditions
change and the demand arises, subject to applicable regulatory
approvals and relief.
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\20\ These costs may involve changes to trade processing systems
(to designate account type), risk management processes (to capture
and relate positions and margin held in multiple account types), and
to treasury and banking processes, systems, and accounts. See, e.g.,
ICE Letter.
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2. Proposed Conditions
The three clearing agency/DCO conditions in the proposed order are
largely consistent with the conditions in paragraphs (a)(3), (4), and
(5) of the 2012 Order, respectively.\21\ The first condition would
require the clearing agency/DCO to obtain any other relief needed to
permit a BD/FCM to maintain cleared swaps customer or affiliate money,
securities, and property received to margin, guarantee, or secure
cleared swaps customer or affiliate positions in cleared CDS in a CFTC
cleared swaps customer account or a CFTC cleared swaps proprietary
account, respectively, for the purpose of clearing such cleared swaps
customer or affiliate positions under the CDS portfolio margin
program.\22\ This condition is designed to help ensure that the
exemption would apply only in circumstances where the regulatory
framework under the CEA and the CFTC's rules is applicable.
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\21\ See 2012 Order, 77 FR at 75216 (discussing the conditions)
and 75220 (setting forth the conditions); Proposed Order, ]] (a)(1),
(2), and (3). The Commission made some technical changes to the DCO/
clearing agency conditions in the proposed order to account for the
elimination of conditions (a)(1) and (2) from the 2012 Order. These
proposed changes include re-numbering the remaining clearing agency/
DCO conditions and moving the definition of ``BD/FCM'' from
condition (a)(1) in the 2012 Order (which would be eliminated) to
condition (a)(1) in the proposed order (which parallels condition
(a)(3) in the 2012 Order). Finally, the Commission is proposing to
replace the term ``shall'' in two places with the term ``will'' and
``must,'' respectively.
\22\ See Proposed Order, ] (a)(1). The proposed order also would
eliminate use of the generic term ``customer'' in the 2012 Order and
instead use the more specific terms ``cleared swaps customer,''
``affiliate,'' ``security-based swap customer,'' and ``securities
customer''. In addition, the proposed order would add specific
language to clarify that cleared CDS positions of cleared swaps
customers are held in CFTC cleared swaps customer accounts and
affiliate positions are held in CFTC cleared swaps proprietary
accounts. These proposed changes reflect the different treatment
each type of person and account would receive under the CEA and
rules thereunder, and applicable bankruptcy laws.
---------------------------------------------------------------------------
The second clearing agency/DCO condition would require the
organization to have appropriate rules and operational practices to
permit a BD/FCM to maintain cleared swaps customer or affiliate money,
securities, and property received to margin, guarantee, or secure
cleared swaps customer or affiliate positions in cleared CDS in a CFTC
cleared swaps customer account or a cleared swaps proprietary account,
respectively, for the purpose of clearing such cleared swaps customer
or affiliate positions under the CDS portfolio margin program.\23\ This
condition also is designed to help ensure the exemption would apply
only in circumstances where the regulatory framework under the CEA and
the CFTC's rules is applicable. The third clearing agency/DCO condition
would require the organization to have rules mandating that each
cleared swaps customer and affiliate of the BD/FCM participating in the
CDS portfolio margin program must be an ``eligible contract
participant'' as defined in Section 1a(18) of the CEA.\24\ Given that
Congress determined it is appropriate to include these limitations in
the Dodd-Frank Act with respect to eligible contract participants, the
Commission preliminarily believes it is appropriate to limit the
exemptions in this proposed order to cleared CDS entered into with
eligible contract participants.\25\
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\23\ See Proposed Order, ] (a)(2). See also supra note 22.
\24\ See Proposed Order, ] (a)(3). The 2012 order provided that
each ``customer'' must be an eligible contract participant. 77 FR
75220. See also supra note 22.
\25\ The Dodd-Frank Act limits the swaps and security-based
swaps transactions that may be entered into by parties that are not
eligible contract participants. For example, under Section 6(l) of
the Exchange Act, only an eligible contract participant may enter
into security-based swaps that are not effected on a national
securities exchange. 15 U.S.C. 78f(l). In addition, security-based
swaps that are not registered pursuant to the Securities Act of 1933
(``Securities Act'') can only be sold to eligible contract
participants. 15 U.S.C. 77e(e). Section 5(e) of the Securities Act
specifically provides that it shall be unlawful to for any person,
directly or indirectly, to make use of any means or instruments of
transportation or communication in interstate commerce or of the
mails to offer to sell, offer to buy or purchase or sell a security-
based swap to any person who is not an eligible contract
participant, unless the transaction is registered under the
Securities Act. Id.
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B. Conditions for BD/FCMs
The first, second, fourth, fifth, and sixth BD/FCM conditions in
the proposed order are largely consistent with the conditions in
paragraphs (b)(1), (2), (4), (5) and (6) of the 2012 Order,
respectively.\26\ The first BD/FCM condition would consist of two
requirements and apply with respect to transactions involving persons
that are not affiliates of the BD/FCM (i.e., cleared swaps
customers).\27\ Under the first requirement, the BD/FCM would need to
maintain cleared swaps customer money, securities, and property
received to margin, guarantee or secure cleared swaps customer
positions consisting of cleared CDS in a CFTC cleared swaps customer
account established and maintained for the purpose of the CDS portfolio
margin program.\28\ This condition is designed to help ensure that--in
the absence of the security-based swap and securities customer
protections afforded by the securities laws--collateral in the account
is subject to the protections afforded by an alternative regulatory
scheme (i.e., the CEA and the CFTC's rules). The intent is to avoid
having the assets in the account fall into a regulatory gap in which
neither the federal securities laws nor the federal commodity futures
laws apply. The condition also is designed to limit the relief to
accounts that are established and maintained specifically for the
purpose of the CDS portfolio margin program.
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\26\ See 2012 Order, 77 FR at 75216-19 (discussing the
conditions) and 75220-21 (setting forth the conditions); Proposed
Order, ]] (b)(1), (2), (4), (5), and (6). The Commission made some
technical and stylistic changes to these conditions, including
replacing the term ``shall'' with ``must'' and capitalizing the
first letter in each of the conditions (and their subparagraphs).
Finally, the Commission inserted the phrase ``Section 8 of the
Exchange Act and'' before ``Exchange Act Rules 8c-1 and 15c2-1'' in
paragraph (b) of the proposed order to be consistent with the other
rule references in the order, which refer to the relevant statute.
See Proposed Order, ] (b).
\27\ See Proposed Order, ] (b)(1).
\28\ See Proposed Order, ] (b)(1)(i). See also supra note 22
(discussing proposed change from the use of the generic term
``customer'' in the 2012 Order to ``cleared swaps customer'' in the
proposed order).
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Under the second requirement, the BD/FCM would need to enter into a
non-conforming subordination agreement with each non-affiliated cleared
swaps customer that covers the customer's money, securities, or
property held in a segregated account.\29\ The non-conforming
subordination agreement would need to contain: (1) A specific
acknowledgment by the cleared swaps customer that such money,
securities or property will not receive customer treatment under the
Exchange Act or Securities Investor Protection Act of 1970 (``SIPA'')
or be treated as ``customer property'' as defined in 11 U.S.C. 741 in a
liquidation of the BD/
[[Page 70661]]
FCM (``stockbroker liquidation''), and that such money, securities or
property will be subject to any applicable protections under Subchapter
IV of Chapter 7 of Title 11 of the United States Code and rules and
regulations thereunder (``commodity broker liquidation provisions'');
and (2) an affirmation by the cleared swaps customer that claims to
``customer property'' as defined in SIPA or 11 U.S.C. 741 against the
BD/FCM will be subordinated to the claims of securities customers and
security-based swap customers.
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\29\ See condition (b)(1)(ii) of 2012 Order.
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The 2012 Order required an affirmation by the customer that all of
its claims with respect to such money, securities, or property against
the BD/FCM will be subordinated to the claims of other securities
customers and security-based swap customers not participating in the
CDS portfolio margin program.\30\ To better clarify that the cleared
swaps customer is not subordinating claims to general creditors, the
Commission is proposing to modify condition (b)(1)(ii) of the 2012
Order, as stated above, to provide that the cleared swaps customer must
affirm that claims to ``customer property'' as defined in SIPA or the
stockbroker liquidation provisions against the BD/FCM will be
subordinated to the claims of securities customers and security-based
swap customers. This modification is designed to more narrowly tailor
the subordination to the portion of the debtor BD/FCM's estate that
comprises ``customer property'' under SIPA and the stockbroker
liquidation schemes.\31\
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\30\ See 2012 Order, 77 FR at 75220.
\31\ See supra note 22.
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This proposed condition is designed to remove portfolio margin
cleared swaps customers from the definitions of ``customer'' under Rule
15c3-3, SIPA, and the stockbroker liquidation provisions with respect
to securities or cash held in CFTC cleared swaps accounts that
otherwise would be subject to the segregation requirements of Rule
15c3-3 and the bankruptcy protections afforded by SIPA and the
stockbroker liquidation provisions. The objective is to avoid a
situation where the portfolio margin cleared swaps customers would be
entitled to a ratable share of ``customer property'' and other
protections afforded by SIPA or the stockbroker liquidation provisions
even though their assets were held in CFTC cleared swaps customer
accounts that were not subject to the segregation requirements of Rule
15c3-3. Assets held in a CFTC cleared swaps customer account would
instead be afforded the protections of the rules of the CFTC governing
the treatment of customer margin held by BD/FCMS and DCOs as well as
the protections of the CEA and commodity broker liquidation provisions.
The proposed condition is not intended to undermine these protections.
The proposed condition also is not intended to require portfolio
margin cleared swaps customers to subordinate their claims, in the
event that their claims as cleared swaps customers are not fully
satisfied by the distribution of assets held in CFTC cleared swaps
customer accounts, to assets that may be included in the debtor's
general estate. In summary, this condition, along with the proposed
disclosure conditions discussed below, is intended to help ensure that
cleared swaps customers clearly understand that any security-based swap
or securities customer protection treatment otherwise available with
respect to securities transactions under the Exchange Act, SIPA, or the
stockbroker liquidation provisions will not be available for cleared
CDS held in a CFTC cleared swaps customer account.
The second BD/FCM condition in the proposed order would apply with
respect to transactions involving affiliates of the BD/FCM and would
consist of three requirements.\32\ Under the first requirement, the BD/
FCM would need to maintain money, securities, and property of
affiliates received to margin, guarantee, or secure positions
consisting of cleared CDS in a ``cleared swaps proprietary account'' as
defined in CFTC Rule 22.1 for the purpose of clearing such positions
under the CDS portfolio margin program.\33\ The purpose of this
requirement is that under the CFTC regulatory framework certain
affiliates are not treated as cleared swaps customers and their assets
are held in proprietary accounts as distinct from CFTC cleared swaps
customer accounts.\34\
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\32\ See Proposed Order, ] (b)(2).
\33\ See Proposed Order, ] (b)(2)(i).
\34\ See 17 CFR 22.1. The Commission preliminarily believes that
this condition is appropriate because affiliates of a BD/FCM that
are not otherwise excluded from the definition of ``customer'' in
Exchange Act Rules 8c-1 and 15c2-1 are customers whose securities
positions cannot be commingled with the broker-dealer's own
proprietary securities positions and therefore could not be held in
a cleared swaps account.
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Under the second requirement, the BD/FCM would need to enter into a
non-conforming subordination agreement with an affiliate.\35\ The non-
conforming subordination agreement would need to contain: (1) A
specific acknowledgment by the affiliate that such money, securities or
property will not receive customer treatment under the Exchange Act or
SIPA or be treated as customer property in a stockbroker liquidation of
the BD/FCM, and that such money, securities or property will be held in
a proprietary account in accordance with the CFTC requirements and will
be subject to any applicable protections under the commodity broker
liquidation provisions; and (2) an affirmation by the affiliate that
claims to ``customer property'' as defined in SIPA or 11 U.S.C. 741
against the BD/FCM will be subordinated to the claims of securities
customers and security-based swap customers.
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\35\ See Proposed Order, ] (b)(2)(ii).
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For the reasons discussed above, the Commission is proposing to
modify the text of the affirmation by an affiliate from the 2012 Order
to more narrowly tailor the subordination to the portion of the debtor
BD/FCM's estate that comprises ``customer property'' under SIPA and the
stockbroker liquidation schemes.\36\ This requirement is designed to
help ensure that affiliates clearly understand that any customer
protection treatment otherwise available with respect to securities
transactions under the Exchange Act, SIPA, or the stockbroker
liquidation provisions will not be available and the account would be
treated as a proprietary account (and not a CFTC cleared swaps customer
account) under the CEA. Consistent with the proposed condition above
with respect to cleared swaps customers that are not affiliates, this
condition is intended to remove affiliates from the definitions of
``customer'' under Rule 15c3-3, SIPA, and the stockbroker liquidation
provisions with respect to securities or cash held in cleared swaps
proprietary accounts that otherwise would be subject to the segregation
requirements of Rule 15c3-3 and the bankruptcy protections afforded by
SIPA and the stockbroker liquidation provisions.
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\36\ See Proposed Order, ] (b)(2)(ii). The 2012 Order required
an affirmation by the affiliate that all of its claims with respect
to such money, securities, or property against the BD/FCM will be
subordinated to the claims of other securities customers and
security-based swap customers not operating under a program to
commingle and portfolio margin CDS. 77 FR at 75220. See also supra
note 22. The modification would require the affiliate to affirm that
that all of its claims to ``customer property'' as defined in SIPA
or 11 U.S.C. 741 against the BD/FCM will be subordinated to the
claims of securities customers and security-based swap customers.
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Under the third requirement, the BD/FCM would need to obtain from
the affiliate an opinion of counsel that the affiliate is legally
authorized to subordinate all of its claims against the
[[Page 70662]]
BD/FCM to those of securities customers and security-based swap
customers.\37\ This condition is designed to help ensure that
affiliates of the BD/FCM do not place any assets in the proprietary
account that the affiliate is not legally authorized to subordinate.
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\37\ See Proposed Order, ] (b)(2)(iii). The 2012 Order required
that the BD/FCM obtain from the affiliate an opinion of counsel that
the affiliate is legally authorized to subordinate all of its claims
against the BD/FCM to those of customers. 77 FR at 75220. See also
supra note 22.
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The condition in paragraph (b)(3) of the 2012 Order provides that
the BD/FCM must require minimum margin levels with respect to any
customer transaction in the CDS portfolio margin program at least equal
to the amount determined using a margin methodology established and
maintained by the BD/FCM that has been approved by the Commission or
the Commission staff.\38\ A commenter responding to the issuance of the
2012 Order supported the requirement for a BD/FCM to assess the credit
risk of counterparties based on the BD/FCM's own risk management
standards, but argued that requiring a unique margin model beyond the
BD/FCM's own credit risk assessment is unwarranted.\39\ This commenter
also stated that this condition ``deters'' efficiency, capital
formation, and competition.\40\ Another commenter responding to the
issuance of the 2012 Order argued that the condition undermines a
fundamental benefit of central clearing: the ability of market
participants to rely on clearing agency/DCO margin requirements.\41\
This commenter believes that this condition reduces transparency and
the ability to anticipate and verify margin calls, and that it
discourages entities from entering the cleared CDS market.\42\
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\38\ See condition (b)(3) of 2012 Order.
\39\ See Letter from Stuart J. Kaswell, Executive Vice President
& Managing Director, General Counsel, Managed Funds Association;
Carl B. Wilkerson, Vice President & Chief Counsel, Securities &
Litigation, American Council of Life Insurers; and
Ji[rcaron][iacute] Krol, Director of Government and Regulatory
Affairs, Alternative Investment Management Association (Dec. 27,
2013) (``MFA/ACLI/AIMA 12/27/2013 Letter'') (comment to the 2012
Order), available at https://www.sec.gov/comments/s7-13-12/s71312.shtml; see also Letter from Stuart J. Kaswell, Executive Vice
President & Managing Director, General Counsel, Managed Funds
Association; Carl B. Wilkerson, Vice President & Chief Counsel,
Securities & Litigation, American Council of Life Insurers; and
Ji[rcaron][iacute] Krol, Director of Government and Regulatory
Affairs, Alternative Investment Management Association (May 10,
2013) (comment to the 2012 Order), available at https://www.sec.gov/comments/s7-13-12/s71312.shtml.
\40\ MFA/ACLI/AIMA 12/27/2013 Letter.
\41\ See Letter from Adam C. Cooper, Senior Managing Director
and Chief Legal Officer, Citadel LLC (Feb. 2, 2016) (``Citadel 2/2/
16 Letter'') (comment to the 2012 Order), available at https://www.sec.gov/comments/s7-13-12/s71312.shtml.
\42\ Citadel 2/2/16 Letter; Letter from Laura Harper Powell,
Associate General Counsel, Managed Funds Association, and Adam
Jacobs-Dean, Managing Director, Global Head of Markets Regulation,
Alternative Investment Management Association (Nov. 19, 2018)
(comment to the Commission's capital, margin, and segregation
rulemaking for SBSDs), available at https://www.sec.gov/comments/s7-08-12/s70812.shtml.
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In the context of the SEC's capital, margin and segregation
rulemaking for SBSDs, another commenter expressed concern that the
conditions in the 2012 Order have proven too restrictive to support a
robust market for cleared CDS.\43\ More specifically, this commenter
recommended that both the CFTC and SEC recognize a harmonized portfolio
margin approach for cleared CDS that defers to the clearing agency/DCO
margin methodologies.\44\ Finally, a commenter expressed concern that
the margin requirements imposed by the Commission have delayed
voluntary buy-side clearing of single-name CDS, with resulting adverse
effects on trading volume and liquidity.\45\
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\43\ See Letter from Walt L. Lukken, President and Chief
Executive Office, Futures Industry Association (Nov. 29, 2018)
(``FIA 11/29/18 Letter'') (comment to the Commission's capital,
margin, and segregation rulemaking for SBSDs), available at https://www.sec.gov/comments/s7-08-12/s70812.shtml.
\44\ Letter from Walt L. Lukken, President and Chief Executive
Office, Futures Industry Association (Nov. 19, 2018) (comment to the
Commission's capital, margin, and segregation rulemaking for SBSDs),
available at https://www.sec.gov/comments/s7-08-12/s70812.shtml; FIA
11/29/18 Letter.
\45\ See Letter from Stuart J. Kaswell, Executive Vice President
& Managing Director, General Counsel, Managed Funds Association (May
18, 2017) (comment to the Commission's capital, margin, and
segregation rulemaking for SBSDs), available at https://www.sec.gov/comments/s7-08-12/s70812.shtml.
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The vast majority of the BD/FCM clearing members of ICE Clear
Credit have obtained approval of their margin methodologies from
Commission staff.\46\ Furthermore, each BD/FCM that has received
approval of its margin methodology already had existing margin models
in place prior to applying to the Commission. Therefore, the firms
needed to make some adjustments to their models in order to meet the
minimum qualitative and quantitative standards set forth in the BD/FCM
staff letters, but did not need to develop new margin models. To date,
all BD/FCMs that have submitted applications to Commission staff to
approve their internal margin methodologies have received approval.
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\46\ See ICC membership, available at https://www.theice.com/clear-credit/participants. Based on Division staff experience in
monitoring the CDS portfolio margin program, the vast majority of
positions are being cleared through ICE Clear Credit, and to a
lesser extent, ICE Clear Europe.
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The Commission preliminarily believes that it would not be prudent
for a BD/FCM to simply defer to the margin methodology of the clearing
agency/DCO in terms of measuring and managing the risk of cleared CDS
in a portfolio margin account, as requested by commenters. Prudent
firms establish and maintain integrated internal risk management
programs that include management policies and procedures designed to
help ensure an awareness of, and accountability for, the risks taken
throughout the firm and to develop tools to address those risks. For
example, there may be idiosyncratic risk factors with respect to a
cleared swaps customer, an affiliate, or the BD/FCM's financial
condition that are not covered by the margin methodology of the
clearing agency/DCO.
At the same time, the Commission also preliminarily believes that
it can promote the prudent operation of the BD/FCMs through a process
of approving their internal risk management programs (rather than their
internal margin methodologies), as discussed below. This may increase
transparency for market participants in terms of being able to
anticipate margin requirements generated by their cleared CDS
portfolios, as the clearing agency/DCO margin methodology will generate
the regulatory margin requirement across all the BD/FCMs.\47\
Accordingly, the Commission is proposing to modify the condition in
paragraph (b)(3) of the 2012 Order to eliminate the requirement that
the Commission or Commission staff approve the BD/FCM's margin
methodology. Instead, the proposed order would require the BD/FCM to
adopt an internal risk management program that is reasonably designed
to identify, measure, and manage the risks arising from its
participation in the CDS portfolio margin program that has been
approved in advance by the Commission or the Commission staff and that
meets the standards described below (``internal risk management
program'').\48\
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\47\ Nothing in the proposed order would preclude a BD/FCM from
setting higher ``house'' margin requirements for some or all of its
customers. See 17 CFR 39.13(g)(8).
\48\ See Proposed Order, ] (b)(3). The proposed order would
contain a provision finding that the BD/FCMs that have received
previous approval of their internal margin methodology from the
Division staff would be deemed to have approved internal risk
management programs for purposes of paragraph (b)(3) of the proposed
order. These BD/FCMs would no longer be required to have minimum
margin levels with respect to any customer transaction in a CDS
portfolio margin program at least equal to the amount determined
using a margin methodology approved by the Commission or the
Commission staff, as required by the 2012 Order. They would instead
comply the internal risk management program standards under
condition (b)(3) of the proposed order.
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[[Page 70663]]
An internal risk management program would facilitate the
identification, measurement, and management of a broader range of risks
than those covered by the clearing agency/DCO margin methodology and,
consequently, help ensure that the BD/FCMs operate in a prudent manner
with respect to the CDS portfolio margin program. Further, an internal
risk management program entails a more comprehensive set of measures to
mitigate risk than a margin methodology.\49\ Consequently, based on the
Commission staff's experience gained in monitoring the CDS portfolio
margin program, approving a firm's internal risk management program
(rather than its internal margin methodology) may foster a more robust
approach to managing risk by BD/FCMs. This approach to managing risk
also will promote consistency with the Commission's final capital,
margin, and segregation rules for SBSDs, which require such firms to be
subject to a risk management rule, as well as with the regulatory
approach adopted by the CFTC with respect to the portfolio margining of
cleared CDS.\50\ The proposed requirement to have an internal risk
management program also is a condition in the BD/FCM staff letters and
all the firms operating under the 2012 Order have implemented such
programs.
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\49\ See, e.g., 17 CFR 240.15c3-1e(d)(1) (``The VaR model used
to calculate market and credit risk for a position must be
integrated into the daily internal risk management system of the
broker or dealer[.]'').
\50\ See Capital, Margin, and Segregation Adopting Release, 84
FR at 43905 (``The Commission proposed that nonbank SBSDs be
required to comply with Rule 15c3-4 to promote the establishment of
effective risk management control systems by these firms.''); and
2013 CFTC Portfolio Margin Order (requiring participants to ``take
appropriate measures to identify, measure, and monitor financial
risk associated with carrying the Security-Based CDS in a cleared
swaps account and implement risk management procedures to address
those financial risks'').
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The requirement that a BD/FCM independently measure risk by
developing and using its own internal model is not designed to impose a
margin collection requirement (or capital charge) or diminish the role
of the clearing agency/DCO margin methodology. Rather, it is intended
to require the BD/FCM to independently measure the potential future
credit risk to cleared swaps customers and affiliates participating in
the CDS portfolio margin program under a different stress scenario in
order to better understand risks and address them as the firm deems
appropriate (e.g., through risk limits, threshold triggers, house
margin, heightened monitoring, or other controls).
Under this proposed condition, a BD/FCM seeking approval of its
internal risk management program would need to submit sufficient
information for the Commission or Commission staff to be able to make a
determination whether its program meets the proposed standards
described below.\51\ In reviewing this information, the Commission or
the Commission staff would be guided by these standards. If a BD/FCM's
internal risk management program is approved for purposes of this
proposed order, the program would be subject to ongoing supervision and
monitoring by the Commission.\52\
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\51\ See generally 17 CFR 240.15c3-1e(a)(1). A BD/FCM would only
need to submit information to the extent it is relevant to the
portfolio margining of cleared CDS. The BD/FCM may seek confidential
treatment for information submitted as part of such application.
\52\ See Proposed Order, ] (c)(1)(ii)(D).
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The first standard for the internal risk management program is that
the BD/FCM would need to calculate a future credit exposure for each
cleared swaps customer and affiliate (sometimes each a
``counterparty'') using a proprietary methodology that meets specified
minimum quantitative and qualitative model standards (``internal risk
model'').\53\ The quantitative standards would be that the internal
risk model:
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\53\ See Proposed Order, ] (c)(1).
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Estimates a potential future exposure over a minimum 10-
day horizon and 99% confidence level and captures all material risk
factors, including but not limited to general movements in credit
spread term structure, basis risk between index and single name
positions, and interest rate risk;
Includes a concentration/liquidity requirement; and
Includes a jump-to-default requirement for the sale of CDS
protection equal to the largest loss of a single name exposure assuming
a conservative recovery rate that may not exceed 40%.
The qualitative standards would require that:
The internal risk model must be adequately documented and
the model documentation must provide a description of the model
assumptions, data inputs, parameters, and methodologies employed to
measure risk;
The internal risk model must be subject to an annual model
review by a model group that is independent of the business function;
The internal risk model must be subject to at least
quarterly backtesting by counterparty or account; and
The BD/FCM must provide written notice to the Commission
or Commission staff prior to implementing any material change to its
internal risk model.
These quantitative and qualitative requirements generally are
consistent with the quantitative and qualitative requirements for
internal risk models under Appendix E to Rule 15c3-1 and under new Rule
18a-1. These rules permit certain broker-dealers and SBSDs,
respectively, to compute capital charges using internal models.\54\ For
example, the standards in the proposed order generally would require
that the model cover a 10-day horizon, 99% confidence level, and
material risks, and that the BD/FCM backtest the model and subject it
to review.\55\
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\54\ See 17 CFR 240.15c3-1e and 18a-1; and Capital, Margin, and
Segregation Adopting Release.
\55\ See 17 CFR 15c3-1e(d).
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The second standard for the internal risk management program is
that it would need to have the following minimum risk management system
standards:
The BD/FCM would need standards to measure and manage risk
exposure arising from counterparties' CDS portfolios that are
independent of any central counterparty margin methodology;
The BD/FCM would need to have an internal credit risk
rating model that assesses the credit risk of each individual
counterparty;
The BD/FCM's monitoring of credit risk would need to
include the prudent setting of an exposure limit for each individual
counterparty, and the exposure limit would need to be reviewed if the
counterparty's credit risk profile changes and at least quarterly;
The BD/FCM would need to have the ability to limit or
reduce the exposure to a counterparty through the collection of
additional margin;
The BD/FCM would need to have documented procedures to
value positions conservatively in view of current market prices and the
amount that might be realized upon liquidation; and
The BD/FCM would need to have well-defined procedures and
systems in place for the daily collection and payment of initial and
variation margin.\56\
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\56\ See Proposed Order, ] (c)(2).
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This proposed standards requirement is a condition in the BD/FCM
staff letters. These proposed risk
[[Page 70664]]
management standards are designed to require a BD/FCM to take prudent
measures to protect the firm from losses that can result from failing
to account for and control risk with respect to its CDS portfolio
margin program. Requiring a BD/FCM to incorporate these proposed
standards is designed to promote the establishment of effective
internal risk management programs to address the risks of portfolio
margining cleared CDS.
The third standard for the internal risk management program is that
the BD/FCM would need to report to the Commission and FINRA staffs on a
monthly basis within 5 business days after month end or as otherwise
requested details of its top 25 counterparties' portfolios as measured
by net credit exposure as well as the top 25 counterparties' portfolios
as measured by gross notional amount.\57\ This proposed requirement is
a condition in the BD/FCM staff letters. Based on Commission staff's
experience with the BD/FCM staff letter requirements, the Commission
preliminarily believes that it would be appropriate to require this
monthly reporting as it will assist Commission staff in monitoring the
risk to the BD/FCM arising from its portfolio margining of cleared CDS.
Understanding the magnitude of this risk will assist the Commission
staff in evaluating the appropriateness of a given firm's internal risk
management program in terms of its procedures and controls to mitigate
risk.
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\57\ See Proposed Order, ] (c)(3).
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The proposed order would not include other conditions in the BD/FCM
staff letters, including the capital concentration charge. Based on
Commission staff experience monitoring the BD/FCMs participating in the
CDS portfolio margin program, the Commission preliminarily believes
that the capital concentration charge and other conditions in the BD/
FCM staff letters may not be necessary in light of the requirement to
have a reasonably designed internal risk management program. A
reasonably designed internal risk management program will provide a BD/
FCM the tools to better understand the risks that arise from its
portfolio margining of cleared CDS and address them as the firm deems
appropriate (e.g., through risk limits, threshold triggers, house
margin, heightened monitoring, or other controls). Therefore, the
Commission is proposing not to incorporate these conditions into the
proposed order.
The fourth BD/FCM condition in the proposed order would require
that the BD/FCM be in compliance with applicable laws and regulations
relating to risk management, capital, and liquidity, and be in
compliance with applicable clearing agency/DCO rules and CFTC
requirements (including margin, segregation, and related books and
records provisions) with respect to CFTC cleared swaps customer
accounts and cleared swaps proprietary accounts subject to the CDS
portfolio margin program.\58\ The purpose of this condition is to help
ensure that the exemption is available only when the BD/FCM is in
compliance with applicable regulatory requirements. The fifth BD/FCM
condition in the proposed order would require that each cleared swaps
customer and affiliate of the BD/FCM participating in the CDS portfolio
margin program be an ``eligible contract participant.'' \59\ As with
the third condition in the proposed order for clearing agency/DCOs, the
Commission preliminarily believes it would be appropriate to limit the
availability of this exemption to eligible contract participants.
Eligible contract participants should have the expertise or resources
to effectively determine the risks associated with engaging in these
types of transactions.
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\58\ See Proposed Order, ] (b)(4). See also supra note 22.
\59\ See Proposed Order, ] (b)(5). The 2012 Order requires that
each customer of the BD/FCM participating in a program to commingle
and portfolio margin CDS be an ``eligible contract participant'' as
defined in Section 1a(18) of the CEA. 77 FR at 75220. See also supra
note 22.
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The sixth BD/FCM condition in the proposed order would require
that, before receiving any money, securities, or property of a cleared
swaps customer or affiliate to margin, guarantee, or secure positions
consisting of cleared CDS, the BD/FCM would need to furnish to the
cleared swaps customer or affiliate a disclosure document containing:
(1) A statement indicating that the cleared swaps customer's or
affiliate's money, securities, and property will be held in a CFTC
cleared swaps account, and that the cleared swaps customer or affiliate
has elected to seek protections under the commodity broker liquidation
provisions with respect to such money, securities, and property; and
(2) a statement that the broker-dealer segregation requirements of
Sections 15(c)(3) and 3E of the Exchange Act and the rules thereunder,
and any customer protections under SIPA and the stockbroker liquidation
provisions, will not apply to such cleared swaps customer or affiliate
money, securities, and property.\60\ The disclosure document would need
to be provided to the cleared swaps customer or affiliate at or prior
to the time that the cleared swaps customer or affiliate opens the CFTC
cleared swaps account and, in all cases, prior to the BD/FCM receiving
any money, securities or property into the CFTC cleared swaps account
of the cleared swaps customer or affiliate. This condition is designed
to provide market participants that elect to participate in the CDS
portfolio margin program with important disclosures regarding the legal
framework that will govern their transactions.
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\60\ See Proposed Order, ] (b)(6). See also supra note 22.
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Accordingly, pursuant to its authority under Sections 3E(c)(2) \61\
and 36 \62\ of the Exchange Act, the Commission preliminarily believes
that the proposed order, under the terms and conditions described
above, would be necessary or appropriate in the public interest and
consistent with the protection of investors.
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\61\ 15 U.S.C. 78c-5(c)(2). Section 3E(c)(2) of the Exchange Act
provides that the Commission may, notwithstanding Section 3E(b) of
the Exchange Act, by rule, regulation, or order prescribe terms and
conditions under which any money, securities, or property of a
customer with respect to cleared security-based swaps may be
commingled and deposited with any other money, securities, or
property received by the broker-dealer or SBSD and required by the
Commission to be separately accounted for and treated and dealt with
as belonging to the security-based swap customer of the broker-
dealer or SBSD.
\62\ 15 U.S.C. 78mm. Section 36 of the Exchange Act authorizes
the Commission to conditionally or unconditionally exempt, by rule,
regulation, or order any person, security, or transaction (or any
class or classes of persons, securities, or transactions) from any
provision of the Exchange Act or any rule or regulation thereunder,
to the extent such exemption is necessary or appropriate in the
public interest, and is consistent with the protection of investors.
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IV. Request for Comments
The Commission is seeking comment on all aspects of the proposed
exemption. In particular, the Commission requests comment on the
following questions. When responding to the request for comment, please
explain your reasoning.
1. Should any of the proposed exemptions or conditions be
eliminated or modified?
2. Are there other or different conditions that should apply to the
proposed exemption?
3. Are there any specific written disclosures to cleared swaps
customers or affiliates that a BD/FCM should be required to provide in
addition to those that are a condition to the proposed exemption?
4. At what stage during the account opening process does the
cleared swaps
[[Page 70665]]
customer or affiliate enter into a non-conforming subordination
agreement as required by the 2012 Order? Is it before, at the same
time, or after the cleared swaps customer or affiliate receives the
required written disclosures from the BD/FCM? Should the proposed
condition related to the written disclosure document be modified to
require that the BD/FCM furnish it to the cleared swaps customer or
affiliate before the customer enters into the non-conforming
subordination agreement with the BD/FCM (and before the BD/FCM receives
any money, securities, or property to margin the CDS positions)?
5. Does the proposed modified text required in the non-conforming
subordination agreements achieve the objectives of: (1) Removing
portfolio margin cleared swaps customers and affiliates from the
definitions of ``customer'' under Rule 15c3-3, SIPA, and the
stockbroker liquidation provisions with respect to securities or cash
held in CFTC cleared swaps accounts; (2) not undermining the
protections afforded to the portfolio margin cleared swaps customers
and affiliates under the rules of the CFTC, the CEA, and commodity
broker liquidation provisions; and (3) not requiring portfolio margin
cleared swaps customers or affiliates to subordinate their claims, in
the event that their cleared swaps customer or affiliate claims are not
fully satisfied by the distribution of assets held in their CFTC
cleared swaps accounts, to assets that may be included in the debtor's
general estate? Is there alternative language that would better achieve
these objectives? Does the text in the 2012 Order achieve these
objectives? If this modification or some other modification were made
to the order, would it require BD/FCMs to amend all their existing
agreements with cleared swaps customers and affiliates participating in
the portfolio margin program? If so, would this be a significant
burden?
6. Should clearing agencies/DCOs be required to provide market
participants with the ability to select an SEC SBS account as an
alternative to a CFTC cleared swaps account?
7. Have market participants expressed an interest in portfolio
margining cleared CDS in an SEC SBS account? If so, how has this
interest changed since 2012?
8. Would there be interest by BD/FCMs in offering market
participants the option to portfolio margin cleared CDS in an SEC SBS
account after the October 6, 2021 compliance date for the SEC's final
capital, margin, and segregation rules for security-based swaps, when
the customer protection framework for security-based swaps is in place?
9. If there was no regulatory requirement to provide market
participants with the ability to select an SEC SBS account as an
alternative to a CFTC cleared swaps account, would clearing agencies/
DCOs be incentivized to offer such an alternative in the future, if
market conditions changed and demand rose for an SEC SBS account
alternative?
10. Are the proposed standards for the BD/FCM's internal risk
management program appropriate?
11. Is it appropriate for the proposed order to deem a BD/FCM to
have an internal risk management program that has been approved by the
Commission or the Commission staff as required by paragraph (b)(3) of
the proposed order if it has received prior approval of its margin
methodology?
12. Would the proposed exemption have a competitive impact--either
positive or negative--on market participants in the context of CDS
clearing? What would be the potential benefits and costs of the
proposed exemption? Would the proposed modifications to the 2012 Order
impact investor protection? If so, what would those impacts be?
By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
Appendix--Text of Proposed Order
It is hereby ordered that any broker-dealer also registered as a
futures commission merchant that has received approval of its margin
methodology by the Commission or Commission staff prior to the date
of this order is deemed to have an internal risk management program
that has been approved by the Commission or the Commission staff as
required by paragraph (b)(3) of this order.
It is hereby further ordered, pursuant to Section 3E(c)(2) and
Section 36 of the Securities Exchange Act of 1934 (``Exchange
Act''), that the following exemptions from Exchange Act requirements
will apply:
(a) Exemption for dually-registered clearing agencies/
derivatives clearing organizations.
A clearing agency registered pursuant to Section 17A of the
Exchange Act and registered as a derivatives clearing organization
pursuant to Section 5b of the CEA (a ``clearing agency/DCO'') will
be exempt from Sections 3E(b), (d), and (e) of the Exchange Act and
any rules thereunder, solely to perform the functions of a clearing
agency for credit default swaps (``CDS'') under a program to
commingle and portfolio margin cleared CDS for cleared swaps
customer and affiliate positions, subject to the following
conditions:
(1) The clearing agency/DCO has obtained any other relief needed
to permit its clearing members that are registered under Section
15(b) of the Exchange Act (other than paragraph (11) thereof) and
also registered as a futures commission merchant pursuant to Section
4f(a)(1) of the CEA (a ``BD/FCM'') (at the BD/FCM's election), to
maintain cleared swaps customer or affiliate money, securities, and
property received by the BD/FCM to margin, guarantee, or secure
cleared swaps customer or affiliate positions in cleared CDS, which
include both swaps and security-based swaps, in a segregated account
established and maintained in accordance with Section 4d(f) of the
CEA and rules thereunder (in the case of a cleared swaps customer)
or a cleared swaps proprietary account (in the case of an affiliate)
for the purpose of clearing (as a clearing member of the clearing
agency/DCO) such cleared swaps customer or affiliate positions under
a program to commingle and portfolio margin CDS.
(2) The clearing agency/DCO has appropriate rules and
operational practices to permit a BD/FCM that is a clearing member
(at the BD/FCM's election) to maintain cleared swaps customer or
affiliate money, securities, and property received by the BD/FCM to
margin, guarantee, or secure cleared swaps customer or affiliate
positions in cleared CDS, which include both swaps and security-
based swaps, in a segregated account established and maintained in
accordance with Section 4d(f) of the CEA and rules thereunder (in
the case of a cleared swaps customer) or a cleared swaps proprietary
account (in the case of an affiliate) for the purpose of clearing
(as a clearing member of the clearing agency/DCO) such cleared swaps
customer or affiliate positions under a program to commingle and
portfolio margin CDS.
(3) The rules of the clearing agency/DCO require that each
cleared swaps customer and affiliate of the BD/FCM participating in
a program to commingle and portfolio margin CDS must be an
``eligible contract participant'' as defined in Section 1a(18) of
the CEA.
(b) Exemption for certain BD/FCMs that elect to offer a program
to commingle and portfolio margin cleared swaps customer and
affiliate positions in cleared CDS. Solely to perform the functions
of a BD/FCM for cleared CDS, with respect to any cleared swaps
customer or affiliate money, securities, and property received by
the BD/FCM to margin, guarantee, or secure cleared swaps customer or
affiliate positions in security-based swaps included in a segregated
account established and maintained in accordance with Section 4d(f)
of the CEA and rules thereunder (in the case of a cleared swaps
customer) or a cleared swaps proprietary account (in the case of an
affiliate) under a program to commingle and portfolio margin cleared
swaps customer or affiliate positions in CDS, a BD/FCM will be
exempt from Exchange Act Sections 3E(b), (d), and (e), and Section
15(c)(3) and Rule 15c3-3 thereunder and any requirement to treat an
affiliate (as defined in association with the definition of
``cleared swaps proprietary account'' pursuant to CFTC Rule 22.1) as
a customer for purposes of Section 8 of the Exchange Act and
Exchange Act Rules 8c-1 and 15c2-1 thereunder, subject to the
following conditions:
[[Page 70666]]
(1) With respect to cleared swaps customers that are not
affiliates of the BD/FCM,
(i) The BD/FCM must maintain cleared swaps customer money,
securities, and property received to margin, guarantee or secure
cleared swaps customer positions consisting of cleared CDS, which
include both swaps and security-based swaps, in a segregated account
established and maintained in accordance with Section 4d(f) of the
CEA and rules thereunder for the purpose of clearing (as a clearing
member or through a clearing member of a clearing agency/DCO
operating pursuant to the exemption in paragraph (a) above) such
cleared swaps customer positions under a program to commingle and
portfolio margin CDS; and
(ii) The BD/FCM must enter into a non-conforming subordination
agreement with each cleared swaps customer. The agreement must
contain a specific acknowledgment by the cleared swaps customer that
such money, securities or property will not receive customer
treatment under the Exchange Act or SIPA or be treated as ``customer
property'' as defined in 11 U.S.C. 741 in a liquidation of the BD/
FCM and that such money, securities or property will be subject to
any applicable protections under Subchapter IV of Chapter 7 of Title
11 of the United States Code and rules and regulations thereunder;
as well as an affirmation by the cleared swaps customer that claims
to ``customer property'' as defined in SIPA or 11 U.S.C. 741 against
the BD/FCM will be subordinated to the claims of securities
customers and security-based swap customers.
(2) With respect to affiliates of the BD/FCM,
(i) The BD/FCM maintains money, securities, and property of
affiliates received to margin, guarantee, or secure positions
consisting of cleared CDS, which include both swaps and security-
based swaps, in a cleared swaps proprietary account for the purpose
of clearing (as a clearing member of a clearing agency/DCO operating
pursuant to the exemption in paragraph (a) above) such positions
under a program to commingle and portfolio margin CDS;
(ii) The BD/FCM enters into a non-conforming subordination
agreement with each affiliate. The agreement must contain a specific
acknowledgment by the affiliate that such money, securities or
property will not receive customer treatment under the Exchange Act
or SIPA or be treated as ``customer property'' as defined in 11
U.S.C. 741 in a liquidation of the BD/FCM, and that such money,
securities or property will be held in a proprietary account in
accordance with the CFTC requirements and will be subject to any
applicable protections under Subchapter IV of Chapter 7 of Title 11
of the United States Code and rules and regulations thereunder; as
well as an affirmation by the affiliate that claims to ``customer
property'' as defined in SIPA or 11 U.S.C. 741 against the BD/FCM
will be subordinated to the claims of securities customers and
security-based swap customers; and
(iii) The BD/FCM obtains from the affiliate an opinion of
counsel that the affiliate is legally authorized to subordinate all
of its claims against the BD/FCM to those of securities customers
and security-based swap customers.
(3) The BD/FCM has adopted an internal risk management program
that is reasonably designed to identify, measure, and manage the
risks arising from its program to allow cleared swaps customers and
affiliates to commingle and portfolio margin CDS that has been
approved in advance by the Commission or the Commission staff and
meets the standards in section (c) below.
(4) The BD/FCM must be in compliance with applicable laws and
regulations relating to risk management, capital, and liquidity, and
must be in compliance with applicable clearing agency/DCO rules and
CFTC requirements (including segregation and related books and
records provisions) for accounts established and maintained in
accordance with Section 4d(f) of the CEA and rules thereunder (in
the case of cleared swaps customers) and for cleared swaps
proprietary accounts (in the case of affiliates), and subject to a
program to commingle and portfolio margin CDS.
(5) Each cleared swaps customer and affiliate of the BD/FCM
participating in a program to commingle and portfolio margin CDS is
an ``eligible contract participant'' as defined in Section 1a(18) of
the CEA.
(6) Before receiving any money, securities, or property of a
cleared swaps customer or affiliate to margin, guarantee, or secure
positions consisting of cleared CDS, which include both swaps and
security-based swaps, under a program to commingle and portfolio
margin CDS, the BD/FCM must furnish to the cleared swaps customer or
affiliate a disclosure document containing the following
information:
(i) A statement indicating that the cleared swaps customer's or
affiliate's money, securities, and property will be held in an
account maintained in accordance with the segregation requirements
of Section 4d(f) of the CEA (in the case of a cleared swaps
customer) or a cleared swaps proprietary account (in the case of an
affiliate), and that the cleared swaps customer or affiliate has
elected to seek protections under Subchapter IV of Chapter 7 of
Title 11 of the United States Code and the rules and regulations
thereunder with respect to such money, securities, and property; and
(ii) A statement that the broker-dealer segregation requirements
of Section 15(c)(3) and Section 3E of the Exchange Act and the rules
thereunder, and any customer protections under SIPA and the
stockbroker liquidation provisions, will not apply to such cleared
swaps customer or affiliate money, securities, and property.
(c) Standards for internal risk management program. The internal
risk management program required pursuant to condition (b)(3) of
this order must have the following standards in place:
(1) Internal Risk Model. The BD/FCM must calculate a future
credit exposure for each cleared swaps customer and affiliate (each
a ``counterparty'') using its own proprietary methodology
(``internal risk model'') subject to the following minimum
quantitative and qualitative model standards:
(i) Quantitative Requirements. (A) The internal risk model must
estimate a potential future exposure over a minimum 10-day horizon
and 99% confidence level and capture all material risk factors,
including but not limited to general movements in credit spread term
structure, basis risk between index and single name positions, and
interest rate risk;
(B) The internal risk model must include a concentration/
liquidity requirement; and
(C) The internal risk model must include a jump-to-default
requirement for the sale of CDS protection equal to the largest loss
of a single name exposure assuming a conservative recovery rate that
may not exceed 40%.
(ii) Qualitative Requirements. (A) The internal risk model must
be adequately documented and the documentation must provide a
description of the model assumptions, data inputs, parameters, and
methodologies employed to measure risk;
(B) The internal risk model must be subject to an annual model
review by a model group that is independent of the business
function;
(C) The internal risk model must be subject to at least
quarterly backtesting by counterparty or account; and
(D) The BD/FCM must provide written notice to the Commission or
Commission staff prior to implementing any material change to its
internal risk model.
(2) Minimum Risk Management System Standards. (A) The BD/FCM
must maintain risk management system standards to measure and manage
risk exposure arising from counterparties' CDS portfolios that are
independent of any central counterparty margin methodology;
(B) The BD/FCM must have an internal credit risk rating model
that assesses the credit risk of each individual counterparty;
(C) The BD/FCM's monitoring of credit risk must include the
prudent setting of an exposure limit for each individual
counterparty and the exposure limit must be reviewed if the
counterparty's credit risk profile changes and at least quarterly;
(D) The BD/FCM must have the ability to limit or reduce the
exposure to a counterparty through the collection of additional
margin;
(E) The BD/FCM must have documented procedures to value
positions conservatively in view of current market prices and the
amount that might be realized upon liquidation; and
(F) The BD/FCM must have well-defined procedures and systems in
place for the daily collection and payment of initial and variation
margin.
(3) Monthly Reporting. The BD/FCM must report to the Commission
and FINRA staffs on a monthly basis within 5 business days after
month end or as otherwise requested details of its top 25
counterparties' portfolios as measured by net credit exposure as
well as the top 25 counterparties' portfolios as measured by gross
notional amount.
[FR Doc. 2020-24612 Filed 11-4-20; 8:45 am]
BILLING CODE 8011-01-P
