Clearing Activities – § 23.605(d), § 1.71(d)

a. Separation of Clearing Unit from Business Trading Unit -

§ 23.605(d)(1) and (2); Separation of Business Trading Unit and Clearing Unit - § 1.71(d)(1) and (2)

As proposed, § 23.605(d)(1) provided that “[n]o [SD] or [MSP] shall directly or indirectly interfere with or attempt to influence the decision of any affiliated clearing member of a [DCO] with regard to the provision of clearing services and activities,” while proposed § 1.71(d)(1) congruently provided that “[n]o [FCM] shall permit any affiliated [SD] or [MSP] to directly or indirectly interfere with, or attempt to influence, the decision of the clearing unit personnel of the [FCM] with regard to the provision of clearing services and activities . . . .”

Likewise, proposed § 23.605(d)(2) provided that “[e]ach [SD and MSP] shall create and maintain an appropriate informational partition, as specified in section 4s(j)(5)(A) of the Act, between business trading units of the [SD or MSP] and clearing member personnel of any affiliated clearing member of a [DCO],” while proposed § 1.71(d)(2) congruently provided that “[e]ach [FCM] shall create and maintain an appropriate informational partition between business trading units of an affiliated [SD] or [MSP] and clearing unit personnel of the [FCM].”

MFA commented that it supports the prohibition of SDs and MSPs from directly or indirectly interfering with, or attempting to influence, the decision of any affiliated clearing member of a DCO with regard to clearing services and activities, as well as the

informational partitions between business trading personnel and personnel of an affiliated clearing member. Pierpont Securities Holdings LLC also supported the Commission’s proposals, contending that the informational partitions between a business trading unit and a clearing unit within a large financial institution must be established and maintained as to all personnel, not just supervisory personnel, and the penalties for violating those restrictions must be meaningful.

Swaps and Derivatives Market Association filed two comments on these rules, both of which were supportive of the proposals. In the first comment, the commenter argued that the proposed separation of trading and clearing units in § 23.605(d) should be expanded so as to require “distant physical separation” of the two. The commenter also expressed support for requiring the use of objective criteria in determining whether to accept clearing customers. In the second letter, the commenter contended that that the restrictions set forth in § 23.605(d), as proposed, correctly address key areas where conflicts arise, and that the independence of clearing members is essential to accomplish several policy goals of the Dodd-Frank Act. In the second comment, the commenter stated its belief that the firewalls mandated by the proposed rules “are critical to reducing potential conflicts between the trading unit of an FCM, IB, SD, or MSP and their clearing unit.”

Michael Greenberger also expressed support for § 23.605(d), as proposed, noting that attempts to tie clearing decisions to trade execution decisions would raise potential conflicts of interest, which could serve to block access to clearing and prevent

competition among execution venues. The commenter also noted that mandatory public disclosure of client acceptance criteria by SDs and MSPs is consistent with legislative

intent. Likewise, Pierpont Securities Holdings LLC also expressed support for the Commission’s proposal, in particular the requirements that no direct or indirect

interference or influence be permitted by the business trading unit on the clearing unit as to (i) whether clearing services will be provided and (ii) how clearing fees will be set.

The Principal Traders Group supported a rule preventing interference by the business trading unit of an SD or MSP, with respect to the decision of an affiliated FCM to accept a client for clearing services, but preferred that the rule be presented in the form recommended by FIA/ISDA/SIFMA below.

In contrast, FIA, ISDA, and SIFMA, in a joint comment, commented that the proposed rules would alter the business operations of integrated financial services firms to the detriment of clients and in a manner disproportionate to achieving the regulatory goals the Commission has identified, including the promotion of effective risk

management. The commenters also argued that the Commission’s proposed application of the conflicts rules to FCM clearing activities is not contemplated by section 732 of the Dodd-Frank Act. FIA/ISDA/SIFMA argued that the proposed rules would impair an SD’s/MSP’s ability to follow risk management best practices. FIA/ISDA/SIFMA

recommended that the Commission not adopt the proposed rules, but instead adopt a rule that prohibits an affiliated SD or MSP from obtaining information from an affiliated FCM’s clearing personnel concerning transactions conducted by FCM clients with either their own clients or with independent SDs or MSPs. FIA/ISDA/SIFMA also expressed support for a rule that would require each FCM’s clearing unit to have independent management that makes its own final decisions regarding clients to which it will offer clearing services as well as the terms for those services. FIA/ISDA/SIFMA also

suggested that the Commission clarify that the rule does not mandate that firms publicize client sales and on-boarding decisions.

UBS Securities LLC echoed certain points made in the FIA/ISDA/SIFMA

comment, particularly with respect to the ability of a financial services firm to operate its swap clearing business as a partnership with its trading business in order to serve clients, while JP Morgan agreed with the FIA/ISDA/SIFMA comment discussed above. JP Morgan also posited that while “it would be appropriate for the CFTC to issue rules prohibiting any activity intended to restrict open access to clearing, . . . we believe a SD/MSP should be permitted to work and share information with its clearing member affiliate to promote and facilitate a client’s access to clearing services or to define the parameters pursuant to which clearing services will be offered.”

The FHLBs argued that the proposed rule goes beyond the standards set forth in the Dodd-Frank Act and that the proposed rule “overly restricts the ability of [SDs and MSPs] to run their trading and clearing operations and effectively service the needs of their end-user counterparties.” The proposed rule also could inhibit SDs and MSPs “from taking prudent, well-informed and timely actions in situations with respect to the closing out of transactions, in a default scenario or otherwise.”

NFA commented that § 1.71(d) is too broad and may negatively impact a firm’s ability to share information about customers to make credit and risk determinations. UBS Securities LLC echoed certain of the points made in the FIA/ISDA/SIFMA comment, particularly with respect to the ability of a financial services firm to operate its swap clearing business as a partnership with its trading business in order to serve clients. Newedge commented that the proposed rule would limit firms’ ability to coordinate,

credit, risk, and other policies, and suggested that rather than prohibiting an affiliated SD or MSP from interfering with a FCM’s decision to provide clearing services, § 1.71(d) should prohibit a FCM from permitting business trading unit personnel of an affiliated SD or MSP from interfering with the FCM’s decision to provide clearing services.

Commenters have expressed divergent views on this issue, with some

commenters strongly favoring the Commission’s proposed rules (and, to a certain extent, requesting that the rule be expanded), while others have advocated that the provision not be adopted. Upon consideration of all the comments, the Commission has determined it appropriate to promulgate the rules largely as they were originally proposed. The

separation of the FCM clearing unit from the interference or influence of an affiliated SD or MSP is crucial to promoting open access to clearing. Open access to clearing will be essential for the expansion of client clearing needed for market participants to comply with the mandatory clearing of swaps as determined by the Commission under section 723 of the Dodd-Frank Act. The Commission believes that the promulgation of the language as proposed would be “appropriate,” as that term is used in section 4d(c) as amended by section 732 of the Dodd-Frank Act. Moreover, the Commission does not believe the rule will hamper risk management. The Commission notes that it has proposed straight-through processing rules,30 _{counterparty clearing documentation}

rules,31 _{and clearing member risk management rules}32 _{that would, if adopted, minimize}

30 _{See Requirements for Processing, Clearing, and Transfer of Customer Positions, 76 FR 13101, 13109}

(Mar. 10, 2011).

31 _{See Customer Clearing Documentation and Timing of Acceptance for Clearing, 76 FR 45730, 45737}

(Aug. 1, 2011).

the counterparty risk to an SD or MSP with respect to transactions required or intended to be cleared.

In response to commenters’ concerns about an FCM’s ability to manage a default scenario without the benefit of the trading expertise in the business trading unit, the Commission is modifying proposed § 1.71(d)(2)(i) to permit the business trading unit of an affiliated SD or MSP to participate in the activities of an FCM during an event of default. Specifically, the business trading unit personnel would be permitted to participate in the activities of the FCM, as necessary, during any default management undertaken by a derivatives clearing organization that results from an event of default and for the purposes of transferring, liquidating, or hedging any proprietary or customer positions as a result of an event of default.

In addition, the Commission is including the term “clearing unit,” as defined in § 23.605(a), in the relevant provisions of § 23.605(d). This change will serve to clarify the scope of the informational partition between the SD or MSP and the personnel or division of a clearing member responsible for the provision of clearing services.

To clarify an issue raised by FIA/ISDA/SIFMA, the Commission notes that SDs and MSPs are not required to publicize their client sales and on-boarding decisions; rather, the criteria used in making those decisions should be publicly available and objective. In other words, “all such decisions regarding the acceptance of customers for clearing should be made in accordance with publicly disclosed, objective, written criteria,” as stated in the preamble of the proposed rule.

b. Division of clearing unit into self-clearing unit and customer clearing unit

The proposed rules did not distinguish between a self-clearing unit (clearing for an SD’s or MSP’s own trades) and a customer clearing unit (clearing for customers and competitors). However, Swaps and Derivatives Market Association commented that the proposed rules should differentiate between the two units. Having considered that comment, the Commission has decided not to modify the language in the manner suggested by the commenter. The Commission believes that subdividing the clearing unit into two separate sub-units would create an unnecessary complication that could erode the firewall mandated by the statute.

c. Prohibition on business unit personnel of an SD or MSP from

supervising personnel of an affiliated DCO-clearing member - § 23.605(d)(2); restrictions on SD and MSP business trading unit supervision of clearing unit of affiliated FCM - § 1.71(d)(2)(ii)

As proposed, § 23.605(d)(2) provided that, at a minimum, the § 23.605(d)(2) informational partitions “shall require that no employee of a business trading unit of a [SD] or [MSP] shall supervise, control, or influence any employee of a clearing member of a derivatives clearing organization,” while proposed, § 1.71(d)(2)(ii) congruently provided that “[n]o employee of a business trading unit of an affiliated [SD] or [MSP] shall supervise, control, or influence any employee of a clearing unit of the [FCM].”

FIA, ISDA, and SIFMA, in a joint comment, posited that because employees of a business trading unit and a clearing unit may be supervised by the same manager,

or MSP from acting as a direct supervisor of any non-management personnel of an affiliated FCM’s clearing unit. The commenter also suggested that salespeople be permitted to associate with an SD or MSP and with an affiliated FCM, and be permitted to act for clients at both entities. Further, the commenter argued that a carve-out should be added to §§ 23.605(d) and 1.71(d) enabling an SD parent to exercise risk management over its affiliated FCM (e.g., approving credit and risk parameters for common and distinct customers) in a manner that is non-discriminatory, non-prejudicial, and for the sole purpose of complying with group risk and credit policies and parameters. In a separate comment, JP Morgan expressed a general agreement with the points raised in the FIA/ISDA/SIFMA letter.

After reviewing the comment, the Commission has decided to adopt the rule with certain modifications. Any influence on clearing unit personnel by upper-level

supervisors involved in business trading unit activities would undermine the conflict-of- interest requirements mandated by new sections 4d(c) and 4s(j)(5) of the CEA, as amended by sections 731 and 732 of the Dodd-Frank Act, respectively, and set forth in the rule. Moreover, the Commission does not believe that the rule language should be changed to permit sales personnel to act for both the trading unit and the clearing unit. The risks associated with this approach, in terms of potential undue influence and interference with clearing decisions has been well-supported by commenters, as discussed above.

With regard to proposed § 1.71(d), the Commission is making certain changes to clarify the intent of the rule. In particular, § 1.71(d)(1)(vi) is modified to prohibit an affiliated SD or MSP from interfering with or influencing decisions related to setting a

particular customer’s fees for clearing services based upon criteria that are not generally available and applicable to other customers of the FCM. Additionally, as proposed § 1.71(d)(2)(i) required that the informational partitions between the business trading unit of the affiliated SD or MSP and the clearing unit personnel of the FCM include a

prohibition on any business trading unit personnel participating in any way with the provision of clearing services. As modified, the rule clarifies that business trading unit personnel may not condition or tie the provision of trading services to the provision of clearing services or otherwise participate in clearing services by improperly incentivizing or encouraging the use of the affiliated FCM.33 _{In addition, as discussed above, business}

trading unit personnel would be permitted to participate in the activities of the FCM in the event of a default.