Daily Rules, Proposed Rules, and Notices of the Federal Government
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On July 21, 2010, President Obama signed the Dodd-Frank Act into law.
Title VII added to the CEA two new categories of Commission registrant (
To apply its regulatory regime to the swap activity of intermediaries, the Commission must make a number of changes to its regulations to conform them to the Dodd-Frank Act. These changes primarily affect part 1 of the Commission's rules, but also affect parts 5, 7, 8, 15, 18, 21, 36, 41, 140, 145, 155, and 166. To the extent the DFA required the Commission to promulgate rules to address certain specific DFA sections, the Commission has proposed or is in the process of proposing such rules separately.
Today's Proposal contains amendments of three different types: ministerial, accommodating, and substantive. Many of the proposed amendments are purely ministerial—for instance, several proposed changes would update definitions to conform them to the CEA as amended by the Dodd-Frank Act; add to the Commission's regulations new terms created by the Dodd-Frank Act; remove all regulations and references pertaining to derivatives transaction execution facilities (“DTEFs”), a category of exchange which was eliminated by the DFA; correct various statutory cross-references to the CEA in the regulations; and remove regulations in whole or in part that were rendered moot by the Commodity Futures Modernization Act of 2000 (“CFMA”).
The proposed accommodating amendments are essential to the implementation of the DFA in that they propose to add swaps, swap markets, and swap entities to numerous definitions and regulations, but are more than ministerial because they require some judgment in drafting. Accommodating amendments would include, among other things, amending numerous definitions in regulation 1.3 to reference or include swaps; creating new definitions as necessary in regulation 1.3; amending recordkeeping requirements to include information on swap transactions; adding references to swaps, swap execution facilities (“SEFs”) and derivatives clearing organizations (“DCOs”) to various part 1 regulations; and amending parts 15, 18, 21, and 36 to implement the DFA's grandfathering and phase-out of exempt boards of trade and exempt commercial markets.
The remaining proposed substantive amendments are changes that would align requirements or procedures across futures and swap markets. They consist of proposed amendments to regulations 1.31 and 1.35 that would harmonize current part 1 recordkeeping requirements with those applicable to SDs and MSPs under proposed part 23 regulations and harmonize certain procedures applicable to swaps with those applicable to futures.
To aid the public in understanding the numerous changes to different parts of the CFTC's regulations explained in the Proposal, the Commission will also publish on its Web site a “redline” of the affected regulations which will clearly reflect the proposed amendments and deletions.
The Commission proposes to revise regulation 1.3 so that its definitions, which are used throughout the regulations, incorporate relevant provisions of the DFA. For instance, proposed regulation 1.3 updates current definitions to conform them to the Dodd-Frank Act's amendments of the same terms in the CEA's definitions section,
The Commission also proposes (1) to simplify or clarify certain existing regulation 1.3 definitions, and (2) to add several new definitions to regulation 1.3, pursuant to amendments to the CEA by the Dodd-Frank Act, existing regulations, and other amendments in the Proposal.
The term “contract market,” for instance, is not defined under the CEA, and is currently defined under regulation 1.3(h) as “a board of trade designated by the Commission as a contract market under the Commodity Exchange Act or in accordance with the provisions of part 33 of this chapter.” In certain provisions throughout the Commission's regulations, contract markets are also referred to as “designated contract markets.” Because both terms are used interchangeably within the regulations, the Commission is proposing to revise the definition to mean contract market and designated contract market (“DCM”). Proposed
The Commission proposes a similar clarification regarding the definition of “customer.” The Proposal simplifies the definition of “customer” by combining two existing definitions, “Customer; commodity customer” in regulation 1.3(k) and “Option customer” in regulation 1.3(jj), and adding swaps.
The Commission proposes to define the term “confirmation” to reflect its differing use in various regulations depending on whether a transaction is executed by an FCM, IB or CTA on the one hand, or by a SD or MSP on the other hand. In the first case, the registrant is acting as an agent. In the second it is acting as a principal.
The Commission also proposes to revise the “Member of a contract market” definition currently found at regulation 1.3(q) and to add to regulation 1.3 a definition of the term “Registered entity,” currently provided in CEA section 1a(40), as revised by the Dodd-Frank Act. The definition of “registered entity” proposed in regulation 1.3 is identical to its CEA counterpart and would include DCOs, DCMs, SEFs, swap data repositories (“SDRs”) and certain electronic trading facilities. To correspond with this new definition, the Commission also proposes to replace the current “Member of a contract market” definition with a new definition of “Member,” which would be nearly identical to the “Member of a registered entity” definition provided in CEA section 1a(34), also as revised by the Dodd-Frank Act.
The Commission proposes to add a definition of the term “order.” This term has not previously been defined, although it is used in several of the regulations,
Because amendments to regulation 1.31 also proposed herein incorporate the term “prudential regulator,” as added to the CEA by the Dodd-Frank Act, the Commission proposes to add it to regulation 1.3.
The Commission proposes to add the term “registrant” to regulation 1.3 so that certain regulations in part 1 can refer to various intermediaries (
The Commission also proposes adding the term “retail forex customer” to regulation 1.3 because it appears in several regulations in part 1 and currently is only defined in part 5. The proposed definition is identical in all material respects to the definition of this term as it currently appears in regulation 5.1(k).
Proposed regulation 1.3 also changes certain definitions so that the Commission's regulations properly refer to both futures and swaps. Additionally, for ease of reference, proposed regulation 1.3 would simply adopt several terms defined under the CEA, including “electronic trading facility,” “organized exchange,” and “trading facility.”
Regulation 1.3(ll) defines the term “physical” as “any good, article, service, right or interest upon which a commodity option may be traded in accordance with the Act and these regulations,”
The “physical” definition was first added to regulation 1.3 in 1983 to enable trading, on DCMs, in options to buy or sell an underlying commodity and has not been substantively amended.
At present, however, options may be traded on both physically deliverable and non-physically deliverable commodities, such as interest rates and temperatures. Using the term “physical” to refer to an option on both physically deliverable commodities and non-physically deliverable commodities may be confusing on its face.
The Commission requests comment on whether any changes to the “physical” definition are necessary or warranted. Should the Commission revise the definition of “physical” to limit it to its common sense meaning? Should the Commission remove it on the theory that the meaning of “physical” is self-evident? Should the Commission address such issues, if at all, in other rulemakings where they arise more directly, such as with respect to emission-related commodities as they relate to the forward exclusion from the swap definition?
The Commission proposes to add swaps on all commodities within the CFTC's jurisdiction to the definition of “commodity interest” in regulation 1.3(yy).
The Dodd-Frank Act adds a definition of “swap” to the CEA.
The Commission proposes to revise regulation 1.4
Pursuant to the foregoing authority, the Commission previously proposed new regulation 23.501(a)(1), which would require “[e]ach swap dealer and major swap participant entering into a swap transaction with a counterparty that is a swap dealer or major swap participant [to] execute a confirmation for the swap transaction,” according to a specified schedule.
Regulation 1.4 currently provides that an FCM, IB, CPO and CTA receiving an electronically signed document is in compliance with Commission regulations requiring signed documents, provided that such entity generally accepts electronic signatures.
In recent years, the phrase “books and records” has evolved with respect to the varying formats used to communicate and store information.
Recognizing that storage formats vary across different types of electronically stored information and to be consistent with current Commission practice and the Federal Rules of Civil Procedure, the proposed changes to regulations 1.31(a)(1), (a)(2), and (b) would require that: (1) All books and records required to be kept by the Act or by the Commission's regulations be kept in their original (for paper records) or native file format (for electronic records); and (2) production of such records be made in a form specified by the Commission. In addition, as provided in the existing regulation, books and records may continue to be stored on electronic storage media, provided, however, that for electronic records, the storage media must preserve the native file format of the electronic records.
Keeping electronic records in their native file format and producing them in a format designated by the Commission should not create any unreasonable burdens on persons required to maintain records under the Act and Commission regulations in light of Federal Rule of Civil Procedure 34(b), which would apply to such persons—and all other persons in possession of investigatory information—upon the filing of an enforcement action in Federal district court. Rule 34(b) permits the requesting party to designate the form or forms in which it wants electronically stored information produced in order to facilitate its usability. This is recognition that “the form of production is more important to the exchange of electronically stored information than of hard-copy materials.”
The Commission also proposes amendments to regulation 1.31 to incorporate two books and records obligations that proposed regulation 23.203(b) applies to SDs and MSPs. Proposed regulation 23.203(b) would require SDs and MSPs to (1) keep
The Commission solicits comments on the potential costs and effects of the proposed new requirement that all books and records be maintained in their original form (for paper) and their native file format (for electronic records) as provided in the proposed rule. Comment also is requested regarding whether the retention period for any communication medium (
Regulation 1.33 requires FCMs to maintain certain records and to regularly furnish monthly and confirmation statements to customers regarding commodity futures and option transactions they have entered into on behalf of customers. The DFA amended the definition of FCM in section 1a of the CEA to authorize an FCM to solicit or accept orders for swaps in addition to commodity futures and option transactions.
Proposed regulation 1.33(a)(3) describes what information on swap positions an FCM must provide in monthly statements to its customers. Proposed regulation 1.33(b)(2) would extend the requirement that an FCM furnish confirmation statements to customers to swaps executed on a customer's behalf and describes what information such a confirmation statement must contain. In addition, the Commission proposes to amend regulation 1.33 to reflect proposed changes to the definitions of the terms “commodity interest,” “customer,” and “open contract” in regulation 1.3.
The Commission proposes to amend regulation 1.35 in several respects. First, the Commission proposes to revise paragraph (a) such that this regulation's recordkeeping obligations would extend to trades executed by FCMs and IBs on SEFs. Those obligations currently apply only to trades executed on DCMs. Similarly, the proposed amendments would extend all of the regulation 1.35 recordkeeping obligations currently applicable to members of DCMs to include “members,” as that term is proposed to be defined in proposed regulation 1.3, of SEFs.
Second, the proposed revisions replace the terms “commodity futures transactions,” “retail forex exchange transactions,” and “commodity option transactions” with the term “commodity interests.” According to the Commission's proposed definition of “commodity interest” in regulation 1.3, “commodity interest” includes all of the aforementioned transactions as well as swaps. Thus, the Commission proposes that regulation 1.35's recordkeeping obligations for transactions in futures, commodity options, and retail forex exchange transactions also apply to swaps.
In relevant part, existing regulation 1.35 requires FCMs, IBs, and DCM members to “keep full, complete, and systematic records, together with all pertinent data and memoranda, of all transactions relating to [their] business of dealing in commodity futures, commodity options and cash commodities,” subject to the requirements of regulation 1.31. Specifically included among the records to be retained under regulation 1.35 are “all orders (filled, unfilled, or canceled), trading cards, signature cards, street books, journals, ledgers, canceled checks, copies of confirmations, copies of statements of purchase and sale, and all other records, data and memoranda” that have been prepared in the course of an FCM's, an IB's, or a DCM member's business of dealing in commodity futures, commodity options, and cash commodities.
On February 5, 2009, the Commission's Division of Market Oversight (“DMO”) issued an advisory stating that “[t]he Commission's recordkeeping regulations, by their terms, do not distinguish between whatever medium is used to record the information covered by the regulations, including emails, instant messages, and any other form of communication created or transmitted electronically.”
Notwithstanding the DMO advisory relating to certain electronic records, the Commission's existing recordkeeping requirements, as they relate to FCMs, IBs and DCM members, remain limited by a 1996 Commission decision,
Consequently, where Commission-regulated persons use oral communications, the Commission has encountered greater difficulties in effectively exercising its enforcement responsibilities, thereby increasing the potential for market abuses. Such difficulties have been particularly acute in cases where the Commission is required to establish a threshold level of knowledge and/or intent on the part of the actor, such as cases involving market manipulation and false reporting. The Commission's enforcement success in such cases often has correlated directly with the
Significant technological advancements in recent years, particularly with respect to the cost of capturing and retaining copies of electronic material, including telephone communications, have made the prospect of enhancing the Commission's recordkeeping requirements for oral communications more economically feasible and systemically prudent. Evidence of these trends was examined in March 2008 by the United Kingdom's Financial Services Authority (“FSA”), which studied the issue of mandating the recording and retention of voice conversations and electronic communications. The FSA issued a Policy Statement detailing its findings and ultimately implemented rules relating to the recording and retention of such communications, including a rule requiring all financial service firms to record any relevant communication by employees on their firm-issued or firm-sanctioned cell phones that will take effect on November 14, 2011.
Under the FSA rules, firms (identified generally as those entities conducting any of the following activities: receiving, executing, arranging for execution of customer orders or transactions carried out on behalf of the firm) must take reasonable steps to record relevant (relevant means conversations or communications between the firm and the client or when the firm is acting on behalf of a client with another person) telephone conversations (including mobile telephones) and keep a copy of relevant electronic communications that enable the referenced activities to be carried out. Firms are required to keep recordings of certain telephone lines for a period of at least six months in a medium that is readily accessible.
In promulgating this rule, the FSA issued guidance stating the following benefits: “i) recorded communication may increase the probability of successful enforcement; ii) this reduces the expected value to be gained from committing market abuse; and iii) this, in principle, leads to increased market confidence and greater price efficiency.” In determining its policy, the FSA conducted a cost-benefit analysis, including eight meetings with several trade associations including the Securities Industry and Financial Markets Association (“SIFMA”), the International Swaps and Derivatives Association (“ISDA”), and the Futures and Options Association (“FOA”). The FSA report estimated that 80% of telephone lines of its firms that would need to be recorded were already being recorded at the time of its study.
Indeed, the futures industry has imposed a requirement on certain of its member firms to tape telephone conversations with customers since 1997. Since then, the National Futures Association (“NFA”) has required member firms with more than a certain percentage of APs who have been disciplined to record all telephone conversations between the member's APs and both existing and potential customers for a period of two years. Those recordings must be retained for a period of five years from the date each tape is created, and the tapes shall be readily accessible during the first two years of the five year period.
Consistent with these developments, the proposed change to regulation 1.35(a) would explicitly require FCMs, RFEDs, IBs and members of DCMs and SEFs to record all oral communications that lead to the execution of transactions in a commodity interest or cash commodity. In addition to increasing consistency across regulatory regimes, this proposal would harmonize regulation 1.35 with the recordkeeping requirements proposed for SDs and MSPs under the Dodd-Frank Act.
The Commission solicits comments on the potential costs and benefits of requiring registrants to record and maintain oral communications as provided in the proposed rule.
As part of the ministerial amendments proposed in this release, the Commission is proposing to renumber portions of regulation 1.35 so that paragraphs currently numbered 1.35(a-1) and 1.35(a-2) will be renumbered 1.35(b) and 1.35(c), respectively. As a result, paragraphs currently numbered 1.35(b), (c), (d) and (e) will be
Because proposed regulation 1.35 extends recordkeeping obligations to swaps, the Commission has proposed special language for swaps, where appropriate. In paragraph (b)(2) (proposed (d)(2)) (records of futures, commodity options, and retail forex exchange transactions for each account), the Commission has proposed adding provision (iv). Proposed regulation 1.35(d)(2)(iv) would require FCMs, IBs, and any clearing members clearing swaps executed on a DCM or SEF to maintain records describing the date, price, quantity, market, commodity, and, if cleared, DCO of each swap.
The Commission recognizes that money managers currently execute bunched swap orders on behalf of clients and allocate the trades to individual clients post-execution. The Commission believes that the bunched order procedures currently applicable to futures can be adapted for use in swap trading. Therefore, the Commission proposes to amend subsection (a-1)(5) (proposed (b)(5)), which addresses post-execution allocation of bunched orders. As discussed below, the Commission also is proposing to delete appendix C to part 1, which predated regulation 1.35(a-1)(5) (proposed (b)(5)) and also addresses bunched orders.
In order to have a single standard for all intermediaries that might have discretion over customer accounts, the Commission is proposing to include FCMs and IBs as eligible account managers in regulation 1.35(a-1)(5) (proposed (b)(5)). Unlike other account managers, however, FCMs and IBs are prohibited from including proprietary trades in a bunched order with customer trades. Accordingly, the Commission is proposing to add a cross-reference in regulation 1.35(a-1)(5) (proposed (b)(5)) to regulations 155.3 and 155.4, which impose that restriction on FCMs and IBs, respectively. The Commission requests comment on whether the proposal to add FCMs and IBs to the list of eligible account managers is appropriate.
The Commission further proposes to amend regulation 1.35(a-1) (proposed (b)) to provide that specific customer account identifiers need not be included in confirmations or acknowledgments provided pursuant to proposed regulation 23.501(a), if the requirements of regulation 1.35(a-1)(5) (proposed (b)(5)) are met. This would enable account managers to bunch orders for trades executed bilaterally with SDs or MSPs. The proposal would require that, similar to the current procedure for futures, the allocation be completed by the end of the day of execution and provided to the counterparty. The Commission requests comment on whether the proposed procedures for handling bunched swap orders would be effective. In particular, the Commission requests comment on whether allocation can be conducted by the end of the day of execution.
The Commission proposes deleting