service^.'^ Like exchanges, DCOs must abide by a separate set of core principles tailored to the specific risks associated with these en ti tie^.

Transcription

1 The Regulation of Futures and Derivatives Panel on Exchange and Clearing Issues ABA Derivatives and Futures Law Committee Annual Program -- Naples, FL January 30,201 0 By Walter ~ukken* In wake of the recent financial crisis, Congress is currently debating the most significant rewriting of financial services legislation since the Great Depression. Part of ths reform effort involves the regulation of over-the-counter (OTC) derivatives due to their role in the financial meltdown. As we move toward a revised regulatory market initastructure and new rules for these novel financial products, it is important for policy makers and industry participants to understand the evolution of futures and derivatives regulation over the last several years. The Commodity Exchange Act (CEA), as amended, ' is the statute authorizing the Commodity Futures Trading Commission's (CFTC) regulation of the commodity futures and options markets and their participants. The foundations of this act date back to 1922, when Congress brought agriculture futures into a modem regulatory ~tructure.~ The CEA generally requires that the trading of all futures contracts occur on a registered futures exchange3 under the exclusive jurisdiction of the CFTC.~ This regulatory structure originally was designed for traditional "open outcry" exchanges to ensure that futures trading occurred in specific physical locations under the watchful eye of a federal regulator. This regimented oversight also took aim at off-exchange "bucket shops," in which individuals would fraudulently solicit hds fiom customers for futures trading and then pocket, or "bucket," the money. Requiring that futures trading occur on a registered exchange among registered brokers greatly minimized this illegal activity. The statutory basis for federal regulation of futures trading recognizes that these transactions are "entered into regularly in interstate and international commerce" and provide "a means for managing and assuming price risks, discovering prices, or disseminating pricing information through trading in liquid, fair and financially secure trading fa~ilities."~ Based on this public mission, the CFTC is charged with responsibility for detecting and preventing price manipulation, ensuring the financial integrity of all transactions, protecting market participants fiom fraud and other abusive trading practices, and promoting responsible innovation and fair ~om~etition.~ These statutory purposes reflect the historic balance the CFTC must seek in preventing wrongful activity in the markets while encouraging fair competition and innovation in the industry. This philosophy is also reflected in the Commodity Futures Modernization Act of 2000 (CFMA), which significantly reformed the regulation of derivative^.^ This legislation * Walt Lukken currently serves as Senior Vice President of NYSE Euronext in its global legal department and formerly served as Commissioner and Acting Chairman, U.S. Commodity Futures Trading Commission from

2 amended the CEA to create a principles-based, tiered regulatory structure and design a more predictable and risk-based regulatory apparatus for derivative instruments, depending on the nature of the products being traded and the sophistication of the market participants. This regulatory structure was further amended by the recent passage of the CFTC Reauthorization Act as part of the Food, Conservation and Energy Act of 2008 (Farm Bill) and is likely to be significantly amended as a result of the recent financial crisis. CFMA'S TIERED REGULATORY DESIGN The CFMA provided a new regulatory structure for the futures exchanges and their participants. The law amended the CEA to lay out different tiers of regulation for exchanges, depending on the types of products being traded and the level of sophistication of the participants trading them. Futures on commodities of finite supply that are more susceptible to manipulation and are offered to the retail public, such as agricultural futures contracts, are more heavily regulated under the designated contract market"@cm) category.9 Those instruments that are less susceptible to manipulation and are offered only to sophisticated investors and institutions would benefit fiom a lighter regulatory touch under the derivatives transaction execution facility (DTEF) registration.10 The law also allowed exchanges that might otherwise qualify for an exclusion fiom the act to opt to be an exempt board of trade (EBOT), the lowest tier of regulation by the CFTC." The intent behind the tiered regulatory structure was to allow exchanges as well as market participants to innovate more rapidly to meet competitive challenges while enabling the CFTC to tailor its regulatory focus to those areas requiring greater government scrutiny.'2 The CFMA transitioned the regulatory structure of the CFTC fiom a rules-based approach to one using principles and guidance, establishing the CFTC as the first U.S. federal financial regulator to adopt this structure. Instead of specifying the means for achieving a specific statutory mandate, the CFMA set forth core principles that are meant to allow participants in these markets to use different methodologies in achieving statutory requirements. In fleshing out these core principles, the law allowed the CFTC to issue "best practice" regulations for complying with the core principles and allowed the CFTC to a prove such acceptable business practices as are submitted to the CFTC for consideration.' The CFTC ultimately retains the authority to approve such practices and also may develop guidance of its own accord. The CFMA also provided exchanges with authority to approve new products and rules through a self-certification process.14 In self-certifying a new rule or product, the exchanges must provide the CFTC with a written declaration that the new contract or rule complies with the act and the CFTC9s regulation^.'^ The CFMA also reserved for exchanges the ability to request CFTC approval of a new rule or contract prior to becoming effective.16 The CFMA further required prior agency approval for rule amendments that materially affect futures on enumerated agricultural c~mmodities.'~ These changes were seen as necessary to allow exchanges the ability to react quickly to the competitive challenges anticipated by the CFMA.'~

3 The CFMA required for the first time that clearinghouses receive their own separate designation as derivatives clearing organizations (DCOs) before providing clearing service^.'^ Like exchanges, DCOs must abide by a separate set of core principles tailored to the specific risks associated with these en ti tie^.^' The CFMA also enabled registered DCOs to clear excluded over-the-counter (OTC) derivatives in an effort to reduce counterparty and systemic risks for these transaction^.^' In 2002, following the demise of Enron, the New York Mercantile Exchange (NYMEX) sought and received approval from the CFTC to clear OTC energy products for the first time. Today, a number of OTC energy derivatives are cleared through regulated clearinghouses, which has reduced systemic risk and allowed regulators a greater window into this marketplace. Clearing for OTC products now extends beyond energy products to financial products such as credit default swaps, forward rate agreements, and foreign currency swaps. And the financial crisis is likely to bring a significant amount of standardized OTC derivatives onto clearinghouses either by regulatory mandate or natural market forces. CFMA'S STATUTORY EXCLUSIONS FOR CERTAIN OTC DERIVATIVES As amended by the CFMA in 2000, the act excludes certain OTC derivatives products from the CFTC's jurisdiction based on the nature of the underlying commodity and the types of participants in the markets. The economic functions of OTC derivatives and futures contracts are similar, as both seek to transfer undesired economic risk from one party to another willing to accept it. However, when the CFMA was designed, many OTC derivativesunlike standardized futures contracts-were not traded on registered htures exchanges, had individually tailored terms, and were privately designed and brokered for sophisticated counterparties by sophisticated financial institutions. Prior to the CFMA, the requirement that futures contracts be traded on-exchange created a degree of uncertainty about the legality of these off-exchange OTC instruments, causing potential systemic risk concerns among policy makers. To address this situation, and based largely on recommendations of the President's Working Group on Financial Markets (PWG), 22 Congress enacted in the CFMA several statutory exclusions from CFTC oversight for certain OTC derivatives. In determining whether the CFTC should have regulatory authority, the CFMA looked to whether the products are being traded by retail customers, whether the products are susceptible to price manipulation, and whether the participants are not otherwise regulated. The CFMA incorporated this approach in several provisions. In the highly liquid financial marketplace, the CFMA excluded from the CFTC's jurisdiction financial products that are traded among large andlor regulated entities, defined as eligible contract participants (ECPs), as long as the trades are not transacted on an exchange-like trading facility.23 The definition of ECPs includes financial institutions, insurance companies, investment companies, commodity pools, corporations, pension plans, governmental entities, broker-dealers, futures commission merchants, floor brokers and traders, and individuals with total assets in excess of $10 million.24

4 The CFMA also excluded fiom CFTC oversight financial products traded on an electronic trading facility if the transactions are entered into on a principal-to-principal basis by ECPS.~' In addition, the CFMA excluded fiom CFTC jurisdiction the electronic trading facilities upon which these products are traded?6 Electronic exchanges were thought to be less susceptible to wrongdoing due to the real-time audit trail created by these entities. By prohibiting brokered trades as a condition to this exclusion, it was believed that participants trading for their own accounts would be more responsible for their actions and subject to greater market discipline?7 The CFMA further excluded hybrid instruments that are predominantly securities, providing a four-part test for determining whether transactions qualify for the exclusion.28 In addition, the CFMA excluded individually negotiated nonagricultural swaps that are entered into by ECPs and not executed on an exchange-like trading facility.29 This provision, which arguably overlaps with other exclusions and exemptions contained in the CFMA, was meant to ensure that conventional bilateral OTC swaps were outside the jurisdiction of the CFTC. As a final legal certainty measure, the CFMA provided that OTC derivatives transactions among ECPs should not be void simply due to a failure of one of the conditions of the exclusion.30 This language aimed to ensure that institutions would not walk away fiom their OTC obligations due to a technical contractual defect. SECURITY FUTURES PRODUCTS The CFMA also lifted the statutory ban on security futures products (SFPs), which had been in place since 1983, and provided a joint regulatory framework between the Securities and Exchange Commission (SEC) and CFTC for allowing the trading of these instruments. The CEA provides the CFTC exclusive jurisdiction over futures on broad-based security in dice^.^' For futures on single securities or narrow-based indices, known collectively as SFPs, the CFMA provided the CFTC and SEC with joint jurisdiction over these instruments as both futures and securities.32 The CFMA and subsequent regulations defined "narrowbased security index" to mean an index that has nine or fewer securities or in which the component securities are weighted in a m&er that could allow the manipulation of a single or small group of securities within the index.33 To avoid duplicative regulation, the CFMA established a system of "notice registration" under which trading facilities and intermediaries that are already registered with either the CFTC or the SEC may register on an expedited basis with the other agency for the limited purpose of trading SFPs. Such notice-registered entities are fully regulated by the primary regulator and subject to limited regulatory requirements imposed by the secondary notice regulator. The trading of SFPs has met with limited success in the United States. The CFMA grandfathered existing equity futures contracts that were trading at the time of its enactment, including several foreign security index futures contracts. This statutory provision was reflected in a June 2002 order issued by the agencies, allowing existing futures on foreign security indices to continue trading in the United States. For non-grandfathered foreign products, the CFMA set a deadline for the SEC and CFTC to develop joint rules for futures on foreign broad-based security index products by December 21,2001. It also

5 provided that the agencies develop joint rules on foreign narrow-based products. As of the date of publication, the agencies have yet to issue joint rules on these foreign products. In March 2008, the CFTC signed a mutual cooperation agreement with the SEC to establish a closer working relationship between the agencies, establish a permanent regulatory liaison between the agencies, provide for enhanced information sharing, and establish several key principles guiding the agencies' consideration of novel derivative products that may reflect elements of both securities and commodity futures or options.34 This agreement led to the expedited, coordinated approval of the trading and clearing of several novel derivative products (futures and option contracts based on shares of certain exchange-traded funds), an outcome expected to enhance legal and regulatory certainty for users of these novel products. RETAIL FOREIGN CURRENCY FRAUD Prior to the CFMA7s enactment, the CEA excluded certain foreign currency transactions from CFTC jurisdiction as long as they did not involve contracts for future delivery "conducted on a board of trade." This ambiguous statutory language, known as the Treasury Amendment because it had been inserted at the behest of the Department of Treasury during the CEA7s enactment in 1974, had been subject to conflicting judicial interpretations that made it difficult for the CFTC to bring fraud actions against off exchange foreign currency futures scams aimed at retail customers.35 To clarify this jurisdictional uncertainty, the CFMA adopted language generally excluding from the CFTC's oversight foreign currency transactions not transacted on a registered futures exchange. However, where off-exchange retail foreign currency futures or options transactions are offered, the CFMA clarified that the CFTC does have jurisdiction unless the offering firm is an "otherwise regulated" entity (such as a bank, a broker-dealer, a financial or investment bank holding company, or an insurance company). The CFMA Wher clarified that the CFTC's antifraud authorities apply to off-exchange foreign currency transactions that futures commission merchants (FCMs) and their affiliates enter into with retail customers. These changes temporarily plugged the loophole that had allowed off-exchange retail foreign currency bucket shops and boiler rooms to flourish. Since 2000, the CFTC has used this authority to aggressively pursue retail foreign currency fraud through enforcement actions and cooperation with local, state, and federal criminal authorities. In 2004, however, the Seventh Circuit Court of Appeals curtailed the CFTC's ability to combat retail off-exchange foreign currency fraud in the Zelener decision.36 The court held that the contracts at issue in that case were not futures contracts, rejecting the CFTC's multifactor test for such determinations, and found that the transactions were a type of rolling spot contract not subject to the CFTC's jurisdiction. Likewise in 2008, the Sixth Circuit Court of Appeals in the Erskine case followed the Zelener reasoning in limiting the CFTC's ability to combat retail foreign currency While both decisions concluded that fraud clearly had been committed, the courts dismissed the cases as not properly within the CFTC's jurisdictional reach. As will be discussed, the CFTC Reauthorization Act of 2008 amended the CFTC's authority over retail foreign exchange (forex) transactions to address many of these issues.

6 EXEMPT COMMERCIAL MARKETS Exempt commercial markets (ECMs) have been the subject of considerable public attention recently given historic high prices in the energy sector in In 2000, the CFMA provided legal and regulatory certainty for certain exempt OTC commodity transactions and markets. The CFMA defined "exempt commodity" as a commodity that is "not an excluded commodity or an agricultural commodity."38 In the CFMA, this exemptive language stated that nothing in the act applies to a transaction in an exempt commodity, which is entered into by ECPs and not traded on a trading facility,39 except that the CFTC retains certain antifraud and anti-manipulation authorities over these exempt transaction^.^^ In addition, the CFMA provided an exemption from the CFTC's jurisdiction, found in 2@)(3) of the CEA, for transactions in exempt commodities traded on an electronic trading facility as long as they are entered into on a principal-toprincipal basis among eligible commercial entities (ECES).~' An eligible commercial entity is generally defined as an ECP that is either a large dealer or a commercial participant in the commodity business.42 As part of the 2(h)(3) exemption, the transactions are subject to certain antifraud and anti-manipulation authorities of the CFTC.~~ The conditioned exemption also requires an ECM relying on the exemption to notify the CFTC of its intention to operate and the names of its owners; to describe the types of commodity categories being traded; to identify its clearing facility, if any; to certify that the facility will comply with the terms of the exemptions; and to certify that the owners of the trading facility are not otherwise statutorily disqualified under the act.44 The ECM has six other requirements; it must: 1. Either provide the CFTC with real-time access to its trading system and protocols, or provide the CFTC with reports on specific trading positions. 2. Maintain books and records for five years. 3. Agree to provide the CFTC with specific information on a special call basis. 4. Agree to submit to the agency's subpoena authority. 5. Agree to comply with all applicable laws and require the same of its participants. 6. Not represent that the facility is registered or in any way recognized by the CFTC.~' CFTC REAUTHORIZATION ACT OF 2008 On May 22,2008, the CFTC Reauthorization Act of 2008 was enacted into law, making improvements to the CEA and the CFTC's authority. The new legislation reauthorized the CFTC through FY 2013, closed the so-called Enron Loophole by allowing enhanced CFTC oversight of ECMs that trade contracts linked to regulated U.S. futures contracts, increased CFTC penalty authority for manipulation and false reporting, clarified the CFTC's antifraud authority for off-exchange principal-to-principal energy trades, and clarified the CFTC's retail foreign currency antifraud authority. The collapse of Enron and the implosion of the Amaranth hedge fund highlighted certain regulatory gaps that had developed in the energy trading sector--commonly known as the Enron Loophole-and the potential need for additional regulatory authorities over OTC

7 energy transactions. Based on a CFTC study and report on ECMs in the fall of 2007, 46 Congress amended the CFTC's authorities for ECMs as part of the Farm Bill. Congress provided that, upon a determination by the CFTC that an ECM futures contract serves a significant price discovery function, the CFTC has four additional authorities: 1. To require large trader position reporting for that contract 2. To require an ECM to adopt position limits or accountability levels for that contract 3. To require an ECM to exercise self-regulatory responsibility over that contract in preventing manipulation 4. To exercise emergency authority (along with the ECM) over that contract On March 23,2009, the CFTC finalized its rules and regulations for these new ECM authorities. To date, the CFTC has filed over 30 notices to ECM alleging that certain contracts are serving a significant price discovery process. In addition, based largely on the recommendations of the PWG, the new authority requires those who participate in the solicitation of retail forex transactions to register with the CFTC. It also closes the loophole that allowed firms to notice register with the SEC as securities broker-dealers-under the CFMA's SFP provisions-and then serve as counterparties to retail off-exchange forex transactions. Lastly, the legislation bolstered the CFTC's enforcement authority over retail off-exchange forex transactions like those in dispute in the Zelener and Erskine cases and required entities that serve as dealers in these markets to maintain $20 million in capital. These amendments to the CEA are designed to strengthen the CFTC's enforcement powers against fraudulent retail foreign currency activity, and CFTC rulemakings for these provisions are expected in mid POST-CRISIS LEGISLATIVE REFORMS In wake of the 2008 financial crisis, the Administration and Congress have proposed broad reform of the regulatory structure of derivatives, which would significantly alter many of the provisions of the CFMA.~~ There appears growing consensus that several of the assumptions of the PWG report on OTC derivatives fiom 1999, on which the CFMA was based, may not have held up during the crisis, including the assumption that large firms can self-police their activities in the OTC derivatives markets. Due to the large size and inter-connected nature of many commercial and investment banks that entered into complex financial products, market discipline broke down during the crisis, causing many of the OTC derivatives markets to freeze up and falter. At the same time, liquidity on exchanges and clearinghouses hit record levels as investors sought transparent pricing and the counterparty guarantees of clearing. This experience has led policy makers to believe that an exchange-traded and central clearing model might prove beneficial for the OTC derivatives infrastructure as well. As a result, all major financial reform proposals include a common framework of bringing standardized derivatives onto regulated trading facilities and clearinghouses. These proposals would repeal the DTEF designation in section 5(a) of the CEA, the exempt board

8 of trade category in section 5(d) of the CEA and the exempt commercial market designation in section 2(h) of the CEA, as enacted in the CFMA, and replace them with an Alternative Swap Execution Facility (ASEF) designation for institutional markets subject to several core principles of regulation, thus flattening the tiered regulatory structure created by the CFMA. These proposals would require non-cleared derivatives to report their trades to either regulatory authorities or a regulated trade repository. In addition, swap dealers and major swap participants would be required to register and become subject to prudential regulation by functional regulators, including requirements for higher capital and margin, client fund segregation, business conduct, reporting, disclosure and audit trails. With the merger of the CFTC and SEC taken off the table by the Administration earlier this year, the legislative proposals largely divide the jurisdiction of OTC derivatives between the SEC and CFTC along historical lines of the Shad-Johnson accord with security-based swaps going to the SEC and non-security-based swaps falling to the CFTC. The proposals also provide the CFTC and SEC the ability to set position limits on the swaps under their respective jurisdictions, all of which perform a significant price discovery function. In implementing many of these provisions, the SEC and CFTC would either be given joint rulemaking authority or highly-coordinated individual rulemaking abilities. Regulated exchanges and clearinghouses could become subject to a newly-created systemic risk regulator or council if they are determined to be systemically important under the various pieces of legislation. Such determination could trigger leverage ratios, liquidity provisions, credit concentrations, enhanced capital, additional reporting and disclosures and risk management requirements, including the need for an institutional living will. The threat to exchanges and clearinghouses of duplicative regulation is high if the primary functional regulator and the systemic risk regulator do not coordinate these regulatory efforts. The systemic risk regulator would also have the unprecedented authority to pre-approve acquisitions of systemically important firms and to sell assets and break up systemically important firms if their size or activities pose a threat to the firm itself or to the broader U.S. economy. While the broad framework of the CFMA would remain intact post enactment of any reform legislation, many of its provisions would be repealed or diluted. The tiered regulatory fiamework will likely be flattened from several designations to two: DCM and ASEF. Legislative proposals also pull back on the rule and product certification process, requiring additional information from exchanges and providing the CFTC the ability to disapprove or delay such certifications more easily. While the principles-based approach to regulation is maintained under these proposals, some of the bills provide the CFTC the authority to designate its rules as the exclusive means for compliance with a core principle, thus diminishing the flexibility of this approach. In conclusion, as policymakers make headway on financial regulatory reform in early 201 0, opportunities exist to improve the infrastructure for financial services products to reflect the risks of these transactions to investors, firms and the U.S. economy. However, the threat of

9 over-regulation is significant, given the lack of trust with the financial sector in general. Legislators must be careful not to enact provisions that drive these transactions away from the transparency of regulated markets in an effort to punish Wall Street. Such a result would run counter to one of the clear lessons of the crisis: that the exchange-traded and cleared model should be encouraged for the transparency, stability and market integrity that such model provides. ENDNOTES 1. Commodity Exchange Act, 7 U.S.C (1994 & Supp. 2003). 2. The original act, known as the Grain Futures Act, was enacted September 21, In 1936, the amendments to the act changed the name to the Commodity Exchange Act and broadened the agricultural commodities covered by the law. 3. CEA 4(a). 4. Id. 2(a)(l)(A). See also Chicago Mercantile Exchange v. SEC, 883 F.2d 537 (7th Cir. 1989). 5. CEA Id. 7. Commodity Futures Modernization Act of 2000, Pub. L. No ,114 Stat (December 2 1,2000). 8. The Food, Conservation and Energy Act, Pub. L. No , 122 Stat (June 2008). 9. CEA Id. 9 5a. 11.Id. 9 5d. 12. At the end of 2007, there were 12 DCMs and 8 EBOTs. To date, there have been no DTEFs. 13. CEA 3 5c(a). 14. Id. 5c(c). 15. Id. 3 5c(c)(l). 16. Id. 5c(c)(2)(A). 17. Id. 5 5c(c)(2)(B). 18. Others have recognized the potential competitive benefits of the self-certification process for the securities industry. See the Department of the Treasury Blueprint for a Modernized Financial Regulatory Structure, March 2008 at 116; available at: CEA 5b. At the end of 2007, there were 11 DCOs. 20. Id. 5b(c)(2) Id. 5b(b). 22. Report of the President's Working Group on Financial Markets: Over-The-Counter Derivatives Market and the Commodity Exchange Act, November 1999 (PWG Report). 23. CEA 2(d)(l). 24. Id. la(12). 25. Id. 2(d)(2). 26. Id. 3 2(e). 27. See PWG Report at CEA 2(f). 29. Id. 2(g). 30. Id. 22(4) Id. 9 2(a)(l)(C)(ii). 32. Id. 2(a)(l)(D)(i). 33. Id. 9 la(25). 34. See u pdf. 35. See, e.g., CFTC v. Frankwell Bullion Ltd., 99 F.3d 299 (9th Cir. 1996). 36. CFTC v. Zelener, 373 F.3d 861 (7th Cir. 2004).

10 37. CFTC v. Erskine, 512 F.3d 309 (6th Cir. 2008). 38. CEA la(14). 39. Id. 2(h)(l). 40. Id. 3 2(h)(2)(B). 41. At the end of 2007,19 ECMs had notified the CFTC of their intention to rely on the 2(h)(3) exemption. 42. Id. la(l1). 43. Id. 3 2(h)(4). 44. Id. 2(h)(5). 45. Id. 46. See e crnreport.pdf. 47. Legislative proposals include: Legislative Language from U.S. Treasury Department's Financial Regulatory Reform, A New Foundation on OTC Derivatives, August 11,2009; the Over-the-counter Derivatives Market Act of 2009, passed by the House Financial Services Committee on October 15,2009; the Derivatives Markets Transparency and Accountability Act of 2009, passed by the House Committee on Agriculture; the Financial Stability Improvement Act of 2009, released by the House Financial Services Committee on October 29,2009; and the Restoring American Financial Stability Act of 2009, revised by Senator Dodd on November

11 REPORT The Journal on the Law of Investment & Risk Management Products Futures & Derivatives Law November 2008 n Volume 28 n Issue 10 Are Customer Segregated/Secured Amount Funds Properly Protected After Lehman? By: Ronald H. Filler Ronald H. Filler is a Professor of Law and the Director of the Center for Financial Services Law at New York Law School. He was formerly a Managing Director in the Capital Markets Prime Services Division at Lehman Brothers Inc., has served on several DCO, governmental, exchange and industry boards and advisory committees, and is a member of the Board of Editors of the FDLR. The short answer is yes for the most part with respect to customer assets held in a customer segregated account in the United States but major changes to the procedures and policies now in place are needed to provide greater customer protection safeguards, especially in connection with assets held outside the United States in CFTC Regulation secured amount accounts, regarding trading on non-u.s. futures exchanges. Most mystery authors normally wait until the last few pages of the last chapter to provide the final clues and solve the mystery. This is, however, a different mystery story even if it s filled with suspense, exciting themes and horror. And for those who do not believe that the role that segregated and secured amount funds play in today s global futures markets is not mysterious and challenging, then they must have slept through the period of the last two weeks in September and most of October. What we all believed were the rules to be applied in the event of an FCM s bankruptcy were all interpreted differently by the various global exchanges and clearing houses. Some clearing houses, like EUREX Clearing AG, LCH Clearnet SA, the CME Clearing House, ICE Clear US and The Clearing Corporation, acted admirably and professionally while others acted in a manner that was not necessarily in the best interests of futures customers. 2 This article will explain what many of us in the futures industry understand to be the role of customer segregated and secured amount accounts, then explain what occurred after Lehman Brothers Holdings Inc., the parent company of Lehman Brothers Inc. ( LBI ), filed for Chapter 11 protection and then provide several recommendations of best practices that this global industry should now consider. Since the brokerage firms today are truly global in their customer and product base, any future solution must be a global approach. CONTINUED ON PAGE 3 Article REPRINT Reprinted from the Futures & Derivatives Law Report. Copyright 2008 Thomson Reuters/West. For more information about this publication please visit thomson.com REPRINT ARTICLE

12 Futures & Derivatives Law Report 2008 Thomson Reuters/West. This publication was created to provide you with accurate and authoritative information concerning the subject matter covered, however it may not necessarily have been prepared by persons licensed to practice law in a particular jurisdiction. The publisher is not engaged in rendering legal or other professional advice, and this publication is not a substitute for the advice of an attorney. If you require legal or other expert advice, you should seek the services of a competent attorney or other professional. For authorization to photocopy, please contact the Copyright Clearance Center at 222 Rosewood Drive, Danvers, MA 01923, USA (978) ; fax (978) or West s Copyright Services at 610 Opperman Drive, Eagan, MN 55123, fax (651) Please outline the specific material involved, the number of copies you wish to distribute and the purpose or format of the use. For subscription information, please contact the publisher at: [email protected] Editorial Board Stephen W. Seemer Publisher, Thomson/Legalworks Carrie A. Petersen Publication Editor, Thomson/West Richard A. Miller Editor-in-Chief, Prudential Financial 751 Broad Street, 21 st Floor, Newark, NJ Phone: (973) Fax: (973) [email protected] Michael S. Sackheim Managing Editor, Sidley Austin LLP 787 Seventh Ave., New York, NY Phone: (212) Fax: (212) [email protected] PAUL ARCHITZEL Alston & Bird Washington, D.C. Geoffrey Aronow Heller Ehrman LLP Washington, D.C. Conrad G. Bahlke OTC Derivatives Editor Weil, Gotshal & Manges New York, NY Rhett Campbell Thompson & Knight LLP Houston, TX ANDREA M. CORCORAN Promontory Financial Group Washington, D.C. W. Iain Cullen Simmons & Simmons London, England Warren N. Davis Sutherland Asbill & Brennan Washington, D.C. Susan C. Ervin Dechert LLP Washington, D.C. Ronald H. Filler Lehman Brothers New York, NY Edward H. Fleischman Linklaters New York, NY Denis M. Forster New York, NY Thomas Lee Hazen University of North Carolina at Chapel Hill Donald L. Horwitz One Chicago Chicago, IL Philip McBride Johnson Skadden Arps Slate Meagher & Flom Washington, D.C. Dennis Klejna MF Global New York, NY Robert M. McLaughlin Katten Muchin Rosenman New York, NY Charles R. Mills Kirkpatrick & Lockhart Washington, D.C. David S. Mitchell Fried, Frank, Harris, Shriver & Jacobson LLP New York, NY Richard E. Nathan Los Angeles Paul J. Pantano McDermott Will and Emery Washington, D.C. Frank Partnoy University of San Diego School of Law Glen A. Rae Banc of America Securities LLC New York, NY Kenneth M. Raisler Sullivan & Cromwell New York, NY Richard A. Rosen Paul, Weiss, Rifkind, Wharton & Garrison LLP New York, NY Kenneth M. Rosenzweig Katten Muchin Rosenman Chicago, IL Thomas A. Russo Lehman Brothers New York, NY Howard Schneider MF Global New York, NY Stephen F. Selig Brown Raysman Millstein Felder & Steiner LLP New York, NY Paul Uhlenhop Lawrence, Kamin, Saunders & Uhlenhop Chicago, IL Emily M. Zeigler Willkie Farr & Gallagher New York, NY Futures & Derivatives Law Report West Legalworks 195 Broadway, 9th Floor New York, NY , Thomson Reuters/West One Year Subscription n 11 Issues n $ (ISSN#: ) Please address all editorial, subscription, and other correspondence to the publishers at [email protected] For authorization to photocopy, please contact the Copyright Clearance Center at 222 Rosewood Drive, Danvers, MA 01923, USA (978) ; fax (978) or West s Copyright Services at 610 Opperman Drive, Eagan, MN 55123, fax (651) Please outline the specific material involved, the number of copies you wish to distribute and the purpose or format of the use. West Legalworks offers a broad range of marketing vehicles. For advertising and sponsorship related inquiries or for additional information, please contact Mike Kramer, Director of Sales. Tel: [email protected]. This publication was created to provide you with accurate and authoritative information concerning the subject matter covered. However, this publication was not necessarily prepared by persons licensed to practice law in a particular jurisdication. The publisher is not engaged in rendering legal or other professional advice, and this publication is not a substitute for the advice of an attorney. If you require legal or other expert advice, you should seek the services of a competent attorney or other professional. Copyright is not claimed as to any part of the original work prepared by a United States Government officer or employee as part of the person s official duties Thomson Reuters/west

13 November 2008 n Volume 28 n Issue 10 Introduction With the demise of Bear Stearns Securities ( Bear ) in March 2008 and now the bankruptcy of LBI, many futures customers have raised serious questions and concerns regarding how and whether their funds held by a futures commission merchant ( FCM ) are protected under such circumstances. 3 Similarly, given the recent credit crisis, the government loans provided to American International Group ( AIG ), the acquisition of Merrill Lynch by Bank of America, the $700 billion bailout approved by Congress and numerous other financial-related matters, customers of broker-dealers ( BD ), insurance companies and banks have raised similar concerns. Not to underestimate the importance of insolvencies involving these other financial institutions, this article will only address the laws, regulations and policies that impact futures customers globally under such circumstances. 4 Rules Governing Futures Accounts at an FCM Substantial financial safeguards and customer protections exist within the futures industry that are designed to protect customer funds in the event of an FCM bankruptcy. Assets held in a futures account at an FCM are protected and governed specifically by applicable laws and CFTC regulations that require the segregation of cash and collateral deposited by customers in conjunction with their futures trading. Pursuant to the Commodity Exchange Act ( CEA ) 5 and applicable CFTC regulations 6, an FCM, must maintain its futures customer assets in at least two different types of customer fund accounts (e.g., segregated and secured amount accounts) and may use a third type (e.g., a non-regulated account), each of which have different priority rights in the event of the FCM s insolvency. The three types of customer fund accounts used by an FCM are: 1. SEGREGATED FUNDS: The first such account, established pursuant to Section 4d(a) (2) of the CEA 7 and CFTC Rule 1.20, is referred to as the customer segregated funds account. It holds the assets of all customers (U.S. and non-u.s.) deposited in conjunction with transactions on all U.S. futures markets. All customer assets are required to be held only in accounts maintained at custodial banks and other permitted financial institutions, including other FCMs and clearing houses that are registered with the CFTC as derivatives clearing organizations (DCOs). All customer segregated accounts are required to be clearly identified as segregated pursuant to CFTC Rule These segregated funds are not permitted to be commingled with the FCM s proprietary funds or used to finance its futures or broker-dealer businesses. The amounts held in the segregated funds accounts are calculated daily as required by CFTC Rule 1.32, and the FCM must take immediate action in the unlikely event that there is ever a shortfall in its segregated funds accounts. This daily calculation must be completed by each FCM by not later than noon on the next business day. However, the customer segregated required amount needs to be in a good control location 8 the night before. Otherwise, the FCM is deemed to be under segregated, and, if the FCM is under-segregated, this must be reported promptly to the CFTC and its respective DSRO. 9 Given this same-day deposit requirement, most large FCMs will deposit a large amount of their own capital in the customer segregated account to ensure that such accounts are never under-segregated. This capital infusion can amount to several hundred million dollars, depending on the total amount held in the segregation pool. 2. SECURED AMOUNT FUNDS: The second type of account, governed by CFTC Rule 30.7, is known as the customer secured amount account and holds the assets of U.S. residents deposited in conjunction with their transactions on non-u.s. futures markets. These funds are also required to be held in accounts at banks and other permitted financial institutions, including non-u.s. clearing houses and members of non-u.s. exchanges, 2008 thomson reuters/west 3

14 Futures & Derivatives Law Report provided such non-u.s. clearing houses and non-u.s. member firms are deemed to be a good secured location. Like segregated funds, secured amount funds are not permitted to be commingled with the FCM s proprietary assets and are calculated daily and represent 100% of that day s customer requirements. 10 FCMs are permitted to secure more than the minimum requirement stated above and can elect to deposit all funds used to trade on non-u.s. markets by all of its clients, including foreign domiciled clients. Like segregated funds as noted above, the calculation for the secured amount requirements must be completed by the following morning but the secured amount requirement must be deposited in a good secured location the night before or the FCM will be deemed to be in default. 11 As noted above with customer segregated accounts, most large FCMs will also deposit their own capital in a secured amount account to prevent any under-funding from occurring 3. NON-REGULATED FUNDS: The third type of account, called the Non-Regulated Customer Credit calculation, contains the assets (cash and open trade equity) of non- U.S. customers deposited in conjunction with transactions on non-u.s. futures markets if such amounts are not included in the secured amount account as noted above. 12 An FCM, also registered as a broker-dealer, may use this third account type, which is governed by Securities and Exchange Commission ( SEC ) Rule 15c3-3. The amounts held in this account reflect the total of the credit balances calculated for each individual account owed by the FCM to its non-u.s. customers for transactions on non-u.s. futures markets less any deposits of cash or securities held with a clearing organization or correspondent clearing broker. 13 Any amounts held in a non-regulated account are not covered by the provisions of the Securities Investor Protection Act ( SIPA ). Each bucket, noted above, contains funds used by customers to margin the relevant futures products, with the difference being whether the futures products are traded on U.S. or non-u.s. futures markets and, for non-us markets only, whether the customer is a U.S. or a non-u.s. entity. In addition to the segregation and secured amount requirements, CFTC regulations restrict where client funds may be placed. CFTC Rule 1.20 requires the FCM to maintain customer segregated funds, whether in the form of cash or collateral, either with a clearinghouse of a U.S. futures exchange registered with the CFTC as a DCO, in a customer segregated account with a bank or with another FCM. In connection with its custodial arrangement, the FCM must obtain what is known as a segregation acknowledgement letter, commonly known as a seg. waiver letter, in which the respective custodial bank or FCM acknowledges and agrees that all assets deposited in this segregated account are for the sole benefit of the FCM s futures customers and are not subject to the claims of any of the FCM s creditors, including that bank or FCM, respectively. Similar letters must also be obtained for the Rule 30.7 secured amount account and the Rule 15c3-3 non-regulated account at the respective custodial bank. All customer assets are therefore held at all times in these accounts at the respective custodial bank or FCM, in accounts at the various clearing houses or with other clearing brokers that act as clearing brokers on the various exchanges around the globe on behalf of the FCM. RECOMMENDATION #1: While the CFTC does not specifically require the use of non-regulated accounts, as this is primarily an SEC requirement for broker-dealers, the CFTC should now prohibit the use of non-regulated accounts by an FCM, that is also registered as a broker-dealer, and require that all funds held by an FCM to margin non-u.s. futures, whether they be for the benefit of a U.S. customer or a non-u.s. customer, be held in a 30.7 Customer Secured Amount Account. This prohibition will prevent any misappropriation of futures customer funds held in a 15c3-3 account as such accounts could arguably be deemed to fall outside the protections afforded by CFTC regulations 1.20 and Thomson Reuters/west

15 November 2008 n Volume 28 n Issue 10 An FCM is also required by CFTC regulations to properly account for and calculate on a daily basis both the amount that it is required to hold in segregation and the amount that actually is in its customer segregated accounts. 14 Any deficiencies in the amounts required must be remedied and reported immediately to the appropriate regulators. Most large FCMs deposit a substantial amount of their own capital in the customer segregated account to provide excess funds in the event a futures customer does not timely meet its margin requirements. This capital infusion may also be used to satisfy customer claims in the event of the FCM s insolvency. Similarly, to provide additional protections to its customers, the FCM must report, in accordance with applicable CFTC regulations, to the appropriate regulators within 24 hours if its net capital falls below the early warning level and must promptly add additional capital to bring its net capital above this level. 15 In the event of the FCM s bankruptcy, 16 futures customer assets are normally protected except as described below. First, assuming no material futures customer-related default exists or was the cause of the FCM s bankruptcy (e.g., the insolvency was the direct result of a non-futures customer or transaction), a bankruptcy filing should have no material impact on customers assets held in the three aforementioned accounts. Under such circumstances, each account should contain 100% of the required amounts and should be transferred back to customers in an orderly fashion. An FCM bankruptcy would be administered under Chapter 7 of the U.S. Bankruptcy Code, which contains specific provisions for the protection of customers in the event of an FCM s insolvency. Under Part 190 of the CFTC s rules, the bankruptcy trustee would have the responsibility of returning the custodied assets back to each futures customer. Creditors of the FCM s bankrupt estate would have no claim to any of the assets held in these three accounts. The assets would be held solely for the benefit of the FCM s futures customers. If, on the other hand, the FCM s bankruptcy resulted from a futures customer s failure to deliver the required margin for its futures trading positions, and the default was greater than all of the shareholder equity of the FCM, then each of the three accounts held at the custodian bank (or an FCM) would be treated independently of each other. Customers assets held in one of these three accounts may not be used to satisfy any shortfalls in another account (e.g., the amounts held in the segregated account at the respective custodial bank or at a DCO may not be used to cover a shortfall held in the non-regulated account). However, as noted in greater detail below, a clearing house, including a DCO, may apply a clearing member firm s customer assets that are on deposit with that respective clearing house to satisfy margin amounts owed to the clearing house by that clearing member firm (and that clearing member firm only) for its customer accounts. In other words, customer assets held by a clearing house may not be used to cover a shortfall in the FCM s house account nor may assets held at one clearing house be applied to cover a shortfall at another clearing house unless a cross-margining arrangement exists with respect to the two clearing houses. The assets of an FCM s futures customers, which trade on the U.S. futures markets, are normally wired directly by those customers into the customer segregated account at the respective custodial bank. The custodian bank would typically maintain different segregated accounts to hold cash and any non-cash collateral, such as U.S. Treasury bills, respectively. This firewall between the bank and the FCM provides important protections to the FCM s futures customers. As noted above, the assets held in these accounts at the bank do not fall within the bankrupt estate and are reserved for payment to customers if the FCM files for bankruptcy. If the bank mishandles futures customers assets held with the FCM, its full shareholder capital should stand behind the accounts. If the FCM is required by an exchange to send cash or collateral to a DCO to meet its customers initial or variation margin requirements, the required amounts are typically sent via wire transfer from the customer segregated account at the respective custodial bank or FCM to another customer segregated account held in the name of the DCO for the benefit of the FCM s futures customers. Therefore, at all times, assets of the FCM s fu thomson reuters/west 5

16 Futures & Derivatives Law Report tures customers, who trade on U.S. futures markets, are held in a customer segregated account at the FCM s or the DCO s custodial bank. Similarly, assets that need to be transferred to clearing brokers or clearing houses outside the U.S. are also sent directly from the 30.7 Secured Amount Account at the bank to the required good secured location. Investments of Futures Customer Assets There are also customer protections relating to the types of permissible investments that an FCM may make with customer assets held by the FCM. Pursuant to CFTC Rule 1.25, the FCM is permitted to invest its futures customers assets in a limited number of permissible investments. 17 In today s marketplace, the most commonly used investment product are money market mutual funds that meet the requirements of CFTC Rule 1.25 and SEC Rule 2a-7 under the Investment Company Act of 1940 (the 1940 Act ). However, any investment loss that may be incurred as a result of such investment must be borne solely by the FCM; its futures customers assume no such investment risk. 18 This concern has been heightened recently by The Reserve Fund which lost a substantial amount of its investment assets through its purchase of commercial paper held in the name of Lehman Brothers and AIG, causing the fund to break the buck. 19 Also, the FCM must receive an acknowledgement from each money market fund that the amounts invested by the FCM on behalf of its customers with the respective money market fund may not be applied to any creditor of the FCM. This is similar to the segregation acknowledgement letter received by FCMs from their custodial banks, as noted above. RECOMMENDATION #2: Given the recent issues that have arisen with respect to money market funds as well as other investments that are permissible under CFTC Regulation 1.25, the CFTC should review CFTC Regulation 1.25 and U.S. clearing houses should review their respective rules regarding deposits made by their clearing member firms, such as the IEF2 Program at the CME Clearing House, to determine what changes, if any, are now needed to these regulations and programs. In particular, they should codify that any FCM or clearing member firm that invests in money market funds or other permissible investments under CFTC Regulation 1.25 on behalf of their futures customers will be held liable for any losses that may occur from such investments and should consider setting guidelines relating to such investments. For example, one such guideline, a portfolio diversification guideline, may state that no FCM should invest more than a particular percentage of its customer assets in any one money market fund or other permissible investment. Also, the money market funds that can be used for such investments by FCMs should be required to accept redemptions on a daily basis and pay such redemption proceeds within a certain time frame, e.g., 24 hours, with only one exception permitted, that is, to do so would cause the fund to break the buck. Good Risk Management Practices The risk management disciplines applied by FCMs and other participants in the futures industry are another significant source of customer protection. To provide the greatest protection to its futures customers, the FCM must exercise a strong risk management practice. This requires establishing a proper trade or credit risk amount for each of its client futures accounts, monitoring such levels frequently and receiving current on-going financial information from each futures customer. This is especially true for those customers who trade an account (or a combination of accounts pursuant to an aggregation concept) that results in a large percentage of the open interest of any single commodity being owned or controlled by a client. Also, while a DCO normally sets adequate and proper initial margin levels, typically involving a one day, two standard deviation test, an FCM should also analyze each of its large futures customers, especially those, as noted above, who hold positions that represent a large percentage of the open interest, and apply a more conservative variation risk ( VAR ) or standard deviation ( SD ) analysis, such as a five day, two SD test, on a daily basis Thomson Reuters/west

17 November 2008 n Volume 28 n Issue 10 If one of the FCM s customers were to fail to meet its margin requirements in a timely manner, which is typically a T+1 standard, 20 that FCM would be required to step in and use its own capital to ensure that other customers are not affected and to satisfy that FCM s obligations as a clearing broker. As noted above, most large FCMs maintain a significant amount of their own capital in the customer segregated and secured amount accounts to provide a first line of protection in the event a customer fails to meet its daily margin requirements. Applicable laws and regulations prohibit that FCM from using the assets of its other, non-defaulting futures customers to meet the obligations of a defaulting client. However, as noted above, this does not prevent a clearing house from applying assets held in a clearing member s customer segregated fund account to cover any deficit that may result from a shortfall in the customer segregated account held on the books of that clearing house. Role of a DCO DCOs also impose important financial safeguards that are intended to ensure financial safety to the markets. Let s assume, for purposes of this article, that the FCM and its foreign affiliates are a clearing member of most of the major global futures exchanges. The exchange clearing house (referred to in the U.S. as a DCO) stands as the guarantor between its clearing members and represents the buyer and seller of every futures contract ( the buyer to every seller and the seller to every buyer ). As such, the clearing houses establish and enforce strict financial requirements for their clearing members to minimize the likelihood of, and the consequences of, a default by one of the parties to a futures transaction. In the event of a default by a clearing member, the following resources are typically available to a DCO. First, the exchange memberships and shares held by a defaulting clearing member and all the margin supporting the positions held in its house account at the clearing house may be used to cover any shortfall in that clearing member firm s customer segregated funds account at the clearing house. Second, each clearing house requires its clearing members to make deposits to the clearing house s Guaranty Fund, also known as a Surety Fund, to provide additional, back-up capital protections to the clearing house in the event of a customer default. The amount deposited by each clearing member firm typically is based on a formula based on the volume and overnight margin requirements maintained by that clearing member firm. At the CME Clearing House, the Guaranty Fund currently totals approximately US$1,800,000,000. Third, in the unlikely event that a clearing member were to default and the proceeds held in the Guaranty Fund were used to cover a shortfall, the DCO will immediately take steps to restore its Guaranty Fund to predefault levels. (For example, the CME Clearing House can require other, non-defaulting clearing member firms to increase their Guaranty Fund deposits by as much as 2.75 times the amount of their security deposits to restore the Fund to pre-default levels.) In its history, no CME clearing member firm has ever defaulted but these safeguards are designed to provide financial protections even in times of significant stress in the financial markets. These protections are further buttressed by the customer margin requirements that are established by the futures exchanges and by the exchanges own market surveillance and financial surveillance programs, all of which provide important customer protections to futures customers. Net Capital Requirements Another customer protection are the financial net capital requirements imposed on all brokerage firms, including FCMs. The minimum adjusted net capital requirement, from an accounting perspective, reflects an amount that equals the total of the current liquid assets on the books of the FCM in excess of the total amount of its liabilities. Most large brokerage firms today are registered as both an FCM and as a BD. 21 Pursuant to CFTC Rule 1.17, the firm must maintain adjusted net capital that is equal to or greater than the sum of customer (8%) and noncustomer (4%) required margin requirements. In the event that the net capital amount determined pursuant to CFTC Rule 1.17 is greater than the 2008 thomson reuters/west 7

18 Futures & Derivatives Law Report amount required under SEC Rule 15c3-1, the firm must meet the greater of these two amounts. In determining its minimum net capital requirements pursuant to the applicable regulations noted above, the firm s assets must be valued conservatively, with most financial assets having their value discounted, using value at risk or scenario analysis, to provide a conservative assessment of their market value. Reporting Requirements Under applicable rules, a broker-dealer/fcm must provide the SEC, the CFTC, FINRA, the National Futures Association ( NFA ) and its designated examining authority and its designated selfregulatory organization (DSRO) (for most large U.S. brokerage firms, this would be FINRA in their broker-dealer capacity and the CME in their FCM capacity) with same-day notice if its regulatory capital drops below the early warning level (a multiple of the net capital requirements mandated by SEC Rule 15c3-1 and CFTC Rule 1.17). Similarly, if at any time the firm s regulatory tentative net capital declines by 20% or more from the last month-end, that firm must, in accordance with applicable SEC and CFTC regulations, immediately notify these regulators regarding this change. The early warning requirements effectively provide an advance indication of potential financial stress that a broker-dealer/fcm may incur and are set significantly above the level at which a broker-dealer/fcm must maintain its minimum net capital requirements. The Lehman Events On September 15, 2008, Lehman Brothers Holdings Inc. ( LB Holdings ), the holding company of all Lehman Brothers entities and the publicly-traded company (NYSE symbol: LEH) filed a petition for bankruptcy under Chapter 11 of Title 11 of the U.S. Bankruptcy Code with the U.S. Bankruptcy Court for the Southern District of New York. 22 Its principal U.S. subsidiary, Lehman Brothers Inc. ( LBI ), a registered broker-dealer and FCM, did not file its petition (a Chapter 7 filing) until the following weekend. The principal U.K. affiliate of LB Holdings, Lehman Brothers International (Europe) ( LBIE ), also submitted its filing on September 15 th. The U.K. Financial Services Authority ( FSA ) appointed Price Waterhouse Coopers ( PWC ) as the Administrator for LBIE. This is similar to the role of a trustee in bankruptcy had LBI made such a filing. LBI had opened a Customer Omnibus Account on the books of LBIE to permit LBI futures customers to trade on the various European exchanges. LBIE was either directly a general clearing member firm ( GCM ) on the clearing houses in Europe, such as LCH Clearnet SA and EUREX Clearing AG, or had established their own customer omnibus accounts on the books of a third party clearing firm on other European exchanges. LBI was the clearing member firm on the U.S. futures exchanges and had opened a futures customer omnibus account with other Lehman Brothers affiliates or third party clearing firms in Canada and Asia. LBIE had opened a customer omnibus account on the books of LBI to allow its futures customers to trade on the U.S., Canadian and Asian markets. All futures customer accounts were opened with either LBI or LBIE. 23 Note that LBIE had many direct futures accounts opened on its books, including some accounts, especially hedge fund accounts, that involved a prime brokerage and cross margin netting arrangement. LBI had similar arrangements with hedge funds on its books but also had a large number of futures-only accounts that were managed by large investment advisory firms. As noted above, the concept of segregated funds is designed to protect the cash and collateral deposited by futures customers to margin their futures positions. These regulations do not directly address the actual futures positions themselves. Given the uncertainty of the situation and the volatility in the marketplace, senior Lehman futures officials worked closely with their futures clients and governmental and exchange officials to transfer the client futures positions to other clearing firms in order to provide these customers with a new home that was properly capitalized. This process started immediately after LB Holdings filed its petition for bankruptcy in the U.S. but not so outside the U.S. PWC, as the newly-appointed Administrator, did not permit the trans Thomson Reuters/west

19 November 2008 n Volume 28 n Issue 10 fer of the open futures positions until late in the day on Wednesday, September 17 th, with the vast majority of the futures positions being transferred on Thursday, September 18 th or Friday, September 19 th. Most of the futures positions held by Lehman s customers, whether they were held on the books of LBI or LBIE, were either moved to other clearing member firms per the instructions of such customers by the close of business on Friday, September 19 th, or they became futures customers of Barclays Capital Inc. ( BCI ), the U.S. affiliate of Barclays Bank PLC. BCI acquired all of the remaining futures customer accounts on the books of LBI after the close of business on September 19 th. Therefore, the system worked for the most part although, as noted above, quicker action was needed. Through the tremendous efforts of many governmental agencies, SROs, firms, exchanges, clearing houses and clients, the goal of transferring the open futures positions was effectively achieved within five days. This reflects the strong working relationships that exist within the global futures community. No other product area or industry can make a similar claim. RECOMMENDATION #3: In the future, it is imperative that any trustee in bankruptcy or administrator that is selected should have a strong futures product knowledge and expertise to allow prompt and immediate transfers of futures positions. Granted, in today s marketplace, prime brokerage accounts and corresponding Cross Margin Netting Agreements ( CMNA ) play a critical role relating to the required funding of the risk margin amounts that control multiple products, including futures accounts, but many futures accounts are stand alone accounts without any prime brokerage ( PB ) or CMNA agreements in place. Accordingly, the margin amounts held in such stand alone accounts will not have been used to finance other related financial transactions and products, such as via a PB or portfolio margining arrangement. All customer omnibus accounts fall within this parameter and must be treated differently than other futures accounts that are highly correlated with other products and PB arrangements. The product expertise for such appointees related to futures is critical, and such appointees, even if they are only granted certain limited powers over futures accounts, must have a thorough knowledge of the global futures markets. Customer protection is the most important goal, and futures positions need to be moved in a very timely manner, especially during a volatile marketplace. Sadly, some European and Asian exchanges took a different path to resolving the issue before them. Even though the accounts were labeled as customer omnibus accounts on their books, they chose to simply liquidate the open futures positions and not participate in any position transfers. Such liquidations came with little or no prior notice to Lehman officials. This should never be allowed again. RECOMMENDATION #4: It is very important that every global exchange recognize the concept of a customer omnibus account or create a special coding on their exchange operational system that can easily identify which positions belong to customers and which positions belong to the clearing member s proprietary traders. Once positions are identified as belonging to a customer of a clearing member or their carrying brokers, these customer positions should not be liquidated but should be allowed to be moved to another firm unless, of course, the client seeks such liquidation. The exchange is protected financially as it can liquidate the clearing firm s proprietary positions and can thus hold these proceeds to protect against a market move in the positions held by the customers or can even issue an increased margin call. To merely liquidate open customer positions promptly without providing alternative approaches to the solution is not an acceptable practice and should not be allowed. This is especially troublesome in today s marketplace as a large number of futures positions are used to hedge against some stock or bond portfolios. By liquidating one leg of these positions, given the market volatility that occurred, some clients incurred even greater damage to their portfolio. Actions taken by an exchange or clearing house to liquidate all customer open positions without first providing an opportunity to have these positions transferred, even if permitted by their rules, should be guarded and not used without greater forethought thomson reuters/west 9

20 Futures & Derivatives Law Report RECOMMENDATION #5: The CFTC and the FSA should consider and establish policies, and perhaps regulations, that require any global futures exchange that holds positions for customers of FCMs in the U.S. or registered investment entities ( RIEs ) in the U.K. to contact the CFTC and the FSA, respectively, before the exchange takes actions to liquidate all customer positions. The CFTC and the FSA could require, via a Memorandum of Understanding ( MOU ), that such exchanges notify them in the event an exchange elects to take actions to liquidate all open customer positions. RECOMMENDATION #6: Regulations need to be established to provide better customer protections for the actual positions held by futures customers globally. As noted above, current regulations only address the cash and collateral used to margin these positions. However, when major events occur, like they did over the weekend of September 12-14, the resulting market volatility caused significant harm to end users who were not able to liquidate their open positions. Regulations need to establish proper guidelines and procedures that an administrator or trustee in bankruptcy must follow to permit the prompt release of open futures positions that are not part of any PB or other risk-based financing arrangement, and to require the exchanges to act accordingly, all in the best interests of the end users of the global futures markets. RECOMMENDATION #7: The global futures industry is just one small part of the total investment landscape. Many products in today s marketplace are intertwined within a total risk portfolio. This reflects the significant growth of prime brokerage globally and the growing concept of portfolio margining. Because different products are so correlated to each other, especially from a risk margin and financing perspective, it is very important that all of these products be treated in a similar manner under new bankruptcy laws and regulations that are clearly now needed. Such laws and regulations must be adopted globally. This requires all of the major countries to meet together to address this global problem. A future with 15 or 20 different sets of laws and regulations is not a very bright one. While uniformity is not needed, commonality of elements and their corresponding interpretations are. A global set of bankruptcy laws and regulations that relate specifically to the insolvency of global brokerage firms and banks are now needed. While open futures positions were, for the most part, transferred within the first five days, the cash and collateral used to margin those positions were not timely transferred. While part of the delay resulted from some difficulty in the accounting and trade confirmation processes, some banks simply refused to transfer the amounts held in customer protected accounts in a timely manner. For example, JP Morgan Chase Bank NA, the U.S. bank that held all of the cash and collateral in the LBI Customer Segregated Account, stopped releasing customer funds on Thursday, September 18 th and continued this hold for many more days. Eventually, it agreed to transfer the cash and collateral held in the Customer Segregated Account. RECOMMENDATION #8: Actions taken by banks that did not release funds in a timely manner were unacceptable. 24 There is no probable cause to place a hold by such banks on segregated funds. Such banks have signed a segregated acknowledgement letter, which clearly states that the bank acknowledges and agrees that the amounts held in a Customer Segregated Account belong solely to the futures customers of the respective FCM and do not belong to any creditors of that FCM or custodial bank. By taking such actions, banks required the end users, in essence, to double segregate by depositing new margin amounts at their new clearing firms. The additional funding requirement adversely impacted their liquidity performance and return and should not have occurred. RECOMMENDATION #9: The CFTC, NFA, FSA and the respective clearing houses should carefully review the entire process of account movement during stressed situations, establish proper guidelines and procedures to require custodial banks, that act in this capacity on behalf of futures customers on a global basis, to transfer customer protected funds in a very timely manner and take enforcement actions against banks that refuse to act in the best interests of the customers Thomson Reuters/west

21 November 2008 n Volume 28 n Issue 10 PWC, the Administrator for LBIE, issued a statement on October 7, 2008, stating it was still reviewing how to deal with requests for transfer of client monies and assets. PWC gave no indication as to when such client assets would be distributed. Other firms appointed to serve as the trustee in bankruptcy in other jurisdictions have also not released any of the funds held in the LBI Customer Omnibus Account on the books of LBIE and other non-u.s. Lehman affiliates. In Japan, for example, the bankruptcy-appointed firm indicated that it would not announce any decision regarding releasing the funds held in LBI s customer segregated account until after November 17, RECOMMENDATION #10: As noted above, the customer omnibus account of a U.S. FCM should receive prompt payment of any amounts held in such accounts in those countries that the CFTC deem to be a good control location over customer funds, once the open positions have been transferred to another clearing member. The CFTC, together with the industry and other foreign governmental agencies, need to review these procedures and establish new guidelines on how such omnibus accounts should be treated. Once the open positions held in a customer omnibus account have been transferred away, then the funds held to margin those positions should be promptly transferred back to such customers or their new clearing member firms. RECOMMENDATION #11: Customer funds held by a brokerage firm or exchange in a country that is deemed to be a good secured location pursuant to CFTC regulations should not be deemed to be subject to the claims of a creditor of the brokerage firm that has filed for bankruptcy and should be protected against such claims. The CFTC should consider whether a non-us exchange, that permits a U.S. FCM to open a customer omnibus account on the books of a clearing member firm of that exchange, should be required to open special bank accounts with a U.S. bank or DCO to hold such initial margin within the U.S. and be subject to the U.S. Bankruptcy Code and Part 190 of the CFTC Regulations in order to facilitate the transfer of such customer funds in a timely manner. RECOMMENDATION #12: The CFTC and the NFA, together with other governments and industry associations, should establish a task force that includes members from the industry and the end user community to determine what new best practices are now needed in the event such a global bankruptcy event ever occurs again. The last such industry task force was established after the Barings collapse in the mid-1990s. There has been considerable change in the way the industry operates since then, in particular the wide-spread use of PB arrangements and new risk management analyses for funding a wide array of financial products. The new task force should consist of a global committee that creates several sub-committees, each having jurisdiction and responsibility over a specific issue or concern. RECOMMENDATION #13: The current caps on FDIC insurance (currently, $100,000) 25 and SIPC ($500,000) are being reviewed for possible increases. The futures industry and the CFTC should meet to determine whether an insurance program is now needed for futures accounts. SIPA specifically excludes futures accounts. However, in light of the actions taken by some of the global exchanges in connection with Lehman s bankruptcy, there is a need to determine whether such an insurance program is now viable and can be properly funded. Conclusion As noted above, the process and procedures that followed the filing of Lehman s bankruptcy did not always flow as well as many believed it should have. The industry and government need to establish a task force that addresses these issues and determine what changes and best practices, if any, are now needed to minimize the impact on customers in the event another such bankruptcy ever occurs. NOTES , Ronald H. Filler. Printed with permission. CFTC stands for the U.S. Commodity Futures Trading Commission, the U.S. governmental agency in charge of regulating the U.S. futures markets and U.S. industry professionals thomson reuters/west 11

22 Futures & Derivatives Law Report 2. Special recognition goes to Acting CFTC Chairman Walt Lukken, NFA President Dan Roth and many other senior CFTC and NFA staff members who provided tremendous assistance to help the futures customers of Lehman Brothers Inc. throughout this period. 3. Another FCM has recently been the subject of bankruptcy proceedings. See Sentinel Management Group, Inc. (U.S. Bankruptcy Court for the Northern District of Illinois, Eastern Division (Case No. 07 B 14987) but this proceeding involved a different set of issues and did not involve transactions in futures contracts. Bear was taken over by J.P. Morgan Bank, with the assistance of the Federal Reserve Bank, in March A broker-dealer must maintain its securities customer assets in compliance with the SEC s customer protection rule (Rule 15c3-3), including maintaining cash in a special reserve account and maintaining fully paid and excess margin securities in a segregated account. In general, the securities accounts maintained at a BD will receive the benefit of expedited administration and the right to recover up to US$100,000 in cash or US$500,000 in securities if its broker-dealer were to become insolvent. Under such a scenario, customer assets held in a securities account would be administered pursuant to a proceeding brought by the Securities Investor Protection Corporation (SIPC) pursuant to the Securities Investor Protection Act (SIPA). If the BD were also registered as an FCM, futures customers should understand, however, that SIPA rules specifically exclude futures customer accounts and their assets from its provisions. Most BDs have purchased a surety bond that provides protection in excess of the amounts provided under SIPC. However, this surety bond would, like SIPA, be limited to only the broker-dealer securities accounts and would not apply to the futures customer assets held by a joint BD-FCM U.S.C. 1 et seq. 6. See CFTC Regulations 1.20 and U.S.C. 6d(a)(2) 8. Good control location is mainly a term used by broker-dealers pursuant to SEC regulations but its meaning here implies an account established in accordance with CFTC regulations. 9. See Interpretative Statement issued by the CFTC on September 26, 2008, regarding funds related to cleared-only contracts. 10. For those jurisdictions (e.g., Germany, Hong Kong, Korea) that do not provide the standard customer asset protection that requires the separation of a Firm s proprietary assets from its customer assets, the FCM may deposit a corresponding amount of its own capital in a good control location, typically in the accounts at its respective custodial bank, to reflect the amounts as determined in its 30.7 daily secured amount calculation (based on the amount for that trade date), in its UK FSA segregation daily calculation (based on the amount as determined on the trade date plus one day) and in its weekly 15c3-3 weekly calculation. This form of double segregation provides significant protections to an FCM s futures customers. 11. Note that, pursuant to applicable CFTC regulations, an FCM is required to deposit all customer cash and securities in a customer segregated fund account but, in reality, is not required to place customer assets in a secured amount account. It can elect to use its own capital to meet the minimum secured amount requirements. 12. If the FCM is also registered as a brokerdealer, then these non-regulated accounts are maintained in accordance with SEC Rule 15c3-3. The Customer Reserve Formula calculation required by SEC Rule 15c3-3 is performed weekly, typically on each Monday reflecting the amounts as of the previous Friday s close of business. The assets held in this account can not be commingled with the FCM s proprietary funds and are maintained in a designated Special Custody Account for the Exclusive Benefit of Customers (EBOC Account) at a designated custodial bank. 13. See Note 4, supra. 14. See CFTC Regulation 1.20 which states in essence: All customer funds shall be separately accounted for and segregated as belonging to commodity or option customers. Such customer funds when deposited with any bank, trust company, clearing organization or another futures commission merchant shall be deposited under an account name which clearly identifies them as such and shows that they are segregated as required by the Act and this part. CFTC Regulation 30.7 contains similar language regarding the treatment of foreign futures and options secured amount accounts. 15. See CFTC Regulation For a more detailed explanation of applicable laws and regulations affecting the bankruptcy Thomson Reuters/west

23 November 2008 n Volume 28 n Issue 10 of an FCM, see Subchapter IV of Chapter 7 of the U.S. Bankruptcy Code and Part 190 of the CFTC Regulations. 17. Pursuant to CFTC Rule 1.25, an FCM may rehypothecate customer funds provided that, at all times, an equivalent amount of the funds being re-hypothecated are maintained in the customer segregated account. 18. This view has been expressed by many industry observers but is not directly covered by any CFTC regulation. 19. The Reserve Fund broke the buck in September 2008, and many other such funds halted redemptions for a 7-day period as permitted by their prospectus. On September 22, 2008, the SEC, pursuant to Section 22(e) of the Investment Company Act of 1940 (the 40 Act ) issued an order temporarily suspending redemptions and postponing payment of shares of two series of The Reserve Fund -- The Primary Fund and The U.S. Government Fund. On September 29, 2008, the Board of Trustees of The Reserve Fund announced that it would liquidate the assets of The Primary Fund. (See Release No ). See also CFTC Staff Interpretative Letter issued on September 24, 2008, to Debra Kokal, Chairman of the Joint Audit Committee. Also, on September 29 th, the U.S. Treasury Department announced that it was opening its Temporary Guarantee Program for Money Market Funds (Press Release hp-1161). In the release, the Treasury Department stated that it will guarantee the share price of any publicly offered eligible public money market fund that is regulated under SEC Rule 2a-7 under the 1940 Act for amounts held by shareholders as of September 19 th. 20. After T+3 days, a capital charge is assessed against the FCM for failing to collect the required margin amount. 21. A few, including Goldman Sachs, Morgan Stanley and Merrill Lynch, were also once licensed as a consolidated supervisory entity ( CSE ). The SEC suspended the CSE program on September 26, See SEC Release A key protection to customers is the special regime applicable to CSEs under the SEC s and CFTC s respective net capital rules (SEC Rule 15c3-1 and CFTC Rule 1.17). As a CSE, the firm would calculate its net capital requirement pursuant to Appendix E to SEC Rule 15c3-1, which establishes alternative net capital requirements and allows the CSE firm to use SEC-approved value at risk or scenario analysis models to calculate and remain in compliance with the SEC and CFTC net capital requirements. The CSE net capital rules effectively require that the CSE firm must maintain at least US $500 million in adjusted net capital and US$1 billion in tentative net capital in order to continue operations. This calculation does not include customer-owned securities. 22. Case No The petition was filed following a special meeting of the Board of Directors of Holdings on September 14, On September 19, 2008, LBI filed a proceeding under the Securities Investor Protection Act of 1970 (Case No ). See also Statement issued by SIPC on September 15, Over this same weekend, Merrill Lynch was acquired by the Bank of America and American International Group ( AIG ) received a $85 billion loan from the U.S. Treasury. All of these events and other similar concerns created huge volatility in the global markets all at once. During this same period, many banks refused to issue credit to other financial institutions, including other banks. Over the weekend of September 19-21, 2008, the U.S. Treasury announced its $700 billion bailout which received Congressional approval on October 3, Section 4d(b) of the CEA states in essence: It shall be unlawful for any person, including but not limited to any clearing agency of a contract market or derivatives transaction execution facility and any depository, that has received any money, securities, or property for deposit in a separate account as provided in paragraph 2 of this section, to hold, dispose of, or use any such money, securities, or property as belonging to the depositing futures commission merchant or any person other than customers of such futures commission merchant. 7 U.S.C. 6d(b). 25. FDIC insurance was increased to $250, on a temporary basis through December 2009 pursuant to the Economic Stabilization Act of 2008 passed on October 3, thomson reuters/west 13

24 Cleared Swap Transactions - Selected Issues American Bar Association Committee on Regulation of Futures and Derivative Investments January 30, 2010 Kenneth M. Rosenzweig Katten Muchin Rosenman LLP 525 W. Monroe St. Chicago, IL [email protected] Ross Pazzol Katten Muchin Rosenman LLP 525 W. Monroe St. Chicago, IL [email protected]

25 I. Introduction In response to the various market disruptions that occurred in 2008, federal regulators have proposed to require the clearing of standardized swap transactions, including transactions between dealers and their buy-side counterparties as a means of reducing systemic risk. In response to this initiative, the Chicago Mercantile Exchange ( CME ) and ICE Trust U.S. LLC ( ICE ) have implemented programs which are designed to permit clearing members and their customers to submit certain credit default swap ( CDS ) transactions to the CME and ICE for clearing. 1 This outline briefly describes and discusses some of the customer protection issues raised by these programs. II. Legal Background A. Segregated Funds. The segregation requirements of the Commodity Exchange Act (the CEA ) are designed to accomplish one paramount objective to prevent a futures commission merchant ( FCM ) from using customer funds to satisfy obligations of the FCM. See Drexel Burnham Lambert, Inc. v. CFTC, 850 F.2d 742 (D.C. Cir. 1988). CFTC Regulations give effect to this requirement by, among other things, requiring banks and clearinghouses to acknowledge that the customer funds 2 being deposited will be held for the benefit of customers and cannot be set off against obligations (i) owed by the depositing FCM (Regulation 1.20), (ii) prohibiting the use of segregated funds for any purpose other than to margin, guarantee or secure customer positions in futures or option contracts traded on a designated contract market (Regulation 1.22), (iii) permitting the deposit of house funds into the customer account ( topping up ) as necessary to prevent undersegregation resulting from one or more customers accounts being undermargined or in deficit (Regulation 1.23), (iv) permitting the investment of customer funds in only those instruments specified by CFTC Regulation 1.25 (U.S. government and municipal securities, and certain sovereign debt, money market mutual funds, commercial paper and repurchase agreements, with further restrictions based on issuer or counterparty capitalization, concentration and liquidity), (v) establishing record-keeping requirements (Regulations 1.27 and 1.32), and (vi) establishing requirements relating to the holding of customer funds offshore and in foreign currencies (Regulation 1.49). 1 These programs have been supported by and developed in cooperation with a group of institutional market participants who have committed to work to achieve customer access to CDS clearing programs that provide for margin segregation and portability of positions. See Letter to The Honorable William Dudley, President, Federal Reserve Bank of New York, from G15 group of commercial and investment banks dated September 8, CFTC Regulation 1.3(gg) defines the term customer funds effectively to include all margin deposits, option premiums, and accruals on open positions, but solely in respect of trades and positions on domestic futures exchanges (i.e., designated contracts markets and derivatives transaction execution facilities). 17 C.F.R. 1.3(gg)

26 B. Foreign Futures Secured Amount. Unlike the segregation requirements that apply to the trading of futures contracts on domestic exchanges, the special set-aside that is required for foreign futures transactions (the secured amount ) is created solely by CFTC Regulations. Specifically, CFTC Regulations 1.3(rr) and 30.7 effectively require an FCM to set aside a secured amount (described below) in a bank account that is held separately from both house funds and the FCM s customer segregated funds account(s). In addition, and although not contemplated by the CFTC s foreign futures regulations, an FCM may establish a secured amount account to hold funds associated with the clearing of other financial instruments that cannot, absent relief from the CFTC, be held in a customer segregated funds account. 3 An FCM is required to set aside as the secured amount only the amount necessary to margin the open positions of its foreign futures and options customers, plus or minus any unrealized gain or loss on such customers open contracts. 4 In other words, unlike the segregation requirements for customers trading U.S. futures contracts, an FCM is not required to set aside the difference between a customer s margin requirements and that customer s margin deposit. In essence, an FCM is permitted to use any excess customer margin for its own purposes (subject, of course, to the requirement that it return to the customer upon demand any funds not required to margin open positions). CFTC Regulation 30.7(d) nonetheless prohibits FCMs from commingling in the same account or accounts money, securities, and property representing the secured amount with customer funds required to be separately accounted for and segregated on behalf of customers that hold positions in U.S. futures and options thereon. C. Bankruptcy. 1. General. On the commencement of every case under the Bankruptcy Code, an automatic stay comes into effect pursuant to Section 362(a) of the Bankruptcy Code, enjoining all persons and entities from attempting to assert contractual rights and other claims against the Bankruptcy Code debtor or to in any way collect, realize on, obtain possession of, or otherwise affect any property of the debtor. Section 556 of the Bankruptcy Code provides, however, that (i) the contractual right of a commodity broker 5 to cause the liquidation, termination, or acceleration 3 CFTC Advisory No. 87-4, Foreign Futures and Options: Compliance and Operational Questions and Answers, Comm. Fut. L. Rep. (CCH) 23,975 (November 18, 1987) C.F.R. 1.3(rr). The term foreign futures and options customer is defined in CFTC Regulation 30.1(c) effectively to include only U.S. persons that are trading on foreign markets. An FCM is nevertheless permitted to include the margin deposits of its non-u.s. customers in the secured amount account. See CFTC Advisory No (alternative methods of calculation). 5 The term commodity broker is defined to include, inter alia, futures commission merchants with respect to which there is a customer. With regard to an FCM, the term customer is defined generally to mean a person for whom the FCM deals and who holds a claim against the FCM arising out of commodity contracts, including claims for the return of margin deposits. With regard to a derivatives clearing organization ( DCO ), customer is defined effectively to mean a clearing member that holds a claim against the DCO for cash, a security or other property that has been received by the DCO to margin, (cont.)

27 of a commodity contract (in essence, futures contracts and options on futures contracts) 6 because of the insolvency or financial condition of the debtor or the commencement of a bankruptcy case with respect to the debtor and (ii) the right to a variation or maintenance margin payment 7 received from a trustee with respect to open commodity contracts shall not be stayed, avoided or otherwise limited by operation of any provision of the Bankruptcy Code or order of any court in any proceeding under the Bankruptcy Code. Further, Section 362(b)(6) permits a commodity broker to exercise its contractual right to offset and net out termination values, payment amounts or other transfer obligations arising under or in connection with commodity contracts notwithstanding the automatic stay. Section 560 of the Bankruptcy Code provides similar rights to persons that are parties to a swap agreement FCM Insolvency. In general, the Bankruptcy Code and CFTC Regulations adopted under Section 20 of the CEA provide for the distribution of customer property to the customers of a bankrupt FCM in priority to the claims of other creditors. Where the FCM was in compliance with the segregation requirements, customers will recover in full their margin deposits and any realized and unrealized profits on their trades and positions, less any realized and unrealized losses, and less commissions and fees attributable to their trading. Where, however, customers net equity claims are larger than the pool of customer property that has been set aside for this purpose, customer property will be distributed to customers on a pro rata basis. More particularly, CFTC Regulation (b) requires that the property of a bankrupt FCM be allocated among account classes, with the property that is so allocated constituting a separate estate of the account class to which it is allocated. 9 CFTC Regulation (c)(1), in turn, provides that property held by or for the account of a customer, which is segregated on behalf of specific account class... must be allocated to the customer estate of the account class for which it is segregated. Thus, for guarantee or secure a commodity contract in such clearing member s proprietary or customers account. See 11 U.S.C. 761(9)(A)-(B). 6 See 11 U.S.C. 761(4). 7 The term margin payment is defined for this purpose as a payment or deposit of cash, a security, or other property, that is commonly known to the commodities trade as original margin, initial margin, maintenance margin, or variation margin, including mark-to-market payments, settlement payments, and final settlement payments made as adjustments to settlement prices. 11 U.S.C. 761(15). 8 The term swap agreement includes any agreement, including the terms and conditions incorporated by reference in such agreement, which is (i) an interest rate swap, option, future, or forward agreement, including a rate floor, rate cap, rate collar, cross-currency rate swap, and basis swap; (ii) a spot, same daytomorrow, tomorrow-next, forward, or other foreign exchange, precious metals, or other commodity agreement; (iii) a currency swap, option, future, or forward agreement; (iv) an equity index or equity swap, option, future, or forward agreement; (v) a debt index or debt swap, option, future, or forward agreement; (vi) a total return, credit spread or credit swap, option, future, or forward agreement; (vii) a commodity index or a commodity swap, option, future, or forward agreement; (viii) a weather swap, option, future, or forward agreement; (ix) an emissions swap, option, future, or forward agreement; or (x) an inflation swap, option, future, or forward agreement. See 11 U.S.C. 101 (53B). 9 The CFTC s bankruptcy rules currently list five account classes that must be recognized as separate account classes by a trustee: (i) futures accounts; (ii) foreign futures accounts; (iii) commodity options accounts; (iv) leverage accounts; and (v) delivery accounts. 17 C.F.R (a)

28 example, customer property that is allocable to the futures account class may not be allocated to make up shortfalls in the foreign futures account class. 10 III. Cleared Credit Default Swaps As noted above, the CME and ICE have adopted programs for the clearing of certain CDS transactions ( cleared CDS transactions ). Under these programs, clearing members may clear their proprietary CDS transactions and also may submit CDS transactions that they have effected with their customers to the CME and ICE for clearing. Since the announcement of these programs, market participants have, in general, focused on: (x) whether the property posted by customers to margin-cleared CDS transactions is segregated from the assets of a clearing member and thus may be recovered by customers in the event of a clearing member default; and (y) the effectiveness of the CME s and ICE s respective procedures for transferring or novating positions and related margin in the event of a clearing member default. A description of the CME and ICE programs and some of the issues that are raised by their respective approaches is set out below. A. CME. The CME s program requires that customers hold their cleared CDS positions with an FCM. As noted above, an FCM must hold property received from customers to margin commodity contracts either in a segregated funds account established under Section 4d of the CEA or in a secured amount account established pursuant to CFTC Regulation The CME has requested CFTC approval for FCMs to hold margin for cleared CDS transactions in a segregated funds account. 12 Until such request is granted, FCMs will hold all margin deposited by customers with respect to cleared CDS in a secured amount account. 13 Thus, under the CME s program, an FCM will be required to forward to the CME the gross amount of its CDS customers margin deposits, and the CME will hold such amounts in a secured amount account in the name of the CME for the benefit of the FCM s customers. One issue that arises in connection with clear CDS transactions is whether, in the event of an FCM s insolvency, customers who held cleared CDS through the FCM would receive the benefits of the distribution scheme that is available to traditional futures customers. In October 2008, the CFTC issued an interpretation in which it took the position that cleared-only contracts (which would include cleared CDS transactions) are commodity contracts within the meaning of the Bankruptcy Code. 14 The CFTC advanced two arguments in support of its position. First, the CFTC stated that cleared-only contracts are contract[s] for the purchase or sale of a 10 See 17 C.F.R (c)(1). 11 See 17 C.F.C. 1.3(rr), The CFTC has previously granted relief of this nature for other swap products. See, e.g., 74 Fed. Reg (March 24, 2009) (margin deposits for certain over-the-counter agricultural swaps permitted to be held in customer segregated funds account). 13 See CME Rule 8F Fed. Reg (October 2, 2008)

29 commodity for future delivery and, therefore, commodity contracts within the meaning of the Bankruptcy Code because cleared-only contracts are processed like futures contracts by a DCO. 15 The CFTC s second argument was based on the premise that because cleared-only contracts have the potential to reduce a customer s futures margin requirements, they should be deemed to be commodity contracts and, therefore, included in the net equity of a customer of a bankrupt commodity broker. 16 One consequence of the CFTC s interpretation is that it has the potential to confer on persons that effect transactions in cleared-only contracts a liquidation priority that may not be contemplated by the Bankruptcy Code. As noted above, the Bankruptcy Code provides that commodity customers share ratably in customer property, to the exclusion of other creditors. 17 The CFTC interpretation, therefore, would allow persons that trade only in cleared-only contracts to share pro rata in the pool of customer property to the exclusion of other creditors. As a consequence, there is the risk that (i) a bankruptcy trustee and commodity customers could challenge the CFTC s interpretation if including such persons as claimants to the pool of customer property reduced the amount available for payment to futures customers and (ii) the trustee and other creditors could challenge the CFTC s interpretation to the extent that it confers a liquidation priority on such persons, who would otherwise rank as general unsecured creditors. The CFTC interpretation also raises issues about how a customer that holds cleared-only contracts in a secured amount account, as opposed to a segregated funds account, would be treated if the FCM became insolvent. As noted above, the Bankruptcy Code and the CFTC s Bankruptcy ( Part 190 ) Regulations provide for the distribution of customer property to the customers of a bankrupt FCM in priority to the claims of other creditors, but on a pro rata basis in the event that customers net equity claims are larger than the pool of customer property that has been set aside for this purpose. Under the CFTC interpretation, a contract that is cleared through a DCO is a commodity contract' under the Bankruptcy Code, and a creditor with a claim based on a cleared-only contract would be a customer of an FCM under the Bankruptcy Code and CFTC regulations. CFTC Regulation (b) requires that the property of a bankrupt FCM be allocated among account classes, however, and the term account class does not currently include cleared-only contracts. 18 Further, CFTC Regulation (c)(2) provides that to the extent there is customer property that cannot be allocated to a particular account class, any such customer property must be allocated among account classes to reduce, to the greatest extent 15 Id. at The statutory definition further requires that any such contract for the purchase or sale of a commodity for future delivery be on, or subject to the rules of, a contract market or a board of trade[.] 11 U.S.C. 761(4)(A). The term contract market is defined to mean a registered entity, which is in turn defined to include a CFTC-registered DCO. 11 U.S.C. 761(7), 761(8); 7 U.S.C. 1a(29). 16 Id U.S.C. 766(h) (FCMs), 766(i) (DCOs); see 11 U.S.C. 761(10) ( customer property ) C.F.R (b). The CFTC s bankruptcy (Part 190) rules require the allocation of customer property to one or more account classes, with margin that has been deposited for trading on a domestic futures exchange (a contract market) or on a non-u.s. exchange being allocated to the futures and foreign futures account classes, respectively. 17 C.F.R (a),

30 possible, any shortfall in the funded balances in one or more account classes. 19 Thus, property held by a bankrupt FCM in a secured amount account with respect to cleared-only contracts could be used to satisfy the claims of other types of customers, which would leave the CDS customers who held such contracts at the bankrupt FCM in the same position as other unsecured creditors of the FCM. The CFTC has accordingly proposed to revise its bankruptcy rules in two respects. 20 First, the CFTC has accordingly proposed to revise CFTC Regulation (a) to provide that if positions and related margin in commodity contracts of one account class are, pursuant to a CFTC order, commingled with positions and related margin of the futures account class, then the former positions and related margin shall be treated as being held in an account of the futures account class. In addition, the CFTC has proposed to amend Regulation (a) to add a sixth and separate account class for a limited group of cleared over-the-counter ( OTC ) derivatives. As defined in proposed Regulation (oo), the positions that would be included in this account class would be limited to those cleared OTC derivatives and related assets: carried by an FCM; cleared by a DCO; with respect to which the CFTC has not issued an order requiring such positions and assets to be held in a customer segregated funds account; but with respect to which such positions and assets are nonetheless required to be segregated in accordance with a rule, regulation or order issued by the CFTC, or which are required to be held in a separate account for cleared OTC derivatives only, in accordance with the rules or bylaws of a DCO. While these proposed amendments to Part 190 may be helpful in resolving some of the issues noted above, there is apparently some residual uncertainty as to whether cleared-only contracts such as cleared CDS would fall squarely within the scope of the Bankruptcy Code and the CFTC s bankruptcy rules. Thus, in an August 17, 2009 submission to Congress, the CFTC recommended that the Bankruptcy Code definition of commodity contract be amended to include a swap agreement that is submitted to a DCO for clearing by a swap clearer (defined generally as a swap dealer, FCM, foreign FCM, leverage transaction merchant, or commodity options dealer that submits a swap to the DCO for clearing). Because the definition of swap agreement in the Bankruptcy Code is quite broad, this change would have the effect of causing all cleared OTC derivatives contracts to come within the scope of the Bankruptcy Code. It is important to note that the clearing of swaps and the holding of cleared swap positions by FCMs for customers highlights a troubling anomaly in the Bankruptcy Code. As noted C.F.R (c) Fed. Reg (August 13, 2009)

31 above, the Bankruptcy Code and the CFTC s Part 190 Regulations provide that customers of an insolvent FCM share pro rata in the pool of customer property held by the FCM to the extent of their net equity claims. However, Section 560 of the Bankruptcy Code also provides that a swap participant may exercise any contractual termination and set-off rights that it may have against its swap counterparty, notwithstanding the insolvency of that counterparty. The definition of swap agreement is very broad, and includes a credit swap, option, future or forward agreement. 21 This raises the question of whether a customer that is entering into a cleared CDS transaction with an FCM can effectively opt out of the loss distribution scheme applicable to customers of FCMs by negotiating revisions to its FCM customer agreement to characterize cleared swap transactions as swap agreements and to provide the customer with contractual termination and set-off rights that may be exercised upon the FCM s insolvency. Finally, even assuming that the CFTC issues an order permitting cleared CDS transactions to be held in a segregated funds account, it is important to note the current version of CME Rule 8F03 provides that a clearing member may hold a customer s cleared CDS positions in a segregated account. Customers that desire to achieve the benefits of segregation therefore need to ensure that they require their FCMs to hold these positions in a segregated account to the extent permissible under applicable law. B. ICE Trust. Under ICE s program, clearing members act as principals vis-à-vis both ICE and their customers. 22 Thus, when a customer executes a CDS trade with a clearing member that both parties have agreed to clear through ICE, the clearing process consists of two steps. First, the clearing member submits to ICE a two-sided trade between the clearing member and ICE, with one side of the trade as a customer position and the other side of the trade as a house position. Simultaneously with ICE s acceptance of the submitted trade, the clearing member records a back-to-back trade with the customer that is not cleared through ICE. Under the ICE program, a customer will transfer cash or securities to secure its obligations under CDS transactions with its clearing member, and the clearing member may ontransfer any such securities to ICE. Clearing members will give ICE daily reports on their customer positions and the amount and form of margin that they have forwarded to ICE with respect to those customers. ICE, in turn, will require clearing members to post collateral with respect to their customer positions on a gross basis (the Gross Amount ). ICE, however, will hold the collateral required to margin the net positions of all the clearing member s customers (the Net Amount ) in a segregated omnibus account (the Net Margin Account ) that ICE U.S.C. 101(53)(B). 22 The following description is based on the description relating to ICE set forth in the Report to the Supervisors of the Major OTC Derivatives Dealers on the Proposals of Centralized CDS Clearing Solutions for the Segregation and Portability of Customer CDS Positions and Related Margin (June 30, 2009), available at

32 establishes solely for the benefit of the clearing member and its customers. The collateral in the Net Margin Account is subject to a lien in favor of ICE and the clearing member. A clearing member may hold the difference between the Gross Amount and the Net Amount (x) in a segregated omnibus account that ICE establishes solely for the benefit of the clearing member and its customers (the Excess Margin Account ), (y) at the clearing member, or (z) at a third-party custodian. ICE will acknowledge that the securities held in the Net Margin Account and the Excess Margin Account are the property of the customers of the relevant clearing member, subject to any lien imposed by ICE or the clearing member. ICE takes the position that customers would likely retain proprietary rights in the securities held in these accounts and get them back after satisfaction of any ICE and clearing member liens. This position assumes, however, that securities transferred by a customer to its clearing member and then retransferred by the clearing member to ICE is a specifically identifiable item of property, the ownership of which can be traced back to the customer. It is not clear that this assumption is consistent with applicable law. By way of background, the transfer and pledge of securities is governed by Articles 8 and 9 of the Uniform Commercial Code (the UCC ). Under Article 8, a person that holds a security through an intermediary (as opposed to holding it directly on the books of the issuer) has a security entitlement to the financial assets credited to its securities account. A securities entitlement, in turn, is a package of rights that a person has against its securities intermediary with respect to the assets credited to its account. 23 The proposition that the transfer of a particular security can be traced through the hands of different persons is not consistent with the transfer and pledge rules established under Article For example, assume that each of a customer, its clearing member and ICE maintains a securities account at a bank (the Bank ). Further assume that the Bank holds securities for the customer and credits the securities to the customer s securities account, thus giving the customer a security entitlement to these securities. In order for the customer to transfer the securities to the clearing member, the Bank would terminate the customer s security entitlement, credit the securities to the clearing member s securities account and identify the clearing member as the entitlement holder to the securities. Similarly, to transfer the securities to ICE, the Bank would terminate the clearing member s securities entitlement, credit the securities to ICE s securities account and identify ICE as the entitlement holder to the securities on its books See UCC Sections 8-102(a)(9), 8-102(a)(17), See Official Comment No. 2 to Section of the UCC. 25 Under the UCC, ICE may perfect its security interest in securities transferred to it by a clearing member by obtaining control of the securities. In order to obtain control of the securities, ICE must (x) become the entitlement holder to the security entitlement, (y) enter into a three-way control agreement with the customer s securities intermediary, or (z) require the clearing member to acknowledge that it is acting on behalf of ICE with respect to the security entitlement that the clearing member holds on the Bank s books. See UCC Section

33 In this scenario, ICE is the entitlement holder to the securities credited to its account, and has a claim against the Bank for the exercise of the rights that comprise such securities. There is no other property held by ICE that can be traced to the customer should the clearing member become insolvent, and the idea that these rights could be so traced is not meaningful because the concept of tracing presumes that the property to be traced is a discrete, specifically identifiable item. 26 The Report also states that ICE should be able to transfer customer CDS positions in the event of clearing member insolvency. In this regard, federal law generally provides that clearing organization rules relating to the close-out and netting of positions, and any security agreements or credit enhancements relating thereto, are enforceable notwithstanding any other provision of law. 27 However, the rules of a clearing organization are only binding on its members, and thus presumably will not be binding on the customers of ICE clearing members. Further, even if these customers agree to be bound by ICE rules, it is not clear that the scope of the protections available under federal law can reasonably be construed as protecting the right of a customer of an insolvent clearing member to transfer its CDS contract to another clearing member. Indeed, ICE seems to acknowledge that this is the case by suggesting that any new legislation relating to CDS clearing include a provision that expressly permits ICE to make such a transfer. * * * NOTE: The information and analysis contained herein were current as of mid-december Intervening changes in law, or in CME or ICE rules, could affect that analysis. 26 ICE does not have a direct relationship with the customers of a clearing member. ICE, therefore, would not be able to act as a securities intermediary for these customers and credit security entitlements to the securities it holds through the Bank to their accounts. 27 See 12 U.S.C (2009)

34 - 1 - FEDERAL RESERVE SYSTEM ICE US Trust LLC New York, New York Order Approving Application for Membership ICE US Trust LLC ( ICE Trust ), a de novo uninsured trust company organized under New York law, 1 has requested the Board s approval under section 9 of the Federal Reserve Act ( Act ) 2 to become a member of the Federal Reserve System. 3 ICE Trust proposes to operate as a central counterparty ( CCP ) and clearinghouse for credit default swap ( CDS ) transactions conducted by its participants. ICE Trust will become a wholly owned subsidiary of ICE US Holding Company LP ( ICE LP ), 4 which will be controlled indirectly by Intercontinental- Exchange, Inc. ( ICE ), 5 an operator of futures exchanges and over-the-counter markets 1 Under New York law, a limited liability trust company may not accept deposits from the general public and must obtain an exemption from the general requirement under state law that New York-chartered banks and trust companies have federal deposit insurance. See New York Banking Law 32, 102a. The New York State Banking Board ( NYSBB ) has approved ICE Trust s charter application and its exemption from the deposit insurance requirement. Letter from NYSBB to Bradley K. Sabel, Esq., December 4, U.S.C. 321 et seq U.S.C. 221 and 321. ICE Trust is a bank for purposes of the Act and, therefore, is eligible for membership in the Federal Reserve System. 4 ICE LP is organized under the law of the Cayman Islands but has consented to the jurisdiction of United States courts and government agencies with respect to matters arising out of federal banking laws. ICE LP also has committed to make available to the Board such information on the operations of ICE Trust and its affiliates as the Board deems necessary to enforce compliance with the Act and other applicable federal law. 5 ICE s wholly owned subsidiary, ICE US Holding Company GP LLC ( ICE GP ), a Delaware limited liability company, will be the general partner of ICE LP. ICE, ICE GP, and ICE LP have committed that ICE LP will not, without the prior approval of the

35 - 2 - for commodities and derivative financial products. 6 ICE has entered into an agreement to acquire The Clearing Corporation ( TCC ), a derivatives clearinghouse. 7 ICE Trust is being organized to reduce the risk associated with the trading and settlement of CDS transactions. 8 The CDS market as measured by the total notional amount of outstanding contracts has grown significantly, from approximately $6.4 trillion by year-end 2004 to approximately $57.3 trillion by mid-year In the second half of 2008, however, dealers in CDS contracts were able to reduce the total notional amount of outstanding contracts by approximately $32 trillion through regular and frequent portfolio compression activity. CCPs interpose themselves between counterparties to financial contracts, becoming the buyer to the seller of the contract and the seller to the contract s buyer. In the absence of a CCP, each market participant bears the risk, known as counterparty credit risk, that one or more of its counterparties will default. By interposing itself between participants and thereby assuming counterparty credit risk, Board, engage in any activity or make any investment other than holding an interest in ICE Trust and TCC. 6 ICE Trust is not a bank as defined in the Bank Holding Company Act ( BHC Act ) (12 U.S.C et seq.). See 12 U.S.C. 1841(c)(1). ICE LP, ICE GP, and ICE, therefore, would not be bank holding companies for purposes of the BHC Act. No bank holding company will directly or indirectly control more than 5 percent of the voting shares of ICE Trust. 7 TCC also will become a wholly owned subsidiary of ICE LP. TCC will provide certain clearing services to ICE Trust. 8 In the simplest form of a CDS arrangement, the seller of a CDS agrees to pay the buyer the full principal amount of the debt obligation underlying the CDS in exchange for periodic payments to cover the cost of the credit-risk protection. The seller is then obligated to pay the buyer if the maker of the obligation defaults or declares bankruptcy. In index-based CDS contracts, the parties payment obligations are based on an index of debt obligations of multiple companies, such as an index of U.S. investment-grade or emerging-market bonds, rather than on a single obligation. 9 See Bank for International Settlements, OTS Derivatives Market Activity in the First Half of 2008 (November 2008); Bank for International Settlements, OTS Derivatives Market Activity in the Second Half of 2005 (May 2006). The notional amount refers to the principal amount of obligations underlying CDS contracts.

36 - 3 - a CCP enables market participants to accept the best bids and offers without concern that a counterparty may default. By assuming counterparty credit risk and enforcing participation standards and margin requirements, CCPs also can help diminish systemic risk in market settlement activities. In addition, establishment of a CCP can lower systemic risk by instituting procedures for the orderly close out of the positions of any participant who defaults and by mutualizing the cost of the close-out process. Proposed Activities ICE Trust would act as the CCP for its participating financial institutions by novating CDS contracts between participants. Through novation, ICE Trust would be positioned between the parties to a CDS contract, thereby becoming the counterparty to each party. ICE Trust would net out the overall positions of each participant and, accordingly, would receive payments from and make payments to each participant on a net basis. In this manner, ICE Trust would reduce the volume of settlement payments among participants and reduce the counterparty, credit, and other risks and the transaction costs associated with CDS contracts. Initially, ICE Trust proposes to clear only contracts that are based on certain CDX North American indices and are submitted by the participants as principals. 10 Incidental to clearing such transactions, ICE Trust also would provide certain transaction-related administrative services to participants. ICE Trust proposes to charge a fee for its CDS clearing services to participants primarily on a per-transaction basis. As a member of the Federal Reserve System, ICE Trust would be eligible to open an account with, and receive payment services from, the Federal Reserve Bank of New York. ICE Trust proposes to obtain a number of services from TCC and ICE. ICE Trust would use TCC s existing infrastructure for clearing operations and its risk-management services. ICE would provide internal audit functions for ICE Trust. 10 These indices include certain investment-grade indices; investment-grade, high-volatility sub-indices; and high-yield indices.

37 - 4 - Factors Governing Board Review of the Proposal In acting on an application for membership in the Federal Reserve System, the Board is required by the Act and Regulation H to consider the financial history and condition of the applying bank; the adequacy of its capital in relation to its assets and to its prospective deposit liabilities and other corporate responsibilities; its future earnings prospects; the general character of its management; whether its corporate powers are consistent with the purposes of the Act; and the convenience and needs of the community to be served. 11 Because ICE Trust s primary business would be acting as a CCP and clearinghouse for CDS transactions, the Board has reviewed the applicable financial and managerial factors in light of the Federal Reserve s Policy on Payments System Risk ( PSR Policy ), including its minimum standards for systemically important central counterparties. 12 These standards address, among other matters, financial resources, measurement and management of credit exposures, margin requirements, and default procedures. Financial Considerations In considering the financial history and condition, future earnings prospects, capital adequacy of ICE Trust, and other financial factors, the Board has reviewed its business plan and financial projections and has assessed the adequacy of ICE Trust s anticipated capital levels in light of its proposed assets and liabilities U.S.C. 322 and 329; 12 CFR 208.3(b)(3). 12 Federal Reserve Policy on Payments System Risk, available at The PSR Policy incorporates the minimum standards for systemically important central counterparties in the Recommendations for Central Counterparties ( RCCP ), jointly issued in November 2004 by the Committee on Payment Settlement Systems of the Bank for International Settlements and by the Technical Committee of the International Organization of Securities Commissioners U.S.C. 322 and 329; 12 CFR 208.3(b)(3). As required by its regulations, the Board has used the definition of capital in Appendix A to Regulation H in assessing ICE Trust s capital adequacy. 12 CFR 208.4(a). In light of the fact that ICE Trust would (1) take no deposits from the general public, (2) have no federal deposit insurance,

38 - 5 - ICE Trust would maintain capital that is adequate to cover its start-up costs, projected operational losses, and unanticipated losses and to allow for an orderly wind-down of positions if confronted with the need to cease operations. In assessing the adequacy of ICE Trust s capital levels, the Board has taken into account the financial resources maintained by ICE Trust to enable it to withstand a default in extreme but plausible market conditions by the participant to which it has the largest exposure. 14 For ICE Trust, as for many CCPs, these resources include margin collateral posted by participants based on the value and risk associated with their open positions and participants contributions to a guaranty fund. The Board expects ICE Trust at all times to maintain financial resources commensurate with the level and nature of the risks to which it is exposed. If a participant defaults, ICE Trust would draw on margin collateral posted by the participant. If the margin collateral is insufficient, ICE Trust would then look to the defaulting participant s guaranty fund contribution. Should the defaulting participant s margin collateral and guaranty fund contribution be insufficient to cover any losses on the defaulted obligations, ICE Trust would be authorized to use, as needed, other participants guaranty fund contributions to satisfy any remaining obligations of the defaulting party. If the guaranty fund in total is inadequate to cover losses on the defaulted obligations, ICE Trust would have the ability to assess additional guaranty fund contributions on nondefaulting participants. (3) engage in no activities apart from serving as a CCP and clearinghouse, and (4) have assets and liabilities that reflect its status as a CCP and clearinghouse, the Board will not require ICE Trust to meet the risk-based capital requirements or the leverage requirements set forth in Appendices A, B, E, and F of Regulation H. The Board retains the authority, however, to specify capital requirements for ICE Trust and to require ICE Trust to increase its capital if the Board at any time concludes that ICE Trust s capital is inadequate in view of its assets, liabilities, and responsibilities. 12 CFR 208.4(a). 14 RCCP at 23.

39 - 6 - To limit the risk of default by participants, ICE Trust proposes to establish strong and objective participant eligibility requirements. For example, only a firm with a net worth of $5 billion or more and a credit rating of A or better may become a participant. Among other criteria, each prospective participant also would be required to demonstrate that it has systems, management, and risk-management expertise with respect to CDS transactions. Margin requirements for participants in ICE Trust would be comprised of two components: (1) initial margin collateral provided at the time of contract novation that is intended to cover losses from a defaulting participant s positions under normal market conditions; and (2) mark-to-market margin requirements that are calculated at the end of each day based on a participant s outstanding positions. ICE Trust plans to regularly perform stress testing on its calculations of credit exposure and margin requirements to determine the sufficiency of the financial resources needed to withstand participant defaults under a range of plausible market scenarios. To ensure its liquidity, margin collateral would be required to be in the form of cash or G7 government debt. In addition to margin requirements, ICE Trust would require each participant to contribute a minimum of $20 million to the guaranty fund plus additional amounts based on the participant s expected level of position exposures. Additional contributions would be assessed at least quarterly. The establishment of ICE Trust as a CCP for CDS contracts is expected to minimize the impact on financial markets of a failure by a single participant by collateralizing counterparty risk exposures through the standardized application of margin and guaranty fund requirements, by reducing exposures through the netting of CDS transactions on a multilateral basis, and by standardizing and centrally managing the close out of a defaulting participant s positions with the CCP. After carefully considering all the facts of record, the Board has concluded that ICE Trust s financial condition, capital adequacy, future earnings prospects, and other financial factors are consistent with approval of the proposal.

40 - 7 - Managerial Considerations In reviewing ICE Trust s managerial resources, the Board has considered carefully the experience of ICE Trust s proposed management, as well as its planned risk-management systems, operations, and anti-money laundering compliance program. In addition, because ICE Trust proposes to be a CCP, the Board has considered ICE Trust s plans for managing the counterparty credit risk, operational risk, legal risk, and other risks that CCPs commonly encounter. 15 The most significant risk that a CCP for CDS transactions experiences is counterparty credit risk. The Board has carefully reviewed ICE Trust s risk-management framework and its ability to measure accurately its exposure to counterparty credit risk. ICE Trust proposes to measure its credit-risk exposures to clearing participants on a daily basis, using a value-at-risk methodology to calculate the appropriate level of margin, and to calculate the margin requirement and collect the required margin collateral from each participant daily. ICE Trust has conducted extensive validation of its models for each of the products it initially intends to clear. The Board also has reviewed independent assessments of ICE Trust s models. To manage concentration risk, ICE Trust will charge additional margin collateral for positions exceeding pre-set notional thresholds. To address liquidity risk, ICE Trust will ensure that it has ready access to sufficient sources of liquidity to meet its payment obligations on a same-day basis. The Board also has reviewed ICE Trust s other mechanisms for controlling counterparty credit risk, including the adequacy of its policies and procedures for identifying any instance of default by a participant and for the orderly close out of a defaulting participant s positions. The Board has carefully reviewed ICE Trust s plan to limit investment risk by investing cash margin it receives in certain highly liquid instruments. To address settlement risks associated with participants payments of 15 ICE Trust has committed that it will provide the Federal Reserve System with a 60-day prior notice of material changes to its rules to provide time for an adequate review by the Federal Reserve System and the opportunity to raise any supervisory or regulatory objections.

41 - 8 - margin collateral, guaranty fund contributions, and other monies, ICE Trust will establish a program to monitor payment concentration among settlement banks, evaluate the impact of settlement-bank failure, and develop measures to mitigate associated risks. The Board has also considered the legal framework within which ICE Trust would operate as a CCP, including the planned contractual arrangements and applicable governing statutes and regulations with respect to the novation process, netting arrangements, settlements, and procedures in the event of a participant default. The Board also has considered information regarding the legal implications of cross-border participation in ICE Trust. In addition, the Board has reviewed ICE Trust s proposed operational and information technology infrastructure, including its business continuity plans and the adequacy of its management controls. Based on this review and all the facts of record, the Board has concluded that the general character of ICE Trust s management is consistent with approval of the proposal. Other Considerations In considering whether the corporate powers exercised by ICE Trust are consistent with the purposes of the Act, the Board notes that ICE Trust s proposed activities are permissible for a state member bank under the Act s applicable provisions. 16 Under Regulation H, ICE Trust would be required to obtain the Board s approval before changing the general character of its business or the scope of the corporate powers it exercises. 17 In addition, ICE Trust has provided the Board with several commitments intended to ensure that the Board will have adequate enforcement authority over ICE Trust as an uninsured state member bank. 18 For these reasons and based on a review of 16 See 12 U.S.C. 330 and CFR 208.3(d)(2). 18 ICE Trust has stipulated that it would be subject to the supervisory, examination, and enforcement authority of the Board under the Federal Deposit Insurance Act as if ICE Trust were an insured depository institution for which the Board is the appropriate federal banking agency under that act.

42 - 9 - the entire record, the Board has concluded that this consideration is consistent with approval of the proposal. The Board also has considered the convenience and needs of the community to be served. 19 As noted, the establishment of ICE Trust as a CCP for CDS contracts is expected to benefit financial markets significantly, by reducing systemic risks associated with counterparty credit exposures in CDS transactions, and thereby enhance the stability of the overall financial system. In addition, ICE Trust would promote greater market transparency by making publicly available the closing settlement price and related volume and open interest data for each cleared product, on terms that are fair, reasonable, and not unreasonably discriminatory. For these reasons and based on a review of the entire record, the Board has concluded that the convenience and needs considerations are consistent with approval of the proposal. Conclusion Based on the foregoing and all the facts of record, including all the commitments, stipulations, and representations made in connection with the application, and subject to all the terms and conditions set forth in this order, the Board has determined that ICE Trust s proposed membership in the Federal Reserve System should be, and hereby is, approved. The Board s approval is specifically conditioned on compliance with Regulation H, 20 with receipt of required authorizations from certain other agencies, 21 and with all the commitments, stipulations, and representations made in connection with the application, including the commitments and conditions discussed in this order. The commitments, stipulations, representations, and conditions relied on in reaching this decision shall be deemed to be conditions imposed in writing by the Board in connection with its findings and decision and, as such, may be enforced in proceedings under applicable law. 19 Because ICE Trust will not accept deposits or have federal deposit insurance, it will not be subject to the Community Reinvestment Act. 12 U.S.C et seq CFR Part Those agencies are the NYSBB and the Securities and Exchange Commission.

43 ICE Trust will become a member of the Federal Reserve System on its purchase of stock in the Federal Reserve Bank of New York ( Reserve Bank ). This transaction must occur not later than three months after the effective date of this order, unless such period is extended for good cause by the Board or the Reserve Bank acting pursuant to delegated authority. By order of the Board of Governors, 22 effective March 4, (signed) Robert dev. Frierson Deputy Secretary of the Board 22 Voting for this action: Chairman Bernanke, Vice Chairman Kohn, and Governors Warsh, Duke, and Tarullo.

44 SECURITIES AND EXCHANGE COMMISSION (Release No ; File No. S ) March 6, 2009 ORDER GRANTING TEMPORARY EXEMPTIONS UNDER THE SECURITIES EXCHANGE ACT OF 1934 IN CONNECTION WITH REQUEST ON BEHALF OF ICE US TRUST LLC RELATED TO CENTRAL CLEARING OF CREDIT DEFAULT SWAPS, AND REQUEST FOR COMMENTS I. Introduction In response to the recent turmoil in the financial markets, the Securities and Exchange Commission ( Commission ) has taken multiple actions to protect investors and ensure the integrity of the nation s securities markets. 1 Today the Commission is taking further action designed to address concerns related to the market in credit default swaps ( CDS ). The overthe-counter ( OTC ) market for CDS has been a source of concerns to us and other financial regulators. These concerns include the systemic risk posed by CDS, highlighted by the possible 1 A nonexclusive list of the Commission's actions to stabilize financial markets during this credit crisis include: adopting a package of measures to strengthen investor protections against naked short selling, including rules requiring a hard T+3 close-out, eliminating the options market maker exception of Regulation SHO, and expressly targeting fraud in short selling transactions (See Securities Exchange Act Release No (September 17, 2008), 73 FR (September 23, 2008)); issuing an emergency order to enhance protections against naked short selling in the securities of primary dealers, Federal National Mortgage Association ( Fannie Mae ), and Federal Home Loan Mortgage Corporation ( Freddie Mac ) (See Securities Exchange Act Release No (July 15, 2008), 73 FR (July 21, 2008)); taking temporary emergency action to ban short selling in financial securities (See Securities Exchange Act Release No (September 18, 2008), 73 FR (September 24, 2008)); approving emergency rulemaking to ensure disclosure of short positions by hedge funds and other institutional money managers (See Securities Exchange Act Release No A (September 21, 2008), 73 FR (September 25, 2008)); proposing rules to strengthen the regulation of credit rating agencies and making the limits and purposes of credit ratings clearer to investors (See Securities Exchange Act Release No (June 16, 2008), 73 FR (June 25, 2008); entering into a Memorandum of Understanding with the Board of Governors of the Federal Reserve System ("FRB") to make sure key federal financial regulators share information and coordinate regulatory activities in important areas of common interest (See Memorandum of Understanding Between the U.S. Securities and Exchange Commission and the Board of Governors of the Federal Reserve System Regarding Coordination and Information Sharing in Areas of Common Regulatory and Supervisory Interest (July 7, 2008),

45 2 inability of parties to meet their obligations as counterparties and the potential resulting adverse effects on other markets and the financial system. 2 Recent credit market events have demonstrated the seriousness of these risks in a CDS market operating without meaningful regulation, transparency, 3 or central counterparties ( CCPs ). 4 These events have emphasized the need for CCPs as mechanisms to help control such risks. 5 A CCP for CDS could be an important step in reducing the counterparty risks inherent in the CDS market, and thereby help mitigate potential systemic impacts. In November 2008, the President s Working Group on Financial Markets stated that the implementation of a CCP for CDS was a top priority 6 and, in furtherance of this recommendation, the Commission, the FRB and the Commodity Futures Trading Commission ( CFTC ) signed a Memorandum of Understanding 7 that establishes a framework for consultation and information sharing on issues related to CCPs for CDS. Given the continued uncertainty in this market, taking action to help foster the prompt development of 2 In addition to the potential systemic risks that CDS pose to financial stability, we are concerned about other potential risks in this market, including operational risks, risks relating to manipulation and fraud, and regulatory arbitrage risks. 3 See Policy Objectives for the OTC Derivatives Market, The President s Working Group on Financial Markets, November 14, 2008, available at policyobjectives.pdf ( Public reporting of prices, trading volumes and aggregate open interest should be required to increase market transparency for participants and the public. ). 4 See The Role of Credit Derivatives in the U.S. Economy Before the H. Agric. Comm., 110 th Cong. (2008) (Statement of Erik Sirri, Director of the Division of Trading and Markets, Commission). 5 6 See id. See Policy Objectives for the OTC Derivatives Market, The President s Working Group on Financial Markets (November 14, 2008), See also Policy Statement on Financial Market Developments, The President's Working Group on Financial Markets (March 13, 2008), Progress Update on March Policy Statement on Financial Market Developments, The President's Working Group on Financial Markets (October 2008), 7 See Memorandum of Understanding Between the Board of Governors of the Federal Reserve System, the U.S. Commodity Futures Trading Commission and the U.S. Securities and Exchange Commission Regarding Central Counterparties for Credit Default Swaps (November 14, 2008),

46 3 CCPs, including granting conditional exemptions from certain provisions of the federal securities laws, is in the public interest. A CDS is a bilateral contract between two parties, known as counterparties. The value of this financial contract is based on underlying obligations of a single entity or on a particular security or other debt obligation, or an index of several such entities, securities, or obligations. The obligation of a seller under a CDS to make payments under a CDS contract is triggered by a default or other credit event as to such entity or entities or such security or securities. Investors may use CDS for a variety of reasons, including to offset or insure against risk in their fixedincome portfolios, to take positions in bonds or in segments of the debt market as represented by an index, or to capitalize on the volatility in credit spreads during times of economic uncertainty. In recent years, CDS market volumes have rapidly increased. 8 This growth has coincided with a significant rise in the types and number of entities participating in the CDS market. 9 The Commission s authority over this OTC market for CDS is limited. Specifically, Section 3A of the Securities Exchange Act of 1934 ( Exchange Act ) limits the Commission s authority over swap agreements, as defined in Section 206A of the Gramm-Leach-Bliley Act. 10 For those CDS that are swap agreements, the exclusion from the definition of security in Section 3A of the Exchange Act, and related provisions, will continue to apply. The Commission s 8 See Semiannual OTC derivatives statistics at end-december 2007, Bank for International Settlements ( BIS ), available at 9 CDS were initially created to meet the demand of banking institutions looking to hedge and diversify the credit risk attendant with their lending activities. However, financial institutions such as insurance companies, pension funds, securities firms, and hedge funds have entered the CDS market U.S.C. 78c-1. Section 3A excludes both a non-security-based and a security-based swap agreement from the definition of security under Section 3(a)(10) of the Exchange Act, 15 U.S.C. 78c(a)(10). Section 206A of the Gramm-Leach-Bliley Act defines a swap agreement as any agreement, contract, or transaction between eligible contract participants (as defined in section 1a(12) of the Commodity Exchange Act...)... the material terms of which (other than price and quantity) are subject to individual negotiation. 15 U.S.C. 78c note.

47 4 action today does not affect these CDS, and this Order does not apply to them. For those CDS that are not swap agreements ( non-excluded CDS ), the Commission s action today provides conditional exemptions from certain requirements of the Exchange Act. The Commission believes that using well-regulated CCPs to clear transactions in CDS would help promote efficiency and reduce risk in the CDS market and among its participants. These benefits could be particularly significant in times of market stress, as CCPs would mitigate the potential for a market participant s failure to destabilize other market participants, and reduce the effects of misinformation and rumors. CCP-maintained records of CDS transactions would also aid the Commission s efforts to prevent and detect fraud and other abusive market practices. A well-regulated CCP also would address concerns about counterparty risk by substituting the creditworthiness and liquidity of the CCP for the creditworthiness and liquidity of the counterparties to a CDS. In the absence of a CCP, participants in the OTC CDS market must carefully manage their counterparty risks because the default by a counterparty can render worthless, and payment delay can reduce the usefulness of, the credit protection that has been bought by a CDS purchaser. CDS participants currently attempt to manage counterparty risk by carefully selecting and monitoring their counterparties, entering into legal agreements that permit them to net gains and losses across contracts with a defaulting counterparty, and often requiring counterparty exposures to be collateralized. 11 A CCP could allow participants to avoid these risks specific to individual counterparties because a CCP novates bilateral trades by entering 11 See generally R. Bliss and C. Papathanassiou, Derivatives clearing, central counterparties and novation: The economic implications (March 8, 2006), at 6. See also New Developments in Clearing and Settlement Arrangements for OTC Derivatives, Committee on Payment and Settlement Systems, BIS, at 25 (March 2007), available at Reducing Risks and Improving Oversight in the OTC Credit Derivatives Market, Before the Sen. Subcomm. On Secs., Ins. and Investments, 110th Cong. (2008) (Statement of Patrick Parkinson, Deputy Director, Division of Research and Statistics, FRB).

48 5 into separate contractual arrangements with both counterparties becoming buyer to one and seller to the other. 12 Through novation, it is the CCP that assumes counterparty risks. For this reason, a CCP for CDS would contribute generally to the goal of market stability. As part of its risk management, a CCP may subject novated contracts to initial and variation margin requirements and establish a clearing fund. The CCP also may implement a loss-sharing arrangement among its participants to respond to a participant insolvency or default. A CCP would also reduce CDS risks through multilateral netting of trades. 13 Trades cleared through a CCP would permit market participants to accept the best bid or offer from a dealer in the OTC market with very brief exposure to the creditworthiness of the dealer. In addition, by allowing netting of positions in similar instruments, and netting of gains and losses across different instruments, a CCP would reduce redundant notional exposures and promote the more efficient use of resources for monitoring and managing CDS positions. Through uniform margining and other risk controls, including controls on market-wide concentrations that cannot be implemented effectively when counterparty risk management is decentralized, a CCP can help prevent a single market participant s failure from destabilizing other market participants and, ultimately, the broader financial system. In this context, IntercontinentalExchange, Inc. ( ICE ) and The Clearing Corporation ( TCC ), on behalf of ICE US Trust LLC ( ICE Trust ), have requested that the Commission 12 Novation is a process through which the original obligation between a buyer and seller is discharged through the substitution of the CCP as seller to buyer and buyer to seller, creating two new contracts. Committee on Payment and Settlement Systems, Technical Committee of the International Organization of Securities Commissioners, Recommendations for Central Counterparties (November 2004) at See New Developments in Clearing and Settlement Arrangements for OTC Derivatives, supra note 11, at 25. Multilateral netting of trades would permit multiple counterparties to offset their open transaction exposure through the CCP, spreading credit risk across all participants in the clearing system and more effectively diffusing the risk of a counterparty's default than could be accomplished by bilateral netting alone.

49 6 grant exemptions from certain requirements under the Exchange Act with respect to the proposed activities of ICE Trust in clearing and settling certain CDS, as well as the proposed activities of certain other persons, as described below. 14 Based on the facts presented and the representations made in the request on behalf of ICE Trust, 15 and for the reasons discussed in this Order, the Commission temporarily is exempting, subject to certain conditions, ICE Trust from the requirement to register as a clearing agency under Section 17A of the Exchange Act solely to perform the functions of a clearing agency for certain non-excluded CDS transactions. The Commission also temporarily is exempting eligible contract participants and others from certain Exchange Act requirements with respect to nonexcluded CDS cleared by ICE Trust. In addition, the Commission temporarily is exempting ICE Trust and certain participants of ICE Trust from the registration requirements of Sections 5 and 6 of the Exchange Act solely in connection with the calculation of mark-to-market prices for nonexcluded CDS cleared by ICE Trust. The Commission s exemptions are temporary and will expire on December 7, To facilitate the operation of one or more CCPs for the CDS market, the Commission has also approved interim final temporary rules providing exemptions under the Securities Act of 1933 and the Exchange Act for non-excluded CDS. 16 Finally, the 14 See Letter from Johnathan Short, InterContinental Exchange, Inc. and Kevin McClear, The Clearing Corporation, to Elizabeth Murphy, Secretary, Commission, February 26, See id. The exemptions we are granting today are based on representations made in the request on behalf of ICE Trust We recognize, however, that there could be legal uncertainty in the event that one or more of the underlying representations were to become inaccurate. Accordingly, if any of these exemptions were to become unavailable by reason of an underlying representation no longer being materially accurate, the legal status of existing open positions in non-excluded CDS associated with persons subject to those unavailable exemptions would remain unchanged, but no new positions could be established pursuant to the exemptions until all of the underlying representations were again accurate. 16 See Securities Act Release No (January 14, 2009).

50 7 Commission has provided temporary exemptions in connection with Sections 5 and 6 of the Exchange Act for transactions in non-excluded CDS. 17 II. Discussion A. Description of ICE Trust s Proposal The exemptive request on behalf of ICE Trust describes how the proposed arrangements for central clearing of CDS by ICE Trust would operate, and makes representations about the safeguards associated with those arrangements, as described below: 1. ICE Trust Organization ICE Trust is organized as a New York State chartered limited liability trust company and has received approval of its application to become a member of the Federal Reserve System. ICE Trust is subject to direct supervision and examination by the New York State Banking Department ( NYSBD ), and, in association with the approval of its applicable to become a member of the Federal Reserve System, will be subject to direct supervision and examination by the FRB, specifically the Federal Reserve Bank of New York. 2. ICE Trust Central Counterparty Services for CDS Initially, ICE Trust s business will be limited to the provision of clearing services for the OTC CDS market. ICE Trust will act as a central counterparty for ICE Trust Participants (as defined below) 18 by assuming, through novation, the obligations of all eligible CDS transactions accepted by it for clearing and collecting margin and other credit support from ICE Trust Participants to collateralize their obligations to ICE Trust. ICE Trust s trade submission process is designed to ensure that it maintains a matched book of offsetting CDS contracts See Securities Exchange Act Release No (December 24, 2008). See note 35, infra.

51 8 Although CDS are currently bilaterally negotiated and executed, major market participants frequently use the Deriv/SERV service of The Depository Trust & Clearing Corporation ( DTCC ) comparison and confirmation service when documenting their CDS transactions. This service creates electronic records of transaction terms and counterparties. As part of this service, market participants separately submit the terms of a CDS transaction to Deriv/SERV in electronic form. Paired submissions are compared to verify that their terms match in all required respects. If a match is confirmed, the parties receive an electronic confirmation of the submitted transaction. All submitted transactions are recorded in the Deriv/SERV Trade Information Warehouse, which serves as the primary registry for submitted transactions. ICE Trust will leverage the Deriv/SERV infrastructure in operating its CDS clearing service. Initially, all trades submitted by Participants for clearing through ICE Trust will be recorded in the Deriv/SERV Trade Information Warehouse. ICE Trust will, initially on a weekly basis, obtain from DTCC matched trades that have been recorded in the Deriv/SERV Trade Information Warehouse as having been submitted for clearing through ICE Trust. Within two months of launch, ICE Trust intends to obtain matched trades from DTCC on a daily basis. Participants may use the facilities of an inter-dealer broker to execute CDS transactions, for example, to access liquidity more rapidly or to maintain pre-execution anonymity and submit such transactions for clearance and settlement to ICE Trust. The inter-dealer brokers do not assume market positions in connection with their intermediation of CDS transactions. Once a matched CDS contract has been forwarded to, or obtained by, ICE Trust, and has been accepted for clearing by it, ICE Trust will clear the CDS contract by becoming the central counterparty to each party to the trade through novation. Deriv/SERV s current infrastructure

52 9 will help to ensure that ICE Trust maintains a matched book of offsetting CDS contracts. Maintaining a matched offsetting book is essential to managing the credit risk associated with CDS submitted to ICE Trust for clearing. Under the ICE Trust s current draft rules ( ICE Trust Rules ), each bilateral CDS contract between two ICE Trust Participants that is submitted, and accepted by ICE Trust, for clearing will be novated. As part of this process, each bilateral CDS contract submitted to ICE Trust will be replaced by two superseding CDS contracts between each of the original parties to the submitted transaction and ICE Trust. Under these new contracts, ICE Trust will act as the counterparty to each of the original parties. As central counterparty to each novated CDS contract, ICE Trust will be able to net offsetting positions on a multilateral basis, even though ICE Trust will have different counterparties with respect to the novated CDS contracts that are being netted. As part of the novation process, the terms and conditions governing the CDS bilaterally negotiated by the submitting counterparties will be superseded by the relevant provisions of the ICE Trust Rules applicable to the relevant CDS transaction. Multilateral netting will significantly reduce the outstanding notional amount of each ICE Trust Participant s CDS portfolio. When ICE Trust acts as the central counterparty to all cleared CDS of an ICE Trust Participant, that participant s positions will be netted down to a single exposure to ICE Trust. 3. ICE Trust Risk Management ICE Trust will mitigate counterparty risk through its margin, guaranty fund, and credit support framework, as set forth in the ICE Trust Rules. ICE Trust s risk management infrastructure and related risk metrics will be structured specifically for the CDS products that

53 10 ICE Trust clears. Each ICE Trust Participant s credit support obligations will be governed by a uniform credit support framework and applicable ICE Trust Rules. ICE Trust represents that it will maintain strict, objectively determined, risk-based margin and guaranty fund requirements, which will be subject to extensive and ongoing regulation and oversight by the FRB and the NYSBD. These requirements will also be consistent with clearing industry practice, Basel II capital adequacy standards, and international standards established for central counterparties as articulated in the Bank for International Settlements / International Organization of Securities Commissions ( IOSCO ) CCP Recommendations. The amount of margin and guaranty fund required of each ICE Trust Participant will be continuously adjusted to reflect the size and profile of, and risk associated with, the ICE Trust Participant s cleared CDS transactions (and related market factors). Pursuant to ICE Trust Rules, each ICE Trust Participant s margin requirement will consist of two components: (1) initial margin, reflecting a risk-based calculation of potential loss on outstanding CDS positions in the event of a significant adverse market movement, and (2) mark-to-market margin, based upon an end-of-day mark-to-market of outstanding positions. Acceptable margin will initially include only cash in specified currencies and G-7 government debt for initial margin and only cash for mark-to-market margin. ICE Trust Participants will be required to cover any end-of-day margin deficit with U.S. dollars by the following morning, and ICE Trust will have the discretion to require and collect additional margin, both at the end of the day and intraday, as it deems necessary. 19 ICE Trust will also maintain a guaranty fund (the Guaranty Fund ) to cover losses arising from an ICE Trust Participant s default on cleared CDS transactions that exceed the 19 An ICE Trust Participant would be permitted to withdraw mark-to-market margin amounts credited to its account to the extent not required to satisfy its initial margin requirement.

54 11 amount of margin held by ICE Trust from the defaulting ICE Trust Participant. Each ICE Trust Participant will be required to contribute a minimum of $20 million to the Guaranty Fund initially when it becomes an ICE Trust Participant and on an ongoing basis, additional amounts based on its actual and anticipated CDS position exposures. The adequacy of the Guaranty Fund will be monitored daily and the need for additional contributions will be determined on at least a monthly basis, based on the size of ICE Trust Participant exposures within the ICE Trust clearing system. As a result, the Guaranty Fund will grow in proportion to the position risk associated with the aggregate volume of CDS cleared by ICE Trust. ICE Trust will also establish rules that mutualize the risk of an ICE Trust Participant default across all ICE Trust Participants. In the event of an ICE Trust Participant s default, ICE Trust may look to the margin posted by such participant, such participant s Guaranty Fund contributions and, if applicable, any recovery from a parent guarantor. In addition, at its discretion, ICE Trust will be authorized to use, to the extent needed, other ICE Trust Participants Guaranty Fund contributions to satisfy any obligations of the defaulting ICE Trust Participant; provided that, any recovery from the defaulting ICE Trust Participant, its parent guarantor, if any, or the sale of the defaulting ICE Trust Participant s positions in ICE Trust will first be used to refund any amounts utilized by ICE Trust from contributions of non-defaulting ICE Trust Participants to the Guaranty Fund. 4. Member Default Following a default by an ICE Trust Participant, ICE Trust has a number of tools available to it under the ICE Trust Rules to ensure an orderly liquidation and unwinding of the open positions of such defaulting ICE Trust Participant. In the first instance, upon determining that a default has occurred, ICE Trust will have the ability to immediately enter into replacement

55 12 CDS transactions with other ICE Trust Participants that are designed to mitigate, to the greatest extent possible, the market risk of the defaulting ICE Trust Participant s open positions. For open positions in which there is no liquid trading market, ICE Trust may enter into covering CDS transactions for which there is a liquid market and that are most closely correlated with such illiquid open positions. After entering into covering transactions in the open market, if any, ICE Trust will seek to close out any remaining open positions of the defaulting ICE Trust Participant (including any initial covering transactions) by using one or more auctions or other commercially reasonable unwind processes. The ICE Trust Rules will prohibit ICE Trust from entering into any replacement transaction if the price of such transaction would be below the least favorable price that would be reasonable to accept for such replacement transaction. To the extent ICE Trust is not able to enter into the necessary replacement transactions through auctions or open market processes, ICE Trust will be entitled to allocate such replacement transactions to the remaining ICE Trust Participants at the floor price established by ICE Trust. B. Temporary Conditional Exemptions from Clearing Agency and Exchange Registration Requirements 1. Exemption from Section 17A of the Exchange Act Section 17A of the Exchange Act sets forth the framework for the regulation and operation of the U.S. clearance and settlement system, including CCPs. Specifically, Section 17A directs the Commission to use its authority to promote enumerated Congressional objectives and to facilitate the development of a national clearance and settlement system for securities transactions. Absent an exemption, a CCP that novates trades of non-excluded CDS that are

56 13 securities and generates money and settlement obligations for participants is required to register with the Commission as a clearing agency. Section 36 of the Exchange Act authorizes the Commission to conditionally or unconditionally exempt any person, security, or transaction, or any class or classes of persons, securities, or transactions, from any provision or provisions of the Exchange Act or any rule or regulation thereunder, by rule, regulation, or order, to the extent that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors. 20 Accordingly, pursuant to Section 36 of the Exchange Act, the Commission finds that it is necessary or appropriate in the public interest and is consistent with the protection of investors to exercise its authority to grant an exemption until December 7, 2009 to ICE Trust from Section 17A of the Exchange Act, solely to perform the functions of a clearing agency for Cleared CDS, 21 subject to the conditions discussed below. Our action today balances the aim of facilitating the prompt establishment of ICE Trust as a CCP for non-excluded CDS transactions which should help reduce systemic risks during a period of extreme turmoil in the U.S. and global financial markets with ensuring that important U.S.C. 78mm. For purposes of this exemption, and the other exemptions addressed in this Order, Cleared CDS means a credit default swap that is submitted (or offered, purchased, or sold on terms providing for submission) to ICE Trust, that is offered only to, purchased only by, and sold only to eligible contract participants (as defined in Section 1a(12) of the Commodity Exchange Act as in effect on the date of this Order (other than a person that is an eligible contract participant under paragraph (C) of that section)), and in which: (i) the reference entity, the issuer of the reference security, or the reference security is one of the following: (A) an entity reporting under the Exchange Act, providing Securities Act Rule 144A(d)(4) information, or about which financial information is otherwise publicly available; (B) a foreign private issuer whose securities are listed outside the United States and that has its principal trading market outside the United States; (C) a foreign sovereign debt security; (D) an asset-backed security, as defined in Regulation AB, issued in a registered transaction with publicly available distribution reports; or (E) an asset-backed security issued or guaranteed by the Fannie Mae, Freddie Mac or the Government National Mortgage Association ( Ginnie Mae ); or (ii) the reference index is an index in which 80 percent or more of the index s weighting is comprised of the entities or securities described in subparagraph (i). As discussed above, the Commission s action today does not affect CDS that are swap agreements under Section 206A of the Gramm-Leach-Bliley Act. See text at note 10, supra.

57 14 elements of Commission oversight are applied to the non-excluded CDS market. In doing so, we are mindful that applying the full scope of the Exchange Act to transactions involving nonexcluded CDS could deter the prompt establishment of ICE Trust as a CCP to settle those transactions. While we are acting so that the prompt establishment of ICE Trust as a CCP for nonexcluded CDS will not be delayed by the need to apply the full scope of Exchange Act Section 17A s requirements that govern clearing agencies, the relief we are providing is temporary and conditional. The limited duration of the exemptions will permit the Commission to gain more direct experience with the non-excluded CDS market after ICE Trust becomes operational, giving the Commission the ability to oversee the development of the centrally cleared nonexcluded CDS market as it evolves. During the exemptive period, the Commission will closely monitor the impact of the CCPs on the CDS market. In particular, the Commission will seek to assure itself that the CCPs do not act in anticompetitive manner or indirectly facilitate anticompetitive behavior with respect to fees charged to members, the dissemination of market data and the access to clearing services by independent CDS exchanges or CDS trading platforms. The Commission will take that experience into account in future actions. Moreover, this temporary exemption in part is based on ICE Trust s representation that it meets the standards set forth in the Committee on Payment and Settlement Systems ( CPSS ) and IOSCO report entitled: Recommendation for Central Counterparties ( RCCP ). 22 The RCCP establishes a framework that requires a CCP to have: (i) the ability to facilitate the prompt 22 The RCCP was drafted by a joint task force ( Task Force ) composed of representative members of IOSCO and CPSS and published in November The Task Force consisted of securities regulators and central bankers from 19 countries and the European Union. The U.S. representatives on the Task Force included staff from the Commission, the FRB, and the CFTC.

58 15 and accurate clearance and settlement of CDS transactions and to safeguard its users assets; and (ii) sound risk management, including the ability to appropriately determine and collect clearing fund and monitor its users trading. This framework is generally consistent with the requirements of Section 17A of the Exchange Act. In addition, this Order is designed to assure that as represented in the request on behalf of ICE Trust information will be available to market participants about the terms of the CDS cleared by ICE Trust, the creditworthiness of ICE Trust or any guarantor, and the clearing and settlement process for the CDS. Moreover, to be within the definition of Cleared CDS for purposes of this exemption (as well as the other exemptions granted through this Order), a CDS may only involve a reference entity, a reference security, an issuer of a reference security, or a reference index that satisfies certain conditions relating to the availability of information about such persons or securities. For non-excluded CDS that are index-based, the definition provides that at least 80 percent of the weighting of the index must be comprised of reference entities, issuers of a reference security, or reference securities that satisfy the information conditions. The definition does not prescribe the type of financial information that must be available nor the location of the particular information, recognizing that eligible contract participants have access to information about reference entities and reference securities through multiple sources. The Commission believes, however, that it is important in the CDS market, as in the market for securities generally, that parties to transactions should have access to financial information that would allow them to appropriately evaluate the risks relating to a particular investment and make more informed investment decisions. 23 Such information availability also will assist ICE Trust 23 The Commission notes the recommendations of the President s Working Group on Financial Markets regarding the informational needs and due diligence responsibilities of investors. See Policy Statement on Financial Market Developments, The President s Working Group on Financial Markets,

59 16 and the buyers and sellers in valuing their Cleared CDS and their counterparty exposures. As a result of the Commission s actions today, the Commission believes that information should be available for market participants to be able to make informed investment decisions, and value and evaluate their Cleared CDS and their counterparty exposures. This temporary exemption is subject to a number of conditions that are designed to enable Commission staff to monitor ICE Trust s clearance and settlement of CDS transactions and help reduce risk in the CDS market. These conditions require that ICE Trust: (i) make available on its Web site its annual audited financial statements; (ii) preserve records related to the conduct of its Cleared CDS clearance and settlement services for at least five years (in an easily accessible place for the first two years); (iii) provide information relating to its Cleared CDS clearance and settlement services to the Commission and provide access to the Commission to conduct on-site inspections of facilities, records and personnel related to its Cleared CDS clearance and settlement services; (iv) notify the Commission about material disciplinary actions taken against any of its members utilizing its Cleared CDS clearance and settlement services, and about the involuntary termination of the membership of an entity that is utilizing ICE Trust s Cleared CDS clearance and settlement services; (v) provide the Commission with changes to rules, procedures, and any other material events affecting its Cleared CDS clearance and settlement services; (vi) provide the Commission with reports prepared by independent audit personnel that are generated in accordance with risk assessment of the areas set forth in the Commission s Automation Review Policy Statements 24 and its annual audited financial March 13, 2008, available at: 24 See Automated Systems of Self-Regulatory Organization, Exchange Act Release No (November 16, 1989), File No. S , and Automated Systems of Self-Regulatory Organization (II), Exchange Act Release No (May 9, 1991), File No. S

60 17 statements prepared by independent audit personnel; and (vii) report all significant systems outages to the Commission. In addition, this relief is conditioned on ICE Trust, directly or indirectly, making available to the public on terms that are fair and reasonable and not unreasonably discriminatory: (i) all end-of-day settlement prices and any other prices with respect to Cleared CDS that ICE Trust may establish to calculate mark-to-market margin requirements for ICE Trust Participants; and (ii) any other pricing or valuation information with respect to Cleared CDS as is published or distributed by ICE Trust. The Commission believes this is an appropriate condition for ICE Trust s exemption from registration as a clearing agency. In Section 11A of the Exchange Act, Congress found that "[i]t is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly markets to assure... the availability to brokers, dealers, and investors of information with respect to quotations for and transactions in securities." 25 The President's Working Group on Financial Markets has stated that increased transparency is a policy objective for the over-the-counter derivatives market, 26 which includes the market for CDS. The condition is designed to further this policy objective of both Congress and the President's Working Group by requiring ICE Trust to make useful pricing data available to the public on terms that are fair and reasonable and not unreasonably discriminatory. Congress adopted these standards for the distribution of data in Section 11A. The Commission long has U.S.C. 78k-1(a)(1)(C)(iii). See also 15 U.S.C. 78k-1(a)(1)(D). See President s Working Group on Financial Markets, Policy Objectives for the OTC Derivatives Market (November 14, 2008), available at ( Public reporting of prices, trading volumes and aggregate open interest should be required to increase market transparency for participants and the public. ).

61 18 applied the standards in the specific context of securities market data, 27 and it anticipates that ICE Trust will distribute its data on terms that generally are consistent with the application of these standards to securities market data. For example, data distributors generally are required to treat subscribers equally and not grant special access, fees, or other privileges to favored customers of the distributor. Similarly, distributors must make their data feeds reasonably available to data vendors for those subscribers who wish to receive their data indirectly through a vendor rather than directly from the distributor. In addition, a distributor s attempt to tie data products that must be made available to the public with other products or services of the distributor would be inconsistent with the statutory requirements. 28 The Commission carefully evaluates any type of discrimination with respect to subscribers and vendors to assess whether there is a reasonable basis for the discrimination given, among other things, the Exchange Act objective of promoting price transparency. 29 Moreover, preventing unreasonable discrimination is a practical means to promote fair and reasonable terms for data distribution because distributors are more likely to act appropriately when the terms applicable to the broader public also must apply to any favored classes of customers See Exchange Act Release No (December 9, 1999), 64 FR 70613, (December 17, 1999) ( Market Information Concept Release ) (discussion of legal standards applicable to market data distribution since Section 11A was adopted in 1975). 28 See Exchange Act Release No (December 2, 2008), 73 FR 74770, (December 9, 2008) ( NYSE ArcaBook Order ) ( [S]ection 6 and Exchange Act Rule 603(a) require NYSE Arca to distribute the ArcaBook data on terms that are not tied to other products in a way that is unfairly discriminatory or anticompetitive. ). 29 See Market Information Concept Release, 64 FR at ( The most important objectives for the Commission to consider in evaluating fees are to assure (1) the wide availability of market information, (2) the neutrality of fees among markets, vendors, broker-dealers, and users, (3) the quality of market information its integrity, reliability, and accuracy, and (4) fair competition and equal regulation among markets and broker-dealers. ). 30 See NYSE ArcaBook Order, 73 FR at ( [T]he proposed fees for ArcaBook data will apply equally to all professional subscribers and all non-professional subscribers... The fees therefore do not

62 19 As a CCP, ICE Trust will collect and process information about CDS transactions, prices, and positions from all of its participants. With this information, a CCP will, among other things, calculate and disseminate current values for open positions for the purpose of setting appropriate margin levels. The availability of such information can improve fairness, efficiency, and competitiveness of the market all of which enhance investor protection and facilitate capital formation. Moreover, with pricing and valuation information relating to Cleared CDS, market participants would be able to derive information about underlying securities and indexes. This may improve the efficiency and effectiveness of the securities markets by allowing investors to better understand credit conditions generally. 2. Exemption from Sections 5 and 6 of the Exchange Act ICE Trust represents that, in connection with its clearing and risk management process, it will calculate an end-of-day settlement price for each Cleared CDS in which an ICE Trust Participant has a cleared position, based on prices submitted by ICE Trust Participants. As part of this mark-to-market process, ICE Trust will periodically require ICE Trust Participants to execute certain CDS trades at the applicable end-of-day settlement price. Requiring ICE Trust Participants to trade CDS periodically in this manner is designed to help ensure that such submitted prices reflect each ICE Trust Participant s best assessment of the value of each of its open positions in Cleared CDS on a daily basis, thereby reducing risk by allowing ICE Trust to impose appropriate margin requirements. Section 5 of the Exchange Act states that "[i]t shall be unlawful for any broker, dealer, or exchange, directly or indirectly, to make use of the mails or any means or instrumentality of unreasonably discriminate among types of subscribers, such as by favoring participants in the NYSE Arca market or penalizing participants in other markets. ).

63 20 interstate commerce for the purpose of using any facility of an exchange... to effect any transaction in a security, or to report any such transactions, unless such exchange (1) is registered as a national securities exchange under section 6 of [the Exchange Act], or (2) is exempted from such registration... by reason of the limited volume of transactions effected on such exchange." 31 Section 6 of the Exchange Act sets forth a procedure whereby an exchange 32 may register as a national securities exchange. 33 To facilitate the establishment of ICE Trust's end-of-day settlement price process, including the periodically required trading described above, the Commission is exercising its authority under Section 36 of the Exchange Act to temporarily exempt ICE Trust and ICE Trust Participants from Sections 5 and 6 of the Exchange Act and the rules and regulations thereunder in connection with ICE Trust's calculation of mark-to-market prices for open positions in Cleared CDS. This temporary exemption is subject to the following conditions: First, ICE Trust must report the following information with respect to the calculation of mark-to-market prices for Cleared CDS to the Commission within 30 days of the end of each quarter, and preserve such reports during the life of the enterprise and of any successor enterprise: The total dollar volume of transactions executed during the quarter, broken down by reference entity, security, or index; and U.S.C. 78e. 32 Section 3(a)(1) of the Exchange Act, 15 U.S.C. 78c(a)(1), defines exchange. Rule 3b-16 under the Exchange Act, 17 CFR 240.3b-16, defines certain terms used in the statutory definition of exchange. See Exchange Act Release No (December 8, 1998), 63 FR (December 22, 1998) (adopting Rule 3b-16 in addition to Regulation ATS) U.S.C. 78f. Section 6 of the Exchange Act also sets forth various requirements to which a national securities exchange is subject.

64 21 The total unit volume and/or notional amount executed during the quarter, broken down by reference entity, security, or index. Reporting of this information will assist the Commission in carrying out its responsibility to supervise and regulate the securities markets. Second, ICE Trust must establish adequate safeguards and procedures to protect participants' confidential trading information. Such safeguards and procedures shall include: (a) limiting access to the confidential trading information of participants to those employees of ICE Trust who are operating the system or responsible for its compliance with this exemption or any other applicable rules; and (b) implementing standards controlling employees of ICE Trust trading for their own accounts. ICE Trust must adopt and implement adequate oversight procedures to ensure that the safeguards and procedures established pursuant to this condition are followed. This condition is designed to prevent any misuse of ICE Trust Participant trading information that may be available to ICE Trust in connection with the daily marking-to-market process of open positions in Cleared CDS. This should strengthen confidence in ICE Trust as a CCP for CDS, promoting participation. Third, ICE Trust must comply with the conditions to the temporary exemption from registration as a clearing agency granted in this Order. As set forth above, this Order is designed to facilitate the prompt establishment of ICE Trust as a CCP for non-excluded CDS. ICE Trust has represented that, to enhance the reliability of end-of-day settlement prices submitted as part of the daily mark-to-market process, it must require periodic trading of Cleared CDS positions by ICE Participants whose submitted end-of-day prices lock or cross. The Commission's temporary exemption from Sections 5 and 6 of the Exchange Act is based on ICE Trust's representation that the end-of-day settlement pricing process, including the periodically required

65 22 trading is integral to its risk management. Accordingly, as a condition to ICE Trust's temporary exemption from Sections 5 and 6 of the Exchange Act, ICE trust must comply with the conditions to the temporary exemption from Section 17A of the Exchange Act in this Order. The Commission is also exempting each ICE Trust Participant from the prohibition in Section 5 of the Exchange Act to the extent that such ICE Trust Participant uses any facility of ICE Trust to effect any transaction in Cleared CDS, or to report any such transaction, in connection with ICE Trust's calculation of mark-to-market prices for open positions in Cleared CDS. Absent an exemption, Section 5 would prohibit any ICE Trust Participant that is a broker or dealer from effecting transactions in Cleared CDS on ICE Trust, which will rely on this order for an exemption from exchange registration. The Commission believes that exempting ICE Trust Participants from the restriction in Section 5 is necessary and appropriate in the public interest and is consistent with the protection of investors because it will facilitate their use of ICE Trust s CCP for Cleared CDS, which for the reasons noted in this Order the Commission believes to be beneficial. Without also exempting ICE Trust Participants from this Section 5 requirement, the Commission's temporary exemption of ICE Trust from Sections 5 and 6 of the Exchange Act would be ineffective, because ICE Trust Participants that are brokers or dealers would not be permitted to effect transactions on ICE Trust in connection with the end-of-day settlement price process. C. Temporary General Exemption for ICE Trust, Certain ICE Trust Participants, and Certain Eligible Contract Participants Applying the full panoply of Exchange Act requirements to participants in transactions in non-excluded CDS likely would deter some participants from using CCPs to clear CDS transactions. At the same time, it is important that the antifraud provisions of the Exchange Act

66 23 apply to transactions in non-excluded CDS; indeed, OTC transactions subject to individual negotiation that qualify as security-based swap agreements already are subject to these antifraud provisions. 34 We thus believe that it is appropriate in the public interest and consistent with the protection of investors temporarily to apply substantially the same framework to transactions by market participants in non-excluded CDS that applies to transactions in security-based swap agreements. Applying substantially the same set of requirements to participants in transactions in non-excluded CDS as apply to participants in OTC CDS transactions will avoid deterring market participants from promptly using CCPs, which would detract from the potential benefits of central clearing. Accordingly, pursuant to Section 36 of the Exchange Act, the Commission finds that it is necessary or appropriate in the public interest and is consistent with the protection of investors to exercise its authority to grant an exemption until December 7, 2009 from certain requirements under the Exchange Act. This temporary exemption applies to ICE Trust, any ICE Trust 34 While Section 3A of the Exchange Act excludes swap agreements from the definition of security, certain antifraud and insider trading provisions under the Exchange Act explicitly apply to security-based swap agreements. See (a) paragraphs (2) through (5) of Section 9(a), 15 U.S.C. 78i(a), prohibiting the manipulation of security prices; (b) Section 10(b), 15 U.S.C. 78j(b), and underlying rules prohibiting fraud, manipulation or insider trading (but not prophylactic reporting or recordkeeping requirements); (c) Section 15(c)(1), 15 U.S.C. 78o(c)(1), which prohibits brokers and dealers from using manipulative or deceptive devices; (d) Sections 16(a) and (b), 15 U.S.C. 78p(a) and (b), which address disclosure by directors, officers and principal stockholders, and short-swing trading by those persons, and rules with respect to reporting requirements under Section 16(a); (e) Section 20(d), 15 U.S.C. 78t(d), providing for antifraud liability in connection with certain derivative transactions; and (f) Section 21A(a)(1), 15 U.S.C. 78u-1(a)(1), related to the Commission s authority to impose civil penalties for insider trading violations. Security-based swap agreement is defined in Section 206B of the Gramm-Leach-Bliley Act as a swap agreement in which a material term is based on the price, yield, value, or volatility of any security or any group or index of securities, or any interest therein.

67 24 Participant 35 which is not a broker or dealer registered under Section 15(b) of the Exchange Act (other than paragraph (11) thereof), and any eligible contract participants 36 other than: eligible contract participants that receive or hold funds or securities for the purpose of purchasing, selling, clearing, settling or holding Cleared CDS positions for other persons; 37 eligible contract participants that are self-regulatory organizations; or eligible contract participants that are registered brokers or dealers. 38 Under this temporary exemption, and solely with respect to Cleared CDS, these persons generally are exempt from provisions of the Exchange Act and the rules and regulations thereunder that do not apply to security-based swap agreements. Those persons thus would still be subject to those Exchange Act requirements that explicitly are applicable in connection with security-based swap agreements. 39 In addition, all provisions of the Exchange Act related to the Commission s enforcement authority in connection with violations or potential violations of such 35 For purposes of this Order, an ICE Trust Participant means any participant in ICE Trust that submits Cleared CDS to ICE Trust for clearance and settlement exclusively (i) for its own account or (ii) for the account of an affiliate that controls, is controlled by, or is under common control with the participant in ICE Trust. In general, this exemption does not apply to any ICE Trust Participant that is registered with the Commission as a broker-dealer. A separate temporary exemption addresses the Cleared CDS activities of registered broker-dealers. See Part II.D., infra. 36 This exemption in general applies to eligible contract participants, as defined in Section 1a(12) of the Commodity Exchange Act as in effect on the date of this Order, other than persons that are eligible contract participants under paragraph (C) of that section. 37 For these purposes, and for the purpose of the definition of Cleared CDS, the terms purchasing and selling mean the execution, termination (prior to its scheduled maturity date), assignment, exchange, or similar transfer or conveyance of, or extinguishing the rights or obligations under, a Cleared CDS, as the context may require. This is consistent with the meaning of the terms purchase or sale under the Exchange Act in the context of security-based swap agreements. See Exchange Act Section 3A(b)(4). 38 A separate temporary exemption addresses the Cleared CDS activities of registered brokerdealers. See Part II.D., infra. Solely for purposes of this Order, a registered broker-dealer, or a broker or dealer registered under Section 15(b) of the Exchange Act, does not refer to someone that would otherwise be required to register as a broker or dealer solely as a result of activities in Cleared CDS in compliance with this Order. 39 See note 34, supra.

68 25 provisions would remain applicable. 40 In this way, the temporary exemption would apply the same Exchange Act requirements in connection with non-excluded CDS as apply in connection with OTC credit default swaps. This temporary exemption, however, does not extend to Sections 5 and 6 of the Exchange Act. 41 The Commission separately issued a conditional exemption from these provisions to all broker-dealers and exchanges. 42 This temporary exemption also does not extend to Section 17A of the Exchange Act; instead, ICE Trust is exempt from registration as a clearing agency under the conditions discussed above. In addition, this exemption does not apply to Exchange Act Sections 12, 13, 14, 15(d), and 16; 43 eligible contract participants and other persons instead should refer to the interim final temporary rules issued by the Commission. Finally, this temporary exemption does not extend to the Commission s administrative proceeding authority under Sections 15(b)(4) and (b)(6), 44 or to certain provisions related to government securities Thus, for example, the Commission retains the ability to investigate potential violations and bring enforcement actions in the federal courts and administrative proceedings, and to seek the full panoply of remedies available in such cases. 41 This Order includes a separate temporary exemption regarding the mark-to-market process of ICE Trust, discussed above. 42 See note 17, supra. A national securities exchange that effects transactions in Cleared CDS would continue to be required to comply with all requirements under the Exchange Act applicable to such transactions. A national securities exchange could form subsidiaries or affiliates that operate exchanges exempt under that order. Any subsidiary or affiliate of a registered exchange could not integrate, or otherwise link, the exempt CDS exchange with the registered exchange including the premises or property of such exchange for effecting or reporting a transaction without being considered a facility of the exchange. See Section 3(a)(2), 15 U.S.C.78c(a)(2) U.S.C. 78l, 78m, 78n, 78o(d), 78p. Exchange Act Sections 15(b)(4) and 15(b)(6), 15 U.S.C. 78o(b)(4) and (b)(6), grant the Commission authority to take action against broker-dealers and associated persons in certain situations. Accordingly, while this exemption generally extends to persons that act as inter-dealer brokers in the market for Cleared CDS and do not hold funds or securities for others, such inter-dealer brokers may be subject to actions under Sections 15(b)(4) and (b)(6) of the Exchange Act. In addition, such inter-dealer brokers may be subject to actions under Exchange Act Section 15(c)(1), 15 U.S.C. 78o(c)(1), which prohibits brokers and dealers from using manipulative or deceptive devices. As noted above, Section 15(c)(1) explicitly applies to security-based swap agreements. Sections

69 26 D. Temporary General Exemption for Certain Registered Broker-Dealers The temporary exemptions addressed above with regard to ICE Trust, certain ICE Trust Participants, and certain eligible contract participants are not available to persons that are registered as broker-dealers with the Commission (other than those that are notice registered pursuant to Section 15(b)(11)). 46 The Exchange Act and its underlying rules and regulations require broker-dealers to comply with a number of obligations that are important to protecting investors and promoting market integrity. We are mindful of the need to avoid creating disincentives to the prompt use of CCPs, and we recognize that the factors discussed above suggest that the full panoply of Exchange Act requirements should not immediately be applied to registered broker-dealers that engage in transactions involving Cleared CDS. At the same time, we also are sensitive to the critical importance of certain broker-dealer requirements to promoting market integrity and protecting customers (including those broker-dealer customers that are not involved with CDS transactions). This calls for balancing the facilitation of the development and prompt implementation of CCPs with the preservation of certain key investor protections. Pursuant to Section 36 of the Exchange Act, the Commission finds that it is necessary or appropriate in the public interest and is consistent with the protection of investors to exercise its authority to grant an exemption until December 7, 2009 from certain Exchange Act requirements. Consistent with 15(b)(4), 15(b)(6) and 15(c)(1), of course, would not apply to persons subject to this exemption who do not act as broker-dealers or associated persons of broker-dealers. 45 This exemption specifically does not extend to the Exchange Act provisions applicable to government securities, as set forth in Section 15C, 15 U.S.C. 78o-5, and its underlying rules and regulations; nor does the exemption extend to related definitions found at paragraphs (42) through (45) of Section 3(a), 15 U.S.C. 78c(a). The Commission does not have authority under Section 36 to issue exemptions in connection with those provisions. See Exchange Act Section 36(b), 15 U.S.C. 78mm(b). 46 Exchange Act Section 15(b)(11) provides for notice registration of certain persons that effect transactions in security futures products. 15 U.S.C. 78o(b)(11).

70 27 the temporary exemptions discussed above, and solely with respect to Cleared CDS, we are exempting registered broker-dealers in general from provisions of the Exchange Act and its underlying rules and regulations that do not apply to security-based swap agreements. As above, we are not excluding registered broker-dealers from Exchange Act provisions that explicitly apply in connection with security-based swap agreements or from related enforcement authority provisions. 47 As above, and for similar reasons, we are not exempting registered broker-dealers from: Sections 5, 6, 12(a) and (g), 13, 14, 15(b)(4), 15(b)(6), 15(d), 16 and 17A of the Exchange Act. 48 Further we are not exempting registered broker-dealers from the following additional provisions under the Exchange Act: (1) Section 7(c), 49 which addresses the unlawful extension of credit by broker-dealers; (2) Section 15(c)(3), 50 which addresses the use of unlawful or manipulative devices by broker-dealers; (3) Section 17(a), 51 regarding broker-dealer obligations to make, keep and furnish information; (4) Section 17(b), 52 regarding broker-dealer records subject to examination; (5) Regulation T, 53 a Federal Reserve Board regulation regarding 47 See notes 34 and 40, supra. As noted above, broker-dealers also would be subject to Section 15(c)(1) of the Exchange Act, which prohibits brokers and dealers from using manipulative or deceptive devices, because that provision explicitly applies in connection with security-based swap agreements. In addition, to the extent the Exchange Act and any rule or regulation thereunder imposes any other requirement on a broker-dealer with respect to security-based swap agreements (e.g., requirements under Rule 17h-1T to maintain and preserve written policies, procedures, or systems concerning the broker or dealer's trading positions and risks, such as policies relating to restrictions or limitations on trading financial instruments or products), these requirements would continue to apply to broker-dealers activities with respect to Cleared CDS. 48 We also are not exempting those members from provisions related to government securities, as discussed above U.S.C. 78g(c). 15 U.S.C. 78o(c)(3). 15 U.S.C. 78q(a). 15 U.S.C. 78q(b). 12 CFR et seq.

71 28 extension of credit by broker-dealers; (6) Exchange Act Rule 15c3-1, regarding broker-dealer net capital; (7) Exchange Act Rule 15c3-3, regarding broker-dealer reserves and custody of securities; (8) Exchange Act Rules 17a-3 through 17a-5, regarding records to be made and preserved by broker-dealers and reports to be made by broker-dealers; and (9) Exchange Act Rule 17a-13, regarding quarterly security counts to be made by certain exchange members and broker-dealers. 54 Registered broker-dealers should comply with these provisions in connection with their activities involving non-excluded CDS because these provisions are especially important to helping protect customer funds and securities, ensure proper credit practices and safeguard against fraud and abuse. 55 E. Solicitation of Comments The Commission intends to monitor closely the development of the CDS market and intends to determine to what extent, if any, additional regulatory action may be necessary. For example, as circumstances warrant, certain conditions could be added, altered, or eliminated. Moreover, because these exemptions are temporary, the Commission will in the future consider whether they should be extended or allowed to expire. The Commission believes it would be prudent to solicit public comment on its action today, and on what action it should take with respect to the CDS market in the future. The Commission is soliciting public comment on all aspects of these exemptions, including: 54 Solely for purposes of this exemption, in addition to the general requirements under the referenced Exchange Act sections, registered broker-dealers shall only be subject to the enumerated rules under the referenced Exchange Act sections. 55 Indeed, Congress directed the Commission to promulgate broker-dealer financial responsibility rules, including rules regarding custody, the use of customer securities and the use of customers deposits or credit balances, and regarding establishment of minimum financial requirements.

72 29 1. Whether the length of this temporary exemption (until December 7, 2009) is appropriate. If not, what should the appropriate duration be? 2. Whether the conditions to these exemptions are appropriate. Why or why not? Should other conditions apply? Are any of the present conditions to the exemptions provided in this Order unnecessary? If so, please specify and explain why such conditions are not needed. 3. Whether ICE Trust ultimately should be required to register as a clearing agency under the Exchange Act. Why or why not? Comments may be submitted by any of the following methods: Electronic comments: Use the Commission s Internet comment form ( or Send an to [email protected]. Please include File Number S on the subject line; or Use the Federal erulemaking Portal ( Follow the instructions for submitting comments. Paper comments: Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC All submissions should refer to File Number S This file number should be included on the subject line if is used. To help us process and review your comments more efficiently, please use only one method. We will post all comments on the Commission s Internet Web site ( Comments are also available for public inspection and copying in the Commission s Public Reference Room, 100 F Street, NE, Washington, DC 20549,

73 30 on official business days between the hours of 10:00 am and 3:00 pm. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. III. Conclusion IT IS HEREBY ORDERED, pursuant to Section 36(a) of the Exchange Act, that, until December 7, 2009: (a) Exemption from Section 17A of the Exchange Act. ICE US Trust LLC ( ICE Trust ) shall be exempt from Section 17A of the Exchange Act solely to perform the functions of a clearing agency for Cleared CDS (as defined in paragraph (e)(1) of this Order), subject to the following conditions: (1) ICE Trust shall make available on its Web site its annual audited financial statements. (2) ICE Trust shall keep and preserve at least one copy of all documents, including all correspondence, memoranda, papers, books, notices, accounts, and other such records as shall be made or received by it relating to its Cleared CDS clearance and settlement services. These records shall be kept for at least five years and for the first two years shall be held in an easily accessible place. (3) ICE Trust shall supply information and periodic reports relating to its Cleared CDS clearance and settlement services as may be reasonably requested by the Commission, and shall provide access to the Commission to conduct on-site inspections of all facilities (including automated systems and systems environment), records, and personnel related to ICE Trust s Cleared CDS clearance and settlement services.

74 31 (4) ICE Trust shall notify the Commission, on a monthly basis, of any material disciplinary actions taken against any of its members utilizing its Cleared CDS clearance and settlement services, including the denial of services, fines, or penalties. ICE Trust shall notify the Commission promptly when ICE Trust involuntarily terminates the membership of an entity that is utilizing ICE Trust s Cleared CDS clearance and settlement services. Both notifications shall describe the facts and circumstances that led to the ICE Trust s disciplinary action. (5) ICE Trust notify the Commission of all changes to rules, procedures, and any other material events affecting its Cleared CDS clearance and settlement services, including its fee schedule and changes to risk management practices, the day before effectiveness or implementation of such rule changes or, in exigent circumstances, as promptly as reasonably practicable under the circumstances. All such rule changes will be posted on ICE Trust s Web site. Such notifications will not be deemed rule filings that require Commission approval. (6) ICE Trust shall provide the Commission with reports prepared by independent audit personnel that are generated in accordance with risk assessment of the areas set forth in the Commission s Automation Review Policy Statements. ICE Trust shall provide the Commission with (beginning in its first year of operation) its annual audited financial statements prepared by independent audit personnel. (7) ICE Trust shall report all significant systems outages to the Commission. If it appears that the outage may extend for 30 minutes or longer, ICE Trust shall report the systems outage immediately. If it appears that the outage will be resolved in less than 30

75 32 minutes, ICE Trust shall report the systems outage within a reasonable time after the outage has been resolved. (8) ICE Trust, directly or indirectly, shall make available to the public on terms that are fair and reasonable and not unreasonably discriminatory: (i) all end-of-day settlement prices and any other prices with respect to Cleared CDS that ICE Trust may establish to calculate mark-to-market margin requirements for ICE Trust Participants; and (ii) any other pricing or valuation information with respect to Cleared CDS as is published or distributed by ICE Trust. (b) Exemption from Sections 5 and 6 of the Exchange Act (1) ICE Trust shall be exempt from the requirements of Sections 5 and 6 of the Exchange Act and the rules and regulations thereunder in connection with its calculation of mark-to-market prices for open positions in Cleared CDS, subject to the following conditions: (i) ICE Trust shall report the following information with respect to the calculation of mark-to-market prices for Cleared CDS to the Commission within 30 days of the end of each quarter, and preserve such reports during the life of the enterprise and of any successor enterprise: (A) The total dollar volume of transactions executed during the quarter, broken down by reference entity, security, or index; and (B) The total unit volume and/or notional amount executed during the quarter, broken down by reference entity, security, or index; (ii) ICE Trust shall establish adequate safeguards and procedures to protect participants' confidential trading information. Such safeguards and

76 33 procedures shall include: (A) limiting access to the confidential trading information of participants to those employees of ICE Trust who are operating the system or responsible for its compliance with this exemption or any other applicable rules; and (B) implementing standards controlling employees of ICE Trust trading for their own accounts. ICE Trust must adopt and implement adequate oversight procedures to ensure that the safeguards and procedures established pursuant to this condition are followed; and (iii) ICE Trust shall satisfy the conditions of the temporary exemption from Section 17A of the Exchange Act set forth in paragraphs (a)(1) (8) of this Order. (2) Any ICE Trust Participant shall be exempt from the requirements of Section 5 of the Exchange Act to the extent such ICE Trust Participant uses any facility of ICE Trust to effect any transaction in Cleared CDS, or to report any such transaction, in connection with ICE Trust's clearance and risk management process for Cleared CDS. (c) Exemption for ICE Trust, certain ICE Trust Participants, and certain eligible contract participants. (1) Persons eligible. The exemption in paragraph (c)(2) is available to: (i) ICE Trust; (ii) Any ICE Trust Participant (as defined in paragraph (e)(2) of this Order), which is not a broker or dealer registered under Section 15(b) of the Exchange Act (other than paragraph (11) thereof); and (iii) Any eligible contract participant (as defined in Section 1a(12) of the Commodity Exchange Act as in effect on the date of this Order (other than a

77 34 person that is an eligible contract participant under paragraph (C) of that section)), other than: (A) an eligible contract participant that receives or holds funds or securities for the purpose of purchasing, selling, clearing, settling, or holding Cleared CDS positions for other persons; (B) an eligible contract participant that is a self-regulatory organization, as that term is defined in Section 3(a)(26) of the Exchange Act; or (C) a broker or dealer registered under Section 15(b) of the Exchange Act (other than paragraph (11) thereof). (2) Scope of exemption. (i) In general. Such persons generally shall, solely with respect to Cleared CDS, be exempt from the provisions of the Exchange Act and the rules and regulations thereunder that do not apply in connection with security-based swap agreements. Accordingly, under this exemption, those persons would remain subject to those Exchange Act requirements that explicitly are applicable in connection with security-based swap agreements (i.e., paragraphs (2) through (5) of Section 9(a), Section 10(b), Section 15(c)(1), paragraphs (a) and (b) of Section 16, Section 20(d) and Section 21A(a)(1) and the rules thereunder that explicitly are applicable to security-based swap agreements). All provisions of the Exchange Act related to the Commission s enforcement authority in connection with violations or potential violations of such provisions also remain applicable. (ii) Exclusions from exemption. The exemption in paragraph (c)(2)(i), however, does not extend to the following provisions under the Exchange Act: (A) Paragraphs (42), (43), (44), and (45) of Section 3(a); (B) Section 5;

78 35 (C) Section 6; (D) Section 12 and the rules and regulations thereunder; (E) Section 13 and the rules and regulations thereunder; (F) Section 14 and the rules and regulations thereunder; (G) Paragraphs (4) and (6) of Section 15(b); (H) Section 15(d) and the rules and regulations thereunder; (I) Section 15C and the rules and regulations thereunder; (J) Section 16 and the rules and regulations thereunder; and (K) Section 17A (other than as provided in paragraph (a)). (d) Exemption for certain registered broker-dealers. A broker or dealer registered under Section 15(b) of the Exchange Act (other than paragraph (11) thereof) shall be exempt from the provisions of the Exchange Act and the rules and regulations thereunder specified in paragraph (c)(2), solely with respect to Cleared CDS, except: (1) Section 7(c); (2) Section 15(c)(3); (3) Section 17(a); (4) Section 17(b); (5) Regulation T, 12 CFR et seq.; (6) Rule 15c3-1; (7) Rule 15c3-3; (8) Rule 17a-3; (9) Rule 17a-4;

79 36 (10) Rule 17a-5; and (11) Rule 17a-13. (e) Definitions. For purposes of this Order: (1) Cleared CDS shall mean a credit default swap that is submitted (or offered, purchased, or sold on terms providing for submission) to ICE Trust, that is offered only to, purchased only by, and sold only to eligible contract participants (as defined in Section 1a(12) of the Commodity Exchange Act as in effect on the date of this Order (other than a person that is an eligible contract participant under paragraph (C) of that section)), and in which: (i) the reference entity, the issuer of the reference security, or the reference security is one of the following: (A) an entity reporting under the Exchange Act, providing Securities Act Rule 144A(d)(4) information, or about which financial information is otherwise publicly available; (B) a foreign private issuer whose securities are listed outside the United States and that has its principal trading market outside the United States; (C) a foreign sovereign debt security; (D) an asset-backed security, as defined in Regulation AB, issued in a registered transaction with publicly available distribution reports; or

80 37 (E) an asset-backed security issued or guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae; or (ii) the reference index is an index in which 80 percent or more of the index s weighting is comprised of the entities or securities described in subparagraph (i). (2) ICE Trust Participant shall mean any participant in ICE Trust that submits Cleared CDS to ICE Trust for clearance and settlement exclusively (i) for its own account or (ii) for the account of an affiliate that controls, is controlled by, or is under common control with the participant in ICE Trust. By the Commission. Elizabeth M. Murphy Secretary

81 Federal Register / Vol. 74, No. 46 / Wednesday, March 11, 2009 / Notices rwilkins on PROD1PC63 with NOTICES Board decisions and notices are available on our Web site at By the Board, Chairman Nottingham, Vice Chairman Mulvey, and Commissioner Buttrey. Decided: March 5, Jeffrey Herzig, Clearance Clerk. [FR Doc. E Filed ; 8:45 am] BILLING CODE P DEPARTMENT OF THE TREASURY Order Granting Temporary Exemptions From Certain Provisions of the Government Securities Act and Treasury s Government Securities Act Regulations in Connection With a Request on Behalf of ICE US Trust LLC Related to Central Clearing of Credit Default Swaps, and Request for Comments AGENCY: Department of the Treasury, Office of the Assistant Secretary for Financial Markets. ACTION: Notice of temporary exemptions. SUMMARY: The Department of the Treasury (Treasury) is granting temporary exemptions from certain provisions of the Government Securities Act of 1986 (GSA) and Treasury s GSA regulations in connection with a request on behalf of ICE US Trust LLC related to the central clearing of credit default swaps that reference government securities. These temporary exemptions are consistent with temporary exemptions the Securities and Exchange Commission recently granted to ICE US Trust LLC related to the central clearing of credit default swaps. Treasury is also soliciting public comment on this Order. DATES: Effective: March 6, FOR FURTHER INFORMATION CONTACT: Lori Santamorena, Executive Director; Lee Grandy, Associate Director; or Kevin Hawkins, Government Securities Specialist; Bureau of the Public Debt, Department of the Treasury, at SUPPLEMENTARY INFORMATION: The following is Treasury s exemptive order: I. Introduction Treasury and other financial regulators have raised concerns related to the over-the-counter ( OTC ) market in credit default swaps ( CDS ). These concerns relate to the potential systemic risk to the financial system posed by such CDS markets. The President s Working Group on Financial Markets ( PWG ) noted in November 2008 that its: Top near-term OTC derivatives priority is to oversee the successful implementation of central counterparty services for credit default swaps. A well-regulated and prudently managed CDS central counterparty can provide immediate benefits to the market by reducing the systemic risk associated with counterparty credit exposures. It also can help facilitate greater market transparency and be a catalyst for a more competitive trading environment that includes exchange trading of CDS. 1 In this context, the Securities and Exchange Commission ( SEC ) recently issued to ICE US Trust LLC ( ICE Trust ), certain participants in ICE Trust, and others, exemptions from certain provisions of the Securities Exchange Act of 1934 ( Exchange Act ). 2 The SEC s exemptions did not cover the Exchange Act provisions applicable to government securities. IntercontinentalExchange, Inc. ( ICE ) and The Clearing Corporation ( TCC ) requested that Treasury grant, pursuant to its authority under Section 15C of the Exchange Act, an exemption for ICE Trust, participants in ICE Trust and their affiliates, 3 and interdealer brokers ( IDBs ) from the provisions of Section 15C(a), (b), and (d) (other than subsection (d)(3)) and the Treasury rules thereunder applicable to government securities brokers and government securities dealers, 4 to the extent they would otherwise be applicable to the activities of any of the foregoing in connection with the offer, execution, termination, clearance, settlement, performance and related activities involving CDS entered into by participants in ICE Trust with other 1 See PWG Announces Initiatives to Strengthen OTC Derivatives Oversight and Infrastructure. U.S. Department of the Treasury press release issued November 14, Available at: The Secretary of the Treasury serves as chairman of the group, which includes the chairmen of the Federal Reserve Board, the Securities and Exchange Commission, and the Commodity Futures Trading Commission, and which worked with the Office of the Comptroller of the Currency and the Federal Reserve Bank of New York on these initiatives. 2 Securities Exchange Act Release No (March 6, 2009). Order Granting Temporary Exemptions Under the Securities Exchange Act of 1934 in Connection with Request on Behalf of ICE US Trust LLC Related to Central Clearing of Credit Default Swaps, and Request for Comments. See The SEC s order relates only to and is necessary only for CDS that are not swap agreements under Section 206A of the Gramm- Leach-Bliley Act. 3 The ICE Trust request defines affiliate to mean an entity that directly, or indirectly through one or more intermediaries, controls or is controlled by, or under common control with, an ICE Trust Participant CFR Chapter IV parts , and 449 were issued under Section 15C(a), (b), and (d). See Part II Section 15C of this Order, infra. VerDate Nov<24> :01 Mar 10, 2009 Jkt PO Frm Fmt 4703 Sfmt 4703 E:\FR\FM\11MRN1.SGM 11MRN1 such participants and submitted to ICE Trust for clearance and settlement. 5 Based on the facts presented and the representations made in the request on behalf of ICE Trust ( the request ), 6 and for legal certainty and other reasons discussed in this Order, the Secretary of the Treasury ( Secretary ) is granting two temporary exemptions. First, the Secretary is granting a temporary exemption to ICE Trust, certain participants in ICE Trust ( ICE Trust Participants ), 7 and certain eligible contract participants ( ECPs ), 8 as defined in the Commodity Exchange Act ( CEA ), from the registration requirements under Section 15C and certain regulations applicable to registered or noticed government securities brokers or government securities dealers. 9 The temporary exemption applies to these entities transactions in Cleared CDS as defined in this Order, 10 which generally are CDS submitted to ICE Trust where the CDS reference a government security. In general, this exemption does not apply to any ICE Trust Participant that is registered or noticed as a government securities broker or a government securities dealer pursuant 5 See Letter from Johnathan Short, IntercontinentalExchange Inc. and Kevin McClear, The Clearing Corporation, to the Commissioner of the Public Debt, Van Zeck, February 26, 2009, available at statreg/gsareg/gsareg.htm. 6 The temporary exemptions contained in this Order are based on the facts and circumstances presented in the request. These temporary exemptions could become unavailable if the facts or circumstances change such that the representations in the request are no longer materially accurate. The status of Cleared CDS submitted to ICE Trust prior to such change would be unaffected. 7 For purposes of this Order, ICE Trust Participant means any participant in ICE Trust that submits CDS that reference a government security to ICE Trust for clearance and settlement exclusively (i) for its own account or (ii) for the account of an affiliate that controls, is controlled by, or is under common control with the participant in ICE Trust. 8 ECPs are defined in Section 1a(12) of the Commodity Exchange Act ( CEA ), 7 U.S.C. 1 et seq. The use of the term ECPs in this Order refers to the definition of ECPs as in effect on the date of this Order, and excludes persons that are ECPs under Section 1a(12)(C). Treasury s exemption provided in this Order to ECPs includes IDBs that are ECPs. 9 As used in this Order, registered or noticed government securities brokers or government securities dealers encompass all brokers, dealers, and entities required to register or file notice pursuant to Section 15C(a)(1) of the Exchange Act. See note 18, infra. 10 For purposes of this Order, Cleared CDS means a credit default swap that is submitted (or offered, purchased, or sold on terms providing for submission) to ICE Trust, that is offered only to, purchased only by, and sold only to ECPs (as defined in Section 1a(12) of the CEA as in effect on the date of this Order (other than a person that is an ECP under paragraph (C) of that section)), and that references a government security.

82 10648 Federal Register / Vol. 74, No. 46 / Wednesday, March 11, 2009 / Notices rwilkins on PROD1PC63 with NOTICES to Section 15C(a)(1) of the Exchange Act. Second, with respect to registered or noticed government securities brokers and government securities dealers that are not financial institutions, 11 the Secretary is granting a temporary exemption from certain Treasury regulatory requirements consistent with the SEC s treatment of registered brokers and dealers in its exemptive order. This temporary exemption similarly applies to these entities transactions in Cleared CDS. II. Section 15C Title I of the Government Securities Act of ( GSA ) amended the Exchange Act by adding Section 15C, authorizing the Secretary to promulgate regulations with respect to transactions in government securities 13 effected by government securities brokers 14 and government securities dealers 15 concerning financial responsibility, protection of customer securities and balances, and recordkeeping and reporting. Under Title I of the GSA, all government securities brokers and government securities dealers are required to comply with the requirements in Treasury s GSA regulations that are set out at 17 CFR parts Treasury s GSA 11 A financial institution is defined in 15 U.S.C. 78c(a)(46). 12 Public Law , 100 Stat (1986). 13 The term government securities, as defined at 15 U.S.C. 78c(a)(42), means: (A) Securities which are direct obligations of, or obligations guaranteed as to principal or interest by, the United States; (B) securities which are issued or guaranteed by the Tennessee Valley Authority or by corporations in which the United States has a direct or indirect interest and which are designated by the Secretary of the Treasury for exemption as necessary or appropriate in the public interest or for the protection of investors; (C) securities issued or guaranteed as to principal or interest by any corporation the securities of which are designated, by statute specifically naming such corporation, to constitute exempt securities within the meaning of the laws administered by the SEC; and (D) generally any put, call, straddle, option, or privilege on a government security other than one that is traded on a national securities exchange or for which quotations are disseminated through an automated quotation system operated by a registered securities association. Certain Canadian government obligations are also included for certain purposes. 14 A government securities broker generally is any person regularly engaged in the business of effecting transactions in government securities for the account of others with certain exclusions. 15 U.S.C. 78c(a)(43). 15 A government securities dealer generally is any person engaged in the business of buying and selling government securities for his own account, through a broker or otherwise, with certain exclusions. 15 U.S.C. 78c(a)(44) CFR part 400 Rules of general application; 17 CFR part 401 Exemptions; 17 CFR part 402 Financial responsibility; 17 CFR part 403 Protection of customer securities and balances; 17 CFR part regulations, for the most part, incorporate with some modifications SEC rules for non-financial institution government securities brokers and government securities dealers and the appropriate regulatory agency 17 rules for financial institutions that are required to file notice as government securities brokers and government securities dealers. 18 Section 15C(a)(5) of the Exchange Act provides that the Secretary: By rule or order, upon the Secretary s own motion or upon application, may conditionally or unconditionally exempt any government securities broker or government securities dealer, or class of government securities brokers or government securities dealers, from any provision of subsection (a), (b), or (d) of this section, other than subsection (d)(3), or the rules thereunder, if the Secretary finds that such exemption is consistent with the public interest, the protection of investors, and the purposes of [the Exchange Act]. As noted above, the SEC recently issued an order granting temporary, conditional exemptions under the Exchange Act to ICE Trust in connection with the clearing and settling of certain CDS, as well as to certain other persons for proposed related activities. 19 The 404 Recordkeeping and preservation of records; 17 CFR part 405 Reports and audit; 17 CFR part 420 Large position reporting; and 17 CFR part 449 Forms, Section 15C of the Securities Exchange Act of The GSA regulations also include requirements for custodial holdings by depository institutions at 17 CFR part 450, which were issued under Title II of the GSA. 17 The definition of appropriate regulatory agency with respect to a government securities broker or a government securities dealer is set out at 15 U.S.C. 78c(a)(34)(G). The definition includes the Board of Governors of the Federal Reserve System, the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Director of Thrift Supervision, and in limited circumstances the SEC. 18 The GSA regulations apply to all classes of government securities brokers and government securities dealers required to register or file notice pursuant to Section 15C(a)(1) of the Exchange Act. This encompasses registered brokers and dealers (including OTC derivatives dealers), registered government securities brokers and registered government securities dealers (those specialized government securities brokers and government securities dealers that conduct a business in only government or other exempted securities (other than municipal securities)), and financial institutions that are required to file notice as government securities brokers and government securities dealers. See 17 CFR and definitions at 17 CFR The GSA regulations also address futures commission merchants that are government securities brokers or government securities dealers, but these entities are not covered in this Order. (The definitions of government securities broker and government securities dealer in 15 U.S.C. 78c(a)(43) and 78c(a)(44) exclude certain persons registered with the Commodity Futures Trading Commission ( CFTC ), but only if such persons effect transactions in government securities that the SEC, in consultation with the CFTC, has determined to be incidental to such persons futures-related business.) 19 See note 2, supra. The SEC s exemptive order applies only to CDS that are not swap agreements VerDate Nov<24> :01 Mar 10, 2009 Jkt PO Frm Fmt 4703 Sfmt 4703 E:\FR\FM\11MRN1.SGM 11MRN1 SEC noted in its order that the temporary exemptions extended neither to the Exchange Act provisions applicable to government securities as set forth in Section 15C and its underlying rules and regulations, nor to the related definitions of government securities, government securities broker, and government securities dealer. The SEC further noted that it does not have authority under Section 36 of the Exchange Act to issue exemptions in connection with these provisions. 20 The request on behalf of ICE Trust states that some CDS include reference obligations or deliverable obligations that may be government securities as defined in Section 3(a)(42) of the Exchange Act. 21 In providing temporary exemptions from certain provisions of Section 15C of the Exchange Act, Treasury is not making a determination, for purposes of this Order, whether particular CDS are government securities. III. CDS A CDS is a bilateral contract between two parties, known as counterparties. The value of this contract is based on underlying obligations of a single entity or on a particular security or other debt obligation, or an index of several such entities, securities, or obligations. The obligation of a seller under a CDS contract to make payments is triggered by a default or other credit event involving such entity or entities or such security or securities. Investors may purchase CDS for a variety of reasons, including to offset or insure against risk in their portfolios, to take synthetic positions in bonds or in segments of the debt market, or to capitalize on credit spreads. In recent years, CDS market volumes have rapidly increased and this growth has coincided with a significant rise in the types and number of entities participating in the CDS market. Under a typical CDS contract, the seller of the contract agrees, in exchange for receiving fixed periodic payments from the purchaser, to assume the credit risk of the underlying obligation(s) and to compensate the purchaser in the event of a default, bankruptcy, or other credit event. A bilateral CDS contract therefore entails counterparty risk between the purchaser and the seller. Currently, CDS participants bilaterally manage counterparty risk by monitoring their counterparties, entering into legal agreements that permit them to net and thus not excluded from the definition of security by Section 3A of the Exchange Act U.S.C. 78mm(b). 21 See note 13, supra.

83 Federal Register / Vol. 74, No. 46 / Wednesday, March 11, 2009 / Notices rwilkins on PROD1PC63 with NOTICES gains and losses across contracts, and requiring counterparty exposures to be collateralized. A central counterparty ( CCP ) could allow participants to avoid risks specific to an individual counterparty because a CCP novates bilateral trades by entering into separate contractual arrangements with each counterparty becoming buyer to each seller and seller to each buyer. 22 Novation is one of the means by which a CCP can assume counterparty risk. For this reason, a CCP for CDS could contribute generally to the goal of mitigating potential systemic risk. As part of its risk management program, a CCP could subject novated contracts to initial and variation margin requirements and establish clearing and guarantee funds. The CCP also could implement a loss-sharing arrangement among its participants to respond to a potential participant insolvency or default. Recent credit market events have demonstrated the need for mechanisms to help manage potential counterparty risks posed by CDS. A prudentlymanaged CCP could help promote efficiency and reduce the potential systemic risk associated with counterparty credit exposures. These benefits could be particularly significant in times of market stress, as CCPs could enhance transparency and mitigate the potential for a market participant s difficulties to destabilize other market participants. IV. ICE Trust As noted above, ICE and TCC, on behalf of ICE Trust, have requested that the Secretary grant exemptions from certain requirements under the Exchange Act with respect to the proposed activities of ICE Trust in clearing and settling certain CDS, as well as the proposed activities of certain other persons. 23 Based on the request, we understand the facts to be as follows. ICE and TCC are each corporations organized under the laws of the State of Delaware. The request states that ICE is in the process of acquiring TCC. ICE Trust is organized as a New York State chartered limited liability trust company, and will become a member of the Federal Reserve System. 24 ICE Trust is subject to direct 22 Novation generally is a process through which the original obligation between a buyer and seller is discharged through the substitution of the CCP as seller to buyer and buyer to seller, creating two new contracts. 23 See note 5, supra. 24 The Federal Reserve Board announced on March 4, 2009, its approval of the application by ICE US Trust LLC to become a member of the Federal Reserve System. See Federal Reserve Board supervision and examination by the New York State Banking Department, and due to its expected membership in the Federal Reserve System, will be subject to direct supervision and examination by the Board of Governors of the Federal Reserve System, specifically by the Federal Reserve Bank of New York. We further understand that CDS transactions entered into by ICE Trust Participants with other ICE Trust Participants will be submitted to ICE Trust for clearance and settlement. The request represents that initially, ICE Trust s business will be limited to the provision of clearing services for a limited range of CDS in the OTC market. During this initial phase, ICE Trust s CDS clearing services will be limited to transactions for the proprietary accounts of ICE Trust Participants (in each case, acting as principal for its own account or the account of an affiliate). ICE Trust will act as a CCP for ICE Trust Participants by assuming, through novation, the obligations of all eligible CDS transactions accepted by it for clearing and by collecting margin and other credit support from ICE Trust Participants to collateralize their obligations to ICE Trust. The request states that ICE Trust anticipates that it will eventually expand the range of CDS contracts eligible for clearing to include single name CDS (which could include issuers of government securities). The request explains that participation in ICE Trust will be open to all qualified applicants, each of whom will clear transactions solely as principal for its own account and not on behalf of other persons. In order to qualify as an ICE Trust Participant, an applicant will be required to satisfy ICE Trust s participant criteria at the time that the applicant applies to ICE Trust and on an ongoing basis thereafter. 25 Among these criteria is a requirement that each ICE Trust Participant is subject to regulation for capital adequacy by a federal or foreign financial regulator or is an affiliate of an entity that is subject to regulation by such a financial regulator (and as a result the ICE Trust Participant would be subject to consolidated holding company group supervision). Although CDS are currently bilaterally negotiated and executed, major market participants frequently use the Deriv/SERV service of The Depository Trust & Clearing Corporation press release, available at a.htm. 25 The request states that the participant criteria are specified in the ICE Trust Rules. VerDate Nov<24> :01 Mar 10, 2009 Jkt PO Frm Fmt 4703 Sfmt 4703 E:\FR\FM\11MRN1.SGM 11MRN1 comparison and confirmation service when documenting their CDS transactions. ICE Trust will leverage the Deriv/SERV infrastructure in operating its CDS clearing service. ICE Trust will collect and process information about CDS transactions and positions from all of its participants. With this information, ICE Trust plans to, among other things, calculate and disseminate current values for open positions for the purpose of setting appropriate margin levels, or have an agent perform these functions on its behalf. ICE Trust believes that the availability of such information could improve the fairness, efficiency, and competitiveness of the market. Moreover, with pricing and valuation information relating to CDS transactions, ICE Trust represents that market participants would be able to derive information about underlying securities and indexes. ICE Trust believes this could improve the efficiency and effectiveness of the securities markets by allowing investors to better understand credit conditions generally. ICE Trust maintains that in addition to reducing the outstanding notional amount of ICE Trust-cleared CDS, it will further mitigate counterparty risk to ICE Trust, ICE Trust Participants, and the CDS market generally through its margin, guaranty fund, and credit support framework. As the counterparty to each of the ICE Trust Participants, ICE Trust will have exposure to default risk by ICE Trust Participants. To address this counterparty credit risk, ICE Trust states that it will require the ICE Trust Participants to provide credit support for their obligations under cleared CDS transactions and has established rules that mutualize the risk of an ICE Trust Participant default across all ICE Trust Participants. ICE Trust s risk management infrastructure and related risk metrics have been structured specifically for the CDS products that ICE Trust clears. Each ICE Trust Participant s credit support obligations will be governed by a uniform credit support framework and applicable ICE Trust Rules. The request also states that ICE Trust Participants may use the facilities of an IDB to execute CDS, for example, to access liquidity more rapidly or to maintain pre-execution anonymity, and submit such transactions for clearance and settlement to ICE Trust. Further, these IDBs may be unregistered with the SEC, may be registered as broker-dealers or government securities brokers or government securities dealers, or may be registered as broker-dealers and

84 10650 Federal Register / Vol. 74, No. 46 / Wednesday, March 11, 2009 / Notices rwilkins on PROD1PC63 with NOTICES operating subject to Regulation ATS. The request indicates that these IDBs, although they are compensated for matching and effecting CDS transactions, do not handle the funds or property of their CDS participants, and similarly do not assume market positions in connection with their intermediation of CDS transactions. The request states that a CDS that does not qualify as a security-based swap agreement may potentially be subject to characterization as a security, and similarly, that a CDS that has one or more reference or deliverable obligations that are government securities and that does not qualify as a security-based swap agreement may potentially be subject to characterization as a government security. The request also asserts that the framework for the regulation of securities broker-dealers has been effective for traditional securities activities, but it has not provided a commercially practical framework for the conduct of broad categories of OTC derivatives activities. The request states that little would be gained by subjecting ICE Trust Participants to regulation as government securities brokers or government securities dealers with respect to any cleared CDS that reference government securities, given that ICE Trust Participants will be sophisticated derivatives market participants, will be acting solely for their own accounts (or the account of their affiliates) and will be limited to firms who are subject to regulation or consolidated supervision by a financial regulator. ICE Trust further states that requiring government securities broker and government securities dealer regulation and imposing the Exchange Act Section 15C government securities regime on any cleared CDS that reference government securities would create a significant and burdensome dislocation of this part of the CDS market and would present a significant obstacle to the adoption of clearing for this and related segments of the CDS market. The request states that the imposition of such additional regulation and regulatory constraints would be unwarranted, would not constitute an efficient allocation of regulatory resources, and would not serve the public interest. ICE Trust believes that, equally important, given the size and significance of the CDS market, proceeding in the face of any material legal uncertainty as to the regulatory status of a significant portion of CDS cleared through ICE Trust would be unacceptable both to market participants and the official sector. The request states that either outcome would produce undesirable consequences and jeopardize the important benefits that the introduction of central clearing for CDS can provide. The request asks for exemptive relief for the avoidance of legal uncertainty, on terms and conditions that would, in effect, permit ICE Trust, ICE Trust Participants and their affiliates, and IDBs to continue to conduct business in cleared CDS that reference government securities on the basis that such transactions would be treated as security-based swap agreements under the Exchange Act. 26 V. Temporary Exemption for ICE Trust, ICE Trust Participants and Certain ECPs Treasury believes that the application of the GSA requirements to certain participants in CDS transactions that are not currently registered or noticed government securities brokers or government securities dealers could deter some market participants from using ICE Trust to clear CDS transactions where the CDS references a government security and thus reduce the CCP benefit of mitigating potential systemic risk. Moreover, based on the representations made in the request for exemptive relief, Treasury has concluded that the CCP facility for CDS proposed by ICE Trust could increase transparency, enhance counterparty risk management, and contribute generally to the goal of mitigating systemic risk. Accordingly, pursuant to Section 15C(a)(5) of the Exchange Act, the Secretary finds that it is consistent with the public interest, the protection of investors, and the purposes of the Exchange Act to grant a temporary exemption until December 6, 2009 from the provisions of Section 15C(a), (b), and (d) (other than subsection (d)(3)) of the Exchange Act, and the rules thereunder. This temporary exemption applies to: (1) ICE Trust, (2) ICE Trust Participants that are not government securities brokers or government securities dealers registered or noticed under Section 15C(a)(1) of the Exchange 26 The approach of the SEC exemptive order was to apply substantially the same framework to CDS transactions that applies to transactions in securitybased swap agreements. See note 2, supra. While Section 3A of the Exchange Act excludes swap agreements from the definition of security, certain antifraud and insider trading provisions under the Exchange Act explicitly apply to securitybased swap agreements. Security-based swap agreement is defined in Section 206B of the Gramm-Leach-Bliley Act as a swap agreement in which a material term is based on the price, yield, value, or volatility of any security or any group or index of securities, or any interest therein. VerDate Nov<24> :01 Mar 10, 2009 Jkt PO Frm Fmt 4703 Sfmt 4703 E:\FR\FM\11MRN1.SGM 11MRN1 Act, and (3) any ECPs 27 other than: (a) ECPs that are registered or noticed government securities brokers or government securities dealers; (b) ECPs that receive or hold funds or securities for the purpose of purchasing, selling, 28 clearing, settling, or holding CDS positions for other persons; and (c) ECPs that are ECPs under Section 1a(12)(C) of the CEA. This temporary exemption applies to these entities transactions in Cleared CDS. 29 VI. Temporary Exemption for Registered or Noticed Government Securities Brokers and Government Securities Dealers That Are Not Financial Institutions The GSA and its underlying rules and regulations require government securities brokers and government securities dealers to comply with a number of obligations that are important to protecting investors and promoting market integrity. Treasury believes it is important to promote the integrity, liquidity, and efficiency of financial markets while at the same time ensuring that risk is mitigated and customers are protected. Treasury also wants to avoid creating obstacles to the use of CCPs for CDS, and recognizes that the factors discussed above suggest that the full range of GSA requirements generally should not be applied immediately to government securities brokers and government securities dealers that engage in transactions involving CDS that reference a government security. The request suggested that to the extent that the SEC s CDS exemptions exclude particular Exchange Act provisions or specify certain conditions to the exemptive relief, the Treasury relief should be issued subject to the same conditions and to compliance with the same excluded provisions, to the 27 Treasury is providing relief to ECPs, including IDBs that are ECPs, consistent with the SEC s order and the treatment of security-based swap agreements under the Exchange Act. A swap agreement is defined under Section 206A of the Gramm-Leach-Bliley Act, in part, as any agreement, contract, or transaction between eligible contract participants (as defined in Section 1a(12) of the Commodity Exchange Act * * * other than a person that is an eligible contract participant under Section 1a(12)(C) of the Commodity Exchange Act * * *) * * * the material terms of which (other than price and quantity) are subject to individual negotiation. 15 U.S.C. 78c note. 28 For the purposes of this Order, the terms purchasing and selling mean the execution, termination (prior to its scheduled maturity date), assignment, exchange, or similar transfer or conveyance of, or extinguishing the rights or obligations under, a cleared CDS transaction, as the context may require. This is consistent with the meaning of the terms purchase or sale under the Exchange Act in the context of security-based swap agreements. See Exchange Act Section 3A(b)(4). 29 See note 10, supra.

85 Federal Register / Vol. 74, No. 46 / Wednesday, March 11, 2009 / Notices rwilkins on PROD1PC63 with NOTICES extent applicable. The SEC order exempts registered broker-dealers from certain provisions and rules under the Exchange Act, but retains certain other requirements such as those related to the protection of customer funds and securities. 30 Government securities brokers and government securities dealers are subject to the requirements in Section 15C and the regulations issued thereunder. Treasury was given authority by Congress in 1986 to issue rules with respect to transactions in government securities effected by government securities brokers and government securities dealers in the areas of financial responsibility, acceptance of custody and use of customer s securities, the carrying and use of customers deposits or credit balances, and the transfer and control of government securities subject to repurchase agreements, records, and reporting. The GSA regulations issued by Treasury reflect a deliberate and responsive approach to regulating the government securities market, and strike a balance between ensuring customer protection and the continued liquidity and efficiency of the market. In addition, Congress directed the Secretary to: (1) Use existing regulations whenever possible, thereby avoiding duplicative requirements; (2) avoid imposing overly burdensome rules; and (3) ensure that the rules did not result in unequal treatment of market participants. 31 Many of the Treasury regulations promulgated under the GSA incorporated with limited modifications the existing SEC regulations (i.e., customer protection, recordkeeping, reports, and audits) that applied to registered brokers and dealers before the passage of the GSA. Treasury generally has exercised its authority under the Exchange Act in a manner that would provide consistency, to the extent possible, between the requirements applicable to registered broker-dealers and government securities brokers and government securities dealers. Therefore, Treasury is providing certain temporary exemptions for government securities brokers and government securities dealers that are not financial institutions from certain GSA regulations to maintain consistency with the requirements applicable to registered broker-dealers with respect to CDS transactions that are submitted to ICE Trust for clearance and settlement. Accordingly, pursuant to Section 15C(a)(5) of the Exchange Act, the 30 See note 2, supra U.S.C. 78o 5(b)(4) and (5). Secretary finds that it is consistent with the public interest, the protection of investors, and the purposes of the Exchange Act to grant a temporary exemption to registered or noticed government securities brokers and government securities dealers that are not financial institutions until December 6, 2009 from the regulations in 17 CFR parts 402, 403, 404, and However, this Order does not exempt registered or noticed government securities brokers or government securities dealers from the following: (1) The capital requirements for registered government securities brokers and government securities dealers in part 402 of the GSA regulations (which are comparable to SEC Rule 15c3 1 on net capital) 33 ; (2) the provisions of part 403 of the GSA regulations that incorporate and modify SEC Rule 15c3 3 on reserves and custody of securities; (3) the provisions of parts 404 and 405 of the GSA regulations that incorporate and modify SEC Rules 17a 3 through 17a 5, 17h 1T and 17h 2T, on records and reports; and (4) the provisions of part 404 of the GSA regulations that incorporate and modify SEC Rule 17a 13 on quarterly security counts. This temporary exemption applies to these entities transactions in Cleared CDS. 34 With respect to noticed government securities brokers and government securities dealers that are financial institutions, the GSA regulations generally adopt the appropriate regulatory agency rules for financial institutions that are comparable to the SEC rules to which the exemption does not extend. The GSA regulations also incorporate rules of the appropriate regulatory agencies that are otherwise applicable to financial institutions. Treasury is not extending the temporary exemption to financial institution government securities brokers and government securities dealers. Financial institution government securities brokers and government securities dealers should continue to comply with existing rules. In issuing this Order, Treasury has consulted with and considered the views of the staffs of the SEC, the Commodity Futures Trading Commission, and the financial 32 The rules in part 400 are excluded because they are rules of general application. The rules in part 401 are excluded because they cover existing exemptions. The rules in part 449 are excluded because they describe forms that are required by other rules. 33 Part 402 does not apply to registered brokerdealers that are subject to Rule 15c See note 10, supra. VerDate Nov<24> :01 Mar 10, 2009 Jkt PO Frm Fmt 4703 Sfmt 4703 E:\FR\FM\11MRN1.SGM 11MRN1 institution appropriate regulatory agencies. VII. Solicitation of Comments Treasury intends to monitor the development of CCPs for the CDS market and determine to what extent, if any, additional action might be necessary. For example, as circumstances warrant, certain conditions could be added, altered, or eliminated from this Order. Treasury will in the future consider whether the temporary exemptions should be extended or allowed to expire. Treasury believes it is prudent to solicit public comment on this Order. Specifically, Treasury is soliciting public comment on all aspects of these temporary exemptions, including: 1. The appropriateness of the length of this temporary exemption (until December 6, 2009). If not appropriate, what should the appropriate duration be? 2. The appropriateness of the extent of the relief granted or any exclusions from the exemptions. You may send comments to: Government Securities Regulations Staff, Bureau of the Public Debt, 799 9th Street, NW., Washington, DC You may also send comments by to [email protected]. Please provide your full name and mailing address. You may download this temporary exemptive Order, and review the comments we receive, from the Bureau of the Public Debt s Web site at The Order and comments also will be available for public inspection and copying at the Treasury Department Library, Room 1428, Main Treasury Building, 1500 Pennsylvania Avenue, NW., Washington, DC To visit the library, call (202) for an appointment. Treasury will continue to consult with, the staffs of the SEC, the Commodity Futures Trading Commission, and the financial institution appropriate regulatory agencies on this matter. VIII. Conclusion It is hereby ordered, pursuant to Section 15C(a)(5) of the Exchange Act, that, until December 6, 2009: (a) Temporary Exemption for ICE Trust, ICE Trust Participants, and Certain ECPs The following persons are exempt from the provisions of Section 15C(a), (b), and (d) (other than subsection (d)(3)) of the Exchange Act, and the rules thereunder: ICE Trust, ICE Trust Participants that are not government

86 10652 Federal Register / Vol. 74, No. 46 / Wednesday, March 11, 2009 / Notices rwilkins on PROD1PC63 with NOTICES securities brokers or government securities dealers registered or noticed under Section 15C(a)(1) of the Exchange Act, and any ECPs 35 other than: (a) ECPs that are registered or noticed government securities brokers or government securities dealers; (b) ECPs that receive or hold funds or securities for the purpose of purchasing, selling, clearing, settling, or holding CDS positions for other persons; and (c) ECPs that are ECPs under Section 1a(12)(C) of the CEA. This temporary exemption applies to these entities transactions in Cleared CDS. 36 (b) Temporary Exemption for Registered or Noticed Government Securities Brokers and Government Securities Dealers that are not Financial Institutions Registered or noticed government securities brokers and government securities dealers that are not financial institutions are exempt from the regulations in 17 CFR parts 402, 403, 404, and 405. However, this Order does not exempt registered or noticed government securities brokers or government securities dealers that are not financial institutions from the following: (1) The capital requirements for registered government securities brokers and government securities dealers in part 402 of the GSA regulations (which are comparable to SEC Rule 15c3 1 on net capital); (2) the provisions of part 403 of the GSA regulations that incorporate and modify SEC Rule 15c3 3 on reserves and custody of securities; (3) the provisions of parts 404 and 405 of the GSA regulations that incorporate and modify SEC Rules 17a 3 through 17a 5, 17h 1T and 17h 2T, on records and reports; and (4) the provisions of part 404 of the GSA regulations that incorporate and modify SEC Rule 17a 13 on quarterly security counts. This temporary exemption applies to these entities transactions in Cleared CDS. The temporary exemptions contained in this Order are based on the facts and circumstances presented in the request. These temporary exemptions could become unavailable if the facts or circumstances change such that the representations in the request are no longer materially accurate. The status of Cleared CDS submitted to ICE Trust 35 See note 8, supra. 36 See note 10, supra. prior to such change would be unaffected. Karthik Ramanathan, Acting Assistant Secretary for Financial Markets. [FR Doc. E Filed ; 4:15 pm] BILLING CODE P DEPARTMENT OF THE TREASURY Financial Crimes Enforcement Network Agency Information Collection Activities; Proposed Collection; Comment Request; Report of International Transportation of Currency or Monetary Instruments AGENCY: Financial Crimes Enforcement Network, Treasury. ACTION: Notice and request for comments regarding the renewal without change of the Report of International Transportation of Currency or Monetary Instruments. SUMMARY: As part of our continuing effort to reduce paperwork and respondent burden, the Financial Crimes Enforcement Network invites the general public and other Federal agencies to comment on an information collection requirement concerning the Report of International Transportation of Currency or Monetary Instruments (the CMIR ). This request for comment is being made pursuant to the Paperwork Reduction Act of 1995 (PRA), Public Law (44 U.S.C. 3506(c)(2)(A)). DATES: Written comments should be received on or before May 11, 2009 to be assured of consideration. ADDRESSES: Direct all written comments to: Regulatory Policy and Programs Division, Financial Crimes Enforcement Network, Department of the Treasury, P.O. Box 39, Vienna, VA , Attention: PRA Comments Report of International Transportation of Currency or Monetary Instruments. Comments also may be submitted by electronic mail to the following Internet address: [email protected] with the caption in the body of the text, Attention: PRA Comments Report of International Transportation of Currency or Monetary Instruments. FOR FURTHER INFORMATION CONTACT: The FinCEN Regulatory Helpline at , select option 6. A copy of the form may also be obtained from the FinCEN Web site at fin105_cmir.pdf. VerDate Nov<24> :01 Mar 10, 2009 Jkt PO Frm Fmt 4703 Sfmt 4703 E:\FR\FM\11MRN1.SGM 11MRN1 SUPPLEMENTARY INFORMATION: Title: Report of International Transportation of Currency or Monetary Instruments. OMB Number: Form Number: FinCEN Form 105. Abstract: The Bank Secrecy Act (BSA), Titles I and II of Public Law , as amended, codified at 12 U.S.C. 1829b, 12 U.S.C , and 31 U.S.C , authorizes the Secretary of the Treasury inter alia to issue regulations requiring records and reports that are determined to have a high degree of usefulness in criminal, tax, or regulatory investigations or proceedings, or in the conduct of intelligence or counter-intelligence activities, including analysis, to protect against international terrorism or to implement counter-money laundering programs and compliance procedures. Regulations implementing Title II of the BSA appear at 31 CFR part 103. The authority of the Secretary to administer the BSA has been delegated to the Director of Financial Crimes Enforcement Network. Pursuant to the BSA, a person or an agent or bailee of the person shall file a report * * * when the person, agent, or bailee knowingly (1) Transports, is about to transport, or has transported, monetary instruments of more than $10,000 at one time (A) From a place in the United States to or through a place outside the United States; or (B) to a place in the United States from or through a place outside the United States; or (2) receives monetary instruments of more than $10,000 at one time transported into the United States from or through a place outside the United States. 31 U.S.C. 5316(a). The requirement of 31 U.S.C. 5316(a) has been implemented through regulations promulgated at 31 CFR and through the instructions to the CMIR. Information collected on the CMIR is made available, in accordance with strict safeguards, to appropriate criminal law enforcement and regulatory personnel in the official performance of their duties. The information collected is of use in investigations involving international and domestic money laundering, tax evasion, fraud, and other financial crimes. Current Actions: Renewal without change. Type of Review: Renewal of a currently approved collection. Affected Public: Individuals, business or other for-profit institutions, and notfor-profit institutions. Estimated Number of Respondents: 280,000. Estimated Time per Respondent: 11 minutes.

87 June 23, 2009 ICE Trust U.S. LLC Response Questionnaire for CDS CCPs on Protection of Customer Initial Margin DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 1 All rights reserved

88 Table of Contents DISCLAIMER June 23, 2009 I. ICE Trust Solution Development Approach...4 II. Factual Matters...5 A. Structure of ICE Trust U.S. LLC...5 B. Structure of Clearing Members...5 C. Structure of Custodians ICE Trust Custodians Clearing Member Custodians...7 D. Structure of Customers...7 E. Expansion/Restriction of Permitted Entity Types...7 III. Segregation and Safekeeping of Initial Margin...9 A. Initial Margin Held at or for ICE Trust Composition of ICE Trust Margin Relationship Between CCP, CM and Customer...10 B. Proposed Clearing Structure Clearing of CDS Basic Non-Member Framework Submission of Client Positions to ICE Trust Client Omnibus Accounts Clearinghouse Margining Client-Member Transaction Documentation Client-Member Transaction Margining Default Rules Certain Rules Regarding Portability of Positions and Margin Investment of Excess Margin Account...27 C. Transfer of Margin from Clearing Members to ICE Trust...28 D. Economic Effects of Proposed Clearing Structure for CCP Margin Return on Investment Allocation of Risk and Returns...29 E. Determination of Required Margin and Related Considerations Required Margin Collection for Customer Segregation Protection Against Collecting Insufficient or Excess Margin Addition of New Products to Clearing Margin Methodology Margin Calls/Collection...31 This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 2 All rights reserved

89 June 23, Mark-to-Market Guaranty Fund Contributions...31 IV. Legal Considerations...34 A. Segregation Requirements under Applicable Law...34 B. Customer Rights to CCP Margin...35 C. Customer Rights to CM Margin...37 D. Legal Enforceability of Portability Framework...37 E. Legal Enforceability of Novation/Netting Framework...39 F. Legislative or Regulatory Reforms; Other Considerations Regulatory Changes: Legislative Changes:...41 V. Appendix - Questionnaire...42 VI. Proposed Legislative Amendments Relating to Treatment of Customer Property and Positions...62 DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 3 All rights reserved

90 June 23, 2009 I. ICE Trust Solution Development Approach ICE Trust U.S. LLC, ( ICE Trust or the Clearinghouse ) has developed a framework for providing segregation of initial margin of non-members and portability of non-member positions (the Non-Member Framework ). In developing its framework, ICE Trust has consulted extensively with numerous buy-side participants, its existing members, as well as with its principal regulators. As an initial matter, ICE Trust notes that there is no formal regulatory framework under existing commodities and futures, banking or securities law that directly addresses the issues of customer margin segregation and portability in the context of a clearinghouse for over-the-counter derivatives. ICE Trust looked at the securities and commodities law frameworks and determined that organizing as a bank would be the best possible solution for the existing CDS market. The approach described herein has been designed to achieve segregation and portability within the constraints of existing insolvency and other laws (which were not necessarily drafted with OTC derivatives clearing in mind). DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 4 All rights reserved

91 June 23, 2009 II. Factual Matters A. Structure of ICE Trust U.S. LLC ICE Trust is a limited purpose, limited liability Trust Company organized under the laws of the State of New York and is a member of the Federal Reserve System. ICE Trust is regulated/supervised by the Federal Reserve and the New York State Banking Department and operates pursuant to an exemption from the Securities and Exchange Commission. ICE Trust is in the process of applying for Registered Overseas Clearing House status with the UK FSA. The implementation of the Non-Member Framework will require approvals of the New York State Banking Department and Federal Reserve as well as additional exemptive relief from the Securities and Exchange Commission and the Department of the Treasury. B. Structure of Clearing Members ICE Trust limits its Clearing Members ( CM or Member )) to those who are able to meet the required membership criteria outlined below. ICE Trust does not otherwise limit participants based on legal entity type (i.e., participants do not have to be a Dealer) or jurisdiction. ICE Trust membership criteria: $5Bn+ Tangible Net Worth (Tangible Net Worth is equal to the Fed Reserve s definition of Tier 1 capital ) If an Applicant does not meet this criteria, it may submit a parent guarantee, at ICE Trust s discretion, provided its parent satisfies the criteria A minimum long-term rating A or equivalent from S&P/Moody s/fitch or equivalent At the discretion of ICE Trust, this requirement could be met by the Applicant s parent If the clearing participant applicant does not have a rating, the ICE Trust, in its discretion, may allow an applicant to demonstrate compliance with this requirement by demonstrating that it meets stringent credit criteria through other means, subject to confirmation by an examination of its books and records DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 5 All rights reserved

92 June 23, 2009 The Applicant must be regulated as to capital adequacy by competent authority such as the Fed, the SEC, CFTC, OCC, FSA or other regulators as determined by ICE Trust This requirement could be met by an affiliate of the Applicant provided the participant would be subject to holding company group supervision Demonstrates operational competence, including: Ability to process expected volumes Adequate systems, equipment and experienced personnel Ability to submit pricing Demonstrates risk management competence based on satisfactory completion of a risk questionnaire and a risk interview ICE Trust also requires CMs to provide a legal opinion establishing the enforceability of ICE Trust rules in the CM s jurisdiction. As noted above, ICE Trust does not limit CMs by jurisdiction, legal entity type or type of regulatory or supervisory authority, although each CM (either itself or as part of a holding company group) must be subject to regulation as to capital adequacy by a competent authority. For CMs based in the United States, regulatory and supervisory authorities generally include the Federal Reserve as supervisory authority at the holding company level and, for CMs that are banks, the OCC or another appropriate banking supervisor. For CMs licensed in the United Kingdom, the FSA would generally be the principal regulatory and supervisory authority. CMs organized in other jurisdictions may be subject to banking authorities in those jurisdictions. C. Structure of Custodians 1. ICE Trust Custodians Currently, ICE Trust uses The Bank of New York Mellon, a New York banking corporation (BNYM), as custodian for certain assets. (As such a banking corporation, BNYM is subject to regulation by the New York Banking Department and Federal Reserve.) ICE Trust may from time to time use other custodians. ICE Trust s rules do not restrict the custodians that ICE Trust may use, but ICE Trust anticipates that any custodian holding IM would be a banking DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 6 All rights reserved

93 June 23, 2009 organization organized under U.S. law that is not a Member or an affiliate of a Member. 2. Clearing Member Custodians ICE Trust rules will require that CM s post the full amount of Clearinghouserequired margin to the CCP; as a result, Members will not have custodians for holding Clearinghouse-required margin. D. Structure of Customers ICE Trust s rules do not restrict the organizational type or jurisdiction of organization of customers. ICE Trust does not monitor the various regulatory or supervisory authorities to which customers may be subject. E. Expansion/Restriction of Permitted Entity Types ICE Trust considered netting implications, regulatory capital implications, operational impacts, adverse pass through effects, legal regime impacts and other factors in drafting its rules applicable to eligible CMs. As a general matter, ICE Trust has drafted its rules to assure that firms have the resources, controls and sophistication to participate in the central clearing function. CMs are required to meet membership criteria designed to ensure each participant has sufficient operational capabilities, financial resources, risk management experience and regulatory oversight to be permitted to participate in ICE Trust s central clearing facility. This requirement is in keeping with regulatory guidance from the Bank of International Settlements ( BIS ) 1. This approach is intended to protect the Clearinghouse and its participants from the risk of default and to minimize operational disruptions in moving positions to the Clearinghouse. ICE Trust focused on the legal framework, particularly the insolvency framework, applicable to CMs in relevant jurisdictions. 1 The BIS Committee on Payment and Settlement Systems and Technical Committee of the International Organization of Securities Commissions (IOSCO) published Recommendations for Central Counterparties Recommendation 2 states A CCP should require participants to have sufficient financial resources and robust operational capacity to meet obligation arising from participation in the CCP. A CCP should have procedures in place to monitor that participation requirements are met on an ongoing basis. A CCP s participation requirements should be objective, publicly disclosed, and permit fair and open access. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 7 All rights reserved

94 June 23, 2009 In accordance with its rules for admission of new CMs, ICE Trust expects that it would focus on these factors, including the appropriate legal and insolvency framework, in the event that new types of CM or CMs in other jurisdictions seek to become members of ICE Trust. As noted above, ICE Trust would seek a legal opinion as to relevant matters under the law applicable to the new CM or type of CM, including in the event of its insolvency. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 8 All rights reserved

95 June 23, 2009 III. Segregation and Safekeeping of Initial Margin A. Initial Margin Held at or for ICE Trust DISCLAIMER 1. Composition of ICE Trust Margin ICE Trust's policies regarding the acceptable forms of non-cash collateral for Initial Margin and their associated haircuts are designed to provide protection for liquidity risk management. In establishing acceptable collateral, ICE Trust considered the liquidity of funds in the event of a CM default and evaluated how quickly funds would be available to cover CM losses. The principal consideration in determining eligible CCP Required Margin was the protection of the clearinghouse and the clearing system as a whole. In coordination with its regulators, ICE Trust established the following acceptable collateral for Initial Margin: i. Acceptable Collateral Acceptable Forms of Non-Cash Collateral for Initial Margin include: US Treasury Securities (Bills, Notes and Bonds) G7 Government Securities (Canada, France, Germany, Italy, Japan, United Kingdom, and United States ) All forms of collateral must continue to meet the criteria below to be considered for approval by ICE Trust: There must be adequate demand for acceptance of the collateral form among current Clearing Participants; An active secondary market with reasonable sized bids must exist; An accurate, reliable and timely price information source must be available to ICE Trust from an independent third party vendor; and ICE Trust must be capable of obtaining a perfected security interest in the collateral type. ii. Initial Margin Collateral Thresholds Given the ability to move cash immediately and the ability to liquidate US Treasuries same day, ICE Trust has established the first threshold for This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 9 All rights reserved

96 June 23, 2009 Initial Margin with respect to these asset types. This first threshold ensures that ICE Trust has immediate, intraday access to cash. The remaining Initial Margin contributions can be met with other forms of acceptable collateral as defined, subject to the defined haircuts. The thresholds are defined in the figure below. Asset Type US dollar cash US dollar denominated assets (Cash and/or US Treasuries) All eligible collateral (includes G7 cash and Sovereign Debt) ICE Trust Collateral Thresholds Minimum Percentage* of Requirement Comments 45% 45% is equivalent to the maximum assumed one day margin movement (assuming a 5-day risk horizon) + 20% 65% is equivalent to the maximum (for a total 65%) assumed two day margin movement (assuming a 5-day risk horizon) The remaining percentage can be any form of acceptable collateral Additional margin will be called if the Clearing Participant does not maintain the appropriate minimums by asset type (regardless of whether the total sum of eligible collateral meets the total margin obligation). DISCLAIMER 2. Relationship Between CCP, CM and Customer CMs are acting as principals vis a vis both the CCP and customers. This approach is consistent with, and builds on, the existing structure of the OTC CDS market. As is the case with most Clearinghouses, ICE Trust has a direct, This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 10 All rights reserved

97 June 23, 2009 principal relationship only with its CMs. As between CMs and their customers, the ICE Trust approach expands upon the existing bilateral ISDA relationship between those parties. As noted herein, in accepting margin from customers, CMs are acting as agent and custodian for customers. In addition, in the case of payments made by ICE Trust in respect of the termination of Client Positions, CMs will receive such payments on behalf of and for the benefit of Clients, for distribution as described in Section B.11 below. The Rules do not currently contemplate that customers will be permitted to clear transactions through non-cm affiliates of CMs. B. Proposed Clearing Structure The basic methodology of ICE Trust s proposed clearing structure is outlined in Sections 1 to 11 below. 1. Clearing of CDS In accordance with its rules (the Rules ), the Clearinghouse operates as a multilateral clearing organization for over-the-counter credit default swap ( CDS ) transactions for purposes of Section 409 of the Federal Deposit Insurance Corporation Improvement Act of 1991, as amended ( FDICIA ). In general, the Clearinghouse accepts for clearing qualifying index (and, in the future, plans to accept single-name) credit default swap transactions entered into between Members. Upon acceptance of a transaction for clearing, the transaction is novated to the Clearinghouse, such that the Clearinghouse becomes the protection seller to the Member that is the protection buyer and the protection buyer to the Member that is the protection seller. The Clearinghouse requires Members to post initial margin (or collateral in lieu thereof), variation margin and special margin to secure their obligations to the Clearinghouse under cleared transactions. 2. Basic Non-Member Framework Pursuant to the Rules, the Clearinghouse is establishing a framework that provides certain protections of clearing for CDS transactions entered into by clients of Members ( Clients ), including the segregation of at least the minimum required initial margin posted by Clients in segregated accounts and DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 11 All rights reserved

98 June 23, 2009 provisions to enhance the transferability, or portability, of such transactions in the event of a Member insolvency (the Non-Member Framework ). 2 Under the Non-Member Framework, the Rules generally distinguish between Client-generated positions ( Client Positions ) and house positions ( House Positions ) for each Member. Client Positions are cleared CDS transactions between the Clearinghouse and the Member that are offset or mirrored on a back-to-back basis by a CDS transaction between the Member and a Client (a Client-Member Transaction ). House Positions are all other cleared CDS transactions between the Member (or any affiliate of a Member) and the Clearinghouse (including so-called house or proprietary transactions). Notwithstanding this distinction, both Client and House Positions are principal-to-principal transactions between the Member and the Clearinghouse. In addition, Client-Member Transactions are principal-toprincipal transactions between the Member and the Client. The Clearinghouse will have no direct relationship with, or liability to, Clients, in respect of Client Positions, Client-Member Transactions or otherwise, except as described herein. The Clearinghouse will record each Client Position submitted by a Member to the Clearinghouse, and will permit Members to identify and close out offsetting Client Positions that reflect positions corresponding to the same Client. Notwithstanding that the Clearinghouse may in this manner retain records of gross Client Positions across different Clients, the obligations of each of the Clearinghouse and the Member to the other at any time in respect of Client Positions shall be determined on a net basis. 3. Submission of Client Positions to ICE Trust Client Positions may be submitted for clearing in two ways. In order to have related Client Positions registered in the Clearinghouse, the Client is required to have one or more designated Members that have agreed to act as the Client s clearing member. 2 Clearinghouse rules will not preclude a Client from trading with a Member on a strictly bilateral, noncleared basis. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 12 All rights reserved

99 June 23, 2009 i. Bilateral Model The Client would execute a trade with a Member as principal. The Member submits a back-to-back trade to the Clearinghouse. Upon acceptance, this would be treated by the Clearinghouse as two positions, a Client Position that mirrors that Client-Member Transaction and an exactly offsetting House Position. ICE Trust Bilateral Model Pre-Clearing Post Clearing The Client agrees to a trade with a CP as principal The CP submits a trade to ICE Trust with one side as a Client trade (Client position) and the other side as a House trade The CP and the Client will simultaneously record the back to back principal to principal trade (Client-CP transaction) Bilateral Trade Client CP Cleared Position Client Omnibus Client CP ICE Trust Back-toback trade House Account ii. Member as a Prime Broker The Client agrees to a trade with a Member (the Executing Dealer ) other than the Client s clearing Member. Pursuant to a give-up agreement, the Client s clearing Member, as prime broker, and the Executing Dealer enter into the trade, which is submitted to the Clearinghouse for clearing. The Member and the Client would simultaneously enter into an offsetting principal trade, which would be a Client-Member Transaction. The leg of the cleared transaction between the Clearinghouse and the Client s Member would be treated as a Client Position. 3 3 In this scenario, the opposite leg between the Clearinghouse and the Executing Dealer would be a House Position. If the Executing Dealer were clearing through another Member, the leg between the Clearinghouse and the Executing Dealer s Member would be a Client Position. If the Executing Dealer is the same legal entity as the prime broker, the result would be the same as in the bilateral model. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 13 All rights reserved

100 June 23, 2009 ICE Trust Prime Broker Model The Client agrees to a trade with a dealer (Executing Dealer) other than the Client s clearing CP Pursuant to a give-up agreement, the Client s clearing CP, as prime broker, and the Executing Dealer enter into the trade, which is cleared by ICE Trust (Client position) The CP and the Client will simultaneously record the back to back principal to principal trade (Client-CP transaction) Client Gives-up Trade with Executing Dealer to the CP Prime Broker Pre-Clearing Client CP Prime Broker Exec. Dealer Post Clearing CP Prime Broker Client Omnibus Client Cleared Position ICE Trust Exec. Dealer House Account If a Client-Member Transaction is terminated because of a default by the Client or otherwise, the related Client Position would by its terms remain in effect, but the Member will be entitled under the Rules to enter into a liquidating trade with another Member that would be submitted for clearing. Such a liquidating trade, which might otherwise be treated as a House trade would offset and close out the Client Position. Alternatively, the Rule may permit a Member in that situation to elect to have the Client Position converted into a House Position. In that case, margin would be moved from the Client Omnibus Account to the House Account or returned to the Member for distribution to the Client, as appropriate. 4. Client Omnibus Accounts The Clearinghouse maintains separate margin accounts for each Member for House Positions and Client Positions. Initial margin for House Positions is posted to the house account (the House Account ) on a net basis and held as under the current Rules. Initial margin for Client Positions of a Member is posted to a segregated client omnibus account (the Client Omnibus Account ) for that Member. The Client Omnibus Account is held by the Clearinghouse, or its subcustodian, for the benefit of Clients of the relevant Member (or the Member as agent or custodian on behalf of such Clients), and is segregated from any other assets of the Member, including assets in the DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 14 All rights reserved

101 June 23, 2009 House Account. 4 The Client Omnibus Account may contain property of Clients that has been transferred or rehypothecated by the CM or proprietary assets of the CM transferred in lieu of Client property. The Client Omnibus Account consists of a cash collateral subaccount for cash margin and a custody subaccount for securities collateral. The cash collateral subaccount will be maintained by the Clearinghouse and will contain initial margin posted as cash by the Member in respect of Client Positions (including cash posted to the Member by the Member s Clients in respect of related Client-Member Transactions and transferred by the Member to the Clearinghouse in respect of such Client Positions). Cash in the cash collateral subaccount may be applied by the Clearinghouse to the obligations of the Member in respect of Client Positions. The custody subaccount of the Client Omnibus Account will hold any non-cash assets posted by the Member in respect of Client Positions (including non-cash assets posted by the Member s Clients in respect of related Client-Member Transactions to the Member as margin and rehypothecated by the Member to the Clearinghouse in respect of such Client Positions). It will be held by the Clearinghouse, as custodian, or by one or more outside financial institutions as subcustodian for the Clearinghouse. The Client Omnibus Account and the assets therein will secure the Member s obligations to the Clearinghouse in respect of Client Positions. The Clearinghouse will also maintain a separate omnibus segregated excess margin custodial account (the Excess Margin Account ), which will hold certain margin provided by Clients to Members in excess of the net minimum margin required by the Clearinghouse. Assets in the Excess Margin Account will not be applied to satisfy or otherwise secure amounts owed by the Member to the Clearinghouse, except as described below. The Excess Margin Account will be maintained by ICE Trust or its subcustodian and will be held for the benefit of Clients of the relevant Member (or the Member as agent and custodian of such Clients), subject to a lien in favor of the Member. The 4 In the circumstance where a Member collects margin from a Client and posts different margin to the Clearinghouse in respect of the related Client Position, the Member would retain an interest in such margin. Members will be required under the Rules to maintain records of any such interest. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 15 All rights reserved

102 June 23, 2009 Excess Margin Account will also consist of a cash subaccount and a custodial subaccount. As described below, a Member will be required to transfer or rehypothecate to the Client Omnibus Account or Excess Margin Account, as applicable, required initial margin posted to the Member by the Client under the related Client-Member Transaction. Pursuant to the Rules, each Member will be deemed to agree that with respect to Client property transferred or rehypothecated to the Client Omnibus Account or Excess Margin Account, (i) cash so transferred will become property of the Clearinghouse (with the Clearinghouse being obligated to return such cash as provided in the Rules for the benefit of the relevant Client (or the Member as agent or custodian thereof)) and (ii) non-cash assets so rehypothecated will remain the property of the relevant Clients, subject to a security interest in favor of the Member (and the Clearinghouse, in the case of the Client Omnibus Account). The CM will be required to maintain records showing the amount and form of excess margin held in the Excess Margin Account for the benefit of each relevant Client (the Client Excess Margin Amount ). 5 Upon the termination of a Client-Member Transaction, the CM will be permitted to withdraw up to the Client Excess Margin Amount for that Client and apply it to amounts owed by the Client under the Client-Member Transaction. 6 Only that Client s Client Excess Margin Amount may be so used; margin posted by other Clients may not be used by the CM. The CM will also be permitted to withdraw amounts from the Excess Margin Account (not to exceed the Client Excess Margin Amount) when required to be returned to the Client under the Client- Member Transaction. The CM may transfer amounts in the Excess Margin Account (taken from Client Excess Margin Amounts of different Clients on a pro rata basis (determined excluding any CP Excess held in the Excess Margin Account)) to the Client Omnibus Account as necessary to satisfy the ICE Net 5 CMs will be required to provide reports or otherwise make information available as to such amounts to both ICE Trust and the relevant Clients. 6 Where the CM is also in default, ICE Trust will be permitted to make such withdrawal and application. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 16 All rights reserved

103 June 23, 2009 margin requirement for Client Positions. The CM will not otherwise be permitted to use or rehypothecate amounts in the Excess Margin Account. In the case of a default by a CM, ICE Trust will be permitted to apply excess margin of a defaulting Client (but not other Clients) held in the Excess Margin Account to satisfy amounts owed by the defaulting CM in respect of Client Positions (to the extent of the defaulting Client s obligation to the CM) 7. In addition, margin in the Excess Margin Account of Clients whose positions are not transferred to another CM as part of the Default Portability Rules may be transferred by ICE Trust to the Client Omnibus Account (pro rata based on such Clients gross margin contributions) to satisfy any increase in the ICE Trust net initial margin requirement as a result of the transfer of some, but not all, positions. 5. Clearinghouse Margining Each Member will be required to post to the Clearinghouse in the Client Omnibus Account initial margin on a net basis across all Client Positions ( ICE Net ), whether for the same or different Clients, in the same manner as generally required for House Positions. 8 The Rules do not specifically limit the Clearinghouse s ability to demand additional, special margin at any time from a CM. For purposes of margining Clients, however, each Member will be required to obtain margin on a gross basis (that is, the Member will be permitted to net across multiple Client-Member Transactions of the same Client, but not across different Clients. Such margin will be pledged by the relevant Client in favor of the Member. Under ICE Trust Rules, such margin must not be subject to liens or other encumbrances in favor of third parties, including affiliates of the CM. Each Member will be required to transfer to the Excess Margin Account the difference between the aggregate gross margin required from Clients 7 Such excess margin will also be deemed applied to the obligation of the defaulting Client to the defaulting CM under its Client-Member Transaction. 8 We note in this regard that the Clearinghouse s exposure to the Member, and the Member s exposure to the Clearinghouse, in respect of Client Positions will also be determined on a net basis across all Client Positions. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 17 All rights reserved

104 June 23, 2009 and the net margin required by the Clearinghouse to be posted to the Client Omnibus Account (such excess, the ICE Excess ). As noted above, the Clearinghouse will not be entitled to use such ICE Excess Margin, and will hold it merely as custodian Client-Member Transaction Documentation Client-Member Transactions will be documented pursuant to a negotiated ISDA Master Agreement between the Client and Member, together with a standard annex in the form approved by the Clearinghouse under the Rules (the Standard Annex ). Under the Standard Annex, Client-Member Transactions will for certain purposes be treated separately from other derivatives between the Client and the Member ( Other Trades ). Specifically, Client-Member Transactions will be subject to the separate Clearinghouse margin requirements discussed below. In addition, the Standard Annex will include a standard definition of Member default, which will be based on a determination by the Clearinghouse under the Rules that a Member is in Default. 10 The Standard Annex will also specify procedures for the exercise of remedies in case of a Member default. If Default Portability Rules are to apply, the Standard Annex will include an agreement and consent on the part of the Client, for the benefit of ICE Trust, for ICE Trust to transfer Client-Member Transactions to a new Member following default or otherwise reestablish replacement transactions with the new Member. The Client will also agree not to exercise termination rights during the Transfer Period (as defined below). In the event the Client-Member Transaction is terminated as 9 Members may require Clients to post additional margin beyond the Clearinghouse gross minimum ( CP Excess ), which may be held as agreed between the Member and the Client. CP Excess may be transferred to the Excess Margin Account. 10 The Standard Annex would not have a standard definition for Client defaults, which would be subject to bilateral agreement between the parties, as is current practice for OTC derivatives. The Standard Annex will also provide that a failure by the CM to perform a payment or delivery obligation under a Client-Member Transaction will constitute an event of default with respect to the CM, regardless of whether the CM is otherwise determined to be in default under the ICE Trust Rules. Such a failure would, however, permit ICE Trust to declare the CM in default under the ICE Trust Rules. If ICE Trust makes such a declaration, the default procedures described herein would apply. If ICE Trust does not declare the CM to be in Default, the Client will be permitted to exercise its bilateral contractual termination remedies against the CM, although the default procedures of the Rules would not apply. In any event, the Client would not have any direct remedy against the Clearinghouse. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 18 All rights reserved

105 June 23, 2009 a result of a Member default, the termination value will be equal to the termination value of the related Client Position as determined by ICE Trust. To facilitate portability, in the event of a Member default, termination amounts owed in respect of Client-Member Transactions will not be netted against termination amounts owed in respect of Other Trades. 7. Client-Member Transaction Margining Under the Rules and the Standard Annex, each Member must obtain initial, variation and any special margin from its Client for Client-Member Transactions in an amount at least equal to the Clearinghouse requirement for the related Client Positions (determined on a gross basis). In the case of initial and any special margin, the Member will be required to receive such margin as agent or custodian for the Client and transfer such margin to either the Client Omnibus Account or the Excess Margin Account at the Clearinghouse. Such margin in the Excess Margin Account will be pledged to the Member. 11 The Rules do not limit a CM s ability to require additional margin from a customer beyond the CCP requirement ( CP Excess ). Treatment of any CP Excess required of the Client by the Member beyond Clearinghouse requirements would be as agreed between the Client and Member. 12 Variation margin posted by a Client may be transferred freely, and it would be expected that such margin may be used to satisfy the Member s variation margin requirements at the Clearinghouse in respect of Client Positions. 11 The Member will be required to reflect such margin in its books and records as being received in a custodial capacity and held in segregation from other assets of the Member, in a manner generally consistent with CFTC Rule In the case of any delay in transferring margin to the Clearinghouse, such margin must be segregated by the Member and may not be otherwise used pending transfer to the Clearinghouse. 12 CP Excess could be held in the Excess Margin Account if agreed by Member and Client. As noted below, there may be limitations on the ability of the Clearinghouse to effect a transfer of margin not held at the Clearinghouse. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 19 All rights reserved

106 June 23, 2009 The Clearinghouse would make available to Members information sufficient for Members to determine their Clients minimum margin requirements in respect of Client-Member Transactions. The Member will be required under the Rules to maintain accurate records as of the identity of Clients, the margin assets posted by each such Clients and the transfer of such assets to the Client Omnibus Account and Excess Margin Account at the Clearinghouse. 8. Default Rules The Rules provide for separate treatment of Client and House Positions in the case of a Default 13 by a Member. The determination of whether a Member is in Default under the Rules is the same with respect to both types of position. The definition of Default under the Rules principally includes objective events (e.g., insolvency filings and failures to transfer margin when required) but does permit ICE Trust to find a Member to be in Default if it determines that the Member appears, in the judgment of ICE Trust, to be likely to fail to meet its obligations to ICE Trust. Depending on the type of event, different levels of management approval and/or regulatory consultation may be required before determining that a Member is in default. Notably, in cases other than an insolvency event or failure to satisfy payment, delivery or margin obligations, holding a Member in default requires a 2/3 majority vote of the ICE Trust board and consultation with the staff of the New York Fed. The Clearinghouse will undertake the Close-Out Process under the Rules separately in respect of House Positions and Client Positions, such that a separate net termination amount will be calculated in respect of the close-out of Client Positions and House Positions. The Rules would prohibit netting between Client Positions and House Positions, except as described below. If a net amount was owed to the Member in respect of Client Positions, the Clearinghouse would not offset that amount against any amount owed by the Member to the Clearinghouse in respect of House Positions. On the other hand, if a net amount was owed by 13 See Rule (a). DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 20 All rights reserved

107 June 23, 2009 the Member in respect of Client Positions, the Clearinghouse would be entitled to offset against that obligation any amount owed to the Member in respect of House Positions. Pursuant to the Rules, net losses to the Clearinghouse arising from Client Positions may be paid from the following sources, in order: (i) the defaulting Member s House margin, (ii) the defaulting Member s Guaranty Fund contribution, (iii) the defaulting Member s Client Omnibus Account together with any excess margin of a defaulting Client of the Member held in the Excess Margin Account 14 and (iv) other Guaranty Fund contributions. 15 Net losses to the Clearinghouse arising from House Positions may be paid from the following sources, in order: (i) the defaulting Member s House margin, (ii) the defaulting Member s Guaranty Fund contribution, and (iii) other Guaranty Fund contributions. Thus, the Clearinghouse only will be permitted to apply margin in a Client Omnibus Account to satisfy obligations of the Member in respect of Client Positions. Such margin could not be used to satisfy obligations in respect of House Positions. Margin in the House Account could potentially be applied to satisfy obligations to the Clearinghouse in respect of Client Positions. The risk waterfall would not vary based on whether the default arises from an insolvency event. i. Identification of Client or House Default ICE Trust will identify in its books and records each position as a Client Position or House Position, based on information provided by the CM. In the event of a CM default, ICE Trust will conduct a separate closing-out process for Client Positions and House Positions and as a result will 14 Pursuant to the Rules and the Standard Annex, any loss in the Client Omnibus Account resulting from application of margin therein by the Clearinghouse under the Rules as a result of a Member default would be allocated among Clients as described in Section 11 below. The appropriate sequence of using the defaulting Client s margin is under consideration. 15 Of course, to the extent the Clearinghouse, pursuant to its Close-Out Process, is able to close out and/or replace transactions of the defaulting Member without loss to the Clearinghouse, application of these assets would not be necessary. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 21 All rights reserved

108 June 23, 2009 determine a separate loss for each type of position. Such losses will be satisfied as described in the risk waterfall above. 9. Certain Rules Regarding Portability of Positions and Margin i. Pre-Default Portability The Rules require a Member, at a Client s request, to agree to transfer Client-Member Transactions and related Client Position to another Member, subject to the satisfaction of certain conditions under the Rules. The Client is responsible for obtaining a new Member to accept the positions to be transferred, and a Member is not required to accept the transfer of positions to it upon a Client request. Under Clearinghouse procedures, the old Member, Client and new Member must enter into a written novation confirmation as to the Client-Member Transactions to be transferred, the date and time the transfer is to be effective, the amount of margin held in the old Member s Client Omnibus Account and/or Excess Margin Accounts that relates to the related Client Positions to be transferred. Upon submission of such agreement to the Clearinghouse and acceptance of it by the Clearinghouse, the Clearinghouse will terminate the related Client Positions and reestablish new Client Positions with the new Member at the same time the Client-Member Transactions are transferred. The Clearinghouse will also transfer the appropriate amount of margin from the Client Omnibus Account and/or Excess Margin Account of the old Member to the Client Omnibus Account and/or Excess Margin Account, as applicable, of the new Member. Each of the old Member, new Member and Client will be responsible for ensuring that their respective margin requirements remain satisfied upon the transfer of positions. ICE Trust Rules do not permit it to mandate that a CM transfer any or all of its customer positions and initial and variation margin (and any associated contractual relationships) to another clearing member, if such CM is not in default, regardless of whether ICE Trust perceives that the CM is in a state of impending financial distress. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 22 All rights reserved

109 June 23, 2009 ii. Post-Default Portability The Rules also include certain procedures to enhance portability of Client Positions, Client-Member Transactions and margin in the case of a Member default ( Default Portability Rules ). As a general matter, pursuant to these rules, the Clearinghouse would seek to find a replacement transaction for Client Positions of the defaulting Member (the Defaulting Member ) with another Member (the New Member ) also willing to take on the related Client-Member Transactions. 16 Members will not be obligated to accept a transfer, or enter into a replacement, of Client-Member Transactions. The Rules will permit the Clearinghouse to transfer, or arrange the transfer of, Client Positions of a Defaulting Member together with related Client- Member Transactions (and margin) to a New Member as part of the Close- Out Process, to the extent such a transfer by the Clearinghouse is permissible under applicable law (including the insolvency law applicable to the relevant Defaulting Member). In such case, following a Member Default, the Clearinghouse would exercise its rights in the Close-Out Process to terminate the relevant Client Positions with the Defaulting Member and seek to obtain replacement transactions with a New Member. In addition to the other provisions of the Close-Out Process, the Rules permit the Clearinghouse, within a specified period (the Transfer Period ) following a Defaulting Member s default and the termination of its related Client Positions by the Clearinghouse, to transfer the relevant Client-Member Transactions (and related margin) of the Defaulting Member to a New Member. The Clearinghouse would be expected to transfer these rights to the New Member taking on the exposure for the related Client Positions through the Close-Out Process. Clearinghouse Rules would require the New Member accepting transfer of these rights to assume the related obligations in favor of the Client. Pursuant to the Rules, the Defaulting Member would agree to the Clearinghouse s right to effect any such transfer. The Client would also consent to such 16 These procedures would only apply in situations where the Defaulting Member s regulator, receiver, trustee or other applicable insolvency administrator did not otherwise transfer or arrange the transfer of the relevant positions. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 23 All rights reserved

110 June 23, 2009 procedures in the Standard Annex for the Client-Member Transactions. The result of these actions (collectively, the Clearinghouse Transfer Procedures ), in effect, would be to allow the Clearinghouse to transfer the Client-Member Transactions from the Defaulting Member to the New Member. If such a transfer were effected, the Clearinghouse would transfer the appropriate initial margin for the related Client Positions from the defaulting Member s Client Omnibus Account to the New Member s Client Omnibus Account, and also transfer the related margin in the Excess Margin Account. Alternatively, the Clearinghouse would have the right under the Rules to achieve effectively the same result through procedures for the termination of existing transactions and establishment of new positions with the New Member ( Clearinghouse Termination/Replacement Procedures ). In the case of a Member default, the Clearinghouse may exercise its rights to terminate the Client Positions with the Defaulting Member, and enter into a replacement transaction with a New Member as part of the Close-Out Process. Both the Clearinghouse Rules and the Standard Annex for Client-Member Transactions would permit the Clearinghouse to procure such New Member to re-establish the Client-Member Transactions on the same terms (the Replacement Client-Member Transactions ). Upon the entry into of the Replacement Client-Member Transactions, (i) the old Client-Member Transaction would be automatically terminated under the terms of the Standard Annex and (ii) under the terms of both the Clearinghouse Rules and the old Client-Member Transaction, no net termination payment would be owed by the Clearinghouse to the defaulting Member in respect of the related Client Position, or by the defaulting Member to the Client in respect of such Client-Member Transaction. 17 The net result would be the reestablishment of the relevant 17 In effect, the obligation of ICE Trust to pay the termination amount in favor of the CM, the obligation of the CM to pay the identical termination amount in favor of the Client, the obligation of the Client to pay an identical amount in favor of the new CM with respect to the establishment of the replacement Client- Member Transaction and the obligation of the new CM to pay an identical amount in favor of ICE Trust in respect of the establishment of the related Client Position would be netted and offset. These obligations could be collapsed further to a bilateral netting between the old and new CMs. For example, the Client would assign its rights against the defaulting Member in respect of the termination payment directly to the DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 24 All rights reserved

111 June 23, 2009 Client Position and related Client-Member Transaction with a New Member. In that case, the Clearinghouse would transfer the appropriate initial margin from the Client Omnibus Account and/or Excess Margin Account to the applicable accounts for the New Member. Under ICE Trust rules, it is expected that the timeline for the transfer or replacement would be approximately [3] business days. If the Clearinghouse did not effect a transfer or termination and replacement under the Default Portability Rules within the Transfer Period (including because no Member was willing to accept transfer or enter into replacement transactions), the Standard Annex would permit the Client to terminate the relevant Client-Member Transactions in accordance with their terms. In that case, remaining assets in the Client Omnibus Account and Excess Margin Account would be returned to the defaulting Member s receiver or trustee for distribution to Clients. ICE Trust will determine the close-out price for Client Positions pursuant to its close-out procedures, which may involve auction or allocation of the relevant positions. Under the Standard Annex, the same close-out price will apply to the related Client-Member Transaction. Because the closeout process for customer positions is conducted separately from the closeout process for house positions, the same close-out price will not necessarily apply to house and customer positions. Additional Portability Considerations: The Rules permit the Clearinghouse to attempt to use the Default Portability Rules for some or all of the relevant Client-Member Transactions. In addition, the Standard Annex will permit Clients to request, at the time they enter into the Standard Annex, whether they want New Member in satisfaction of the Client s initial payment obligation for the Replacement Client-Member Transaction. ICE Trust would similarly assign its rights against the New Member in respect of its initial payment in respect of the establishment of the new Client Position directly to the Defaulting Member in satisfaction of ICE Trust s obligation to make the termination payment to the Defaulting Member. The resulting payment obligations between the Defaulting Member and New Member would be netted in accordance with the Rules. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 25 All rights reserved

112 June 23, 2009 their Client-Member Transactions to be subject to the Default Portability Rules. 18 The Clearinghouse may, but will not be obligated to, take into account such requests as well as requests from Clients to have positions transferred to, or not to, specific Members and any prearrangements among Members and Clients as to the transfer of positions. Depending on the circumstances, such elections and arrangements may facilitate or complicate any attempt by the Clearinghouse to move Client-Member Transactions. In addition, it is not clear that the Clearinghouse will be able to move, or cause the relevant Member to move, CP Excess not held in the Excess Margin Account. This may affect the willingness of a Member to accept transfer of Client-Member Transactions. With respect to documentation, if the New Member and Client have entered into an ISDA Master Agreement, the transferred or replaced Client-Member Transactions will be subject to that agreement, together with the Standard Annex. If those parties have not entered into an ISDA Master Agreement, the transferred or replaced Client-Member Transactions will be subject to the terms of a standard form ISDA Master Agreement specified in the Rules, which the Client and New Member would have to replace with a negotiated ISDA within a specified period. A New Member may be less willing to accept transferred or replaced Client-Member Transactions if it has not previously entered into an ISDA Master Agreement with the Client. In order to implement the Default Portability Procedures, ICE Trust will rely on information provided by Members as to the identity, positions and margin of Clients, although ICE Trust will not generally have a direct relationship with those Clients. Members will be required to provide such information to ICE Trust on a daily basis. Portability is enhanced by having IM held at the CCP on a gross basis through the combination of the Client Omnibus Account and Excess Margin Account (such that the CCP can move the margin together with 18 Clients or CMs in jurisdictions requiring automatic termination or providing for automatic setoff upon insolvency may be limited in their ability to have default portability rules apply. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 26 All rights reserved

113 DISCLAIMER June 23, 2009 the related positions). Under ICE Trust rules and documentation, the existence of non-cleared trades (whether in or out of the money) should not significantly affect portability given the contractual separation of such trades from cleared trades (although they may affect a customer s desire to have portability rules apply). 10. Investment of Excess Margin Account Subject to regulatory approvals, assets in Excess Margin Account could be invested in a broader range of assets than assets in the Client Margin Account (which the Clearinghouse may need to access in the event of a Member default). ICE Trust would propose a range of permitted investment consistent with investments permitted under CFTC Rule The nature of investments within those permitted under Clearinghouse rules, and allocation of any income from investments, will be subject to agreement between the Member and its Clients. 11. Allocation of Losses Among Clients In the case of the liquidation of a Client s positions as a result of a CM default, the Rules and Standard Annex will provide for the determination and allocation of losses and gains among Clients on a CM default as follows: As noted above, the termination value of each Client s Client-Member Transactions will be calculated on the basis of the termination values determined by ICE Trust with respect to the related Client Positions. Where a Client owes the CM on a net basis in respect of the Client s Client-Member Transactions, that Client s margin (whether in the Client Omnibus Account or the Excess Margin Account) will be applied to satisfy that obligation (and will thereupon be available to pay amounts owed to ICE Trust in respect of the related Client Positions and to other Clients in respect of their Client-Member Transactions). Clients owed by the CM on a net basis will have a claim for that amount, together with the portion of their margin contributed to the Client Omnibus Account (a Net Termination Claim ). An amount of proceeds equal to the sum of (i) the remaining amount in the Client Omnibus Account (including any net amounts paid by ICE Trust in respect of the termination of Client Positions), plus (ii) any termination amounts paid by Clients plus (iii) This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 27 All rights reserved

114 June 23, 2009 the amount of any Client s excess margin applied to a Client s obligations will be available for distribution to Clients in respect of their Net Termination Claims. In the event such proceeds are insufficient to pay all Net Termination Claims, Clients will share in such proceeds pro rata based on their respective Net Termination Claims. Each Client will be separately entitled to the return of its excess margin in the Excess Margin Account, except to the extent such margin is applied to satisfy its obligations to the CM. To facilitate these arrangements, ICE Trust is considering requiring that each CM will pledge its rights against its Clients under the related Client-Member Transactions (together with related credit support and proceeds thereof) (i) first in favor of ICE Trust to secure its obligations in respect of the related Client Positions and (ii) second in favor of Clients of the CM to secure amounts owed to such Clients upon termination of their Client-Member Transactions. C. Transfer of Margin from Clearing Members to ICE Trust CMs are required to post margin to ICE Trust for the Client Omnibus Account within the strict timelines set forth in Section III-E-5, whether they are on-posting customer margin or using their own assets. Failure to provide margin within such timelines will constitute a default by the CM under the Rules. While there is no specific requirement about how quickly a CM must transfer margin posted by customers, to the extent a CM does not do so within the required margin timeframe it will be required to post its own assets. ICE Excess Margin will be required to be transferred to the Excess Margin Account promptly upon receipt by the Member. To the extent a CM has received customer margin and not transferred it to ICE Trust, the margin must be held by the CM in segregation from the CM s assets. ICE Trust has considered having Clients post margin directly to ICE Trust. To ICE Trust s knowledge, it would be unusual for a clearing organization for futures, securities or other derivatives to accept CCP Margin directly from, or otherwise have a direct DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 28 All rights reserved

115 DISCLAIMER June 23, 2009 contractual relationship with, customers that are not themselves CMs. Such an approach could expose the Clearinghouse to additional liability to customers, result in additional compliance obligations and could raise various operational considerations, including as to margin timing. D. Economic Effects of Proposed Clearing Structure for CCP Margin In evaluating the proposed clearing structure, ICE Trust analyzed the economic costs/benefits of the segregation model. 1. Return on Investment If IM is held at ICE Trust, the Clearinghouse will pass through the return on that property. However, as noted above, there are significant limitations on the types of eligible margin assets at ICE Trust, and the return may be correspondingly limited. ICE Trust plans to permit a wider range of investments for assets in the Excess Margin Account, as such amounts will not be used to pay Member liabilities to the Clearinghouse. 2. Allocation of Risk and Returns The risk and return on investment of customer margin would be allocated by agreement between the CM and its customer. ICE Trust rules would not prevent the risk and return from being passed through to customers. E. Determination of Required Margin and Related Considerations 1. Required Margin Collection for Customer Segregation ICE Trust will determine ICE Gross Margin to be collected by Members from Clients based on a single client portfolio (gross exposure) and will not net multiple customer portfolios. Positions within the single Client s portfolio will be netted for margining purposes providing offsets for a particular Client portfolio. 2. Protection Against Collecting Insufficient or Excess Margin The ICE Trust Risk Management Framework ensures that the Clearinghouse has sufficient funds to cover potential Clearing Participant default losses under distressed market conditions. ICE Trust collects conservative, but not excessive, margins to collateralize risk. This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 29 All rights reserved

116 June 23, 2009 i. Potential Impact of Collecting Insufficient or Excess Margin Collection of excess margin could result in loss of liquidity and investment return for customers and CMs, as compared to other potential uses for those assets. Collection of insufficient margin may increase the risk of a CM or customer default and/or result in a shortfall in the event of such a default. Because customer margin will be held on an omnibus basis, customers are exposed to the risk of a shortfall in customer funds, even if caused by the default of another customer. Collection of insufficient margin may also increase the likelihood that losses from a default would be charged against guaranty fund contributions, which could cause other CMs to share in losses from another CM s default. 3. Addition of New Products to Clearing Prior to accepting a new product type for clearing, ICE Trust must consult with the Risk Committee and may consult with the non-member Advisory Committee to evaluate the acceptability of the new product. The ultimate decision to add a new product lies with the ICE Trust Board. ICE Trust must also gain approval from its regulators prior to clearing a new product. 4. Margin Methodology ICE Trust employs a robust methodology that accounts for instrument risk, hedging benefits and concentration charges. The methodology identifies all risk factors, generates plausible market scenarios for all risk factors, allows for a wide range of portfolio strategies and financial instruments and estimates portfolio replacement value in response to generated scenarios. ICE Trust provides robust margin reporting to CMs through a web report distribution system. To enable customer segregation, ICE Trust is in the process of developing a margin calculation tool for CMs and Clients that provides access to ICE Trust margin requirement determination. CMs will be able to enter Client portfolios into the tool to establish margin requirements. Clients will be able to view margin requirements upon demand. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 30 All rights reserved

117 June 23, Margin Calls/Collection In the normal course of business, ICE Trust will publish margin requirements by 4 AM EST (via SWIFT Messaging). Payments are due no later than 9:00 AM EST. Clearing Participants will be considered in default if full payment is not received by 9:00 AM EST (barring technical difficulties). DISCLAIMER 6. Mark-to-Market ICE Trust utilizes a dynamic price collection and settlement price calculation process to determine the mark-to-market. On a daily basis, each clearing member must submit a bid/offer for each instrument for which it has an open position. ICE Trust uses a pricing algorithm to calculate an End of Day (EOD) Settlement Price per product. To ensure accuracy of bid/offers submitted by CMs, ICE Trust requires CMs, on a frequent basis, to trade at the calculated EOD Settlement Price. ICE Trust monitors intra-day pricing to evaluate market conditions and manage its risk. ICE Trust does not anticipate providing intra-day pricing to its CMs or CM s Clients. 7. Guaranty Fund Contributions While CM Guaranty Fund requirements will take into account both Client and House positions, ICE Trust does not anticipate that Client funds will be applied to Guaranty Fund contributions for the CM. Therefore, portability of Client Guaranty Funds is not relevant. F. Clearing Cycle Client Positions will be cleared within the same weekly clearing cycle in use today for CM-CM transactions. ICE Trust s weekly clearing cycle leverages the industry standard DTCC s Deriv/SERV trade matching capabilities and the Trade Information Warehouse ( TIW ). The weekly cycle begins each Monday and concludes with the clearingeligible trades booked on Friday. The process is broken down into three main parts: This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 31 All rights reserved

118 June 23, 2009 I. Identification of the Trades for Clearing: ICE Trust and CMs will exchange files to identify which trades will be cleared. ICE Trust will then provide each firm a preliminary file of instructions for the trades for which the firm and its counterparty have both agreed to clear. Both the CM and the Client have to flag the trade for clearing in order for ICE Trust to clear the trade. II. Dress Rehearsal: Each firm will make sure that any post- trade amendments have not affected the trades already selected for clearing and confirm the clearing instructions for those trades. During this review period, ICE Trust will receive a file update from DTCC and will reconcile it with the proposed cleared trades to identify any trades that will no longer be eligible for clearing. DISCLAIMER III. Action: The action phase will begin when all clearing participants approve the final clearing instruction files. ICE Trust will then do the following: Send a notice that the input of the final instructions can begin. Confirm the version of the instruction file to be used. Margin collection will also occur within the established weekly clearing cycle timeline. ICE Trust will collect margin by 9:00AM on the Monday following the clearing cycle for both House and Client Positions. ICE Trust will provide technology to facilitate clearing of Client trades by CM. Clients will be able to request clearing of trades and track the status of the trades (e.g., cleared, uncleared) through the technology provided by ICE Trust. ICE Trust will be able to deliver trade instructions to DTCC on behalf of Clients to enable the clearing of Related Client Transactions. ICE Trust plans to implement an accelerated clearing cycle in the future. Pursuant to ICE Trust Rules, CMs will be required to segregate Client margin posted in connection with Client-Member Transactions prior to the completion of the clearing cycle. G. Amendments to Clearing Structure This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 32 All rights reserved

119 June 23, 2009 Pursuant to its Rules, ICE Trust is required to consult with its Risk Committee prior to making certain material modifications to its Rules and/or clearing structure. The Risk Committee includes representatives appointed by CMs. ICE Trust also is in the process of establishing a non-member advisory committee, which will include representatives of buy-side firms. ICE Trust expects that it would consult with the non-member advisory committee as well in connection with material modifications to the Rules and/or the clearing structure that would affect buy-side firms. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 33 All rights reserved

120 June 23, 2009 IV. Legal Considerations The following discussion is based principally on U.S., English and German law. Additional detail will be subsequently provided for other potentially relevant jurisdictions. A. Segregation Requirements under Applicable Law There is no formal U.S. regulatory or governmental segregation requirement applicable to ICE Trust or its members with respect to cleared CDS transactions. 19 In consultation with, and subject to the approval of, its principal regulators, however, ICE Trust will adopt rules providing for segregation of customer IM by the Clearinghouse and by members. To the extent ICE Trust, any CM or any custodian accepts margin in a custodial capacity as required under ICE Trust rules, it will be subject to the requirements applicable to such custodial property under applicable law, including the UCC. CMs that are regulated by the FSA will be subject to the UK's Client Asset Rules or similar express trust arrangements when they deposit client assets or money with ICE Trust. Under these arrangements, a CM that transfers client assets as Margin to ICE Trust, is required, before a client transaction account is first opened with ICE Trust, to: (a) notify ICE Trust that the CM is under an obligation to keep client assets separate from the CM's own assets, by placing client assets in a client account; (b) instruct ICE Trust that any assets paid to ICE Trust in respect of client transactions are to be credited to the CM's client transaction account. A written acknowledgement of the requirement of the CM to segregate client assets must be given by ICE Trust. 19 While there is no formal segregation requirements applicable to ICE Trust, under current U.S. law, ICE Trust's segregation plan offers the greatest protection for OTC credit default swaps in the event of a clearing member default. As stated earlier, ICE Trust came to this conclusion after looking at the bankruptcy protection schemes under securities and commodities law. For example, in order for CDS market participants to claim favorable bankruptcy treatment pursuant to the Commodity Exchange Act, credit default swaps must be segregated pursuant to CEA section 4d. Segregating an OTC swap pursuant to 4d would require the CFTC to expand the definition of commodity contract as defined in the bankruptcy code. It is unclear whether the CFTC has this power, and it is possible that commingling CDS with futures with this legal uncertainty would delay transfer of customer funds (futures and CDS customer funds) until a court decided whether the CFTC had the authority to redefine commodity contract. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 34 All rights reserved

121 DISCLAIMER June 23, 2009 CMs that are German credit institutions regulated by the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht or "BaFin") are subject to applicable German law and the BaFin rules with regard to the treatment of client money and assets. In general, German law and the BaFin rules do not require that any client assets or money be segregated from the CM s own assets in connection with cleared CDS transactions. However, German law recognizes segregation of client assets held with a defaulting institution in certain circumstances, including where assets are held in a segregated trust account. ICE Trust rules will require such segregated trust arrangements with respect to client assets or money deposited by a German CM with ICE Trust. B. Customer Rights to CCP Margin The Clearinghouse will not directly have a contractual or legal relationship with the customers of a CM. However, the CCP will hold IM for the benefit of the customers of the CM (or for the CM as agent or custodian for such customers), rather than for the CM itself in its principal capacity. IM will be transferred by the customer to the CM on a custodial basis such that such IM remains the property of the customer. Further transfer of such IM to the Clearinghouse in the manner provided for in the Rules and the Standard Annex should not change the rights of the customer under this framework. However, because such IM will be held by the Clearinghouse on an omnibus basis, it will be necessary for the customer to claim return of such IM through the defaulting CM or its receiver or trustee, and the ability of a customer to obtain such margin will depend on the records of the CM. Considerations: Customers should hold proprietary (i.e., ownership) rights in the non-cash IM held at the CCP (or the CCP s custodian), and not merely contractual rights to recovery of the IM vis-à-vis the defaulted CCP (or the CCP s custodian). With respect to cash IM held at the CCP, the CCP will have a contractual obligation to repay such IM as provided in the Rules. That obligation will be held by the CM as agent and custodian for the Clients. Accordingly, as between the Client and the CM, the Client should have proprietary rights in such claim against the CCP. The principal relevant U.S. legal standard with respect to tracing or other requirements necessary to demonstrate proprietary rights in the IM is set forth in UCC article 8. This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 35 All rights reserved

122 June 23, 2009 The principal relevant legal standard under English law with respect to tracing or other requirements necessary to demonstrate proprietary rights in IM collected by English CMs is set forth in the UK client asset rules and applicable English trust law. The principal relevant legal standard under German law with respect to tracing or other requirements necessary to demonstrate proprietary rights in IM collected by German CMs is based on (i) IM being held in a segregated trust account as described in Section IV.A. above and (ii) the German CM keeping accurate books and records with respect to the IM that reflect the correct attribution of IM in the segregated trust account to the relevant customer. By Clients maintaining proprietary rights, IM should not be subject to the insolvency estate of the defaulting CM, and accordingly should not be subject to the claims of general creditors of the defaulting CM. o By the terms of the Rules and Standard Annex, Client margin will be held solely for the benefit of Clients with respect to cleared CDS transactions and not other custodial customers. o Nonetheless, if the CM (or any custodian) were to become insolvent and there were a shortfall in custodial assets of a particular type (i.e., a particular CUSIP for securities assets), it is possible that Clients that have deposited that asset with a CM may share losses with other custodial customers of the CM that had deposited the same asset. Under article 8 of the UCC, such sharing would generally be on a pro rata basis. Article 8 requires a custodian (technically, a securities intermediary ) to maintain sufficient assets to cover all claims of custodial customers to the relevant asset. Although there is no specific regulatory regime that limits the claims on Client assets of other custodial customers, the custodial business of banks and other financial institutions is subject to regulatory supervision and examination, which may help limit the risk of such a shortfall. In fact, there are few cases where U.S. financial institution failures have resulted in a loss to custodial or trust customers from a shortfall in custodial or trust assets. o In practice, the possibility of other custodial claims on Client assets may depend on the books and records of the CM in its trust or custodial DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 36 All rights reserved

123 June 23, 2009 business. 20 If there are inaccuracies in such books and records (including because of a failure to properly reflect the rehypothecation of securities of other custodial customers as required by the UCC), claims of Clients may be adversely affected. Clearinghouse rules will require Members to keep accurate books and records with respect to segregated, custodial assets (among other matters), although the Clearinghouse itself would have limited ability to police this. Under ICE Trust Rules and the Standard Annex, a shortfall in CCP margin in the Client Omnibus Account will be allocated first to any defaulting customer of the relevant CM and thereafter to other CDS customers on a pro rata basis. C. Customer Rights to CM Margin The CM will be required to transfer all IM (other than CP Excess) to the Clearinghouse. As a result, such margin should not be held at the CM. To the extent any such IM is held at the CM pending transfer to the Clearinghouse, the Rules will require that be held by the CM on a segregated custodial basis such that such IM remains the property of the customer. A customer s rights to CP Excess will depend on the manner in which the customer and CM agree that such CP Excess is to be held. D. Legal Enforceability of Portability Framework In summary, U.S. insolvency laws (including FDICIA, the FDIA and the Bankruptcy Code) generally uphold the enforceability of a clearing organization s rights to terminate and net contracts with, and apply security of, an insolvent CM. 21 By contrast, these laws do not specifically address the enforceability of rights of a clearinghouse to transfer positions (and related margin). Accordingly, there are uncertainties as to the enforceability of a general right of a clearinghouse to transfer positions on default. To enhance enforceability within the existing insolvency law framework, ICE Trust has established rules that provide ICE Trust a security interest in the rights of the insolvent 20 These risks exist with any custodian in the event of its insolvency, whether the CM itself, an affiliate or a third party. 21 This would apply to a CM that is an insured U.S. bank, a NY-state chartered branch of a foreign bank, a federally chartered branch of a foreign bank or an unregulated entity eligible to be a debtor under the Bankruptcy Code. Under the Rules and the Standard Annex, Clients may not be permitted to exercise termination rights until the end of the specified transfer period for Default Portability Rules. This limitation should not be inconsistent with the various protections for termination rights under applicable insolvency law. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 37 All rights reserved

124 DISCLAIMER June 23, 2009 CM against the relevant customers. In the event of a CM default, ICE Trust s ability to enforce such security and transfer or sell the defaulting CM s rights against the customer to a new member, should generally be respected. Alternatively, ICE Trust rules permit the termination of the relevant contracts and reestablishment of new contracts with a new CM, which generally should also be respected under existing law. As noted below, various regulatory or legislative actions could further enhance the enforceability of portability rules in the U.S. As noted above, ICE Trust s default and portability rules would be subject to any rights of the CM s receiver or other insolvency trustee or similar party under applicable law to transfer positions. With respect to CMs that are insured U.S. banks, the FDIC would generally have the power within the one-business-day period following its appointment as receiver to transfer derivative contracts of the CM to a new financial institution, which may be an existing institution or a bridge bank. (During that one-business-day period, ICE Trust would not be permitted to exercise remedies against the insolvent CM.) In making any such transfer, the FDIC is required to transfer all derivative transactions of the defaulting CM (whether cleared or uncleared) with a particular counterparty or its affiliate, or transfer none of such transactions. This requirement could in some circumstances hinder the FDIC s ability to transfer positions. Similar limitations on exercise of remedies may apply to CMs that are federally chartered branches of foreign banks, but generally would not apply to CMs that are NY-state chartered branches of foreign banks or unregulated U.S. entities. Under English law, in summary, two separate pieces of legislation provide ICE Trust with a series of protections against the effects of insolvency of a CM: (a) Part VII of the Companies Act 1989, which provides protections for 'market contracts' to which a recognised overseas clearing house (ROCH) is party, certain collateral taken by a clearing house and the default rules and default procedures of a ROCH (ICE Trust intends is seeking to become a ROCH but does not yet have this status); and (b) Financial Collateral Directive (2002/47/EC) as implemented in the UK by the Financial Collateral Arrangements (No. 2) Regulations 2003 (S.I. 2003/3226), which provides protections to persons who take certain kinds of financial collateral. These protections are available regardless of ROCH status and allow for ICE Trust to enforce close-out netting provisions and realize collateral. This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 38 All rights reserved

125 June 23, 2009 In the event of a Clearing Member's default, ICE Trust s ability to use collateral and transfer or sell the defaulting CM s contracts and Client-Member Transactions should be protected by such legislation. For the purposes of German law, ICE Trust is likely to be considered a settlement system for the purposes of the EU Settlement Finality Directive, although there is some uncertainty in this analysis because settlement systems are normally required to be notified to the European Commission by the EU member state whose laws are applicable to it and ICE Trust is subject to the laws of a non-eu member state. In such case, in the event of a German CM s default, ICE Trust will be entitled to rely on the protective effects of sec. 340 para. 3 InsO of the German Insolvency Code in recognizing that ICE Trust, as a settlement system, and its Rules (including those concerning, inter alia, netting, irrevocability of transactions, margin and collateral) will be binding on the German insolvency administrator of the insolvent German CM in order to prevent the invalidation of the operations of ICE Trust as a non-eu settlement system. Based on the above, the Rules should also be generally enforceable against a German CM irrespective of the issuance of any moratorium by the BaFin or the commencement of insolvency proceedings in Germany. The enforceability of the contemplated transfer of customer IM under the Rules is also dependent on the customer IM being held in a segregated trust account as described in Section IV.A. above. ICE Trust rules would not contemplate portability of positions of a customer that itself is insolvent. E. Legal Enforceability of Novation/Netting Framework In the U.S., in summary, FDICIA generally upholds the right of a clearing organization to terminate and net transactions under its rules in the event of a member insolvency and to apply related security. In the case of members that are insured U.S. banks, the FDIA generally also upholds such rights in the event of a receivership, provided that such rights cannot be exercised during the one-business-day period following the appointment of the receiver and are subject to the rights of the receiver to repudiate or transfer such positions during that time. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 39 All rights reserved

126 DISCLAIMER June 23, 2009 In the case of a customer insolvency, the CM s rights to enforce its contractual rights to terminate and net transactions and apply related security would also generally be protected under the U.S. Bankruptcy Code, to the extent applicable. The netting framework under English law is supported by the Companies Act 1989 and Financial Collateral Regulations, as noted above. Under German law, the applicable conflict-of-laws provisions of the German Insolvency Code for netting arrangements such as the ISDA Master Agreement generally uphold the application of the governing law of the arrangement. Therefore, the enforceability of the termination of open positions, the determination of the close-out amounts and the netting thereof in accordance with the Rules would not be subject to substantive German insolvency law or any avoidance action by an insolvency administrator under the German Insolvency Code. Such laws also generally protect contracts from challenge based on claims of preferential or fraudulent transfer in the period prior to an insolvency filing, absent actual intent to delay or hinder creditors. F. Legislative or Regulatory Reforms; Other Considerations There are several U.S. regulatory or legislative reforms that might enhance the legal certainty of the framework described above. In particular, 1. Regulatory Changes: For CMs that are regulated entities, the appropriate regulator (such as the FDIC for insured U.S. bank CMs) could provide confirmation that it would respect the segregation of, and cooperate with the return of, IM and would not seek to interfere with, and would cooperate with, attempts by the clearinghouse to implement portability rules. More generally, such regulators could provide guidance as to the manner in which they would expect to treat cleared transactions in the event of the insolvency of a regulated entity Regulators could also provide clarity as to the capital treatment of cleared transactions As noted above, ICE Trust is seeking ROCH status in the UK. This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 40 All rights reserved

127 June 23, Legislative Changes: Relevant statutes (including FDICIA) could be amended to cover explicitly the enforceability of clearinghouse rights to transfer positions (including customer positions) and related margin, in addition to being able to terminate and net such transactions and apply security Relevant statutes could be amended to provide the FRB or other appropriate regulator authority to create a regulatory framework for the segregation of customer property in connection with cleared CDS, analogous to the Section 4d/part 190 framework under the CEA The FDIA could be amended to allow the FDIC to transfer cleared positions separately from non-cleared positions. Attached in Part VI are sample provisions that would implement these legislative changes.. DISCLAIMER This document is solely for information purposes and has been provided in response to questions posed by the ad hoc group of buy-side and sell-side participants (the Group ) in connection with the Group s report. It is intended for the benefit of the members of the trade associations represented by the Group, regulators and others who are interested in the clearing and settlement process for credit default swaps. It is a summary presentation of the services proposed to be provided by ICE Trust U.S. LLC for the clearing of credit default swaps and is not a binding commercial offer or definitive statement of terms or specifications for the clearing of credit default swaps. Such services are subject to change. This document must not be reproduced in whole or in part or used for other purposes except with the consent in writing of ICE Trust U.S. LLC and then only on the condition that this notice is included in any such reproduction. Copyright ICE Trust U.S. LLC. Page 41 All rights reserved

128 June 23, 2009 V. Appendix - Questionnaire Please see the references in the questionnaire below for links to specific answers in the response. Questionnaire for CDS CCPs on Protection of Customer Initial Margin This questionnaire has been prepared by an ad hoc group (comprising both buy-side and sell-side constituents) 1 to more fully understand the rights of customers i.e., buy-side and other market participants proposing to clear CDS transactions through clearing members ( CM ) of a central CDS counterparty ( CCP ) to initial margin ( IM ) posted in connection with the central clearing of certain CDS transactions. The questions are divided into two sections. The first part solicits responses to several factual matters regarding the clearing structure of the CCP, the precise means by which IM is held by the CCP and CMs (and their custodians, if applicable), and the CCP s proposals as to segregation and portability of customer positions and initial and variation margin (and any associated contractual relationships). 2 The second part solicits responses as to the legal treatment of the CCP s proposed clearing structure. As the latter inquiry is largely dependent on the legal and contractual framework governing the CCP, the CMs and the customers (and the relationships between them), the questions in the second part should be considered under the laws of all jurisdictions relevant to the CCP (and its custodian, if applicable), the CMs (and their custodians, if applicable) and the customers. We note that although similar or identical questions are posed throughout certain portions of the questionnaire, this repetition arises from the need to consider the questions for each level at which IM is held: (i) IM held at the CCP (or the CCP s custodian) referred to in this questionnaire as CCP Margin, and (ii) IM held at a CM (or the CM s custodian) referred to in this questionnaire as Dealer Margin. I. Factual Matters A. Composition and Structure of the CCP, CMs, Custodians and Customers Structure of the CCP 1 This group was formed at the behest of the Federal Reserve Bank of New York, and consists of buy-side members Alliance Bernstein, Barclays Global Investors, Blue Mountain, Brevan Howard, D.E. Shaw, Goldman Sachs Asset Management, King Street and PIMCO, and sell-side members Barclays Capital, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley and UBS. ISDA, the Asset Managers Group of SIFMA, and Managed Funds Association are facilitating and observing the group s activities. 2 If the CCP is envisioning a multi-step approach to implementation, please detail both the interim and final phases, and an approximate time frame for achievement of the latter. If customers or CMs may elect one of multiple options with respect to any aspect of the clearing structure, please describe all such options. Copyright ICE Trust U.S. LLC. Page 42 All rights reserved

129 June 23, Please describe the legal structure (e.g., entity type, jurisdiction, governing structure, etc.) of the CCP. Include references to any required licenses or registration orders obtained in connection with the establishment of the CCP. See Section II, A. 2. Please list all relevant regulatory and supervisory authorities of the CCP. 3. Please detail any legal or regulatory segregation requirements applicable to customer IM held at the CCP. Structure of CMs 4. Please describe the legal structures applicable to the CMs. See Section II, B. a. Does the CCP restrict either the (i) organizational type (e.g., banks, broker-dealers, futures commission merchants, unregulated entities, etc.) or (ii) jurisdictions of organization of CMs? (Note: This will be key, as much of the legal analysis will depend on the insolvency laws applicable to the CMs.) 5. Please list all relevant regulatory and supervisory authorities applicable to the CMs. 6. Please detail any legal or regulatory segregation requirements applicable to customer IM held at the CM. Structure of Custodians (If Applicable) 7. Please describe the legal structures applicable to the custodians used by the CCP and CMs to hold IM. See Section II, C. a. Does the CCP restrict either the (i) organizational type or (ii) jurisdictions of organization of entities that may serve as custodians of the CCP or CMs to hold IM? Are there any restrictions on whether such custodians may be affiliated with the CCP or CMs? (Note: This will be key, as much of the legal analysis will depend on the insolvency laws applicable to the respective custodians, to the extent IM is held by custodians.) 8. Please list all relevant regulatory and supervisory authorities applicable to the custodians. Copyright ICE Trust U.S. LLC. Page 43 All rights reserved

130 9. Please detail any legal or regulatory segregation requirements applicable to customer IM held at the custodians. Structure of the Customers 10. Please describe the legal structures applicable to the customers. See Section II, D. June 23, 2009 a. Does the CCP restrict either the (i) organizational type or (ii) jurisdictions of organization of customers? (Note: This may be important, as some of the legal analysis may depend on the insolvency laws applicable to the customers.) 11. Please list all relevant regulatory and supervisory authorities applicable to the customers. Expansion/Restriction of Permitted Entity Types 12. In weighing the relative benefits and drawbacks of expanding or restricting the entity types and jurisdictions of the CMs, customers and custodians, what factors did the CCP consider in its analysis? For example, to what extent did the CCP consider the following issues in reaching its proposed structure? See Section II, E. a. Netting implications for CMs and their affiliates (from a credit, accounting and capital perspective); b. Regulatory capital implications for CMs and their affiliates; c. Operational efficiencies or inefficiencies, and other business implications of operating through the permitted entity types; d. Adverse pass-through effects (e.g., unfavorable pricing) flowing from the CMs to customers as a result of the foregoing; and e. The legal regime applicable to the proposed clearing framework upon an insolvency of a CM, customer or custodian. 13. What is the process for approval and consideration of risks presented by additional CM or custodian entity types (by way of inclusion of new CMs or custodians or mergers of existing CMs or custodians in a manner that changes the applicable legal structure)? B. Segregation and Safekeeping of IM Copyright ICE Trust U.S. LLC. Page 44 All rights reserved

131 June 23, 2009 IM Held at or for the CCP ( CCP Margin ) 3 Composition of CCP Margin 1. Please describe the types of assets (e.g., Treasury securities, US dollars, non-us currencies, etc.) that may be deposited as CCP Margin to satisfy IM requirements imposed by the CCP ( Required Margin ). To what extent did customer protection considerations affect the CCP s determination in this regard? See Section III, A, 1. Nature of Relationship Between CCP, CMs, Custodians and Customers 2. Please describe the nature of the legal and contractual relationship between the CCP, the CMs, custodians, the customers and any other relevant parties, specifically addressing the following: See Section III, A, 2. a. Are CMs acting as agents or principals (or operating with aspects of both) vis-à-vis (i) the CCP and (ii) customers? Please elaborate. b. If customers are permitted to clear transactions through non-cm affiliates of the CM, who in turn clear through the affiliated CM, please describe in detail the mechanics of such an arrangement. Description of Proposed Clearing Structure 4 3. Please detail the manner in which customers will post CCP Margin. See Section III, B. a. Will the CCP Margin be posted pursuant to pledge or title transfer arrangements? b. May the CCP Margin consist of property posted by customers and pledged or transferred to the CCP, or must it consist of the proprietary assets of the CM? 3 Please also answer the questions below with respect to excess variation margin (i.e., mark-to-market margin posted by customers in excess of the CCP s requirements), to the extent excess variation margin is treated differently from CCP Excess Margin. 4 Please address the relevant questions with respect to each proposed clearing structure. For instance, if the CCP has one clearing structure for transactions entered into directly between a customer and its CM / prime broker, and another for transactions originally entered into between a customer and an executing broker that are subsequently given up to the customer s CM / prime broker, please respond to the questions with respect to each proposed clearing structure. Copyright ICE Trust U.S. LLC. Page 45 All rights reserved

132 June 23, Please detail the manner in which CCP Margin will be held (noting any circumstances in which the default clearing structure may be modified by elections available to CMs or customers), distinguishing between various categories of margin to the extent appropriate e.g., (i) Required Margin, (ii) margin in excess of that required by the CCP to secure performance obligations in connection with cleared transactions ( CCP Excess Margin ), (iii) margin posted in respect of requirements imposed by CMs on their customers in excess of the CCP s margin requirements ( Dealer Excess Margin ), etc. and specifically addressing the following: a. CCP Margin Held Directly at a CCP (or at a Custodian Holding Solely for the Benefit of the CCP) If the CCP will hold CCP Margin directly (without a custodian), or the custodian will hold CCP Margin only for the CCP (rather than for individual CMs or customers (individually or as a group)), please detail all aspects of the arrangement that are relevant from a customer protection standpoint, specifically addressing the following: i. The manner in which the CCP holds the CCP Margin, distinguishing to the extent relevant between various categories and types of CCP Margin (e.g., securities or cash), and identifying in particular: 1. On behalf of whom the CCP is holding the property itself, the CMs or the customers (as a group or individually); 2. Whether CCP Margin securing the positions of a particular CDS customer will be segregated from (i) the CCP Margin posted by other CDS customers and (ii) the property of other custodial claimants of the CCP or instead, commingled in a single omnibus account (either for CDS customers or custodial claimants of the CCP generally); a. In whose name(s) has/have the account(s) been established? 3. Whether CCP Margin securing customer positions will be segregated from the CCP Margin securing proprietary positions of CMs; 4. Any operational practices (whether voluntary or mandated by regulators) relevant to the analysis of customer protection and the sharing of any shortfalls in custodial property; 5 5 See clause (ii) of note 6. Copyright ICE Trust U.S. LLC. Page 46 All rights reserved

133 June 23, Under what circumstances CCP Excess Margin held at the CCP may be (i) withdrawn by the CM or customers or (ii) applied by CMs or the CCP. ii. Whether the CCP has the right to rehypothecate or cause liens to be placed on the CCP Margin e.g., to potential lenders or liquidity providers to the CCP and if so, whether any such liens have been subordinated or waived; and iii. Whether investment of CCP Margin in interest-bearing instruments or vehicles (e.g., overnight sweeps into repos) is permitted or required, and if so, in what types of instruments or vehicles. 1. Who obtains the economic benefit of investment of CCP Margin in permitted instruments? Who bears the risk of loss? 2. How does the above response differ as between Required Margin and CCP Excess Margin posted to the CCP? b. CCP Margin Held at a Custodian (Whether the Custodian is Holding for the CCP, Individual CMs or Customers) If the CCP will hold CCP Margin at a custodian, please detail all aspects of the custodial arrangement that are relevant from a customer protection standpoint, specifically addressing the following: i. The manner in which the custodian holds the CCP Margin, distinguishing to the extent applicable between various types of CCP Margin (e.g., securities or cash), and identifying in particular: 1. On whose behalf the custodian is holding the property the CCP, the CMs or the customers (as a group or individually); 2. Whether CCP Margin securing the positions of a particular CDS customer will be segregated from (i) the CCP Margin posted by other CDS customers and (ii) the property of other custodial claimants of the custodian, or instead, commingled in a single omnibus account (either for CDS customers or custodial claimants of the custodian generally); a. In whose name(s) has/have the account(s) been established? Copyright ICE Trust U.S. LLC. Page 47 All rights reserved

134 June 23, Whether CCP Margin securing customer positions will be segregated from the CCP Margin securing proprietary positions of CMs; 4. Any operational practices (whether voluntary or mandated by regulators) relevant to the analysis of customer protection and the sharing of any shortfalls in custodial property; 6 and 5. Under what circumstances CCP Excess Margin held at the custodian may be (i) withdrawn by the CM or customers or (ii) applied by CMs or the CCP. ii. Whether the custodian has the right to rehypothecate or cause liens to be placed on the CCP Margin, and if so, whether any such liens have been subordinated or waived; iii. Whether investment of CCP Margin in interest-bearing instruments or vehicles (e.g., overnight sweeps into repos) is permitted or required, and if so, in what types of instruments or vehicles; and 1. Who obtains the economic benefit of investment of CCP Margin in permitted instruments? Who bears the risk of loss? 2. How does the above response differ as between Required Margin and CCP Excess Margin posted to the CCP? iv. How the risk of the custodian s insolvency is allocated among the CCP, the CMs and the customers (as a group and individually). Transfer of CCP Margin from CMs to the CCP 5. If CCP Margin will be deposited by customers at their respective CMs, and subsequently transferred to the CCP, please address the following (distinguishing between various categories of CCP Margin (e.g., Required Margin, CCP Excess Margin, Dealer Excess Margin, etc.) and types of CCP Margin (e.g., securities or cash) to the extent relevant): a. How long will it typically take for a CM to transfer CCP Margin posted by customers to the CCP? 6 For example, please consider, to the extent relevant, (i) whether the intermediary is a UCC securities intermediary that credits securities to a securities account in the name of a particular customer or customers generally, and whether the securities intermediary debits securities from the securities accounts of its customers upon any rehypothecation of such securities, and (ii) whether any cash held by the intermediary is maintained as a segregated special deposit that remains property of a particular customer or customers generally under applicable law (as distinguished from a general deposit in which legal title to the cash passes to the intermediary). Copyright ICE Trust U.S. LLC. Page 48 All rights reserved

135 June 23, 2009 b. In the intervening period, where at a CM will the CCP Margin be held? c. At what point is the CM deemed to be in default for failing to transfer CCP Margin to the CCP? d. What considerations militate in favor of, or against, allowing customers to deposit CCP Margin directly with the CCP? Economic Effects of Proposed Clearing Structure for CCP Margin See Section III, D. 6. Please describe the economic benefits or disadvantages (from the perspective of CMs and their customers) of the proposed clearing structure for holding IM at the CCP or its custodian (as opposed to at CMs or their custodians). a. Do CMs have the ability to generate returns on customer property under the proposed structure? b. To what extent do the benefits or disadvantages of the proposed structure flow through from CMs to their customers? Determination of Required Margin and Related Considerations See Section III, E. 7. Is Required Margin determined on the basis of net exposures (i.e., by netting offsetting positions across different customers) or gross exposures? Are offsetting positions within a particular customer-cm relationship netted for this purpose? 8. Please describe whether margin requirements will be reported and published, and whether calculations are replicable by the CCP upon demand from a CM or customer. 9. Are there any restrictions on the ability of the CCP to demand additional margin from a CM or customer? 10. Are there any restrictions on the ability of a CM to demand additional margin from its customer? 11. Is the required amount of CM guarantee fund contributions relating to customer positions at the CCP determined on the basis of net or gross clearing exposures? Are offsetting positions of a single customer netted for this purpose? Copyright ICE Trust U.S. LLC. Page 49 All rights reserved

136 June 23, Please discuss the approximate timeline for trade execution, submission to the CCP and novation, and how the CCP s structure in this regard (together with any other operational efficiencies) affects the customer protection analysis. Allocation of Risk upon CM Default 13. In the event of a CM default to the CCP, please detail the risk waterfall among guarantee fund contributions, Required Margin securing CM proprietary positions, Required Margin securing customer positions, and any other applicable source of funds (e.g., CCP Excess Margin, to the extent accessible by the clearinghouse), drawing distinctions between defaulting and non-defaulting parties where relevant. See Section III, B, 8. a. How does the applicable risk waterfall vary (if at all) depending upon whether the default arises from an insolvency event, as opposed to a noninsolvency event? b. How does the applicable risk waterfall vary (if at all) depending upon the nature of the IM being applied i.e., is IM securing customer positions applied in a different manner from IM securing proprietary CM positions? c. In the event of a CM default arising from a failure to post sufficient margin, how does the applicable risk waterfall vary (if at all) depending upon whether the failure to post sufficient margin arose in respect of customer positions, rather than proprietary positions? i. Please explain (to the extent applicable) how the CCP s methodology for isolating the origins of the CM default permits the CCP to identify, in a sufficiently precise manner, which risk waterfall applies in any particular instance (especially in circumstances under which the CM default may have arisen from multiple complex and interlocking factors). 14. If a CM has defaulted on an obligation to its customer in respect of a cleared transaction (or a transaction related to a cleared transaction), but is not otherwise in default to the CCP, what are the customer s remedies against the CCP? IM Held at or for the CM ( Dealer Margin ) Permitted Asset Types for Customer Margin 15. Do the types of assets that may be deposited as margin with the CM differ from the types of assets that qualify as Required Margin? Copyright ICE Trust U.S. LLC. Page 50 All rights reserved

137 June 23, 2009 Description of Proposed Clearing Structure for Dealer Margin 7 See Section III, B, 4, Section III, B, 5 and Section III, B, Please detail the manner in which customers will post Dealer Margin. a. Will Dealer Margin be posted pursuant to pledge or title transfer arrangements? 17. Please detail the manner in which Dealer Margin will be held (noting any circumstances in which the default clearing structure may be modified by elections available to customers), specifically addressing the following and distinguishing between different types of margin (e.g., cash versus securities) and categories of margin (e.g., Required Margin, CCP Excess Margin, Dealer Excess Margin and any other applicable categories of margin) where appropriate: a. Dealer Margin Held Directly at a CM (or at a Custodian Holding Solely for the Benefit of the CM) If the CM will hold Dealer Margin directly (without a custodian), or the custodian will hold Dealer Margin only for the CM (rather than for customers (individually or as a group)), please detail all aspects of the arrangement that are relevant from a customer protection standpoint, specifically addressing the following: i. The manner in which the CM holds the Dealer Margin, distinguishing to the extent applicable between various types of Dealer Margin (e.g., securities or cash), and identifying in particular: 1. Whether Dealer Margin securing the positions of a particular CDS customer will be segregated from (i) the Dealer Margin posted by other CDS customers and (ii) the property of other custodial claimants of the CM, or instead, commingled in a single omnibus account (either for CDS customers or custodial claimants of the CM generally); a. In whose name(s) has/have the account(s) been established? 2. Whether Dealer Margin securing customer positions will be segregated from the margin securing proprietary positions of CMs; 3. Any operational practices (whether voluntary or mandated by regulators) relevant to the analysis of customer 7 See note 4. Copyright ICE Trust U.S. LLC. Page 51 All rights reserved

138 June 23, 2009 protection and the sharing of any shortfalls in custodial property; 8 and 4. Under what circumstances Dealer Margin may be (i) withdrawn by customers or (ii) applied by CMs or the CCP. ii. Whether the CM has the right to rehypothecate or cause liens to be placed on Dealer Margin, and if so, whether any such liens have been subordinated or waived; and v. Whether investment of Dealer Margin in interest-bearing instruments or vehicles (e.g., overnight sweeps into repos) is permitted or required, and if so, in what types of instruments or vehicles. 1. Who obtains the economic benefit of investment of Dealer Margin in permitted instruments? Who bears the risk of loss? b. Dealer Margin Held at a Custodian (Whether the Custodian is Holding for the CM or the Customers) If the CM will hold Dealer Margin at a custodian, please detail all aspects of the custodial arrangement that are relevant from a customer protection standpoint, specifically addressing the following: i. The manner in which the custodian holds the Dealer Margin, distinguishing to the extent applicable between various types of Dealer Margin (e.g., securities or cash), and identifying in particular: 1. On whose behalf the custodian is holding the property the CM or the customers; 2. Whether Dealer Margin securing the positions of a particular CDS customer will be segregated from (i) the Dealer Margin posted by other CDS customers and (ii) the property of other custodial claimants of the custodian or instead, commingled in a single omnibus account (either for CDS customers or custodial claimants of the custodian generally); a. In whose name(s) has/have the account(s) been established? 8 See note 6. Copyright ICE Trust U.S. LLC. Page 52 All rights reserved

139 June 23, Whether Dealer Margin securing customer positions will be segregated from Dealer Margin securing the proprietary positions of CMs; and 4. Any operational practices (whether voluntary or mandated by regulators) relevant to the analysis of customer protection and the sharing of any shortfalls in custodial property. 9 ii. Whether the custodian has the right to rehypothecate or cause liens to be placed on the Dealer Margin that is not posted to the CCP, and if so, whether any such liens have been subordinated or waived; vi. Whether investment of Dealer Margin that is not posted to the CCP in interest-bearing instruments or vehicles (e.g., overnight sweeps into repos) is permitted or required, and if so, in what types of instruments or vehicles; 1. Who obtains the economic benefit of investment of Dealer Margin in permitted instruments? Who bears the risk of loss? vii. Under what circumstances Dealer Margin may be (i) withdrawn by customers or (ii) applied by CMs or the CCP; and viii. How the risk of the custodian s insolvency is allocated among the CMs and the customers (as a group and individually). C. Portability 1. Please consider whether a customer s positions and initial and variation margin (and any associated contractual relationships) can be ported to another CM, under each of the following scenarios. See Section III, B, 9. a. Can a customer effect a voluntary, pre-cm default transfer of its positions and margin (and any associated contractual relationships)? From which entities must the customer obtain consent before effecting such a transfer? b. Does the CCP have the authority to mandate that a CM transfer any or all of its customer positions and initial and variation margin (and any associated contractual relationships) to another clearing member, if such CM is not in default (as defined in the CCP s rules)? 9 See note 6. Copyright ICE Trust U.S. LLC. Page 53 All rights reserved

140 June 23, 2009 i. Does the answer change if the CM, although not in default, is perceived by the CCP to be in a state of impending financial distress? ii. To what extent is a default under the CCP s rules the product of the CCP s subjective determination, rather than being determined by reference to objectively verifiable events? c. How does the CCP intend to transfer customer positions and initial and variation margin (and any associated contractual relationships) from a defaulting CM to a non-defaulting CM? Please elaborate on the following details (distinguishing between Required Margin, CCP Excess Margin, Dealer Excess Margin and any other categories of margin where relevant): i. The expected timeline from CM default to re-establishment of customer positions and initial and variation margin (and any associated contractual relationships) at a non-defaulting CM; ii. The mechanism for transferring customer positions and initial and variation margin (and any associated contractual relationships) to a non-defaulting CM, including a description of: 1. How customer positions and initial and variation margin (and any associated contractual relationships) are allocated and how transferee CMs are selected (including whether a non-defaulting CM and its customers can be forced by the CCP to accept a transfer of positions through auction, assignment or other allocation procedures); 2. Whether customer positions and initial and variation margin (and any associated contractual relationships) in respect of cleared transactions can be effectively transferred separately from non-cleared transactions between the defaulting CM and its customers; 3. Whether the treatment of CCP Margin differs from the treatment of Dealer Margin, from a portability perspective; and 4. Any pledge or other arrangements designed to facilitate transfer of customer positions and initial and variation margin (and any associated contractual relationships). iii. Any procedures designed to control the effect of market movements on the value of customer positions during the pendency of the transfer e.g., institution of hedge positions subsequent to the CM default, or assigned allocation of customer Copyright ICE Trust U.S. LLC. Page 54 All rights reserved

141 D. Documentation Required Documentation June 23, 2009 margin deficits to non-defaulting CMs and the allocation of losses if the customer positions cannot be assigned to a nondefaulting CM. 1. Who determines the close-out price applicable to terminated positions? If the CCP, does the CCP s close-out price flow through to the customer? How is the close-out price determined? Does the same close-out price apply to CM-customer positions and offsetting CM-CCP proprietary positions? 2. How does the CCP account for any unpaid variation margin obligations that may have accrued subsequent to the default of the CM? iv. Any limitations on the rights of customers to (a) terminate noncleared transactions with CMs upon a CM default, or (b) set off their obligations under non-cleared transactions against obligations to CMs under cleared transactions; v. Whether affiliate and third-party liens or cross-margining and netting arrangements in respect of non-cleared transactions affect the portability analysis; vi. Whether the defaulting CM s contractual agreements with the customer are binding upon the transferee CM and such customer upon any transfer of the customer s positions and initial and variation margin, or whether the transferee CM and such customer can (or must) execute a new set of documentation; vii. In connection with a transfer of customer positions and initial and variation margin (and any associated contractual relationships) to a non-defaulting CM, any rights of customers to elect not to transfer the associated margin, and instead, to apply such margin as a setoff against other amounts that may be payable to the defaulting CM (while separately posting new IM to the transferee CM); and viii. The effects on the portability analysis of (a) IM at the CCP for customer positions being posted on a gross or net basis (as applicable), (b) the existence of Dealer Margin held at the defaulting CM, and (c) non-cleared trades between the defaulting CM and its customers being in-the-money or out-of-themoney (as applicable) to the CM. Copyright ICE Trust U.S. LLC. Page 55 All rights reserved

142 June 23, What trading documentation will CMs (and their custodians, if applicable) and customers need to execute with the CCP (and its custodian, if applicable) in order to have customer transactions cleared? See Section III, B, 6. a. Please discuss the extent to which the CCP knows the customers under the required documentation, and how this affects the customer protection analysis. 2. What trading documentation will customers need to execute with CMs (and their custodians, if applicable) in order to have their transactions cleared? 3. Please describe any legal, operational or other issues arising from the adoption by CMs and customers of a pledge arrangement (from an existing title transfer structure), or of a title transfer arrangement (from an existing pledge structure), for the provision of collateral security. Key Terms of Standardized Documentation 4. Please describe the material terms of any documentation standardized by the CCP, including (but not limited to) terms relating to: a. Circumstances under which posted margin may be returned to customers, and all related conditions and requirements; b. Specification of events of default and termination events with respect to the CM (noting any distinctions drawn between insolvency and noninsolvency events) or customer; c. Standstill upon the occurrence of a CM default; d. Advance elections to liquidate or transfer cleared contracts; e. Advance consents (particularly those obtained to enhance portability of cleared contracts); f. Limitations on rehypothecation; g. Limitations on setoff against non-cleared bilateral transactions between customers and their CMs; and h. Close-out calculations. Modification of Proposed Clearing Structure Copyright ICE Trust U.S. LLC. Page 56 All rights reserved

143 June 23, Please state the circumstances in which the CCP has the ability to amend by rule or order any aspect of its proposed clearing structure. II. Legal Considerations As stated in the introductory note to this questionnaire, the following questions should be considered under the laws of all jurisdictions relevant to the CCP (and its custodian, if applicable), the CMs (and their custodians, if applicable) and the customers. In the responses below, please highlight any areas of legal uncertainty. For matters requiring reasoned legal judgment, please state the level of legal comfort associated with the relevant response. See Section IV. Customer Rights to CCP Margin 1. Please detail the ability of customers to recover IM held at the CCP (or the CCP s custodian) upon the insolvency of the CCP (or the CCP s custodian) distinguishing between Required Margin, CCP Excess Margin, Dealer Excess Margin and any other categories of margin where relevant in the event their positions are liquidated rather than transferred. Consider all relevant facts, including: (i) the manner in which the IM is held at the CCP or its custodian; (ii) the nature of the customer obligations secured by liens on the IM; (iii) the composition of the IM (e.g., whether the IM consists of securities or cash); (iv) in the event of the insolvency of the CCP s custodian, any restrictions (legal or otherwise) on the ability of the CCP to recover IM from the insolvent custodian; and (v) any other matters described in your responses to the questions above that are relevant to this analysis. Analyze how these facts ultimately affect the conclusions reached. a. What is the legal nature of the customers rights in the IM held at the CCP (or the CCP s custodian)? i. To the extent relevant to this analysis, please consider whether customers hold proprietary (i.e., ownership) rights in the IM held at the CCP (or the CCP s custodian), or merely contractual rights to recovery of the IM vis-à-vis the defaulted CCP (or the CCP s custodian). 1. How does the selection of pledge versus title transfer for the provision of collateral security affect this determination? 2. What are the relevant legal standards with respect to tracing or other requirements necessary to demonstrate proprietary rights in the IM? Copyright ICE Trust U.S. LLC. Page 57 All rights reserved

144 June 23, What is the practical effect of maintaining proprietary versus contractual rights? ii. If the distinction between proprietary versus contractual rights to the IM held at the CCP (or the CCP s custodian) is irrelevant as a legal matter, please describe the legal framework that is relevant to the analysis. b. How is a shortfall in CCP Margin and other custodial property (i.e., property held in a custodial capacity for purposes unrelated to the clearing of CDS) held by the CCP (or its custodian) allocated as between the CCP (or the CCP s custodian), the CMs, the customers (as a group and individually) and other custodial claimants? Distinguish where relevant between Required Margin, CCP Excess Margin, Dealer Excess Margin and any other categories of margin. Customer Rights to Dealer Margin i. With what other types of custodial claimants may the customers potentially be required to share with in the event of a shortfall in custodial property? 1. Are there any applicable regulatory regimes that limit the claims of those who may share in CCP Margin? ii. Is it possible to contractually vary the sharing regime that would otherwise apply in any particular instance (e.g., by holding CCP Margin at a third party custodian)? 2. Please detail the ability of customers to recover IM held at the CM (or the CM s custodian) upon the insolvency of the CM (or the CM s custodian) distinguishing between Required Margin, CCP Excess Margin, Dealer Excess Margin and any other categories of margin where relevant in the event their positions are liquidated rather than transferred. Consider all relevant facts, including: (i) the manner in which the IM is held at the CM or its custodian; (ii) the nature of the customer obligations secured by liens on the IM; (iii) the composition of the IM (e.g., whether IM consists of securities or cash); (iv) in the event of the insolvency of the CM s custodian, any restrictions (legal or otherwise) on the ability of the CM to recover IM from the insolvent custodian; and (v) any other matters described in your responses to the questions above that are relevant to this analysis. Analyze how these facts ultimately affect the conclusions reached. a. What is the legal nature of the customers rights in the IM held at the CM (or the CM s custodian)? Copyright ICE Trust U.S. LLC. Page 58 All rights reserved

145 June 23, 2009 iii. To the extent relevant to this analysis, please consider whether customers hold proprietary (i.e., ownership) rights in the IM held at the CM (or the CM s custodian), or merely contractual rights to recovery of the IM vis-à-vis the CM (or the CM s custodian). 1. How does the selection of pledge versus title transfer for the provision of collateral security affect this determination? 2. What are the relevant legal standards with respect to tracing or other requirements necessary to demonstrate proprietary rights in the IM? 3. What is the practical effect of maintaining proprietary versus contractual rights? iv. If the distinction between proprietary versus contractual rights to the IM held at the CM (or the CM s custodian) is irrelevant as a legal matter, please discuss the legal framework that is relevant to the analysis. b. How is a shortfall in Dealer Margin and other custodial property (i.e., property held in a custodial capacity for purposes unrelated to cleared CDS) held by the CM (or its custodian) allocated as between the CMs, the customers (as a group and individually) and other custodial claimants? Distinguish where applicable between Required Margin, CCP Excess Margin, Dealer Excess Margin and any other categories of margin where relevant. i. Are there any applicable regulatory regimes that limit the claims of those who may share in Dealer Margin? ii. Is it possible to contractually vary the sharing regime that would otherwise apply in any particular instance (e.g., by holding Dealer Margin at a third party custodian)? Legal Enforceability of Portability Framework 3. Please discuss the legal enforceability of the CCP s portability framework in the event of either or both (i) a CM insolvency (or the insolvency of the CM s custodian) and/or (ii) a customer insolvency. In particular, consider how the enforceability of the portability framework is affected by the following: a. Whether, if either the CCP or insolvency trustee/receiver of the CM transfers any cleared positions and margin (and any associated contractual relationships) of the defaulted CM with the CCP, it must also transfer the defaulting CM s (i) other cleared positions and margin (and any associated Copyright ICE Trust U.S. LLC. Page 59 All rights reserved

146 June 23, 2009 contractual relationships) with the CCP, and (ii) non-cleared positions (and associated margin and contractual relationships) with customers of the defaulting CM; b. The effect of any standstill provisions upon default, and the interplay of such provisions with any statutorily protected termination rights; c. Any affiliate and third-party liens or cross-margining and netting arrangements; d. Any setoff rights or limitations between cleared and non-cleared trades; e. Any mandatory setoff requirements for CMs or customers under applicable law; f. Any pledge arrangements or other provisions for collateral security between CMs and customers related to cleared transactions; and g. Whether the CM is acting as principal (rather than as agent) vis-à-vis the CCP in respect of customer transactions. Legal Enforceability of Novation/Netting Framework 4. Please discuss the legal enforceability of the CCP s novation and netting framework in the event of either or both (i) a CM insolvency (or the insolvency of the CM s custodian) or (ii) a customer insolvency, giving due regard to the CCP s ability (and, in the event of a customer insolvency, a CM s ability) to exercise its legal and contractual remedies on (a) IM held at the CCP (or the CCP s custodian) and (b) IM held at the CM (or the CM s custodian). a. How would challenges to the validity or enforceability to an underlying bilateral transaction (prior to novation) e.g., if a transaction was entered into in bad faith, fraudulently, or in contemplation of insolvency affect the enforceability of the novated transaction, in the event of either or both (i) a CM insolvency or (ii) a customer insolvency? Considerations Relating to Netting vis-à-vis the CCP 5. Please evaluate, from an accounting and regulatory capital perspective, the ability of CMs to net (i) proprietary positions against other proprietary positions and (ii) customer positions against proprietary positions, in each case vis-à-vis the CCP, upon a CCP default or insolvency. Enforcement and Monitoring Mechanisms 6. Please describe any enforcement or monitoring mechanisms (imposed by the CCP, applicable regulatory authorities or otherwise) designed to ensure that CMs Copyright ICE Trust U.S. LLC. Page 60 All rights reserved

147 June 23, 2009 (and their custodians, to the extent applicable) comply with their obligations in respect of any legal or contractual requirements described in your response above. Legislative or Regulatory Reforms 7. As requested above, please identify in your responses above any areas of legal uncertainty and the level of legal comfort provided on various aspects of the proposed framework. Please consider whether there are any legislative or regulatory reforms that would be helpful to clarify or improve the legal framework governing any of the foregoing issues and areas of legal uncertainty identified above. If so, describe any such proposed reforms in detail. Other Considerations 8. Please feel free to elaborate on any topic you deem to be relevant to the analysis of customer protection or systemic risk issues. Copyright ICE Trust U.S. LLC. Page 61 All rights reserved

148 June 23, 2009 VI. Proposed Legislative Amendments Relating to Treatment of Customer Property and Positions 1. Section 404 of the Federal Deposit Insurance Corporation Improvement Act of 1991 (12 U.S.C. 4404) is amended by inserting the following new subsection (i): (i) Enforceability of Position Transfer Provisions (1) The rights of a clearing organization pursuant to one or more netting contracts (A) to transfer or cause the transfer of the failed member s rights and obligations under contracts or positions of the failed member with the clearing organization, together with related security agreements or arrangements or credit enhancements and property transferred thereunder, to one or more other members of the clearing organization; and (B) to transfer or cause the transfer of the failed member s rights and obligations under related or offsetting contracts or positions between the failed member and a non-member, together with related security agreements or arrangements or credit enhancements and property transferred thereunder, to one or more other members of the clearing organization; shall be enforceable in accordance with their terms, and shall not be stayed, avoided or otherwise limited by any State or Federal law. (2) In the case of a failed member that is a depository institution subject to the Federal Deposit Insurance Act, the exercise by the clearing organization of rights pursuant to subsection (a) above shall be subject to the limitations set forth in Section 11(e)(10)(B) of the Federal Deposit Insurance Act to the same extent applicable to the exercise of termination rights for qualified financial contracts. This provision is intended to provide certainty that a clearing organization can exercise rights under its rules to transfer positions of a defaulting member, in addition to terminating or liquidating those positions, which FDICIA currently addresses. It also would allow the clearing organization to cause the transfer of related positions between the defaulting member and customers to a new member, to the extent permitted under its rules,. Clause (2) preserves certain limitations on the exercise of remedies against an insured depository institution in the event of a receivership or conservatorship. 2. Section 404 of the Federal Deposit Insurance Corporation Improvement Act of 1991 (12 U.S.C. 4404) is amended by inserting the following new subsection (j): Copyright ICE Trust U.S. LLC. Page 62 All rights reserved

149 June 23, 2009 (j) Notwithstanding any provision of State or Federal law, the [the applicable federal regulator] may provide, by rule or regulation (i) with respect to a member of a clearing organization (other than a clearing organization that is registered with the Securities and Exchange Commission as a securities clearing agency or with the Commodity Futures Trading Commission as a derivatives clearing organization), the manner in which cash, securities, or other property pledged or transferred to such member by non-members of the clearing organization (regardless of whether such cash, securities or property is held with the member, the clearing organization or a third party) in connection with contracts or positions between the non-member and the member that are offset by or related to contracts or positions between the member and the clearing organization shall be segregated and held and the manner in which such cash, securities or other property may be invested; and (ii) with respect to a failed member of a clearing organization (other than a clearing organization that is registered with the Securities and Exchange Commission as a securities clearing agency or with the Commodity Futures Trading Commission as a derivatives clearing organization), where such failed member is the subject of a receivership or conservatorship under the Federal Deposit Insurance Act or similar proceeding under applicable state law, is a debtor in a proceeding under title 11 of the United States Code or is subject to other applicable insolvency or similar proceedings (1) that certain cash, securities or other property pledged or transferred to such failed member by non-members of the clearing organization in connection with contracts or positions between the non-member and the failed member that are offset by or related to contracts or positions between the failed member and the clearing organization (regardless of whether such cash, securities or property is held with the failed member, the clearing organization or a third party) shall not be the property of such failed member; (2) that certain of the failed member s rights in such contracts or positions with the clearing organization, including payments received in respect thereof, shall not be the property of such failed member; (3) the method by which the business of such failed member with respect to such contracts or positions and related cash, securities or property is to be conducted or liquidated after the appointment of a receiver, conservator, trustee or similar person or filing of a petition or proceeding under such title, including the manner in which property described in (1) or (2) is to be delivered or returned to non-members. This provision would give the appropriate federal regulator authority to establish rules as to the manner in which segregated property is to be held by a clearing member and in which it may be invested. It would also Copyright ICE Trust U.S. LLC. Page 63 All rights reserved

150 June 23, 2009 allow the regulator to establish clear rules as to the segregated status of property pledged by customers of a failed clearing member and as to the customer s right to the return of any excess amounts posted, free of claims of general creditors. The provision is similar to the grant of authority to the CFTC in Section 20 of the Commodity Exchange Act to establish its Part 190 rules as to the treatment of customer property and positions. 3. Section 11(e) of the Federal Deposit Insurance Act (12 U.S.C. 1821(e)) is amended in subclause (9)(A) by adding the following new subclause (iii): (iii) Notwithstanding clauses (i) and (ii) above, the conservator or receiver for a depository institution may transfer (or not transfer) cleared qualified financial contracts between any person or any affiliate and the depository institution in default separately from other qualified financial contracts between such person or its affiliate and the depository institution in default, provided that all such cleared qualified financial contracts between such person or its affiliate and the depository institution in default, together with any claims and related security or other credit enhancement, are transferred to the same financial institution or are not transferred. Cleared qualified financial contracts means a qualified financial contract (A) entered into between the depository institution and a clearing organization of which it is a member or (B) entered into between the depository institution and a non-member of the clearing organization on terms that mirror or offset a qualified financial contract between the depository institution and the clearing organization. This provision would modify the requirement in the Federal Deposit Insurance Act that all qualified financial contracts between a defaulting depository institution and any person or its affiliate be either transferred together or not at all, to allow cleared transactions to be transferred separately from non-cleared transactions. This would facilitate moving of cleared contracts carried with a failed clearing member to a new clearing member, for example. Copyright ICE Trust U.S. LLC. Page 64 All rights reserved

151 STATE OF NEW YORK BANKING DEPA.RTMENT ONE STATE S met NEW YO=, NY March 4, Mr. Bradley Sabel Shearman & Sterling LLP 599 Lexington Avenue New York, NY Dear Mr. Sabel: We are pleased to enclose two originally executed copies of the Restated Articles of Organization of ICE US Trust LLC (the "Trust Company"), with the Department" approval attached thereto, providing for a change in the sole member of the Trust Company from ICE US Trust Holding Company LLC to ICE US Holding Company L.P. As required by Section 1003(7) of the Banking Law, we shall file a copy of the Restated Articles of Organization in the office of the County Clerk. Yours truly, / David S. Fredsall Deputy Superintendent of Banks

152 @anking Department I, David S. Fredsall, Deputy Superintenldent of Banks of the State of New York, DO HEREBY APPROVE the annexed Certificate entitled "RESTATED ARTICLES OF ORGANIZATION OF ICE US TRUST LLC UNDER SECTION 8007 OF THE NEW YORK BANKING LAIVV," providing that the sole member of ICE US Trust LLC is to be ICE US Holdling Company L.P., and have caused the filing of said Certificate in the Office of the Superintendent of Banks on March 4, my hand and ojficial seal of the Banking Department at the City of New York, this 4th day of March in the Year two thousand and nine. ~4+'7- d Deputy Superintendent of Banks

153 RESTATED ARTICLES OF ORGANIZATION OF ICE US TRUST LLC UNDER SECTION 8007 OF THE NEW YORK BANKING LAW The original articles of organization of ICE US Trust LLC, a New York limited purpose limited liability trust company, (the "Company"), filed by the Superintendent of Banks, New York State Banking Department, on December 4, 2008, are hereby amended to effect certain amendments authorized by the New York Banking Law, specifically to reflect that the sole member of ICE US Trust LLC is ICE US Holding Corl~pany L.P. and to replace the words "ICE US Trust Holding Campany LLC" in paragraphs "Thirdn and "Fourth" of the articles organization with the words "ICE US Holding Company L.P." The text of the articles of organization, as-amended heretofore, are hereby restated as further amended to read as herein set forth in full below. This restatement of the articles organization has been authorized by a resolution of the Board of Managers of the Company adopted at its special meeting on March 2, 2009 and by unanimous written consent of ICE US Holding Compariy L.P., the sole member of ICE US Trust LLC. First. The name by which the limited liability trust company is to be known is ICE US Trust LLC Second. The place where its principal office is to be located is 875 Third Avenue, New York, NY Third. The amount of the capital contribution of ICE US Holding Company L.P. as the sole member is to be thirty five million Dollars ($35,000,000.00). LLC, Fourth. ICE US Holding Company L.P. is to have a 100% membership interest in ICE US Trust Fifth. The name, place of residence, and citizenship of each organizer is as follows: Full Name Jeffrey C. Sprecher Residence Atlanta, GA citizens hi^ USA Scott A. Hill Marietta, GA USA

154 John Harding Vincent Tese Frederic Salerno Northfield, IL New York, N'v' Rye, NY USA USA USA Sixth. The term of existence of the company is tlo be 100 years. Seventh. The number of managers is to be not less than seven nor more than thirty. Eighth. The names of the initial members of the board of managers until the first annual meeting of the member are as follows: Jeffrey C, Sprecher Scott A. Hill John Harding Vincent Tese Frederic Salerno Fred Hatfield Terrence Martell Chairman Manager Manager Manager Manager Manager Manager Ninth. The cbmpany is to exercise the powers conferred by Section 100 of the Banking Law; provided, however, the company shall neither accept deposits nor make loans except pursuant to the exercise of the fiduciary powers specified in Section 100 of the Banking Law. Tenth. Management of the company is to be vested in the board of managers [SIGNATURE PAGE FOLLOWS]

155 STATE OF GEORGIA) COUNTY OF I//k SS : Jeffrey C. SDrecher, being duly sworn, deposes and says, that he is the President of ICE US Trust LLC, the New York limited purpose limited liability trust company mentioned and described in the foregoing instrument, that he has read and signed the same, and that the statements contained therein are true. D Nam : Je rev C. Sprecher Sworn ta before me this STATE OF GEORGIA) COUNTY OF 6 I+ ss: Scott A. Hill, being duly sworn, deposes and says, that he is the Secretary of ICE US Trust LLC, the New York limited purpose limited liability trust company mentioned and described in the foregoing instrument, that he has read and sisned the same, and that the statements contained therein are true. Title: Secretary Sworn to before me this QAJ Notary Public [Signature Page - Restated Organization Certificate of ICE US Trust LLC]

156 O Comptroller of the Currency Administrator of National Banks Washington, DC Interpretive Letter #1113 March 4, 2009 March USC CFR (a) Subject: [ ] ( Bank ) Membership in The IntercontinentalExchange US Trust ( ICE Trust ) Credit Default Swap Clearinghouse Dear [ ]: This responds to your request that the Office of the Comptroller of the Currency ( OCC ) confirm that it is permissible for the Bank to participate as a clearing member of ICE Trust, a clearinghouse for over-the-counter ( OTC ) credit default swaps ( CDS ). 1 ICE Trust is a New York trust company, which will be a member of the Federal Reserve System and subject to the regulatory and supervisory requirements of the Federal Reserve Board ( FRB ) and the New York State Banking Department. ICE Trust will meet the statutory requirements for a multilateral clearing organization ( MCO ), 2 as a State member bank. As an MCO, ICE Trust will be permitted to clear CDS, as OTC derivatives. 3 1 A CDS is a bilateral OTC contract designed to transfer the credit exposure of specified products between parties. The buyer of a CDS receives credit protection, whereas the seller of the swap guarantees the credit worthiness of the obligor on the product in exchange for a fixed payment or a series of fixed payments. Effectively, the risk of default is transferred from the buyer of the CDS to the seller. 2 An MCO is a system utilized by more than two participants in which the bilateral credit exposures of participants arising from the transactions cleared are effectively eliminated and replaced by a system of guarantees, insurance, or mutualized risk of loss. 12 U.S.C. 4421(1). 3 See 12 U.S.C et seq., and ICE Trust Rule ( Rule ) 611. OTC derivative transactions are defined in 12 U.S.C to include any agreement, contract, or transaction that is a credit spread or credit swap or that is a swap on one or more occurrences of any event, equity security, or other equity instrument, debt security or other debt instrument. CDS fit within this definition of OTC derivatives.

157 For the reasons discussed below, we conclude that the Bank may participate as a clearing member of ICE Trust, provided the Bank, prior to becoming a member, establishes a comprehensive risk management framework 4 to govern the risks associated with its membership, and receives a written supervisory no-objection from its examiner-in-charge ( EIC ). Background ICE Trust will provide CDS clearing services to its clearing participants ( members ). Membership is open to market participants that meet the clearinghouse s membership criteria. 5 The Bank proposes to become an ICE Trust clearing member. ICE Trust will novate and clear the trades executed by its members. 6 Bilateral contracts entered into by its members will be replaced by two superseding CDS contracts between ICE Trust and each party to the bilateral transactions. Under the new contracts, ICE Trust will assume the counterparties obligations under the original contracts and effectively become the central counterparty (i.e., the buyer to every seller and the seller to every buyer) to CDS trades. For admission to ICE Trust, member applicants must have a minimum tangible net worth (Tier 1 capital) of $5 billion. 7 Potential members or their parents must have a minimum long term rating of at least A or its equivalent from designated or equivalent rating agencies or otherwise demonstrate to the satisfaction of the FRB that it satisfies stringent credit criteria. 8 A member (or its affiliate) must be licensed and regulated for capital adequacy by a competent authority. 9 Members must provide initial and mark-tomarket margin, and contribute collateral ( Required Contributions ) to ICE Trust s guaranty fund ( Fund ), 10 which is available to cover a member s default. 11 The 4 The risk management framework should focus on the qualitative controls necessary to address the risks of the Bank s activities and, in addition, provide for the Bank s compliance with quantitative restrictions discussed below. 5 Membership criteria are designed to insure that each member has sufficient operational capabilities, financial resources, risk management experience and regulatory oversight to be permitted to become an ICE Trust member. ICE Trust Risk Management Framework ( RMF ) IV. 6 Rule Rule 201(b)(ii) and RMF IV. 8 Rule 201(b)(iii) and RMF IV. This criterion is not met if an applicant is rated below A and the applicant will not be admitted as an ICE Trust clearing member. Id. 9 RMF IV, A. Competent authorities include the OCC, the FRB, the U.K Financial Services Authority or any other regulatory body ICE Trust designates from time to time for this purpose. Rule 201(b)(i). 10 The Fund is designed to provide adequate funds to cover simultaneous losses associated with the default of the two clearing members with the greatest potential up-side (widening spread) losses (i.e., uncollateralized losses). RMF IV. 2

158 Required Contribution is based on the risk profile of the member s portfolio, subject to a $20 million minimum. 12 The Required Contribution is determined based on the nature and scope of, and risk associated with, each member s activities. If a clearing member s portfolio presents greater risk, ICE Trust may require the member to increase the amount of its Required Contribution. 13 ICE Trust calculates each member s Required Contribution on a daily basis. 14 If a member s calculated Required Contribution for a particular day exceeds the prior day s calculated contribution by 5% or exceeds the total Fund by 5%, ICE Trust will make a demand for the member to provide cash or collateral to the Fund, sufficient to cover the deficit, which must be met within one hour. 15 The Rules define acts that constitute member defaults and describe the actions the clearinghouse may take once it declares a member in default. 16 In the event of a member default, the Fund may be used to pay the costs of closing out a defaulting member s liabilities that exceed the defaulting member s cash/collateral (margin accounts) or guarantee. ICE Trust will notify members whenever it makes a charge to the Fund. 17 ICE Trust may liquidate the losses resulting from a member s default using this priority schedule: (1) the ICE Trust Priority Contribution; 18 (2) the non-defaulting members Required Contributions (not to exceed an average of $50 million per non-defaulting member) and ICE Trust s Pro Rata Contribution 19 applied pro rata to the loss based on the relative size of such contributions, and (3) the remainder of each non-defaulting member s Required Contribution applied pro rata to the remaining loss based on the relative size of such contributions Rules and 801 and RMF IV. ICE Trust is also required to make capital contributions to the Fund of up to $100 million, which includes up to $50 million representing a first loss contribution ( ICE Trust Priority Contribution ) and the lesser of $50 million or the average Required Contribution ( ICE Trust Pro Rata Contribution ). Rule RMF, Appendix 3 and ICE Trust Clearing Participant Application Documents ( PAD ). 13 PAD. 14 RMF IV. 15 Rule 801 and RMF IV. 16 A member is in default if, for example, the member: (1) fails to meet or is likely to fail to meet the member s contract obligations with the clearinghouse, (2) fails to pay margin by prescribed deadlines, (3) is suspended or expelled or has privileges revoked by ICE Trust, or (4) has a guarantor who fails or is likely to fail to meet any of its obligations or is in default under a guarantee to ICE Trust. Rule (a). 17 Rule 802(d). 18 The ICE Trust Priority Contribution is a contribution provided by ICE Trust to the Fund of up to $50 million representing a first loss contribution. Rule The ICE Trust Pro Rata Contribution is a contribution provided by ICE Trust to the Fund that is the lesser of $50 million or the average Required Contribution. 20 Rules 801 and

159 If ICE Trust draws on the Fund to cover a member default, resulting in a member having an amount of collateral in the Fund less than the member s Required Contribution, the member must pay to the Fund an amount sufficient to restore the member s Required Contribution ( Additional Assessment ) prior to the opening of business on the next business day. 21 This amount is dynamic and can change from one day to the next based on changes in the member s transaction volume. Before the Additional Assessment is due, a non-defaulting member may provide ICE Trust with a notice of intent to withdraw from membership, thus becoming a Retiring Participant. 22 As a Retiring Participant, the amount of the Additional Assessment going forward may meet, but will not exceed, in total, a member s Required Contribution prior to the default. 23 Thus, a Retiring Participant has the ability to limit its contingent liability for the default of other members to twice the member s Required Contribution as of the day of default, subject to Monthly Adjustments. Following the first day on which the Retiring Participant no longer has any open positions, ICE Trust is not entitled to increase a Retiring Participant s Required Contribution. 26 If the Fund is insufficient to discharge the obligations of the defaulting member, taking into account the Additional Assessments, or ICE Trust determines that a winding up of outstanding CDS is prudent or ICE Trust defaults, ICE Trust will determine close-out values for all open positions (Wound-up Contracts) and determine a single net amount 21 Rule 802(b)(iv). If the entirety of the ICE Trust Pro Rata Contribution was not paid out under Rules 801(c)(i) and 802(b)(ii), the excess of the contribution will be available up to the ICE Trust Default Maximum, along with any Additional Assessments, to cover a default. 22 A Retiring Participant is a clearing member who has notified ICE Trust of its intention to terminate its status as a clearing member or who has been notified by ICE Trust of its intention to terminate the member s status as a member. Rule RMF I. 24 While ICE Trust calculates each member s Required Contribution daily, ICE Trust does not adjust a member s Required Contribution until month s end, to reflect the average daily Required Contribution for the month (the Monthly Adjustment ), which may result in a positive or negative change in a Retiring Participant s Additional Assessment. Rules 101 and 801, and RMF IV. Moreover, a Retiring Participant continues to be responsible for any deficit where the member s Required Contribution for a particular day exceeds the prior day s calculated contribution by 5% or exceeds the total Fund by 5%. Rule 801 and RMF IV. A Retiring Participant is responsible for the Monthly Adjustment and deficit amounts if the member has open positions at any time during the month with respect to which ICE Trust calculates and demands these amounts. Rule 801. A Retiring Participant s obligations remain outstanding until ICE Trust s return of a Retiring Participant s Fund contribution, which is subject to the timing and formula provisions of Rule The Bank, as a Retiring Participant, would continue to monitor its activities pursuant to its risk management framework (see text below under Safety and Soundness) in order, among other things, to ensure that the Required Contribution and Additional Assessment did not exceed the Bank s lending limit at the time advances of funds are made to ICE Trust. 12 U.S.C. 84 and 12 C.F.R. Part Rule

160 owed by or to each member. 27 ICE Trust will apply all amounts collected from members who owe ICE Trust a net amount under the Wound-up Contracts, plus all available amounts in the Fund, to pay all net amounts owed by ICE Trust to members under the Wound-up Contracts, subject to ICE Trust s limits on liability. ICE Trust will return a Retiring Participant s Fund contribution minus any portion used to cover the obligations of a defaulting member or in connection with Wound-up Contracts. 30 A defaulting member s obligations remain a liability of the member and related guarantor, which ICE Trust may collect from the member s margin, collateral or other assets of such member or guarantor or by legal process. 31 If ICE Trust recovers funds from a defaulting member, it is obligated to repay contributions paid by the clearing members, as reflected in steps (4) through (6) below, subject to the following payment priority: (1) to costs and expenses (including legal fees and expenses related to collection); (2) to certain related unreimbursed costs and expenses (e.g., costs and expenses of sale, opens positions, closing out) (Rule 802(a)); (3) to any deficiencies owed to members under Wound-up Contracts (Rule 804); (4) to members and ICE Trust for contributions to the Fund that were charged for the defaulting member s deficiency under Rule 802(b)(iv) (whether or not the member remains a member at the time of collection), first to members to the extent they were charged after the ICE Trust Default Maximum was reached and thereafter to the members and ICE Trust, in proportion and up to the amount each was charged; (5) to the members whose contributions were charged for the deficiency under Rule 802(b)(iii) in proportion and up to the amount of the charge, and (6) to ICE Trust and any member whose contribution was charged for the deficiency under Rule 802(b)(ii) (whether or not such members remain members at the time of collection) in proportion and up to the amount each was charged, (7) to ICE Trust for and up to the amount of the charge against the ICE Trust Priority Contribution, provided that ICE Trust contributes any amount recovered to the Fund for credit to the 27 Rule 804(a). 28 Id. Under Rule 312, ICE Trust s liability for member contract obligations is limited to amounts on deposit with the Fund (subject to Additional Assessment limits), the ICE Trust Priority Contribution, the ICE Trust Pro Rata Contribution (including such unpaid amounts up to the ICE Trust Default Maximum, which is no more than $50 million per the calculation under Rule 802(b)(v)), and any amount ICE Trust collects from a member or the member s guarantor for its obligations or Wound-up contracts. ICE Trust s liability to a member for contract obligations may not exceed the aggregate amount paid to ICE Trust by a member within the twelve-month period preceding any claim therefore. 29 ICE Trust and any Retiring Participant may agree to establish a new general guarantee fund and have ICE Trust accept for clearing, replacements for some or all of the Wound-up Contracts. Rule 804(b). 30 The timing of ICE Trust s return of a Retiring Participant s Fund contribution is determined under the formula set forth in Rule Rule 802(c). 5

161 ICE Trust Priority Contribution, and (8) the payment of any of the defaulting member s other obligations. 32 Discussion For the reasons discussed below, we believe a national bank has authority to become an ICE Trust clearing member under the NBA, provided the bank, prior to becoming a member, establishes a comprehensive risk management framework to govern the risks associated with membership as described below, and receives a written supervisory noobjection letter from its EIC. Banks must limit their exposures to ICE Trust to amounts equal to or below their Section 84 limits, as discussed below. National Bank Act The NBA permits national banks to engage in foreign and domestic clearing activities, subject to safety and soundness limitations, as activities that are part of the business of banking because the activities are functionally equivalent to bank permissible credit and financial intermediation activities. 33 The NBA also permits national banks to provide default fund contributions to clearinghouses as bank permissible guaranties and as activities incidental to bank permissible activities. Clearing is a form of extending credit, one of the main functions of banking institutions. 34 A clearing agent substitutes its credit for that of its customers. A clearing agent is liable to a clearinghouse for performance on all submitted contracts, and assumes, with respect to the clearinghouse, the risk of other member defaults. The clearing function also is akin to two other traditional bank credit functions: providing bankers acceptances and letters of credit. 35 The credit function provided by the Bank in its clearing capacity is part of the business of banking because a principal business of a 36 bank is to extend credit. National bank clearing activities also are functionally consistent with the primary role of banks as financial intermediaries. The role of a bank is to act as an intermediary, facilitating the flow of money and credit among different parts of the economy. 37 The role of a bank intermediary takes many forms: providing payments transmission services, 32 Id. 33 See, e.g. OCC Interpretive Letter No (Jan. 10, 2005) ( IL No ); IL No. 929 (Feb. 11, 2002) ( IL No. 929 ); and OCC Interpretive Letter No. 494 (Dec. 29, 1989) ( IL No. 494 ). 34 Id. 35 Id. 36 Id. 37 See, e.g., OCC No-Objection Letter No (Feb. 16, 1990) and OCC No-Objection Letter No (July 20, 1977). 6

162 borrowing from savers and lending to users, and participating in the capital markets, as here. As the recognized intermediaries between other, non-bank participants in the financial markets and the payment systems, banks possess the expertise to make exchanges of payments and securities between, and settle transactions for, parties and to manage their own intermediation position. 38 A long line of OCC precedents support the conclusion that the Bank s proposed clearing services are within the legally authorized powers of national banks. 39 Moreover, the OCC has permitted national banks and their foreign branches to join clearinghouses and other entities that require members to cover a portion of the losses arising from the default of other members, as bank permissible guaranties, where the bank had a substantial interest in being a member and its liability was de minimis or limited, and did not exceed Section 84 or lower EIC-established limits. 40 Under 12 C.F.R (a), a national bank is permitted to guarantee the obligations of another party if the bank has a substantial interest of its own in the transaction. This regulation provides, in part, that [a] national bank may lend its credit, bind itself as a surety to indemnify another, or otherwise become a guarantor... if: (a) The bank has a substantial interest in the performance of the transaction involved. 41 Here, the Bank has a substantial interest in agreeing to cover a portion of the losses of defaulting ICE Trust clearing members where this obligation is an integral part of permissible clearing activities. The Bank seeks to become an ICE Trust clearing member as an effective and efficient means of clearing CDS trades. The Bank must agree to cover a portion of the losses of defaulting clearing members as a condition of ICE Trust clearing membership. Thus, the Bank has a substantial interest in committing to provide the guarantee as a condition to ICE Trust membership, subject to the limits described below. 38 See OCC Interpretive Letter 892 (Sept. 8, 2000). 39 See, e.g., Unpublished Letter (Dec. 13, 1995) (national bank membership in Exchange Clearing House Limited (ECHO)); OCC Operating Subsidiary Notice Application Control No. 94-ML (Sept. 21, 1994) (national bank clearing membership in SIMEX); IL No. 494, supra (national bank and operating subsidiary as exchange clearing member); OCC Interpretive Letter No. 422 (Apr. 11, 1988 (national bank and operating subsidiary clearing and exchange memberships); OCC Interpretive Letter No. 384 (May 18, 1987) (same); OCC Interpretive Letter No. 380 (Dec. 29, 1986); (execution, clearance, and exchange membership); and OCC Interpretive Letter No. 372 (Nov. 7, 1986) (same). 40 See, e.g. OCC Interpretive Letter No (Sept. 6, 2006) ( IL No ) and IL Nos and 929, supra C.F.R (a). A nexus between a bank permissible transaction and a guaranty may provide the substantial interest for the bank. See, e.g., IL No. 929, supra (bank s provision of a default fund contribution/guaranty was incidental to the business of bank s clearing and execution activities and satisfied substantial interest needed for issuance of a guarantee) and OCC Interpretive Letter No. 376 (Oct. 25, 1986) (national bank s guarantee of third party securities borrowers conduct was incidental to the bank s securities lending program and constituted a sufficient substantial interest). 7

163 OCC precedent also clearly establishes that national banks may contribute to funds to guarantee the potential losses of others, in order to engage in bank permissible activities, where the bank s potential liability for the defaults of others is limited. For example, in IL No. 929, the OCC found it permissible for a national bank, via its foreign branch, to contribute to a foreign clearinghouse s default fund in order to clear bank permissible 42 derivative contracts where the liability for other member defaults was limited. Clearinghouse members were required to contribute to the default fund to cover losses caused by any defaulting member. In the event of a member default, the clearinghouse could seek additional contributions to the default fund by non-defaulting members. The non-defaulting members had the option of contributing the additional funds or resigning their membership. Thus, the resignation option provided members the ability to limit their liability for the default of other members to the member s original default fund contribution. The OCC found that the branch s participation in the foreign clearinghouse was permissible because the bank could limit its liability and the bank had a substantial interest in contributing to the default fund so that it could engage in bank permissible clearing activities. The OCC also concluded that it was permissible for national banks to contribute to the loss allocation system of a domestic clearinghouse as a condition to membership, where liability for the losses of other members was limited. 43 Clearinghouse members were required to maintain clearing fund deposits in an account to be used by the clearinghouse to cover losses in the event of a member default. Any losses remaining after applying the deposit could be allocated to non-defaulting members. In that event, a non-defaulting member could either pay the amount of the loss or terminate its membership. If a netting member terminated its membership, its loss allocation liability was limited to its clearing fund deposit. As a result, a member national bank could limit its liability to its initial required fund deposit. Thus, the OCC determined that a member s obligation to cover the losses of defaulting members was limited and that the bank had a substantial interest in providing the guaranty in order to engage in bank authorized clearing activities. Similarly, the OCC permitted a national bank to become a member of domestic independent systems operators ( ISOs ), which operate much like clearinghouses, to execute bank permissible electricity derivative transactions. 44 As a condition to membership, the bank was to participate in a program that subjected members to potential unlimited liability for any losses allocated to members arising from member defaults. The ISOs had systems in place to mitigate the risk of additional assessments and the bank s exposure was subject to the limits of Section 84 as a legal matter. 45 The OCC determined that the bank had a substantial interest in covering such potential losses as an integral part of ISO membership and the liability exposure was sufficiently limited where 42 IL No. 929, supra. 43 IL No. 1014, supra. 44 IL No. 1071, supra. 45 The arrangement was also subject to any additional limits imposed by the bank s EIC. 8

164 the ISO had risk of loss mitigants in place and the bank established risk management systems and controls to estimate and maintain its potential liabilities within Section 84 limits or lower limits imposed by the EIC. Recently, in OCC Interpretive Letter No (Oct. 14, 2008), the OCC determined that a national bank had a substantial interest in joining a foreign clearinghouse as a custodian clearing member, where clearing members were subject to potentially unlimited liability for the defaults of other clearinghouse members. In the event that the clearing fund was not sufficient to cover a member default, the clearinghouse had the right to assess the remaining balance against all members in proportion to each member s contribution to the fund. While the by-laws, rules and regulations of the clearinghouse did not specifically limit the Bank s exposure to the clearinghouse, the OCC determined that a national bank could join the clearinghouse where it had systems in place to mitigate the risk of additional assessments, and could limit its exposure to the clearinghouse to its Section 84 limits. Based on all the foregoing, we conclude that it is permissible under the NBA for the Bank to become a clearing member of ICE Trust, provided the Bank establishes a comprehensive risk management framework and limits its exposures to ICE Trust to its Section 84 limits or a lower exposure limit established by the EIC, in light of the size of the Bank, the nature and volume of its activities, and the characteristics of the clearinghouse. 46 The Bank s membership in ICE Trust should enable the Bank to reduce its counterparty credit risk and operational risk from derivatives transactions since the clearinghouse will act as a central counterparty and net members positions. However, because each member assumes obligations to cover losses from other defaulting members, membership also can create a complex, contingent forward credit exposure. Accordingly, prior to joining ICE Trust, the Bank should establish a comprehensive risk management framework addressing risks arising from these exposures. Safety and Soundness When national banks join clearinghouses or exchanges that impose liability on members for other members defaults, banks should implement a comprehensive risk management framework to measure and manage the risks arising from these exposures, including: Effective oversight by senior management; Policies and procedures that identify and quantify the level(s) of counterparty credit risk, at both inception of membership and an on-going basis; 46 Under the lending limit, 12 U.S.C. 84 and 12 C.F.R. Part 32, a national bank s loans and extensions of credit to one borrower are limited to 15 percent of the bank s capital and surplus, subject to certain exceptions and with the application of certain loan combination rules. Additionally, a bank s credit exposures must be consistent with safe and sound banking practices. Accordingly, the Bank must limit its exposure to ICE Trust so that amounts of funds advanced as margin or Fund contributions do not exceed an amount equal to, if not below, the Section 84 limits, in light of the size of the Bank, the nature and volume of its activities, and the characteristics of the clearinghouse. 9

165 Limits and other controls on the level(s) of risk with respect to counterparty credit, concentrations, and other relevant market factors; A systematic approach to capture exposure in the entire clearinghouse; Regular reports that accurately present the nature and level(s) of risk taken, and demonstrate compliance with approved policies and limits; and Auditing procedures to ensure the integrity of measurement, control, and reporting systems. Policies and Procedures Exchange and clearinghouse memberships should be governed by appropriate policies and procedures. Bank policies should establish a formal process for approving membership in a central counterparty, as well as ongoing monitoring of risk exposure. This process should include the necessary control and oversight functions, including credit risk management, audit, legal, and compliance. Policies should include: Clearly defined roles and responsibilities for management of risks associated with membership; Guidelines on the types of exchanges and clearinghouses the bank may join; A well-defined risk tolerance for exchange and clearinghouse risks so that the bank can establish meaningful risk limits; A formal process for approval of membership in exchanges or clearinghouses; A comprehensive due diligence review prior to joining an exchange or clearinghouse; An initial legal review by bank counsel; Ongoing reviews by bank counsel to assess any changes in membership requirements and ensure the bank complies with all membership requirements and other applicable limits and restrictions; Periodic credit reviews of current memberships on exchanges and clearinghouses, including monitoring of potential risk exposure and ensuring compliance with boardapproved credit limits; and Annual reviews by internal audit to assess compliance with bank policies. Due Diligence Banks should conduct a thorough due diligence of exchanges or clearinghouses prior to becoming a member. Banks should evaluate the credit assessment that the central counterparty uses for its members, both at inception and on an ongoing basis. The due diligence should be of appropriate depth to enable bank management to develop a thorough understanding of the operational framework of the exchange or clearinghouse, and the quality of its risk management systems. At a minimum, this should include an: 10

166 in-depth knowledge of the central counterparty s role, membership criteria and structure, corporate governance, and management team; analysis of the credit quality of the central counterparty; understanding of membership agreement and requirements, including the default- practices, including sharing protocol; analysis of central counterparty credit risk management collateral, margin, and netting requirements; analysis of settlement and default procedures; analysis by legal counsel of any default-sharing precedents and any other applicable limits or restrictions; understanding of the regulatory requirements of the exchange or clearinghouse; and assessment of key risks associated with joining the exchange or clearinghouse. Bank management should establish internal risk limits that are prudent in light of the bank's financial condition, capital levels, and management's expertise. The bank s risk tolerance for concentrations and credit exposures to central counterparties should be reflected in policies and procedures. Ongoing Monitoring and Reporting Bank policies should require a periodic review of all central counterparties for which the bank is a member. The policies should clearly define the scope and responsibilities for conducting these reviews. Bank management should obtain accurate and timely information from the exchange or clearinghouse to assess and monitor potential liability based upon the bank s level of activity and applicable laws, rules, and regulations. Bank management should also keep abreast of changes in membership rules and in member activity, on a periodic basis, to assess how its contingent risk exposure is changing as a part of the process. Potential exposure should be monitored individually and in aggregate for all exchange and clearinghouse memberships. Bank management should develop contingency strategies to mitigate risks associated with exchange or clearinghouse membership, including establishing risk triggers and an approval process for executing contingency risk mitigation strategies. The contingency risk mitigation strategies should include internal limits when the bank must adjust its activities to avoid exceeding limits on potential advances of funds to the exchange or clearinghouse arising from defaults of other members if at any time the cumulative payments under its contingent obligations approach these limits. Senior management should ensure a membership compliance review is conducted for each exchange or clearinghouse. This review should be conducted at inception and appropriate intervals thereafter. The Bank represents that it has established a comprehensive risk management framework addressing the risks associated with its membership in ICE Trust that satisfies the above standards. 11

167 Conclusion We conclude that the Bank may participate as a clearing member of ICE Trust, provided the Bank, prior to becoming a member, establishes a comprehensive risk management framework to govern the risks associated with its membership as described above, and receives a written supervisory no-objection letter from its EIC. Our conclusions are specifically based on the Bank s representations, and any change in facts or circumstances could result in a different conclusion. If you have any questions concerning this letter, please contact Tena M. Alexander, Senior Counsel, Securities and Corporate Practices Division, at (202) Sincerely, signed Julie L. Williams First Senior Deputy Comptroller And Chief Counsel 12

168 Federal Register / Vol. 74, No. 179 / Thursday, September 17, 2009 / Rules and Regulations cprice-sewell on DSK2BSOYB1PROD with RULES DATES: Effective Dates: 0901 UTC, October 22, FOR FURTHER INFORMATION CONTACT: Colby Abbott, Airspace and Rules Group, Office of System Operations Airspace and AIM, Federal Aviation Administration, 800 Independence Avenue, SW., Washington, DC 20591; telephone: (202) SUPPLEMENTARY INFORMATION: History On November 3, 1994, a final rule for Airspace Docket No. 94 ASW 12, was published in the Federal Register (59 FR 55030), changing the time of designation for Restricted Areas R 5103A, R 5103B, R 5103C, and R 5103D at McGregor, NM. In that rule, the preamble discussion stated the time of designation was being changed from the existing time of designation, local time; other times by NOTAM to local time, Monday Friday; other times by NOTAM to lessen the burden on the public and accurately reflect their actual time of use. However, in the regulatory language, the time of designation was published as local time, Monday Friday, other times by NOTAM. Having changed the semicolon between the days of the week and NOTAM provision to a comma unintentionally linked the NOTAM provision to the days of the week listed in the legal description only. The unintended consequence of this error is that the NOTAM provision does not apply to Saturdays or Sundays, as it did previous to that final rule. Had a semicolon been published in the regulatory text between the days of the week and the NOTAM provision, the other times by NOTAM provision would apply daily. Subsequent to the rule published November 3, 1994, (59 FR 55030), a second rule affecting R 5103A, R 5103B, R 5103C, and R 5103D was published December 13, 2004, (69 FR 72113), Airspace Docket No. 04 ASW 11, FAA Docket No. FAA This second rule modified the boundaries and designated altitudes for Restricted Areas R 5103A, R 5103B, and R 5103C, and revoked R 5103D to allow the U.S. Army to activate the restricted areas in a manner that was more consistent with the actual utilization of the airspace. As a result of this action, the correction to Restricted Area R 5103D is not necessary as it no longer exists. Based on the original intent of the final rule published November 3, 1994, and subsequently modified by a second final rule published December 13, 2004, the NOTAM provisions for R 5103A, R 5103B, and R 5103C should be applicable daily, outside the local time, Monday through Friday, published hours currently listed in that final rule. This action corrects that error by amending the time of designation for R 5103A, R 5103B, and R 5103C to read, local time, Monday Friday; other times by NOTAM. List of Subjects in 14 CFR Part 73 Airspace, Prohibited areas, Restricted areas. Correction to Final Rule Accordingly, pursuant to the authority delegated to me, the legal description as published in the Federal Register on November 3, 1994 (59 FR 55030), Airspace Docket 94 ASW 12, and incorporated by reference in 14 CFR 73, is corrected as follows: [Amended] On page 55031, correct the airspace description for the time of designation for Restricted Areas R 5103A, R 5103B, and R 5103C, to read as follows: * * * * * R 5103A McGregor, NM [Amended] By removing the current Time of designation local time, Monday- Friday, other times by NOTAM. and substituting the following: Time of designation local time Monday- Friday; other times by NOTAM. R 5103B McGregor, NM [Amended] By removing the current Time of designation local time, Monday- Friday, other times by NOTAM. and substituting the following: Time of designation local time Monday- Friday; other times by NOTAM. R 5103C McGregor, NM [Amended] By removing the current Time of designation local time, Monday- Friday, other times by NOTAM. and substituting the following: Time of designation local time Monday- Friday; other times by NOTAM. * * * * * Issued in Washington, DC, on August 27, Ellen Crum, Acting Manager, Airspace and Rules Group. [FR Doc. E Filed ; 8:45 am] BILLING CODE P VerDate Nov<24> :59 Sep 16, 2009 Jkt PO Frm Fmt 4700 Sfmt 4700 E:\FR\FM\17SER1.SGM 17SER1 SECURITIES AND EXCHANGE COMMISSION 17 CFR parts 230, 240 and 260 [Release Nos ; ; ; File No. S ] RIN 3235 AK26 Extension of Temporary Exemptions for Eligible Credit Default Swaps To Facilitate Operation of Central Counterparties To Clear and Settle Credit Default Swaps AGENCY: Securities and Exchange Commission. ACTION: Interim final temporary rules; extension. SUMMARY: We are adopting amendments to the expiration dates in our interim final temporary rules that provide exemptions under the Securities Act of 1933, the Securities Exchange Act of 1934, and the Trust Indenture Act of 1939 for certain credit default swaps in order to facilitate the operation of one or more central counterparties for those credit default swaps. Under the amendments, the expiration dates of the interim final temporary rules will be extended to November 30, DATES: Effective Date: This rule is effective September 17, 2009, and the expiration dates for the interim final temporary rules and amendments published January 22, 2009 (74 FR 3967) is extended from September 25, 2009 to November 30, FOR FURTHER INFORMATION CONTACT: Amy M. Starr, Senior Special Counsel, or Sebastian Gomez Abero, Attorney, Office of Chief Counsel, Division of Corporation Finance, at (202) , U.S. Securities and Exchange Commission, 100 F Street, NE., Washington, DC SUPPLEMENTARY INFORMATION: We are adopting amendments to the following rules: interim final temporary Rule 239T and Rule 146 under the Securities Act of 1933 ( Securities Act ), 1 interim final temporary Rule 12a 0T and Rule 12h 1(h)T under the Securities Exchange Act of 1934 ( Exchange Act ), 2 and interim final temporary Rule 4d 11T under the Trust Indenture Act of 1939 ( Trust Indenture Act ). 3 I. Background In January 2009, we adopted interim final temporary Rule 239T and a temporary amendment to Rule 146 under the Securities Act, interim final 1 15 U.S.C. 77a et seq U.S.C. 78a et seq U.S.C. 77aaa et seq.

169 47720 Federal Register / Vol. 74, No. 179 / Thursday, September 17, 2009 / Rules and Regulations cprice-sewell on DSK2BSOYB1PROD with RULES temporary Rules 12a 10T and 12h 1(h)T under the Exchange Act, and interim final temporary Rule 4d 11T under the Trust Indenture Act (collectively, the Interim Final Temporary Rules ). 4 We adopted these rules in connection with temporary exemptive orders we issued to a clearing agency acting as a central counterparty ( CCP ), which exempted the CCP from the requirement to register as a clearing agency under Section 17A of the Exchange Act 5 solely to perform the functions of a clearing agency for certain credit default swap ( CDS ) transactions. The exemptive orders also exempted certain eligible contract participants 6 and others from certain Exchange Act requirements with respect to certain CDS. 7 Also at that time, we temporarily exempted any exchange that effects transactions in certain CDS from the requirements under Sections 5 and 6 of the Exchange Act 8 to register as a national securities exchange, and any broker or dealer that effects transactions on an exchange in certain CDS from the requirements of Section 5 of the Exchange Act. The Interim Final Temporary Rules, and the temporary exemptive orders we provided under the Exchange Act, were intended to facilitate the operation of one or more CCPs that clear and settle CDS transactions while enabling us to provide oversight to the CDS market. 9 Since the adoption of the interim final rules, only one CCP, ICE U.S. Trust LLC ( ICE Trust ), has been actively engaged as a CCP in clearing CDS transactions in the U.S. in accordance with our exemptions. 10 As of August 28, 2009, ICE Trust had cleared more than 22,800 CDS transactions with a notional value of $1.9 trillion. 11 We believe that the clearing of CDS transactions by ICE Trust has contributed and we anticipate will continue to contribute to increased 4 See Exchange Act Release No (Jan. 14, 2009) U.S.C. 78q 1. 6 See 7 U.S.C. 1a(12). 7 See Exchange Act Release Nos and (Dec. 24, 2008) U.S.C. 78e and 78f. 9 For a discussion of concerns related to the market in CDS, and the development of the exemptive orders and interim temporary rules, see Exchange Act Release No (Jan. 14, 2009). 10 See Exchange Act Release No (Mar. 6, 2009), 74 FR (Mar. 12, 2009) (temporary exemption for ICE U.S. Trust LLC). 11 See Historical Daily Volume Report ICE Trust U.S., available at marketdata/reports/ ReportCenter.shtml?reportId=26. transparency 12 and the reduction of systemic risk in the CDS market. 13 We also granted exemptive orders to four other CCPs to clear CDS, two of which were approved in July The Chicago Mercantile Exchange, to whom we granted an exemptive order in March 2009, has indicated that it continues to work with buy and sell participants in the CDS market to promote its CCP. 15 ICE Clear Europe Limited ( ICE Europe ) and Eurex Clearing AG ( Eurex ) have begun clearing CDS transactions in Europe. 16 Since the adoption of the Interim Final Temporary Rules, a number of legislative initiatives relating to the regulation of derivatives, including CDS, have been introduced by members of Congress and recommended by the United States Department of the Treasury ( Treasury ). 17 Congress has 12 See Testimony of Mark Lenczowski, Managing Director and Assistant General Counsel at JPMorgan Chase & Co., to the Senate Agriculture Committee (June 4, 2009) (In his testimony, Mr. Lenczowski indicated, in the context of CDS clearing by ICE Trust, that [c]learing is a highly transparent process. * * * ). 13 As of June 30, 2009, ICE Trust had reduced the notional amount of CDS open interest, or net exposure, from over $1.3 trillion to $168.5 billion by clearing trades and netting positions. See, Quarterly Report on Form 10 Q for the quarter ended June 30, 2009 (filed on August 5, 2009). ICE Trust also has a guarantee fund that provides additional protection in the event of a clearing participant default. See Exchange Act Release No , supra Note See Exchange Act Release No (July 23, 2009) (temporary exemption for Eurex Clearing AG); Exchange Act Release No (July 23, 2009) (temporary exemption for ICE Clear Europe Limited); Exchange Act Release No (Mar. 13, 2009) (temporary exemption for Chicago Mercantile Exchange Inc.); and Exchange Act Release No (Dec. 24, 2008) (temporary exemption for LIFFE A&M and LCH.Clearnet Ltd.). LIFFE A&M and LCH.Clearnet Ltd., to whom we granted exemptive orders in December 2008, indicated that they will suspend their plans to clear CDS. See, Alastair Marsh, NYSE Liffe and LCH.Clearnet close CDS clearing service (Aug. 12, 2009), available at showpage.html?page= See Christine Birkner, CDS Clearing Battle (Buy Side vs. Sell Side), Futures (July 1, 2009) ( A spokesperson for CME Group says, We continue to work with buy and sell participants to demonstrate the value of our offering. ). 16 See Press Release, IntercontinentalExchange, ICE Clear Europe Clears Euro 51 Billion in Third Week of European CDS Processing; Announces New CDS Clearing Member (Aug. 17, 2009), available at releasedetail.cfm?releaseid= See also, Press Release, Eurex Clearing AG, Eurex Credit Clear Clears First Single Name CDS Worldwide (Aug. 28, 2009), available at about/press/press_647_en.html. 17 See, e.g., Derivatives Trading Integrity Act of 2009 (S. 272) (introduced by Senator Tom Harkin in January 2009); The Derivatives Markets Transparency and Accountability Act (H.R. 977) (introduced by Representative Collin Peterson in February 2009); Authorizing the Regulation of Swaps Act (S. 961) (introduced by Senator Carl Levin and Senator Susan Collins in May 2009); VerDate Nov<24> :59 Sep 16, 2009 Jkt PO Frm Fmt 4700 Sfmt 4700 E:\FR\FM\17SER1.SGM 17SER1 not yet taken definitive action with respect to any of the legislative initiatives or the Treasury proposals. Separately, in July 2009, the Committee on Payment and Settlement Systems ( CPSS ) and the Technical Committee of the International Organization of Securities Commissions ( IOSCO ) established a working group to review the application of the CPSS IOSCO Recommendations for Central Counterparties ( Recommendations ) with respect to OTC derivatives. 18 The Recommendations set out standards for risk management of CCPs. The working group plans to identify key issues that can arise when a CCP provides central clearing services for OTC derivatives transactions. 19 At the time of adoption of the Interim Final Temporary Rules, we requested comment on various aspects of the rule provisions. We received a total of 15 letters, only two of which commented specifically on the interim temporary final rules. Those two letters generally supported allowing CCPs to clear and settle CDS transactions in accordance with the terms of the Interim Final Temporary Rules; but neither of the commenters specifically addressed the duration of the Interim Final Temporary Rules and temporary amendments. 20 The other commenters raised issues not directly related to this rulemaking. 21 Treasury s framework for regulatory reform (released in June 2009); Derivative Trading Accountability and Disclosure Act (H.R. 3300) (introduced by Representative Michael McMahon in July 2009); Description of Principles for OTC Derivatives Legislation (announced by Representative Barney Frank and Representative Collin Peterson in July 2009); Senator Charles Schumer s announcement that he is drafting a bill establishing central trade repositories for OTC derivatives markets (August 2009); and Over-the- Counter Derivatives Markets Act of 2009 (prepared by Treasury and sent to Congress in August 2009). 18 See Press Release, Bank for International Settlements, CPSS IOSCO working group on the review of the Recommendations for Central Counterparties (July 20, 2009), available at http: // 19 Where necessary, the working group will propose guidance on how CCPs for OTC derivatives may meet the standards set out by the recommendations and will identify any areas in which the recommendations might be strengthened or expanded to better address risks associated with the central clearing of OTC derivatives. Participants in the working group include representatives of the central banks that are members of the CPSS, representatives of the securities regulators that are members of the IOSCO Technical Committee, and representatives of the International Monetary Fund and the World Bank. Id. 20 See letters from the Yale Law School Capital Markets and Financial Instruments Clinic (March 23, 2009) and from IDX Capital (March 23, 2009). 21 The public comments we received are available for inspection in the Commission s Public Reference Room at 100 F St., NE., Washington, DC in File No. S They are also available online at s70209.shtml.

170 Federal Register / Vol. 74, No. 179 / Thursday, September 17, 2009 / Rules and Regulations cprice-sewell on DSK2BSOYB1PROD with RULES The Interim Final Temporary Rules expire on September 25, We have determined that it is necessary and appropriate to extend the expiration date of the Interim Final Temporary Rules to November 30, II. Discussion of the Final Temporary Rules We are adopting amendments to the Interim Final Temporary Rules to extend the expiration date of each of the rules to November 30, We are not making any other changes to the Interim Final Temporary Rules. A. Securities Act Rule 239T and Rule 146 Securities Act Rule 239T exempts from all provisions of the Securities Act, except the anti-fraud provisions of Section 17(a), certain CDS ( eligible CDS ) 23 that are offered and sold only to eligible contract participants, 24 and that are being or will be issued or cleared by a CCP satisfying the conditions set forth in the CCP exemptions, or registered as a clearing agency under Section 17A of the Exchange Act ( Registered or Exempt CCP ). Hence, under Securities Act Rule 239T, the offer and sale of eligible CDS are exempt from the registration requirements of the Securities Act if the eligible CDS is or will be issued or cleared by a Registered or Exempt CCP, and offered and sold only to an eligible contract participant. Communications used in connection with such offers and sales are not subject to Section 12(a)(2) liability under the Securities Act. Securities Act Rule 239T assures the availability of information to buyers and sellers of CDS due to certain information conditions in the CCP exemptive orders See Section III, infra, for a discussion of why the extension of time is necessary. 23 See 17 CFR T(d). 24 For purposes of Securities Act Rule 239T, eligible contract participant has the same meaning as in Section 1a(12) of the Commodity Exchange Act (the CEA ), as in effect on the date of adoption of Rule 239T, except that the term does not include a person who is an eligible contract participant pursuant to Section 1a(12)(C) of the CEA. 17 CFR T(a)(2). 25 We note that among the conditions of the exemptions, or representations in the exemptive requests on which we are relying, from clearing registration are that: (1) Information is available about the terms of the CDS, the creditworthiness of the CCP or any guarantor, and the clearing and settlement process for the CDS; and (2) the reference entity, the issuer of the reference security, or the reference security is one of the following: an entity reporting under the Exchange Act, providing Securities Act Rule 144A(d)(4) information, or about which financial information is otherwise publicly available; a foreign private issuer that has securities listed outside the United States and has its principal trading market outside the United States; a foreign sovereign debt security; an asset- As we noted in January 2009, absent this exemption, the Securities Act may require registration of the offer and sale of eligible CDS that are or will be issued or cleared by a Registered or Exempt CCP. Without also exempting the offers and sales of the eligible CDS by a Registered or Exempt CCP from the registration requirements of the Securities Act and the Exchange Act and the provisions of the Trust Indenture Act, we believe that the CCPs would not be able to operate in the manner contemplated by the Exchange Act exemptive orders. In addition, the Securities Act, Exchange Act and Trust Indenture Act exemptions are intended to encourage market participants to clear their CDS through the CCPs. Securities Act Rule 239T also provides that any offer or sale of an eligible CDS that is or will be issued or cleared by a Registered or Exempt CCP by or on behalf of the issuer of a security, an affiliate of such issuer, or an underwriter, if such security is delivered in settlement or whose value is used to determine the amount of the settlement obligation, will constitute a contract for sale of, sale of, offer for sale, or offer to sell such security under Section 2(a)(3) of the Securities Act. 26 This provision is intended to ensure that an eligible CDS that is or will be issued or cleared by a Registered or Exempt CCP cannot be used by an issuer, affiliate of an issuer or underwriter to circumvent the registration requirements of Section 5 with respect to an issuer s security for such eligible CDS. 27 As a result, a transaction by such persons in an eligible CDS that is or will be issued or cleared by a Registered or Exempt CCP having such securities of the issuer also is a transaction in the issuer s securities that must be registered under the Securities Act, unless an exemption from registration is available. We also adopted on an interim final temporary basis an amendment to Securities Act Rule 146. Under the temporary amendment to Rule 146, eligible contract participants that are sold eligible CDS in reliance on interim backed security, as defined in Regulation AB [17 CFR ], issued in a registered transaction with publicly available distribution reports; an asset-backed security issued or guaranteed by Fannie Mae, Freddie Mac or the Government National Mortgage Association; or indexes in which 80 percent or more of the index s weight is comprised of these reference entities or reference securities. See, e.g., Exchange Act Release No , supra Note CRF T(c). 27 This provision is similar to the condition in the Securities Act exemption in Rule 238 for standardized options [17 CFR ] and in Securities Act Section 2(a)(3) [15 U.S.C. 77b(a)(3)] relating to security futures products. VerDate Nov<24> :59 Sep 16, 2009 Jkt PO Frm Fmt 4700 Sfmt 4700 E:\FR\FM\17SER1.SGM 17SER1 final temporary Securities Act Rule 239T are defined as qualified purchasers under Section 18(b)(3) of the Securities Act and thereby such eligible CDS that are or will be issued or cleared by a Registered or Exempt CCP are considered covered securities under Section 18 of the Securities Act and exempt from state blue sky laws. 28 B. Exchange Act Rule 12a 10T and Rule 12h 1(h)T In January 2009, we also adopted two Interim Final Temporary Rules relating to Exchange Act registration of eligible CDS that are or have been issued or cleared by a Registered or Exempt CCP. Exchange Act Rule 12a 10T exempts eligible CDS that are or have been issued or cleared by a Registered or Exempt CCP from the provisions of Section 12(a) of the Exchange Act under certain conditions. 29 Exchange Act Rule 12h 1(h)T exempts eligible CDS that are or have been issued or cleared by a Registered or Exempt CCP from the provisions of Section 12(g) of the Exchange Act under certain conditions. 30 C. Trust Indenture Act Rule 4d 11T We also adopted a rule under Section 304(d) of the Trust Indenture Act that exempts any eligible CDS, as defined in Securities Act Rule 239T and offered and sold in reliance on Securities Act Rule 239T, from having to comply with the provisions of the Trust Indenture Act. 31 III. Amendment of Expiration Date of Interim Final Temporary Rules In January 2009, we adopted the interim final rules on a temporary basis until September 25, 2009 because we anticipated that this date would provide us with adequate time to evaluate the availability of the exemptions applicable to CDS CCPs and nonexcluded CDS, and whether any conditions or provisions of such CFR (c)T. State securities regulation of covered securities generally is limited under Section 18(b). Under Section 18(b)(3), covered securities are securities offered and sold to qualified purchasers, as defined by the Commission U.S.C. 78l(a) CFR h 1(h)T; 15 U.S.C. 78l(g). 31 Rule 4d 11T. The Trust Indenture Act applies to debt securities sold through the use of the mails or interstate commerce. Section 304 of the Trust Indenture Act exempts from the Act a number of securities and transactions. Section 304(a) of the Trust Indenture Act exempts securities that are exempt under Securities Act Section 3(a), but does not exempt from the Trust Indenture Act securities that are exempt by Commission rule. Accordingly, while Securities Act Rule 239T exempts the offer and sale of eligible CDS satisfying certain conditions from all the provisions of the Securities Act (other than Section 17(a)), the Trust Indenture Act would continue to apply.

171 47722 Federal Register / Vol. 74, No. 179 / Thursday, September 17, 2009 / Rules and Regulations cprice-sewell on DSK2BSOYB1PROD with RULES exemptions should be modified. At the time we adopted the Interim Final Temporary Rules, we indicated that we could act to extend the expiration date of such rules. 32 We have now determined that it is necessary to extend the expiration date of the Interim Final Temporary Rules for the following reasons. First, we adopted the interim final rules to foster the development of CCPs by providing exemptions from certain regulatory provisions that might otherwise prevent them from engaging in such activities in the manner contemplated by the exemptive orders. To date, there has been only one CCP (ICE Trust) that has begun to clear and settle CDS transactions in the U.S. and two CCPs (ICE Europe and Eurex) that have begun to clear and settle CDS transactions in Europe. Extending the expiration date of our Interim Final Temporary Rules would not only allow ICE Trust, ICE Europe and Eurex to continue to clear and settle CDS transactions, it would also enable other CCPs to start clearing and settling CDS transactions in the manner contemplated by the exemptive orders. Competition among CCPs clearing CDS transactions could give participants more choice for their trading needs and may reduce clearing fees. 33 In addition, the extension would give us more time to evaluate the rule and assess its effect on the CDS market and the market participants. As reflected in the CPSS IOSCO Recommendations, our fellow regulators around the world are also thinking about how to address the risks associated with the central clearing of OTC derivatives, and this remains an open and current topic of discussion for all securities regulators. Finally, Treasury has delivered financial regulatory reform proposals to Congress, and several bills to regulate derivatives 32 See Section III of Exchange Act Release No (Jan. 14, 2009). 33 See Harrington and Leising, supra note 15 (quoting Theo Lubke, an official with the Federal Reserve Bank of New York responsible for the central bank s efforts to curb risk in the CDS market, as stating that A competitive [CCP clearing] environment, at least in the short run, is beneficial. We don t want the first mover to be the winner just because they re the first mover. We would like to see real choice in the market for a period of time to determine which is the better mousetrap. ). See also, Financial Services: Cost of Trading Going Down, Survey Finds, Europolitics (July 17, 2009) (citing European Commissioner Charlie McCreevy, I particularly welcome the [European Commission] study s findings concerning the decreases in costs for trading and clearing and to some extent also for settlement services since This confirms the positive impact on competition of the Markets in Financial Instruments Directive and the code of conduct on clearing and settlement. ). and the derivatives markets have been introduced in Congress. Absent an exemption, the offer and sale of eligible CDS that are or will be issued or cleared by a Registered or Exempt CCP may have to be registered under the Securities Act, the eligible CDS that have been so issued or cleared may have to be registered as a class under the Exchange Act, and the provisions of the Trust Indenture Act may need to be complied with. We believe that the Interim Final Temporary Rules have facilitated and anticipate that they will continue to facilitate the use by eligible contract participants of CDS CCPs. Absent an extension of the expiration date of the interim final rules, we believe that the CCPs would not be able to operate in the manner contemplated by the exemptive orders. We note that the expiration dates of certain of these exemptive orders currently extend until April 23, We are, therefore, adopting amendments to each of the interim final rules to extend the expiration date of the rules to November 30, Extending the expiration dates for this length of time will allow us to continue to monitor the development and operation of CCPs in the CDS market under the current, evolving regulatory and legislative environment. IV. Certain Administrative Law Matters Section 553(b) of the Administrative Procedure Act ( APA ) 34 generally requires an agency to publish notice of a proposed rule making in the Federal Register. This requirement does not apply, however, if the agency for good cause finds (and incorporates the finding and a brief statement of reasons therefor in the rules issued) that notice and public procedure thereon are impracticable, unnecessary, or contrary to the public interest. 35 The Commission finds good cause to act immediately to extend the expiration date of the Interim Final Temporary Rules. When we adopted the rules in January of this year, we sought sufficient time to evaluate the appropriateness of the exemptions and the role of CCPs in the CDS market. Since that time, we have granted orders to four additional CDS CCPs exempting them from the requirement to register as a clearing agency under Section 17A of the Exchange Act. Two of these orders were granted as recently as July 2009, and one CCP has started to clear CDS transactions in the U.S. and two have begun clearing CDS in Europe. In addition, there have been a number of 34 5 U.S.C. 553(b) U.S.C. 553(b)(B). VerDate Nov<24> :59 Sep 16, 2009 Jkt PO Frm Fmt 4700 Sfmt 4700 E:\FR\FM\17SER1.SGM 17SER1 recent and still developing legislative and regulatory initiatives relating to the regulation of derivatives, including CDS. Finally, we note that commenters had an opportunity to comment on the length of the temporary rules in January of this year and that this extension is of a limited duration. Therefore, we believe there is good cause to extend the exemption until November 30, 2010 and find that notice and solicitation of comment on the extension to be impracticable, unnecessary, or contrary to the public interest. 36 The APA also generally requires that an agency publish an adopted rule in the Federal Register 30 days before it becomes effective. 37 However, this requirement does not apply if the agency finds good cause not to delay the effective date. 38 For similar reasons to those explained above, the Commission finds good cause not to delay the effective date. V. Paperwork Reduction Act The Interim Final Temporary Rules do not impose any new collections of information within the meaning of the Paperwork Reduction Act of 1995 ( PRA ), 39 nor do they create any new filing, reporting, recordkeeping, or disclosure reporting requirements for a CCP that is or will be issuing or clearing eligible CDS. Accordingly, we did not submit the Interim Final Temporary Rules to the Office of Management and Budget for review in accordance with the PRA. 40 We requested comment on whether our conclusion that there are no collections of information is correct, and we did not receive any comment. The extension of the expiration dates does not change our analysis. VI. Cost-Benefit Analysis In January 2009, we adopted the Interim Final Temporary Rules under the Securities Act, the Exchange Act and the Trust Indenture Act that exempt eligible CDS that are or will be issued or cleared by a Registered or Exempt CCP and offered and sold only to eligible contract participants from all provisions of the Securities Act, other than the Section 17(a) anti-fraud provision, as well as from the registration requirements under Section 36 This finding also satisfies the requirements of 5 U.S.C. 808(2), allowing the rule amendment to become effective notwithstanding the requirement of 5 U.S.C. 801 (if a Federal agency finds that notice and public comment are impractical, unnecessary or contrary to the public interest, a rule shall take effect at such time as the Federal agency promulgating the rule determines ) U.S.C. 553(d) U.S.C. 553(d)(3) U.S.C et seq U.S.C. 3507(d) and 5 CFR

172 Federal Register / Vol. 74, No. 179 / Thursday, September 17, 2009 / Rules and Regulations cprice-sewell on DSK2BSOYB1PROD with RULES 12 of the Exchange Act and from the provisions of the Trust Indenture Act. The Interim Final Temporary Rules were intended to facilitate the operation of one or more CCPs to act as a clearing agency in the CDS market to reduce some of the risks in the CDS market. Today, we are adopting amendments to such rules to extend their expiration date to November 30, Since the adoption of the Interim Final Temporary Rules, one CCP (ICE Trust) has been actively engaged as a CCP in clearing CDS transactions in the U.S. in accordance with terms of the exemptive orders, and two other CCPs (ICE Europe and Eurex) have begun clearing CDS transactions in Europe. In addition, a number of legislative initiatives relating to the regulation of derivatives, including CDS, have been introduced by members of Congress and recommended by the United States Department of the Treasury. 41 Extending the expiration dates of the Interim Final Temporary Rules for this length of time will allow us to continue to monitor the development and operation of CCPs in the CDS market under the current, evolving regulatory and legislative environment. A CDS is a bilateral contract between two parties, known as counterparties. The value of this financial contract is based on underlying obligations of a single entity, or on a particular security or other debt obligation, or an index of several such entities, securities, or obligations. The obligation of a seller to make payment under a CDS contract is triggered by a default or other credit event as to such entity or entities or such security or securities. Investors may use CDS for a variety of reasons, including to offset or insure against risk in their fixed-income portfolios, to take synthetic positions in bonds or in segments of the debt market as represented by an index, or to capitalize on the volatility in credit spreads during times of economic uncertainty. In recent years, CDS market volumes have rapidly increased. 42 This growth has coincided with a significant rise in the types and number of entities participating in the CDS market See Section I, supra, for additional discussion of developments in this area since the adoption of the Interim Final Temporary Rules. 42 See Semiannual OTC derivatives statistics at end-december 2008, Bank for International Settlements ( BIS ), available at CDSs were initially created to meet the demand of banking institutions looking to hedge and diversify the credit risk attendant with their lending activities. However, other financial institutions such as insurance companies, pension funds, securities firms and hedge funds have entered the CDS market. In a CCP arrangement, both parties entering a CDS novate their trades to the CCP, and the CCP stands in as the counterparty to all parties of the CDS it clears. Through this novation process, the counterparty risk of a CDS is effectively concentrated in the CCP. A. Benefits We are extending the termination date of the Interim Final Temporary Rules that provide exemptions from certain provisions of the Securities Act, the Exchange Act and the Trust Indenture Act, subject to certain conditions described in the CCP exemptive orders and in the exemptions themselves to further facilitate the operation of CCPs in the CDS market. The conditions and representations in the CCP exemptive orders and exemptions require that information be available about the terms of the CDS, the creditworthiness of the CCP or any guarantor, and the clearing and settlement process for the CDS. Additionally, the conditions require that financial information about the reference entity, the issuer of the reference security, or the reference security be publicly available. We believe that the Interim Final Temporary Rules and the exemptions under the Exchange Act, have facilitated and we anticipate will continue to facilitate the operation of CCPs 44 while enabling us to provide oversight to the non-excluded CDS market. 45 We believe that the operation of at least one CCP over the last six months in accordance with our exemptions has increased transparency, 46 increased available information about exposures to particular reference entities or reference securities, 47 and reduced risks to participants in the market for CCPcleared CDS. 48 Not extending the termination date could cause significant disruptions in this market. Therefore, we believe this extension provides important benefits. Absent an exemption, the offer and sale of eligible CDS that are and will be issued or cleared by a Registered or Exempt CCP would have to be registered under the Securities Act, the eligible 44 See Karen Brettell, Banks to submit 95 pct of eligible CDS for clearing (Sep. 1, 2009), available at idusn ?pagenumber=1&virtual BrandChannel= See e.g., Exchange Act Release No , supra Note 10 (our exemptions require that the CCPs provide us with, among other things, access to conduct on-site inspections of facilities, records and personnel). 46 See Testimony of Mark Lenczowski, supra Note See e.g., Exchange Act Release No , supra Note See IntercontinentalExchange, supra Note 13. VerDate Nov<24> :59 Sep 16, 2009 Jkt PO Frm Fmt 4700 Sfmt 4700 E:\FR\FM\17SER1.SGM 17SER1 CDS that are or have been issued or cleared by a Registered or Exempt CCP would have to be registered as a class under the Exchange Act, and the provisions of the Trust Indenture Act would apply. We believe that the Interim Final Temporary Rules exempting the registration of eligible CDS issued or cleared by a Registered or Exempt CCP under certain conditions have facilitated and we anticipate will continue to facilitate the use by eligible contract participants of CDS CCPs. Without also exempting the offers and sales of eligible CDS issued or cleared by a Registered or Exempt CCP from the registration requirements of the Securities Act and the Exchange Act and the provisions of the Trust Indenture Act, we believe that the CCPs would not be able to operate in the manner contemplated by the exemptive orders. The interim final temporary exemptions treat eligible CDS issued or cleared by a Registered or Exempt CCP under the Securities Act and the Exchange Act in the same manner as certain other types of derivative contracts, such as security futures products and standardized options. 49 A Registered or Exempt CCP issuing or clearing eligible CDS benefits from the temporary exemptions because it does not have to file registration statements with us covering the offer and sale of the eligible CDS. The registration form most applicable to a CCP is a Form S 20, which is the form that is used by options clearing houses that do not qualify for our exemption in Securities Act Rule from registering the offer and sale of standardized options. If a CCP is not required to register the offer and sale of eligible CDS (on Form S 20, for example), it would not have to incur the costs of such registration, including legal and accounting costs. Some of these costs, of course, such as the costs of obtaining audited financial statements, may still be incurred as a result of the operations of the entity as a CCP and the regulatory oversight of the central counterparty operations. In addition, if any of the CCPs are entities that are subject to the periodic reporting requirements of the Exchange Act, the cost of filing a registration statement covering the eligible CDS would be lessened further as the information regarding the CCP already would be prepared. The availability of exemptions under the Securities Act, the Exchange 49 See, e.g., Securities Act Section 3(a)(14) [15 U.S.C. 77c(a)(14)], Securities Act Rule 238 [17 CFR ]; Exchange Act Section 12(a) [15 U.S.C. 78l], and Exchange Act Rule 12h 1(d) and (e) [17 CFR h 1(d) and (e)] CFR

173 47724 Federal Register / Vol. 74, No. 179 / Thursday, September 17, 2009 / Rules and Regulations cprice-sewell on DSK2BSOYB1PROD with RULES Act, and the Trust Indenture Act also would mean that CCPs would not incur the costs of preparing disclosure documents describing eligible CDS and from preparing indentures and arranging for the services of a trustee. B. Costs The Interim Final Temporary Rules exempting offers and sales of eligible CDS that are or will be issued or cleared by a Registered or Exempt CCP have facilitated and we anticipate will continue to facilitate the use by eligible contract participants of CDS CCPs that are the subject of exemptive orders at some costs to the CCP or investors. Absent an exemption, a CCP may have to file a registration statement covering the offer and sale of the eligible CDS, may have to satisfy the applicable provisions of the Trust Indenture Act, and may have to register the class of eligible CDS that it has issued or cleared under the Exchange Act, which would provide investors with civil remedies in addition to antifraud remedies. While a CCP registration statement covering eligible CDS (or the offer and sale of such eligible CDS) may provide certain information about the CCP, CDS contract terms, and the identification of reference entities or reference securities, it would not necessarily provide the type of information necessary to assess the credit risk of the reference entity or reference security. Further, while a CCP registration statement would provide information to the CDS market participants, as well as to the market as a whole, a condition of the clearing agency exemption in the exemptive orders is that the CCPs make their audited financial statements and other information about themselves publicly available. We recognize that a consequence of the exemptions has been and will continue to be the unavailability of certain remedies under the Securities Act and the Exchange Act and certain protections under the Trust Indenture Act. While an investor would be able to pursue an antifraud action in connection with the purchase and sale of eligible CDS under Exchange Act Section 10(b), 51 it would not be able to pursue civil remedies under Sections 11 or 12 of the Securities Act. 52 We could still pursue an antifraud action in the offer and sale of eligible CDS issued or cleared by a CCP. 53 We believe that the incremental costs from the extension of the expiration date of the Interim Final Temporary Rules will be minimal U.S.C. 78j(b) U.S.C. 77k and 77l. 53 See 15 U.S.C. 77q and 15 U.S.C. 78j(b). because the amendments are merely an extension of such Interim Final Temporary Rules and such extension will not affect the information and remedies available to investors as a result of the Interim Final Temporary Rules. VII. Consideration of Impact on the Economy, Burden on Competition and Promotion of Efficiency, Competition and Capital Formation Section 23(a)(2) of the Exchange Act 54 requires us, when adopting rules under the Exchange Act, to consider the impact that any new rule would have on competition. Section 23(a)(2) prohibits us from adopting any rule that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act. In addition, Section 2(b) 55 of the Securities Act and Section 3(f) 56 of the Exchange Act require us, when engaging in rulemaking where we are required to consider or determine whether an action is necessary or appropriate in the public interest, to also consider whether the action will promote efficiency, competition, and capital formation. The Interim Final Temporary Rules we are extending today exempt eligible CDS issued or cleared by a Registered or Exempt CCP from all provisions of the Securities Act, other than the Section 17(a) antifraud provision, as well as from the registration requirements under Section 12 of the Exchange Act and the provisions of the Trust Indenture Act. Because these interim final temporary exemptions are available to any Registered or Exempt CCP offering and selling eligible CDS, we do not believe that the exemptions impose a burden on competition. Although only one CCP is currently clearing and settling CDS in the U.S., we believe the extension will increase the opportunity for other CCPs to compete in the marketplace. We also believe that the ability to settle CDS through CCPs has improved and we anticipate will continue to improve the transparency of the CDS market and provide greater assurance to participants as to the capacity of the eligible CDS counterparty to perform its obligations under the eligible CDS. ICE Trust, for example, makes available on its Web site information about open interests, or net exposure, volume and pricing of CDS transactions. We believe that increased transparency in the CDS market could help to decrease further U.S.C. 78w(a)(2) U.S.C. 77b(b) U.S.C. 78c(f). VerDate Nov<24> :59 Sep 16, 2009 Jkt PO Frm Fmt 4700 Sfmt 4700 E:\FR\FM\17SER1.SGM 17SER1 market turmoil and thereby facilitate the capital formation process. VIII. Regulatory Flexibility Act Certification The Commission certified pursuant to 5 U.S.C. 605(b) that the Interim Final Temporary Rules would not have a significant economic impact on a substantial number of small entities. The Interim Final Temporary Rules exempt eligible CDS that are or will be issued or cleared by a Registered or Exempt CCP. None of the entities that are eligible to meet the requirements of the exemption from registration under Section 17A is a small entity. We received no comments on the certification. IX. Statutory Authority and Text of the Rules and Amendments The amendments described in this release are being adopted under the authority set forth in Sections 18, 19 and 28 of the Securities Act; Sections 12(h), 23(a) and 36 of the Exchange Act; and Section 304(d) of the Trust Indenture Act. List of Subjects in 17 CFR Parts 230, 240 and 260 Reporting and recordkeeping requirements, Securities. Text of the Rules and Amendments Accordingly, we are temporarily amending 17 CFR parts 230, 240, and 260 as follows and the expiration date for the interim final temporary rules published January 22, 2009 (74 FR 3967) is extended from September 25, 2009, to November 30, PART 230 GENERAL RULES AND REGULATIONS, SECURITIES ACT OF The authority citation for Part 230 continues to read, in part, as follows: Authority: 15 U.S.C. 77b, 77c, 77d, 77f, 77g, 77h, 77j, 77r, 77s, 77z 3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78t, 78w, 78ll(d), 78mm, 80a 8, 80a 24, 80a 28, 80a 29, 80a 30, and 80a 37, unless otherwise noted. * * * * * and [Amended] 2. In (c)T, in the last sentence, remove the words September 25, 2009 and add, in their place, the words November 30, In T(e), remove the words September 25, 2009 and add, in their place, the words November 30, 2010.

174 Federal Register / Vol. 74, No. 179 / Thursday, September 17, 2009 / Rules and Regulations cprice-sewell on DSK2BSOYB1PROD with RULES PART 240 GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF The authority citation for Part 240 continues to read, in part, as follows: Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z 2, 77z 3, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 78j, 78j 1, 78k, 78k 1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u 5, 78w, 78x, 78ll, 78mm, 80a 20, 80a 23, 80a 29, 80a 37, 80b 3, 80b 4, 80b 11, and 7201 et seq.; and 18 U.S.C. 1350, unless otherwise noted. * * * * * a 10T and h 1 [Amended] 5. In a 10T(b), remove the words September 25, 2009 and add, in their place, the words November 30, In h 1(h)T, in the last sentence, remove the words September 25, 2009 and add, in their place, the words November 30, PART 260 GENERAL RULES AND REGULATIONS, TRUST INDENTURE ACT OF The authority citation for Part 260 continues to read as follows: Authority: 15 U.S.C. 77eee, 77ggg, 77nnn, 77sss, 78ll(d), 80b 3, 80b 4, and 80b d 11T [Amended] 8. Section 260.4d 11T is amended by removing the words September 25, 2009 and adding, in their place, the words November 30, 2010 in the last sentence. September 14, By the Commission. Elizabeth M. Murphy, Secretary. [FR Doc. E Filed ; 8:45 am] BILLING CODE P DEPARTMENT OF HEALTH AND HUMAN SERVICES Food and Drug Administration 21 CFR Parts 510 and 522 [Docket No. FDA 2009 N 0665] New Animal Drugs; Fomepizole AGENCY: Food and Drug Administration, HHS. ACTION: Final rule. List of Subjects SUMMARY: The Food and Drug Administration (FDA) is amending the 21 CFR Part 510 animal drug regulations to reflect the original approval of an abbreviated new animal drug application (ANADA) filed by Synerx Pharma, LLC. The ANADA provides for the veterinary prescription use of fomepizole injectable solution as an antidote for ethylene glycol (antifreeze) poisoning in dogs. DATES: This rule is effective September 17, FOR FURTHER INFORMATION CONTACT: John K. Harshman, Center for Veterinary Medicine (HFV 104), Food and Drug Administration, 7500 Standish Pl., Rockville, MD 20855, , e- mail: [email protected]. SUPPLEMENTARY INFORMATION: Synerx Pharma, LLC, 100 N. State St., Newtown, PA , filed ANADA that provides for veterinary prescription use of Fomepizole for Injection as an antidote for ethylene glycol (antifreeze) poisoning in dogs. Synerx Pharma, LLC s Fomepizole for Injection is approved as a generic copy of Paladin Laboratories ANTIZOL VET (fomepizole), approved under NADA The ANADA is approved as of 2009, and the regulations are amended in 21 CFR to reflect the approval. In addition, Synerx Pharma, LLC, is not currently listed in the animal drug regulations as a sponsor of an approved application. Accordingly, 21 CFR (c) is being amended to add entries for this sponsor. In accordance with the freedom of information provisions of 21 CFR part 20 and 21 CFR (e)(2)(ii), a summary of safety and effectiveness data and information submitted to support approval of this application may be seen in the Division of Dockets Management (HFA 305), Food and Drug Administration, 5630 Fishers Lane, rm. 1061, Rockville, MD 20852, between 9 a.m. and 4 p.m., Monday through Friday. FDA has determined under 21 CFR that this action is of a type that does not individually or cumulatively have a significant effect on the human environment. Therefore, neither an environmental assessment nor an environmental impact statement is required. This rule does not meet the definition of rule in 5 U.S.C. 804(3)(A) because it is a rule of particular applicability. Therefore, it is not subject to the congressional review requirements in 5 U.S.C Administrative practice and procedure, Animal drugs, Labeling, VerDate Nov<24> :59 Sep 16, 2009 Jkt PO Frm Fmt 4700 Sfmt 4700 E:\FR\FM\17SER1.SGM 17SER1 Reporting and recordkeeping requirements. 21 CFR Part 522 Animal drugs. Therefore, under the Federal Food, Drug, and Cosmetic Act and under authority delegated to the Commissioner of Food and Drugs and redelegated to the Center for Veterinary Medicine, 21 CFR parts 510 and 522 are amended as follows: PART 510 NEW ANIMAL DRUGS 1. The authority citation for 21 CFR part 510 continues to read as follows: Authority: 21 U.S.C. 321, 331, 351, 352, 353, 360b, 371, 379e. 2. In , in the table in paragraph (c)(1), alphabetically add an entry for Synerx Pharma, LLC ; and in the table in paragraph (c)(2), numerically add an entry for to read as follows: Names, addresses, and drug labeler codes of sponsors of approved applications. * * * * * (c) * * * (1) * * * Firm name and address Drug labeler code * * * * * Synerx Pharma, LLC, N. State St., Newtown, PA * * * * * (2) * * * Drug labeler code Firm name and address * * * * * Synerx Pharma, LLC, 100 N. State St., Newtown, PA * * * * * PART 522 IMPLANTATION OR INJECTABLE DOSAGE FORM NEW ANIMAL DRUGS 3. The authority citation for 21 CFR part 522 continues to read as follows: Authority: 21 U.S.C. 360b. 4. In , revise paragraph (b) to read as follows: Fomepizole. * * * * *

175 SECURITIES AND EXCHANGE COMMISSION (Release No ; File No. S ) December 24, 2008 Order Pursuant to Section 36 of the Securities Exchange Act of 1934 Granting Temporary Exemptions from Sections 5 and 6 of the Exchange Act for Broker-Dealers and Exchanges Effecting Transactions in Credit Default Swaps I. Background In response to the recent turmoil in the financial markets, the Securities and Exchange Commission ("Commission") has taken multiple actions to protect investors and ensure the integrity of the nation's securities markets. 1 Today, we are taking further action designed to address concerns related to the market in credit default swaps ( CDS ). The over-the-counter ( OTC ) market for CDS has been a source of concerns to us and other financial regulators. These concerns include the systemic risk posed by CDS, highlighted by the possible inability of parties to meet their obligations as counterparties and the potential resulting adverse effects on other markets and the 1 A nonexclusive list of the Commission's actions to stabilize financial markets during this credit crisis include: adopting a package of measures to strengthen investor protections against naked short selling, including rules requiring a hard T+3 close-out, eliminating the options market maker exception of Regulation SHO, and expressly targeting fraud in short selling transactions (See Securities Exchange Act Release No (September 17, 2008), 73 FR (September 23, 2008)); issuing an emergency order to enhance protections against naked short selling in the securities of primary dealers, Fannie Mae, and Freddie Mac (See Securities Exchange Act Release No (July 15, 2008), 73 FR (July 21, 2008)); taking temporary emergency action to ban short selling in financial securities (See Securities Exchange Act Release No (September 18, 2008), 73 FR (September 24, 2008)); approving emergency rulemaking to ensure disclosure of short positions by hedge funds and other institutional money managers (See Securities Exchange Act Release No A (September 21, 2008), 73 FR (September 25, 2008)); proposing rules to strengthen the regulation of credit rating agencies and making the limits and purposes of credit ratings clearer to investors (See Securities Exchange Act Release No (June 16, 2008), 73 FR (June 25, 2008); entering into a Memorandum of Understanding with the Board of Governors of the Federal Reserve System ("FRB") to make sure key federal financial regulators share information and coordinate regulatory activities in important areas of common interest (See Memorandum of Understanding Between the U.S. Securities and Exchange Commission and the Board of Governors of the Federal Reserve System Regarding Coordination and Information Sharing in Areas of Common Regulatory and Supervisory Interest (July 7, 2008),

176 financial system. 2 Recent credit market events have demonstrated the seriousness of these risks in a CDS market operating without meaningful regulation, transparency, 3 or central counterparties ( CCPs ). 4 These events have emphasized the need for CCPs as mechanisms to help control such risks. 5 A CCP for CDS could be an important step in reducing the counterparty risks inherent in the CDS market, and thereby help mitigate potential systemic impacts. In November 2008, the President s Working Group on Financial Markets stated that the implementation of a CCP for CDS was a top priority 6 and, in furtherance of this recommendation, the Commission, the FRB and the Commodity Futures Trading Commission ( CFTC ) signed a Memorandum of Understanding 7 that establishes a framework for consultation and information sharing on issues related to CCPs for CDS. Given the continued uncertainty in this market, taking In addition to the potential systemic risks that CDS pose to financial stability, we are concerned about other potential risks in this market, including operational risks, risks relating to manipulation and fraud, and regulatory arbitrage risks. See Policy Objectives for the OTC Derivatives Market, The President s Working Group on Financial Markets (November 14, 2008), ( Public reporting of prices, trading volumes and aggregate open interest should be required to increase market transparency for participants and the public. ). See The Role of Credit Derivatives in the U.S. Economy Before the H. Agric. Comm., 110 th Cong. (2008) (Statement of Erik Sirri, Director of the Division of Trading and Markets, Commission). See id. See Policy Objectives for the OTC Derivatives Market, The President s Working Group on Financial Markets (November 14, 2008), See also Policy Statement on Financial Market Developments, The President's Working Group on Financial Markets (March 13, 2008), Progress Update on March Policy Statement on Financial Market Developments, The President's Working Group on Financial Markets (October 2008), See Memorandum of Understanding Between the Board of Governors of the Federal Reserve System, the U.S. Commodity Futures Trading Commission and the U.S. Securities and Exchange Commission Regarding Central Counterparties for Credit Default Swaps (November 14, 2008), 2

177 action to help foster the prompt development of CCPs, including granting conditional exemptions from certain provisions of the federal securities laws, is in the public interest. A CDS is a bilateral contract between two parties, known as counterparties. The value of this financial contract is based on underlying obligations ("reference obligations") of a single entity (a "reference entity") or on a particular security or other debt obligation ("reference security"), or an index of several such entities, securities, or obligations. The obligation of a seller under a CDS to make payments under a CDS contract is triggered by a default or other credit event as to such entity or entities or such security or securities. Investors may use CDS for a variety of reasons, including to offset or insure against risk in their fixed-income portfolios, to take positions in bonds or in segments of the debt market as represented by an index, or to capitalize on the volatility in credit spreads during times of economic uncertainty. In recent years, CDS market volumes have rapidly increased. 8 This growth has coincided with a significant rise in the types and number of entities participating in the CDS market. 9 The Commission's authority over this OTC market for CDS is limited. Specifically, Section 3A of the Securities Exchange Act of 1934 ("Exchange Act") limits the Commission's authority over swap agreements, as defined in Section 206A of the Gramm-Leach-Bliley Act. 10 For those CDS that are swap agreements, the exclusion See Semiannual OTC derivatives statistics at end-december 2007, Bank for International Settlements ("BIS"), CDS were initially created to meet the demand of banking institutions looking to hedge and diversify the credit risk attendant with their lending activities. However, financial institutions such as insurance companies, pension funds, securities firms, and hedge funds have entered the CDS market. 15 U.S.C. 78c-1. Section 3A excludes both a non-security-based and a security-based swap agreement from the definition of "security" under Section 3(a)(10) of the Exchange Act, 15 U.S.C. 78c(a)(10). Section 206A of the Gramm-Leach-Bliley Act defines a "swap agreement" as "any agreement, contract, or transaction between eligible contract participants (as defined in section 3

178 from the definition of security in Section 3A of the Exchange Act, and related provisions, will continue to apply. The Commission's action today does not affect these CDS, and this order does not apply to them. For those CDS that are not swap agreements ("non- excluded CDS"), the Commission's action today provides certain exemptions to exchanges that effect transactions in such non-excluded CDS and to brokers and dealers that effect transactions in non-excluded CDS on exchanges, and is designed to facilitate the development of one or more CDS exchanges. In companion actions today, the Commission is temporarily exempting, subject to conditions, LCH.Clearnet Ltd. from the requirement to register as a clearing agency under Section 17A of the Exchange Act solely to perform the functions of a clearing 11 agency for non-excluded CDS transactions. 12 To facilitate the operation of one or more CCPs for the CDS market, the Commission has also approved interim final temporary rules providing exemptions under the Securities Act of 1933 and Exchange Act for nonexcluded CDS a(12) of the Commodity Exchange Act...)... the material terms of which (other than price and quantity) are subject to individual negotiation." 15 U.S.C. 78c note. The Commission found that credit default options and credit default basket options, which are essentially exchange-traded equivalents of OTC CDS, proposed by the Chicago Board Options Exchange, were securities because they are options based on the value of a security or securities, options on an interest in a security or securities, or options based on the value of an interest in a security or securities. See Securities Exchange Act Release No (June 6, 2007), 72 FR 32372, (June 12, 2007) (File No. SR-CBOE ) ( CBOE CDO Order ); Securities Exchange Act Release No (August 17, 2007), 72 FR (August 22, 2008) (File No. SR-CBOE ) (together with the CBOE CDO Order, the CBOE Orders ). The Commission made special note that, "because credit default options will be exchange-traded and not individually negotiated,... they are not qualifying swap agreements under Section 206A of the Gramm-Leach-Bliley Act,... and, therefore, not excluded from the definition of security by Section 3A of the Exchange Act." 72 FR at n. 39. Unlike the options at issue in the CBOE Orders, which had fixed payouts in the event of a default or other credit event, the CDS that are the subject of the Commission s actions today may provide for the delivery of a debt security or securities against a specified amount, or a cash payment based on the value of a debt security or securities. For those CDS that are not qualifying swap agreements, that have payouts tied to the delivery of debt securities, or that are based on the value of debt securities, there may be arguments in addition to those in the CBOE Orders that such CDS are security options. See Securities Exchange Act Release No (December 24, 2008) (File No. S ). 4

179 In conjunction with these exemptions, the Commission in this order is providing a temporary exemption to any exchange that effects or reports transactions in non-excluded CDS and is not otherwise subject to the requirements under Sections 5 and 6 of the Exchange Act 13 from the requirement to register as a national securities exchange, and to any broker or dealer that effects or reports transactions in non-excluded CDS on such an exempt exchange. 14 The exemptions in this order are subject to the conditions discussed below. The Commission believes that the CDS market would benefit from the development of exchanges for non-excluded CDS. As the Commission has previously noted when approving a proposed rule change by the Chicago Board Options Exchange to list and trade certain CDS contracts, there are several benefits to trading such products on exchanges rather than over-the-counter. 15 These benefits include a centralized market, standardized contract specifications, transparent quotations, and transaction reporting. 16 Exchange trading would permit real-time matching of orders, and enhance transparency of the CDS market by promoting dissemination of pre-trade quotations as well as posttrade transaction information. Additional pre-trade and post-trade transparency would enable exchange subscribers to better assess market depth and liquidity and allow regulators to better surveil for violations of the securities laws U.S.C. 78e and 78f. A national securities exchange that effects transactions in CDS would continue to be required to comply with all requirements under the Exchange Act applicable to such transactions. A national securities exchange could form subsidiaries or affiliates that operate exchanges exempt under this order. Any subsidiary or affiliate of a registered exchange could not integrate, or otherwise link, the exempt CDS exchange with the registered exchange, including the premises or property of such exchange for effecting or reporting a transaction, without being considered a "facility of the exchange." See Section 3(a)(2) of the Exchange Act, 15 U.S.C. 78c(a)(2). See CBOE Orders, supra note 11. Id. 5

180 Accordingly, the Commission is using its authority under Section 36 of the Exchange Act 17 to exempt temporarily any exchange that effects transactions in nonexcluded CDS and is not otherwise subject to the requirements under Sections 5 and 6 of the Exchange Act, 18 and the rules and regulations thereunder, from the requirement to register as a national securities exchange under Section 6 of the Exchange Act, 19 and from the prohibition in Section 5 of the Exchange Act 20 against effecting transactions as an exchange unless it is registered as a national securities exchange or exempt from registration due to the limited volume of its transactions. The Commission finds that such action is necessary and appropriate in the public interest and consistent with the protection of investors to facilitate the operation of one or more CDS exchanges in connection with the establishment of one or more CCP that clear and settle non-excluded CDS. 21 The Commission is also temporarily exempting brokers and dealers from the Section 5 prohibition against effecting or reporting transactions in securities otherwise than on a national securities exchange or an exchange that is exempt from registration due to its limited volume. The conditions to these exemptions will enable to the Commission to oversee the development of CDS exchanges, and to take such additional action as we may deem necessary to promote the public interest and the protection of investors. Moreover, the limited duration of the exemptions provided today will enable one or more CDS exchanges to become operational while we gain experience with the CDS market and U.S.C. 78mm. 15 U.S.C. 78e and 78f. 15 U.S.C. 78f. 15 U.S.C. 78e. See supra note 12. 6

181 evaluate public input, including comments we receive on the temporary exemptions granted in today's order. II. Discussion Section 5 of the Exchange Act states that "[i]t shall be unlawful for any broker, dealer, or exchange, directly or indirectly, to make use of the mails or any means or instrumentality of interstate commerce for the purpose of using any facility of an exchange... to effect any transaction in a security, or to report any such transactions, unless such exchange (1) is registered as a national securities exchange under section 6 of [the Exchange Act], or (2) is exempted from such registration... by reason of the limited volume of transactions effected on such exchange." 22 Section 6 of the Exchange Act sets forth a procedure whereby an exchange 23 may register as a national securities exchange. 24 Section 36 of the Exchange Act provides that the Commission, "by rule, regulation, or order, may conditionally or unconditionally exempt any person, security, or transaction, or any class or classes of persons, securities, or transactions, from any provision or provisions of [the Exchange Act] or of any rule or regulation thereunder, to the extent that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors." To facilitate the establishment of one or more exchanges for non-excluded CDS, the Commission is exercising its authority under U.S.C. 78e. Section 3(a)(1) of the Exchange Act, 15 U.S.C. 78c(a)(1), defines "exchange." Rule 3b-16 under the Exchange Act, 17 CFR 240.3b-16, defines certain terms used in the statutory definition of exchange. See Securities Exchange Act Release No (December 8, 1998), 63 FR (December 22, 1998) ("Regulation ATS Adopting Release") (adopting Rule 3b-16 in addition to Regulation ATS). 15 U.S.C. 78f. Section 6 of the Exchange Act also sets forth various requirements to which a national securities exchange is subject. 7

182 Section 36 of the Exchange Act to temporarily exempt any exchange, broker or dealer that effects transactions in non-excluded CDS from the prohibition in Section 5 of the Exchange Act and (in the case of exchanges) the requirements in Section 6 of the Exchange Act and the rules and regulations thereunder. These temporary exemptions are subject to certain conditions, discussed further below. These conditions on exchanges generally mirror those applicable to alternative trading systems, which are securities trading systems that the Commission previously exempted from exchange registration. 25 This temporary exemption is designed to allow brokers, dealers, and exchanges to effect transactions in non-excluded CDS on exchanges, subject to certain conditions. The Commission believes the exemption, together with the conditions, is necessary in the public interest and consistent with the protection of investors. In addition, the Commission believes that these conditions will not impede the ability of brokers, dealers, and exchanges to compete in the market for CDS. The limited term of this exemption will provide the Commission with adequate time to evaluate the application of this exemption to non-excluded CDS exchanges, and whether such conditions should be modified. In particular, the Commission will be considering whether Regulation ATS, with or without modifications, could apply to systems that match orders in non-excluded CDS of multiple buyers and sellers. 25 See Regulation ATS, 17 CFR et seq. In 1998, the Commission exercised its exemptive authority under Section 36 of the Exchange Act and its general authority under Section 11A of the Exchange Act, 15 U.S.C. 78k-1, to establish a regulatory framework for "alternative trading systems," which perform many of the same functions as exchanges. Under this framework, an entity that, like an exchange, matches the orders in securities of multiple buyers and sellers according to established, non-discretionary methods is exempt from the definition of "exchange" if it instead registers as a broker-dealer and complies with Regulation ATS. Regulation ATS is designed, among other things, "to adopt a regulatory framework that addresses [the Commission s] concerns without jeopardizing the commercial viability of these markets." Regulation ATS Adopting Release, supra note 23, 63 FR at

183 This temporary exemption is available only to exchanges that effect transactions in non-excluded CDS. To the extent that an exchange is otherwise subject to the requirements of Section 5 of the Exchange Act, it must register with the Commission as a national securities exchange under Section 6 of the Exchange Act and the rules and regulations thereunder or comply with the terms of another exemption. Similarly, a broker or dealer is temporarily exempt from the prohibition in Section 5 only to the extent that it effects transactions in non-excluded CDS on an exchange or reports such transactions on an exchange. The Commission believes that this order will facilitate the establishment of one or more exchanges that effect transactions in non-excluded CDS. For this reason and the reasons discussed above, 26 the Commission believes that these exemptions are necessary or appropriate in the public interest and consistent with the protection of investors. As noted, the conditions under which CDS exchanges must operate to qualify for the exemption from exchange registration being granted today are modeled on requirements applicable to alternative trading systems. Like an alternative trading system, a CDS exchange must keep records about its operations, its subscribers, and their orders. 27 A CDS exchange also must provide the Commission with trading information on a quarterly basis 28 and establish procedures to ensure the confidential treatment of trading information. 29 Likewise, a CDS exchange must permit the Commission to examine its premises, systems, and records and must cooperate with the examination of See supra notes and accompanying text. Compare 17 CFR (b)(8), , and Compare 17 CFR (b)(9). Compare 17 CFR (b)(10). 9

184 its subscribers. 30 These requirements are designed to allow the Commission to monitor market developments, to ascertain how new entrants are affecting the national market system, and to promote compliance with the federal securities laws generally. The Commission believes that temporarily exempting exchanges that effect transactions in non-excluded CDS from exchange registration, subject to these conditions, is necessary or appropriate in the public interest and is consistent with the protection of investors. A. Exemption from Sections 5 and 6 of the Exchange Act for Exchanges 1. No Self-Regulatory Authority To be exempt under this order, the exchange must not: (a) set rules governing the conduct of subscribers other than the conduct of such subscribers trading on such exchange; or (b) discipline subscribers under the Exchange Act other than by exclusion from trading. That is, an exempted exchange may not exercise self-regulatory authority over its subscribers. The Commission intends this condition to be the same requirement as applies to alternative trading systems under Regulation ATS. As described in the Regulation ATS Adopting Release, self-regulatory authority would include, for example, any restrictions on subscribers' activities outside of the exchange or imposing as a condition of participation any requirement for which the exchange would examine subscribers for compliance. The requirement in Regulation ATS and this condition are based on the Commission's belief that an organization, association, or group of persons that could exercise self-regulatory authority over its subscribers should be registered as an self-regulatory organization ("SRO") and subject to the full responsibilities and supervision that registration entails. The Commission continues to believe that rules 30 Compare 17 CFR (b)(7). 10

185 governing exchange subscriber conduct may be imposed and enforced only by SROs because of the potential that they may be applied for anti-competitive purposes. However, as we noted in connection with adopting Regulation ATS, the Commission does not intend this condition to preclude a trading system from applying credit standards to its subscribers or requiring subscribers to provide financial information relevant to their activity on the system Recordkeeping In addition, to be exempt under this order, an exchange must maintain an audit trail of orders that it receives and transactions that it effects. These records are critical to the Commission's ability to oversee the CDS market, detect and deter illicit market activity, and take action as necessary to address manipulation and fraud, including insider trading. These recordkeeping and record preservation requirements are comparable to those required under Regulation ATS and tailored to apply to non-excluded CDS. 32 Specifically, an exchange must make and keep the following records for a period of not less than three years, the first two years in an easily accessible place: A record of subscribers in the exchange (identifying any affiliations between the exchange and subscribers in the exchange, including common directors, officers, or owners); Daily summaries of trading, including: (a) information identifying CDS in which transactions are effected; and (b) transaction volume, expressed in terms of number of trades and total U.S. dollar notional value; See Regulation ATS Adopting Release, supra note 23, 63 FR at See 17 CFR (b)(8), , and

186 Time-sequenced records of order information, including: (a) identity of the party entering an order; (b) identification of non-excluded CDS contract (including the reference entity, security, or index, and notional value); (c) date and time that order was received; (d) price (whether expressed as credit spread, rate, strike, or coupon); (e) whether the order is to buy or sell and any order conditions; (f) any subsequent modification or cancellation of the order; (g) date and time the order was executed, the size (e.g., notional value amount) executed, and the price; and (h) identity of the parties to the transaction. 33 In addition, as a condition of this exemption, an exchange must preserve the following records: For a period of not less than three years, the first two years in an easily accessible place, all notices provided by such exchange to subscribers generally, whether written or communicated through automated means, including, but not limited to, notices addressing hours of system operations, system malfunctions, changes to system procedures, maintenance of hardware and software, instructions 33 These information items, with one exception, must be recorded and kept current by alternative trading systems pursuant to Regulation ATS. See 17 CFR (b)(8) and (c). Alternative trading systems are not required by Regulation ATS to keep records of the identity of the party entering an order. The Commission believes, however, that such information could be important to its ability to enforce the securities laws and is, therefore, to be kept as a condition to this exemption. Alternative trading systems must be registered with the Commission as a brokerdealer, and are therefore subject to additional Commission recordkeeping rules. See 17 CFR (b)(1). An exchange that avails itself of this exemption, however, may not otherwise be subject to requirements under the Exchange Act. 12

187 pertaining to access to the market and denials of, or limitations on, access to the exchange; and During the life of the enterprise and of any successor enterprise, the exchange's organizational documents and copies of reports filed with the Commission pursuant to this exemption. An exchange exempt pursuant to this order may comply with these recordkeeping and record preservation requirements through use of a service bureau, depository, or other recordkeeping service that maintains and preserves these records on behalf of the exchange. An agreement with a service bureau, depository, or other recordkeeping service will not relieve the exchange from the responsibility to prepare and maintain the specified records. The Commission believes that the types of records an exchange would be required to make and keep pursuant to this condition are records an exchange would keep in the normal course of its business and, therefore, that this condition is not unduly burdensome. 3. Regulatory Reporting An exchange that relies on this order must, within five days of commencing operation, submit a notice to the Commission 34 that includes the following information: 1. Full legal name of the exchange; 2. A description of the exchange's ownership structure; 3. Contact person and contact information; 4. A general description of the CDS contracts that trade on the exchange; and 34 Any such notice should be sent to: Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549, and be noted as regarding "CDS Exchange Exemption from Registration." 13

188 5. A description of how the exchange operates. This information is essential for the Commission to understand developments in the CDS market. Any subsequent action regarding this exemption for example, whether it should be modified, extended, or allowed to expire is predicated on understanding which market participants are relying on it. In the future, different regulatory frameworks may be appropriate for different market participants. These notices will enable the Commission to commence a dialog with the relevant market participants. In addition, an exchange that relies on this exemption must report the following information to the Commission within 30 days of the end of each quarter: 1. The total dollar volume of transactions executed during the quarter, broken down by reference entity, security, or index; 2. The total unit volume and/or notional amount executed during the quarter, broken down by reference entity, security, or index; and 3. A list of all subscribers that effected transactions on the exchange during the quarter. Reporting of this information will assist the Commission in carrying out its responsibility to supervise and regulate the securities markets. This information is similar to that which an alternative trading system must provide quarterly See 17 CFR (b)(9)(i); Form ATS-R, 17 CFR The Commission notes that an alternative trading system is not required to report to the Commission its transaction volume by security; only aggregate volumes must be reported to the Commission. Reports in most equity securities and many debt securities traded on an ATS are required to be reported to an SRO on a transaction-by-transaction basis. This is the not the case for CDS. For this reason, the Commission is conditioning this exemption on an exchange providing quarterly information to the Commission on trading volume broken down by reference entity, security, or index. The Commission believes it is appropriate to require this more specific information from CDS exchanges to better understand the development of the exchange-traded market in non-excluded CDS. 14

189 4. Confidentiality of Trading Information An exchange relying on this order also must establish adequate safeguards and procedures to protect subscribers' confidential trading information. Such safeguards and procedures shall include: (a) limiting access to the confidential trading information of subscribers to those employees of the exchange who are operating the system or responsible for its compliance with this exemption or any other applicable rules; and (b) implementing standards controlling employees of the exchange trading for their own accounts. The exchange must adopt and implement adequate oversight procedures to ensure that the safeguards and procedures established pursuant to this condition are followed. This condition, which closely tracks a requirement applicable to alternative trading systems, 36 is designed to prevent the misuse of subscriber trading information that is available to the exchange. This should strengthen confidence in the exchange, promoting participation. 5. Commission Jurisdiction Finally, an exchange that relies on this order must provide access to the Commission to conduct on-site inspections of its facilities (including automated systems and systems environment), records, and personnel related to exchange activities. The exchange must cooperate with the Commission in connection with the investigation of any exchange subscribers. This requirement is similar to one in Regulation ATS that applies to alternative trading systems. 37 Recent market events have clearly demonstrated the importance of the CDS market and its potential to impact other markets, including the equity securities markets See 17 CFR (b)(10). See 17 CFR (b)(7). 15

190 It is therefore imperative that the Commission have examination authority over any exchange that effects transactions in non-excluded CDS, with regard to its compliance with the conditions of the exemption provided under this order as well as enforcement of the antifraud provisions of the securities laws, including the prohibitions on insider trading. Particularly because the CDS market is so large and involves many market participants that are not directly subject to the Commission's authority, cooperation by the CDS exchange with the Commission in any investigation or enforcement action is crucial. B. Exemption from Section 5 of the Exchange Act for Brokers and Dealers Absent an exemption, Section 5 of the Exchange Act 38 would prohibit brokers and dealers from effecting transactions in non-excluded CDS on an exchange that is not a national securities exchange because of that exchange's reliance on this order. The Commission finds that temporarily exempting brokers and dealers that effect transactions in non-excluded CDS on such an exchange from this restriction in Section 5 is necessary and appropriate in the public interest and is consistent with the protection of investors because it will facilitate brokers' and dealers' use of CDS exchanges, which for the reasons noted above the Commission believes would be beneficial. Without also exempting brokers and dealers from this Section 5 requirement, the Commission's temporary exemption of CDS exchanges would be ineffective, because brokers and dealers would not be permitted to effect transactions on those exchanges. Section 5 of the Exchange Act recognizes that there are situations where brokers and dealers should be permitted to trade on an exchange that is not registered as a U.S.C. 78e. 16

191 national securities exchange. Section 5 provides in relevant part that brokers and dealers may effect transactions on an exchange that the Commission, by reason of the limited volume of transactions effected on such exchange, has exempted from registration under Section 6. Brokers and dealers are also permitted to effect transactions on alternative trading systems, which are exempted from the definition of "exchange" and thus do not fall within the restriction of Section 5. For the reasons noted above, the Commission finds that it is consistent with the public interest and the protection of investors to grant a temporary exemption from Section 5 of the Exchange Act to any broker or dealer that effects transactions in non-excluded CDS, or reports such transactions, on an exchange that is exempted pursuant to this order. C. Solicitation of Comments The Commission intends to monitor closely the development of the CDS market and intends to determine to what extent, if any, additional regulatory action may be necessary. For example, as circumstances warrant, certain conditions could be added, altered, or eliminated. Moreover, because this exemption is temporary, the Commission will in the future consider whether it should be extended or allowed to expire. The Commission believes it would be prudent to solicit public comment on its action today, and what action it should take with respect to the CDS market in the future. The Commission is soliciting public comment on all aspects of this exemption, including: 1. Whether the length of this temporary exemption (until September 25, 2009) is appropriate. If not, what should the appropriate duration be? 2. Whether the conditions to the exemption are appropriate. Why or why not? Should other conditions apply? Are any of the present conditions to 17

192 the exemption provided in this order unnecessary? If so, please specify and explain why such conditions are not needed. 3. Whether exchanges relying on this exemption should ultimately be required to register under the Exchange Act. Why or why not? 4. Whether exchanges for non-excluded CDS can reasonably comply with Regulation ATS. Why or why not? If not, what aspects or conditions of Regulation ATS are problematic? Comments may be submitted by any of the following methods: Electronic Comments: Use the Commission s Internet comment form ( Send an to [email protected]. Please include File Number S on the subject line; or Use the Federal erulemaking Portal ( Follow the instructions for submitting comments. Paper Comments: Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC All submissions should refer to File Number S This file number should be included on the subject line if 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 Web site ( Comments are also available for public 18

193 inspection and copying 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; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. III. Conclusion IT IS HEREBY ORDERED pursuant to Section 36 of the Exchange Act that until September 25, 2009, an exchange is exempt from the requirements of Sections 5 and 6 of the Exchange Act 39 and the rules and regulations thereunder to the extent that such exchange effects or reports transactions in non-excluded CDS and is not otherwise required to register as a national securities exchange, subject to the following conditions: (1) The exchange must not: (a) set rules governing the conduct of subscribers other than the conduct of such subscribers trading on such exchange; or (b) discipline subscribers other than by exclusion from trading; (2) The exchange must make and keep for a period of not less than three years, the first two years in an easily accessible place, the following records: A record of subscribers in the exchange (identifying any affiliations between the exchange and subscribers in the exchange, including common directors, officers, or owners); Daily summaries of trading, including (a) information identifying CDS in which transactions are effected; and (b) transaction volume, expressed in terms of number of trades and total U.S. dollar notional value; U.S.C. 78e and 78f. 19

194 Time-sequenced records of order information, including: (a) identity of the party entering an order; (b) identification of non-excluded CDS contract (including the reference entity, security, or index, and notional value); (c) date and time that order was received; (d) price (whether expressed as credit spread, rate, strike, or coupon); (e) whether the order is to buy or sell and any order conditions; (f) any subsequent modification or cancellation of the order; (g) date and time the order was executed, the size (e.g., notional value amount) executed, and the price; and (h) identity of the parties to the transaction; (3) The exchange must preserve the following records: For a period of not less than three years, the first two years in an easily accessible place, all notices provided by such exchange to subscribers generally, whether written or communicated through automated means, including, but not limited to, notices addressing hours of system operations, system malfunctions, changes to system procedures, maintenance of hardware and software, instructions pertaining to access to the market and denials of, or limitations on, access to the exchange; and During the life of the enterprise and of any successor enterprise, the exchange's organizational documents and copies of reports filed with the Commission pursuant to this exemption; (4) An exchange must, within five days of commencing operation, submit a notice to the Commission that includes the following information: Full legal name of the exchange; 20

195 A description of the exchange's ownership structure; Contact person and contact information; A general description of what CDS contracts trade on the exchange; and A description of how the exchange operates; (5) An exchange must report the following information to the Commission within 30 days of the end of each quarter: The total dollar volume of transactions executed during the quarter, broken down by reference entity, security, or index; The total unit volume and/or notional amount executed during the quarter, broken down by reference entity, security, or index; and A list of all subscribers that effected transactions on the exchange during the quarter; (6) The exchange must establish adequate safeguards and procedures to protect subscribers' confidential trading information. Such safeguards and procedures shall include: (a) limiting access to the confidential trading information of subscribers to those employees of the exchange who are operating the system or responsible for its compliance with this exemption or any other applicable rules; and (b) implementing standards controlling employees of the exchange trading for their own accounts. The exchange must adopt and implement adequate oversight procedures to ensure that the safeguards and procedures established pursuant to this condition are followed; and (7) The exchange must provide access to the Commission to conduct on-site inspections of its facilities (including automated systems and systems environment), 21

196 records, and personnel related to exchange activities. The exchange must cooperate with the Commission in connection with the investigation of any exchange subscribers. IT IS FURTHER ORDERED pursuant to Section 36 of the Exchange Act that until September 25, 2009, a broker or dealer that effects transactions in non-excluded CDS, or reports such transactions, on an exchange that is exempted pursuant to this order is exempt from Section 5 of the Exchange Act. By the Commission. Florence E. Harmon Acting Secretary 22

197 P DEPARTMENT OF THE TREASURY Order Extending Temporary Exemptions from Certain Government Securities Act Provisions and Regulations in Connection with a Request from ICE Trust U.S. LLC Related to Central Clearing of Credit Default Swaps AGENCY: Department of the Treasury, Office of the Under Secretary for Domestic Finance. ACTION: Notice of extension of temporary exemptions. SUMMARY: The Department of the Treasury (Treasury) is extending its March 6, 2009 order providing temporary exemptions from certain Government Securities Act of 1986 (GSA) provisions and regulations in connection with a request from ICE Trust U.S. LLC (ICE Trust, formerly ICE US Trust LLC) related to the central clearing of credit default swaps (CDS) that reference government securities. This extension of temporary exemptions is consistent with an extension of temporary exemptions the Securities and Exchange Commission (SEC) recently granted to ICE Trust related to the central clearing of CDS. 1 EFFECTIVE DATE: December 7, FOR FURTHER INFORMATION CONTACT: Lori Santamorena, Lee Grandy, or Kevin Hawkins; Bureau of the Public Debt, Department of the Treasury, at SUPPLEMENTARY INFORMATION: The following is Treasury's order extending the temporary exemptions: 1 See the SEC's website at for the recent Securities Exchange Act Release. Order Extending and Modifying Temporary Exemptions Under the Securities Exchange Act of 1934 in Connection with Request on Behalf of ICE Trust U.S. LLC Related to Central Clearing of Credit Default Swaps, and Request for Comments. See The SEC's order relates only to and is necessary only for CDS that are not swap agreements under Section 206A of the Gramm-Leach-Bliley Act.

198 2 I. INTRODUCTION On March 6, 2009, the SEC issued to ICE Trust, certain participants in ICE Trust, and others exemptions from certain provisions of the Securities Exchange Act of 1934 (Exchange Act). 2 The SEC s exemptions did not cover the Exchange Act provisions applicable to government securities. 3 Also, on March 6, 2009, Treasury issued an order that granted temporary exemptions that were consistent with certain of the temporary exemptions granted by the SEC. 4 Specifically, the March 6, 2009 order granted to (1) ICE Trust, (2) certain participants in ICE Trust (ICE Trust Participants) 5 that are not registered or noticed government securities brokers and government securities dealers 6 under section 15C(a)(1) of the Exchange Act, and (3) certain eligible contract participants 2 Securities Exchange Act Release No (March 6, 2009). Order Granting Temporary Exemptions Under the Securities Exchange Act of 1934 in Connection with Request on Behalf of ICE US Trust LLC Related to Central Clearing of Credit Default Swaps, and Request for Comments. See The SEC's order relates only to and is necessary only for CDS that are not swap agreements under Section 206A of the Gramm-Leach-Bliley Act. 3 The term government securities is defined at 15 U.S.C. 78c(a)(42). As with the March 6, 2009 order, Treasury is not making a determination in this order as to whether particular CDS are government securities FR 10647, March 11, 2009, Order Granting Temporary Exemptions from Certain Provisions of the Government Securities Act and Treasury s Government Securities Act Regulations in Connection with a Request on Behalf of ICE US Trust LLC Related to Central Clearing of Credit Default Swaps, and Request for Comments (March 6, 2009 order). 5 For purposes of this Order, ICE Trust Participant means any participant in ICE Trust that submits CDS that reference a government security to ICE Trust for clearance and settlement exclusively (i) for its own account or (ii) for the account of an affiliate that controls, is controlled by, or is under common control with the participant in ICE Trust. 6 As used in this order, registered or noticed government securities brokers and government securities dealers encompass all brokers, dealers, and entities required to register or file notice pursuant to Section 15C(a)(1) of the Exchange Act. The GSA regulations apply to all classes of government securities brokers and government securities dealers required to register or file notice pursuant to Section 15C(a)(1) of the Exchange Act. This encompasses registered brokers and dealers (including OTC derivatives dealers), registered government securities brokers and registered government securities dealers (those specialized government securities brokers and government securities dealers that conduct a business in only government or other exempted securities (other than municipal securities)), and financial institutions that are required to file notice as government securities brokers and government securities dealers. The GSA regulations also address futures commission merchants that are government securities brokers or government securities dealers, but these entities are not covered in this order.

199 3 (ECPs) 7 temporary exemptions until December 6, 2009, from certain GSA provisions and regulations. 8 The exemption applied to these entities transactions in cleared CDS, which generally are CDS submitted to ICE Trust where the CDS reference a government security. In addition, with respect to registered or noticed government securities brokers and government securities dealers that are not financial institutions, the order granted a temporary exemption from certain GSA regulatory requirements consistent with the SEC s treatment of registered brokers and dealers in its exemptive order. That temporary exemption similarly applied to those entities transactions in cleared CDS. 9 Together with its order, Treasury solicited public comment on all aspects of the temporary exemptions and received no comments. ICE Trust has requested that Treasury extend the temporary exemptions in the March 6, 2009 order. 10 ICE Trust also requested that Treasury grant certain supplemental exemptive relief to accommodate customer clearing. 11 ICE Trust has stated that the existing order has allowed the financial industry to advance the goal of centralized clearing of CDS, and that allowing the order to expire could jeopardize this progress. It also states that the order should be extended because 7 ECPs are defined in Section 1a(12) of the Commodity Exchange Act, 7 U.S.C. 1 et seq. The use of the term ECPs in this order refers to the definition of ECPs in effect on the date of this order, and excludes persons that are ECPs under Section 1a(12)(C). The temporary exemptions provided to ECPs in this order also apply to interdealer brokers that are ECPs CFR Chapter IV parts , and 449 were issued under Section 15C(a), (b), and (d) of the Exchange Act. 9 For purposes of this order, cleared CDS means a credit default swap that is submitted (or offered, purchased, or sold on terms providing for submission) to ICE Trust, that is offered only to, purchased only by, and sold only to ECPs (as defined in Section 1a(12) of the Commodity Exchange Act as in effect on the date of this order (other than a person that is an ECP under paragraph (C) of that section)), and that references a government security. 10 See Letter from Kevin McClear, ICE Trust U.S. LLC, to the Commissioner of the Public Debt, Van Zeck, December 3, 2009, available at 11 Id. ICE Trust's request includes a discussion of and request for supplemental exemptive relief to include Client Member Transactions and the Non-Member Framework, as well as a request for an exemption to Clearing Members in connection with the receiving or holding of funds or securities from other persons.

200 4 allowing it to expire would create uncertainty as to the regulatory status of cleared trades and clearing participants and that it would be premature to allow the order to expire at this stage in the development of ICE and ICE Trust, given the goal to expand the availability of CDS clearing. ICE Trust s request described how ICE Trust currently clears CDS and how the proposed arrangements for central clearing of customers' CDS transactions would operate. The request also made representations about the safeguards associated with those arrangements. Since it began operation, ICE Trust has been subject to examination by the New York State Banking Department, the Federal Reserve Bank of New York, and the SEC. ICE Trust states that these examinations have addressed numerous aspects of ICE Trust's activities, including compliance with safety and soundness requirements. ICE Trust has cleared through acceptance and novation the proprietary CDS transactions of its clearing members since March 9, As of October 30, 2009, ICE Trust represents that it had cleared approximately $2.6 trillion notional amount of CDS contracts based on indices of securities. ICE Trust also intends to clear single-name CDS contracts based on individual reference entities or securities. Treasury finds that the circumstances upon which it issued the March 6, 2009 order, including the need for increasing transparency and mitigation of potential systemic risk, still exist. Therefore, Treasury believes that continuing the temporary exemptions given in that order is warranted and appropriate. Treasury believes that applying the GSA requirements to certain CDS market participants that are not registered or noticed government securities brokers or government securities dealers could deter some of them from using ICE Trust to clear CDS transactions where the CDS references a government

201 5 security, and thereby reduce the potential systemic risk mitigation and other benefits of central clearing. Treasury continues to balance the need to avoid creating disincentives to the prompt use of CCPs against the critical importance of certain government securities broker and government securities dealer requirements in promoting market integrity and protecting customers. Moreover, Treasury agrees that it would be premature to allow the exemptions to expire given ICE Trust's stage of development. For similar reasons, Treasury believes that the full range of GSA requirements generally should not be applied immediately to government securities brokers and government securities dealers that engage in transactions involving CDS that reference a government security. Treasury bases this extension of the order on the facts and circumstances presented and representations made by ICE Trust in the request. Treasury relies on these facts and representations in granting this temporary exemption. Accordingly, pursuant to Section 15C(a)(5) of the Exchange Act, the Secretary finds that it is consistent with the public interest, the protection of investors, and the purposes of the Exchange Act to extend the temporary exemptions granted in the March 6, 2009 order until March 7, Consistent with the original order, the extension of the temporary exemptions does not apply to financial institution government securities brokers and government securities dealers. They should continue to comply with existing rules. In issuing this extension, Treasury has consulted with and considered the views of the staffs of the SEC, the Commodity Futures Trading Commission, and the appropriate regulatory agencies for financial institutions The definition of appropriate regulatory agency with respect to a government securities broker or a government securities dealer is set out at 15 U.S.C. 78c(a)(34)(G). The definition includes the Board of

202 6 Since Treasury is in the process of finalizing action with regard to ICE Trust s request that Treasury grant supplemental relief to permit an expansion of its clearing services to include the clearance of the CDS transactions of its clearing members customers, this order only extends the exemptions granted in the March 6, 2009 order. CONCLUSION IT IS HEREBY ORDERED, pursuant to Section 15C(a)(5) of the Exchange Act, that the order Treasury issued effective March 6, 2009 (74 FR 10647, March 11, 2009) is amended by replacing the expiration date of December 6, 2009, with a new expiration date of March 7, 2010, and in all other respects that order remains in effect. The temporary exemptions contained in this order are based on the facts and circumstances presented in the request. These temporary exemptions could become unavailable if the facts or circumstances change such that the representations in the request are no longer materially accurate. If the SEC were to withdraw its order or modify the terms of its order, Treasury may revoke or modify this order accordingly. The status of cleared CDS submitted to ICE Trust prior to such change would be unaffected. Michael S. Barr, Acting Under Secretary for Domestic Finance. Governors of the Federal Reserve System, the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Director of Thrift Supervision, and, in limited circumstances, the SEC.

203 [FR Doc Filed 12/03/2009 at 4:15 pm; Publication Date: 12/07/2009] 7

204 SECURITIES AND EXCHANGE COMMISSION (Release No ; File No. S ) December 4, 2009 ORDER EXTENDING AND MODIFYING TEMPORARY EXEMPTIONS UNDER THE SECURITIES EXCHANGE ACT OF 1934 IN CONNECTION WITH REQUEST FROM ICE TRUST U.S. LLC RELATED TO CENTRAL CLEARING OF CREDIT DEFAULT SWAPS, AND REQUEST FOR COMMENTS I. Introduction Over the past year, the Securities and Exchange Commission ( Commission ) has taken multiple actions to protect investors and ensure the integrity of the nation s securities markets, including actions 1 designed to address concerns related to the market in credit default swaps ( CDS ). 2 The over-the-counter ( OTC ) market for CDS has been a source of 1 See generally Securities Exchange Act Release No (Jul. 23, 2009), 74 FR (Jul. 29, 2009) (temporary exemptions in connection with CDS clearing by ICE Clear Europe Limited), Securities Exchange Act Release No (Jul. 23, 2009), 74 FR (Jul. 29, 2009) (temporary exemptions in connection with CDS clearing by Eurex Clearing AG), Securities Exchange Act Release No (Mar. 13, 2009), 74 FR (Mar. 19, 2009) (temporary exemptions in connection with CDS clearing by Chicago Mercantile Exchange Inc.), Securities Exchange Act Release No (Mar. 6, 2009), 74 FR (Mar. 12, 2009) (temporary exemptions in connection with CDS clearing by ICE US Trust LLC (now ICE Trust U.S. LLC )) (hereinafter, the March ICE Trust Order ), Securities Exchange Act Release No (Dec. 24, 2008), 74 FR 139 (Jan. 2, 2009) (temporary exemptions in connection with CDS clearing by LIFFE A&M and LCH.Clearnet Ltd.) and other Commission actions discussed therein. In addition, we have issued interim final temporary rules that provide exemptions under the Securities Act of 1933 and the Securities Exchange Act of 1934 for CDS to facilitate the operation of one or more central counterparties for the CDS market. See Securities Act Release No (Jan. 14, 2009), 74 FR 3967 (Jan. 22, 2009) (initial approval); Securities Act Release No (Sep. 14, 2009), 74 FR (Sep. 17, 2009) (extension until Nov. 30, 2010). Further, the Commission has provided temporary exemptions in connection with Sections 5 and 6 of the Securities Exchange Act of 1934 for transactions in CDS. See Securities Exchange Act Release No (Dec. 24, 2008), 74 FR 133 (Jan. 2, 2009) (initial exemption); Securities Exchange Act Release No (Sep. 25, 2009), 74 FR (Oct. 1, 2009) (extension until Mar. 24, 2010). 2 A CDS is a bilateral contract between two parties, known as counterparties. The value of this financial contract is based on underlying obligations of a single entity ( reference entity ) or on a particular security or other debt obligation, or an index of several such entities, securities, or obligations. The obligation of a seller to make payments under a CDS contract is triggered by a default or other credit event as to such entity or entities or such security or securities. Investors may

205 2 particular concern to us and other financial regulators, and we have recognized that facilitating the establishment of central counterparties ( CCPs ) for CDS can play an important role in reducing the counterparty risks inherent in the CDS market, and thus can help mitigate potential systemic impacts. We have therefore found that taking action to help foster the prompt development of CCPs, including granting temporary conditional exemptions from certain provisions of the federal securities laws, is in the public interest. 3 The Commission s authority over the OTC market for CDS is limited. Specifically, Section 3A of the Securities Exchange Act of 1934 ( Exchange Act ) limits the Commission s authority over swap agreements, as defined in Section 206A of the Gramm- Leach-Bliley Act. 4 For those CDS that are swap agreements, the exclusion from the definition of security in Section 3A of the Exchange Act, and related provisions, will continue to apply. The Commission s action today does not affect these CDS, and this Order does not apply to them. For those CDS that are not swap agreements ( non-excluded CDS ), the Commission s action today provides temporary conditional exemptions from certain requirements of the Exchange Act. use CDS for a variety of reasons, including to offset or insure against risk in their fixed-income portfolios, to take positions in bonds or in segments of the debt market as represented by an index, or to take positions on the volatility in credit spreads during times of economic uncertainty. Growth in the CDS market has coincided with a significant rise in the types and number of entities participating in the CDS market. CDS were initially created to meet the demand of banking institutions looking to hedge and diversify the credit risk attendant to their lending activities. However, financial institutions such as insurance companies, pension funds, securities firms, and hedge funds have entered the CDS market. 3 4 See generally actions referenced in note 1, supra. 15 U.S.C. 78c-1. Section 3A excludes both a non-security-based and a security-based swap agreement from the definition of security under Section 3(a)(10) of the Exchange Act, 15 U.S.C. 78c(a)(10). Section 206A of the Gramm-Leach-Bliley Act defines a swap agreement as any agreement, contract, or transaction between eligible contract participants (as defined in section 1a(12) of the Commodity Exchange Act...)... the material terms of which (other than price and quantity) are subject to individual negotiation. 15 U.S.C. 78c note.

206 3 The Commission believes that using well-regulated CCPs to clear transactions in CDS provides a number of benefits, by helping to promote efficiency and reduce risk in the CDS market and among its participants, contributing generally to the goal of market stability, and by requiring maintenance of records of CDS transactions that would aid the Commission s efforts to prevent and detect fraud and other abusive market practices. 5 Earlier this year, the Commission granted temporary conditional exemptions to ICE Trust U.S. LLC ( ICE Trust ) and certain related parties to permit ICE Trust to clear and settle CDS transactions. 6 Those exemptions are scheduled to expire on December 7, ICE Trust has requested that the Commission extend the exemptions, and expand them to address activities in connection with ICE Trust clearing CDS transactions of its members customers (in addition to clearing CDS transactions of members and their affiliates, as permitted by the current exemption). 7 5 See generally actions referenced in note 1, supra. 6 For purposes of this Order, Cleared CDS means a credit default swap that is submitted (or offered, purchased, or sold on terms providing for submission) to ICE Trust, that is offered only to, purchased only by, and sold only to eligible contract participants (as defined in Section 1a(12) of the Commodity Exchange Act as in effect on the date of this Order (other than a person that is an eligible contract participant under paragraph (C) of that section)), and in which: (i) the reference entity, the issuer of the reference security, or the reference security is one of the following: (A) an entity reporting under the Exchange Act, providing Securities Act Rule 144A(d)(4) information, or about which financial information is otherwise publicly available; (B) a foreign private issuer whose securities are listed outside the United States and that has its principal trading market outside the United States; (C) a foreign sovereign debt security; (D) an asset-backed security, as defined in Regulation AB, issued in a registered transaction with publicly available distribution reports; or (E) an asset-backed security issued or guaranteed by the Federal National Mortgage Association ( Fannie Mae ), the Federal Home Loan Mortgage Corporation ( Freddie Mac ) or the Government National Mortgage Association ( Ginnie Mae ); or (ii) the reference index is an index in which 80 percent or more of the index s weighting is comprised of the entities or securities described in subparagraph (i). As discussed above, the Commission s action today does not affect CDS that are swap agreements under Section 206A of the Gramm-Leach-Bliley Act. See text at note 4, supra. 7 See Letter from Kevin McClear, ICE Trust, to Elizabeth Murphy, Secretary, Commission, Dec. 4, 2009 ( December 2009 request ).

207 4 Based on the facts presented and the representations made on behalf of ICE Trust, 8 and for the reasons discussed in this Order, and subject to certain conditions, the Commission is extending the exemption granted in the March ICE Trust Order, and is expanding it to accommodate customer clearing. Specifically, the Commission is extending the temporary ICE Trust conditional exemption from clearing agency registration under Section 17A of the Exchange Act solely to perform the functions of a clearing agency for certain non-excluded CDS transactions. The Commission also is extending the temporary exemption of eligible contract participants and others from certain Exchange Act requirements with respect to nonexcluded CDS cleared by ICE Trust. In addition, this order conditionally exempts on a temporary basis ICE Trust clearing members from broker-dealer registration requirements and related requirements in connection with using ICE Trust to clear CDS transactions of their customers. The Commission further is extending the temporary exemption of ICE Trust and certain of its clearing members from the registration requirements of Sections 5 and 6 of the Exchange Act solely in connection with the calculation of mark-to-market prices for non- Market participants have committed to achieve customer access to CDS clearing by December 15, See Letter from dealers and buy-side institutions to Federal Reserve Bank of New York (Jun. 2, 2009) ( ( It is our goal to achieve buy-side access to CDS clearing (through either direct CCP membership or customer clearing) with customer initial margin segregation and portability of customer transactions no later than December 15, ). 8 See December 2009 request. The exemptions we are granting today are based on all of the representations made in the December 2009 request on behalf of ICE Trust, which incorporate representations made on behalf of ICE Trust as part of the request that preceded our earlier relief in connection with CDS clearing by ICE Trust. We recognize, however, that there could be legal uncertainty in the event that one or more of the underlying representations were to become inaccurate. Accordingly, if any of these exemptions were to become unavailable by reason of an underlying representation no longer being materially accurate, the legal status of existing open positions in non-excluded CDS that previously had been cleared pursuant to the exemptions would remain unchanged, but no new positions could be established pursuant to the exemptions until all of the underlying representations were again accurate.

208 5 excluded CDS cleared by ICE Trust. These exemptions are temporary and will expire on March 7, II. Discussion A. Description of ICE Trust s Activities to Date and Proposed Customer Clearing Activities ICE Trust s request for an extension of its current temporary exemptions and for an expansion of those exemptions to accommodate clearing of customer CDS transactions describes how ICE Trust has cleared CDS to date and how the proposed arrangements for central clearing of customer CDS transactions would operate. 9 The request also makes representations about the safeguards associated with those arrangements, as described below ICE Trust CDS Clearing Activity to Date ICE Trust has cleared the proprietary index CDS transactions of its clearing members since March 9, 2009, through acceptance and novation of those transactions. 11 As of October 30, 2009, ICE Trust had cleared approximately $2.64 trillion notional amount of CDS contracts based on indices of securities. ICE Trust intends in the near future to also clear single-name CDS contracts based on individual reference entities or securities. 9 See December 2009 request, supra note 7. The description in this Order of ICE Trust s proposed activities also is based on the provisions of ICE Trust s rules. 10 ICE Trust has represented that there have been no material changes to the representations made in the letter that preceded the relief we initially granted to it, apart from the proposal to clear customer CDS transactions, and ICE Trust has incorporated the representations made in its earlier letter into the current request for relief. 11 ICE Trust novates those cleared proprietary CDS transactions by becoming the seller of credit protection to the clearing member that is the buyer under the CDS, and the buyer of credit protection from the clearing member that is the seller under the CDS. ICE Trust collects initial and mark-tomarket margin to secure each clearing member s obligations to ICE Trust under the cleared transactions, and ICE Trust has established a guaranty fund to provide additional financial protection in the case of clearing member default.

209 6 In clearing CDS transactions, ICE Trust has made use of procedures, described in the initial request for relief, whereby it has periodically required participants to execute certain CDS trades at the applicable end-of-day settlement price to enhance the reliability of end-ofday settlement prices submitted as part of the daily mark-to-market process. 12 ICE Trust represents that it wishes to continue periodically requiring clearing members to execute certain CDS trades in this manner, and has requested the extension of the applicable relief. 2. Proposed Activity Clearing CDS Transactions of Members Clients ICE Trust has proposed a Non-Member Framework for clearing the CDS transactions of its members clients. Under this framework, client positions could be submitted to ICE Trust for clearing in one of two ways. First, under the bilateral model, clients could execute a CDS transaction directly with a clearing member (acting in a principal capacity), followed by the clearing member submitting a trade to ICE Trust with terms corresponding to the client-member trade; if the latter trade is accepted by ICE Trust, 13 two positions would be created within ICE Trust a Client Position of the clearing member that mirrors the transaction between the client and the clearing member, and an offsetting House Position of the clearing member In particular, as part of this mark-to-market process, ICE Trust periodically requires clearing members to execute certain CDS trades at the price where the prices submitted by clearing members cross. ICE Trust requires these trades on 30 random days during any year and at the end of each quarter. 13 ICE Trust will accept all CDS that meet the standards set forth in its rules, unless it determines not to accept the transaction for risk management reasons. 14 Client Positions are cleared CDS transactions between ICE Trust and the clearing member that are offset or mirrored on a back-to-back basis by CDS transactions between the clearing member and the client. House Positions are all other cleared CDS transactions of a member, or affiliate, and ICE Trust. ICE Trust would not have market exposure in connection with that transaction because it would have two offsetting positions with the clearing member.

210 7 Alternatively, under the prime broker or designated clearing member (or DCM ) model, a client could agree to a CDS transaction with an ICE Trust clearing member ( executing dealer ) other than the member that clears the client s transactions. Then, pursuant to a give-up or similar agreement, the clearing member (as prime broker) and the executing dealer would enter into a trade that is submitted to ICE Trust for clearing, and the clearing member and the client would simultaneously enter into a trade. 15 The net result would be that the client s clearing member and the client would be counterparties to one transaction, the clearing member would have a Client Position with ICE Trust, and the executing dealer would have a House Position with ICE Trust. 16 ICE Trust has no rule requiring an executing dealer to be a clearing member. ICE Trust Clearing Rule 314, moreover, requires that ICE Trust ensure that there shall be open access to its clearing system for all execution venues and trade processing platforms. 17 ICE Trust expects that transactions under the DCM model will be submitted to ICE Trust through one or more authorized trade processing platforms that will facilitate the affirmation of the trade terms by the client, executing dealer and DCM, as well as the 15 ICE Trust expects that, initially, client transactions likely will be submitted for clearing using the DCM model. These transactions will be subject to DCM Standard Terms, published by ICE Trust, that will provide procedures and timing requirements for submitting transactions to clearing. ICE Trust expects that the bilateral model will be used initially for back-loading of existing transactions into central clearing. 16 As with the bilateral model, ICE Trust would not have market exposure in connection with the cleared transaction. In this situation the clearing member s Client Position with ICE Trust would offset the executing dealer s House Position with ICE Trust. 17 ICE Trust Clearing Rule 314. Based on market feedback, ICE Trust anticipates that, initially, executing dealers will be Clearing Members. ICE Trust does not prohibit an executing dealer that is not a Clearing Member from having a trade submitted for clearance at ICE Trust through the Clearing Member. However, currently none of the authorized trade processing platforms permit, as an operational matter, such an arrangement. ICE Trust Clearing Rules, however, do provide for open access to its clearing system for all execution venues and trade processing platforms.

211 8 electronic submission of the affirmed trade to ICE Trust for clearing. 18 ICE Trust also expects that the platform would submit, to the relevant parties, notice of ICE Trust s acceptance or rejection of the trade. Authorized trade processing platforms may provide additional back-office or similar services to clearing members or clients. ICE Trust expects to enter into arrangements to accept transactions from multiple authorized trade processing platforms. 19 Under the framework for clearing client transactions, ICE Trust would have no direct relationship with, or liability to, clients. To facilitate the transfer or liquidation of clientmember transactions in the event of clearing member default, however, clearing members would pledge to ICE Trust the clearing members rights under the client-member transactions and their rights to related margin, to secure the clearing members obligations to ICE Trust under the related client positions, and the clearing member s obligations to other clients under other client-member transactions. The cleared CDS transaction between the clearing member and its client will be documented pursuant to a negotiated International Swaps and Derivatives Association ( ISDA ) master agreement between those parties, supplemented by a standard annex approved by ICE Trust. This standard annex would treat these cleared client-member CDS 18 Under this approach, for example, when a client and executing dealer agree to the terms of a transaction (including that the transaction should be submitted to ICE Trust for clearing), the executing dealer will submit the trade terms to the authorized trade processing platform, which will forward those terms to the client for affirmation. Once the client has affirmed the trade, the platform will forward those terms to the DCM designated by the client for affirmation. Once all three parties have affirmed the transaction, it will be submitted to ICE Trust for clearing. ICE Trust will determine whether to accept or reject the submitted trade in accordance with its risk management policies and procedures. 19 ICE Trust states that it has committed to ensure that there will be open access to ICE Trust s clearing system for platforms that meet ICE Trust s qualifications and criteria to provide the necessary services.

212 9 transactions differently from other derivatives transactions between those parties: it would make the cleared CDS transactions subject to separate ICE Trust margin requirements, it would incorporate a standard definition of clearing member default (based on a determination by ICE Trust), and it would specify procedures for remedies in the case of clearing member default. As discussed below, under the standard annex the client could also agree that certain default portability rules would apply Framework for Collection and Protection of Client Margin ICE Trust states that the Non-Member Framework is intended to protect clients from default by their clearing members, particularly with regard to their initial margin. Also, the Non-Member Framework, and central clearing of CDS generally, is intended to enhance the financial stability of CDS markets as a whole. 21 a. Margin requirements for clearing members and clients ICE Trust rules will require clearing members to collect initial and variation margin from clients for CDS transactions cleared by ICE Trust, in an amount at least equal to the amount of margin ICE Trust would require on a gross basis for the related Client Positions. Clearing members would be able to collect additional margin from customers beyond what ICE Trust rules require. 22 Clearing members will be permitted to calculate the initial margin collected from individual clients on a net basis, across all of the CDS transactions of that customer that are cleared through ICE Trust. Clearing members, however, would not be permitted to net across 20 See part II.A.4.c, infra. 21 ICE Trust states that it will implement a program to monitor for its clearing members compliance with this segregation framework. 22 As discussed below, this Order sets forth conditions intended to protect all of the margin that clearing members collect from their clients, including this type of additional margin.

213 10 multiple clients cleared through ICE Trust. This required ICE Gross Margin that a clearing member collects from a client must be pledged by the client in favor of the clearing member, and must not be subject to liens or other encumbrances in favor of third-parties. Under ICE Trust rules, clearing members must post the ICE Gross Margin they collect from clients to ICE Trust, as custodian, promptly upon receipt, and it is expected that clearing members would transfer this margin on the business day of receipt. 23 Prior to posting, the clearing member must maintain that ICE Gross Margin in a segregated client omnibus account or in an individual segregated client account, on its own books or on the books of a custodian, pursuant to which the clearing member would receive the margin in an agency or custodial capacity. ICE Trust will determine a net initial margin requirement for each clearing member with regard to the cleared CDS positions of all of the member s clients. Clearing members could use collateral posted by clients to satisfy this ICE Net Margin obligation. 24 b. Treatment of client margin required pursuant to ICE Trust rules Clearing members must post all the margin they collect from customers pursuant to ICE Trust requirements both the ICE Net Margin and the remainder of the margin that 23 ICE Trust states, however, that this may not be feasible when the clearing member receives the client margin toward the end of the business day. Clearing members and clients may agree that the clearing member will post with ICE Trust a different type of collateral than what the client posts with ICE Trust, and that the collateral posted with ICE Trust will become the client s property. Thus, for example, a client and clearing member may agree that cash collateral that the client posts to the clearing member may be invested in U.S. Treasury securities, and posted to ICE Trust as such. 24 Clearing members also may initially satisfy this obligation with their proprietary assets, pending receipt of required margin from their clients.

214 11 clearing members collect from their clients pursuant to ICE Trust rules to the Custodial Client Omnibus Margin Account 25 that would be maintained at ICE Trust or a subcustodian. The Custodial Client Omnibus Margin Account will be held for the benefit of all clients of the relevant clearing member (or for the clearing member as agent or custodian on behalf of such clients), and will be segregated from other assets of the clearing member (including assets in its proprietary House Account ). The Custodial Client Omnibus Margin Account will consist of a cash collateral subaccount for cash margin and a custody subaccount for securities collateral. ICE Trust will maintain title to cash in the cash collateral subaccount (ICE Trust, however, will be obligated to return the cash as required for the benefit of the relevant client or of the clearing member as the client s agency or custodian), and ICE Trust will hold assets in the custody subaccount as custodian (subject to a security interest in favor of the clearing member or ICE Trust as applicable). Assets in the Custodial Client Omnibus Margin Account may be invested in a range of investments as permitted by ICE Trust s Custodial Asset Policies, 26 and the clearing member and its client may agree how the return on those investments may be distributed between them. ICE Trust rules will require clearing members to maintain records of the identity of the clients, the margin they post, the transfer of those assets to the Custodial Client Omnibus Margin Account and the use of that margin. 25 The Custodial Client Omnibus Margin Account is one or more accounts maintained by or on behalf of ICE Trust with respect to a Participant for the purposes of holding on an omnibus basis margin of Non-Participant Parties posted to that Participant in respect of their respective Minimum ICE Trust Required Initial Margin and Participant Excess Margin requirements, as applicable. ICE Trust rules state that ICE Trust may establish a separate account or subaccount with respect to a portion of the Custodial Client Omnibus Margin Account corresponding to the Net Client Omnibus Margin Amount. 26 ICE Trust states that these generally include assets of the type allowed under CFTC Rule However, a narrower range of assets is acceptable margin for satisfying the net margin requirement. This includes only cash in specified currencies and G-7 government debt for initial margin, and only cash for mark-to-market margin.

215 12 c. Treatment of additional margin that clearing members collect from clients beyond ICE Trust requirements Clearing members may collect margin from clients, in connection with Cleared CDS transactions, in excess of the margin that ICE Trust rules require they collect. ICE Trust permits this additional margin to be posted to the Custodial Client Omnibus Margin Account, but does not require that it be posted to that account. Under the conditions of this Order s temporary exemption from certain broker-dealer related requirements of the Exchange Act, however, such additional margin must be posted either to the Custodial Client Omnibus Margin Account, or else to a third-party custodian that is unaffiliated with the clearing member. 27 The temporary exemption from those broker-dealer related requirements is unavailable to any clearing member that fails to segregate customer collateral in that manner. d. Treatment of variation margin ICE Trust states that the amount of variation margin that must be provided to a client, or by a client, will be determined daily for that client s portfolio based on ICE Trust s end-ofday settlement price determinations. ICE Trust further states that in the event that ICE Trust owes variation margin to a clearing member in respect of client positions that have moved in the client s favor, the standard annex would provide that the clearing member has a corresponding obligation to provide variation margin in favor of clients See Part II.E, infra. 28 Over the duration of this temporary exemption, the staff intends to evaluate the protections afforded to clients mark-to-market profits associated with Cleared CDS positions, and to consider the potential benefits of requiring clearing members to segregate clients variation margin in connection with Cleared CDS positions.

216 13 4. Default and portability rules a. Termination amounts In the event a client-member transaction is terminated due to clearing member default, termination amounts owed by a client on CDS transactions cleared by ICE Trust would not be netted against termination amounts owed with respect to the client s other trades with that clearing member. This is intended to facilitate portability of positions. Moreover, in the event of member default, ICE Trust would undertake a close-out process that separately would calculate net termination with respect to the closeout of the clearing member s House Positions and its Client Positions. ICE Trust would not undertake this process, however, in the event that the defaulting clearing member s receiver (such as the Federal Deposit Insurance Corporation or similar authority) transfers the relevant positions to another non-defaulting entity in accordance with applicable law. The rules generally would not permit netting between a clearing member s Client Positions and House Positions; however, ICE Trust would offset any amount that the clearing member owes to ICE Trust in respect of Client Positions against any amount that ICE Trust owes to the clearing member in respect of House Positions. If a clearing member default is due to a default resulting from a client s position, ICE Trust may use the margin posted to the clearing member s Custodial Client Omnibus Margin Account up to the amount of the ICE Net Margin requirement. 29 ICE Trust will not be able to 29 ICE Trust cannot use a client s positions in this account if the clearing member s default was the result of its proprietary activities, rather than the result of a default resulting from a client s position. In the event of a clearing member s default resulting from a Client Position, net losses to ICE Trust would be paid from the following sources in order: (i) any margin of the defaulting client held in the Custodial Client Omnibus Margin Account, to the extent of that client's obligations to the clearing member; (ii) amounts received from clients under their client-member transactions; (iii) the

217 14 access the remainder of the assets of a non-defaulting client in the account in amounts above the net margin requirement. 30 The Commission notes that, as a result of these rules, clients of a clearing member are subject to the risk of loss resulting from the default of another client of that clearing member, up to the amount of the clearing member s net margin requirement. b. Pre-default portability ICE Trust rules require clearing members to agree to the transfer of client-member transactions and related positions upon client request, provided that the client obtains a new clearing member willing to accept the positions. In connection with that transfer, ICE Trust would move related margin between the Custodial Client Omnibus Margin Accounts of the two clearing members. c. Post-default portability If a client agrees to the application of the default rules set forth in the standard annex, it would consent that, in the event of the clearing member s default, ICE Trust may transfer client-member transactions to a new clearing member, or otherwise establish replacement transactions. 31 The client also would agree not to exercise its rights to terminate during the transfer period. 32 defaulting clearing member s house margin; (iv) the defaulting clearing member s contribution to the guaranty fund; (v) the defaulting clearing member s Custodial Client Omnibus Margin Account up to the amount of the net margin requirement; and (vi) other guaranty fund contributions. ICE Trust would not need to apply these assets to the extent it can close out or replace the defaulting clearing member s transactions without loss to ICE Trust. 30 ICE Trust, however, could apply all of the margin that a defaulting client has posted into the account. 31 Under the standard annex, only the client and not the clearing member can elect as to whether the default portability rules will apply to the cleared transaction. If the client does not agree to the use of the default portability rules, then the customer could apply the liquidation procedures discussed below in part II.A.4.d upon the clearing member s default. 32 The transfer period will be limited to three business days or fewer.

218 15 If the clearing member is in default, ICE Trust rules would permit ICE Trust to transfer, or arrange for the transfer of, the defaulting clearing member s client positions and related transactions and margin to a new clearing member. Alternatively, ICE Trust could terminate the existing transactions and establish new positions with the new clearing member. ICE Trust may attempt to transfer some or all of the client-member transactions. Also, ICE Trust may (but would not be obligated to) take into account client prearrangements for the use of one or more backup clearing members to which their transactions would be transferred in the event their primary clearing member defaults. d. Liquidation procedures If ICE Trust is unable to transfer or terminate and replace client-member transactions during the transfer period, the client may terminate the client-member transactions as provided by the terms of the agreement. 33 ICE Trust then would determine the close-out price for the client positions and the client-member transaction. If a client owes the clearing member with respect to the cleared CDS transactions, the client s margin in the Custodial Client Omnibus Margin Account will be applied to satisfy that obligation, and thereafter would be available to pay amounts owed to ICE Trust in connection with the related client positions and other clients in respect of their client-member transactions. Conversely, clients owed by the clearing member on a net basis will have a claim for that amount, together with their pro rata share of margin being used to satisfy the ICE Net Margin Requirement The client alternatively may opt out of the liquidation procedures, in which case the clientmember transactions also will be terminated. 34 Clients will have available, in respect of their Net Termination Claims, an amount equal to the sum of: (i) the remaining amount of the ICE Net Margin Requirement after application by ICE Trust together with any net amounts paid by ICE Trust in respect of the termination of Client Positions, plus

219 16 Clients will be separately entitled to the return of their remaining excess margin in the Custodial Client Omnibus Margin Account, except to the extent the margin is applied to satisfy the client s obligation to the clearing member. 35 Clients will share in the assets in the Custodial Client Omnibus Margin Account in proportion of their claims, but will not be entitled to the return of specific assets in that account. 5. Other Clearing Member Requirements Related to Customer Clearing ICE Trust states that before offering the Non-Member Framework, it will adopt a requirement that clearing members subject to the framework are regulated by: (i) a signatory to the International Organization of Securities Commissions ( IOSCO ) Multilateral Memorandum of Understanding Concerning Consultation and Cooperation and the Exchange of Information, or (ii) a signatory to a bilateral arrangement with the Commission for enforcement cooperation. B. Extended Temporary Conditional Exemption from Clearing Agency Registration Requirement On March 6, 2009, in connection with its efforts to facilitate the establishment of one or more central counterparties ( CCP ) for Cleared CDS, the Commission issued the March ICE Trust Order, conditionally exempting ICE Trust from clearing agency registration under (ii) any termination amounts paid by Clients that is not applied by ICE Trust, plus (iii) the amount of any client s excess margin applied to its obligations. If these proceeds are insufficient to pay all Net Termination Claims, clients will share in the proceeds pro rata, based on their respective claims. 35 The Standard Annex provides that if the clearing member is in default and the Client owes a net termination payable, amounts the client owes to the clearing member cannot be netted with amounts the clearing member owes to the Client in respect of any non-cleared Client position. Funds that the client owes to the clearing member in respect of this net termination payable secure the clearing member s obligations in favor of ICE Trust and as such will be paid directly to ICE Trust. Conversely, where the client has a net termination claim against the clearing member, the client may net the amount owed to the client against amounts owed by the client in respect of a non-cleared position.

220 17 Section 17A of the Exchange Act on a temporary basis. Subject to the conditions in that order, ICE Trust is permitted to act as a CCP for Cleared CDS by novating trades of nonexcluded CDS that are securities and generating money and settlement obligations for participants without having to register with the Commission as a clearing agency. The March ICE Trust Order expires on December 7, Pursuant to its authority under Section 36 of the Exchange Act, 36 for the reasons described herein, the Commission is extending the exemption granted in that Order until March 7, In the March ICE Trust order, the Commission recognized the need to ensure the prompt establishment of ICE Trust as a CCP for CDS transactions. The Commission also recognized the need to ensure that important elements of Section 17A of the Exchange Act, which sets forth the framework for the regulation and operation of the U.S. clearance and settlement system for securities, apply to the non-excluded CDS market. Accordingly, the temporary exemption in the March ICE Trust Order was subject to a number of conditions designed to enable Commission staff to monitor ICE Trust s clearance and settlement of CDS transactions. 37 Moreover, the temporary exemption in that order in part was based on ICE Trust s representation that it met the standards set forth in the Committee on Payment and Settlement Systems ( CPSS ) and IOSCO report entitled: Recommendation for Central Counterparties ( RCCP ). 38 The RCCP establishes a framework that requires a CCP to have U.S.C. 78mm. Section 36 of the Exchange Act authorizes the Commission to conditionally or unconditionally exempt any person, security, or transaction, or any class or classes of persons, securities, or transactions, from any provision or provisions of the Exchange Act or any rule or regulation thereunder, by rule, regulation, or order, to the extent that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors ). 38 See Securities Exchange Act Release No (Mar. 6, 2009), 74 FR (Mar. 12, The RCCP was drafted by a joint task force ( Task Force ) composed of representative members of IOSCO and CPSS and published in November The Task Force consisted of

221 18 (i) the ability to facilitate the prompt and accurate clearance and settlement of CDS transactions and to safeguard its users assets; and (ii) sound risk management, including the ability to appropriately determine and collect clearing fund and monitor its users trading. This framework is generally consistent with the requirements of Section 17A of the Exchange Act. The Commission believes that continuing to facilitate the central clearing of CDS transactions including customer CDS transactions through a temporary conditional exemption from Section 17A would provide important risk management and systemic benefits by avoiding an interruption in those CCP clearance and settlement services. Any interruption in CCP clearance and settlement services for CDS transactions would eliminate in the future the benefits ICE Trust provides to the non-excluded CDS market during the exemptive period. Accordingly, and consistent with our findings in the March ICE Trust Order, we find pursuant to Section 36 of the Exchange Act that it is necessary and appropriate in the public interest and is consistent with the protection of investors for the Commission to extend, until March 7, 2010, the relief provided from the clearing agency registration requirements of Section 17A by the March ICE Trust Order. Our action today balances the aim of facilitating ICE Trust s continued service as a CCP for non-excluded CDS transactions with ensuring that important elements of Commission oversight are applied to the non-excluded CDS market. The continued use of temporary exemptions will permit the Commission to continue to develop direct experience with the non-excluded CDS market. During the extended exemptive period, the Commission securities regulators and central bankers from 19 countries and the European Union. The U.S. representatives on the Task Force included staff from the Commission, the Federal Reserve Board, and the Commodity Futures Trading Commission.

222 19 will continue to monitor closely the impact of the CCPs on the CDS market. In particular, the Commission will seek to assure itself that ICE Trust does not act in an anticompetitive manner or indirectly facilitate anticompetitive behavior with respect to fees charged to members, the dissemination of market data, and the access to clearing services by independent CDS exchanges or CDS trading platforms. This temporary extension of the March ICE Trust Order also is designed to assure that as represented in the request on behalf of ICE Trust information will continue to be available to market participants about the terms of the CDS cleared by ICE Trust, the creditworthiness of ICE Trust or any guarantor, and the clearance and settlement process for the CDS. 39 The Commission believes continued operation of ICE Trust consistent with the conditions of this Order will facilitate the availability to market participants of information that should enable them to make better informed investment decisions and better value and evaluate their Cleared CDS and counterparty exposures relative to a market for CDS that is not centrally cleared. This temporary extension of the March ICE Trust Order is subject to a number of conditions that are designed to enable Commission staff to continue to monitor ICE Trust s clearance and settlement of CDS transactions and help reduce risk in the CDS market. These conditions require that ICE Trust: (i) make available on its Web site its annual audited financial statements; (ii) preserve records related to the conduct of its Cleared CDS clearance and settlement services for at least five years (in an easily accessible place for the first two 39 The Commission believes that it is important in the CDS market, as in the market for securities generally, that parties to transactions should have access to financial information that would allow them to evaluate appropriately the risks relating to a particular investment and make more informed investment decisions. See generally Policy Statement on Financial Market Developments, The President s Working Group on Financial Markets, March 13, 2008, available at:

223 20 years); (iii) provide information relating to its Cleared CDS clearance and settlement services to the Commission and provide access to the Commission to conduct on-site inspections of facilities, records and personnel related to its Cleared CDS clearance and settlement services; (iv) notify the Commission about material disciplinary actions taken against any of its members utilizing its Cleared CDS clearance and settlement services, and about the involuntary termination of the membership of an entity that is utilizing ICE Trust s Cleared CDS clearance and settlement services; (v) provide the Commission with changes to rules, procedures, and any other material events affecting its Cleared CDS clearance and settlement services; (vi) provide the Commission with reports prepared by independent audit personnel that are generated in accordance with risk assessment of the areas set forth in the Commission s Automation Review Policy Statements 40 and its annual audited financial statements prepared by independent audit personnel; and (vii) report all significant systems outages to the Commission. In addition, this temporary extension of the March ICE Trust Order is conditioned on ICE Trust, directly or indirectly, making available to the public on terms that are fair and reasonable and not unreasonably discriminatory: (i) all end-of-day settlement prices and any other prices with respect to Cleared CDS that ICE Trust may establish to calculate mark-tomarket margin requirements for ICE Trust clearing members; and (ii) any other pricing or valuation information with respect to Cleared CDS as is published or distributed by ICE Trust. The Commission believes this is an appropriate condition for ICE Trust s temporary continued exemption from registration as a clearing agency. 40 See Automated Systems of Self-Regulatory Organization, Exchange Act Release No (November 16, 1989), File No. S , and Automated Systems of Self-Regulatory Organization (II), Exchange Act Release No (May 9, 1991), File No. S

224 21 As a CCP, ICE Trust collects and processes information about CDS transactions, prices, and positions from all of its participants. With this information, a CCP calculates and disseminates current values for open positions for the purpose of setting appropriate margin levels. The availability of such information can improve fairness, efficiency, and competitiveness of the market all of which enhance investor protection and facilitate capital formation. Moreover, with pricing and valuation information relating to Cleared CDS, market participants would be able to derive information about underlying securities and indexes. This may improve the efficiency and effectiveness of the securities markets by allowing investors to better understand credit conditions generally. C. Extended Temporary Conditional Exemption from Exchange Registration Requirements When we initially provided exemptions in connection with CDS clearing by ICE Trust, we granted a temporary conditional exemption to ICE Trust from the requirements of Sections 5 and 6 of the Exchange Act, and the rules and regulations thereunder, in connection with ICE Trust s calculation of mark-to-market prices for open positions in Cleared CDS. We also temporarily exempted ICE Trust participants from the prohibitions of Section 5 to the extent that they use ICE Trust to effect or report any transaction in Cleared CDS in connection with ICE Trust s calculation of mark-to-market prices for open positions in Cleared CDS. Section 5 of the Exchange Act contains certain restrictions relating to the registration of national securities exchanges, 41 while Section 6 provides the procedures for registering as a national securities exchange In particular, Section 5 states:

225 22 We granted these temporary exemptions to facilitate the establishment of ICE Trust s end-of-day settlement price process. ICE Trust had represented that in connection with its clearing and risk management process it would calculate an end-of-day settlement price for each Cleared CDS in which an ICE Trust participant has a cleared position, based on prices submitted by the participants. ICE Trust stated that as part of this mark-to-market process, it periodically would require participants to execute certain CDS trades at the applicable end-ofday settlement price, to help ensure that the prices that the participants submit reflect their assessment of the value of each open position in Cleared CDS, thereby reducing risk by helping ICE Trust to impose appropriate margin requirements. As part of its current request, ICE Trust has stated that since it has commenced clearing operations for Cleared CDS, it has periodically required ICE Trust clearing members to execute certain CDS trades at the applicable end-of-day settlement price. ICE Trust further represents that it wishes to continue periodically requiring clearing members to execute certain CDS trades in this manner. As discussed above, we have found in general that it is necessary or appropriate in the public interest, and is consistent with the protection of investors, to facilitate continued CDS clearing by ICE Trust. Consistent with that finding and in reliance on ICE Trust's representation that the end-of-day settlement pricing process, including the periodically 15 U.S.C. 78e. 42 It shall be unlawful for any broker, dealer, or exchange, directly or indirectly, to make use of the mails or any means or instrumentality of interstate commerce for the purpose of using any facility of an exchange... to effect any transaction in a security, or to report any such transactions, unless such exchange (1) is registered as a national securities exchange under section 6 of [the Exchange Act], or (2) is exempted from such registration... by reason of the limited volume of transactions effected on such exchange U.S.C. 78f. Section 6 of the Exchange Act also sets forth various requirements to which a national securities exchange is subject.

226 23 required trading, is integral to its risk management we further find that it is necessary or appropriate in the public interest, and is consistent with the protection of investors that we exercise our authority under Section 36 of the Exchange Act to extend, until March 7, 2010, ICE Trust s temporary exemption from Sections 5 and 6 of the Exchange Act in connection with its calculation of mark-to-market prices for open positions in Cleared CDS, and ICE Trust clearing members temporary exemption from Section 5 with respect to such trading activity. 43 The temporary exemption for ICE Trust will continue to be subject to three conditions. First, ICE Trust must report the following information with respect to its calculation of markto-market prices for Cleared CDS to the Commission within 30 days of the end of each quarter, and preserve such reports during the life of the enterprise and of any successor enterprise: The total dollar volume of transactions executed during the quarter, broken down by reference entity, security, or index; and The total unit volume and/or notional amount executed during the quarter, broken down by reference entity, security, or index. Reporting of this information will assist the Commission in carrying out its responsibility to supervise and regulate the securities markets. Second, ICE Trust must establish and maintain adequate safeguards and procedures to protect participants' confidential trading information. Such safeguards and procedures shall include: (a) limiting access to the confidential trading information of participants to those 43 We are making a technical modification to this exemption so it refers to ICE Trust s clearing members rather than ICE Trust Participants. The latter defined term was used in our earlier Order consistent with the scope of that Order, and the term no longer is necessary given the expansion of our exemptive relief to accommodate customer clearing by ICE Trust. See note 46, infra.

227 24 employees of ICE Trust who are operating the system or responsible for its compliance with this exemption or any other applicable rules; and (b) establishing and maintaining standards controlling employees of ICE Trust trading for their own accounts. ICE Trust must establish and maintain adequate oversight procedures to ensure that the safeguards and procedures established pursuant to this condition are followed. This condition is designed to prevent any misuse of ICE Trust clearing member trading information that may be available to ICE Trust in connection with the daily marking-to-market process of open positions in Cleared CDS. This should strengthen confidence in ICE Trust as a CCP for CDS, thus promoting participation in central clearing of CDS. Third, ICE Trust must comply with the conditions to the temporary exemption from Section 17A of the Exchange Act in this Order, given that this exemption is granted in the context of our goal of continuing to facilitate ICE Trust s ability to act as a CCP for nonexcluded CDS, and given ICE Trust s representation that the end-of-day settlement pricing process, including the periodically required trading, is integral to its risk management. D. Modified and Extended Temporary Conditional General Exemption for ICE Trust and Certain Eligible Contract Participants As we recognized when we initially provided temporary exemptions in connection with CDS clearing by ICE Trust, applying the full panoply of Exchange Act requirements to participants in transactions in non-excluded CDS likely would deter some participants from using CCPs to clear CDS transactions. We also recognized that it is important that the antifraud provisions of the Exchange Act apply to transactions in non-excluded CDS,

228 25 particularly given that OTC transactions subject to individual negotiation that qualify as security-based swap agreements already are subject to those provisions. 44 As a result, we concluded that it is appropriate in the public interest and consistent with the protection of investors temporarily to apply substantially the same framework to transactions by market participants in non-excluded CDS that applies to transactions in security-based swap agreements. Consistent with that conclusion, we temporarily exempted ICE Trust, and certain members and eligible contract participants from a number of Exchange Act requirements, while excluding certain enforcement-related and other provisions from the scope of the exemption. We believe that continuing to facilitate the central clearing of CDS transactions by ICE Trust through this type of temporary exemption will provide important risk management benefits and systemic benefits. We also believe that facilitating the central clearing of customer CDS transactions, subject to the conditions in this Order, will provide an opportunity for the customers of ICE Trust clearing members to control counterparty risk. 44 While Section 3A of the Exchange Act excludes swap agreements from the definition of security, certain antifraud and insider trading provisions under the Exchange Act explicitly apply to security-based swap agreements. See (a) paragraphs (2) through (5) of Section 9(a), 15 U.S.C. 78i(a), prohibiting the manipulation of security prices; (b) Section 10(b), 15 U.S.C. 78j(b), and underlying rules prohibiting fraud, manipulation or insider trading (but not prophylactic reporting or recordkeeping requirements); (c) Section 15(c)(1), 15 U.S.C. 78o(c)(1), which prohibits brokers and dealers from using manipulative or deceptive devices; (d) Sections 16(a) and (b), 15 U.S.C. 78p(a) and (b), which address disclosure by directors, officers and principal stockholders, and short-swing trading by those persons, and rules with respect to reporting requirements under Section 16(a); (e) Section 20(d), 15 U.S.C. 78t(d), providing for antifraud liability in connection with certain derivative transactions; and (f) Section 21A(a)(1), 15 U.S.C. 78u-1(a)(1), related to the Commission s authority to impose civil penalties for insider trading violations. Security-based swap agreement is defined in Section 206B of the Gramm-Leach-Bliley Act as a swap agreement in which a material term is based on the price, yield, value, or volatility of any security or any group or index of securities, or any interest therein.

229 26 Accordingly, pursuant to Section 36 of the Exchange Act, the Commission finds that it is necessary or appropriate in the public interest and is consistent with the protection of investors to exercise its authority to grant an exemption until March 7, 2010 from certain requirements under the Exchange Act. To account for the additional relief we are granting in connection with customer CDS clearing by ICE Trust, we are modifying the parameters of the relief we previously granted. As revised, this temporary exemption applies to ICE Trust and to any eligible contract participants 45 including any ICE Trust clearing member 46 other than: eligible contract participants that are self-regulatory organizations; or eligible contract participants that are registered brokers or dealers. 47 As before, under this temporary exemption, and solely with respect to Cleared CDS, those persons generally are exempt from the provisions of the Exchange Act and the rules and regulations thereunder that do not apply to security-based swap agreements. Thus, those persons would still be subject to those Exchange Act requirements that explicitly are applicable in connection with security-based swap agreements. 48 In addition, all provisions of the Exchange Act related to the Commission s enforcement authority in connection with 45 This exemption in general applies to eligible contract participants, as defined in Section 1a(12) of the Commodity Exchange Act as in effect on the date of this Order, other than persons that are eligible contract participants under paragraph (C) of that section. 46 The prior exemption specifically applied to any ICE Trust Participant, which was defined to exclude those members that submitted customer CDS trades for clearing. In light of our expansion of the ICE Trust relief to accommodate customer clearing, we no longer are limiting the exemption in that way, and are not using the ICE Trust Participant definition. 47 A separate temporary exemption addresses the Cleared CDS activities of registered brokerdealers. See Part II.F, infra. Solely for purposes of this Order, a registered broker-dealer, or a broker or dealer registered under Section 15(b) of the Exchange Act, does not refer to someone that would otherwise be required to register as a broker or dealer solely as a result of activities in Cleared CDS in compliance with this Order. 48 See note 44, supra.

230 27 violations or potential violations of such provisions would remain applicable. 49 In this way, the temporary exemption would apply the same Exchange Act requirements in connection with non-excluded CDS as apply in connection with OTC credit default swaps. In light of the temporary conditional exemption discussed below that we are granting from certain Exchange Act requirements related to broker-dealers, we are modifying this temporary exemption by excluding from its scope the broker-dealer registration requirements of Section 15(a)(1), 50 and the other requirements of the Exchange Act, including paragraphs (4) and (6) of Section 15(b), 51 and the rules and regulations thereunder that apply to a broker or dealer that is not registered with the Commission. Consistent with our earlier exemptions, and for the same reasons, this temporary exemption also does not extend to: the exchange registration requirements of Exchange Act Sections 5 and 6; 52 the clearing agency registration requirements of Exchange Act Section 49 Thus, for example, the Commission retains the ability to investigate potential violations and bring enforcement actions in the federal courts as well as in administrative proceedings, and to seek the full panoply of remedies available in such cases U.S.C. 78o(a)(1). 51 Exchange Act Sections 15(b)(4) and 15(b)(6), 15 U.S.C. 78o(b)(4) and (b)(6), grant the Commission authority to take action against broker-dealers and associated persons in certain situations. 52 These are subject to a separate temporary class exemption. See note 1, supra. A national securities exchange that effects transactions in Cleared CDS would continue to be required to comply with all requirements under the Exchange Act applicable to such transactions. A national securities exchange could form subsidiaries or affiliates that operate exchanges exempt under that order. Any subsidiary or affiliate of a registered exchange could not integrate, or otherwise link, the exempt CDS exchange with the registered exchange including the premises or property of such exchange for effecting or reporting a transaction without being considered a facility of the exchange. See Section 3(a)(2), 15 U.S.C. 78c(a)(2). This Order also includes a separate temporary exemption from Sections 5 and 6 in connection with the mark-to-market process of ICE Trust, discussed above, at note 41 and accompanying text.

231 28 17A; the requirements of Exchange Act Sections 12, 13, 14, 15(d), and 16; 53 or certain provisions related to government securities. 54 To take advantage of this temporary exemption from Exchange Act requirements, moreover, ICE Trust clearing members must be in material compliance with ICE Trust rules. Also, to help promote compliance with the exemption discussed below that we are granting from certain Exchange Act requirements specifically related to broker-dealers, this more general Exchange Act exemption is conditioned on any ICE Trust clearing member that participates in the clearing of Cleared CDS transactions on behalf of other persons annually providing a certification to ICE Trust that attests to whether the clearing member is relying on the temporary exemption from broker-dealer related requirements described below. 55 E. Conditional Temporary Exemption from Broker-Dealer Related Requirements for Certain Clearing Members of ICE Trust and Others The March ICE Trust Order did not address clearing of customer transactions by ICE Trust, and that order thus did not provide ICE Trust clearing members that hold customer collateral in connection with cleared CDS transactions with an exemption from broker-dealer requirements under the Exchange Act. Absent an exception or exemption, persons that effect U.S.C. 78l, 78m, 78n, 78o(d), 78p. Eligible contract participants and other persons instead should refer to the interim final temporary rules issued by the Commission. See note 1, supra. 54 This exemption specifically does not extend to the Exchange Act provisions applicable to government securities, as set forth in Section 15C, 15 U.S.C. 78o-5, and its underlying rules and regulations; nor does the exemption extend to related definitions found at paragraphs (42) through (45) of Section 3(a), 15 U.S.C. 78c(a). The Commission does not have authority under Section 36 to issue exemptions in connection with those provisions. See Exchange Act Section 36(b), 15 U.S.C. 78mm(b). 55 This condition requiring clearing members to convey information to ICE Trust as a repository for regulators, and other conditions of this Order that require clearing members or others to convey information (e.g., an audit report related to the clearing member s compliance with exemptive conditions) to ICE Trust, does not impose upon ICE Trust any independent duty to audit or otherwise review that information. These conditions also do not impose on ICE Trust any independent fiduciary or other obligation to any customer of a clearing member.

232 29 transactions in non-excluded CDS that are securities may be required to register as brokerdealers pursuant to Section 15(a)(1) of the Exchange Act. 56 Moreover, certain other requirements of the Exchange Act could apply to such persons, as broker-dealers, regardless of whether they are registered with the Commission. It is consistent with our investor protection mandate to require securities intermediaries that receive or hold funds and securities on behalf of others to comply with standards that safeguard the interests of their customers. For example, a registered brokerdealer is required to segregate assets held on behalf of customers from proprietary assets because segregation will assist customers in recovering assets in the event the broker-dealer fails. To the extent that funds and securities are not segregated, they could be used by an intermediary to fund its own business and could be attached to satisfy debts of the intermediary if it were to fail. 57 Moreover, the maintenance of adequate capital and liquidity 56 Section 15(a)(1) generally provides that, absent an exception or exemption, a broker or dealer that uses the mails or any means of interstate commerce to effect transactions in, or to induce or attempt to induce the purchase or sale of, any security must register with the Commission. Section 3(a)(4) of the Exchange Act generally defines a broker as any person engaged in the business of effecting transactions in securities for the account of others, but excludes certain bank securities activities. 15 U.S.C. 78c(a)(4). Section 3(a)(5) of the Exchange Act generally defines a dealer as any person engaged in the business of buying and selling securities for his own account, but includes exceptions for certain bank activities. 15 U.S.C. 78c(a)(5). Exchange Act Section 3(a)(6) defines a bank as a bank or savings association that is directly supervised and examined by state or federal banking authorities (with certain additional requirements for banks and savings associations that are not chartered by a federal authority or a member of the Federal Reserve System). 15 U.S.C. 78c(a)(6). 57 In the context of the December 15 commitment for customer CDS clearing, an ISDA buyside/sell-side committee issued a report extensively analyzing the legal issues associated with segregating the collateral that customers post with members. See Distilled Report (Jul. 13, 2009) ( Full Report (Jun. 30, 2009) ( see also Press Release, New York Fed Welcomes CDS Central Counterparty Legal Analysis (Jul. 13, 2009) ( ( Segregation and portability are key elements in building robust central counterparties. We requested the analysis because market participants were not making enough progress to analyze and address these buy-side issues. This is a good first step and, as we move the OTC derivatives market to central clearing, we

233 30 protects customers, CCPs and other market participants. Adequate books and records (including both transactional and position records) are necessary to facilitate day to day operations as well as to help resolve situations in which an intermediary fails and either a regulatory authority or receiver is forced to liquidate the firm. Appropriate records also are necessary to allow examiners to review for improper activities, such as insider trading or fraud. At the same time, requiring intermediaries that receive or hold funds and securities on behalf of customers in connection with transactions in non-excluded CDS to register as broker-dealers may deter the use of CCPs in customer CDS transactions, which would cause customers to lose the counterparty risk benefits of central clearing, and would lessen the systemic risk reduction benefits associated with central clearing. Those factors argue in favor of flexibility in applying the requirements of the Exchange Act to these intermediaries, conditioned on requiring the intermediaries to take reasonable steps to help increase the likelihood that their customers would be protected in the event the intermediary became insolvent, even if those safeguards are as not as strong as those required of registered broker-dealers. This requires us to balance the goals of promoting the central clearing of customer CDS transactions against the goal of protecting customers, and to be mindful that these conditions cannot provide legal certainty that customer collateral in fact would be protected in the event an ICE Trust clearing member were to become insolvent. In granting the temporary exemption, we also are relying on ICE Trust s representation that before offering the Non-Member Framework, it will adopt a requirement that non-u.s. clearing members subject to the framework are regulated by: (i) a signatory to will work to strengthen the regulatory and legal environment for buy-side clearing, said William C. Dudley, president of the New York Fed. ).

234 31 the IOSCO Multilateral Memorandum of Understanding Concerning Consultation and Cooperation and the Exchange of Information, or (ii) a signatory to a bilateral arrangement with the Commission for enforcement cooperation. 58 Accordingly, pursuant to Section 36 of the Exchange Act, the Commission finds that it is necessary or appropriate in the public interest and is consistent with the protection of investors to exercise its authority to grant a conditional exemption until March 7, 2010, with respect to certain Exchange Act requirements related to broker-dealers. This exemption is available to ICE Trust clearing members other than registered broker-dealers. This exemption also is available to any eligible contract participant, other than a registered broker-dealer, that does not receive or hold funds or securities for the purpose of purchasing, selling, clearing, settling, or holding Cleared CDS positions for other persons. 59 Solely with respect to Cleared CDS, those persons temporarily will be exempt from the broker-dealer registration requirements of Section 15(a)(1), and the other requirements of the Exchange Act (other than 58 Non-U.S. clearing members that do not meet these criteria would not be eligible to rely on this exemption. 59 In some circumstances, an eligible contract participant that does not hold customer funds or securities nonetheless may act as a dealer in securities transactions, or as a broker (such as an interdealer broker). Solely for purposes of this requirement, an eligible contract participant would not be viewed as receiving or holding funds or securities for purpose of purchasing, selling, clearing, settling, or holding Cleared CDS positions for other persons, if the other persons involved in the transaction would not be considered customers of the eligible contract participant under the analysis used for determining whether certain persons would be considered customers of a broker-dealer under Exchange Act Rule 15c3-3(a)(1). For these purposes, and for the purpose of the definition of Cleared CDS, the terms purchasing and selling mean the execution, termination (prior to its scheduled maturity date), assignment, exchange, or similar transfer or conveyance of, or extinguishing the rights or obligations under, a Cleared CDS, as the context may require. This is consistent with the meaning of the terms purchase or sale under the Exchange Act in the context of security-based swap agreements. See Exchange Act Section 3A(b)(4).

235 32 paragraphs (4) and (6) of Section 15(b) 60 ) and the rules and regulations thereunder that apply to a broker or dealer that is not registered with the Commission. For all ICE Trust clearing members regardless of whether they receive or hold customer collateral in connection with Cleared CDS this temporary exemption is conditioned on the clearing member being in material compliance with ICE Trust s rules, as well as on the clearing member being in compliance with applicable laws and regulations relating to capital, liquidity, and segregation of customers funds and securities (and related books and records provisions) with respect to Cleared CDS. For ICE Trust clearing members that receive or hold funds or securities of U.S. persons (or who receive or hold funds or securities of any person in the case of a U.S. clearing member) other than for an affiliate that controls, is controlled by, or is under common control with the clearing member in connection with Cleared CDS, this temporary exemption further is conditioned on the customer not being a natural person, and on the clearing member providing certain risk disclosures to the customer As noted above, see note 51, supra, Exchange Act Sections 15(b)(4) and 15(b)(6) grant the Commission authority to take action against broker-dealers and associated persons in certain situations. Accordingly, while this exemption from broker-dealer requirements generally extends to persons that act as broker-dealers in the market for Cleared CDS (potentially including inter-dealer brokers that do not hold funds or securities for others), such persons may be subject to actions under Sections 15(b)(4) and (b)(6) of the Exchange Act. In addition, such persons may be subject to actions under Exchange Act Section 15(c)(1), 15 U.S.C. 78o(c)(1), which prohibits brokers and dealers from using manipulative or deceptive devices. As noted above, Section 15(c)(1) explicitly applies to security-based swap agreements. Sections 15(b)(4), 15(b)(6) and 15(c)(1), of course, would not apply to persons subject to this exemption who do not act as broker-dealers or associated persons of broker-dealers. 61 The clearing member must disclose that it is not regulated by the Commission and that U.S. broker-dealer segregation requirements and protections under the Securities Investor Protection Act will not apply, that the insolvency law of the applicable jurisdiction may affect the customer s ability to recover funds and securities or the speed of any such recovery, and (if applicable) that non-u.s. members may be subject to an insolvency regime that is materially different from that applicable to U.S. persons.

236 33 Also, those clearing members that receive or hold such customer funds or securities must transfer those funds and securities, as promptly as practicable after receipt, to either the Custodial Client Omnibus Margin Account at ICE Trust 62 or an account held by a third-party custodian, as described below. Collateral that is held at a third-party custodian, moreover, must either be held: (1) in the name of the customer, subject to an agreement in which the customer, the clearing member and the custodian are parties, acknowledging that the assets held therein are customer assets used to collateralize obligations of the customer to the clearing member, and that the assets held in the account may not otherwise be pledged or rehypothecated by the clearing member or the custodian; or (2) in an omnibus account for which the clearing member maintains daily records as to the amount owing to each customer, and which is subject to an agreement between the clearing member and the custodian specifying: (i) that all account assets are held for the exclusive benefit of the clearing member s customers and are being kept separate from any other accounts that the clearing member maintains with the custodian; (ii) that the account assets may not be used as security for a loan to the clearing member by the custodian, and shall be subject to no right, charge, security interest, lien, or claim of any kind in favor of the custodian or any person claiming through the custodian; and (iii) that the assets may not otherwise be pledged or rehypothecated by the clearing member or the custodian. 63 Under either approach, the third-party custodian cannot be affiliated with the 62 Cash collateral transferred to ICE Trust may be invested in Eligible Custodial Assets, as defined in ICE Trust's Custodial Asset Policies. See note 26 supra and accompanying text. Also, collateral transferred to ICE Trust may be held at a subcustodian. 63 We do not contemplate that either of these approaches involving the use of a third-party custodian would interfere with the ability of a clearing member and its customer to agree as to how any return or losses earned on those assets would be distributed between the clearing member and its customer.

237 34 clearing member. 64 Moreover, if the third-party custodian is a U.S. entity, it must be a bank (as that term is defined in Section 3(a)(6) of the Exchange Act), have total regulatory capital of at least $1 billion, 65 and have been approved to engage in a trust business by an appropriate regulatory agency. A custodian that is not a U.S. entity must have regulatory capital of at least $1 billion, 66 and must provide the clearing member, the customer and ICE Trust with a legal opinion providing that the account assets are subject to regulatory requirements in the custodian s home jurisdiction designed to protect, and provide for the prompt return of, custodial assets in the event of the custodian s insolvency, and that the assets held in that account reasonably could be expected to be legally separate from the clearing member s assets in the event of the clearing member s insolvency. Also, cash collateral posted with the third-party custodian may be invested in other assets, consistent with the investment policies that govern collateral held at ICE Trust. 67 Finally, a clearing member that uses a third-party custodian to hold customer collateral must notify ICE Trust of that use. Also, the restriction in both approaches on the clearing member s and the custodian s ability to rehypothecate these customer funds and securities does not preclude that collateral from being transferred to ICE Trust as necessary to satisfy variation margin requirements in connection with the customer s CDS position. 64 For purposes of the Order, an affiliated person of a clearing member mean any person who directly or indirectly controls a clearing member or any person who is directly or indirectly controlled by or under common control with a clearing member; ownership of 10 percent or more of an entity s common stock will be deemed prima facie control of that entity. This standard is analogous to the standard used to identify affiliated persons of broker-dealers under Exchange Act Rule 15c3-3(a)(13), 17 CFR c3-3(a)(13). 65 In particular, custodians that are U.S. entities must have total capital, as calculated to meet the applicable requirements imposed by the entity s appropriate regulatory agency, of at least $1 billion. The term appropriate regulatory agency is defined in Section 3(a)(34) of the Exchange Act, 15 U.S.C. 78c(a)(34)). 66 Custodians that are non-u.s. entities, particularly must have total capital, as calculated to meet the applicable requirements imposed by the foreign financial regulatory authority of at least $1 billion. The term foreign financial regulatory authority is defined in Section 3(a)(52) of the Exchange Act, 15 U.S.C. 78c(a)(52)). 67 See note 26, supra.

238 35 To the extent there is any delay in the clearing member transferring such funds and securities to ICE Trust or a third-party custodian, 68 the clearing member must effectively segregate the collateral in a way that, pursuant to applicable law, could reasonably be expected to effectively protect the collateral from the clearing member s creditors. The clearing member may not permit customers to opt out of such segregation even if applicable regulations or laws otherwise would permit such opt out. To facilitate compliance with the segregation practices that are required as a condition to this temporary exemption, the clearing member also must annually provide ICE Trust with a self-assessment that it is in compliance with the requirements, along with a report by the clearing member's independent third-party auditor that attests to that assessment. The report must be dated the same date as the clearing member s annual audit report (but may be separate from it), and must be produced in accordance with the standards that the auditor follows in auditing the clearing member s financial statements. Finally, to support these segregation practices and enhance the ability to detect and deter circumstances in which clearing members fail to segregate customer collateral consistent with the exemption, this temporary exemption is conditioned on the clearing member agreeing to provide the Commission with access to information related to Cleared CDS transactions. 69 In particular, the clearing member would provide the Commission (upon request and subject to agreements reached between the Commission or the U.S. Government and an appropriate 68 This provision is intended to address short-term technology or operational issues. ICE Trust rules require collateral to be transferred promptly on receipt, with the expectation that margin would be transferred on the same business day. 69 This requirement for clearing members to make information available to the Commission is consistent with a requirement in Exchange Act Rule 15a-6, which exempts certain foreign brokerdealers from registering with the Commission. See Exchange Act Rule 15a-6(a)(3)(i)(B).

239 36 foreign securities authority 70 ) with information or documents within the clearing member s possession, custody, or control, as well as testimony of clearing member personnel and assistance in taking the evidence of other persons, that relates to Cleared CDS transactions. If, after the clearing member has exercised its best efforts to provide this information (including requesting the appropriate governmental body and, if legally necessary, its customers), the clearing member nonetheless is prohibited from providing the information by applicable foreign law or regulations, this temporary exemption shall not longer be available to the clearing member. 71 We recognize that requiring clearing members that receive or hold customer collateral to satisfy these conditions will not guarantee that a customer would receive the return of its collateral in the event of a clearing member s insolvency, particularly in light of the factspecific nature of the insolvency process and the multiplicity of insolvency regimes that may apply to ICE Trust s members clearing for U.S. customers. We believe, however, that these are reasonable steps for increasing the likelihood that customers would be able to access collateral in such an insolvency event. We also recognize that these customers generally may be expected to be sophisticated market participants that should be able to weigh the risks associated with entering into arrangements with intermediaries that are not registered brokerdealers, particularly in light of the disclosure required as a condition to this temporary exemption. 70 The term foreign securities authority is defined in Section 3(a)(50) of the Exchange Act, 15 U.S.C. 78c(a)(50). 71 Consistent with the discussion above as to the loss of an exemption due to an underlying representation no longer being accurate, see note 8, supra, if a clearing member were to lose the benefit of this exemption due to the failure to provide information to the Commission as the result of a prohibition by an applicable foreign law or regulation, the legal status of existing open positions in non-excluded CDS associated with those clearing members and its customers would remain unchanged, but the clearing member could not establish new CDS positions pursuant to the exemption.

240 37 F. Extended Temporary General Exemption for Certain Registered Broker-Dealers When we initially provided exemptions in connection with CDS clearing by ICE Trust, we granted limited exemptions from Exchange Act requirements to registered brokerdealers in connection with their activities involving Cleared CDS. In crafting these temporary exemptions, we balanced the need to avoid creating disincentives to the prompt use of CCPs against the critical role that certain broker-dealers play in promoting market integrity and protecting customers (including broker-dealer customers that are not involved with CDS transactions). In light of the risk management and systemic benefits in continuing to facilitate CDS clearing by ICE Trust through targeted exemptions to registered broker-dealers, the Commission finds pursuant to Section 36 of the Exchange Act that it is necessary or appropriate in the public interest and is consistent with the protection of investors to exercise its authority to extend this temporary registered broker-dealer exemption from certain Exchange Act requirements until March 7, Consistent with the temporary exemptions discussed above, and solely with respect to Cleared CDS, we are temporarily exempting registered broker-dealers from provisions of the Exchange Act and the rules and regulations thereunder that do not apply to security-based swap agreements. As discussed above, we are not excluding registered broker-dealers from Exchange Act provisions that explicitly apply in connection with security-based swap 72 The temporary exemptions addressed above with regard to ICE Trust, certain clearing members and certain eligible contract participants are not available to persons that are registered as broker-dealers with the Commission (other than those that are notice registered pursuant to Exchange Act Section 15(b)(11)). Exchange Act Section 15(b)(11) provides for notice registration of certain persons that effect transactions in security futures products. 15 U.S.C. 78o(b)(11).

241 38 agreements or from related enforcement authority provisions. 73 As above, and for similar reasons, we are not exempting registered broker-dealers from: Sections 5, 6, 12(a) and (g), 13, 14, 15(b)(4), 15(b)(6), 15(d), 16 and 17A of the Exchange Act. 74 Further we are not exempting registered broker-dealers from the following additional provisions under the Exchange Act: (1) Section 7(c), 75 regarding the unlawful extension of credit by broker-dealers; (2) Section 15(c)(3), 76 regarding the use of unlawful or manipulative devices by broker-dealers; (3) Section 17(a), 77 regarding broker-dealer obligations to make, keep and furnish information; (4) Section 17(b), 78 regarding broker-dealer records subject to examination; (5) Regulation T, 79 a Federal Reserve Board regulation regarding extension of credit by broker-dealers; (6) Exchange Act Rule 15c3-1, regarding broker-dealer net capital; (7) Exchange Act Rule 15c3-3, regarding broker-dealer reserves and custody of securities; (8) Exchange Act Rules 17a-3 through 17a-5, regarding records to be made and preserved by broker-dealers and reports to be made by broker-dealers; and (9) Exchange Act Rule 17a-13, regarding quarterly security counts to be made by certain exchange members and broker- 73 See notes 44 and 49, supra. As noted above, broker-dealers also would be subject to Section 15(c)(1) of the Exchange Act, which prohibits brokers and dealers from using manipulative or deceptive devices, because that provision explicitly applies in connection with security-based swap agreements. In addition, to the extent the Exchange Act and any rule or regulation thereunder imposes any other requirement on a broker-dealer with respect to security-based swap agreements (e.g., requirements under Rule 17h-1T to maintain and preserve written policies, procedures, or systems concerning the broker or dealer's trading positions and risks, such as policies relating to restrictions or limitations on trading financial instruments or products), these requirements would continue to apply to broker-dealers activities with respect to Cleared CDS. 74 We also are not exempting those members from provisions related to government securities, as discussed above U.S.C. 78g(c). 15 U.S.C. 78o(c)(3). 15 U.S.C. 78q(a). 15 U.S.C. 78q(b). 12 CFR et seq.

242 39 dealers. 80 Registered broker-dealers must comply with these provisions in connection with their activities involving non-excluded CDS because these provisions are especially important to helping protect customer funds and securities, ensure proper credit practices and safeguard against fraud and abuse. 81 G. Solicitation of Comments When we granted our initial exemptions relief in connection with CDS clearing by ICE Trust, we solicited comment on all aspects of the exemptions, and specifically requested comment as to the duration of the temporary exemptions, the appropriateness of the exemptive conditions, and whether ICE Trust should be required to register as a clearing agency under the Exchange Act. We received no comments in response this request. In connection with this Order extending the exemptions granted in connection with CDS clearing by ICE Trust, and expanding that relief to accommodate central clearing of customer CDS transactions, we reiterate our request for comments on all aspects of the exemptions. We particularly request comments as to the relief we are granting in connection with customer clearing, including whether ICE Trust members that clear customer CDS transactions should be required to register as broker-dealers, whether the conditions that we have placed on the relief adequately protect customer funds and securities from the threat posed by clearing member insolvency, whether additional conditions or requirements are appropriate to promote compliance with the requirements of the exemptions, and what, if any, additional conditions would be appropriate. We also particularly request comment on 80 Solely for purposes of this temporary exemption, in addition to the general requirements under the referenced Exchange Act sections, registered broker-dealers shall only be subject to the enumerated rules under the referenced Exchange Act sections. 81 Indeed, Congress directed the Commission to promulgate broker-dealer financial responsibility rules, including rules relating to custody, the use of customer securities, the use of customers deposits or credit balances, and the establishment of minimum financial requirements.

243 40 whether additional conditions, such as a segregation requirement, are necessary to protect customers mark-to-market profits associated with Cleared CDS transactions that are held at clearing members; in that regard, commenters particularly are invited to discuss whether, in practice, there are impediments to customers receiving such mark-to-market profits from their clearing members promptly after they are earned. Comments may be submitted by any of the following methods: Electronic comments: Use the Commission s Internet comment form ( or Send an to [email protected]. Please include File Number S on the subject line; or Use the Federal erulemaking Portal ( Follow the instructions for submitting comments. Paper comments: Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC All submissions should refer to File Number S This file number should be included on the subject line if is used. To help us process and review your comments more efficiently, please use only one method. We will post all comments on the Commission s Internet Web site ( Comments are also available for public inspection and copying in the Commission s Public Reference Room, 100 F Street, NE, Washington, DC 20549, on official business days between the hours of 10:00 am and 3:00 pm. All comments received will be posted without change; we do not edit

244 41 personal identifying information from submissions. You should submit only information that you wish to make available publicly. III. Conclusion IT IS HEREBY ORDERED, pursuant to Section 36(a) of the Exchange Act, that, until March 7, 2010: (a) Exemption from Section 17A of the Exchange Act. ICE Trust U.S. LLC ( ICE Trust ) shall be exempt from Section 17A of the Exchange Act solely to perform the functions of a clearing agency for Cleared CDS (as defined in paragraph (f)(1) of this Order), subject to the following conditions: (1) ICE Trust shall make available on its Web site its annual audited financial statements. (2) ICE Trust shall keep and preserve at least one copy of all documents, including all correspondence, memoranda, papers, books, notices, accounts, and other such records as shall be made or received by it relating to its Cleared CDS clearance and settlement services. These records shall be kept for at least five years and for the first two years shall be held in an easily accessible place. (3) ICE Trust shall supply information and periodic reports relating to its Cleared CDS clearance and settlement services as may be reasonably requested by the Commission, and shall provide access to the Commission to conduct on-site inspections of all facilities (including automated systems and systems environment), records, and personnel related to ICE Trust s Cleared CDS clearance and settlement services.

245 42 (4) ICE Trust shall notify the Commission, on a monthly basis, of any material disciplinary actions taken against any of its members utilizing its Cleared CDS clearance and settlement services, including the denial of services, fines, or penalties. ICE Trust shall notify the Commission promptly when ICE Trust involuntarily terminates the membership of an entity that is utilizing ICE Trust s Cleared CDS clearance and settlement services. Both notifications shall describe the facts and circumstances that led to ICE Trust s disciplinary action. (5) ICE Trust shall notify the Commission of all changes to rules, procedures, and any other material events affecting its Cleared CDS clearance and settlement services, including its fee schedule and changes to risk management practices, the day before effectiveness or implementation of such rule changes or, in exigent circumstances, as promptly as reasonably practicable under the circumstances. All such rule changes will be posted on ICE Trust s Web site. Such notifications will not be deemed rule filings that require Commission approval. (6) ICE Trust shall provide the Commission with reports prepared by independent audit personnel that are generated in accordance with risk assessment of the areas set forth in the Commission s Automation Review Policy Statements. ICE Trust shall provide the Commission (beginning in its first year of operation) with its annual audited financial statements prepared by independent audit personnel. (7) ICE Trust shall report all significant systems outages to the Commission. If it appears that the outage may extend for 30 minutes or longer, ICE Trust shall report the systems outage immediately. If it appears that the outage will be resolved in

246 43 less than 30 minutes, ICE Trust shall report the systems outage within a reasonable time after the outage has been resolved. (8) ICE Trust, directly or indirectly, shall make available to the public on terms that are fair and reasonable and not unreasonably discriminatory: (i) all end-of-day settlement prices and any other prices with respect to Cleared CDS that ICE Trust may establish to calculate mark-to-market margin requirements for ICE Trust clearing members; and (ii) any other pricing or valuation information with respect to Cleared CDS as is published or distributed by ICE Trust. (b) Exemption from Sections 5 and 6 of the Exchange Act (1) ICE Trust shall be exempt from the requirements of Sections 5 and 6 of the Exchange Act and the rules and regulations thereunder in connection with its calculation of mark-to-market prices for open positions in Cleared CDS, subject to the following conditions: (i) ICE Trust shall report the following information with respect to the calculation of mark-to-market prices for Cleared CDS to the Commission within 30 days of the end of each quarter, and preserve such reports during the life of the enterprise and of any successor enterprise: (A) The total dollar volume of transactions executed during the quarter, broken down by reference entity, security, or index; and (B) The total unit volume and/or notional amount executed during the quarter, broken down by reference entity, security, or index;

247 44 (ii) ICE Trust shall establish and maintain adequate safeguards and procedures to protect clearing members confidential trading information. Such safeguards and procedures shall include: (A) limiting access to the confidential trading information of clearing members to those employees of ICE Trust who are operating the system or responsible for its compliance with this exemption or any other applicable rules; and (B) establishing and maintaining standards controlling employees of ICE Trust trading for their own accounts. ICE Trust must establish and maintain adequate oversight procedures to ensure that the safeguards and procedures established pursuant to this condition are followed; and (iii) ICE Trust shall satisfy the conditions of the temporary exemption from Section 17A of the Exchange Act set forth in paragraphs (a)(1) (8) of this Order. (2) Any ICE Trust clearing member shall be exempt from the requirements of Section 5 of the Exchange Act to the extent such ICE Trust clearing member uses any facility of ICE Trust to effect any transaction in Cleared CDS, or to report any such transaction, in connection with ICE Trust's clearance and risk management process for Cleared CDS. (c) Exemption for ICE Trust, ICE Trust clearing members, and certain eligible contract participants. (1) Persons eligible. The exemption in paragraph (c)(2) is available to:

248 45 (i) ICE Trust; and (ii) Any eligible contract participant (as defined in Section 1a(12) of the Commodity Exchange Act as in effect on the date of this Order (other than a person that is an eligible contract participant under paragraph (C) of that section)), including any ICE Trust clearing member, other than: (A) an eligible contract participant that is a self-regulatory organization, as that term is defined in Section 3(a)(26) of the Exchange Act; or (B) a broker or dealer registered under Section 15(b) of the Exchange Act (other than paragraph (11) thereof). (2) Scope of exemption. (i) In general. Subject to the conditions specified in paragraph (c)(3) of this subsection, such persons generally shall, solely with respect to Cleared CDS, be exempt from the provisions of the Exchange Act and the rules and regulations thereunder that do not apply in connection with security-based swap agreements. Accordingly, under this exemption, those persons remain subject to those Exchange Act requirements that explicitly are applicable in connection with security-based swap agreements (i.e., paragraphs (2) through (5) of Section 9(a), Section 10(b), Section 15(c)(1), paragraphs (a) and (b) of Section 16, Section 20(d) and Section 21A(a)(1) and the rules thereunder that explicitly are applicable to security-based swap agreements). All provisions of the Exchange Act related to the Commission s enforcement authority in

249 46 connection with violations or potential violations of such provisions also remain applicable. (ii) Exclusions from exemption. The exemption in paragraph (c)(2)(i), however, does not extend to the following provisions under the Exchange Act: (A) Paragraphs (42), (43), (44), and (45) of Section 3(a); (B) Section 5; (C) Section 6; (D) Section 12 and the rules and regulations thereunder; (E) Section 13 and the rules and regulations thereunder; (F) Section 14 and the rules and regulations thereunder; (G) The broker-dealer registration requirements of Section 15(a)(1), and the other requirements of the Exchange Act (including paragraphs (4) and (6) of Section 15(b)) and the rules and regulations thereunder that apply to a broker or dealer that is not registered with the Commission; (H) Section 15(d) and the rules and regulations thereunder; (I) Section 15C and the rules and regulations thereunder; (J) Section 16 and the rules and regulations thereunder; and (K) Section 17A (other than as provided in paragraph (a)). (3) Conditions for ICE Trust clearing members. (i) Any ICE Trust clearing member relying on this exemption must be in material compliance with the rules of ICE Trust.

250 47 (ii) Any ICE Trust clearing member relying on this exemption that participates in the clearing of Cleared CDS transactions on behalf of other persons must annually provide a certification to ICE Trust that attests to whether the clearing member is relying on the exemption from broker-dealer related requirements set forth in paragraph (d) of this Order. (d) Exemption from broker-dealer related requirements for ICE Trust clearing members and certain eligible contract participants. (1) Persons eligible. The exemption in paragraph (d)(2) is available to: (i) Any ICE Trust clearing member (other than one that is registered as a broker or dealer under Section 15(b) of the Exchange Act (other than paragraph (11) thereof)); and (ii) Any eligible contract participant that does not receive or hold funds or securities for the purpose of purchasing, selling, clearing, settling, or holding Cleared CDS positions for other persons (other than one that is registered as a broker or dealer under Section 15(b) of the Exchange Act (other than paragraph (11) thereof)). (2) Scope of exemption. The persons described in paragraph (d)(1) shall, solely with respect to Cleared CDS, be exempt from the broker-dealer registration requirements of Section 15(a)(1) and the other requirements of the Exchange Act (other than Sections 15(b)(4) and 15(b)(6)) and the rules and regulations thereunder that apply to a broker or dealer that is not registered with the Commission, subject to the conditions set forth in paragraph (d)(3) with respect to ICE Trust clearing members.

251 48 (3) Conditions for ICE Trust clearing members. (i) General condition for ICE Trust clearing members. An ICE Trust clearing member relying on this exemption must be in material compliance with the rules of ICE Trust, and also must be in material compliance with applicable laws and regulations relating to capital, liquidity, and segregation of customers funds and securities (and related books and records provisions) with respect to Cleared CDS. (ii) Additional conditions for ICE Trust clearing members that receive or hold customer funds or securities. Any ICE Trust clearing member that receives or holds funds or securities for the purpose of purchasing, selling, clearing, settling, or holding Cleared CDS positions for U.S. persons (or for any person if the clearing member is a U.S. clearing member) other than for an affiliate that controls, is controlled by, or is under common control with the clearing member also shall comply with the following conditions with respect to such activities: (A) The U.S. person (or any person if the clearing member is a U.S. clearing member) for whom the clearing member receives or holds such funds or securities shall not be natural persons; (B) The clearing member shall disclose to such U.S. person (or to any such person if the clearing member is a U.S. clearing member) that the clearing member is not regulated by the Commission and that U.S. broker-dealer segregation requirements and protections under the Securities Investor Protection Act will not apply to any funds or

252 49 securities held by the clearing member, that the insolvency law of the applicable jurisdiction may affect such persons ability to recover funds and securities, or the speed of any such recovery, in an insolvency proceeding, and, if applicable, that non-u.s. clearing members may be subject to an insolvency regime that is materially different from that applicable to U.S. persons; (C) As promptly as practicable after receipt, the clearing member shall transfer such funds and securities (other than those promptly returned to such other person) to: (I) the clearing member s Custodial Client Omnibus Margin Account at ICE Trust; or (II) an account held by a third-party custodian, subject to the following requirements: (a) the funds and securities must be held either: (1) in the name of a customer, subject to an agreement to which the customer, the clearing member and the custodian are parties, acknowledging that the assets held therein are customer assets used to collateralize obligations of the customer to the clearing member, and that the assets held in that account may not otherwise be pledged or rehypothecated by the clearing member or the custodian; or

253 50 (2) in an omnibus account for which the clearing member maintains a daily record as to the amount held in the account that is owed to each customer, and which is subject to an agreement between the clearing member and the custodian specifying that: (i) all assets in that account are held for the exclusive benefit of the clearing member's customers and are being kept separate from any other accounts maintained by the clearing member with the custodian; (ii) the assets held in that account shall at no time be used directly or indirectly as security for a loan to the clearing member by the custodian and shall be subject to no right, charge, security interest, lien, or claim of any kind in favor of the custodian or any person claiming through the custodian; and (iii) the assets held in that account may not otherwise be pledged or

254 51 rehypothecated by the clearing member or the custodian; (b) the custodian may not be an affiliated person of the clearing member (as defined at paragraph (f)(2)); and (1) if the custodian is a U.S. entity, it must be a bank (as that term is defined in section 3(a)(6) of the Exchange Act), have total capital, as calculated to meet the applicable requirements imposed by the entity s appropriate regulatory agency (as defined in section 3(a)(34) of the Exchange Act), of at least $1 billion, and have been approved to engage in a trust business by its appropriate regulatory agency; (2) if the custodian is not a U.S. entity, it must have total capital, as calculated to meet the applicable requirements imposed by the foreign financial regulatory authority (as defined in section 3(a)(52) of the Exchange Act) responsible for setting capital requirements for the entity, equating to at least $1 billion, and provide the clearing member, the customer and ICE Trust with a legal opinion providing that the

255 52 assets held in the account are subject to regulatory requirements in the custodian s home jurisdiction designed to protect, and provide for the prompt return of, custodial assets in the event of the insolvency of the custodian, and that the assets held in that account reasonably could be expected to be legally separate from the clearing member s assets in the event of the clearing member's insolvency; (c) such funds may be invested in Eligible Custodial Assets as that term is defined in ICE Trust's Custodial Asset Policies; and (d) the clearing member must provide notice to ICE Trust that it is using the third-party custodian to hold customer collateral. (D) To the extent there is any delay in transferring such funds and securities to the third-parties identified in paragraph (C), the clearing member shall effectively segregate the collateral in a way that, pursuant to applicable law, is reasonably expected to effectively protect such funds and securities from the clearing member s creditors. The clearing member shall not permit such persons to opt out of such segregation even if regulations or laws otherwise would permit such opt out.

256 53 (E) The clearing member annually must provide ICE Trust with (I) an assessment by the clearing member that it is in compliance with all the provisions of paragraphs (d)(3)(ii)(a) through (D) in connection with such activities, and (II) a report by the clearing member s independent thirdparty auditor that attests to, and reports on, the clearing member's assessment described in paragraph (d)(3)(ii)(e)(i) and that is (a) dated as of the same date as, but which may be separate and distinct from, the clearing member's annual audit report; (b) produced in accordance with the auditing standards followed by the independent third party auditor in its audit of the clearing member's financial statements. (F) The clearing member shall provide the Commission (upon request or pursuant to agreements reached between the Commission or the U.S. Government and any foreign securities authority (as defined in Section 3(a)(50) of the Exchange Act)) with any information or documents within the possession, custody, or control of the clearing member, any testimony of personnel of the clearing member, and any assistance in taking the evidence of other persons, wherever located, that the Commission requests and that relates to Cleared CDS

257 54 transactions, except that if, after the clearing member has exercised its best efforts to provide the information, documents, testimony, or assistance, including requesting the appropriate governmental body and, if legally necessary, its customers (with respect to customer information) to permit the clearing member to provide the information, documents, testimony, or assistance to the Commission, the clearing member is prohibited from providing this information, documents, testimony, or assistance by applicable foreign law or regulations, then this exemption shall not longer be available to the clearing member. (e) Exemption for certain registered broker-dealers. A broker or dealer registered under Section 15(b) of the Exchange Act (other than paragraph (11) thereof) shall be exempt from the provisions of the Exchange Act and the rules and regulations thereunder specified in paragraph (c)(2), solely with respect to Cleared CDS, except: (1) Section 7(c); (2) Section 15(c)(3); (3) Section 17(a); (4) Section 17(b); (5) Regulation T, 12 CFR et seq.; (6) Rule 15c3-1; (7) Rule 15c3-3; (8) Rule 17a-3; (9) Rule 17a-4;

258 55 (10) Rule 17a-5; and (11) Rule 17a-13. (f) Definitions. (1) For purposes of this Order, the term Cleared CDS shall mean a credit default swap that is submitted (or offered, purchased, or sold on terms providing for submission) to ICE Trust, that is offered only to, purchased only by, and sold only to eligible contract participants (as defined in Section 1a(12) of the Commodity Exchange Act as in effect on the date of this Order (other than a person that is an eligible contract participant under paragraph (C) of that section)), and in which: (i) the reference entity, the issuer of the reference security, or the reference security is one of the following: (A) an entity reporting under the Exchange Act, providing Securities Act Rule 144A(d)(4) information, or about which financial information is otherwise publicly available; (B) a foreign private issuer whose securities are listed outside the United States and that has its principal trading market outside the United States; (C) a foreign sovereign debt security; (D) an asset-backed security, as defined in Regulation AB, issued in a registered transaction with publicly available distribution reports; or (E) an asset-backed security issued or guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae; or

259 56 (ii) the reference index is an index in which 80 percent or more of the index s weighting is comprised of the entities or securities described in subparagraph (1). (2) For purposes of this Order, the term Affiliated Person of the Clearing Member shall mean any person who directly or indirectly controls a clearing member or any person who is directly or indirectly controlled by or under common control with the clearing member. Ownership of 10 percent or more of the common stock of the relevant entity will be deemed prima facie control of that entity. By the Securities and Exchange Commission. December 4, 2009 Florence E. Harmon Deputy Secretary

260 A Case for the Applicability of Rule 17f-6 of the Investment Company Act To Over the Counter Clearing By: Christopher Bowen In December 2009, the clearinghouse of the Chicago Mercantile Exchange ( CME ) launched over-the-counter clearing of transactions in certain types of Credit Default Swaps ( CDS ). In using the CME s pre-existing Derivatives Clearing Organization ( DCO ), to clear OTC contracts, a variety of issues arose which underscored the need to review the regulatory structure as it applied to listed futures (and securities products) to determine what adjustments (and exemptions) would be necessary to facilitate the clearing of CDS products. This note discusses just one issue of a number of issues relating to the project. ISSUE The CME cleared CDS solution anticipates significant buy-side participation. In the weeks prior to the launch of the solution, an issue was identified by certain participants that Securities and Exchange Commission ( Commission ) Rule 17f-6 under the Investment Company Act of 1940 (the 1940 Act ) did not apply to OTC instruments and that, unless the rule was interpreted to include such instruments, the participation of registered investment companies could be hindered. The following arguments support the conclusion that that, for the purposes of Rule 17f-6, a registered investment company (a Fund ) should be permitted to treat cleared CME CDS positions as Exchange-Traded Futures Contracts and Commodity Options as defined thereunder. 1 DISCUSSION Rule 17f-6 Rule 17f-6 permits a Fund to maintain its assets with a registered Futures Commission Merchant ( FCM ) and certain other entities, including clearing organizations such as the CME, in connection with effecting transactions in futures contracts and commodity options traded on both U.S. and foreign exchanges, subject to meeting certain conditions. Specifically, Rule 17f-6 requires a written contract between the Fund and the FCM containing certain provisions, including a provision that (i) the FCM will comply with the segregation requirements of Section 4d of the Commodity Exchange Act ( CEA ) and the CFTC s rules promulgated thereunder, or as applicable, the secured amount requirement for foreign futures and options contracts under CFTC Rule 30.7; (ii) the FCM may place and maintain the Fund s assets to effect its transactions with another FCM, a clearing organization, a U.S. or foreign bank, or a member of a foreign board of trade and if so the FCM must obtain an acknowledgment that such assets are held on behalf of the FCM s customers in accordance with the CEA 1 A letter requesting such relief was submitted to the Commission in November The Commission is still considering this request. 1

261 and CFTC rules; and (iii) the FCM will promptly furnish copies of extracts from its records or such other information pertaining to the Fund s assets as the Commission may request. Also, to protect the Fund s assets from loss in the event of the FCM s bankruptcy, any gains on Fund transactions may be maintained with the FCM only in de minimis amounts. Rule 17f-6 enables a Fund to engage in trading futures contracts and commodity options in essentially the same manner as other futures market participants under conditions which are designed to assure safekeeping of the Fund s assets in keeping with the safe custody requirements of Section 17(f) of the 1940 Act. Prior to adoption of Rule 17f-6, FCMs were not permitted to maintain custody of investment company assets and Commission staff had required investment companies to maintain their initial margin deposits in separate accounts with a third party custodian bank. FCMs therefore needed to advance their own funds to meet investment company margin obligations with the clearing organization or other clearing FCM used to effect such transactions. 2 In adopting Rule 17f-6, the Commission recognized the safeguards for customer assets provided by the CEA and the CFTC s rules, including segregation of customer funds and the secured amount requirement and FCM net capital and financial reporting requirements, and concluded that third party safekeeping accounts could be redundant or unnecessary in view of these safeguards. Rule 17f-6 does not, however, permit a Fund to deposit assets with an FCM that is an affiliated person of the Fund or an affiliated person of such person, due to special concerns about custody of Fund assets by affiliates. In response to the Commission s adoption of Rule 17f-6, the CFTC staff subsequently revisited its position on the use of third party safekeeping accounts, so that FCMs are not viewed as in compliance with applicable segregation or secured amount requirements under the CEA and the CFTC s rules if they deposit, hold or maintain margin funds for customer accounts in third party safekeeping accounts, except if the FCM is ineligible to hold the assets of a Fund customer under Rule 17f-6, because of its affiliation with the Fund or the Fund s adviser. See 70 Fed. Reg (May 11, 2005). Rule 17f-6 permits a Fund to maintain its assets to effect futures or options on futures transactions with a registered FCM, without regard to whether the FCM is a clearing member FCM or acts in an introducing capacity by maintaining a clearing relationship with a clearing member FCM. However, pursuant to CME Rules, a customer wishing to clear CDS transactions on the CME may do so only if the customer maintains an account with (i) a CME Group clearing member FCM who meets the additional requirements to clear CDS transactions for customers or with (ii) a CME Group clearing member FCM who acts as an introducing FCM by maintaining a clearing relationship with another CME Group clearing member FCM who meets the requirements to clear CDS transactions for customers. Thus, in either case, the Fund s account will be carried on the books of a CME Group clearing member FCM. 2 See 59 Fed. Reg (June 1, 1994) (proposing Rule 17f-6 for public comment). By diverting capital which would otherwise be available to the FCM, third party safekeeping accounts were thought to create systemic liquidity risks in the marketplace, particularly during periods of market stress. Id. at

262 Protections Afforded by CME Clearing and the Clearing of CDS Contracts From a policy perspective, treating CDS contracts that are cleared by the CME as Exchange-Traded Futures Contracts and Commodity Options for purposes of Rule 17f-6 is consistent with the approach taken by the Commission and the staff in applying the safe custody requirements of Section 17(f) of the 1940 Act in response to significant developments in the financial markets. In this regard, the Commission and the staff have previously sought to provide Funds with flexibility in their custodial arrangements where necessary to facilitate their investment and trading activities in an efficient manner, as long as Fund assets are adequately protected by procedures similar to the applicable rules under Section 17(f), including situations in which there was not literal compliance with the provisions of the relevant rule. Even though cleared CDS contracts are not literally Exchange-Traded Futures Contracts and Commodity Options as defined in Rule 17f-6, cleared CDS contracts are functionally equivalent to such instruments and that each of the conditions set forth in Rule 17f-6 will be satisfied in all respects. A discussion of the CME clearing model and the attendant protections and benefits which inure to the benefit of all customers (including 40 Act customers) are as follows: - Clearing and Settlement CME Group Inc. ( CME Group ), a Delaware stock corporation, is the holding company for the Chicago Mercantile Exchange Inc. ( CME ), as well as certain other exchanges. CME was founded in 1898 as a not-for-profit corporation; in 2000 CME demutualized and became a shareholder-owned corporation. CME is a Designated Contract Market ( DCM ), regulated by the Commodity Futures Trading Commission ( CFTC ), for the trading of futures contracts and options on futures contracts. In addition, CME Group operates its own clearing house, which is a division of CME and, as noted above, is a DCO regulated by the CFTC. The clearing house clears, settles and guarantees the performance of all transactions for which CME Group provides clearing services. As a DCO, the CME is required to comply with the 18 CFTC Core Principles applicable to registered DCMs and the 14 CFTC Core Principles applicable to DCOs. 3 CME s rules alone or in combination with laws and regulations applicable to CME and its clearing members require that any CME clearing member who purchases, sells, or holds CDS positions for other persons (i.e., customers including any Fund): (1) must be registered with the CFTC as an FCM; (2) effectively segregate funds and securities of other persons (except positions held in proprietary accounts of the clearing member, i.e., positions of the clearing member or affiliates of the clearing member) that it holds in its custody or control for the purpose of purchasing, selling, or holding CDS positions; (3) maintain adequate capital and liquidity; and (4) maintain sufficient books and records to establish (a) that the CME clearing member is maintaining adequate capital and liquidity and (b) separate ownership of the funds, securities, and positions it may hold for the purpose of purchasing, selling, or holding CDS positions for other 3 The DCM and DCO Core Principles are set forth in Sections 5(d) and 5b(c)(2) of the Commodity Exchange Act. 3

263 persons and those it holds for its proprietary accounts. - Segregated Funds and Securities CFTC regulations and CME rules require any clearing member who clears CDS transactions for customers to be registered as an FCM and to segregate customer funds and property from the proprietary positions of the clearing member and its affiliates. Accounts segregated pursuant to Section 4d of the CEA and the regulations pertinent thereto contain the funds of customers trading futures contracts and options on futures contracts on U.S. exchanges that are DCMs. The CFTC also permits funds margining cleared OTC transactions to be held in Section 4d accounts by clearing FCMs and clearing houses, if the CFTC has issued a Section 4d order that covers the specific product being cleared. 4 If CME receives a Section 4d order from the CFTC, all funds and property received from customers of FCMs, including Funds, in connection with purchasing, selling or holding CDS positions will be subject to the requirements of CFTC Rule 1.20, et seq. promulgated under Section 4d. Rule 1.20, et seq., requires that customer positions and property be separately accounted for and segregated from the positions and property of the FCM. Customer property will be deposited under an account name that clearly identifies it as such and shows it is appropriately segregated as required by the CEA and Rule 1.20, et seq. In accordance with CME Rule 8F03, prior to issuance of a Section 4d order, all CDS contracts submitted to CME for clearing for the account of a clearing member FCM s customer must be assigned and held in an account subject to CFTC Rule Rule 30.7 accounts contain funds of U.S.-domiciled customers trading futures and options contracts on foreign exchanges (FCMs may choose to include the funds of non- U.S.-domiciled customers trading these products as well.) These accounts may also contain the funds of customers engaged in non-regulated transactions, including cleared OTC transactions. Like Rule 1.20, et seq., Rule 30.7 requires that customer positions and property be separately held and accounted for from the positions and property of the FCM, and that customer property be deposited under an account name that clearly identifies it as customer property. CME Rule 8F03 reiterates that [a]ll collateral deposited as performance bond to support positions in such [Rule] 30.7 account and all positions, collateral or cash in such account shall be segregated from the Clearing Member s proprietary account. CME s Audit Department regularly inspects the books and records of clearing members to ensure, among other things, their compliance with these segregation requirements. - Adequate Capital and Liquidity CME Group clearing members who are broker-dealers or FCMs maintain capital and liquidity in accordance with relevant Commission and CFTC rules and regulations. In addition, CME s requirements for minimum capital contributions, contribution to the 4 CME has petitioned the CFTC for such an order pursuant to Section 4d with respect to cleared CDS contracts. The CFTC has previously issued such orders pursuant to Section 4d to CME with respect to cleared over-the-counter derivative products involving Eurodollar and currency contracts, as well as agricultural and ethanol swaps. 4

264 guaranty fund based on risk factors, maintenance margin, and mark to market with immediate payment of losses assure adequate capital and liquidity for clearing member firms who are not broker-dealers or FCMs (i.e., clearing members who only carry positions for proprietary or non-customer accounts), as well as those who are brokerdealers or FCMs. Clearing member FCMs subject to CFTC net capital requirements must maintain Adjusted Net Capital ( ANC ) at prescribed levels. CME and the CFTC have adopted a risk-based capital requirement as the regulatory minimum capital requirement. Capital requirements are monitored by CME s Audit Department and ANC requirements vary to reflect the risk of each clearing member s positions as well as CME s assessment of each clearing member s internal controls, risk management policies and back office operations. CME has established additional capital and guaranty fund contribution requirements for CME Group clearing members authorized to clear CDS. To clear CDS, whether for proprietary or customer accounts, a clearing member must maintain $500 million in ANC. CDS clearing members must also make initial guaranty fund contributions with respect to CDS that will be a minimum of $50 million each. Those CDS clearing members with ANC of less than $1 billion must maintain excess margin with the clearing house that is equal to their guaranty fund contributions with respect to CDS. CDS clearing members with less than $5 billion in ANC are also subject to daily capital reporting. Clearing members must have tools to manage appropriate requirements with respect to their customers. CME Rule 982 requires clearing members to establish written risk management policies and procedures, including monitoring the risks assumed by specific customers. To facilitate such controls with respect to CDS transactions, CME s clearing systems include functionality that permits clearing members to register customer accounts and specify customer credit limits. Control features of CME s clearing systems will ensure that CDS transactions cannot be submitted to clearing for non-registered accounts or if the positions resulting from the transaction or transactions would cause a specified daily exposure limit to be exceeded. CME determines the acceptability of different collateral types and determines appropriate haircuts. A list of acceptable collateral and applicable haircuts is available at Collateral requirements for CDS contracts eligible for clearing will appropriately reflect the specific risks of such CDS contracts, including jump-todefault and the consequences of a liquidity event caused by the defaults. - Sufficient Books and Records Broker-dealers and FCMs who are clearing members must meet their respective SEC and CFTC recordkeeping requirements. CME Rule 8F04(9) requires each FCM who is a clearing member to keep the same books and records for OTC derivatives (including CDS contracts) submitted to CME for clearing as the FCM is required to keep under CFTC recordkeeping requirements. CME reserves the right to examine clearing member books at all times. The same audit procedures would apply whether full CFTC segregation under Section 4d is in place or if alternate means of segregation are employed pursuant to Rule

265 Clearing members are required under CME Rules, the CEA and CFTC regulations to maintain adequate accounting systems, internal accounting controls and procedures for safeguarding customer and clearing member assets. These requirements will apply to CDS contracts cleared by CME. These systems, controls and procedures must be robust enough to allow the clearing member to demonstrate to the CME Group Audit Department that it maintains adequate capital and liquidity. In addition, the systems, controls and procedures must be able to evidence the separate ownership of funds, securities and positions it may hold for the purpose of purchasing, selling or holding CDS positions for customers and those it holds for its own proprietary accounts. Audit Department staff routinely examine clearing members to ensure compliance with these standards. Further, Audit Department staff may prescribe additional accounting, reporting, financial and/or operational requirements for clearing members and clearing members must comply with such requirements. - Section 4d of the CEA and Rule 30.7 As set forth in the adopting release for Rule 17f-6, these provisions stipulate that an FCM must collect required margin from each customer to cover the margin obligations of that customer and prohibit an FCM from using one customer s funds to cover the obligations of another customer, and also from commingling customer assets with the FCM s own assets. If an FCM fails to have sufficient funds in segregation, it must immediately report that violation to the CFTC and its designated self-regulatory organization. As a result, FCMs typically maintain a cushion of their own funds in segregation to avoid triggering a notice requirement. The CME has petitioned the CFTC for an Order pursuant to Section 4d of the CEA that would permit customer funds used to margin, secure, or guarantee cleared CDS contracts to be held in Section 4d segregated customer accounts. If this petition is granted, the CME and FCMs clearing through the CME will be authorized to commingle customer funds used to margin cleared CDS contracts with other funds held in customer segregated accounts maintained in accordance with Section 4d of the CEA and CFTC rules. Given that the CFTC has not yet issued the requested relief under Section 4d of the CEA, the CME and FCMs clearing through the CME will commingle funds used to margin cleared CDS contracts with other funds held in customer secured amount accounts maintained in accordance with CFTC Rule As alluded to previously, Rule 30.7 sets forth a segregation requirement applicable to accounts of U.S. customers who trade futures contracts and commodity options traded on foreign exchanges. Under Rule 30.7, an FCM must maintain in a separate account or accounts assets in an amount sufficient to cover the secured amount required to be set aside for such customer accounts. This amount generally reflects the assets required to margin the foreign futures and options transactions of the FCM s U.S. customers (and may include the assets required to margin the foreign futures and options transactions of the FCM s non- U.S. customers). Just as with funds in segregation, if an FCM fails to have sufficient secured amount funds set aside in Rule 30.7 accounts, it must immediately report that violation to the CFTC and its designated self-regulatory organization. 6

266 In connection with adopting Rule 17f-6, the Commission determined to permit a Fund to maintain assets with a registered FCM in respect of engaging in commodity trades effected on both foreign, as well as, U.S. exchanges. In doing so, the Commission noted the applicability of the regulatory framework for foreign futures and options transactions under the CFTC s Part 30 Rules, including the secured amount and FCM net capital requirements, which are designed to provide protection for the assets of U.S. customers trading futures contracts and commodity options on foreign exchanges. See 61 Fed. Reg at and n.17 and It is permissible for FCMs and clearing organizations to include different types of non-regulated transactions in foreign futures and options accounts of U.S. customers under applicable CFTC guidance. The CME therefore has not requested any exemptive relief from the CFTC with respect to holding margin funds for cleared CDS contracts in Rule 30.7 accounts. - Benefits of the Clearing Solution CME, acting as central counterparty, will reduce counterparty risk inherent in the CDS market and mitigate the risk and potential systemic impacts of counterparty failures. By clearing and settling CDS contracts, CME will substitute itself as buyer to the CDS seller and the seller to the CDS buyer. As a result, CDS counterparties, just as futures market participants, will no longer be exposed to each others credit risk. Instead, each counterparty, including Fund customers, will receive the benefit of CME s extensive package of financial safeguards for CDS transactions which are accepted for clearing by CME. CME will also have the ability to reduce the risk of collateral flows by netting positions in similar instruments and by netting gains and losses across different instruments. As a result, instead of a CDS market participant having a large volume of trades, some offsetting, with many counterparties, participants will benefit from netting. Moreover, centralized clearing will provide more flexibility to trade in and out of positions, and will allow for the expeditious transfer or liquidation of the positions of a troubled or defaulting clearing member, including a clearing member who is a registered FCM. If a clearing member is troubled (i.e., it fails to meet minimum financial requirements or its financial or operational condition may jeopardize the CME s integrity, or negatively impact the financial markets), then CME may take action pursuant to Rules 974 (Failure to Meet Minimum Financial Requirements) or 975 (Emergency Financial Conditions). In the event of a default by a CME clearing member, the process will be governed by applicable CME Rules, including Chapter 8-F (Over-the-Counter Derivative Clearing), including but not limited to Rules 8F06 (Clearing Member Default), 8F07 (Guaranty Fund Deposit), 8F13 (Insolvency and Liquidation) and 8F25 (Default Management Committee). Chapter 8-F further incorporates the general CME Rules relating to defaults, including but not limited to Rules 802 (Protection of Clearing House), 913 (Withdrawal From Clearing Membership), 974 (Failure to Meet Minimum Financial Requirements), 975 (Emergency Financial Conditions), 976 (Suspension of Clearing Members), 978 (Open Trades of Suspended Clearing Members), and 979 (Suspended or Expelled Clearing Members). 7

267 In the event of a clearing member default, CME may access its financial safeguard package as necessary. CME s financial safeguards package is a combination of each clearing member s collateral on deposit to support its positions, the collateral of its customers to support customer positions, CME surplus funds, security deposits and assessment powers. Pursuant to CME Rules 816 and 8F04 of the CME Rulebook, clearing members who clear CDS contracts will be subject to an additional guaranty fund deposit requirement as described above. Furthermore, the calculation of that portion of a clearing member s security deposit that is related to the risk of its CDS position will be scaled upward by a factor of four. CME s financial safeguards package is measured and stress tested each month to ensure that CME can, at a minimum, cover its largest net debtor in addition to smaller defaults in a hypothetical stress-test situation. Changes to clearing member contributions to the financial safeguards package are calculated quarterly. Any changes to financial safeguard policies are reviewed and approved by CME s Clearing House Risk Committee and changes that could reduce the financial safeguards available with respect to cleared CDS transactions will also be subject to review by the CDS Advisory Board. The clearing solution will enhance the transparency of the CDS market, through reporting of CDS settlement prices and aggregate open interest. The availability of such information will improve the fairness, efficiency, and competitiveness of CDS markets, which, in turn, will enhance investor protection and facilitate capital formation. The clearing solution also will reduce operational risk and costs by enhancing the efficiency of CDS trading and clearing. Integrating CME clearing with market participants middle and back office infrastructures will reduce manual processes, operational risk, and the likelihood of costly errors. The CME clearing solution also will help ensure that eligible trades are cleared and settled in a timely manner, thereby reducing the operational risks associated with unconfirmed and failed trades. In sum, cleared CDS transactions will be cleared and margined under the CME clearing solution in the same manner as exchange-traded futures contracts and will be treated similarly to conventional futures contracts or options on futures contracts for purposes of a Fund posting margin with a registered clearing member FCM and the flow of a Fund s margin funds to secure such positions. In this respect, cleared CDS transactions are functionally equivalent to conventional futures contracts or options on futures contracts and should be viewed as analogous to such contracts for purposes of Rule 17f-6, as discussed below. CONCLUSION As stated above, treating CDS contracts that are cleared by the CME as Exchange-Traded Futures Contracts and Commodity Options for purposes of Rule 17f-6 is consistent with the approach taken by the Commission and the staff in applying the safe custody requirements of Section 17(f) of the 1940 Act in response to significant developments in the financial markets. In this regard, the Commission and the staff have sought to provide Funds with flexibility in their custodial arrangements where 8

268 necessary to facilitate their investment and trading activities in an efficient manner, as long as Fund assets are adequately protected by procedures similar to the applicable rules under Section 17(f), including situations in which there was not literal compliance with the provisions of the relevant rule. Even though cleared CDS contracts are not literally Exchange-Traded Futures Contracts and Commodity Options as defined in Rule 17f-6, cleared CDS contracts are functionally equivalent to such instruments, each of the conditions set forth in Rule 17f-6 will be satisfied in all respects, and application of the Rule to cleared CDS contracts is sound from a policy perspective. 9