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From Securities Regulation Daily, March 16, 2016

Commission approves substituted compliance framework, amends trade option exemption

By Kevin Kulling, J.D.

The CFTC has approved a substituted compliance framework for dually registered central counterparties (CCPs) located in the European Union in a follow up to the equivalence agreement between the U.S. and the EU. Separately, the CFTC approved a final rule to amend the trade option exemption by eliminating certain reporting and recordkeeping requirements for end-users.

Substituted Compliance. CFTC Chairman Timothy Massad made the announcement in remarks to the FIA International Futures Industry Conference being held in Boca Raton, Florida. Massad said that European CCPs registered with the CFTC can now comply with many CFTC rules by meeting the corresponding European Market Infrastructure Regulation (EMIR) requirements.

Massad said that the equivalence agreement is an important step in achieving cross-border harmonization of derivatives regulation. It provides a foundation for cooperation among regulators in the oversight of the global clearinghouses and resolves the issues that were standing in the way of Europe recognizing U.S. CCPs, he said.

The CFTC unanimously approved a comparability determination that will harmonize the regimes. It will also streamline the registration process. The determination identifies the rules for which the CFTC will grant substituted compliance, including rules related to CCP financial resources, risk management, settlement procedures, and default management.

In his remarks, Massad noted that the agreement provides for some modest changes. For example, U.S. CCPs that seek recognition will show that they can comply with certain EU requirements, including two-day liquidation periods for house margins.

Massad also said that the parties agreed to a specific exemption for U.S. agricultural contracts which is critical, he said, because of the strong nexus of these contracts to the U.S., their importance to American farmers and ranchers and the lower degree of systemic interconnectedness.

The determination will be published in the Federal Register and will be effective upon publication.

No-action relief. As part of the substituted compliance determination for the EU, the CFTC’s Division of Clearing and Risk (DCR) staff provided no-action relief from the application of Commission regulations to discrete aspects of a clearinghouse’s non-U.S. clearing activities.

Future action. Massad said that the equivalence accord provides a good basis for further work with Europe and other jurisdictions on cross-border harmonization. Resolving the equivalence issue also allows the CFTC to turn more attention to swap trading rules, where the CFTC is working with European counterparts to understand similarities and differences in the rules in order to make further progress toward harmonization, he said.

Massad said that he will ask the Commission to consider a number of rule changes to enhance trading and participation on swap execution facilities, including formalizing a number of the no-action positions the staff has taken.

Commissioner comments. In a written statement, CFTC Commissioner J. Christopher Giancarlo said that the substituted compliance action furthers the commitment to a common approach for transatlantic CCPs. Giancarlo said that the agreement between the European Commission (EC) and the CFTC avoids “unacceptable changes to four decades of U.S. clearinghouse margin policy and higher costs of hedging risk for America’s farmers, ranchers, financial institutions, energy firms and manufacturers.” He said that while the end result is a good one, “the approach taken to get here was needlessly circuitous and uncertain.” Giancarlo said the slow process resulted from the EC and CFTC conducting a line by line rule analysis.

“The CFTC and its global counterparts must now recommit themselves to work together to implement an equivalence and substituted compliance process, particularly for swaps execution and the cross-border activities of swap dealers and major swaps participants, based on common principles in order to increase regulatory harmonization and reduce market balkanization,” he said in the statement.

Final rule on trade options. Massad also announced at the FIA conference that the CFTC approved a final rule on trade options. According to Massad, the approved changes will reduce the burdens on commercial businesses using the instruments. The final rule recognizes that trade options are different from the swaps that were the focus of Dodd-Frank reforms, Massad said. It eliminates certain reporting and recordkeeping obligations for commercial users.

The final rule, which will become effective upon publication in the Federal Register, removes reporting and recordkeeping requirements for trade option counterparties that are neither swap dealers nor major swap participants (Non-SD/MSPs), including commercial end-users that transact in trade options in connection with their businesses.

The CFTC has eliminated the Form TO annual notice reporting requirement for otherwise unreported trade options in CFTC regulation 32.3(b). Additionally, Non SD/MSPs will not be subject to part 45 reporting requirements in connection with their trade options. Recordkeeping requirements have been eliminated for Non-SD/MSPs in connection with their trade option activities. CFTC No Action Letter 13-08 will be withdrawn upon the effective date. CFTC Commissioner Bowen issued a Concurring Statement on the Rule.

Other activity highlighted. In his FIA remarks, Massad also highlighted CFTC activity concerning clearinghouse resiliency. He noted that there have been several meetings regarding the issue, including in Frankfurt, Germany, that discussed work done in subcommittees of the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO). Massad said that clearinghouse resiliency will continue to be at the forefront of the CFTC’s agency’s agenda.

Residual interest rule. Massad also touted the CFTC’s work in the customer protection arena. He said that the staff conducted a roundtable regarding the residual interest rule, which addresses when a futures commission merchant (FCM) must cover a customer’s account if it becomes undermargined. The roundtable consensus was that the CFTC should not accelerate the residual interest deadline, because that would lead to operational difficulties, particularly for small customers.

Status of proposed rules. Massad also noted that the comment deadline recently passed for a proposal to enhance cybersecurity protection in the markets, and the comment deadline for a proposal on automated trading is in March. Massad said that the proposals illustrate that the CFTC is looking ahead and taking action to address future threats to financial stability.

Massad said that the threat of cyberattacks may be the greatest threat facing the financial system today and that the proposal requires that the private firms that run the critical infrastructure in the markets should follow best practices when it comes to testing defenses and other protections. Massad reiterated that focus on the issue will not cease and they will continue to make it a priority in their examinations. He said that he expects cybersecurity to be a top priority for the agency in the years ahead.

As to automated trading, Massad said the proposal seeks to minimize the risk that it will result in market disruptions by requiring adequate risk controls, monitoring and other measures. The agency hopes to finalize both of these rules later this year, Massad said.

MainStory: TopStory CFTCNews ClearanceSettlement Derivatives DoddFrankAct InternationalNews RiskManagement Swaps

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