As predicted, the rule making regarding derivatives and the alphabet soup being concomitantly created thereby are continuing unabated as 2011 gets underway.
The Commodity Futures Trading Commission (‘‘CFTC’’) has proposed regulations to further implement new statutory provisions enacted by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (‘‘Dodd- Frank Act’’). See Governance Requirements for Derivatives Clearing Organizations, Designated Contract Markets, and Swap Execution Facilities; Additional Requirements Regarding the Mitigation of Conflicts of Interest, 17 CFR Parts 1, 37, 38, 39, and 40 (January 6, 2011).
Specifically, the CFTC proposes certain substantive requirements on the resolution of conflicts of interest applicable to derivatives clearing organizations (‘‘DCOs’’), designated contract markets (‘‘DCMs’’), and swap execution facilities (‘‘SEFs’’). These requirements address reporting, transparency in decision-making, and limitations on use or disclosure of non-public information, among other items.
For DCOs and DCMs, the CFTC also proposes regulations concerning governance fitness standards and the composition of governing bodies. Finally, for publicly-traded DCMs, the CFTC proposes diversity regulations for Boards of Directors (“BoD”).
Conflicts of Interest
The CFTC proposes certain requirements related to (i) reporting, (ii) identification and mitigation of conflicts of interest, (iii) transparency of governance arrangements, and (iv) limitations on use or disclosure of non-public information.
Reporting Requirements
The CFTC proposes to mandate that each DCO, DCM, or SEF submit to the Commission within 30 days after each election of its BoD:
• A list of all members of the BoD, each committee with a composition requirement (including any Executive Committee), and each other committee that has the authority to amend or constrain the action of the BoD.
• A description of the relationship, if any, between such directors and the registered entity or the members of the registered entity (and, in each case, any affiliates thereof).
• The basis for any determination that a director qualifies as a Public Director.
• A description of how the composition of the BoD and each of the abovementioned committees allows the registered entity to comply with applicable core principles, regulations, as well as to the rules of the registered entity.
Derivatives Clearing Organizations ("DCO's")
The CFTC proposes to require each DCO to have a Risk Management Committee (“RMC”), with at least (i) thirty-five percent public directors and (ii) ten percent customer representatives. If a DCO would like to have greater clearing member participation in risk management, then it may cause its RMC to delegate to a subcommittee (the ‘‘RMC Subcommittee’’) decisions implicating whether (i) a product is capable of being cleared and (ii) particular entities or categories of entities are capable of performing such clearing.
Designated Contract Markets ("DCMs") and Swap Execution Facilities ("SEFs")
The CFTC proposes to require each DCM or SEF to have (i) a ROC with all public directors and (ii) a Membership or Participation Committee with thirty-five percent public directors.
In addition to the above, the CFTC proposes to require the ROC to prepare an annual report to the BoD assessing various components of the DCM or SEF regulatory program.
Regulatory Program
The CFTC proposes to require that, as part of its regulatory program, each DCO, DCM, or SEF must establish, maintain, and enforce written procedures to:
• Identify, on an ongoing basis, existing and potential conflicts of interest.
• Make fair and non-biased decisions in the event of a conflict of interest.
Transparency Requirements
The CFTC proposes rules to require each DCO, DCM, or SEF to:
• Make available certain information to the public and relevant authorities.
• Ensure that the information made available is current, accurate, clear and readily accessible.
• Disclose summaries of certain significant decisions.
With respect to a DCM or a SEF, significant decisions would relate to access, membership, and disciplinary procedures. With respect to a DCO, significant decisions would relate to open access, membership, and the finding of products acceptable (or not acceptable) for clearing. The CFTC proposes to require that the DCO specifically disclose whether (i) its BoD has rejected a recommendation or superseded an action of the RMC, or (ii) the RMC has rejected a recommendation or superseded an action of the RMC Subcommittee.
Limitation on Use or Disclosure of Non-Public Information
The CFTC proposes to require each DCO, DCM, or SEF to establish and maintain written policies and procedures on safeguarding non- public information. These policies and procedures must, at a minimum, preclude a DCO, DCM, or SEF owner, director, officer, or employee from using or disclosing any non-public information gained through their interest or position, absent prior written consent from the DCO, DCM, or SEF, as applicable.
Governance
In addition to Conflicts of Interest rules, the CFTC also proposes DCO and DCM regulations on governance fitness and the composition of governing boards. Further, the CFTC proposes DCM regulations covering diversity of certain BoD.
Governance Fitness Requirements
The CFTC proposes to require each DCM and DCO to specify and enforce fitness standards for (i) directors, (ii) members of any Disciplinary Panel, and (iii) members of the Disciplinary Committee. These standards shall include, at a minimum, (i) those bases for refusal to register a person under Section 8a(2) of the Commodity Exchange Act (“CEA”), and (2) the absence of a significant history of serious disciplinary offenses, such as those that would be disqualifying under §1.63 of the Commission’s regulations.
Also, the CFTC proposes to require each DCM and DCO to specify and enforce fitness standards for (i) its members and affiliates thereof, (ii) persons with direct access to the DCM or, in the case of a DCO, to its settlement and clearing activities, (iii) natural persons who, directly or indirectly, own greater than ten percent of any one class of equity interest in a DCM or DCO, and (v) parties affiliated with (A) directors, (B) members of any Disciplinary Panel, and (C) members of the Disciplinary Committee.
Further, the CFTC proposes to require each DCM and DCO to collect and verify information that supports compliance with the standards articulated above and provide that information to the Commission annually. In addition to the above, the CFTC proposes to mandate that members and certain other persons must agree to become subject to the jurisdiction of the DCM or the DCO, as a condition of access.
Transparency Requirements
Derivatives Clearing Organizations ("DCOs"):
• Each DCO shall make available to the public, as well as relevant authorities (including the CFTC), a description of the manner in which its governance arrangements permit the consideration of the views of owners (whether voting or non-voting) and its participants, including, without limitation, clearing members and customers.
• Such description shall include, at a minimum: the general method by which the DCO learns of the views of owners (other than through the exercise of voting power) and participants (other than through representation on the DCO BoD or any DCO committee) and the manner in which the DCO considers such views.
Composition of the Board of Directors
Designated Contract Markets ("DCMs")
The CFTC proposes to require each DCM to design and institute a process for considering the range of opinions that market participants hold with respect to (i) the functioning of an existing market (including governance arrangements) and (ii) new rules or rule amendments.
Derivatives Clearing Organizations ("DCOs")
The CFTC is proposing to require that a DCO BoD include at least ten percent customer representatives. However, in case the Commission decides to keep such requirement at the RMC level, the CFTC is alternatively re-proposing that the RMC (or the RMC Subcommittee) be composed of at least ten percent customer representatives.
Diversity of Designated Contract Markets ("DCM") Board of Directors
The CFTC proposes to permit each publicly-traded DCM the flexibility to determine (i) the standards by which a BoD could be deemed broad and culturally diverse, and (ii) the manner in which the DCM Board of Directors meets that standard.
The Commission proposes that each such DCM make available its diversity standards to the public and relevant authorities (including the Commission) as part of its compliance with transparency requirements. Further, the CFTC proposes that each such DCM provide the Commission with an annual certification of the manner in which its BoD meets its diversity standards.
Public Comment
Public comments must be submitted to the CFTC by March 7, 2011.
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Robert Kiggins, Esq. of McCarthy Fingar LLP, is author of the blog, and may be reached at (914) 385-1024 or rkiggins@mccarthyfingar.com.
Nothing is this blog is intended to or may be relied upon as specific legal advice. Securities and related laws are complex and competent counsel should be consulted. Views expressed by the author in this article are his own and not those of any other person.
