
[Federal Register: March 19, 2009 (Volume 74, Number 52)]
[Notices]               
[Page 11781-11792]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr19mr09-121]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-59578; File No. S7-06-09]

 
Order Granting Temporary Exemptions Under the Securities Exchange 
Act of 1934 in Connection with Request of Chicago Mercantile Exchange 
Inc. and Citadel Investment Group, L.L.C. Related to Central Clearing 
of Credit Default Swaps, and Request for Comments

March 13, 2009.

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

[[Page 11782]]

Commission is 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 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 
CCPs, including granting conditional exemptions from certain provisions 
of the Federal securities laws, is in the public interest.
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    \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. 58572 (September 17, 2008), 73 
FR 54875 (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. 58166 (July 15, 2008), 73 
FR 42379 (July 21, 2008)); taking temporary emergency action to ban 
short selling in financial securities (See Securities Exchange Act 
Release No. 58592 (September 18, 2008), 73 FR 55169 (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. 58591A (September 21, 2008), 73 
FR 55557 (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. 57967 (June 16, 2008), 73 FR 36212 (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), http://www.sec.gov/news/press/2008/2008-134_mou.pdf).
    \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 http://www.ustreas.gov/press/releases/reports/
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., 110th Cong. (2008) (Statement of Erik 
Sirri, Director of the Division of Trading and Markets, Commission).
    \5\ See id.
    \6\ See Policy Objectives for the OTC Derivatives Market, The 
President's Working Group on Financial Markets (November 14, 2008), 
http://www.ustreas.gov/press/releases/reports/policyobjectives.pdf. 
See also Policy Statement on Financial Market Developments, The 
President's Working Group on Financial Markets (March 13, 2008), 
http://www.treas.gov/press/releases/reports/
pwgpolicystatemktturmoil_03122008.pdf; Progress Update on March 
Policy Statement on Financial Market Developments, The President's 
Working Group on Financial Markets (October 2008), http://
www.treas.gov/press/releases/reports/q4progress%20update.pdf.
    \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), http://www.treas.gov/press/releases/reports/finalmou.pdf.
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    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 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\
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    \8\ See Semiannual OTC derivatives statistics at end-December 
2007, Bank for International Settlements (``BIS''), available at 
http:/www.bis.org/statistics/otcder/dt1920a.pdf.
    \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.
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    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 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.
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    \10\ 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.
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    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 into separate contractual 
arrangements with both counterparties--becoming buyer to one

[[Page 11783]]

and seller to the other.\12\ Through novation, it is the CCP that 
assumes counterparty risks.
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    \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 http://www.bis.org/pub/cpss77.pdf; ``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).
    \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 66.
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    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.
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    \13\ 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.
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    In this context, The Chicago Mercantile Exchange Inc. (``CME'') and 
Citadel Investment Group, L.L.C. (``Citadel'') have requested that the 
Commission grant exemptions from certain requirements under the 
Exchange Act with respect to their proposed activities in clearing and 
settling certain CDS, as well as the proposed activities of certain 
other persons, as described below.\14\
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    \14\ See Letter from Adam Cooper, Citadel Investment Group, 
L.L.C. and Ann K. Shuman, Chicago Mercantile Exchange, Inc., to 
Elizabeth M. Murphy, Secretary, Commission, March 12 , 2008.
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    Based on the facts that CME and Citadel have presented and the 
representations they have made,\15\ and for the reasons discussed in 
this Order, the Commission temporarily is exempting, subject to certain 
conditions, CME 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 non-
excluded CDS cleared by CME. The Commission's exemptions are temporary 
and will expire on December 14, 2009. 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 
Commission has provided temporary exemptions in connection with 
Sections 5 and 6 of the Exchange Act for transactions in non-excluded 
CDS.\17\
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    \15\ See id. The exemptions we are granting today are based on 
representations made by CME and Citadel. 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. 8999 (January 14, 2009).
    \17\ See Securities Exchange Act Release No. 59165 (December 24, 
2008).
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II. Discussion

A. Description of CME and Citadel's Proposal

    The exemptive request by CME and Citadel describes how their 
proposed arrangements for central clearing of CDS would operate, and 
makes representations about the safeguards associated with those 
arrangements, as described below:
1. CME Organization
    CME Group Inc. (``CME Group''), a Delaware stock corporation, is 
the holding company for CME, as well as Board of Trade of the City of 
Chicago, Inc., New York Mercantile Exchange, Inc., Commodity Exchange, 
Inc. and their subsidiaries.
    CME is a designated contract market (``DCM''), regulated by the 
CFTC, for the trading of futures and options on futures contracts. In 
addition, CME Group operates its own clearing house, which is a 
division of CME. The CME clearing house is a derivates clearing 
organization (``DCO'') regulated by the CFTC. The clearing house 
clears, settles and guarantees the performance of all transactions 
matched through the execution facilities and on third party exchanges 
for which CME Group provides clearing services. The clearing house 
operates with the oversight of the Clearing House Risk Committee 
(``CHRC''). The CHRC is made up of a group of clearing member 
representatives who represent the interests of the clearing house as 
well as clearing members of CME Group.
    CME is required to comply with the eighteen CFTC Core Principles 
applicable to registered DCMs and the fourteen CFTC Core Principles 
applicable to DCOs.\18\ The CFTC conducts regular audits or risk 
reviews of CME with respect to these Core Principles. CME is registered 
and in good standing with the CFTC. In addition, CME is notice 
registered with the Commission as a special purpose national securities 
exchange for the purpose of trading securities futures products. In the 
U.K., CME is a Recognised Overseas Investment Exchange and a Recognised 
Overseas Clearing House, subject to regulation by the U.K. Financial 
Services Authority.
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    \18\ The DCM and DCO Core Principles are set forth in 7 U.S.C. 
7(b), 7a-1(c)(2)(A).
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2. CME Central Counterparty Services for CDS
    CME as part of its clearing services would be interposed as central 
counterparty for transactions in Cleared CDS (as defined below).\19\ 
CME would provide clearing and settlement services for transactions in 
Cleared CDS submitted to or executed on the CMDX platform.\20\ CME 
would also accept for clearing directly from participants trades in 
Cleared CDS that are not executed on or processed through CMDX.
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    \19\ See note 29, infra.
    \20\ Citadel and CME have entered into a joint venture (to be 
named ``CMDX'') to provide a trading and clearing solution for CDS. 
CMDX trading, booking and migration services would be available only 
to persons that satisfy the definition of an ``eligible contract 
participant'' in Section 1a(12) of the Commodity Exchange Act 
(``CEA'') (other than paragraph (C) thereof). In addition, each 
participant on the CMDX platform must be a clearing member of CME or 
have a clearing relationship with a CME clearing member that agrees 
to assume responsibility for the participant's CDS contracts cleared 
by CME. Initially, CMDX would offer CDS that mirror as closely as 
possible the terms of existing OTC CDS. The coupons and maturities 
would be standardized to the extent necessary to permit centralized 
clearing.

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[[Page 11784]]

    Specifically, CME would accept for clearing (i) trades that are 
matched on the CMDX platform, (ii) pre-existing non-standard trades 
that are submitted to clearing through the CMDX migration facility, and 
(iii) new bilaterally-executed trades in standardized products that are 
submitted to CME for clearing directly by the participants (using CME's 
Clearing 360\TM\ API or similar facility that CME makes available).\21\
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    \21\ Non-standard trades that are migrated to CME would 
ultimately be converted to a standard, centrally cleared contract. 
Migration may only occur if both counterparties to a trade agree to 
the process and both are clearing members or have the appropriate 
relationship with a clearing member. CMDX would also supply 
participants a data file of the original bilateral positions that 
were accepted into clearing via the migration process, so that 
participants may send appropriate exit records to the DTCC Trade 
Information Warehouse.
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    The trades submitted to or executed on the CMDX platform would be 
processed straight-through to CME for clearing and settlement. CME 
clearing and settlement of Cleared CDS would operate using the 
established systems, procedures and financial safeguards package that 
stand behind trading in CME's primary futures market, and such 
activities would be subject to CFTC oversight of risk management and 
collateralization procedures. CME Rulebook Chapter 8-F sets forth the 
rules governing clearing and settlement of all products, instruments, 
and contracts in OTC derivatives, including but not limited to CDS 
contracts, swaps and forward rate agreements that the CME clearinghouse 
has designated as eligible for clearing.
3. CME Risk Management
    CME clearing members that are broker-dealers or futures commission 
merchants maintain capital and liquidity in accordance with relevant 
SEC and CFTC rules and regulations. In addition, CME has requirements 
for minimum capital contribution, contribution to the guaranty fund 
based on risk factors, maintenance margin, and mark to market with 
immediate payment of losses applicable to clearing member firms.
    CME has adopted a risk-based capital requirement. Capital 
requirements are monitored by CME's Audit Department and 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.
    Clearing members also would 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.
    CME would extend its current monitoring procedures to Cleared CDS 
cleared by CME. CME would monitor for and investigate unusual trading 
patterns or volumes. Customer account reporting would allow CME to view 
the positions held by individual accounts. The positions of each 
account would be analyzed throughout the day to monitor any accounts 
that may have significant losses due to market moves. In addition, 
significant changes in positions from day to day would be analyzed and 
reported to CME clearing house senior management.
    CME would include stress testing of the different CDS clearing 
house margin factors to capture moves beyond the one-day 99% standard 
on the macro and sector moves and the five-day 99% standard for the 
idiosyncratic shocks. This would be considered in designing the 
financial safeguards package, adding concentration types of margining 
and routine stress testing. Also, the CDS clearing house margin factor 
parameters would be reviewed daily as a back-testing procedure to 
ensure the parameters are providing the desired coverage. CME would 
also review on a daily basis the margin collected by CME on CDS 
portfolios and compare those amounts to next-day market moves so that 
actual portfolio effects can be determined and gauged against the 
margin coverage. In addition, CME would evaluate the concentration of 
CDS positions beyond the margin factors and compare them against 
overall open interest and liquidity in the CDS market.
    CME will extend its scenario based stress testing techniques for 
concentration margining to Cleared CDS. The concentration stress test 
results will be evaluated relative to excess adjusted net capital for 
each segregated pool. If the hypothetical losses exceed the excess 
adjusted net capital for a clearing member's segregated pool, then an 
additional margin charge will be applied to the clearing member's 
position. The additional margin charge is calculated based on the 
magnitude of the hypothetical losses in excess of the clearing member's 
excess adjusted net capital.
    CME determines the acceptability of different collateral types and 
determines appropriate haircuts.\22\ Collateral requirements for 
Cleared CDS would endeavor to reflect the specific risks of Cleared 
CDS, including jump-to-default and the consequences of a liquidity 
event caused by the defaults.
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    \22\ A list of acceptable collateral and applicable haircuts is 
available at www.cme.com.
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4. Member Default
    If a clearing member is troubled (i.e., it fails to meet minimum 
financial requirements or its financial or operational condition may 
jeopardize the integrity of the CME, or negatively impact the financial 
markets), the 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 clearing member of CME, the 
process would be governed by applicable CME Rules.\23\
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    \23\ See, e.g., CME Rulebook Chapter 8-F (Over-the-Counter 
Derivative Clearing), including but not limited to Rules 8F06 
(Clearing Member Default), 8F07 (Security Deposit) and 8F13 
(Insolvency and Liquidation). Chapter 8-F further incorporates the 
general CME Rules relating to defaults, including but not limited to 
Rules 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).
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    In the event of a 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 their 
positions, CME surplus funds, security deposits and assessment 
powers.\24\
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    \24\ CME indicates that excluding collateral supporting open 
positions, which total approximately $116 billion, the total 
financial safeguards package is nearly $7 billion, comprised of: (1) 
CME surplus funds of $57 million; (2) clearing member security 
deposits of approximately $1.751 billion; and (3) assessment powers 
of approximately $4.816 billion (as of December 31, 2008). Clearing 
members that clear Cleared CDS would be subject to an additional $5 
million security deposit requirement. Furthermore, the calculation 
of that portion of a clearing member's security deposit that is 
related to the risk of its CDS position would be scaled upward by a 
factor of three.
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5. Customer Rules and Other Requirements
    Prior to issuance of an order from the CFTC under Section 4d of the 
CEA (``4d order''), all Cleared CDS submitted to CME for clearing for 
the account of a clearing member's customer must be assigned and held 
in an account subject to CFTC Regulation 30.7.\25\ Regulation

[[Page 11785]]

30.7 requires that customer positions and property be separately held 
and accounted for from the positions and property of the futures 
commission merchant, 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 Regulation Sec.  30.7 account and all 
positions, collateral or cash in such account shall be segregated from 
the Clearing Member's proprietary account.''
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    \25\ 17 CFR 30.7.
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    Upon the issuance of a 4d order from the CFTC, the segregation and 
protection of customer funds and property would be controlled by 
Section 4d of the CEA \26\ and the regulations pertinent thereto; all 
funds and property received from customers of futures commission 
merchants in connection with purchasing, selling or holding CDS 
positions would be subject to the requirements of CFTC Regulation 1.20, 
et seq. promulgated under Section 4d. This regulation would apply to 
the purchasing, selling, and holding of CDS positions. This regulation 
would require that customer positions and property be separately 
accounted for and segregated from the positions and property of the 
futures commission merchant. 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 Regulation 1.20, et 
seq.
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    \26\ 7 U.S.C. 6d.
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    In addition, customer margin requirements for a broker-dealer are 
generally set by the broker-dealer's self-regulatory organizations 
(e.g., the Financial Industry Regulatory Authority, commonly referred 
to as ``FINRA''). One purpose for customer margin requirements is to 
assure that broker-dealers collect sufficient margin from customers to 
protect the broker-dealer against the event that an adverse price move 
causes a customer default, leaving the broker-dealer with the 
responsibility for the transaction. FINRA intends to amend its customer 
margin rule to include margin requirements for Cleared CDS.\27\
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    \27\ See SR-FINRA-2009-012, available at http://www.finra.org/
Industry/Regulation/RuleFilings/2009/P118121.
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B. Temporary Conditional Exemption From Clearing Agency Registration 
Requirement

    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 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.\28\
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    \28\ 15 U.S.C. 78mm.
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    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 14, 2009 to CME from 
Section 17A of the Exchange Act, solely to perform the functions of a 
clearing agency for Cleared CDS,\29\ subject to the conditions 
discussed below.
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    \29\ 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 CME, 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: (1) 
The reference entity, the issuer of the reference security, or the 
reference security is one of the following: (i) An entity reporting 
under the Exchange Act, providing Securities Act Rule 144A(d)(4) 
information, or about which financial information is otherwise 
publicly available; (ii) a foreign private issuer whose securities 
are listed outside the United States and that has its principal 
trading market outside the United States; (iii) a foreign sovereign 
debt security; (iv) an asset-backed security, as defined in 
Regulation AB, issued in a registered transaction with publicly 
available distribution reports; or (v) an asset-backed security 
issued or guaranteed by the Fannie Mae, the Freddie Mac, or the 
Government National Mortgage Association (``Ginnie Mae''); or (2) 
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). 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.
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    Our action today balances the aim of facilitating the prompt 
establishment of CME 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 
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 non-excluded CDS could deter the 
prompt establishment of CME as a CCP to settle those transactions.
    While we are acting so that the prompt establishment of CME as a 
CCP for non-excluded 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 CME becomes operational, giving the Commission the ability 
to oversee the development of the centrally cleared non-excluded 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 CME's 
representation that it meets the standards set forth in the Committee 
on Payment and Settlement Systems (``CPSS'') and International 
Organization of Securities Commissions (``IOSCO'') report entitled: 
Recommendation for Central Counterparties (``RCCP'').\30\ The RCCP 
establishes a framework that requires a CCP to have: (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

[[Page 11786]]

consistent with the requirements of Section 17A of the Exchange Act.
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    \30\ The RCCP was drafted by a joint task force (``Task Force'') 
composed of representative members of IOSCO and CPSS and published 
in November 2004. 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.
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    In addition, this Order is designed to assure that--as CME and 
Citadel have represented--information will be available to market 
participants about the terms of the CDS cleared by CME, the 
creditworthiness of CME 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.\31\ Such information availability also will assist CME 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.
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    \31\ 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, March 13, 2008, available at http://
www.treas.gov/press/releases/reports/pwgpolicystatemktturmoil_
03122008.pdf.
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    This temporary exemption is subject to a number of conditions that 
are designed to enable Commission staff to monitor CME's clearance and 
settlement of CDS transactions and help reduce risk in the CDS market. 
These conditions require that CME: (i) Make available on its Web site 
its annual audited financial statements; (ii) preserve records of all 
activities related to the business of CME as a CCP for Cleared CDS for 
at least five years (in an easily accessible place for the first two 
years); (iii) supply information relating to its Cleared CDS clearance 
and settlement services \32\ to the Commission and provide access to 
the Commission to conduct on-site inspections of facilities and records 
related to its Cleared CDS clearance and settlement services and will 
provide the Commission access to its personnel to answer reasonable 
questions during any such inspections; \33\ (iv) notify the Commission 
about material disciplinary actions taken against CME clearing members 
with respect to Cleared CDS clearance and settlement services, and 
about the involuntary termination of the membership of an entity using 
those services; (v) notify the Commission of all changes to rules as 
defined under the CFTC rules, fees, 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 
\34\ and its annual audited financial statements prepared by 
independent audit personnel; (vii) report all significant systems 
outages to the Commission; and (viii) not materially change its 
methodology for determining Cleared CDS margin levels without prior 
written approval from the Commission, and from FINRA with respect to 
customer margin requirements that would apply to broker-dealers.
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    \32\ Clearance and settlement services would include services in 
association with CME's CMDX migration facility, as well as 
activities associated with margin services.
    \33\ The Commission will conduct routine examinations no more 
often than annually, although it may inspect more frequently for 
cause. Moreover, the Commission will limit the scope of such 
inspections to confirming compliance with the requirements set forth 
in this Order, including compliance with the securities laws 
applicable to CME's Cleared CDS business and operations. The 
Commission will make reasonable efforts to coordinate any 
inspections with the CFTC or other regulatory bodies with 
jurisdiction in order to conduct joint inspections where possible.
    \34\ See Automated Systems of Self-Regulatory Organization, 
Exchange Act Release No. 27445 (November 16, 1989), File No. S7-29-
89, and Automated Systems of Self-Regulatory Organization (II), 
Exchange Act Release No. 29185 (May 9, 1991), File No. S7-12-91.
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    In addition, this relief is conditioned on CME, 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 
CME may establish to calculate mark-to-market margin requirements for 
CME participants; and (ii) any other pricing or valuation information 
with respect to Cleared CDS as is published or distributed by CME. The 
Commission believes this is an appropriate condition for CME'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.'' \35\ The President's Working Group on 
Financial Markets has stated that increased transparency is a policy 
objective for the over-the-counter derivatives market,\36\ 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 CME 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 applied the standards in the 
specific context of securities market data, and it anticipates that CME 
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. The Commission carefully 
evaluates any type of

[[Page 11787]]

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. 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.
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    \35\ 15 U.S.C. 78k-1(a)(1)(C)(iii). See also 15 U.S.C. 78k-
1(a)(1)(D).
    \36\ See President's Working Group on Financial Markets, Policy 
Objectives for the OTC Derivatives Market (November 14, 2008), 
available at http://www.ustreas.gov/press/releases/reports/
policyobjectives.pdf (``Public reporting of prices, trading volumes 
and aggregate open interest should be required to increase market 
transparency for participants and the public.'').
---------------------------------------------------------------------------

    As a CCP, CME will collect and process information about CDS 
transactions 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.

C. Temporary General Exemption for CME 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 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.\37\
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    \37\ 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.
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    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 14, 2009 from 
certain requirements under the Exchange Act. This temporary exemption 
applies to CME and to certain eligible contract participants \38\ 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; \39\ eligible 
contract participants that are self-regulatory organizations; or 
eligible contract participants that are registered brokers or 
dealers).\40\
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    \38\ 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.
    \39\ 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 in a parallel 
manner when certain persons would not 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).
    A separate temporary conditional exemption addresses members of 
CME that hold funds or securities for the purpose of purchasing, 
selling, clearing, settling, or holding Cleared CDS positions for 
other persons. See Part II.D, infra.
    \40\ A separate temporary exemption addresses the Cleared CDS 
activities of registered-broker-dealers. See Part II.E, 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.
---------------------------------------------------------------------------

    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.\41\ In 
addition, all provisions of the Exchange Act related to the 
Commission's enforcement authority in connection with violations or 
potential violations of such provisions would remain applicable.\42\ 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.
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    \41\ See note 37, supra.
    \42\ 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.
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    This temporary exemption, however, does not extend to Sections 5 
and 6 of the Exchange Act. The Commission separately issued a 
conditional exemption from these provisions to all broker-dealers and 
exchanges.\43\ This temporary exemption also does not extend to Section 
17A of the Exchange Act; instead, CME 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; \44\ eligible contract participants and other persons instead 
should refer to the interim final temporary rules issued by the

[[Page 11788]]

Commission. Finally, this temporary exemption does not extend to the 
Commission's administrative proceeding authority under Sections 
15(b)(4) and (b)(6),\45\ or to certain provisions related to government 
securities.\46\
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    \43\ 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).
    \44\ 15 U.S.C. 78l, 78m, 78n, 78o(d), 78p.
    \45\ 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 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.
    \46\ 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).
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D. Conditional Temporary General Exemption for Certain Clearing Members 
of CME

    Absent an exception, persons that effect transactions in non-
excluded CDS that are securities may be required to register as broker-
dealers pursuant to Section 15(a)(1) of the Exchange Act.\47\ Moreover, 
certain reporting and other requirements of the Exchange Act could 
apply to such persons, as broker-dealers, regardless of whether they 
are registered with the Commission.
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    \47\ 15 U.S.C. 78o(a)(1). This section 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 provides 
11 exceptions for 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).
---------------------------------------------------------------------------

    It is consistent with our investor protection mandate to require 
that intermediaries in securities transactions that receive or hold 
funds and securities on behalf of others comply with standards that 
safeguard the interests of their customers. For example, registered 
broker-dealers are required to segregate assets held on behalf of 
customers from proprietary assets, because segregation will assist 
customers in recovering assets in the event the intermediary fails. To 
the extent that funds and securities are not segregated, they could be 
used by a participant to fund its own business and could be attached to 
satisfy debts of the participant were the participant to fail. 
Moreover, the maintenance of adequate capital and liquidity 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 a participant 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 CDS transactions, to the detriment of the 
markets and market participants generally. Also, as noted above with 
regard to other eligible contract participants to non-excluded CDS 
transactions, immediately applying the panoply of Exchange Act 
requirements to centrally cleared transactions may deter the use of 
CCPs for CDS transactions.
    Those factors argue in favor of flexibility in applying the 
requirements of the Exchange Act to these intermediaries. Along with 
those factors, in granting an exemption here we are particularly 
relying on the representation of CME that CME's rules alone or in 
combination with laws and regulations applicable to CME and its 
clearing members require that any CME clearing member that purchases, 
sells, or holds CDS positions for other persons, solely as they relate 
to CDS: (1) Must be registered with the CFTC as a futures commission 
merchant; (2) effectively segregates funds and securities of other 
persons (except positions held in proprietary accounts of the clearing 
member, which may include, for example, positions of employees 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) maintains adequate capital and liquidity; and (4) 
maintains 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 persons and those it holds for its proprietary accounts.
    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 December 14, 2009 
from certain Exchange Act requirements. In general, we are providing a 
temporary exemption, subject to the conditions discussed below, to any 
CME clearing member registered as a futures commission merchant 
pursuant to Section 4f(a)(1) of the Commodity Exchange Act (``FCM'') 
(but that is not registered as a broker-dealer under Section 15(b) of 
the Exchange Act (other than paragraph (11) thereof)) that receives or 
holds funds or securities for the purpose of purchasing, selling, 
clearing, settling or holding Cleared CDS positions for other persons. 
Solely with respect to Cleared CDS, those members generally will be 
exempt from those provisions of the Exchange Act and the underlying 
rules and regulations that do not apply to security-based swap 
agreements.
    As with the exemption discussed above that is applicable to CME and 
certain eligible contract participants, and for the same reasons, this 
exemption for CME clearing members that receive or hold funds and 
securities does not extend to Exchange Act provisions that explicitly 
apply in connection with security-based swap agreements,\48\ or to 
related enforcement authority provisions.\49\ As with the exemption 
discussed above, we also are not exempting those members 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.\50\
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    \48\ See note 37, supra.
    \49\ See note 42, supra.
    \50\ Nor are we exempting those members from provisions related 
to government securities, as discussed above.
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    This temporary exemption is subject to the member complying with 
conditions that are important for protecting customer funds and 
securities. Particularly, the member must be in material compliance 
with the rules of CME, and applicable laws and

[[Page 11789]]

regulations, relating to capital, liquidity, and segregation of 
customers' \51\ funds and securities (and related books and records 
provisions) with respect to non-excluded CDS.\52\ Also, to the extent 
that the member receives or holds funds or securities of U.S. eligible 
contract participants for the purpose of purchasing, selling, clearing, 
settling or holding non-excluded CDS positions for those persons, this 
exemption is predicated on the member satisfying the following 
condition: The member must segregate such funds and securities of U.S. 
customers from the member's own assets (i.e., the member may not permit 
U.S. customers to ``opt out'' of applicable segregation requirements 
for such funds and securities even if regulations or laws would permit 
the person to ``opt out'').
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    \51\ The term ``customer,'' solely for purposes of Part III(c) 
and (d), infra, and corresponding references in this Order, means a 
``customer'' as defined under CFTC Regulation 1.3(k). 17 CFR 1.3(k).
    \52\ A member would not be ``in material compliance'' if it 
failed in any way to segregate customer funds and securities 
consistent with these rules, laws and regulations. In that 
circumstance, the member could not rely on this exemption.
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E. Temporary General Exemption for Certain Registered Broker-Dealers 
Including Certain Broker-Dealer-FCMs

    The temporary exemptions addressed above--with regard (i) to CME 
and certain eligible contract participants and (ii) to certain CME 
clearing members that receive or hold funds and securities of others--
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)).\53\ 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).
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    \53\ 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).
---------------------------------------------------------------------------

    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 14, 2009 from 
certain Exchange Act requirements. Consistent with the temporary 
exemptions discussed above, and solely with respect to Cleared CDS, we 
are exempting registered broker-dealers (including registered broker-
dealers that are also FCMs (``BD-FCMs'')) 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, including BD-FCMs, from Exchange Act 
provisions that explicitly apply in connection with security-based swap 
agreements or from related enforcement authority provisions.\54\ As 
above, and for similar reasons, we are not exempting registered broker-
dealers, including BD-FCMs, 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.\55\
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    \54\ See notes 37 and 42, 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.
    \55\ We also are not exempting those members from provisions 
related to government securities, as discussed above.
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    Further we are not exempting registered broker-dealers from the 
following additional provisions under the Exchange Act: (1) Section 
7(c),\56\ which addresses the unlawful extension of credit by broker-
dealers; (2) Section 15(c)(3),\57\ which addresses the use of unlawful 
or manipulative devices by broker-dealers; (3) Section 17(a),\58\ 
regarding broker-dealer obligations to make, keep and furnish 
information; (4) Section 17(b),\59\ regarding broker-dealer records 
subject to examination; (5) Regulation T,\60\ 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-dealers.\61\ 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.\62\
---------------------------------------------------------------------------

    \56\ 15 U.S.C. 78g(c).
    \57\ 15 U.S.C. 78o(c)(3).
    \58\ 15 U.S.C. 78q(a).
    \59\ 15 U.S.C. 78q(b).
    \60\ 12 CFR 220.1 et seq.
    \61\ 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. Broker-dealers 
will, however, continue to be subject to applicable rules of self-
regulatory organizations of which they are a member, including 
applicable margin rules.
    \62\ 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.
---------------------------------------------------------------------------

    However, CME clearing members that are BD-FCMs that holds customer 
funds and securities for the purpose of purchasing, selling, clearing, 
settling or holding CDS positions cleared by CME in a futures account 
(as that term is defined in Rule 15c3-3(a)(15) [17 CFR 240.15c3-
3(a)(15)]) also shall be exempt from Exchange Act Rule 15c3-3, subject 
to the following conditions: (1) The CME clearing member shall be in 
material compliance with the rules of CME, and 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; \63\ (2) the CME clearing 
member shall segregate such funds and securities of U.S. customers from 
the CME clearing member's own assets (i.e., the member may not permit 
U.S. customers to ``opt out'' of applicable segregation requirements 
for such funds and securities even if regulations or laws would permit 
the customer to ``opt out''); and (3) the CME clearing member shall 
comply with the margin rules for Cleared CDS of the self-regulatory

[[Page 11790]]

organization that is its designated examining authority \64\ (e.g., 
FINRA).
---------------------------------------------------------------------------

    \63\ See note 52, supra.
    \64\ See 17 CFR 240.17d-1 for a description of a designated 
examining authority.
---------------------------------------------------------------------------

F. 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:
    1. Whether the length of this temporary exemption (until December 
14, 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 CME ultimately should be required to register as a 
clearing agency under the Exchange Act. Why or why not?
    4. Whether CME members that receive or hold funds or securities for 
the purpose of purchasing, selling, clearing, settling or holding non-
excluded CDS positions for other persons ultimately should be required 
to register as broker-dealers? Why or why not?
Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/other.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number S7-06-09 on the subject line; or
     Use the Federal eRulemaking Portal (http://
www.regulations.gov/). 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 20549-1090.

All submissions should refer to File Number S7-06-09. This file number 
should be included on the subject line if e-mail 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 
(http://www.sec.gov/rules/other.shtml). 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 a.m. and 3 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(a) of the Exchange 
Act, that, until December 14, 2009:
    (a) Exemption from Section 17A of the Exchange Act.
    The Chicago Mercantile Exchange Inc. (``CME'') 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) of this 
Order), subject to the following conditions:
    (1) CME shall make available on its Web site its annual audited 
financial statements.
    (2) CME shall keep and preserve records of all activities related 
to the business of CME as a central counterparty for Cleared CDS. 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) CME shall supply such information and periodic reports relating 
to its Cleared CDS clearance and settlement services as may be 
reasonably requested by the Commission. CME shall also provide access 
to the Commission to conduct on-site inspections of all facilities 
(including automated systems and systems environment), and records 
related to its Cleared CDS clearance and settlement services. CME will 
provide the Commission with access to its personnel to answer 
reasonable questions during any such inspections related to its Cleared 
CDS clearance and settlement services.
    (4) CME shall notify the Commission, on a monthly basis, of any 
material disciplinary actions taken against any CME clearing members 
utilizing its Cleared CDS clearance and settlement services, including 
the denial of services, fines, or penalties. CME shall notify the 
Commission promptly when CME involuntarily terminates the membership of 
an entity that is utilizing CME's Cleared CDS clearance and settlement 
services. Both notifications shall describe the facts and circumstances 
that led to CME's disciplinary action.
    (5) CME shall notify the Commission of all changes to rules as 
defined under the CFTC rules, fees, and any other material events 
affecting its Cleared CDS clearance and settlement services, including 
material changes to risk management models. In addition, CME will post 
any rule or fee changes on the CME Web site. CME shall provide the 
Commission with notice of all changes to its rules not less than one 
day prior to effectiveness or implementation of such rule changes or, 
in exigent circumstances, as promptly as reasonably practicable under 
the circumstances. Such notifications will not be deemed rule filings 
that require Commission approval.
    (6) CME shall provide the Commission with annual reports and any 
associated field work concerning its Cleared CDS clearance and 
settlement services 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. CME shall provide 
the Commission (beginning in its first year of operation) with its 
annual audited financial statements prepared by independent audit 
personnel for CME.
    (7) CME shall report to the Commission all significant outages of 
clearing systems having a material impact on its Cleared CDS clearance 
and settlement services. If it appears that the outage may extend for 
30 minutes or longer, CME shall report the systems outage immediately. 
If it appears that the outage will be resolved in less than 30 minutes, 
CME shall report the systems outage within a reasonable time after the 
outage has been resolved.
    (8) CME, 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 CME may establish to calculate 
mark-to-market margin requirements for CME clearing members; and (ii) 
any other pricing or valuation information with respect to Cleared CDS 
as is published or distributed by CME.
    (9) CME shall not materially change its methodology for determining 
Cleared CDS margin levels without prior written approval from the 
Commission, and from FINRA with respect to customer margin requirements 
that would apply

[[Page 11791]]

to broker-dealers. (b) Exemption for CME and certain eligible contract 
participants.
    (1) Persons eligible. The exemption in paragraph (b)(2) is 
available to:
    (i) CME; 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)), 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 
(b)(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) 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)).
    (c) Exemption for certain CME clearing members.
    Any CME clearing member registered as a futures commission merchant 
pursuant to Section 4f(a)(1) of the Commodity Exchange Act (but that is 
not registered as a broker or dealer under Section 15(b) of the 
Exchange Act (other than paragraph (11) thereof)) that receives or 
holds funds or securities for the purpose of purchasing, selling, 
clearing, settling or holding Cleared CDS for other persons shall be 
exempt from the provisions of the Exchange Act and the rules and 
regulations thereunder specified in paragraph (b)(2), solely with 
respect to Cleared CDS, subject to the following conditions:
    (1) The CME clearing member shall be in material compliance with 
the rules of CME, and 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; 
and
    (2) To the extent that the CME clearing member receives or holds 
funds or securities of U.S. customers for the purpose of purchasing, 
selling, clearing, settling, or holding Cleared CDS positions, the CME 
clearing member shall segregate such funds and securities of U.S. 
customers from the CME clearing member's own assets (i.e., the member 
may not permit U.S. customers to ``opt out'' of applicable segregation 
requirements for such funds and securities even if regulations or laws 
would permit the customer to ``opt out'').
    (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 (b)(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 200.1 et seq.;
    (6) Rule 15c3-1;
    (7) Rule 15c3-3;
    (8) Rule 17a-3;
    (9) Rule 17a-4;
    (10) Rule 17a-5; and
    (11) Rule 17a-13;

provided, that a CME clearing member that is a broker or dealer 
registered under Section 15(b) of the Exchange Act (other than 
paragraph (11) thereof) and that is also registered as a futures 
commission merchant pursuant to Section 4f(a)(1) of the Commodity 
Exchange Act and that holds customer funds and securities for the 
purpose of purchasing, selling, clearing, settling or holding Cleared 
CDS in a futures account (as that term is defined in Rule 15c3-3(a)(15) 
[17 CFR 240.15c3-3(a)(15)]) also shall be exempt from Exchange Act Rule 
15c3-3, subject to the following conditions:
    (1) The CME clearing member shall be in material compliance with 
the rules of CME, and 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;
    (2) The CME clearing member shall segregate such funds and 
securities of U.S. customers from the CME clearing member's own assets 
(i.e., the member may not permit U.S. customers to ``opt out'' of 
applicable segregation requirements for such funds and securities even 
if regulations or laws would permit the customer to ``opt out''); and
    (3) The CME clearing member shall collect from each customer the 
amount of margin that is not less than the amount required for Cleared 
CDS under the margin rule of the self-regulatory organization that is 
its designated examining authority.
    (e) For purposes of this Order, ``Cleared CDS'' shall mean a credit 
default swap that is submitted (or offered, purchased or sold on terms 
providing for submission) to CME, 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:
    (1) The reference entity, the issuer of the reference security, or 
the reference security is one of the following:
    (i) An entity reporting under the Exchange Act, providing 
Securities Act Rule 144A(d)(4) information, or about which financial 
information is otherwise publicly available;
    (ii) a foreign private issuer whose securities are listed outside 
the United States and that has its principal trading market outside the 
United States;
    (iii) a foreign sovereign debt security;
    (iv) an asset-backed security, as defined in Regulation AB, issued 
in a registered transaction with publicly available distribution 
reports; or

[[Page 11792]]

    (v) an asset-backed security issued or guaranteed by Fannie Mae, 
Freddie Mac or Ginnie Mae; or
    (2) 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).

    By the Commission.
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-5927 Filed 3-18-09; 8:45 am]
