Ensuring Everything Is Above Board: CFTC Proposes Simplified Rules for SEF and DCM Governance, Independence and Mitigating Conflicts of Interest

Seeking to ensure that designated contract markets (DCMs) and swap execution facilities (SEFs) adequately incorporate an independent perspective, the Commodity Futures Trading Commission (CFTC) has proposed new rules and amendments to existing regulations to establish governance and fitness requirements for market regulation functions as well as conflict of interest standards. The CFTC’s stated purpose for proposing the new and amended requirements is to ensure that SEFs and DCMs can effectively execute their crucial role as self-regulatory organizations by preventing individuals with certain disciplinary or criminal histories from holding positions that exert influence over the exchange's governance and operations.

The proposal – adopted on February 20, 2024 – seeks to establish uniform minimum fitness requirements for both SEFs and DCMs, as their respective officers, board members, committee members, disciplinary panels and dispute resolution panels share identical responsibilities in governing and overseeing operations, including market regulation functions. The proposed requirements also address limitations on the use and disclosure by employees and certain others of material non-public information; requirements relating to chief regulatory officers, chief compliance officers and regulatory oversight committees, as well as CFTC notification requirements of certain changes in the ownership or corporate or organizational structure of a SEF or DCM.

Since 2001, the CFTC has proposed and implemented guidance along with acceptable practices aimed at addressing conflicts of interest and enhancing governance standards for the exchanges that the agency regulates. In 2010, the CFTC proposed but never adopted rules on governance and conflicts of interest for SEFs and DCMs. 

The proposal defines “market regulation functions” as the responsibilities related to trade practice surveillance, market surveillance, real-time market monitoring, audit trail data and recordkeeping enforcement, investigations of possible SEF or DCM rule violations and disciplinary actions. 

As noted above, the proposal includes new as well as amended requirements related governance and conflicts of interest. 

• Board of Directors: The proposal would extend DCM Core Principle 16’s 35 percent “public directors” requirement to SEF boards of directors and adopt additional requirements to increase transparency and accountability of SEF boards. 
• Public Directors: The proposal would apply the DCM Core Principle 16 definition of “public director” to both DCMs and SEFs, which requires that the director have no material relationship with the SEF or DCM.
• Nominating Committee: Current CFTC regulations do not require SEFs or DCMs to have a nominating committee identify board candidates who are qualified and represent the diverse interests of participants and members of the SEF or DCM. The proposal would mandate each to create a nominating committee.
• Regulatory Oversight Committee (ROC): The proposal would require SEF and DCM regulatory oversight committees to be composed of only public directors with further obligations regarding committee conduct, meetings and documentation practices. Adopting the current DCM ROC acceptable practices for both SEFs and DCMs, the CFTC also aims to bolster the ROC requirements by integrating best practices identified by CFTC staff during routine oversight. CFTC staff have observed significant variations among DCMs in their implementation of ROC administrative and procedural standards. DCM CRO: The DCM Chief Regulatory Officer would administer the DCM’s market regulation functions and have supervisory authority over all staff performing the DCM’s market regulation functions.
• DCM CRO: The DCM Chief Regulatory Officer would administer the DCM’s market regulation functions and have supervisory authority over all staff performing the DCM’s market regulation functions.
• SEF CCO: The SEF Chief Compliance Officer would retain the existing duties under Part 37 regulations, report directly to the board of directors, and take responsible steps to resolve material conflicts of interest and conflicts of interest between business functions and compliance requirements. New requirements include SEF regulatory oversight committee approval for appointment or removal of the CCO to help insulate the CCO from undue influence. CCOs would be required to establish procedures for the disclosure of actual or potential conflicts of interest as well as designate a qualified person to serve in the CCO’s place for any matter for which the CCO has the conflict. Disciplinary Committee: The proposal would enhance the existing DCM Core Principle 16 to require at least two persons on disciplinary and appellate panels, prohibit a disciplinary panel member from voting or deliberating on any matter where that member has a conflict of interest, and extend the public participant requirement for disciplinary panel decision appeals.
• Conflicts of Interest in Decision-making: Both SEFs and DCMs would be required to establish policies and procedures mandating that any officer or board member, as well as members of committees or disciplinary panels, disclose any actual or potential conflicts of interest before deliberating on any matter, and refrain from voting on said matter.
• Limitations on the Use and Disclosure of Material Non-public Information: Drawing from existing SEF and DCM obligations to prohibit key members from trading on material nonpublic information for their own or on behalf of any other account, the proposal would require SEFs and DCMs to establish policies and procedures on safeguarding the use and disclosure of material non-public information. Furthermore, any employee, member of the board of directors, committee member, consultant, or person with an ownership interest of 10 percent or more in the SEF or DCM would be prohibited from disclosing or trading related commodity interests based on any material non-public information obtained through performance of their official duties. The proposed rules expand the trading prohibition at the product level to “related commodity interests” and at the person/entity level to direct owners.

The effective date of the proposed rules would be 60 days after publication of the final regulations in the Federal Register. The CFTC considers this effective date suitable as DCMs have already integrated numerous requirements adopted from DCM Core Principle 16 Acceptable Practices. Furthermore, many SEFs have voluntarily incorporated components of these standards to illustrate their compliance with SEF Core Principle 12. In terms of the mandatory compliance date, the CFTC proposes a compliance date of one year after the effective date of the final regulations. The CFTC believes this will provide current SEFs and DCMs, as well as prospective SEF and DCM applicants, with adequate time to comply with the final regulations.

Chairman Rostin Behnam endorsed the proposed rules by emphasizing that these rules would “simplify the CFTC’s rules for conflicts and governance fitness standards by harmonizing the regulatory regimes for SEFs and DCMs.” Commissioner Christy Goldsmith Romero added that “exchanges serve as the front line for market integrity” and maintained that the proposed rules largely codify existing guidance. Alternatively, Commissioner Kristin N. Johnson dissented, stating that she considered the proposed rules to be ‘materially incomplete’ because they fail to address DCOs and market participants who have adopted vertically integrated market structures.

The CFTC requested that public comments be submitted on or before April 22, 2024.