2011-2643
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Federal Register, Volume 76 Issue 26 (Tuesday, February 8, 2011)[Federal Register Volume 76, Number 26 (Tuesday, February 8, 2011)]
[Proposed Rules]
[Pages 6715-6727]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-2643]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 23
RIN 3038-AC96
Swap Trading Relationship Documentation Requirements for Swap
Dealers and Major Swap Participants
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)
is proposing regulations to implement new statutory provisions
established under Title VII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Dodd-Frank Act). Section 731 of the Dodd-Frank
Act added a new section 4s(i) to the Commodity Exchange Act (CEA),
which requires the Commission to prescribe standards for swap dealers
and major swap participants related to the timely and accurate
confirmation, processing, netting, documentation, and valuation of
swaps. The proposed rules would establish requirements for swap trading
relationship documentation for swap dealers and major swap
participants.
DATES: Submit comments on or before April 11, 2011.
ADDRESSES: You may submit comments, identified by RIN number 3038-AC96
and Swap Trading Relationship Documentation Requirements for Swap
Dealers and Major Swap Participants, by any of the following methods:
Agency Web site, via its Comments Online process at http://comments.cftc.gov. Follow the instructions for submitting comments
through the Web site.
Mail: David A. Stawick, Secretary of the Commission,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW., Washington, DC 20581.
Hand Delivery/Courier: Same as mail above.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Please submit your comments using only one method.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
http://www.cftc.gov. You should submit only information that you wish
to make available publicly. If you wish the Commission to consider
information that may be exempt from disclosure
[[Page 6716]]
under the Freedom of Information Act, a petition for confidential
treatment of the exempt information may be submitted according to the
established procedures in Sec. 145.9 of the Commission's regulations,
17 CFR 145.9.
The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from http://www.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other applicable laws, and may be accessible under
the Freedom of Information Act.
FOR FURTHER INFORMATION CONTACT: Sarah E. Josephson, Associate
Director, 202-418-5684, sjosephson@cftc.gov; Frank N. Fisanich, Special
Counsel, 202-418-5949, ffisanich@cftc.gov; or Jocelyn Partridge,
Special Counsel, 202-418-5926, jpartridge@cftc.gov; Division of
Clearing and Intermediary Oversight, Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington,
DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
On July 21, 2010, President Obama signed the Dodd-Frank Act.\1\
Title VII of the Dodd-Frank Act \2\ amended the Commodity Exchange Act
(CEA) \3\ to establish a comprehensive regulatory framework to reduce
risk, increase transparency, and promote market integrity within the
financial system by, among other things: (1) Providing for the
registration and comprehensive regulation of swap dealers and major
swap participants; (2) imposing clearing and trade execution
requirements on standardized derivative products; (3) creating rigorous
recordkeeping and real-time reporting regimes; and (4) enhancing the
Commission's rulemaking and enforcement authorities with respect to all
registered entities and intermediaries subject to the Commission's
oversight.
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\1\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the
Dodd-Frank Act may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.
\2\ Pursuant to section 701 of the Dodd-Frank Act, Title VII may
be cited as the ``Wall Street Transparency and Accountability Act of
2010.''
\3\ 7 U.S.C. 1 et seq.
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Section 731 of the Dodd-Frank Act amends the CEA by adding a new
section 4s, which sets forth a number of requirements for swap dealers
and major swap participants. Specifically, section 4s(i) of the CEA
establishes swap documentation standards for those registrants.
Section 4s(i)(1) requires swap dealers and major swap participants
to ``conform with such standards as may be prescribed by the Commission
by rule or regulation that relate to timely and accurate confirmation,
processing, netting, documentation, and valuation of all swaps.'' Under
section 4s(i)(2), the Commission is required to adopt rules ``governing
documentation standards for swap dealers and major swap participants.''
The Commission is proposing the regulations governing swap
documentation discussed below, pursuant to the authority granted under
sections 4s(h)(1)(D), 4s(h)(3)(D), 4s(i), and 8a(5) of the CEA.\4\ The
Dodd-Frank Act requires the Commission to promulgate these provisions
by July 15, 2011.\5\
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\4\ Section 8a(5) of the CEA authorizes the Commission to
promulgate such regulations as, in the judgment of the Commission,
are reasonably necessary to effectuate any of the provisions or to
accomplish any of the purposes of the CEA.
\5\ This is the sixth rulemaking to be proposed regarding
internal business conduct standards for swap dealers and major swap
participants. Prior notices of proposed rulemaking are available on
the Commission's Web site at http://www.cftc.gov.
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The proposed regulations reflect consultation with staff of the
following agencies: (i) The Securities and Exchange Commission; (ii)
the Board of Governors of the Federal Reserve System; (iii) the Office
of the Comptroller of the Currency; and (iv) the Federal Deposit
Insurance Corporation. Staff from each of these agencies has had the
opportunity to provide oral and/or written comments to the proposal,
and the proposed regulations incorporate elements of the comments
provided.
In designing these rules, the Commission has taken care to minimize
the burden on those parties that will not be registered with the
Commission as swap dealers or major swap participants. To the extent
that market participants believe that additional measures should be
taken to reduce the burden or increase the benefits of documenting swap
transactions, the Commission welcomes all comments.
II. Proposed Regulations
The proposed regulations would set forth certain requirements for
documenting the swap trading relationship between swap dealers, major
swap participants, and their counterparties. Documentation of swaps is
a critical component of the bilaterally-traded, over-the-counter (OTC)
derivatives market and has been the focus of significant domestic and
international attention in recent years.
A. Background on Documentation and Standardization
The OTC derivatives markets traditionally have been characterized
by privately negotiated transactions entered into by two
counterparties, in which each party assumes and manages the credit risk
of the other. While OTC derivatives are traded by a diverse set of
market participants, such as banks, hedge funds, pension funds, and
other institutional investors, as well as corporate, governmental, and
other end-users, a relatively few number of dealers are, by far, the
most significantly active participants. As such, the default of a
dealer may result in significant losses for the counterparties of that
dealer, either from the counterparty exposure to the defaulting dealer
or from the cost of replacing the defaulted trades in times of market
stress.\6\
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\6\ See Financial Stability Board, ``Implementing OTC
Derivatives Market Reforms: Report of the OTC Derivatives Working
Group,'' (Oct. 10, 2010), available at http://www.financialstabilityboard.org/publications/r_101025.pdf.
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OTC derivatives market participants typically have relied on the
use of industry standard legal documentation, including master netting
agreements, definitions, schedules, and confirmations, to document
their swap trading relationships. This industry standard documentation,
such as the widely used ISDA Master Agreement and related definitions,
schedules, and confirmations specific to particular asset classes,
offers a framework for documenting the transactions between
counterparties for OTC derivatives products.\7\ The standard
documentation is designed to set forth the legal, trading, and credit
relationship between the parties and to facilitate cross-product
netting of transactions in the event that parties have to close-out
their position with one another.
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\7\ The International Swaps and Derivatives Association (ISDA)
is a trade association for the OTC derivatives industry (http://www.isda.org).
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One important method of addressing the credit risk that arises from
OTC derivatives transactions is the use of bilateral close-out netting.
Parties seek to achieve enforceable bilateral netting by documenting
all of their transactions under master netting agreements.\8\ Following
the occurrence of a default by one of the counterparties (such as
bankruptcy or insolvency), the
[[Page 6717]]
exposures from individual transactions between the two parties are
netted and consolidated into a single net ``lump sum'' obligation. A
party's overall exposure is therefore limited to this net sum. That
exposure then may be offset by the available collateral previously
provided being applied against the net exposure. As such, it is
critical that the netting provisions between the parties are legally
enforceable and that the collateral may be used to meet the net
exposure. In recognition of the risk-reducing benefits of close-out
netting, many jurisdictions provide favorable treatment of netting
arrangements in bankruptcy,\9\ and favorable capital and accounting
treatment to parties that have enforceable netting agreements in
place.\10\
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\8\ Enforceable bilateral netting arrangements are a common
commercial practice and are an important part of risk management and
minimization of capital costs.
\9\ See e.g., 11 U.S.C. 561 (protecting contractual right to
terminate, liquidate, accelerate, or offset under a master netting
agreement and across contracts).
\10\ See 12 CFR 3, Appendix C; 12 CFR 208, Appendix F; 12 CFR
225, Appendix G; and 12 CFR 325, Appendix D (banking regulations
regarding qualifying master netting agreements).
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There is also a risk that inadequate documentation of open swap
transactions could result in collateral and legal disputes, thereby
exposing counterparties to significant counterparty credit risk. By way
of contrast, adequate documentation between counterparties offers a
framework for establishing the trading relationship between the
parties. The use of common legal documentation also encourages
standardization of traded products. This, in turn, may facilitate
central clearing and trading as sufficient standardization is a
prerequisite for central clearing and trading on an exchange or
electronic platform.
In response to the global economic crisis, in September 2009, G-20
Leaders agreed in Pittsburgh to critical elements relating to OTC
derivatives reform, including a provision that ``[a]ll standardized OTC
derivative contracts should be traded on exchanges or electronic
trading platforms, where appropriate, and cleared through central
counterparties. * * *'' \11\ In June 2010 in Toronto, the G-20 Leaders
reaffirmed this commitment, and expressly stated their objective of
increasing standardization in the OTC derivatives markets.\12\ With the
passage of the Dodd-Frank Act in July 2010, Congress expressly
recognized the link between standardized swaps and clearing, as
well.\13\
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\11\ See Group of Twenty, ``Leaders' Statement: The Pittsburgh
Summit,'' (Sept. 24-25, 2009), available at http://www.pittsburghsummit.gov/mediacenter/129639.htm.
\12\ See The G-20 Toronto Summit Declaration (Jun. 26-27, 2010),
available at
http://www.g20.utoronto.ca/2010/g20_declaration_en.pdf. In
Annex II, the declaration stated, ``We pledged to work in a
coordinated manner to accelerate the implementation of over-the-
counter (OTC) derivatives regulation and supervision and to increase
transparency and standardization.''
\13\ ``It is expected that the standardized, plain vanilla, high
volume swaps contracts--which according to the Treasury Department
are about 90 percent of the $600 trillion swaps market--will be
subject to mandatory clearing.'' 156 Cong. Rec. S5921 (daily ed.
Jul. 15, 2010) (statement of Sen. Lincoln).
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In addition, increasing standardization of swap documentation
should improve the market in a number of other ways, including:
Facilitating automated processing of transactions; increasing the
fungibility of the contracts, which enables greater market liquidity;
improving valuation and risk management; increasing the reliability of
price information; reducing the number of problems in matching trades;
and facilitating reporting to swap data repositories.\14\
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\14\ These benefits were articulated by the Financial Stability
Board's OTC Derivatives Working Group in its report, ``Implementing
OTC Derivatives Market Reforms,'' (Oct. 10, 2010), available at
http://www.financialstabilityboard.org/publications/r_101025.pdf.
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Product and process standardization are also key conditions for
increased automation and central clearing of OTC derivatives. As a
result of targeted supervisory encouragement since 2005,\15\ credit
derivative market participants have standardized CDS product design and
post-trade processes in tandem, leading to greater operational
efficiencies, encouraging higher volumes of standardized transactions,
and most significantly, providing the requisite operational environment
for the implementation of centralized risk-reducing infrastructure,
including central counterparty clearing.
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\15\ Since 2005, the Federal Reserve Bank of New York (FRBNY)
has led a targeted, supervisory effort to enhance operational
efficiency and performance in the OTC derivatives market, among
other things, by increasing standardization. Known as the OTC
Derivatives Supervisors' Group (ODSG), the FRBNY leads an on-going
effort with OTC derivatives dealers' primary supervisors, trade
associations, industry utilities, and private vendors, through which
market participants (including buy-side participants) regularly set
goals and commitments to bring infrastructure, market design, and
risk management improvements to all OTC derivatives asset classes.
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Many standardized processes have been established for CDS legal
documentation and trading conventions, and in turn, the standardization
of product design has enabled market participants to implement
infrastructure that automates and centralizes trading, recordkeeping,
trade compression, and clearing. For example, the standardization of
coupons in the single-name CDS product was largely motivated by the
desire to create an efficient process for offsetting contracts. The
market-wide adoption of fixed coupons allowed single-name CDS
instruments to be centrally cleared, in effect standardizing
counterparty credit risk management in these products. The ``Big Bang
Protocol'' further standardized a number of critical operational
processes.\16\ The protocol: (i) ``Hardwired'' a standard auction
mechanism into CDS trading documentation, eliminating the need for ad
hoc protocols; (ii) incorporated the resolutions of the ISDA
Determinations Committees into the terms of standard CDS documentation;
and (iii) instituted a common standard effective date for CDS
transactions. Codifying key standardized processes into CDS products
has brought greater certainty to managing the risk of CDS transactions
and has provided the structural foundation for greater automation,
higher volumes in standardized transactions, and ultimately the
establishment of centralized risk-reducing infrastructure, such as
central counterparties.
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\16\ See 2009 ISDA Credit Derivatives Determinations Committees
and Auction Settlement CDS Protocol, available at: http://www.isda.org/bigbangprot/docs/Big-Bang-Protocol.pdf.
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B. Proposed Swap Trading Relationship Documentation Rule
To promote the ``timely and accurate * * * documentation * * * of
all swaps'' under Sec. 4s(i)(1) of the CEA, proposed Sec. 23.504(a)
would require that swap dealers and major swap participants establish,
maintain, and enforce written policies and procedures reasonably
designed to ensure that each swap dealer or major swap participant and
its counterparties have agreed in writing to all of the terms governing
their swap trading relationship and have executed all agreements
required by proposed Sec. 23.504.
Proposed Sec. 23.504(b)(1) would specify that the swap trading
relationship documentation include written agreement by the parties on
terms relating to payment obligations, netting of payments, events of
default or other termination events, netting of obligations upon
termination, transfer of rights and obligations, governing law,
valuation, and dispute resolution procedures. Proposed Sec.
23.504(b)(2) would establish that all confirmations of swap
transactions, as required under previously proposed Sec. 23.501, would
be considered to be part of the required swap trading relationship
documentation.
[[Page 6718]]
Swap trading relationship documentation under proposed Sec.
23.504(b)(3)(i) and (ii) also would include credit support arrangements
containing initial and variation margin requirements at least as high
as those set by the Commission (for swap dealers and major swap
participants that are not banks) and by prudential regulators (for
entities that are banks). These credit support arrangements also would
be required to identify the forms of eligible assets that may be used
as margin and asset valuation haircuts.
Under proposed Sec. 23.504(b)(3)(iii) and (iv), the credit support
arrangements between swap dealers and major swap participants would
include documentation of the treatment of any assets used as margin for
uncleared swaps. These provisions are intended to work together with
the rules previously proposed under section 4s(l) of the CEA,\17\ and
thus require documentation as to whether the funds and other property
are to be segregated with an independent third party, in accordance
with Sec. 23.601(e). The provisions also are designed to work together
with rules to be proposed under section 4s(e) of the CEA that relate to
margin requirements.
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\17\ See 75 FR 75432, Notice of Proposed Rulemaking, Protection
of Collateral of Counterparties to Uncleared Swaps; Treatment of
Securities in a Portfolio Margining Account in a Commodity Broker
Bankruptcy, Dec. 3, 2010.
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Under Sec. 23.601, as previously proposed, swap dealers and major
swap participants trading uncleared swaps would be required to notify
each counterparty that the counterparty has the right to require
segregation of the funds or other property that it supplies as
``initial margin,'' a term defined in previously proposed Sec.
23.600.\18\ At the request of the counterparty, the swap dealer or
major swap participant would be required to segregate such initial
margin with an independent third party. Under section 4s(l) of the CEA,
this segregation requirement would not apply to variation margin
payments. Proposed Sec. 23.602(a)(2), however, would permit the swap
dealer or major swap participant and the counterparty to agree that
variation margin also may be held in a segregated account. Under
proposed Sec. 23.601(e), swap dealers and major swap participants
would notify each counterparty of the opportunity to revisit their
segregation decision once per calendar year.
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\18\ See 75 FR 75438 (``Initial margin means money, securities,
or property posted by a party to a swap as performance bond to cover
potential future exposures arising from changes in the market value
of the position.'').
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Swap dealers and major swap participants also must comply with
proposed Sec. 23.603(a), which would provide that segregated initial
margin may only be invested consistent with the standards for
investment of customer funds that the Commission applies to exchange-
traded futures (see Sec. 1.25 of Commission regulations), and with
proposed Sec. 23.603(b), which would provide that swap dealers and
major swap participants and their counterparties may enter into any
commercial arrangement, in writing, regarding the investment of
segregated initial margin and the related allocation of the gains and
losses resulting from such investments. The Commission anticipates that
documentation of the foregoing matters would be included in the trading
relationship documentation required pursuant to proposed Sec.
23.504(b)(3)(iii).
Swap dealers and major swap participants could maintain standard
templates for documenting their trading relationships as a way of
complying with the requirements of Sec. 23.504. The Commission would
also consider it a sound practice for swap dealers and major swap
participants to require senior management in the business trading and
risk management units to approve all templates, and any material
modifications to them. The Commission recognizes the work that the
industry has undertaken over the past several years to update and
standardize the documentation it relies upon for various asset classes,
and the Commission encourages market participants to adopt standardized
confirmation templates, standardized master confirmation
agreements,\19\ standardized product definitions, and other
standardized documentation developed by the industry. Standardized
documentation and definitions promote standardized products, which may
lead to greater liquidity and more efficient pricing. In addition,
increased product standardization may bring systemic risk-reduction
benefits as the risks associated with standardized products are better
understood by the entire marketplace.
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\19\ Standard Master Confirmation Agreements that have been
published include:
2004 Sovereign Master Credit Derivatives Confirmation Agreement.
2003 Master Credit Derivatives Confirmation Agreement (Asia-
Pacific).
2003 Master Credit Derivatives Confirmation Agreement (European-
North American).
2009 Americas Master Equity Derivatives Confirmation Agreement.
2008 Americas Master Designated/Exchange-Traded Contract Option
Confirmation Agreement.
2007 Americas Master Variance Swap Confirmation Agreement.
2004 Americas Interdealer Master Equity Derivatives Confirmation
Agreement.
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C. Proposed Swap Valuation Provisions
Swap valuation disputes have long been recognized as a significant
problem in the OTC derivatives market.\20\ The ability to determine
definitively the value of a swap at any given time lies at the center
of many of the OTC derivatives market reforms contained in the Dodd-
Frank Act and is a cornerstone of risk management. Swap valuation is
also crucial for determining capital and margin requirements applicable
to swap dealers and major swap participants and therefore plays a
primary role in risk mitigation for uncleared swaps.
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\20\ See ISDA Collateral Committee, ``Commentary to the Outline
of the 2009 ISDA Protocol for Resolution of Disputed Collateral
Calls,'' June 2, 2009 (stating ``Disputed margin calls have
increased significantly since late 2007, and especially during 2008
have been the driver of large (sometimes > $1 billion)
uncollateralized exposures between professional firms.'').
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The Commission recognizes that swap valuation is not always an easy
task. In some instances, there is widespread agreement on valuation
methodologies and the source of formula inputs for frequently traded
swaps. These swaps are the proverbial ``low-hanging fruit,'' and many
have been accepted for clearing (i.e., commonly traded interest rate
swaps and credit default swaps). However, parties often dispute
valuations of thinly traded swaps where there is not widespread
agreement on valuation methodologies or the source for formula inputs.
Many of these swaps are thinly traded either because of their limited
use as risk management tools or because they are simply too customized
to have comparable counterparts in the market. As many of these swaps
are valued by dealers internally by ``marking-to-model,'' their
counterparties may dispute the inputs and methodologies used in the
model. As uncleared swaps are bilateral, privately negotiated
contracts, on-going swap valuation for purposes of initial and
variation margin calculation and swap terminations or novations, has
also been largely a process of on-going negotiation between the
parties. The inability to agree on the value of a swap became
especially acute during the 2007-2009 financial crisis when there was
widespread failure of the market inputs needed to value many swaps.\21\
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\21\ The failure of the market to set a price for mortgage-
backed securities led to wide disparities in the valuation of CDS
referencing mortgage-backed securities (especially collateralized
debt obligations). Such wide disparities led to large collateral
calls from dealers on AIG, hastening its downfall. See CBS News,
``Calling AIG? Internal Docs Reveal Company Silent About Dozens Of
Collateral Calls,'' Jun. 23, 2009, available at: http://www.cbsnews.com/stories/2009/06/23/cbsnews_investigates/main5106672.shtml.
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[[Page 6719]]
The Commission believes that prudent risk management requires that
market participants be able to value their own swaps in a predictable
and objective manner; the failure to do so may lead to systemic risk.
Accordingly, to promote the ``timely and accurate * * * valuation of
all swaps'' under Sec. 4s(i)(1) of the CEA, proposed Sec.
23.504(b)(4) would require that the swap trading documentation include
written documentation in which the parties agree on the methods,
procedures, rules and inputs for determining the value of each swap at
any time from execution to the termination, maturity, or expiration of
the swap. The agreed methods, procedures, rules and inputs would be
required to constitute a complete and independently verifiable
methodology for valuing each swap entered into between the parties.
Proposed Sec. 23.504(b)(4)(iii) would require that the methodology
include complete alternative methods for determining the value of the
swap in the event that one or more inputs to the methodology become
unavailable or fail, such as during times of market stress or
illiquidity. All agreements on valuation would be considered part of
the swap trading relationship documentation.
This proposed rule is an important complement to previously
proposed Sec. 23.502 (portfolio reconciliation), which requires swap
dealers and major swap participants to resolve a dispute over the
valuation of a swap within one business day. By requiring agreement
with each counterparty on the methods and inputs for valuation of each
swap, it is expected that Sec. 23.504(b)(4) will assist swap dealers
and major swap participants to resolve valuation disputes in a timely
manner, thereby reducing risk.
D. Submission of Swaps for Clearing
Under proposed Sec. 23.504(b)(6), upon acceptance of a swap by a
registered derivatives clearing organization (DCO), each swap dealer
and major swap participant would be required to create a record
containing certain items of information,\22\ along with a statement
that in accordance with the rules of the DCO, the original swap is
extinguished and is replaced by equal and opposite swaps between
clearing members and the DCO. This provision would require that all
terms of the cleared swap conform to the templates established under
the DCO's rules, and that all terms of the swap, as carried on the
books of the clearing member, conform to the terms of the cleared swap
established under the DCO's rules.
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\22\ Such information includes the date and time the swap was
accepted for clearing, the name of the DCO clearing the swap, the
name of the clearing member clearing the swap for the swap dealer or
major swap participant, and, if known, the name of the clearing
member clearing the swap for the counterparty.
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Proposed Sec. 23.504(b)(6), while addressing the issues prescribed
under Sec. 4s(i)(1) of the CEA, is intended to correspond to proposed
Sec. 39.12(b)(4).\23\ The purpose of these provisions is to encourage
the standardization of swaps and to avoid differences that could
compromise the benefits of clearing between the terms of a swap as
carried at the DCO level and at the clearing member level. Any such
differences would raise both customer protection and systemic risk
concerns. From a customer protection standpoint, if the terms of the
swap at the customer level differ from those at the clearing level,
then the customer will not receive the full transparency and liquidity
benefits of clearing, and legal and basis risk will be introduced into
the customer position. Similarly, from a systemic perspective, any
differences could diminish overall price discovery and liquidity and
increase uncertainties and unnecessary costs into the insolvency
resolution process. Standardizing the terms of a swap upon clearing
would facilitate trading and promote the mitigation of risk for all
participants in the swap markets.
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\23\ The proposed Notice of Proposed Rulemaking, Risk Management
Requirements for Derivatives Clearing Organizations under part 39
are available on the Commission's Web site at http://www.cftc.gov.
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Standardization also will impose structure on the general economic
function of the contract and will facilitate automated processing and
the ability for participants to replicate the trade easily. This allows
market participants to trade in and out of contracts easily and lowers
transaction costs, which in turn enables greater market liquidity and
expansion of the market to more participants.
E. Documentation Audit and Recordkeeping
In keeping with prudent risk management, Sec. 23.504(c) would
require an annual audit of the swap trading relationship documentation
required by Sec. 23.504 to ensure compliance with approved
documentation policies and procedures and Commission regulations.
Proposed Sec. 23.504(d) would require swap dealers and major swap
participants to keep records in compliance with this section.
F. Reporting Swap Valuation Disputes
Proposed Sec. 23.504(e) would require that swap dealers and major
swap participants promptly notify the Commission, any applicable
prudential regulator, and the Securities and Exchange Commission with
regard to security-based swap agreements if any swap valuation dispute
is not resolved within one business day, if the dispute is with a
counterparty that is a swap dealer or major swap participant; or within
five business days, if the dispute is with a counterparty that is not a
swap dealer or major swap participant. This proposed rule would
complement previously proposed Sec. 23.502, which requires portfolio
reconciliation and resolution of valuation disputes. It also would
allow authorities to recognize and respond to outstanding swap
valuation disputes, which if left uncollateralized, may lead to
systemic risk.
G. Proposed End User Exception Documentation Rule
Proposed Sec. 23.505 would work together with the swap data
recordkeeping and reporting requirements rules and end-user exception
to mandatory clearing rules, both previously proposed by the
Commission.\24\ Under these previously proposed rules, ``a swap
otherwise subject to mandatory clearing is subject to an elective
exception from clearing if one party to the swap is not a financial
entity, is using the swaps to hedge or mitigate commercial risk, and
notifies the Commission * * * how it generally meets its financial
obligations associated with entering into non-cleared swaps (the `end-
user clearing exception').'' \25\ Under previously proposed Sec. 39.6,
the end-user clearing exception is elected by providing ten additional
items of information to a swap data repository (SDR) through a ``check-
the-box notification process.'' \26\ As explained in the swap data
recordkeeping and reporting rules, swap dealers and major swap
participants will have the responsibility for reporting to SDRs ``with
respect to the majority of swaps.'' \27\ In order to ensure that swap
dealers and major swap participants comply with all mandatory clearing
requirements and in light of their unique reporting obligations, it is
critical that they possess documentation
[[Page 6720]]
sufficient to support a reasonable belief that their counterparties
meet the statutory requirements for electing an exception from
mandatory clearing. Accordingly, the Commission is proposing Sec.
23.505.
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\24\ See Swap Data Recordkeeping and Reporting Requirements, 75
FR 76573, Dec. 8, 2010, and End-User Exception to Mandatory Clearing
of Swaps, 75 FR 80747, Dec. 23, 2010.
\25\ 75 FR at 80748.
\26\ 75 FR at 80749 and 80755.
\27\ 75 FR at 76593; see also section 4r of the CEA.
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Proposed Sec. 23.505 would require swap dealers and major swap
participants to obtain documentation from any counterparty seeking to
exercise its rights under the end-user clearing exception from the
mandatory clearing requirement under section 2h(7) of the CEA. For
swaps subject to the mandatory clearing requirement, the proposed rule
would require that swap dealers and major swap participants comply with
any mandatory clearing requirement by obtaining documentation
sufficient to provide the swap dealer or major swap participant with a
reasonable basis to believe that its counterparty meets the statutory
conditions required for an exception from a mandatory clearing
requirement, as defined in section 2h(7) of the CEA.
H. Application of Proposed Regulations to Existing Swap Documentation
The Commission recognizes that amending all existing trading
relationship documentation would present a substantial undertaking for
the market. Therefore, the Commission invites comment on the
implementation of proposed Sec. 23.504. While much of the existing
swap documentation among swap dealers, major swap participants, and
their counterparties likely would be in compliance with Sec.
23.504(b), the Commission requests comment on an appropriate interval
following the effective date of the regulations after which to require
compliance. This interval is expected to be somewhat shorter for swap
documentation among swap dealers and major swap participants, and
somewhat longer for swap documentation between swap dealers, major swap
participants, and counterparties that are not swap dealers or major
swap participants.
The Commission also recognizes that many swap dealers and major
swap participants may have dormant trading relationships with
counterparties where swap documentation has been executed, but no
trades are presently in effect thereunder or there are trades that will
run-off over a short period of time, and there is no intention to enter
into new trades. Therefore, the Commission invites comment on whether
to provide a safe harbor for dormant trading relationships.
I. Comment Requested
The Commission requests comment on all aspects of proposed
Sec. Sec. 23.504 and 23.505. The Commission recognizes that there will
be differences in the size and scope of the business of particular swap
dealers and major swap participants. Therefore, comments are solicited
on whether certain provisions of the proposed regulations should be
modified or adjusted to reflect the differences among swap dealers and
major swap participants or differences among asset classes. In
particular, the Commission requests comment on the following questions:
How long would swap dealers and major swap participants
require to bring their existing documentation into compliance with
Sec. 23.504? Will compliance take less time for existing documentation
between such registrants and longer for existing documentation between
registrants and non-registrants? Would three months following the
effective date of the rules be long enough for registrants to bring
existing documentation among themselves into compliance? Would six
months following the effective date of the rules be long enough for
registrants to bring existing documentation with non-registrants into
compliance?
Should Sec. 23.504 include a safe harbor for swaps
entered into on, or subject to the rules of, a board of trade
designated as a contract market?
Should Sec. 23.504 require that the governing body of
each swap dealer or major swap participant approve the policies and
procedures for agreeing with each counterparty to all the terms
governing the trading relationship?
Should any other aspects of the trading relationship be
required to be included in Sec. 23.504?
Should the requirement for agreement on events of default
or termination events be further defined? For example, should parties
be required to specify all cross default implications and potential
claims with regard to their respective affiliates and any other present
or future debt obligations or transactions?
Should Sec. 23.504 specifically delineate the types of
payment obligation terms that must be included in the trading
relationship documentation?
Should specific requirements for dispute resolution be
included in Sec. 23.504 (such as time limits), and if so, what
requirements are appropriate for all swaps?
Should the valuation agreement in Sec. 23.504(b)(4)
require greater specificity? If so, what level of detail should be
required?
Should the valuation methodology provision in Sec.
23.504(b)(4) expressly prohibit use of internal and/or proprietary
inputs and methods and if not, why are inputs and methods developed and
verifiable only by one party to the swap transaction acceptable given
the safety and soundness and transparency objectives of the Dodd-Frank
Act?
If internal and/or proprietary inputs or procedures are
permitted under Sec. 23.504(b)(4), should the swap dealer or major
swap participant be required to disclose such information and the
sources thereof to the counterparty and regulators in sufficient detail
for them to undertake comparative analysis of such information and
verify the valuation calculations?
Under proposed Sec. 23.504(b)(6)(v), should all the terms
of the cleared swap be required to conform to the templates established
by the DCO or are there particular terms or rights under the swap that
could be retained without prejudice to the need to standardize swaps
for the purposes of clearing?
Is the requirement that each swap dealer and major swap
participant conduct an independent internal or external audit of no
less than 5% of the swap trading relationship documentation required by
the rule executed during the previous twelve month period appropriate?
Would a failure of swap trading relationship documentation
to comply with the requirements of proposed Sec. 23.504 create
uncertainty regarding the enforceability of swaps transacted under such
non-compliant documentation? If so, how should this uncertainty be
addressed in the rules?
Are the requirements of proposed Sec. 23.505 appropriate?
How should swap dealers and major swap participants verify that their
counterparties are properly claiming an exception from a given
mandatory clearing requirement?
Are there any anticompetitive implications to the proposed
rules? If so, how could the proposed rules be implemented to achieve
the purposes of the CEA in a less anticompetitive manner?
III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) requires that agencies
consider whether the rules they propose will have a significant
economic impact on a substantial number of small entities.\28\ The
Commission previously has established certain definitions of ``small
entities'' to be used in evaluating the impact of its regulations on
small entities in accordance with the RFA.\29\
[[Page 6721]]
The proposed rules would affect swap dealers and major swap
participants.
---------------------------------------------------------------------------
\28\ 5 U.S.C. 601 et seq.
\29\ 47 FR 18618, Apr. 30, 1982.
---------------------------------------------------------------------------
Swap dealers and major swap participants are new categories of
registrants. Accordingly, the Commission has not previously addressed
the question of whether such persons are, in fact, small entities for
purposes of the RFA. The Commission previously has determined, however,
that futures commission merchants should not be considered to be small
entities for purposes of the RFA.\30\ The Commission's determination
was based, in part, upon the obligation of futures commission merchants
to meet the minimum financial requirements established by the
Commission to enhance the protection of customers' segregated funds and
protect the financial condition of futures commission merchants
generally.\31\ Like futures commission merchants, swap dealers will be
subject to minimum capital and margin requirements and are expected to
comprise the largest global financial firms. The Commission is required
to exempt from swap dealer designation any entities that engage in a de
minimis level of swaps dealing in connection with transactions with or
on behalf of customers. The Commission anticipates that this exemption
would tend to exclude small entities from registration. Accordingly,
for purposes of the RFA for this rulemaking, the Commission is hereby
proposing that swap dealers not be considered ``small entities'' for
essentially the same reasons that futures commission merchants have
previously been determined not to be small entities and in light of the
exemption from the definition of swap dealer for those engaging in a de
minimis level of swap dealing.
---------------------------------------------------------------------------
\30\ Id. at 18619.
\31\ Id.
---------------------------------------------------------------------------
The Commission also has previously determined that large traders
are not ``small entities'' for RFA purposes.\32\ In that determination,
the Commission considered that a large trading position was indicative
of the size of the business. Major swap participants, by statutory
definition, maintain substantial positions in swaps or maintain
outstanding swap positions that create substantial counterparty
exposure that could have serious adverse effects on the financial
stability of the United States banking system or financial markets.
Accordingly, for purposes of the RFA for this rulemaking, the
Commission is hereby proposing that major swap participants not be
considered ``small entities'' for essentially the same reasons that
large traders have previously been determined not to be small entities.
---------------------------------------------------------------------------
\32\ Id. at 18620.
---------------------------------------------------------------------------
Moreover, the Commission is carrying out Congressional mandates by
proposing this regulation. Specifically, the Commission is proposing
these regulations to comply with the Dodd-Frank Act, the aim of which
is to reduce systemic risk presented by swap dealers and swap market
participants through comprehensive regulation. The Commission does not
believe that there are regulatory alternatives to those being proposed
that would be consistent with the statutory mandate. Accordingly, the
Chairman, on behalf of the Commission, hereby certifies pursuant to 5
U.S.C. 605(b) that the proposed rules will not have a significant
economic impact on a substantial number of small entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act (PRA) \33\ imposes certain requirements
on Federal agencies (including the Commission) in connection with their
conducting or sponsoring any collection of information as defined by
the PRA. This proposed rulemaking would result in new collection of
information requirements within the meaning of the PRA. The Commission
therefore is submitting this proposal to the Office of Management and
Budget (OMB) for review in accordance with 44 U.S.C. 3507(d) and 5 CFR
1320.11. The title for this collection of information is ``Swap Trading
Relationship Documentation Requirements for Swap Dealers and Major Swap
Participants.'' An agency may not conduct or sponsor, and a person is
not required to respond to, a collection of information unless it
displays a currently valid control number. The OMB has not yet assigned
this collection a control number.
---------------------------------------------------------------------------
\33\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
The collection of information under these proposed rules is
necessary to implement new section 4s(i) the CEA, which expressly
requires the Commission to adopt rules governing documentation
standards for swap dealers and major swap participants and explicitly
obligates such registrants to conform to the documentation standards
established by the Commission. The required recordkeeping is
particularly essential to ensuring that each swap dealer and major swap
participant documents all of the terms of its swap trading
relationships with its counterparties. Obligating certain swap market
participants to memorialize, in writing, their mutual agreement with
respect to margin requirements, margin assets, payment and netting,
termination events, the calculation and netting of obligations upon
termination, transfer of rights and obligations, governing law,
valuation methods and inputs, and dispute resolution procedures would
decrease the likelihood of significant counterparty disputes; promote
transaction standardization; enhance the parties' abilities to engage
in risk-reducing exercises such as bilateral offset, portfolio
reconciliation, and portfolio compression; provide for more timely and
orderly resolution of events of default; and enhance the stability of
the market place as a whole. The proposed regulations also would ensure
that certain important information regarding cleared swaps would be
preserved and would assist in ensuring compliance with the mandatory
clearing requirements of the Act and Commission regulations by
requiring the maintenance of documentation demonstrating that the
statutory conditions for an exception to those requirements have been
satisfied. The reporting requirement established by the proposed rules
would ensure that the Commission is provided with timely notification
of swap valuation disputes that relevant market participants have been
unable to resolve promptly.
The proposed regulation would be an important part of the
Commission's regulatory program for swap dealers and major swap
participants. The information required to be preserved would be used by
representatives of the Commission and any examining authority
responsible for reviewing the activities of the swap dealer or major
swap participant to ensure compliance with the CEA and applicable
Commission regulations.
If the proposed regulations are adopted, responses to this
collection of information would be mandatory. The Commission will
protect proprietary information according to the Freedom of Information
Act and 17 CFR part 145, ``Commission Records and Information.'' In
addition, section 8(a)(1) of the CEA strictly prohibits the Commission,
unless specifically authorized by the CEA, from making public ``data
and information that would separately disclose the business
transactions or market positions of any person and trade secrets or
names of customers.'' The Commission also is required to protect
certain information contained in a government system of records
according to the Privacy Act of 1974, 5 U.S.C. 552a.
1. Information Provided By Reporting Entities/Persons
Proposed Sec. 23.504 generally would require swap dealers and
major swap participants to develop and retain
[[Page 6722]]
written swap trading relationship documentation (including the parties'
agreement with respect to the terms specified in the regulation; credit
support arrangements; valuation methods, procedures and inputs; records
of important information regarding their cleared swaps; and written
policies and procedures for maintaining the documentation required by
the proposed rule). It also would require swap dealers and major swap
participants to report to the Commission and, as applicable, to the
Securities and Exchange Commission or prudential regulators, swap
valuation disputes that have not been resolved between the parties
within designated time frames. Proposed Sec. 23.505 would require swap
dealers and major swap participants to obtain documentation sufficient
to provide a reasonable basis on which to believe that a counterparty
meets the statutory conditions necessary for an exception from the
mandatory clearing requirements, where applicable.
The information collection burden associated with the proposed
regulations is estimated to be 6,168 hours per year, at an initial
annual cost of $684,300 for each swap dealer and major swap
participant. The aggregate information collection burden is estimated
to be 1,850,400 hours per year, at an initial annual aggregate cost of
$205,290,000. Burden means the total time, effort or financial
resources expended by persons to generate, maintain, retain, disclose,
or provide information to or for a Federal agency. The Commission has
characterized the annual costs as initial costs as the Commission
anticipates that the cost burdens will be reduced dramatically over
time as the agreements and other records required by the proposed
regulations become increasingly standardized within the industry.
The Commission anticipates that the majority of the information
collection burden would arise from the recordkeeping obligations
contained in Sec. 23.504(b). Proposed Sec. 23.504(b) would require
each swap dealer and major swap participant to create and maintain
written trading relationship documentation that contains the parties'
agreement with respect to all of the terms of the parties' trading
relationship including, without limitation, the terms delineated in
Sec. 23.504(b)(1); the parties' credit support arrangements, including
the margin-related terms described in Sec. 23.504(b)(3); and the
parties' agreement with respect to the particular procedures and inputs
that will be used to determine the value of a swap from execution to
termination, maturity, or expiration in a manner that can be
independently replicated as required by Sec. 23.504(b)(4). It also
requires swap dealers and major swap participants to make and maintain
records of cleared swaps containing the data contained in proposed
Sec. 23.504(b)(6).
Maintenance of written credit support arrangements and other
trading relationship documentation that contain the terms required to
be memorialized by the proposed Sec. Sec. 23.504(b)(1) and (3) is
prudent business practice and the Commission anticipates that swap
dealers and major swap participants already maintain some form of this
documentation with each of their counterparties in the ordinary course
of their business. Moreover, proposed Sec. 23.504(b)(2) provides that
the swap transaction confirmations described under previously proposed
Sec. 23.501 would be considered part of the parties' trading
relationship documentation and thus, pre-existing swap confirmations
that include the terms required by Sec. 23.504 would obviate the need
for the parties to develop new documentation with respect to those
terms.\34\ Accordingly, any additional expenditure related to
Sec. Sec. 23.504(b)(1) and (3) likely would be limited to the time
initially required to review and, as needed, to re-negotiate and amend,
existing trading relationship documentation to ensure that it
encompasses all of the required terms and to develop a system for
maintaining any newly created records. Many of the amended provisions
are likely to apply to multiple counterparties, thereby reducing the
per counterparty hour burden.
---------------------------------------------------------------------------
\34\ The information collection burden associated with the
maintenance of confirmations of swaps transactions was calculated
and accounted for in previously proposed regulations. See
Confirmation, Portfolio Reconciliation, and Portfolio Compression
Requirements for Swap Dealers and Major Swap Participants, 75 FR
81519, Dec. 28, 2010.
---------------------------------------------------------------------------
With respect to the valuation agreement requirement established by
proposed Sec. 23.504(b)(4), the Commission believes that swap dealers
and major swap participants are likely to have existing, internal
mechanisms for valuing their swaps transactions and thus, the hour
burden associated with this obligation would be limited to the time
needed to negotiate agreements with counterparties on mutually
acceptable valuation methods, should their individual valuation
procedures differ, and to commit the agreement to writing as part of
the parties' swap trading relationship documentation. It is likely that
the need for new valuation agreements may be limited further to
instances of complex or highly customized swaps transactions, as the
valuation methods for ``plain vanilla'' swaps are likely to be somewhat
standardized.
The Commission estimates the initial annual hour burden associated
with negotiating, drafting, and maintaining the swap trading
relationship documentation described above that is required by proposed
Sec. 23.504(b) (excluding the cleared swap records required by
proposed Sec. 23.504(b)(6)), to be 10 hours per counterparty, or an
average of 5,400 hours per swap dealer or major swap participant. As
stated above, the Commission expects that this annual per registrant
burden would be reduced considerably over time as there would be little
need to modify the swap trading relationship documentation on an
ongoing basis. Once a swap dealer or major swap participant modifies
its pre-existing documentation with each of its counterparties, the
annual burden associated with the swap trading relationship
documentation would be minimal. In addition, because all swap dealers
and major swap participants would be required to maintain the swap
trading relationship documentation established by the proposed
regulation, the Commission believes that it is likely that many of the
terms of such documentation would become progressively more
standardized within the industry, further reducing the bilateral
negotiation and drafting responsibilities associated with the
regulation.
With respect to the required records of cleared swaps, the
Commission estimates that swap dealers and major swap participants will
spend an average of 2 hours per trading day, or 504 hours per year,
maintaining the required data for these transactions. The Commission
notes that the specific information required for each transaction is
limited and is of the type that would be maintained in a prudent market
participant's ordinary course of business. The Commission also notes
that the statement required to be preserved for each cleared swap
likely would become common to each derivatives clearing organization.
In addition to the above, the Commission anticipates that swap
dealers and major swap participants will spend an average of 16 hours
per year drafting and, as needed, updating the written policies and
procedures required by proposed Sec. 23.504(a); 4 hours per year
maintaining records of the results of the annual documentation
compliance audits mandated by proposed Sec. 23.504(c); and 220 hours
per year, or 1 hour per end user, maintaining records of the
[[Page 6723]]
documentation required by proposed Sec. 23.505.
The only reporting requirement contained in the proposed rules is
the obligation of swap dealers and major swap participants to report
swap valuation disputes that are not resolved between the participants
within designated time periods. The Commission expects that swap
dealers and major swap participants will spend an average of 24 hours
per year satisfying this requirement.
The hour burden calculations below are based upon a number of
variables such as the number of swap dealers and major swap
participants in the marketplace, the average number of counterparties
of each of these registrants, and the average hourly wage of the
employees of these registrants that would be responsible for satisfying
the obligations established by the proposed regulation. Swap dealers
and major swap participants are new categories of registrants.
Accordingly, it is not currently known how many swap dealers and major
swap participants will become subject to these rules, and this will not
be known to the Commission until the registration requirements for
these entities become effective after July 16, 2011, the date on which
the Dodd-Frank Act becomes effective. While the Commission believes
there will be approximately 200 swap dealers and 50 major swap
participants, it has taken a conservative approach, for PRA purposes,
in estimating that there will be a combined number of 300 swap dealers
and major swap participants who will be required to comply with the
recordkeeping requirements of the proposed rules. The Commission
estimated the number of affected entities based on industry data.
Similarly, due to the absence of prior experience in regulating
swap dealers and major swap participants and with regulations similar
to the proposed rules, the actual, average number of counterparties
that a swap dealer or major swap participant is likely to have and the
average size of its portfolio with particular counterparties is
uncertain. Consistent with other proposed rulemakings, the Commission
has estimated that each of the 14 major swap dealers has an average
7,500 counterparties and the other 286 swap dealers and major swap
participants have an average of 200 counterparties per year, for an
average of 540 total counterparties per registrant.
The Commission anticipates that the written policies and procedures
required by the proposed regulations, along with the recordkeeping and
reporting requirements, typically would be drafted and maintained by
in-house counsel and financial or operational managers within the
firm.\35\ According to the Bureau of Labor Statistics findings, the
mean hourly wage of an employee under occupation code 23-1011,
``Lawyers,'' that is employed by the ``Securities and Commodity
Contracts Intermediation and Brokerage Industry'' is $82.22.\36\ The
mean hourly wage of an employee under occupation code 11-3031,
``Financial Managers,'' (which includes operations managers) in the
same industry is $74.41.\37\ Because swap dealers and major swap
participants include large financial institutions whose employees'
salaries may exceed the mean wage provided, however, the Commission
generally has estimated the cost burden of the proposed regulations
based upon an average salary of $100 per hour. To account for the
possibility that the services of outside counsel may be required to
satisfy the requirements associated with negotiating, drafting, and
maintaining the required trading relationship documentation (except the
cleared swap records), the Commission has used an average salary of
$125 per hour to calculate this burden for one half of the necessary
hours.
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\35\ The written policies and procedures also may be drafted and
maintained by the chief compliance officer of the swap dealer or
major swap participant. According to recent Bureau of Labor
Statistics findings, the mean hourly wage of any employee under
occupation code 13-1401, ``Compliance Officers, Except Agriculture,
Construction, Health and Safety, and Transportation,'' that is
employed by the ``Securities and Commodity Contracts Intermediation
and Brokerage Industry is $38.77. http://www.bls.gov/oes/current/oes131041.htm.
\36\ http://www.bls.gov/oes/2099/mayowe23.1011.htm.
\37\ http://www.bls.gov/oes/current/oes113031.htm.
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Based upon the above, the estimated hour burden was calculated as
follows:
Drafting and Updating Policies and Procedures. This hour burden
arises from the time necessary to develop and periodically update the
policies and procedures required by the proposed regulations.
Number of registrants: 300.
Frequency of collection: Initial drafting, updating as needed.
Estimated number of annual responses per registrant: 1.
Estimated aggregate number of annual responses: 300.
Estimated annual hour burden per registrant: 16 hours.
Estimated aggregate annual hour burden: 4,800 burden hours [300
registrants x 16 hours per registrant].
Swap Trading Relationship Documentation (excluding cleared swaps
records). This hour burden arises from the proposed obligation that
swap dealers and major swap participants execute and maintain swap
trading relationship documentation.
Number of registrants: 300.
Frequency of collection: At least once per counterparty.
Estimated number of annual responses per registrant: 540 [one set
of agreements per counterparty].
Estimated aggregate number of annual responses: 162,000 [300
registrants x 540 counterparties].
Estimated annual hour burden per registrant: 5,400 [540
counterparties x 10 hours per counterparty].
Estimated aggregate annual hour burden: 1,620,000 [300 registrants
x 5,400 hours per registrant].
Cleared Swap Recordkeeping. This hourly burden arises from the
proposed requirement that swap dealers and major swap participants make
and maintain records of specified information related to each swap
accepted for clearing by a derivatives clearing organization.
Number of registrants: 300.
Frequency of collection: Daily.
Estimated number of annual responses per registrant: 252 [252
trading days per year].\38\
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\38\ Consistent with the Commission's proposed regulations that
would require swap dealers and major swap participants to compile
and maintain certain transaction records (including daily trading
records), the Commission has estimated the hour burden associated
with the cleared swap recordkeeping requirement by approximating the
number of hours per trading day that an employee of a swap dealer or
major swap participant likely would spend compiling and retaining
the relevant records. See Reporting, Recordkeeping, and Daily
Trading Record Requirements for Swap Dealers and Major Swap
Participants, 75 FR 76666, Dec. 9, 2010.
---------------------------------------------------------------------------
Estimated aggregate number of annual responses: 75,600 [300
registrants x 252 trading days].
Estimated annual hour burden per registrant: 504 [252 trading days
x 2 hours per trading day].
Estimated aggregate hour burden: 151,200 [300 registrants x 504
hours].
Audit Recordkeeping. This hourly burden arises from the proposed
requirement that swap dealers and major swap participants make and
maintain records of the results of their annual internal or external
audits to examine for compliance with the requirements of the proposed
regulations.
Number of registrants: 300.
Frequency of collection: Annually.
Estimated number of annual responses per registrant: 1.
Estimated aggregate number of annual responses: 300 [300
registrants x 1].
Estimated annual hour burden per registrant: 4.
[[Page 6724]]
Estimated aggregate annual hour burden: 1,200 [300 registrants x 4
hours].
Valuation Dispute Reporting. This hourly burden arises from the
proposed requirement that swap dealers and major swap participants
submit reports of certain unresolved valuation disputes.
Number of registrants: 300.
Frequency of collection: As applicable.
Estimated number of annual responses per registrant: 240.
Estimated aggregate number of annual responses: 72,000 [300
registrants x 240 responses].
Estimated annual hour burden per registrant: 24.
Estimated aggregate annual hour burden: 7,200 [300 registrants x 24
hours].
End user Exception Documentation Recordkeeping. This hourly burden
arises from the proposed requirement that swap dealers and major swap
participants make and maintain records of its end user exception
documentation. x
Number of registrants: 300.
Frequency of collection: Once per applicable counterparty.
Estimated number of annual responses per registrant: 220.\39\
---------------------------------------------------------------------------
\39\ The Commission estimates that half of the counterparties
that are not swap dealers or major swap participants may claim the
end user exception on an annual basis.
---------------------------------------------------------------------------
Estimated aggregate number of annual responses: 66,000 [300
registrants x 220 responses].
Estimated annual hour burden per registrant: 220 [220 responses x 1
hour per response].
Estimated aggregate annual hour burden: 66,000 [300 registrants x
220 responses].
In addition to the per hour burden discussed above, the Commission
anticipates that swap dealers and major swap participants may incur
certain start-up costs in connection with the proposed recordkeeping
obligations. Such costs would include the expenditures related to
developing and installing new recordkeeping technology or re-
programming or updating existing recordkeeping technology and systems
to enable the swap dealer or major swap participant to collect,
maintain, and re-produce any newly required records. The Commission
believes that swap dealers and major swap participants generally could
adapt their current infrastructure to accommodate the new or amended
technology and thus, no significant infrastructure expenditures would
be needed. The Commission estimates the programming burden hours
associated with technology improvements to be 40 hours.
According to recent Bureau of Labor Statistics findings, the mean
hourly wages of computer programmers under occupation code 15-1021 and
computer software engineers under program codes 15-1031 and 1032 are
between $34.10 and $44.94.\40\ Because swap dealers and major swap
participants generally will be large entities that may engage employees
with wages above the mean, the Commission has conservatively chosen to
use a mean hourly programming wage of $60 per hour. Accordingly, the
start-up burden associated with the required technological improvements
would be $2,400 [$60 x 40 hours per affected registrant] or $720,000 in
the aggregate.
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\40\ http://www.bls.gov/oes/current/oes113031.htm.
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2. Information Collection Comments
The Commission invites the public and other Federal agencies to
comment on any aspect of the recordkeeping burdens discussed above. The
Commission specifically requests comment on the variables used in the
above-referenced hourly burden calculations. For example, the
Commission requests comment on the following:
What is the total number of swap dealers and major swap
participants in the marketplace?
What is the average number of counterparties that a swap
dealer or major swap participant is likely to have?
What percentage of those counterparties are other swap
dealers or major swap participants?
What percentage of those counterparties is likely to meet
the statutory qualifications required for an exception from the
mandatory clearing requirement, as defined in section 2h(7) of the CEA
and Sec. 39.6?
What is the average size (number of swaps) of a portfolio
that a swap dealer or major swap participant is likely to have with a
particular type of counterparty?
To what extent do swap dealers and major swap participants
currently enter into agreements that would satisfy the requirements of
proposed Sec. 23.504?
To what extent would swap dealers and major swap
participants be able to standardize the swap trading relationship
documentation required by Sec. 23.504?
To what extent would swap dealers and major swap
participants be required to utilize the services of outside counsel in
negotiating and drafting the swap trading relationship documentation
and valuation and termination rights agreements that would be required
by proposed Sec. 23.504?
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits
comments in order to: (i) Evaluate whether the proposed collection of
information is necessary for the proper performance of the functions of
the Commission, including whether the information will have practical
utility; (ii) evaluate the accuracy of the Commission's estimate of the
burden of the proposed collection of information; (iii) determine
whether there are ways to enhance the quality, utility, and clarity of
the information to be collected; and (iv) minimize the burden of the
collection of information on those who are to respond, including
through the use of automated collection techniques or other forms of
information technology.
Comments may be submitted directly to the Office of Information and
Regulatory Affairs, by fax at (202) 395-6566 or by e-mail at
OIRAsubmissions@omb.eop.gov. Please provide the Commission with a copy
of submitted comments so that all comments can be summarized and
addressed in the final rule preamble. Refer to the Addresses section of
this notice of proposed rulemaking for comment submission instructions
to the Commission.
A copy of the supporting statements for the collections of
information discussed above may be obtained by visiting RegInfo.gov.
OMB is required to make a decision concerning the collection of
information between 30 and 60 days after publication of this document
in the Federal Register. Therefore, a comment is best assured of having
its full effect if OMB receives it within 30 days of publication.
C. Cost-Benefit Analysis
Section 15(a) of the CEA \41\ requires the Commission to consider
the costs and benefits of its actions before issuing a rulemaking under
the CEA. By its terms, section 15(a) does not require the Commission to
quantify the costs and benefits of a new regulation or to determine
whether the benefits of the rule outweigh its costs; rather, it
requires that the Commission ``consider'' the costs and benefits of its
actions.
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\41\ 7 U.S.C. 19(a).
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Section 15(a) further specifies that costs and benefits of a
proposed rulemaking shall be evaluated in light of five broad areas of
market and public concern: (1) Protection of market participants and
the public; (2) efficiency, competitiveness, and
[[Page 6725]]
financial integrity of futures markets; (3) price discovery; (4) sound
risk management practices; and (5) other public interest
considerations. The Commission may, in its discretion, give greater
weight to any one of the five enumerated considerations and could, in
its discretion, determine that, notwithstanding its costs, a particular
regulation was necessary or appropriate to protect the public interest
or to effectuate any of the provisions or to accomplish any of the
purposes of the CEA.
Summary of proposed requirements. The proposed regulations would
implement new section 4s(i) of the CEA, which was added by section 731
of the Dodd-Frank Act. The proposed regulations would establish certain
documentation requirements applicable to swap dealers and major swap
participants and related recordkeeping and reporting obligations.
Costs. With respect to costs, the Commission has determined that
the cost that would be borne by swap dealers and major swap
participants to institute the policies and procedures, make and
maintain the records, and perform the event-based reporting necessary
to satisfy the new regulatory requirements are far outweighed by the
benefits that would accrue to the financial system as a whole as a
result of the implementation of the rules.
For example, memorializing the specific terms of the swap trading
relationship and swap transactions between counterparties is prudent
business practice and, in fact, many market participants already use
standardized documentation. Accordingly, it is believed that many, if
not most, swap dealers and major swap participants currently execute
and maintain trading relationship documentation of the type required by
proposed Sec. 23.504 in the ordinary course of their businesses,
including documentation that contains several of the terms that would
be required by the proposed rules. Thus, the hour and dollar burdens
associated with the swap trading relationship documentation
requirements may be limited to amending existing documentation to
expressly include any additional terms required by the proposed rules.
The Commission recognizes that swap dealers and major swap
participants may face certain costs, such as the legal fees associated
with negotiating and drafting the required documentation modifications,
as they and their counterparties come into compliance with the new
regulations. However, the Commission also believes that, to the extent
that any substantial amendments or additions to existing documentation
would be needed, such revisions would likely apply to multiple
counterparties, thereby reducing the per counterparty burden imposed
upon swap dealers and major swap participants. The Commission further
expects the per hour and dollar burdens to be incurred predominantly in
the first year or two after the effective date of the final
regulations. Once a swap dealer or major swap participant has changed
its pre-existing documentation with each of its counterparties to
comply with the proposed rules, there likely will be little need to
further modify such documentation on an ongoing basis. In addition, the
Commission anticipates that standardized swap trading relationship
documentation will develop quickly and progressively within the
industry, dramatically reducing the cost to individual participants.
The Commission expects the per hour burden associated with the
remaining requirements of Sec. Sec. 23.504 and 23.505 to be relatively
minimal. The same is true of the sole reporting requirement contained
in Sec. 23.504. Such reporting is event-based and the Commission
expects that instances of valuation disputes will decrease over time as
valuation agreements are committed to writing pursuant to the proposed
regulations.
Finally, the Commission notes that most swap dealers and major swap
participants have back office personnel, operational systems, and
resources capable of maintaining the required records, performing the
periodic reporting, and otherwise adjusting to the new regulatory
framework without material diversion of resources away from commercial
operations or substantial capital investment.
Benefits. With respect to benefits, the Commission has determined
that the proposed regulations that would require a swap dealer or major
swap participant to document its swap trading relationship with each of
its counterparties will promote standardization of documents and
transactions, facilitate central trading and clearing, promote legal
and financial certainty, decrease the number and scope of counterparty
disputes, promote the timely resolution of disputes when they occur,
and enhance the parties' abilities to engage in risk-reducing
activities and will result in reduced risk, increased transparency, and
greater liquidity and market integrity in the swaps marketplace.
Moreover, the cleared swap records that are required to be preserved
and the mandatory reporting of unresolved valuation disputes will be
valuable tools in the Commission's oversight of the affected
registrants. Therefore, the Commission believes it is prudent to
prescribe these proposed regulations.
Public Comment. The Commission invites public comment on its cost-
benefit considerations. Commentators are also invited to submit any
data or other information that they may have quantifying or qualifying
the costs and benefits of the proposed rules with their comment
letters.
List of Subjects in 17 CFR Part 23
Antitrust, Commodity futures, Conduct standards, Conflict of
Interests, Major swap participants, Reporting and recordkeeping, Swap
dealers, Swaps.
For the reasons stated in this release, the Commission proposes to
amend 17 CFR part 23, as proposed to be added in FR Doc. 2010-29024,
published in the Federal Register on November 23, 2010 (75 FR 71379),
and as proposed to be amended in FR Doc. 2010-32264, published in the
Federal Register on December 28, 2010 (75 FR 81519) as follows:
PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS
1. The authority citation for part 23 is revised to read as
follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,
9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.
2. Revise the table of contents for part 23, subpart I to read as
follows:
Subpart I--Swap Documentation
Sec.
23.500 Definitions.
23.501 Swap confirmation.
23.502 Portfolio reconciliation.
23.503 Portfolio compression.
23.504 Swap trading relationship documentation.
23.505 End user exception documentation.
3. Add Sec. 23.504 and Sec. 23.505 to part 23, subpart I, to read
as follows:
Sec. 23.504 Swap trading relationship documentation.
(a) Policies and procedures. Each swap dealer and major swap
participant shall establish, maintain, and enforce written policies and
procedures reasonably designed to ensure that, prior to or
contemporaneously with entering into a swap transaction with any
counterparty, other than a derivatives clearing organization, the swap
dealer or major swap participant executes written swap trading
relationship documentation with its counterparty that complies with the
requirements of this section. The
[[Page 6726]]
policies and procedures shall be approved in writing by senior
management of the swap dealer and major swap participant, and a record
of the approval shall be retained.
(b) Swap trading relationship documentation. (1) The swap trading
relationship documentation shall be in writing and shall include all
terms governing the trading relationship between the swap dealer or
major swap participant and its counterparty, including, without
limitation, terms addressing payment obligations, netting of payments,
events of default or other termination events, calculation and netting
of obligations upon termination, transfer of rights and obligations,
governing law, valuation, and dispute resolution procedures.
(2) The swap trading relationship documentation shall include all
confirmations of swap transactions under Sec. 23.501.
(3) The swap trading relationship documentation shall include
credit support arrangements, which shall contain, in accordance with
applicable requirements under Commission regulations or regulations
adopted by prudential regulators and without limitation, the following:
(i) Initial and variation margin requirements;
(ii) Types of assets that may be used as margin and asset valuation
haircuts;
(iii) Investment and rehypothecation terms for assets used as
margin for uncleared swaps; and
(iv) Custodial arrangements for margin assets, including whether
margin assets are to be segregated with an independent third party, in
accordance with Sec. 23.601(e).
(4) The swap trading relationship documentation shall include
written documentation in which the parties agree on the methods,
procedures, rules, and inputs for determining the value of each swap at
any time from execution to the termination, maturity, or expiration of
such swap. To the maximum extent practicable, the valuation of each
swap shall be based on objective criteria, such as recently-executed
transactions or valuations provided by independent third parties such
as derivatives clearing organizations.
(i) Such methods, procedures, rules, and inputs shall be agreed for
each swap prior to or contemporaneously with execution and shall be
stated with the specificity necessary to allow the swap dealer, major
swap participant, counterparty, the Commission, and any applicable
prudential regulator to determine the value of the swap independently
in a substantially comparable manner.
(ii) Such methods, procedures, and rules shall include alternative
methods for determining the value of the swap in the event of the
unavailability or other failure of any input required to value the
swap, provided that the alternative methods for valuing the swap comply
with the requirements of this section.
(iii) Provided that the requirements of this paragraph, including
the independent valuation requirement of paragraph (b)(4)(i) of this
section, are satisfied, a swap dealer or major swap participant is not
required to disclose to the counterparty confidential, proprietary
information about any model it may use internally to value a swap for
its own purposes.
(5) [Reserved]
(6) Upon acceptance of a swap by a derivatives clearing
organization, the swap trading relationship documentation shall include
a record of the following information:
(i) The date and time the swap was accepted for clearing;
(ii) The name of the derivatives clearing organization;
(iii) The name of the clearing member clearing for the swap dealer
or major swap participant;
(iv) The name of the clearing member clearing for the counterparty,
if known; and
(v) A statement that in accordance with the rules of the
derivatives clearing organization:
(A) The original swap is extinguished;
(B) The original swap is replaced by equal and opposite swaps
between clearing members and the derivatives clearing organization;
(C) All terms of the cleared swap conform to templates established
under the derivatives clearing organization's rules; and
(D) All terms of the swap, as carried on the books of the clearing
member, conform to the terms of the cleared swap established under the
derivatives clearing organization's rules.
(c) Audit of swap trading relationship documentation. At least once
during each calendar year, each swap dealer and major swap participant
shall have an independent internal or external auditor examine no less
than 5% of the swap trading relationship documentation required by this
section created during the previous twelve month period to ensure
compliance with Commission regulations and the written policies and
procedures established pursuant to this section. A record of the
results of each audit shall be retained.
(d) Recordkeeping. Each swap dealer and major swap participant
shall maintain all documents required to be created pursuant to this
section in accordance with Sec. 1.31 of this chapter and shall make
them available promptly upon request to any representative of the
Commission or any applicable prudential regulator, or with regard to
swaps defined in section 1a(47)(A)(v) of the Act, to any representative
of the Commission, the Securities and Exchange Commission, or any
applicable prudential regulator.
(e) Reporting. Each swap dealer and major swap participant shall
promptly notify the Commission and any applicable prudential regulator,
or with regard to swaps defined in section 1a(47)(A)(v) of the Act, the
Commission, the Securities and Exchange Commission, and any applicable
prudential regulator, of any swap valuation dispute not resolved
within:
(1) One (1) business day, if the dispute is with a counterparty
that is a swap dealer or major swap participant; or
(2) Five (5) business days, if the dispute is with a counterparty
that is not a swap dealer or major swap participant.
Sec. 23.505 End user exception documentation.
(a) For swaps excepted from a mandatory clearing requirement. Each
swap dealer and major swap participant shall obtain documentation
sufficient to provide a reasonable basis on which to believe that its
counterparty meets the statutory conditions required for an exception
from a mandatory clearing requirement, as defined in section 2h(7) of
the Act and Sec. 39.6 of this chapter. Such documentation shall
include:
(1) The identity of the counterparty;
(2) That the counterparty has elected not to clear a particular
swap under section 2h(7) of the Act and Sec. 39.6 of this chapter;
(3) That the counterparty is a non-financial entity, as defined in
section 2h(7)(C) of the Act;
(4) That the counterparty is hedging or mitigating a commercial
risk; and
(5) That the counterparty generally meets its financial obligations
associated with non-cleared swaps.
(b) Recordkeeping. Each swap dealer and major swap participant
shall maintain all documents required to be obtained pursuant to this
section in accordance with Sec. 1.31 of this chapter and shall make
them available promptly upon request to any representative of the
Commission or any applicable prudential regulator, or with regard to
swaps defined in section 1a(47)(A)(v) of
[[Page 6727]]
the Act, to any representative of the Commission, the Securities and
Exchange Commission, or any applicable prudential regulator.
Issued in Washington, DC on January 13, 2011 by the Commission.
David A. Stawick,
Secretary of the Commission.
Appendices to Swap Trading Relationship Documentation Requirements for
Swap Dealers and Major Swap Participants--Commissioners Voting Summary
and Statements of Commissioners
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendix 1--Commissioners Voting Summary
On this matter, Chairman Gensler and Commissioners Dunn,
Sommers, Chilton and O'Malia voted in the affirmative; no
Commissioner voted in the negative.
Appendix 2--Statement of Chairman Gary Gensler
I support the proposed rulemaking that establishes swap trading
relationship documentation requirements for swap dealers and major
swap participants. The proposed regulations are consistent with the
express mandate of the Dodd-Frank Act to prescribe standards for the
timely and accurate confirmation, processing, netting, documentation
and valuation of swap transactions. One of the primary goals of the
Dodd-Frank Act was to establish a comprehensive regulatory framework
that would reduce risk, increase transparency and promote market
integrity within the financial system. The proposed regulations
accomplish this objective by establishing procedures that will
promote legal certainty regarding terms of swap transactions, early
resolutions of valuation disputes, enhanced understanding of one
counterparty's risk exposure to another, reduced operational risk
and increased operational efficiency. One of the key chapters from
the 2008 financial crisis was when large financial players,
including AIG, had valuation disputes and other problems regarding
documentation standards. These rules will directly address many of
these issues, highlighting issues for senior management and
regulators earlier and lowering risk to the public.
Appendix 3--Commissioner Scott D. O'Malia
I respectfully dissent from the Commission's decision to propose
requirements regarding the inclusion of Title II of the Dodd-Frank
Act (Title II) and the Federal Deposit Insurance Act (FDIA) in the
swap documentation used by swap dealers (Dealers) and major swap
participants (MSP). This proposal would require Dealers and MSP to
include a provision in their swap documentation which will prevent
their counterparties from exercising certain private, contractual
rights in the event that a swap becomes subject to the processes of
either Title II or FDIA. In particular, the proposal requires
counterparties to explicitly consent to the resolution processes set
forth in Title II or FDIA, which includes a one-day stay on the
termination, liquidation or netting of swaps with a ``covered
financial company'' as that term is defined under Title II. Title II
also provides the Federal Deposit Insurance Company (FDIC) with an
unchecked authority to repudiate contracts and preference which
creditors receive payments. Finally, the proposal asks whether swap
agreements which contain cross default provisions should also
subject counterparty affiliates to a ``covered financial company''
designation or treat them as an insured depository institution under
FDIA.
The Commission's proposal relies on its authorities in Title VII
of the Dodd-Frank Act regarding swap documentation. Asking parties
to agree upon and include valuation language in their swap
agreements under this authority is one thing, but dictating that one
party forego its legal contractual rights simply because its
counterparty becomes subject to an overly vague and far reaching
statute intended to address ``systemic risk to the financial
system'' is quite another. If the FDIC authority to require this
provision under Title II was clear, then there would be no need for
the Commission to prop up the banking regulator's ability to
exercise its resolution authority. In its best attempt to justify
the proposal, the Commission claims that it is merely trying to put
counterparties on notice of the already existing requirements of
Title II and FDIA, but neither the proposal regarding an explicit
consent to transfer, nor the discussion regarding affiliates and
cross default agreements is a reflection of language already
included in Title II or FDIA. At the very least, if the CFTC had any
specific role under Title II or FDIA, then it would be clear how we
would inform the treatment of the market participants that we
regulate and their transactions in the case of a default. We do not.
By raising these objections, I hope that market participants
will become fully aware of the legal regime that they will be
subject to by virtue of entering into a swap agreement. I don't
believe it is in our best interest to adopt seemingly redundant and
unnecessary requirements into our regulations or to adopt
requirements under the guise of our Title VII authorities that
clearly exceeds the already broad statutory authority Congress
decided to provide the FDIC under both Title II and FDIA. As a
result, I cannot support this proposal.
[FR Doc. 2011-2643 Filed 2-7-11; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: February 8, 2011
See Also:
