2010-29831

FR Doc 2010-29831[Federal Register: December 3, 2010 (Volume 75, Number 232)]

[Proposed Rules]

[Page 75432-75439]

From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[DOCID:fr03de10-14]

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Proposed Rules

Federal Register

________________________________________________________________________

This section of the FEDERAL REGISTER contains notices to the public of

the proposed issuance of rules and regulations. The purpose of these

notices is to give interested persons an opportunity to participate in

the rule making prior to the adoption of the final rules.

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[[Page 75432]]

COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 23 and 190

RIN 3038-AD28

Protection of Collateral of Counterparties to Uncleared Swaps;

Treatment of Securities in a Portfolio Margining Account in a Commodity

Broker Bankruptcy

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (the ``Commission'')

hereby proposes rules to implement new statutory provisions enacted by

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection

Act (the ``Dodd-Frank Act''). Specifically, the proposed rules

contained herein impose requirements on swap dealers (``SDs'') and

major swap participants (``MSPs'') with respect to the treatment of

collateral posted by their counterparties to margin, guarantee, or

secure uncleared swaps. Additionally, such proposed rules ensure that,

for purposes of subchapter IV of chapter 7 of the Bankruptcy Code:

Securities held in a portfolio margining account that is a futures

account constitute ``customer property''; and owners of such account

constitute ``customers''.

DATES: Submit comments on or before February 1, 2011.

ADDRESSES: You may submit comments, identified by RIN number 3038-AD28,

by any of the following methods:

Agency Web site, via its Comments Online process: 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 by 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 you believe is exempt from disclosure under the

Freedom of Information Act, a petition for confidential treatment of

the exempt information may be submitted according to the procedures

established in CFTC Regulation 145.9, 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: Robert B. Wasserman, Associate

Director, Division of Clearing and Intermediary Oversight (DCIO), at

202-418-5092 or rwasserman@cftc.gov; Martin White, Assistant General

Counsel, at 202-418-5129 or mwhite@cftc.gov; Nancy Liao Schnabel,

Special Counsel, DCIO, at 202-418-5344 or nschnabel@cftc.gov; in each

case, also at the 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 new regulatory framework for

swaps and certain security-based swaps. The legislation was enacted to

reduce risk, increase transparency, and promote market integrity within

the financial system by, among other things: (i) Providing for the

registration and comprehensive regulation of SDs and MSPs;\4\ (ii)

imposing mandatory clearing and trade execution requirements on

clearable swap contracts; (iii) creating robust recordkeeping and real-

time reporting regimes; and (iv) enhancing the rulemaking and

enforcement authorities of the Commission with respect to, among

others, all registered entities and intermediaries subject to the

oversight of the Commission.

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\1\ See Dodd-Frank 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.

\4\ In this release, the terms ``swap dealer'' and ``major swap

participant'' shall have the meanings set forth in Section 721(a) of

the Dodd-Frank Act, which added Sections 1a(49) and (33) of the CEA.

However, Section 721(c) of the Dodd-Frank Act directs the Commission

to promulgate rules to further define, among other terms, ``swap

dealer'' and ``major swap participant.'' The Commission anticipates

that such rulemaking will be completed by the statutory deadline of

July 15, 2011. See, e.g., http://www.cftc.gov/Lawregulation/

Otcderivatives/OTC_2_Definitions.Html.

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Section 724(c) of the Dodd-Frank Act amends the CEA to add, as

section 4s(l) thereof, provisions concerning the rights of

counterparties to SDs and MSPs with respect to the treatment of margin

for uncleared swaps. As discussed further in Part II of this preamble,

these changes are implemented in proposed new Subpart L to Part 23 of

Title 17, Sec. Sec. 23.600 through 23.609.

Section 713(c) of the Dodd-Frank Act amends the CEA to add, as

section 20(c) thereof, a provision that requires the Commission to

exercise its authority to clarify the legal status, in the event of a

commodity broker \5\ bankruptcy, of (i)

[[Page 75433]]

securities in a portfolio margining account held as a futures account,

and (ii) an owner of such account. As discussed further in Part III of

this preamble, these changes are implemented in proposed amendments to

Sec. Sec. 190.01(k) and 190.08(a)(1)(i).

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\5\ Commission regulation (``Regulation'') 190.01(f) defines

``commodity broker'' as ``any person who is registered or required

to register as a futures commission merchant under the Commodity

Exchange Act including a person registered as such under Parts 32

and 33 of this chapter, and a `commodity options dealer,' `foreign

futures commission merchant,' `clearing organization,' and `leverage

transaction merchant' with respect to which there is a `customer' as

those terms are defined in this section, but excluding a person

registered as a futures commission merchant under section 4f(a)(2)

of the Commodity Exchange Act.'' Pursuant to the Bankruptcy Code, 11

U.S.C. 101 et seq., if a commodity broker experiences bankruptcy, it

must be liquidated in accordance with chapter 7, subchapter IV

(``Subchapter IV''). In the event of such liquidation, Subchapter IV

provides certain protections for collateral that customers deposit

with the commodity broker. Pursuant to its authority under Section

20 of the CEA, the Commission has interpreted Subchapter IV in

promulgating Regulation Part 190.

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Part IV below describes proposed technical amendments to Regulation

part 190 that are not required by the Dodd-Frank Act, but rather

address the changes to 11 U.S.C. 764(b) implemented by Public Law 111-

16, the Statutory Time-Periods Technical Amendments Act of 2009.

Specifically, such act changed the time period (i.e., from five (5)

business days to seven (7) calendar days) during which a transfer of

``commodity contracts'' \6\ and ``customer property'' \7\ becomes not

avoidable by the trustee in a commodity broker bankruptcy.

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\6\ Section 761(4) of the Bankruptcy Code, 11 U.S.C. 761(4),

defines ``commodity contract.''

\7\ Regulation 190.01(n) defines ``customer property'' as ``the

property subject to pro rata distribution in a commodity broker

bankruptcy which is entitled to the priority set forth in Section

766(h) of the Bankruptcy Code and includes certain cash, securities,

and other property as set forth in Sec. 190.08(a).''

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The Commission requests comment on all aspects of this release.

II. Segregation of Margin for SD and MSP Counterparties With Respect to

Uncleared Swaps

New Section 4s(l) of the CEA, enacted by Section 724(c) of the

Dodd-Frank Act, sets forth certain requirements concerning the rights

of counterparties of SDs and MSPs with respect to the segregation of

collateral supplied for margining, guaranteeing, or securing uncleared

swaps.\8\ Such requirements \9\ include:

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\8\ It should be noted that this rulemaking addresses

segregation of margin, and does not address what amount of margin,

if any, a counterparty is required to post.

\9\ Such requirements do not apply to ``variation margin

payments.'' Section 724(c) of the Dodd-Frank Act does not set forth

a definition for such term. The Commission has proposed such a

definition below.

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An SD or MSP must notify each counterparty at the

beginning of a swap transaction that the counterparty has the right to

require segregation of the funds or other property that it supplies to

margin, guarantee, or secure its obligations; and

At the request of the counterparty, the SD or MSP must

segregate such funds or other property with an independent third party.

To implement the statute, the Commission proposes new subpart L to

part 23 of title 17.

A. Regulation 23.600: Definitions

The Commission proposes to define ``segregate'' according to its

commonly-understood meaning: To keep two or more items in separate

accounts, and to avoid combining them in the same transfer between two

accounts.

The Commission has never before defined ``initial margin'' (for

which a counterparty has the right to segregation pursuant to CEA

Section 4s(l)) or ``variation margin'' (for which a counterparty does

not have such a right) in a regulation. The distinction between

``initial margin'' and ``variation margin'' established in proposed

Sec. 23.600 is temporally-based:

1. Initial Margin

``Initial margin'' is defined as an amount calculated based on

anticipated exposure to future changes in the value of a swap.

2. Variation Margin

``Variation margin'' is defined as an amount calculated to cover

the current exposure arising from changes in the market value of the

position since the trade was executed or the previous time the position

was marked to market.

The Commission may also consider, in a future rulemaking, placing

an expanded version of these definitions (to include initial and

variation margin with respect to futures and options on futures) in

Part 1, and incorporating those definitions by reference here.

The Commission seeks comment on the appropriateness of these

definitions in this context, and on the potential use of such expanded

definitions.

B. Regulation 23.601: Notification of Right to Segregation

1. Required Notification

Proposed Regulation 23.601(a) incorporates the statutory

requirement of Section 4s(l)(1)(A) of the CEA that a SD or MSP must

notify each counterparty with respect to an uncleared swap that the

counterparty has the right to require that initial margin posted by

that counterparty be segregated in accordance with these rules. The

Commission interprets the language of Section 4s(l)(1)(A) of the CEA

that the counterparty must be ``notified * * * [of a] right to require

segregation'' to mean that this right can be grasped or renounced, at

the election of the counterparty.\10\ Congress's description as a

``right'' of what would otherwise be a simple matter for commercial

negotiation suggests that this decision is an important one, with a

certain degree of favor given to an affirmative election.

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\10\ See also CEA Section 4s(l)(4) (referring to cases where the

counterparty ``does not choose to require segregation'' of margin).

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The Commission has not proposed any particular disclosure

requirements with respect to this notification. Should the SD or MSP be

required to disclose the cost of segregation, whether the cost of fees

to be paid to the custodian (if the SD or MSP is aware of the amount of

such fees), or differences in the terms of the swap that the SD or MSP

is willing to offer to the counterparty (e.g., differences in the fixed

interest rate for an interest rate swap) if the counterparty elects or

renounces the right to segregation?

2. Limitation of Right--Variation Margin

Proposed Regulation 23.601(b) incorporates the limitation in

Section 4s(l)(2)(B)(i) of the CEA that the right to segregation does

not apply to variation margin.

3. Counterparty Notification

The Commission regards the inclusion of the term ``right to require

segregation'' as requiring that this decision is taken at an

appropriate level of the counterparty organization. Proposed Regulation

23.601(c) requires that such notification be made to certain senior

decisionmakers, in descending order of preference. Notification is made

to the Chief Risk Officer, or the Chief Executive Officer, or to the

highest level decisionmaker for the counterparty. The Commission seeks

comment as to whether this list of decision-makers is appropriate, in

particular, whether it is appropriate for ``Special Entities'' as such

term is defined in Section 4s(h)(1)(C) of the CEA (e.g. a

municipality).

4. Required Confirmation

Proposed Sec. 23.601(d) requires that the SD or MSP must obtain

from the counterparty confirmation of receipt of such notification by

the specified decisionmaker, and the election to require segregation or

not, before the terms of the swap are confirmed. The SD or MSP must

maintain records of such confirmation and election as business records

in accordance with Regulation 1.31.

5. Limitation of Responsibility To Notify

The requirement in Section 4s(l)(1)(A) of the CEA that notification

be made ``at

[[Page 75434]]

the beginning of a swap transaction'' could be read to require such

notification at the beginning of each swap transaction. Such repetitive

notification could, however, be redundant. On the other hand, the

importance of the decision discussed above suggests that some periodic

reconsideration might be appropriate. Proposed Sec. 23.601(e) seeks to

balance these considerations by providing that notification of a

particular counterparty by a particular SD or MSP need only be made

once in any calendar year.

6. Power To Change Election With Regard to Segregation

Proposed Sec. 23.601(f) makes clear that a counterparty's election

to require segregation of initial margin, or not to require such

segregation, may be changed at the discretion of the counterparty upon

delivery of written notice, and shall be applicable with respect to

swaps entered into between the parties after such delivery.

The Commission seeks comments on the issues referred to in this

section I(B).

C. Regulation 23.602: Requirements for Segregated Collateral

1. Independent Custodian and Separate Account

Pursuant to Section 4s(l)(3) of the CEA, proposed Regulation

23.602(a)(1) requires initial margin segregated in accordance with an

election under proposed Regulation 23.601 to be segregated with a

custodian that is independent of both the SD or MSP and the

counterparty. Proposed Sec. 23.602(a)(2) requires the initial margin

to be held in an account designated as a segregated account for and on

behalf of the counterparty. While, as noted above, the right to

segregation does not apply to variation margin, the regulation provides

the swap dealer or major swap participant and the counterparty may

agree that variation margin may also be held in such an account.

Proposed Sec. 23.602(a)(1) does not require that the initial

margin be held in an account that is independent of any affiliate of

the SD or MSP or the counterparty, in order to permit parties to engage

in swaps transactions with affiliates of their usual depositories.

Comment is requested as to whether this approach is appropriate.

Moreover, the proposed regulation does not specify which party (the

counterparty, or the SD or MSP) has the right to designate a custodian,

thus, by implication, leaving the choice to the agreement of the

parties. Is this approach appropriate? Should either party be entitled

to choose a custodian? If so, what restrictions, if any, should be

placed on that choice?

2. Requirements for Custody Agreement

Proposed Sec. 23.602(b) is intended to provide a balance between

the minimum interests of (i) the counterparty posting the initial

margin, (ii) the SD or MSP for whom the initial margin is posted, and

(iii) the custodian, while avoiding the necessity for time-consuming

and expensive interpleader proceedings.\11\ The custody agreement

applicable to such initial margin must be in writing, and must include

the custodian as a party. To ensure that the SD or MSP receives the

initial margin promptly in case it is entitled to do so, and that the

initial margin is returned to the counterparty in case it is entitled

to such return, the agreement must provide that turnover of control

shall be made promptly upon presentation of a statement in writing,

signed by an authorized person under penalty of perjury, that one party

is entitled to such turnover pursuant to an agreement between the

parties. The requirement of a signature under oath or under penalty of

perjury pursuant to 28 U.S.C. 1746 is intended to ensure that such

statement is not lightly made.\12\ Otherwise, withdrawal of collateral

may only be made pursuant to the agreement of both the counterparty and

the SD or MSP, with the non-withdrawing party also receiving immediate

notice of such withdrawal.\13\ The Commission requests comment on

whether the foregoing approach is appropriate, including on whether a

statement under penalty of perjury should be required, and on whether

such a statement, if required, should be required to be based on

personal knowledge.

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\11\ If the SD or MSP and the counterparty were to make

competing claims to the collateral, and if the custodian did not

have a means under the agreement among the parties to decide between

such claims without risking legal liability, the custodian would

likely choose to interplead the collateral.

\12\ See 18 U.S.C. 1621 (Perjury Generally).

\13\ The importance of taking steps to ensure that unauthorized

withdrawals are not made is enhanced by the findings of the

Commission's Division of Clearing and Intermediary Oversight in

Financial and Segregation Interpretation 10-1, 20 FR 24768, 24770

(May 11, 2005) (``Findings by both Commission audit staff and the

SROs of actual releases of customer funds [from third-party

custodial accounts], without the required knowledge or approval of

the FCMs, further demonstrate that the risks associated with third-

party custodial accounts are real and material, not merely

theoretical.'').

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D. Regulation 23.603: Investment of Segregated Collateral

1. Limitations on Investments

Section 4s(l)(2)(B)(ii)(I) of the CEA refers to ``commercial

arrangements regarding the investment of segregated funds or other

property that may only be invested in such investments as the

Commission may permit by rule or regulation.'' Proposed Sec. 22.603(a)

accordingly provides 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, Regulation

Sec. 1.25. That regulation has been designed to permit an appropriate

degree of flexibility in making investments with segregated property,

while safeguarding such property for the parties who have posted it,

and decreasing the credit, market, and liquidity risk exposures of the

parties who are relying on that margin.\14\

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\14\ See generally Investment of Customer Funds and Funds Held

in an Account for Foreign Futures and Foreign Options Transactions,

75 FR 67642, 67652-53 (Nov. 3, 2010) (Release proposing amendments

to Commission Regulation 1.25).

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This regulation governs only investments of initial margin posted

by the counterparty, and does not govern what collateral is eligible to

be posted as such margin.

2. Commercial Arrangements Regarding Investments and Allocations

As required by new Section 4s(l)(2)(B)(ii) of the CEA, proposed

Regulation 22.603(b) provides that the SD or MSP and the counterparty

may enter into any commercial arrangement, in writing, regarding the

investment of segregated initial margin and the related allocation of

gains and losses resulting from such investment.

E. Regulation 23.604: Requirements for Non-Segregated Collateral

Section 4s(l)(4) of the CEA mandates that, if the counterparty does

not choose to require segregation, the SD or MSP shall report to the

counterparty, on a quarterly basis, ``that the back office procedures

of the swap dealer or major swap participant relating to margin and

collateral requirements are in compliance with the agreement of the

counterparties.'' This provision is implemented in proposed Sec.

22.604(a), which requires that such reports be made no later than the

fifteenth (15th) business day of each calendar quarter for the

preceding calendar quarter. Proposed Regulation 22.604(a) makes the

Chief Compliance Officer of the SD or MSP required by Section 4s(k) of

the CEA responsible for such report.

[[Page 75435]]

Proposed Sec. 22.604(b) provides that this obligation shall apply no

earlier than the 90th calendar day after the first swap is transacted

between the counterparties.

F. Effective Date

The Commission requests comment on the appropriate timing of

effectiveness for the final rules for Part 23. Specifically, is six

months after the promulgation of final rules sufficient? If not, please

specify a recommended time period, and explain in detail the reasons

why a shorter period will not be sufficient.

III. Portfolio Margining Accounts

Section 713(c) of the Dodd-Frank Act added Section 20(c) of the

CEA, which specifies that the Commission ``shall exercise its authority

to ensure that securities held in a portfolio margining account carried

as a futures account are customer property and the owners of those

accounts are customers for the purposes of'' Subchapter IV. To

implement this provision, the Commission proposes changes to Sec. Sec.

190.01(k) and 190.08(a)(1)(i).

A. Regulation 190.01(k): Definition of Customer

The ``customer'' portion of this provision is implemented in the

proposed amendment to Sec. 190.01(k), which adds to the definition of

``customer'' the sentence ``To the extent not otherwise included,

customer shall include the owner of a portfolio margining account

carried as a futures account.''

B. Regulation 190.08(a)(1)(i)(F): Definition of Customer Property

The ``customer property'' portion of this provision is implemented

in proposed Sec. 190.08(a)(1)(i)(F), which adds to the definition of

``customer property'' the sentence ``To the extent not otherwise

included, securities held in a portfolio margining account carried as a

futures account.''

C. Effective Date of Proposal

The Commission believes that these rule amendments clarify existing

law, and thus may be made effective immediately upon promulgation of a

final rule. Comment is solicited with respect to these conclusions.

IV. Statutory Time-Periods Technical Amendments Act of 2009

The purpose of this portion of the rulemaking is to implement

Public Law 111-16, the Statutory Time-Periods Technical Amendments Act

of 2009, which (in relevant part) changed the time period in 11 U.S.C.

764(b), discussed below, from five (business) days to seven (calendar)

days. As noted above, these changes are not related to the Dodd-Frank

Act.

Certain sections of the Bankruptcy Code \15\ provide the trustee of

a debtor the power to avoid (i.e., retract) certain transfers of

property from the debtor, whether shortly before or after the

bankruptcy filing, that would otherwise allow a creditor to obtain more

than that creditor would in a bankruptcy distribution. Section 764(b)

of the Bankruptcy Code provides that a trustee may not avoid a transfer

of ``commodity contracts'' \16\ or ``customer property'' \17\ that is

authorized by the Commission, whether before or after the transfer,

before the specified time period after the bankruptcy ``order for

relief.''

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\15\ See 11 U.S.C. 544, 545, 547, 548, 724(a).

\16\ See supra note 6.

\17\ See supra note 7.

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The change in the statutory deadline should be reflected in the

relevant Commission regulations. Moreover, under current business and

legal practice, emergency matters (such as transfers during a

bankruptcy) may be accomplished outside of business hours. Accordingly,

the words ``the close of business on the fourth business day after the

order for relief'' are replaced by the words ``11:59 P.M. on the

seventh day after the order for relief'' in proposed Sec. 190.02(e)(1)

(trustee to use best efforts to effect transfer before this time),

Sec. 190.02(f)(1) (deadline for transfer of dealer option contracts),

Sec. 190.06(g)(2)(i)(A) (prohibition of avoidance of transfers of

which the Commission is notified prior to the transfer pursuant to

Sec. 190.02(a)(2) and does not disapprove), and Sec. 190.06(g)(2)(ii)

(prohibition of avoidance of transfers at the direction of the

Commission).

These amendments would only affect ``commodity brokers ''\18\ in

bankruptcy, and are meant to make Part 190 consistent with amendments

to the Bankruptcy Code. Accordingly, the Commission proposes to make

the foregoing amendments to part 190 effective immediately upon

promulgation of a final rule.

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\18\ See supra note 5.

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V. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (``RFA'') was adopted to address the

concerns that government regulations may have a significant and/or

disproportionate effect on small businesses. To mitigate this risk, the

RFA requires agencies to conduct an initial and final regulatory

flexibility analysis for each rule of general applicability for which

the agency issues a general notice of proposed rulemaking.\19\ These

analyses must describe the impact of the proposed rule on small

entities, including a statement of the objectives and the legal bases

for the rulemaking; an estimate of the number of small entities to be

affected; identification of federal rules that may duplicate, overlap,

or conflict with the proposed rules; and a description of any

significant alternatives to the proposed rule that would minimize any

significant impacts on small entities.\20\

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\19\ 5 U.S.C. 601 et seq.

\20\ 5 U.S.C. 603, 604.

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The proposed Regulations will impose regulatory obligations on SDs

and MSPs. The Commission has already established certain definitions of

``small entities'' to be used in evaluating the impact of its rules on

such small entities in accordance with the RFA.\21\ SDs and MSPs are

new categories of registrant. Accordingly, the Commission has not

previously decided whether such persons are, in fact, small entities

for purposes of the RFA.

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\21\ 47 FR 18618 (Apr. 30, 1982).

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The Commission previously has determined that FCMs should not be

considered to be small entities for purposes of the RFA. The

Commission's determination was based in part upon their obligation to

meet the minimum financial requirements established by the Commission

to enhance the protection of customers' segregated funds and protect

the financial condition of FCMs generally.\22\ Like FCMs, SDs 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 designation entities that engage in a de minimis level

of swaps dealing in connection with transactions with or on behalf of

customers. Accordingly, for purposes of the RFA, the Commission is

hereby determining that SDs not be considered ``small entities'' for

essentially the same reasons that FCMs have previously been determined

not to be small entities.

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\22\ Id. at 18619.

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The Commission has also previously determined that large traders

are not ``small entities'' for RFA purposes.\23\ The Commission

considered the size of a trader's position to be the only appropriate

test for purposes of large trader reporting.\24\ MSPs maintain

substantial positions in swaps, creating substantial counterparty

exposure that

[[Page 75436]]

could have serious adverse effects on the financial stability of the

United States banking system or financial markets. Accordingly, for

purposes of the RFA, the Commission is hereby determining that MSPs not

be considered ``small entities'' for essentially the same reasons that

large traders have previously been determined not to be small entities.

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\23\ Id. at 18620.

\24\ Id.

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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

Provisions of proposed new Regulation Part 23 include new

information disclosure and recordkeeping requirements that constitute

the collection of information within the meaning of the Paperwork

Reduction Act of 1995 (``PRA'').\25\ The Commission therefore is

submitting this proposed collection of information to the Office of

Management and Budget (``OMB'') for review in accordance with 44 U.S.C.

3507(d) and 5 CFR 1320.11. Under the PRA, 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.\26\

The title for this collection of information is ``Disclosure and

Retention of Certain Information Relating to Swaps Customer

Collateral,'' OMB Control Number 3038-NEW. The collection of

information will be mandatory. The information in question will be held

by private entities and, to the extent it involves consumer financial

information, may be protected under Title V of the Gramm-Leach-Bliley

Act as amended by the Dodd-Frank Act.\27\ 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 OMB control number.

This collection of information has not yet been assigned an OMB control

number.

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\25\ 44 U.S.C. 3501 et seq.

\26\ Id.

\27\ See generally 75 FR 66014, Notice of Proposed Rulemaking,

Privacy of Consumer Financial Information; Conforming Amendments

Under Dodd-Frank Act (October 27, 2010).

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1. Information Provided by Reporting Entities

Proposed Sec. 23.601 requires SDs and/or MSPs to notify each

counterparty to an uncleared swap transaction that the counterparty may

require that the counterparty's initial margin be held in a segregated

account. The notification must be provided at the beginning of each

swap transaction. However, notification need only be given once a year

to any particular counterparty. The SD or MSP must provide the

notification to the chief risk officer of the counterparty, if such an

officer exists; and otherwise to another appropriate official of the

counterparty as specified in the regulation. The SD or MSP must obtain

a receipt of the notification and maintain it as a business record. The

purpose of proposed Sec. 23.601 is to implement Section 4s(l)(1)(A) of

the CEA which requires SDs and MSPs in uncleared swaps transactions to

notify counterparties that they have the right to require segregation

of their initial margin deposits.

Proposed Sec. 23.604 requires the chief compliance officer of each

SD or MSP to report on a quarterly basis to each counterparty that does

not choose to require segregation of initial margin on whether or not

the back-office procedures of the SD or MSP relating to margin and

collateral requirements were, at any point during the previous quarter,

not in compliance with the agreement of the counterparties. The purpose

of this requirement is to implement Section 4s(1)(4) of the CEA, which

requires these reports.

The disclosure requirement of proposed Sec. 23.601 is expected to

apply to about 300 entities.\28\ Each such entity will be required to

make the required disclosure once each year to each of its

counterparties in uncleared swaps transactions. It is expected that

each disclosure would require approximately 0.3 hours of staff time by

staff with a salary level of approximately $20 per hour. Because of the

absence of experience under the new requirements of the Dodd-Frank Act,

it is uncertain what average number of uncleared swaps counterparties

will be dealt with annually by swap dealers and major swap

participants. Assuming that each of 14 major swap dealers or major swap

participants makes the required disclosure to 5,000-10,000

counterparties per year, and each of the 286 remaining swap dealers or

major swap participants makes the required disclosure to 200

counterparties per year, there would be a total of approximately

130,000-200,000 disclosures per year, and thus the estimated total

annual burden would be approximately 40,000-60,000 hours and $800,000-

$1,200,000.\29\

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\28\ This estimate is based on the assumption that there will be

about 250 SDs and 50 MSPs.

\29\ The estimate of the number of counterparties receiving

disclosure from each swap dealer or major swap participant takes

into consideration the possibility that a single counterparty may

deal with more than one swap dealer or major swap participant in a

year. Thus, the total number of required disclosures may exceed the

total number of counterparties making use of uncleared swaps subject

to the disclosure requirement.

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The disclosure requirement of proposed Regulation 23.604 will apply

to the same 300 entities as the requirement of proposed Regulation

23.601. Each such entity will be required to make the required

disclosure four times each year to each of its uncleared swaps

counterparties that does not choose to require segregation of capital.

Because there is as yet no experience with the effect of the disclosure

of the right to segregation of collateral and other requirements of the

Dodd-Frank Act, it is uncertain how many uncleared swaps counterparties

will decline such segregation. Assuming that half of all uncleared

swaps counterparties do not choose segregation of collateral, proposed

Sec. 23.604 would require a total of approximately 260,000-400,000

disclosures annually. It is expected that each disclosure would, on

average, require approximately 0.3 hours of staff time by staff with a

salary level of about $30 per hour.\30\ The estimated total annual

burden would be approximately 80,000-120,000 hours and $2,400,000-

$3,500,000.

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\30\ The time and level of personnel required for the disclosure

required by proposed Sec. 23.604 in particular transactions will

depend, to some extent, on the specifics of the agreement of the

parties with regard to the back-office procedures of the SD relating

to margin and collateral requirements, and the extent to which such

agreements with regard to procedures are standardized at a

particular SD. The average burden figure thus reflects a varying

level of burden in particular transactions.

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2. Information Collection Comments

The Commission invites the public and other federal agencies to

comment on any aspect of the reporting and recordkeeping burdens

discussed above. 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.

[[Page 75437]]

Comments may be submitted directly to the OMB 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 release. Consequently, a comment to OMB is most assured of being

fully effective if received by OMB (and the Commission) within 30 days

after publication of this notice of proposed rulemaking.

C. Cost-Benefit Analysis

Section 15(a) of the CEA \31\ 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) of the CEA does not require the

Commission to quantify the costs and benefits of a rule or to determine

whether the benefits of the rulemaking outweigh its costs; rather, it

requires that the Commission ``consider'' the costs and benefits of its

actions. Section 15(a) of the CEA further specifies that the costs and

benefits 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 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 areas

and could in its discretion determine that, notwithstanding its costs,

a particular rule is necessary or appropriate to protect the public

interest or to effectuate any of the provisions or accomplish any of

the purposes of the CEA.

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\31\ 7 U.S.C. 19(a).

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1. Cost-Benefit Analysis of Proposed Part 23

a. Summary of Proposed Requirements

Proposed Part 23 of the Commission's regulations implements the

requirement of newly-enacted Section 4s(l) of the CEA that

counterparties to uncleared swaps transactions with SDs and MSPs be

given the right to require to require segregation of their initial

margin in an account separate from those of the SD or MSP. Proposed

Part 23 also implements the statutory requirement that SDs and MSPs

notify their counterparties of this right. Additionally, amendments are

being made to Part 190 of the Commission's regulations that would

clarify existing law, particularly that (i) ``customer property,'' for

purposes of Regulation Part 190, includes securities held in a

portfolio margining account carried as a futures account, and (ii)

``customers,'' for purposes of Regulation part 190, includes owners of

such a portfolio margining account. Technical amendments also are being

proposed for part 190. These amendments would change the deadline for

certain actions in bankruptcy proceedings to conform with recent

amendments to the Bankruptcy Code, as well as current business and

legal practice.

b. Costs

The costs directly imposed by proposed part 23 and the amendments

to Part 190 relate to the protection of market participants, the risk

management practices of market participants, and the efficiency of

bankruptcy proceedings. If proposed part 23 and the proposed amendments

to Part 190 are not implemented, it will be less likely that a market

participant will be informed of their option to require segregation of

their initial margin from the assets of the SD or MSP opposite which

the market participant will be transacting swaps. The segregation

option is intended to preserve the assets of the market participant in

the event of an insolvency of the SD or MSP.

c. Benefits

The benefits of proposed part 23 relate to the protection of market

participants and the financial integrity of the futures and swap

markets. The proposed regulatons would ensure that segregated accounts

for initial margin are available in all uncleared swaps transactions

involving SDs or MSPs and that counterparties are informed of their

availability. This could result in the increased use of segregated

accounts with resulting reduced risk of loss of collateral by

counterparties in the event of the insolvency of an SD or MSP and

reduced chance of counterparty assets being intentionally or

inadvertently misused. In addition proposed Regulation Part 23 can be

expected to increase the likelihood that any lack of use of segregated

collateral accounts by uncleared swaps counterparties is the result of

genuine choices by counterparties and reduce the likelihood that it is

the result of inertia, market power, or other market imperfections.

The definitions and technical amendments being proposed for Part

190 similarly are intended to relate to the protection of market

participants, as well as to efficiency associated with bankruptcy

proceedings. The definitional changes are expected to increase legal

certainty in some circumstances. The technical amendments are intended

to increase the efficiency with which certain acts in bankruptcy

proceedings of commodity brokers are carried out by insuring

consistency between the Regulations, the Bankruptcy Code, and current

bankruptcy practice.

3. Public Comment

The Commission invites public comment on its cost-benefit

considerations. Commenters are also are invited to submit any data or

other information that they may have quantifying or qualifying the

costs and benefits of the proposal with their comment letters.

List of Subjects

17 CFR Part 23

Consumer protection, Reporting and recordkeeping requirements,

Swaps.

17 CFR Part 190

Bankruptcy, Brokers, Commodity futures, Reporting and recordkeeping

requirements, Swaps.

For the reasons stated in this release, the Commission hereby

proposes to amend 17 CFR part 23 as previously proposed in FR Doc.

2010-29024, published on November 23, 2010 (75 FR 71379) and part 190

as follows:

PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

1. The authority citation for Part 23 continues to read as follows:

Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6c, 6p, 6s, 9, 9a, 13b,

13c, 16a, 18, 19, 21 as amended by Pub. L. 111-203, 124 Stat. 1376

(Jul. 21, 2010).

2. Add subpart L to read as follows:

Subpart L--Segregation of Assets Held as Collateral in Uncleared Swap

Transactions

Sec.

23.600 Definitions.

23.601 Notification of right to segregation.

23.602 Requirements for segregated margin.

23.603 Investment of segregated initial margin.

23.604 Requirements for non-segregated margin.

[[Page 75438]]

Subpart L--Segregation of Assets Held as Collateral in Uncleared

Swap Transactions

Sec. 23.600 Definitions.

``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.

``Margin'' means both Initial Margin and Variation Margin.

``Segregate.'' To segregate two or more items is to keep them in

separate accounts, and to avoid combining them in the same transfer

between two accounts.

``Variation Margin'' means a payment made by a party to a swap to

cover the current exposure arising from changes in the market value of

the position since the trade was executed or the previous time the

position was marked to market.

Sec. 23.601 Notification of right to segregation.

(a) At the beginning of each swap transaction that is not submitted

for clearing, a swap dealer or major swap participant shall notify each

counterparty to such transaction that the counterparty has the right to

require that any Initial Margin the counterparty provides in connection

with such transaction be segregated in accordance with Sec. Sec.

23.602 and 23.603 of this part.

(b) The right referred to in paragraph (a) of this section does not

extend to Variation Margin.

(c) The notification referred to in paragraph (a) of this section

shall be made to the Chief Risk Officer, or, if there is no such

Officer, the Chief Executive Officer, or if none, the highest-level

decisionmaker for the counterparty.

(d) Prior to confirming the terms of any such swap, the swap dealer

or major swap participant shall obtain from the counterparty

confirmation of receipt by the person specified in paragraph (c) of

this section of the notification specified in paragraph (a) of this

section, and an election to require such segregation or not. The swap

dealer or major swap participant shall maintain such confirmation and

such election as business records pursuant to Sec. 1.31 of this

chapter.

(e) Notification pursuant to paragraph (a) of this section to a

particular counterparty by a particular swap dealer or major swap

participant need only be made once in any calendar year.

(f) A counterparty's election to require segregation of initial

margin, or not to require such segregation, may be changed at the

discretion of the counterparty upon written notice delivered to the

swap dealer or major swap participant, which changed election shall be

applicable to all swaps entered into between the parties after such

delivery.

Sec. 23.602 Requirements for segregated margin.

(a) Initial margin that is segregated pursuant to an election under

Sec. 23.601 of this part must be:

(1) Segregated with a custodian that is independent of both the

swap dealer or major swap participant and the counterparty, and

(2) Held in an account segregated, and designated as such, for and

on behalf of the counterparty. Such an account may, if the swap dealer

or major swap participant and the counterparty agree, also hold

Variation Margin.

(b) Any agreement for the segregation of Margin pursuant to this

section shall be in writing, shall include the custodian as a party,

and shall provide that:

(1) Turnover of control of such margin, either to the counterparty

or to the swap dealer or major swap participant, shall be made promptly

upon presentation to the custodian of a statement in writing, made

under oath or under penalty of perjury as specified in 28 U.S.C. 1746,

by an authorized representative of either such party, stating that such

party is entitled to such control pursuant to an agreement between such

parties. The other party shall be immediately notified of such

turnover, and

(2) Any withdrawal of such margin, other than pursuant to paragraph

(b)(1) of this section, shall only be made pursuant to the agreement of

both the counterparty and the swap dealer or major swap participant,

and notification of such withdrawal shall be given immediately to the

non-withdrawing party.

Sec. 23.603 Investment of segregated initial margin.

(a) Initial Margin that is segregated pursuant to an election under

Sec. 23.601 may only be invested consistent with Sec. 1.25 of this

chapter.

(b) Subject to paragraph (a) of this section, the swap dealer or

major swap participant and the counterparty may enter into any

commercial arrangement, in writing, regarding the investment of such

Initial Margin, and the related allocation of gains and losses

resulting from such investment.

Sec. 23.604 Requirements for non-segregated margin.

(a) The chief compliance officer of each swap dealer or major swap

participant shall report to each counterparty that does not choose to

require segregation of Initial Margin pursuant to Sec. 23.601(a), no

later than the fifteenth business day of each calendar quarter, on

whether or not the back office procedures of the swap dealer or major

swap participant relating to margin and collateral requirements were,

at any point during the previous calendar quarter, not in compliance

with the agreement of the counterparties.

(b) The obligation specified in paragraph (a) of this section shall

apply with respect to each counterparty no earlier than the 90th

calendar day after the date on which the first swap is transacted

between the counterparty and the swap dealer or major swap participant.

PART 190--BANKRUPTCY

3. The authority citation for Part 190 continues to read as

follows:

Authority: 7 U.S.C. 1a, 2, 4a, 6c, 6d, 6g, 7a, 12, 19, and 24,

and 11 U.S.C. 362, 546, 548, 556, and 761-766, unless otherwise

noted.

4. Amend Sec. 190.01(k) to read as follows:

Sec. 190.01 Definitions.

* * * * *

(k) Customer shall have the same meaning as that set forth in

section 761(9) of the Bankruptcy Code. To the extent not otherwise

included, customer shall include the owner of a portfolio margining

account carried as a futures account.

* * * * *

Sec. 190.02 [Amended]

5. In Sec. 190.02, amend paragraphs (e)(1) and (f)(1)(i) by

removing the words ``the close of business on the fourth business day

after the order for relief'' and adding, in their place, the words

``11:59 P.M. on the seventh day after the order for relief.''

Sec. 190.06 [Amended]

6. In Sec. 190.06, amend paragraph (g)(2)(i)(A) by removing the

words ``the close of business on the fourth business day after the

entry of the order for relief'' and adding, in their place, the words

``11:59 P.M. on the seventh day after the order for relief''; and amend

paragraph (g)(2)(ii) by removing the words ``the close of business on

the fourth business day after the order for relief'' and adding, in

their place, the words ``11:59 P.M. on the seventh day after the order

for relief''.

7. Amend Sec. 190.08 by redesignating paragraph (a)(1)(i)(F) as

[[Page 75439]]

Sec. 190.08(a)(1)(i)(G), and by adding a new paragraph (a)(1)(i)(F):

Sec. 190.08 Allocation of property and allowance of claims.

* * * * *

(a) * * *

(1) * * *

(i) * * *

(F) To the extent not otherwise included, securities held in a

portfolio margining account carried as a futures account;

* * * * *

Issued in Washington, DC, on November 19, 2010, by the

Commission.

David A. Stawick,

Secretary of the Commission.

Statement of Chairman Gary Gensler

Protection of Collateral of Counterparties to Uncleared Swaps;

Treatment of Securities in a Portfolio Margining Account in a Commodity

Broker Bankruptcy

I support the proposed rulemaking concerning protection of

collateral of counterparties to uncleared swaps. The proposal

includes important protections for end-users when entering into

bilateral or customized swaps. The proposal follows the

Congressional direction that end-users must have a choice to have

any initial margin that they post with a swap dealer to be kept in a

segregated account and with a third party custodian. The proposed

rules would protect market participants while promoting the

financial integrity of the marketplace. The proposal also includes

necessary housekeeping details with regard to the Bankruptcy code.

[FR Doc. 2010-29831 Filed 12-2-10; 8:45 am]

BILLING CODE 6351-01-P

Last Updated: December 3, 2010