2011-24128

Federal Register, Volume 76 Issue 182 (Tuesday, September 20, 2011)[Federal Register Volume 76, Number 182 (Tuesday, September 20, 2011)]

[Proposed Rules]

[Pages 58176-58186]

From the Federal Register Online via the Government Printing Office [www.gpo.gov]

[FR Doc No: 2011-24128]

[[Page 58176]]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 23

RIN 3038-AC96; 3038-AC97

Swap Transaction Compliance and Implementation Schedule: Trading

Documentation and Margining Requirements Under Section 4s of the CEA

AGENCY: Commodity Futures Trading Commission.

ACTION: Further notice of proposed rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)

is proposing regulations that would establish a schedule to phase in

compliance with previously proposed requirements, including the swap

trading relationship documentation requirement under proposed 17 CFR

23.504, 76 FR 6715 (Feb. 8, 2011) and the margin requirements for

uncleared swaps under proposed 17 CFR 23.150 through 23.158, 76 FR

23732 (Apr. 28, 2011). This release is a continuation of those

rulemakings. The proposed schedules would provide relief in the form of

additional time for compliance with these requirements. This relief is

intended to facilitate the transition to the new regulatory regime

established by the Dodd-Frank Act in an orderly manner that does not

unduly disrupt markets and transactions. The Commission is requesting

comment on the proposed compliance schedules, Sec. Sec. 23.175 and

23.575, described in this release.

DATES: Submit comments on or before November 4, 2011.

ADDRESSES: For comments on proposed compliance schedule Sec. 23.175,

you may submit comments identified by RIN number 3038-AC97 and Swap

Transaction Compliance and Implementation Schedule: Trading

Documentation and Margining Requirements under Section 4s of the

Commodity Exchange Act (CEA). For comments on proposed compliance

schedule Sec. 23.575, you may submit comments identified by RIN number

3038-AC96 and Swap Transaction Compliance and Implementation Schedule:

Trading Documentation and Margining Requirements under Section 4s of

the CEA. Comments may be submitted 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 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: Mark D. Higgins, Counsel, Office of

the General Counsel, 202-418-5864, mhiggins@cftc.gov; or Camden Nunery,

Office of the Chief Economist, cnunnery@cftc.gov, 202-418-5723,

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 Wall Street

Reform and Consumer Protection Act (Dodd-Frank Act).\1\ Title VII of

the Dodd-Frank Act amends the CEA \2\ to establish a comprehensive new

regulatory framework for swaps. The legislation was enacted 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 robust

recordkeeping and real-time reporting regimes; and (4) enhancing the

rulemaking and enforcement authorities of the Commission with respect

to, among others, 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).

\2\ 7 U.S.C. 1 et seq.

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To implement the Dodd-Frank Act, the Commission has to-date issued

55 advance notices of proposed rulemaking or notices of proposed

rulemaking, two interim final rules, 12 final rules, and one proposed

interpretive order. By the beginning of May 2011, the Commission had

published in the Federal Register a significant number of notices of

proposed rulemaking, which represented a substantially complete mosaic

of the Commission's proposed regulatory framework under Title VII. In

recognition of that fact and with the goal of giving market

participants additional time to comment on the proposed new regulatory

framework for swaps, either in part or as a whole, the Commission

reopened or extended the comment period of many of its proposed

rulemakings through June 3, 2011.\3\ In total, the Commission has

received over 20,000 comments in response to its Dodd-Frank Act

rulemaking proposals.

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\3\ See Reopening and Extension of Comment Periods for

Rulemakings Implementing the Dodd-Frank Wall Street Reform and

Consumer Protection Act, 76 FR 25274, May 4, 2011.

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To give the public an opportunity to comment further on

implementation phasing, on May 2-3, 2011, the Commission, along with

the Securities and Exchange Commission (SEC), held a joint, two-day

roundtable on issues related to implementation.\4\ In connection with

this roundtable, Commission staff proposed thirteen concepts to be

considered regarding implementation phasing, and staff asked a series

of questions based on the concepts outlined.\5\ The Commission has

received numerous comments in

[[Page 58177]]

response to both its roundtable and the staff concepts and

questions.\6\

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\4\ The transcripts from the roundtable are available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/csjac_transcript050311.pdf (``Day 1 Roundtable Tr.'') and http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/csjac_transcript050211.pdf (``Day 2 Roundtable Tr.'').

\5\ See ``CFTC Staff Concepts and Questions Regarding Phased

Implementation of Effective Dates for Final Dodd-Frank Rules,''

available at http://cftc.gov/ucm/groups/public/@newsroom/documents/file/staffconcepts050211.pdf.

\6\ Such comments are available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1000.

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These comments have come from a variety of existing and potential

market infrastructures, such as clearinghouses, trading platforms, and

swap data repositories. Comments also have come from entities that may

potentially be swap dealers (SDs) or major swap participants (MSPs), as

well as those financial entities that may not be required to register

with the Commission, but whose swap transactions may have to be

conducted in compliance with certain requirements under Section 4s of

the CEA by virtue of their trading with registered SDs or MSPs. For

example, the swap transactions between SDs or MSPs and their

counterparties will be subject to certain documentation of trading and

margining requirements as proposed by the Commission in ``Swap Trading

Relationship Documentation Requirements for Swap Dealers and Major Swap

Participants,'' 76 FR 6715 (Feb. 8, 2011),\7\ (hereinafter ``Trading

Documentation'') and ``Margin Requirements for Uncleared Swaps for Swap

Dealers and Major Swap Participants,'' 76 FR 23732 (Apr. 28, 2011)

(hereinafter ``Margin Requirements'').\8\

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\7\ CFTC Docket 3038-AC96.

\8\ CFTC Docket 3038-AC97.

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One of the key themes to emerge from the comments received by the

Commission is that some market participants may require more time to

ensure that their swap transactions comply with certain new regulatory

requirements that will apply when they enter into swap transactions

with registered SDs and MSPs.\9\ For example, one commenter requested a

``meaningful'' period after finalization of the suite of rulemakings

that is applicable to it before actual compliance will be required.\10\

Similarly, several trade associations recommended the Commission allow

``sufficient'' time for infrastructure and business practices to

develop before requiring compliance with the new requirements.\11\ A

group of international banks commented that the Commission should defer

compliance until December 31, 2012, at which point the regulatory

timetable as per the September 2009 G20 Pittsburgh statement will have

reached a conclusion.\12\ Another commenter noted that some entities

may be able to comply relatively quickly with certain documentation

requirements that are largely consistent with current business

practices while other requirements may need a longer implementation

period.\13\ Although commenters varied in their recommendations

regarding the time it would take to bring their swaps into compliance

with the new regulatory requirements, many commenters agreed on phasing

in compliance with these requirements by type of market participant

based on a variety of factors, including a market participant's

experience, resources, and the size and complexity of its

transactions.\14\ The Commission has taken these comments into

consideration in developing these proposed compliance schedules.

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\9\ E.g., Letter from Electric Trade Association, dated May 4,

2011 at 5; Letter from John R. Gidman, Association of Institutional

Investors, dated June 10, 2011 at 3-4.

\10\ Letter from the Coalition of Physical Energy Companies,

dated Mar. 14, 2011 at 4.

\11\ Letter from the Futures Industry Association, the Financial

Services Forum, the International Swaps and Derivatives Association

and the Securities Industry and Financial Markets Association, dated

May 4, 2011 at 5.

\12\ Letter from the Bank of Tokyo-Mitsubishi UFJ, Ltd., et al.,

dated May 6, 2011 at 6.

\13\ Letter from the Financial Services Roundtable, dated May

12, 2011 at 4.

\14\ These comments are more fully discussed later in the

preamble.

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The swap transaction compliance requirements that are the focus of

this proposed rulemaking include compliance with certain provisions of

the Trading Documentation and Margin Requirements under Section 4s of

the CEA.\15\ The Commission's proposed compliance schedules are

designed to afford affected market participants a reasonable amount of

time to bring their transactions into compliance with such

requirements. The proposed schedules also would provide relief in the

form of additional time for compliance with these transaction

compliance requirements and are further explained below. This relief is

intended to facilitate the transition to the new regulatory regime

established by the Dodd-Frank Act in an orderly manner that does not

unduly disrupt markets and transactions.

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\15\ The Commission also is proposing Swap Transaction

Compliance and Implementation Schedule: Clearing and Trade Execution

Requirements under Section 2(h) of the CEA.

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Under this further notice of proposed rulemaking, the Commission is

seeking additional public comment on proposed compliance schedules that

ultimately would be included in final rules regarding Trading

Documentation and Margin Requirements.\16\ The proposed schedules would

be finalized and become effective at such time as the final Trading

Documentation and Margin Requirement rules were published in the

Federal Register.

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\16\ This release should be considered to be a continuation of

the rulemaking undertaken by CFTC Dockets 3038-AC96 and 3038-AC97.

Only comments pertaining to the proposed compliance schedule will be

considered as part of this Further Notice.

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II. Proposed Regulation

A. Authority To Implement Proposed Regulations

In this further notice of proposed rulemaking, the Commission

relies on its general authority to phase in compliance with the rules

and regulations enacted pursuant to the Dodd-Frank Act. Section 712(f)

of Title VII also authorizes the Commission to promulgate rules to

prepare for the effective dates of the provisions of the Dodd-Frank

Act.\17\ In addition, the Commission relies on Section 8(a)(5) of the

CEA, which 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. In accordance with this authority, the proposed regulations

would amend part 23 of the Commission's regulations to phase compliance

with previously proposed rules related to Trading Documentation and

Margin Requirements under Section 4s of the CEA.

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\17\ Section 712(f) of the Dodd-Frank Act states: ``Beginning on

the date of enactment of this Act and notwithstanding the effective

date of any provision of this Act, the [Commission] * * * may, in

order to prepare for the effective dates of the provisions of this

Act--(1) promulgate rules, regulations, or orders permitted or

required by this Act * * *.''

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B. Implementation Phasing of Trading Documentation Under Section 4s(i)

of the CEA

1. Background on the Trading Documentation Requirement

Section 731 of the Dodd-Frank Act added a new Section 4s(i)(2) to

the CEA that requires the Commission to adopt rules governing

documentation standards for SDs and MSPs. As described in Section

4s(i)(1), these documentation standards, as prescribed by the

Commission, ``relate to the timely and accurate confirmation,

processing, netting, documentation, and valuation of all swaps.'' On

January 13, 2011, the Commission proposed regulations related to the

Trading Documentation that SDs and MSPs must enter into with their

counterparties in order to establish a swap trading relationship and

document the swap transactions that occur pursuant to that

relationship.\18\

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\18\ See Swap Trading Relationship Documentation Requirements

for Swap Dealers and Major Swap Participants, 76 FR 6715, Feb. 8,

2011.

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[[Page 58178]]

Specifically, previously proposed Sec. 23.504(a) would require SDs

and MSPs to establish, maintain, and enforce written policies and

procedures designed to ensure that each SD or MSP and its counterparty

agree in writing to all terms of their swap trading relationship and

have executed all agreements required by the rules.\19\ The proposal

also would address the essential documentation needed to establish a

trading relationship with a registered SD or MSP. Proposed Sec.

23.504(b)(1) would require that the trading 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.\20\ Proposed Sec. 23.504(b)(2) would establish

that all confirmations of swap transactions, as required under proposed

Sec. 23.501, would be considered to be part of the required swap

trading relationship documents.\21\

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\19\ 76 FR at 6725.

\20\ 76 FR at 6726. In large part, proposed Sec. 23.504(b)(1)

reflects existing trading relationship documentation between

counterparties, such as the widely-used ISDA Master Agreement, but

does propose additional documentation requirements.

\21\ 76 FR at 6717 and 6726. In particular, under proposed Sec.

23.504(b)(2) parties must document the confirmation of their swap

transactions. The Commission proposed the timing requirements for

confirmation under Sec. 23.501 in Confirmation, Portfolio

Reconciliation, and Portfolio Compression Requirements for Swap

Dealers and Major Swap Participants, 75 FR 81519, Dec. 28, 2010.

However, the writing necessary for confirmation is required pursuant

to Sec. 23.504(b)(2) and was proposed under the Trading

Documentation rules.

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Proposed Sec. 23.504(b)(3) would require that the trading

documentation include documentation of the credit support arrangements

between the counterparties. These arrangements would include the

counterparties' agreement on initial and variation margin

requirements,\22\ the types of assets that may be used as margin, and

the investment and rehypothecation terms for those assets. The proposal

also would include the custodial arrangements for margin assets,

including whether margin assets are to be segregated with an

independent third party in accordance with Section 4s(l) of the

CEA.\23\

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\22\ See section II.C below for further discussion of Margin

Requirements. Proposed Sec. 23.504(b)(3)(i)-(iii) is intended to

work together with, and serve as a cross-reference to, rules

proposed by the Commission in its Margin Requirements proposal,

Sec. 23.151 (76 FR at 23744), as well as rules proposed by the

prudential regulators related to initial and variation margin

requirements for SDs and MSPs that are banks. See Margin and Capital

Requirements for Covered Swap Entities, 76 FR 27564, 27589, May 11,

2011 (proposing Sec. --.5 relating to documentation of margin

matters). While proposed Sec. 23.504 would apply to all SDs and

MSPs registered with the Commission, the specific initial and

variation margin requirements for SDs or MSPs would depend on

whether the entity has a prudential regulator as that term is

defined under Section 1a(39) of the CEA.

\23\ As explained in the preamble to the Trading Documentation

proposal, proposed Sec. 23.504(b)(3)(iii) and (iv) are intended to

work together with rules proposed under section 4s(l) of the CEA. 76

FR at 6718 (citing Protection of Collateral of Counterparties to

Uncleared Swaps; Treatment of Securities in a Portfolio Margining

Account in a Commodity Broker Bankruptcy, 75 FR 75432, Dec. 3,

2010). Accordingly, documentation of the collateral arrangements

required under proposed Sec. 23.601-603 would be included in the

trading documentation required under Sec. 23.504. Previously

proposed Sec. 23.601 requires that the SD and MSP notify each

counterparty of the counterparty's right to elect for segregation of

the collateral it supplies as initial margin. Previously proposed

Sec. 23.602 sets forth requirements for the treatment of segregated

margin, including the use of an independent custodian and the

requirement for a written agreement that includes the custodian as a

party, and also allows for the SD or MSP to agree in writing with

its counterparty that variation margin may also be held in a

segregated account. Previously proposed Sec. 23.603 relates to the

investment and use of collateral.

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Proposed Sec. 23.504(b)(4) would require that a SD or MSP and its

counterparty agree on how they will value each swap transaction into

which they enter from the point of execution until the termination,

maturity, or expiration of the swap.\24\ Proposed Sec. 23.504(b)(6)

would establish certain documentation requirements for bilaterally-

executed swaps that are subsequently submitted for clearing to a DCO.

Finally, proposed Sec. 23.504(b)(5), the subject of a separate notice

of proposed rulemaking,\25\ would require that a SD or MSP and its

counterparty include in their Trading Documentation ``a provision that

confirms both parties' understanding of how the new orderly liquidation

authority under the Title II of the Dodd-Frank Act and the Federal

Deposit Insurance Act may affect their portfolios of uncleared,

bilateral swaps.'' \26\

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\24\ 76 FR at 6719. The valuation that would be established

under Sec. 23.504(b)(4) is relied upon in the Margin Requirements

rule Sec. 23.156(b)(1) as the basis for calculating variation

margin. Similar valuation provisions also were included by the

prudential regulators in their Margin and Capital Requirements

proposal. See 76 FR 27589.

\25\ Orderly Liquidation Termination Provision in Swap Trading

Relationship Documentation for Swap Dealers and Major Swap

Participants, 76 FR 6708, Feb. 8, 2011.

\26\ 76 FR at 6709.

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The audit, recordkeeping, and reporting provisions of proposed

Sec. 23.504(c), (d), and (e) that were proposed by the Commission at

the same time as proposed Sec. 23.504(a) and (b) would not be subject

to the compliance schedule proposed below because the Commission

believes that compliance with those requirements rests solely with

registered SDs and MSPs and would not require that SDs or MSPs work

with their non-registrant counterparties to comply with these

requirements.\27\ The Commission solicits comment on whether the

compliance schedule should be applied to these provisions as well. The

Commission also solicits comment regarding whether the compliance

schedule should be applied to proposed Sec. 23.505, which relates to

end-user exception documentation.

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\27\ While the compliance schedule proposed in this release

would not apply to these provisions, the compliance dates for SDs

and MSPs to come into compliance with these provisions will be taken

up when the Commission adopts final rules.

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The Commission observes that before swap dealers and major swap

participants could be required to comply with Sec. 23.504, the

Commission must adopt final rules related to confirmation of swap

transactions \28\ and the protection of collateral for uncleared

swaps.\29\ This is because the substance of the required documentation

under proposed Sec. 23.504 is found in those two rulemakings. For this

reason, the Commission anticipates that it will finalize the

confirmation and protection of collateral proposals at approximately

the same time that it finalizes the Trading Documentation rule.

Consequently, the compliance schedules proposed under this release

would not become effective until the Commission finalizes those two

proposals in addition to the Trading Documentation rule.\30\

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\28\ Confirmation, Portfolio Reconciliation, and Portfolio

Compression Requirements for Swap Dealers and Major Swap

Participants, 75 FR 81519, Dec. 28, 2010. The Commission notes that

rules related to portfolio reconciliation (Sec. 23.502) and

portfolio compression (Sec. 23.503) were not cross-referenced in

the Trading Documentation rule and would not be required to be

included in the counterparties' primary trading relationship

documentation. However, if the Commission finalizes those

requirements at the same time as the Trading Documentation rule

parties may, in their discretion, include documentation establishing

compliance with such provisions in their primary documentation, if

applicable.

\29\ Protection of Collateral of Counterparties to Uncleared

Swaps; Treatment of Securities in a Portfolio Margining Account in a

Commodity Broker Bankruptcy, 75 FR 75432, Dec. 3, 2010.

\30\ In promulgating final rules regarding the timing of

confirmation by SDs, MSPs, and their counterparties, the Commission

will ensure that compliance with the final confirmation requirements

work together with the compliance schedule as proposed under this

release.

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In addition, the Commission recognizes that the swap transaction

compliance schedules that are the subject of this proposal reference

terms such as ``swap,'' ``swap dealer,'' and ``major swap participant''

that are the subject of rulemaking under sections 712(d)(1) and 721(c)

of the Dodd-Frank

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Act.\31\ The Commission and the SEC have proposed rules that would

further define each of these terms.\32\ As such, and in a manner

consistent with the temporary relief provided in the Commission's

Effective Date Order,\33\ the Commission must adopt final rules

regarding the further definitions in question prior to requiring

compliance with the Trading Documentation rule.

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\31\ Section 712(d)(1) provides: ``Notwithstanding any other

provision of this title and subsections (b) and (c), the Commodity

Futures Trading Commission and the Securities and Exchange

Commission, in consultation with the Board of Governors [of the

Federal Reserve System], shall further define the terms `swap',

`security-based swap', `swap dealer', `security-based swap dealer',

`major swap participant', `major security-based swap participant',

and `security-based swap agreement' in section 1a(47)(A)(v) of the

Commodity Exchange Act (7 U.S.C. 1a(47)(A)(v)) and section 3(a)(78)

of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(78)).''

Section 721(c) provides: ``To include transactions and entities that

have been structured to evade this subtitle (or an amendment made by

this subtitle), the Commodity Futures Trading Commission shall adopt

a rule to further define the terms `swap', `swap dealer', `major

swap participant', and `eligible contract participant'.''

\32\ Further Definition of ``Swap Dealer,'' ``Security-Based

Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based

Swap Participant,'' and ``Eligible Contract Participant''; Proposed

Rule, 75 FR 80174, Dec. 21, 2010 and Further Definition of ``Swap,''

``Security-Based Swap,'' and ``Security-Based Swap Agreement'';

Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 76 FR

29818, May 23, 2011.

\33\ See Effective Date for Swap Regulation, 76 FR 42508, Jul.

19, 2011.

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Lastly, the Commission must adopt final rules relating to the

registration, including procedures for the provisional registration, of

SDs and MSPs.\34\ The finalization of these rules would enable SDs and

MSPs to register with the Commission. As explained in the preamble to

the proposed registration rule for SDs and MSPs, the Commission would

afford SDs and MSPs an overall phased implementation approach with

regard to the specific requirements under Section 4s (the ``Section 4s

Requirements'').\35\ In other words, SDs and MSPs would be able to

provisionally register with the Commission and come into compliance

with the Section 4s Requirements within the compliance deadlines set

forth in the respective final implementing rulemakings.\36\ The

specific compliance schedules proposed in this release comport with the

approach discussed in the proposed registration rules.

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\34\ Registration of Swap Dealers and Major Swap Participants,

75 FR 71379, Nov. 23, 2010.

\35\ The Section 4s Requirements include capital and margin,

reporting and recordkeeping, daily trading records, business conduct

standards, documentation standards, risk management and trading

duties, designation of a chief compliance officer, and segregation

with regard to uncleared swaps. 75 FR at 71380.

\36\ In accordance with the preamble to the Registration

proposal, the Commission anticipates finalizing other Section 4s

Requirements, such as those rules proposed under Section 4s(e)

(capital requirements), Section 4s(f) (reporting and recordkeeping),

Section 4s(g) (daily trading records), Section 4s(h) (business

conduct standards), Section 4s(j) (duties, including trading, risk

management, disclosure of information, conflicts of interest, and

antitrust considerations), and Section 4s(k) (designation of a chief

compliance officer), and providing for specific compliance deadlines

in the respective final implementing rulemakings based on the

extensive public comment already received.

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Another proposed rule under Section 4s of the CEA indicated that

certain requirements could be met through the use of swap trading

relationship documentation (e.g., in the ISDA master agreement). The

disclosure and documentation requirements proposed under the ``Business

Conduct Standards for Swap Dealers and Major Swap Participants With

Counterparties'' rulemaking \37\ could be included in Trading

Documentation at the discretion of the SD or MSP and its counterparty.

However, there is no express requirement under either the proposed

Business Conduct Standards with Counterparties rules or proposed Sec.

23.504 that the proposed disclosure and documentation requirements be

included in the Trading Documentation. For that reason, issues related

to compliance dates for the Business Conduct Standards with

Counterparties rules will be taken up when finalizing that proposal.

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\37\ 75 FR 80638, Dec. 22, 2010.

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2. Compliance Schedule for Documentation Requirements--Sec. 23.575

As stated above, the Commission is proposing a compliance schedule,

Sec. 23.575, that is specific to the documentation requirements of

proposed Sec. 23.504. Under the proposed compliance schedule in Sec.

23.575, an SD or MSP would be afforded ninety (90), one hundred eighty

(180), or two hundred and seventy (270) days to bring its Trading

Documentation with its various counterparties into compliance with the

requirements of proposed Sec. 23.504, depending on the identity of

each such counterparty. The categorization by type of counterparty is

discussed further below.

As a practical matter, in order for SDs and MSPs to comply with the

requirements of proposed Sec. 23.504, they will need to work with each

of their counterparties, including non-registrants, to review,

negotiate, execute, and deliver the documentation required by proposed

Sec. 23.504. Because every bilateral swap transaction has two

counterparties, if a non-registrant is trading with a registered SD or

MSP, the swap transactions entered into by those two parties would be

subject to the new regulatory regime established by Section 4s of

CEA.\38\ For this reason, the Commission is focusing on phasing swap

transaction compliance.

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\38\ Recognizing this reality, the Commission previously

proposed rules under which SDs and MSPs would have policies and

procedures to bring their transactions with all their counterparties

into compliance with the requirements of Section 4s(i) of the CEA.

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The Commission recognizes that a number of new regulations under

Section 4s will apply to swap transactions where the counterparty to an

SD or MSP is not registered with the Commission. In such cases, the

Commission is affording more time for those transactions to be brought

into compliance with the new regulations. Moreover, registered SDs or

MSPs may require additional time to bring their transactions into

compliance with respect to non-registrant counterparties that have

hundreds or thousands of managed accounts, referred to as third-party

subaccounts for the purposes of this proposal.

In many instances, as noted in the proposing release for Sec.

23.504, counterparties already will have in place industry standard

documentation in the form of the widely-used ISDA master agreement,

definitions, schedules, confirmations, and credit support annex to

document their trades. The Commission anticipates that some of this

existing documentation will meet some of the requirements of proposed

Sec. 23.504. However, it may be necessary for parties to negotiate

certain amendments or additional documentation to comply with the new

rules. In these instances, and in instances where counterparties have

not previously documented their trading relationship and/or individual

transactions, the Commission proposes to afford relief in the form of

additional time to comply.

C. Implementation Phasing of the Margin Documentation Requirements

Under Section 4s(e) of the CEA

1. Background on the Margin for Uncleared Swaps Requirements

Section 731 of the Dodd-Frank Act added a new Section 4s(e) to the

CEA that explicitly requires the Commission to adopt rules establishing

margin requirements for all registered SDs and MSPs that are not

banks.\39\ Under

[[Page 58180]]

Section 4s(e)(2)(B), the Commission is required to adopt rules for non-

bank SDs and MSPs imposing ``both initial and variation margin

requirements on all swaps that are not cleared by a registered

derivatives clearing organization.''

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\39\ Section 4s(e) applies a bifurcated approach that requires

each SD and MSP for which there is a prudential regulator to meet

margin requirements established by the applicable prudential

regulator, and each SD and MSP for which there is no prudential

regulator to comply with Commission's regulations governing margin.

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On April 28, 2011, the Commission issued proposed regulations to

implement the margin requirements for uncleared swaps for SDs and MSPs

for which there is no prudential regulator (referred to as ``covered

swap entities'' or ``CSEs'' under the proposal).\40\ The proposed

Margin Requirements recognized that specific margin requirements would

vary by the type of counterparty entering into a swap with a CSE. For

instance, the proposed rules would not impose any margin requirements

on swaps between CSEs and non-financial end users.\41\

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\40\ Margin Requirements for Uncleared Swaps for Swap Dealers

and Major Swap Participants, 75 FR 23732, Apr. 28, 2011.

\41\ 76 FR at 23734.

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The provisions of the proposed Margin Requirements include

definitions (Sec. 23.150), documentation regarding credit support

arrangements (Sec. 23.151), the specific margin requirements between

CSEs and their counterparties (Sec. Sec. 23.152-23.154), provisions

for the calculation of initial margin (Sec. 23.155), provisions for

the calculation of variation margin (Sec. 23.156), requirements for

the forms of margin (Sec. 23.157), and custodial arrangement

requirements (Sec. 23.158). Specific margin requirements vary by the

type of counterparty with which a CSE is trading--another SD or MSP

\42\ (Sec. 23.152), a financial entity (Sec. 23.153), or a non-

financial entity (Sec. 23.154).

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\42\ In some instances this SD or MSP counterparty may be

subject to regulation by a prudential regulator. The margin rules

proposed by the Commission and those proposed by the prudential

authorities require any CSE to collect margin, but do require a CSE

to post margin. Under this approach, a non-bank SD or MSP will look

to the Commission's rules when calculating the margin that should be

collected from its counterparty, and a bank SD or MSP will look to

the prudential regulators' rules when calculating the margin that

should be collected from its counterparty. As a result, in a trade

between a bank SD and a non-bank SD, the initial margin amounts

collected by each side could differ depending on the applicable

rules.

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As explained above with regard to the Trading Documentation rules,

the Commission observes that no CSE could be required to comply with

final Margin Requirements rules until (1) the Commission adopts further

definitions of ``swap,'' ``swap dealer,'' and ``major swap

participant''; and (2) the Commission adopts registration rules for SDs

and MSPs. As noted above, the proposed Margin Requirements cross-

reference certain provisions in the Trading Documentation rule. As a

result, the final Trading Documentation rule would have to be published

in the Federal Register prior to requiring compliance with the final

Margin Requirements.\43\

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\43\ The Commission's proposed capital rules for SDs and MSPs

are related to the proposed Margin Requirements rules, but the

margin rules are not dependent on implementation of the capital rule

in order to take effect.

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2. Compliance Schedule for Margin Requirements Documentation--Sec.

23.175

In this further notice of proposed rulemaking, the Commission is

proposing a compliance schedule, Sec. 23.175, that is specific to the

Margin Requirements of proposed Sec. 23.150 through Sec. 23.158.

Under the proposed Margin Requirements, an SD or MSP for which there is

no prudential regulator, is defined as a ``covered swap entity.'' For

consistency, this term also would be used in the proposed compliance

schedule. In order to achieve compliance with the Margin Requirement, a

CSE would be required to execute documentation regarding credit support

arrangements and custodial arrangements with its counterparties. This

documentation, required by proposed Sec. 23.151 and Sec. 23.158,

would specify in advance material terms such as how margin would be

calculated, what types of assets would be permitted to be posted, what

margin thresholds, if any, would apply, and where margin would be held.

As stated in the proposal, having comprehensive documentation in place

at the time of transaction execution would allow each party to a swap

to manage its risks more effectively throughout the life of the swap

and to avoid disputes regarding issues such as valuation.\44\

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\44\ 76 FR 23734. As stated in the proposal, margining

requirements would also apply to swaps where one side of the trade

is not registered with the Commission. 76 FR 23732-36.

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Under the proposed compliance schedule, a covered swap entity would

be afforded ninety (90), one hundred eighty (180), or two hundred and

seventy (270) days (depending on the identity of its counterparty) to

come into compliance with all of the Margin Requirements. The

categorization by type of counterparty is discussed further below.

D. Three-Part Implementation Phasing

The Commission believes that it is in the public interest to afford

SDs and MSPs over which the Commission has jurisdiction relief in the

form of additional time to comply with proposed rules related to

Trading Documentation (Sec. 23.504) and Margin Requirements (Sec.

23.150-23.158), depending on the type of counterparty with which the SD

or MSP is trading.

These proposed compliance schedules, Sec. Sec. 23.575 and 23.175,

seek to achieve the best balance among several goals. First, the

Commission believes that SDs or MSPs may require additional time to

work with certain market participants to bring their swaps into

compliance with the new requirements of proposed Trading Documentation

(Sec. 23.504) and Margin Requirements (Sec. 23.150-23.158). This is

particularly true for those market participants that have hundreds or

thousands of managed accounts, referred to as third-party subaccounts

for the purposes of this proposal.

As one commenter noted, ``[i]n the context of asset managers, the

account set up process has to be multiplied over hundreds of

subaccounts. Processing all of these subaccounts will take time even

for the largest and most technologically advanced asset managers.''

\45\ In light of this, the Commission is proposing to afford SDs and

MSPs with additional time to come into compliance with the requirements

of Trading Documentation (Sec. 23.504) and Margin Requirements (Sec.

23.150-23.158) for swaps involving entities that are defined as

``third-party subaccounts'' because of the additional burden associated

with documenting such accounts.

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\45\ Letter from Karrie McMillan, Investment Company Institute,

dated June 10, 2011at 9-10.

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Moreover, several commentators emphasized the need to have adequate

time to educate their clients regarding the new regulatory

requirements.\46\ For instance, market participants that may not be

registered with the Commission would be less familiar with the new

regulatory requirements. In addition, market participants with third-

party subaccounts would have to educate additional clients.

Accordingly, swaps involving either type of participant should be given

additional time to comply with the new requirements.

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\46\ See Letter from Financial Services Forum, Futures Industry

Association, International Swaps and Derivatives Association, and

Securities Industry Association, dated May 4, 2011; Letter from

Karrie McMillan, Investment Company Institute, dated June 10, 2011

at 10-11.

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Another goal of the proposed compliance schedule is derived from

the Commission's belief that it is important to have a cross-section of

market participants involved at the outset of implementing the

requirements under Trading Documentation (Sec. 23.504) and Margin

[[Page 58181]]

Requirements (Sec. Sec. 23.150-23.158). Accordingly, the Commission

proposes that the first phase of implementation include SDs, MSPs and

``active funds'' (a term that is defined and discussed further below)

that are experienced, have the resources, and can come into compliance

more readily than entities that trade swaps less frequently. The

Commission believes that having a cross-section of market participants

involved at the outset will facilitate the development of systems

necessary for SDs and MSPs to achieve compliance with the new

requirements.

The Commission proposes a compliance schedule that affords

additional time for SDs and MSPs to come into compliance with the

requirements of Trading Documentation (Sec. 23.504) and Margin

Requirements (Sec. Sec. 23.150-23.158) based on the type of

counterparty with which they are trading. Market participants that are

financial entities, as defined in Section 2(h)(7)(C) of the CEA, are

grouped into the following four categories:

Category 1 Entities include swap dealers, security-based

swap dealers, major swap participants, major security-based swap

participants, or active funds.

Category 2 Entities include commodity pools; private funds

as defined in Section 202(a) of the Investment Advisors Act of 1940

other than active funds; employee benefit plans identified in

paragraphs (3) and (32) of section 3 of the Employee Retirement Income

and Security Act of 1974; or persons predominantly engaged in

activities that are in the business of banking, or in activities that

are financial in nature as defined in Section 4(k) of the Bank Holding

Company Act of 1956, provided that the entity is not a third-party

subaccount.

Category 3 Entities include Category 2 Entities whose

positions are held as third-party subaccounts.

Category 4 Entities includes any person not included in

Categories 1, 2, or 3.

Phase 1--Category 1 Entities

Category 1 Entities include those dealers and major participants in

the swap and security-based swap markets that will be required to

register with the Commission or the Securities and Exchange Commission

(SEC).\47\ Under Title VII, these market participants will be required

to register with either the CFTC or SEC as a result of their swaps or

security-based swaps activities. Based on their level of market

experience, and based on their status as registrants, the Commission

believes they should be capable of complying with proposed Trading

Documentation (Sec. 23.504) and Margin Requirements (Sec. Sec.

23.150-23.158) no later than 90 days from the date of adoption of final

rules.

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\47\ If a security-based swap dealer or a major security-based

swap participant is not yet required to register with the SEC at

such time as the Commission issues final rules Sec. 23.504 or

Sec. Sec. 23.150-23.158, then the security-based swap dealer or a

major security-based swap participant would be treated as a Category

2 Entity.

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The Commission also is proposing to include those entities it

defines as ``active funds'' in the first category of market

participants. The proposed definition of ``active fund'' would mean any

private fund as defined in section 202(a) of the Investment Advisors

Act of 1940, that is not a third-party subaccount and that executes 20

or more swaps per month based on a monthly average over the 12 months

preceding the publication of either Sec. 23.504 or Sec. Sec. 23.150-

23.158, as applicable.\48\ By including these entities in Category 1,

the Commission seeks to achieve the goal of ensuring a cross-section of

market participants are included at the outset of trading and margining

documentation implementation.

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\48\ It should be noted that many commodity pools meet the

definition of private fund under section 202(a) of the Investment

Advisors Act of 1940. Such a commodity pool would only be a Category

1 Entity if it met the other criteria of an active fund.

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The Commission is relying on the definition of private fund from

Section 2(h)(7)(C) of the CEA, as well as Section 402 of the Dodd-Frank

Act. However, the Commission is limiting the definition in two ways.

First, the definition excludes third-party subaccounts, as discussed

further below. Second, the definition is limited to those private funds

that execute 20 or more swaps per month based on the average over the

12 months preceding either (1) the Commission's adoption of Sec.

23.150 through Sec. 23.158 in the case of Sec. 23.175; or (2) the

Commission's adoption of Sec. 23.504 in the case of Sec. 23.575.

Based on a preliminary assessment, the Commission believes the proposed

numerical threshold for active funds is appropriate because a private

fund that conducts this volume of swaps would be likely to have: (1)

Sufficient resources to enter into arrangements that comply with the

Trading Documentation and Margin Requirements earlier than other types

of market participants; and (2) sufficient market experience to

contribute meaningfully to the ``buy-side'' perspective as industry

standards are being developed.\49\ In defining ``active fund''

accordingly, the Commission believes it has included those market

participants that are likely to be among the most experienced

participants with expertise and resources needed to come into

transaction compliance quickly.

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\49\ The Commission is unaware of any position-level or

transaction-level data on private fund swap activity in a publicly

available form. In order to determine private fund activity levels

the Commission consulted with academics focusing their research in

this area, with industry participants, and with groups that

represent the industry.

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Phase 2--Category 2 Entities

Next, the Commission proposes to phase in compliance for any swap

transaction between an SD or MSP and a Category 2 Entity. The

Commission is proposing to afford swap transactions between these types

of market participants 180 days from the dates of adoption of Trading

Documentation (Sec. 23.504) and Margin Requirements (Sec. Sec.

23.150-23.158) to come into compliance. This additional time takes into

consideration the fact that Category 2 Entities will not be required to

be registered with the Commission and they may be less experienced and

less frequent users of the swap markets than those in Category 1.

Additionally, these financial entities may not have the same level of

resources to review, analyze, negotiate, and enter into arrangements

that comply with the new Trading Documentation and Margin Requirements

as those in Category 1.

Phase 3--Category 3 and 4 Entities

Finally, the Commission proposes to afford an SD or MSP trading

with a Category 3 or 4 Entity 270 days from adoption of final rules

relating to Trading Documentation (Sec. 23.504) and Margin

Requirements (Sec. Sec. 23.150-23.158) to enter into arrangements that

comply with the new rules.

The Commission is proposing to afford SDs and MSPs with additional

time to work with entities that are defined as ``third-party

subaccounts'' to bring their documentation into compliance. Under the

proposed definition, a third-party subaccount is a managed account that

requires specific approval by the beneficial owner of the account to

execute documentation necessary for executing, confirming, margining,

or clearing swaps. By way of non-exclusive example, if investment

management firm X manages the assets of pension fund Y, and does so in

a separate account that requires the approval of pension fund Y to

execute necessary documentation, then that account would be afforded

270 days to come into compliance. On the other hand, if pension fund Y

manages its own assets, it would fall within

[[Page 58182]]

Category 2 and be afforded 180 days to come into compliance. Likewise,

if investment management firm X does not manage the assets of third

parties, then it would fall within Category 2. The Commission is

proposing to afford Category 3 an additional 90 days beyond the 180

days proposed for Category 2 because such entities may have

documentation obligations for hundreds or even thousands of third-party

subaccounts, and each such account must meet the requirements of

Trading Documentation (Sec. 23.504) and Margin Requirements

(Sec. Sec. 23.150-23.158). For example, according to a statement made

during the Joint SEC-CFTC Roundtable by Mr. William DeLeon of the firm

Pacific Investment Management Company, LLC (PIMCO), PIMCO manages

hundreds of third-party subaccounts, as defined above.\50\

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\50\ Day-2 Roundtable Tr. at 62.

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The Commission is proposing to afford an SD or MSP trading with any

other person (defined as a Category 4 Entity) 270 days to enter into

arrangements that comply with the new rules.

The Commission stresses that nothing would prohibit any person from

complying in advance of the proposed compliance schedule. Indeed, the

Commission would encourage market participants that can come into

compliance more quickly to do so.

E. Comment Requested

The Commission requests comment on all aspects of the proposed

compliance schedules, Sec. Sec. 23.175 and 23.575. The Commission may

consider alternatives to the proposed compliance schedules and is

requesting comment on the following questions:

What, if any, other rules should have been taken into

consideration when proposing an implementation schedule regarding

margin or documentation requirements? If applicable, how should the

implementation requirements of those other rules be taken into

consideration?

What factors, if any, would prevent an entity in any of

the proposed categories from adhering to the compliance schedules

proposed by the Commission? How much additional time would be needed to

address these factors?

Are there other considerations that the Commission should

have taken into account when designing this tiered implementation

schedule? Are the timeframes outlined in this implementation schedule

adequate? If not, what alternative schedule should the Commission

consider, and why?

What other entities, if any, should be included in

Category 1, 2, or 3, and why?

What adjustments to the compliance schedule and/or other

steps could the Commission take to ensure there is adequate

representation from all market participants at the outset of

implementing the requirements under Trading Documentation (Sec.

23.504) and Margin Requirements (Sec. Sec. 23.150-23.158)?

Is an entity's average monthly swap transaction activity a

useful proxy for that entity's ability to comply with the Trading

Documentation and Margin Requirements? Or whether an entity is required

to be registered with the Commission (rather than whether an entity is

already registered with the Commission)?

Is the Commission's definition of ``active fund'' overly

inclusive or under-inclusive? Should the numerical threshold for number

of monthly swap transactions be higher or lower than 20? If so, why?

Should the number of monthly swap transactions be linked to swap

activity in a particular asset class?

Should the Commission exclude from the definition of

``active fund'' any investment advisor of private funds acting solely

as an advisor to private funds with assets under management in the

United States of less than $150,000,000, as provided for in the

reporting exemption for private funds under Section 408 of the Dodd-

Frank Act?

Would it be more appropriate for the Commission to measure

a market participant's level of swap activity by measuring notional

turnover and/or open exposure as suggested by some commenters? \51\

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\51\ Letter from Adam C. Cooper, Citadel, dated June 3, 2011,

Appendix B.

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Are there any anticompetitive implications to the proposed

compliance schedules? If so, how could the proposed rules be

implemented to achieve the purposes of the CEA in a less

anticompetitive manner? If so, please quantify those costs, if

possible, and provide underlying data sources, assumptions, and

calculations.

Are there additional costs or benefits associated with the

current proposal that the Commission has not already taken into

account? Please discuss any such costs in detail and quantify in dollar

terms, if possible.

Are there any assumptions, including quantitative

assumptions, underlying the Commission's cost benefit analysis that the

Commission should consider?

Should the Commission consider an alternative

implementation schedule? Would such an alternative schedule reduce the

costs market participants will bear? Please describe any such

alternative implementation schedule in detail, including how it will

reduce costs and the benefits it will likely deliver. If possible,

please quantify the cost and benefits associated with any alternative.

If providing dollar values, please describe any data sources,

assumptions, and calculations used to generate them.

Should a compliance schedule such as those proposed herein

apply to the disclosure and documentation requirements proposed in the

Business Conduct Standards for Counterparties proposal? If so, should

the compliance schedule be adjusted, and in what manner?

III. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act requires that agencies consider

whether the rules they propose will have a significant economic impact

on a substantial number of small entities and, if so, provide a

regulatory flexibility analysis respecting the impact.\52\ The rules

proposed by the CFTC provide compliance schedules for certain new

statutory requirements of the Dodd Frank Act and do not by themselves

impose significant new regulatory requirements. Accordingly, the

Chairman, on behalf of the CFTC, 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. The CFTC invites

public comment on this determination.

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\52\ 5 U.S.C. 601 et seq.

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B. Paperwork Reduction Act

The Paperwork Reduction Act (``PRA'') \53\ imposes certain

requirements on Federal agencies (including the Commission) in

connection with conducting or sponsoring any collection of information

as defined by the PRA. This Further Notice of Proposed Rulemaking, if

approved, would not require a new collection of information from any

persons or entities.

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\53\ 44 U.S.C. 3507(d).

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C. Consideration of Costs and Benefits

Section 15(a) of the CEA \54\ requires the Commission to consider

the costs and benefits of its action before promulgating a regulation

under the CEA. Section 15(a) of the CEA specifies

[[Page 58183]]

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

regulation is necessary or appropriate to protect the public interest

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

purposes of the Act.

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\54\ 7 U.S.C. 19(a).

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The purpose of this proposed rule is to afford SDs and MSPs

additional time to comply with the Trading Documentation and the Margin

Requirements beyond that which is provided for in the Dodd-Frank Act.

Section 754 of the Dodd-Frank Act provides that required rulemakings

can be considered to be effective 60 days after publication of the

final rule or regulation. Without the proposed rule, SDs and MSPs could

be required to comply with Trading Documentation (Sec. 23.504) and

Margin Requirements (Sec. Sec. 23.150-23.158) rules without any

implementation phasing of the sort provided for by the proposed

compliance schedules.

The Commission recognizes that requiring immediate compliance with

the new requirements could indirectly impose costs on market

participants that may not be registered with the Commission and those

market participants that have hundreds or thousands of third-party

subaccounts to bring into compliance. Accordingly, and in an effort to

protect the public interest by facilitating an orderly transition to a

new regulatory environment, the Commission's proposed compliance

schedules would provide a substantial benefit in that they would afford

SDs and MSPs adequate time to modify or create the requisite

documentation in collaboration with their counterparties.

1. Protection of Market Participants and the Public

The Trading Documentation (Sec. 23.504) and Margin Requirements

(Sec. Sec. 23.150-23.158) rules for which the Commission has proposed

compliance schedules would encourage transparency in the swap market by

requiring that SDs, MSPs, and their counterparties clarify, in writing,

many aspects of their trading relationship prior to entering into a

swap, and also that they clarify many specific details related to

margining their swaps. The proposed compliance schedules would further

the objectives of Sections 4s(e) and 4s(i) of the CEA by establishing

an orderly process for their implementation. The proposed compliance

schedules have several benefits that contribute to protection of the

public as well as market participants.

It is in the public interest that the largest and most active

participants in the swap markets come into compliance with Sections

4s(e) and 4s(i) of the CEA as soon as possible, in order to facilitate

an orderly transition to the new regulatory environment for swaps. The

proposed compliance schedules would prioritize compliance for Category

1 Entities because these entities are likely responsible for a large

portion of the swap transactions occurring in this market. But the

schedule would do so in a way that still safeguards the interests of

the Category 1 Entities by providing the additional time that these

entities need in order to document new trading relationship and

margining arrangements required by Sections 4s(e) and 4s(i) of the CEA.

The additional time provided by the proposed compliance schedules

would create several benefits for the SDs, MSPs, and their

counterparties. First, if market participants were concerned that they

might not be able to meet statutory compliance timelines, it is likely

that they would incur additional costs associated with the potential

lack of regulatory compliance. Providing additional time for compliance

through the proposed compliance schedule would reduce the costs that

market participants may incur mitigating risks during the transition

period, and would re-direct those resources to achieving compliance

with the new rules.

Second, if Category 2, 3, or 4 Entities want to come into

compliance ahead of the timeframes proposed for their SD or MSP

counterparties through the compliance schedules, they may work with

their SD and MSP counterparties to do so. Category 2, 3, or 4 Entities

may wish to achieve compliance earlier in order to achieve the benefits

associated with greater clarity in their trading relationships and

margin arrangements for non-cleared swaps. They also may wish to take

advantage of newly developed template agreements as they develop. Such

early compliance by market participants would provide additional

protection for the public by decreasing the risks associated with

failing to document trading relationships and swap transactions

properly, as well as decreasing the risks associated with failing to

collateralize the credit exposure posed by uncleared swaps.

Additionally, early compliance would have the benefit of increasing

clarity about how margin will be handled for non-cleared swaps.

Category 3 Entities have the additional challenge of transitioning

hundreds, and in some cases, thousands of subaccounts into compliance

with the new documentation requirements for trading relationships and

margining non-cleared swaps. The proposed compliance schedules would

afford Category 3 Entities additional time to educate their customers

about the new requirements, and then negotiate and formalize new

trading and margining agreements between their customers and SDs or

MSPs. Each of these tasks requires time. By giving Category 3 Entities

and their counterparties 270 days to come into compliance, the

Commission is attempting to provide adequate time for these entities to

come into compliance without the need for significant additional legal

assistance. The Commission also is attempting to avoid the risk of

inadequate documentation and inappropriate margining arrangements that

may result from a more rushed process. Both of these results would tend

to reduce costs and risk for both SDs and MSPs and their Category 3

Entities counterparties.

As far as costs are concerned, by establishing a 3-month, 6-month,

and 9-month compliance schedule for SDs and MSPs to achieve compliance

with their counterparties that are Category 1, Category 2, and Category

3 and 4 Entities, respectively, the proposed compliance schedule would

delay certain benefits that would result from more timely and accurate

documentation by SDs and MSPs, as well as timely compliance with Margin

Requirements for non-cleared swaps. Those costs primarily include a

delay in decreasing the risks associated with the failure to document

trading relationships and swap transactions properly, as well as a

delay in terms of decreasing the risks associated with not

collateralizing the credit exposure posed by uncleared swaps.

The proposed compliance schedules seek to balance the cost to SDs,

MSPs, and the Category 1 Entities that would be associated with bearing

a larger proportion of the ``start-up'' costs associated with most

promptly implementing the Trading Documentation and Margin

Requirements. SDs, MSPs, and Category 1 Entities are the entities

likely to expend the most resources establishing industry standard

agreements that can then be used by other market participants. It is

appropriate for the

[[Page 58184]]

entities that are likely to be among the most active participants in

these markets to shoulder a larger percentage of the relatively fixed

start-up costs.

2. Efficiency, Competitiveness, and Financial Integrity of the Markets

The SDs, MSPs, and Category 1 Entities that constitute the first

phase under the proposed compliance schedules will be likely to work

together to establish methods for compliance that other market

participants may later consider. The experience with swaps that the

first group of market participants brings to this process should help

to ensure the integrity and effectiveness of their solutions. These

solutions will likely be helpful to other market participants that

comply later. This approach is likely to result in benefits for a broad

group of market participants.

Moreover, it is critical that a cross-section of market

participants is involved in developing the solutions that become

industry conventions in order to ensure that those approaches promote

the efficiency, competitiveness, and integrity of participants on both

the buy-side and sell-side. Category 1 includes market participants

from both sides, which helps ensure that the interests of both will be

represented well as the industry identifies and solves the problems

that are necessary for compliance.

With respect to the activities of Category 1 participants,

providing them 90 days to come into compliance after the Trading

Documentation (Sec. 23.504) and Margin Requirements (Sec. Sec.

23.150-23.158) are published in the Federal Register would create some

time and opportunity for industry coordination as multiple

participants, representing both the sell-side and buy-side of the

market, identify shared questions and work to develop sound answers.

This is likely to facilitate better compliance systems and processes,

which reduces the start-up costs of implementing new regulations for

these and other entities, which is expected to lower costs to the

public by promoting standardization.

Lastly, in the absence of the proposed compliance schedules, some

entities have expressed concern that they would be unable to comply

with the new requirements and would choose to leave the swap market

altogether or avoid the market for some period of time. If this

occurred, it could reduce liquidity and might increase spreads in the

market. By providing additional time for compliance, this rule reduces

the chance that these adverse effects will occur in the swap market and

facilitates an orderly transition to the new regulatory environment.

As for costs related to the efficiency, competitiveness, and

financial integrity of the markets, the proposed compliance schedules

would allow for delayed compliance dates for new Trading Documentation

and Margin Requirements. The schedules would delay the benefits of the

new requirements that would come from more expeditious implementation.

3. Price Discovery

As noted above, the Trading Documentation rule contains a

requirement that an SD or MSP and its counterparty agree on how they

will value each swap transaction into which they enter from the point

of execution until the termination, maturity, or expiration of the

swap. Prompt implementation of this requirement would facilitate price

discovery between the counterparties to a swap. Delay in implementing

this provision may inhibit price discovery to the extent that

counterparties fail to value their swaps on a timely and accurate

basis. In this way, the proposed rule would delay the benefits of

increased price transparency that could flow from a more expeditious

implementation of the Trading Documentation rule. Additionally, a

disorderly implementation may inhibit price discovery to the extent

that counterparties fail to value their swaps on a timely and accurate

basis; whereas, an orderly implementation process would promote

communication between counterparties, which is essential to price

discovery.

4. Sound Risk Management Practices

To the extent that the proposed compliance schedule would delay

implementation of the Trading Documentation (Sec. 23.504) and Margin

Requirements (Sec. Sec. 23.150-23.158) rules, the swap market could

suffer costs in terms of poor risk management resulting from a failure

to document trading relationships and swap transactions properly, as

well as from failure to collateralize the outstanding credit exposure

posed by uncleared swaps through appropriate margining.

However, there are risk management benefits to be gained from the

proposed compliance schedule. For instance, if SDs and MSPs were

expected to comply with Trading Documentation (Sec. 23.504) and Margin

Requirements (Sec. Sec. 23.150-23.158) on timelines that they could

not meet, it is possible that some firms may avoid the swap market for

a period of time, which could expose them to risks they could have

otherwise used swaps to mitigate. Therefore, by providing a timetable

for orderly implementation, this rule could encourage continued

participation in the swap markets and the continued use of swaps for

risk mitigation purposes.

5. Other Public Interest Considerations

There are public interest benefits to phasing in compliance using

the implementation structure proposed in this release. The proposed

implementation structure generally allows market participants to comply

with the requirements of Dodd-Frank as quickly and efficiently as

possible and thereby provides a sound basis for achieving the

overarching Dodd-Frank goals of risk reduction and increased market

transparency.

In sum, the Commission has considered the costs and benefits as

required by Section 15(a) and is proposing the compliance schedules

discussed herein. The Commission invites public comment on its cost-

benefit considerations. Commenters are also 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 in 17 CFR Part 23

Antitrust, Commodity futures, Conduct standards, Conflicts of

interest, Major swap participants, Reporting and recordkeeping, Swap

dealers, Swaps.

For the reasons stated in the preamble, 17 CFR part 23 is proposed

to be amended 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-1, 6c, 6p, 6r, 6s, 6t, 9,

9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.

2. Add Sec. 23.175 to subpart E to read as follows:

Sec. 23.175 Compliance schedule.

(a) Definitions. For the purposes of this rule:

Active Fund means any private fund as defined in section 202(a) of

the Investment Advisors Act of 1940, that is not a third-party

subaccount and that executes 20 or more swaps per month based on a

monthly average over the 12 months preceding the publication of Sec.

23.150 through Sec. 23.158 in the Federal Register.

Category 1 Entity means (1) A swap dealer, (2) a security-based

swap dealer; (3) a major swap participant; (4) a major security-based

swap participant; or (5) an active fund.

[[Page 58185]]

Category 2 Entity means (1) A commodity pool; (2) a private fund as

defined in section 202(a) of the Investment Advisors Act of 1940 other

than an active fund; (3) an employee benefit plan as defined in

paragraphs (3) and (32) of section 3 of the Employee Retirement Income

and Security Act of 1974; or (4) a person predominantly engaged in

activities that are in the business of banking, or in activities that

are financial in nature as defined in section 4(k) of the Bank Holding

Company Act of 1956, provided that, in each case, the entity is not a

third-party subaccount.

Category 3 Entity means a Category 2 Entity whose positions are

held as a third-party subaccount.

Category 4 Entity means any person not included in Categories 1, 2,

or 3.

Covered swap entity means a swap dealer or major swap participant

for which there is no prudential regulator.

Third-party Subaccount means a managed account that requires

specific approval by the beneficial owner of the account to execute

documentation necessary for executing, confirming, margining, or

clearing swaps.

(b) Compliance Schedule. The following schedule for compliance with

the requirements of Sec. 23.150 through Sec. 23.158 shall apply:

(1) For swap transactions with a Category 1 Entity, a covered swap

entity shall comply with the requirements of Sec. 23.150 through Sec.

23.158 no later than ninety (90) days from the date of publication of

such requirements in the Federal Register.

(2) For swap transactions with a Category 2 Entity, a covered swap

entity shall comply with the requirements of Sec. 23.150 through Sec.

23.158 no later than one hundred and eighty (180) days from the date of

publication of such requirements in the Federal Register.

(3) For swap transactions with a Category 3 Entity or a Category 4

Entity, a covered swap entity shall comply with the requirements of

Sec. 23.150 through Sec. 23.158 no later than two hundred and seventy

(270) days from the date of publication of such requirements in the

Federal Register.

(c) Nothing in this rule shall prohibit any person from complying

voluntarily with the requirements of Sec. 23.150 through Sec. 23.158

sooner than the compliance schedule provided in paragraph (b).

3. Add new Sec. 23.575 to part 23, subpart I, to read as follows:

Sec. 23.575 Compliance schedule.

(a) Definitions. For the purposes of this rule:

Active Fund means any private fund as defined in section 202(a) of

the Investment Advisors Act of 1940, that is not a third-party

subaccount and that executes 20 or more swaps per month based on a

monthly average over the 12 months preceding the publication of Sec.

23.504 in the Federal Register.

Category 1 Entity means (1) A swap dealer, (2) a security-based

swap dealer; (3) a major swap participant; (4) a major security-based

swap participant; or (5) an active fund.

Category 2 Entity means (1) A commodity pool; (2) a private fund as

defined in section 202(a) of the Investment Advisors Act of 1940 other

than an active fund; (3) an employee benefit plan as defined in

paragraphs (3) and (32) of section 3 of the Employee Retirement Income

and Security Act of 1974; or (4) a person predominantly engaged in

activities that are in the business of banking, or in activities that

are financial in nature as defined in section 4(k) of the Bank Holding

Company Act of 1956, provided that, in each case, the entity is not a

third-party subaccount.

Category 3 Entity means a Category 2 Entity whose positions are

held as a third-party subaccount.

Category 4 Entity means any person not included in Categories 1, 2,

or 3.

Third-party Subaccount means a managed account that requires

specific approval by the beneficial owner of the account to execute

documentation necessary for executing, confirming, margining, or

clearing swaps.

(b) Compliance schedule. The following schedule for compliance with

the requirements of Sec. 23.504 shall apply:

(1) For swap transactions with a Category 1 Entity, a swap dealer

or major swap participant shall comply with the requirements of Sec.

23.504 no later than ninety (90) days from the date of publication of

such requirements in the Federal Register.

(2) For swap transactions with a Category 2 Entity, a swap dealer

or major swap participant shall comply with the requirements of Sec.

23.504 no later than one hundred and eighty (180) days from the date of

publication of such requirements in the Federal Register.

(3) For swap transactions with a Category 3 Entity or a Category 4

Entity, a swap dealer or major swap participant shall comply with the

requirements of Sec. 23.504 no later than two hundred and seventy

(270) days from the date of publication of such requirements in the

Federal Register.

(c) Nothing in this rule shall prohibit any person from complying

voluntarily with the requirements of Sec. 23.504 sooner than the

compliance schedule provided in paragraph (b).

Issued in Washington, DC, on September 8, 2011, by the

Commission.

David A. Stawick,

Secretary of the Commission.

Appendices To Swap Transaction Compliance and Implementation Schedule:

Trading Documentation and Margining Requirements Under Section 4s of

the CEA--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, and Chilton voted in the affirmative; Commissioner O'Malia

voted in the negative.

Appendix 2--Statement of Chairman Gary Gensler

I support this proposal to establish schedules to phase in

compliance with previously proposed requirements, including the swap

trading relationship documentation requirement and the margin

requirements for uncleared swaps. The proposal would provide greater

clarity to swap dealers and major swap participants regarding the

timeframe for bringing their swap transactions into compliance with

new documentation and margining rules. The proposal also would make

the market more open and transparent, while giving market

participants an adequate amount of time to comply. The proposal

would help facilitate an orderly transition to a new regulatory

environment for swaps.

Appendix 3--Statement of Commissioner Scott O'Malia

I respectfully dissent from the Commission's decision today to

approve for Federal Register publication two rule proposals related

to implementation entitled ``Swap Transaction Compliance and

Implementation Schedule: Clearing and Trade Execution Requirements

under Section 2(h) of the CEA'' and ``Swap Transaction Compliance

and Implementation Schedule: Trading Documentation and Margining

Requirements under Section 4s of the CEA.'' For quite some time, I

have been asking that the Commission publish for notice and comment

a comprehensive implementation schedule that addresses the entire

mosaic of rule proposals under the Dodd-Frank Act. I believe the

Commission should have proposed a comprehensive schedule that

detailed, at a minimum:

For each registered entity (e.g., swap dealer and major

swap participants), compliance dates for each of its entity-specific

obligations (e.g., all obligations under Section 4s of the Commodity

Exchange Act) under Dodd-Frank; and

For each market-wide obligation (e.g., the clearing and

trading mandates), the

[[Page 58186]]

entities affected (whether registered or unregistered) along with

appropriate compliance dates.

Such a schedule would have complemented and informed existing

proposals and provided structure to future determinations.

Additionally, a proposal regarding such a schedule should have

adequately analyzed the costs and benefits of alternatives,

including appropriate quantification. Unfortunately, the two rule

proposals that the Commission approved today fail to either propose

a comprehensive schedule or provide an adequate cost benefit

analysis.

The Commission's proposals also fail to request comment on a

number of issues that I believe are important considerations in

developing an implementation plan. As a result, I am encouraging

commenters to submit responses to the questions below as part of

their comments on the two rule proposals.

Swap Transaction Compliance and Implementation Schedule: Clearing

and Trade Execution Requirements under Section 2(h) of the CEA

Should the Commission provide guidance on how it will

make and communicate a mandatory clearing determination prior to

considering the first such determination? If so, what information

should be included in guidance?

As section II(E) of the proposal states: ``When issuing

a mandatory clearing determination, the Commission would set an

effective date by which all market participants would have to

comply. In other words, the proposed compliance schedules would be

used only when the Commission believes that phasing is necessary

based on the considerations outlined in this release. The Commission

will provide the public with notice of its intent to rely upon the

compliance schedule pursuant to the process outlined in Sec.

39.5(b)(5).'' To afford more certainty to market participants,

should the Commission instead create a presumption that it will rely

on the compliance schedule for each mandatory clearing determination

that it issues, unless it finds that the compliance schedule is not

necessary to achieve the benefits set forth in the proposal (e.g.,

facilitating the transition to the new regulatory regime established

by the Dodd-Frank Act in an orderly manner that does not unduly

disrupt markets and transactions)?

What, if any, other issues not addressed in current

proposed or final rulemakings should the Commission have taken into

consideration when proposing the compliance schedule? For example,

should the Commission have considered the extent to which its

clearing and trade execution requirements apply to entities and

transactions located outside the United States? Also, should the

Commission have considered the extent to which such requirements

apply to transactions between affiliates (whether domestic or cross-

border)? If applicable, how should the Commission adjust the

proposed compliance schedule to account for such issues?

What, if any, adjustments should the Commission make to

the proposed compliance schedule for trade execution requirements if

the Commission makes a determination that a group, category, type,

or class of swaps, rather than a specific swap, is subject to

mandatory clearing? Would such adjustments vary depending on the

manner in which the Commission defines group, category, type, or

class?

Swap Transaction Compliance and Implementation Schedule: Trading

Documentation and Margining Requirements Under Section 4s of the

CEA

What, if any, other issues not addressed in current

proposed or final rulemakings should the Commission have taken into

consideration when proposing the compliance schedule? For example,

should the Commission have considered the extent to which its

documentation and margin requirements apply to entities and

transactions located outside the United States? Also, should the

Commission have considered the extent to which such requirements

apply to transactions between affiliates (whether domestic or cross-

border)? If applicable, how should the Commission adjust the

proposed compliance schedule to account for such issues?

Finally, I want to be clear that I support completing the final

Dodd-Frank rulemakings in a reasonable time frame. I believe that

the timely implementation of such rulemakings is important. Knowing

when and how the markets are required to do what is vital to the

success of implementing the new market structure required under the

Dodd-Frank Act. When billions of dollars are at stake, you simply do

not rely on guesses and estimates based on vague conditions.

[FR Doc. 2011-24128 Filed 9-19-11; 8:45 am]

BILLING CODE 6351-01-P

Last Updated: September 20, 2011