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2010-29009

  • FR Doc 2010-29009[Federal Register: November 23, 2010 (Volume 75, Number 225)]

    [Proposed Rules]

    [Page 71397-71408]

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

    [DOCID:fr23no10-19]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Part 23

    RIN 3038-AC96

    Regulations Establishing and Governing the Duties of Swap Dealers

    and Major Swap Participants

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Notice of proposed rulemaking.

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    SUMMARY: The Commodity Futures Trading Commission is proposing

    regulations to implement new statutory provisions enacted by Title VII

    of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The

    proposed regulations set forth certain duties imposed upon swap dealers

    and major swap participants registered with the Commission with regard

    to: Risk management procedures; monitoring of trading to prevent

    violations of applicable position limits; diligent supervision;

    business continuity and disaster recovery; disclosure and the ability

    of regulators to obtain general information; and antitrust

    considerations. The proposed regulations would implement the new

    statutory framework of section 4s(j) of the Commodity Exchange Act,

    added by section 731 of the Dodd-Frank Act, excepting regulations

    related to conflicts of interest pursuant to section 4s(j)(5), which

    will be addressed in a separate rulemaking. These regulations set forth

    certain duties with which swap dealers and major swap participants must

    comply to maintain registration as a swap dealer or major swap

    participant.

    DATES: Submit comments on or before January 24, 2011.

    ADDRESSES: You may submit comments, identified by RIN number 3038-AC96

    and Duties of Swap Dealers and Major Swap Participants, by any of the

    following methods:

    [[Page 71398]]

    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 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 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: Sarah E. Josephson, Associate

    Director, 202-418-5684, sjosephson@cftc.gov; Frank N. Fisanich, Special

    Counsel, 202-418-5949, ffisanich@cftc.gov; or Jocelyn Partridge,

    Special Counsel, 202-418-5926, jpartridge@cftc.gov; Division of

    Clearing and Intermediary Oversight, Commodity Futures Trading

    Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington,

    DC 20581.

    SUPPLEMENTARY INFORMATION:

    I. Background

    On July 21, 2010, President Obama signed the Dodd-Frank Wall Street

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

    the Dodd-Frank Act \2\ amended the Commodity Exchange Act (CEA) \3\ to

    establish a comprehensive regulatory framework to reduce risk, increase

    transparency, and promote market integrity within the financial system

    by, among other things: (1) Providing for the registration and

    comprehensive regulation of swap dealers and major swap participants;

    (2) imposing clearing and trade execution requirements on standardized

    derivative products; (3) creating rigorous recordkeeping and real-time

    reporting regimes; and (4) enhancing the rulemaking and enforcement

    authorities of the Commodity Futures Trading Commission (Commission or

    CFTC) with respect to all registered entities and intermediaries

    subject to the Commission's oversight.

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    \1\ See Dodd-Frank Wall Street Reform and Consumer Protection

    Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the

    Dodd-Frank Act may be accessed at http://www.cftc.gov/LawRegulation/

    OTCDERIVATIVES/index.htm.

    \2\ Pursuant to Section 701 of the Dodd-Frank Act, Title VII may

    be cited as the ``Wall Street Transparency and Accountability Act of

    2010.''

    \3\ 7 U.S.C. 1 et seq.

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    Section 731 of the Dodd-Frank Act amends the CEA by inserting after

    section 4r a new section 4s that sets forth registration and regulatory

    requirements, including a variety of business conduct standards and

    duties, with which swap dealers and major swap participants must comply

    to maintain registration as a swap dealer or major swap participant.

    As part of an overall business conduct regime for swap dealers and

    major swap participants, section 4s(j) of the CEA sets forth certain

    duties for swap dealers and major swap participants, including the duty

    to: (1) Monitor trading to prevent violations of applicable position

    limits; (2) establish risk management procedures adequate for managing

    the day-to-day business of the swap dealer or major swap participant;

    (3) disclose to the Commission and to applicable prudential regulators

    \4\ general information relating to swaps trading, practices, and

    financial integrity; (4) establish and enforce internal systems and

    procedures to obtain information needed to perform all of the duties

    prescribed by Commission regulations; (5) implement conflict-of-

    interest systems and procedures; \5\ and (6) refrain from taking any

    action that would result in an unreasonable restraint of trade or

    impose a material anticompetitive burden on trading or clearing. In

    this release, the Commission is proposing six regulations specifically

    addressing risk management, monitoring of positions limits, diligent

    supervision, business continuity and disaster recovery, the

    availability of general information, and antitrust considerations. The

    Commission would adopt these implementing regulations pursuant to

    authority granted under sections 4s(h)(1)(D), 4s(h)(3)(D), 4s(j)(7),

    and 8a(5) of the CEA.\6\ The Dodd-Frank Act requires the Commission to

    promulgate these provisions by July 15, 2011.

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    \4\ This term is defined for the purposes of this rulemaking and

    generally has the same meaning as section 1(a)(39) of the Commodity

    Exchange Act, which includes the Board of Governors of the Federal

    Reserve System, the Office of the Comptroller of the Currency, the

    Federal Deposit Insurance Corporation, the Farm Credit Association,

    and the Federal Housing Finance Agency.

    \5\ Conflicts of interest under section 4s(j)(5) of the CEA will

    be addressed in a separate rulemaking and the rules pertaining to

    conflicts of interest are not included in the following proposed

    rules.

    \6\ Section 8a(5) of the CEA authorizes the Commission, to

    promulgate such regulations as, in the judgement of the Commission,

    are reasonably necessary to effectuate any of the provisions or to

    accomplish any of the purposes of the CEA.

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    The proposed regulations reflect consultation with staff of the

    following agencies: (i) The Securities and Exchange Commission; (ii)

    the Board of Governors of the Federal Reserve System; (iii) the Office

    of the Comptroller of the Currency; and (iv) the Federal Deposit

    Insurance Corporation. Staff from each of these agencies has had the

    opportunity to provide oral and/or written comments to the proposal,

    and the proposed regulations incorporate elements of the comments

    provided.

    The Commission requests comment on all aspects of the proposed

    regulations, as well as comment on the specific provisions and issues

    highlighted in the discussion below. The Commission further requests

    comment on an appropriate effective date for final regulations,

    including comment on whether it would be appropriate to have staggered

    or delayed effective dates for some regulations based on the nature or

    characteristics of the activities or entities to which they apply.

    Moreover, the Commission recognizes that there will be differences in

    the size and scope of the business of particular swap dealers and major

    swap participants. Therefore, comments are solicited on whether certain

    provisions of the proposed regulations should be modified or adjusted

    to reflect the differences among swap dealers or major swap

    participants.

    II. Proposed Regulations

    A. Structure and Approach

    The proposed regulations set forth business conduct standards with

    which swap dealers and major swap participants must comply. Such duties

    [[Page 71399]]

    are outlined in section 4s(j) of the CEA and include: (1) Monitoring of

    trading; (2) risk management procedures; (3) disclosure of general

    information; (4) ability to obtain information; (5) conflicts of

    interest; and (6) antitrust considerations. Section 4s(j)(7) requires

    the Commission to prescribe rules implementing the enumerated duties.

    The proposed regulations will be grouped under a new subpart to

    part 23, chapter I, title 17 of the Code of Federal Regulations. The

    proposed regulations generally address monitoring of trading and risk

    management together in a single rule requiring each swap dealer and

    major swap participant to establish a comprehensive risk management

    program (rule 23.600). Although part of a comprehensive risk management

    program, monitoring of trading for compliance with applicable position

    limits (rule 23.601); diligent supervision of a swap dealer's or major

    swap participant's business (rule 23.602); and business continuity and

    disaster recovery requirements (rule 23.603) are addressed in separate

    rules for ease of reference. The availability for disclosure and

    inspection of general information (rule 23.606) and antitrust

    considerations (rule 23.607) also are addressed in separate rules.

    Conflicts of interest under section 4s(j)(5) of the CEA (rule 23.605)

    will be addressed in a separate notice of proposed rulemaking to be

    released at the same time as this proposal.

    B. Risk Management

    1. Overview

    Sections 4s(h)(1)(D), 4s(h)(3)(D), and 4s(j) of the CEA authorize

    the Commission to adopt those regulations regarding business conduct

    and risk management that the Commission deems necessary for the public

    interest and in furtherance of the CEA. Pursuant to this authority, the

    Commission is proposing regulation 23.600 to require swap dealers and

    major swap participants to establish a risk management program for

    monitoring and managing the risks associated with their business

    activities.

    The proposed risk management regulation contemplates that each

    legal entity that falls within the definition of swap dealer or major

    swap participant under the CEA and Commission regulations would be

    required to establish a risk management program and risk management

    unit. However, the Commission recognizes that the business activities

    engaged in and risks faced by one affiliate may increase the risk

    exposure or alter overall risk profile of another affiliate or the

    entity as a whole, and that, to be effective, a risk management program

    must protect against the risks resulting from the activities of

    interconnected or otherwise related entities. Accordingly, the proposed

    regulations would require each swap dealer and major swap participant

    to be able to demonstrate that, to the extent possible, it is taking an

    integrated approach to risk management at the consolidated entity

    level.

    Participants in the swap markets are exposed to various risks,

    including, but not limited to: (1) Market risk; \7\ (2) credit risk;

    \8\ (3) liquidity risk; \9\ (4) foreign currency risk; \10\ (5) legal

    risk; \11\ (6) operational risk; \12\ and (7) settlement risk.\13\

    Managing all relevant risks should be integrated into the swap dealer

    and major swap participant's overall risk management structure. The

    Commission believes this approach is particularly warranted given that

    swap dealers and major swap participants may hold positions in a

    variety of financial instruments.

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    \7\ Market risk includes the risk that prices or rates will

    adversely change due to economic forces. This risk includes, among

    other things, changes in correlations between or among products

    (including all types of basis risk), volatility of market prices,

    and the sensitivity of option positions to other market factors.

    \8\ Credit risk includes the risk that a counterparty will be

    unable to meet fully its financial obligations when due or at any

    time in the future.

    \9\ Liquidity risk includes the risk that a firm will not be

    able to settle its obligations when due and/or without adverse price

    changes.

    \10\ Foreign currency risk is the risk arising from movements of

    foreign exchange rates.

    \11\ Legal risk includes risk of loss due to an unenforceable

    contract, an ultra vires act of a counterparty, or failure to comply

    with applicable law.

    \12\ Operational risk includes the risk of loss due to

    deficiencies in information systems, internal processes and

    staffing, or disruptions from external events that result in the

    reduction, deterioration, or breakdown in services or controls

    within the firm.

    \13\ Settlement risk includes the risk of loss arising when a

    party meets its payment obligation under a contract before its

    counterparty meets its payment obligation. Settlement risk lasts

    from the time an outgoing payment instruction can no longer be

    canceled unilaterally until the time the incoming payment is

    received with finality and reconciled.

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    Some of these risks are due, in part, to the characteristics of

    swap products and the way swap markets have evolved over time. For

    example, some swaps are customized or designed with unique

    characteristics that may present previously unforeseen or unpredictable

    risks. Also, for swaps not accepted for clearing, market participants

    face risks associated with the financial and legal ability of

    counterparties to perform under the terms of specific transactions. As

    part of a risk management program, risk managers must carefully review

    any unique product characteristics that may pose unusual risks and take

    steps to manage potential risks before trading commences.

    In the past, the importance of risk management has been highlighted

    by significant losses experienced by several large financial firms.

    Some of these losses were caused by unauthorized and undisclosed

    employee trading. In each case, these losses went virtually undetected

    by management because of the lack of proper internal procedures,

    including the separation of responsibility for recording the trades on

    the firms' books from the personnel responsible for trading. Internal

    risk management policies and procedures promote the stability, safety,

    and soundness of firms by reducing the risk of significant losses,

    which, in turn, may reduce the risk that spreading losses would cause

    defaults by multiple firms, thereby undermining markets as a whole.

    The Commission recognizes that an individual firm must have the

    flexibility to implement specific policies and procedures unique to its

    circumstances. The Commission's rule has been designed such that the

    specific elements of a risk management program will vary depending on

    the size and complexity of a swap dealer's or major swap participant's

    business operations. Risk management policies are expected to provide

    for appropriate risk measurement methodologies, compliance monitoring

    and reporting, and on-going testing and assessment of the overall

    effectiveness of the program. Consequently, proposed regulations

    23.600, 23.601, 23.602, and 23.603 would establish the general

    parameters for the design, implementation, review, and testing of a

    swap dealer's or major swap participant's risk management program, as

    well as a limited number of additional elements that the Commission

    believes are essential to an appropriate risk management program.

    The proposed rules would require a swap dealer or major swap

    participant to adopt policies and procedures to monitor and manage its

    risks, assess the effectiveness of those policies and procedures, and

    modify or update them, as necessary, from time to time. In addition,

    the proposed rule would require certain elements to be included in each

    swap dealer and major swap participant's risk management program to

    ensure that internal systems protect against universal risks. For

    example, to ensure the independence of the risk management process, the

    unit at the firm responsible for monitoring risk must be independent

    from the business trading unit whose activities create the risks. In

    addition, to ensure that trading

    [[Page 71400]]

    losses cannot be hidden, personnel responsible for recording

    transactions in the books of the swap dealer or major swap participant

    cannot be the same as those responsible for executing transactions.

    Similarly, all accounts, including suspense accounts, must be

    monitored.

    Finally, the swap dealer's or major swap participant's management

    must periodically review the firm's business activities for consistency

    with established risk management policies. This will ensure that

    personnel are operating within the scope of activity that management

    has determined to be permissible.

    2. Risk Management Program

    Proposed regulation 23.600(b) provides a general requirement that a

    swap dealer or major swap participant establish and maintain a risk

    management program reasonably designed to monitor and manage the risks

    associated with its business as a swap dealer or major swap

    participant. It further provides (1) That such risk management program

    consist of written policies and procedures; (2) that such policies and

    procedures be approved by the governing body of the swap dealer or

    major swap participant and be furnished to the Commission; and (3) that

    a risk management unit that is independent from the business trading

    unit be established to administer the risk management program.

    The proposed regulations would require swap dealers and major swap

    participants to provide copies of the risk management policies and

    procedures to the Commission in order to allow the Commission to

    monitor the status of risk management practices among swap dealers and

    major swap participants. Submission of such policies and procedures to

    the Commission without further comment or action by the Commission or

    Commission staff should not be construed as an endorsement of the

    completeness or effectiveness of the risk management policies and

    procedures and no swap dealer or major swap participant should make a

    representation to the contrary. The Commission invites comments on the

    submission of risk management policies and procedures and, more

    generally, on whether the provisions of 23.600 have achieved a

    sufficient level of detail for the purposes of designing a

    comprehensive risk management program.

    Proposed regulation 23.600(c) would provide a non-exclusive list of

    the elements that must be a part of the risk management program of a

    swap dealer or major swap participant. Such policies and procedures

    should include: (1) Identifying risks and setting of risk tolerance

    limits; (2) providing periodic risk exposure reports to senior

    management and the governing body; (3) establishing a new product

    policy; and (4) establishing a risk management program that takes into

    account market risk, credit risk, liquidity risk, foreign currency

    risk, legal risk, operational risk, and settlement risk, including a

    process for evaluating and addressing risks associated with the use of

    models to derive market valuations or otherwise calculate or evaluate

    risk exposures. The regulation also would establish requirements for

    supervision of the business unit of a swap dealer or major swap

    participant, including monitoring of limits on individual traders and

    establishing procedures governing the use, supervision, and testing of

    any algorithmic trading program. The objective is to ensure that those

    capable of committing the capital of the swap dealer or major swap

    participant are properly supervised and subject to approved limits.

    Additionally, the risk management program should set forth requirements

    for compliance with Commission regulations related to capital and

    margin and for monitoring overall compliance with the risk management

    program. The rule also would require that swap dealers and major swap

    participants establish policies and procedures (1) to require the use

    of central counterparties for clearing where clearing is required

    pursuant to Commission regulation or order, and (2) to use central

    clearing as a means of mitigating counterparty credit risk.

    To ensure the continued effectiveness of a risk management program,

    proposed regulation 23.600(e) would require quarterly review and

    testing of the adequacy of each swap dealer and major swap

    participant's risk management program by internal audit staff or a

    qualified external, third party service. The Commission requests

    comment on these proposed audit and review requirements.

    C. Monitoring of Position Limits

    Proposed regulation 23.601 would require swap dealers and major

    swap participants to establish policies and procedures to monitor,

    detect, and prevent violations of applicable position limits

    established by the Commission, a designated contract market, or a swap

    execution facility. This rule implements section 4s(j)(1) of the CEA,

    which requires each swap dealer and major swap participant to monitor

    its trading in swaps to prevent violations of applicable position

    limits. In order to prevent violations, each swap dealer and major swap

    participant would be required to provide training to all relevant

    employees on applicable position limits, actively monitor trading,

    implement an early warning system, test the effectiveness of its

    policies and procedures, and report quarterly to its senior management

    and governing body on compliance with applicable position limits. The

    Commission requests comment on how much time would be needed for swap

    dealers and major swap participants to come into compliance with new

    position limits that may be imposed.

    D. Diligent Supervision

    Proposed regulation 23.602 implements section 4s(h)(1)(B) of the

    CEA, which requires each swap dealer and major swap participant to

    conform with Commission regulations related to diligent supervision of

    the business of the swap dealer and major swap participant. The

    proposed regulation provides (1) a requirement for diligent supervision

    reasonably designed to achieve compliance with the CEA and Commission

    regulations, and (2) requirements for qualification of supervisors and

    grants of appropriate supervisory authority.

    E. Business Continuity and Disaster Recovery

    Given the observed interconnectedness of the current swap market,

    and as part of a comprehensive risk management program, the Commission

    believes that each swap dealer and major swap participant should be

    required to establish and maintain a business continuity and disaster

    recovery plan that is reasonably designed to minimize any disruption to

    the financial markets in the event of an emergency or a disruption of a

    swap dealer's or major swap participant's business operations. Proposed

    regulation 23.603 would require swap dealers and major swap

    participants to establish and maintain a business continuity and

    disaster recovery plan designed to enable the swap dealer or major swap

    participant to resume normal operations within one business day of an

    emergency or other disruption.

    To accomplish this task, swap dealers and major swap participants

    would be required to provide the Commission with emergency contacts;

    identify essential documents, data, facilities, infrastructure, and

    personnel, and maintain sufficient back-up facilities in a reasonably

    separate geographic location; design a plan for communicating with

    persons essential

    [[Page 71401]]

    for recovery; and annually test the business continuity and disaster

    recovery plan's effectiveness.

    The Commission invites comments regarding whether a comprehensive

    business continuity and disaster recovery plan is necessary for all

    entities that may register with the Commission as swap dealers or major

    swap participants and whether one business day is sufficient time for

    recovery of essential business operations. The Commission also invites

    comments regarding an appropriate effective date for this regulation

    given the amount of time and cost that may be necessary for

    implementation of a comprehensive business continuity and disaster

    recovery plan.

    F. Disclosure and Ability To Obtain Information

    In order to carry out its oversight and examination

    responsibilities, the Commission would require access to certain

    information of swap dealers and major swap participants.\14\ Sections

    4s(j)(3) and 4s(j)(4) of the CEA require a swap dealer or major swap

    participant to (1) disclose to the Commission and to the swap dealer's

    or major swap participant's prudential regulator information regarding

    the terms and conditions of its swaps, its swap trading operations,

    mechanisms, and practices; its financial integrity protections relating

    to swaps, and other information relevant to its trading in swaps; and

    (2) establish internal systems to obtain necessary information to

    perform any of the functions described in section 4s and for disclosure

    of information to the Commission or prudential regulator upon request.

    Proposed regulation 23.606 would implement these requirements.

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    \14\ The oversight, supervision, and examination regimes for

    swap dealers and major swap participants remain under consideration

    by the Commission. The Commission is considering whether it will

    directly handle oversight, whether it may delegate authority to

    perform oversight to one or more self-regulatory organizations

    (SROs), or whether a combination of Commission and SRO oversight

    would be the optimal approach.

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    Proposed regulation 23.606(a) requires that swap dealers and major

    swap participants make available for disclosure and inspection all

    information required by the Commission, including those items listed in

    section 4s(j)(3). This information would be required to be disclosed

    promptly to the Commission or applicable prudential regulator in the

    manner and frequency as set forth in the relevant regulation. Proposed

    regulation 23.606(b) would require a swap dealer or major swap

    participant to establish and maintain adequate internal systems that

    will permit it to obtain any information required to satisfy its duties

    under section 4s(j) of the CEA.

    G. Antitrust Considerations

    Section 4s(j)(6) of the CEA prohibits a swap dealer or major swap

    participant from adopting any process or taking any action that results

    in any unreasonable restraint of trade or imposes any material

    anticompetitive burden on trading or clearing, unless necessary or

    appropriate to achieve the purposes of the CEA. Proposed regulation

    23.607 would implement these prohibitions by requiring that the swap

    dealer or major swap participant adopt policies and procedures that

    would prevent unreasonable restraint of trade or the imposition of a

    material anticompetitive burden on trading or clearing.

    III. Related Matters

    A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) requires that agencies

    consider whether the rules they propose will have a significant

    economic impact on a substantial number of small entities.\15\ The

    Commission previously has established certain definitions of ``small

    entities'' to be used by the Commission in evaluating the impact of its

    regulations on small entities in accordance with the RFA.\16\ The

    proposed rules would affect swap dealers and major swap participants.

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    \15\ 5 U.S.C. 601 et seq.

    \16\ 47 FR 18618, Apr. 30, 1982.

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    Swap dealers and major swap participants are new categories of

    registrants. Accordingly, the Commission has not previously addressed

    the question of whether such persons are, in fact, small entities for

    purposes of the RFA. However, the Commission previously has determined

    that futures commission merchants should not be considered to be small

    entities for purposes of the RFA.\17\ The Commission's determination

    was based, in part, upon the obligation of futures commission merchants

    to meet the minimum financial requirements established by the

    Commission to enhance the protection of customers' segregated funds and

    protect the financial condition of futures commission merchants

    generally.\18\ Like futures commission merchants, swap dealers will be

    subject to minimum capital and margin requirements and are expected to

    comprise the largest global financial firms. The Commission is required

    to exempt from swap dealer designation any entities that engage in a de

    minimis level of swaps dealing in connection with transactions with or

    on behalf of customers. The Commission anticipates that this exemption

    would tend to exclude small entities from registration. Accordingly,

    for purposes of the RFA for this rulemaking, the Commission is hereby

    proposing that swap dealers not be considered ``small entities'' for

    essentially the same reasons that futures commission merchants have

    previously been determined not to be small entities and in light of the

    exemption from the definition of swap dealer for those engaging in a de

    minimis level of swap dealing.

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    \17\ Id. at 18619.

    \18\ Id.

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    The Commission has also previously determined that large traders

    are not ``small entities'' for RFA purposes.\19\ In that determination,

    the Commission considered that a large trading position was indicative

    of the size of the business. Major swap participants, by statutory

    definition, maintain substantial positions in swaps or maintain

    outstanding swap positions that create substantial counterparty

    exposure that could have serious adverse effects on the financial

    stability of the United States banking system or financial markets.

    Accordingly, for purposes of the RFA for this rulemaking, the

    Commission is hereby proposing that major swap participants not be

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

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

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    \19\ Id. at 18620.

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    Moreover, the Commission is carrying out Congressional mandates by

    proposing this regulation. Specifically, the Commission is proposing

    these regulations to comply with the Dodd-Frank Act, the aim of which

    is to reduce systemic risks presented by swap dealers and swap market

    participants through comprehensive regulation. The Commission does not

    believe that there are regulatory alternatives to those being proposed

    that would be consistent with the statutory mandate. Accordingly, the

    Chairman, on behalf of the Commission, hereby certifies pursuant to 5

    U.S.C. 605(b) that the proposed rules will not have a significant

    economic impact on a substantial number of small entities.

    B. Paperwork Reduction Act

    The Paperwork Reduction Act (PRA) \20\ imposes certain requirements

    on Federal agencies in connection with their conducting or sponsoring

    any collection of information as defined by the PRA. This proposed

    rulemaking would result in new collection of

    [[Page 71402]]

    information requirements within the meaning of the PRA. The Commission

    therefore is submitting this proposal to the Office of Management and

    Budget (OMB) for review in accordance with 44 U.S.C. 3507(d) and 5 CFR

    1320.11. The title for this collection of information is ``Regulations

    Establishing and Governing the Duties of Swap Dealers and Major Swap

    Participants.'' The OMB has not yet assigned this collection a control

    number. 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.

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    \20\ 44 U.S.C. 3501 et seq.

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    The collection of information under these proposed rules is

    necessary to implement certain provisions of the CEA, as amended by the

    Dodd-Frank Act. Specifically, it is essential to ensuring that swap

    dealers and major swap participants maintain risk management programs,

    business continuity and disaster recovery plans, procedures to ensure

    compliance with position limits, and antitrust procedures. Commission

    staff would use the information when conducting the Commission's

    examination and oversight program to evaluate the completeness and

    effectiveness of the procedures adopted by the registrants.

    If the proposed regulations are adopted, responses to this

    collection of information would be mandatory. The Commission will

    protect proprietary information according to the Freedom of Information

    Act and 17 CFR part 145, ``Commission Records and Information.'' In

    addition, section 8(a)(1) of the CEA strictly prohibits the Commission,

    unless specifically authorized by the CEA, from making public ``data

    and information that would separately disclose the business

    transactions or market positions of any person and trade secrets or

    names of customers.'' The Commission is also required to protect

    certain information contained in a government system of records

    according to the Privacy Act of 1974, 5 U.S.C. 552a.

    1. Information Provided by Reporting Entities/Persons

    The proposed regulation would require each swap dealer and major

    swap participant to establish a risk management program (including

    specific policies for compliance with position limits and to ensure

    business continuity and disaster recovery); establish policies to

    prevent unreasonable restraints of trade and anticompetitive burdens;

    establish systems to diligently supervise the activities relating to

    its business; and make certain information available for disclosure and

    inspection by the Commission. These requirements may impose PRA

    burdens. The burden associated with the proposed regulation per

    registrant is estimated to be 204.5 hours per year, at an annual cost

    of $20,450. For purposes of the PRA, the term ``burden'' means the

    ``time, effort, or financial resources expended by persons to generate,

    maintain, or provide information to or for a Federal Agency.'' \21\

    This burden will result from the development of the required policies

    and procedures, satisfaction of various reporting obligations and the

    documentation of required testing.

    ---------------------------------------------------------------------------

    \21\ 44 U.S.C. 3502(2).

    ---------------------------------------------------------------------------

    It is not currently known how many swap dealers and major swap

    participants will become subject to these rules, and this will not be

    known to the Commission until the registration requirements for these

    entities become effective after July 16, 2011, the date on which the

    Dodd-Frank Act becomes effective. While the Commission believes that

    there may likely be approximately 200 swap dealers and 50 major swap

    participants, it has taken a conservative approach, for PRA purposes,

    in estimating that there will be a combined number of 300 swap dealers

    and major swap participants who will be required to establish and

    implement risk management policies and procedures under the proposed

    rules. The Commission estimated the number of affected entities based

    on industry data.

    According to recent Bureau of Labor Statistics, the mean hourly

    wage of an employee under occupation code 11-3031, ``Financial

    Managers,'' (which includes financial risk managers) that is employed

    by the ``Securities and Commodity Contracts Intermediation and

    Brokerage'' industry is $74.41.\22\ Because swap dealers and major swap

    participants include large financial institutions whose risk management

    employees' salaries may exceed the mean wage, the Commission has

    estimated the cost burden of these proposed regulations based upon an

    average salary of $100 per hour. Accordingly, the estimated burden was

    calculated as follows:

    ---------------------------------------------------------------------------

    \22\ http://www.bls.gov/oes/current/oes113031.htm.

    ---------------------------------------------------------------------------

    Drafting, Filing, Updating and Distributing Risk Management Program

    (Including Position Limit Procedures and Business Continuity and

    Disaster Recovery Plan)

    Number of registrants: 300.

    Estimated number of responses: 300.

    Estimated total annual burden per registrant: 160 hours.

    Frequency of collection: One-time filing with the Commission,

    annual distribution, updating as needed.

    Total annual burden: 48,000 burden hours [300 registrants x 160

    hours].

    Quarterly Risk Exposure Reports

    Number of registrants: 300.

    Estimated number of responses: 1,200 [300 registrants x 4 reports].

    Estimated total annual burden per registrant: 32 hours.

    Frequency of collection: Quarterly.

    Total annual burden: 9,600 burden hours [300 registrants x 32

    hours].

    Quarterly Documentation of Risk Management Testing

    Number of registrants: 300.

    Estimated number of responses: 1,200 [300 registrants x 4 tests].

    Estimated total annual burden per registrant: 4 hours.

    Frequency of collection: Quarterly.

    Total annual burden: 1,200 hours [300 registrants x 4 hours].

    Documentation of Annual Position Limit Compliance Training and Audit

    Number of registrants: 300.

    Estimated number of responses: 300.

    Estimated total annual burden per registrant: 2 hours.

    Frequency of collection: Annually.

    Total annual burden: 600 hours [300 registrants x 2 hours].

    Quarterly Documentation of Position Limit Compliance

    Number of registrants: 300.

    Estimated number of responses: 1,200 [300 registrants x 4 reports].

    Estimated total annual burden per registrant: 2 hours.

    Frequency of collection: Quarterly.

    Total annual burden: 600 hours [300 registrants x 2 hours].

    Documentation of Position Limit Violations

    Number of registrants: 300.

    Estimated number of responses: 600 [300 registrants x 2 documents].

    Estimated total annual burden per registrant: .5.

    Frequency of collection: As needed.

    Total annual burden: 150 hours [300 registrants x .5 hours].

    Filing Emergency Contact Information and Annual Documentation of

    Business Continuity Testing

    Number of registrants: 300.

    Estimated number of responses: 300.

    Estimated total annual burden per registrant: 1 hour.

    Frequency of collection: Annual.

    Total annual burden: 300 hours.

    [[Page 71403]]

    Documentation of Risk Assessment of New Products

    Number of registrants: 300.

    Estimated number of responses: 1,500 [300 registrants x 5

    documents].

    Estimated total annual burden per registrant: 3 hours.

    Frequency of collection: As needed.

    Total annual burden: 900 hours [300 registrants x 3 hours].

    Based upon the above, the aggregate cost for all registrants is

    61,350 burden hours and $6,135,000 [61,350 x $100 per hour].

    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.

    Comments may be submitted directly to the Office of Information and

    Regulatory Affairs, by fax at (202) 395-6566 or by e-mail at

    OIRAsubmissions@omb.eop.gov. Please provide the Commission with a copy

    of submitted comments so that all comments can be summarized and

    addressed in the final rule preamble. Refer to the Addresses section of

    this notice of proposed rulemaking for comment submission instructions

    to the Commission. A copy of the supporting statements for the

    collections of information discussed above may be obtained by visiting

    http://www.RegInfo.gov. OMB is required to make a decision concerning

    the collection of information between 30 and 60 days after publication

    of this document in the Federal Register. Therefore, a comment is best

    assured of having its full effect if OMB (and the Commission) receives

    it within 30 days of publication.

    C. Cost-Benefit Analysis

    Section 15(a) of the CEA \23\ requires the Commission to consider

    the costs and benefits of its actions before issuing a rulemaking under

    the CEA. By its terms, Section 15(a) does not require the Commission to

    quantify the costs and benefits of a new regulation or to determine

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

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

    actions.

    ---------------------------------------------------------------------------

    \23\ 7 U.S.C. 19(a).

    ---------------------------------------------------------------------------

    Section 15(a) further specifies that costs and benefits of a

    proposed rulemaking shall be evaluated in light of five broad areas of

    market and public concern: (1) Protection of market participants and

    the public; (2) efficiency, competitiveness, and financial integrity of

    futures markets; (3) price discovery; (4) sound risk management

    practices; and (5) other public interest considerations. The Commission

    may, in its discretion, give greater weight to any one of the five

    enumerated considerations and could, in its discretion, determine that,

    notwithstanding its costs, a particular regulation was necessary or

    appropriate to protect the public interest or to effectuate any of the

    provisions or to accomplish any of the purposes of the CEA.

    Summary of proposed requirements. The proposed regulations would

    implement certain provisions of section 731 of the Dodd-Frank Act,

    which adds a new section 4s(j) to the Commodity Exchange Act. The

    proposed regulations would set forth certain duties imposed upon swap

    dealers and major swap participants registered with the Commission with

    regard to: (1) Risk management procedures; (2) monitoring of trading to

    prevent violations of applicable position limits; (3) diligent

    supervision; (4) business continuity and disaster recovery; (5)

    disclosure and the ability of regulators to obtain general information;

    and (6) antitrust considerations.

    Costs. With respect to costs, the Commission has determined that

    for swap dealers and major swap participants, costs to institute risk

    management systems and personnel in order to satisfy the new regulatory

    requirements are far outweighed by the benefits to the financial system

    as a whole. The proposed rules would require a swap dealer or major

    swap participant to consider a number of issues affecting its business

    environment when creating its risk management system. For example, a

    swap dealer or major swap participant would need to consider, among

    other things, the experience and qualifications of relevant risk

    management personnel, as well as the separation of duties among

    personnel in the business unit, when designing and implementing its

    risk management policies and procedures. These considerations would

    help facilitate the development of a risk management program that

    appropriately addresses the risks posed by the swap dealer's or major

    swap participant's business and the environment in which such business

    is being conducted. In addition, these considerations would guide a

    swap dealer or major swap participant in the implementation of specific

    policies and procedures unique to its circumstances.

    It is estimated that the average amount of time a swap dealer or

    major swap participant would spend annually implementing its

    comprehensive risk management program would be 204.5 hours. Based on an

    hourly wage rate of $100, Commission staff estimates that each

    registrant could expend up to $20,450 annually to comply with the

    proposed rules. This would result in an aggregated cost of $6,135,000

    annually (300 registrants x $20,450).

    Most swap dealers and major swap participants have adequate

    resources and existing risk management structures that are capable of

    adjusting to the new regulatory framework without material diversion of

    resources away from commercial operations.

    Benefits. With respect to benefits, the proposed regulations would

    require swap dealers and major swap participants to assess and monitor

    the adequacy of their risk management under standards established by

    the Commission. This would further the goal of avoiding market

    disruptions and financial losses to market participants and the general

    public. The proposed regulations also would promote prudent risk

    management, oversight and stability, thereby fostering efficiency and a

    greater ability to compete in the broader financial markets. The

    proposed regulations would reward efficiency insofar as swap dealers

    and major swap participants that operate efficiently would have lower

    operating costs and thus would require fewer resources to comply with

    the regulations. Finally, the proposed regulations are designed to

    ensure that swap dealers and major swap participants can sustain their

    market operations and meet their financial obligations to market

    participants, thus contributing to the integrity of the financial

    markets. Therefore, the Commission believes it is prudent to require

    risk management

    [[Page 71404]]

    requirements for swap dealers and major swap participants.

    Public Comment. 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 proposed rules with their comment letters.

    List of Subjects in 17 CFR Part 23

    Antitrust, Commodity futures, Conduct standards, Conflict of

    interests, Major swap participants, Reporting and recordkeeping, Swap

    dealers, Swaps.

    For the reasons stated in this release, the Commission proposes to

    amend 17 CFR part 23 (as proposed in a separate proposed rule published

    elsewhere in this issue of the Federal Register) as follows:

    PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

    Authority and Issuance

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

    Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,

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

    2. Subpart J is added to read as follows:

    Subpart J--Duties of Swap Dealers and Major Swap Participants

    Sec.

    23.600 Risk Management Program for swap dealers and major swap

    participants.

    23.601 Monitoring of position limits.

    23.602 Diligent supervision.

    23.603 Business continuity and disaster recovery.

    23.604 [Reserved]

    23.605 [Reserved]

    23.606 General information: Availability for disclosure and

    inspection.

    23.607 Antitrust considerations.

    Subpart J--Duties of Swap Dealers and Major Swap Participants

    Sec. 23.600 Risk Management Program for swap dealers and major swap

    participants.

    (a) Definitions. For purposes of this subpart J, the following

    terms shall be defined as provided.

    (1) Affiliate. This term means, with respect to any person, a

    person controlling, controlled by, or under common control with, such

    person.

    (2) Business trading unit. This term means any department,

    division, group, or personnel of a swap dealer or major swap

    participant or any of its affiliates, whether or not identified as

    such, that performs or is involved in any pricing, trading, sales,

    marketing, advertising, solicitation, structuring, or brokerage

    activities on behalf of a registrant.

    (3) Clearing unit. This term means any department, division, group,

    or personnel of a registrant or any of its affiliates, whether or not

    identified as such, that performs any proprietary or customer clearing

    activities on behalf of a registrant.

    (4) Governing body. This term typically means, with respect to:

    (i) A sole proprietorship, the proprietor;

    (ii) A corporation, its board of directors;

    (iii) A partnership, any general partner;

    (iv) A limited liability company or limited liability partnership,

    the manager, managing member or those members vested with management

    authority; or

    (v) Any other person, the body or person with ultimate decision-

    making authority over the activities of such person.

    (5) Prudential regulator. This term has the same meaning as section

    1a(39) of the Commodity Exchange Act and includes the Board of

    Governors of the Federal Reserve System, the Office of the Comptroller

    of the Currency, the Federal Deposit Insurance Corporation, the Farm

    Credit Association, and the Federal Housing Finance Agency, as

    applicable to the swap dealer or major swap participant. The term also

    includes the Federal Deposit Insurance Corporation, with respect to any

    financial company as defined in section 201 of under the Dodd-Frank

    Wall Street Reform and Consumer Protection Act or any insured

    depository institution under the Federal Deposit Insurance Act, and

    with respect to each affiliate of any such company or institution.

    (6) Senior management. This term means, with respect to a

    registrant, such registrant's chief executive officer and any officer

    with supervisory duties who reports directly to the chief executive

    officer.

    (b) Risk management program. (1) Purpose. Each swap dealer and

    major swap participant shall establish, document, maintain, and enforce

    a system of risk management policies and procedures designed to monitor

    and manage the risks associated with the business of the swap dealer or

    major swap participant. For purposes of this regulation, such policies

    and procedures shall be referred to collectively as a ``Risk Management

    Program.''

    (2) Written policies and procedures. Each swap dealer and major

    swap participant shall maintain written policies and procedures that

    describe the Risk Management Program of the swap dealer or major swap

    participant.

    (3) Approval by governing body. The Risk Management Program and the

    written risk management policies and procedures shall be approved, in

    writing, by the governing body of the swap dealer or major swap

    participant.

    (4) Furnishing to the Commission. Each swap dealer and major swap

    participant shall furnish a copy of its written risk management

    policies and procedures to the Commission upon application for

    registration. Where there is a material change in the risk management

    policies and procedures, updated risk management policies and

    procedures reflecting that change shall be furnished to the Commission

    within sixty (60) calendar days after the end of the fiscal quarter in

    which the change occurred.

    (5) Risk management unit. As part of its Risk Management Program,

    each swap dealer and major swap participant shall establish and

    maintain a risk management unit with sufficient authority; qualified

    personnel; and financial, operational, and other resources to carry out

    the risk management program established pursuant to this regulation.

    The risk management unit shall report directly to senior management and

    shall be independent from the business trading unit.

    (c) Elements of the Risk Management Program. The Risk Management

    Program of each swap dealer and major swap participant shall include,

    at a minimum, the following elements:

    (1) Identification of risks and risk tolerance limits. (i) The Risk

    Management Program should take into account market, credit, liquidity,

    foreign currency, legal, operational, settlement, and any other

    applicable risks together with a description of the risk tolerance

    limits set by the swap dealer or major swap participant and the

    underlying methodology. The risk tolerance limits shall be reviewed and

    approved quarterly by senior management and annually by the governing

    body. Exceptions to risk tolerance limits shall require prior approval

    of, at a minimum, a supervisor in the risk management unit.

    (ii) The Risk Management Program shall take into account risks

    posed by affiliates and take an integrated approach to risk management

    at the consolidated entity level.

    (iii) The Risk Management Program shall include policies and

    procedures for detecting breaches of risk tolerance limits set by the

    swap dealer or major swap participant, and alerting supervisors within

    the risk management unit and senior management, as appropriate.

    [[Page 71405]]

    (2) Periodic Risk Exposure Reports. (i) The risk management unit of

    each swap dealer and major swap participant shall provide to senior

    management and to its governing body quarterly written reports setting

    forth the market, credit, liquidity, foreign currency, legal,

    operational, settlement, and any other applicable risk exposures of the

    swap dealer or major swap participant; any recommended changes to the

    Risk Management Program; the recommended time frame for implementing

    those changes; and the status of any incomplete implementation of

    previously recommended changes to the Risk Management Program. For

    purposes of this regulation, such reports shall be referred to as

    ``Risk Exposure Reports.'' The Risk Exposure Reports also shall be

    provided to the senior management and the governing body immediately

    upon detection of any material change in the risk exposure of the swap

    dealer or major swap participant.

    (ii) Furnishing to the Commission. Each swap dealer and major swap

    participant shall furnish copies of its Risk Exposure Reports to the

    Commission within five (5) business days of providing such reports to

    its senior management.

    (3) New product policy. The Risk Management Program of each swap

    dealer and major swap participant shall include a new product policy

    that is designed to identify and take into account the risks of any new

    product prior to engaging in transactions involving the new product.

    The new product policy should include the following elements:

    (i) Consideration of the type of counterparty with which the new

    product will be transacted; the product's characteristics and economic

    function; and whether the product requires a novel pricing methodology

    or presents novel legal and regulatory issues.

    (ii) Identification and analysis of the relevant risks of the new

    product and how they will be managed. The risk analysis should include

    an assessment of any product, market, credit, liquidity, foreign

    currency, legal, operational, settlement, and any other risks

    associated with the new product. Product risk characteristics may

    include, but are not limited to, volatility, non-linear price

    characteristics, jump-to-default risk, and any correlation between the

    value of the product and the counterparty's creditworthiness.

    (iii) An assessment, signed by a supervisor in the risk management

    unit, as to whether the new product would materially alter the overall

    entity-wide risk profile of the swap dealer or major swap participant.

    If the new product would materially alter the overall risk profile of

    the swap dealer or major swap participant, the new product must be pre-

    approved by the governing body before any transactions are effectuated.

    (iv) A requirement that the risk management unit review the risk

    analysis to identify any necessary modifications to the Risk Management

    Program and implement such modifications prior to engaging in

    transactions involving the new product.

    (4) Specific risk management considerations. The Risk Management

    Program of each swap dealer and major swap participant shall include,

    but not be limited to, policies and procedures necessary to monitor and

    manage the following risks:

    (i) Market risk. Market risk policies and procedures shall take

    into account, among other things:

    (A) Daily measurement of market exposure, including exposure due to

    unique product characteristics, volatility of prices, basis and

    correlation risks, leverage, sensitivity of option positions, and

    position concentration, to comply with market risk tolerance limits;

    (B) Timely and reliable valuation data derived from, or verified

    by, sources that are independent of the business trading unit, and if

    derived from pricing models, that the models have been independently

    validated by qualified, independent persons; and

    (C) Reconciliation of profits and losses resulting from valuations

    with the general ledger at least once each business day.

    (ii) Credit risk. Credit risk policies and procedures shall take

    into account, among other things:

    (A) Daily measurement of overall credit exposure to comply with

    counterparty credit limits;

    (B) Monitoring and reporting of violations of counterparty credit

    limits performed by personnel that are independent of the business

    trading unit; and

    (C) Regular valuation of collateral used to cover credit exposures

    and safeguarding of collateral to prevent loss, disposal,

    rehypothecation, or use unless appropriately authorized.

    (iii) Liquidity risk. Liquidity risk policies and procedures shall

    take into account, among other things:

    (A) Daily measurement of liquidity needs;

    (B) Testing of procedures to liquidate all non-cash collateral in a

    timely manner and without significant effect on price; and

    (C) Application of appropriate collateral haircuts that accurately

    reflect market and credit risk.

    (iv) Foreign currency risk. Foreign currency risk policies and

    procedures shall take into account, among other things:

    (A) Daily measurement of the amount of capital exposed to

    fluctuations in the value of foreign currency to comply with applicable

    limits; and

    (B) Establishment of safeguards against adverse currency

    fluctuations.

    (v) Legal risk. Legal risk policies and procedures shall take into

    account, among other things:

    (A) Determinations that transactions and netting arrangements

    entered into have a sound legal basis; and

    (B) Establishment of documentation tracking procedures designed to

    ensure the completeness of relevant documentation and to resolve any

    documentation exceptions on a timely basis.

    (vi) Operational risk. Operational risk policies and procedures

    shall take into account, among other things:

    (A) Secure and reliable operating and information systems with

    adequate, scalable capacity, and independence from the business trading

    unit;

    (B) Safeguards to detect, identify, and promptly correct

    deficiencies in operating and information systems; and

    (C) Reconciliation of all operating and information systems.

    (vii) Settlement risk. Settlement risk policies and procedures

    shall take into account, among other things:

    (A) Establishment of standard settlement instructions with each

    counterparty;

    (B) Procedures to track outstanding settlement items and aging

    information in all accounts, including nostro and suspense accounts;

    and

    (C) Procedures to ensure timely payments to counterparties and to

    resolve any late payments.

    (5) Use of central counterparties. Each swap dealer and major swap

    participant shall establish policies and procedures relating to its use

    of central counterparties. Such policies and procedures shall:

    (i) Require the use of central counterparties where clearing is

    required pursuant to Commission regulation or order, unless the

    counterparty has properly invoked a clearing exemption under Commission

    regulations;

    (ii) Set forth the conditions for use of central counterparties for

    clearing when available as a means of mitigating counterparty credit

    risk; and

    (iii) Require diligent investigation into the adequacy of the

    financial resources

    [[Page 71406]]

    and risk management procedures of any central counterparty through

    which the swap dealer or major swap participant clears.

    (6) Compliance with margin and capital requirements. Each swap

    dealer and major swap participant shall satisfy all capital and margin

    requirements established by the Commission or prudential regulator, as

    applicable.

    (7) Monitoring of compliance with Risk Management Program. Each

    swap dealer and major swap participant shall establish policies and

    procedures to detect violations of the Risk Management Program; to

    encourage employees to report such violations to senior management,

    without fear of retaliation; and to take specified disciplinary action

    against employees who violate the Risk Management Program.

    (d) Business trading unit. Each swap dealer and major swap

    participant shall establish policies and procedures that, at a minimum:

    (1) Require all trading policies be approved by the governing body

    of the swap dealer or major swap participant;

    (2) Require that traders execute transactions only with

    counterparties for whom credit limits have been established;

    (3) Provide specific quantitative or qualitative limits for traders

    and personnel able to commit the capital of the swap dealer or major

    swap participant;

    (4) Monitor each trader throughout the trading day to prevent the

    trader from exceeding any limit to which the trader is subject, or from

    otherwise incurring undue risk;

    (5) Require each trader to follow established policies and

    procedures for executing and confirming all transactions;

    (6) Establish means to detect unauthorized trading activities or

    any other violation of policies and procedures;

    (7) Ensure that trade discrepancies are brought to the immediate

    attention of management of the business trading unit and are

    documented;

    (8) Ensure that the risk management unit reviews brokers'

    statements, reconciles brokers' charges to estimates, reviews and

    monitors broker's commissions, and initiates payment to brokers;

    (9) Ensure that use of algorithmic trading programs is subject to

    policies and procedures governing the use, supervision, maintenance,

    testing, and inspection of the program; and

    (10) Require the separation of personnel in the business trading

    unit from personnel in the risk management unit.

    (e) Review and testing. (1) Risk Management Programs shall be

    reviewed and tested on at least a quarterly basis, or upon any material

    change in the business of the swap dealer or major swap participant

    that is reasonably likely to alter the risk profile of the swap dealer

    or major swap participant.

    (2) The quarterly reviews of the Risk Management Program shall

    include an analysis of adherence to, and the effectiveness of, the risk

    management policies and procedures, and any recommendations for

    modifications to the Risk Management Program. The quarterly testing

    shall be performed by qualified internal audit staff that are

    independent of the business trading unit being audited or by a

    qualified third party audit service reporting to staff that are

    independent of the business trading unit. The results of the quarterly

    reviews of the Risk Management Program shall be promptly reported to

    and reviewed by, the chief compliance officer, senior management, and

    governing body of the swap dealer or major swap participant.

    (3) Each swap dealer and major swap participant shall document all

    internal and external reviews and testing of its Risk Management

    Program and written risk management policies and procedures including

    the date of the review or test; the results; any deficiencies

    identified; the corrective action taken; and the date that corrective

    action was taken. Such documentation shall be provided to Commission

    staff, upon request.

    (f) Distribution of risk management policies and procedures. The

    Risk Management Program shall include procedures for the timely

    distribution of its written risk management policies and procedures to

    relevant supervisory personnel. Each swap dealer and major swap

    participant shall maintain records of the persons to whom the risk

    management policies and procedures were distributed and when they were

    distributed.

    (g) Recordkeeping. (1) Each swap dealer and major swap participant

    shall maintain copies of all written approvals required by this

    section.

    (2) All records or reports that a swap dealer or major swap

    participant is required to maintain pursuant to this regulation shall

    be maintained in accordance with 17 CFR 1.31 and shall be made

    available promptly upon request to representatives of the Commission

    and to representatives of applicable prudential regulators.

    Sec. 23.601 Monitoring of position limits.

    (a) Each swap dealer and major swap participant shall establish and

    enforce written policies and procedures that are designed to monitor

    for and prevent violations of applicable position limits established by

    the Commission, a designated contract market, or a swap execution

    facility, and to monitor for and prevent improper reliance upon any

    exemptions or exclusions from such position limits. For purposes of

    this regulation, such policies and procedures shall be referred to as

    ``Position Limit Procedures.'' The Position Limit Procedures shall be

    incorporated into the Risk Management Program of the swap dealer or

    major swap participant.

    (b) For purposes of the Position Limit Procedures, each swap dealer

    and major swap participant shall convert all swap positions into

    equivalent futures positions using the methodology set forth in

    Commission regulations.

    (c) Each swap dealer and major swap participant shall provide

    training to all relevant personnel on applicable position limits on an

    annual basis and promptly upon any change to applicable position

    limits. Each swap dealer and major swap participant shall maintain

    records of such training including the substance of the training and

    the identity of those receiving training.

    (d) Each swap dealer and major swap participant shall diligently

    monitor its trading activities and diligently supervise the actions of

    its partners, officers, employees, and agents to ensure compliance with

    the Position Limit Procedures of the swap dealer or major swap

    participant.

    (e) The Position Limit Procedures of each swap dealer and major

    swap participant shall implement an early warning system designed to

    detect and alert its senior management when position limits are in

    danger of being breached (such as when trading has reached a percentage

    threshold of the applicable position limit, and when position limits

    have been exceeded). Any detected violation of applicable position

    limits shall be reported promptly to the firm's governing body and to

    the Commission. Each swap dealer and major swap participant shall

    maintain a record of any early warning received, any position limit

    violation detected, any action taken as a result of either, and the

    date action was taken.

    (f) Each swap dealer and major swap participant shall test its

    Position Limit Procedures for adequacy and effectiveness each month and

    maintain records of such monthly tests; the results thereof; any action

    that is taken as a result thereof including, without limitation, any

    recommendations for

    [[Page 71407]]

    modifications to the firm's Position Limit Procedures; and the date

    action was taken.

    (g) Each swap dealer and major swap participant shall document its

    compliance with applicable position limits established by the

    Commission, a designated contract market, or a swap execution facility

    in a written report on a quarterly basis. Such report shall be promptly

    reported to and reviewed by the chief compliance officer, senior

    management, and governing body of the swap dealer or major swap

    participant, and shall include, without limitation, a list of all early

    warnings received, all position limit violations, the action taken in

    response, the results of the monthly position limit testing required by

    this regulation, any deficiencies in the Position Limit Procedures, the

    status of any pending amendments to the Position Limit Procedures, and

    any action taken to amend the Position Limit Procedures to ensure

    compliance with all applicable position limits. Each swap dealer and

    major swap participant shall retain a copy of this report.

    (h) On an annual basis, each swap dealer and major swap participant

    shall audit its Position Limit Procedures as part of the audit of its

    Risk Management Program required by Commission regulations.

    (i) All records required to be maintained pursuant to these

    regulations shall be maintained in accordance with 17 CFR 1.31 and

    shall be made available promptly upon request to representatives of the

    Commission and to representatives of applicable prudential regulators.

    Sec. 23.602 Diligent supervision.

    (a) Supervision. Each swap dealer and major swap participant shall

    establish and maintain a system to supervise, and shall diligently

    supervise, all activities relating to its business performed by its

    partners, members, officers, employees, and agents (or persons

    occupying a similar status or performing a similar function). Such

    system shall be reasonably designed to achieve compliance with the

    requirements of the Commodity Exchange Act and Commission regulations.

    (b) Supervisory System. Such supervisory system shall provide, at a

    minimum, for the following:

    (1) The designation, where applicable, of a person with authority

    to carry out the supervisory responsibilities of the swap dealer or

    major swap participant for all activities relating to its business as a

    swap dealer or major swap participant.

    (2) The use of reasonable efforts to determine that all supervisors

    are qualified and meet such standards of training, experience,

    competence, and such other qualification standards as the Commission

    finds necessary or appropriate.

    Sec. 23.603 Business continuity and disaster recovery.

    (a) Business continuity and disaster recovery plan required. Each

    swap dealer and major swap participant shall establish and maintain a

    written business continuity and disaster recovery plan that outlines

    the procedures to be followed in the event of an emergency or other

    disruption of its normal business activities. The business continuity

    and disaster recovery plan shall be designed to enable the swap dealer

    or major swap participant to continue or to resume any operations by

    the next business day with minimal disturbance to its counterparties

    and the market, and to recover all documentation and data required to

    be maintained by applicable law and regulation.

    (b) Essential components. The business continuity and disaster

    recovery plan of a swap dealer or major swap participant shall include

    the following components:

    (1) Identification of the documents, data, facilities,

    infrastructure, personnel and competencies essential to the continued

    operations of the swap dealer or major swap participant and to fulfill

    the obligations of the swap dealer or major swap participant.

    (2) Identification of the supervisory personnel responsible for

    implementing each aspect of the business continuity and disaster

    recovery plan and the emergency contacts required to be provided

    pursuant to this regulation.

    (3) A plan to communicate with the following persons in the event

    of an emergency or other disruption, to the extent applicable to the

    operations of the swap dealer or major swap participant: Employees;

    counterparties; swap data repositories; execution facilities; trading

    facilities; clearing facilities; regulatory authorities; data,

    communications and infrastructure providers and other vendors; disaster

    recovery specialists and other persons essential to the recovery of

    documentation and data, the resumption of operations, and compliance

    with the Commodity Exchange Act and Commission regulations.

    (4) Procedures for, and the maintenance of, back-up facilities,

    systems, infrastructure, personnel and other resources to achieve the

    timely recovery of data and documentation and to resume operations as

    soon as reasonably possible and generally within the next business day.

    (5) Maintenance of back-up facilities, systems, infrastructure and

    personnel in one or more areas that are geographically separate from

    the swap dealer's or major swap participant's primary facilities,

    systems, infrastructure and personnel (which may include contractual

    arrangements for the use of facilities, systems and infrastructure

    provided by third parties).

    (6) Back-up or copying, with sufficient frequency, of documents and

    data essential to the operations of the swap dealer or major swap

    participant or to fulfill the regulatory obligations of the swap dealer

    or major swap participant and storing the information off-site in

    either hard-copy or electronic format.

    (7) Identification of potential business interruptions encountered

    by third parties that are necessary to the continued operations of the

    swap dealer or major swap participant and a plan to minimize the impact

    of such disruptions.

    (c) Distribution to employees. Each swap dealer and major swap

    participant shall distribute a copy of its business continuity and

    disaster recovery plan to relevant employees and promptly provide any

    significant revision thereto. Each swap dealer and major swap

    participant shall maintain copies of the business continuity and

    disaster recovery plan at one or more accessible off-site locations.

    Each swap dealer and major swap participant shall train relevant

    employees on applicable components of the business continuity and

    disaster recovery plan.

    (d) Commission notification. Each swap dealer and major swap

    participant shall promptly notify the Commission of any emergency or

    other disruption that may affect the ability of the swap dealer or

    major swap participant to fulfill its regulatory obligations or would

    have a significant adverse effect on the swap dealer or major swap

    participant, its counterparties, or the market.

    (e) Emergency contacts. Each swap dealer and major swap participant

    shall provide to the Commission the name and contact information of two

    employees who the Commission can contact in the event of an emergency

    or other disruption. The individuals identified shall be authorized to

    make key decisions on behalf of the swap dealer or major swap

    participant and have knowledge of the firm's business continuity and

    disaster recovery plan. The swap dealer or major swap participant shall

    provide the Commission with any updates to this information promptly.

    [[Page 71408]]

    (f) Review and modification. A member of the senior management of

    each swap dealer and major swap participant shall review the business

    continuity and disaster recovery plan annually or upon any material

    change to the business. Any deficiencies found or corrective action

    taken shall be documented.

    (g) Testing. Each business continuity and disaster recovery plan

    shall be tested annually by qualified, independent internal audit

    personnel or a qualified third party audit service. The date the

    testing was performed shall be documented, together with the nature and

    scope of the testing, any deficiencies found, any corrective action

    taken, and the date that corrective action was taken.

    (h) Business continuity and disaster recovery plans required by

    other regulatory authorities. A swap dealer or major swap participant

    shall comply with the requirements of this regulation in addition to

    any business continuity and disaster recovery requirements that are

    imposed upon the swap dealer or major swap participant by its

    prudential regulator or any other regulatory or self-regulatory

    authority.

    (i) Recordkeeping. The business continuity and disaster recovery

    plan of the swap dealer and major swap participant and all other

    records required to be maintained pursuant to this section shall be

    maintained in accordance with Commission Regulation Sec. 1.31 and

    shall be made available promptly upon request to representatives of the

    Commission and to representatives of applicable prudential regulators.

    Sec. 23.604 [Reserved]

    Sec. 23.605 [Reserved]

    Sec. 23.606 General information: Availability for disclosure and

    inspection.

    (a) Disclosure of information. (1) Each swap dealer and major swap

    participant shall make available for disclosure to and inspection by

    the Commission and its prudential regulator, as applicable, all

    information required by, or related to, the Commodity Exchange Act and

    Commission regulations, including:

    (i) The terms and condition of its swaps;

    (ii) Its swaps trading operations, mechanisms, and practices;

    (iii) Financial integrity and risk management protections relating

    to swaps; and

    (iv) Any other information relevant to its trading in swaps.

    (2) Such information shall be made available promptly, upon

    request, to Commission staff and the staff of the applicable prudential

    regulator, at such frequency and in such manner as is set forth in the

    Commodity Exchange Act, Commission regulations, or the regulations of

    the applicable prudential regulator.

    (b) Ability to provide information. (1) Each swap dealer and major

    swap participant shall establish and maintain reliable internal data

    capture, processing, storage, and other operational systems sufficient

    to capture, process, record, store, and produce all information

    necessary to satisfy its duties under the Commodity Exchange Act and

    Commission regulations. Such systems shall be designed to produce the

    information within the time frames set forth in the Commodity Exchange

    Act and Commission regulations or upon request, as applicable.

    (2) Each swap dealer and major swap participant shall establish,

    implement, maintain, and enforce written procedures for the capture,

    processing, recording, storage, and production of all information

    necessary to satisfy its duties under the Commodity Exchange Act and

    Commission regulations.

    (c) Record retention. All records or reports that a swap dealer or

    major swap participant is required to maintain pursuant to this

    regulation shall be maintained in accordance with 17 CFR 1.31 and shall

    be made available promptly upon request to representatives of the

    Commission and to representatives of applicable prudential regulators.

    Sec. 23.607 Antitrust considerations.

    (a) No swap dealer or major swap participant shall adopt any

    process or take any action that results in any unreasonable restraint

    of trade, or impose any material anticompetitive burden on trading or

    clearing, unless necessary or appropriate to achieve the purposes of

    the Commodity Exchange Act.

    (b) Consistent with its obligations under paragraph (a) of this

    section, each swap dealer and major swap participant shall adopt

    policies and procedures to prevent actions that result in unreasonable

    restraint of trade, or impose any material anticompetitive burden on

    trading or clearing.

    Issued in Washington, DC, on November 10, 2010, by the

    Commission.

    David A. Stawick,

    Secretary of the Commission.

    Statement of Chairman Gary Gensler

    Regulations Establishing and Governing the Duties of Swap Dealers and

    Major Swap Participants

    I support the proposed business conduct standards rulemaking

    that establishes risk management policies for swap dealers and major

    swap participants. One of the primary goals of the Dodd-Frank Act

    was to bring swap dealers and major swap participants under

    comprehensive regulation to reduce risk to the financial system and

    to the economy as a whole. The proposed rules are consistent with

    the Congressional requirement that swap dealers and major swap

    participants: (1) Monitor trading to prevent violations of position

    limits; (2) establish risk management procedures for managing their

    day-to-day business; (3) disclose to the Commission and to

    applicable prudential regulators general information relating to

    trading practices and financial integrity of swaps; (4) establish

    and enforce internal systems and procedures to obtain information

    needed to perform all of the duties prescribed; (5) implement

    conflicts of interest systems and procedures; and (6) refrain from

    unreasonably restraining trade or imposing an anticompetitive burden

    on trading or clearing.

    [FR Doc. 2010-29009 Filed 11-22-10; 8:45 am]

    BILLING CODE 6351-01-P

    Last Updated: November 23, 2010