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2010-29831

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

    [Proposed Rules]

    [Page 75432-75439]

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

    [DOCID:fr03de10-14]

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    Proposed Rules

    Federal Register

    ________________________________________________________________________

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

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

    notices is to give interested persons an opportunity to participate in

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

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    [[Page 75432]]

    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Parts 23 and 190

    RIN 3038-AD28

    Protection of Collateral of Counterparties to Uncleared Swaps;

    Treatment of Securities in a Portfolio Margining Account in a Commodity

    Broker Bankruptcy

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Notice of proposed rulemaking.

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

    hereby proposes rules to implement new statutory provisions enacted by

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

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

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

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

    collateral posted by their counterparties to margin, guarantee, or

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

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

    Securities held in a portfolio margining account that is a futures

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

    constitute ``customers''.

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

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

    by any of the following methods:

    Agency Web site, via its Comments Online process: http://

    comments.cftc.gov. Follow the instructions for submitting comments

    through the Web site.

    Mail: David A. Stawick, Secretary of the Commission,

    Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st

    Street, NW., Washington, DC 20581.

    Hand Delivery/Courier: Same as mail above.

    Federal eRulemaking Portal: http://www.regulations.gov.

    Follow the instructions for submitting comments.

    Please submit your comments by only one method.

    All comments must be submitted in English, or if not, accompanied

    by an English translation. Comments will be posted as received to

    http://www.cftc.gov. You should submit only information that you wish

    to make available publicly. If you wish the Commission to consider

    information that you believe is exempt from disclosure under the

    Freedom of Information Act, a petition for confidential treatment of

    the exempt information may be submitted according to the procedures

    established in CFTC Regulation 145.9, 17 CFR 145.9.

    The Commission reserves the right, but shall have no obligation, to

    review, pre-screen, filter, redact, refuse or remove any or all of your

    submission from http://www.cftc.gov that it may deem to be

    inappropriate for publication, such as obscene language. All

    submissions that have been redacted or removed that contain comments on

    the merits of the rulemaking will be retained in the public comment

    file and will be considered as required under the Administrative

    Procedure Act and other applicable laws, and may be accessible under

    the Freedom of Information Act.

    FOR FURTHER INFORMATION CONTACT: Robert B. Wasserman, Associate

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

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

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

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

    case, also at the Commodity Futures Trading Commission, Three Lafayette

    Centre, 1155 21st Street, NW., Washington, DC 20581.

    SUPPLEMENTARY INFORMATION:

    I. Background

    On July 21, 2010, President Obama signed the Dodd-Frank Act.\1\

    Title VII of the Dodd-Frank Act \2\ amended the Commodity Exchange Act

    (``CEA'') \3\ to establish a comprehensive new regulatory framework for

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

    reduce risk, increase transparency, and promote market integrity within

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

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

    imposing mandatory clearing and trade execution requirements on

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

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

    enforcement authorities of the Commission with respect to, among

    others, all registered entities and intermediaries subject to the

    oversight of the Commission.

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    \1\ See Dodd-Frank Act, Public Law. 111-203, 124 Stat. 1376

    (2010). The text of the Dodd-Frank Act may be accessed at http://

    www.cftc.gov./LawRegulation/OTCDERIVATIVES/index.htm.

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

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

    2010.''

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

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

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

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

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

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

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

    that such rulemaking will be completed by the statutory deadline of

    July 15, 2011. See, e.g., Http://Www.Cftc.Gov/Lawregulation/

    Otcderivatives/OTC_2_Definitions.Html.

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

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

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

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

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

    Title 17, Sec. Sec. 23.600 through 23.609.

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

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

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

    commodity broker \5\ bankruptcy, of (i)

    [[Page 75433]]

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

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

    this preamble, these changes are implemented in proposed amendments to

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

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

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

    to register as a futures commission merchant under the Commodity

    Exchange Act including a person registered as such under Parts 32

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

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

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

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

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

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

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

    must be liquidated in accordance with chapter 7, subchapter IV

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

    provides certain protections for collateral that customers deposit

    with the commodity broker. Pursuant to its authority under Section

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

    promulgating Regulation Part 190.

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

    Part IV below describes proposed technical amendments to Regulation

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

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

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

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

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

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

    avoidable by the trustee in a commodity broker bankruptcy.

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

    defines ``commodity contract.''

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

    property subject to pro rata distribution in a commodity broker

    bankruptcy which is entitled to the priority set forth in Section

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

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

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    The Commission requests comment on all aspects of this release.

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

    Uncleared Swaps

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

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

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

    collateral supplied for margining, guaranteeing, or securing uncleared

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

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    \8\ It should be noted that this rulemaking addresses

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

    if any, a counterparty is required to post.

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

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

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

    definition below.

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    An SD or MSP must notify each counterparty at the

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

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

    margin, guarantee, or secure its obligations; and

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

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

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

    part 23 of title 17.

    A. Regulation 23.600: Definitions

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

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

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

    accounts.

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

    which a counterparty has the right to segregation pursuant to CEA

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

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

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

    Sec. 23.600 is temporally-based:

    1. Initial Margin

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

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

    2. Variation Margin

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

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

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

    was marked to market.

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

    an expanded version of these definitions (to include initial and

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

    Part 1, and incorporating those definitions by reference here.

    The Commission seeks comment on the appropriateness of these

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

    definitions.

    B. Regulation 23.601: Notification of Right to Segregation

    1. Required Notification

    Proposed Regulation 23.601(a) incorporates the statutory

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

    notify each counterparty with respect to an uncleared swap that the

    counterparty has the right to require that initial margin posted by

    that counterparty be segregated in accordance with these rules. The

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

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

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

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

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

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

    certain degree of favor given to an affirmative election.

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

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

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    The Commission has not proposed any particular disclosure

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

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

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

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

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

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

    renounces the right to segregation?

    2. Limitation of Right--Variation Margin

    Proposed Regulation 23.601(b) incorporates the limitation in

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

    not apply to variation margin.

    3. Counterparty Notification

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

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

    appropriate level of the counterparty organization. Proposed Regulation

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

    decisionmakers, in descending order of preference. Notification is made

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

    highest level decisionmaker for the counterparty. The Commission seeks

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

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

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

    municipality).

    4. Required Confirmation

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

    from the counterparty confirmation of receipt of such notification by

    the specified decisionmaker, and the election to require segregation or

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

    maintain records of such confirmation and election as business records

    in accordance with Regulation 1.31.

    5. Limitation of Responsibility To Notify

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

    be made ``at

    [[Page 75434]]

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

    notification at the beginning of each swap transaction. Such repetitive

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

    importance of the decision discussed above suggests that some periodic

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

    balance these considerations by providing that notification of a

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

    once in any calendar year.

    6. Power To Change Election With Regard to Segregation

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

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

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

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

    swaps entered into between the parties after such delivery.

    The Commission seeks comments on the issues referred to in this

    section I(B).

    C. Regulation 23.602: Requirements for Segregated Collateral

    1. Independent Custodian and Separate Account

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

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

    election under proposed Regulation 23.601 to be segregated with a

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

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

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

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

    segregation does not apply to variation margin, the regulation provides

    the swap dealer or major swap participant and the counterparty may

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

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

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

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

    in swaps transactions with affiliates of their usual depositories.

    Comment is requested as to whether this approach is appropriate.

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

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

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

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

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

    placed on that choice?

    2. Requirements for Custody Agreement

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

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

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

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

    and expensive interpleader proceedings.\11\ The custody agreement

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

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

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

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

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

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

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

    is entitled to such turnover pursuant to an agreement between the

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

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

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

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

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

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

    whether the foregoing approach is appropriate, including on whether a

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

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

    personal knowledge.

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

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

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

    such claims without risking legal liability, the custodian would

    likely choose to interplead the collateral.

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

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

    withdrawals are not made is enhanced by the findings of the

    Commission's Division of Clearing and Intermediary Oversight in

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

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

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

    custodial accounts], without the required knowledge or approval of

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

    party custodial accounts are real and material, not merely

    theoretical.'').

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    D. Regulation 23.603: Investment of Segregated Collateral

    1. Limitations on Investments

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

    arrangements regarding the investment of segregated funds or other

    property that may only be invested in such investments as the

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

    accordingly provides that segregated initial margin may only be

    invested consistent with the standards for investment of customer funds

    that the Commission applies to exchange-traded futures, Regulation

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

    degree of flexibility in making investments with segregated property,

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

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

    parties who are relying on that margin.\14\

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

    in an Account for Foreign Futures and Foreign Options Transactions,

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

    to Commission Regulation 1.25).

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    This regulation governs only investments of initial margin posted

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

    be posted as such margin.

    2. Commercial Arrangements Regarding Investments and Allocations

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

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

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

    investment of segregated initial margin and the related allocation of

    gains and losses resulting from such investment.

    E. Regulation 23.604: Requirements for Non-Segregated Collateral

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

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

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

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

    collateral requirements are in compliance with the agreement of the

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

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

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

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

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

    the CEA responsible for such report.

    [[Page 75435]]

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

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

    between the counterparties.

    F. Effective Date

    The Commission requests comment on the appropriate timing of

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

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

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

    why a shorter period will not be sufficient.

    III. Portfolio Margining Accounts

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

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

    to ensure that securities held in a portfolio margining account carried

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

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

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

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

    A. Regulation 190.01(k): Definition of Customer

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

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

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

    customer shall include the owner of a portfolio margining account

    carried as a futures account.''

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

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

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

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

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

    futures account.''

    C. Effective Date of Proposal

    The Commission believes that these rule amendments clarify existing

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

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

    IV. Statutory Time-Periods Technical Amendments Act of 2009

    The purpose of this portion of the rulemaking is to implement

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

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

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

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

    Act.

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

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

    property from the debtor, whether shortly before or after the

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

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

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

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

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

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

    relief.''

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

    \16\ See supra note 6.

    \17\ See supra note 7.

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

    The change in the statutory deadline should be reflected in the

    relevant Commission regulations. Moreover, under current business and

    legal practice, emergency matters (such as transfers during a

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

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

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

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

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

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

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

    which the Commission is notified prior to the transfer pursuant to

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

    (prohibition of avoidance of transfers at the direction of the

    Commission).

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

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

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

    the foregoing amendments to part 190 effective immediately upon

    promulgation of a final rule.

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    \18\ See supra note 5.

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    V. Related Matters

    A. Regulatory Flexibility Act

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

    concerns that government regulations may have a significant and/or

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

    RFA requires agencies to conduct an initial and final regulatory

    flexibility analysis for each rule of general applicability for which

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

    analyses must describe the impact of the proposed rule on small

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

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

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

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

    significant alternatives to the proposed rule that would minimize any

    significant impacts on small entities.\20\

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

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

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    The proposed Regulations will impose regulatory obligations on SDs

    and MSPs. The Commission has already established certain definitions of

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

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

    new categories of registrant. Accordingly, the Commission has not

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

    for purposes of the RFA.

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

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    The Commission previously has determined that FCMs should not be

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

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

    meet the minimum financial requirements established by the Commission

    to enhance the protection of customers' segregated funds and protect

    the financial condition of FCMs generally.\22\ Like FCMs, SDs will be

    subject to minimum capital and margin requirements, and are expected to

    comprise the largest global financial firms. The Commission is required

    to exempt from designation entities that engage in a de minimis level

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

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

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

    essentially the same reasons that FCMs have previously been determined

    not to be small entities.

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    \22\ Id. at 18619.

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    The Commission has also previously determined that large traders

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

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

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

    substantial positions in swaps, creating substantial counterparty

    exposure that

    [[Page 75436]]

    could have serious adverse effects on the financial stability of the

    United States banking system or financial markets. Accordingly, for

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

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

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

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    \23\ Id. at 18620.

    \24\ Id.

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    Accordingly, the Chairman, on behalf of the Commission, hereby

    certifies pursuant to 5 U.S.C. 605(b) that the proposed rules will not

    have a significant economic impact on a substantial number of small

    entities.

    B. Paperwork Reduction Act

    Provisions of proposed new Regulation Part 23 include new

    information disclosure and recordkeeping requirements that constitute

    the collection of information within the meaning of the Paperwork

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

    submitting this proposed collection of information to the Office of

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

    3507(d) and 5 CFR 1320.11. Under the PRA, an agency may not conduct or

    sponsor, and a person is not required to respond to, a collection of

    information unless it displays a currently valid control number.\26\

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

    Retention of Certain Information Relating to Swaps Customer

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

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

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

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

    Act as amended by the Dodd-Frank Act.\27\ An agency may not conduct or

    sponsor, and a person is not required to respond to, a collection of

    information unless it displays a currently valid OMB control number.

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

    number.

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

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

    \26\ Id.

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

    Privacy of Consumer Financial Information; Conforming Amendments

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

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

    1. Information Provided by Reporting Entities

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

    counterparty to an uncleared swap transaction that the counterparty may

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

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

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

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

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

    officer exists; and otherwise to another appropriate official of the

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

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

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

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

    notify counterparties that they have the right to require segregation

    of their initial margin deposits.

    Proposed Sec. 23.604 requires the chief compliance officer of each

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

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

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

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

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

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

    requires these reports.

    The disclosure requirement of proposed Sec. 23.601 is expected to

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

    make the required disclosure once each year to each of its

    counterparties in uncleared swaps transactions. It is expected that

    each disclosure would require approximately 0.3 hours of staff time by

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

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

    it is uncertain what average number of uncleared swaps counterparties

    will be dealt with annually by swap dealers and major swap

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

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

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

    major swap participants makes the required disclosure to 200

    counterparties per year, there would be a total of approximately

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

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

    $1,200,000.\29\

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

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

    about 250 SDs and 50 MSPs.

    \29\ The estimate of the number of counterparties receiving

    disclosure from each swap dealer or major swap participant takes

    into consideration the possibility that a single counterparty may

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

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

    total number of counterparties making use of uncleared swaps subject

    to the disclosure requirement.

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

    The disclosure requirement of proposed Regulation 23.604 will apply

    to the same 300 entities as the requirement of proposed Regulation

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

    disclosure four times each year to each of its uncleared swaps

    counterparties that does not choose to require segregation of capital.

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

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

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

    will decline such segregation. Assuming that half of all uncleared

    swaps counterparties do not choose segregation of collateral, proposed

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

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

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

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

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

    $3,500,000.

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

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

    required by proposed Sec. 23.604 in particular transactions will

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

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

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

    agreements with regard to procedures are standardized at a

    particular SD. The average burden figure thus reflects a varying

    level of burden in particular transactions.

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

    2. Information Collection Comments

    The Commission invites the public and other federal agencies to

    comment on any aspect of the reporting and recordkeeping burdens

    discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission

    solicits comments in order to: (i) Evaluate whether the proposed

    collection of information is necessary for the proper performance of

    the functions of the Commission, including whether the information will

    have practical utility; (ii) evaluate the accuracy of the Commission's

    estimate of the burden of the proposed collection of information; (iii)

    determine whether there are ways to enhance the quality, utility, and

    clarity of the information to be collected; and (iv) minimize the

    burden of the collection of information on those who are to respond,

    including through the use of automated collection techniques or other

    forms of information technology.

    [[Page 75437]]

    Comments may be submitted directly to the OMB Office of Information

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

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

    of submitted comments so that all comments can be summarized and

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

    this notice of proposed rulemaking for comment submission instructions

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

    collections of information discussed above may be obtained by visiting

    RegInfo.gov. OMB is required to make a decision concerning the

    collection of information between 30 and 60 days after publication of

    this release. Consequently, a comment to OMB is most assured of being

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

    after publication of this notice of proposed rulemaking.

    C. Cost-Benefit Analysis

    Section 15(a) of the CEA \31\ requires the Commission to consider

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

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

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

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

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

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

    benefits shall be evaluated in light of five broad areas of market and

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

    (2) efficiency, competitiveness, and financial integrity of futures

    markets; (3) price discovery; (4) sound risk management practices; and

    (5) other public interest considerations. The Commission may in its

    discretion give greater weight to any one of the five enumerated areas

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

    a particular rule is necessary or appropriate to protect the public

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

    the purposes of the CEA.

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

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

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

    1. Cost-Benefit Analysis of Proposed Part 23

    a. Summary of Proposed Requirements

    Proposed Part 23 of the Commission's regulations implements the

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

    counterparties to uncleared swaps transactions with SDs and MSPs be

    given the right to require to require segregation of their initial

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

    Part 23 also implements the statutory requirement that SDs and MSPs

    notify their counterparties of this right. Additionally, amendments are

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

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

    purposes of Regulation Part 190, includes securities held in a

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

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

    such a portfolio margining account. Technical amendments also are being

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

    certain actions in bankruptcy proceedings to conform with recent

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

    legal practice.

    b. Costs

    The costs directly imposed by proposed part 23 and the amendments

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

    management practices of market participants, and the efficiency of

    bankruptcy proceedings. If proposed part 23 and the proposed amendments

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

    participant will be informed of their option to require segregation of

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

    the market participant will be transacting swaps. The segregation

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

    the event of an insolvency of the SD or MSP.

    c. Benefits

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

    participants and the financial integrity of the futures and swap

    markets. The proposed regulatons would ensure that segregated accounts

    for initial margin are available in all uncleared swaps transactions

    involving SDs or MSPs and that counterparties are informed of their

    availability. This could result in the increased use of segregated

    accounts with resulting reduced risk of loss of collateral by

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

    reduced chance of counterparty assets being intentionally or

    inadvertently misused. In addition proposed Regulation Part 23 can be

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

    collateral accounts by uncleared swaps counterparties is the result of

    genuine choices by counterparties and reduce the likelihood that it is

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

    The definitions and technical amendments being proposed for Part

    190 similarly are intended to relate to the protection of market

    participants, as well as to efficiency associated with bankruptcy

    proceedings. The definitional changes are expected to increase legal

    certainty in some circumstances. The technical amendments are intended

    to increase the efficiency with which certain acts in bankruptcy

    proceedings of commodity brokers are carried out by insuring

    consistency between the Regulations, the Bankruptcy Code, and current

    bankruptcy practice.

    3. Public Comment

    The Commission invites public comment on its cost-benefit

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

    other information that they may have quantifying or qualifying the

    costs and benefits of the proposal with their comment letters.

    List of Subjects

    17 CFR Part 23

    Consumer protection, Reporting and recordkeeping requirements,

    Swaps.

    17 CFR Part 190

    Bankruptcy, Brokers, Commodity futures, Reporting and recordkeeping

    requirements, Swaps.

    For the reasons stated in this release, the Commission hereby

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

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

    as follows:

    PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

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

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

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

    (Jul. 21, 2010).

    2. Add subpart L to read as follows:

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

    Transactions

    Sec.

    23.600 Definitions.

    23.601 Notification of right to segregation.

    23.602 Requirements for segregated margin.

    23.603 Investment of segregated initial margin.

    23.604 Requirements for non-segregated margin.

    [[Page 75438]]

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

    Swap Transactions

    Sec. 23.600 Definitions.

    ``Initial Margin'' means money, securities, or property posted by a

    party to a swap as performance bond to cover potential future exposures

    arising from changes in the market value of the position.

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

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

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

    between two accounts.

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

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

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

    position was marked to market.

    Sec. 23.601 Notification of right to segregation.

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

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

    counterparty to such transaction that the counterparty has the right to

    require that any Initial Margin the counterparty provides in connection

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

    23.602 and 23.603 of this part.

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

    extend to Variation Margin.

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

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

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

    decisionmaker for the counterparty.

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

    or major swap participant shall obtain from the counterparty

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

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

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

    dealer or major swap participant shall maintain such confirmation and

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

    chapter.

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

    particular counterparty by a particular swap dealer or major swap

    participant need only be made once in any calendar year.

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

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

    discretion of the counterparty upon written notice delivered to the

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

    applicable to all swaps entered into between the parties after such

    delivery.

    Sec. 23.602 Requirements for segregated margin.

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

    Sec. 23.601 of this part must be:

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

    swap dealer or major swap participant and the counterparty, and

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

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

    or major swap participant and the counterparty agree, also hold

    Variation Margin.

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

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

    and shall provide that:

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

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

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

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

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

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

    parties. The other party shall be immediately notified of such

    turnover, and

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

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

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

    and notification of such withdrawal shall be given immediately to the

    non-withdrawing party.

    Sec. 23.603 Investment of segregated initial margin.

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

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

    chapter.

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

    major swap participant and the counterparty may enter into any

    commercial arrangement, in writing, regarding the investment of such

    Initial Margin, and the related allocation of gains and losses

    resulting from such investment.

    Sec. 23.604 Requirements for non-segregated margin.

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

    participant shall report to each counterparty that does not choose to

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

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

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

    swap participant relating to margin and collateral requirements were,

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

    with the agreement of the counterparties.

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

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

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

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

    PART 190--BANKRUPTCY

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

    follows:

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

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

    noted.

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

    Sec. 190.01 Definitions.

    * * * * *

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

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

    included, customer shall include the owner of a portfolio margining

    account carried as a futures account.

    * * * * *

    Sec. 190.02 [Amended]

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

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

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

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

    Sec. 190.06 [Amended]

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

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

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

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

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

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

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

    for relief''.

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

    [[Page 75439]]

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

    Sec. 190.08 Allocation of property and allowance of claims.

    * * * * *

    (a) * * *

    (1) * * *

    (i) * * *

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

    portfolio margining account carried as a futures account;

    * * * * *

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

    Commission.

    David A. Stawick,

    Secretary of the Commission.

    Statement of Chairman Gary Gensler

    Protection of Collateral of Counterparties to Uncleared Swaps;

    Treatment of Securities in a Portfolio Margining Account in a Commodity

    Broker Bankruptcy

    I support the proposed rulemaking concerning protection of

    collateral of counterparties to uncleared swaps. The proposal

    includes important protections for end-users when entering into

    bilateral or customized swaps. The proposal follows the

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

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

    segregated account and with a third party custodian. The proposed

    rules would protect market participants while promoting the

    financial integrity of the marketplace. The proposal also includes

    necessary housekeeping details with regard to the Bankruptcy code.

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

    BILLING CODE 6351-01-P

    Last Updated: December 3, 2010



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