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2010-32264

  • FR Doc 2010-32264[Federal Register: December 28, 2010 (Volume 75, Number 248)]

    [Proposed Rules]

    [Page 81519-81532]

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

    [DOCID:fr28de10-55]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Part 23

    RIN 3038-AC96

    Confirmation, Portfolio Reconciliation, and Portfolio Compression

    Requirements for Swap Dealers and Major Swap Participants

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Notice of proposed rulemaking.

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

    is proposing regulations to implement new statutory provisions

    established under Title VII of the Dodd-Frank Wall Street Reform and

    Consumer Protection Act (Dodd-Frank Act). Section 731 of the Dodd-Frank

    Act added a new section 4s(i) to the Commodity Exchange Act (CEA),

    which requires the Commission to prescribe standards for swap dealers

    and major swap participants related to the timely and accurate

    confirmation, processing, netting, documentation, and valuation of

    swaps. The proposed rules would establish requirements for swap

    confirmation, portfolio reconciliation, and portfolio compression for

    swap dealers and major swap participants.

    DATES: Submit comments on or before February 28, 2011.

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

    and Confirmation, Portfolio Reconciliation, and Portfolio Compression

    Requirements for Swap Dealers and Major Swap Participants, by any of

    the following methods:

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

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

    through the Web site.

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

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

    Street, NW., Washington, DC 20581.

    Hand Delivery/Courier: Same as mail above.

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

    Follow the instructions for submitting comments.

    Please submit your comments using only one method.

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

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

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

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

    information that may be exempt from disclosure under the Freedom of

    Information Act, a petition for confidential treatment of the exempt

    information may be submitted according to the established procedures in

    Sec. 145.9 of the Commission's regulations, 17 CFR 145.9.

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

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

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

    inappropriate for publication, such as obscene language. All

    submissions that have been redacted

    [[Page 81520]]

    or removed that contain comments on the merits of the rulemaking will

    be retained in the public comment file and will be considered as

    required under the Administrative Procedure Act and other applicable

    laws, and may be accessible under the Freedom of Information Act.

    FOR FURTHER INFORMATION CONTACT: Sarah E. Josephson, Associate

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

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

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

    Clearing and Intermediary Oversight, Commodity Futures Trading

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

    DC 20581.

    SUPPLEMENTARY INFORMATION:

    I. Background

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

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

    (CEA) \3\ to establish a comprehensive regulatory framework to reduce

    risk, increase transparency, and promote market integrity within the

    financial system by, among other things: (1) Providing for the

    registration and comprehensive regulation of swap dealers and major

    swap participants; (2) imposing clearing and trade execution

    requirements on standardized derivative products; (3) creating rigorous

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

    Commission's rulemaking and enforcement authorities with respect to all

    registered entities and intermediaries subject to the Commission's

    oversight.

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

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

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

    OTCDERIVATIVES/index.htm.

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

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

    2010.''

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

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    Section 731 of the Dodd-Frank Act amends the CEA by adding a new

    Section 4s, which sets forth a number of requirements for swap dealers

    and major swap participants. Specifically, section 4s(i) of the CEA

    establishes swap documentation standards for those registrants.

    Section 4s(i)(1) requires swap dealers and major swap participants

    to ``conform with such standards as may be prescribed by the Commission

    by rule or regulation that relate to timely and accurate confirmation,

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

    section 4s(i)(2), the Commission is required to adopt rules ``governing

    documentation standards for swap dealers and major swap participants.''

    The Commission is proposing the regulations on swap confirmation,

    portfolio reconciliation, and portfolio compression \4\ discussed

    below, pursuant to the authority granted under sections 4s(h)(1)(D),

    4s(h)(3)(D), 4s(i), and 8a(5) of the CEA. \5\ The Dodd-Frank Act

    requires the Commission to promulgate these provisions by July 15,

    2011.

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    \4\ The Commission may propose additional rules related to

    documentation provisions under section 4s(i) of the CEA.

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

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

    are reasonably necessary to effectuate any of the provisions or to

    accomplish any of the purposes of the CEA.

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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.

    II. Proposed Regulations

    The proposed regulations would prescribe standards for the timely

    and accurate confirmation of swaps and would require the reconciliation

    and compression of swap portfolios. Confirmation, portfolio

    reconciliation, and portfolio compression have been recognized as

    important post-trade processing mechanisms for reducing risk and

    improving operational efficiency by both current market participants

    and their regulators.

    With respect to confirmation, prudent practice requires that, after

    coming to an agreement on the terms of a transaction, parties document

    the transaction in a complete and definitive written record so there is

    legal certainty about the terms of their agreement. Through portfolio

    reconciliation, counterparties are able to resolve any discrepancies or

    disputes as early as possible and arrive at an understanding of their

    overall risk exposure to one another. Portfolio compression allows for

    a reduction in outstanding trade count and outstanding gross notional

    value by replacing redundant trades with a smaller number of trades and

    reduced gross notional value. This process reduces operational risk and

    increases operational efficiency because there are fewer trades to

    maintain, and results in a more accurate expression of market size.

    In the past few years, market participants and regulators have paid

    particular attention to the post-trade processing of swaps. For

    example, operational issues associated with the over-the-counter (OTC)

    derivatives market have been the focus of reports and recommendations

    by the President's Working Group on Financial Markets (PWG).\6\ In

    response to the financial crisis in 2008, the PWG called on the

    industry to improve trade matching and confirmation and to promote

    portfolio reconciliation.

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    \6\ See, e.g., Press Release, ``President's Working Group on

    Financial Markets, Progress Summary on OTC Derivatives Operational

    Improvements'' (Nov. 2008).

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    Since 2005, the Federal Reserve Bank of New York (FRBNY) has led a

    targeted, supervisory effort to enhance operational efficiency and

    performance in the OTC derivatives market, by increasing automation in

    processing and by promoting the timely confirmation of trades. Known as

    the OTC Derivatives Supervisors' Group (ODSG), the FRBNY leads an on-

    going effort with OTC derivatives dealers' primary supervisors, trade

    associations, industry utilities, and private vendors, through which

    market participants (including buy-side participants) regularly set

    goals and commitments to bring infrastructure, market design, and risk

    management improvements to all OTC derivatives asset classes. Over the

    years, the ODSG has expanded its focus from credit derivatives to

    include interest rate derivatives, equity derivatives, foreign exchange

    derivatives, and commodity derivatives. Along with this expanded focus

    has come increased engagement with market participants on cross-asset

    class issues. Specifically, the ODSG encouraged the industry to commit

    itself to a number of reforms, including improved operational

    performance with respect to the OTC derivatives confirmation process,

    portfolio reconciliation, and portfolio compression. The regulations

    proposed by the Commission would build upon the ODSG's work.

    It is important to note at the outset, that the Commission expects

    that swap dealers and major swap participants would be able to comply

    with each of the proposed rules by executing a swap on a swap execution

    facility (SEF) or on a designated contract market (DCM), or by clearing

    the swap through a derivatives clearing organization (DCO). For swaps

    executed on a SEF or a DCM, the SEF or DCM will provide the

    counterparties with a definitive written

    [[Page 81521]]

    record of the terms of their agreement, which will serve as a

    confirmation of the swap. Similarly, if a swap is executed bilaterally,

    but subsequently submitted to a DCO for clearing, the DCO will require

    a definitive written record of all terms to the counterparties'

    agreement prior to novation by the DCO; this too would serve as a

    confirmation of the swap.

    When a swap is cleared by a central counterparty, the problems that

    portfolio reconciliation is designed to solve (agreement on all terms

    and the valuation of the swap) no longer exist because the

    clearinghouse (1) requires a definitive written record of all terms of

    the swap; and (2) arrives at a settlement price for all cleared swaps

    on a daily basis. Additionally, the Commission is considering a

    proposed regulation that would require DCOs to offer portfolio

    compression exercises on a regular basis. The proposed rule for swap

    dealers and major swap participants has been designed to complement the

    proposed DCO rule.

    In designing these rules, the Commission has taken care to minimize

    the burden on those parties that will not be registered with the

    Commission as swap dealers or major swap participants. To the extent

    that market participants believe that additional measures should be

    taken to reduce the burden or increase the benefits of confirmation,

    reconciliation, and compression for the swaps market, the Commission

    welcomes all comments.

    The Commission requests comment on all aspects of proposed

    Sec. Sec. 23.500 (definitions), 23.501 (confirmation), 23.502

    (portfolio reconciliation), and 23.503 (portfolio compression), 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. The Commission

    recognizes that there will be differences in the size and scope of the

    business of particular swap dealers and major swap participants.

    Therefore, comments are solicited on whether certain provisions of the

    proposed regulations should be modified or adjusted to reflect the

    differences among swap dealers and major swap participants or

    differences among asset classes.

    A. Swap Confirmation

    1. Background

    Over the past several years, OTC derivatives market participants

    and their regulators have paid particular attention to the timely

    confirmation of swaps. The Government Accountability Office (GAO) found

    that the rapid expansion of trading volume of swaps, such as credit

    derivatives since 2002, caused stresses on the operational

    infrastructure of market participants. These stresses in turn caused

    the participants' back office systems to fail to confirm the increased

    volume of trades for a period of time.\7\ The GAO found that the lack

    of automation in trade processing and the purported assignment of

    positions by transferring parties to third parties without notice to

    their counterparties were factors contributing to this backlog. If

    transactions, whether newly executed or recently transferred to another

    party, are left unconfirmed, there is no definitive written record of

    the contract terms. Thus, in the event of a dispute, the terms of the

    agreement must be reconstructed from other evidence, such as e-mail

    trails or recorded trader conversations. This process is cumbersome and

    may not be wholly accurate. Moreover, if purported transfers of swaps,

    in whole or in part, are made without giving notice to the remaining

    parties and obtaining their consent, disputes may arise as to which

    parties are entitled to the benefits and subject to the burdens of the

    transaction.

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    \7\ U.S. Government Accountability Office, ``Credit Derivatives:

    Confirmation Backlogs Increased Dealers' Operational Risks, But Were

    Successfully Addressed After Joint Regulatory Action,'' GAO-07-716

    (2007) at pages 3-4.

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    As the work of the ODSG demonstrates, the industry is capable of

    swift movement to contemporaneous execution and confirmation. A large

    back-log of unexecuted confirmations in the credit default swap (CDS)

    market created by prolonged negotiations and inadequate confirmation

    procedures were the subject of the first industry commitments made by

    participating dealers to ODSG.\8\ In October 2005, the participating

    dealers committed to reduce by 30% the number of confirmations

    outstanding more than 30 days within four months. In March 2006, the

    dealers committed to reduce the number of outstanding confirmations by

    70% by June 30, 2006. By September 2006, the industry had reduced the

    number of all outstanding CDS confirmations by 70%, and the number of

    CDS confirmations outstanding more than 30 days by 85%. The industry

    achieved these targets largely by moving 80% of total trade volume in

    CDS to confirmation on electronic platforms, eliminating backlogs in

    new trades. Today, over 90% of ``electronically eligible'' \9\ CDS

    trades are confirmed electronically, the majority on the day of

    execution and up to 98% within two days.\10\

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    \8\ See October 4, 2005 industry commitment letter to the

    Federal Reserve Bank of New York, available at http://

    www.newyorkfed.org/newsevents/news_archive/markets/2005/

    an050915.html.

    \9\ It remains unclear precisely how much of the total CDS

    market is not ``electronically eligible,'' as eligibility is

    determined by the OTC derivatives market participants.

    \10\ See March 1, 2010 Summary of OTC Derivatives Commitments

    provided to the Federal Reserve Bank of New York, available at

    http://www.newyorkfed.org/newsevents/news/markets/2010/100301_

    table.pdf.

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    The ODSG has established a supervisory goal for all transactions to

    be confirmed as soon as possible after the time of execution. Ideally,

    this would mean that there would be a written or electronic document

    executed by the parties to a swap for the purpose of evidencing all of

    the terms of the swap, including the terms of any termination (prior to

    its scheduled maturity date), assignment, novation, exchange, or

    similar transfer or conveyance of, or extinguishing of rights or

    obligations.

    In the case of electronically processed transactions, all such

    transactions should be matched and confirmed, at a minimum, on the same

    day the trade was executed. For electronically processed transactions,

    confirmation typically is effected by a third-party ``matching''

    process. If transactions are not confirmed in a timely manner, backlogs

    of outstanding unconfirmed trades develop, increasing risk. Timely and

    accurate confirmation of transactions is critical for all downstream

    operational and risk management processes, including the correct

    calculation of cash flows and discharge of settlement obligations as

    well as accurate measurement of counterparty credit exposures. Timely

    confirmation also allows any rejections, exceptions, and/or

    discrepancies to be identified and resolved more quickly.

    Another ODSG objective is a marketplace that electronically

    processes as many transactions as possible in as many parts of the

    processing life cycle as possible, but particularly in the ``upstream''

    parts of the life cycle, where transaction information is first entered

    into the system (trade capture). To achieve this objective, as many

    transactions as possible and practicable should be executed on

    electronic platforms, such

    [[Page 81522]]

    as SEFs, in order to approach the ideal of ``straight-through

    processing.'' Otherwise, transactions should be keyed into electronic

    systems as soon as possible after execution.

    2. Proposed Confirmation Rule

    To promote the efficient operation of the swap market, and to

    facilitate market participants' overall risk management, the Commission

    is proposing confirmation Sec. 23.501.

    For the purposes of proposed Sec. 23.501, proposed Sec. 23.500

    would provide certain critical definitions pertaining to confirmation.

    An acknowledgment would be defined as a written or electronic record of

    all the terms of a swap signed and sent by one party to another. When

    one party acknowledges the terms of a swap and its counterparty

    verifies it, the result is the issuance of a confirmation that reflects

    the terms of the swap between the parties. A confirmation thus would be

    defined as a written or electronic record of a swap that has been

    signed and sent by one party and verified by the other where that

    record has been manually, electronically, or by some other legally

    equivalent means, signed by the receiving counterparty. Finally,

    proposed Sec. 23.500 would define execution to be a legally-binding

    oral, written, or electronic agreement by the parties. For the purposes

    of the confirmation rule, the term swap transaction is defined to

    include any event that would result in a new swap or a change in the

    terms of a swap, including execution, termination, assignment,

    novation, exchange, transfer, amendment, conveyance, or extinguishing

    of rights or obligations under a swap.

    With regard to both acknowledgments and confirmations, the

    Commission intends that all the terms of a swap transaction be provided

    for acknowledgment and confirmation. The objective is that parties have

    full written agreement on all terms as soon as practicable after

    execution and also upon any ownership event during the life of the

    swap. Such life cycle events would include any termination (prior to

    the scheduled maturity date of the swap), assignment, novation,

    exchange, transfer, amendment, or conveyance of, or extinguishing of

    rights or obligations under the swap.\11\ For each of these events, the

    parties should have written documentation evidencing all the terms of

    the transaction, as soon as possible after the transaction occurs. This

    approach to documenting ``life cycle event data'' is consistent with

    the Commission's proposed rules for reporting swap data to a swap data

    repository.\12\

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    \11\ Life cycle events would also include corporate actions

    affecting a security or securities on which the swap is based (e.g.,

    a merger, dividend, stock split or bankruptcy).

    \12\ The Notice of Proposed Rulemaking for Swap Data

    Recordkeeping and Reporting Requirements is available on the

    Commission's Web site: http://comments.cftc.gov/FederalRegister/

    Proposed.aspx.

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    The timely and accurate confirmation of all swaps and life cycle

    events for existing swaps would ensure that the parties know the terms

    of their executed transactions and the identities of their

    counterparties at all times. Confirming all swap transactions on the

    day of execution should be standard for all market participants.

    However, the Commission recognizes some entities that will not be

    registered as swap dealers or major swap participants may not have the

    operational capacity to confirm their swap transactions as quickly as

    swap dealers and major swap participants. Accordingly, the Commission

    is proposing a bifurcated approach for confirmations. Swap dealers and

    major swap participants entering into swap transactions with other swap

    dealers or major swap participants would be required to obtain a

    confirmation on the same calendar day as execution (i.e., no later than

    T+0).

    On the other hand, swap dealers and major swap participants

    entering into swap transactions with counterparties that are not swap

    dealers or major swap participants would be required to send an

    acknowledgment for each swap on the same calendar day as execution

    (i.e., no later than T+0). Swap dealers and major swap participants

    would then have policies and procedures in place to confirm the swap

    with financial entities as defined in proposed Sec. 23.500 \13\ on the

    same calendar day as execution and with all other entities not later

    than the next business day following execution.

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    \13\ This definition is taken from the end user exception to the

    clearing requirement under section 2(h)(7)(C)(i) of the CEA. The

    term financial entity includes the following eight entities: (i) A

    swap dealer; (ii) a security-based swap dealer; (iii) a major swap

    participant; (iv) a major security-based swap participant; (v) a

    commodity pool as defined in section 1a(10) of the CEA; (vi) a

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

    Act of 1940 (15 U.S.C. 80-b-2(a)); (vii) an employee benefit plan as

    defined in paragraphs (3) and (32) of section 3 of the Employee

    Retirement Income Security Act of 1974 (29 U.S.C. 1002); or (viii) a

    person predominantly engaged in activities that are in the business

    of banking or financial in nature, as defined in section 4(k) of the

    Bank Holding Company Act of 1956. See 7 U.S.C. 2(h)(7)(C)(i). The

    definition would include the statutory exclusion and limitation as

    contained in section 2(h)(7)(C) and also would include any

    Commission regulations promulgated pursuant to the statutory

    section.

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    The Commission also is proposing that the times prescribed for

    achieving swap acknowledgment and confirmation vary depending upon

    whether transactions are electronically executed or electronically

    processed. Under proposed Sec. 23.501(a)(1), all swap dealers and

    major swap participants entering into swap transactions with other swap

    dealers or major swap participants would be required to confirm their

    swap transactions according to the following timeframe:

    For any swap transaction that has been executed and

    processed electronically, within 15 minutes of execution;

    For any swap transaction that is not electronically

    executed, but that will be processed electronically, within 30 minutes

    of execution; or

    For any swap transaction that cannot be processed

    electronically by the swap dealer or major swap participant, within the

    same calendar day as execution.

    Under proposed Sec. 23.501(a)(2), swap dealers and major swap

    participants entering into swap transactions with counterparties that

    are not swap dealers or major swap participants would be required to

    send an acknowledgment of each swap transaction according to the

    following timeframe:

    For any swap transaction that has been executed and

    processed electronically, within 15 minutes of execution;

    For any swap transaction that is not executed

    electronically, but that will be processed electronically, within 30

    minutes after execution; or

    For any swap transaction that cannot be processed

    electronically by the swap dealer or major swap participant, within the

    same calendar day as execution.

    For those swap transactions entered into with counterparties that

    are not swap dealers or major swap participants, under proposed Sec.

    23.501(a)(3), swap dealers and major swap participants would be

    required to establish written policies and procedures reasonably

    designed to ensure confirmation with financial entities on the same

    calendar day as execution and with all other entities by the next

    business day after the swap transaction is executed. These procedures

    must include a requirement that, prior to entering into any swap

    transaction, the swap dealer or major swap participant furnish to a

    prospective counterparty, or receive from a prospective counterparty, a

    draft acknowledgment specifying all terms of the swap transaction other

    than pricing and terms to be definitively agreed to at execution. As is

    currently the custom in many swap markets, including credit

    [[Page 81523]]

    and equity derivative markets, the parties may rely on a standard

    confirmation agreement.

    Under proposed Sec. 23.501(b), a swap dealer or major swap

    participant would be required to keep records regarding the processing

    of swap acknowledgments and confirmations. These records would include

    the time and date of transmission or receipt of any acknowledgment or

    confirmation, the length of time between transmission of any

    acknowledgment to a counterparty and receipt of the signed

    confirmation, and the length of time between execution and confirmation

    of the swap.

    In order to retain flexibility for all market participants, the

    proposed rules do not prescribe a particular venue or platform for

    confirmation. As noted above, currently many swap transactions are

    electronically processed by third-party ``matching'' services. While

    the Commission encourages the continued use and expansion of these

    services, the approach taken in the proposed rule would allow parties

    the ability to confirm bilaterally through whatever means they select,

    so long as they are able to meet the schedule laid out in the rule.

    In a similar effort to retain flexibility, at this time, the

    Commission is not prescribing the acknowledgment or confirmation

    documentation that market participants must use. The Commission

    encourages the use of master confirmation agreements and other

    standardized documentation that has been developed by the industry in

    an effort to reduce confirmation backlogs, among other things. However,

    the most critical aspect of the confirmation rule is that all the terms

    of the swap are agreed to in writing and in a timely manner.

    The proposed rules would apply to all new swaps and to all swap

    transactions, as that term is defined in the rules, entered into after

    the effective date of the regulation.

    3. Comments Requested

    The Commission requests comment on all aspects of proposed Sec.

    23.501. In particular, the Commission requests comment on the following

    questions:

    Does the proposed rule appropriately allocate the

    responsibility for providing the swap acknowledgments?

    Is it feasible to require that all acknowledgments be

    provided electronically?

    Should the proposed rule require swap dealers and major

    swap participants to provide a swap acknowledgment or confirmation more

    quickly, particularly for transactions that are executed or processed

    electronically?

    Does the proposed rule provide sufficient time for swap

    dealers and major swap participants to provide swap acknowledgments to

    their counterparties?

    Are there swap transactions for which all of the terms

    required to be included on an acknowledgment or in a confirmation would

    not be known on the same calendar day as execution? If so, please

    describe these swap transactions and include the terms that would not

    be known on the same calendar day as execution, as well as the reason

    these terms would not be known.

    Is it necessary to clarify further that the confirmation

    rule would apply to life cycle events, such as termination, assignment,

    novation, exchange, transfer, amendment, or conveyance?

    Are there other post-execution events for which a

    confirmation should be executed?

    Should counterparties be permitted to agree expressly that

    certain life cycle events (such as assignment of payable rights), do

    not require subsequent confirmations? Are there life cycle events that

    can be carved out of the rule while still achieving the purpose of the

    rule? Should more time be permitted for confirmation of certain life

    cycle events, such as transfers resulting from a merger, consolidation,

    or transfer of all assets to another entity?

    Should the Commission require that electronic matching

    services or confirmation platforms be used where reasonably

    practicable?

    Does the term ``processed electronically'' require more

    clarification? If so, what definition would be effective and flexible

    enough to accommodate future market innovation?

    Should the Commission require that all swaps be processed

    electronically?

    Are there circumstances where swap dealers and major swap

    participants have the ability to process a transaction electronically,

    but should not be required to do so?

    Has the Commission properly accounted for current industry

    practice with respect to the time necessary to confirm swap

    transactions?

    Would the proposed rule unduly restrict the types of swaps

    that swap dealers and major swap participants may enter into or the

    persons that may be their counterparties?

    Should executing a swap on a SEF or DCM be deemed to

    satisfy the confirmation requirement?

    Should clearing a swap through a DCO be deemed to satisfy

    the confirmation requirement?

    Should the terms calendar day and business day be further

    defined and has the rule properly accounted for counterparties in

    different time zones executing swaps?

    B. Swap Portfolio Reconciliation

    1. Background

    Section 4s(i) of the CEA directs the Commission to prescribe

    regulations for the timely and accurate confirmation, processing,

    documentation, and valuation of all swaps entered into by swap dealers

    and major swap participants. Disputes related to confirming the terms

    of a swap, as well as swap valuation disputes,\14\ have long been

    recognized as a significant problem in the OTC derivatives market.

    Portfolio reconciliation is considered an effective means of

    identifying and resolving these disputes. Specifically, portfolio

    reconciliation is a post-execution processing and risk management

    technique that is designed to: (1) Identify and resolve discrepancies

    between the counterparties with regard to the terms of a swap either

    immediately after execution or during the life of the swap; (2) ensure

    effective confirmation of all the terms of the swap; and (3) identify

    and resolve discrepancies between the counterparties regarding the

    valuation of the swap. In some instances, portfolio reconciliation also

    may facilitate the identification and resolution of discrepancies

    between the counterparties with regard to valuations of collateral held

    as margin.

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    \14\ See ISDA Collateral Committee, ``Commentary to the Outline

    of the 2009 ISDA Protocol for Resolution of Disputed Collateral

    Calls,'' June 2, 2009 (stating ``Disputed margin calls have

    increased significantly since late 2007, and especially during 2008

    have been the driver of large (sometimes > $1 billion) un-

    collateralized exposures between professional firms.'').

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    The Commission recognizes that the industry has made significant

    progress in adopting the use of portfolio reconciliation to decrease

    the number of swap disputes.\15\ In December 2008, the ODSG's group of

    14 major dealers committed to execute daily portfolio reconciliations

    for collateralized portfolios in excess of 500 trades between

    participating dealers by June of 2009.\16\ As of May 2009, all

    participating dealers were satisfying this commitment. In October 2009,

    the

    [[Page 81524]]

    ODSG committed to publishing a feasibility study on market-wide

    portfolio reconciliation that would set forth how regular portfolio

    reconciliation could be extended beyond the ODSG dealers to include

    smaller banks, buy-side participants, and derivative end users.

    Consistent with this publication, the ODSG dealers expanded their

    portfolio reconciliation commitment in March 2010 to include monthly

    reconciliation of collateralized portfolios in excess of 1,000 trades

    with any counterparty. Most recently, the industry has been preparing a

    new ``Convention on the Investigation of Disputed Margin Calls'' and a

    new ``Formal Market Polling Procedure'' that are intended to ``create a

    consistent and predictable process * * * that eliminates present

    uncertainties and delays.'' \17\

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

    \15\ The Commission also recognizes and encourages the industry

    practice of immediately transferring undisputed collateral amounts.

    \16\ See June 2, 2009 summary of industry commitments, available

    at http://www.isda.org/c_and_a/pdf/060209table.pdf.

    \17\ See ``ISDA 2010 Convention on the Investigation of Disputed

    Margin Calls'' and ``ISDA 2010 Formal Market Polling Procedure.''

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

    Accordingly, the Commission is proposing Sec. 23.502, which would

    require swap dealers and major swap participants to reconcile their

    portfolios with one another and provide counterparties who are not

    registered as swap dealers or major swap participants with regular

    opportunities for portfolio reconciliation. In order for the

    marketplace to realize the full risk reduction benefits of portfolio

    reconciliation, the Commission is proposing to expand portfolio

    reconciliation to all transactions, whether collateralized or

    uncollateralized. For the swap market to operate efficiently and to

    reduce systemic risk, portfolio reconciliation should be a proactive

    process that delivers a consolidated view of counterparty exposure down

    to the transaction level. By identifying and managing mismatches in key

    economic terms and valuation for individual transactions across an

    entire portfolio, overall risk can be identified and reduced.

    2. Proposed Portfolio Reconciliation Rule

    For the purposes of proposed Sec. 23.502, swap portfolio

    reconciliation would be defined in proposed Sec. 23.500 as a process

    by which the two parties to one or more swaps: (1) Exchange the terms

    of all swaps in the portfolio between the parties; (2) exchange each

    party's valuation of each swap in a portfolio between the parties as of

    the close of business on the immediately preceding business day; and

    (3) resolve any discrepancy in material terms and valuations. Valuation

    would be defined in proposed Sec. 23.500 as the current market value

    or net present value of a swap, and material terms would be defined as

    all terms of a swap required to be reported in accordance with part 45

    of this chapter.

    Proposed Sec. 23.502(a) would require swap dealers and major swap

    participants to reconcile swap portfolios with other swap dealers or

    major swap participants with the following frequency: Daily for

    portfolios consisting of 300 or more swaps, at least weekly for

    portfolios consisting of 50 to 300 swaps, and at least quarterly for

    portfolios consisting of fewer than 50 swaps. Swap dealers and major

    swap participants would be required to resolve immediately any

    discrepancy in a material term identified as part of a portfolio

    reconciliation process. The Commission is proposing an immediate

    resolution requirement for material terms for the same reasons that

    necessitate timely confirmation--parties need to know the terms of

    their executed agreements with one another. A discrepancy in the terms

    of a swap likely indicates that the parties have failed to confirm the

    swap in accordance with Commission regulations, and, therefore, the

    parties should take immediate action to resolve the discrepancy. This

    requirement would support and ensure compliance with proposed Sec.

    23.501, which requires a confirmation of all terms of a swap.

    The Commission believes that requiring reconciliation of all swap

    portfolios among swap dealers and major swap participants (rather than

    only collateralized portfolios, as contemplated by the ODSG work) is

    appropriate because CEA section 4s(e) requires that swap dealers and

    major swap participants will be subject to minimum capital and margin

    requirements. As a result, the Commission anticipates that most, if not

    all, swaps entered by swap dealers and major swap participants will be

    subject to some form of collateralization. The Commission also believes

    that requiring more frequent reconciliation of smaller portfolios is

    appropriate because section 2(a)(13)(G) of the CEA requires all swaps

    to be reported to a registered swap data repository, and, therefore,

    the Commission anticipates that swap dealers and major swap

    participants will be able to efficiently reconcile their internal

    records with their counterparties electronically by reference to data

    in the repositories. The threshold of 300 swaps for daily

    reconciliation is intended to capture swap portfolios where there is a

    high likelihood that the swap dealer or major swap participant's

    counterparty will have the technological capacity to perform

    reconciliation processes electronically.

    Under proposed Sec. 23.502(a)(5), swap dealers and major swap

    participants would be required to resolve any discrepancy in a

    valuation identified as part of a portfolio reconciliation process

    within one business day. The Commission recognizes that there may be

    reasonable grounds for some variation in the calculation of swap

    valuation at any given time. Consequently, the proposed rule would not

    require that swap dealers and major swap participants expend resources

    to resolve all discrepancies in the valuation of the swap, but only if

    the difference between the lower valuation and the higher is greater

    than 10%.

    In addition, given that there are a number of services and

    industry-led initiatives that may facilitate resolution of valuation

    disputes, at this time the Commission is not proposing to mandate that

    swap dealers and major swap participants implement any specific

    procedure for resolution of a discrepancy in the valuation of a swap.

    Rather, it is only proposing a deadline for dispute resolution of one

    business day following discovery of such discrepancy.

    For swap portfolios with entities other than swap dealers or major

    swap participants, proposed Sec. 23.502(b) would require swap dealers

    and major swap participants to establish written policies and

    procedures to perform reconciliation, but would not prescribe the

    manner in which the reconciliation must be performed. For example, the

    exchange of terms and valuations between the counterparties may consist

    of one party reviewing the details and valuations delivered by the

    other party and either affirming or objecting to such details and

    valuations. The frequency parameters of portfolio reconciliation would

    be similar to those for swap portfolios between swap dealers or major

    swap participants.\18\ There are some important distinctions in the

    proposed treatment of swap portfolios between a swap dealer or major

    swap participant and others that promote flexibility for those entities

    that will not be registered with the Commission. Swap dealers and major

    swap participants would be required simply to establish written

    procedures reasonably designed to resolve any discrepancies in the

    material terms or valuation of each swap identified as part

    [[Page 81525]]

    of a portfolio reconciliation process in a timely fashion. Again,

    differences in valuation of a swap need not be deemed a discrepancy

    unless the difference between the lower valuation and the higher

    valuation is greater than 10% of the higher valuation.

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

    \18\ The frequency thresholds are similar: Daily for portfolios

    consisting of 500 or more swaps, at least weekly for portfolios

    consisting of 100-500 swaps, and at least quarterly for portfolios

    consisting of less than 100 swaps.

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

    Proposed Sec. 23.502(c) would create a safe harbor for cleared

    swaps because portfolio reconciliation is needed primarily for

    uncleared swaps. When swaps are cleared, the clearinghouse requires

    that each swap be matched prior to novation by the clearinghouse.

    Moreover, once cleared, clearinghouses determine daily settlement

    prices, which preclude any valuation disputes.

    The proposed rule would apply to all swaps within a swap portfolio

    as of the effective date of the regulation.

    Finally, proposed Sec. 23.502(d) would require that swap dealers

    and major swap participants maintain records of each discrepancy

    identified during portfolio reconciliation and the length of time taken

    to resolve that discrepancy.

    3. Comments Requested

    The Commission requests comment on all aspects of proposed Sec.

    23.502(d). In particular, the Commission requests comment on the

    following questions:

    Are the proposed deadlines for swap portfolio discrepancy

    resolution in the proposed regulation appropriate?

    Are the reconciliation thresholds and frequency

    requirements appropriate?

    Are swap dealers and major swap participants likely to

    have a large number of counterparties with whom they would be required

    to perform daily reconciliation that do not have the technological

    capacity to perform reconciliation processes electronically?

    Is the proposal that a valuation difference of less than

    10% not be deemed to be a discrepancy appropriate? If not, please

    provide a suggested valuation discrepancy threshold.

    Should the proposed rule include a provision that requires

    discrepancy resolution if the aggregate of valuation differences of

    less than 10% across a portfolio exceeds a certain threshold? If so,

    please provide a suggested threshold.

    How would the requirement to resolve valuation

    discrepancies in one day for swaps among swap dealers and major swap

    participants affect the very detailed and complex industry initiatives

    currently being considered for resolving valuation disputes?

    Should all terms of a swap transaction be reconciled or

    just the key economic terms?

    Should all discrepancies in swap transaction terms be

    resolved or just the material ones?

    Should the definition of material terms be clarified?

    Should financial entities as defined in proposed Sec.

    23.500 be required to participate in portfolio reconciliation under

    proposed Sec. 23.502(a)?

    C. Portfolio Compression

    1. Background

    Section 4s(i) of the CEA directs the Commission to prescribe

    regulations for the timely and accurate processing and netting of all

    swaps entered into by swap dealers and major swap participants.

    Portfolio compression is an important, post-trade processing and

    netting mechanism that can be an effective and efficient tool for the

    timely and accurate processing and netting of swaps by market

    participants. Accordingly, the Commission is proposing Sec. 23.503,

    which would require swap dealers and major swap participants to engage

    in certain bilateral and multilateral portfolio compression exercises.

    Portfolio compression is a mechanism whereby substantially similar

    transactions among two or more counterparties are terminated and

    replaced with a smaller number of transactions of decreased notional

    value in an effort to reduce the risk, cost, and inefficiency of

    maintaining unnecessary transactions on the counterparties' books. In

    many cases, these redundant or economically-equivalent positions serve

    no useful business purpose, but can create unnecessary risk,\19\ as

    well as operational and capital inefficiencies. In a portfolio

    compression exercise, swap market participants whose combined

    portfolios include outstanding transactions that contain substantially

    similar economic terms and/or that would result in redundant payments

    wholly or partially net their swaps by terminating the original swaps

    and replacing them with a smaller number of new transactions that have

    a lower gross notional value.

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

    \19\ Federal Reserve Bank of New York Staff Report No. 424:

    ``Policy Perspectives on OTC Derivatives Market Infrastructure,''

    Jan. 2010 (revised Mar. 2010).

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

    Market vendors assert that as many as 40,000 trades can be

    terminated in a single portfolio compression cycle.\20\ Because

    portfolio compression participants are permitted to establish their own

    credit, market, and cash payment risk tolerances and to establish their

    own mark-to-market values for the transactions to be compressed, the

    process does not alter the risk profiles of the individual participants

    beyond a level acceptable to the participant.

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

    \20\ See http://www.trioptima.com.

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

    Portfolio compression exercises can be performed on a bilateral or

    multilateral basis. Multilateral compression exercises are preferable

    because the larger number of participants significantly increases the

    number of trades that can be eliminated and removes the need for

    bilateral negotiation between counterparties. In a multilateral

    portfolio compression exercise, the replacement swaps may be with the

    same or different counterparties.

    The benefits of portfolio compression to both individual market

    participants and to the market as a whole are considerable. The reduced

    transaction count decreases operational risk generally as there are

    fewer trades to maintain, process, and settle.\21\ The reduction in the

    outstanding gross notional value of the swaps also allows for increased

    capital liquidity and efficiency. Firms can set aside less capital for

    their positions while maintaining their desired risk positions in the

    market. The diminished operational risk for the individual market

    participants achieved by portfolio compression, in turn, may lessen

    systemic risk and enhance the overall stability of the financial

    markets. Compression also may provide a more accurate expression of

    overall market size and composition, and provide market participants

    with a more precise picture of their exposures.

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

    \21\ See ``ISDA 2009 A Yearbook of ISDA Activities,''

    International Swaps and Derivatives Association, Inc. (2009).

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

    The usefulness of portfolio compression as a risk management tool

    has been acknowledged widely. In 2008, the PWG identified frequent

    portfolio compression of outstanding trades as a key policy objective

    in the effort to strengthen the OTC derivatives market

    infrastructure.\22\ Similarly, the 2010 staff report outlining policy

    perspectives on OTC derivatives infrastructure issued by the FRBNY

    identified trade compression as an element of strong risk management

    and recommended that market participants engage in regular, market-wide

    portfolio compression exercises.\23\

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

    \22\ ``Policy Objectives for the OTC Derivatives Markets,''

    President's Working Group on Financial Markets (Nov. 14, 2008).

    \23\ Federal Reserve Bank of New York Staff Report No. 424:

    ``Policy Perspectives on OTC Derivatives Market Infrastructure,''

    Jan. 2010 (revised Mar. 2010).

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

    The value of portfolio compression also is illustrated by existing

    market participation in compression exercises.

    [[Page 81526]]

    In March 2010, the Depository Trust and Clearing Corporation (DTCC)

    explicitly attributed the reduction in the gross notional value of the

    contracts in its warehouse to industry supported portfolio

    compression.\24\ TriOptima, which offers the TriReduce portfolio

    compression service, estimates that it has terminated $106.3 trillion

    gross notional of interest rate swaps and $66.9 trillion gross notional

    of credit swaps since its inception in 2003.\25\ Similarly, Creditex

    and Markit, which offer portfolio compression exercises in single name

    credit default swaps, have enabled participating institutions to

    eliminate $4.5 trillion in notional between late 2008 through 2009.\26\

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

    \24\ DTCC Press Release, ``DTCC Trade Information Warehouse

    Completes Record Year Processing OTC Credit Derivatives'' (Mar. 11,

    2010). Notably, beginning in August 2008, ISDA encouraged

    compression exercises for credit default swaps by selecting the

    service provider and defining the terms of service.

    \25\ See http://www.trioptima.com. Between 2007 and 2008,

    TriOptima reduced $54.7 trillion gross notional of interest rate

    swaps and $49.1 trillion gross notional of credit swaps. In March of

    2010, the staff of the Federal Reserve Bank of New York estimated

    that since 2008 nearly $50 trillion gross notional of credit default

    swap positions has been eliminated through portfolio compression.

    Federal Reserve Bank of New York Staff Report No. 424: ``Policy

    Perspectives on OTC Derivatives Market Infrastructure,'' Jan. 2010

    (revised Mar. 2010).

    \26\ See http://www.isdacdsmarketplace.com.

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

    2. Proposed Compression Rule

    Based upon these considerations, the Commission is proposing Sec.

    23.503, which would impose certain portfolio compression requirements

    upon swap dealers and major swap participants. Specifically, swap

    dealers and major swap participants would be required to participate in

    multilateral compression exercises that are offered by those DCOs or

    self-regulatory organizations of which the swap dealer or major swap

    participant is a member. The Commission would encourage swap dealers

    and major swap participants to work with the DCOs and self-regulatory

    organizations of which they are members to develop portfolio

    compression opportunities.

    The portfolio compression obligation would be limited to swaps in

    which the counterparty is also a swap dealer or major swap participant

    and swaps that are eligible for inclusion in the exercise, as

    determined by those conducting the compression exercise and agreed to

    by those participating in the exercise. A swap dealer or major swap

    participant would be permitted to exclude swaps from a compression

    exercise if including the swap would be reasonably likely to increase

    significantly the risk exposure of the swap dealer or major swap

    participant. A swap dealer or major swap participant also would be

    permitted to establish counterparty, market, cash payment, and other

    risk tolerances and to exclude potential counterparties from the

    compression exercise, provided that the swap dealer or major swap

    participant is not using the risk tolerances or counterparty exclusions

    to evade the compression requirements.

    In recognition that portfolio compression currently is not

    available for all asset classes and all transactions within an asset

    class,\27\ the Commission also is proposing that swap dealers and major

    swap participants be required to terminate bilaterally all fully

    offsetting swaps between them by the close of business on the business

    day following the day the parties entered into the offsetting swap

    transaction and to engage annually in bilateral portfolio compression

    exercises with counterparties that are also swap dealers or major swap

    participants. Swap dealers and major swap participants need not engage

    in bilateral portfolio compression exercises, however, to the extent

    that the counterparties have mutually participated in a multilateral

    exercise involving the swaps between them during the same year.

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

    \27\ At the present time, the principal portfolio compression

    vendors offer compression exercises for limited types of trades in a

    limited number of asset classes. Compression currently is available

    for certain interest rate swaps and credit default swaps and, to a

    lesser degree, specific energy products. For example, TriOptima's

    TriReduce service provides portfolio compression services for: (1)

    Interest rate swap transactions in twenty-three currencies; (2)

    credit default swaps (index, single name, and tranches); and (3) a

    more limited number of energy products. Markit and Creditex offer

    portfolio compression for credit default swaps.

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

    The Commission anticipates that portfolio compression exercises

    will be offered by additional vendors and will encompass additional

    products and asset classes as the industry progresses toward increased

    product standardization and centralized clearing. To afford the

    Commission the flexibility to react to the expected future availability

    and need for portfolio compression exercises, proposed Sec. 23.503

    also would require swap dealers and major swap participants to

    participate in all multilateral portfolio compression exercises

    required by Commission regulation or order.

    Proposed Sec. 23.503 would not mandate portfolio compression

    exercises for swaps outstanding between a swap dealer or a major swap

    participant and counterparties that are neither swap dealers nor major

    swap participants. Instead, swap dealers and major swap participants

    would be required to maintain written policies and procedures for

    periodically terminating all fully offsetting swaps and periodically

    engaging in compression exercises.

    The proposed rule would apply to all swaps within a swap portfolio

    as of the effective date of the regulation.

    3. Comments Requested

    The Commission is requesting comment on all aspects of the

    portfolio compression rule, and specifically requests comment on the

    following questions:

    Should the Commission require swap dealers and major swap

    participants to engage in bilateral and multilateral compression

    exercises, particularly with respect to transactions where the

    counterparty is not a swap dealer or major swap participant?

    Should the compression requirement be restricted to

    particular asset classes?

    With what frequency should bilateral or multilateral

    compression be required?

    What are the costs associated with engaging in bilateral

    and multilateral compression and are such costs a barrier to

    participation?

    Should the Commission expressly define the transactions

    that are eligible for inclusion in a portfolio compression exercise or

    leave that determination to those conducting the compression exercise

    and/or to those participating in the exercise?

    What factors (e.g., sufficiently standardized terms) would

    render a particular swap eligible or ineligible for inclusion in a

    bilateral or multilateral compression exercise?

    Should the Commission provide specific risk management,

    accounting, regulatory, and other rationale under which a swap dealer

    or major swap participant may exclude particular swaps transactions

    from a multilateral portfolio compression exercise?

    How much time would be sufficient to allow swap dealers

    and major swap participants to come into compliance with the proposed

    portfolio compression requirements?

    Should the Commission require participation in compression

    exercises conducted only by registered derivatives clearing

    organizations or by all central counterparties of which the swap dealer

    or major swap participant may be a member?

    Should financial entities as defined in proposed Sec.

    23.500 be subject to the provisions of Sec. 23.503(a), (b), and (c)?

    [[Page 81527]]

    III. Related Matters

    A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) requires that agencies

    consider whether the rules they propose will have a significant

    economic impact on a substantial number of small entities.\28\ The

    Commission previously has established certain definitions of ``small

    entities'' to be used in evaluating the impact of its regulations on

    small entities in accordance with the RFA.\29\ The proposed rules would

    affect swap dealers and major swap participants.

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

    \28\ 5 U.S.C. 601 et seq.

    \29\ 47 FR 18618, Apr. 30, 1982.

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

    Swap dealers and major swap participants are new categories of

    registrants. Accordingly, the Commission has not previously addressed

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

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

    that futures commission merchants should not be considered to be small

    entities for purposes of the RFA.\30\ The Commission's determination

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

    to meet the minimum financial requirements established by the

    Commission to enhance the protection of customers' segregated funds and

    protect the financial condition of futures commission merchants

    generally.\31\ Like futures commission merchants, swap dealers will be

    subject to minimum capital and margin requirements and are expected to

    comprise the largest global financial firms. The Commission is required

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

    minimis level of swaps dealing in connection with transactions with or

    on behalf of customers. The Commission anticipates that this exemption

    would tend to exclude small entities from registration. Accordingly,

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

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

    essentially the same reasons that futures commission merchants have

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

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

    minimis level of swap dealing.

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

    \30\ Id. at 18619.

    \31\ Id.

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

    The Commission also has previously determined that large traders

    are not ``small entities'' for RFA purposes.\32\ In that determination,

    the Commission considered that a large trading position was indicative

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

    definition, maintain substantial positions in swaps or maintain

    outstanding swap positions that create substantial counterparty

    exposure that could have serious adverse effects on the financial

    stability of the United States banking system or financial markets.

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

    Commission is hereby proposing that major swap participants not be

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

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

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

    \32\ Id. at 18620.

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

    Moreover, the Commission is carrying out Congressional mandates by

    proposing this regulation. Specifically, the Commission is proposing

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

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

    participants through comprehensive regulation. The Commission does not

    believe that there are regulatory alternatives to those being proposed

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

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

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

    economic impact on a substantial number of small entities.

    B. Paperwork Reduction Act

    The Paperwork Reduction Act (PRA) \33\ imposes certain requirements

    on Federal agencies (including the Commission) in connection with their

    conducting or sponsoring any collection of information as defined by

    the PRA. This proposed rulemaking would result in new collection of

    information requirements within the meaning of the PRA. The Commission

    therefore is submitting this proposal to the Office of Management and

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

    1320.11. The title for this collection of information is

    ``Confirmation, Portfolio Reconciliation, and Portfolio Compression

    Requirements for Swap Dealers and Major Swap Participants.'' An agency

    may not conduct or sponsor, and a person is not required to respond to,

    a collection of information unless it displays a currently valid

    control number. The OMB has not yet assigned this collection a control

    number.

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

    \33\ 44 U.S.C. 3501 et seq.

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

    The collection of information under these proposed rules is

    necessary to implement 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 document the terms of all of their

    swaps, reconcile their swap portfolios to resolve any discrepancies or

    disputes, and wholly or partially terminate some or all outstanding

    swaps through regular compression exercises. Commission staff would use

    the information related to each of these important risk-reducing

    activities when conducting the Commission's examination and oversight

    program with respect to 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 also is required to protect

    certain information contained in a government system of records

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

    1. Information Provided by Reporting Entities/Persons

    Proposed Sec. Sec. 23.501, 23.502, and 23.503 would require swap

    dealers and major swap participants to make and retain records of

    confirmations, portfolio reconciliations, and portfolio compression

    exercises. The proposed regulations do not impose any reporting

    requirements. The proposed regulations will be an important part of the

    Commission's regulatory program for swap dealers and major swap

    participants. The information required to be preserved would be used by

    representatives of the Commission and any examining authority

    responsible for reviewing the activities of the swap dealer or major

    swap participant to ensure compliance with the CEA and applicable

    Commission regulations.

    The annual burden associated with these proposed regulations is

    estimated to be 1,282.5 hours, at an annual cost of $1,282,250 for each

    swap dealer and major swap participant. Burden means the total time,

    effort or financial resources expended by persons to generate,

    maintain, retain, disclose, or provide information to or for a Federal

    agency. Specifically, the Commission anticipates that swap dealers and

    major swap participants will spend an average of 40 hours per year

    drafting and

    [[Page 81528]]

    updating the policies and procedures required by the proposed

    regulations; 252 hours per year making and retaining the acknowledgment

    and confirmation records required by proposed Sec. 23.501; 812 hours

    per year making and retaining the portfolio reconciliation records

    required by proposed Sec. 23.502; and 178.5 hours per year making and

    retaining the bilateral offset and portfolio compression records

    required by proposed Sec. 23.503.

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

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

    known to the Commission until the registration requirements for these

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

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

    will be approximately 200 swap dealers and 50 major swap participants,

    it has taken a conservative approach, for PRA purposes, in estimating

    that there will be a combined number of 300 swap dealers and major swap

    participants who will be required to comply with the recordkeeping

    requirements of the proposed rules. The Commission estimated the number

    of affected entities based on industry data.

    According to recent Bureau of Labor Statistics findings, the mean

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

    Managers,'' (which includes operations managers) that is employed by

    the ``Securities and Commodity Contracts Intermediation and Brokerage''

    industry is $74.41.\34\ Because swap dealers and major swap

    participants include large financial institutions whose operations

    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.

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

    \34\ http://www.bls.gov/oes/current/oes113031.htm.

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

    Accordingly, the estimated burden was calculated as follows:

    Drafting and Updating Policies and Procedures. This hourly burden

    arises from the time necessary to develop and periodically update the

    policies and procedures required by the proposed regulations.

    Number of registrants: 300.

    Frequency of collection: Initial implementation, updating as

    needed.

    Estimated number of annual responses per registrant: 1.

    Estimated aggregate number of annual responses: 300.

    Estimated annual hour burden per registrant: 40 hours.

    Estimated aggregate annual hour burden: 12,000 burden hours [300

    registrants x 40 hours per registrant].

    Acknowledgment and Confirmation Recordkeeping. This hourly burden

    arises from the proposed requirement that swap dealers and major swap

    participants make and maintain records of the date and time of

    transmission to, or receipt from, a counterparty of an acknowledgment

    or confirmation; the length of time between the acknowledgment and

    confirmation of each swap; and the length of time between execution and

    confirmation of each swap.

    Number of registrants: 300.

    Frequency of collection: daily.

    Estimated number of annual responses per registrant: 252 [252

    trading days].

    Estimated aggregate number of annual responses: 75,600 [300

    registrants x 252 trading days].

    Estimated annual hour burden per registrant: 252 [252 trading days

    x 1 hour per day].

    Estimated aggregate annual hour burden: 75,600 burden hours [300 x

    252 hours].

    Portfolio Reconciliation Recordkeeping. This hourly burden arises

    from the proposed requirement that swap dealers and major swap

    participants make and maintain records of the portfolio reconciliation

    exercises in which they engage. Registrants would be required to

    reconcile portfolios with counterparties that are swap dealers and

    major swap participants on a daily, weekly, or quarterly basis,

    depending upon the size of the portfolio. They also would be required

    to maintain policies and procedures for conducting portfolio

    reconciliation with other counterparties with similar frequency.

    Number of registrants: 300.

    Frequency of collection: daily, weekly, or quarterly.

    Estimated number of annual responses per registrant: 8,120.\35\

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

    \35\ Due to the absence of prior experience in regulating swap

    dealers and major swap participants and with regulations similar to

    the proposed rules, the actual, average number of counterparties

    that a swap dealer or major swap participant is likely to have and

    the average size of its portfolio with particular counterparties is

    uncertain. The estimate of 5,600 portfolio reconciliation records is

    based upon the assumption that each swap dealer and major swap

    participant engages in swap transactions with approximately one

    third (100) of the other swap dealers or major swap participants and

    that 10% of such portfolios would require daily reconciliation; 20%

    would require weekly reconciliation; and 70% would require quarterly

    reconciliation. The estimate also is based upon the assumption that

    a swap dealer or major swap participant has an average of 440 other

    counterparties and that all of the portfolios with those

    counterparties generally would be limited to quarterly

    reconciliation. Consistent with other proposed rulemakings, the

    Commission has estimated that each of the 14 major swap dealers has

    an average 7,500 counterparties and the other 286 swap dealers and

    major swap participants have an average of 200 counterparties per

    year, for an average of 540 total counterparties per registrant. The

    Commission estimates that 440 of those counterparties would not be

    other swap dealers or major swap participants.

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

    Estimated aggregate number of annual responses: 2,436,000 [300

    registrants x 8,120 responses].

    Estimated annual hour burden per registrant: 812 hours [8,120 x .10

    hours per response].

    Estimated aggregate annual hour burden: 243,600 burden hours [300

    registrants x 812 hours per registrant].

    Portfolio Compression Recordkeeping. This hourly burden results

    from the proposed requirement that swap dealers and major swap

    participants make and maintain records of the bilateral offsets and

    portfolio compression exercises in which they participate, including

    the beginning and completion dates; the swaps that were included and

    excluded; the applicable risk tolerance levels; and the results of the

    particular exercise. The proposed regulations would require that each

    swap dealer and major swap participant terminate fully offsetting

    swaps; participate in certain multilateral compression exercises; and

    participate in annual bilateral portfolio compression exercises with

    each counterparty that is also a swap dealer or major swap participant

    (except to the extent that the counterparties participate in

    multilateral compression exercises for the same swaps). Swap dealers

    and major swap participants also would be required to maintain policies

    and procedures for periodically engaging in portfolio compression

    exercises with other counterparties.

    Number of registrants: 300.

    Frequency of collection: As needed.

    Estimated number of annual responses per registrant: 1,029 [24

    multilateral compression records \36\] + [465 bilateral compression

    exercise

    [[Page 81529]]

    records \37\] + [540 bilateral offset records \38\].

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

    \36\ This estimate assumes that swap dealers and major swap

    participants would engage in multilateral compression exercises for

    2 asset classes at an average rate of 12 multilateral compression

    exercises per year (approximately 1 per month).

    \37\ As with other approximations set forth in this proposal,

    the estimate of 465 bilateral compression exercise records is based

    upon the assumption that each swap dealer and major swap participant

    engages in swap transactions with approximately one third (100) of

    the other swap dealers or major swap participants. Because it is

    anticipated that most swaps between swap dealers and major swap

    participants would be eligible for multilateral portfolio

    compression exercises, the Commission expects that a swap dealer or

    major swap participant would need to engage in annual bilateral

    compression with only one quarter of (25) such counterparties. The

    estimate also is based upon the assumption that the average swap

    dealer or major swap participant has an average of 440 non-swap

    dealer or major swap participant counterparties and would engage in

    1 bilateral portfolio compression exercise with each. This would

    result in a total of 465 bilateral portfolio compression records (25

    + 440).

    \38\ This estimate is based upon the assumption that each swap

    dealer and major swap participant will have an average of 1 set of

    swaps that is eligible for annual bilateral offset with each of its

    estimated 540 counterparties per year.

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

    Estimated aggregate number of annual responses: 308,700 [300

    registrants x 1,029 responses per year].

    Estimated annual hour burden per registrant: 178.5 hours [24

    multilateral compression records x .5 hours per records] + [465

    bilateral compression exercise records x .3 hours per records] + [540

    bilateral offset records x .05 hours per record].

    Estimated aggregate annual hour burden: 53,550 burden hours [300

    registrants x 178.5 hours per registrant].

    Based upon the above, the aggregate hourly burden for all

    registrants is 334,350 hours and $33,435,000 [334,350 x $100 per hour].

    In addition to the per hour burden discussed above, the Commission

    anticipates that swap dealers and major swap participants may incur

    minimal start-up costs in connection with the proposed recordkeeping

    obligations. Such costs would include the expenditures related to

    developing and installing new recordkeeping technology or re-

    programming or updating existing recordkeeping technology and systems

    to enable the swap dealer or major swap participant to collect,

    maintain, and re-produce any newly required records. The Commission

    believes that swap dealers and major swap participants generally could

    adapt their current infrastructure to accommodate the new or amended

    technology and thus, no significant infrastructure expenditures would

    be needed. The Commission estimates the programming burden hours

    associated with technology improvements to be 40 hours.

    According to recent Bureau of Labor Statistics findings, the mean

    hourly wages of computer programmers under occupation code 15-1021 and

    computer software engineers under program codes 15-1031 and 1032 are

    between $34.10 and $44.94.\39\ Because swap dealers and major swap

    participants generally will be large entities that may engage employees

    with wages above the mean, the Commission has conservatively chosen to

    use a mean hourly programming wage of $60 per hour. Accordingly, the

    start-up burden associated with the required technological improvements

    would be $2,400 [$60 x 40 hour per affected registrant] or $720,000 in

    the aggregate.

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

    \39\ http://www.bls.gov/oes/current/oes113031.htm.

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

    2. Information Collection Comments

    The Commission invites the public and other Federal agencies to

    comment on any aspect of the recordkeeping burdens discussed above. The

    Commission specifically requests comment on the variables used in the

    above-referenced hourly burden calculations. For example, the

    Commission requests comment on the following:

    What is the total number of swap dealers and major swap

    participants in the marketplace?

    What is the average number of counterparties that a swap

    dealer or major swap participant is likely to have?

    What percentage of those counterparties are other swap

    dealers or major swap participants?

    What is the average size (number of swaps) of a portfolio

    that a swap dealer or major swap participant is likely to have with a

    particular type of counterparty?

    What is the average number of acknowledgment and

    confirmation records that a swap dealer or major swap participant would

    likely be required to make under the proposed regulations?

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

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

    information is necessary for the proper performance of the functions of

    the Commission, including whether the information will have practical

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

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

    whether there are ways to enhance the quality, utility, and clarity of

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

    collection of information on those who are to respond, including

    through the use of automated collection techniques or other forms of

    information technology.

    Comments may be submitted directly to the Office of Information and

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

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

    of submitted comments so that all comments can be summarized and

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

    this notice of proposed rulemaking for comment submission instructions

    to the Commission.

    A copy of the supporting statements for the collections of

    information discussed above may be obtained by visiting RegInfo.gov.

    OMB is required to make a decision concerning the collection of

    information between 30 and 60 days after publication of this document

    in the Federal Register. Therefore, a comment is best assured of having

    its full effect if OMB receives it within 30 days of publication.

    C. Cost-Benefit Analysis

    Section 15(a) of the CEA\40\ 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.

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

    \40\ 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 new section 4s(i) of the CEA which was added by section 731

    of the Dodd-Frank Act. The proposed regulations would set forth certain

    requirements for swap confirmations, portfolio reconciliation, and

    portfolio compression applicable to swap dealers

    [[Page 81530]]

    and major swap participants and related recordkeeping requirements.

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

    the nominal cost that would be borne by swap dealers and major swap

    participants to institute the policies and procedures and recordkeeping

    systems necessary to satisfy the new regulatory requirements are far

    outweighed by the benefits that would accrue to the financial system as

    a whole as a result of the implementation of the rules. It is expected

    that any additional cost imposed by the confirmation, portfolio

    reconciliation, and portfolio compression requirements of proposed

    Sec. Sec. 23.501, 23.502, and 23.503 would be minimal because the

    confirmation, reconciliation, and compression processes required under

    the rules are already part of a prudent operational processing regime

    that many, if not most, swap dealers and major swap participants

    already undertake as part of their ordinary course of business.

    Moreover, most swap dealers and major swap participants have

    adequate resources and existing back office operational systems that

    are capable of adjusting to the new regulatory framework without

    material diversion of resources away from commercial operations. As

    discussed in the preamble, there are also numerous third-party vendors

    that provide confirmation, compression, and reconciliation services.

    Some of these providers charge fees based on results achieved (such as

    number of swaps compressed) and, thus, the cost would be necessarily

    proportionate to the benefit.

    Benefits. With respect to benefits, the Commission has determined

    that the proposed regulations would require a swap dealer or major swap

    participant to confirm, reconcile, and compress their swaps in a manner

    that will result in reduced risk, increased transparency, and greater

    market integrity in the swaps market. The proposed swap confirmation,

    portfolio reconciliation, and portfolio compression rules would further

    the goal of avoiding market disruptions and financial losses to market

    participants and the general public. Among other benefits, the proposed

    rules would promote levels of operational scalability and resilience

    that are most evident in periods of sustained high volume and market

    volatility. Therefore, the Commission believes it is prudent to

    prescribe these proposed regulations.

    Public Comment. The Commission invites public comment on its cost-

    benefit considerations. Commentators are also invited to submit any

    data or other information that they may have quantifying or qualifying

    the costs and benefits of the proposed rules with their comment

    letters.

    List of Subjects in 17 CFR Part 23

    Antitrust, Commodity futures, Conduct standards, Conflict of

    Interests, Major swap participants, Reporting and recordkeeping, Swap

    dealers, Swaps.

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

    amend 17 CFR part 23, as proposed to be added in FR Doc. 2010-XXXX,

    published on XXXX (75 FR XXXX), as follows:

    PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

    1. The authority citation for part 23 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 I, (consisting of Sec. Sec. 23.500, 23.501, 23.502, and

    23.503) is added to read as follows:

    Subpart I--Swap Documentation

    Sec.

    23.500 Definitions.

    23.501 Swap confirmation.

    23.502 Portfolio reconciliation.

    23.503 Portfolio compression.

    Subpart I--Swap Documentation

    Sec. 23.500 Definitions.

    For purposes of subpart I, the following terms shall be defined as

    provided.

    (a) Acknowledgment means a written or electronic record of all of

    the terms of a swap signed and sent by one counterparty to the other.

    (b) Bilateral portfolio compression exercise means an exercise in

    which two swap counterparties wholly or partially terminate some or all

    of the swaps outstanding between those counterparties and replace those

    swaps with a smaller number of swaps whose combined notional value is

    less than the combined notional value of the original swaps included in

    the exercise.

    (c) Confirmation means the consummation (electronically or

    otherwise) of legally binding documentation (electronic or otherwise)

    that memorializes the agreement of the counterparties to all of the

    terms of a swap transaction. A confirmation must be in writing (whether

    electronic or otherwise) and must legally supersede any previous

    agreement (electronically or otherwise). A confirmation is created when

    an acknowledgment is manually, electronically, or by some other legally

    equivalent means, signed by the receiving counterparty.

    (d) Execution means, with respect to a swap transaction, an

    agreement by the counterparties (whether orally, in writing,

    electronically, or otherwise) to the terms of the swap transaction that

    legally binds the counterparties to such terms under applicable law.

    (e) Financial entity has the meaning given to the term in section

    2h(7)(C) of the Act and any Commission regulations promulgated

    thereunder, provided that the term shall not include a swap dealer or

    major swap participant.

    (f) Fully offsetting swaps means swaps of equivalent terms where no

    net cash flow would be owed to either counterparty after the offset of

    payment obligations thereunder.

    (g) Material terms means all terms of a swap required to be

    reported in accordance with part 45 of this chapter.

    (h) Multilateral portfolio compression exercise means an exercise

    in which multiple swap counterparties wholly or partially terminate

    some or all of the swaps outstanding among those counterparties and

    replace the swaps with a smaller number of swaps whose combined

    notional value is less than the combined notional value of the original

    swaps included in the exercise. The replacement swaps may be with the

    same or different counterparties.

    (i) Portfolio reconciliation means any process by which the two

    parties to one or more swaps:

    (1) Exchange the terms of all swaps in the swap portfolio between

    the counterparties;

    (2) Exchange each counterparty's valuation of each swap in the swap

    portfolio between the counterparties as of the close of business on the

    immediately preceding business day; and

    (3) Resolve any discrepancy in material terms and valuations.

    (j) Processed electronically means to be entered into a swap dealer

    or major swap participant's computerized processing systems to

    facilitate clearance and settlement.

    (k) Prudential regulator has the meaning given to the term in

    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 the Dodd-Frank Wall

    Street Reform and Consumer Protection Act or any insured depository

    institution

    [[Page 81531]]

    under the Federal Deposit Insurance Act, and with respect to each

    affiliate of any such company or institution.

    (l) Swap portfolio means all swaps currently in effect between a

    particular swap dealer or major swap participant and a particular

    counterparty.

    (m) Swap transaction means any event that results in a new swap or

    in a change to the terms of a swap, including execution, termination,

    assignment, novation, exchange, transfer, amendment, conveyance, or

    extinguishing of rights or obligations of a swap.

    (n) Unwind proposal means a proposal offered by the sponsor of a

    multilateral portfolio compression exercise which, if accepted, would

    wholly or partially terminate some or all of the original swaps

    included in the exercise.

    (o) Valuation means the current market value or net present value

    of a swap.

    Sec. 23.501 Swap confirmation.

    (a) Confirmation.

    (1) Each swap dealer and major swap participant entering into a

    swap transaction with a counterparty that is a swap dealer or major

    swap participant shall execute a confirmation for the swap transaction

    according to the following schedule:

    (i) For any swap transaction that has been executed and processed

    electronically, within 15 minutes of execution;

    (ii) For any swap transaction that is not executed electronically,

    but that will be processed electronically, within 30 minutes of

    execution; or

    (iii) For any swap transaction that cannot be processed

    electronically by the swap dealer or major swap participant, within the

    same calendar day as execution.

    (2) Each swap dealer and major swap participant entering into a

    swap transaction with a counterparty that is not a swap dealer or a

    major swap participant shall send an acknowledgment of such swap

    transaction according to the following schedule:

    (i) For any swap transaction that has been executed and processed

    electronically, within 15 minutes of execution;

    (ii) For any swap transaction that is not executed electronically,

    but that will be processed electronically, within 30 minutes of

    execution; or

    (iii) For any swap transaction that cannot be processed

    electronically by the swap dealer or major swap participant, within the

    same calendar day as execution.

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

    maintain, and enforce written policies and procedures reasonably

    designed to ensure that it executes a confirmation for each swap

    transaction that it enters into with a counterparty that is a financial

    entity within the same calendar day as execution and with a

    counterparty that is not a swap dealer, major swap participant, or a

    financial entity not later than the next business day after execution.

    Such procedures shall include a requirement that, prior to execution of

    any such swap, the swap dealer or major swap participant furnish to a

    prospective counterparty, or receive from a prospective counterparty, a

    draft acknowledgment specifying all terms of the swap transaction other

    than the applicable pricing and other relevant terms that are to be

    expressly agreed at execution.

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

    shall make and retain a record of:

    (i) The date and time of transmission to, or receipt from, a

    counterparty of any acknowledgment;

    (ii) The date and time of transmission to, or receipt from, a

    counterparty of any confirmation;

    (iii) The length of time between acknowledgment and confirmation of

    each swap; and

    (iv) The length of time between execution and confirmation of each

    swap.

    (2) All records required to be maintained pursuant to this section

    shall be maintained in accordance with Sec. 1.31 and shall be made

    available promptly upon request to any representative of the Commission

    or any applicable prudential regulator, or with regard to swaps defined

    in section 1a(47)(A)(v), to any representative of the Commission, the

    Securities and Exchange Commission, or any applicable prudential

    regulator.

    Sec. 23.502 Portfolio reconciliation.

    (a) Swaps with swap dealers or major swap participants. Each swap

    dealer and major swap participant shall engage in portfolio

    reconciliation as follows for all swaps in which its counterparty is

    also a swap dealer or major swap participant.

    (1) Each swap dealer or major swap participant shall agree in

    writing with each of its counterparties on the terms of the portfolio

    reconciliation.

    (2) The portfolio reconciliation may be performed on a bilateral

    basis by the counterparties or by a qualified third party.

    (3) The portfolio reconciliation shall be performed no less

    frequently than:

    (i) Once each business day for each swap portfolio that includes

    300 or more swaps;

    (ii) Once each week for each swap portfolio that includes more than

    50 but fewer than 300 swaps on any business day during any week; and

    (iii) Once each calendar quarter for each swap portfolio that

    includes no more than 50 swaps at any time during the calendar quarter.

    (4) Each swap dealer and major swap participant shall resolve

    immediately any discrepancy in a material term of a swap identified as

    part of a portfolio reconciliation.

    (5) Each swap dealer and major swap participant shall resolve any

    discrepancy in a valuation identified as part of a portfolio

    reconciliation within one business day. A difference between the lower

    valuation and the higher valuation of less than 10% of the higher

    valuation need not be deemed a discrepancy.

    (b) Swaps with entities other than swap dealers or major swap

    participants. Each swap dealer and major swap participant shall

    establish, maintain, and enforce written policies and procedures for

    engaging in portfolio reconciliation as follows for all swaps in which

    its counterparty is neither a swap dealer nor a major swap participant.

    (1) Each swap dealer or major swap participant shall agree in

    writing with each of its counterparties on the terms of the portfolio

    reconciliation.

    (2) The portfolio reconciliation may be performed on a bilateral

    basis by the counterparties or by a qualified third party.

    (3) The portfolio reconciliation shall be performed no less

    frequently than:

    (i) Once each business day for each swap portfolio that includes

    500 or more swaps;

    (ii) Once each week for each swap portfolio that includes more than

    100 but fewer than 500 swaps on any business day during any week; and

    (iii) Once each calendar quarter for each swap portfolio that

    includes no more than 100 swaps at any time during the calendar

    quarter.

    (4) Each swap dealer or major swap participant shall establish,

    maintain, and enforce written procedures reasonably designed to resolve

    any discrepancies in the material terms or valuation of each swap

    identified as part of a portfolio reconciliation process in a timely

    fashion. A difference between the lower valuation and the higher

    valuation of less than 10% of the higher valuation need not be deemed a

    discrepancy.

    (c) Reconciliation of cleared swaps. Nothing in this section shall

    apply to a

    [[Page 81532]]

    swap that is cleared by a derivatives clearing organization.

    (d) Recordkeeping. A record of each swap portfolio reconciliation,

    including a record of each discrepancy and the length of time for

    resolution of each discrepancy not resolved within one business day,

    shall be maintained in accordance with Sec. 1.31 and shall be made

    available promptly upon request to any representative of the Commission

    or any applicable prudential regulator, or with regard to swaps defined

    in section 1a(47)(A)(v) of the Act, to any representative of the

    Commission, the Securities and Exchange Commission, or any applicable

    prudential regulator.

    Sec. 23.503 Portfolio compression.

    (a) Bilateral offset. Each fully offsetting swap between a swap

    dealer or major swap participant and another swap dealer or major swap

    participant shall be terminated no later than the close of business on

    the business day following the day on which the counterparties entered

    into the fully offsetting swap.

    (b) Bilateral compression. Each swap dealer and major swap

    participant shall engage in a bilateral portfolio compression exercise

    for each swap in which the counterparty is also a swap dealer or major

    swap participant at least once per calendar year, except to the extent

    that the swap dealer or major swap participant and the counterparty

    have participated in a multilateral compression exercise involving such

    swap during the same calendar year.

    (c) Multilateral compression. Each swap dealer and major swap

    participant shall engage in the following portfolio compression

    exercises for each swap in which its counterparty is also a swap dealer

    or major swap participant:

    (1) Each swap dealer and major swap participant shall participate

    in all multilateral portfolio compression exercises required by

    Commission regulation or order.

    (2) Each swap dealer and major swap participant shall participate

    in all multilateral portfolio compression exercises that are initiated,

    offered, or sponsored by any of the following entities to the extent

    that any swap in the portfolio of the swap dealer or major swap

    participant is eligible for inclusion in the exercise:

    (i) Any derivatives clearing organization of which the swap dealer

    or major swap participant is a member; or

    (ii) Any self-regulatory organization of which the swap dealer or

    major swap participant is a member.

    (3) Each swap dealer and major swap participant shall comply with

    the following with respect to each multilateral portfolio compression

    exercise in which it participates:

    (i) Transactions included. Each swap dealer and major swap

    participant shall include in the multilateral portfolio compression

    exercise all swaps in which its counterparty is also a swap dealer or

    major swap participant that are eligible to be included in the

    particular exercise, unless including the swap would be reasonably

    likely to significantly increase the risk exposure of the swap dealer

    or major swap participant.

    (ii) Counterparty, market, and cash payment risk tolerances.

    Notwithstanding Sec. 23.503(c)(3)(i), a swap dealer or a major swap

    participant may establish counterparty, market, cash payment, or other

    risk tolerances or exclude specific potential counterparties, provided

    that the swap dealer or major swap participant does not use such risk

    tolerances or counterparty exclusions to evade the requirements of this

    regulation.

    (iii) Acceptance of unwind proposal. No swap dealer or major swap

    participant shall unreasonably withhold, delay, or condition consent to

    an unwind proposal.

    (d) Policies and procedures.

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

    maintain, and enforce written policies and procedures for engaging in

    the bilateral and multilateral portfolio compression exercises required

    by this section with respect to all swaps in which its counterparty is

    also a swap dealer or major swap participant.

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

    maintain, and enforce written policies and procedures for periodically

    terminating fully offsetting swaps and for periodically engaging in

    portfolio compression exercises with respect to swaps in which its

    counterparty is an entity other than a swap dealer or major swap

    participant, to the extent that the outstanding swaps are able to be

    terminated through a portfolio compression exercise.

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

    shall make and maintain a record of each bilateral offset and each

    bilateral or multilateral portfolio compression exercise in which it

    participates, including the beginning and completion dates of the

    offset or exercise; the included swaps and counterparties thereto; the

    swaps that were eligible for inclusion in the exercise, but were

    excluded by the swap dealer or major swap participant and the reason

    for the exclusion; the counterparty, market, cash payment, or other

    risk tolerance levels set by the swap dealer or major swap participant;

    and the results of the compression, including the identification of the

    swaps that were terminated and any new swaps and the counterparties

    thereto that resulted from the exercise.

    (2) All records required to be maintained pursuant to this section

    shall be maintained in accordance with Sec. 1.31 and shall be made

    available promptly upon request to any representative of the Commission

    or any applicable prudential regulator, or with regard to swaps defined

    in section 1a(47)(A)(v) of the Act, to any representative of the

    Commission, the Securities and Exchange Commission, or any applicable

    prudential regulator.

    Issued in Washington, DC on December 16, 2010, by the

    Commission.

    David A. Stawick,

    Secretary of the Commission.

    Appendices to Confirmation, Portfolio Reconciliation, and Portfolio

    Compression Requirements for Swap Dealers and Major Swap Participants--

    Commissioners Voting Summary and Statements of Commissioners

    Note: The following appendices will not appear in the Code of

    Federal Regulations.

    Appendix 1--Commissioners Voting Summary

    On this matter, Chairman Gensler and Commissioners Dunn,

    Sommers, Chilton and O'Malia voted in the affirmative. No

    Commissioner voted in the negative.

    Appendix 2--Statement of Chairman Gary Gensler

    I support the proposed rulemaking that establishes essential

    business conduct standards for swap dealers and major swap

    participants. Today's rule establishes confirmation, portfolio

    reconciliation and portfolio compression requirements for such

    parties. The proposed regulations are consistent with Congress's

    direction through the Dodd-Frank Act to prescribe standards for the

    timely and accurate confirmation, processing, netting and valuation

    of swap transactions. One of the primary goals of Dodd-Frank Act was

    to establish a comprehensive regulatory framework that would reduce

    risk, increase transparency and promote market integrity. The

    proposed regulations accomplish this goal by establishing procedures

    that will promote legal certainty regarding swap transactions, early

    resolutions of valuation disputes, enhanced understanding of one

    counterparty's risk exposure to another, reduced operational risk

    and increased operational efficiency.

    [FR Doc. 2010-32264 Filed 12-27-10; 8:45 am]

    BILLING CODE 6351-01-P

    Last Updated: December 28, 2010