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2011-2642

  • Federal Register, Volume 76 Issue 26 (Tuesday, February 8, 2011)[Federal Register Volume 76, Number 26 (Tuesday, February 8, 2011)]

    [Proposed Rules]

    [Pages 6708-6715]

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

    [FR Doc No: 2011-2642]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Part 23

    RIN 3038-AC96

    Orderly Liquidation Termination Provision in Swap Trading

    Relationship Documentation 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 rule would set forth parameters for the inclusion

    of an orderly liquidation termination provision in the swap trading

    relationship documentation for swap dealers and major swap

    participants.

    DATES: Submit comments on or before April 11, 2011.

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

    and Orderly Liquidation Termination Provision in Swap Trading

    Relationship Documentation 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 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:

    [[Page 6709]]

    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.''

    On January 13, 2011, the Commission voted to issue a notice of

    proposed rulemaking entitled, ``Swap Trading Relationship Documentation

    Requirements for Swap Dealers and Major Swap Participants.'' This

    proposed regulation supplements that proposal and sets forth another

    element of the swap trading relationship documentation that swap

    dealers, major swap participants, and their counterparties must include

    in their documentation. The Commission is proposing the regulation

    discussed below, pursuant to the authority granted under sections

    4s(h)(1)(D), 4s(h)(3)(D), 4s(a), 4s(i), and 8a(5) of the CEA.\4\ The

    Dodd-Frank Act requires the Commission to promulgate these provisions

    by July 15, 2011.\5\

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    \4\ 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.

    \5\ This is the seventh rulemaking to be proposed regarding

    internal business conduct standards for swap dealers and major swap

    participants. Prior notices of proposed rulemaking are available on

    the Commission's Web site at http://www.cftc.gov.

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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 (Board of

    Governors); (iii) the Office of the Comptroller of the Currency; and

    (iv) the Federal Deposit Insurance Corporation (FDIC). Staff from each

    of these agencies has had the opportunity to provide comments to the

    proposal, and the proposed regulations incorporate elements of the

    comments provided.

    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 documenting swap

    transactions, the Commission welcomes all comments.

    II. Proposed Regulation

    This proposed rulemaking supplements a prior notice of proposed

    rulemaking under which two rules were proposed--Sec. Sec. 23.504 and

    23.505. This proposal would set forth another element of the swap

    trading relationship documentation that swap dealers, major swap

    participants, and their counterparties must include in their

    documentation under Sec. 23.504(b). The provision would require that

    swap dealers and major swap participants include in the documentation

    with each of their counterparties a provision that confirms both

    parties' understanding of how the new orderly liquidation authority

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

    Insurance Act (FDIA) may affect their portfolios of uncleared, over-

    the-counter, bilateral swaps.\6\

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    \6\ As proposed, this provision would not apply to swaps cleared

    by a derivatives clearing organization (DCO). The Commission does

    not believe it is necessary to address cleared swaps in this

    rulemaking because they are addressed in section 210(c)(8)(G) of the

    Dodd-Frank Act, but solicits comment on this issue.

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    The Commission believes that the inclusion of this type of

    provision in the swap trading relationship documentation used by swap

    dealers and major swap participants registered with the Commission

    would promote legal certainty for market participants and lower

    litigation risk during times of significant market stress. In

    particular, the proposal would ensure both counterparties to a swap

    understand that under particular, unique circumstances, described in

    detail below, if one of the counterparties defaults, the non-defaulting

    party's positions could be transferred to a new, solvent counterparty

    by the FDIC, and the non-defaulting party may not be able to terminate

    its claims against the defaulting counterparty until 5 p.m. (U.S.

    eastern time) on the business day following the day the FDIC is

    appointed receiver. This stay would facilitate the FDIC's orderly

    liquidation of the defaulting counterparty's swap positions. This stay

    also is critical because it would allow the FDIC the requisite time to

    transfer the defaulter's open swap positions, claims, and collateral

    with the objective of avoiding widespread market disruption in the form

    of fire sales and contagion risk.

    A. Background

    The recent financial crisis, particularly the tumultuous events of

    2008, revealed that U.S. financial regulatory authorities lacked an

    orderly resolution mechanism for certain large financial companies. The

    lack of such a resolution mechanism led to the need for government bail

    outs of financial companies considered ``too big to fail'' and

    contributed to major financial market dislocations resulting from the

    disorderly insolvency of Lehman Brothers Inc. and its affiliates under

    the Federal bankruptcy code.

    One of the key lessons of the financial crisis is that for

    systemically important institutions, the traditional bankruptcy process

    may be too slow and cumbersome to effectively deal with defaults that

    require near instant action to diminish their effect on other entities

    and the financial system as a whole.\7\ This is especially true for

    financial companies with significant derivatives positions that require

    frequent adjustments based on trading strategies

    [[Page 6710]]

    and the need to manage exposure to market risk.

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    \7\ For example, over two years after the bankruptcy process for

    Lehman Brothers Holding Inc. began, it remains ongoing and active.

    On December 15, 2010, creditors filed a plan of reorganization by an

    ad hoc group of Lehman creditors despite Lehman's filing of a plan

    of reorganization on March 15, 2010. By contrast, under the special

    provisions under Commission regulation for treatment of cleared

    futures contracts, Lehman's futures business was resolved within a

    matter of weeks.

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    With the passage of the Dodd-Frank Act, Congress sought to address

    these problems though the enactment of Title II, which establishes an

    ``orderly liquidation authority'' under which systemically important

    financial companies can be resolved in an orderly manner. This

    authority is separate from, but consistent with, the Federal bankruptcy

    and State dissolution laws.

    B. Orderly Liquidation Under Title II of Dodd-Frank

    Under Title II of the Dodd-Frank Act, Congress provided ``the

    necessary authority to liquidate failing financial companies \8\ that

    pose a significant risk to the financial stability of the United States

    in a manner that mitigates such risk and minimizes moral hazard.'' \9\

    To this end, Title II establishes a process under which, upon the

    recommendation of the FDIC and the Board of Governors, and after

    consultation with the President, the Secretary of the Treasury appoints

    the FDIC as the receiver to wind down the affairs of, and liquidate the

    assets of, the financial company whose default may pose a systemic risk

    to the financial markets. Accordingly, the decision to act under Title

    II would be taken under conditions that would have ``serious adverse

    effects on financial stability in the United States.'' \10\

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    \8\ Under Title II, section 201(a)(11), a financial company

    includes, among other things, a bank holding company, a nonbank

    financial company supervised by the Board of Governors, or a

    company, or a subsidiary (other than an insured depository

    institution or an insurance company) of a company, that is

    predominantly engaged in activities that the Board of Governors has

    determined are financial in nature or incidental thereto.

    \9\ Section 204(a) of the Dodd-Frank Act.

    \10\ Section 203(b)(2) of the Dodd-Frank Act.

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    1. Entities Eligible for Liquidation Under Title II

    Title II provides certain Federal financial regulatory authorities

    with the power, but not the obligation, to conduct an orderly wind down

    of a financial company. If the authorities decide not to act, the

    regular insolvency processes under the Federal bankruptcy code or

    banking laws would apply. For instance, non-bank swap dealers and major

    swap participants would be subject to the bankruptcy code's chapter 7

    or chapter 11 proceedings.\11\

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    \11\ In general, Chapter 7 allows for the liquidation of a

    debtor entity and Chapter 11 allows a debtor entity to reorganize

    its affairs.

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    Title II applies to a class of business entities, referred as

    ``covered financial companies,'' that meet certain criteria as

    determined by the Secretary of the Treasury under a process described

    in the next section. This class potentially could include swap dealers

    and major swap participants registered with the Commission. For

    example, under Title II, any company that is registered as a swap

    dealer or major swap participant with the Commission and designated as

    a systemically important financial institution (SIFI) by the Financial

    Stability Oversight Council (FSOC) under a process laid out in Title I

    of the Dodd-Frank Act,\12\ could be deemed to be a ``covered financial

    company'' under Title II.\13\

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    \12\ Section 113 of the Dodd-Frank Act sets forth the process by

    which U.S. nonbank financial companies may be designated as

    systemically important. The term U.S. nonbank financial company is

    defined in section 102(a)(4)(B) of the Dodd-Frank Act.

    \13\ Entities that are designated as SIFIs under Title I of the

    Dodd-Frank Act are considered to be supervised by the Board of

    Governors of the Federal Reserve System, and thus meet the

    definition of financial company under section 201(a)(11)(B)(ii).

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    It also is possible that a swap dealer or a major swap participant

    might be deemed to be a ``covered financial company'' independent of

    Title I's FSOC designation process. Under Title II, such a company

    could be deemed to be a ``financial company'' if that entity is (1)

    predominantly engaged in financial activities \14\ and (2) those

    financial activities generate 85% or more of the company's

    revenues.\15\ A ``covered financial company'' is a financial company

    for which a determination has been made under section 203(b) of the

    Dodd-Frank Act by the Secretary of the Treasury. A prerequisite to that

    determination process is the written recommendation of both the FDIC

    and the Board of Governors.

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    \14\ Financial activities are defined by reference to section

    4(k) of the Bank Holding Company Act, 12 U.S.C. 1843(k), which

    includes activities such as dealing in or making a market in

    securities and any other activity that may be identified under rules

    or orders issued by the Board of Governors. See 12 U.S.C. 1843(k)(4)

    and 12 CFR 225.28.

    \15\ Section 201(a)(11)(B)(iii) or (iv) and section 201(b) of

    the Dodd Frank Act.

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    2. Process for Determining Whether Title II Authority Should Be Invoked

    In making a determination to act under Title II, the Secretary of

    the Treasury (in consultation with the President) must determine that,

    among other things: (1) The financial company is in default or in

    danger of default; \16\ (2) the default of the financial company would

    have a serious adverse effect on the financial stability of the United

    States; and (3) no viable private sector alternative is available to

    prevent the default. The Secretary must make a specific determination

    that any effect on the claims or interests of creditors,

    counterparties, and shareholders is appropriate.\17\

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    \16\ The phrase ``default or in danger of default'' is defined

    in Title II, section 203(c)(4), to include situations where an

    entity has, or likely will promptly, be subject to a bankruptcy

    action; the entity has incurred losses that have or are likely to

    deplete all of its capital and there is no reasonable prospect of

    avoiding such a depletion; the entity's assets are less than its

    obligations to creditors and others; and the entity is, or is likely

    to be, unable to make its payments in the normal course of business.

    See also 12 U.S.C. 1813(x)(2) (providing a similar definition under

    the FDIA).

    \17\ Section 203(b) of the Dodd-Frank Act. Additional factors

    the Secretary must consider include: (1) Any action under the

    liquidation authority would avoid or mitigate such adverse effects

    on the financial system, the cost to the general fund of the

    Treasury, and the potential to increase excessive risk taking on the

    part of creditors, counterparties, and shareholders in the financial

    company; (2) a Federal regulatory agency has ordered the covered

    financial company to convert all of its convertible debt instruments

    that are subject to a regulatory order; and (3) the company

    satisfies the definition of ``financial company'' in section

    201(a)(11) of the Dodd-Frank Act.

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    In order to meet each of these criteria, it is likely that a

    financial company would have to have a significant level of market and

    credit exposure and its default would be likely to pose a grave risk to

    financial markets. Only after these determinations have been made would

    the FDIC be granted resolution authority under Title II.

    C. Resolution by the FDIC Under FDIA.

    Before describing the FDIC's resolution authority under Title II,

    it is important to note that the FDIC also may have resolution

    authority over a swap dealer or major swap participant that is an

    insured depository institution. Generally speaking, an insured

    depository institution is defined under section 3(c) of the Federal

    Deposit Insurance Act (FDIA) as any bank or savings association the

    deposits of which are insured by the FDIC.\18\ Under the FDIA, the FDIC

    has the authority to liquidate or wind up the affairs of an insured

    depository institution. Some swap dealers and major swap participants

    registered with the Commission may be insured depository institutions.

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    \18\ 12 U.S.C. 1813(c).

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    D. Role of the FDIC in the Orderly Liquidation of Swap Dealers and

    Major Swap Participants Under Either Title II or the FDIA

    In many ways, the Title II resolution approach is modeled upon the

    FDIA. Indeed, as discussed below, certain Title II provisions are

    identical to provisions in FDIA. Consequently, the FDIC would be able

    to exercise similar powers with regard to swap dealers and major swap

    [[Page 6711]]

    participants regardless of whether the FDIC was acting under Title II

    or FDIA. Under either statutory authority, it is likely that the

    orderly wind-down and liquidation of those large firms whose demise may

    have systemic implications would have similar characteristics. For

    example, under both Title II and the FDIA, the FDIC would have the

    authority to transfer open positions, claims, and collateral to a

    receiving entity in an effort to move quickly to stabilize what could

    be deteriorating market conditions.\19\

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    \19\ The FDIC also would have the authority to merge the covered

    financial company with another company under section 210(a)(1)(G) of

    the Dodd-Frank Act.

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    As part of the resolution authority in Title II and in the existing

    provisions of the FDIA for insured depository institutions, the FDIC is

    given a one business day period in which to transfer swaps and certain

    other contracts to a solvent third party financial institution. For

    this transfer authority to be effective, a brief stay on the ability of

    counterparties to terminate, liquidate, or net is necessary.

    Specifically, under section 210(c)(10) of Dodd-Frank or 11(e)(10)

    of FDIA, parties to qualified financial contracts \20\ are prohibited

    from terminating, liquidating, or netting out positions solely by

    reason of the appointment of the FDIC as receiver or the financial

    condition of the insured depository institution, covered financial

    company, or covered subsidiary in receivership until the close of the

    next business day following the date of appointment of the FDIC as

    receiver. A party is also precluded from exercising any such

    contractual rights after it has received notice that its qualified

    financial contract has been transferred to another financial

    institution--including a bridge financial company. The effect of these

    provisions is to provide the FDIC one day after its appointment as

    receiver to consummate a transfer of a qualified financial contract to

    either a private acquirer or to a newly created bridge bank or

    financial company. Absent one of these two types of transfers within

    the allotted time frame, parties may exercise their contractual rights.

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    \20\ Qualified financial contracts include any securities

    contract, commodity contract, forward contract, repurchase

    agreement, swap agreement, and any similar agreement as determined

    by the FDIC. Section 210(c)(8)(D) of the Dodd-Frank Act and section

    11(e)(8)(D) of FDIA.

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    E. Application to Swaps

    Swaps subject to the Commission's jurisdiction under Title VII of

    the Dodd-Frank Act would appear to be subject to orderly liquidation

    under either Title II or the FDIA by virtue of the fact that they fall

    under the definition of ``qualified financial contract'' under those

    two statutes.\21\ The definition of qualified financial contract is

    identical under both Title II and FDIA and includes securities

    contracts, commodity contracts,\22\ forward contracts, repurchase

    agreements, swap agreements, and any other contract determined by the

    FDIC to be a qualified financial contract.

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    \21\ Section 210(c) applies to contracts entered into before the

    appointment of a receiver under Title II. There is an analogous

    provision under the FDIA. See section 210(c)(8)(D) of the Dodd-Frank

    Act and section 11(e)(8)(D) of FDIA.

    \22\ Under this definition, futures contracts subject to the

    Commission's jurisdiction are considered to be qualified financial

    contracts.

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    The Commission recognizes the potential for regulatory arbitrage if

    the definition of qualified financial contract does not apply to swaps

    under Title VII. Moreover, the Commission believes that should the need

    for an orderly liquidation of any systemically important swap dealer or

    major swap participant arise, it would be most appropriate and

    practicable for all swaps held on the books of those entities to be

    considered to be part of a comprehensive and orderly resolution

    process.

    F. Commission Involvement in an Orderly Liquidation

    While the Commission is not granted explicit authority under Title

    II, that section does recognize the need for all U.S. financial

    authorities to work together and to ``take all steps necessary and

    appropriate to assure that all parties * * * having responsibility for

    the condition of the financial company bear losses consistent with

    their responsibility * * *.'' \23\ In addition, if the FDIC is

    appointed receiver of a swap dealer or major swap participant for which

    the Commission is the primary regulator, the FDIC is required to

    consult with the Commission ``for purposes of ensuring an orderly

    liquidation of the entity.'' \24\ As part of its consultative role, the

    Commission might have information on defaulting swap dealers or major

    swap participants that is relevant to the resolution process. Moreover,

    the Commission may have responsibility for potential transferees, i.e.,

    firms to which open swap positions might be transferred.

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    \23\ Section 204(a)(3) of the Dodd-Frank Act.

    \24\ Section 204(c)(1) and (3) of the Dodd-Frank Act.

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    G. Proposed Regulation Sec. 23.504(b)(5)

    Previously proposed Sec. 23.504(a) would require that swap dealers

    and major swap participants establish, maintain, and enforce written

    policies and procedures reasonably designed to ensure that each swap

    dealer or major swap participant and its counterparties have agreed in

    writing to all of the terms governing their swap trading relationship.

    Under previously proposed Sec. 23.504(b), swap trading relationship

    documentation would include written agreement by the parties on certain

    terms, including general provisions on payment obligations, netting of

    payments, events of default or other termination events, transfer of

    rights and obligations, and governing law.

    Proposed Sec. 23.504(b)(5) would supplement the prior proposal by

    requiring the inclusion of a written agreement by the parties to comply

    with the FDIC's transfer authority under section 210(c)(9) and (10) of

    the Dodd-Frank Act and with the nearly identical sections under the

    FDIA.\25\ This provision under the swap trading relationship

    documentation could be invoked only if a party to the documentation is

    deemed to be a ``covered financial company'' under Title II or is an

    insured depository institution and the FDIC is appointed as a receiver.

    Under either scenario, the proposed rule refers to this party as the

    ``covered party.''

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    \25\ Sections 11(e)(9) and (10) of the FDIA; codified at 12

    U.S.C. 1821(e)(9) and (10).

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    The language of proposed Sec. 23.504(b)(5)(i) very closely tracks

    the statutory language of section 210(c)(10)(B) of the Dodd-Frank Act

    and section 11(e)(10)(B) of the FDIA. Under this provision,

    counterparties will acknowledge in their trading relationship

    documentation that neither will exercise any right to terminate a swap

    due to the appointment of the FDIC as a receiver under Title II or the

    FDIA \26\ until the close of the next business day after such

    appointment, or it receives notice that the FDIC has transferred its

    swaps to a performing third party (including a bridge bank, bridge

    financial institution, or other government-run financial institution).

    This stay provision would expire at 5 p.m. on the business day after

    the FDIC is appointed as receiver or as soon as the non-defaulting

    party receives notice that the FDIC has transferred the defaulting

    party's swaps positions, claims, and property supporting the positions

    pursuant to section 210(c)(9)(A) of the Dodd-Frank Act or section

    11(e)(9)(A) of the FDIA.

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    \26\ The counterparties may be able to specify in their

    individual documentation that only Title II would apply if neither

    counterparty would be subject to resolution under the FDIA, i.e.

    neither party is an insured depository institution.

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    [[Page 6712]]

    Proposed Sec. 23.504(b)(5)(ii) would track the language of section

    210(c)(9)(A) of the Dodd-Frank Act and section 11(e)(9)(A) of the FDIA

    and would require the parties to agree that if the FDIC decides to

    transfer swaps of the party in receivership, the FDIC will transfer all

    swaps between the parties to one financial institution, along with all

    claims and credit support related to such swaps.

    Proposed Sec. 23.504(b)(5)(iii) would require each party to

    consent to any transfer described in Sec. 23.504(b)(5)(ii). Including

    an agreement to consent to the transfer of swaps to a solvent entity

    under the strict requirements of Title II or FDIA will facilitate the

    orderly wind-down of the defaulting firm and promote the prompt

    resolution of market uncertainty and allow a return to regular trading

    strategy for non-defaulting counterparties.

    The Commission believes that the proposed regulation is important

    insofar as it will ensure that counterparties to swap transactions are

    on notice that, under particular, unique circumstances, their swap

    positions, claims, and the property supporting those positions may be

    transferred and that there may be a brief stay on their ability to

    terminate a swap. As described above, the provision would only be

    applicable in situations where the counterparties are financial

    institutions that could be designated covered financial companies under

    Title II or are insured depository institutions under FDIA.

    The Commission also believes that this provision would facilitate

    the resolution process by minimizing the potential litigation when such

    resolution authority is exercised. Minimizing litigation risk is

    important for facilitating a quick and effective resolution process;

    particularly when the alternative, the sudden collapse of the covered

    financial company, poses systemic risk.

    It is also worth noting that the inclusion of this provision in

    swap trading relationship documentation may help bring about broad

    equivalence with regard to the treatment of swaps globally. This is

    relevant because Congress recognized the need for greater international

    coordination relating to the orderly liquidation of financial companies

    by directing the Comptroller General of the United States to study ways

    to increase effective international coordination.\27\

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    \27\ Section 202(f) of the Dodd-Frank Act.

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    H. Comment Requested

    The Commission requests comment on all aspects of proposed Sec.

    23.504(b)(5). In particular, the Commission requests comment on the

    following questions:

    Are there any swaps as defined under Title VII of the

    Dodd-Frank Act that should not be considered to be qualified financial

    contracts as that term is defined under Title II of the Dodd-Frank Act

    and FDIA?

    Under what circumstances could the requirements of Sec.

    23.504(b)(5) allow for recognition of non-US authorities operating

    under legal provisions similar to that provided under Title II of the

    Dodd-Frank Act? Would inclusion of non-US authorities be useful with

    respect to financial companies that may have global operations through

    multiple subsidiaries and branches, including insured depository

    institutions?

    What steps can be taken to encourage standard

    documentation templates developed by industry groups, such as ISDA, to

    recognize the need to include termination stay provisions similar to

    those provided for under Title II and FDIA?

    Are there any anticompetitive implications to the proposed

    rules? If so, how could the proposed rules be implemented to achieve

    the purposes of the CEA in a less anticompetitive manner?

    Given the use in swaps of cross default provisions

    referencing agreements with affiliates, should ``covered party'', as

    defined in Sec. 23.504(b)(5), also include affiliates of entities that

    may be designated as covered financial companies under Title II or that

    are insured depository institutions under FDIA?

    Does the Commission have legal authority to include

    affiliates in this way?

    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. The Commission previously has determined, however,

    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-

    [[Page 6713]]

    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 ``Orderly

    Liquidation Termination Provision in Swap Trading Relationship

    Documentation 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 this proposed regulation is

    necessary to implement new section 4s(i) of the CEA, which expressly

    requires the Commission to adopt rules governing documentation

    standards for swap dealers and major swap participants and explicitly

    obligates such registrants to conform to the documentation standards

    established by the Commission. The documentation required to be

    executed and maintained would be an important part of the Commission's

    regulatory program for swap dealers and major swap participants.

    Specifically, the required recordkeeping is essential to ensuring that

    swap dealers and major swap participants include in their trading

    relationship documentation certain agreements that are designed to

    enhance the consistent treatment of swaps in the event the FDIC is

    appointed receiver under Title II of the Dodd-Frank Act or the FDIA.

    The records 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.

    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. 23.504(b)(5) supplements previously proposed

    regulations that would establish trading swap relationship

    documentation requirements for swap dealers and major swap

    participants. Specifically, proposed Sec. 23.504(b)(5) would require

    swap dealers and major swap participants to include in the

    documentation they execute with each counterparty a written agreement

    about events that will transpire if the FDIC is appointed as receiver

    under Title II of the Dodd-Frank Act or the FDIA.

    The information collection burden associated with drafting and

    maintaining the agreements required by the proposed regulation is

    estimated to be 270 hours per year, at an initial annual cost of

    $27,000 for each swap dealer and major swap participant. The aggregate

    information collection burden is estimated to be 81,000 hours per year,

    at an initial annual aggregate cost of $8,100,000. 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.

    The Commission has characterized the annual cost as an initial cost

    as the Commission anticipates that the agreements required by the

    proposed regulation generally would not require significant bilateral

    negotiation and, therefore, are likely to become standardized within

    the industry rather rapidly. Moreover, the Commission expects that

    there would be little need to modify the agreements on an ongoing

    basis. Accordingly, once a swap dealer or major swap participant has

    drafted the required agreements and incorporated them into its swaps

    trading documentation, the annual burden associated with the proposed

    regulation would be quite minimal.\34\

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

    \34\ The Commission notes that swap dealers and major swap

    participants also would be required to develop written policies and

    procedures to maintain the obligatory agreements as part of their

    swaps trading relationship documentation. The costs associated with

    these policies and procedures have been accounted for in the

    Commission's prior proposal of the rest of regulation Sec. 23.504.

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

    The hour burden calculation set forth below is based upon certain

    variables such as the number of swap dealers and major swap

    participants in the marketplace, the average number of counterparties

    of each of these registrants, and the average hourly wage of the

    employees that would be responsible for satisfying the obligation

    established by the proposed regulation. Swap dealers and major swap

    participants are new categories of registrants. Accordingly, it is not

    currently known how many swap dealers and major swap participants will

    become subject to these rules, and this will not be known to the

    Commission until the registration requirements for these entities

    become effective after July 16, 2011, the date on which the Dodd-Frank

    Act becomes effective. While the Commission believes that there 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.

    Similarly, 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 is

    uncertain. 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 anticipates that agreements required by the proposed

    regulations typically would be drafted and maintained by a swap dealer

    or major swap participant's in-house

    [[Page 6714]]

    counsel or by financial or operational managers within the firm.

    According to the Bureau of Labor Statistics findings, the mean hourly

    wage of an employee under occupation code 23-1011, ``Lawyers,'' that is

    employed by the ``Securities and Commodity Contracts Intermediation and

    Brokerage Industry'' is $82.22.\35\ The mean hourly wage of an employee

    under occupation code 11-3031, ``Financial Managers,'' (which includes

    operations managers) in the same industry is $74.41.\36\ Because swap

    dealers and major swap participants include large financial

    institutions whose employees' salaries may exceed the mean wage,

    however, the Commission has estimated the cost burden of the proposed

    regulations based upon an average salary of $100 per hour.

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

    \35\ http://www.bls.gov/oes/2099/mayowe23.1011.htm.

    \36\ http://www.bls.gov/oes/current/oes113031.htm.

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

    Based upon the above, the estimated hour burden was calculated as

    follows:

    Agreement to Orderly Liquidation Termination Provision.

    Number of registrants: 300.

    Frequency of collection: At least once per counterparty.

    Estimated number of annual responses per registrant: 540 [one per

    counterparty].

    Estimated aggregate number of annual responses: 162,000 [300

    registrants x 540 counterparties].

    Estimated annual hour burden per registrant: 270 [540

    counterparties x .5 hours per counterparty].

    Estimated aggregate annual hour burden: 81,000 [300 registrants x

    270 hours per registrant].

    As stated above, the agreements required by proposed Sec.

    23.504(b)(5) would be required to be incorporated into the swaps

    trading relationship documentation obligations established by

    previously proposed subsections of Sec. 23.504(b). The Commission does

    not anticipate that swap dealers and major swap participants would

    incur any start-up costs in connection with the proposed recordkeeping

    obligations, other than those previously noted and accounted for in the

    prior proposal.

    2. Information Collection Comments

    The Commission invites the public and other Federal agencies to

    comment on any aspect of the recordkeeping burden discussed above.

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

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

    information is necessary for the proper performance of the functions of

    the Commission, including whether the information will have practical

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

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

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

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

    collection of information on those who are to respond, including

    through the use of automated collection techniques or other forms of

    information technology.

    Comments may be submitted directly to the Office of Information and

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

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

    of submitted comments so that all comments can be summarized and

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

    this notice of proposed rulemaking for comment submission instructions

    to the Commission.

    A copy of the supporting statements for the collections of

    information discussed above may be obtained by visiting 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 \37\ 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.

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

    \37\ 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 regulation would

    implement new section 4s(i) of the CEA, which was added by section 731

    of the Dodd-Frank Act. The proposed regulation would establish certain

    swap trading relationship documentation requirements applicable to swap

    dealers and major swap participants and related recordkeeping

    obligations.

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

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

    participants to satisfy the new regulatory requirement is far

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

    a whole as a result of the implementation of the rule. The Commission

    believes that the annual cost burden per registrant ultimately would be

    quite minimal as the agreements it requires are likely to become

    standardized and applicable to most counterparties, thereby negating

    the need for individual negotiation and drafting. They also would be

    able to be maintained using a registrant's pre-existing recordkeeping

    mechanisms.

    Benefits. With respect to benefits, the Commission believes that

    the proposed regulation would ensure that swaps are treated

    consistently in the event of an appointment of the FDIC under either

    Title II of the Dodd-Frank Act or the FDIA. Providing the opportunity

    for swap dealers, major swap participants, and their counterparties to

    reach a written agreement about events that will transpire if the FDIC

    is appointed as receiver under Title II of the Dodd-Frank Act or the

    FDIA, will promote legal certainty and lower litigation risk at crucial

    times of market stress. Therefore, the Commission believes it is

    prudent to prescribe this proposed regulation.

    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. 2010-29024,

    published in the

    [[Page 6715]]

    Federal Register on November 23, 2010 (75 FR 71379), and as proposed to

    be amended elsewhere in this issue of the Federal Register, as follows:

    PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

    1. The authority citation for part 23 is revised 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. Amend proposed Sec. 23.504 by adding paragraph (b)(5) to read

    as follows:

    Sec. 23.504 Swap trading relationship documentation.

    * * * * *

    (b) * * *

    (5) The swap trading relationship documentation shall include

    written documentation in which the counterparties agree that in the

    event a counterparty is a covered financial company (as defined in

    section 201(a)(8) of the Dodd-Frank Wall Street Reform and Consumer

    Protection Act) or an insured depository institution (as defined in 12

    U.S.C. 1813) for which the Federal Deposit Insurance Corporation (FDIC)

    has been appointed as a receiver (the ``covered party''):

    (i) The counterparty that is not the covered party may not exercise

    any right that such counterparty that is not the covered party has to

    terminate, liquidate, or net any swap solely by reason of the

    appointment of the FDIC as receiver for the covered party (or the

    insolvency or financial condition of the covered party):

    (A) Until 5 p.m. (U.S. eastern time) on the business day following

    the date of the such appointment; or

    (B) After the counterparty that is not the covered party has

    received notice that the swap has been transferred pursuant to section

    210(c)(9)(A) of the Dodd-Frank Wall Street Reform and Consumer

    Protection Act or 12 U.S.C. 1821(e)(9)(A);

    (ii) A transfer pursuant to section 210(c)(9)(A) of the Dodd-Frank

    Wall Street Reform and Consumer Protection Act or 12 U.S.C.

    1821(e)(9)(A) may include:

    (A) All swaps between a counterparty that is not a covered party,

    or any affiliate of such counterparty that is not a covered party, and

    the covered party;

    (B) All claims of a counterparty that is not a covered party, or

    any affiliate of such counterparty that is not a covered party, against

    the covered party under any such swap (other than any claim which,

    under the terms of any such swap, is subordinated to the claims of

    general unsecured creditors of such covered party);

    (C) All claims of the covered party against a counterparty that is

    not a covered party, or any affiliate of such counterparty that is not

    a covered party, under any such swap; and

    (D) All property securing or any other credit enhancement for any

    swap described in paragraph (b)(5)(i)(A) of this section or any claim

    described in paragraphs (b)(5)(i)(B) or (C) of this section under any

    such swap; and

    (iii) The counterparty that is not the covered party consents to

    any transfer described in paragraph (b)(5)(ii) of this section.

    * * * * *

    Issued in Washington, DC, on January 20, 2011 by the Commission.

    David A. Stawick,

    Secretary of the Commission.

    Appendices To Swap Trading Relationship Documentation 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

    and Chilton voted in the affirmative; Commissioner O'Malia voted in

    the negative.

    Appendix 2--Statement of Chairman Gary Gensler

    I support the proposed rulemaking that establishes documentation

    requirements for swap dealers and major swap participants, ensuring

    consistency with statutory provisions in the event of an orderly

    liquidation of a swap dealer or major swap participant. The proposed

    regulation requires the inclusion of a provision in the swap trading

    relationship documentation that would inform counterparties that, if

    a swap dealer or major swap participant becomes a covered financial

    company subject to the resolution authority of the Federal Deposit

    Insurance Corporation, there may be a one-day stay on the ability of

    its counterparties to terminate, liquidate or net their uncleared

    swaps. The proposed rulemaking should lower litigation risk during

    times of significant market stress and promote an orderly and

    effective resolution process for large financial entities.

    [FR Doc. 2011-2642 Filed 2-7-11; 8:45 am]

    BILLING CODE 6351-01-P

    Last Updated: February 8, 2011



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