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, [email protected]; Frank N. Fisanich, Special
Counsel, 202-418-5949, [email protected]; or Jocelyn Partridge,
Special Counsel, 202-418-5926, [email protected]; 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.
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\28\ 5 U.S.C. 601 et seq.
\29\ 47 FR 18618, Apr. 30, 1982.
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Swap dealers and major swap participants are new categories of
registrants. Accordingly, the Commission has not previously addressed
the question of whether such persons are, in fact, small entities for
purposes of the RFA. 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.
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\30\ Id. at 18619.
\31\ Id.
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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.
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\32\ Id. at 18620.
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Moreover, the Commission is carrying out Congressional mandates by
proposing this regulation. Specifically, the Commission is proposing
these regulations to comply with the Dodd-
[[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.
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\33\ 44 U.S.C. 3501 et seq.
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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\
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\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.
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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.
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\35\ http://www.bls.gov/oes/2099/mayowe23.1011.htm.
\36\ http://www.bls.gov/oes/current/oes113031.htm.
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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
[email protected]. 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.
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\37\ 7 U.S.C. 19(a).
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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