2011-2643

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

[Proposed Rules]

[Pages 6715-6727]

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

[FR Doc No: 2011-2643]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 23

RIN 3038-AC96

Swap Trading Relationship Documentation Requirements for Swap

Dealers and Major Swap Participants

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

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

is proposing regulations to implement new statutory provisions

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

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

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

which requires the Commission to prescribe standards for swap dealers

and major swap participants related to the timely and accurate

confirmation, processing, netting, documentation, and valuation of

swaps. The proposed rules would establish requirements for swap 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 Swap Trading Relationship Documentation Requirements for Swap

Dealers and Major Swap Participants, by any of the following methods:

Agency Web site, via its Comments Online process at http://comments.cftc.gov. Follow the instructions for submitting comments

through the Web site.

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

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

Street, NW., Washington, DC 20581.

Hand Delivery/Courier: Same as mail above.

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

Follow the instructions for submitting comments.

Please submit your comments using only one method.

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

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

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

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

information that may be exempt from disclosure

[[Page 6716]]

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:

I. Background

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

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

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

risk, increase transparency, and promote market integrity within the

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

registration and comprehensive regulation of swap dealers and major

swap participants; (2) imposing clearing and trade execution

requirements on standardized derivative products; (3) creating rigorous

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

Commission's rulemaking and enforcement authorities with respect to all

registered entities and intermediaries subject to the Commission's

oversight.

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

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

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

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

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

2010.''

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

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

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

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

establishes swap documentation standards for those registrants.

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

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

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

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

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

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

The Commission is proposing the regulations governing swap

documentation discussed below, pursuant to the authority granted under

sections 4s(h)(1)(D), 4s(h)(3)(D), 4s(i), and 8a(5) of the CEA.\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 sixth 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; (iii) the Office

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

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

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

and the proposed regulations incorporate elements of the comments

provided.

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 Regulations

The proposed regulations would set forth certain requirements for

documenting the swap trading relationship between swap dealers, major

swap participants, and their counterparties. Documentation of swaps is

a critical component of the bilaterally-traded, over-the-counter (OTC)

derivatives market and has been the focus of significant domestic and

international attention in recent years.

A. Background on Documentation and Standardization

The OTC derivatives markets traditionally have been characterized

by privately negotiated transactions entered into by two

counterparties, in which each party assumes and manages the credit risk

of the other. While OTC derivatives are traded by a diverse set of

market participants, such as banks, hedge funds, pension funds, and

other institutional investors, as well as corporate, governmental, and

other end-users, a relatively few number of dealers are, by far, the

most significantly active participants. As such, the default of a

dealer may result in significant losses for the counterparties of that

dealer, either from the counterparty exposure to the defaulting dealer

or from the cost of replacing the defaulted trades in times of market

stress.\6\

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\6\ See Financial Stability Board, ``Implementing OTC

Derivatives Market Reforms: Report of the OTC Derivatives Working

Group,'' (Oct. 10, 2010), available at http://www.financialstabilityboard.org/publications/r_101025.pdf.

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OTC derivatives market participants typically have relied on the

use of industry standard legal documentation, including master netting

agreements, definitions, schedules, and confirmations, to document

their swap trading relationships. This industry standard documentation,

such as the widely used ISDA Master Agreement and related definitions,

schedules, and confirmations specific to particular asset classes,

offers a framework for documenting the transactions between

counterparties for OTC derivatives products.\7\ The standard

documentation is designed to set forth the legal, trading, and credit

relationship between the parties and to facilitate cross-product

netting of transactions in the event that parties have to close-out

their position with one another.

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\7\ The International Swaps and Derivatives Association (ISDA)

is a trade association for the OTC derivatives industry (http://www.isda.org).

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One important method of addressing the credit risk that arises from

OTC derivatives transactions is the use of bilateral close-out netting.

Parties seek to achieve enforceable bilateral netting by documenting

all of their transactions under master netting agreements.\8\ Following

the occurrence of a default by one of the counterparties (such as

bankruptcy or insolvency), the

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exposures from individual transactions between the two parties are

netted and consolidated into a single net ``lump sum'' obligation. A

party's overall exposure is therefore limited to this net sum. That

exposure then may be offset by the available collateral previously

provided being applied against the net exposure. As such, it is

critical that the netting provisions between the parties are legally

enforceable and that the collateral may be used to meet the net

exposure. In recognition of the risk-reducing benefits of close-out

netting, many jurisdictions provide favorable treatment of netting

arrangements in bankruptcy,\9\ and favorable capital and accounting

treatment to parties that have enforceable netting agreements in

place.\10\

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\8\ Enforceable bilateral netting arrangements are a common

commercial practice and are an important part of risk management and

minimization of capital costs.

\9\ See e.g., 11 U.S.C. 561 (protecting contractual right to

terminate, liquidate, accelerate, or offset under a master netting

agreement and across contracts).

\10\ See 12 CFR 3, Appendix C; 12 CFR 208, Appendix F; 12 CFR

225, Appendix G; and 12 CFR 325, Appendix D (banking regulations

regarding qualifying master netting agreements).

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There is also a risk that inadequate documentation of open swap

transactions could result in collateral and legal disputes, thereby

exposing counterparties to significant counterparty credit risk. By way

of contrast, adequate documentation between counterparties offers a

framework for establishing the trading relationship between the

parties. The use of common legal documentation also encourages

standardization of traded products. This, in turn, may facilitate

central clearing and trading as sufficient standardization is a

prerequisite for central clearing and trading on an exchange or

electronic platform.

In response to the global economic crisis, in September 2009, G-20

Leaders agreed in Pittsburgh to critical elements relating to OTC

derivatives reform, including a provision that ``[a]ll standardized OTC

derivative contracts should be traded on exchanges or electronic

trading platforms, where appropriate, and cleared through central

counterparties. * * *'' \11\ In June 2010 in Toronto, the G-20 Leaders

reaffirmed this commitment, and expressly stated their objective of

increasing standardization in the OTC derivatives markets.\12\ With the

passage of the Dodd-Frank Act in July 2010, Congress expressly

recognized the link between standardized swaps and clearing, as

well.\13\

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\11\ See Group of Twenty, ``Leaders' Statement: The Pittsburgh

Summit,'' (Sept. 24-25, 2009), available at http://www.pittsburghsummit.gov/mediacenter/129639.htm.

\12\ See The G-20 Toronto Summit Declaration (Jun. 26-27, 2010),

available at

http://www.g20.utoronto.ca/2010/g20_declaration_en.pdf. In

Annex II, the declaration stated, ``We pledged to work in a

coordinated manner to accelerate the implementation of over-the-

counter (OTC) derivatives regulation and supervision and to increase

transparency and standardization.''

\13\ ``It is expected that the standardized, plain vanilla, high

volume swaps contracts--which according to the Treasury Department

are about 90 percent of the $600 trillion swaps market--will be

subject to mandatory clearing.'' 156 Cong. Rec. S5921 (daily ed.

Jul. 15, 2010) (statement of Sen. Lincoln).

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In addition, increasing standardization of swap documentation

should improve the market in a number of other ways, including:

Facilitating automated processing of transactions; increasing the

fungibility of the contracts, which enables greater market liquidity;

improving valuation and risk management; increasing the reliability of

price information; reducing the number of problems in matching trades;

and facilitating reporting to swap data repositories.\14\

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\14\ These benefits were articulated by the Financial Stability

Board's OTC Derivatives Working Group in its report, ``Implementing

OTC Derivatives Market Reforms,'' (Oct. 10, 2010), available at

http://www.financialstabilityboard.org/publications/r_101025.pdf.

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Product and process standardization are also key conditions for

increased automation and central clearing of OTC derivatives. As a

result of targeted supervisory encouragement since 2005,\15\ credit

derivative market participants have standardized CDS product design and

post-trade processes in tandem, leading to greater operational

efficiencies, encouraging higher volumes of standardized transactions,

and most significantly, providing the requisite operational environment

for the implementation of centralized risk-reducing infrastructure,

including central counterparty clearing.

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\15\ Since 2005, the Federal Reserve Bank of New York (FRBNY)

has led a targeted, supervisory effort to enhance operational

efficiency and performance in the OTC derivatives market, among

other things, by increasing standardization. Known as the OTC

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

effort with OTC derivatives dealers' primary supervisors, trade

associations, industry utilities, and private vendors, through which

market participants (including buy-side participants) regularly set

goals and commitments to bring infrastructure, market design, and

risk management improvements to all OTC derivatives asset classes.

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Many standardized processes have been established for CDS legal

documentation and trading conventions, and in turn, the standardization

of product design has enabled market participants to implement

infrastructure that automates and centralizes trading, recordkeeping,

trade compression, and clearing. For example, the standardization of

coupons in the single-name CDS product was largely motivated by the

desire to create an efficient process for offsetting contracts. The

market-wide adoption of fixed coupons allowed single-name CDS

instruments to be centrally cleared, in effect standardizing

counterparty credit risk management in these products. The ``Big Bang

Protocol'' further standardized a number of critical operational

processes.\16\ The protocol: (i) ``Hardwired'' a standard auction

mechanism into CDS trading documentation, eliminating the need for ad

hoc protocols; (ii) incorporated the resolutions of the ISDA

Determinations Committees into the terms of standard CDS documentation;

and (iii) instituted a common standard effective date for CDS

transactions. Codifying key standardized processes into CDS products

has brought greater certainty to managing the risk of CDS transactions

and has provided the structural foundation for greater automation,

higher volumes in standardized transactions, and ultimately the

establishment of centralized risk-reducing infrastructure, such as

central counterparties.

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\16\ See 2009 ISDA Credit Derivatives Determinations Committees

and Auction Settlement CDS Protocol, available at: http://www.isda.org/bigbangprot/docs/Big-Bang-Protocol.pdf.

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B. Proposed Swap Trading Relationship Documentation Rule

To promote the ``timely and accurate * * * documentation * * * of

all swaps'' under Sec. 4s(i)(1) of the CEA, 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 and have executed all agreements

required by proposed Sec. 23.504.

Proposed Sec. 23.504(b)(1) would specify that the swap trading

relationship documentation include written agreement by the parties on

terms relating to payment obligations, netting of payments, events of

default or other termination events, netting of obligations upon

termination, transfer of rights and obligations, governing law,

valuation, and dispute resolution procedures. Proposed Sec.

23.504(b)(2) would establish that all confirmations of swap

transactions, as required under previously proposed Sec. 23.501, would

be considered to be part of the required swap trading relationship

documentation.

[[Page 6718]]

Swap trading relationship documentation under proposed Sec.

23.504(b)(3)(i) and (ii) also would include credit support arrangements

containing initial and variation margin requirements at least as high

as those set by the Commission (for swap dealers and major swap

participants that are not banks) and by prudential regulators (for

entities that are banks). These credit support arrangements also would

be required to identify the forms of eligible assets that may be used

as margin and asset valuation haircuts.

Under proposed Sec. 23.504(b)(3)(iii) and (iv), the credit support

arrangements between swap dealers and major swap participants would

include documentation of the treatment of any assets used as margin for

uncleared swaps. These provisions are intended to work together with

the rules previously proposed under section 4s(l) of the CEA,\17\ and

thus require documentation as to whether the funds and other property

are to be segregated with an independent third party, in accordance

with Sec. 23.601(e). The provisions also are designed to work together

with rules to be proposed under section 4s(e) of the CEA that relate to

margin requirements.

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\17\ See 75 FR 75432, Notice of Proposed Rulemaking, Protection

of Collateral of Counterparties to Uncleared Swaps; Treatment of

Securities in a Portfolio Margining Account in a Commodity Broker

Bankruptcy, Dec. 3, 2010.

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Under Sec. 23.601, as previously proposed, swap dealers and major

swap participants trading uncleared swaps would be required to notify

each counterparty that the counterparty has the right to require

segregation of the funds or other property that it supplies as

``initial margin,'' a term defined in previously proposed Sec.

23.600.\18\ At the request of the counterparty, the swap dealer or

major swap participant would be required to segregate such initial

margin with an independent third party. Under section 4s(l) of the CEA,

this segregation requirement would not apply to variation margin

payments. Proposed Sec. 23.602(a)(2), however, would permit the swap

dealer or major swap participant and the counterparty to agree that

variation margin also may be held in a segregated account. Under

proposed Sec. 23.601(e), swap dealers and major swap participants

would notify each counterparty of the opportunity to revisit their

segregation decision once per calendar year.

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\18\ See 75 FR 75438 (``Initial margin means money, securities,

or property posted by a party to a swap as performance bond to cover

potential future exposures arising from changes in the market value

of the position.'').

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Swap dealers and major swap participants also must comply with

proposed Sec. 23.603(a), which would provide that segregated initial

margin may only be invested consistent with the standards for

investment of customer funds that the Commission applies to exchange-

traded futures (see Sec. 1.25 of Commission regulations), and with

proposed Sec. 23.603(b), which would provide that swap dealers and

major swap participants and their counterparties may enter into any

commercial arrangement, in writing, regarding the investment of

segregated initial margin and the related allocation of the gains and

losses resulting from such investments. The Commission anticipates that

documentation of the foregoing matters would be included in the trading

relationship documentation required pursuant to proposed Sec.

23.504(b)(3)(iii).

Swap dealers and major swap participants could maintain standard

templates for documenting their trading relationships as a way of

complying with the requirements of Sec. 23.504. The Commission would

also consider it a sound practice for swap dealers and major swap

participants to require senior management in the business trading and

risk management units to approve all templates, and any material

modifications to them. The Commission recognizes the work that the

industry has undertaken over the past several years to update and

standardize the documentation it relies upon for various asset classes,

and the Commission encourages market participants to adopt standardized

confirmation templates, standardized master confirmation

agreements,\19\ standardized product definitions, and other

standardized documentation developed by the industry. Standardized

documentation and definitions promote standardized products, which may

lead to greater liquidity and more efficient pricing. In addition,

increased product standardization may bring systemic risk-reduction

benefits as the risks associated with standardized products are better

understood by the entire marketplace.

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\19\ Standard Master Confirmation Agreements that have been

published include:

2004 Sovereign Master Credit Derivatives Confirmation Agreement.

2003 Master Credit Derivatives Confirmation Agreement (Asia-

Pacific).

2003 Master Credit Derivatives Confirmation Agreement (European-

North American).

2009 Americas Master Equity Derivatives Confirmation Agreement.

2008 Americas Master Designated/Exchange-Traded Contract Option

Confirmation Agreement.

2007 Americas Master Variance Swap Confirmation Agreement.

2004 Americas Interdealer Master Equity Derivatives Confirmation

Agreement.

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C. Proposed Swap Valuation Provisions

Swap valuation disputes have long been recognized as a significant

problem in the OTC derivatives market.\20\ The ability to determine

definitively the value of a swap at any given time lies at the center

of many of the OTC derivatives market reforms contained in the Dodd-

Frank Act and is a cornerstone of risk management. Swap valuation is

also crucial for determining capital and margin requirements applicable

to swap dealers and major swap participants and therefore plays a

primary role in risk mitigation for uncleared swaps.

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\20\ See ISDA Collateral Committee, ``Commentary to the Outline

of the 2009 ISDA Protocol for Resolution of Disputed Collateral

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

increased significantly since late 2007, and especially during 2008

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

uncollateralized exposures between professional firms.'').

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The Commission recognizes that swap valuation is not always an easy

task. In some instances, there is widespread agreement on valuation

methodologies and the source of formula inputs for frequently traded

swaps. These swaps are the proverbial ``low-hanging fruit,'' and many

have been accepted for clearing (i.e., commonly traded interest rate

swaps and credit default swaps). However, parties often dispute

valuations of thinly traded swaps where there is not widespread

agreement on valuation methodologies or the source for formula inputs.

Many of these swaps are thinly traded either because of their limited

use as risk management tools or because they are simply too customized

to have comparable counterparts in the market. As many of these swaps

are valued by dealers internally by ``marking-to-model,'' their

counterparties may dispute the inputs and methodologies used in the

model. As uncleared swaps are bilateral, privately negotiated

contracts, on-going swap valuation for purposes of initial and

variation margin calculation and swap terminations or novations, has

also been largely a process of on-going negotiation between the

parties. The inability to agree on the value of a swap became

especially acute during the 2007-2009 financial crisis when there was

widespread failure of the market inputs needed to value many swaps.\21\

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\21\ The failure of the market to set a price for mortgage-

backed securities led to wide disparities in the valuation of CDS

referencing mortgage-backed securities (especially collateralized

debt obligations). Such wide disparities led to large collateral

calls from dealers on AIG, hastening its downfall. See CBS News,

``Calling AIG? Internal Docs Reveal Company Silent About Dozens Of

Collateral Calls,'' Jun. 23, 2009, available at: http://www.cbsnews.com/stories/2009/06/23/cbsnews_investigates/main5106672.shtml.

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The Commission believes that prudent risk management requires that

market participants be able to value their own swaps in a predictable

and objective manner; the failure to do so may lead to systemic risk.

Accordingly, to promote the ``timely and accurate * * * valuation of

all swaps'' under Sec. 4s(i)(1) of the CEA, proposed Sec.

23.504(b)(4) would require that the swap trading documentation include

written documentation in which the parties agree on the methods,

procedures, rules and inputs for determining the value of each swap at

any time from execution to the termination, maturity, or expiration of

the swap. The agreed methods, procedures, rules and inputs would be

required to constitute a complete and independently verifiable

methodology for valuing each swap entered into between the parties.

Proposed Sec. 23.504(b)(4)(iii) would require that the methodology

include complete alternative methods for determining the value of the

swap in the event that one or more inputs to the methodology become

unavailable or fail, such as during times of market stress or

illiquidity. All agreements on valuation would be considered part of

the swap trading relationship documentation.

This proposed rule is an important complement to previously

proposed Sec. 23.502 (portfolio reconciliation), which requires swap

dealers and major swap participants to resolve a dispute over the

valuation of a swap within one business day. By requiring agreement

with each counterparty on the methods and inputs for valuation of each

swap, it is expected that Sec. 23.504(b)(4) will assist swap dealers

and major swap participants to resolve valuation disputes in a timely

manner, thereby reducing risk.

D. Submission of Swaps for Clearing

Under proposed Sec. 23.504(b)(6), upon acceptance of a swap by a

registered derivatives clearing organization (DCO), each swap dealer

and major swap participant would be required to create a record

containing certain items of information,\22\ along with a statement

that in accordance with the rules of the DCO, the original swap is

extinguished and is replaced by equal and opposite swaps between

clearing members and the DCO. This provision would require that all

terms of the cleared swap conform to the templates established under

the DCO's rules, and that all terms of the swap, as carried on the

books of the clearing member, conform to the terms of the cleared swap

established under the DCO's rules.

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\22\ Such information includes the date and time the swap was

accepted for clearing, the name of the DCO clearing the swap, the

name of the clearing member clearing the swap for the swap dealer or

major swap participant, and, if known, the name of the clearing

member clearing the swap for the counterparty.

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Proposed Sec. 23.504(b)(6), while addressing the issues prescribed

under Sec. 4s(i)(1) of the CEA, is intended to correspond to proposed

Sec. 39.12(b)(4).\23\ The purpose of these provisions is to encourage

the standardization of swaps and to avoid differences that could

compromise the benefits of clearing between the terms of a swap as

carried at the DCO level and at the clearing member level. Any such

differences would raise both customer protection and systemic risk

concerns. From a customer protection standpoint, if the terms of the

swap at the customer level differ from those at the clearing level,

then the customer will not receive the full transparency and liquidity

benefits of clearing, and legal and basis risk will be introduced into

the customer position. Similarly, from a systemic perspective, any

differences could diminish overall price discovery and liquidity and

increase uncertainties and unnecessary costs into the insolvency

resolution process. Standardizing the terms of a swap upon clearing

would facilitate trading and promote the mitigation of risk for all

participants in the swap markets.

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\23\ The proposed Notice of Proposed Rulemaking, Risk Management

Requirements for Derivatives Clearing Organizations under part 39

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

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Standardization also will impose structure on the general economic

function of the contract and will facilitate automated processing and

the ability for participants to replicate the trade easily. This allows

market participants to trade in and out of contracts easily and lowers

transaction costs, which in turn enables greater market liquidity and

expansion of the market to more participants.

E. Documentation Audit and Recordkeeping

In keeping with prudent risk management, Sec. 23.504(c) would

require an annual audit of the swap trading relationship documentation

required by Sec. 23.504 to ensure compliance with approved

documentation policies and procedures and Commission regulations.

Proposed Sec. 23.504(d) would require swap dealers and major swap

participants to keep records in compliance with this section.

F. Reporting Swap Valuation Disputes

Proposed Sec. 23.504(e) would require that swap dealers and major

swap participants promptly notify the Commission, any applicable

prudential regulator, and the Securities and Exchange Commission with

regard to security-based swap agreements if any swap valuation dispute

is not resolved within one business day, if the dispute is with a

counterparty that is a swap dealer or major swap participant; or within

five business days, if the dispute is with a counterparty that is not a

swap dealer or major swap participant. This proposed rule would

complement previously proposed Sec. 23.502, which requires portfolio

reconciliation and resolution of valuation disputes. It also would

allow authorities to recognize and respond to outstanding swap

valuation disputes, which if left uncollateralized, may lead to

systemic risk.

G. Proposed End User Exception Documentation Rule

Proposed Sec. 23.505 would work together with the swap data

recordkeeping and reporting requirements rules and end-user exception

to mandatory clearing rules, both previously proposed by the

Commission.\24\ Under these previously proposed rules, ``a swap

otherwise subject to mandatory clearing is subject to an elective

exception from clearing if one party to the swap is not a financial

entity, is using the swaps to hedge or mitigate commercial risk, and

notifies the Commission * * * how it generally meets its financial

obligations associated with entering into non-cleared swaps (the `end-

user clearing exception').'' \25\ Under previously proposed Sec. 39.6,

the end-user clearing exception is elected by providing ten additional

items of information to a swap data repository (SDR) through a ``check-

the-box notification process.'' \26\ As explained in the swap data

recordkeeping and reporting rules, swap dealers and major swap

participants will have the responsibility for reporting to SDRs ``with

respect to the majority of swaps.'' \27\ In order to ensure that swap

dealers and major swap participants comply with all mandatory clearing

requirements and in light of their unique reporting obligations, it is

critical that they possess documentation

[[Page 6720]]

sufficient to support a reasonable belief that their counterparties

meet the statutory requirements for electing an exception from

mandatory clearing. Accordingly, the Commission is proposing Sec.

23.505.

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\24\ See Swap Data Recordkeeping and Reporting Requirements, 75

FR 76573, Dec. 8, 2010, and End-User Exception to Mandatory Clearing

of Swaps, 75 FR 80747, Dec. 23, 2010.

\25\ 75 FR at 80748.

\26\ 75 FR at 80749 and 80755.

\27\ 75 FR at 76593; see also section 4r of the CEA.

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Proposed Sec. 23.505 would require swap dealers and major swap

participants to obtain documentation from any counterparty seeking to

exercise its rights under the end-user clearing exception from the

mandatory clearing requirement under section 2h(7) of the CEA. For

swaps subject to the mandatory clearing requirement, the proposed rule

would require that swap dealers and major swap participants comply with

any mandatory clearing requirement by obtaining documentation

sufficient to provide the swap dealer or major swap participant with a

reasonable basis to believe that its counterparty meets the statutory

conditions required for an exception from a mandatory clearing

requirement, as defined in section 2h(7) of the CEA.

H. Application of Proposed Regulations to Existing Swap Documentation

The Commission recognizes that amending all existing trading

relationship documentation would present a substantial undertaking for

the market. Therefore, the Commission invites comment on the

implementation of proposed Sec. 23.504. While much of the existing

swap documentation among swap dealers, major swap participants, and

their counterparties likely would be in compliance with Sec.

23.504(b), the Commission requests comment on an appropriate interval

following the effective date of the regulations after which to require

compliance. This interval is expected to be somewhat shorter for swap

documentation among swap dealers and major swap participants, and

somewhat longer for swap documentation between swap dealers, major swap

participants, and counterparties that are not swap dealers or major

swap participants.

The Commission also recognizes that many swap dealers and major

swap participants may have dormant trading relationships with

counterparties where swap documentation has been executed, but no

trades are presently in effect thereunder or there are trades that will

run-off over a short period of time, and there is no intention to enter

into new trades. Therefore, the Commission invites comment on whether

to provide a safe harbor for dormant trading relationships.

I. Comment Requested

The Commission requests comment on all aspects of proposed

Sec. Sec. 23.504 and 23.505. The Commission recognizes that there will

be differences in the size and scope of the business of particular swap

dealers and major swap participants. Therefore, comments are solicited

on whether certain provisions of the proposed regulations should be

modified or adjusted to reflect the differences among swap dealers and

major swap participants or differences among asset classes. In

particular, the Commission requests comment on the following questions:

How long would swap dealers and major swap participants

require to bring their existing documentation into compliance with

Sec. 23.504? Will compliance take less time for existing documentation

between such registrants and longer for existing documentation between

registrants and non-registrants? Would three months following the

effective date of the rules be long enough for registrants to bring

existing documentation among themselves into compliance? Would six

months following the effective date of the rules be long enough for

registrants to bring existing documentation with non-registrants into

compliance?

Should Sec. 23.504 include a safe harbor for swaps

entered into on, or subject to the rules of, a board of trade

designated as a contract market?

Should Sec. 23.504 require that the governing body of

each swap dealer or major swap participant approve the policies and

procedures for agreeing with each counterparty to all the terms

governing the trading relationship?

Should any other aspects of the trading relationship be

required to be included in Sec. 23.504?

Should the requirement for agreement on events of default

or termination events be further defined? For example, should parties

be required to specify all cross default implications and potential

claims with regard to their respective affiliates and any other present

or future debt obligations or transactions?

Should Sec. 23.504 specifically delineate the types of

payment obligation terms that must be included in the trading

relationship documentation?

Should specific requirements for dispute resolution be

included in Sec. 23.504 (such as time limits), and if so, what

requirements are appropriate for all swaps?

Should the valuation agreement in Sec. 23.504(b)(4)

require greater specificity? If so, what level of detail should be

required?

Should the valuation methodology provision in Sec.

23.504(b)(4) expressly prohibit use of internal and/or proprietary

inputs and methods and if not, why are inputs and methods developed and

verifiable only by one party to the swap transaction acceptable given

the safety and soundness and transparency objectives of the Dodd-Frank

Act?

If internal and/or proprietary inputs or procedures are

permitted under Sec. 23.504(b)(4), should the swap dealer or major

swap participant be required to disclose such information and the

sources thereof to the counterparty and regulators in sufficient detail

for them to undertake comparative analysis of such information and

verify the valuation calculations?

Under proposed Sec. 23.504(b)(6)(v), should all the terms

of the cleared swap be required to conform to the templates established

by the DCO or are there particular terms or rights under the swap that

could be retained without prejudice to the need to standardize swaps

for the purposes of clearing?

Is the requirement that each swap dealer and major swap

participant conduct an independent internal or external audit of no

less than 5% of the swap trading relationship documentation required by

the rule executed during the previous twelve month period appropriate?

Would a failure of swap trading relationship documentation

to comply with the requirements of proposed Sec. 23.504 create

uncertainty regarding the enforceability of swaps transacted under such

non-compliant documentation? If so, how should this uncertainty be

addressed in the rules?

Are the requirements of proposed Sec. 23.505 appropriate?

How should swap dealers and major swap participants verify that their

counterparties are properly claiming an exception from a given

mandatory clearing requirement?

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?

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\

[[Page 6721]]

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-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 ``Swap Trading

Relationship Documentation Requirements for Swap Dealers and Major Swap

Participants.'' An agency may not conduct or sponsor, and a person is

not required to respond to, a collection of information unless it

displays a currently valid control number. The OMB has not yet assigned

this collection a control number.

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

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The collection of information under these proposed rules is

necessary to implement new section 4s(i) 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 required recordkeeping is

particularly essential to ensuring that each swap dealer and major swap

participant documents all of the terms of its swap trading

relationships with its counterparties. Obligating certain swap market

participants to memorialize, in writing, their mutual agreement with

respect to margin requirements, margin assets, payment and netting,

termination events, the calculation and netting of obligations upon

termination, transfer of rights and obligations, governing law,

valuation methods and inputs, and dispute resolution procedures would

decrease the likelihood of significant counterparty disputes; promote

transaction standardization; enhance the parties' abilities to engage

in risk-reducing exercises such as bilateral offset, portfolio

reconciliation, and portfolio compression; provide for more timely and

orderly resolution of events of default; and enhance the stability of

the market place as a whole. The proposed regulations also would ensure

that certain important information regarding cleared swaps would be

preserved and would assist in ensuring compliance with the mandatory

clearing requirements of the Act and Commission regulations by

requiring the maintenance of documentation demonstrating that the

statutory conditions for an exception to those requirements have been

satisfied. The reporting requirement established by the proposed rules

would ensure that the Commission is provided with timely notification

of swap valuation disputes that relevant market participants have been

unable to resolve promptly.

The proposed regulation would be an important part of the

Commission's regulatory program for swap dealers and major swap

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

representatives of the Commission and any examining authority

responsible for reviewing the activities of the swap dealer or major

swap participant to ensure compliance with the CEA and applicable

Commission regulations.

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 generally would require swap dealers and

major swap participants to develop and retain

[[Page 6722]]

written swap trading relationship documentation (including the parties'

agreement with respect to the terms specified in the regulation; credit

support arrangements; valuation methods, procedures and inputs; records

of important information regarding their cleared swaps; and written

policies and procedures for maintaining the documentation required by

the proposed rule). It also would require swap dealers and major swap

participants to report to the Commission and, as applicable, to the

Securities and Exchange Commission or prudential regulators, swap

valuation disputes that have not been resolved between the parties

within designated time frames. Proposed Sec. 23.505 would require swap

dealers and major swap participants to obtain documentation sufficient

to provide a reasonable basis on which to believe that a counterparty

meets the statutory conditions necessary for an exception from the

mandatory clearing requirements, where applicable.

The information collection burden associated with the proposed

regulations is estimated to be 6,168 hours per year, at an initial

annual cost of $684,300 for each swap dealer and major swap

participant. The aggregate information collection burden is estimated

to be 1,850,400 hours per year, at an initial annual aggregate cost of

$205,290,000. 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 costs as initial costs as the Commission

anticipates that the cost burdens will be reduced dramatically over

time as the agreements and other records required by the proposed

regulations become increasingly standardized within the industry.

The Commission anticipates that the majority of the information

collection burden would arise from the recordkeeping obligations

contained in Sec. 23.504(b). Proposed Sec. 23.504(b) would require

each swap dealer and major swap participant to create and maintain

written trading relationship documentation that contains the parties'

agreement with respect to all of the terms of the parties' trading

relationship including, without limitation, the terms delineated in

Sec. 23.504(b)(1); the parties' credit support arrangements, including

the margin-related terms described in Sec. 23.504(b)(3); and the

parties' agreement with respect to the particular procedures and inputs

that will be used to determine the value of a swap from execution to

termination, maturity, or expiration in a manner that can be

independently replicated as required by Sec. 23.504(b)(4). It also

requires swap dealers and major swap participants to make and maintain

records of cleared swaps containing the data contained in proposed

Sec. 23.504(b)(6).

Maintenance of written credit support arrangements and other

trading relationship documentation that contain the terms required to

be memorialized by the proposed Sec. Sec. 23.504(b)(1) and (3) is

prudent business practice and the Commission anticipates that swap

dealers and major swap participants already maintain some form of this

documentation with each of their counterparties in the ordinary course

of their business. Moreover, proposed Sec. 23.504(b)(2) provides that

the swap transaction confirmations described under previously proposed

Sec. 23.501 would be considered part of the parties' trading

relationship documentation and thus, pre-existing swap confirmations

that include the terms required by Sec. 23.504 would obviate the need

for the parties to develop new documentation with respect to those

terms.\34\ Accordingly, any additional expenditure related to

Sec. Sec. 23.504(b)(1) and (3) likely would be limited to the time

initially required to review and, as needed, to re-negotiate and amend,

existing trading relationship documentation to ensure that it

encompasses all of the required terms and to develop a system for

maintaining any newly created records. Many of the amended provisions

are likely to apply to multiple counterparties, thereby reducing the

per counterparty hour burden.

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\34\ The information collection burden associated with the

maintenance of confirmations of swaps transactions was calculated

and accounted for in previously proposed regulations. See

Confirmation, Portfolio Reconciliation, and Portfolio Compression

Requirements for Swap Dealers and Major Swap Participants, 75 FR

81519, Dec. 28, 2010.

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With respect to the valuation agreement requirement established by

proposed Sec. 23.504(b)(4), the Commission believes that swap dealers

and major swap participants are likely to have existing, internal

mechanisms for valuing their swaps transactions and thus, the hour

burden associated with this obligation would be limited to the time

needed to negotiate agreements with counterparties on mutually

acceptable valuation methods, should their individual valuation

procedures differ, and to commit the agreement to writing as part of

the parties' swap trading relationship documentation. It is likely that

the need for new valuation agreements may be limited further to

instances of complex or highly customized swaps transactions, as the

valuation methods for ``plain vanilla'' swaps are likely to be somewhat

standardized.

The Commission estimates the initial annual hour burden associated

with negotiating, drafting, and maintaining the swap trading

relationship documentation described above that is required by proposed

Sec. 23.504(b) (excluding the cleared swap records required by

proposed Sec. 23.504(b)(6)), to be 10 hours per counterparty, or an

average of 5,400 hours per swap dealer or major swap participant. As

stated above, the Commission expects that this annual per registrant

burden would be reduced considerably over time as there would be little

need to modify the swap trading relationship documentation on an

ongoing basis. Once a swap dealer or major swap participant modifies

its pre-existing documentation with each of its counterparties, the

annual burden associated with the swap trading relationship

documentation would be minimal. In addition, because all swap dealers

and major swap participants would be required to maintain the swap

trading relationship documentation established by the proposed

regulation, the Commission believes that it is likely that many of the

terms of such documentation would become progressively more

standardized within the industry, further reducing the bilateral

negotiation and drafting responsibilities associated with the

regulation.

With respect to the required records of cleared swaps, the

Commission estimates that swap dealers and major swap participants will

spend an average of 2 hours per trading day, or 504 hours per year,

maintaining the required data for these transactions. The Commission

notes that the specific information required for each transaction is

limited and is of the type that would be maintained in a prudent market

participant's ordinary course of business. The Commission also notes

that the statement required to be preserved for each cleared swap

likely would become common to each derivatives clearing organization.

In addition to the above, the Commission anticipates that swap

dealers and major swap participants will spend an average of 16 hours

per year drafting and, as needed, updating the written policies and

procedures required by proposed Sec. 23.504(a); 4 hours per year

maintaining records of the results of the annual documentation

compliance audits mandated by proposed Sec. 23.504(c); and 220 hours

per year, or 1 hour per end user, maintaining records of the

[[Page 6723]]

documentation required by proposed Sec. 23.505.

The only reporting requirement contained in the proposed rules is

the obligation of swap dealers and major swap participants to report

swap valuation disputes that are not resolved between the participants

within designated time periods. The Commission expects that swap

dealers and major swap participants will spend an average of 24 hours

per year satisfying this requirement.

The hour burden calculations below are based upon a number of

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 of these registrants that would be responsible for satisfying

the obligations 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

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 and the

average size of its portfolio with particular counterparties 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 the written policies and procedures

required by the proposed regulations, along with the recordkeeping and

reporting requirements, typically would be drafted and maintained by

in-house counsel and financial or operational managers within the

firm.\35\ 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.\36\ 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.\37\ Because swap dealers and major swap

participants include large financial institutions whose employees'

salaries may exceed the mean wage provided, however, the Commission

generally has estimated the cost burden of the proposed regulations

based upon an average salary of $100 per hour. To account for the

possibility that the services of outside counsel may be required to

satisfy the requirements associated with negotiating, drafting, and

maintaining the required trading relationship documentation (except the

cleared swap records), the Commission has used an average salary of

$125 per hour to calculate this burden for one half of the necessary

hours.

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\35\ The written policies and procedures also may be drafted and

maintained by the chief compliance officer of the swap dealer or

major swap participant. According to recent Bureau of Labor

Statistics findings, the mean hourly wage of any employee under

occupation code 13-1401, ``Compliance Officers, Except Agriculture,

Construction, Health and Safety, and Transportation,'' that is

employed by the ``Securities and Commodity Contracts Intermediation

and Brokerage Industry is $38.77. http://www.bls.gov/oes/current/oes131041.htm.

\36\ http://www.bls.gov/oes/2099/mayowe23.1011.htm.

\37\ http://www.bls.gov/oes/current/oes113031.htm.

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

follows:

Drafting and Updating Policies and Procedures. This hour burden

arises from the time necessary to develop and periodically update the

policies and procedures required by the proposed regulations.

Number of registrants: 300.

Frequency of collection: Initial drafting, updating as needed.

Estimated number of annual responses per registrant: 1.

Estimated aggregate number of annual responses: 300.

Estimated annual hour burden per registrant: 16 hours.

Estimated aggregate annual hour burden: 4,800 burden hours [300

registrants x 16 hours per registrant].

Swap Trading Relationship Documentation (excluding cleared swaps

records). This hour burden arises from the proposed obligation that

swap dealers and major swap participants execute and maintain swap

trading relationship documentation.

Number of registrants: 300.

Frequency of collection: At least once per counterparty.

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

of agreements per counterparty].

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

registrants x 540 counterparties].

Estimated annual hour burden per registrant: 5,400 [540

counterparties x 10 hours per counterparty].

Estimated aggregate annual hour burden: 1,620,000 [300 registrants

x 5,400 hours per registrant].

Cleared Swap Recordkeeping. This hourly burden arises from the

proposed requirement that swap dealers and major swap participants make

and maintain records of specified information related to each swap

accepted for clearing by a derivatives clearing organization.

Number of registrants: 300.

Frequency of collection: Daily.

Estimated number of annual responses per registrant: 252 [252

trading days per year].\38\

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\38\ Consistent with the Commission's proposed regulations that

would require swap dealers and major swap participants to compile

and maintain certain transaction records (including daily trading

records), the Commission has estimated the hour burden associated

with the cleared swap recordkeeping requirement by approximating the

number of hours per trading day that an employee of a swap dealer or

major swap participant likely would spend compiling and retaining

the relevant records. See Reporting, Recordkeeping, and Daily

Trading Record Requirements for Swap Dealers and Major Swap

Participants, 75 FR 76666, Dec. 9, 2010.

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

registrants x 252 trading days].

Estimated annual hour burden per registrant: 504 [252 trading days

x 2 hours per trading day].

Estimated aggregate hour burden: 151,200 [300 registrants x 504

hours].

Audit Recordkeeping. This hourly burden arises from the proposed

requirement that swap dealers and major swap participants make and

maintain records of the results of their annual internal or external

audits to examine for compliance with the requirements of the proposed

regulations.

Number of registrants: 300.

Frequency of collection: Annually.

Estimated number of annual responses per registrant: 1.

Estimated aggregate number of annual responses: 300 [300

registrants x 1].

Estimated annual hour burden per registrant: 4.

[[Page 6724]]

Estimated aggregate annual hour burden: 1,200 [300 registrants x 4

hours].

Valuation Dispute Reporting. This hourly burden arises from the

proposed requirement that swap dealers and major swap participants

submit reports of certain unresolved valuation disputes.

Number of registrants: 300.

Frequency of collection: As applicable.

Estimated number of annual responses per registrant: 240.

Estimated aggregate number of annual responses: 72,000 [300

registrants x 240 responses].

Estimated annual hour burden per registrant: 24.

Estimated aggregate annual hour burden: 7,200 [300 registrants x 24

hours].

End user Exception Documentation Recordkeeping. This hourly burden

arises from the proposed requirement that swap dealers and major swap

participants make and maintain records of its end user exception

documentation. x

Number of registrants: 300.

Frequency of collection: Once per applicable counterparty.

Estimated number of annual responses per registrant: 220.\39\

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\39\ The Commission estimates that half of the counterparties

that are not swap dealers or major swap participants may claim the

end user exception on an annual basis.

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Estimated aggregate number of annual responses: 66,000 [300

registrants x 220 responses].

Estimated annual hour burden per registrant: 220 [220 responses x 1

hour per response].

Estimated aggregate annual hour burden: 66,000 [300 registrants x

220 responses].

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

anticipates that swap dealers and major swap participants may incur

certain start-up costs in connection with the proposed recordkeeping

obligations. Such costs would include the expenditures related to

developing and installing new recordkeeping technology or re-

programming or updating existing recordkeeping technology and systems

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

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

believes that swap dealers and major swap participants generally could

adapt their current infrastructure to accommodate the new or amended

technology and thus, no significant infrastructure expenditures would

be needed. The Commission estimates the programming burden hours

associated with technology improvements to be 40 hours.

According to recent Bureau of Labor Statistics findings, the mean

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

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

between $34.10 and $44.94.\40\ Because swap dealers and major swap

participants generally will be large entities that may engage employees

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

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

start-up burden associated with the required technological improvements

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

the aggregate.

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\40\ http://www.bls.gov/oes/current/oes113031.htm.

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2. Information Collection Comments

The Commission invites the public and other Federal agencies to

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

Commission specifically requests comment on the variables used in the

above-referenced hourly burden calculations. For example, the

Commission requests comment on the following:

What is the total number of swap dealers and major swap

participants in the marketplace?

What is the average number of counterparties that a swap

dealer or major swap participant is likely to have?

What percentage of those counterparties are other swap

dealers or major swap participants?

What percentage of those counterparties is likely to meet

the statutory qualifications required for an exception from the

mandatory clearing requirement, as defined in section 2h(7) of the CEA

and Sec. 39.6?

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

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

particular type of counterparty?

To what extent do swap dealers and major swap participants

currently enter into agreements that would satisfy the requirements of

proposed Sec. 23.504?

To what extent would swap dealers and major swap

participants be able to standardize the swap trading relationship

documentation required by Sec. 23.504?

To what extent would swap dealers and major swap

participants be required to utilize the services of outside counsel in

negotiating and drafting the swap trading relationship documentation

and valuation and termination rights agreements that would be required

by proposed Sec. 23.504?

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 \41\ 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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\41\ 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

[[Page 6725]]

financial integrity of futures markets; (3) price discovery; (4) sound

risk management practices; and (5) other public interest

considerations. The Commission may, in its discretion, give greater

weight to any one of the five enumerated considerations and could, in

its discretion, determine that, notwithstanding its costs, a particular

regulation was necessary or appropriate to protect the public interest

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

purposes of the CEA.

Summary of proposed requirements. The proposed regulations would

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

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

documentation requirements applicable to swap dealers and major swap

participants and related recordkeeping and reporting 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 institute the policies and procedures, make and

maintain the records, and perform the event-based reporting necessary

to satisfy the new regulatory requirements are far outweighed by the

benefits that would accrue to the financial system as a whole as a

result of the implementation of the rules.

For example, memorializing the specific terms of the swap trading

relationship and swap transactions between counterparties is prudent

business practice and, in fact, many market participants already use

standardized documentation. Accordingly, it is believed that many, if

not most, swap dealers and major swap participants currently execute

and maintain trading relationship documentation of the type required by

proposed Sec. 23.504 in the ordinary course of their businesses,

including documentation that contains several of the terms that would

be required by the proposed rules. Thus, the hour and dollar burdens

associated with the swap trading relationship documentation

requirements may be limited to amending existing documentation to

expressly include any additional terms required by the proposed rules.

The Commission recognizes that swap dealers and major swap

participants may face certain costs, such as the legal fees associated

with negotiating and drafting the required documentation modifications,

as they and their counterparties come into compliance with the new

regulations. However, the Commission also believes that, to the extent

that any substantial amendments or additions to existing documentation

would be needed, such revisions would likely apply to multiple

counterparties, thereby reducing the per counterparty burden imposed

upon swap dealers and major swap participants. The Commission further

expects the per hour and dollar burdens to be incurred predominantly in

the first year or two after the effective date of the final

regulations. Once a swap dealer or major swap participant has changed

its pre-existing documentation with each of its counterparties to

comply with the proposed rules, there likely will be little need to

further modify such documentation on an ongoing basis. In addition, the

Commission anticipates that standardized swap trading relationship

documentation will develop quickly and progressively within the

industry, dramatically reducing the cost to individual participants.

The Commission expects the per hour burden associated with the

remaining requirements of Sec. Sec. 23.504 and 23.505 to be relatively

minimal. The same is true of the sole reporting requirement contained

in Sec. 23.504. Such reporting is event-based and the Commission

expects that instances of valuation disputes will decrease over time as

valuation agreements are committed to writing pursuant to the proposed

regulations.

Finally, the Commission notes that most swap dealers and major swap

participants have back office personnel, operational systems, and

resources capable of maintaining the required records, performing the

periodic reporting, and otherwise adjusting to the new regulatory

framework without material diversion of resources away from commercial

operations or substantial capital investment.

Benefits. With respect to benefits, the Commission has determined

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

swap participant to document its swap trading relationship with each of

its counterparties will promote standardization of documents and

transactions, facilitate central trading and clearing, promote legal

and financial certainty, decrease the number and scope of counterparty

disputes, promote the timely resolution of disputes when they occur,

and enhance the parties' abilities to engage in risk-reducing

activities and will result in reduced risk, increased transparency, and

greater liquidity and market integrity in the swaps marketplace.

Moreover, the cleared swap records that are required to be preserved

and the mandatory reporting of unresolved valuation disputes will be

valuable tools in the Commission's oversight of the affected

registrants. Therefore, the Commission believes it is prudent to

prescribe these proposed regulations.

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

benefit considerations. Commentators are also invited to submit any

data or other information that they may have quantifying or qualifying

the costs and benefits of the proposed rules with their comment

letters.

List of Subjects in 17 CFR Part 23

Antitrust, Commodity futures, Conduct standards, Conflict of

Interests, Major swap participants, Reporting and recordkeeping, Swap

dealers, Swaps.

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

amend 17 CFR part 23, as proposed to be added in FR Doc. 2010-29024,

published in the Federal Register on November 23, 2010 (75 FR 71379),

and as proposed to be amended in FR Doc. 2010-32264, published in the

Federal Register on December 28, 2010 (75 FR 81519) 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. Revise the table of contents for part 23, subpart I to read as

follows:

Subpart I--Swap Documentation

Sec.

23.500 Definitions.

23.501 Swap confirmation.

23.502 Portfolio reconciliation.

23.503 Portfolio compression.

23.504 Swap trading relationship documentation.

23.505 End user exception documentation.

3. Add Sec. 23.504 and Sec. 23.505 to part 23, subpart I, to read

as follows:

Sec. 23.504 Swap trading relationship documentation.

(a) Policies and procedures. Each swap dealer and major swap

participant shall establish, maintain, and enforce written policies and

procedures reasonably designed to ensure that, prior to or

contemporaneously with entering into a swap transaction with any

counterparty, other than a derivatives clearing organization, the swap

dealer or major swap participant executes written swap trading

relationship documentation with its counterparty that complies with the

requirements of this section. The

[[Page 6726]]

policies and procedures shall be approved in writing by senior

management of the swap dealer and major swap participant, and a record

of the approval shall be retained.

(b) Swap trading relationship documentation. (1) The swap trading

relationship documentation shall be in writing and shall include all

terms governing the trading relationship between the swap dealer or

major swap participant and its counterparty, including, without

limitation, terms addressing payment obligations, netting of payments,

events of default or other termination events, calculation and netting

of obligations upon termination, transfer of rights and obligations,

governing law, valuation, and dispute resolution procedures.

(2) The swap trading relationship documentation shall include all

confirmations of swap transactions under Sec. 23.501.

(3) The swap trading relationship documentation shall include

credit support arrangements, which shall contain, in accordance with

applicable requirements under Commission regulations or regulations

adopted by prudential regulators and without limitation, the following:

(i) Initial and variation margin requirements;

(ii) Types of assets that may be used as margin and asset valuation

haircuts;

(iii) Investment and rehypothecation terms for assets used as

margin for uncleared swaps; and

(iv) Custodial arrangements for margin assets, including whether

margin assets are to be segregated with an independent third party, in

accordance with Sec. 23.601(e).

(4) The swap trading relationship documentation shall include

written documentation in which the parties agree on the methods,

procedures, rules, and inputs for determining the value of each swap at

any time from execution to the termination, maturity, or expiration of

such swap. To the maximum extent practicable, the valuation of each

swap shall be based on objective criteria, such as recently-executed

transactions or valuations provided by independent third parties such

as derivatives clearing organizations.

(i) Such methods, procedures, rules, and inputs shall be agreed for

each swap prior to or contemporaneously with execution and shall be

stated with the specificity necessary to allow the swap dealer, major

swap participant, counterparty, the Commission, and any applicable

prudential regulator to determine the value of the swap independently

in a substantially comparable manner.

(ii) Such methods, procedures, and rules shall include alternative

methods for determining the value of the swap in the event of the

unavailability or other failure of any input required to value the

swap, provided that the alternative methods for valuing the swap comply

with the requirements of this section.

(iii) Provided that the requirements of this paragraph, including

the independent valuation requirement of paragraph (b)(4)(i) of this

section, are satisfied, a swap dealer or major swap participant is not

required to disclose to the counterparty confidential, proprietary

information about any model it may use internally to value a swap for

its own purposes.

(5) [Reserved]

(6) Upon acceptance of a swap by a derivatives clearing

organization, the swap trading relationship documentation shall include

a record of the following information:

(i) The date and time the swap was accepted for clearing;

(ii) The name of the derivatives clearing organization;

(iii) The name of the clearing member clearing for the swap dealer

or major swap participant;

(iv) The name of the clearing member clearing for the counterparty,

if known; and

(v) A statement that in accordance with the rules of the

derivatives clearing organization:

(A) The original swap is extinguished;

(B) The original swap is replaced by equal and opposite swaps

between clearing members and the derivatives clearing organization;

(C) All terms of the cleared swap conform to templates established

under the derivatives clearing organization's rules; and

(D) All terms of the swap, as carried on the books of the clearing

member, conform to the terms of the cleared swap established under the

derivatives clearing organization's rules.

(c) Audit of swap trading relationship documentation. At least once

during each calendar year, each swap dealer and major swap participant

shall have an independent internal or external auditor examine no less

than 5% of the swap trading relationship documentation required by this

section created during the previous twelve month period to ensure

compliance with Commission regulations and the written policies and

procedures established pursuant to this section. A record of the

results of each audit shall be retained.

(d) Recordkeeping. Each swap dealer and major swap participant

shall maintain all documents required to be created pursuant to this

section in accordance with Sec. 1.31 of this chapter and shall make

them available promptly upon request to any representative of the

Commission or any applicable prudential regulator, or with regard to

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

of the Commission, the Securities and Exchange Commission, or any

applicable prudential regulator.

(e) Reporting. Each swap dealer and major swap participant shall

promptly notify the Commission and any applicable prudential regulator,

or with regard to swaps defined in section 1a(47)(A)(v) of the Act, the

Commission, the Securities and Exchange Commission, and any applicable

prudential regulator, of any swap valuation dispute not resolved

within:

(1) One (1) business day, if the dispute is with a counterparty

that is a swap dealer or major swap participant; or

(2) Five (5) business days, if the dispute is with a counterparty

that is not a swap dealer or major swap participant.

Sec. 23.505 End user exception documentation.

(a) For swaps excepted from a mandatory clearing requirement. Each

swap dealer and major swap participant shall obtain documentation

sufficient to provide a reasonable basis on which to believe that its

counterparty meets the statutory conditions required for an exception

from a mandatory clearing requirement, as defined in section 2h(7) of

the Act and Sec. 39.6 of this chapter. Such documentation shall

include:

(1) The identity of the counterparty;

(2) That the counterparty has elected not to clear a particular

swap under section 2h(7) of the Act and Sec. 39.6 of this chapter;

(3) That the counterparty is a non-financial entity, as defined in

section 2h(7)(C) of the Act;

(4) That the counterparty is hedging or mitigating a commercial

risk; and

(5) That the counterparty generally meets its financial obligations

associated with non-cleared swaps.

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

shall maintain all documents required to be obtained pursuant to this

section in accordance with Sec. 1.31 of this chapter and shall make

them available promptly upon request to any representative of the

Commission or any applicable prudential regulator, or with regard to

swaps defined in section 1a(47)(A)(v) of

[[Page 6727]]

the Act, to any representative of the Commission, the Securities and

Exchange Commission, or any applicable prudential regulator.

Issued in Washington, DC on January 13, 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, Chilton and O'Malia voted in the affirmative; no

Commissioner voted in the negative.

Appendix 2--Statement of Chairman Gary Gensler

I support the proposed rulemaking that establishes swap trading

relationship documentation requirements for swap dealers and major

swap participants. The proposed regulations are consistent with the

express mandate of the Dodd-Frank Act to prescribe standards for the

timely and accurate confirmation, processing, netting, documentation

and valuation of swap transactions. One of the primary goals of the

Dodd-Frank Act was to establish a comprehensive regulatory framework

that would reduce risk, increase transparency and promote market

integrity within the financial system. The proposed regulations

accomplish this objective by establishing procedures that will

promote legal certainty regarding terms of swap transactions, early

resolutions of valuation disputes, enhanced understanding of one

counterparty's risk exposure to another, reduced operational risk

and increased operational efficiency. One of the key chapters from

the 2008 financial crisis was when large financial players,

including AIG, had valuation disputes and other problems regarding

documentation standards. These rules will directly address many of

these issues, highlighting issues for senior management and

regulators earlier and lowering risk to the public.

Appendix 3--Commissioner Scott D. O'Malia

I respectfully dissent from the Commission's decision to propose

requirements regarding the inclusion of Title II of the Dodd-Frank

Act (Title II) and the Federal Deposit Insurance Act (FDIA) in the

swap documentation used by swap dealers (Dealers) and major swap

participants (MSP). This proposal would require Dealers and MSP to

include a provision in their swap documentation which will prevent

their counterparties from exercising certain private, contractual

rights in the event that a swap becomes subject to the processes of

either Title II or FDIA. In particular, the proposal requires

counterparties to explicitly consent to the resolution processes set

forth in Title II or FDIA, which includes a one-day stay on the

termination, liquidation or netting of swaps with a ``covered

financial company'' as that term is defined under Title II. Title II

also provides the Federal Deposit Insurance Company (FDIC) with an

unchecked authority to repudiate contracts and preference which

creditors receive payments. Finally, the proposal asks whether swap

agreements which contain cross default provisions should also

subject counterparty affiliates to a ``covered financial company''

designation or treat them as an insured depository institution under

FDIA.

The Commission's proposal relies on its authorities in Title VII

of the Dodd-Frank Act regarding swap documentation. Asking parties

to agree upon and include valuation language in their swap

agreements under this authority is one thing, but dictating that one

party forego its legal contractual rights simply because its

counterparty becomes subject to an overly vague and far reaching

statute intended to address ``systemic risk to the financial

system'' is quite another. If the FDIC authority to require this

provision under Title II was clear, then there would be no need for

the Commission to prop up the banking regulator's ability to

exercise its resolution authority. In its best attempt to justify

the proposal, the Commission claims that it is merely trying to put

counterparties on notice of the already existing requirements of

Title II and FDIA, but neither the proposal regarding an explicit

consent to transfer, nor the discussion regarding affiliates and

cross default agreements is a reflection of language already

included in Title II or FDIA. At the very least, if the CFTC had any

specific role under Title II or FDIA, then it would be clear how we

would inform the treatment of the market participants that we

regulate and their transactions in the case of a default. We do not.

By raising these objections, I hope that market participants

will become fully aware of the legal regime that they will be

subject to by virtue of entering into a swap agreement. I don't

believe it is in our best interest to adopt seemingly redundant and

unnecessary requirements into our regulations or to adopt

requirements under the guise of our Title VII authorities that

clearly exceeds the already broad statutory authority Congress

decided to provide the FDIC under both Title II and FDIA. As a

result, I cannot support this proposal.

[FR Doc. 2011-2643 Filed 2-7-11; 8:45 am]

BILLING CODE 6351-01-P

Last Updated: February 8, 2011