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

[Proposed Rules]

[Pages 6708-6715]

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

[FR Doc No: 2011-2642]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 23

RIN 3038-AC96

Orderly Liquidation Termination Provision in Swap Trading

Relationship Documentation for Swap Dealers and Major Swap Participants

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

———————————————————————–

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

is proposing regulations to implement new statutory provisions

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

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

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

which requires the Commission to prescribe standards for swap dealers

and major swap participants related to the timely and accurate

confirmation, processing, netting, documentation, and valuation of

swaps. The proposed rule would set forth parameters for the inclusion

of an orderly liquidation termination provision in the swap trading

relationship documentation for swap dealers and major swap

participants.

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

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

and Orderly Liquidation Termination Provision in Swap Trading

Relationship Documentation for Swap Dealers and Major Swap

Participants, by any of the following methods:

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

through the Web site.

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

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

Street, NW., Washington, DC 20581.

Hand Delivery/Courier: Same as mail above.

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

Follow the instructions for submitting comments.

Please submit your comments using only one method.

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

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

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

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

information that may be exempt from disclosure under the Freedom of

Information Act, a petition for confidential treatment of the exempt

information may be submitted according to the established procedures in

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

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

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

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

inappropriate for publication, such as obscene language. All

submissions that have been redacted or removed that contain comments on

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

file and will be considered as required under the Administrative

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

the Freedom of Information Act.

FOR FURTHER INFORMATION CONTACT: Sarah E. Josephson, Associate

Director, 202-418-5684, [email protected]; Frank N. Fisanich, Special

Counsel, 202-418-5949, [email protected]; or Jocelyn Partridge,

Special Counsel, 202-418-5926, [email protected]; Division of

Clearing and Intermediary Oversight, Commodity Futures Trading

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

DC 20581.

SUPPLEMENTARY INFORMATION:

[[Page 6709]]

I. Background

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

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

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

risk, increase transparency, and promote market integrity within the

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

registration and comprehensive regulation of swap dealers and major

swap participants; (2) imposing clearing and trade execution

requirements on standardized derivative products; (3) creating rigorous

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

Commission’s rulemaking and enforcement authorities with respect to all

registered entities and intermediaries subject to the Commission’s

oversight.

—————————————————————————

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.

—————————————————————————

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

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

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

establishes swap documentation standards for those registrants.

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

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

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

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

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

documentation standards for swap dealers and major swap participants.”

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

proposed rulemaking entitled, “Swap Trading Relationship Documentation

Requirements for Swap Dealers and Major Swap Participants.” This

proposed regulation supplements that proposal and sets forth another

element of the swap trading relationship documentation that swap

dealers, major swap participants, and their counterparties must include

in their documentation. The Commission is proposing the regulation

discussed below, pursuant to the authority granted under sections

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

Dodd-Frank Act requires the Commission to promulgate these provisions

by July 15, 2011.5

—————————————————————————

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

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

are reasonably necessary to effectuate any of the provisions or to

accomplish any of the purposes of the CEA.

5 This is the seventh rulemaking to be proposed regarding

internal business conduct standards for swap dealers and major swap

participants. Prior notices of proposed rulemaking are available on

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

—————————————————————————

The proposed regulations reflect consultation with staff of the

following agencies: (i) The Securities and Exchange Commission; (ii)

the Board of Governors of the Federal Reserve System (Board of

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

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

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

proposal, and the proposed regulations incorporate elements of the

comments provided.

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

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

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

that market participants believe that additional measures should be

taken to reduce the burden or increase the benefits of documenting swap

transactions, the Commission welcomes all comments.

II. Proposed Regulation

This proposed rulemaking supplements a prior notice of proposed

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

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

trading relationship documentation that swap dealers, major swap

participants, and their counterparties must include in their

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

swap dealers and major swap participants include in the documentation

with each of their counterparties a provision that confirms both

parties’ understanding of how the new orderly liquidation authority

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

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

the-counter, bilateral swaps.6

—————————————————————————

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

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

not believe it is necessary to address cleared swaps in this

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

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

—————————————————————————

The Commission believes that the inclusion of this type of

provision in the swap trading relationship documentation used by swap

dealers and major swap participants registered with the Commission

would promote legal certainty for market participants and lower

litigation risk during times of significant market stress. In

particular, the proposal would ensure both counterparties to a swap

understand that under particular, unique circumstances, described in

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

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

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

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

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

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

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

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

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

with the objective of avoiding widespread market disruption in the form

of fire sales and contagion risk.

A. Background

The recent financial crisis, particularly the tumultuous events of

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

orderly resolution mechanism for certain large financial companies. The

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

outs of financial companies considered “too big to fail” and

contributed to major financial market dislocations resulting from the

disorderly insolvency of Lehman Brothers Inc. and its affiliates under

the Federal bankruptcy code.

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

systemically important institutions, the traditional bankruptcy process

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

require near instant action to diminish their effect on other entities

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

financial companies with significant derivatives positions that require

frequent adjustments based on trading strategies

[[Page 6710]]

and the need to manage exposure to market risk.

—————————————————————————

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

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

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

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

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

provisions under Commission regulation for treatment of cleared

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

matter of weeks.

—————————————————————————

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

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

“orderly liquidation authority” under which systemically important

financial companies can be resolved in an orderly manner. This

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

and State dissolution laws.

B. Orderly Liquidation Under Title II of Dodd-Frank

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

necessary authority to liquidate failing financial companies 8 that

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

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

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

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

consultation with the President, the Secretary of the Treasury appoints

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

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

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

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

effects on financial stability in the United States.” 10

—————————————————————————

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

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

financial company supervised by the Board of Governors, or a

company, or a subsidiary (other than an insured depository

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

predominantly engaged in activities that the Board of Governors has

determined are financial in nature or incidental thereto.

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

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

—————————————————————————

1. Entities Eligible for Liquidation Under Title II

Title II provides certain Federal financial regulatory authorities

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

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

regular insolvency processes under the Federal bankruptcy code or

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

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

or chapter 11 proceedings.11

—————————————————————————

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

debtor entity and Chapter 11 allows a debtor entity to reorganize

its affairs.

—————————————————————————

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

“covered financial companies,” that meet certain criteria as

determined by the Secretary of the Treasury under a process described

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

and major swap participants registered with the Commission. For

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

dealer or major swap participant with the Commission and designated as

a systemically important financial institution (SIFI) by the Financial

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

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

company” under Title II.13

—————————————————————————

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

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

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

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

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

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

Governors of the Federal Reserve System, and thus meet the

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

—————————————————————————

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

might be deemed to be a “covered financial company” independent of

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

could be deemed to be a “financial company” if that entity is (1)

predominantly engaged in financial activities 14 and (2) those

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

revenues.15 A “covered financial company” is a financial company

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

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

determination process is the written recommendation of both the FDIC

and the Board of Governors.

—————————————————————————

14 Financial activities are defined by reference to section

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

includes activities such as dealing in or making a market in

securities and any other activity that may be identified under rules

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

and 12 CFR 225.28.

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

the Dodd Frank Act.

—————————————————————————

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

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

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

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

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

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

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

prevent the default. The Secretary must make a specific determination

that any effect on the claims or interests of creditors,

counterparties, and shareholders is appropriate.17

—————————————————————————

16 The phrase “default or in danger of default” is defined

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

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

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

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

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

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

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

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

the FDIA).

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

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

liquidation authority would avoid or mitigate such adverse effects

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

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

part of creditors, counterparties, and shareholders in the financial

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

financial company to convert all of its convertible debt instruments

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

satisfies the definition of “financial company” in section

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

—————————————————————————

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

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

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

financial markets. Only after these determinations have been made would

the FDIC be granted resolution authority under Title II.

C. Resolution by the FDIC Under FDIA.

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

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

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

insured depository institution. Generally speaking, an insured

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

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

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

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

depository institution. Some swap dealers and major swap participants

registered with the Commission may be insured depository institutions.

—————————————————————————

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

—————————————————————————

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

Major Swap Participants Under Either Title II or the FDIA

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

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

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

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

[[Page 6711]]

participants regardless of whether the FDIC was acting under Title II

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

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

have systemic implications would have similar characteristics. For

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

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

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

be deteriorating market conditions.19

—————————————————————————

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

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

the Dodd-Frank Act.

—————————————————————————

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

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

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

other contracts to a solvent third party financial institution. For

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

counterparties to terminate, liquidate, or net is necessary.

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

of FDIA, parties to qualified financial contracts 20 are prohibited

from terminating, liquidating, or netting out positions solely by

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

condition of the insured depository institution, covered financial

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

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

receiver. A party is also precluded from exercising any such

contractual rights after it has received notice that its qualified

financial contract has been transferred to another financial

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

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

receiver to consummate a transfer of a qualified financial contract to

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

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

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

—————————————————————————

20 Qualified financial contracts include any securities

contract, commodity contract, forward contract, repurchase

agreement, swap agreement, and any similar agreement as determined

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

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

—————————————————————————

E. Application to Swaps

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

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

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

under the definition of “qualified financial contract” under those

two statutes.21 The definition of qualified financial contract is

identical under both Title II and FDIA and includes securities

contracts, commodity contracts,22 forward contracts, repurchase

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

FDIC to be a qualified financial contract.

—————————————————————————

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

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

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

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

22 Under this definition, futures contracts subject to the

Commission’s jurisdiction are considered to be qualified financial

contracts.

—————————————————————————

The Commission recognizes the potential for regulatory arbitrage if

the definition of qualified financial contract does not apply to swaps

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

for an orderly liquidation of any systemically important swap dealer or

major swap participant arise, it would be most appropriate and

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

considered to be part of a comprehensive and orderly resolution

process.

F. Commission Involvement in an Orderly Liquidation

While the Commission is not granted explicit authority under Title

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

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

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

the condition of the financial company bear losses consistent with

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

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

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

consult with the Commission “for purposes of ensuring an orderly

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

Commission might have information on defaulting swap dealers or major

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

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

firms to which open swap positions might be transferred.

—————————————————————————

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

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

—————————————————————————

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

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

and major swap participants establish, maintain, and enforce written

policies and procedures reasonably designed to ensure that each swap

dealer or major swap participant and its counterparties have agreed in

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

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

documentation would include written agreement by the parties on certain

terms, including general provisions on payment obligations, netting of

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

rights and obligations, and governing law.

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

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

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

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

FDIA.25 This provision under the swap trading relationship

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

deemed to be a “covered financial company” under Title II or is an

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

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

“covered party.”

—————————————————————————

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

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

—————————————————————————

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

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

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

counterparties will acknowledge in their trading relationship

documentation that neither will exercise any right to terminate a swap

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

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

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

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

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

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

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

party receives notice that the FDIC has transferred the defaulting

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

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

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

—————————————————————————

26 The counterparties may be able to specify in their

individual documentation that only Title II would apply if neither

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

neither party is an insured depository institution.

—————————————————————————

[[Page 6712]]

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

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

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

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

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

claims and credit support related to such swaps.

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

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

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

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

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

resolution of market uncertainty and allow a return to regular trading

strategy for non-defaulting counterparties.

The Commission believes that the proposed regulation is important

insofar as it will ensure that counterparties to swap transactions are

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

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

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

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

applicable in situations where the counterparties are financial

institutions that could be designated covered financial companies under

Title II or are insured depository institutions under FDIA.

The Commission also believes that this provision would facilitate

the resolution process by minimizing the potential litigation when such

resolution authority is exercised. Minimizing litigation risk is

important for facilitating a quick and effective resolution process;

particularly when the alternative, the sudden collapse of the covered

financial company, poses systemic risk.

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

swap trading relationship documentation may help bring about broad

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

relevant because Congress recognized the need for greater international

coordination relating to the orderly liquidation of financial companies

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

to increase effective international coordination.27

—————————————————————————

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

—————————————————————————

H. Comment Requested

The Commission requests comment on all aspects of proposed Sec.

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

following questions:

Are there any swaps as defined under Title VII of the

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

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

and FDIA?

Under what circumstances could the requirements of Sec.

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

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

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

respect to financial companies that may have global operations through

multiple subsidiaries and branches, including insured depository

institutions?

What steps can be taken to encourage standard

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

recognize the need to include termination stay provisions similar to

those provided for under Title II and FDIA?

Are there any anticompetitive implications to the proposed

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

the purposes of the CEA in a less anticompetitive manner?

Given the use in swaps of cross default provisions

referencing agreements with affiliates, should “covered party”, as

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

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

are insured depository institutions under FDIA?

Does the Commission have legal authority to include

affiliates in this way?

III. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA) requires that agencies

consider whether the rules they propose will have a significant

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

Commission previously has established certain definitions of “small

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

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

affect swap dealers and major swap participants.

—————————————————————————

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

29 47 FR 18618, Apr. 30, 1982.

—————————————————————————

Swap dealers and major swap participants are new categories of

registrants. Accordingly, the Commission has not previously addressed

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

purposes of the RFA. The Commission previously has determined, however,

that futures commission merchants should not be considered to be small

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

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

to meet the minimum financial requirements established by the

Commission to enhance the protection of customers’ segregated funds and

protect the financial condition of futures commission merchants

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

subject to minimum capital and margin requirements and are expected to

comprise the largest global financial firms. The Commission is required

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

minimis level of swaps dealing in connection with transactions with or

on behalf of customers. The Commission anticipates that this exemption

would tend to exclude small entities from registration. Accordingly,

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

proposing that swap dealers not be considered “small entities” for

essentially the same reasons that futures commission merchants have

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

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

minimis level of swap dealing.

—————————————————————————

30 Id. at 18619.

31 Id.

—————————————————————————

The Commission also has previously determined that large traders

are not “small entities” for RFA purposes.32 In that determination,

the Commission considered that a large trading position was indicative

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

definition, maintain substantial positions in swaps or maintain

outstanding swap positions that create substantial counterparty

exposure that could have serious adverse effects on the financial

stability of the United States banking system or financial markets.

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

Commission is hereby proposing that major swap participants not be

considered “small entities” for essentially the same reasons that

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

—————————————————————————

32 Id. at 18620.

—————————————————————————

Moreover, the Commission is carrying out Congressional mandates by

proposing this regulation. Specifically, the Commission is proposing

these regulations to comply with the Dodd-

[[Page 6713]]

Frank Act, the aim of which is to reduce systemic risk presented by

swap dealers and swap market participants through comprehensive

regulation. The Commission does not believe that there are regulatory

alternatives to those being proposed that would be consistent with the

statutory mandate. Accordingly, the Chairman, on behalf of the

Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that the

proposed rules will not have a significant economic impact on a

substantial number of small entities.

B. Paperwork Reduction Act

The Paperwork Reduction Act (PRA) 33 imposes certain requirements

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

conducting or sponsoring any collection of information as defined by

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

information requirements within the meaning of the PRA. The Commission

therefore is submitting this proposal to the Office of Management and

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

1320.11. The title for this collection of information is “Orderly

Liquidation Termination Provision in Swap Trading Relationship

Documentation for Swap Dealers and Major Swap Participants.” An agency

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

a collection of information unless it displays a currently valid

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

number.

—————————————————————————

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

—————————————————————————

The collection of information under this proposed regulation is

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

requires the Commission to adopt rules governing documentation

standards for swap dealers and major swap participants and explicitly

obligates such registrants to conform to the documentation standards

established by the Commission. The documentation required to be

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

regulatory program for swap dealers and major swap participants.

Specifically, the required recordkeeping is essential to ensuring that

swap dealers and major swap participants include in their trading

relationship documentation certain agreements that are designed to

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

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

The records required to be preserved would be used by representatives

of the Commission and any examining authority responsible for reviewing

the activities of the swap dealer or major swap participant to ensure

compliance with the CEA and applicable Commission regulations.

If the proposed regulations are adopted, responses to this

collection of information would be mandatory. The Commission will

protect proprietary information according to the Freedom of Information

Act and 17 CFR part 145, “Commission Records and Information.” In

addition, section 8(a)(1) of the CEA strictly prohibits the Commission,

unless specifically authorized by the CEA, from making public “data

and information that would separately disclose the business

transactions or market positions of any person and trade secrets or

names of customers.” The Commission also is required to protect

certain information contained in a government system of records

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

1. Information Provided By Reporting Entities/Persons

Proposed Sec. 23.504(b)(5) supplements previously proposed

regulations that would establish trading swap relationship

documentation requirements for swap dealers and major swap

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

swap dealers and major swap participants to include in the

documentation they execute with each counterparty a written agreement

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

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

The information collection burden associated with drafting and

maintaining the agreements required by the proposed regulation is

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

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

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

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

total time, effort or financial resources expended by persons to

generate, maintain, retain, disclose, or provide information to or for

a Federal agency.

The Commission has characterized the annual cost as an initial cost

as the Commission anticipates that the agreements required by the

proposed regulation generally would not require significant bilateral

negotiation and, therefore, are likely to become standardized within

the industry rather rapidly. Moreover, the Commission expects that

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

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

drafted the required agreements and incorporated them into its swaps

trading documentation, the annual burden associated with the proposed

regulation would be quite minimal.34

—————————————————————————

34 The Commission notes that swap dealers and major swap

participants also would be required to develop written policies and

procedures to maintain the obligatory agreements as part of their

swaps trading relationship documentation. The costs associated with

these policies and procedures have been accounted for in the

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

—————————————————————————

The hour burden calculation set forth below is based upon certain

variables such as the number of swap dealers and major swap

participants in the marketplace, the average number of counterparties

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

employees that would be responsible for satisfying the obligation

established by the proposed regulation. Swap dealers and major swap

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

currently known how many swap dealers and major swap participants will

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

Commission until the registration requirements for these entities

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

Act becomes effective. While the Commission believes that there will be

approximately 200 swap dealers and 50 major swap participants, it has

taken a conservative approach, for PRA purposes, in estimating that

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

participants who will be required to comply with the recordkeeping

requirements of the proposed rules. The Commission estimated the number

of affected entities based on industry data.

Similarly, due to the absence of prior experience in regulating

swap dealers and major swap participants and with regulations similar

to the proposed rules, the actual, average number of counterparties

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

uncertain. Consistent with other proposed rulemakings, the Commission

has estimated that each of the 14 major swap dealers has an average

7,500 counterparties and the other 286 swap dealers and major swap

participants have an average of 200 counterparties per year, for an

average of 540 total counterparties per registrant.

The Commission anticipates that agreements required by the proposed

regulations typically would be drafted and maintained by a swap dealer

or major swap participant’s in-house

[[Page 6714]]

counsel or by financial or operational managers within the firm.

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

wage of an employee under occupation code 23-1011, “Lawyers,” that is

employed by the “Securities and Commodity Contracts Intermediation and

Brokerage Industry” is $82.22.35 The mean hourly wage of an employee

under occupation code 11-3031, “Financial Managers,” (which includes

operations managers) in the same industry is $74.41.36 Because swap

dealers and major swap participants include large financial

institutions whose employees’ salaries may exceed the mean wage,

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

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

—————————————————————————

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

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

—————————————————————————

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

follows:

Agreement to Orderly Liquidation Termination Provision.

Number of registrants: 300.

Frequency of collection: At least once per counterparty.

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

counterparty].

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

registrants x 540 counterparties].

Estimated annual hour burden per registrant: 270 [540

counterparties x .5 hours per counterparty].

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

270 hours per registrant].

As stated above, the agreements required by proposed Sec.

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

trading relationship documentation obligations established by

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

not anticipate that swap dealers and major swap participants would

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

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

prior proposal.

2. Information Collection Comments

The Commission invites the public and other Federal agencies to

comment on any aspect of the recordkeeping burden discussed above.

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

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

information is necessary for the proper performance of the functions of

the Commission, including whether the information will have practical

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

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

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

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

collection of information on those who are to respond, including

through the use of automated collection techniques or other forms of

information technology.

Comments may be submitted directly to the Office of Information and

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

[email protected]. Please provide the Commission with a copy

of submitted comments so that all comments can be summarized and

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

this notice of proposed rulemaking for comment submission instructions

to the Commission.

A copy of the supporting statements for the collections of

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

OMB is required to make a decision concerning the collection of

information between 30 and 60 days after publication of this document

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

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

C. Cost-Benefit Analysis

Section 15(a) of the CEA 37 requires the Commission to consider

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

the CEA. By its terms, section 15(a) does not require the Commission to

quantify the costs and benefits of a new regulation or to determine

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

requires that the Commission “consider” the costs and benefits of its

actions.

—————————————————————————

37 7 U.S.C. 19(a).

—————————————————————————

Section 15(a) further specifies that costs and benefits of a

proposed rulemaking shall be evaluated in light of five broad areas of

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

the public; (2) efficiency, competitiveness, and financial integrity of

futures markets; (3) price discovery; (4) sound risk management

practices; and (5) other public interest considerations. The Commission

may, in its discretion, give greater weight to any one of the five

enumerated considerations and could, in its discretion, determine that,

notwithstanding its costs, a particular regulation was necessary or

appropriate to protect the public interest or to effectuate any of the

provisions or to accomplish any of the purposes of the CEA.

Summary of proposed requirements. The proposed regulation would

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

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

swap trading relationship documentation requirements applicable to swap

dealers and major swap participants and related recordkeeping

obligations.

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

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

participants to satisfy the new regulatory requirement is far

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

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

believes that the annual cost burden per registrant ultimately would be

quite minimal as the agreements it requires are likely to become

standardized and applicable to most counterparties, thereby negating

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

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

mechanisms.

Benefits. With respect to benefits, the Commission believes that

the proposed regulation would ensure that swaps are treated

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

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

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

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

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

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

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

prudent to prescribe this proposed regulation.

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

benefit considerations. Commentators are also invited to submit any

data or other information that they may have quantifying or qualifying

the costs and benefits of the proposed rules with their comment

letters.

List of Subjects in 17 CFR Part 23

Antitrust, Commodity futures, Conduct standards, Conflict of

Interests, Major swap participants, Reporting and recordkeeping, Swap

dealers, Swaps.

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

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

published in the

[[Page 6715]]

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

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

PART 23–SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

1. The authority citation for part 23 is revised to read as

follows:

Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,

9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.

2. Amend proposed Sec. 23.504 by adding paragraph (b)(5) to read

as follows:

Sec. 23.504 Swap trading relationship documentation.

* * * * *

(b) * * *

(5) The swap trading relationship documentation shall include

written documentation in which the counterparties agree that in the

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

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

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

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

has been appointed as a receiver (the “covered party”):

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

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

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

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

insolvency or financial condition of the covered party):

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

the date of the such appointment; or

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

received notice that the swap has been transferred pursuant to section

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

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

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

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

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

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

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

the covered party;

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

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

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

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

general unsecured creditors of such covered party);

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

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

a covered party, under any such swap; and

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

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

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

such swap; and

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

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

* * * * *

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

David A. Stawick,

Secretary of the Commission.

Appendices To Swap Trading Relationship Documentation Requirements for

Swap Dealers and Major Swap Participants–Commissioners Voting Summary

and Statements of Commissioners

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

Federal Regulations.

Appendix 1–Commissioners Voting Summary

On this matter, Chairman Gensler and Commissioners Dunn, Sommers

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

the negative.

Appendix 2–Statement of Chairman Gary Gensler

I support the proposed rulemaking that establishes documentation

requirements for swap dealers and major swap participants, ensuring

consistency with statutory provisions in the event of an orderly

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

regulation requires the inclusion of a provision in the swap trading

relationship documentation that would inform counterparties that, if

a swap dealer or major swap participant becomes a covered financial

company subject to the resolution authority of the Federal Deposit

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

its counterparties to terminate, liquidate or net their uncleared

swaps. The proposed rulemaking should lower litigation risk during

times of significant market stress and promote an orderly and

effective resolution process for large financial entities.

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

BILLING CODE 6351-01-P

Last Updated: February 8, 2011