Protection of Collateral of Counterparties to Uncleared Swaps; Treatment of Securities in a Portfolio Margining Account in a Commodity Broker Bankruptcy

Summary

The Commodity Futures Trading Commission (the ``Commission'') hereby proposes rules to implement new statutory provisions enacted by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the ``Dodd-Frank Act''). Specifically, the proposed rules contained herein impose requirements on swap dealers (``SDs'') and major swap participants (``MSPs'') with respect to the treatment of collateral posted by their counterparties to margin, guarantee, or secure uncleared swaps. Additionally, such proposed rules ensure that, for purposes of subchapter IV of chapter 7 of the Bankruptcy Code: Securities held in a portfolio margining account that is a futures account constitute ``customer property''; and owners of such account constitute ``customers''.

Full text

SUMMARY: The Commodity Futures Trading Commission (the ``Commission'') 
hereby proposes rules to implement new statutory provisions enacted by 
Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection 
Act (the ``Dodd-Frank Act''). Specifically, the proposed rules 
contained herein impose requirements on swap dealers (``SDs'') and 
major swap participants (``MSPs'') with respect to the treatment of 
collateral posted by their counterparties to margin, guarantee, or 
secure uncleared swaps. Additionally, such proposed rules ensure that, 
for purposes of subchapter IV of chapter 7 of the Bankruptcy Code: 
Securities held in a portfolio margining account that is a futures 
account constitute ``customer property''; and owners of such account 
constitute ``customers''.

DATES: Submit comments on or before February 1, 2011.

ADDRESSES: You may submit comments, identified by RIN number 3038-AD28, 
by any of the following methods:
     Agency Web site, via its Comments Online process: 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 by 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 you believe is exempt from disclosure under the 
Freedom of Information Act, a petition for confidential treatment of 
the exempt information may be submitted according to the procedures 
established in CFTC Regulation 145.9, 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: Robert B. Wasserman, Associate 
Director, Division of Clearing and Intermediary Oversight (DCIO), at 
202-418-5092 or rwasserman@cftc.gov; Martin White, Assistant General 
Counsel, at 202-418-5129 or mwhite@cftc.gov; Nancy Liao Schnabel, 
Special Counsel, DCIO, at 202-418-5344 or nschnabel@cftc.gov; in each 
case, also at the 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 new regulatory framework for 
swaps and certain security-based swaps. The legislation was enacted to 
reduce risk, increase transparency, and promote market integrity within 
the financial system by, among other things: (i) Providing for the 
registration and comprehensive regulation of SDs and MSPs;\4\ (ii) 
imposing mandatory clearing and trade execution requirements on 
clearable swap contracts; (iii) creating robust recordkeeping and real-
time reporting regimes; and (iv) enhancing the rulemaking and 
enforcement authorities of the Commission with respect to, among 
others, all registered entities and intermediaries subject to the 
oversight of the Commission.
---------------------------------------------------------------------------

    \1\ See Dodd-Frank 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.
    \4\ In this release, the terms ``swap dealer'' and ``major swap 
participant'' shall have the meanings set forth in Section 721(a) of 
the Dodd-Frank Act, which added Sections 1a(49) and (33) of the CEA. 
However, Section 721(c) of the Dodd-Frank Act directs the Commission 
to promulgate rules to further define, among other terms, ``swap 
dealer'' and ``major swap participant.'' The Commission anticipates 
that such rulemaking will be completed by the statutory deadline of 
July 15, 2011. See, e.g., Http://Www.Cftc.Gov/Lawregulation/Otcderivatives/OTC_2_Definitions.Html.
---------------------------------------------------------------------------

    Section 724(c) of the Dodd-Frank Act amends the CEA to add, as 
section 4s(l) thereof, provisions concerning the rights of 
counterparties to SDs and MSPs with respect to the treatment of margin 
for uncleared swaps. As discussed further in Part II of this preamble, 
these changes are implemented in proposed new Subpart L to Part 23 of 
Title 17, Sec. Sec.  23.600 through 23.609.
    Section 713(c) of the Dodd-Frank Act amends the CEA to add, as 
section 20(c) thereof, a provision that requires the Commission to 
exercise its authority to clarify the legal status, in the event of a 
commodity broker \5\ bankruptcy, of (i) securities in a portfolio margining account held as a futures account, 
and (ii) an owner of such account. As discussed further in Part III of 
this preamble, these changes are implemented in proposed amendments to 
Sec. Sec.  190.01(k) and 190.08(a)(1)(i).
---------------------------------------------------------------------------

    \5\ Commission regulation (``Regulation'') 190.01(f) defines 
``commodity broker'' as ``any person who is registered or required 
to register as a futures commission merchant under the Commodity 
Exchange Act including a person registered as such under Parts 32 
and 33 of this chapter, and a `commodity options dealer,' `foreign 
futures commission merchant,' `clearing organization,' and `leverage 
transaction merchant' with respect to which there is a `customer' as 
those terms are defined in this section, but excluding a person 
registered as a futures commission merchant under section 4f(a)(2) 
of the Commodity Exchange Act.'' Pursuant to the Bankruptcy Code, 11 
U.S.C. 101 et seq., if a commodity broker experiences bankruptcy, it 
must be liquidated in accordance with chapter 7, subchapter IV 
(``Subchapter IV''). In the event of such liquidation, Subchapter IV 
provides certain protections for collateral that customers deposit 
with the commodity broker. Pursuant to its authority under Section 
20 of the CEA, the Commission has interpreted Subchapter IV in 
promulgating Regulation Part 190.
---------------------------------------------------------------------------

    Part IV below describes proposed technical amendments to Regulation 
part 190 that are not required by the Dodd-Frank Act, but rather 
address the changes to 11 U.S.C. 764(b) implemented by Public Law 111-
16, the Statutory Time-Periods Technical Amendments Act of 2009. 
Specifically, such act changed the time period (i.e., from five (5) 
business days to seven (7) calendar days) during which a transfer of 
``commodity contracts'' \6\ and ``customer property'' \7\ becomes not 
avoidable by the trustee in a commodity broker bankruptcy.
---------------------------------------------------------------------------

    \6\ Section 761(4) of the Bankruptcy Code, 11 U.S.C. 761(4), 
defines ``commodity contract.''
    \7\ Regulation 190.01(n) defines ``customer property'' as ``the 
property subject to pro rata distribution in a commodity broker 
bankruptcy which is entitled to the priority set forth in Section 
766(h) of the Bankruptcy Code and includes certain cash, securities, 
and other property as set forth in Sec.  190.08(a).''
---------------------------------------------------------------------------

    The Commission requests comment on all aspects of this release.

II. Segregation of Margin for SD and MSP Counterparties With Respect to 
Uncleared Swaps

    New Section 4s(l) of the CEA, enacted by Section 724(c) of the 
Dodd-Frank Act, sets forth certain requirements concerning the rights 
of counterparties of SDs and MSPs with respect to the segregation of 
collateral supplied for margining, guaranteeing, or securing uncleared 
swaps.\8\ Such requirements \9\ include:
---------------------------------------------------------------------------

    \8\ It should be noted that this rulemaking addresses 
segregation of margin, and does not address what amount of margin, 
if any, a counterparty is required to post.
    \9\ Such requirements do not apply to ``variation margin 
payments.'' Section 724(c) of the Dodd-Frank Act does not set forth 
a definition for such term. The Commission has proposed such a 
definition below.
---------------------------------------------------------------------------

     An SD or MSP must notify each counterparty at the 
beginning of a swap transaction that the counterparty has the right to 
require segregation of the funds or other property that it supplies to 
margin, guarantee, or secure its obligations; and
     At the request of the counterparty, the SD or MSP must 
segregate such funds or other property with an independent third party.
    To implement the statute, the Commission proposes new subpart L to 
part 23 of title 17.

A. Regulation 23.600: Definitions

    The Commission proposes to define ``segregate'' according to its 
commonly-understood meaning: To keep two or more items in separate 
accounts, and to avoid combining them in the same transfer between two 
accounts.
    The Commission has never before defined ``initial margin'' (for 
which a counterparty has the right to segregation pursuant to CEA 
Section 4s(l)) or ``variation margin'' (for which a counterparty does 
not have such a right) in a regulation. The distinction between 
``initial margin'' and ``variation margin'' established in proposed 
Sec.  23.600 is temporally-based:
1. Initial Margin
    ``Initial margin'' is defined as an amount calculated based on 
anticipated exposure to future changes in the value of a swap.
2. Variation Margin
    ``Variation margin'' is defined as an amount calculated to cover 
the current exposure arising from changes in the market value of the 
position since the trade was executed or the previous time the position 
was marked to market.
    The Commission may also consider, in a future rulemaking, placing 
an expanded version of these definitions (to include initial and 
variation margin with respect to futures and options on futures) in 
Part 1, and incorporating those definitions by reference here.
    The Commission seeks comment on the appropriateness of these 
definitions in this context, and on the potential use of such expanded 
definitions.

B. Regulation 23.601: Notification of Right to Segregation

1. Required Notification
    Proposed Regulation 23.601(a) incorporates the statutory 
requirement of Section 4s(l)(1)(A) of the CEA that a SD or MSP must 
notify each counterparty with respect to an uncleared swap that the 
counterparty has the right to require that initial margin posted by 
that counterparty be segregated in accordance with these rules. The 
Commission interprets the language of Section 4s(l)(1)(A) of the CEA 
that the counterparty must be ``notified * * * [of a] right to require 
segregation'' to mean that this right can be grasped or renounced, at 
the election of the counterparty.\10\ Congress's description as a 
``right'' of what would otherwise be a simple matter for commercial 
negotiation suggests that this decision is an important one, with a 
certain degree of favor given to an affirmative election.
---------------------------------------------------------------------------

    \10\ See also CEA Section 4s(l)(4) (referring to cases where the 
counterparty ``does not choose to require segregation'' of margin).
---------------------------------------------------------------------------

    The Commission has not proposed any particular disclosure 
requirements with respect to this notification. Should the SD or MSP be 
required to disclose the cost of segregation, whether the cost of fees 
to be paid to the custodian (if the SD or MSP is aware of the amount of 
such fees), or differences in the terms of the swap that the SD or MSP 
is willing to offer to the counterparty (e.g., differences in the fixed 
interest rate for an interest rate swap) if the counterparty elects or 
renounces the right to segregation?
2. Limitation of Right--Variation Margin
    Proposed Regulation 23.601(b) incorporates the limitation in 
Section 4s(l)(2)(B)(i) of the CEA that the right to segregation does 
not apply to variation margin.
3. Counterparty Notification
    The Commission regards the inclusion of the term ``right to require 
segregation'' as requiring that this decision is taken at an 
appropriate level of the counterparty organization. Proposed Regulation 
23.601(c) requires that such notification be made to certain senior 
decisionmakers, in descending order of preference. Notification is made 
to the Chief Risk Officer, or the Chief Executive Officer, or to the 
highest level decisionmaker for the counterparty. The Commission seeks 
comment as to whether this list of decision-makers is appropriate, in 
particular, whether it is appropriate for ``Special Entities'' as such 
term is defined in Section 4s(h)(1)(C) of the CEA (e.g. a 
municipality).
4. Required Confirmation
    Proposed Sec.  23.601(d) requires that the SD or MSP must obtain 
from the counterparty confirmation of receipt of such notification by 
the specified decisionmaker, and the election to require segregation or 
not, before the terms of the swap are confirmed. The SD or MSP must 
maintain records of such confirmation and election as business records 
in accordance with Regulation 1.31.
5. Limitation of Responsibility To Notify
    The requirement in Section 4s(l)(1)(A) of the CEA that notification 
be made ``at the beginning of a swap transaction'' could be read to require such 
notification at the beginning of each swap transaction. Such repetitive 
notification could, however, be redundant. On the other hand, the 
importance of the decision discussed above suggests that some periodic 
reconsideration might be appropriate. Proposed Sec.  23.601(e) seeks to 
balance these considerations by providing that notification of a 
particular counterparty by a particular SD or MSP need only be made 
once in any calendar year.
6. Power To Change Election With Regard to Segregation
    Proposed Sec.  23.601(f) makes clear that a counterparty's election 
to require segregation of initial margin, or not to require such 
segregation, may be changed at the discretion of the counterparty upon 
delivery of written notice, and shall be applicable with respect to 
swaps entered into between the parties after such delivery.
    The Commission seeks comments on the issues referred to in this 
section I(B).

C. Regulation 23.602: Requirements for Segregated Collateral

1. Independent Custodian and Separate Account
    Pursuant to Section 4s(l)(3) of the CEA, proposed Regulation 
23.602(a)(1) requires initial margin segregated in accordance with an 
election under proposed Regulation 23.601 to be segregated with a 
custodian that is independent of both the SD or MSP and the 
counterparty. Proposed Sec.  23.602(a)(2) requires the initial margin 
to be held in an account designated as a segregated account for and on 
behalf of the counterparty. While, as noted above, the right to 
segregation does not apply to variation margin, the regulation provides 
the swap dealer or major swap participant and the counterparty may 
agree that variation margin may also be held in such an account.
    Proposed Sec.  23.602(a)(1) does not require that the initial 
margin be held in an account that is independent of any affiliate of 
the SD or MSP or the counterparty, in order to permit parties to engage 
in swaps transactions with affiliates of their usual depositories. 
Comment is requested as to whether this approach is appropriate. 
Moreover, the proposed regulation does not specify which party (the 
counterparty, or the SD or MSP) has the right to designate a custodian, 
thus, by implication, leaving the choice to the agreement of the 
parties. Is this approach appropriate? Should either party be entitled 
to choose a custodian? If so, what restrictions, if any, should be 
placed on that choice?
2. Requirements for Custody Agreement
    Proposed Sec.  23.602(b) is intended to provide a balance between 
the minimum interests of (i) the counterparty posting the initial 
margin, (ii) the SD or MSP for whom the initial margin is posted, and 
(iii) the custodian, while avoiding the necessity for time-consuming 
and expensive interpleader proceedings.\11\ The custody agreement 
applicable to such initial margin must be in writing, and must include 
the custodian as a party. To ensure that the SD or MSP receives the 
initial margin promptly in case it is entitled to do so, and that the 
initial margin is returned to the counterparty in case it is entitled 
to such return, the agreement must provide that turnover of control 
shall be made promptly upon presentation of a statement in writing, 
signed by an authorized person under penalty of perjury, that one party 
is entitled to such turnover pursuant to an agreement between the 
parties. The requirement of a signature under oath or under penalty of 
perjury pursuant to 28 U.S.C. 1746 is intended to ensure that such 
statement is not lightly made.\12\ Otherwise, withdrawal of collateral 
may only be made pursuant to the agreement of both the counterparty and 
the SD or MSP, with the non-withdrawing party also receiving immediate 
notice of such withdrawal.\13\ The Commission requests comment on 
whether the foregoing approach is appropriate, including on whether a 
statement under penalty of perjury should be required, and on whether 
such a statement, if required, should be required to be based on 
personal knowledge.
---------------------------------------------------------------------------

    \11\ If the SD or MSP and the counterparty were to make 
competing claims to the collateral, and if the custodian did not 
have a means under the agreement among the parties to decide between 
such claims without risking legal liability, the custodian would 
likely choose to interplead the collateral.
    \12\ See 18 U.S.C. 1621 (Perjury Generally).
    \13\ The importance of taking steps to ensure that unauthorized 
withdrawals are not made is enhanced by the findings of the 
Commission's Division of Clearing and Intermediary Oversight in 
Financial and Segregation Interpretation 10-1, 20 FR 24768, 24770 
(May 11, 2005) (``Findings by both Commission audit staff and the 
SROs of actual releases of customer funds [from third-party 
custodial accounts], without the required knowledge or approval of 
the FCMs, further demonstrate that the risks associated with third-
party custodial accounts are real and material, not merely 
theoretical.'').
---------------------------------------------------------------------------

D. Regulation 23.603: Investment of Segregated Collateral

1. Limitations on Investments
    Section 4s(l)(2)(B)(ii)(I) of the CEA refers to ``commercial 
arrangements regarding the investment of segregated funds or other 
property that may only be invested in such investments as the 
Commission may permit by rule or regulation.'' Proposed Sec.  22.603(a) 
accordingly provides 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, Regulation 
Sec.  1.25. That regulation has been designed to permit an appropriate 
degree of flexibility in making investments with segregated property, 
while safeguarding such property for the parties who have posted it, 
and decreasing the credit, market, and liquidity risk exposures of the 
parties who are relying on that margin.\14\
---------------------------------------------------------------------------

    \14\ See generally Investment of Customer Funds and Funds Held 
in an Account for Foreign Futures and Foreign Options Transactions, 
75 FR 67642, 67652-53 (Nov. 3, 2010) (Release proposing amendments 
to Commission Regulation 1.25).
---------------------------------------------------------------------------

    This regulation governs only investments of initial margin posted 
by the counterparty, and does not govern what collateral is eligible to 
be posted as such margin.
2. Commercial Arrangements Regarding Investments and Allocations
    As required by new Section 4s(l)(2)(B)(ii) of the CEA, proposed 
Regulation 22.603(b) provides that the SD or MSP and the counterparty 
may enter into any commercial arrangement, in writing, regarding the 
investment of segregated initial margin and the related allocation of 
gains and losses resulting from such investment.

E. Regulation 23.604: Requirements for Non-Segregated Collateral

    Section 4s(l)(4) of the CEA mandates that, if the counterparty does 
not choose to require segregation, the SD or MSP shall report to the 
counterparty, on a quarterly basis, ``that the back office procedures 
of the swap dealer or major swap participant relating to margin and 
collateral requirements are in compliance with the agreement of the 
counterparties.'' This provision is implemented in proposed Sec.  
22.604(a), which requires that such reports be made no later than the 
fifteenth (15th) business day of each calendar quarter for the 
preceding calendar quarter. Proposed Regulation 22.604(a) makes the 
Chief Compliance Officer of the SD or MSP required by Section 4s(k) of 
the CEA responsible for such report. Proposed Sec.  22.604(b) provides that this obligation shall apply no 
earlier than the 90th calendar day after the first swap is transacted 
between the counterparties.

F. Effective Date

    The Commission requests comment on the appropriate timing of 
effectiveness for the final rules for Part 23. Specifically, is six 
months after the promulgation of final rules sufficient? If not, please 
specify a recommended time period, and explain in detail the reasons 
why a shorter period will not be sufficient.

III. Portfolio Margining Accounts

    Section 713(c) of the Dodd-Frank Act added Section 20(c) of the 
CEA, which specifies that the Commission ``shall exercise its authority 
to ensure that securities held in a portfolio margining account carried 
as a futures account are customer property and the owners of those 
accounts are customers for the purposes of'' Subchapter IV. To 
implement this provision, the Commission proposes changes to Sec. Sec.  
190.01(k) and 190.08(a)(1)(i).

A. Regulation 190.01(k): Definition of Customer

    The ``customer'' portion of this provision is implemented in the 
proposed amendment to Sec.  190.01(k), which adds to the definition of 
``customer'' the sentence ``To the extent not otherwise included, 
customer shall include the owner of a portfolio margining account 
carried as a futures account.''

B. Regulation 190.08(a)(1)(i)(F): Definition of Customer Property

    The ``customer property'' portion of this provision is implemented 
in proposed Sec.  190.08(a)(1)(i)(F), which adds to the definition of 
``customer property'' the sentence ``To the extent not otherwise 
included, securities held in a portfolio margining account carried as a 
futures account.''

C. Effective Date of Proposal

    The Commission believes that these rule amendments clarify existing 
law, and thus may be made effective immediately upon promulgation of a 
final rule. Comment is solicited with respect to these conclusions.

IV. Statutory Time-Periods Technical Amendments Act of 2009

    The purpose of this portion of the rulemaking is to implement 
Public Law 111-16, the Statutory Time-Periods Technical Amendments Act 
of 2009, which (in relevant part) changed the time period in 11 U.S.C. 
764(b), discussed below, from five (business) days to seven (calendar) 
days. As noted above, these changes are not related to the Dodd-Frank 
Act.
    Certain sections of the Bankruptcy Code \15\ provide the trustee of 
a debtor the power to avoid (i.e., retract) certain transfers of 
property from the debtor, whether shortly before or after the 
bankruptcy filing, that would otherwise allow a creditor to obtain more 
than that creditor would in a bankruptcy distribution. Section 764(b) 
of the Bankruptcy Code provides that a trustee may not avoid a transfer 
of ``commodity contracts'' \16\ or ``customer property'' \17\ that is 
authorized by the Commission, whether before or after the transfer, 
before the specified time period after the bankruptcy ``order for 
relief.''
---------------------------------------------------------------------------

    \15\ See 11 U.S.C. 544, 545, 547, 548, 724(a).
    \16\ See supra note 6.
    \17\ See supra note 7.
---------------------------------------------------------------------------

    The change in the statutory deadline should be reflected in the 
relevant Commission regulations. Moreover, under current business and 
legal practice, emergency matters (such as transfers during a 
bankruptcy) may be accomplished outside of business hours. Accordingly, 
the words ``the close of business on the fourth business day after the 
order for relief'' are replaced by the words ``11:59 P.M. on the 
seventh day after the order for relief'' in proposed Sec.  190.02(e)(1) 
(trustee to use best efforts to effect transfer before this time), 
Sec.  190.02(f)(1) (deadline for transfer of dealer option contracts), 
Sec.  190.06(g)(2)(i)(A) (prohibition of avoidance of transfers of 
which the Commission is notified prior to the transfer pursuant to 
Sec.  190.02(a)(2) and does not disapprove), and Sec.  190.06(g)(2)(ii) 
(prohibition of avoidance of transfers at the direction of the 
Commission).
    These amendments would only affect ``commodity brokers ''\18\ in 
bankruptcy, and are meant to make Part 190 consistent with amendments 
to the Bankruptcy Code. Accordingly, the Commission proposes to make 
the foregoing amendments to part 190 effective immediately upon 
promulgation of a final rule.
---------------------------------------------------------------------------

    \18\ See supra note 5.
---------------------------------------------------------------------------

V. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') was adopted to address the 
concerns that government regulations may have a significant and/or 
disproportionate effect on small businesses. To mitigate this risk, the 
RFA requires agencies to conduct an initial and final regulatory 
flexibility analysis for each rule of general applicability for which 
the agency issues a general notice of proposed rulemaking.\19\ These 
analyses must describe the impact of the proposed rule on small 
entities, including a statement of the objectives and the legal bases 
for the rulemaking; an estimate of the number of small entities to be 
affected; identification of federal rules that may duplicate, overlap, 
or conflict with the proposed rules; and a description of any 
significant alternatives to the proposed rule that would minimize any 
significant impacts on small entities.\20\
---------------------------------------------------------------------------

    \19\ 5 U.S.C. 601 et seq.
    \20\ 5 U.S.C. 603, 604.
---------------------------------------------------------------------------

    The proposed Regulations will impose regulatory obligations on SDs 
and MSPs. The Commission has already established certain definitions of 
``small entities'' to be used in evaluating the impact of its rules on 
such small entities in accordance with the RFA.\21\ SDs and MSPs are 
new categories of registrant. Accordingly, the Commission has not 
previously decided whether such persons are, in fact, small entities 
for purposes of the RFA.
---------------------------------------------------------------------------

    \21\ 47 FR 18618 (Apr. 30, 1982).
---------------------------------------------------------------------------

    The Commission previously has determined that FCMs should not be 
considered to be small entities for purposes of the RFA. The 
Commission's determination was based in part upon their obligation to 
meet the minimum financial requirements established by the Commission 
to enhance the protection of customers' segregated funds and protect 
the financial condition of FCMs generally.\22\ Like FCMs, SDs 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 designation entities that engage in a de minimis level 
of swaps dealing in connection with transactions with or on behalf of 
customers. Accordingly, for purposes of the RFA, the Commission is 
hereby determining that SDs not be considered ``small entities'' for 
essentially the same reasons that FCMs have previously been determined 
not to be small entities.
---------------------------------------------------------------------------

    \22\ Id. at 18619.
---------------------------------------------------------------------------

    The Commission has also previously determined that large traders 
are not ``small entities'' for RFA purposes.\23\ The Commission 
considered the size of a trader's position to be the only appropriate 
test for purposes of large trader reporting.\24\ MSPs maintain 
substantial positions in swaps, creating 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, the Commission is hereby determining that MSPs not 
be considered ``small entities'' for essentially the same reasons that 
large traders have previously been determined not to be small entities.
---------------------------------------------------------------------------

    \23\ Id. at 18620.
    \24\ Id.
---------------------------------------------------------------------------

    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

    Provisions of proposed new Regulation Part 23 include new 
information disclosure and recordkeeping requirements that constitute 
the collection of information within the meaning of the Paperwork 
Reduction Act of 1995 (``PRA'').\25\ The Commission therefore is 
submitting this proposed collection of information to the Office of 
Management and Budget (``OMB'') for review in accordance with 44 U.S.C. 
3507(d) and 5 CFR 1320.11. Under the PRA, 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.\26\ 
The title for this collection of information is ``Disclosure and 
Retention of Certain Information Relating to Swaps Customer 
Collateral,'' OMB Control Number 3038-NEW. The collection of 
information will be mandatory. The information in question will be held 
by private entities and, to the extent it involves consumer financial 
information, may be protected under Title V of the Gramm-Leach-Bliley 
Act as amended by the Dodd-Frank Act.\27\ 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 OMB control number. 
This collection of information has not yet been assigned an OMB control 
number.
---------------------------------------------------------------------------

    \25\ 44 U.S.C. 3501 et seq.
    \26\ Id.
    \27\ See generally 75 FR 66014, Notice of Proposed Rulemaking, 
Privacy of Consumer Financial Information; Conforming Amendments 
Under Dodd-Frank Act (October 27, 2010).
---------------------------------------------------------------------------

1. Information Provided by Reporting Entities
    Proposed Sec.  23.601 requires SDs and/or MSPs to notify each 
counterparty to an uncleared swap transaction that the counterparty may 
require that the counterparty's initial margin be held in a segregated 
account. The notification must be provided at the beginning of each 
swap transaction. However, notification need only be given once a year 
to any particular counterparty. The SD or MSP must provide the 
notification to the chief risk officer of the counterparty, if such an 
officer exists; and otherwise to another appropriate official of the 
counterparty as specified in the regulation. The SD or MSP must obtain 
a receipt of the notification and maintain it as a business record. The 
purpose of proposed Sec.  23.601 is to implement Section 4s(l)(1)(A) of 
the CEA which requires SDs and MSPs in uncleared swaps transactions to 
notify counterparties that they have the right to require segregation 
of their initial margin deposits.
    Proposed Sec.  23.604 requires the chief compliance officer of each 
SD or MSP to report on a quarterly basis to each counterparty that does 
not choose to require segregation of initial margin on whether or not 
the back-office procedures of the SD or MSP relating to margin and 
collateral requirements were, at any point during the previous quarter, 
not in compliance with the agreement of the counterparties. The purpose 
of this requirement is to implement Section 4s(1)(4) of the CEA, which 
requires these reports.
    The disclosure requirement of proposed Sec.  23.601 is expected to 
apply to about 300 entities.\28\ Each such entity will be required to 
make the required disclosure once each year to each of its 
counterparties in uncleared swaps transactions. It is expected that 
each disclosure would require approximately 0.3 hours of staff time by 
staff with a salary level of approximately $20 per hour. Because of the 
absence of experience under the new requirements of the Dodd-Frank Act, 
it is uncertain what average number of uncleared swaps counterparties 
will be dealt with annually by swap dealers and major swap 
participants. Assuming that each of 14 major swap dealers or major swap 
participants makes the required disclosure to 5,000-10,000 
counterparties per year, and each of the 286 remaining swap dealers or 
major swap participants makes the required disclosure to 200 
counterparties per year, there would be a total of approximately 
130,000-200,000 disclosures per year, and thus the estimated total 
annual burden would be approximately 40,000-60,000 hours and $800,000-
$1,200,000.\29\
---------------------------------------------------------------------------

    \28\ This estimate is based on the assumption that there will be 
about 250 SDs and 50 MSPs.
    \29\ The estimate of the number of counterparties receiving 
disclosure from each swap dealer or major swap participant takes 
into consideration the possibility that a single counterparty may 
deal with more than one swap dealer or major swap participant in a 
year. Thus, the total number of required disclosures may exceed the 
total number of counterparties making use of uncleared swaps subject 
to the disclosure requirement.
---------------------------------------------------------------------------

    The disclosure requirement of proposed Regulation 23.604 will apply 
to the same 300 entities as the requirement of proposed Regulation 
23.601. Each such entity will be required to make the required 
disclosure four times each year to each of its uncleared swaps 
counterparties that does not choose to require segregation of capital. 
Because there is as yet no experience with the effect of the disclosure 
of the right to segregation of collateral and other requirements of the 
Dodd-Frank Act, it is uncertain how many uncleared swaps counterparties 
will decline such segregation. Assuming that half of all uncleared 
swaps counterparties do not choose segregation of collateral, proposed 
Sec.  23.604 would require a total of approximately 260,000-400,000 
disclosures annually. It is expected that each disclosure would, on 
average, require approximately 0.3 hours of staff time by staff with a 
salary level of about $30 per hour.\30\ The estimated total annual 
burden would be approximately 80,000-120,000 hours and $2,400,000-
$3,500,000.
---------------------------------------------------------------------------

    \30\ The time and level of personnel required for the disclosure 
required by proposed Sec.  23.604 in particular transactions will 
depend, to some extent, on the specifics of the agreement of the 
parties with regard to the back-office procedures of the SD relating 
to margin and collateral requirements, and the extent to which such 
agreements with regard to procedures are standardized at a 
particular SD. The average burden figure thus reflects a varying 
level of burden in particular transactions.
---------------------------------------------------------------------------

2. Information Collection Comments
    The Commission invites the public and other federal agencies to 
comment on any aspect of the reporting and recordkeeping burdens 
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 OMB Office of Information 
and Regulatory Affairs, by fax at (202) 395-6566 or by e-mail at 
OIRAsubmissions@omb.eop.gov. Please provide the Commission with a copy 
of submitted comments so that all comments can be summarized and 
addressed in the final rule preamble. Refer to the ADDRESSES section of 
this notice of proposed rulemaking for comment submission instructions 
to the Commission. A copy of the supporting statements for the 
collections of information discussed above may be obtained by visiting 
RegInfo.gov. OMB is required to make a decision concerning the 
collection of information between 30 and 60 days after publication of 
this release. Consequently, a comment to OMB is most assured of being 
fully effective if received by OMB (and the Commission) within 30 days 
after publication of this notice of proposed rulemaking.

C. Cost-Benefit Analysis

    Section 15(a) of the CEA \31\ 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) of the CEA does not require the 
Commission to quantify the costs and benefits of a rule or to determine 
whether the benefits of the rulemaking outweigh its costs; rather, it 
requires that the Commission ``consider'' the costs and benefits of its 
actions. Section 15(a) of the CEA further specifies that the costs and 
benefits 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 areas 
and could in its discretion determine that, notwithstanding its costs, 
a particular rule is necessary or appropriate to protect the public 
interest or to effectuate any of the provisions or accomplish any of 
the purposes of the CEA.
---------------------------------------------------------------------------

    \31\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------

1. Cost-Benefit Analysis of Proposed Part 23
a. Summary of Proposed Requirements
    Proposed Part 23 of the Commission's regulations implements the 
requirement of newly-enacted Section 4s(l) of the CEA that 
counterparties to uncleared swaps transactions with SDs and MSPs be 
given the right to require to require segregation of their initial 
margin in an account separate from those of the SD or MSP. Proposed 
Part 23 also implements the statutory requirement that SDs and MSPs 
notify their counterparties of this right. Additionally, amendments are 
being made to Part 190 of the Commission's regulations that would 
clarify existing law, particularly that (i) ``customer property,'' for 
purposes of Regulation Part 190, includes securities held in a 
portfolio margining account carried as a futures account, and (ii) 
``customers,'' for purposes of Regulation part 190, includes owners of 
such a portfolio margining account. Technical amendments also are being 
proposed for part 190. These amendments would change the deadline for 
certain actions in bankruptcy proceedings to conform with recent 
amendments to the Bankruptcy Code, as well as current business and 
legal practice.
b. Costs
    The costs directly imposed by proposed part 23 and the amendments 
to Part 190 relate to the protection of market participants, the risk 
management practices of market participants, and the efficiency of 
bankruptcy proceedings. If proposed part 23 and the proposed amendments 
to Part 190 are not implemented, it will be less likely that a market 
participant will be informed of their option to require segregation of 
their initial margin from the assets of the SD or MSP opposite which 
the market participant will be transacting swaps. The segregation 
option is intended to preserve the assets of the market participant in 
the event of an insolvency of the SD or MSP.
c. Benefits
    The benefits of proposed part 23 relate to the protection of market 
participants and the financial integrity of the futures and swap 
markets. The proposed regulatons would ensure that segregated accounts 
for initial margin are available in all uncleared swaps transactions 
involving SDs or MSPs and that counterparties are informed of their 
availability. This could result in the increased use of segregated 
accounts with resulting reduced risk of loss of collateral by 
counterparties in the event of the insolvency of an SD or MSP and 
reduced chance of counterparty assets being intentionally or 
inadvertently misused. In addition proposed Regulation Part 23 can be 
expected to increase the likelihood that any lack of use of segregated 
collateral accounts by uncleared swaps counterparties is the result of 
genuine choices by counterparties and reduce the likelihood that it is 
the result of inertia, market power, or other market imperfections.
    The definitions and technical amendments being proposed for Part 
190 similarly are intended to relate to the protection of market 
participants, as well as to efficiency associated with bankruptcy 
proceedings. The definitional changes are expected to increase legal 
certainty in some circumstances. The technical amendments are intended 
to increase the efficiency with which certain acts in bankruptcy 
proceedings of commodity brokers are carried out by insuring 
consistency between the Regulations, the Bankruptcy Code, and current 
bankruptcy practice.
3. Public Comment
    The Commission invites public comment on its cost-benefit 
considerations. Commenters are also are invited to submit any data or 
other information that they may have quantifying or qualifying the 
costs and benefits of the proposal with their comment letters.

List of Subjects

17 CFR Part 23

    Consumer protection, Reporting and recordkeeping requirements, 
Swaps.

17 CFR Part 190

    Bankruptcy, Brokers, Commodity futures, Reporting and recordkeeping 
requirements, Swaps.
    For the reasons stated in this release, the Commission hereby 
proposes to amend 17 CFR part 23 as previously proposed in FR Doc. 
2010-29024, published on November 23, 2010 (75 FR 71379) and part 190 
as follows:

PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

    1. The authority citation for Part 23 continues to read as follows:

    Authority:  7 U.S.C. 1a, 2, 6, 6a, 6b, 6c, 6p, 6s, 9, 9a, 13b, 
13c, 16a, 18, 19, 21 as amended by Pub. L. 111-203, 124 Stat. 1376 
(Jul. 21, 2010).

    2. Add subpart L to read as follows:
Subpart L--Segregation of Assets Held as Collateral in Uncleared Swap 
Transactions
Sec.
23.600 Definitions.
23.601 Notification of right to segregation.
23.602 Requirements for segregated margin.
23.603 Investment of segregated initial margin.
23.604 Requirements for non-segregated margin. Subpart L--Segregation of Assets Held as Collateral in Uncleared 
Swap Transactions


Sec.  23.600  Definitions.

    ``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.
    ``Margin'' means both Initial Margin and Variation Margin.
    ``Segregate.'' To segregate two or more items is to keep them in 
separate accounts, and to avoid combining them in the same transfer 
between two accounts.
    ``Variation Margin'' means a payment made by a party to a swap to 
cover the current exposure arising from changes in the market value of 
the position since the trade was executed or the previous time the 
position was marked to market.


Sec.  23.601  Notification of right to segregation.

    (a) At the beginning of each swap transaction that is not submitted 
for clearing, a swap dealer or major swap participant shall notify each 
counterparty to such transaction that the counterparty has the right to 
require that any Initial Margin the counterparty provides in connection 
with such transaction be segregated in accordance with Sec. Sec.  
23.602 and 23.603 of this part.
    (b) The right referred to in paragraph (a) of this section does not 
extend to Variation Margin.
    (c) The notification referred to in paragraph (a) of this section 
shall be made to the Chief Risk Officer, or, if there is no such 
Officer, the Chief Executive Officer, or if none, the highest-level 
decisionmaker for the counterparty.
    (d) Prior to confirming the terms of any such swap, the swap dealer 
or major swap participant shall obtain from the counterparty 
confirmation of receipt by the person specified in paragraph (c) of 
this section of the notification specified in paragraph (a) of this 
section, and an election to require such segregation or not. The swap 
dealer or major swap participant shall maintain such confirmation and 
such election as business records pursuant to Sec.  1.31 of this 
chapter.
    (e) Notification pursuant to paragraph (a) of this section to a 
particular counterparty by a particular swap dealer or major swap 
participant need only be made once in any calendar year.
    (f) A counterparty's election to require segregation of initial 
margin, or not to require such segregation, may be changed at the 
discretion of the counterparty upon written notice delivered to the 
swap dealer or major swap participant, which changed election shall be 
applicable to all swaps entered into between the parties after such 
delivery.


Sec.  23.602  Requirements for segregated margin.

    (a) Initial margin that is segregated pursuant to an election under 
Sec.  23.601 of this part must be:
    (1) Segregated with a custodian that is independent of both the 
swap dealer or major swap participant and the counterparty, and
    (2) Held in an account segregated, and designated as such, for and 
on behalf of the counterparty. Such an account may, if the swap dealer 
or major swap participant and the counterparty agree, also hold 
Variation Margin.
    (b) Any agreement for the segregation of Margin pursuant to this 
section shall be in writing, shall include the custodian as a party, 
and shall provide that:
    (1) Turnover of control of such margin, either to the counterparty 
or to the swap dealer or major swap participant, shall be made promptly 
upon presentation to the custodian of a statement in writing, made 
under oath or under penalty of perjury as specified in 28 U.S.C. 1746, 
by an authorized representative of either such party, stating that such 
party is entitled to such control pursuant to an agreement between such 
parties. The other party shall be immediately notified of such 
turnover, and
    (2) Any withdrawal of such margin, other than pursuant to paragraph 
(b)(1) of this section, shall only be made pursuant to the agreement of 
both the counterparty and the swap dealer or major swap participant, 
and notification of such withdrawal shall be given immediately to the 
non-withdrawing party.


Sec.  23.603  Investment of segregated initial margin.

    (a) Initial Margin that is segregated pursuant to an election under 
Sec.  23.601 may only be invested consistent with Sec.  1.25 of this 
chapter.
    (b) Subject to paragraph (a) of this section, the swap dealer or 
major swap participant and the counterparty may enter into any 
commercial arrangement, in writing, regarding the investment of such 
Initial Margin, and the related allocation of gains and losses 
resulting from such investment.


Sec.  23.604  Requirements for non-segregated margin.

    (a) The chief compliance officer of each swap dealer or major swap 
participant shall report to each counterparty that does not choose to 
require segregation of Initial Margin pursuant to Sec.  23.601(a), no 
later than the fifteenth business day of each calendar quarter, on 
whether or not the back office procedures of the swap dealer or major 
swap participant relating to margin and collateral requirements were, 
at any point during the previous calendar quarter, not in compliance 
with the agreement of the counterparties.
    (b) The obligation specified in paragraph (a) of this section shall 
apply with respect to each counterparty no earlier than the 90th 
calendar day after the date on which the first swap is transacted 
between the counterparty and the swap dealer or major swap participant.

PART 190--BANKRUPTCY

    3. The authority citation for Part 190 continues to read as 
follows:

    Authority: 7 U.S.C. 1a, 2, 4a, 6c, 6d, 6g, 7a, 12, 19, and 24, 
and 11 U.S.C. 362, 546, 548, 556, and 761-766, unless otherwise 
noted.

    4. Amend Sec.  190.01(k) to read as follows:


Sec.  190.01  Definitions.

* * * * *
    (k) Customer shall have the same meaning as that set forth in 
section 761(9) of the Bankruptcy Code. To the extent not otherwise 
included, customer shall include the owner of a portfolio margining 
account carried as a futures account.
* * * * *


Sec.  190.02  [Amended]

    5. In Sec.  190.02, amend paragraphs (e)(1) and (f)(1)(i) by 
removing the words ``the close of business on the fourth business day 
after the order for relief'' and adding, in their place, the words 
``11:59 P.M. on the seventh day after the order for relief.''


Sec.  190.06  [Amended]

    6. In Sec.  190.06, amend paragraph (g)(2)(i)(A) by removing the 
words ``the close of business on the fourth business day after the 
entry of the order for relief'' and adding, in their place, the words 
``11:59 P.M. on the seventh day after the order for relief''; and amend 
paragraph (g)(2)(ii) by removing the words ``the close of business on 
the fourth business day after the order for relief'' and adding, in 
their place, the words ``11:59 P.M. on the seventh day after the order 
for relief''.
    7. Amend Sec.  190.08 by redesignating paragraph (a)(1)(i)(F) as Sec.  190.08(a)(1)(i)(G), and by adding a new paragraph (a)(1)(i)(F):


Sec.  190.08  Allocation of property and allowance of claims.

* * * * *
    (a) * * *
    (1) * * *
    (i) * * *
    (F) To the extent not otherwise included, securities held in a 
portfolio margining account carried as a futures account;
* * * * *

    Issued in Washington, DC, on November 19, 2010, by the 
Commission.
David A. Stawick,
Secretary of the Commission.

Statement of Chairman Gary Gensler

Protection of Collateral of Counterparties to Uncleared Swaps; 
Treatment of Securities in a Portfolio Margining Account in a Commodity 
Broker Bankruptcy

    I support the proposed rulemaking concerning protection of 
collateral of counterparties to uncleared swaps. The proposal 
includes important protections for end-users when entering into 
bilateral or customized swaps. The proposal follows the 
Congressional direction that end-users must have a choice to have 
any initial margin that they post with a swap dealer to be kept in a 
segregated account and with a third party custodian. The proposed 
rules would protect market participants while promoting the 
financial integrity of the marketplace. The proposal also includes 
necessary housekeeping details with regard to the Bankruptcy code.

[FR Doc. 2010-29831 Filed 12-2-10; 8:45 am]
BILLING CODE 6351-01-P  

References

Loading most recent entriesloading

Feedback