[Federal Register Volume 83, Number 146 (Monday, July 30, 2018)]
[Proposed Rules]
[Pages 36484-36494]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-16176]


=======================================================================
-----------------------------------------------------------------------

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 23

RIN 3038-AE78


Segregation of Assets Held as Collateral in Uncleared Swap 
Transactions

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rule.

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

SUMMARY: The Commodity Futures Trading Commission (``Commission'' or 
``CFTC'') is proposing to amend selected provisions of its regulations 
in order to simplify certain requirements for swap dealers (``SDs'') 
and major swap participants (``MSPs'') concerning notification of 
counterparties of their right to segregate initial margin for uncleared 
swaps, and to modify requirements for the handling of segregated 
initial margin (the ``Proposal'').

DATES: Comments must be received on or before September 28, 2018.

ADDRESSES: You may submit comments, identified by RIN 3038-AE78, by any 
of the following methods:
    <bullet> CFTC Comments Portal: https://comments.cftc.gov. Select 
the ``Submit Comments'' link for this rulemaking and follow the 
instructions on the Public Comment Form.
    <bullet> Mail: Send to Christopher Kirkpatrick, Secretary of the 
Commission, Commodity Futures Trading Commission, Three Lafayette 
Centre, 1155 21st Street NW, Washington, DC 20581.
    <bullet> Hand Delivery/Courier: Follow the same instructions as for 
Mail, above.
    Please submit your comments using only one of these methods. To 
avoid possible delays with mail or in-person deliveries, submissions 
through the CFTC Comments Portal are encouraged.
    All comments must be submitted in English, or if not, accompanied 
by an English translation. Comments will be posted as received to 
https://comments.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 (``FOIA''),\1\ a petition for confidential 
treatment of the exempt information may be submitted according to the 
procedures set forth in Sec.  145.9 of the Commission's regulations.\2\
---------------------------------------------------------------------------

    \1\ 5 U.S.C. 552.
    \2\ 17 CFR 145.9 (2017). Commission regulations referred to 
herein are found at 17 CFR chapter I, and can be accessed through 
the Commission's website, www.cftc.gov.
---------------------------------------------------------------------------

    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 https://comments.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 FOIA.

FOR FURTHER INFORMATION CONTACT: Matthew Kulkin, Director, (202) 418-
5213, <a href="/cdn-cgi/l/email-protection#d5b8bea0b9bebcbb95b6b3a1b6fbb2baa3"><span class="__cf_email__" data-cfemail="1875736d74737176587b7e6c7b367f776e">[email protected]</span></a>; Erik Remmler, Deputy Director, (202) 418-7630, 
<a href="/cdn-cgi/l/email-protection#6a0f180f0707060f182a090c1e09440d051c"><span class="__cf_email__" data-cfemail="2d485f48404041485f6d4e4b594e034a425b">[email protected]</span></a>; or Christopher Cummings, Special Counsel, (202) 418-
5445, <a href="/cdn-cgi/l/email-protection#315252445c5c585f564271525745521f565e47"><span class="__cf_email__" data-cfemail="c7a4a4b2aaaaaea9a0b487a4a1b3a4e9a0a8b1">[email protected]</span></a>, Division of Swap Dealer and Intermediary 
Oversight, Commodity Futures Trading Commission, 1155 21st Street NW, 
Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

I. Introduction

A. Existing Requirements

    Subpart L of the Commission's regulations (``Segregation of Assets 
Held as Collateral in Uncleared Swap Transactions'' consisting of 
Regulations 23.700 through 23.704) was published in the Federal 
Register on November 6, 2013 and became effective January 6, 2014.\3\ 
Subpart L implements the requirements for segregation of initial margin 
for uncleared swap transactions set forth in section 4s(l) of the 
Commodity Exchange Act (``CEA'' or the ``Act'').\4\
---------------------------------------------------------------------------

    \3\ See 78 FR 66621 (Nov. 6, 2013).
    \4\ 7 U.S.C. 6s(l) (2012 & Supp. 2015). Like the Commission's 
regulations, the CEA can be accessed through the Commission's 
website.
---------------------------------------------------------------------------

    CEA section 4s(l) addresses segregation of initial margin held as 
collateral in certain uncleared swap transactions. The section applies 
only to swaps between a counterparty and an SD or MSP that are not 
submitted for clearing to a derivatives clearing

[[Page 36485]]

organization (``DCO''). It requires that an SD or MSP notify a 
counterparty that the counterparty has the right to require that any 
funds or property the counterparty provides as initial margin be 
segregated in a separate account from the SD's or MSP's assets. The 
separate account must be held by an independent third-party custodian 
and designated as a segregated account for the counterparty. CEA 
section 4s(l) does not preclude the counterparty and the SD or MSP from 
agreeing to their own terms regarding investment of initial margin 
(subject to any regulations adopted by the Commission) or allocation of 
gains or losses from such investment. If the counterparty elects not to 
require segregation of margin, the SD or MSP is required to report 
quarterly to the counterparty that the SD's or MSP's back office 
procedures relating to margin and collateral are in compliance with the 
agreement between the counterparty and the SD or MSP.
    In January 2016, the Commission adopted margin requirements for 
certain uncleared swaps applicable to SDs and MSPs for which there is 
no prudential regulator (``CFTC Margin Rule'').\5\ The prudential 
regulators (``Prudential Regulators'') include the Federal Reserve 
Board, the Office of the Comptroller of the Currency, the Federal 
Deposit Insurance Corporation, the Farm Credit Administration, and the 
Federal Housing Finance Agency.\6\ The Prudential Regulators adopted 
margin requirements similar to the CFTC Margin Rule for swaps entered 
into by SDs and MSPs that they regulate (``Prudential Regulator Margin 
Rules'') in November 2015.\7\ The CFTC Margin Rule and the Prudential 
Regulator Margin Rules establish initial and variation margin 
requirements for SDs and MSPs.\8\
---------------------------------------------------------------------------

    \5\ Margin Requirements for Uncleared Swaps for Swap Dealers and 
Major Swap Participants, 81 FR 636 (Jan. 6, 2016). The CFTC Margin 
Rule, which became effective April 1, 2016, is codified in part 23 
of the Commission's regulations. 17 CFR 23.150 through 23.159, 
23.161.
    \6\ 7 U.S.C. 1a(39).
    \7\ See Margin and Capital Requirements for Covered Swap 
Entities, 80 FR 74840 (Nov. 30, 2015).
    \8\ See 17 CFR 23.151.
---------------------------------------------------------------------------

    Prior to the CFTC Margin Rule effective date of April 1, 2016, if 
initial margin was to be exchanged by counterparties to uncleared swaps 
involving an SD or MSP, the requirements of subpart L applied. The CFTC 
Margin Rule amended Regulation 23.701 to clarify that from and after 
the effective date of the CFTC Margin Rule, the requirements of 
Regulations 23.702 and 23.703 did not apply in those circumstances 
where segregation is mandatory under the CFTC Margin Rule.\9\ As a 
result, Regulations 23.702 and 23.703 generally only apply when initial 
margin is to be exchanged between an SD or MSP and (i) a nonfinancial 
end-user, or (ii) a financial end-user without ``material swaps 
exposure,'' as defined in the CFTC Margin Rule.
---------------------------------------------------------------------------

    \9\ 81 FR 704 (Jan. 6, 2016). The amendment did not address the 
application of subpart L to swaps subject to mandatory segregation 
under the Prudential Regulator Margin Rules. As described below, 
this Proposal would clarify that the swaps subject to the Prudential 
Regulator Margin Rules are to be addressed in the same manner as 
swaps subject to the CFTC Margin Rule.
---------------------------------------------------------------------------

    Regulation 23.700 defines certain terms used in subpart L. 
Regulation 23.701 requires an SD or MSP: (1) To notify each 
counterparty to a swap that is not submitted for clearing, that the 
counterparty has the right to require that any initial margin it 
provides be segregated; (2) to identify a creditworthy custodian that 
is a non-affiliated legal entity, independent of the SD or MSP and the 
counterparty, to act as depository for segregated margin assets; and 
(3) to provide information regarding the costs of such segregation. The 
regulation specifies that the notification is to be made (with receipt 
confirmed in writing) to an officer (of the counterparty) responsible 
for management of collateral (or to specified alternative person(s)), 
and that it need only be made once in any calendar year. Finally, the 
regulation provides that a counterparty can change its election to 
require (or not to require) segregation of initial margin by written 
notice to the SD or MSP.
    Regulation 23.702 reiterates the requirement that the custodian be 
a legal entity independent of the SD or MSP and the counterparty. It 
also requires that segregated initial margin be held in an account 
segregated for, and on behalf of, the counterparty and designated as 
such. Finally, the regulation specifies that the segregation agreement 
is to provide that: (1) Withdrawals from the segregated account be made 
pursuant to agreement of both the counterparty and the SD or MSP, with 
notification to the non-withdrawing party; and (2) the custodian can 
turn over segregated assets upon presentation of a sworn statement that 
the presenting party is entitled to control of the assets pursuant to 
agreement among the parties.
    Regulation 23.703 restricts investment of segregated assets to 
investments permitted under Regulation 1.25, and (subject to that 
restriction) permits the SD or MSP and the counterparty to agree in 
writing as to investment of margin and allocation of gains and losses.
    Regulation 23.704 requires the SD's or MSP's chief compliance 
officer (``CCO'') to report quarterly to any counterparty that does not 
elect to segregate initial margin whether or not the SD's or MSP's back 
office procedures regarding margin and collateral requirements were, at 
any point in the previous calendar quarter, not in compliance with the 
agreement of the counterparties.

B. Factors Considered by the Commission

    After more than four years of administering subpart L of part 23, 
the Commission has observed that the detailed requirements of those 
regulations have proven difficult for SDs and MSPs to implement and to 
satisfy in a reasonably efficient manner. These observations have been 
buttressed by suggestions submitted in response to the Commission's 
Project KISS initiative as described below. In addition, the Commission 
understands that very few swap counterparties have exercised their 
rights to elect to segregate initial margin collateral pursuant to 
subpart L during the four years the regulations have been effective.
    Early in the implementation period, in response to multiple 
inquiries, Commission staff issued Staff Letter 14-132 (October 31, 
2014) \10\ providing interpretative guidance to SDs and MSPs regarding 
application of certain of the segregated margin requirements. In 
particular, the letter noted concerns expressed by SDs and MSPs that 
despite their earnest efforts to obtain confirmation of receipt of 
notification and election regarding segregation, failure by a 
counterparty to respond to the SD or MSP could bar any further swap 
transactions with the counterparty until a response was received.\11\ 
However, notwithstanding the issuance of Staff Letter 14-132, issues 
regarding compliance with subpart L continue to be raised.\12\
---------------------------------------------------------------------------

    \10\ See CFTC Staff Letter No. 14-132 (October 31, 2014), 
available at https://www.cftc.gov/sites/default/files/idc/groups/public/@lrlettergeneral/documents/letter/14-132.pdf.
    \11\ The Proposal would address generally some of the confusion 
that prompted the issuance of Staff Letter 14-132 in the context of 
other changes to subpart L that are proposed.
    \12\ For example, issues regarding compliance with these 
regulations have been raised with the National Futures Association 
as recently as January 2018, indicating ongoing uncertainty. See pp. 
6-7 of the transcript of the NFA Swap Dealer Examination Webinar, 
January 18, 2018, available at https://www.nfa.futures.org/members/member-resources/files/transcripts/sdexamswebinartranscriptjan2018.pdf.

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

[[Page 36486]]

    On May 9, 2017, the Commission published in the Federal Register a 
request for information \13\ pursuant to the Commission's Project KISS 
initiative seeking suggestions from the public for simplifying the 
Commission's regulations and practices, removing unnecessary burdens, 
and reducing costs. A number of suggestions received addressed various 
provisions of subpart L. In general, the suggestions echoed Commission 
staff concerns that the requirements in subpart L may be more 
burdensome than is necessary to achieve the purposes of the statute and 
that the requirements may be counterproductive by discouraging the use 
of individual segregation accounts.\14\ Persons responding to Project 
KISS also noted that some requirements cause confusion because they 
overlap with segregation requirements in the margin regulations more 
recently adopted by the CFTC and Prudential Regulators.\15\ 
Furthermore, responders noted that the requirements in subpart L are 
overly prescriptive eliminating the possibility for reasonable 
bilateral negotiation of certain terms that takes place in the normal 
course to determine appropriate collateral arrangements based on the 
circumstances of the broader counterparty relationship.\16\
---------------------------------------------------------------------------

    \13\ See 82 FR 21494 (May 6, 2017) and 82 FR 23765 (May 24, 
2017).
    \14\ See, e.g. letter from the Financial Services Roundtable 
(``FSR Letter''), dated September 30, 2017 at 55 (noting that 
``compliance with these regulations has proven to be unduly 
burdensome for swap dealers when weighed against the protections 
afforded to swap counterparties thereunder''), https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61427&SearchText=.
    \15\ Id. See also letter from the Securities Industry and 
Financial Markets Association (``SIFMA Letter'') dated September 29, 
2017 at 2 (``These requirements create unnecessarily burdensome 
obligations, which in many instances are duplicative or create 
confusion due to parallel mandatory collateral segregation 
requirements found within the CFTC and [prudential regulator] rules 
on margin requirements for non-centrally cleared swaps, and similar 
requirements in foreign jurisdictions.'').
    \16\ See SIFMA Letter at 2. See also letter from the Global 
Foreign Exchange Division of the Global Financial Markets 
Association, dated September 29, 2017.
---------------------------------------------------------------------------

    Responders also asserted that counterparties to uncleared swaps 
rarely elect to require segregation of margin pursuant to the existing 
provisions of subpart L.\17\ Commission staff has observed evidence of 
minimal uptake of the election to segregate. In addition, Commission 
staff has discussed this issue with the National Futures Association 
(``NFA'') to ascertain NFA's observations from examining a substantial 
number of SDs in connection with the implementation of subpart L. Based 
on this experience, it appears that for nearly every SD examined, fewer 
than five counterparties elected segregation pursuant to subpart L 
since registration. For some SDs, not a single counterparty has elected 
to segregate pursuant to subpart L.
---------------------------------------------------------------------------

    \17\ See FSR Letter at 55 (``Our members have advised that 
counterparties (i) rarely, if ever, elect to segregate [initial 
margin] and (ii) have found little use for receiving the 
notices.'').
---------------------------------------------------------------------------

    In light of these considerations, the Commission is proposing to 
amend the regulations governing segregation of margin for uncleared 
swaps. The Commission believes that the amendments proposed today will 
reduce unnecessary burdens on registrants and market participants by 
simplifying some overly detailed provisions, thereby reducing the 
intricate and prescriptive requirements that have been found during 
implementation to provide little or no benefit. These changes will also 
facilitate more efficient swap execution by eliminating complexity and 
confusion that slows down documentation and negotiation of hedging and 
other swap transactions. Finally, the amendments, by reducing the 
prescriptive elements of the rule, potentially could encourage more 
segregation (as was intended by the statute) by providing flexibility 
for the parties to establish segregation arrangements that better suit 
their specific needs.
    At the same time that the Commission is proposing specific changes, 
it is seeking comment from the public on the appropriateness of these 
changes, as well as suggestions for other amendments that can 
streamline, simplify, and reduce the costs of these regulations without 
sacrificing the protections called for by CEA section 4s(l).

II. The Proposal

A. Regulation 23.700--Definitions

    Section 23.700 defines ``Margin'' as ``both Initial Margin and 
Variation Margin.'' \18\ As proposed to be amended, subpart L would no 
longer refer collectively to initial margin and variation margin, since 
the right to require segregation applies only to initial margin, and 
not to variation margin. Thus, there is no need for the separate 
defined term ``Margin.'' The Commission therefore proposes to eliminate 
the definition of Margin from Regulation 23.700, and to make conforming 
changes to subpart L by replacing the term ``Margin'' with ``Initial 
Margin'' in Regulations 23.701, 23.702, and 23.703.\19\
---------------------------------------------------------------------------

    \18\ See 17 CFR 23.700.
    \19\ A grammatical change is also proposed for the definition of 
the term ``segregate.''
---------------------------------------------------------------------------

B. Regulation 23.701--Notification of the Right To Require Segregation

    Paragraphs (a) and (b) of Regulation 23.701 direct an SD or MSP to 
notify each counterparty of the right to require segregation of initial 
margin. The language used is consistent with CEA section 4s(l). 
Paragraphs (c), (d) and (e) add specific requirements not expressly 
established in the statute. Paragraph (c) requires the SD or MSP to 
furnish the required notification to an officer of the counterparty 
responsible for management of collateral, or if no such person is 
identified by the counterparty, then to the chief risk officer, or if 
there is no such officer, to the chief executive officer, or if none, 
the highest-level decision-maker for the counterparty. Paragraph (d) 
requires the SD or MSP, ``prior to confirming the terms of any such 
swap,'' to obtain confirmation of receipt of the notification, and the 
counterparty's election to require or not require segregation of 
initial margin (such confirmation to be retained in accordance with 
Regulation 1.31). Paragraph (e) provides that the notification need be 
made only once in any calendar year.\20\ Finally, paragraph (f) 
provides that the counterparty may change the segregation election at 
its discretion by providing a written notice to the SD or MSP. 
Paragraph (f) is not being amended in this Proposal except to 
redesignate it as paragraph (d).
---------------------------------------------------------------------------

    \20\ Some confusion has been caused by the requirement in 
paragraph (d) to provide the notice ``prior to confirming the terms 
of any such swap,'' and the requirement in paragraph (e) to provide 
the notice once in any calendar year.
---------------------------------------------------------------------------

    Based on staff's implementation experience and on suggestions 
received in connection with Project KISS, the Commission believes that 
these requirements are unnecessarily prescriptive and that they do not 
reflect the practical realities of how over-the-counter swap 
transactions are negotiated and managed by the parties. Accordingly, 
the Commission is proposing to modify the notification requirement in 
paragraph (a) and to remove the requirements in existing paragraphs 
(c), (d) and (e).
    Under the Proposal, paragraph (a) would be revised to require that 
the notification to a counterparty be made prior to execution of the 
first uncleared swap transaction that provides for the

[[Page 36487]]

exchange of initial margin,\21\ not prior to each transaction or 
annually as currently prescribed by paragraphs (d) and (e).\22\ CEA 
section 4s(l) requires notification of the right to segregate ``at the 
beginning of a swap transaction.'' The Commission is interpreting that 
phrase to mean at the beginning of an SD's or MSP's swap transaction 
relationship with each counterparty.
---------------------------------------------------------------------------

    \21\ This revision is consistent with guidance provided in Staff 
Letter 14-132, cited above.
    \22\ Thus, under the Proposal paragraph (e) of Regulation 23.701 
(providing that the notification need only be made once in any 
calendar year) would become unnecessary, and is proposed to be 
deleted.
---------------------------------------------------------------------------

    This interpretation is consistent with the Commission's stated view 
when it originally proposed and adopted Regulation 23.701(e), which 
only requires notice once a year. With respect to the phrase in the 
statute ``at the beginning of a swap transaction,'' the Commission 
noted that ``[w]hile this language could be read to require 
transaction-by-transaction notification, where the parties have a pre-
existing or on-going relationship, such repetitive notification could 
be redundant, costly and needlessly burdensome.'' \23\
---------------------------------------------------------------------------

    \23\ 78 FR 66625.
---------------------------------------------------------------------------

    When adopting final Regulation 23.701(e), the Commission considered 
comments requesting a loosening of the once-per-year notice requirement 
and rejected the requests in the belief that requiring notification 
once each year would balance the burden of providing notices and 
getting responses with the importance of the right to segregate initial 
margin.\24\ At this time, based on implementation experience, the 
Commission is proposing to require notification at the beginning of a 
swap trading relationship that provides for exchange of initial margin. 
The importance of the notification informing the counterparty of the 
right to segregate is paramount at the beginning of the SD/MSP--
counterparty relationship. It is at the time the parties initiate the 
first transaction that the decision to segregate initial margin will 
typically be made.\25\ Subsequent notifications are repetitive to the 
initial notification and risk adding confusion over the duration of the 
contractual relationship of the parties. In this regard, the Commission 
understands that counterparties rarely change their election, once 
made. Accordingly, in addition to modifying the notification 
requirement in paragraph (a), the Commission proposes to eliminate 
paragraph (e)'s annual notification requirement in lieu of the proposed 
notification at the beginning of the first uncleared swap transaction 
that provides for exchange of initial margin.
---------------------------------------------------------------------------

    \24\ Id.
    \25\ For existing master netting agreements for which the SD has 
already sent a segregation notice, the Commission is of the view 
that such notice would be sufficient for purposes of complying with 
the amended regulations, if adopted, and therefore the SD would not 
be required to send a new notice.
---------------------------------------------------------------------------

    Paragraph (a) would also be revised to eliminate the notification 
requirement where segregation is mandatory under Regulation 23.157 and 
where it is mandated under applicable rules adopted by a Prudential 
Regulator under CEA section 4s(e)(3). Paragraph (a)(2) (the requirement 
that the notification identify one or more creditworthy, independent 
custodians) would be deleted because selection of a custodian can be 
made when and if the counterparty elects to require segregation. 
Because very few counterparties elect to require segregation, it is 
unnecessarily burdensome to require an SD or MSP to confirm which 
custodians are available and continually update its notification form 
with the name of the custodian(s) available. Moreover, the Commission 
understands that a counterparty's initial decision to consider 
requiring (or not requiring) segregation is driven principally by 
whether the counterparty is concerned about protecting its initial 
margin and the terms of the segregation agreement, and not by the 
identity of the custodian. Similarly, paragraph (a)(3) (information 
regarding the price for segregation for each custodian) would be 
deleted because such pricing may vary for each segregation arrangement 
and would normally be subject to negotiation. To the extent pricing 
would be a factor in the decision to segregate, counterparties can and 
do discuss pricing as a term of the custodial arrangement when the 
counterparty indicates an interest in segregation. Moreover, the 
requirements in paragraphs (a)(2) and (a)(3) are not found in CEA 
section 4s(l).
    Similarly, the Proposal would eliminate the requirement in current 
paragraph (c) that the SD or MSP provide the notification to a person 
at the counterparty with a specific job title. Based on implementation 
experience, the Commission is of the view that the regulation as 
initially adopted is unnecessarily prescriptive in dictating who must 
receive the notification. For example, in many cases, the person at the 
counterparty best situated to evaluate the notification and the 
decision to segregate will be a person directly involved in negotiating 
the swap regardless of that person's title. The Commission notes that 
in removing the specific designation of officers to receive the 
notification it is not eliminating the expectation that each registrant 
will use reasonable judgment in identifying an appropriate person at 
the counterparty who can evaluate the right to elect segregation (and 
either act on it or bring it to the attention of someone in a position 
to act on it). The Commission continues to believe that, to be 
effective, the notification must be made to a person at the 
counterparty who understands its meaning and, to the extent necessary, 
can direct it to the appropriate personnel at the counterparty. The 
proposed change seeks to advance the same underlying policy objective 
as the current requirement (namely that the notification be given to 
appropriate personnel at the counterparty), but would recognize that 
dictating how counterparties communicate the information in question 
creates unnecessary burdens and potentially hinders the ability of the 
parties to direct the information to the person(s) best situated to 
evaluate it.
    As proposed, new paragraph (c) would simplify requirements in 
existing Regulation 23.701 by providing that ``[i]f the counterparty 
elects to segregate initial margin, the terms of segregation shall be 
established by written agreement.''
    As noted above, the Commission is proposing to eliminate the 
additional requirements in existing paragraph (d), which are more 
extensive than the notification requirements set forth in CEA section 
4s(l). Subsequent to adoption of subpart L, experience with 
implementation of the requirements of Regulation 23.701 has made the 
Commission aware of problems experienced by registrants in complying 
with these additional requirements. For example, persons seeking 
guidance have noted that paragraph (d)'s current requirement that the 
SD not execute a swap with the counterparty until it receives 
confirmation of the counterparty's receipt of the notification has the 
potential to block swap trading in some circumstances.\26\ Instances of 
forestalled trading caused by this requirement could be particularly 
harmful for nonfinancial end-users that have ongoing, dynamic hedging 
programs (to hedge, for example, commodity price risk or foreign 
exchange risk).
---------------------------------------------------------------------------

    \26\ See Staff Letter 14-132, cited above.
---------------------------------------------------------------------------

    Based on implementation experience, compliance with the existing 
segregation notification requirements in the regulation necessitates 
lengthy explanations and instructions from SDs and MSPs to their 
counterparties and imposes additional administrative

[[Page 36488]]

processes requiring counterparties to take steps that are outside of 
the normal course of transacting in swaps. Some of these steps cause 
transaction delays and deviations from established business procedures 
for collateral custodial arrangements and disclosure of counterparty 
rights generally, and do not advance the counterparty's right to 
segregate initial margin. For nonfinancial end-user counterparties who 
tend to use swaps primarily for hedging purposes, these added 
compliance steps often cause confusion and uncertainty that can inhibit 
opportune, timely hedging. For counterparties that execute swaps 
frequently and have determined that they wish to segregate, the 
additional requirements merely add unnecessary hurdles to the 
transaction process. Accordingly, the Commission does not believe that 
the burdens imposed by these prescriptive requirements provide 
meaningful regulatory benefits beyond those provided by the provisions 
in proposed amended Regulation 23.701.

C. Regulation 23.702--Requirements for Segregated Margin

    Existing Regulation 23.702 sets forth requirements for the custody 
of initial margin segregated pursuant to a counterparty's election 
under Regulation 23.701. Paragraph (c)(2) of Regulation 23.702 provides 
specific requirements for the withdrawal and turnover of control of 
initial margin. In particular, paragraph (c)(2) requires the custodian 
to turn over control of initial margin upon presentation of a written 
statement made by an authorized representative under oath or under 
penalty of perjury as specified in 28 U.S.C. 1746. The Statement must 
state that the counterparty, SD or MSP, as the case may be, is entitled 
to assume control of the initial margin pursuant to the parties' 
agreement. The other party must be immediately notified of the turnover 
of control.
    The Commission believes that, while paragraph (c)(2) may generally 
be consistent with the manner in which custodial arrangements work, the 
prescriptive requirements of the regulation, including requiring a 
specific form, the language used, and the certification needed, do not 
account for change in control arrangements in custodial agreements that 
are sometimes customized to reflect the unique business facts and 
circumstances that may exist between any two parties and the custodian. 
For example, the unique nature of the collateral posted or the specific 
terms of change in control triggers may warrant different notice 
procedures than those specified by paragraph (c)(2). Alternative notice 
procedures may allow for more timely and effective change in control 
under real-world circumstances and better protect each party's 
interests. Accordingly, the Commission believes that more flexibility 
is warranted, and that it is more appropriate to leave these matters up 
to negotiation by the parties.

D. Regulation 23.703--Investment of Segregated Margin

    Regulation 23.703 requires initial margin segregated pursuant to 
subpart L to be invested consistent with Commission Regulation 1.25. 
Regulation 1.25 sets forth standards for investment of customer funds 
by a futures commission merchant or derivatives clearing organization 
in the context of exchange-traded futures and cleared swaps. When 
proposing Regulation 23.703, the Commission expressed its view that 
Regulation 1.25 ``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.'' \27\
---------------------------------------------------------------------------

    \27\ See 75 FR 75432, 75434 (Dec. 3, 2010).
---------------------------------------------------------------------------

    A suggestion in response to the Project KISS initiative noted that 
Regulation 1.25 is designed to protect exchange customers for which 
margin investment decisions are outside of their control.\28\ 
Regulation 1.25 includes fairly extensive and specific requirements as 
to the mechanisms for holding and investing margin and the qualitative 
aspects of the investments held. With respect to initial margin for 
uncleared swaps that is not held in accordance with Regulation 23.157 
or with the Prudential Regulator Margin Rules, the margin investment 
decisions are typically a matter of contract subject to negotiation 
between the parties. As such, each counterparty has a voice in how the 
initial margin may be invested.
---------------------------------------------------------------------------

    \28\ See SIFMA Letter at 4.
---------------------------------------------------------------------------

    In addition, the terms of most exchange-traded and cleared products 
are standardized and the customer's primary relationship with the FCM 
or DCO centers upon the trading and clearing of those standardized 
products. Conversely, over-the-counter swaps, by their nature, tend to 
be more customized and are often part of a broader financial 
relationship. For example: Interest rate swaps with end-users are often 
designed to match maturities of loans or bonds, with the rate of the 
swap tied to the rate on the loan or bond; commodity swaps often hedge 
the counterparty's physical commodity production or consumption risks 
that arise from a particular commercial enterprise; and foreign 
exchange swaps often hedge an entity's exposure to cross-border 
commercial transactions. In each case, the SD or MSP sometimes plays 
additional financial roles, such as providing a loan or other credit or 
liquidity support, brokering physical commodity purchases or sales, or 
acting as a correspondent bank. Accordingly, each counterparty, 
particularly nonfinancial end-user counterparties, may find better 
transactional efficiencies and may be better served and protected in 
related credit transactions if the types of collateral and the 
investment procedures and mechanisms used are determined through 
bilateral negotiation of the terms thereof by the parties.
    Given the greater breadth and variability, both in the terms and 
purposes of uncleared swaps and in the nature of the relationship 
between the counterparty and the SD or MSP, the Commission believes a 
regulation that provides greater flexibility for the parties to 
negotiate appropriate initial margin investment terms will, in most 
cases, better serve the interests of the parties. For the same reasons, 
allowing greater flexibility may also encourage more counterparties to 
elect to segregate pursuant to subpart L.
    The Commission recognizes that in some circumstances, nonfinancial 
end-user counterparties might have less negotiating leverage with a 
sophisticated SD or MSP. However, the regulations as originally adopted 
give little or no flexibility for counterparties and SDs or MSPs to 
negotiate mutually beneficial terms and to consider other factors such 
as the broader financial relationship between the parties. For 
nonfinancial end-user counterparties the segregation of initial margin 
is at their discretion. If these counterparties have a voice in how 
segregated initial margin is invested, the returns of which they will 
often receive, they may be more likely to elect to require segregation.

E. Regulation 23.704--Requirements for Non-Segregated Margin

    Existing Regulation 23.704(a) requires the CCO of each SD or MSP to 
report quarterly to each counterparty that does not elect segregation 
of initial margin on whether or not the SD's or MSP's back office 
procedures relating to margin and collateral requirements failed at any 
time during the previous calendar quarter to comply with the agreement 
of

[[Page 36489]]

the counterparties.\29\ The Commission believes it is unnecessary to 
specify that the CCO be the individual that makes such reports, so long 
as the information is provided to counterparties. For many firms, 
middle or back office staff, not the CCO, implement collateral 
management pursuant to the terms of each collateral management 
agreement. Those staff people are therefore better situated to assess 
compliance with agreements and to provide the quarterly report. 
Accordingly, there are likely personnel at each SD other than the CCO 
who are better situated to more accurately and efficiently provide the 
report.\30\ The Commission therefore proposes to require that the SD or 
MSP make the reports without specifying any particular person to 
perform that requirement. The Commission further proposes to simplify 
the language regarding timing of the required reports to eliminate 
uncertainty as to the regulation's meaning. With respect to paragraph 
(b) of the regulation, the Commission is proposing to specify that the 
reports required under paragraph (a) need be delivered only to 
counterparties who choose not to require segregation (as opposed to the 
current wording that simply says ``with respect to each counterparty'') 
to more closely follow the statutory language underlying this 
requirement.
---------------------------------------------------------------------------

    \29\ Consistent with Staff Letter 14-132, the Commission 
confirms that the reporting requirement under Regulation 23.704 does 
not apply if no initial margin will be required as part of the swap 
transaction.
    \30\ The Commission notes that the CCO continues to be 
responsible, under Commission regulation 3.3, to report in the CCO 
annual report any material non-compliance issues involving back 
office procedure relating to margin and collateral requirements.
---------------------------------------------------------------------------

III. Request for Comment

    The Commission requests comments, generally, regarding the proposed 
changes to Regulations 23.700, 23.701, 23.702, 23.703, and 23.704. The 
Commission also specifically requests comment on the following 
questions:
    <bullet> Are the proposed amendments to subpart L appropriate in 
light of the requirements of CEA section 4s(l) and in light of the 
commercial realities encountered by SDs, MSPs, and counterparties 
engaging in uncleared swap transactions?
    <bullet> Should the Commission revise or eliminate any other 
provisions of subpart L? Are there additional ways in which the 
Commission can simplify, streamline, and reduce the costs of these 
regulations without impairing the rights and safeguards intended by CEA 
section 4s(l)?
    <bullet> Do the proposed amendments appropriately preserve the 
rights of counterparties articulated in CEA section 4s(l)? Is the 
Commission's proposed interpretation of CEA section 4s(l)(1)(A) 
reasonable given the commercial realities of uncleared swaps 
transactions and relationships between SDs and MSPs and their 
counterparties?
    <bullet> As proposed, Regulation 23.701(a) provides that ``[a]t the 
beginning of the first swap transaction that provides for the exchange 
of Initial Margin'' an SD or MSP must notify the counterparty of its 
right to require segregation of initial margin. Should the Commission 
provide specific benchmark events that call for delivery of a 
segregation notification? If so, would entering into a master netting 
agreement or other contractual relationship be appropriate? What other 
events may be relevant for marking ``the beginning of the first swap 
transaction''? Should the Commission provide that the counterparty may 
request or opt to continue to receive an annual or some other periodic 
notification? Should the Commission provide that the counterparty may 
request or opt to receive notification at the beginning of each swap 
transaction?
    <bullet> The Commission notes that the proposed deletion of 
paragraph (a)(2) of Regulation 23.701 (requirement to identify one or 
more custodians as an acceptable depository for segregated initial 
margin) also removes language specifying that one of the identified 
custodians ``be a creditworthy non-affiliate.'' Under the Proposal, 
Regulation 23.702(a) would continue to require that the custodian 
``must be a legal entity independent of both the swap dealer or major 
swap participant and the counterparty.'' Should the Commission adopt 
more specific financial or affiliation qualifications for the custodian 
that an SD or MSP uses as a depository for segregated initial margin, 
and if so, what should those qualifications be?
    <bullet> Under Regulation 23.703(a), margin that is segregated 
pursuant to an election under Regulation 23.701 may only be invested 
consistent with Regulation 1.25. How has the limitation impacted 
counterparties' decisions to make an election under Regulation 23.701?

IV. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') requires Federal agencies 
to consider whether the regulations they propose will have a 
significant economic impact on a substantial number of small entities 
and, if so, provide a regulatory flexibility analysis respecting the 
impact.\31\ Whenever an agency publishes a general notice of proposed 
rulemaking for any regulation, pursuant to the notice-and-comment 
provisions of the Administrative Procedure Act,\32\ a regulatory 
flexibility analysis or certification typically is required.\33\ 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.\34\ The Commission has 
previously established that SDs, and MSPs and ECPs \35\ are not small 
entities for purposes of the RFA.\36\
---------------------------------------------------------------------------

    \31\ 5 U.S.C. 601 et seq.
    \32\ 5 U.S.C. 553. The Administrative Procedure Act is found at 
5 U.S.C. 500 et seq.
    \33\ See 5 U.S.C. 601(2), 603, 604, and 605.
    \34\ See Registration of Swap Dealers and Major Swap 
Participants, 77 FR 2613 (Jan. 19, 2012).
    \35\ Eligible contract participants, as defined in CEA section 
1a(18), 7 U.S.C. 1a(18).
    \36\ See Further Definition of ``Swap Dealer,'' ``Security-Based 
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based 
Swap Participant'' and ``Eligible Contract Participant,'' 77 FR 
30596, 30701 (May 23, 2012).
---------------------------------------------------------------------------

    Accordingly, the Chairman, on behalf of the Commission, hereby 
certifies pursuant to 5 U.S.C. 605(b) that the Proposal will not have a 
significant economic impact on a substantial number of small entities.

B. Paperwork Reduction Act

1. Background
    The Paperwork Reduction Act of 1995 (``PRA'') \37\ imposes certain 
requirements on Federal agencies (including the Commission) in 
connection with their conducting or sponsoring a collection of 
information as defined by the PRA. The Proposal would result in such a 
collection, as discussed below. A person is not required to respond to 
a collection of information unless it displays a currently valid 
control number issued by the Office of Management and Budget (``OMB''). 
The Proposal contains a collection of information for which the 
Commission has previously received a control number from OMB. The title 
for this collection of information is ``Disclosure and Retention of 
Certain Information Relating to Swaps Customer Collateral, OMB control 
number 3038-0075.'' \38\ Collection 3038-0075 is currently in force 
with its control number having been provided by OMB.
---------------------------------------------------------------------------

    \37\ 44 U.S.C. 3501 et seq.
    \38\ See OMB Control No. 3038-0075, https://www.reginfo.gov/public/do/PRAOMBHistory?ombControlNumber=3038-0075# (last visited 
June 29, 2017).
---------------------------------------------------------------------------

    The Commission is proposing to revise collection 3038-0075 to

[[Page 36490]]

incorporate proposed changes to reduce the number of notices a SD or 
MSP must provide to its counterparties with respect to the rights of 
such counterparties to segregate initial margin for uncleared swaps. 
The Commission does not believe the Proposal would impose any other new 
collections of information that require approval of OMB under the PRA.
2. Modification of Collection 3038-0075
    The Proposal would modify collection 3038-0075 by eliminating the 
requirement that the notification of the right to segregate be provided 
on an annual basis to a specified officer of the counterparty such that 
the notice would only need to be provided once to each counterparty at 
the beginning of the first non-cleared swap transaction that provides 
for the exchange of initial margin. The Commission originally estimated 
that each SD and MSP would, on average, provide the segregation notice 
to approximately 1,300 counterparties each year and that the burden for 
preparing and furnishing the notice would be 2 hours, for an annual 
burden of 2,600 hours.\39\ The Commission is estimating that each SD 
and MSP would, on average, have approximately 300 new counterparties 
each year for a total burden of 600 hours per registrant. Accordingly, 
the Commission is proposing to revise its overall burden estimate 
associated with Regulation 23.701 for this collection by reducing the 
per registrant annual burden by 2,000 hours.
---------------------------------------------------------------------------

    \39\ See 78 FR at 66631.
---------------------------------------------------------------------------

C. Cost-Benefit Considerations

1. Background
    Section 15(a) of the CEA requires the Commission to consider the 
costs and benefits of its actions before promulgating a regulation 
under the CEA or issuing certain orders.\40\ Section 15(a) 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. With respect to the proposed regulation changes 
discussed above, the Commission considers the costs and benefits 
resulting from its discretionary determinations with respect to the 
section 15(a) factors, and seeks comments from interested persons 
regarding the nature and extent of such costs and benefits.
---------------------------------------------------------------------------

    \40\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------

2. Regulations 23.700, 23.701, 23.702 and 23.703--Notification of Right 
to Initial Margin Segregation
    The baseline for these cost and benefit considerations is the 
status quo, which is existing market conditions and practice in 
response to the requirements of current Sec. Sec.  23.700, 23.701, 
23.702, and 23.703.\41\ Subpart L: (1) Requires SDs or MSPs to notify 
counterparties of the right to segregate initial margin; (2) 
establishes certain procedures regarding the notification; and (3) 
establishes certain requirements for the initial margin segregation 
arrangements.
---------------------------------------------------------------------------

    \41\ See 78 FR at 66632-36 (discussing the cost-benefit 
considerations with regard to the segregation regulation).
---------------------------------------------------------------------------

    The Commission is proposing a more flexible approach that reduces 
some regulatory burdens that provide little or no corresponding 
benefit. The Proposal would eliminate the definition of ``Margin'' 
because it would no longer be needed. The Proposal would also revise 
when the segregation notice is required. Additionally, the Proposal 
would eliminate the requirements that (1) the SD or MSP provide the 
segregation notice to an officer of the counterparty with specific 
qualifications, and (2) the SD or MSP obtain the counterparty's 
confirmation of receipt of the segregation notice. Finally, the 
Proposal would allow the parties to establish the notice of change of 
control provisions and the commercial arrangements for investment of 
segregated collateral by contract instead of imposing specific 
requirements.
(i) Cost and Benefit Considerations
    The general purpose of the changes proposed is to reduce burdens 
and improve the benefits intended by subpart L. The Commission 
preliminarily believes the proposed changes to subpart L would not 
impose any new requirements on registrants and instead would reduce or 
make the regulations more flexible allowing market participants to use 
standard market practices regarding the implementation of the initial 
margin segregation requirements. The simplification of the notification 
requirements would likely reduce the time needed to complete the 
notification process and may facilitate more efficient and timely 
trading for new customer relationships. The proposed changes would also 
reduce costs by eliminating the requirements for those swaps that must 
comply with the Prudential Regulator Margin Rules mandatory margin 
requirements. In addition, the changes will provide benefits to the 
parties to swaps by allowing the parties to establish by contract the 
terms for collateral management and for change in control and 
investment of segregated initial margin in a manner that better suits 
their business needs. To the extent the parties would be able to 
negotiate more efficient segregation agreements and agree to investment 
arrangements that generate higher returns that are passed on to the 
counterparty, as is most often the case for uncleared swaps, the 
parties would benefit. The Commission believes that the simplification 
of the requirements and greater flexibility will therefore encourage 
more counterparties to elect to segregate initial margin.
    As noted above, in some circumstances, nonfinancial end-user 
counterparties might have less negotiating leverage when negotiating 
the terms of segregation agreements with experienced SDs or MSPs. 
Reducing the prescriptive requirements in the current rule could 
therefore reduce protections for the counterparties. However, it is not 
clear how incentives or disincentives may impact the negotiating 
choices of SDs and MSPs as well as the counterparties and therefore the 
extent to which the requirements provide protections. For example, 
regarding the choice of investments, the SD or MSP may seek to restrict 
investments to the most liquid investments that would be easily 
liquidated if the counterparty defaults. Those liquid investments, 
which would likely be similar to the investments permitted under 
Regulation 1.25, may in turn generate lower returns passed on to the 
SD/MSP's counterparties. Conversely, the current regulations give 
little or no flexibility for counterparties and SDs or MSPs to 
negotiate mutually beneficial terms and consider other factors such as 
the broader financial relationship between the parties. Furthermore, 
for nonfinancial end-user counterparties, the segregation of initial 
margin is discretionary. If the counterparties have no voice in how 
segregated initial margin is invested, there may be less incentive for 
the counterparty to elect to require segregation.
    The Commission believes that the proposed changes to subpart L 
might lead to reduced costs for registrants, because they would no 
longer have to comply with some of the more prescriptive requirements 
imposed by the regulations. The Commission is, however, unable to 
quantify the potential cost savings because the cost savings depend on 
numerous factors that are particular to each SD or MSP

[[Page 36491]]

and each counterparty relationship. For example, the factors affecting 
the costs involved could include: The size and complexity of an SD's 
dealing activities, the complexity of the swap transactions, the level 
of sophistication of each counterparty, the degree to which automated 
notice technologies may be used to satisfy these requirements, and the 
nature of the custodial and investment documents in particular 
segregation arrangements.
(ii) Section 15(a) Considerations
a. Protection of Market Participants and the Public
    Subpart L is intended to provide counterparties to SDs and MSPs 
with notice of the right to elect to segregate initial margin. The 
Commission recognizes that the proposed changes to make the regulations 
less prescriptive might potentially negatively impact the goal of 
protecting market participants by removing specific requirements for 
the segregation agreements. However, the Commission is of the view that 
the intended purpose and benefits of subpart L remain in place because 
the Proposal continues to implement the statutory requirements. In 
addition, the parties and the selected custodian would now have the 
flexibility to establish requirements for margin segregation through 
negotiated contracts that meet their respective needs, thereby 
providing market participants with the flexibility and opportunity to 
protect themselves better by contract. Finally, the greater flexibility 
provided by the amended regulations may increase the voluntary use of 
initial margin segregation by counterparties, a process that was 
intended to provide better protection for the counterparty in the event 
of default by the SD or MSP.
b. Efficiency, Competitiveness, and Financial Integrity of Markets
    Subpart L promotes the financial integrity of markets by providing 
for the protection of counterparty collateral and by mitigating 
systemic risk that may result from the loss of access to the collateral 
in the event of a counterparty default. As discussed above, given that 
registrants would still be expected to enter into segregation 
arrangements with counterparties that elect to segregate, and, with the 
amendments, registrants would now be able to develop segregation 
arrangements tailored to their businesses and swap transactions, the 
Commission is of the view that the proposed changes likely would have a 
positive impact on market integrity.
    The Commission preliminarily believes that the proposed amendments 
will not have a significant impact on the competiveness or efficiency 
of markets because this rulemaking only affects how collateral is 
protected and segregated but not how market participants elect to 
trade.
c. Price Discovery
    The Commission believes the proposed amendments to subpart L will 
not have a significant effect on price discovery.
d. Sound Risk Management
    Subpart L provides for the management and protection of 
counterparty collateral and therefore mitigates the risk of loss of 
access to the collateral, which loss can have an adverse impact on 
registrants, counterparties and the U.S. financial markets. As 
discussed, the proposed changes remove certain prescriptive 
requirements, but do not alter the overall principles of the existing 
requirements of subpart L. Therefore, the Commission is of the view 
that sound risk management practices will not be adversely impacted by 
the proposed changes.
e. Other Public Interest Considerations
    The Commission has not identified any other public purpose 
considerations for the proposed changes to subpart L.
(iii) Request for Comment
    The Commission invites comment on its preliminary consideration of 
the costs and benefits associated with the proposed changes to subpart 
L, especially with respect to the five factors the Commission is 
required to consider under CEA section 15(a). In addressing these areas 
and any other aspect of the Commission's preliminary cost-benefit 
considerations, the Commission encourages commenters to submit any data 
or other information they may have quantifying and/or qualifying the 
costs and benefits of the proposal. The Commission also specifically 
requests comment on the following questions:
    <bullet> To what extent do the proposed amendments reduce or 
increase burdens and costs for SDs or MSPs or their counterparties?
    <bullet> To what extent do the proposed amendments impact 
collateral management risk considerations?
    <bullet> Will there be any effects on the financial system if 
initial margin is not invested pursuant to Regulation 1.25? If yes, 
please explain.
    <bullet> Are counterparties to SDs or MSPs at a substantial 
disadvantage when negotiating the terms for segregation arrangements 
that would no longer be required if the proposed amendments are 
adopted? Would that disadvantage cause them to receive unfair terms on 
those segregation arrangements? Are there mitigating factors?
    <bullet> Would the elimination of the requirement to list at least 
one non-affiliated custodian and the cost of the custodial services 
have an effect on the selection of an independent custodian and the 
cost of the services to the non-SD/MSP counterparty? If yes, please 
explain.

D. Antitrust Considerations

    Section 15(b) of the CEA requires the Commission to take into 
consideration the public interest to be protected by antitrust laws and 
endeavor to take the least anticompetitive means of achieving the 
purposes of the CEA, in issuing any order or adopting any Commission 
rule or regulation (including any exemption under section 4(c) or 
4c(b)), or in requiring or approving any bylaw, rule, or regulation of 
a contract market or registered futures association established 
pursuant to section 17 of the CEA.\42\
---------------------------------------------------------------------------

    \42\ See 7 U.S.C. 19(b).
---------------------------------------------------------------------------

    The Commission believes that the public interest to be protected by 
the antitrust laws is generally to protect competition. The Commission 
requests comment on whether the proposed rule implicates any other 
specific public interest to be protected by the antitrust laws.
    The Commission has considered the proposed rule to determine 
whether it is anticompetitive and has preliminarily identified no 
anticompetitive effects. The Commission requests comment on whether the 
proposed rule is anticompetitive and, if it is, what the 
anticompetitive effects are.
    Because the Commission has preliminarily determined that the 
proposed rule is not anticompetitive and has no anticompetitive 
effects, the Commission has not identified any less anticompetitive 
means of achieving the purposes of the Act. The Commission requests 
comment on whether there are less anticompetitive means of achieving 
the relevant purposes of the Act that would otherwise be served by 
adopting the proposed rule.

List of Subjects in 17 CFR Part 23

    Custodians, Major swap participants, Margin, Segregation, Swap 
dealers, Swaps, Uncleared swaps.

    For the reasons stated in the preamble, the Commodity Futures

[[Page 36492]]

Trading Commission proposes to amend 17 CFR part 23 as follows:

PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

0
1. The authority citation for part 23 continues 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.
    Section 23.160 also issued under 7 U.S.C. 2(i); Sec. 721(b), 
Pub. L. 111-203, 124 Stat. 1641 (2010).

0
2. Revise subpart L to read as follows:
Subpart L--Segregation of Assets Held as Collateral in Uncleared Swap 
Transactions
Sec.
23.700 Definitions.
23.701 Notification of right to segregation.
23.702 Requirements for segregated initial margin.
23.703 Investment of segregated initial margin.
23.704 Requirements for non-segregated margin.

Subpart L--Segregation of Assets Held as Collateral in Uncleared 
Swap Transactions


Sec.  23.700   Definitions.

    As used in this subpart:
    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.
    Segregate means to keep two or more items in separate accounts, and 
to avoid combining them in the same transfer between two accounts.
    Variation Margin means a payment made by or collateral posted 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.  23.701   Notification of right to segregation.

    (a) At the beginning of the first swap transaction that provides 
for the exchange of Initial Margin, a swap dealer or major swap 
participant must notify the counterparty 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.  23.702 and 23.703, except in those circumstances where 
segregation is mandatory pursuant to Sec.  23.157 or rules adopted by 
the prudential regulators pursuant to section 4s(e)(2)(A) of the Act.
    (b) The right referred to in paragraph (a) of this section does not 
extend to Variation Margin.
    (c) If the counterparty elects to segregate Initial Margin, the 
terms of segregation shall be established by written agreement.
    (d) A counterparty's election, if applicable, 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.  23.702  Requirements for segregated initial margin.

    (a) The custodian of Initial Margin, segregated pursuant to an 
election under Sec.  23.701, must be a legal entity independent of both 
the swap dealer or major swap participant and the counterparty.
    (b) Initial Margin that is segregated pursuant to an election under 
Sec.  23.701 must be held in an account segregated for, and on behalf 
of, the counterparty, and designated as such. Such an account may, if 
the swap dealer or major swap participant and the counterparty agree, 
also hold Variation Margin.
    (c) Any agreement for the segregation of Initial Margin pursuant to 
this section shall be in writing, shall include the custodian as a 
party, and shall provide that any instruction to withdraw Initial 
Margin shall be in writing and that notification of the withdrawal 
shall be given immediately to the non-withdrawing party.


Sec.  23.703   Investment of segregated initial margin.

    The swap dealer or major swap participant and the counterparty may 
enter into any commercial arrangement, in writing, regarding the 
investment of Initial Margin segregated pursuant to Sec.  23.701 and 
the related allocation of gains and losses resulting from such 
investment.


Sec.  23.704  Requirements for non-segregated margin.

    (a) 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.  23.701(a), on a quarterly basis, no later than 
the fifteenth business day after the end of the quarter, 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.
    (b) The obligation specified in paragraph (a) of this section shall 
apply 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.

    Issued in Washington, DC, on July 24, 2018, by the Commission.
Christopher Kirkpatrick,
Secretary of the Commission.

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

Appendices to Segregation of Assets Held as Collateral in Uncleared 
Swap Transactions--Commission Voting Summary, Chairman's Statement, and 
Commissioner's Statement

Appendix 1--Commission Voting Summary

    On this matter, Chairman Giancarlo and Commissioners Quintenz 
and Behnam voted in the affirmative. No Commissioner voted in the 
negative.

Appendix 2--Statement of Chairman J. Christopher Giancarlo

    After more than four years of administering the final rules in 
subpart L of part 23 (Commission Regulations 23.700-23.704), CFTC 
staff have observed that the detailed requirements of these 
regulations have been difficult and burdensome for swap dealers to 
satisfy. The requirements have also caused some confusion by end 
user counterparties who rely on our markets to hedge commercial 
risk. These observations were supported by comments made in response 
to the Commission's Project KISS initiative.
    Congress mandated that counterparties of swap dealers be given a 
choice regarding whether or not they elect the protections that come 
from segregation of initial margin collateral, which I support. Part 
of this important decision is protected by making sure the 
counterparty clearly, and easily, understands its rights. It appears 
that very few swap counterparties have exercised their right to make 
that choice. Part of the reluctance may be because that choice is 
accompanied by a range of overly complicated regulatory requirements 
and obligations.
    The swaps market is a marketplace of professional market 
participants. It is closed to retail participation. Public policy is 
not well served by imposing prescriptive consumer and investor 
protections in markets that exclusively serve professional market 
participants.
    This proposal looks to reduce the burdens, costs and confusion 
that have proved counterproductive and discouraged the election of 
segregation. This proposal will also make it more efficient for 
counterparties, such as pension funds, insurance companies, and 
community banks, to be able to elect segregation and receive those 
protections while hedging their risk in the swaps markets.

[[Page 36493]]

    As part of the proposal, the Commission would permit more 
flexibility in custodial arrangements and margin investment. Rather 
than the current prescriptive requirements of the regulation, it 
would leave it up to commercial negotiation by professional trading 
counterparties. Another change is removing the overly prescriptive 
requirement that initial margin segregation be invested pursuant to 
Commission Regulation 1.25, in the anticipation that doing so could 
encourage more segregation elections.
    Enabling the election of segregation is a bipartisan goal, 
starting with a unanimous Commission rulemaking by a previous 
commission. Now with time and experience, we see that this goal 
could be more easily met, and changes to the rules are appropriate 
to better further these important public policy objectives.
    I support this proposed rule from the Division of Swap Dealer & 
Intermediary Oversight. I look forward to hearing comments on the 
proposal.

Appendix 3--Concurring Statement of Commissioner Rostin Behnam

    I respectfully concur with the Commodity Futures Trading 
Commission's (the ``Commission'' or ``CFTC'') approval of its 
proposed rule (the ``Proposal'') regarding amendments to subpart L 
of the Commission's Regulations (``Segregation of Assets Held as 
Collateral in Uncleared Swap Transactions'' consisting of 
Regulations 23.700 through 23.704), which implement Section 4s(l) of 
the Commodity Exchange Act (``CEA'' or the ``Act''). While I have 
strong reservations about the Commission's proposed interpretation 
of CEA section 4s(l) and its slash and burn approach to ``simplify'' 
requirements for swap dealers (``SDs'') and major swap participants 
(``MSPs'') absent meaningful consideration of the impact on swap 
counterparties, I am hopeful that the Proposal's solicitation of 
comments on these key points will produce a balanced record from 
which to adopt a final rule that more precisely simplifies the 
current requirements and provides tailored regulatory relief.
    Since joining the Commission, I have emphasized both my strong 
opposition to any rollbacks of Dodd-Frank initiatives and my belief 
that, while a more principles-based approach may be suitable in 
certain situations, any changes must be narrowly targeted to ensure 
that core reforms remain whole and intact. I am concerned that this 
Proposal forgoes a surgical approach in favor of a blunt, 
insensitive strike at the purpose of the statute and implementing 
regulations.
    While the preamble purports that the Proposal is supported by 
Commission experience, in reality the Commission heavily relies on a 
few comment letters from a limited segment of the market submitted 
in response to its ``Project KISS'' initiative. In the absence of 
corroborative evidence from those most impacted by the Proposal--
non-financial end-users and financial end-users without ``material 
swaps exposure,'' as defined in the CFTC Margin Rule \1\--I am 
concerned that the Commission's proposed amendments take too much of 
a shoot first, ask questions later tactic. While I am supportive of 
the Project KISS initiative, I believe that the exercise requires a 
more diligent approach to evaluating the potential impact of 
proposing amendments to existing rules.
---------------------------------------------------------------------------

    \1\ 17 CFR 23.150-23.159, 23.161.
---------------------------------------------------------------------------

    My greatest concerns with the Proposal relate to the 
Commission's proposed interpretation of the notice requirement in 
CEA section 4s(l)(1) and the proposed removal of all limitations on 
the investment of margin that is segregated pursuant to an election 
under Regulation 23.701. As I explain below, I am concerned that the 
Proposal's focus on reducing burdens to SDs and MSPs through 
amending the rules in subpart L may obscure valid issues regarding 
implementation--matters which may be resolved through more precise 
amendments with less chance of negatively impacting market 
participants.
    The Commission previously interpreted the language in CEA 
section 4s(l)(1)(A) ``as a segregation right that can be elected or 
renounced by the SD's or MSP's counterparty.'' \2\ Citing the plain 
language of the statute, the Commission noted Congress's emphasis on 
the importance of the ability of a counterparty to elect to have its 
collateral segregated by describing segregation as a ``right.'' \3\ 
Regarding this ``right,'' the Commission understood that, ``the 
statute does not merely grant counterparties the legal right to 
segregation; it specifically requires that the existence of this 
right be communicated to them.'' \4\ At a minimum, the Commission 
determined that this requirement is met when an SD or MSP provides 
notification to a counterparty at least once in each calendar year 
in which the SD or MSP enters a swap with the counterparty.\5\ At 
the time, the Commission recognized that requiring notification on a 
transaction-by-transaction basis--e.g., ``at the beginning of a swap 
transaction,'' \6\ may be overly costly and burdensome, and that 
annual notification ``ensures that the right to segregation is 
called to the attention of the counterparties reasonably close in 
time to the point at which they make decisions regarding the 
handling of collateral for particular swaps transactions.'' \7\ 
While the Commission considered requiring only an initial 
notification, it rejected that approach, noting the importance of 
the counterparty's right to elect to have its collateral segregated, 
and the minimal administrative burden on SDs and MSPs.\8\
---------------------------------------------------------------------------

    \2\ Protection of Collateral of Counterparties to Uncleared 
Swaps; Treatment of Securities in a Portfolio Margining Account in a 
Commodity Broker Bankruptcy, 78 FR 66621, 66623 (Nov. 6, 2013).
    \3\ Id. at 66623 and 66625.
    \4\ Id. at 66625.
    \5\ Id.; 17 CFR 23.701(e).
    \6\ 7 U.S.C. 6s(l)(1)(A) (emphasis added).
    \7\ 78 FR at 66635 (emphasis added); see also 78 FR at 66633 
(adding that annual notice offers this benefit ``without requiring 
excessive or repetitive notification in cases where a counterparty 
engages in multiple swaps with a particular SD or MSP over the 
course of a year.'').
    \8\ 78 FR at 66633 (``The Commission believes that the cost of 
requiring SDs and MSPs to deliver one notification per year to each 
counterparty is not overly burdensome, particularly when one 
considers the importance of the counterparty's decision to require 
segregation and the large dollar volume of business that is 
typically done by SDs and MSPs.'').
---------------------------------------------------------------------------

    The Commission and subpart L are largely silent with regard to 
content and delivery manner and method of the notice required by CEA 
section 4s(l)(1)(A) other than provisions in Regulation 23.701(a)(1) 
and (2) requiring the notification to identify one or more 
creditworthy, independent custodians and to include information 
regarding the price of segregation for each custodian, to the extent 
the SD or MSP has such information.\9\ Though not specifically 
required by CEA section 4s(l)(1)(A), the Commission determined that 
this limited set of disclosures represents information material to a 
counterparty's informed decision making process regarding exercise 
of the right to segregation and when considering a segregation 
package offered by an SD or MSP.\10\
---------------------------------------------------------------------------

    \9\ 17 CFR 23.701(a)(2) and (3). While Commission Regulation 
23.701(d) requires the SD or MSP to obtain confirmation of receipt 
of the segregation notification, since 2014, the Commission has 
permitted SDs and MSPs to rely on negative consent for purposes of 
Regulation 23.701(d), provided that the notice under Regulation 
23.701(a) includes a prominent and unambiguous statement to that 
effect. See CFTC Staff Letter No. 14-132 (Oct. 31, 2014) at 7, 
available at https://www.cftc.gov/sites/default/files/idc/groups/public/@lrlettergeneral/documents/letter/14-132.pdf; See also 
Transcript of the NFA Swap Dealer Examinations Webinar at 6 (Jan. 
18, 2018), available at https://www.nfa.futures.org/members/member-resources/files/transcripts/sdexamswebinartranscriptjan2018.pdf.
    \10\ See 78 FR at 66624.
---------------------------------------------------------------------------

    The Proposal would amend subpart L, in part, to require a 
single, one-time notification to a counterparty of their right to 
require segregation of any initial margin the counterparty provides 
in connection with all transactions following the first transaction 
that provides for the exchange of initial margin. The Proposal would 
also entirely remove Regulations 23.701(a)(2) and (3), generally 
finding that, since very few counterparties elect to require 
segregation, the underlying activity of ``confirming which 
custodians are available'' is ``unnecessarily burdensome'' and that 
pricing for segregation may vary, is normally subject to 
negotiation, and can be discussed when the counterparty indicates an 
interest in segregation. Consistent with CEA section 4s(l)(1)(B), 
the Proposal preserves the ability of a counterparty to change its 
election upon written notice.
    In proposing these amendments, the Commission appears to be 
taking the view that a counterparty's decision with regard to 
segregation is made with respect to a trading relationship with a 
particular SD or MSP at the relationship's inception, and that while 
these types of counterparties are sophisticated enough to elect 
segregation and negotiate the terms of segregation arrangements, the 
annual receipt of a notice reminding them that they may change their 
election at any time is confusing. It also assumes that evidence of 
minimal uptake of

[[Page 36494]]

the election to segregate indicates that subpart L is largely 
superfluous.
    While it may be true that swap counterparties have not elected 
segregation in droves, CEA section 4s(l) and subpart L are not 
intended to advance any particular outcome. Rather they concern the 
rights of counterparties to SDs and MSPs and aim to increase the 
safety in the market for uncleared swaps by creating a self-
effectuating requirement for the segregation of counterparty initial 
margin in an entity legally separate from the SD or MSP.\11\ As 
previously noted by the Commission in proposing subpart L, a goal of 
the regulation was 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.'' \12\ Indeed, based on some of the preamble 
discussion, it may be that we should consider the possibility that 
swap counterparties are not electing segregation specifically 
because the current system of annual notification does not provide 
them adequate notice of their ongoing right to segregation. If that 
is the case, the appropriate Commission response may be more (or 
clearer) notification, rather than the reduction in notification 
proposed today.
---------------------------------------------------------------------------

    \11\ Id. at 66621 and 66632.
    \12\ Protection of Collateral of Counterparties to Uncleared 
Swaps; Treatment of Securities in a Portfolio Margining Account in a 
Commodity Broker Bankruptcy, 75 FR 75432, 75437 (proposed Dec. 3, 
2010).
---------------------------------------------------------------------------

    I am concerned that the Commission's proposal could undermine 
the right to segregation as well as Congressional intent by removing 
the periodic notification and minimal disclosures currently required 
by subpart L. I believe there are prescriptive elements of subpart L 
that can be removed with little impact to counterparties.\13\ 
However, I am concerned by the Proposal's reliance on 
representations by SDs and unverified assumptions regarding 
counterparty behavior to justify regulatory rollbacks in the absence 
of further examination of whether and how the manner in which the 
annual notice requirement is currently implemented has contributed 
to claims of confusion and burden. I am also concerned that the 
Proposal may discourage commenters from suggesting alternative means 
of complying with the current language in Regulation 23.701(a) which 
may better preserve Congressional intent.\14\
---------------------------------------------------------------------------

    \13\ I also believe that the Commission can respond to specific 
burdens identified by SDs and MSPs by, for example, codifying staff 
interpretive guidance. See, e.g. Letter from the Financial Services 
Roundtable at 56 (Sept. 30, 2017) (urging the Commission to codify 
its interpretation in CFTC Staff Letter No. 14-132 with respect to 
SDs' ability to rely on negative consent), https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61427&SearchText=.
    \14\ For example, through the use of additional clauses in 
customer onboarding or relationship documentation as a means to 
append the required notification and disclosures to each new swap 
confirmation thereby ensuring and simultaneously documenting that 
the counterparty is notified of their right to require segregation 
at least at the beginning of each swap transaction.
---------------------------------------------------------------------------

    I am similarly concerned that the Proposal's removal of the 
requirement in Regulation 23.703 that limits the investment of 
initial margin segregated pursuant to subpart L to be invested 
consistent with Commission Regulation 1.25 is a knee-jerk response 
to a single Project KISS comment letter that ignores current 
practice and presupposes that the rollback will encourage more 
counterparties to elect to segregate pursuant to subpart L, which, 
as stated above, is not the goal of the statute or implementing 
regulation. While I am not opposed to permitting greater flexibility 
with regard to the investment of initial margin, I would have 
preferred that the Commission seek additional information regarding 
whether and how the current limitations in Regulation 23.703 have 
impacted counterparties and their decision making under subpart L 
before proposing alternative regulatory language.
    I commend the Commission and its staff for engaging through 
Project KISS in efforts to identify and reduce unnecessary burdens 
in the Commission regulations. I appreciate staff's consideration 
and inclusion of several of my suggested edits to this Proposal. To 
be clear, I believe the Proposal provides for many sound 
improvements to subpart L that respond to ongoing concerns and 
confusion created by the finalization of the CFTC and Prudential 
Regulator Margin Rules and CFTC interpretive guidance.\15\ However, 
where the Proposal aims to strip out regulatory provisions that the 
Commission previously determined were essential to effectuating the 
language and purpose of CEA section 4s(l), I believe the Commission 
may be engaging in shortsighted and unnecessary rollbacks to the 
detriment of the swap counterparties subpart L is intended to 
protect.
---------------------------------------------------------------------------

    \15\ See CFTC Staff Letter No. 14-132, supra note 9.

[FR Doc. 2018-16176 Filed 7-27-18; 8:45 am]
 BILLING CODE 6351-01-P


</pre><script data-cfasync="false" src="/cdn-cgi/scripts/5c5dd728/cloudflare-static/email-decode.min.js"></script></body>
</html>