Vol. 77 Tuesday, 

No. 176 September 11, 2012 

Part II 

Commodity Futures Trading Commission 

17 CFR Part 23 

Confirmation, Portfolio Reconciliation, Portfolio Compression, and Swap 

Trading Relationship Documentation Requirements for Swap Dealers and 

Major Swap Participants; Final Rule 


sroberts on DSK5SPTVN1PROD with RULES
55904 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

1Commission regulations referred to herein are 

found at 17 CFR Ch. 1. 

2See 75 FR 81519 (Dec. 28, 2010) (Confirmation, 

Portfolio Reconciliation, and Portfolio Compression 

Requirements for Swap Dealers and Major Swap 

Participants (Confirmation NPRM)); 76 FR 6715 

(Feb. 8, 2011) (Swap Trading Relationship 

Documentation Requirements for Swap Dealers and 

Major Swap Participants (Documentation NPRM)); 

and 76 FR 6708 (Feb. 8, 2011) (Orderly Liquidation 

Termination Provision in Swap Trading 

Relationship Documentation for Swap Dealers and 

Major Swap Participants (Orderly Liquidation 

NPRM)). 

3See 76 FR 25274 (May 4, 2011) (extending or reopening comment periods for multiple Dodd-Frank 

proposed rulemakings). 4Comment files for each proposed rulemaking 

can be found on the Commission Web site, 

www.cftc.gov. 5The Commission also reviewed the proposed 

rule of the Securities and Exchange Commission 

concerning trade acknowledgement and verification 

of security-based swap transactions. See 76 FR 3859 

(Jan. 21, 2011). 

6See ESMA Consultation Paper 2012/379, Draft 

Technical Standards for the Regulation of OTC 

Derivatives, CCPs and Trade Repositories (June 25, 

2012) (ESMA Draft Technical Standards). 

COMMODITY FUTURES TRADING 

COMMISSION 

17 CFR Part 23 

RIN 3038–AC96 

Confirmation, Portfolio Reconciliation, 

Portfolio Compression, and Swap 

Trading Relationship Documentation 

Requirements for Swap Dealers and 

Major Swap Participants 

AGENCY: Commodity Futures Trading 

Commission. 

ACTION: Final rule. 

SUMMARY: The Commodity Futures 

Trading Commission (Commission or 

CFTC) is adopting regulations to 

implement certain provisions of Title 

VII of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act 

(Dodd-Frank Act). Section 731 of the 

Dodd-Frank Act added a new section 

4s(i) to the Commodity Exchange Act 

(CEA), which requires the Commission 

to prescribe standards for swap dealers 

(SDs) and major swap participants 

(MSPs) related to the timely and 

accurate confirmation, processing, 

netting, documentation, and valuation 

of swaps. These regulations set forth 

requirements for swap confirmation, 

portfolio reconciliation, portfolio 

compression, and swap trading 

relationship documentation for SDs and 

MSPs. 

DATES: The rules will become effective 

November 13, 2012. Specific 

compliance dates are discussed in the 

SUPPLEMENTARY INFORMATION. 

FOR FURTHER INFORMATION CONTACT: 

Frank N. Fisanich, Chief Counsel, 202– 

418–5949, ffisanich@cftc.gov, Ward P. 

Griffin, Associate Chief Counsel, 202– 

418–5425, wgriffin@cftc.gov Division of 

Swap Dealer and Intermediary 

Oversight, and Hannah Ropp, 

Economist, 202–418–5228, 

hropp@cftc.gov, Office of the Chief 

Economist, Commodity Futures Trading 

Commission, Three Lafayette Centre, 

1155 21st Street NW., Washington, DC 

20581. 

SUPPLEMENTARY INFORMATION

Table of Contents 

I. Background 

II. Comments on the Notices of Proposed 

Rulemaking 

A. Regulatory Structure 

B. Swap Trading Relationship 

Documentation 

C. End User Exception Documentation 

D. Swap Confirmation 

E. Portfolio Reconciliation 

F. Portfolio Compression 

III. Effective Dates and Compliance Dates 

A. Comments Regarding Compliance Dates 

B. Compliance Dates 

IV. Cost Benefit Considerations 

A. Statutory Mandate to Consider the Costs 

and Benefits of the Commission’s Action 

B. Background 

C. Swap Confirmation 

D. Portfolio Reconciliation 

E. Portfolio Compression 

F. Swap Trading Relationship 

Documentation 

G. Swap Valuation Methodologies 

V. Related Matters 

A. Regulatory Flexibility Act 

B. Paperwork Reduction Act 

I. Background 

The Commission is hereby adopting 

§ 23.500 through § 23.505 1 setting forth 

standards for the timely and accurate 

confirmation of swaps, requiring the 

reconciliation and compression of swap 

portfolios, and setting forth 

requirements for documenting the swap 

trading relationship between SDs, 

MSPs, and their counterparties. These 

regulations are being adopted by the 

Commission pursuant to the authority 

granted under sections 4s(h)(1)(D), 

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

Section 4s(i)(1) of the CEA, requires SDs 

and MSPs to ‘‘conform with such 

standards as may be prescribed by the 

Commission by rule or regulation that 

relate to timely and accurate 

confirmation, processing, netting, 

documentation, and valuation of all 

swaps.’’ Documentation of swaps is a 

critical component of the bilaterallytraded, over-the-counter (OTC) 

derivatives market, while confirmation, 

portfolio reconciliation, and portfolio 

compression have been recognized as 

important post-trade processing 

mechanisms for reducing risk and 

improving operational efficiency. Each 

of these processes has been the focus of 

significant domestic and international 

attention in recent years by both market 

participants and their regulators. 

II. Comments on the Notices of 

Proposed Rulemaking 

The final rules adopted herein were 

proposed in three separate notices of 

proposed rulemaking.2 Each proposed 

rulemaking was subject to an initial 60- 

day public comment period and a reopened comment period of 30 days.3

The Commission received a total of 

approximately 62 comment letters 

directed specifically at the proposed 

rules.4 The Commission considered 

each of these comments in formulating 

the final regulations.5

The Chairman and Commissioners, as 

well as Commission staff, participated 

in numerous meetings with 

representatives of potential SDs and 

MSPs, trade associations, public interest 

groups, traders, and other interested 

parties. In addition, the Commission has 

consulted with other U.S. financial 

regulators including: (i) The Securities 

and Exchange Commission (SEC); (ii) 

the Board of Governors of the Federal 

Reserve System; (iii) the Office of the 

Comptroller of the Currency; and (iv) 

the Federal Deposit Insurance 

Corporation. Staff from each of these 

agencies has had the opportunity to 

provide oral and/or written comments 

to this adopting release, and the final 

regulations incorporate elements of the 

comments provided. 

The Commission is mindful of the 

benefits of harmonizing its regulatory 

framework with that of its counterparts 

in foreign countries. The Commission 

has therefore monitored global advisory, 

legislative, and regulatory proposals, 

and has consulted with foreign 

regulators in developing the final 

regulations. Specifically, Commission 

staff has consulted with the European 

Securities and Markets Authority 

(ESMA), which has recently released a 

consultation paper for the regulation of 

OTC derivatives containing draft 

technical standards that are 

substantially similar to some of the rules 

adopted by the Commission in this 

release, as further noted below.6

A. Regulatory Structure 

Several commenters raised general 

concerns with the legal authority for or 

structure of the proposed rules, or their 

possible effect on existing transactions. 

1. Statutory Authority for the Proposed 

Rules 

The Working Group of Commercial 

Energy Firms (The Working Group) 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55905 

commented that many of the specific 

provisions in the proposed rules are not 

required by section 731 of the DoddFrank Act and that such provisions are 

not ‘‘reasonably necessary’’ to achieve 

the goals of the CEA. The Working 

Group believes that the Commission 

could meet its statutory mandate by 

publishing principle-based rules, rather 

than the detailed approach of the 

proposed rules. Dominion Resources, 

Inc. (Dominion) also asserted that the 

proposed rules would achieve a 

regulatory scope beyond what is 

required by section 4s(i) and may 

require end users to change their 

business practices. Dominion requested 

that the proposed rules be further 

tailored to ensure the effect of the rules 

is limited to SDs and MSPs. 

The Commission notes that section 

731 of the Dodd-Frank Act added a new 

section 4s(i) to the CEA that states that 

each registered SD and MSP shall 

conform with such standards as may be 

prescribed by the Commission by rule or 

regulation that relate to timely and 

accurate confirmation, processing, 

netting, documentation, and valuation 

of all swaps. Section 4s(i) also states 

that the Commission shall adopt rules 

governing documentation standards for 

SDs and MSPs. 

Swaps and swap trading relationship 

documentation are contractual 

arrangements that necessarily involve 

more than a single party. The 

Commission believes that the statutory 

requirement that the Commission adopt 

rules governing documentation 

standards relating to confirmation, 

processing, netting, documentation, and 

valuation of all swaps reflects the intent 

of Congress to have the Commission 

adopt rules that necessarily effect SDs, 

MSPs, and their swap counterparties. 

The Commission also believes the rules 

establish a set of documentation 

standards for prudent risk management 

for registered SDs and MSPs while 

minimizing the burdens on non-SDs and 

non-MSPs. 

2. Application to Existing Swaps and 

Documentation 

In response to a request for comment 

in the Documentation NPRM asking 

how long SDs and MSPs should have to 

bring existing swap documentation into 

compliance with the proposed rules and 

whether a safe harbor should be 

provided for dormant trade 

documentation, the International Swaps 

and Derivatives Association (ISDA) and 

the Securities Industry and Financial 

Markets Association (SIFMA), in a joint 

comment letter (ISDA & SIFMA), 

strongly urged the Commission to 

specify that only new transactions 

entered into after the effective date of 

the rules are subject to the rules’ 

requirements, and that it is not 

mandatory to amend terms or 

agreements that apply to transactions 

entered into prior to such date. ISDA & 

SIFMA further argued that Commission 

rules relating to business conduct, the 

confirmation process, confidentiality 

and privacy, collateral segregation 

requirements, and margin and capital 

may all directly or indirectly require 

registrants to make amendments to 

existing relationship documentation, 

and that it would be extremely 

inefficient, time consuming and costly 

for registrants to engage in separate 

rounds of amendments with their 

trading counterparties for each set of 

Dodd-Frank Act rulemakings. ISDA & 

SIFMA recommended that registrants be 

permitted to develop plans to update 

their agreements in an integrated 

manner for the full range of Dodd-Frank 

Act requirements, and implementation 

timelines should reflect the 

requirements of such an approach, 

keeping in mind that those requirements 

will not be known until the scope and 

terms of all of the relevant Commission 

regulations (and those of the SEC) are 

more clearly delineated. 

The Working Group and the Financial 

Services Roundtable (FSR) also urged 

the Commission to apply the rules to 

new swaps only, arguing that 

renegotiation of existing documentation 

would take significantly longer than six 

months; may be impossible in some 

cases; and is not a good use of limited 

resources of market participants that 

will already be taxed with the necessary 

changes mandated by the Dodd-Frank 

Act and the Commission’s other rules. 

Likewise, the Coalition for Derivatives 

End-Users urged the Commission to 

exempt trades entered into before the 

enactment of the Dodd-Frank Act from 

the requirements of the rules and the 

Managed Funds Association (MFA) 

strongly objected to the Commission 

applying any of these requirements to 

existing contracts. MFA argued that 

section 739(5) of the Dodd-Frank Act 

specifically provides that the DoddFrank Act shall not constitute a 

‘‘regulatory change, or similar event 

* * * that would permit a party to 

terminate, renegotiate, modify, amend, 

or supplement one or more transactions 

under the swap.’’ MFA believes that 

imposing these requirements on existing 

agreements would clearly require that 

existing agreements be ‘‘renegotiated.’’ 

The Federal Home Loan Banks 

(FHLBs) noted on the other hand that 

netting of pre-existing transactions with 

new transactions is critical to efficient 

hedging, and thus documentation for 

pre-existing swaps will need to be 

modified to maintain the benefits of 

netting. 

Having considered these comments, 

the Commission agrees with 

commenters that the rules should not 

apply retrospectively and will require 

compliance with the rules only with 

respect to swaps entered after the date 

on which compliance with the rules is 

required, as discussed below. With 

respect to the comment of the FHLBs, 

the Commission notes that the rules 

would not prohibit parties from 

arranging their documentation to 

maintain the benefits of netting between 

pre-existing swaps and swaps entered 

after the date compliance with the rules 

is required if they so choose. In 

addition, with regard to ISDA & 

SIFMA’s argument that swap trading 

documentation would need to be 

amended when rules relating to 

segregation and margin are finalized, the 

Commission observes that those rules 

are likely to provide for additional time 

for documentation to be brought into 

compliance. 

3. Legal Certainty 

With respect to the validity of 

transactions where the parties fail to 

comply with the rules, The Working 

Group argued that for the sake of legal 

certainty, a failure to comply with the 

proposed rules should not result in 

invalidation of swaps entered into 

under deficient swap trading 

relationship documentation. The 

Coalition of Physical Energy Companies 

(COPE) recommended that the 

Commission make clear that section 739 

of the Dodd-Frank Act, regarding legal 

certainty, applies to the proposed 

regulations so that SD or MSP 

noncompliance with the rules will not 

otherwise affect the enforceability of a 

swap. MFA and the International Energy 

Credit Association (IECA) also believe 

that it is imperative that the 

Commission affirmatively clarify that 

defects in required regulatory 

documentation do not render a contract 

void or voidable by one of the parties or 

constitute a breach of the swap 

documentation. IECA added that a party 

should not have a private right of action 

with respect to documentation that does 

not comply with the rules. IECA further 

requested that the Commission add 

specific language to proposed § 23.504. 

The FHLBs made the same argument as 

IECA, adding that the Commission can 

enforce the provisions through penalties 

for SDs and MSPs. 

Upon consideration of these 

comments, the Commission is clarifying 

that it is not the intent of the rules to 

provide swap counterparties with a 


sroberts on DSK5SPTVN1PROD with RULES
55906 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

7The International Swaps and Derivatives 

Association (ISDA) is a trade association for the 

OTC derivatives industry (http://www.isda.org). 

basis for voiding or rescinding a swap 

transaction based solely on the failure of 

the parties to document the swap 

transaction in compliance with the 

rules. However, the Commission 

believes it does not have the authority 

to immunize SDs or MSPs from private 

rights of action for conduct within the 

scope of section 22 of the CEA, i.e., for 

violations of the CEA. In the interest of 

legal certainty, to avoid disruptions in 

the swaps market, and to reduce 

compliance costs, the Commission has 

determined that it will, in the absence 

of fraud, consider an SD or MSP to be 

in compliance with the rules if it has 

complied in good faith with its policies 

and procedures reasonably designed to 

comply with the requirements of each 

rule. 

4. Standing of the ISDA Agreements 

Several commenters requested that 

the Commission clarify the standing 

under the rules of the ISDA Master 

Agreement and Credit Support Annex 

(the ISDA Agreements), which are 

prevalent in the swaps market. 

Specifically, ISDA & SIFMA commented 

that the proposed rules could create 

uncertainty as to the level of 

documentation required because the 

proposed rules require that ‘‘all terms’’ 

governing the swap trading relationship 

be documented. ISDA & SIFMA thus 

requested that the Commission 

acknowledge the general adequacy of 

the ISDA Agreements for purposes of 

the rule to enhance legal certainty and 

market stability. Similarly, COPE argued 

that many end users have already 

negotiated existing documentation 

under the ISDA architecture and thus 

requested that the Commission make 

clear that: (1) ISDA Agreements or any 

substantially similar master agreements 

satisfy the documentation requirements 

of the final rules; (2) in accordance with 

the ISDA Agreements and applicable 

state law, swaps are binding when made 

orally; and (3) long-form confirmations 

that contain all requisite legal terms to 

establish a binding agreement also 

satisfy the requirements of the rules. 

IECA also recommended that the 

Commission expressly state that the 

ISDA Agreements satisfy the 

documentation requirements of the final 

rules or state how the ISDA Agreements 

are deficient to eliminate any confusion. 

Finally, the Coalition for Derivatives 

End-Users argued that, given that the 

ISDA Agreements are used by nearly all 

end users and that such documentation 

substantially complies with the 

proposed rules, the Commission should 

expressly state that the ISDA 

Agreements satisfy the documentation 

requirements of the rules. 

On the other hand, the Committee on 

the Investment of Employee Benefit 

Assets (CIEBA) anticipates that ISDA 

may initiate a uniform protocol to 

conform existing ISDA Agreements to 

the requirements of the rules. In this 

regard, CIEBA stated that ISDA 

protocols, which in the past have 

typically been developed by dealerdominated ISDA committees, are not 

form documents that can be revised by 

the parties. Rather, CIEBA argues, end 

users may only adopt these protocols on 

a ‘‘take it or leave it’’ basis, which may 

not be in their best interests. 

Accordingly, CIEBA recommended that 

the Commission not, either explicitly or 

implicitly, require market participants 

to consent to ISDA protocols in order to 

comply with the Dodd-Frank Act or the 

Commission’s regulations. 

The Commission notes that many 

comments received with respect to this 

and other rulemakings stated that swaps 

are privately negotiated bilateral 

contracts. Although the Commission 

recognizes that the ISDA Agreements in 

their pre-printed form as published by 

ISDA are capable of compliance with 

the rules, such agreements are subject to 

customization by counterparties. In 

addition, the Commission notes that 

while the pre-printed form of the ISDA 

Master Agreement is capable of 

addressing the requirements of 

proposed § 23.504(b)(1), it is not 

possible to determine if the pre-printed 

form of the ISDA Credit Support Annex 

will comply with proposed 

§ 23.504(b)(3), because that section 

requires that the documentation include 

credit support arrangements that 

comply with the Commission’s rules 

regarding initial and variation margin 

and custodial arrangements, which have 

been proposed but not yet finalized. 

Further, the Commission does not 

believe that the standard ISDA 

Agreements address the swap valuation 

requirements of § 23.504(b)(4), the 

orderly liquidation termination 

provisions of § 23.504(b)(5), or the 

clearing records required by 

§ 23.504(b)(6). Given the foregoing, the 

Commission declines to endorse the 

ISDA Agreements as meeting the 

requirements of the rules in all 

instances. 

5. Identical Rules Applicable to SDs and 

MSPs 

The proposed regulations did not 

differentiate between SDs and MSPs, 

but, rather, applied identical rules to 

both types of entities. In this regard, 

BlackRock commented that MSPs are 

buy-side entities, yet many of the 

proposed documentation standards are 

designed to regulate dealing activity. 

BlackRock believes these requirements 

should not apply to MSPs because they 

are unnecessary and will cause both 

MSPs and the Commission to use 

resources inefficiently. 

The Commission is not modifying the 

regulations to differentiate between SDs 

and MSPs. The Commission observes 

that section 4s(i) of the CEA, as added 

by the Dodd-Frank Act, does not 

differentiate between SDs and MSPs. 

The Commission thus has determined 

that the intent of section 4s(i) is to apply 

the same requirements to MSPs and 

SDs, and the Commission is taking the 

same approach in the final regulations. 

B. Swap Trading Relationship 

Documentation—§ 23.504 

Section 4s(i)(1) requires swap dealers 

and major swap participants to 

‘‘conform with such standards as may 

be prescribed by the Commission by 

rule or regulation that relate to timely 

and accurate confirmation, processing, 

netting, documentation, and valuation 

of all swaps.’’ Under section 4s(i)(2), the 

Commission is required to adopt rules 

‘‘governing documentation standards for 

swap dealers and major swap 

participants.’’ 

OTC derivatives market participants 

typically have relied on the use of 

industry standard legal documentation, 

including master netting agreements, 

definitions, schedules, and 

confirmations, to document their swap 

trading relationships. This industry 

standard documentation, such as the 

widely used ISDA Master Agreement 

and related definitions, schedules, and 

confirmations specific to particular asset 

classes, offers a framework for 

documenting the transactions between 

counterparties for OTC derivatives 

products.7 The standard documentation 

is designed to set forth the legal, trading, 

and credit relationship between the 

parties and to facilitate netting of 

transactions in the event that parties 

have to close-out their position with one 

another or determine credit exposure for 

margin and collateral management. 

Notwithstanding the standardization of 

such documentation, some or all of the 

terms of the master agreement and other 

documents are subject to negotiation 

and modification. 

To promote the ‘‘timely and accurate 

* * * documentation * * * of all 

swaps’’ under section 4s(i)(1) of the 

CEA, in the Documentation NPRM, the 

Commission proposed § 23.504(a), 

which required that swap dealers and 

major swap participants establish, 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55907 

maintain, and enforce written policies 

and procedures reasonably designed to 

ensure that each swap dealer or major 

swap participant and its counterparties 

have agreed in writing to all of the terms 

governing their swap trading 

relationship and have executed all 

agreements required by proposed 

§ 23.504. The Commission received 

approximately 31 comment letters in 

response to the Documentation NPRM 

and considered each comment in 

formulating the final rules, as discussed 

below. 

1. Application to Swaps Executed on a 

SEF or DCM, or Cleared by a DCO 

In response to a request for comment 

in the Documentation NPRM regarding 

whether proposed § 23.504 should 

include a safe harbor for swaps entered 

into on, or subject to the rules of, a 

board of trade designated as a contract 

market, ISDA & SIFMA, as well as the 

American Benefits Counsel and the 

Committee on Investment of Employee 

Benefit Assets (jointly, ABC & CIEBA), 

recommended that the Commission 

provide such a safe harbor for swaps 

executed on a swap execution facility 

(SEF) or designated contract market 

(DCM). ISDA & SIFMA commented that 

the safe harbor is especially needed for 

those transactions where the SD or MSP 

will not know the identity of its 

counterparty until just before or after 

execution. ISDA & SIFMA also urged 

the Commission to clarify that the term 

‘‘swap trading relationship 

documentation’’ is used to describe only 

bilateral documentation between parties 

to uncleared swaps. MFA also 

recommended that the Commission 

clarify that exchange traded or cleared 

swaps, which will be subject to standard 

contract terms, are not subject to the 

documentation rules. The Working 

Group commented that the swap trading 

relationship requirement in § 23.504(a) 

includes a carve-out for swaps cleared 

with a DCO, but § 23.504(b)(6) includes 

express requirements for the swap 

trading relationship documentation 

with respect to cleared swaps. Given the 

apparent contradiction, The Working 

Group requested that the Commission 

clarify whether the other requirements 

of § 23.504 apply to swaps that are 

intended to be cleared 

contemporaneously with execution or 

that are executed on a SEF or DCM. 

In response to The Working Group’s 

comment expressing confusion about 

whether § 23.504 applies to swaps that 

are cleared by a DCO and to ISDA & 

SIFMA’s comment regarding 

applicability to cleared swaps, as well 

as the applicability to pre-existing 

swaps per the discussion above, the 

Commission is modifying § 23.504 to 

clarify the overall applicability of the 

rule by adding a new paragraph (a)(1) as 

set forth in the regulatory text of this 

rule. 

This revision clarifies the 

circumstances under which the rule 

applies. The proviso in § 23.504(a)(1)(ii) 

would achieve the rule’s goal of 

avoiding differences between the terms 

of a swap as carried at the DCO level 

and at the clearing member level, which 

could compromise the benefits of 

clearing. Any such differences raise 

both customer protection and systemic 

risk concerns. From a customer 

protection standpoint, if the terms of the 

swap at the customer level differ from 

those at the clearing level, then the 

customer will not receive the full 

transparency and liquidity benefits of 

clearing, and legal and basis risk will be 

introduced into the customer position. 

Similarly, from a systemic perspective, 

any differences could diminish overall 

price discovery and liquidity and 

increase uncertainties and unnecessary 

costs into the insolvency resolution 

process. The cross reference to 

§ 39.12(b)(6) imports the specific 

requirements that had been included in 

proposed § 23.504(b)(6)(v). See below 

for a more complete discussion of 

§ 23.504(b)(6). 

In response to the comment from 

ISDA & SIFMA, the Commission 

clarifies that swaps executed 

anonymously on a SEF or traded on a 

DCM prior to clearing by a DCO are not 

subject to the requirements of § 23.504. 

For those swaps that are not executed 

anonymously, the swap trading 

relationship documentation 

requirements of § 23.504 would apply. 

2. Viability of Long-Form Confirmations 

as Swap Trading Relationship 

Documentation—§ 23.504(a) & (b) 

Proposed § 23.504(b) required that all 

terms governing the trading relationship 

between an SD or MSP and its 

counterparty be documented in writing. 

Proposed § 23.504(a) required that SDs 

and MSPs establish policies and 

procedures reasonably designed to 

ensure that the required swap trading 

relationship documentation be executed 

prior to or contemporaneously with 

entering into a swap transaction with 

any counterparty. The Commission 

notes the industry practice whereby 

counterparties enter into a ‘‘long-form 

confirmation’’ after execution of 

transaction, where the long-form 

confirmation contains both the terms of 

the transaction and many, if not all, 

terms usually documented in a master 

agreement until such time as a complete 

master agreement is negotiated and 

executed. 

The Office of the Comptroller of the 

Currency (OCC) commented that the 

proposed rule may require master 

agreements between all counterparties 

even if a ‘‘long-form’’ confirmation 

would sufficiently address legal risks, 

creating a significant expense and 

burden for end users. Similarly, IECA 

commented that long form 

confirmations that incorporate the terms 

of a standard master agreement are 

useful for certain new transaction 

relationships. In this respect, IECA 

recommends that § 23.504(b)(1) be 

modified to make clear that terms can be 

incorporated by reference. 

In response to these comments, the 

Commission has determined that so 

long as a ‘‘long-form’’ confirmation 

includes all terms of the trading 

relationship documented in writing 

prior to or contemporaneously with the 

assumption of risk arising from swap 

transactions, the ‘‘long-form’’ 

confirmation would comply with the 

rules. However, the Commission is not 

modifying the rule to permit execution 

of a long-form confirmation subsequent 

to the execution of a swap transaction, 

which the Commission believes results 

in some period, however short, in which 

the terms of the trading relationship 

between the parties are not in written 

form. In response to the comment of 

IECA, the rule does not prohibit 

incorporation of terms by reference. 

Thus, so long as the terms incorporated 

by reference are in written form, the 

documentation would be in compliance 

with the rule. 

3. Confirmation Execution Timing and 

Swap Trading Relationship 

Documentation—§ 23.504(a) & (b)(2) 

Proposed § 23.504(b)(2) states that 

swap trading relationship 

documentation includes transaction 

confirmations. Proposed § 23.504(a) 

requires swap trading relationship 

documentation to be executed prior to 

or contemporaneously with entering 

into any swap with a counterparty. 

However, proposed § 23.501 provides 

for specific post-execution time periods 

for confirming swaps. This apparent 

contradiction was identified by a 

number of commenters. 

In order to reconcile the apparent 

contradiction, ISDA & SIFMA 

recommended that confirmations be 

excluded from swap trading 

relationship documentation and be 

treated solely in § 23.501. MFA also 

recommended that confirmations be 

treated solely in § 23.501, noting that if 

forced to choose between quick 

execution and the negotiation of all 


sroberts on DSK5SPTVN1PROD with RULES
55908 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

terms, the proposed rule’s timing 

requirements might substantially limit 

end users’ ability to engage in proper 

risk management using tailored swaps. 

MFA also commented that unless 

modified, the rule might decrease the 

number of transactions in the markets, 

thereby decreasing liquidity and 

increasing volatility. 

IECA noted that many short term 

transactions are executed orally and 

often documented by recording, ending 

before a written confirmation can be 

completed. IECA also stated that if all 

confirmations must be in writing, the 

additional employee time cost for each 

market participant would be substantial 

and is not included in the annual cost 

analysis. The Working Group also 

commented that in some instances, it 

may take longer to negotiate a written 

confirmation for a swap or complete the 

necessary mid- and back-office 

processes than the planned duration of 

the swap at issue. IECA recommended 

that proposed § 23.504(b)(2) be modified 

by adding at the end, ‘‘which 

confirmations need not be in writing.’’ 

MetLife commented that the 

requirement to document ‘‘all’’ terms of 

a trading relationship is overly 

burdensome. MetLife believes the 

documentation subject to regulation 

should be clarified to mean two sets of 

documents: A master agreement, credit 

support arrangement and master 

confirmation agreement and second, 

transaction specific confirmations. The 

confirmations can include any trade 

specific terms including specific 

valuation methodologies or inputs not 

already contained in the master 

documentation. Differentiation would 

assist with clarity for policies and 

procedures and with the audit 

requirements. 

The Coalition for Derivatives EndUsers and The Working Group 

commented that the rule may require 

pre-trade negotiation and disadvantage 

the party that is most sensitive to the 

timing of the swap in such negotiations. 

The Working Group believes such party 

may have to accept less than favorable 

terms in order to execute within its 

desired time frame, and that the rule 

would make it very difficult for parties 

to enter into short-term swaps. The 

Coalition for Derivatives End-Users 

point out that end-users often trade by 

auction and given the low probability of 

winning, SDs will not want to incur the 

expense of negotiating documents in 

advance. The Coalition for Derivatives 

End-Users also point out that even 

where established relationships exist, 

newly formed affiliates may trade based 

on existing expectations, but without 

the documents fully executed. 

On the other hand, CIEBA 

commended the Commission for 

including all terms in swap trading 

relationship documentation. CIEBA 

believes this approach will minimize 

the potential for disputes over swap 

terms during the confirmation process 

caused by the introduction of new 

‘‘standard’’ terms after the swap is 

executed, which CIEBA stated is a 

frequent occurrence. CIEBA 

recommended that the Commission 

confirm in its final rules that the 

requirement that documentation ‘‘shall 

include all terms governing the trading 

relationship between the swap dealer or 

major swap participant and its 

counterparty’’ would require all terms to 

be in writing prior to or at the time of 

entering into the swap transaction, 

except for terms such as price, quantity 

and tenor, that are customarily agreed to 

contemporaneously with entering into a 

swap transaction. CIEBA recommended 

that the rule require these remaining 

terms to be documented in writing 

contemporaneously with entering into 

the swap transaction. 

Having considered these comments, 

the Commission has determined that 

proposed § 23.504(a) should be clarified 

with respect to the inclusion of swap 

confirmations in swap trading 

relationship documentation. The 

Commission is therefore modifying the 

proposed rule to make clear that the 

timing of confirmations of swap 

transactions is subject to § 23.501, and 

that swap trading relationship 

documentation other than confirmations 

of swap transactions is required to be 

executed prior to or contemporaneously 

with entering into any swap transaction. 

The Commission does not, however, 

agree with commenters suggesting that 

terms governing a swap or a trading 

relationship need not be in writing. The 

Commission recognizes that binding 

swap contracts may be created orally 

under applicable law and the rule does 

not affect parties’ ability to enforce such 

contracts. However, an orderly swap 

market and the goal of reducing 

operational risk require that such oral 

contracts be appropriately documented 

as soon as possible. In response to the 

comments of CIEBA, the Commission 

believes the modifications to the 

confirmation time periods in § 23.501 

discussed below adequately address 

CIEBA’s concerns. Given the foregoing, 

the Commission is modifying proposed 

§ 23.504(a) to read as set forth in the 

regulatory text of this rule 

4. Swap Trading Relationship 

Documentation Among Affiliates 

The proposed regulations did not 

include an exemption or different rules 

for documenting swap trading 

relationships between affiliates. Shell 

Energy North America (Shell) 

commented that an end user trading 

with an affiliated SD/MSP does not have 

valuation, trade, and documentation 

risks that nonaffiliated entities may 

have, that such transactions only 

allocate risk within the legal entity, and, 

accordingly, affiliate transactions 

should be exempted from the 

documentation rules. 

The Commission is not persuaded 

that the risk of undocumented (and 

therefore objectively indiscernible) 

terms governing swaps is obviated 

because the trading relationship is with 

an affiliate. The Commission has 

regulatory interests in knowing or being 

able to discover the full extent of a 

registered SD’s or MSP’s risk exposure, 

whether to external or affiliated 

counterparties, and is not modifying the 

rule in response to this comment. The 

Commission observes that to the extent 

certain risks are not present in affiliate 

trading relationships, the 

documentation of the terms related to 

such risks should be non-controversial 

and easily accomplished. For example, 

because affiliates are generally under 

common control, the documentation of 

an agreement on valuation 

methodologies should not require 

extensive negotiation as it may between 

non-affiliated counterparties. 

5. Use of ‘‘Enforce’’ in Proposed 

§ 23.504(a) 

Proposed § 23.504(a) required that 

each SD and MSP establish, maintain, 

and enforce policies and procedures 

designed to ensure that prior to or 

contemporaneously with entering into a 

swap transaction, it executes swap 

trading relationship documentation that 

complies with the rules. 

CEIBA questions what is intended by 

the requirement for SDs and MSPs to 

‘‘enforce policies and procedures’’ in 

§ 23.504(a). CEIBA believes the use of 

the term ‘‘enforce’’ with respect to SDs’ 

and MSPs’ procedures is contrary to the 

Dodd-Frank Act, because it implies that 

such procedures have the force of law 

and can be imposed on counterparties 

absent mutual agreement. CIEBA 

recommended that the word ‘‘enforce’’ 

should be deleted. 

Having considered this comment, the 

Commission is modifying the proposed 

rule by replacing the term ‘‘enforce’’ 

with the term ‘‘follow.’’ The intent of 

the term ‘‘enforce’’ in the proposed rule 

was to require SDs and MSPs to in fact 

follow the policies and procedures 

established to meet the requirements of 

the proposed rule, rather than to enforce 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55909 

its internal policies and procedures 

against third parties. 

6. Payment Obligation Terms— 

§ 23.504(b) 

In the Documentation NPRM, the 

Commission asked whether the 

proposed rules should specifically 

delineate the types of payment 

obligation terms that must be included 

in the trading relationship 

documentation. 

CIEBA commented that the 

Commission need not dictate every term 

that must appear in swap trading 

relationship documentation, and that it 

is important to defined benefit plans to 

be able to negotiate payment obligation 

terms in their documentation. 

The Commission agrees with CIEBA 

on this issue and has not modified the 

rule to further define the types of 

payment obligation terms required to be 

specified in swap trading relationship 

documentation. 

7. Additional Requirements for Events 

of Default and Termination Events 

In the Documentation NPRM, the 

Commission asked whether the 

requirement for agreement on events of 

default or termination events should be 

further defined, such as adding 

provisions related to cross default. 

The Coalition for Derivatives EndUsers commented that the ISDA 

documentation sufficiently addresses 

these issues and that parties should be 

allowed to negotiate these terms 

bilaterally so the Commission need not 

further define such terms. CIEBA agreed 

that parties should be allowed to 

negotiate these terms bilaterally so the 

Commission need not further define 

such terms. 

The Commission agrees with the 

commenters on this point and has not 

modified the rule to further define the 

types of events of defaults and 

termination events required to be 

specified in swap trading relationship 

documentation. 

8. Senior Management Approval of 

Documentation Policies and 

Procedures—§ 23.504(a) 

Proposed § 23.504(a) required SDs’ 

and MSPs’ documentation policies and 

procedures to be approved in writing by 

senior management of the SD or MSP. 

The Working Group raised a concern 

that this requirement will be used to the 

negotiating advantage by SDs and MSPs 

who will claim that the form of 

documentation had been approved for 

regulatory purposes and cannot be 

changed without a prohibitively lengthy 

internal approval process. In addition, 

The Working Group argued that rigid 

documentation standards that must be 

approved by senior management could 

severely limit the flexibility of SDs, 

ending the ability of end users to obtain 

customized swaps in a timely manner. 

The Working Group recommended that 

the Commission allow current practice 

to continue where trading managers can 

authorize deviations from standard 

trade documentation so long as such 

amendment does not violate the 

overarching policies and procedures set 

by internal management authorized by 

the governing body. 

MFA similarly commented that the 

senior management approval 

requirement, together with the 

cumulative effect of the proscriptive 

documentation rules, may lead to the 

institutionalization of the terms favored 

by SDs and MSPs. As a result, MFA is 

concerned that SDs and MSPs will 

compel their customers to accept 

unfavorable terms or forego timesensitive market opportunities. 

Accordingly, MFA recommended that 

each party should be free to assess 

requisite approval levels for various 

kinds of swap activity based on its 

unique organizational structure. 

IECA commented that review by 

senior management is an unnecessary 

use of management time. Most SDs and 

MSPs have risk management policies 

that provide a framework for elevating 

issues through levels of management as 

applicable. By requiring senior 

management to review too many 

modifications, many that can be 

reviewed by lower levels with 

appropriate expertise, it is likely that 

senior management may actually miss 

the major issues that should get 

attention. Also, IECA argued that the 

chilling effect of the rule could stifle 

risk management efforts, innovation, 

and increase counterparty risk as review 

processes become too rigid in order to 

comply with regulatory requirements. 

The Commission is not modifying the 

rule based on these comments. The 

commenters’ concerns are overly broad 

because the rule requires senior 

management of SDs and MSPs to 

approve the ‘‘policies and procedures’’ 

governing swap trading documentation 

practices, not to approve each 

agreement, transaction, or modifications 

thereto. The rule does not prohibit SDs 

and MSPs from establishing policies 

and procedures instituting a framework 

for elevating issues through a hierarchy 

of management as each sees fit, so long 

as such framework has been approved 

in writing by senior management. 

9. Dispute Resolution Procedures— 

§ 23.504(b)(1) 

Proposed § 23.504(b)(1) required SDs’ 

and MSP’s swap trading relationship 

documentation to include dispute 

resolution procedures. In the 

Documentation NPRM preamble, the 

Commission asked whether the 

proposed rules should include specific 

requirements for dispute resolution 

(such as time limits), and if so, what 

requirements are appropriate for all 

swaps. 

ISDA & SIFMA objected that the 

requirement that the parties agree to 

dispute resolution procedures is not 

authorized by the Dodd-Frank Act and 

that denying parties to a swap access to 

the judicial system is not a measure that 

should be taken lightly or without 

Congressional consideration. Similarly, 

IECA believes the proposed regulations 

for dispute resolution are too specific 

and could violate separation of powers 

under the Constitution. 

On the other hand, CIEBA responded 

that the rules should not include 

specific requirements, with the 

exception of requiring the availability of 

independent valuation agents that are 

agreed upon by the parties. CIEBA 

recommended that the Commission 

propose only a set of fair and evenhanded principles for resolving 

disputes. 

In response to these comments, the 

Commission is modifying the proposed 

rule to delete the term ‘‘procedures’’ 

from the requirement that swap trading 

relationship documentation include 

‘‘terms addressing * * * dispute 

resolution procedures.’’ The 

Commission notes that the rule as 

proposed was not intended to require 

SDs and MSPs to agree with their 

counterparties on specific procedures to 

be followed in the event of a dispute, 

but rather to require that dispute 

resolution be addressed in a manner 

agreeable to both parties, whether it be 

in the form of specific procedures or a 

general statement that disputes will be 

resolved in accordance with applicable 

law. The Commission believes that 

some form of agreement on the handling 

of disputes between SDs, MSPs, and 

their counterparties will be essential to 

ensuring the orderly operation of the 

swaps market. 

10. Documentation of Credit Support 

Arrangements—§ 23.504(b)(3) 

Proposed § 23.504(b)(3) required that 

the swap trading relationship 

documentation include certain specified 

details of the credit support 

arrangements of the parties. 

Better Markets recommended that the 

Commission revise the proposed rule to 


sroberts on DSK5SPTVN1PROD with RULES
55910 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

8See Subpart H of Part 23 of the Commission’s 

Regulations, Business Conduct Standards for Swap 

Dealers and Major Swap Participants with 

Counterparties, 77 FR 9734, 9824 (Feb. 17, 2012). 

In addition, to the extent that any cost of credit may 

be embedded in the price of a swap, the 

Commission believes that the disclosure of the midmarket mark, which must be disclosed when an SD 

or MSP discloses the price of a swap, will facilitate 

greater transparency concerning the embedded cost 

of credit. Id. at 9765–66 (discussing new 

§ 23.431(a)(3)(i)). 

9See 17 CFR 23.600(c)(4)(v)(A) requiring SDs and 

MSPs to establish policies and procedures to 

monitor and manage legal risk, including policies 

and procedures that take into account 

determinations that transactions and netting 

arrangements entered into have a sound legal basis. 

77 FR 20128, 20206 (Apr. 3, 2012). 

require documentation of the terms 

under which credit may be extended to 

a counterparty by a registrant in the 

form of forbearance from funding of 

margin and the cost of such credit 

extension, arguing that such credit 

extension and the cost thereof, which is 

embedded in the price of a swap, 

seriously impairs the transparency of 

the market by concealing the true price 

of a swap divorced from the cost of 

credit. 

Michael Greenberger commented that 

leaving terms and rules regarding credit 

extension and transactional fees to 

subjective desires of market participants 

will be counterproductive. Mr. 

Greenberger supports the comment 

letter by Better Markets, Inc., which 

urges the Commission to propose 

definitive rules requiring 

documentation of credit extension and 

transactional fees. 

COPE asked the Commission to clarify 

that the rule requires trading 

documentation to include any 

applicable margin provisions and 

related haircuts, but does not require 

margining and haircuts unless agreed by 

the parties. IECA echoed the COPE 

comment, stating that the proposed rule 

is unclear whether parties can enter into 

a swap that requires no margin, as is 

contemplated in the Dodd Frank Act. 

CIEBA commented that proposed 

§ 23.504(b)(3) should be clarified by 

adding the words ‘‘if any’’ to the end of 

each of subsections (i) through (iv) to 

make clear that end users are not 

required to post initial margin or allow 

rehypothecation. 

Having considered these comments, 

the Commission is of the view that the 

proposed rule was not intended to 

require margin or related terms where 

such are not required pursuant to other 

Commission regulations or the 

applicable regulations adopted by 

prudential regulators. The proposed rule 

was intended to require written 

documentation of any credit support 

arrangement, whether that be a 

guarantee, security agreement, a 

margining agreement, or other collateral 

arrangement, but only to require written 

documentation of margin terms if 

margin requirements are imposed by 

Commission regulations, the regulations 

of prudential regulators, or are 

otherwise agreed between SDs, MSPs, 

and their counterparties. Thus, in 

response to commenters’ requests for 

clarification, the Commission is 

modifying the proposed rule as 

recommended by CIEBA by adding ‘‘if 

any’’ at the end of each of subsections 

(i) through (iv) of § 23.504(b)(3). The 

Commission expects that other forms of 

credit support arrangements will be 

documented in accordance with the rule 

as well. 

However, the Commission is not 

revising the rule to enumerate the terms 

of any extension of credit that are 

required to be included in the 

documentation, as recommended by 

Better Markets. The Commission 

believes that the rule, as proposed and 

as adopted by this release, already 

requires documentation of initial and 

variation margin requirements, which 

necessarily will entail documentation of 

any extension of credit, i.e., the 

documentation will reflect whether 

margining is subject to any credit 

extension threshold. Thus, to the extent 

applicable, credit support arrangements 

must include, at a minimum, the 

maximum amount of credit to be 

extended, the method for determining 

how much credit has been extended, 

and any term of the facility and early 

call rights. During negotiations 

regarding credit support arrangements, 

counterparties would be well served to 

address issues related to the embedded 

cost of credit. The Commission also 

observes that transactional fees are 

required to be disclosed under § 23.431 

of the Business Conduct Standards for 

SDs and MSPs Dealing with 

Counterparties.8

11. Legal Enforceability of Netting and 

Collateral Arrangements—§ 23.504 

The proposed regulations did not 

require SDs and MSPs to document the 

legal enforceability of netting and 

collateral arrangements in the swap 

trading relationship documentation. 

In this regard, Volvo Financial 

Services Europe (Volvo) recommended 

that the Commission adopt a rule that 

states clearly that credit support 

arrangements should include legal 

opinions (updated annually) verifying 

the perfection of security interests in 

collateral supporting net exposures. 

Volvo argued that lack of legal certainty 

contributed to losses in the 2008 

financial crisis where counterparties 

discovered that un-perfected security 

interests resulted in the unenforceability 

of pledged collateral. Specifically, Volvo 

recommended that the Commission 

revise the proposed rules to require: (i) 

Mandatory collateralization, (ii) robust 

legal opinions (updated annually) on 

enforceability of collateral 

arrangements, (iii) zero risk weighting if 

robust legal opinions are obtained, and 

(iv) regular collateral audits by the 

Commission to ensure that market 

participants perform the perfection 

formalities of security interests. 

Although the Commission agrees with 

the commenter that SDs and MSPs 

should support their collateral 

arrangements with all necessary legal 

analysis, the Commission has not made 

any changes to the proposed rule based 

on this comment because the 

Commission believes (1) Volvo’s 

concerns regarding margining of 

uncleared swaps are addressed in the 

Commission’s proposed margin rules, or 

the prudential regulators’ proposed 

margin rules, as applicable, and (2) 

Volvo’s concerns regarding the legal 

enforceability of collateral arrangements 

is addressed in risk management rules 

adopted by the Commission in 

February, 2012.9

12. Valuation Methodology 

Requirement—§ 23.504(b)(4) 

Proposed § 23.504(b)(4) required that 

the swap trading relationship 

documentation of each SD and MSP 

with their counterparties include an 

agreement in writing on the methods, 

procedures, rules, and inputs for 

determining the value of each swap at 

any time from execution to the 

termination, maturity, or expiration of 

such swap. 

a. Comments Received 

Twenty of the comment letters 

received by the Commission addressed 

the proposed valuation requirement in 

§ 23.504(b)(4). Many of those comments 

raised similar concerns about the 

proposal, as summarized thematically, 

below: 

The Working Group, ISDA & SIFMA, 

FSR, White & Case, Morgan Stanley, 

COPE, MFA, IECA, FHLBs, Hess Energy 

Trading Company, LLC (Hess), 

Riverside Risk Advisors LLC, and 

Edison Electric Institute (EEI) 

commented that valuation disputes 

provide valuable information to both 

market participants and regulators about 

pricing dislocations and associated 

credit risks and a static, rigid valuation 

methodology necessarily produces 

values that become increasingly 

outdated over time and could impede 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55911 

the transmission of this important risk 

information. 

The Working Group, ISDA & SIFMA, 

FSR, Markit, Freddie Mac, COPE, MFA, 

FHLBs, CIEBA, EEI, and the Coalition of 

Derivatives End Users commented that 

requiring agreement on valuation 

methodologies and set alternative 

methods will materially increase the 

pre-execution negotiating burden 

without an offsetting benefit and 

agreement on models for complex swaps 

would require negotiations that could 

take sophisticated professionals months 

to complete, if such could be completed 

at all. 

The Working Group, FSR, OCC, and 

Markit commented that it is impossible 

to state valuation methodologies with 

the required specificity without 

disclosing proprietary information about 

the parties’ internal models. 

OCC and Hess commented that 

requiring agreement on valuation 

methodologies may discourage 

development of more refined, dynamic 

swap valuation models, which would 

lead to use of less sophisticated or 

vanilla models that are less accurate 

than their proprietary counterparts. 

ISDA & SIFMA and IECA commented 

that agreeing on a methodology that 

could survive the loss of any input to 

the valuation is wholly unworkable, 

will diminish standardization as parties 

negotiate bespoke approaches to 

valuation, and will undermine legal 

certainty if the valuation methodology is 

determined not to be adaptable to all 

circumstances. 

COPE, FHLBs, MFA, EEI, and Markit 

commented that there is no business 

need for swap-by-swap valuation 

formulas because valuation of exposures 

with counterparties is usually 

conducted on a portfolio basis and 

documented in a master agreement, and 

that agreement on swap-by-swap 

valuation formulas also is likely to 

disrupt trading. 

Several commenters also 

recommended alternative approaches to 

the valuation requirement. The Working 

Group, Morgan Stanley, MFA, IECA, 

FHLBs, CIEBA, and MetLife suggested 

that the focus of the rule should be on 

the valuation dispute resolution process 

rather than valuation methodologies 

that include fallback alternatives and 

other static terms. MetLife specifically 

recommended that the Commission 

establish ‘‘mandatory dispute resolution 

guidelines’’ that include a requirement 

for a third party arbiter after a set period 

of time. 

With respect to valuation 

methodologies, CIEBA and Chris 

Barnard recommended that the rule 

require SDs to value swaps on the basis 

of transparent models that can be 

replicated by their counterparty. The 

Working Group requested that the 

Commission clarify that parties are 

permitted to use different valuation 

methodologies under different 

circumstances (i.e., mid-market 

valuation for collateral purposes and 

replacement cost valuation for 

terminations). Markit and MFA 

requested that the Commission clarify 

that parties may rely on a more general 

set of inputs, models, and fallbacks for 

valuation purposes, rather than the 

exhaustive fallbacks required by the 

rule. White & Case and IECA 

recommended that the Commission 

permit parties to change the valuation 

method and inputs as the market 

changes over time. Freddie Mac 

suggested that the rule should provide 

that the valuation methodology 

requirement can be satisfied by 

executing industry standard 

documentation that provides for a 

commercially reasonable valuation 

methodology. The Coalition of 

Derivatives End Users, IECA, and Chris 

Barnard recommended that proprietary 

inputs be allowed under the rule. 

More generally, FSR recommended 

that the Commission withdraw the 

proposed valuation requirement until 

the Commission has the time to conduct 

a thorough study, including a 

comprehensive cost-benefit analysis, 

whereas Markit recommended that the 

rule be modified to explicitly allow 

parties to comply with the rule by 

agreeing that an independent third party 

may provide any or all of the elements 

required to agree upon the valuation of 

swaps. The Coalition of Derivatives End 

Users recommended that the 

Commission change the rule to require 

SDs and MSPs to provide commercially 

reasonable information to substantiate 

its valuations upon an end user’s 

request, instead of requiring extensive 

pre-trade documentation of valuation 

methodology. 

The Working Group recommended 

that the Commission modify the rule to 

provide that the valuation requirements 

for cleared swaps or swaps executed on 

a trading facility should be satisfied by 

referencing the price provided by the 

relevant DCO or facility, while Markit 

recommended that the Commission 

clarify that neither prices of recently 

executed transactions or any other 

single pricing input should be regarded 

as preferable inputs for the valuation of 

swaps and explicitly permit parties to 

use pricing sources other than DCOs, 

even for cleared swaps. 

A number of commenters supported 

the rule. Chris Barnard strongly 

supported the requirement that the 

agreed methods, procedures, rules and 

inputs constitute a ‘‘complete and 

independently verifiable methodology 

for valuing each swap entered into 

between the parties,’’ and that the 

methodology must include alternatives 

‘‘in the event that one or more inputs to 

the methodology become unavailable or 

fail.’’ Mr. Barnard also supported the 

requirement for SDs and MSPs to 

‘‘resolve a dispute over the valuation of 

a swap within one business day.’’ 

Michael Greenberger generally 

supported the valuation methodology 

rule to promote transparency and 

financial integrity. MetLife agreed with 

the proposal that parties should 

determine upfront what the valuation 

methodologies will be to help mitigate 

disputes, but believes that disputes will 

not be eliminated by the rule. 

CIEBA commended the Commission 

for requiring objective and specific 

valuation mechanisms in swaps 

documentation and believes that this 

requirement will limit the potential for 

valuation disputes. However, CIEBA 

believes requiring objective and specific 

valuation mechanisms is not enough. In 

addition to requiring SDs to value swaps 

using transparent models that can be 

replicated by their counterparties, 

CIEBA recommended that the 

Commission require the mechanisms or 

procedures by which disputes are 

resolved to be fair and even-handed and 

should not override existing contractual 

protections negotiated by the parties. 

b. Commission Response 

Having considered these comments, 

the Commission is modifying and 

clarifying the proposal in a number of 

ways. First, in response to concerns 

from non-financial entities regarding the 

cost and the challenges of pre-execution 

negotiation, the Commission is 

modifying the rule to require valuation 

documentation only at the request of 

non-financial entities. In other words, 

non-financial entities will have the 

ability, but not the obligation, to enter 

into negotiations on valuation with their 

SD or MSP counterparties. As discussed 

below, the rule will continue to apply 

to SDs, MSPs, and financial entities. 

While the Commission agrees with 

commenters regarding the importance of 

using transparent models that can be 

replicated, the Commission recognizes 

concerns about protecting proprietary 

information used in internal valuation 

models. Thus, the Commission has 

modified the rule to clarify the 

requirement that the agreement on 

valuation use objective criteria, such as 

recently-executed transactions and 

valuations provided by independent 

third parties. In this regard, the 


sroberts on DSK5SPTVN1PROD with RULES
55912 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

10To the extent that one or both parties foresee 

that the valuation method or inputs agreed for a 

swap or a class or category of swaps will likely 

require modification, parties would be well-served 

to agree in advance in their swap trading 

relationship documentation on an appropriate 

arrangement for accommodating such 

modifications. 

11SDs and MSPs that are banks are subject to the 

requirements of section 4s(i). In addition, under the 

prudential regulators’ margin proposal, SDs and 

MSPs that are banks would be required to have 

documentation in place that specifies the ‘‘(1) [t]he 

methods, procedures, rules, and inputs for 

determining the value of each swap * * * for 

purposes of calculating variation margin 

requirements; and (2) [t]he procedures by which 

any disputes concerning the valuation of swaps 

* * * or the valuation of assets collected or posted 

as initial margin or variation margin, may be 

resolved.’’ Margin and Capital Requirements for 

Covered Swap Entities, 76 FR 27564, 27589 (May 

11, 2011). 

12Under § 23.600(c)(1)(1)(iii), the risk 

management program requires SDs and MSPs to 

have policies and procedures for detecting breaches 

of risk tolerance limits set by an SD or MSP, and 

alerting supervisors within the risk management 

unit and senior management, as appropriate. 

Commission agrees with The Working 

Group that the valuation requirements 

for cleared swaps or swaps executed on 

a trading facility would be satisfied by 

referencing the price provided by the 

relevant DCO, SEF, or DCM. 

Additionally, the Commission 

confirms commenters’ understanding 

that proprietary models may be used for 

purposes of valuation, provided that 

both parties agree to the use of one 

party’s confidential, proprietary model. 

An agreement by the parties to use one 

party’s confidential, proprietary model 

is sufficient to satisfy the requirements 

of § 23.504(b)(4)(i), including the 

requirement that the parties agree on the 

methods, procedures, rules and inputs 

for determining the value of each swap. 

On the other end of the spectrum from 

simply agreeing to use one party’s 

model, counterparties may, if they 

choose, elect to negotiate precisely 

which model and inputs will govern the 

valuation of their swaps. Counterparties 

would be free to elect either of these 

options or many other possibilities 

under the terms of § 23.504(b)(4) so long 

as the resulting valuations are sufficient 

to comply with the margin requirements 

under section 4s(e) of the CEA and the 

risk management requirements under 

section 4s(j) of the CEA, and there is a 

dispute resolution process in place or a 

viable alternative method for 

determining the value of the swap. 

Moreover, the Commission is modifying 

proposed § 23.504(b)(4)(iii) to clarify 

that confidential, proprietary model 

information is protected under the rule. 

To address concerns that the use of 

the phrase ‘‘methods, procedures, rules, 

and inputs’’ could be interpreted as 

requiring agreement on the precise 

model and all inputs for valuing a swap, 

the Commission is modifying the rule 

text to require that parties agree on ‘‘the 

process, including methods, procedures, 

rules, and inputs for determining the 

value of each swap.’’ 

Importantly, the Commission is 

responding to commenters’ concerns 

about the requirement that the valuation 

documentation be stated with sufficient 

specificity to allow the SD, MSP, the 

Commission, and any prudential 

regulator to value the swap 

‘‘independently in a substantially 

comparable manner.’’ Commenters 

viewed this standard as problematic 

because they read it to require 

disclosure of proprietary information or 

to prevent the updating or revising of 

models, among other things. 

Accordingly, the Commission has 

determined to remove this provision 

from the final rule. So long as the 

valuation documentation is stated with 

sufficient specificity to determine the 

value of the swap for purposes of 

complying with the requirements of the 

rule—namely, the margin and risk 

management requirements under 

section 4s of the CEA and Part 23 of 

Commission regulations—the 

requirements of § 23.504(b)(4)(i) would 

be met. 

Under this approach, parties may rely 

on a general set of methods, inputs, 

models, and fallbacks for valuation 

purposes so long as the process is 

sufficient to determine the value of a 

swap. In response to concerns that the 

proposal would require a methodology 

that would be static or rigid over time, 

the Commission is further modifying the 

rule to make explicitly clear that the 

parties may agree on a process, 

including methods or procedures for 

modifying or amending the valuation 

process as circumstances require and as 

the market changes over time.10

The Commission does not disagree 

with commenters that differences in 

valuations can provide valuable 

information to both market participants 

and regulators about pricing 

dislocations and associated credit risks. 

Moreover, the objective is not to 

produce values that become 

increasingly outdated over time. Rather, 

the Commission believes that by 

requiring agreement between 

counterparties on the methods and 

inputs for valuation of each swap, 

§ 23.504(b)(4) will assist SDs and MSPs 

and their counterparties to arrive at 

valuations necessary for margining and 

internal risk management, and to 

resolve valuation disputes in a timely 

manner, thereby reducing risk. 

Agreement between SDs, MSPs, and 

their financial entity counterparties on 

the proper daily valuation of the swaps 

in their swap portfolio is an essential 

component of the Commission’s margin 

proposal. Under proposed § 23.151, 

non-bank SDs and MSPs must 

document the process by which they 

will arrive at a valuation for each swap 

for the purpose of collecting initial and 

variation margin in compliance with the 

requirements of § 23.504. All non-bank 

SDs and MSPs must collect variation 

margin from their non-bank SD, MSP, 

and financial entity counterparties for 

uncleared swaps on a daily basis. 

Variation margin requires a daily 

valuation for each swap. For swaps 

between non-bank SDs and MSPs and 

non-financial entities, no margin is 

required to be exchanged under 

Commission regulation, but the nonbank SDs and MSPs must calculate a 

hypothetical variation margin 

requirement for each uncleared swap for 

risk management purposes under 

proposed § 23.154(b)(6).11 The daily 

valuation agreed to by the 

counterparties is necessary for 

compliance with the margin 

requirements proposed by the 

Commission and the prudential 

regulators under section 4s(e) of the 

CEA. 

In addition to the fact that arriving at 

a daily valuation is one of the building 

blocks for the margin rules, timely and 

accurate valuations are essential for the 

risk management of swaps by SDs and 

MSPs. Under § 23.600(c)(4)(i), the 

Commission required that SDs and 

MSPs have risk management policies 

and procedures that take into account 

the daily measurement of market 

exposure, along with timely and reliable 

valuation data. The valuation 

documentation requirements under 

§ 23.504(b) and the risk management 

provisions of § 23.600 work together to 

ensure that SDs and MSPs have the 

most accurate and reliable valuation 

data available for internal risk 

management and for collateralization of 

risk exposures with counterparties. This 

is not to say that valuation disputes can 

be prevented entirely or that these 

disputes do not, at times, offer useful 

insight into the marketplace. Indeed, 

risk management personnel and 

management within the SD or MSP 

should pay particular attention to 

different valuations for the same swap 

originating within their organization or 

from outside the entity. For these 

purposes, the Commission expects that 

valuation disputes that are not resolved 

in accordance with these rules be 

elevated to senior management in the 

firm.12 However, the final rule reflects 

the recognition that accurate and 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55913 

13See 77 FR 9734, 9767–68 (Feb. 17, 2012); see 

also Swap Data Recordkeeping and Reporting 

Requirements, 77 FR 2136, (Jan. 13, 2012) (defining 

‘‘valuation data’’ by reference to section 

4s(h)(3)(B)(iii) of the CEA and § 23.431. 14See § 23.431(d). SDs and MSPs must provide a 

daily mark for uncleared swaps that is the midmarket mark of the swap which does not include 

amounts for profit, credit reserve, hedging, funding, 

liquidity, or any other costs or adjustments. 

15This provision corresponds to § 39.12(b)(6), 

which establishes parallel requirements for DCOs 

clearing swaps. Both proposals have been modified 

in a similar manner for the final rules. 

reliable valuations are the foundation of 

margining and risk management. 

The Commission also agrees with 

commenters that the trading 

documentation should be permitted to 

focus on the valuation dispute 

resolution process rather than 

exclusively on fallback methodologies, 

and has further modified the rule to 

allow for either fallback methodologies 

or agreement on a dispute resolution 

process, but does not think it necessary 

or desirable to specify a standard 

dispute resolution process at this time, 

as requested by MetLife. 

Lastly, the Commission wishes to 

distinguish its use of the terms 

‘‘valuation’’ under section 4s(i) of the 

CEA and ‘‘daily mark’’ under section 

4s(h). In its final rules for Business 

Conduct Standards for SDs and MSPs 

with Counterparties, the Commission 

explained that the daily mark for 

uncleared swaps represented the midmarket mark of a swap provided by an 

SD or MSP to its counterparty.13 The 

mid-market mark of the swap represents 

an objective value that provides 

counterparties with a baseline to assess 

swap valuations for other purposes.14

By contrast, in § 23.504(b)(4), the 

Commission is requiring that SDs, 

MSPs, and their counterparties agree to 

a process for determining the current 

market value or net present value of a 

swap for purposes of collateralizing the 

risk posed by the swap and internal risk 

management. The critical difference 

being the agreement of both 

counterparties to the process for 

determining the value of a swap, rather 

than just the SD’s or MSP’s calculation 

of the mid-market value of the swap. 

13. Application to Cleared Swaps— 

§ 23.504(b)(6) 

Proposed § 23.504(b)(6) required the 

swap trading relationship 

documentation of SDs and MSPs to 

include certain items upon acceptance 

of a swap for clearing by a DCO, 

including documentation of each 

counterparty’s clearing member, the 

date and time the swap was cleared, that 

the swap conforms to the terms of the 

DCO’s templates, and that the clearing 

member’s books reflect the terms of the 

swap at the DCO. The proposed 

regulation also required the 

documentation to contain a statement 

that the original swap is extinguished 

and replaced by a swap subject to the 

rules of the DCO. 

ISDA & SIFMA urged the Commission 

to clarify that the term ‘‘swap trading 

relationship documentation’’ is used to 

describe only bilateral documentation 

between parties to uncleared swaps. 

ISDA & SIFMA recommend that the 

Commission not finalize § 23.504(b)(6) 

because ISDA & SIFMA (1) Saw no need 

to record the identity of its 

counterparty’s clearing member; (2) 

recommended that the obligation to 

provide notice of the date and time of 

clearing and the identity of the DCO is 

deemed satisfied when the counterparty 

receives a clearing report from the DCO; 

(3) objected to notifying the 

counterparty of the SD’s or MSP’s 

clearing member as that information 

may be sensitive and is not material to 

the counterparty; and (4) saw no need 

to state facts about the counterparty’s 

cleared swap in trading relationship 

documentation. 

CME commented that existing 

clearing houses use an agency model 

with FCMs acting as the agent and 

guarantor for customers, providing 

numerous benefits. To preserve the 

agency structure, CME requested that 

§ 23.504(b)(6)(v)(B) be changed to read 

‘‘The original swap is replaced by equal 

and opposite swaps with the derivatives 

clearing organization.’’ 

CME further commented that under 

the rule the anonymity of the customer 

of the clearing member on the other side 

of the trade to the clearing member will 

be lost. CME does not believe the 

anonymity needs to be lost to serve the 

purposes of the documentation rules. 

MFA commented that one of the 

benefits of central clearing is 

anonymity, such that once parties 

submit a swap for central clearing, it 

need not retain or know any information 

about the counterparty. MFA 

recommended that the final rule not 

require any identifying information 

about the parties and their firms. 

The Commission has considered the 

commenters’ recommendation to delete 

the clearing record provisions of 

§ 23.504(b)(6)(iii) and (iv) and agrees 

that there is no need to include in the 

trading documentation a record of the 

names of the clearing members for the 

SD, MSP, or counterparty. The 

Commission notes that the new 

applicability provision added to 

§ 23.504(a)(1) provides that the swap 

trading relationship documentation rule 

does not apply to swaps executed 

anonymously on a DCM or SEF, but 

believes that anonymity may also be 

important in the execution of swaps 

executed off-facility, such as in the 

execution of block trades with asset 

managers where allocation may take 

place following acceptance of the block 

trade for clearing by a DCO. Once a 

swap is accepted for clearing, the 

identity of a counterparty’s clearing 

member is no longer relevant and 

requiring such a record has the 

possibility to undermine the anonymity 

of central clearing. Therefore, those 

provisions have been deleted from the 

final rule. Similarly, § 23.504(b)(6)(i) 

and (ii) have been removed because 

those records will be captured under the 

SD and MSP recordkeeping 

requirement, § 23.201(a)(3), and the 

Commission believes those records are 

sufficient. 

With regard to proposed 

§ 23.504(b)(6)(v), the Commission has 

retained but streamlined the provision, 

as recommended by ISDA & SIFMA and 

CME, to include only the text in 

§ 23.504(b)(6) set forth in the regulatory 

text of this rule. 

The Commission continues to believe 

that swap trading relationship 

documentation should make clear the 

effects of clearing a trade with a DCO; 

i.e., that the original swap is 

extinguished and replaced with a swap 

facing the DCO that conforms to the 

terms established under the DCO’s 

rules. The Commission has determined 

that an orderly swap market requires 

this notice to clarify that the terms of 

the swap under a DCO’s rules are 

definitive and trump any contradictory 

terms that may have been included in 

the swap as executed between an SD or 

MSP and its counterparty.15

14. Annual Audit of 5 Percent of Swap 

Trading Relationship Documentation— 

§ 23.504(c) 

Proposed § 23.504(c) required that 

SDs and MSPs, at least once during each 

calendar year, have an independent 

internal or external auditor examine no 

less than 5 percent of the swap trading 

relationship documentation created 

during the previous twelve month 

period to ensure compliance with 

Commission regulations and the written 

policies and procedures established 

pursuant to § 23.504. 

In response to the proposal, ISDA & 

SIFMA, FSR, and Hess urged the 

Commission to adopt a principles-based 

approach to the audit requirement and 

only require SDs and MSPs to conduct 

periodic audits sufficient to identify 

material weaknesses in their 

documentation policies and procedures. 


sroberts on DSK5SPTVN1PROD with RULES
55914 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

16Compare with ESMA Draft Technical 

Standards, Article 4 RM, subsection 2, (stating that 

‘‘counterparties shall report to the competent 

authority * * * any disputes between 

counterparties relating to an OTC derivative 

contract, its valuation or the exchange of collateral 

for an amount or a value higher than EUR 15 

million and outstanding for at least 15 business 

days.’’) 

Similarly, IECA recommended that the 

Commission require an audit of a 

random sample, rather than 5 percent, 

which IECA found too costly. 

Commenting on a different aspect of the 

proposal, Michael Greenberger thought 

that allowing internal audits, as 

opposed to external, could undermine 

transparency and accountability. 

In response to commenters and as a 

cost-saving measure, the Commission is 

modifying the proposed rule in 

accordance with the alternative 

recommended by ISDA & SIFMA, FSR, 

and Hess by removing the 5 percent 

audit requirement and replacing it with 

a more general requirement that SDs 

and MSPs conduct periodic audits 

sufficient to identify material 

weaknesses in their documentation 

policies and procedures. With respect to 

Mr. Greenberger’s comment, the 

Commission continues to believe that 

internal auditors are sufficient as a 

record of the results of each audit will 

be retained and can be reviewed by 

Commission staff during examinations 

of the SD or MSP or investigations by 

Commission enforcement staff. 

15. Dispute Reporting—§ 23.504(e) 

The proposed regulations required 

SDs and MSPs to notify the Commission 

and any applicable prudential regulator 

or the SEC of any swap valuation 

dispute not resolved within one 

business day, if the dispute is with a 

counterparty that is an SD or MSP, or 

within five business days if the dispute 

is with any other counterparty. 

In response to the proposal, ISDA & 

SIFMA recommended that the 

Commission should limit reporting to 

material disputes at the portfolio level, 

urging the Commission to accept the 

materiality thresholds for reporting 

established by the OTC Derivatives 

Supervisors’ Group process, which 

require reporting of disputes above a 

certain dollar threshold and only after 

such disputes have had a proper time to 

mature. ISDA & SIFMA argued that rule 

as proposed will be overly burdensome 

and the over-reporting will cause 

substantial informational ‘‘noise.’’ 

MFA strongly agreed that the 

Commission should adopt rules related 

to valuation disputes and their timely 

resolution, but questioned whether 

regulators need notice of every 

unresolved dispute regardless of their 

materiality from a systemic risk or 

regulatory perspective. MFA also 

commented that the proposed dispute 

resolution period of one business day 

for unresolved disputes among SDs and 

MSPs is too short, arguing that valuation 

disputes may require discussion and 

negotiation by and among several levels 

of management and many different 

operational teams at an SD or MSP. 

MFA thus recommended that the 

Commission provide for five business 

days to resolve a valuation dispute in an 

account before they must give regulators 

notice and only require notice to 

regulators where the amount in dispute 

exceeds either (a) $100 million, or (b) 

both 10 percent of the higher of the 

parties’ valuation and $50 million. In 

addition, MFA strongly believes that 

any notices of disputes should be 

treated confidentially by regulators, and 

not be subject to public access. 

IECA argued that the proposed rule 

should be removed because it creates an 

unlevel playing field by creating 

pressure on a party that wants to avoid 

reporting to concede in any dispute. 

MetLife agreed that the Commission 

should establish strict timelines for 

reporting disputes, but argued that the 

periods proposed are too short to allow 

parties to resolve disputes on their own. 

MetLife recommended that disputes 

between SD/MSPs should be given 3 

days before reporting is required and be 

subject to a materiality condition of 10 

percent of the calculated valuation of 

the swap in dispute. 

Hess recommended that the 

Commission limit reporting to material 

disputes dependent on the risk the 

dispute may pose to the financial 

system taking into account the size of 

the dispute relative to the size of the 

trade, the collateral involved, and the 

size of the parties involved. 

For the reasons submitted by these 

commenters, the Commission has 

determined that only material swap 

valuation disputes should be reported to 

the Commission, any applicable 

prudential regulator, and the SEC (with 

regard to swaps defined in section 

1a(47)(A)(v) of the Act). Thus, the 

Commission is modifying the rule to 

provide that SDs and MSPs shall 

provide notice of any swap valuation 

dispute in excess of $20,000,000 (or its 

equivalent in any other currency).16 The 

Commission has determined that the 

$20,000,000 materiality threshold for 

reporting is sufficiently high to 

eliminate unnecessary ‘‘noise’’ from 

over-reporting, but not so high as to 

eliminate reporting that the Commission 

may find of regulatory value, such as a 

large number of relatively small 

disputes that in aggregate could provide 

the Commission with information 

regarding a widespread market 

disruption. 

In addition, the Commission is 

modifying the requirement for SDs and 

MSPs to report unresolved valuation 

disputes within one business day if the 

dispute is with a counterparty that is a 

SD or MSP. SDs and MSPs now will be 

required to report unresolved valuation 

disputes within three business days. For 

disputes with counterparties that are not 

SDs or MSPs, the rule is unchanged 

from the proposal, requiring that 

unresolved disputes be reported within 

five business days. 

The Commission has also determined 

that the reporting requirement of the 

rule better fits with the resolution 

requirement under the portfolio 

reconciliation rule at § 23.502 and has 

renumbered the rule as § 23.502(c). The 

Commission notes that the reporting 

requirement under the rule as adopted 

is distinct from the swap valuation 

methodology requirement under 

§ 23.504(b)(4), discussed above, and the 

time period requirement for SDs and 

MSPs to resolve swap valuation 

disputes in § 23.502, discussed below. 

16. Orderly Liquidation Termination— 

§ 23.504(b)(5) 

Proposed § 23.504(b)(5) required SDs 

and MSPs to include in their swap 

trading relationship documentation an 

agreement with their counterparties 

that, in the event a counterparty is a 

covered financial company (as defined 

in section 201(a)(8) of the Dodd-Frank 

Act) or an insured depository institution 

(as defined in 12 U.S.C. 1813) for which 

the Federal Deposit Insurance 

Corporation (FDIC) has been appointed 

as a receiver (the ‘‘covered party’’), the 

non-covered party is subject to certain 

limitations specified by law following 

the appointment of the FDIC as receiver 

of the covered party and the noncovered party acknowledges that the 

FDIC may take certain actions with 

respect to the transactions governed by 

such documentation. 

In response to the proposal, ISDA & 

SIFMA and FSR argued that because the 

rule language is not identical to section 

210 of the Dodd-Frank Act, the 

proposed rule requiring an agreement 

between counterparties in swap trading 

relationship documentation could 

inadvertently expand FDIC powers 

beyond limits set by Congress by 

creating a discrepancy between the 

FDIC’s actual powers under Title II of 

the Dodd-Frank Act and the treatment 

consented to by the parties. ISDA & 

SIFMA believe that any discrepancy 

could operate to strip parties of legal 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55915 

rights to challenge their treatment under 

Title II of the Dodd-Frank Act. This, in 

turn, could raise questions about 

whether the rule is a proper exercise of 

the Commission’s rulemaking authority. 

ISDA & SIFMA recommended that the 

Commission revise the rule to only 

require a notice of the relevant 

provisions of Title II. 

CIEBA also noted that the proposed 

language is similar to, but not the same 

as, the statutory text in the Dodd-Frank 

Act and the FDIA, and could harm its 

constituents. By substituting terms and 

apprising parties of some, but not all, of 

their rights, the proposed rule increases 

the risk of disputes and creates 

uncertainty as to what will be required 

to comply with both the statute and the 

regulatory regime. As an example, 

CIEBA cited section 210(c)(9)(A)(i) of 

the Dodd-Frank Act, which states that, 

in the context of orderly liquidation, the 

FDIC may elect to ‘‘transfer to one 

financial institution, (i) all qualified 

financial contracts * * * or (ii) transfer 

none of the qualified financial contracts, 

claims, property or other credit 

enhancement referred to in clause (i) 

(with respect to such person and any 

affiliate of such person).’’ In contrast to 

this statutory language, the proposed 

rule uses ‘‘may,’’ which suggests that 

the FDIC has the discretion to transfer 

less than all qualified financial contracts 

in contrast to its statutory requirement 

to transfer all or none. CIEBA also notes 

that the proposed regulation would 

remain effective even if the statutory 

provision it implements is repealed or 

amended. This could result in parties 

being forced to waive rights that protect 

their financial interest in times of 

market turmoil. In the alternative, 

CIEBA recommended that the 

Commission require the documentation 

to include a written statement in which 

the counterparties agree that they will 

comply with the requirements, if any, of 

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

Act and section 11(e)(10)(B) of the 

Federal Deposit Insurance Act, or 

instead, require an SD or MSP to 

include a statement thereof in its risk 

disclosure documents. At the least, 

CIEBA requests that the Commission 

add an additional section to proposed 

§ 23.504(b)(5) to reflect a counterparty’s 

right to suspend payments to the 

covered party for the period of the stay, 

as provided in section 210(c)(8)(F)(ii) of 

the Dodd-Frank Act. 

EEI & NRECA also objected to the 

proposed rule, arguing that a statutory 

provision intended to encourage 

cooperation between the FDIC and the 

Commission does not provide the 

Commission with authority to 

unilaterally establish new jurisdiction 

for itself and that the Commission 

should allow the FDIC to take the lead 

as contemplated by Title II of the DoddFrank Act. EEI & NRECA stated that 

energy end users would be particularly 

harmed by the proposed rule because 

swaps would be covered by the rule, but 

not physical transactions, causing 

energy end users to separately 

collateralize swaps and physical 

transactions, eliminating their ability to 

cost-effectively hedge commercial risks 

using swaps. 

The FHLBs acknowledged the 

potential applicability of the orderly 

liquidation provisions of the DoddFrank Act, but also objected to the 

inclusion of the provisions in the swap 

documentation as the provisions would 

apply notwithstanding such inclusion 

and doing so could create legal 

uncertainty since other liquidation 

regimes are not listed in the documents. 

MetLife objected specifically to the 

requirement to include consent to FDIC 

liquidation, arguing that such consent 

may foreclose a party’s right to appeal 

or challenge the FDIC’s actions. MetLife 

also raised concerns that blanket 

consent could place the remaining party 

in a position where it has unwanted 

excessive credit exposure to the new 

counterparty, resulting in violation of 

state law requirements with respect to 

credit ratings and other credit quality 

requirements. MetLife requested that the 

section be removed or that a provision 

be added to allow a party to object to 

any proposed transfer. 

Hess argued that the provision is not 

appropriate because the large majority 

of SDs and MSPs will likely not be 

‘‘covered financial companies’’ and as of 

now, the actual application of Title II is 

unclear. Hess recommended that the 

rule only require SDs and MSPs to 

provide notice of the possibility of FDIC 

liquidation. 

Chris Barnard commented that the 

authority of the FDIC is statutory in 

nature, and so would automatically 

apply to the relevant swaps, overriding 

any current practice. Given this point, 

Mr. Barnard believes the provision is 

redundant. 

In contrast to the foregoing, Better 

Markets fully supported the proposed 

rule, stating that the proposed rule 

represents a clarification of a 

fundamental feature of swaps; the 

consequences of a default by an SD or 

MSP. Better Markets stated that a basic 

premise of derivatives in bankruptcy is 

the exemption from the automatic stay 

such that the non-defaulting party may 

immediately terminate and apply 

collateral post insolvency. Better 

Markets agreed that the proposed rule 

documents an important exception to 

that right newly created in the DoddFrank Act. Better Markets believes that 

clarity, both at inception of a swap and 

at default, is the foundation of the 

Dodd-Frank Act, because lack of clarity 

contributed heavily to the financial 

crisis and caused much harm. 

The Commission has carefully 

considered each of the comments 

received on the proposal. At the outset, 

the Commission believes that, in the 

context of the proposed rules, it is not 

possible to track the statutory language 

of Title II of the Dodd-Frank Act any 

more closely. Given the imperfectability 

of reproducing such statutory language 

and the context in which it appears in 

the rule, the Commission is sensitive to 

commenters’ concerns that the rule 

could have a different legal effect in 

application as compared to application 

of the statutory language. The 

Commission is also aware that the 

statutory provisions will apply to 

covered financial companies and 

insured depository institutions placed 

into FDIC receivership even if not 

included in this rule. Therefore, the 

Commission has determined that the 

best course is to revise the proposed 

rule to require that swap trading 

relationship documentation contain 

only a notice as to whether the SD or 

MSP or its counterparty is an insured 

depository institution or financial 

company and that the orderly 

liquidation provisions of the DoddFrank Act and the FDIA may limit the 

rights of the parties under their trading 

relationship documentation in the event 

either party is deemed a ‘‘covered 

financial company’’ or is otherwise 

subject to having the FDIC appointed as 

a receiver. 

C. End User Exception Documentation— 

§ 23.505 

1. Overlap With Proposed § 39.6 

The proposed regulation required SDs 

and MSPs, when transacting with 

market participants claiming the 

exception to clearing under section 

2(h)(7) of the CEA, to obtain 

documentation sufficient to provide a 

reasonable basis on which to believe 

that its counterparty meets the statutory 

conditions required for the exception. 

Various requirements for the 

documentation were listed in the 

proposed rule. 

In response to the proposal, The 

Working Group and Encana Marketing 

(USA), Inc. (Encana) argued that 

because proposed § 39.6 would require 

SDs and MSPs to collect and report the 

information relevant to the section 

2(h)(7) clearing exception, the proposed 

rule should be revised to impose no 


sroberts on DSK5SPTVN1PROD with RULES
55916 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

17See End-User Exception to the Clearing 

Requirement for Swaps, 77 FR 42560, 42590 (July 

19, 2012). 

documentation obligations with regard 

to this exception. Encana also 

commented that in the alternative, 

§ 23.505 should only require that SDs 

and MSPs obtain ‘‘documentation’’ that 

the counterparty qualifies as an end user 

in the transaction documents, but did 

not specify what form such 

documentation should take. COPE also 

commented that the proposed rule is 

burdensome and redundant to proposed 

§ 39.6 and believes that the attestation 

required by proposed § 39.6 should be 

sufficient. 

Michael Greenberger, on the other 

hand, believes a check-the-box approach 

is insufficient, and recommended 

enhanced reporting requirements 

ensuring that the calculation 

methodology and the effectiveness of 

the hedged position are well 

documented. Better Markets also 

recommended enhanced reporting, 

suggesting that end users report their 

hedging transactions to SDRs as 

provided in proposed § 39.6. Requiring 

end users to provide information for 

each transaction to SDs and MSPs 

separately is overly burdensome 

whereas direct reporting to SDRs would 

amount to only a slight change from 

current prudent practice at many end 

users. 

Having considered these comments, 

the Commission is adopting the rule as 

proposed with one exception. The 

Commission has permitted entities that 

qualify for the exception to the clearing 

requirement under section 2(h)(7) of the 

Act to report information directly to an 

SDR regarding how they generally 

expect to meet their financial 

obligations associated with non-cleared 

swaps on an annual basis in 

anticipation of electing the exception for 

one or more swaps.17 Thus, an electing 

counterparty could be directly reporting 

the information necessary for SD and 

MSP compliance with proposed 

§ 23.505(a)(3) through (5). Therefore, the 

Commission has modified the proposed 

rule to clarify that SDs and MSPs need 

not obtain documentation from any 

counterparty that claims an exception 

from required clearing if that 

counterparty is reporting directly to an 

SDR regarding how it generally expects 

to meet its financial obligations 

associated with its non-cleared swaps, 

and the SD or MSP has confirmed that 

the counterparty has made its annual 

submission. 

2. Reasonable Basis—§ 23.505(a) 

The proposed regulation required that 

SDs or MSPs have a reasonable basis to 

believe its counterparty meets the 

statutory conditions required for an 

exception from a clearing requirement. 

In response to the proposal, ISDA & 

SIFMA requested that the Commission 

clarify that the ‘‘reasonable basis to 

believe’’ standard in the proposed rule 

may be satisfied by reliance on written 

representations from the counterparty, 

absent facts that reasonably should have 

put the swap dealer or major swap 

participant on notice that its 

counterparty may be ineligible for the 

end user exception. ISDA & SIFMA 

argued that registrants should not have 

to investigate their counterparty’s 

representations or obtain detailed 

representations as to the facts 

underlying the company’s 

qualifications. 

The Coalition for Derivatives EndUsers supports the ‘‘check-the-box’’ 

approach in proposed § 39.6 for end 

users to use to qualify for the clearing 

exception, and is therefore concerned 

that the ‘‘reasonable basis’’ obligation in 

proposed § 23.505(a) could undermine 

the simplicity of the check-the-box 

approach. The Coalition for Derivatives 

End-Users argues that if SDs and MSPs 

must verify end user information, they 

may start to require unnecessary and 

costly documentation from end users 

such as legal opinions or other 

documents, rather than serving as 

passive conduits of information. 

After considering these comments, the 

Commission has determined to adopt 

the rule as proposed on this issue. The 

Commission is of the view that, contrary 

to commenters’ concerns, the 

‘‘reasonable basis’’ standard in the 

proposed rule does not require 

independent investigation of 

information or documentation provided 

by a counterparty electing the exception 

from required clearing. The Commission 

believes that so long as an SD or MSP 

has obtained information, 

documentation, or a representation that 

on its face provides a reasonable basis 

to conclude that the counterparty 

qualifies for the exception under section 

2(h)(7), then, in the absence of facts that 

reasonably should have put the SD or 

MSP on notice that its counterparty may 

be ineligible for the exception, no 

further investigation would be 

necessary. The Commission does not 

believe that the rule requires legal 

certainty on the part of SDs or MSPs. 

3. Disclosure of Information by End 

Users 

The proposed regulation required SDs 

and MSPs to obtain documentation that 

its counterparty seeking to qualify for 

the clearing exception generally meets 

its financial obligations associated with 

non-cleared swaps. 

Better Markets argued that the 

proposed rule should require 

documentation in accordance with the 

Dodd-Frank Act, i.e., documentation as 

to how the counterparty generally meets 

its obligations associated with noncleared swaps, including how it would 

meet any obligation to immediately 

fund margin upon the occurrence of a 

credit trigger. 

ISDA & SIFMA commented that the 

Dodd-Frank Act merely requires a 

counterparty to notify the Commission 

as to how it generally meets its financial 

obligations. ISDA & SIFMA 

recommended that § 23.505(a)(5) be 

deleted or clarified such that a registrant 

can satisfy the requirement by obtaining 

a representation from its counterparty or 

by obtaining the documentation only 

with respect to swap-related obligations 

to the particular SD or MSP. 

In the view of COPE, EEI, and CIEBA, 

the requirement for the SD/MSP to get 

information from end users is anticompetitive and inappropriate as it 

requires an end user to inform its SD or 

MSP counterparty, a potential 

competitor, of proprietary details about 

its business, including its hedging 

activities. Each recommended that no 

more than a representation from the end 

user should be required. COPE also 

objects to the rule placing the SD or 

MSP in the role of regulator responsible 

for determining if the information 

received is sufficient. 

As explained above, the Commission 

is modifying the proposed rule to clarify 

that SDs and MSPs need not obtain 

documentation from any counterparty 

that claims an exception from required 

clearing if that counterparty is reporting 

directly to an SDR under § 39.6(b) 

regarding how it generally expects to 

meet its financial obligations associated 

with its non-cleared swaps, and the SD 

or MSP has confirmed that the 

counterparty has made its annual 

submission. Thus, any entity seeking to 

claim the exception from clearing may 

avoid revealing any information it 

considers sensitive to its SD or MSP 

counterparty by self-reporting directly 

to an SDR under § 39.6(b). The 

Commission notes that protections 

against release of reported proprietary 

information are addressed in the SDR 

rules finalized by the Commission. 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55917 

18U.S. Government Accountability Office, 

‘‘Credit Derivatives: Confirmation Backlogs 

Increased Dealers’ Operational Risks, But Were 

Successfully Addressed After Joint Regulatory 

Action,’’ GAO–07–716 (2007) at pages 3–4. 

19See October 4, 2005 industry commitment 

letter to the Federal Reserve Bank of New York, 

available at http://www.newyorkfed.org/

newsevents/news_archive/markets/2005/

an050915.html. 

20See G15 Industry Confirmation Data dated 

April 4, 2012 provided by ISDA, available at 

www.cftc.gov. 

D. Swap Confirmation—§ 23.501 

Confirmation has been recognized as 

an important post-trade processing 

mechanism for reducing risk and 

improving operational efficiency by 

both market participants and their 

regulators. Prudent practice requires 

that, after coming to an agreement on 

the terms of a transaction, parties 

document the transaction in a complete 

and definitive written record so there is 

legal certainty about the terms of their 

agreement. 

Over the past several years, OTC 

derivatives market participants and 

their regulators have paid particular 

attention to the timely confirmation of 

swaps. The Government Accountability 

Office (GAO) found that the rapid 

expansion of the trading volume of 

swaps, such as credit derivatives since 

2002, caused stresses on the operational 

infrastructure of market participants. 

These stresses in turn caused the 

participants’ back office systems to fail 

to confirm the increased volume of 

trades for a period of time.18 The GAO 

found that the lack of automation in 

trade processing and the purported 

assignment of positions by transferring 

parties to third parties without notice to 

their counterparties were factors 

contributing to this backlog. If 

transactions, whether newly executed or 

recently transferred to another party, are 

left unconfirmed, there is no definitive 

written record of the contract terms. 

Thus, in the event of a dispute, the 

terms of the agreement must be 

reconstructed from other evidence, such 

as email trails or recorded trader 

conversations. This process is 

cumbersome and may not be wholly 

accurate. Moreover, if purported 

transfers of swaps, in whole or in part, 

are made without giving notice to the 

remaining parties and obtaining their 

consent, disputes may arise as to which 

parties are entitled to the benefits and 

subject to the burdens of the transaction. 

The Commission believes the work of 

the OTC Derivatives Supervisors Group 

(ODSG) demonstrates that the industry 

is capable of swift movement to 

contemporaneous execution and 

confirmation. A large back-log of 

unexecuted confirmations in the credit 

default swap (CDS) market created by 

prolonged negotiations and inadequate 

confirmation procedures were the 

subject of the first industry 

commitments made by participating 

dealers to the ODSG.19 In October 2005, 

the participating dealers committed to 

reduce by 30 percent the number of 

confirmations outstanding more than 30 

days within four months. In March 

2006, the dealers committed to reduce 

the number of outstanding 

confirmations by 70 percent by June 30, 

2006. By September 2006, the industry 

had reduced the number of all 

outstanding CDS confirmations by 70 

percent, and the number of CDS 

confirmations outstanding more than 30 

days by 85 percent. The industry 

achieved these targets largely by moving 

80 percent of total trade volume in CDS 

to confirmation on electronic platforms, 

eliminating backlogs in new trades. 

By the end of 2011, the largest dealers 

were electronically confirming over 95 

percent of OTC credit derivative 

transactions, and 90 percent were 

confirmed on the same day as execution 

(T+0). For the same period, the largest 

dealers were electronically confirming 

over 70 percent of OTC interest rate 

derivatives (over 90 percent of trades 

with each other), and over 80 percent 

were confirmed T+0. The rate of 

electronic confirmation of OTC 

commodity derivatives was somewhat 

lower—just over 50 percent, but over 90 

percent for transactions between the 

largest dealers.20

The Commission further recognizes 

the ODSG supervisory goal for all 

transactions to be confirmed as soon as 

possible after the time of execution. 

Ideally, this would mean that there 

would be a written or electronic 

document executed by the parties to a 

swap for the purpose of evidencing all 

of the terms of the swap, including the 

terms of any termination (prior to its 

scheduled maturity date), assignment, 

novation, exchange, or similar transfer 

or conveyance of, or extinguishing of 

rights or obligations. 

The Commission believes that timely 

and accurate confirmation of swaps is 

critical for all downstream operational 

and risk management processes, 

including the correct calculation of cash 

flows, margin requirements, and 

discharge of settlement obligations as 

well as accurate measurement of 

counterparty credit exposures. Timely 

confirmation also allows any rejections, 

exceptions, and/or discrepancies to be 

identified and resolved more quickly. 

To this end, in the Confirmation NPRM, 

the Commission proposed § 23.501, 

which prescribed standards for the 

timely and accurate confirmation of 

swap transactions. The Commission 

received approximately 27 comment 

letters in response to the Confirmation 

NPRM and considered each in 

formulating the final rules, as discussed 

below. 

1. Uniform Application of Proposed 

Rules to All Asset Classes 

In the Confirmation NPRM, the 

Commission solicited comments on 

whether certain provisions of the 

proposed regulations should be 

modified or adjusted to reflect the 

differences among asset classes. 

In response to the request for 

comments, ISDA noted that the work 

done by the industry with the ODSG led 

to customization of documentation and 

confirmation timeframes to account for 

the differences between asset classes, 

and even between products within asset 

classes, but the proposed confirmation 

requirements do not allow for this same 

flexibility. However, ISDA did not 

suggest specific timeframes for the 

Commission’s rules. 

The FHLBs recommended that the 

Commission exercise caution in 

applying rules to all swap asset classes 

equally as procedures that are 

appropriate for interest rate swaps may 

be insufficient or unnecessary for other 

types of swaps. 

The Global Foreign Exchange Division 

of AFME, SIFMA, and ASIFMA (GFED) 

commented that the Commission should 

take into account the high volume of 

transactions and wider universe of 

participants in the foreign exchange 

industry when promulgating its final 

rules. 

The Working Group requested that the 

Commission revise the rules to permit 

current practice in the energy swap 

market where one party sends an 

acknowledgement to the other party and 

the acknowledgement is deemed a 

legally binding confirmation if the 

receiving party does not object within 

three business days. The Working Group 

believes this practice is efficient because 

(i) It eliminates the risk of open 

confirmations, (ii) dealers need not 

chase for a physically signed 

confirmation, and (iii) counterparties 

need not respond if terms are 

acceptable. 

BG Americas & Global LNG (BGA) 

commented that energy commodity 

trading companies typically extract 

trading data in a batched cycle at the 

end of the day and generate 

confirmations the following day. BGA 

does not believe it is clear that 

expedited confirmation would enhance 


sroberts on DSK5SPTVN1PROD with RULES
55918 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

21See 17 CFR 45.1. 

transparency or reduce systemic risk 

and is therefore outweighed by the 

enormous cost for registrants that would 

have to add resources to perform rolling 

confirmations and correct errors. 

As discussed further below, in section 

III.B.2, the Commission has made every 

effort to tailor the confirmation 

requirements by asset class based on 

data provided by major market 

participants. The Commission has 

achieved such tailoring by modifying 

the time periods for confirmation by 

asset class along with a generous 

compliance phase-in period, but has 

retained an otherwise uniform rule 

across asset classes. The Commission 

believes the uniform standard with 

appropriate differences in time periods 

and compliance periods will lead to 

efficient use of limited regulatory 

resources, while also reducing 

implementation costs for affected 

market participants. 

2. Use of ‘‘Enforce’’ in Proposed Rules 

§ 23.501(a)(3), § 23.502(b), 

§ 23.502(b)(4), and § 23.503(d) 

The proposed regulations require SDs 

and MSPs to establish, maintain, and 

enforce written policies and procedures 

to accomplish a number of 

requirements, including confirmation 

with financial entities and non-financial 

entities; portfolio reconciliation; 

valuation dispute resolution; and 

bilateral and multilateral compression 

and termination of fully offsetting 

swaps. 

In regard to the use of ‘‘enforce’’ in 

these provisions, ABC & CIEBA 

requested that the Commission delete 

the term wherever it appears because 

SDs and MSPs are not ‘‘registered 

entities’’ under section 1(a)(40) of the 

CEA and therefore Congress did not 

intend for SDs and MSPs to have the 

self-regulatory authority to enforce 

compliance with their internal policies 

and procedures. Similarly, Freddie Mac 

commented that the requirement in the 

proposed rules that SDs enforce policies 

designed to ensure confirmation with 

non-SD, non-MSP counterparties within 

the short deadlines mandated by the 

proposed rules could result in SDs 

exerting undue pressure on such 

counterparties to quickly assent to the 

terms of a trade as framed by the SD in 

the form of a condition to execution of 

a swap, with the risk that the swap 

could become void or otherwise fail. 

The Commission is sensitive to these 

concerns, and has accordingly modified 

the proposed rules by replacing each 

instance of the term ‘‘enforce’’ with the 

term ‘‘follow.’’ The Commission 

observes that the intent of the term 

‘‘enforce’’ in the proposed rules was to 

require SDs and MSPs to in fact follow 

the policies and procedures established 

to meet the requirements of the 

proposed rules, rather than to require an 

SD or MSP to enforce its internal 

policies and procedures against third 

parties. 

3. Definition of ‘‘Acknowledgement’’— 

§ 23.500(a) 

The proposed regulations defined 

‘‘acknowledgement’’ to mean ‘‘a written 

or electronic record of all of the terms 

of a swap signed and sent by one 

counterparty to the other.’’ 

Commenting on this definition, GFED 

requested that the Commission clarify 

whether an ‘‘acknowledgement’’ is the 

same as a ‘‘trade affirmation’’ in the FX 

market, which is matching of economic 

fields only, and MFA recommended that 

the Commission revise the definition to 

provide that an acknowledgement need 

only specify the primary economic 

terms of a swap (rather than all terms). 

Despite these comments, the 

Commission is adopting the definition 

of acknowledgement as proposed. The 

intent of the definition was to make 

clear that an SD or MSP must provide 

its non-SD, non-MSP counterparties 

with a complete record of all terms of 

an executed swap transaction. The 

Commission believes that to achieve the 

timely confirmation goals of § 23.501, 

mistaken, misunderstood, or disputed 

terms must be identified quickly. To do 

so, a counterparty needs to see 

documentation reflecting all of the 

terms of the swap transaction as the SD 

or MSP understands them. The 

Commission therefore does not agree 

with commenters that an 

acknowledgement need contain only the 

primary economic terms of a swap 

transaction. In reaching this conclusion, 

the Commission recognizes that 

requiring delivery of an 

acknowledgement containing all terms 

may require the parties to agree to more 

terms at execution than are agreed 

under some current market practices, 

but, given the critical role confirmation 

plays in all downstream operational and 

risk management processes, the 

Commission believes that any 

additional pre-execution burden 

imposed is justified. 

4. Definition of ‘‘Confirmation’’— 

§ 23.500(c) 

The proposed regulations defined 

‘‘swap confirmation’’ to mean ‘‘the 

consummation (electronically or 

otherwise) of legally binding 

documentation (electronic or otherwise) 

that memorializes the agreement of the 

parties to all the terms of the swap. A 

confirmation must be in writing 

(whether electronic or otherwise) and 

must legally supersede any previous 

agreement (electronically or 

otherwise).’’ 

Reacting to this definition, ABC & 

CIEBA explained that where a lead 

fiduciary for a pension fund negotiates 

ISDA documentation on a relationship 

basis, there sometimes will be a 

provision that the master agreement’s 

terms legally supersede the 

confirmation’s terms unless the 

fiduciary entering the plan into the 

swap represents that inconsistent terms 

in the confirmation are more beneficial 

to the plan. ABC & CIEBA therefore 

requested that the Commission clarify 

that the phrase ‘‘legally supersede any 

previous agreement’’ is only intended to 

apply to prior agreements outside the 

scope of the package of documentation 

that makes up the master agreement 

between the parties (i.e., master 

agreements, credit support agreements, 

all confirmations, etc.). 

Similarly, the Asset Management 

Group of SIFMA (AMG) explained that 

in current practice, some clients to asset 

managers require that terms in the 

confirmation of a swap cannot 

supersede conflicting terms in a client’s 

master agreement. AMG therefore also 

recommended that the Commission 

clarify the proposed rule to provide that 

a confirmation will not legally 

supersede the contractual arrangements 

agreed on by the parties. 

On a different tack, GFED requested 

clarification as to whether 

‘‘confirmation’’ means only actual legal 

confirmation execution or whether it 

may also include matching services that 

do not provide a legally binding 

confirmation of all terms, but merely 

affirmation of trade economics, and 

ISDA requested clarification that 

confirmation may be accomplished by 

use of matching services under which 

some buy-side firms ‘‘affirm’’ trades. 

Jason Copping offered an alternative 

definition of ‘‘confirmation’’ under 

which a swap is confirmed when all 

parties accept the terms and no change 

to the terms would be legally binding 

until all parties agree to such changes. 

In response to these comments, the 

Commission reiterates that the intent of 

the proposed rule was to require the 

terms of a confirmation to include all of 

the binding terms of the swap. This 

definition is the same definition 

adopted by the Commission in the Swap 

Data Recordkeeping and Reporting rules 

in part 45 of the Commission’s 

regulations.21 In addition, under the 

Swap Data Recordkeeping and 

Reporting rules, all terms agreed in a 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55919 

22See 17 CFR 45.3. 

23See e.g., Margin Requirements for Uncleared 

Swaps for Swap Dealers and Major Swap 

Participants, 76 FR 23732, 23744 (Apr. 28, 2011). 

confirmation must be reported to an 

SDR.22 Therefore, in addition to the 

need for all terms to be confirmed for 

purposes of downstream operational 

processing and risk management, the 

Commission has a strong interest in 

consistent rules for the swap market. 

For these reasons, the Commission is 

adopting the definition of confirmation 

as proposed. 

With respect to the comments of ABC 

& CIEBA and AMG, the Commission 

understands the practice explained by 

these commenters to mean that some 

confirmations of swaps incorporate by 

reference certain terms that are 

delineated in master agreements and 

that the parties have agreed that such 

terms trump any inconsistent terms that 

may appear in a confirmation. The 

Commission clarifies that the rules 

adopted herein do not prohibit the 

practice of incorporation by reference. 

Therefore, if counterparties want to 

include certain standard provisions in 

their master agreements that will control 

each swap transaction executed, this 

approach would be acceptable so long 

as they ensure that their books and 

records and the confirmation data 

reported to an SDR reflects the actual 

terms of each swap transaction. Given 

the Commission’s interest in ensuring 

the integrity of data reported to an SDR, 

contradictory or conflicting swap 

transaction terms in an SD’s or MSP’s 

books and records or in data reported to 

an SDR when reconciled with an SD’s 

or MSP’s books and records could 

indicate non-compliance with the both 

the confirmation rule adopted herein 

and the swap data reporting rules under 

part 45 of the Commission’s regulations. 

Moreover, the Commission clarifies 

that any specific agreed-upon collateral 

requirements in a confirmation, which 

may go beyond what exists in the 

collateral support arrangements under 

the swap trading relationship 

documentation, would be required to be 

confirmed according to the timeframes 

discussed below. 

5. Definition of Financial Entity– 

§ 23.500(e) 

The Commission proposed to define 

‘‘financial entity’’ to have the same 

meaning as given to the term in section 

2(h)(7)(C) of the Act, excepting SDs and 

MSPs. Subsequent to the proposal, the 

Commission proposed a number of rules 

that contained slightly differing 

definitions of the term.23 The 

Commission has therefore determined to 

revise the definition of ‘‘financial 

entity’’ for purposes of the rules adopted 

herein to be consistent with its other 

rules applicable to SDs and MSPs. Thus, 

‘‘financial entity’’ has been defined in 

the rule adopted in this release to mean 

‘‘a counterparty that is not a swap dealer 

or a major swap participant and that is 

one of the following. (1) A commodity 

pool as defined in section 1a(5) of the 

Act, (2) A private fund as defined in 

section 202(a) of the Investment 

Advisers Act of 1940, (3) An employee 

benefit plan as defined in paragraphs (3) 

and (32) of section 3 of the Employee 

Retirement Income and Security Act of 

1974, (4) A person predominantly 

engaged in activities that are in the 

business of banking, or in activities that 

are financial in nature as defined in 

section 4(k) of the Bank Holding 

Company Act of 1956, and (5) a 

security-based swap dealer or a major 

security-based swap participant.’’ 

6. Electronic Execution and 

Processing—§ 23.501(a)(1) & (2); 

Definition of ‘‘Processed 

Electronically’’—§ 23.500(j) 

The proposed regulations prescribed 

trade acknowledgement delivery and 

confirmation deadlines for swap 

transactions that are executed and 

processed electronically, and different 

deadlines for swaps that are not 

executed electronically but are 

processed electronically. The proposed 

regulations provided that ‘‘processed 

electronically’’ means ‘‘to be entered 

into a swap dealer or major swap 

participant’s computerized processing 

systems to facilitate clearance and 

settlement.’’ In addition, the 

Commission requested comment on 

whether the term ‘‘processed 

electronically’’ required more 

clarification, and, if so, what definition 

would be effective and flexible enough 

to accommodate future market 

innovation. 

In response to the proposal, ABC & 

CIEBA urged the Commission to ensure 

that the proposed confirmation rule 

does not indirectly impose on benefit 

plans processes that will require thirdparty service providers or new 

technology by expressly stating that a 

party to an uncleared swap that is not 

an SD or MSP has the right to determine 

whether the confirmation will occur 

electronically or manually. AMG also 

recommended that a party to an 

uncleared swap that is not an SD or 

MSP should have the right to determine 

whether the confirmation will occur 

electronically or manually. 

The Working Group and MFA warned 

that the Commission should not 

mandate confirmation through an 

electronic matching platform because 

electronic matching is unlikely to be 

able to capture all terms of customized 

transactions. Chatham Financial Corp. 

(Chatham) also argued that the 

Commission should not mandate 

confirmation through an electronic 

matching platform, because such a 

mandate could preclude end-users from 

entering into swaps not yet available on 

matching platforms and could increase 

costs for end-users that do not engage in 

the volume of swaps necessary to justify 

the additional costs of connecting to 

electronic matching platforms. 

ISDA commented that electronic 

execution and processing standards 

should be phased and aspirational 

because development by the industry 

will be required to meet the timelines of 

the proposed rules. ISDA also argued 

that the proposed life cycle 

confirmation requirement will 

undermine the move to electronic 

execution and processing, because not 

all life cycle events are currently 

supported by electronic platforms across 

asset classes. 

MarkitSERV supports the 

Commission’s goal of having as many 

transactions as possible be executed on 

electronic platforms, and recommended 

that the Commission require all swap 

transaction information to be 

communicated electronically if a 

registrant has the ability to do so, and 

encourage (but not require in all cases) 

the use of electronic matching and 

confirmation platforms. 

Many commenters raised questions 

regarding what would constitute 

electronic processing. MFA requested 

that the Commission clarify if 

‘‘processed electronically’’ only refers to 

swaps confirmed through electronic 

confirmation or matching services, or 

whether ‘‘processed electronically’’ 

could refer to a registrant entering trade 

information into its trade capture 

system, the generation of an 

acknowledgement from such system and 

the forwarding of such 

acknowledgement to a counterparty by 

facsimile, email, or other electronic 

method, while GFED requested that the 

Commission clarify whether a SWIFT 

confirmation would meet the definition 

of ‘‘processed electronically’’ under the 

proposed rules. The Working Group also 

questioned whether confirming a swap 

via email would constitute electronic 

processing. The FHLBs requested that 

the Commission clarify if ‘‘processed 

electronically’’ only refers to swaps 

confirmed through electronic 

confirmation or matching services, 

while ISDA recommended that the 

Commission not define ‘‘processed 

electronically’’ to include all 


sroberts on DSK5SPTVN1PROD with RULES
55920 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

transactions for which some element of 

the transaction is captured or processed 

through electronic means, but define it 

with reference to a firm or platform’s 

‘‘middleware,’’ which will actually 

drive the process. Finally, MetLife 

recommended that the Commission 

more clearly define the terms 

‘‘processed electronically’’ and 

‘‘executed electronically’’ because 

MetLife needs more information to 

determine whether the proposed time 

frames for confirmation are realistic 

within current market capabilities. 

Having considered these comments, 

the Commission acknowledges the 

concerns expressed by market 

participants regarding the coerced use of 

matching platforms and is accordingly 

modifying the proposed rule to delete 

the definition of ‘‘processed 

electronically’’ and delete the 

provisions of the rule mandating 

acknowledgement and confirmation 

deadlines for swaps that are executed or 

processed electronically. In place of 

these provisions, the rule has been 

modified to provide that swap 

transactions among SDs and MSPs or 

between such registrants and financial 

entities should be confirmed as soon as 

technologically practicable, but in any 

event by the end of the first business 

day following the day of execution (as 

modified for time zone and business day 

differences, discussed in detail below). 

The Commission believes this change 

will eliminate any confusion as to 

whether a method of swap execution 

and confirmation qualifies as 

‘‘electronic.’’ As explained further 

below, the modified rule would provide 

a single deadline for confirmation of 

swap transactions among registrants, a 

single deadline for confirmation of swap 

transactions between registrants and 

financial entities, and a single deadline 

for confirmation of swap transactions 

between registrants and all other 

entities, with appropriate adjustments of 

the compliance deadlines by swap asset 

class for implementation of the rule. 

7. Delivery of Draft Acknowledgement 

to Non-SD, Non-MSP Counterparties 

§ 23.501(a)(3) 

Proposed § 23.501(a)(3) required SDs 

and MSPs to establish a procedure such 

that, prior to execution of any swap 

with a non-SD or non-MSP, the 

registrant furnish to a prospective 

counterparty a draft acknowledgment 

specifying all terms of the swap 

transaction other than the applicable 

pricing and other relevant terms that are 

to be expressly agreed at execution. 

Commenting on the proposal, ISDA 

argued that the requirement to provide 

a draft acknowledgement prior to 

execution may cause loss of timely 

execution opportunities, and may 

require end-users to engage significant 

legal resources for review of all 

proposed transactions, rather than just 

executed transactions. ISDA 

recommended that non-dealer 

counterparties be permitted to waive the 

delivery of draft acknowledgements. 

MFA similarly argued that the proposed 

rule will (i) Prevent end users from 

executing promptly when the market is 

favorable; (ii) cause end users to 

concede on terms in order to get timely 

execution; (iii) cause a decrease in the 

number of transactions, which will 

decrease liquidity and increase 

volatility; and (iv) cause wider bid/ask 

spreads or less market-making because 

of an increase in risk between pricing 

and execution. Freddie Mac also 

believes that the proposed rule would 

delay prompt execution of hedging 

transactions because end users will be 

required to review draft 

acknowledgements. 

MarkitSERV argued that requiring a 

draft acknowledgement is unnecessarily 

burdensome because (i) multiple SDs 

competing for a trade would all be 

required to furnish a draft 

acknowledgement, and (ii) many 

transactions executed through 

automated electronic systems can 

complete a confirmation promptly after 

execution. MarkitSERV recommended 

that the Commission require draft 

acknowledgements to contain only 

terms necessary to determine price 

(rather than all terms) and only require 

delivery of draft acknowledgements for 

swaps that cannot be processed 

electronically and where confirmation is 

not reasonably expected to be 

completed within 24 hours. 

On the other hand, ABC & CIEBA 

agreed with the Commission’s proposal 

to require all terms, except terms related 

to price, be disclosed in writing prior to 

the time of execution. AMG also 

supported the proposed rule, but 

recommended that the Commission 

revise the rule to provide an exception 

for swaps where the parties have 

previously agreed to non-pricing-related 

terms. 

Finally, MetLife recommended that 

the Commission revise the proposed 

rule to specifically indicate which party 

is responsible for delivery of an 

acknowledgement and which party is 

responsible for the return confirmation. 

Having considered the commenters’ 

concerns, but cognizant of the support 

for the proposed rule by some 

commenters, the Commission is 

modifying the proposed rule to require 

delivery of a draft acknowledgement, 

but only upon request of an SD’s or 

MSPs’ non-SD, non-MSP counterparty 

prior to execution. 

With respect to MetLife’s comment, 

the Commission believes the rule as 

proposed clearly states that it is the SD’s 

or MSP’s responsibility to deliver an 

acknowledgement when trading with a 

counterparty that is not an SD or MSP. 

The SD or MSP is required to have 

policies and procedures reasonably 

designed to ensure that its counterparty 

returns a confirmation or otherwise 

completes the confirmation process. 

With respect to trades solely among SDs 

and MSPs, the Commission does not 

believe it is necessary to prescribe 

responsibility for delivery of an 

acknowledgement because both parties 

would be required to comply with the 

confirmation deadline set forth in the 

rule as adopted herein. 

8. Time Period for Confirmation— 

§ 23.501(a)(1) & (3) 

Proposed § 23.501 provided time 

periods for confirmation as set forth at 

75 FR 81519, 81531 (Dec. 28, 2010). 

The Commission received 27 

comments with respect to the proposed 

rule’s time periods for confirmation. 

Below, the comments are described 

according to the following categories: 

(A) General comments on the 

proposed time periods; 

(B) Comments on proposed time 

periods for confirmation with non-SDs 

and non-MSPs; 

(C) Comments on time periods for 

confirmation with financial entities; 

(D) Comments on confirmation of 

swaps between parties in different time 

zones; and 

(E) Comments on confirmation of 

swaps executed near end of trading day. 

(A) Comments on Time Periods 

Generally 

ISDA stated that the proposed rules 

place an unnecessary burden upon the 

inception of transactions, may increase 

risk by leading to needless disputes and 

operational lapses, and require 

substantially more than is necessary to 

create an initial record of a legally 

binding agreement. ISDA also argued 

that: (i) The time periods proposed are 

impractical as certain terms required to 

be included in a confirmation may not 

be known on the same calendar day as 

execution (e.g., initial rates may follow 

trade commitment by days); and (ii) 

valuation methodologies required to be 

agreed prior to execution pursuant to 

proposed § 23.504(b)(4), may also slow 

down the confirmation process to the 

extent such methodologies are required 

to be reflected in the confirmation. ISDA 

recommended an alternative framework: 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55921 

• Execution of a swap on a SEF or 

DCM or clearing a swap should be 

deemed to satisfy any confirmation 

requirements. 

• Electronic execution and processing 

standards should be phased and 

aspirational as development by the 

industry will be required. 

• The Commission should conduct a 

study in order to better understand the 

potential barriers to complying with the 

proposed timelines for confirmation in 

each asset class. 

• The Commission should institute 

an approach similar to that utilized by 

the ODSG; an ongoing dialogue between 

the Commission and leaders in the 

industry to obtain a commitment from 

the industry to tighten confirmation 

timeframes over an extended period, 

with existing risk mitigants to address 

Commission concerns in the interim. 

The Working Group also objected to 

the time periods between execution and 

confirmation in the proposed rules 

because: (i) The time periods effectively 

will require all terms of a swap to be 

negotiated prior to execution, and that 

such requirement will disadvantage the 

party that is most sensitive to timing of 

market conditions and may force that 

party to accept less optimal economic 

terms or reduced negotiating leverage in 

order to meet the confirmation deadline; 

and (ii) the Commission has not 

articulated any benefit from the 

requirement that non-registrants 

confirm a swap no later than the day 

after execution that would outweigh the 

cost for most non-registrants to comply 

with the rule. 

MarkitSERV commented that the time 

periods specified in the proposed rules 

for confirmation are not feasible in 

many cases and recommended the 

following alternative: 

• The time period within which 

confirmation is required to be 

completed should not begin with 

execution, but only from the point when 

all relevant data and information to 

define the swap has been obtained (e.g., 

allocations). 

• Acknowledgements should be sent 

within a time period after all 

information has been obtained and 

confirmation should be completed 

within a time period after an 

acknowledgement has been received. 

• Non-electronically executed and 

non-electronically processed 

transactions should be confirmed within 

24 hours of execution, rather than 

within the same calendar day. 

• The confirmation requirement 

should consist of ‘‘economic tie-out’’ of 

key economic terms rather than 

confirmation of all terms. 

• Electronic processing should be 

defined to include the capability for 

electronic communication. 

AMG argued that same calendar day 

or next business day confirmation may 

not be appropriate for complex or 

customized uncleared swaps, including 

swaps entered by asset managers that 

must allocate block trades among their 

clients. AMG also recommended that 

the Commission revise the proposed 

rules to provide for a delay in 

confirmation for legitimate disputes 

between the parties if the parties are 

seeking to resolve the dispute in a 

timely fashion. 

BGA commented that the 15 minute 

and 30 minute deadlines for 

confirmation or acknowledgement in 

the proposed rules are unworkable and 

inconsistent with current practice. BGA 

stated that energy commodity trading 

companies typically extract trading data 

in a batched cycle at the end of the day 

and generate confirmations the 

following day. BGA does not believe it 

is clear that expedited confirmation 

would enhance transparency or reduce 

systemic risk and is therefore 

outweighed by the enormous cost for 

registrants that would have to add 

resources to perform rolling 

confirmations and correct errors. BGA 

also argued that swaps executed on 

electronic platforms and through 

broker/dealers as clearing agents should 

not require a confirmation. 

Chatham argued that the proposed 

timeframes for confirmation could result 

in decreased accuracy as parties will 

rush to complete transaction 

documentation without thorough 

review. 

The FHLBs stated that currently 

available electronic swap processing 

systems do not support customized 

terms in swaps used by the FHLBs and 

therefore the same business day 

deadline is not sufficient for swaps that 

require manual processing. The FHLBs 

also stated that for some swaps (e.g., 

forward settling interest rate swaps), all 

terms may not be known when the swap 

is executed. 

MetLife requested that the 

Commission extend the timeframe for 

delivery and return of confirmations for 

transactions not executed on a SEF or 

DCM as such are often highly structured 

and customized and it is unreasonable 

to expect parties to generate a 

confirmation within the timeframe set 

forth in the proposed rules. MetLife 

recommended that the Commission 

revise the proposed rules to provide 

three business days following execution 

for delivery of an acknowledgement for 

such transactions and at least two 

business days following receipt of an 

acknowledgement to review and return 

a confirmation. 

GFED stated that the various 

deadlines are significantly too short for 

many FX swap trades and 

inappropriately rely on both parties 

complying with the proposed rules. 

GFED recommends that the Commission 

revise the proposed rules, as such are 

applied to FX swap trades, taking into 

account: (i) The method of confirmation 

(electronic/paper); (ii) the complexity of 

the underlying transaction (e.g., vanilla 

options vs. basket options); and (iii) the 

counterparty type. 

MFA recommended that the 

Commission specify no timeframe for 

confirmation, allowing parties to 

execute whenever market conditions are 

favorable with the expectation that they 

may negotiate non-economic terms later. 

(B) Comments on Time Periods for 

Confirmation With Non-SDs and NonMSPs 

With respect to the proposed 

confirmation time periods for swaps 

between an SD or MSP and a non-SD or 

non-MSP specifically, ISDA commented 

that the rule lacks clarity on how nonregistrant counterparties can be required 

to comply with the confirmation 

requirements. The FHLBs echoed 

ISDA’s comment, arguing that the 

proposed timeframe may lead SDs and 

MSPs to put undue pressure on end 

users to execute confirmations before 

such parties have had an opportunity to 

fully review such confirmations. To 

alleviate this concern, the FHLBs argued 

that the proposed rules should allow 

SDs and MSPs at least 48 hours to 

provide end users with an 

acknowledgement, at least two business 

days for end users to review 

acknowledgements and execute 

confirmations, and provide for an 

exception from the confirmation 

deadlines for complex or unique swap 

transactions (as determined by the 

parties) upon notice to the Commission 

detailing the unique or complex aspects 

of the swap and the date by which a 

confirmation will be executed. 

Chatham recommended an alternative 

confirmation requirement for swaps 

with non-SDs and non-MSPs: 

• For electronically confirmed swaps, 

an acknowledgement would be required 

to be submitted electronically on the 

same or next business day after 

execution, and swap terms would be 

required to be affirmed, matched or 

otherwise confirmed or a notice of 

discrepancy provided within three 

business days; any discrepancy would 

be required to be resolved and the swap 

confirmed within five business days 


sroberts on DSK5SPTVN1PROD with RULES
55922 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

24Compare with ESMA Draft Technical 

Standards, Article 1 RM, subsection 2, (stating that 

uncleared OTC derivatives ‘‘shall be confirmed, 

where available via electronic means, as soon as 

possible and at the latest by the end of the same 

business day.’’). 

25See 17 CFR 43.2, Real-Time Public Reporting 

of Swap Transaction Data, 77 FR 1182, 1243–44 

(Jan. 9, 2012); 17 CFR 45.3, Swap Data 

Recordkeeping and Reporting Requirements, 77 FR 

2136, 2199–2200 (Jan. 13, 2012). 

26Compare with ESMA Draft Technical 

Standards, Article 1 RM, subsection 3, (stating that 

uncleared OTC derivatives ‘‘shall be confirmed as 

soon as possible and at the latest by the end of the 

second business day following the date of 

execution.’’). 

after the discrepancy was 

communicated. 

• For non-electronically confirmed 

swaps, an acknowledgement would be 

required to be issued within one 

business day of execution; a notice of 

discrepancy provided within five 

business days; and confirmation 

required within 30 days. 

Dominion commented that the energy 

industry standard is to achieve 

confirmation of uncleared swaps not 

executed on an electronic platform 

within three business days, and that 

such standard is often documented in 

participants’ existing master 

agreements. Dominion thus argued that 

the proposed next business day 

confirmation requirement may conflict 

with end user contractual rights and 

obligations, and may cause end users to 

incur costs even though the Commission 

has not articulated a justifiable benefit 

to end users or the market. 

(C) Comments on Time Periods for 

Confirmation With Financial Entities 

Specifically with respect to 

confirmation of swap transactions 

between an SD or MSP and a financial 

entity, ABC & CIEBA stated that the 

‘‘same business day’’ confirmation 

requirement would impose costly 

increases in operational capacity for 

pension funds, which may discourage 

use of swaps or limit trading to earlier 

parts of the trading day. ABC & CIEBA 

recommended that the Commission 

provide for a ‘‘close of next business 

day’’ time limit for benefit plans and 

other non-SD, non-MSP counterparties. 

AMG also argued that financial entities 

should not be subject to shorter time 

periods for confirmation than nonfinancial end-users because many may 

not have the operational resources to 

meet the demands of the proposed rules. 

Similarly, Freddie Mac argued that it 

often takes several business days to 

correct and execute confirmations, and 

the proposed rules would not permit 

sufficient time for correction of draft 

confirmations or resolution of disputes 

over trade terms. 

While MFA agreed with the proposed 

longer time period for confirmation for 

swap transactions between an SD or 

MSP and counterparties that are not SDs 

or MSPs, but objected to a shorter time 

period for financial entity end users as 

compared to other end users. MFA 

argued that designation as a financial 

entity does not necessarily correlate 

with a large swap portfolio or being 

highly sophisticated with respect to 

swaps, and the short time period for 

confirmation applicable to financial 

entities under the proposed rules may 

cause unwarranted disadvantages in 

negotiation of swap terms with SDs and 

MSPs. 

Finally, the OCC believes that the 

same calendar day trade confirmation 

requirement for financial entities would 

eliminate or significantly reduce 

customized transactions between 

registrants and such entities, leading to 

less effective risk management. The 

OCC argued that the short confirmation 

deadline will require the parties to 

negotiate all terms prior to execution, 

leading to the unnecessary expenditure 

of resources for transactions that are 

never executed. The OCC further argued 

that negotiation prior to execution will 

delay execution, which itself can create 

risks in fast moving markets. 

(D) Comments on Confirmation of 

Swaps Between Parties in Different 

Time Zones 

The Commission received several 

comments concerned with the proposed 

time periods for confirmation as applied 

to swap transactions between parties in 

different time zones. 

Commenting on this aspect of the 

proposed rule, ISDA stated that crossborder transactions frequently require 

more than one day to confirm due to 

business day and time zone differences; 

Chatham and GFED also commented 

that the proposed timeframes fail to 

account for coordination across time 

zones. 

(E) Comments on Confirmation of 

Swaps Executed at End of Day 

The Commission also received several 

comments concerned with the proposed 

same day confirmation requirement for 

swap transactions among SDs and MSPs 

and between an SD or MSP and a 

financial entity as applied to swap 

transactions executed near the end of 

the trading day. 

In this regard, ISDA, Chatham, the 

FHLBs, AMG, and GFED each 

commented that the rules should 

account for transactions executed 

toward the end of the business day that 

leave little or no time for same-day 

confirmation. To account for this issue, 

AMG recommended that parties should 

be given no less than 24 hours to 

confirm trades, while the FHLBs 

recommended that swap transactions 

executed after 3:00 p.m. EST should be 

considered executed on the immediately 

following business day. 

Commission Response 

The Commission has considered the 

many comments with respect to the 

proposed time periods for confirmation 

and has decided to revise the proposed 

rule in a number of ways to better attune 

the rule to the intention of the 

Commission’s proposal, the concerns 

raised by commenters, and the needs of 

the market. The Commission has revised 

the proposed rule as discussed below. 

The proposed time periods for swaps 

executed or processed electronically 

have been replaced in their entirety by 

a requirement that, subject to a 

compliance phase-in schedule, all 

swaps among SDs and MSPs or between 

SDs, MSPs, and financial entities be 

confirmed ‘‘as soon as technologically 

practicable,’’ but no later than the end 

of the first business day following the 

day of execution.24 The Commission 

believes this change still requires 

electronically executed or processed 

trades to be confirmed quickly, but is 

responsive to commenters that have 

provided examples of processing 

operations that contain some electronic 

elements but are not ‘‘straight-through’’ 

in the sense intended by the proposed 

rules and therefore are incapable of 

meeting the proposed 15 or 30 minute 

deadlines. 

In revising the rule, the Commission 

also was persuaded by the comments of 

market participants that are concerned 

with the possibility of pressure by their 

dealer counterparties to make costly 

changes to their operating systems in 

order to meet the required confirmation 

deadlines. The Commission notes that 

these changes also make the 

confirmation rule consistent with the 

real-time public reporting rules and the 

rules mandating deadlines for the 

reporting of swap data to SDRs, both of 

which use ‘‘as soon as technologically 

practicable’’ as the applicable 

standard.25

With respect to the proposed time 

periods for swaps executed between SDs 

and MSPs and counterparties that are 

not SDs, MSPs, or financial entities, the 

Commission has modified the rule to 

require, subject to a compliance phasein schedule, policies and procedures 

reasonably designed to ensure that a 

confirmation is executed no later than 

the end of second business day after 

execution.26 The Commission believes 

this change will afford SDs and MSPs an 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55923 

27Compare with ESMA Draft Technical 

Standards, Article 1 RM, subsection 3, (stating that 

where an uncleared OTC derivative transaction ‘‘is 

concluded after 16.00 local time, or when the 

transaction is concluded with a counterparty that is 

located in a different time zone that does not allow 

for same day confirmation, the confirmation shall 

take place as soon as possible and at the latest by 

the end of the next business day.’’) 

28See 71 CFR 45.1, Swap Data Recordkeeping and 

Reporting, 77 FR 2136, 2197 (Jan. 13, 2012). 

29See Customer Clearing Documentation, Timing 

of Acceptance for Clearing, and Clearing Member 

Risk Management, 77 FR 21278, 21306 (Apr. 9, 

2012) (providing that ‘‘Orders eligible for postexecution allocation must be allocated by an 

eligible account manager in accordance with the 

following: (A) Allocations must be made as soon as 

practicable after the entire transaction is executed, 

but in any event no later than the following times: 

For cleared trades, account managers must provide 

allocation information to futures commission 

merchants no later than a time sufficiently before 

the end of the day the order is executed to ensure 

that clearing records identify the ultimate customer 

for each trade. For uncleared trades, account 

managers must provide allocation information to 

the counterparty no later than the end of the 

calendar day that the swap was executed.’’). 

extra business day to confirm their swap 

transactions with non-financial entities 

and is more consistent with the time 

periods suggested by commenters. 

In response to commenters, as 

discussed above, the Commission is 

revising the proposed rule to state 

explicitly that swaps executed on a SEF 

or DCM, and swaps cleared by a DCO, 

will be deemed to have met the 

confirmation requirements so long as: (i) 

confirmation of all terms of the 

transaction takes place at the same time 

as execution on a SEF or DCM; or (ii) 

the parties submit the swap for clearing 

no later than the time that confirmation 

would otherwise be required and the 

DCO confirms the terms of the swap 

upon acceptance for clearing. To ensure 

that no swap transaction goes 

unconfirmed, the modified rule also 

contains a backstop requirement for SDs 

and MSPs to confirm a swap for which 

the registrant receives notice that a SEF, 

DCM, or DCO has failed to provide a 

confirmation on the same day as it 

receives such notice. 

Based on the comments received, the 

Commission is also modifying the 

proposed rule to adjust the confirmation 

deadline for swaps among SDs and 

MSPs and between SDs, MSPs, and 

financial entities whenever the parties 

(i) execute a swap near the end of the 

trading day (i.e., after 4 p.m.), or (ii) 

execute a swap with a counterparty 

located in a different time zone. The 

Commission has been persuaded by 

commenters that registrants should not 

be required to maintain back-office 

operations 24 hours a day or 7 days a 

week in order to meet the proposed 

confirmation deadlines. The 

Commission has been particularly 

sensitive to comments stating that the 

proposed confirmation deadlines may 

discourage trade execution late in the 

day. Specifically, the Commission has 

made the following changes to the 

proposed rule: 

• To account for time-zone issues, the 

‘‘day of execution’’ has been defined to 

be the calendar day of the party to the 

swap that ends latest, giving the parties 

the maximum amount of time to 

confirm the transaction within the 

deadlines required by the rule. 

• To account for end-of-day trading 

issues, the definition of ‘‘day of 

execution’’ deems such day to be the 

next succeeding business day if 

execution occurs after 4:00 p.m. in the 

place of either counterparty. 

• To account for non-business day 

trading, the ‘‘day of execution’’ is also 

deemed to be the next succeeding 

business day if execution occurs on a 

day that is not a business day.27

The Commission notes that this 

approach is consistent with the business 

day definition in the Swap Data 

Recordkeeping and Reporting Rules 

finalized by the Commission in 

December 2011.28

Despite several commenters’ 

concerns, however, the Commission has 

declined to modify the proposed 

requirement that SDs and MSPs 

establish policies and procedures 

reasonably designed to ensure that 

swaps with financial entities meet the 

same confirmation deadlines as swaps 

among SDs and MSPs. While the 

Commission recognizes that an SD or 

MSP may not be able to ensure that a 

non-registrant financial entity abides by 

the confirmation deadline in each and 

every instance, it believes that ‘‘policies 

and procedures reasonably designed to 

ensure’’ is not the same as requiring a 

guarantee of compliance. Therefore, the 

Commission believes that the rule 

contains sufficient flexibility because it 

only requires that the SDs and MSPs 

make reasonable efforts to confirm 

swaps with financial entities by the 

stated deadline. 

As discussed below in section III.B.2, 

the Commission is phasing in 

compliance with each of the time 

periods required under § 23.501. This 

compliance schedule is set forth in the 

rule text and seeks to further address 

concerns from market participants 

regarding the timing of compliance. 

9. Allocation of Block Trades 

The proposed regulations did not 

address confirmation in the context of 

block trades that must be allocated prior 

to confirmation. 

With respect to the allocation of block 

trades, ISDA argued that the proposed 

confirmation rule will be difficult for 

asset managers to implement because 

asset managers often execute block 

trades and then allocate the block to two 

or more clients, a process than can take 

significantly longer than the 

confirmation time periods because the 

allocation process hinges on compliance 

processes or receipt by investment 

managers of instructions from their 

clients. In ISDA’s view, if finalized as 

proposed, the rule could force 

investment managers to execute 

individual trades for their clients, 

increasing pricing and operational costs. 

AMG echoed this point. 

Intercontinental Exchange, Inc. (ICE) 

also pointed out that the confirmation 

deadlines in the proposed rules may 

make it impossible for asset managers to 

make post-execution allocation of 

trades. ICE stated that its own trade 

processing service for CDS requires that 

trades be allocated within two hours of 

execution and recommended that the 

Commission adopt a similar standard. 

While the Commission acknowledges 

that allocation of block trades is 

required to achieve confirmation, it 

notes that the modifications to the rule 

outlined above replaces the 15 and 30 

minute confirmation deadlines with a 

requirement that swaps be confirmed 

‘‘as soon as technologically practicable, 

or in any event by the end of the first 

business day following the day of 

execution.’’ The Commission thus 

believes that the rule as modified allows 

registrants and the asset managers for 

their counterparties the flexibility to 

work out an efficient and timely 

allocation process within the deadlines 

for confirmation as adopted in this 

release. The Commission also notes that 

recent amendments to Commission 

regulation § 1.35 address the allocation 

issue by requiring that account 

managers must provide allocation 

information to the counterparty no later 

than the end of the calendar day that the 

swap was executed.29

10. Time Period for Delivery of 

Acknowledgement—§ 23.501(a)(2) 

Proposed § 23.501(a)(2) set forth at 75 

FR 81519, 81531 (Dec. 28, 2010) 

required SDs and MSPs to send an 

acknowledgement containing all of the 

terms of a swap transaction to each 

counterparty that is not an SD or MSP. 

In response to the proposal, ISDA 

asserted that the time periods proposed 

are impractical because: (i) Certain 

terms required to be included in an 

acknowledgement may not be known on 


sroberts on DSK5SPTVN1PROD with RULES
55924 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

30See Confirmation NPRM at 81520. 

31See Derivatives Clearing Organization General 

Provisions and Core Principles, 76 FR 69334, 69438 

(Nov. 8, 2011). Under § 39.12(b)(7), DCOs are 

required to accept or reject for clearing as quickly 

after execution as would be technologically 

practicable if fully automated systems were used all 

contracts that are listed for clearing by the DCO and 

are executed on or subject to the rules of a DCM 

or a SEF. See Customer Clearing Documentation, 

Timing of Acceptance for Clearing, and Clearing 

Member Risk Management, 77 FR 21278, 21309 

(April 9, 2012). 

32See Core Principles and Other Requirements for 

Designated Contract Markets, 77 FR 36612, 36705 

(June 19, 2012). 

33See Core Principles and Other Requirements for 

Swap Execution Facilities, 76 FR 1214, 1240 (Jan. 

7, 2011). 

the same calendar day as execution (e.g., 

initial rates may follow trade 

commitment by days); and (ii) valuation 

methodologies required to be agreed 

prior to execution pursuant to proposed 

§ 23.504(b)(4) may also slow down the 

acknowledgement process to the extent 

such methodologies are required to be 

reflected in the acknowledgement. 

Similarly, MarkitSERV recommended 

that acknowledgements be sent within a 

time period after all information has 

been obtained (rather than after 

execution), while AMG argued that the 

time periods are unnecessarily short and 

do not bear a reasonable relationship to 

the systemic risk goals of the DoddFrank Act, would be burdensome for 

uncleared swaps which merit more 

individualized treatment, and could 

impose excessive costs on swap market 

participants. 

Based on these comments and other 

considerations discussed above, the 

Commission has revised the proposed 

rule to delete the 15 and 30 minute 

acknowledgement delivery deadlines 

and replace them with a requirement, 

subject to a compliance phase-in 

schedule, that an acknowledgement be 

provided ‘‘as soon as technologically 

practicable, but in any event by the end 

of the day of execution;’’ to state 

explicitly that the acknowledgement 

requirement will be deemed satisfied by 

executing a swap on a DCM or SEF, or 

clearing the swap through a DCO; and 

to provide for an adjustment to the ‘‘day 

of execution’’ to account for time-zone 

differences and end-of-day trading 

issues. The Commission believes these 

changes are responsive to the foregoing 

comments. However, in response to the 

comments of ISDA and MarkitSERV 

regarding terms that may not be known 

until after the acknowledgement 

delivery deadline has passed, the 

Commission believes that an 

acknowledgement could meet the 

requirement that all terms be included 

by describing where and when the ‘‘to 

be determined’’ terms will be obtained 

and provide for incorporation by 

reference once the terms are known. 

As discussed below in section III.B.2, 

the Commission is phasing in 

compliance with each of the time 

periods required under § 23.501, 

including the acknowledgement 

requirement. 

11. Confirmation Through Execution on 

a SEF or DCM and/or Clearing on a DCO 

The proposed regulations did not 

contain specific provisions regarding 

confirmation through execution on a 

SEF or DCM, or clearing on a DCO. 

However, in the Confirmation NPRM, 

the Commission stated: ‘‘It is important 

to note at the outset, that the 

Commission expects that swap dealers 

and major swap participants would be 

able to comply with each of the 

proposed rules by executing a swap on 

a swap execution facility (SEF) or on a 

designated contract market (DCM), or by 

clearing the swap through a derivatives 

clearing organization (DCO). For swaps 

executed on a SEF or a DCM, the SEF 

or DCM will provide the counterparties 

with a definitive written record of the 

terms of their agreement, which will 

serve as a confirmation of the swap. 

Similarly, if a swap is executed 

bilaterally, but subsequently submitted 

to a DCO for clearing, the DCO will 

require a definitive written record of all 

terms to the counterparties’ agreement 

prior to novation by the DCO; this too 

would serve as a confirmation of the 

swap.’’ 30

Commenting on this aspect of the 

proposal, Chris Barnard supported the 

idea that SDs and MSPs will be able to 

comply with the proposed rule by 

executing a swap on a SEF, a DCM, or 

by clearing the swap through a DCO, 

and supported the greater use of these 

facilities. Each of ISDA, CME, ICE, The 

Working Group, the FHLBs, MetLife, 

MFA, and Chatham recommended that 

the Commission explicitly clarify in the 

final rules that the confirmation 

processes of SEFs, DCMs, and DCOs 

satisfy the requirements of the 

confirmation rules. 

MarkitSERV however asserted that the 

Commission should not presume that 

execution on a SEF will automatically 

result in confirmation of a swap because 

the execution and confirmation of a 

swap are separate and distinct activities, 

and it is possible that SEFs and DCMs 

may offer execution services without 

necessarily providing confirmation 

services. MarkitSERV recommended 

that the Commission prescribe 

standards for any confirmation service 

that may be offered to ensure that SEFs 

and DCMs produce a complete, legally 

binding record of each swap based on a 

recognized legal framework. 

MarkitSERV also recommended that 

SEFs and DCMs be permitted to allow 

qualified third parties to perform the 

confirmation function after swap 

execution. 

Based on these comments and other 

considerations discussed above, the 

Commission has revised the proposed 

rules to state explicitly that swaps 

executed on a SEF or DCM, and swaps 

cleared by a DCO, will be deemed to 

have met the confirmation requirements 

so long as: (i) confirmation of all terms 

of the transaction takes place at the 

same time as execution on a SEF or 

DCM; or (ii) the parties submit the swap 

for clearing no later than the time that 

confirmation would otherwise be 

required and the DCO confirms the 

terms of the swap upon acceptance for 

clearing. Under § 39.12(b)(8), DCOs are 

required to provide a confirmation of all 

the terms of each cleared swap, and this 

confirmation is required to take place at 

the same time the swap is accepted for 

clearing.31 Under Core Principle 11 for 

DCMs and § 38.601, DCMs must clear all 

transactions executed on or through the 

DCM through a Commission-registered 

DCO.32 In essence, confirmation for 

DCM-executed swaps will occur either 

at the same time as execution or upon 

submission to a DCO. The Commission’s 

rules for SEFs, including the proposed 

confirmation rule, § 37.6(b), have yet to 

be finalized.33 However, to the extent 

that a SEF offers confirmation services 

upon execution or provides for the 

timely submission of a swap for 

clearing, SDs and MSPs would be able 

to take advantage of the provisions of 

§ 23.501(a)(4). 

With respect to MarkitSERV’s 

comments, the Commission notes that if 

a SEF or DCM does not provide 

confirmation services, the confirmation 

deadlines of the rule will control. The 

standards for confirmation by SEFs and 

the ability of a SEF to allow a third 

party to provide the confirmation 

service are outside the scope of this 

adopting release. 

12. Confirmation of Swap Transaction 

and Ownership Modifications— 

§ 23.500(m) 

The proposed regulations required 

SDs and MSPs to comply with the 

confirmation requirements for all ‘‘swap 

transactions.’’ The proposed regulations 

defined ‘‘swap transaction’’ as any event 

that results in a new swap or in a change 

to the terms of a swap, including 

execution, termination, assignment, 

novation, exchange, transfer, 

amendment, conveyance, or 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55925 

extinguishing of rights or obligations of 

a swap. 

In response to this requirement, ISDA 

stated that some ‘‘market’’ life cycle 

events (e.g., option exercise notices, 

various notices sent by calculation 

agent, etc.) captured by the definition of 

‘‘swap transaction’’ are already 

described in the original confirmation 

and sees no benefit to confirming those 

events. ISDA distinguished ‘‘market’’ 

from ‘‘legal’’ life cycle events (e.g., 

novations and terminations), which 

currently are confirmed. ISDA stated 

that industry methodologies have been 

developed around the confirmation of 

legal life cycle events at great time and 

expense and recommends that the 

Commission defer to industry standards 

and to allow market participants to 

bilaterally agree that certain life cycle 

events do not require subsequent 

confirmation. ISDA believes that the 

proposed life cycle confirmation 

requirement will undermine the move 

to electronic execution and processing, 

because not all life cycle events are 

currently supported by electronic 

platforms across asset classes. 

BGA recommended that the 

Commission revise the proposed 

definition of ‘‘swap transaction’’ to 

include only those life-cycle events that 

impact the economics or settlement of 

the trade, as current practice of energy 

commodity trading companies is not to 

send new confirmations for events like 

novations. 

GFED believes that the Commission 

should exclude FX swaps from any lifecycle event confirmation requirement. 

GFED states that efficient processes 

around trade events already exist (e.g., 

option exercises confirmed as new 

trades), and that ISDA has developed a 

novation protocol in wide use that is 

moving the industry toward novation 

without confirmation. 

While MFA supports confirmation of 

life-cycle events, it recommended that 

the Commission not mandate specific 

timing requirements for the 

confirmation of life-cycle events. MFA 

states that once a life-cycle event occurs, 

parties to a swap may need to 

renegotiate certain trade terms and a 

timing requirement is likely to 

disadvantage end users in such 

negotiation with SDs. 

The Working Group recommended 

that confirmation of changes to material 

economic or legal terms of a swap 

should be confirmed, but the 

confirmation should only be required 

within a reasonable period of time, 

rather than the time periods imposed for 

newly executed swaps. The Working 

Group also argued that events related to 

the underlying exposure of a swap 

should not be subject to any 

confirmation requirement as they are 

generally addressed in master trading 

agreements or the applicable 

confirmation. 

Having considered these comments, 

the Commission has determined not to 

modify the proposed rule with respect 

to this issue. In reaching this 

conclusion, the Commission observes 

that the definition of ‘‘swap transaction’’ 

would require confirmation of changes 

to the terms of a swap that have been 

agreed between the parties or that 

change the ownership of a swap. 

However, the definition does not require 

confirmation of events that may impact 

the economics of the swap. To the 

extent that the documented terms of a 

swap are agreed to in advance and 

provide for automatic changes to terms 

upon the occurrence of a defined event, 

the Commission believes that such 

change would not require confirmation 

pursuant to the rule. 

13. Legal Uncertainty for Swaps 

Following Failure to Comply With Swap 

Confirmation Rules 

The proposal did not address the 

issue of the legal standing or 

enforceability of a swap transaction that 

is not confirmed within the time periods 

mandated by the proposed rules. 

In respect of this issue, the FHLBs 

commented that such failure should not 

affect the enforceability of the swaps 

because such an outcome would lead to 

legal uncertainty in the swap market, 

and The Working Group recommended 

that the Commission clearly indicate the 

regulatory and legal consequences of 

one or more parties to a swap failing to 

meet the timing requirements for 

acknowledgement and confirmation, 

asserting its view that a swap should not 

be invalidated for the failure to meet the 

timing requirements of the proposed 

rules. 

MFA also argued that legal certainty 

of trade execution is vital for all market 

participants and the proposed rules may 

lead to uncertainty as to the 

enforceability of transactions that fail to 

be confirmed in compliance with the 

requirements of the proposed rules. To 

avoid this result, MFA recommended 

that the rule be revised to require only 

that an SD or MSP deliver an 

acknowledgement specifying the 

primary economic terms of a swap 

(rather than all terms), and specify no 

timeframe for confirmation. 

Recognizing the concerns raised by 

commenters with respect to legal 

certainty, the Commission notes that it 

is not the intent of the confirmation rule 

to provide swap counterparties with a 

basis for voiding or rescinding a swap 

transaction based solely on the failure of 

the parties to confirm the swap 

transaction in compliance with the 

proposed rules. In the absence of fraud, 

the Commission will consider an SD or 

MSP to be in compliance with the 

confirmation rule if it has complied in 

good faith with its policies and 

procedures reasonably designed to 

comply with the requirements. 

However, the Commission notes that it 

does not have the authority to immunize 

SDs or MSPs from private rights of 

action for conduct within the scope of 

section 22 of the CEA, i.e., violations of 

the CEA. 

14. Recordkeeping Requirements for 

Acknowledgements and Confirmation— 

§ 23.501(b) 

Proposed § 23.501(b) required SDs 

and MSPs to keep a record of the date 

and time of transmission of 

acknowledgements and confirmations, a 

record of the length of time between 

acknowledgement and confirmation, 

and a record of the length of time 

between execution and confirmation. 

Commenting on the proposal, The 

Working Group recommended that only 

a time stamp on acknowledgements and 

confirmations be required as the 

remainder of the required records in the 

proposed rules could be determined 

from the timestamps on these 

documents. The Working Group also 

requested that the Commission clarify 

how the recordkeeping requirements in 

the proposed confirmation rule apply to 

lifecycle events because timestamps for 

some lifecycle events would not make 

sense. 

MarkitSERV recommended that the 

Commission clarify that an SD’s or 

MSP’s recordkeeping requirements may 

be delegated to a third-party 

confirmation platform and the 

conditions under which such delegation 

may be done. 

BGA argued that energy commodity 

traders place orders with broker/dealers 

and may be unaware of the time at 

which a trade is actually executed, and 

unable to keep accurate records of the 

length of time between execution and 

confirmation of a swap. BGA therefore 

recommended that the Commission 

remove the recordkeeping requirements 

from the proposed rules. 

GFED commented that the time stamp 

requirements of the proposed 

recordkeeping rules would require 

significant technology investment as 

current systems typically do not time 

stamp at issuance or receipt. 

Having considered these comments, 

the Commission is modifying the 

recordkeeping requirement. First, the 

Commission is removing the 


sroberts on DSK5SPTVN1PROD with RULES
55926 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

requirement that SDs and MSPs keep 

records of the length of time between 

the acknowledgment and confirmation 

of a swap, as well as the time between 

execution and confirmation, as this 

information can be readily ascertained 

by reviewing other records. Second, the 

cross-reference to § 1.31 has been 

changed to refer to the record retention 

rule applicable to SDs and MSPs, 

§ 23.203. Apart from these 

modifications, the Commission believes 

the records required to be made and 

maintained under § 23.501(b) are the 

minimum necessary to monitor 

compliance with the rule. In addition, 

the Commission notes that certain items 

in the recordkeeping requirement is 

information that will be required for 

compliance with other Commission 

rules, such as the time of execution for 

real-time public reporting of pricing and 

transaction data and for reporting to an 

SDR. 

In response to MarkitSERV, the rule 

does not prohibit SDs and MSPs from 

relying on third-party service providers 

to achieve compliance with the rule, 

although the responsibility for 

compliance cannot be delegated. 

Finally, in response to The Working 

Group’s comment, the Commission is 

not persuaded that it is impossible to 

keep time-stamped records of key 

changes in ownership including such 

significant events as execution, 

termination, assignment, novation, 

exchange, transfer, amendment, 

conveyance, or extinguishing of rights 

or obligations. The Commission believes 

that its clarification of the ‘‘swap 

transaction’’ definition above alleviates 

any concern that the rule imposes an 

impossible recordkeeping requirement. 

E. Portfolio Reconciliation—§ 23.502 

Portfolio reconciliation is a postexecution processing and risk 

management technique that is designed 

to: (i) Identify and resolve discrepancies 

between the counterparties with regard 

to the terms of a swap either 

immediately after execution or during 

the life of the swap; (ii) ensure effective 

confirmation of all the terms of the 

swap; and (iii) identify and resolve 

discrepancies between the 

counterparties regarding the valuation 

of the swap. In some instances, portfolio 

reconciliation also may facilitate the 

identification and resolution of 

discrepancies between the 

counterparties with regard to valuations 

of collateral held as margin. 

Accordingly, in the Confirmation 

NPRM, the Commission proposed 

§ 23.502, which required SDs and MSPs 

to reconcile their swap portfolios with 

one another and provide counterparties 

who are not registered as SDs or MSPs 

with regular opportunities for portfolio 

reconciliation. In order for the 

marketplace to realize the full risk 

reduction benefits of portfolio 

reconciliation, the Commission also 

proposed to expand portfolio 

reconciliation to all transactions, 

whether collateralized or 

uncollateralized. For the swap market to 

operate efficiently and to reduce 

systemic risk, the Commission believed 

that portfolio reconciliation should be a 

proactive process that delivers a 

consolidated view of counterparty 

exposure down to the transaction level. 

By identifying and managing 

mismatches in key economic terms and 

valuation for individual transactions 

across an entire portfolio, the 

Commission’s proposal sought to 

require a process in which overall risk 

can be identified and reduced. The 

Commission received numerous 

comments to the portfolio reconciliation 

proposal and considered each in 

formulating the final rules, as discussed 

below. 

1. Statutory Basis for Portfolio 

Reconciliation 

The proposed portfolio reconciliation 

regulations were proposed pursuant to 

section 4s(i) of the CEA, as added by 

section 731 of the Dodd-Frank Act, 

which directs the Commission to 

prescribe regulations for the timely and 

accurate confirmation, processing, 

netting, documentation, and valuation 

of all swaps entered into by SDs and 

MSPs. 

The Working Group commented that 

the Commission should delete the 

reconciliation requirements from the 

proposed rule because section 731 of the 

Dodd-Frank Act does not require the 

Commission to issue rules on portfolio 

reconciliation and the Commission has 

not fully analyzed the potential effect on 

the market. 

In response to The Working Group’s 

comment, the Commission notes that 

portfolio reconciliation involves both 

confirmation and valuation and serves 

as a mechanism to ensure accurate 

documentation. Thus, the reconciliation 

requirements finalized herein are within 

the scope of section 4s(i) of the CEA. 

Moreover, the Commission reiterates its 

statement in the Confirmation NPRM 

that disputes related to confirming the 

terms of a swap, as well as swap 

valuation disputes impacting margin 

payments, have long been recognized as 

a significant problem in the OTC 

derivatives market, and portfolio 

reconciliation is considered an effective 

means of identifying and resolving these 

disputes. 

2. General Comments to Portfolio 

Reconciliation—§ 23.502 

Proposed § 23.502 required SDs and 

MSPs to engage in periodic swap 

portfolio reconciliation with their swap 

counterparties. Swap portfolio 

reconciliation is defined in the 

proposed rule as a process by which the 

two parties to one or more swaps: (i) 

Exchange the terms of all swaps in the 

portfolio between the parties; (ii) 

exchange each party’s valuation of each 

swap in a portfolio between the parties 

as of the close of business on the 

immediately preceding business day; 

and (iii) resolve any discrepancy in 

material terms and valuations. 

While Chris Barnard supported the 

proposed reconciliation requirements, 

several commenters objected to certain 

aspects of the rule. 

GFED commented that the portfolio 

reconciliation requirements are likely to 

be onerous, require significant 

investment in new infrastructure, and 

have few benefits for shorter dated FX 

swaps. GFED therefore recommended 

that the rules require only: (i) 

Reconciliation of portfolio valuations 

(as opposed to differences in valuation 

or trade specifics at the transaction 

level) because there is existing market 

infrastructure in place for this purpose; 

and (ii) reconciliation on a weekly basis 

with longer timeframes for resolving 

discrepancies that reflect the global 

nature of the FX market. 

MFA stated that current market 

practice is for market participants to 

engage in portfolio reconciliation at the 

transactional level only if there are 

portfolio-level discrepancies that result 

in margin disputes, and MFA 

recommended that the Commission only 

require portfolio reconciliation upon the 

occurrence of a material dispute 

regarding margin to avoid unnecessary 

expense. MFA also believes the 

Commission should accommodate 

participants with differing policies, 

procedures, business models, structures, 

and types of swaps by providing general 

principles and guidelines as to what 

constitutes best practices, but not 

prescriptive rules. 

ISDA stated that current portfolio 

reconciliation processes in the industry 

are a means of identifying the source of 

a material collateral dispute at the 

portfolio level. ISDA believes the draft 

2011 Convention on Portfolio 

Reconciliation and the Investigation of 

Disputed Margin Calls and the draft 

2011 Formal Market Polling Procedure, 

developed pursuant to industry 

commitments to the ODSG, which ISDA 

believes will be widely adopted by OTC 

derivatives market participants, should 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55927 

34For example, DTCC’s Trade Information 

Warehouse maintains the centralized global 

electronic database for virtually all CDS contracts 

outstanding in the marketplace. The repository 

maintains the most current credit default swap 

contract details on the official legal, or gold record, 

for both cleared and bilateral CDS transactions. 

play a more significant role in shaping 

the proposed reconciliation rules. 

Specifically, ISDA believes that 

portfolio reconciliation should be 

defined by reference to generallyaccepted industry standards, as 

instituted through the ODSG process, 

and reflected in data standards and best 

practices as published by ISDA. 

While TriOptima supports the regular 

reconciliation of all portfolios and 

believes that this will identify issues 

that can minimize counterparty credit 

exposure and operational risk, 

TriOptima also believes that the 

Commission should not require 

registrants to agree on reconciliation 

procedures, but should encourage the 

use of industry-wide practices and 

protocols. 

The Commission has not modified the 

rule based on these comments, but 

certain elements of the rule have been 

modified based on specific comments 

received, as discussed below. The 

Commission believes that regular 

portfolio reconciliation will prevent 

most disputes from arising and therefore 

does not recommend that portfolio 

reconciliation be performed only on an 

ad hoc basis in response to a material 

margin dispute at the portfolio level. 

The Commission notes that portfolio 

reconciliation is not required for cleared 

swaps where the DCO holds the 

definitive record of the trade and 

determines a binding daily valuation for 

each swap cleared by the DCO. 

Therefore the Commission believes that 

portfolio reconciliation will become less 

burdensome as the bilateral portfolios of 

SDs and MSPs become significantly 

smaller over time as a result of required 

clearing of swaps. In addition, the need 

for portfolio reconciliation may be 

obviated at such time as all swaps are 

reported to SDRs. For example, if an 

SDR record of a swap is, by agreement 

of the parties, the legally operative 

documentation of the swap, the parties 

need only consult the SDR record to 

reconcile their portfolios.34

3. Reconciliation of Material Terms— 

§ 23.502(a)(4) & (b)(4) 

The proposed regulations required 

SDs and MSPs to resolve any 

discrepancy in material terms of swaps 

in a swap portfolio discovered during 

the process of portfolio reconciliation. 

Commenting on this aspect of the 

proposal, ISDA stated that current 

portfolio reconciliation processes in the 

industry are not meant to resolve swap 

terms that do not lead to a material 

collateral dispute and that the proposed 

rule would cause reconciliation to 

become a replacement for the 

confirmation process. Similarly, The 

Working Group stated that the 

Commission should not require 

reconciliation of terms other than 

valuations to avoid imposing substantial 

costs on market participants in the 

absence of any immediate need. 

MarkitSERV asserted that the purpose 

of portfolio reconciliation is the 

resolution of disputes that materially 

impact collateralization at the portfolio 

level, and thus it is unnecessarily 

burdensome to require any discrepancy 

in material terms to be resolved. 

MarkitSERV recommended that the 

Commission only require reconciliation 

of terms that could have a material 

impact on the valuation or 

collateralization of a swap. 

The FHLBs commented that it is not 

necessary to repeatedly reconcile all 

terms of swaps that have been reported 

to a SDR as most if not all such terms 

will not change from day-to-day or even 

month-to-month. The FHLBs believe 

that SDRs will be in the best position to 

efficiently and effectively detect and 

manage discrepancies in the material 

terms of a swap transaction. Likewise, 

MetLife recommended that the 

Commission revise the proposed 

reconciliation rule to require only the 

reconciliation of variable economic 

terms, as the repeated review of static 

terms confirmed during the 

confirmation process would be an 

undue burden and expense. 

TriOptima, on the other hand, 

recognized that the Commission’s 

proposal focuses on reconciliation of 

material terms in portfolios. TriOptima 

believes that this is appropriate because 

the priority in reconciliation is on 

completeness of trade population, rather 

than granularity in trade details. 

Having considered these comments, 

the Commission is not making any 

change to the proposed requirement that 

all discrepancies in material terms be 

resolved. The Commission is not 

persuaded by commenters that a 

discrepancy in the terms of individual 

swaps would not be material to the 

swap portfolio as a whole unless such 

discrepancies impact collateralization at 

the portfolio level. Rather, the 

Commission believes that a discrepancy 

in the material terms of a swap indicates 

a failure in the confirmation process or 

a failure in a trade input or processing 

system. As noted in the preamble to the 

proposed rules, the Commission 

believes that the requirement that all 

swaps be reported to an SDR will reduce 

the burden imposed by the rule by 

facilitating efficient, electronic 

reconciliation for SDs, MSPs, and their 

counterparties. Accordingly, the two 

requirements are consistent and 

mutually reinforcing. 

4. Frequency of Portfolio 

Reconciliation—§ 23.502(b) 

Proposed § 23.502(b) required SDs 

and MSPs to reconcile swap portfolios 

with other SDs or MSPs with the 

following frequency: Daily for portfolios 

consisting of 300 or more swaps, at least 

weekly for portfolios consisting of 50 to 

300 swaps, and at least quarterly for 

portfolios consisting of fewer than 50 

swaps. For portfolios with 

counterparties other than SDs or MSPs, 

the proposed regulations required SDs 

and MSPs to establish policies and 

procedures for reconciling swap 

portfolios: Daily for swap portfolios 

consisting of 500 or more swaps, weekly 

for portfolios consisting of more than 

100 but fewer than 500 swaps, and at 

least quarterly for portfolios consisting 

of fewer than 100 swaps. 

Several commenters supported the 

frequency of reconciliation required by 

the proposed rule. Chris Barnard 

supported the frequency of the proposed 

reconciliation requirements, while 

TriOptima stated that a large number of 

SDs and MSPs already regularly 

reconcile their portfolios with each 

other and with other entities and that 

the increased frequency and inclusion 

of smaller portfolios as proposed should 

prove no obstacle to such entities. 

However, several commenters 

recommended alternatives. ISDA 

recommended that the Commission 

accept the portfolio size/frequency 

gradation established by the ODSG 

process, as that may change over time, 

which ISDA believes provides an 

internationally consistent and flexible 

standard. ISDA does not believe the 

proposed rule should distinguish 

between counterparty types for 

determining frequency of reconciliation 

because transaction population is an 

adequate guide. The Working Group 

argued that the frequency of portfolio 

reconciliation should be left up to the 

counterparties because they have the 

sophistication necessary to determine 

whether and with what frequency 

reconciliation is required in their own 

circumstances, which may be daily, 

weekly, upon discovery of a dispute, or 

not at all. In the alternative, The 

Working Group recommended that 

portfolio reconciliation be required 

quarterly with any counterparty with 

which a registrant has more than 100 

swaps, and annually with all other 


sroberts on DSK5SPTVN1PROD with RULES
55928 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

35 In December 2008, the ODSG’s group of 14 

major dealers committed to execute daily portfolio 

reconciliations for collateralized portfolios in 

excess of 500 trades between participating dealers 

by June of 2009. See June 2, 2009 summary of 

industry commitments, available at http://www.

isda.org/c_and_a/pdf/060209table.pdf. As of May 

2009, all participating dealers were satisfying this 

commitment. The ODSG dealers expanded their 

portfolio reconciliation commitment in March 2010 

to include monthly reconciliation of collateralized 

portfolios in excess of 1,000 trades with any 

counterparty. 

36Compare with ESMA Draft Technical 

Standards, Article 2 RM, subsection 4, (stating that 

‘‘In order to identify at an early stage, any 

discrepancy in a material term of the OTC 

derivative contract, including its valuation, the 

portfolio reconciliation shall be performed: * * * 

each business day when the counterparties have 

500 or more OTC derivative contracts outstanding 

with each other; * * * once per month for a 

portfolio of fewer than 300 OTC derivative contracts 

outstanding with a counterparty; * * * once per 

week for a portfolio between 300 and 499 OTC 

derivative contracts outstanding with a 

counterparty.’’) 

counterparties. Finally, Chatham 

recommended that the Commission 

revise the proposed rules to provide that 

reconciliation with end users is only 

required for swaps with maturities 

greater than one year and at the 

following frequency: Weekly for 

portfolios of 500 or more swaps; 

quarterly for portfolios of 100 to 500 

swaps; annually for portfolios of 50 to 

100 swaps; and optional reconciliation 

for portfolios of 50 or less swaps. 

Still other commenters objected more 

generally to the required frequency of 

reconciliation. Dominion argued that 

the rule should not override any 

contractual right that end users may 

have regarding reconciliation, including 

frequency and the process for resolving 

disputes, while AMG argued that 

reconciliation required under the 

proposed rules is unnecessarily frequent 

and imposes excessive costs that do not 

bear a reasonable relationship to the 

systemic risk goals of the Dodd-Frank 

Act. 

Finally, the OCC stated that many SDs 

will not be among the G–14 largest OTC 

derivatives dealers and, given the 

incremental progression that was 

necessary for the G–14 OTC derivatives 

dealers to develop the infrastructure 

necessary to increase reconciliation 

amongst themselves from weekly 

reconciliation for portfolios with 5,000 

or more trades in 2008 to the current 

daily reconciliation for portfolios of 500 

or more trades, the Commission should 

provide sufficient time for all registrants 

to develop required infrastructure. 

Having considered these comments, 

the Commission is modifying the 

proposed rule to require daily 

reconciliation of swap portfolios among 

SDs and MSPs only for swap portfolios 

of 500 or more swaps. The Commission 

continues to believe that the 

requirement that all swaps be reported 

to an SDR will lead to efficient, 

electronic reconciliation for SDs and 

MSPs, but, at the urging of commenters, 

has reduced the required frequency of 

reconciliation to match the frequency of 

reconciliation currently undertaken by 

the largest prospective SDs.35 In 

addition, the daily reconciliation 

requirement for swap portfolios among 

SDs and MSPs of 500 or more swaps 

brings the rule into conformance with 

international regulatory efforts.36

For portfolios with counterparties 

other than SDs or MSPs, the 

Commission is adopting the 

recommendation proposed by The 

Working Group—that portfolio 

reconciliation be required quarterly 

with any counterparty with which a 

registrant has more than 100 swaps, and 

annually with all other counterparties. 

The Commission believes this approach 

is largely consistent with that 

recommended by Chatham, and it 

responds, in part, to concerns expressed 

by AMG. The Commission believes it 

also will serve to lower the costs of the 

rule. Despite this change in the 

frequency of reconciliation required for 

portfolios with non-SD, non-MSP 

counterparties, the Commission 

reiterates its belief that periodic 

reconciliation with all counterparties is 

a best practice for those using swaps. 

In response to Dominion’s concern 

about the rule overriding contractual 

rights of market participants, the 

Commission wishes to clarify that 

parties are free to negotiate and elect 

whatever dispute resolution 

mechanisms they so choose. The 

reconciliation rule merely sets forth the 

minimum requirements and timing for 

reconciliation of swap portfolios. The 

rule is not intended to override 

contractual rights so long as SDs and 

MSPs are in compliance with these 

limited provisions. 

5. Exchange of Swap Data for Portfolio 

Reconciliation—§ 23.500(i) & § 23.502(b) 

The preamble to the proposed 

regulations stated that portfolio 

reconciliation could consist of one party 

reviewing the trade details and 

valuations delivered by the other party 

and either affirming or objecting to such 

details and valuations. MarkitSERV 

recommended that the Commission 

clarify the circumstances in which both 

parties would be required to exchange 

swap data and circumstances in which 

only one party would be required to 

send swap data to its counterparty for 

verification. Consistent with its prior 

statement, the Commission prefers to 

permit maximum flexibility and 

innovation in the process and thus will 

leave the circumstances of exchange or 

verification to the discretion of SDs, 

MSPs, and their counterparties. 

6. Portfolio Reconciliation With NonSDs/MSPs—§ 23.502 

The proposed regulation required SDs 

and MSPs to establish written policies 

and procedures for engaging in portfolio 

reconciliation with non-SDs and nonMSPs, which includes the reconciliation 

of valuations for each swap in the 

parties’ portfolio. 

Commenting on the proposal, 

MarkitSERV stated that buy-side firms 

view valuation data as private 

information. To allow for 

confidentiality, MarkitSERV 

recommends that the Commission 

permit non-SDs and non-MSPs to 

perform portfolio reconciliation via 

third parties in a process that would 

only disclose valuation data when a 

discrepancy exceeds the threshold set 

forth in the proposed rules. 

Dominion asserted that section 4s(i) of 

the CEA required the Commission to 

adopt regulations for netting and 

valuation for SDs and MSPs, but not end 

users, and objects that the proposed 

rules require SDs and MSPs to establish 

policies for reconciliation with end 

users and for resolution of valuation 

disputes with end users in a timely 

fashion. Dominion is concerned that an 

end user will be required to provide SDs 

with proprietary market valuations that 

could be used against the interests of the 

end user. Dominion therefore 

recommended that the Commission 

clarify that an SD’s or MSP’s written 

procedures may not require end users to 

disclose any proprietary market 

information for purposes of dispute 

resolution. 

The FHLBs argued that end users 

should not be subject to the same 

reconciliation requirements as SDs and 

MSPs because the swap portfolios of 

end users do not pose a significant risk 

to the overall financial system and the 

reconciliation requirements may 

increase the costs of swaps for end 

users. Chatham similarly argued that 

non-SDs and non-MSPs using swaps to 

hedge risk do not pose systemic risk so 

daily or weekly reconciliation is not 

necessary. 

As discussed above, the Commission 

is modifying the proposed rule to 

change the word ‘‘enforce’’ to ‘‘follow.’’ 

Based on commenters’ concerns that an 

SD or MSP cannot force a non-registrant 

to abide by the portfolio reconciliation 

requirements, the Commission is further 

modifying the proposed rule to require 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55929 

37Under typical DCO rules, clearing members are 

bound by the settlement price of the DCO and the 

product specifications of cleared swaps are set by 

the DCO. 

only that SDs and MSPs establish 

policies and procedures reasonably 

designed to ensure that they engage in 

portfolio reconciliation with nonregistrants with the modified frequency 

discussed above. The Commission 

believes that ‘‘reasonably designed to 

ensure’’ is not the same as requiring a 

guarantee of compliance. Therefore, the 

Commission believes that the rule, as 

modified, would require that the SDs 

and MSPs make reasonable efforts to 

engage in portfolio reconciliation with 

non-registrants, but would not give SDs 

or MSPs the authority to require it of 

their non-registrant counterparties. 

In addition, the Commission is 

modifying the proposed rule to clarify 

that discrepancies in material terms or 

valuation disputes that become known 

to the parties before the quarterly or 

annual reconciliation with non-SDs, 

non-MSPs, should be resolved in a 

timely fashion. With this change, the 

Commission notes that non-SD, nonMSP counterparties may bring a 

discrepancy or dispute to an SD’s or 

MSP’s attention and the SD or MSP 

counterparty must work to resolve those 

identified discrepancies and disputes. 

7. Portfolio Reconciliation With DCOs 

for Cleared Swaps—§ 23.502(c) 

The proposed regulations stated that 

the portfolio reconciliation 

requirements will not apply to swaps 

cleared by a DCO. 

With respect to this provision, 

MarkitSERV recommended that the 

Commission require SDs and MSPs to 

regularly reconcile their positions in 

cleared swaps against SDRs, DCOs, and 

clearing brokers to correct discrepancies 

between the DCO record and a firm’s 

internal records. 

The Commission has determined not 

to follow MarkitSERV’s 

recommendation on this point. DCOs 

maintain the definitive record of the 

positions of each of their clearing 

members (both house and customer) and 

mark those positions to a settlement 

price at least once a day.37 Accordingly, 

the Commission believes that cleared 

swaps do not present the same 

documentation and valuation issues that 

uncleared swaps do. The Commission 

notes that reconciliation of swap data 

between DCOs and SDRs is beyond the 

scope of this rulemaking, which is 

adopting regulations with respect to SDs 

and MSPs only. 

8. Portfolio Reconciliation by ‘‘Qualified 

Third Parties’’—§ 23.502(b) 

The proposed regulations permitted 

portfolio reconciliation to be performed 

on behalf of SDs, MSPs, and their 

counterparties by a qualified third party. 

Commenting on this proposal, ABC & 

CIEBA and AMG separately 

recommended that the Commission not 

require use of ‘‘qualified’’ third parties 

for portfolio reconciliation, but, rather 

should explicitly require that use of any 

third party service provider must be 

agreed by both parties and recognize 

that each party may use a different third 

party for reconciliation. Specifically, 

ABC & CIEBA recommended that 

§ 23.502(b)(1) and (2) be revised to read 

as follows: 

‘‘(1) Each swap dealer or major swap 

participant shall agree in writing with each 

of its counterparties on the terms of the 

portfolio reconciliation, including agreement 

on the selection of any third party. 

(2) The portfolio reconciliation may be 

performed on a bilateral basis by the 

counterparties or by one or more third parties 

selected by the counterparties in accordance 

with § 23.502(b)(1).’’ 

In response to these comments, the 

Commission is modifying the proposed 

rule to delete the word ‘‘qualified,’’ to 

require that the use of a third-party 

service provider be subject to agreement 

of the parties, and to provide that each 

party may use a different third party so 

long as the provisions of the rule are 

met. Further, per AMG’s comments, the 

Commission expects that parties will 

determine if the third-party is qualified 

based on their own policies. 

9. Reconciliation Discrepancy 

Resolution Procedures—§ 23.502(b)(4) 

The proposed regulations required 

that SDs and MSPs establish procedures 

reasonably designed to resolve any 

discrepancies in the material terms or 

valuation of each swap identified in the 

portfolio reconciliation process. 

Commenting on this aspect of the 

proposal, ABC & CIEBA recommended 

that the Commission revise 

§ 23.502(b)(4) in order to ensure that 

reconciliation dispute resolution by SDs 

and MSPs is fair, impartial, and evenhanded. 

The Commission agrees that 

reconciliation dispute resolution should 

be fair, impartial, and even-handed as 

recommended by ABC & CIEBA, but 

believes that the commenter’s concern 

will be addressed by deleting the word 

‘‘enforce’’ as discussed above. The 

Commission expects that SDs and MSPs 

will cooperate with their counterparties 

and any applicable third-party service 

provider in resolving discrepancies 

brought to light through portfolio 

reconciliation. 

10. Time Period for Resolution of 

Discrepancies in Material Terms— 

§ 23.502(a)(4) & (b)(4) 

With regard to portfolio reconciliation 

among SDs and MSPs, the proposed 

regulations required that any 

discrepancy in material terms be 

resolved immediately. 

Freddie Mac stated that in some cases 

it may be impossible to resolve a 

discrepancy in material terms 

immediately, as required under 

§ 23.502(a)(4). Freddie Mac 

recommended that the Commission 

should revise the proposed rules to 

provide that the timely and accurate 

processing and valuation requirements 

of the Dodd-Frank Act will be deemed 

satisfied whenever swaps are subject to 

a master netting agreement and 

collateral pledge agreement under 

which the parties mark net portfolio 

value to market and exchange collateral 

on the basis of such valuation as 

promptly as commercially reasonable. 

Having considered Freddie Mac’s 

comment, the Commission is adopting 

the rule as proposed with respect to 

immediate resolution of discrepancies 

in material terms in swaps among SDs 

and MSPs. Given the timely 

confirmation requirements of all terms 

of a swap as established under § 23.501, 

the Commission believes an immediate 

resolution of any material term 

discrepancy is appropriate. 

Additionally, the Commission believes 

that a longer period is not justified 

because resolution of a discrepancy in a 

material term will likely require an 

amendment of the trade record in the 

relevant SDR, which, for regulatory 

oversight purposes, should be as 

accurate as possible. 

11. Resolution of Valuation Disputes in 

Portfolio Reconciliation—§ 23.502(a)(5) 

& (b)(4) 

With regard to portfolio reconciliation 

among SDs and MSPs, the proposed 

regulations required that any 

discrepancy in the valuation of a swap 

be resolved within one business day. 

With regard to portfolio reconciliation 

between SDs or MSPs and nonregistrants, the proposed regulations 

required that SDs and MSPs have 

policies and procedures reasonably 

designed to resolve any discrepancy in 

the valuation of a swap in a timely 

fashion. 

With respect to this aspect of the 

proposal, ISDA commented that parties 

to a good-faith dispute should have a 

commercially reasonable timeframe in 

which to consult in order to find an 


sroberts on DSK5SPTVN1PROD with RULES
55930 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

appropriate resolution of the dispute. 

ISDA believes the draft 2011 

Convention on Portfolio Reconciliation 

and the Investigation of Disputed 

Margin Calls and the draft 2011 Formal 

Market Polling Procedure, developed 

pursuant to industry commitments to 

the ODSG, which ISDA believes will be 

widely adopted by OTC derivatives 

market participants, should play a more 

significant role in shaping the proposed 

reconciliation rules. The Working 

Group, the FHLBs, and AMG also 

recommended that the Commission 

support the valuation dispute resolution 

methodology sponsored by ISDA. 

In addition to its general comments, 

ISDA made specific recommendations: 

• Resolution is labor intensive and to 

avoid undue costs, discrepancies in 

terms and valuations should only 

require resolution if such are causing 

material portfolio-level collateral 

transfer disputes, rather than on a 

transaction by transaction basis, as it 

allows for the possibility that material 

but offsetting differences may exist in a 

portfolio. 

• Again to avoid undue costs, a 

materiality standard should apply to 

any mandated resolution requirement, 

because, in the absence of a 

collateralization requirement or a live 

dispute as to collateralization, 

discrepancies in valuation may be 

allowed to subsist as potentially 

harmless and may disappear through 

changes in portfolio composition over 

time. ISDA recommends that the ODSG 

resolution tolerances be adopted by the 

Commission, as such tolerances may be 

amended over time. 

• Resolution of a valuation dispute 

should mean that the discrepancy in a 

portfolio-level margin dispute is 

reduced such that it is within the 

applicable resolution tolerance, rather 

than requiring exact agreement. 

• Resolution of a valuation dispute 

should not require parties to make 

adjustments to their books and records. 

• Parties should be free to agree to 

accept that there is a difference in 

opinion as to value, so long as 

appropriate capital is held against any 

potential collateral shortfall. 

With respect to the proposal to 

require valuation disputes to be 

resolved within one business day, ISDA 

stated that a one-day timeframe for 

resolution of valuation discrepancies is 

infeasible, especially when applied to 

parties across vastly different global 

time zones, due to the need to analyze 

reconciliation results, escalate for 

trader-to-trader discussion or to senior 

management. Further, ISDA argued that 

some disputes prove to be intractable 

and must be resolved through a market 

poll, which requires time to build and 

populate a valuation model, which may 

take hours or even days. AMG also 

argued that the time periods are 

unnecessarily short and do not bear a 

reasonable relationship to the systemic 

risk goals of the Dodd-Frank Act, noting 

that the time periods are not consistent 

with recent ISDA dispute resolution 

protocols or other methodologies 

incorporated in master agreements, and 

could impose excessive costs on swap 

market participants. 

AMG recommended that the 

Commission clarify the consequences of 

failing to resolve a valuation dispute 

within the mandated timeframe. Freddie 

Mac stated that in some cases it may be 

impossible to resolve a discrepancy in 

valuation within one business day, 

while BGA does not believe that 

registrants should be penalized for 

failing to meet the one business day 

resolution deadline. BGA argued that (i) 

SDs and MSPs do not have control over 

their counterparties so resolution may 

take more than a day; and (ii) a hard 

deadline may disadvantage SDs and 

MSPs in negotiating a resolution with a 

counterparty that is not subject to a 

deadline. Finally, The Working Group 

argued that the proposed requirement 

that valuation disputes between 

registrants be resolved within one 

business day is not workable due to the 

complex calculations required, 

involvement of multiple functional 

groups within a registrant, and 

possibility that resolution of a dispute 

may require modifications to a valuation 

model that could create further 

discrepancies for other swaps that are 

valued using the same model. The 

Working Group believes the 

Commission should require only that 

registrants begin the valuation dispute 

resolution process upon discovery of a 

dispute, but permit counterparties to 

resolve the dispute within a reasonable 

time period. 

The FHLBs requested that the 

Commission specify the meaning of ‘‘in 

a timely fashion’’ as it relates to 

discrepancy resolution with end users. 

The Working Group also had a 

number of recommendations with 

respect to the proposed rule: 

• The Commission should not adopt 

valuation dispute resolution rules that 

may be burdensome for markets where 

no problem exists, such as swap markets 

with underlying physical markets that 

provide an objective basis for swap 

valuations. 

• The proposed reconciliation rules 

should apply only to valuation disputes 

on a portfolio basis, and not on a 

transaction basis, as it would be 

unnecessarily burdensome to analyze 

the valuation of individual swaps unless 

there is a material dispute as to the 

portfolio level exposure between the 

parties. 

• Parties should have the right to 

continue to exchange collateral without 

resolving a discrepancy exceeding 10 

percent if they conclude that the 

discrepancy is not material in their 

particular circumstances. 

With respect to the proposed 10 

percent threshold before a dispute 

would require resolution, Chatham 

argued that a percentage threshold of 10 

percent difference is insufficient 

because it will impose a significant 

burden in cases where the absolute 

value of the swap is small, such as just 

after a swap is executed and in the 

period just before maturity. MFA also 

recommended that the Commission 

revise the proposed rule to provide that 

a valuation discrepancy must not only 

exceed 10 percent, but must also exceed 

some reasonable dollar threshold, and 

must result in one party being unwilling 

to satisfy a collateral call from the other 

party. On the other hand, MetLife 

supported the 10 percent buffer for 

designation of valuation discrepancies, 

but recommended that the Commission 

extend the deadline for valuation 

dispute resolution from 1 to at least 3 

business days with respect to highly 

structured and customized swaps. 

TriOptima provided context with 

respect to valuation dispute resolution 

in the swaps market. TriOptima 

commented that swaps are valued using 

internal models, which use inputs 

derived from observable sources or 

internal calculations and reflect a 

party’s view on the market; that for 

many swaps, there is only sparse or 

episodic liquidity in similar contracts, 

which can be used to calibrate internal 

valuation models; and that there is 

valuable information for regulators in a 

spectrum of differing valuations of a 

swap. As an example, TriOptima 

hypothesized that regulators could have 

had an early warning sign in the run up 

to the 2008 financial crisis when some 

market participants realized earlier than 

others that the price of credit risk was 

too low and raised the price in their 

internal valuations as opposed to 

counterparties that did not recognize the 

change in credit risk. With respect to the 

proposal, TriOptima argued that forcing 

convergence on swap valuations 

between parties could be detrimental to 

the stability and resilience of the 

financial system by creating a 

disincentive for firms to use their own 

judgment in setting market values, 

removing a valuable diagnostic tool for 

regulators. TriOptima further stated that 

there is a difference between an internal 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55931 

38Compare with ESMA Draft Technical 

Standards, Article 4 RM, subsection 2, (stating that 

‘‘counterparties shall, when concluding OTC 

derivative contracts with each other have agreed 

detailed procedures and processes in relation to 

* * * resolution of disputes in a timely manner; 

* * * resolution of disputes that are not resolved 

within five business days, including third party 

arbitration or a market polling mechanism.’’) 

39Compare with ESMA Draft Technical 

Standards, Article 4 RM, subsection 2, (stating that 

‘‘counterparties shall report to the competent 

authority * * * any disputes between 

counterparties relating to an OTC derivative 

contract, its valuation or the exchange of collateral 

for an amount or a value higher than EUR 15 

million and outstanding for at least 15 business 

days.’’) 

valuation used for regulatory capital 

purposes and a valuation agreed with a 

counterparty for use in calculating 

margin. If the agreed valuation is lower 

than the internal valuation, a party must 

reserve capital for the unsecured 

exposure. Therefore, TriOptima argued 

that if the Commission requires the 

parties to agree on a valuation for 

internal purposes, the unsecured 

exposure disappears and less capital 

will be reserved, reducing stability and 

resilience in the financial markets. 

TriOptima recommended that the 

Commission focus on establishing 

principles for how to determine the 

margining amount on a portfolio level, 

rather than forcing parties to agree on 

valuation of individual transactions, 

with a key element in such principles 

being consistency. For valuation 

differences that persist after excluding 

errors and inconsistencies, TriOptima 

believes the parties should be allowed 

to agree to disagree and face the credit 

risk and capital consequences of having 

unsecured exposures. 

The Commission recognizes the view 

that there is valuable information for 

market participants and regulators in a 

spectrum of differing valuations of a 

swap. The Commission also is cognizant 

of the ongoing efforts by industry and 

ISDA to improve the existing valuation 

dispute resolution process. Based on 

meetings between Commission staff and 

ISDA’s Collateral Steering Committee, 

the Commission understands that 

ISDA’s draft 2011 Convention on 

Portfolio Reconciliation and the 

Investigation of Disputed Margin Calls 

and the draft 2011 Formal Market 

Polling Procedure has reduced valuation 

dispute resolution to a 30-day process. 

Issues related to swap valuations are 

woven through a number of 

Commission rule proposals. For 

instance, § 23.504(e), as adopted in this 

release, requires SDs and MSPs to report 

valuation disputes in excess of 

$20,000,000 lasting longer than three 

business days to the Commission, while 

under § 23.504(b)(4) SDs and MSPs are 

required to agree on valuation 

methodologies with their 

counterparties. The Commission 

believes that by requiring agreement 

with each counterparty on the methods 

and inputs for valuation of each swap, 

it is expected that § 23.504(b)(4) will 

assist SDs and MSPs to resolve 

valuation disputes in a timely manner, 

thereby reducing risk. 

Agreement between SDs, MSPs, and 

their counterparties on the proper daily 

valuation of the swaps in their swap 

portfolio also is essential for the 

Commission’s margin proposal. As 

discussed above, under proposed rule 

§ 23.151, non-bank SDs and MSPs must 

document the process by which they 

will arrive at a valuation for each swap 

for the purpose of collecting initial and 

variation margin. All non-bank SDs and 

MSPs must collect variation margin 

from their non-bank SD, MSP, and 

financial entity counterparties for 

uncleared swaps on a daily basis. 

Variation margin requires a daily 

valuation for each swap. For swaps 

between non-bank SDs and MSPs and 

non-financial entities, no margin is 

required to be exchanged under 

Commission regulation, but the nonbank SDs and MSPs must calculate a 

hypothetical variation margin 

requirement for each uncleared swap for 

risk management purposes under 

proposed § 23.154(b)(6). 

Given that arriving at a daily 

valuation is one of the building blocks 

for the margin rules and is essential for 

the mitigation of risk posed by swaps, 

the Commission expects that SDs and 

MSPs as a matter of best practice will 

work to resolve valuation disputes for 

swaps with other SDs and MSPs within 

one business day. However, the 

Commission is modifying this provision 

to require that valuation disputes be 

subject to policies and procedures 

reasonably designed to ensure that such 

disputes are resolved within five 

business days, as discussed further 

below. The Commission has determined 

to make no change to the requirement 

that valuation disputes between SDs, 

MSPs, and non-SDs or non-MSPs be 

subject to policies and procedures 

reasonably designed to ensure that such 

disputes are resolved ‘‘in a timely 

fashion.’’ 

The Commission is persuaded by 

commenters that some valuation 

disputes may be difficult to resolve 

within the one-day timeframe and is 

therefore modifying the rule such that it 

no longer requires resolution, but 

instead requires that SDs and MSPs 

establish procedures reasonably 

designed to ensure that swap valuation 

disputes are resolved within five 

business days.38 Thus SDs and MSPs 

will not violate the rule if they fail to 

resolve a particular dispute within five 

business days, so long as they have 

followed their reasonably designed 

procedures. In addition, the rule will 

require SDs and MSPs to have policies 

and procedures identifying how they 

will comply with any variation margin 

requirements pending resolution of a 

valuation dispute. The rule already 

requires SDs and MSPs to establish 

procedures to resolve valuation disputes 

with non-SD/MSP counterparties in a 

timely fashion. 

Regarding the safe harbor for 

valuation differences of less than 10 

percent, the Commission believes the 10 

percent threshold is appropriate as it 

provides certainty as to which disputes 

must be resolved. The Commission 

believes the efficiency of a bright line 

rule, as opposed to the formulas and 

discretion in the alternatives presented 

by commenters, will better serve the 

operational processes of SDs and MSPs 

and the regulatory oversight of the 

Commission. 

12. Reporting of Valuation Disputes to 

the Commission 

The proposed regulations required 

SDs and MSPs to keep records of 

valuation disputes and the time to 

resolution of such disputes, but did not 

require SDs or MSPs to report such 

disputes to the Commission. However, 

as noted by the New York City Bar 

Committee on Futures and Derivatives 

(NYCB), proposed § 23.504(e) required 

valuation disputes among SDs and 

MSPs outstanding for more than one 

business day, or five business days for 

disputes between an SD or MSP and a 

non-SD, non-MSP counterparty to be 

reported to the Commission. 

In this regard, ISDA recommended 

that the Commission require monthly 

reporting of margin disputes 

outstanding more than 15 days that 

exceed the applicable tolerances, which 

is consistent with current ODSG 

commitments. MetLife recommended a 

period of 90 days before reporting is 

required. 

As discussed above, the Commission 

is modifying this provision to require 

reporting within three business days, 

and it has added a $20,000,000 

threshold for reporting of disputes. The 

Commission believes the less frequent 

reporting provided by the threshold will 

alleviate the concerns of the 

commenters.39


sroberts on DSK5SPTVN1PROD with RULES
55932 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

40See 17 CFR 23.202(a)(3)(iii), Reporting, 

Recordkeeping, and Daily Trading Records 

Requirements for Swap Dealers and Major Swap 

Participants, 77 FR 20128, 20201 (April 3, 2012). 

41See ‘‘Policy Objectives for the OTC Derivatives 

Markets,’’ President’s Working Group on Financial 

Markets (Nov. 14, 2008). 

42See Federal Reserve Bank of New York Staff 

Report No. 424: ‘‘Policy Perspectives on OTC 

Derivatives Market Infrastructure,’’ Jan. 2010 

(revised Mar. 2010). 

13. Recordkeeping Requirement for 

Portfolio Reconciliation—§ 23.502(d) 

The proposed regulations required 

SDs and MSPs to make and retain a 

record of each portfolio reconciliation, 

including a record of each discrepancy 

and the time to resolution of each 

discrepancy. 

ISDA objected to the recordkeeping 

requirement for portfolio reconciliation, 

arguing that it should consist only of 

disputes, and not of the entire process. 

Specifically, ISDA recommended that 

records be kept of the date of the initial 

dispute, the resolution of the dispute, 

the date of resolution, and the net 

portfolio valuations of the two parties. 

Further, ISDA requested an explicit 

statement that access to third party 

reconciliation services’ records will 

satisfy the obligation to permit 

inspection of the records by supervisors. 

Similarly, The Working Group 

requested that the Commission clarify 

that the records required to be kept in 

relation to valuation dispute resolution 

pertain only to discrepancies that 

exceed the 10 percent buffer. 

The Commission notes that its 

recordkeeping rule for SDs and MSPs 

includes a recordkeeping requirement 

that SDs and MSPs make and keep a 

record of each portfolio reconciliation, 

including the number of portfolio 

reconciliation discrepancies and the 

number of swap valuation disputes 

(including the time-to-resolution of each 

valuation dispute and the age of 

outstanding valuation disputes, 

categorized by transaction and 

counterparty).40 In the interests of 

streamlining regulatory requirements, 

the Commission is modifying 

§ 23.502(d) to cross reference § 23.202 

and delete the substantive requirements. 

The Commission has also revised the 

cross-reference to § 1.31 to a crossreference to the SD and MSP record 

retention rule, § 23.203. 

In response to comments of ISDA and 

The Working Group, the Commission 

believes that the level of detail included 

in portfolio reconciliation records is left 

to the reasonable discretion of SDs and 

MSPs so long as the basic requirements 

of the rule are met. 

F. Portfolio Compression—§ 23.503 

Section 4s(i) of the CEA directs the 

Commission to prescribe regulations for 

the timely and accurate processing and 

netting of all swaps entered into by 

swap dealers and major swap 

participants. Portfolio compression is an 

important, post-trade processing and 

netting mechanism that can be an 

effective and efficient tool for the timely 

and accurate processing and netting of 

swaps by market participants. Portfolio 

compression is a mechanism whereby 

substantially similar transactions among 

two or more counterparties are 

terminated and replaced with a smaller 

number of transactions of decreased 

notional value in an effort to reduce the 

risk, cost, and inefficiency of 

maintaining unnecessary transactions 

on the counterparties’ books. Because 

portfolio compression participants are 

permitted to establish their own credit, 

market, and cash payment risk 

tolerances and to establish their own 

mark-to-market values for the 

transactions to be compressed, the 

process does not alter the risk profiles 

of the individual participants beyond a 

level acceptable to the participant. The 

usefulness of portfolio compression as a 

risk management tool has been 

acknowledged widely. 

In 2008, the PWG identified frequent 

portfolio compression of outstanding 

trades as a key policy objective in the 

effort to strengthen the OTC derivatives 

market infrastructure.41 Similarly, the 

2010 staff report outlining policy 

perspectives on OTC derivatives 

infrastructure issued by the FRBNY 

identified trade compression as an 

element of strong risk management and 

recommended that market participants 

engage in regular, market-wide portfolio 

compression exercises.42

Based upon these considerations, the 

Commission proposed § 23.503, which 

imposed certain portfolio compression 

requirements upon SDs and MSPs. The 

Commission received numerous 

comments to the portfolio compression 

proposal and considered each in 

formulating the final rules, as discussed 

below. 

1. Statutory Basis for Portfolio 

Compression 

The proposed portfolio compression 

regulations were proposed pursuant to 

section 4s(i) of the CEA, which directs 

the Commission to prescribe regulations 

for the timely and accurate 

confirmation, processing, netting, 

documentation, and valuation of all 

swaps entered into by SDs and MSPs. 

Commenting on the proposal, ISDA 

stated that the portfolio compression 

requirements lack an explicit statutory 

basis in the Dodd-Frank Act, and should 

be left to the judgment of market 

participants. Likewise, The Working 

Group stated that section 731 of the 

Dodd-Frank Act does not require the 

Commission to issue rules on portfolio 

compression and believes the final rules 

should not include portfolio 

compression requirements. 

In response to these comments, 

section 4s(i) of the CEA clearly 

authorizes the Commission to prescribe 

standards for the netting of swaps. As 

explained in the Confirmation NPRM, 

portfolio compression is a post-trade 

processing and netting mechanism 

whereby substantially similar 

transactions among two or more 

counterparties are terminated and 

replaced with a smaller number of 

transactions of decreased notional 

value. 

2. Definition of ‘‘Multilateral Portfolio 

Compression Exercise’’—§ 23.500(h) 

The proposed regulations defined 

‘‘multilateral portfolio compression 

exercise’’ as an exercise in which 

multiple swap counterparties wholly or 

partially terminate some or all of the 

swaps outstanding among those 

counterparties and replace the swaps 

with a smaller number of swaps whose 

combined notional value is less than the 

combined notional value of the original 

swaps included in the exercise. The 

replacement swaps may be with the 

same or different counterparties. 

With respect to this definition, 

TriOptima commented that the 

proposed definition of ‘‘multilateral 

portfolio compression exercise’’ is too 

narrow and recommends that the 

Commission revise the definition to 

read: ‘‘an exercise in which multiple 

swap counterparties wholly terminate or 

change the notional value of some or all 

of the swaps submitted by the 

counterparties for inclusion in the 

portfolio compression and, depending 

on the methodology employed, replace 

the terminated swaps with other swaps 

whose combined notional value (or 

some other measures of risk) is less than 

the combined notional value (or some 

other measure of risk) of the terminated 

swaps in the compression exercise.’’ 

ISDA recommended the same changes 

as those recommended by TriOptima for 

the same reasons. 

Based on the explanations of 

commenters, the Commission is 

persuaded that the proposed definition 

was unnecessarily narrow and the 

Commission has accordingly modified 

the definition of ‘‘multilateral portfolio 

compression exercise’’ in the manner 

recommended by commenters. In 

addition, for the sake of consistency, the 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55933 

43Compare with ESMA Draft Technical 

Standards, Article 3 RM, subsection 2, (stating that 

‘‘counterparties with 500 or more OTC derivative 

contracts outstanding which are not centrally 

cleared shall have procedures to regularly, and at 

least twice a year, analyse the possibility to conduct 

a portfolio compression exercise in order to reduce 

their counterparty credit risk and engage in such 

portfolio compression exercise.’’) 

44See 17 CFR 39.13(h)(4), Derivatives Clearing 

Organization General Provisions and Core 

Principles, 76 FR 69334, 69383 (Nov. 8, 2011). 

definition of ‘‘bilateral portfolio 

compression exercise’’ has also been 

modified in a consistent manner. 

3. Mandatory Portfolio Compression— 

§ 23.503 

The proposed regulations required 

SDs and MSPs to engage in bilateral and 

multilateral portfolio compression 

exercises with respect to all swaps in 

which their counterparty is also an SD 

or MSP. In contrast, the proposed 

regulations required SDs and MSPs to 

establish policies and procedures for 

engaging in portfolio compression with 

swap counterparties that are not SDs or 

MSPs. 

On this issue, The Working Group 

argued that portfolio compression is 

only beneficial in markets where there 

is a high degree of transaction 

standardization and a high volume of 

redundant trades, and therefore 

recommended that the Commission only 

impose mandatory compression 

exercises on markets where the ratio of 

gross market value to notional size 

(which is a rough estimation of the level 

of redundant trades) shows that the 

benefits of compression outweigh the 

substantial cost of engaging in the 

exercise. The Working Group also 

recommended that the Commission not 

impose mandatory compression in 

markets where compression platforms 

have not yet been designed, tested, and 

approved by the Commission. 

Markit pointed out that portfolio 

compression was recently attempted in 

the commodities and foreign exchange 

asset classes, but was not pursued 

further because the trial cycles had 

limited success, and is concerned that 

mandatory participation under the 

proposed rules might lead to 

compression for a range of uncleared 

swaps where the potential benefits do 

not justify the cost of the exercise, 

particularly for the large number of 

potential SDs and MSPs that currently 

do not participate in compression 

cycles. Costs identified by Markit 

include changes to participant’s risk 

systems and connectivity enhancements 

that would allow for the booking and 

processing of a large volume of swaps 

(thousands) in as short a period as a 

single day. Markit recommended an 

alternative to the proposal in which the 

Commission would establish thresholds 

for determining whether a category of 

non-cleared swaps should be subject to 

any mandatory compression exercise 

and the frequency of such exercises. 

Markit believes such thresholds should 

be related to the minimum number of 

swaps, number of participants, number 

of swaps per participant, amount of 

ongoing trading activity, degree of 

standardization in the product, and the 

notional amount of transactions that 

must be compressed. 

With respect to compression between 

SDs and MSPs and non-SDs, non-MSPs, 

Markit believes that there will be no 

noteworthy benefit from requiring nondealer counterparties to participate in 

portfolio compression exercises for 

uncleared swaps, as such entities have 

portfolios with a very small number of 

offsetting transactions and often have 

complicated arrangements with prime 

brokers making compression more 

difficult and costly. 

Freddie Mac commented that 

mandatory portfolio compression 

should be limited to swaps that match 

and offset cash flows exactly, and that 

any compression requirement allow for 

exceptions for end users relying on 

swaps for hedging purposes or that 

otherwise believe the termination of an 

existing swap would have an adverse 

effect on remaining trades. 

Providing the view of a portfolio 

compression vendor, TriOptima stated 

that for many smaller institutions and 

for larger institutions trading illiquid 

swaps, the net to gross ratio of a 

portfolio is sometimes close to 100 

percent, meaning that all swaps in the 

portfolio are in the same market-risk 

direction. TriOptima argued that it 

would not be productive for such 

institutions to take part in multilateral 

compression as many transactions 

designated as hedges for accounting 

purposes must be excluded from 

compression, and either no transactions 

could be compressed or the resulting 

notional reduction would be minimal. 

TriOptima therefore recommended that 

the Commission remove any mandatory 

compression requirement from the 

proposed rule and instead focus on 

creating incentives for institutions to 

take part in portfolio compression. 

TriOptima noted that most capital 

requirements are based on net risk 

positions and therefore recommended 

that the Commission create capital or 

other incentives to reduce gross risk 

positions. 

Based on the comments received, the 

Commission has concluded that it may 

be premature to require SDs and MSPs 

to engage in mandatory bilateral and 

multilateral compression exercises for 

all asset classes at this time. Although 

the Commission agrees with Markit’s 

comment that compression 

opportunities should be based on an 

analysis of the market, including the 

number of swaps, number of 

participants, number of swaps per 

participant, amount of ongoing trading 

activity, degree of standardization in the 

product, and the notional amount of 

transactions that could be compressed, 

it does not foresee that it will have the 

resources to make such a determination 

or to set thresholds for mandatory 

compression. In addition, as discussed 

more fully below, the Commission is 

modifying the bilateral offset 

requirement for swaps between SDs and 

MSPs that are ‘‘fully offsetting.’’ 

Accordingly, the Commission has 

modified the proposed rules to remove 

the mandatory bilateral and multilateral 

compression requirements and has 

replaced them with a requirement that 

SDs and MSPs establish policies and 

procedures for periodically engaging in 

portfolio compression exercises with 

counterparties that are also SDs or MSPs 

and for engaging in portfolio 

compression with all other 

counterparties upon request.43 In this 

regard, the Commission anticipates that 

in order to be in compliance with the 

rule, an SD’s or MSP’s policies and 

procedures would include procedures 

for engaging in periodic evaluation of 

compression opportunities, written 

policies establishing when the SD or 

MSP would consider a compression 

opportunity to be materially beneficial, 

and procedures for engaging in those 

opportunities when such arise. These 

policies and procedures would also be 

required to address how the SD and 

MSP would determine which swaps to 

include and exclude from compression 

exercises and what risk tolerances it 

would accept. 

The Commission has also modified 

the rule to clarify that (1) non-SDs/MSPs 

are not required to engage in portfolio 

compression exercises with SDs and 

MSPs, but (2) that SDs and MSPs must 

engage in portfolio compression 

exercises with non-SDs/MSPs upon 

request. 

As further support for the 

modifications, the Commission notes 

that in the proposed DCO rules, the 

Commission proposed that DCOs must 

offer multilateral compression, but the 

final DCO rule provided that 

participation in compression exercises 

by clearing members and their 

customers would be voluntary.44


sroberts on DSK5SPTVN1PROD with RULES
55934 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

4. Swaps Eligible for Compression— 

§ 23.503 

Proposed § 23.503 required SDs and 

MSPs to include all swaps in their 

compression exercises with other SDs 

and MSPs and swaps with other 

counterparties to the extent that the 

swaps are able to be terminated through 

a portfolio compression exercise. 

With respect to this aspect of the 

proposal, BlackRock recommended that 

the Commission revise the proposed 

compression rules to more fully 

promote the compression of 

substantially similar, but not fully 

offsetting, swaps. 

The Commission believes that the 

concerns underlying BlackRock’s 

comment is addressed by the changes to 

the proposed rule as discussed above, 

specifically the modification requiring 

SDs and MSPs to engage in compression 

with non-SDs and non-MSPs at the 

request of such parties. The Commission 

believes it is prudent to permit the 

parties to agree on the method and 

venue of compression, rather than 

having the Commission prescribe the 

method and venue. 

5. Application of Portfolio Compression 

to Non-SD/MSPs 

In the Confirmation NPRM, the 

Commission requested comment on 

whether it should require SDs and MSPs 

to engage in compression exercises with 

counterparties that are not SDs or MSPs. 

The Commission also requested 

comment on whether financial entities 

as defined in proposed § 23.500 should 

be subject to the same compression 

requirements as SDs and MSPs. 

In response to this request for 

comments, Markit stated that there will 

be no noteworthy benefit from requiring 

non-dealer counterparties to participate 

in portfolio compression exercises for 

uncleared swaps because such entities 

have portfolios with a very small 

number of offsetting transactions and 

often have complicated arrangements 

with prime brokers making compression 

more difficult and costly. 

ISDA also identified several issues 

with the proposal to apply compression 

requirements to non-SDs: 

• Current portfolio compression 

exercises only achieve successful results 

by limiting exercises to a single assetclass and a relatively small and 

homogeneous group of participants (i.e., 

the G14 dealers), which limits the 

difficulty and range of attendant risks. 

• Multilateral compression cycles are 

typically managed with automated tools 

to support tear up and new trade 

creation that end-users usually do not 

possess, and the costs of obtaining such 

tools cannot be justified by the benefits. 

• The requirement for bilateral 

netting of swaps not covered by 

multilateral or cleared compression 

processes will impose onerous tasks 

with only limited benefit for end-users 

who engage in trades that are typically 

more bespoke. 

ABC & CIEBA commented that benefit 

plans should not be subject to the 

proposed portfolio compression rule 

because every swap of a benefit plan 

serves a business purpose and benefit 

plan swap portfolios contain no 

redundant positions. ABC & CIEBA also 

argued that benefit plans may have 

multiple investment advisers with 

individual mandates and portfolio 

compression could result in losses if 

market movements that had been 

previously hedged are undone by 

compression. ABC & CIEBA thus urged 

the Commission to require SDs and 

MSPs to obtain explicit consent of end 

user counterparties prior to compression 

of any swap. 

AMG, Dominion, the FHLBs, and 

Chatham echoed the concerns of ABC & 

CIEBA, commenting that non-SDs and 

non-MSPs (including financial entities) 

should not be subject to mandatory or 

involuntary portfolio compression due 

to legitimate reasons for offsetting, but 

beneficial swap positions, such as 

hedging specific assets. Thus, AMG, 

Dominion, and the FHLBs 

recommended that the Commission 

revise the proposed rules to require SDs 

and MSPs to obtain the explicit consent 

of its end user counterparties prior to 

compression of any swap. BlackRock 

recommended that the Commission 

require SDs and MSPs to engage in 

bilateral and multilateral compression 

exercises with counterparties that are 

not SDs or MSPs, if such parties chose 

to do so. 

MFA similarly recommended that 

portfolio compression be an option for 

end users, but not an obligation as 

portfolio compression is only 

appropriate for entities with portfolios 

large enough to yield meaningful 

benefits that outweigh the expense of a 

compression exercise. MFA further 

stated that end users should not be 

required to engage in multilateral 

portfolio compression for cleared swaps. 

GFED believes that portfolio 

compression is unnecessary for nondealer end users as volumes are too 

small. 

With respect to compression with 

financial entities, the FHLBs 

commented that financial entities 

should not be subject to the same 

compression requirements as SDs and 

MSPs as the swap portfolios of such 

entities do not, by definition, pose a 

significant risk to the overall financial 

system, such requirements could have 

adverse effects for such entities because 

their tax and accounting treatment may 

differ significantly from those of SDs, 

and such requirements may discourage 

financial entities from using swaps for 

hedging or risk mitigation. 

Freddie Mac believes that mandatory 

portfolio compression should be limited 

to swaps that match and offset cash 

flows exactly, and that any compression 

requirement allow for exceptions for 

end users relying on swaps for hedging 

purposes or that otherwise believe the 

termination of an existing swap would 

have an adverse effect on remaining 

trades. 

With respect to insurers, NAIC stated 

that state insurance laws require 

insurers to ‘‘tag’’ each swap position to 

specific hedging, replication, or income 

generation transactions, giving 

insurance regulators complete 

transparency into the swap position 

carried by insurers. NAIC is concerned 

that the proposed compression 

requirements, despite the exception in 

§ 23.503(c)(3)(i), may require SDs and 

MSPs to terminate fully offsetting swaps 

that include swaps held by insurers for 

hedging of specific assets and liabilities, 

hindering state regulators’ ability to 

regulate insurers. NAIC requested that 

the Commission modify the rule so that 

any swap position of an insurer that is 

specifically designated as a hedge as 

required by state insurance statutory 

accounting rules be allowed to remain 

outstanding and not be subject to 

portfolio compression rules. 

MetLife also strongly opposed any 

mandated compression of offsetting 

swap positions. MetLife believes that 

the safe harbor in the proposed rules for 

exclusion of swaps ‘‘likely to increase 

significantly the risk exposure’’ of a 

party is not sufficiently broad to protect 

a party’s essential hedging transactions. 

MetLife recommended that MSPs and 

other end users be permitted to opt out 

of compression for transactions that are 

bona fide hedges. Specifically, MetLife 

stated that the compression 

requirements may conflict with state 

insurance laws governing allocation of 

hedging transactions to specific assets 

and liabilities. MetLife concurred with 

other commenters in urging the 

Commission to exclude insurance 

companies from any mandatory 

portfolio compression requirement. 

On the other hand, Eris Exchange 

stated that it has clearly heard that the 

swap trading community welcomes the 

Commission’s proposed compression 

rule. Eris Exchange believes the end 

user community is optimistic that 

financial reform will lead to greater 

position netting and the ability to more 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55935 

45Compare with ESMA Draft Technical 

Standards, Article 3 RM, subsection 3, (stating that 

‘‘counterparties shall terminate each of the fully 

offset OTC derivative contracts not later than when 

the compression exercise is finalized.’’) 

46See 17 CFR 39.13(h)(4), Derivatives Clearing 

Organization General Provisions and Core 

Principles, 76 FR 69334, 69383 (Nov. 8, 2011). 

freely unwind aged swap trades without 

having to go through a cumbersome 

novation process involving substantial 

operational burden and negotiated upfront payments. 

Having considered these comments, 

the Commission notes that, as discussed 

above, the rule has been modified to 

require SDs and MSPs to establish 

policies and procedures for engaging in 

portfolio compression with non-SDs and 

non-MSPs when requested by such 

counterparties. The Commission 

believes this change addresses the 

comments of non-SDs and non-MSPs 

discussed above. 

6. Application of Portfolio Compression 

by Asset Class 

Proposed § 23.503 applied uniformly 

to all swaps, regardless of asset class. 

The Commission requested comment 

regarding whether the compression 

requirement should be restricted to 

particular asset classes. 

ISDA commented that compression in 

asset classes other than credit and 

interest rates would be extremely costly 

and the benefits would be limited. ISDA 

stated that the industry will need to 

develop practices for each additional 

asset class because methods used in one 

asset class are not portable to other asset 

classes with distinct characteristics. 

ISDA specifically recommended that the 

following asset classes be excluded from 

any compression requirements: 

• Foreign exchange swaps, which 

achieve compression through daily 

trade aggregation in CLS and have short 

tenors; 

• Equity derivatives, because they are 

broadly positional in nature, there is a 

lack of standardization, and they are 

broadly hedged; and 

• Commodity derivatives, because 

notional amounts are low and 

compression may only be worthwhile 

for oil and precious metals. 

GFED also recommended that the 

Commission exclude foreign exchange 

swaps from the portfolio compression 

requirements as most foreign exchange 

swaps are short dated (i.e., three to six 

months average, one month for options) 

and the costs of implementation likely 

outweigh the limited benefits. 

As noted above, Markit stated that 

portfolio compression was recently 

attempted in the commodities and 

foreign exchange asset classes, but was 

not pursued further because the trial 

cycles had limited success. 

As discussed above, the Commission 

has modified the rule to remove the 

mandatory compression requirement 

and replace it with a requirement that 

SDs and MSPs establish policies and 

procedures for the regular evaluation of 

compression opportunities with other 

SDs and MSPs, when appropriate, and 

for engaging in compression with nonSDs and non-MSPs upon request. The 

Commission believes this change 

addresses commenters’ concerns 

regarding the inappropriate or 

inefficient application of portfolio 

compression to certain asset classes. 

7. Bilateral Uncleared Swap Portfolio 

Compression—§ 23.503(b) 

Proposed § 23.503(b) required SDs 

and MSPs to engage in bilateral 

portfolio compression exercises at least 

once every calendar year with their 

swap counterparties that were also SDs 

or MSPs, unless the SD or MSP 

participated in a multilateral 

compression exercise in which such 

counterparties also participated. 

With respect to this proposal, ISDA 

commented that the move to clearing 

will reduce the need for bilateral/ 

uncleared trade compression because 

most fungible, liquid products in the 

credit and rates markets will be in 

DCOs. 

The Commission believes that the 

changes to the proposed rule discussed 

above will address commenters’ 

concerns regarding the inefficient 

application of portfolio compression to 

uncleared swaps. Specifically, the rule 

as adopted will not require SDs and 

MSPs to engage in bilateral 

compression, but only require that 

registrants establish policies and 

procedures for periodically engaging in 

such compression where appropriate. 

8. Termination of Fully-Offsetting 

Bilateral Swaps—§ 23.503(a) 

Proposed § 23.503(a) required SDs 

and MSPs to terminate fully offsetting 

swaps with other SDs or MSPs no later 

than the close of business on the 

business day following the day the fully 

offsetting swap was executed. 

Commenting on this proposal, The 

Working Group stated that an SD or 

MSP with a regulatory requirement for 

functional separation may have 

legitimate reasons for maintaining 

offsetting long and short positions, thus 

the Commission should not mandate 

termination of fully-offsetting swaps, 

but only require that registrants have 

policies and procedures for termination 

of such swaps in appropriate 

circumstances. The Working Group also 

argued that requiring registrants to run 

and monitor daily systems for the 

detection of completely offsetting swaps 

where there are likely to be none is 

unnecessarily burdensome. Finally, The 

Working Group believes that the one 

business day time period for terminating 

fully-offsetting swaps is unnecessarily 

burdensome and should be revised to 

allow for one week. 

ISDA believes the requirement for 

registrants to terminate fully-offsetting 

swaps between registrants to be 

unnecessary because such swaps are not 

sources of material risk. ISDA believes 

compliance with the rule would be 

extremely difficult and expensive to 

implement as compliance will require 

new processes to identify single 

offsetting trades. In addition, ISDA 

stated that perfectly offsetting swaps are 

not common and recommends the 

Commission clarify whether only 

perfect offsets are required to be 

terminated. 

The Commission finds these 

comments persuasive and is modifying 

the rule to require only that SDs and 

MSPs establish policies and procedures 

to terminate fully offsetting swaps with 

other SDs and MSPs in a timely fashion, 

where appropriate. The Commission 

believes this modification allows SDs 

and MSPs to design policies and 

procedures that permit the maintenance 

of offsetting long and short positions for 

legitimate business reasons.45 The 

Commission has also determined to 

remove the one-day termination 

requirement as a cost-saving measure 

and to replace it with the phrase ‘‘in a 

timely fashion.’’ 

9. Compression of Cleared Swaps 

The proposed regulation did not 

differentiate between cleared swaps and 

uncleared swaps. 

In this respect, ISDA believes that no 

compression requirement should attach 

to cleared trades, but, in the alternative, 

ISDA recommended the Commission 

clarify that complying with a DCOs 

compression requirements will satisfy 

the compression requirements of the 

proposed rule. Likewise, MFA stated 

that end users should not be required to 

engage in multilateral portfolio 

compression for cleared swaps. 

Having considered these comments, 

and in light of the portfolio compression 

requirements under the Commission’s 

regulations for DCOs,46 the Commission 

has concluded that it is unnecessary to 

apply the requirements of this rule to 

swaps that are cleared by a DCO and has 

modified the rule accordingly. The 

Commission notes that this change is 

parallel to the portfolio reconciliation 


sroberts on DSK5SPTVN1PROD with RULES
55936 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

rule, which also does not apply to 

swaps cleared by a DCO. 

10. Mandatory Multilateral Compression 

Offered by a DCO or SRO— 

§ 23.503(c)(2) 

Proposed § 23.503(c)(2) required SDs 

and MSPs to participate in all 

multilateral portfolio compression 

exercises offered by a DCO of which the 

SD or MSP is a member or an SRO of 

which the SD or MSP is a member. 

Commenting on this aspect of the 

proposal, both ISDA and TriOptima 

stated that mandating compression 

offered by a DCO or SRO will inhibit 

competition among providers of 

compression services. ISDA is 

concerned that members of DCOs and 

SROs may become bound to 

compression services with inadequate 

transparency, insufficient testing and 

lack of price competition. ISDA 

recommends that the Commission 

permit registrants to select the 

compression service provider, including 

for DCO or SRO-mandated compression 

exercises. 

As discussed above, the Commission 

has removed the mandatory 

compression requirements from the rule 

as adopted. Nonetheless, in response to 

these comments, the Commission agrees 

that the rule should not demonstrate a 

preference for any type of compression 

services provider and has accordingly 

modified the rule to require SDs and 

MSPs to evaluate multilateral 

compression exercises initiated, offered, 

or sponsored by any third party. This 

change also comports with the decision 

to change the final DCO rules to provide 

for voluntary participation in 

compression exercises. 

11. Risk Tolerances in Multilateral 

Portfolio Compression— 

§ 23.503(c)(3)(ii) 

Proposed § 23.503(c)(3)(ii) permitted 

SDs and MSPs to establish counterparty, 

market, cash payment, and other risk 

tolerances, and to exclude specific 

potential counterparties for the 

purposes of multilateral compression 

exercises. 

Commenting on this aspect of the 

proposal, The Working Group 

recommended that the Commission 

grant market participants broad 

discretion when setting ‘‘risk 

tolerances’’ for multilateral compression 

exercises, including: 

• A broad array of risks for which 

swaps may be excluded from the 

exercise (e.g., regulatory risk, financial 

statement risk); 

• The ability to express preference for 

preserving swaps with one counterparty 

over another for credit risk management 

purposes; and 

• The ability to require that only 

identical swaps and not substantially 

similar swaps can be compressed. 

Having removed the mandatory 

multilateral compression requirement 

from the rule, the Commission has also 

removed the portions of the rule related 

to setting risk tolerances. However, 

under the revised rule, SDs and MSPs 

must establish policies and procedures 

for engaging in multilateral compression 

exercises, and the Commission expects 

that these policies and procedures will 

address how the SD and MSP would 

determine which swaps to include and 

exclude from compression exercises and 

what risk tolerances it would accept. 

The Commission believes that this 

change addresses commenters’ concerns 

regarding the discretion to determine 

risk tolerances in multilateral 

compression exercises. 

12. Portfolio Compression Service 

Provider Standards 

The proposed regulations did not 

prescribe standards for portfolio 

compression service providers, and 

Markit recommended that, due to the 

complexity of multilateral compression 

exercises, the Commission establish 

standards for compression service 

providers to ensure competency, timely 

service, and sufficient resources. The 

process for choosing compression 

service providers should be fair and 

open. Freddie Mac urged the 

Commission to closely scrutinize the 

necessity and propriety of the terms of 

business demanded by prospective 

service providers (including SDRs, SEFs 

and DCOs) and disapprove overreaching 

terms such as open-ended 

indemnification, disclaimer of liability, 

assertions of ownership over 

transactional data, and other intellectual 

property of service users. 

Given that the rule as adopted no 

longer contains a mandatory 

compression requirement, the 

Commission believes that these 

comments regarding standards for 

service providers and overreaching 

terms are best addressed by competition 

in the market for providers of 

compression services. 

13. Recordkeeping Requirement for 

Portfolio Compression—§ 23.503(e) 

Propose § 23.503(e) required SDs and 

MSPs to maintain records of each 

bilateral and multilateral compression 

exercise, including dates, the swaps 

included in the exercise, the eligible 

swaps excluded from the exercise and 

the reason for such exclusion, the 

counterparty and risk tolerances 

specified for the exercise, and the 

results of the exercise. ISDA commented 

that the recordkeeping requirement for 

portfolio compression is too prescriptive 

in its detail. The Commission is 

modifying the rule to require simply 

that SDs and MSPs maintain complete 

and accurate records of all compression 

exercises. As a matter of good practice, 

the Commission anticipates that market 

participants will make and maintain all 

necessary records of any swaps that are 

netted down, new swaps entered into, 

and any swaps that are submitted for 

compression but not compressed. In 

addition, the Commission observes that 

the rule does not prohibit SDs and MSPs 

from relying on third-party service 

providers to achieve compliance with 

the rule, although the responsibility for 

compliance cannot be delegated. 

III. Effective Dates and Compliance 

Dates 

In the Documentation NPRM and 

Confirmation NPRM, the Commission 

requested comment on the length of 

time necessary for registrants to come 

into compliance with the proposed 

rules. As discussed further below, the 

Commission also proposed a 

compliance schedule, § 23.575, for swap 

trading relationship documentation, 

§ 23.504, in a separate release in 

September 2011. 

A. Comments Regarding Compliance 

Dates 

1. Documentation NPRM 

With respect to § 23.504, The Working 

Group recommended that the 

Commission delay promulgating rules 

on swap documentation until it has 

finalized all required rules to be issued 

under the Dodd-Frank Act and can fully 

analyze the potential effect of 

documentation rules on the swap 

markets, or, in the alternative, adopt a 

general framework with an extended 

period of time for implementation to 

allow market participants to design 

appropriate documentation standards. 

Further, if the Commission should 

decide to make the proposed rules 

applicable to existing transactions, then 

The Working Group recommended that 

the Commission provide a short term 

safe-harbor for existing transactions and 

give the market 36 months to come into 

compliance. If the Commission should 

decide not to make the proposed rules 

applicable to existing transactions, then 

The Working Group recommended that 

the Commission give the market 12 

months to come into compliance. 

ISDA & SIFMA requested that the 

Commission defer proposing an 

implementation timeline until the 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55937 

47See Swap Transaction Compliance and 

Implementation Schedule: Trading Documentation 

and Margining Requirements under Section 4s of 

the CEA, 76 FR 58176 (Sept. 20, 2011) 

(Implementation Schedule NPRM). 

48The trading documentation and margining 

requirements compliance schedules were proposed 

in one release. See id. The clearing requirement and 

trade execution requirement were proposed in 

another release, Swap Transaction Compliance and 

Implementation Schedule: Clearing and Trade 

Execution Requirements under Section 2(h) of the 

CEA, 76 FR 58186 (Sept. 20, 2011). The 

Commission finalized the compliance schedule for 

the clearing requirement on July 24, 2012. See Swap 

Transaction Compliance and Implementation 

Schedule: Clearing Requirement Under Section 2(h) 

of the CEA, 77 FR 44441 (July 30, 2012). The 

compliance schedules for margin for uncleared 

swaps and the trade execution requirement will be 

finalized separately. 

Commission’s rules and the SEC’s rules 

relating to trading documentation are 

fully developed and the industry has 

been given the opportunity to address 

implementation issues with the 

Commission at that time. 

FSR believes that the renegotiation of 

existing documentation would take 

significantly longer than six months and 

urged the Commission to recognize that 

negotiation of new credit support 

arrangements, including third-party 

custody arrangements, will be 

particularly time-consuming and thus 

requested that the Commission provide 

an appropriately long implementation 

timeframe. The Coalition of Derivatives 

End-Users proposed a period of not less 

than two years for implementation for 

end users because it is unclear how each 

SD and MSP would seek to implement 

changes to comply with swap 

documentation rules for both existing 

and new swaps. The Coalition believes 

this period of time will allow for 

discussions and negotiations across all 

swap counterparty relationships. 

IECA recommended that a long 

implementation period be provided. 

Otherwise, SDs will have an advantage 

because they have more resources to 

apply than end users and it is likely that 

any standard amendment would come 

from industry groups such as ISDA, 

which primarily represents the interests 

of SDs. CIEBA is also concerned that a 

deadline for SDs and MSPs to bring 

their documentation into compliance 

would allow SDs and MSPs to present 

buy-side participants with a newly 

standardized set of documentation, and 

would result in buy-side participants 

having insufficient input into the 

substance of the documentation. CIEBA 

also noted that a number of its members 

reported that it is not uncommon for 

SDs to take up to a year to finalize an 

ISDA agreement with a pension plan 

fiduciary. If SDs were required to revise 

all their swap agreements, CIEBA 

believes that it could take years. 

In contrast to the foregoing comments, 

Michael Greenberger commented that 

since many dealers already use 

documentation that will comply with 

the regulations, allowing a maximum of 

thirty days to comply with the rules 

following adoption should suffice. 

In addition to the foregoing 

comments, the Commission received 

comments with respect to proposed 

compliance schedules for a number of 

proposed rules, including § 23.504.47 In 

September 2011, the Commission 

proposed four compliance schedules for 

four separate provisions of the DoddFrank Act, including: (i) The clearing 

requirement; (ii) the trade execution 

requirement; (iii) trading documentation 

under section 4s; and (iv) margining 

requirements for uncleared swaps.48 In 

its proposal, Swap Transaction 

Compliance and Implementation 

Schedule: Trading Documentation and 

Margining Requirements under Section 

4s of the CEA, (Implementation 

Schedule NPRM), the Commission 

stated that the proposed compliance 

schedule for § 23.504 was designed to 

afford affected market participants a 

reasonable amount of time to bring their 

transactions into compliance with the 

requirements of the rule and to provide 

relief in the form of additional time for 

compliance. The schedule was intended 

to facilitate the transition to the new 

regulatory regime established by the 

Dodd-Frank Act in an orderly manner 

that does not unduly disrupt markets 

and transactions. To this end, the 

Commission proposed § 23.575, under 

which an SD or MSP would be afforded 

ninety (90), one hundred eighty (180), or 

two hundred and seventy (270) days to 

bring its swap trading relationship 

documentation with its various 

counterparties into compliance with the 

requirements of § 23.504, depending on 

the identity of each such counterparty. 

In the proposal, market participants that 

are financial entities, as defined in 

section 2(h)(7)(C) of the CEA, were 

grouped into the following four 

categories: 

• Category 1 Entities included SDs, 

security-based swap dealers, MSPs, 

major security-based swap participants, 

and active funds (defined as any private 

fund as defined in section 202(a) of the 

Investment Advisers Act of 1940), that 

is not a third-party subaccount and that 

executes 20 or more swaps per month 

based on a monthly average over the 12 

months preceding this adopting release. 

• Category 2 Entities included 

commodity pools; private funds as 

defined in section 202(a) of the 

Investment Advisers Act of 1940 other 

than active funds; employee benefit 

plans identified in paragraphs (3) and 

(32) of section 3 of the Employee 

Retirement Income and Security Act of 

1974; or persons predominantly engaged 

in activities that are in the business of 

banking, or in activities that are 

financial in nature as defined in section 

4(k) of the Bank Holding Company Act 

of 1956, provided that the entity is not 

a third-party subaccount. 

• Category 3 Entities include Category 

2 Entities whose positions are held as 

third-party subaccounts. 

• Category 4 Entities includes any 

person not included in Categories 1, 2, 

or 3. 

Proposed § 23.575 required SDs and 

MSPs to be in compliance with § 23.504 

no later than 90 days after publication 

of the final rule in the Federal Register 

for swap transactions with a Category 1 

Entity, no later than 180 days after 

publication for swap transactions with a 

Category 2 Entity, and no later than 270 

days after publication for swap 

transactions with a Category 3 Entity or 

Category 4 Entity. 

The Commission received 

approximately 19 comments with 

respect to the compliance phasing 

proposal, each of which it considered in 

finalizing the compliance dates for the 

rule, as discussed below. 

a. Definition of ‘‘Active Fund’’ 

The proposal defined ‘‘active fund’’ as 

‘‘any private fund as defined in section 

202(a) of the Investment Advisers Act of 

1940, that is a not a third party 

subaccount and that executes 20 or 

more swaps per month based on a 

monthly average over the 12 months 

preceding * * *.’’ 

Commenting on this definition, the 

Association of Institutional Investors 

(AII) stated that basing the definition on 

an average of 20 swap transactions per 

month is arbitrary. AII believes that the 

Commission should collect data under 

swap transaction reporting rules and 

then make a determination, but, in the 

alternative, AII recommended that the 

threshold be higher and that the 

definition specify the type of swaps that 

count towards the threshold. FIA/ISDA/ 

SIFMA and Vanguard also commented 

that the average monthly threshold 

should be raised, and recommended 

that the threshold be raised to include 

only those funds averaging more than 

200 transactions per month. 

MFA recommended that the 

definition be eliminated because it is 

over-inclusive, difficult to administer, 

and unnecessarily divides the class of 

buy-side market participants. Under 

MFA’s view, all private funds should be 

Category 2 Entities. If the Commission 

does not delete the definition, MFA 


sroberts on DSK5SPTVN1PROD with RULES
55938 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

requested clarification regarding those 

swaps that are to be included in the 

calculation, e.g., novations, 

amendments, partial tear-ups, etc. 

On a different tack, FSR stated that 

the definition of ‘‘active fund’’ is 

unclear and needs further clarification 

to distinguish between active fund and 

‘‘third-party subaccount.’’ FSR 

represented that its fund manager 

members believe that most (if not all) 

entities that would fall into the term 

‘‘active fund’’ would also constitute 

‘‘third-party subaccounts.’’ 

The American Council of Life Insurers 

(ACLI) commented that the frequency of 

trading is not an appropriate indicator 

of experience or available resources for 

determining which entities can comply 

most quickly. Similarly CDE 

recommended a minimum notional 

amount monthly average threshold to 

avoid capturing smaller end-users and 

excluding hedges and inter-affiliate 

swaps from the monthly average 

threshold. 

On the other hand, Better Markets and 

Chris Barnard supported the proposal, 

stating that average monthly trading 

volume is the appropriate proxy for 

determining an entity’s ability to 

comply with the proposed 

implementation schedule and is better 

than notional volume. 

The Alternative Investment 

Management Association (AIMA) also 

believes that the average number of 

swaps executed during the previous 12 

months is a good proxy for determining 

what is an active fund, but 

recommended that the definition should 

include private funds regardless of 

whether they are a third party 

subaccount or not. Otherwise, private 

funds that are not subaccounts will be 

disadvantaged relative to those that are, 

in terms of the cost of entering into 

swaps during the course of the 

implementation schedule. AIMA 

considered alternatives to the definition 

but believes that instituting an ‘‘assets 

under management’’ threshold for the 

definition of active fund may be 

problematic, as notwithstanding such a 

threshold, a manager may invest in 

other types of financial instruments 

such that they do not in fact have the 

experience or resources to more quickly 

comply with the regulations. AIMA also 

believes that commodity pools that are 

not private funds, but that execute 20 or 

more swaps on average per month, 

should be included in the definition. 

Having considered the comments 

received, the Commission believes that 

the definition of ‘‘active fund’’ 

appropriately uses a transaction-based 

trigger to distinguish between funds 

more active in the swaps market and 

those that are less so. However, in 

response to comments that an average of 

20 transactions per month may be 

overly inclusive and may cause some 

smaller entities, less well-positioned for 

compliance with shorter 

implementation timeframes, to fall 

within the definition. Accordingly, the 

Commission has determined to raise the 

threshold to 200 swap transactions on 

average per month so as to ensure only 

more active participants in the market 

are included within the definition. The 

Commission also agrees with 

commenters that establishing an 

appropriate minimum notional amount 

applicable to all participants in the 

swap market, or assets under 

management standard, to be 

impracticable. 

However, the Commission does not 

believe it is appropriate to create 

exclusions for the types of swap 

transactions within the definition given 

the administrative burdens of 

monitoring such distinctions for 

purposes of the proposed 

implementation schedule. In response 

to commenters seeking clarification of 

what types of swap transactions are to 

be included in the monthly calculation, 

the Commission notes that the proposed 

implementation schedule, and the 

compliance dates adopted in this 

release, both refer to ‘‘swaps’’ and not 

‘‘swap transactions.’’ ‘‘Swap 

transaction’’ is defined in § 23.500 to 

include assignments, novations, 

amendments, and other events that 

§ 23.501 requires to be documented by 

confirmation. Therefore, in response to 

commenter’s concerns, the Commission 

confirms that the active fund threshold 

of 200 swaps per month refers to 

‘‘swaps’’ as defined in section 1a(47) of 

the CEA and Commission regulations, 

but would not include assignments, 

novations, amendments, or like events 

that occur with respect to existing 

swaps. 

b. Definition of ‘‘Third-party 

Subaccount’’ 

The Implementation Schedule NPRM 

defined ‘‘third-party subaccount’’ to 

mean ‘‘a managed account that requires 

the specific approval by the beneficial 

owner of the account to execute 

documentation necessary for executing, 

confirming, margining or clearing 

swaps.’’ Third-party subaccounts were 

designated as Category 3 Entities, 

whereas other funds were designated 

Category 1 or Category 2 Entities. 

With respect to this definition, AII 

commented that the definition is too 

narrow given the administrative work 

required in managing an account, 

regardless of the execution authority. 

Further, AII stated that execution 

authority is not an industry standard, 

and thus divides the universe of 

separate accounts inappropriately. 

Similarly, the Investment Company 

Institute (ICI) stated that third party 

subaccounts, whether subject to the 

specific execution authority of the 

beneficiary or not, require managers to 

work closely with clients when entering 

into trading agreements on the 

customer’s behalf. As such, no 

distinction should be made based on 

specific execution authority or lack 

thereof, and that all third party accounts 

should be uniformly classified as 

Category 3 Entities, allowing for a 270 

day compliance period. 

FIA/ISDA/SIFMA also recommended 

that all accounts managed for third 

parties, regardless of the execution 

authority, should be in the Category 3 

Entity implementation phase. FIA/ 

ISDA/SIFMA recommended that the 

Commission adopt a definition of 

‘‘third-party fund’’ that is any fund that 

is not a private fund and is sub-advised 

by a subadvisor that is independent of 

and unaffiliated with the fund sponsor. 

A ‘‘third-party subaccount’’ would be 

defined as any account that is not a fund 

and is managed by an asset manager, 

irrespective of the level of delegation 

granted by the account owner by the 

account owner to the asset manager. 

Based on the comments received, the 

Commission is revising the definition of 

Third-Party Subaccount to mean an 

account that is managed by an 

investment manager that (1) is 

independent of and unaffiliated with 

the account’s beneficial owner or 

sponsor, and (2) is responsible for the 

documentation necessary for the 

account’s beneficial owner to document 

swaps as required under section 4s(i) of 

the CEA. In modifying this definition, 

the Commission is taking into account 

the point made by AII, FIA/ISDA/ 

SIFMA, and ICI that all investment 

managers will need additional time to 

comply with the trading documentation 

requirements regardless of whether they 

have explicit execution authority. 

However, the definition retains the 

nexus between the investment manager 

and the documentation needed for 

swaps under section 4s(i) of the CEA. In 

other words, if the investment manager 

has no responsibility for documenting 

the swap trading relationships, then that 

account would be required to come into 

compliance with the documentation 

requirements within 180 days. For those 

accounts under the revised definition, 

however, the Commission believes that 

the 270-day deadline is more 

appropriate. Given the general notice 

that investment managers have had 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55939 

49Similarly, the Commission would consider 

allowing entities to petition for additional time to 

comply to the extent that they discover that they 

have exceeded the de minimis threshold under the 

swap dealer definition and are required to register 

during the 90-day period for Category 1. 

about the Dodd-Frank Act’s 

documentation requirements for SDs 

and MSPs since the enactment of the 

statute in July, 2010, managers should 

have been able to consider and plan the 

infrastructure and resources that are 

necessary for all of their accounts, 

including Third-Party Subaccounts, to 

comply with the documentation 

requirements. Thus, the 180- and 270- 

day deadlines should provide adequate 

time to accommodate all managed 

accounts. 

c. Definitions of Categories of Entities 

The Commission received several 

comments with respect to the 

definitions of the categories of entities 

to which the proposed implementation 

schedules applied. 

Encana and EEI, National Rural 

Electric Cooperative Association, and 

Electric Power Supply Association 

(Joint Associations) believe that the 

definition of Category 4 Entity under the 

proposed implementation schedules 

should expressly include non-financial 

end users. 

The Coalition for Derivatives EndUsers argued that financial end-users 

should be treated identically to nonfinancial end-users because they do not 

pose systemic risk, and therefore, 

should be given the most time to 

comply with the requirements. 

ICI requested clarification that a 

market participant can determine 

whether it is an MSP for purposes of the 

proposed implementation schedules at 

the same time that it is required to 

review its status as an MSP under other 

Commission and SEC rules. 

CIEBA requested that in-house ERISA 

funds should be in the group with the 

longest compliance time, and not 

Category 2 Entities, arguing that these 

funds are not systemically risky, and 

they typically rely upon third-party 

managers for some portion of their fund 

management. Splitting in-house and 

external accounts (i.e., those accounts 

meeting the Implementation Schedule 

NPRM’s definition of third-party 

subaccount and which are therefore 

Category 3 Entities) of the same ERISA 

plan will impact risk management given 

different implementation schedules. 

The distinction will also cause pension 

funds to bear the costs of compliance 

because they will need to comply prior 

to their third party managers who would 

be better positioned to provide insight 

and services in this regard. 

The Commission considered the 

foregoing comments, and has 

determined to modify the category 

definitions in certain respects. In 

response to Encana and the Joint 

Associations, non-financial entities are 

clearly included amongst Category 4 

Entities and SDs and MSPs are given 

270 days to comply with the 

documentation requirement with 

respect to such entities. 

With respect to issues raised by the 

Coalition for Derivatives End-Users 

regarding those financial entities 

included in Category 2, the Commission 

believes that those entities have been 

correctly categorized based upon the 

distinction between financial and nonfinancial entities under section 2(h)(7) 

of the CEA. The Commission believes 

that, just as Congress has required 

financial entities to be subject to 

required clearing due to their 

importance to the financial system, SDs 

and MSPs should be required to meet 

the documentation requirements of 

§ 23.504 with such entities prior to 

being required to meet such 

documentation requirements with nonfinancial entities. However, the 

definition of Category 2 Entity is 

modified by removing the reference to 

ERISA plans. The Commission 

recognizes the concerns raised by 

CIEBA regarding splitting in-house and 

external accounts (i.e., those accounts 

meeting the definition of Third-Party 

Subaccount and permitted 270 days) of 

the same ERISA plan. In response to 

these concerns, the Commission is 

removing the reference to employee 

benefit plans as defined in paragraphs 

(3) and (32) of section 3 of the Employee 

Retirement Income and Security Act of 

1974. As a result, these ERISA plans 

will be afforded the longest compliance 

period (270 days). 

In response to the comment from ICI, 

the Commission confirms that a 

potential MSP may be able to review its 

obligation to register as an MSP at the 

same time it is reviewing where it fits 

under the compliance dates adopted in 

this release depending on the nature 

and scope of an MSP’s swaps activities. 

The Commission notes that its rule 

further defining MSP was published on 

May 23, 2012, and its rule further 

defining ‘‘swap’’ was published on 

August 13, 2012, so potential MSPs will 

necessarily have to review their 

registration obligations ahead of 

complying with the compliance dates 

adopted herein. However, if an entity 

discovers that it has crossed the 

threshold established under the MSP 

rules and is required to register during 

the 90-day period for Category 1 

Entities, the Commission would permit 

that entity to petition for additional time 

to come into compliance with the 

§ 23.504.49

d. Proposed Implementation Schedule 

As outlined above, proposed § 23.575 

required SDs and MSPs to be in 

compliance with § 23.504 no later than 

90 days after publication of the final 

rule in the Federal Register for swap 

transactions with a Category 1 Entity, no 

later than 180 days after publication for 

swap transactions with a Category 2 

Entity, and no later than 270 days after 

publication for swap transactions with a 

Category 3 Entity or Category 4 Entity. 

With respect to the proposed 

schedule, FIA/ISDA/SIFMA believes 

that the proposed implementation 

schedule should be lengthened because 

of the significant burden associated with 

the documentation requirements. FIA/ 

ISDA/SIFMA argued that it would be 

impossible to begin complying with all 

of the documentation requirements of 

§ 23.504 at the same time. 

AII stated that the proposed 

implementation schedule does not 

provide enough time for institutional 

investment advisors to comply given the 

volume of document negotiations that 

will need to occur concurrently, as well 

as operational changes required by the 

Commission and other regulators under 

the Dodd-Frank Act. AII argued that 

institutional investment advisers also 

will face special challenges trying to 

allocate block trades across multiple 

categories of counterparty, and 

managing multiple implementation 

schedules. AII believes that tight 

timeframes will create an imbalance in 

negotiations with smaller counterparties 

at risk of being ‘‘shut out of the market’’ 

if they do not accept terms of the dealer 

community. AII therefore recommended 

that all market participants should have 

18 months to come into compliance 

after the rules have been finalized. 

Encana believes non-financial end 

users should get more time to comply 

with the regulations given less 

familiarity with Commission regulations 

and the need to develop and implement 

policies and procedures. 

CDE stated that it is unlikely that endusers and other entities relied on by 

end-users will be able to meet the 

requirements § 23.504 if the 

requirements are imposed on all swaps 

at the same time. 

Chris Bernard generally agreed with 

the proposed implementation schedule, 

though he believes that documentation 

relating to the swap valuation 

provisions of § 23.504(b)(4) should be 

prioritized within the compliance 

schedule. 


sroberts on DSK5SPTVN1PROD with RULES
55940 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

The California Public Employees’ 

Retirement System, the Colorado PERA, 

the Missouri State Employees’ 

Retirement System, the Teacher 

Retirement System of Texas, and the 

State of Wisconsin Investment Board 

recommended a one year phase-in for 

pension funds because the strict 

procedures that exist to protect their 

participants may hamper their ability to 

more quickly make the required changes 

to documents and procedures. 

FSR commented that compliance 

periods should be substantially longer, 

with Category 2 lasting at least a year, 

and not starting until a significantly 

longer Category 1 has completed. As 

smaller market participants face the risk 

of accepting unsuitable terms or being 

shut out of the market given the tight 

timeframes and lack of resources, 

additional time should be granted to 

entities hedging in the ordinary course 

of business. 

ICI stated that implementation should 

be longer, such as 18–24 months to 

accommodate all of the changes that are 

necessary in the market, arguing that too 

short a deadline will disadvantage 

smaller market participants who may be 

shut out of the market. ICI also 

recommended that the proposed 

implementation schedules should only 

begin after all related rules are finalized. 

ACLI stated that 180 days for Category 

2 Entities is insufficient for insurance 

companies that will need to work with 

state regulators on changes to 

operations, to negotiate documents of 

first impression, especially given the 

scope of the documentation to be 

negotiated or changed. 

The Commission acknowledges the 

concerns of commenters regarding 

negotiation imbalances if the scope of 

documentation to be changed is large, 

but believes that, with the modifications 

to the rules outlined above, most market 

participants will have documentation 

already in place that either meets the 

requirements of the rule or could meet 

such requirements with relatively 

modest amendments. Thus, the 

Commission believes that these changes 

plus the staggered timeframes of the 

compliance dates adopted in this release 

adequately address the concerns of 

commenters regarding the time and 

effort necessary to complete the 

necessary documentation. 

2. Confirmation NPRM 

With respect to §§ 23.501, 23.502, and 

23.503 generally, GFED argued that the 

Commission should not implement the 

proposed rules prior to Treasury 

determining which foreign exchange 

products are subject to the proposed 

rules to avoid unnecessary costs and 

burdens, while MFA believes that the 

Commission should evaluate the notable 

differences in experience and resources 

of market participants related to posttrade processes prior to publishing final 

rules. MFA believes that the 

Commission’s goals would be best 

served, and market disruption avoided, 

by providing market participants with 

additional time to design, test, and 

implement processes required to 

comply with the proposed rules. 

Specifically with respect to § 23.501, 

MarkitSERV believes that the rules 

should be phased in based on a productby-product analysis of complexity and 

average time to confirm similar 

transactions, while Chatham believes 

the confirmation requirements should 

be phased-in over 6 to 12 months and 

that non-SDs and non-MSPs should be 

the last participants required to comply 

with the rules. In addition, ISDA 

provided the Commission with details 

of the current percentage of transactions 

electronically traded and confirmed, 

voice traded and electronically 

confirmed, voice traded and manually 

confirmed, and electronically traded 

and manually confirmed by eight large 

dealers in the five major swap asset 

classes (credit, rates, commodities, 

foreign exchange, and equity 

derivatives). ISDA provided the 

Commission with a break-down of this 

data showing time to confirmation by 

asset class, and the differences between 

electronic confirmation in dealer-todealer transactions versus transactions 

with other counterparty types. 

Specifically with respect to § 23.502, 

Chatham recommended that the 

Commission provide end-users with at 

least six months to one year to comply 

with the proposed reconciliation rules, 

while the OCC stated that many SDs 

will not be among the G–14 largest OTC 

derivatives dealers and, given the 

incremental progression that was 

necessary for the G–14 OTC derivatives 

dealers to develop the infrastructure 

necessary to increase reconciliation 

amongst themselves from weekly 

reconciliation for portfolios with 5,000 

or more trades in 2008 to the current 

daily reconciliation for portfolios of 500 

or more trades, the Commission must 

provide sufficient time for all registrants 

to develop the required infrastructure. 

With respect to § 23.503, ISDA urged 

the Commission to consider a long 

phase-in period for any compression 

requirement due to significant 

administrative and logistical issues. 

B. Compliance Dates 

Having considered the comments 

received, the Commission is adopting 

the effective and compliance dates as set 

forth below. 

1. Swap Trading Relationship 

Documentation—§ 23.504 

The effective date of § 23.504 will be 

the date that is 60 days after publication 

of the final rules in the Federal Register. 

The Commission proposed a 

compliance schedule, § 23.575, but has 

determined not to finalize its schedule 

in the form of a rule. Rather, compliance 

periods are outlined below. With 

respect to swap transactions with SDs, 

security-based swap dealers, MSPs, 

major security-based swap participants, 

or any private fund, as defined in 

section 202(a) of the Investment 

Advisers Act of 1940, that is not a thirdparty subaccount (defined below) and 

that executes 200 or more swaps per 

month based on a monthly average over 

the 12 months preceding this adopting 

release (active funds), SDs and MSPs 

must comply with § 23.504 by January 

1, 2013. 

With respect to swap transactions 

with commodity pools; private funds as 

defined in section 202(a) of the 

Investment Advisers Act of 1940 other 

than active funds; or persons 

predominantly engaged in activities that 

are in the business of banking, or in 

activities that are financial in nature as 

defined in section 4(k) of the Bank 

Holding Company Act of 1956, provided 

that the entity is not an account that is 

managed by an investment manager that 

(1) is independent of and unaffiliated 

with the account’s beneficial owner or 

sponsor, and (2) is responsible for the 

documentation necessary for the 

account’s beneficial owner to document 

swaps as required under section 4s(i) of 

the CEA (third-party subaccounts), SDs 

and MSPs must comply with § 23.504 

by April 1, 2013. 

With respect to swap transactions 

with any other counterparty, SDs and 

MSPs must comply with § 23.504 by 

July 1, 2013. 

2. Swap Confirmation—§ 23.501 

The effective date of §§ 23.500 and 

23.501 will be the date that is 60 days 

after publication of the final rules in the 

Federal Register. 

With respect to confirmation, the 

Commission is establishing an 

implementation schedule in the rule, 

differentiated by swap asset class. For 

credit swaps and interest rate swaps 

(including cross-currency swaps), SDs 

and MSPs will be required to confirm 

swap transactions with other SDs and 

MSPs as soon as technologically 

practicable, but in any event by the end 

of the second day after the day of 

execution until February 28, 2014. After 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55941 

February 28, 2014, SDs and MSPs must 

comply with the requirements of 

paragraph (a)(1). 

For equity swaps, foreign exchange 

swaps, and other commodity swaps, 

SDs and MSPs will be required to 

confirm swap transactions with other 

SDs and MSPs as soon as 

technologically practicable, but in any 

event by the end of the third day after 

the day of execution until August 31, 

2013. For the period between September 

1, 2013 and August 31, 2014, SDs and 

MSPs will be required to confirm 

equity, foreign exchange, and other 

commodity swap transactions with 

other SDs and MSPs as soon as 

technologically practicable, but in any 

event by the end of the second day after 

the day of execution. After August 31, 

2014, SDs and MSPs must comply with 

the requirements of paragraph (a)(1). 

For credit and interest rate swap 

transactions (including cross-currency 

swaps) with counterparties that are not 

SDs or MSPs, SDs and MSPs will be 

required to send an acknowledgement of 

swap transactions as soon as 

technologically practicable, but in any 

event by the end of the first day after the 

day of execution until February 28, 

2014. After February 28, 2014, SDs and 

MSPs must comply with the 

requirements of paragraph (a)(2). 

For equity, foreign exchange, and 

other commodity swap transactions 

with counterparties that are not SDs or 

MSPs, SDs and MSPs will be required 

to send an acknowledgement of swap 

transactions as soon as technologically 

practicable, but in any event by the end 

of the second day after the day of 

execution until August 31, 2013. For the 

period between September 1, 2013 and 

August 31, 2014, SDs and MSPs will be 

required to send an acknowledgement of 

equity, foreign exchange, and other 

commodity swap transactions with 

counterparties that are not SDs or MSPs 

as soon as technologically practicable, 

but in any event by the end of the first 

day after the day of execution. After 

August 31, 2014, SDs and MSPs must 

comply with the requirements of 

paragraph (a)(2). 

For credit and interest rate swap 

transactions (including cross-currency 

swaps) with financial entities, SDs and 

MSPs will be required to establish 

policies and procedures reasonably 

designed to ensure that they confirm 

swap transactions as soon as 

technologically practicable, but in any 

event by the end of the second day after 

the day of execution until February 28, 

2014. After February 28, 2014, SDs and 

MSPs must comply with the 

requirements of paragraph (a)(3)(i). 

For equity, foreign exchange, and 

other commodity swap transactions 

with financial entities, SDs and MSPs 

will be required to establish policies 

and procedures reasonably designed to 

ensure that they confirm swap 

transactions as soon as technologically 

practicable, but in any event by the end 

of the third day after the day of 

execution until August 31, 2013. For the 

period between September 1, 2013 and 

August 31, 2014, SDs and MSPs will be 

required to establish policies and 

procedures reasonably designed to 

ensure that they confirm equity, foreign 

exchange, and other commodity swap 

transactions with financial entities as 

soon as technologically practicable, but 

in any event by the end of the second 

day after the day of execution. After 

August 31, 2014, SDs and MSPs must 

comply with the requirements of 

paragraph (a)(3)(i). 

For credit and interest rate swap 

transactions (including cross-currency 

swaps) with counterparties that are not 

SDs, MSPs, or financial entities, SDs 

and MSPs will be required to establish 

policies and procedures reasonably 

designed to ensure that they confirm 

swap transactions as soon as 

technologically practicable, but in any 

event by the end of the fifth day after 

the day of execution until August 31, 

2013. For the period between September 

1, 2013 and August 31, 2014, SDs and 

MSPs will be required to establish 

policies and procedures reasonably 

designed to ensure that they confirm 

credit and interest rate swap 

transactions with counterparties that are 

not SDs, MSPs, or financial entities as 

soon as technologically practicable, but 

in any event by the end of the third day 

after the day of execution. After August 

31, 2014, SDs and MSPs must comply 

with the requirements of paragraph 

(a)(3)(ii). 

For equity, foreign exchange, and 

other commodity swap transactions 

with counterparties that are not SDs, 

MSPs, or financial entities, SDs and 

MSPs will be required to establish 

policies and procedures reasonably 

designed to ensure that they confirm 

swap transactions as soon as 

technologically practicable, but in any 

event by the end of the seventh day after 

the day of execution until August 31, 

2013. For the period between September 

1, 2013 and August 31, 2014, SDs and 

MSPs will be required to establish 

policies and procedures reasonably 

designed to ensure that they confirm 

equity, foreign exchange, and other 

commodity swap transactions with 

counterparties that are not SDs, MSPs, 

or financial entities as soon as 

technologically practicable, but in any 

event by the end of the fourth day after 

the day of execution. After August 31, 

2014, SDs and MSPs must comply with 

the requirements of paragraph (a)(3)(ii). 

Solely for purposes of the 

implementation schedule applicable to 

§ 23.501, swaps are divided into the 

following asset classes: 

Credit swap means any swap that is 

primarily based on instruments of 

indebtedness, including, without 

limitation: Any swap primarily based on 

one or more broad-based indices related 

to instruments of indebtedness; and any 

swap that is an index credit swap or 

total return swap on one or more indices 

of debt instruments. 

Equity swap means any swap that is 

primarily based on equity securities, 

including, without limitation: Any swap 

primarily based on one or more broadbased indices of equity securities; and 

any total return swap on one or more 

equity indices. 

Foreign exchange swap has the 

meaning set forth in section 1a(25) of 

the CEA. It does not include swaps 

primarily based on rates of exchange 

between different currencies, changes in 

such rates, or other aspects of such rates 

(sometimes known as ‘‘cross-currency 

swaps’’). 

Interest rate swap means any swap 

which is primarily based on one or more 

interest rates, such as swaps of 

payments determined by fixed and 

floating interest rates; or any swap 

which is primarily based on rates of 

exchange between different currencies, 

changes in such rates, or other aspects 

of such rates (sometimes known as 

‘‘cross-currency swaps’’). 

Other commodity swap means any 

swap not included in the credit, equity, 

foreign exchange, or interest rate asset 

classes, including, without limitation, 

any swap for which the primary 

underlying item is a physical 

commodity or the price or any other 

aspect of a physical commodity. 

3. Portfolio Reconciliation & Portfolio 

Compression 

The effective date of §§ 23.502 and 

23.503 will be the date that is 60 days 

after publication of the final rules in the 

Federal Register. 

With respect to § 23.502 (Portfolio 

Reconciliation) and § 23.503 (Portfolio 

Compression), SDs and MSPs that are 

currently regulated by a U.S. prudential 

regulator or are registrants of the SEC 

must comply with §§ 23.502 and 23.503 

by the date that is 90 days after 

publication of this final rule in the 

Federal Register. SDs and MSPs that are 

not currently regulated by a U.S. 

prudential regulator and are not 

registrants of the SEC must comply with 


sroberts on DSK5SPTVN1PROD with RULES
55942 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

50Subpart H of Part 23 of the Commission’s 

Regulations, Business Conduct Standards for Swap 

Dealers and Major Swap Participants with 

Counterparties, 77 FR 9734, 9824 (Feb. 17, 2012). 

51 ISDA is partnering with Markit to launch a 

technology-based solution enabling counterparties 

to amend their OTC derivatives documentation 

quickly and efficiently to comply with Dodd-Frank 

regulatory requirements. See http://www2.isda.org/ 

dodd-frank-documentation-initiative/. 

52The Commission’s decision to defer 

compliance does not reflect an endorsement of the 

industry-led effort, nor does it imply that the 

Commission has reviewed the documentation 

protocol for compliance with Commission rules. All 

market participants are subject to the new 

compliance dates regardless of whether they 

participate in the protocol. 

53 7 U.S.C. 19(a). 

54Although by its terms section 15(a)(2)(B) of the 

CEA applies to futures markets only, the 

Commission finds this factor useful in analyzing 

regulations pertaining to swap markets as well. 

55On October 3, 2008, President Bush signed the 

Emergency Economic Stabilization Act of 2008, 

which was principally designed to allow the U.S. 

Treasury and other government agencies to take 

action to restore liquidity and stability to the U.S. 

financial system (e.g., the Troubled Asset Relief 

Program—also known as TARP—under which the 

U.S. Treasury was authorized to purchase up to 

$700 billion of troubled assets that weighed down 

the balance sheets of U.S. financial institutions). 

See Pub. L. 110–343, 122 Stat. 3765 (2008). 

56See Financial Crisis Inquiry Commission, ‘‘The 

Financial Crisis Inquiry Report: Final Report of the 

National Commission on the Causes of the 

Financial and Economic Crisis in the United 

States,’’ Jan. 2011, at xxvii, available at http://www.

gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf 

[hereinafter the FCIC Report]. 

57See id. at 25 (concluding that ‘‘enactment of 

* * * [the Commodity Futures Modernization Act 

of 2000 (‘‘CFMA’’)] to ban the regulation by both 

the federal and state governments of over-thecounter (OTC) derivatives was a key turning point 

in the march toward the financial crisis.’’). See also 

id. at 343 (‘‘Lehman, like other large OTC 

derivatives dealers, experienced runs on its 

derivatives operations that played a role in its 

failure. Its massive derivatives positions greatly 

complicated its bankruptcy, and the impact of its 

bankruptcy through interconnections with 

derivatives counterparties and other financial 

institutions contributed significantly to the severity 

and depth of the financial crisis.’’) and id. at 353 

(‘‘AIG’s failure was possible because of the 

sweeping deregulation of [OTC] derivatives, [* * *] 

including capital and margin requirements that 

would have lessened the likelihood of AIG’s failure. 

The OTC derivatives market’s lack of transparency 

and of effective price discovery exacerbated the 

collateral disputes of AIG and Goldman Sachs and 

similar disputes between other derivatives 

counterparties.’’). 

§§ 23.502 and 23.503 by the date that is 

180 days after publication of this final 

rule in the Federal Register. 

C. Compliance Date Extension for 

Certain Business Conduct Standards 

With Counterparties 

ISDA members have requested that 

the Commission align the compliance 

dates for the provisions of subpart H of 

part 23 that involve documentation 50

with the trading relationship 

documentation rules in this release. 

ISDA members have represented that 

industry-led efforts are underway to 

facilitate compliance with new DoddFrank Act documentation requirements 

and an alignment of compliance dates 

would allow the most efficient 

transition to compliance with part 23’s 

documentation requirements.51

The Commission has decided to defer 

the compliance dates for certain 

provisions of subpart H until January 1, 

2013. Compliance with the following 

provisions will be deferred until January 

1, 2013: §§ 23.402; 23.410(c); 23.430; 

23.431(a)–(c); 23.432; 23.434(a)(2), (b), 

and (c); 23.440; and 23.450.52

Compliance with all other provisions 

will continue to be required by October 

15, 2012. 

IV. Cost Benefit Considerations 

Section 15(a) of the CEA 53 requires 

the Commission to consider the costs 

and benefits of its actions before 

promulgating a regulation under the 

CEA or issuing certain orders. 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; 54

(3) price discovery; (4) sound risk 

management practices; and (5) other 

public interest considerations. The 

Commission considers the costs and 

benefits resulting from its discretionary 

determinations with respect to the 

Section 15(a) factors. 

Under section 731 of the Dodd-Frank 

Wall Street Reform and Consumer 

Protection Act (Dodd-Frank Act), 

Congress directed the Commission to 

‘‘adopt rules governing documentation 

standards for swap dealers and major 

swap participants.’’ The statutory 

provision in question, section 4(s)(i)(1) 

of the CEA, laid out a broad and general 

directive relating to ‘‘timely and 

accurate confirmation, processing, 

netting, documentation, and valuation 

of all swaps.’’ In promulgating the final 

rules subject to this release, the 

Commission has taken its direction from 

the statutory text, but is exercising its 

discretion with regard to the specific 

requirements set forth in the rules— 

namely, to require SDs and MSPs to 

meet certain confirmation deadlines for 

their swap transactions with other SDs 

and MSPs, to have policies and 

procedures for confirming swap 

transactions with financial entities and 

non-financial entities within certain 

time periods, to engage in regular 

portfolio reconciliation and portfolio 

compression, and to ensure that their 

swaps are governed by appropriate 

trading relationship documentation. 

In exercising its discretion, the 

Commission has taken into account a 

series of voluntary industry initiatives, 

including efforts to improve the 

confirmation, reconciliation, 

compression, documentation, and 

valuation of swaps, as well as the 

overarching goals of the Dodd-Frank 

Act: reducing systemic risk, increasing 

transparency, and promoting integrity 

within the financial system. As 

discussed below, these industry efforts 

provide a useful reference point for 

considering the Commission’s action. 

In the context of the relevant statutory 

provision and ongoing industry 

initiatives, in the sections that follow, 

the Commission discusses each 

requirement individually in light of 

cost-benefit issues raised by 

commenters and suggested alternatives. 

The Commission also summarizes and 

considers costs and benefits collectively 

for the set of confirmation, portfolio 

reconciliation, and portfolio 

compression rules, and separately for 

the swap trading relationship 

documentation rules. 

A. Background 

In the fall of 2008, an economic crisis 

threatened to freeze U.S. and global 

credit markets. The federal government 

intervened to buttress the stability of the 

U.S. financial system.55 The crisis 

revealed the vulnerability of the U.S. 

financial system and economy to widespread systemic risk resulting from, 

among other things, poor risk 

management practices of financial firms 

and the lack of supervisory oversight for 

certain financial institutions as a 

whole.56 More specifically, the crisis 

and the attendant failure of a series of 

large financial institutions demonstrated 

the need for direct regulation of the OTC 

derivatives markets.57

American International Group (AIG) 

is an example of how the stability of a 

large financial institution could be 

undermined by certain failures in risk 

management, internal controls with 

respect to trading positions, 

documentation, and valuation, AIG was 

a regulated U.S. insurance company 

nearly undone by its collateral posting 

obligations under swaps entered into by 

its subsidiary, AIG Financial Products 

(AIGFP). AIGFP suffered enormous 

losses from credit default swaps that it 

issued on certain underlying securities, 

which, because AIGFP’s performance on 

such credit default swaps had been 

guaranteed by its parent, caused credit 

agencies to downgrade the credit rating 

of the entire AIG corporation. The 

downgrade triggered collateral calls and 

induced a liquidity crisis at AIG, which 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55943 

58The Federal Reserve Bank of New York 

explained its intervention as a means of preventing 

contagion concerns resulting from an AIG default 

from spreading financial losses to other firms. The 

FCIC argued and Gretchen Morgenson reported that 

the entire U.S. financial system might have been 

threatened by such a large default. See FCIC Report 

at 200–02 and 344–52 and Gretchen Morgenson, 

‘‘Behind Insurer’s Crisis, Blind Eye to a Web of 

Risk,’’ N.Y. Times, Sept. 27, 2008 [hereinafter 

Morgenson Article]. Corrected version published 

Sept. 30, 2008, available at http://www.nytimes.

com/2008/09/28/business/28melt.html?

pagewanted=all. 

59See Testimony Before the Financial Crisis 

Inquiry Commission, including AIG/Goldman 

Sachs Collateral Call Timeline, available at http:// 

fcic-static.law.stanford.edu/cdn_media/fcictestimony/2010-0701-AIG-Goldman-supportingdocs.pdf (timeline documenting valuation disputes 

and collateral calls); Testimony of Joseph Cassano, 

available at http://fcic-static.law.stanford.edu/cdn_

media/fcic-testimony/2010-0630-Cassano.pdf; and 

AIG Statement Summary, available at http://fcicstatic.law.stanford.edu/cdn_media/fcic-testimony/

2010-0630-AIG-Statement-Summary.pdf. 

60The failure of the market to set a price for 

mortgage-backed securities led to wide disparities 

in the valuation of CDS referencing mortgagebacked securities (especially collateralized debt 

obligations). ‘‘The illiquid market for some 

structured credit products, auction rate securities, 

and other products backed by opaque portfolios led 

to major write-downs across the industry in 2008. 

The resulting depletion of capital led to credit 

downgrades, which in turn drove counterparty 

collateral calls and sales of illiquid assets. This 

further depleted capital balances. Widening CDS 

spreads have become widely viewed as a leading 

indicator of a bank’s financial health and viability.’’ 

PriceWaterhouseCoopers, ‘‘Lehman Brothers’ 

Bankruptcy: Lessons learned for the survivors,’’ 

Informational presentation for clients, August 2009, 

at 12, available at http://www.pwc.com/en_JG/jg/

events/Lessons-learned-for-the-survivors.pdf. In 

addition, such wide disparities led to large 

collateral calls from dealers on AIG, hastening its 

downfall. See CBS News, ‘‘Calling AIG? Internal 

Docs Reveal Company Silent About Dozens Of 

Collateral Calls,’’ Jun. 23, 2009, available at: http:// 

www.cbsnews.com/stories/2009/06/23/cbsnews_

investigates/main5106672.shtml. 

61See Morgenson Article. 

62Congressional Oversight Panel, June Oversight 

Report: The AIG Rescue, Its Impact on Markets, and 

the Government’s Exit Strategy, June 10, 2010, at 

24, available at http://cybercemetery.unt.edu/

archive/cop/20110402010341/cop.senate.gov/

documents/cop-061010-report.pdf. 

63See In re Lehman Brothers Holdings Inc., 08– 

13555, and Giddens v. Barclays Capital Inc., 09– 

01732, U.S. Bankruptcy Court, Southern District of 

New York; see also Linda Sandler, ‘‘Lehman 

Derivatives Records a ‘Mess,’ Barclays Executive 

Says,’’ Bloomberg, Aug. 30, 2010, available at 

http://www.bloomberg.com/news/2010-08-30/

lehman-derivatives-records-a-mess-barclaysexecutive-says.html (reporting on testimony 

provided in previously cited Lehman bankruptcy 

proceeding). 

64See PriceWaterhouseCoopers, ‘‘Lehman 

Brothers’ Bankruptcy: Lessons learned for the 

survivors,’’ Informational presentation for clients, 

August 2009, at 12–24, available at http://www.pwc.

com/en_JG/jg/events/Lessons-learned-for-thesurvivors.pdf. 

65The President’s Working Group on Financial 

Markets, ‘‘Policy Statements on Financial Market 

Developments,’’ Mar. 2008, available at http://www.

treasury.gov/resource-center/fin-mkts/Documents/

pwgpolicystatemktturmoil_03122008.pdf. 

66Pub. L. 111–203, 124 Stat. 1376 (2010). The text 

of the Dodd-Frank Act is available at http://www.

cftc.gov/ucm/groups/public/@swaps/documents/

file/hr4173_enrolledbill.pdf. 

67 7 U.S.C. 1, et seq. 

68Prior to the adoption of Title VII, swaps and 

security-based swaps were by and large 

unregulated. The CFMA excluded financial OTC 

swaps from regulation under the CEA, provided 

that trading occurred only among ‘‘eligible contract 

participants.’’ Swaps based on exempt 

commodities—including energy and metals—could 

be traded among eligible contract participants 

without CFTC regulation, but certain CEA 

provisions against fraud and manipulation 

continued to apply to these markets. No statutory 

exclusions were provided for swaps on agricultural 

commodities by the CFMA, although they could be 

traded under certain regulatory exemptions 

provided by the CFTC prior to its enactment. Swaps 

based on securities were subject to certain SEC 

enforcement authorities, but the SEC was 

prohibited from prophylactic regulation of such 

swaps. 

69The provisions of the CEA relating to swaps 

that were enacted by Title VII of the Dodd-Frank 

Act are also referred to herein as ‘‘the Dodd-Frank 

requirements.’’ 

70Legislatures and regulators in a number of 

foreign jurisdictions are undertaking significant 

regulatory reforms over the swaps market and its 

participants. See CFTC and SEC, Joint Report on 

International Swap Regulation Required by Section 

Continued 

resulted in over $85 billion of indirect 

assistance from the Federal Reserve 

Bank of New York to prevent AIG’s 

default.58

The inability to value its portfolio 

accurately and agree on valuations with 

its counterparties posed a serious 

problem for AIG during the financial 

crisis.59 Swap valuation disputes were 

common, because, among other things, 

there was widespread market opacity for 

many of the inputs needed to properly 

value many swaps.60 As reported during 

the fall of 2008, ‘‘the methods that A.I.G. 

used to value its derivatives portfolio 

began to come under fire from trading 

partners.’’ 61 As explained by a 

Congressional panel, ‘‘the threats within 

[AIG’s] businesses emanated from 

outsized exposure to the deteriorating 

mortgage markets, owing to grossly 

inadequate valuation and risk controls, 

including insufficient capital buffers as 

losses and collateral calls mounted’’ 

(emphasis added).62

The financial crisis also highlighted 

the significance of substandard or 

missing legal documentation. For 

example, the Lehman Brothers Holding 

Inc. (LBHI) bankruptcy offers another 

stark lesson on how failures in risk 

management, documentation, and 

valuation can contribute to the ultimate 

collapse of an entire financial 

institution. During the days leading up 

the LBHI’s bankruptcy, potential buyers 

were stymied by the state of Lehman’s 

books.63 As recognized by 

PriceWaterhouseCoopers in a lessons 

learned document put together after the 

Lehman bankruptcy, effective risk 

management requires the existence of 

sound documentation, daily 

reconciliation of portfolios, rigorously 

tested valuation methodologies, and 

sound collateralization practices.64

More broadly, the President’s 

Working Group (PWG) on Financial 

Policy noted shortcomings in the OTC 

derivative markets as a whole during the 

crisis. The PWG identified the need for 

an improved integrated operational 

structure supporting OTC derivatives, 

specifically highlighting the need for an 

enhanced ability to manage 

counterparty risk through ‘‘netting and 

collateral agreements by promoting 

portfolio reconciliation and accurate 

valuation of trades.’’ 65

Congress sought to address the 

deficiencies in the regulatory system 

that contributed to the financial crisis 

through the enactment of the DoddFrank Act, which was signed by 

President Obama on July 21, 2010.66

Title VII of the Dodd-Frank Act 

amended the CEA 67 to overhaul the 

structure and oversight of the OTC 

market that previously had been subject 

to little or no oversight.68 One of the 

cornerstones of this legislation is the 

establishment of a new statutory 

framework for comprehensive 

regulation of financial institutions that 

participate in the swaps market as SDs 

or MSPs, which must register and are 

subject to greater oversight and 

regulation.69 This new framework for 

SDs and MSPs seeks to reduce the 

potential for the recurrence of the type 

of financial and operational stresses that 

contributed to the 2008 crisis. 

Efforts to regulate the swaps market 

are underway not only in the United 

States but also abroad in the wake of the 

2008 financial crisis. In 2009, leaders of 

the Group of 20 (G–20)—whose 

membership includes the European 

Union (EU), the United States, and 18 

other countries—agreed that: (i) OTC 

derivatives contracts should be reported 

to trade repositories; (ii) all 

standardized OTC derivatives contracts 

should be cleared through central 

counterparties and traded on exchanges 

or electronic trading platforms, where 

appropriate, by the end of 2012; and (iii) 

non-centrally cleared contracts should 

be subject to higher capital 

requirements. In line with the G–20 

commitment, much progress has been 

made to coordinate and harmonize 

international reform efforts, but the pace 

of reform varies among jurisdictions and 

disparities in regulations remain due to 

differences in cultures, legal and 

political traditions, and financial 

systems.70


sroberts on DSK5SPTVN1PROD with RULES
55944 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

719(c) of the Dodd-Frank Wall Street Reform and 

Consumer Protection Act, Jan. 31, 2012, at 23, 

available at http://www.cftc.gov/ucm/groups/

public/@swaps/documents/file/dfstudy_isr_

013112.pdf. For example, the European Parliament 

adopted the substance of the European Market 

Infrastructure Regulation (‘‘EMIR’’) on March 29, 

2012. As discussed below, ESMA has proposed 

regulations that are very similar to those being 

adopted by the Commission in this release. 

71See, e.g., Press Release, ‘‘President’s Working 

Group on Financial Markets, Progress Summary on 

OTC Derivatives Operational Improvements’’ (Nov. 

2008). 

72 ‘‘No more Fed letter commitments expected, 

says Dudley,’’ Risk Magazine, May 16, 2012, 

available at http://www.risk.net/risk-magazine/

news/2174981/fed-letter-commitments-expecteddudley (William Dudley, president of the Federal 

Reserve Bank of New York, stated ‘‘Now we’re 

moving to a new regime, where the OTC derivatives 

market is being regulated for the first time. As we 

do that, and the SEC and CFTC stand up in terms 

of regulation, it’s completely appropriate for us to 

stand down.’’). 

73 Dodd-Frank Act, Preamble. 

74See U.S. Department of the Treasury, ‘‘The 

Financial Crisis Response—In Charts,’’ April 2012, 

available at http://www.treasury.gov/resourcecenter/data-chart-center/Documents/20120413_

FinancialCrisisResponse.pdf. See also 

Congressional Budget Office, The Budge and 

Economic Outlook: Fiscal Years 2012–2022, at 26 

(Jan. 2012) (explaining gross domestic product 

(GDP) has fallen dramatically and it is not expected 

to return to normal levels until at least 2018. At that 

time, the cumulative shortfall in GDP relative to 

potential GDP is expected to reach $5.7 trillion). 

75See CoreLogic, ‘‘CoreLogic Reports 66,000 

Completed Foreclosures Nationally,’’ May 2012, 

available at http://www.corelogic.com/about-us/

news/corelogic-reports-66,000-completedforeclosures-nationally-in-april.aspx. 

76See U.S. Census Bureau, ‘‘Income, Poverty, and 

Health Insurance Coverage in the United States: 

2010,’’ at 14 (Sept. 2010), available at http://www.

census.gov/prod/2011pubs/p60-239.pdf. 

77U.S. Government Accountability Office, 

‘‘Credit Derivatives: Confirmation Backlogs 

Increased Dealers’ Operational Risks, But Were 

Successfully Addressed After Joint Regulatory 

Action,’’ GAO–07–716 (2007) at 3–4. 

78See October 4, 2005 industry commitment 

letter to the Federal Reserve Bank of New York, 

available at http://www.newyorkfed.org/

newsevents/news_archive/markets/2005/

an050915.html. 

Even before the passage of the DoddFrank Act, market participants and 

regulators had been paying particular 

attention to the post-trade processing of 

swaps. For example, operational issues 

associated with the OTC derivatives 

market have been the focus of reports 

and recommendations by the PWG.71 In 

response to the financial crisis in 2008, 

the PWG called on the industry to 

improve trade matching and 

confirmation and to promote portfolio 

reconciliation. 

Significantly, beginning in 2005, the 

Federal Reserve Bank of New York 

(FRBNY) undertook a targeted, 

supervisory effort to enhance 

operational efficiency and performance 

in the OTC derivatives market, by 

increasing automation in processing and 

by promoting the timely confirmation of 

trades. Known as the OTC Derivatives 

Supervisors’ Group (ODSG), the FRBNY 

led an effort with OTC derivatives 

dealers’ primary supervisors, trade 

associations, industry utilities, and 

private vendors, through which market 

participants (including buy-side 

participants) regularly set goals and 

commitments to bring infrastructure, 

market design, and risk management 

improvements to all OTC derivatives 

asset classes. Over the years, the ODSG 

expanded its focus from credit 

derivatives to include interest rate 

derivatives, equity derivatives, foreign 

exchange derivatives, and commodity 

derivatives. Along with this expanded 

focus came increased engagement with 

market participants on cross-asset class 

issues. Specifically, the ODSG 

encouraged the industry to commit itself 

to a number of reforms, including 

improved operational performance with 

respect to the OTC derivatives 

confirmation process, portfolio 

reconciliation, and portfolio 

compression. The regulations being 

adopted by the Commission in this 

adopting release build upon the ODSG’s 

work.72 The specific operational 

performance enhancements upon which 

each of the Commission’s rules included 

in this adopting release expressly build, 

the comments to the rule proposals 

related to the costs and benefits of such 

rules, and the Commission’s 

consideration of the costs and benefits 

of such rules are discussed below. 

This final rule implements DoddFrank Act section 731, which is an 

important component of the 

comprehensive set of reforms passed by 

Congress to protect the American public 

and ‘‘promote the financial stability of 

the United States’’ in the wake of a 

financial crisis and the resulting 

recession that was caused in part by the 

lack of adequate regulation of financial 

markets.73 The damage to the American 

public has been tremendous. According 

to the U.S. Department of the Treasury, 

over $19 trillion in household wealth 

and over 8.8 million jobs were lost 

during the recession that began in late 

2008.74 Between September 2008 and 

May 2012 there have been 

approximately 3.6 million completed 

home foreclosures across the country.75

The U.S. Census Bureau estimates that 

the number of households living below 

the poverty level rose 2.6 percent from 

2007 to 2010.76 The overarching 

purpose and benefit of this final rule, 

together with the other rules the 

Commission is implementing under 

Title VII of the Dodd-Frank Act is to 

identify and fix the structural 

weaknesses that contributed to the 

financial crisis in an effort to avoid a 

repeat of the same. 

B. Swap Confirmation 

The Government Accountability 

Office (GAO) found that the rapid 

expansion of the trading volume of 

swaps, such as credit derivatives, since 

2002, caused stresses on the operational 

infrastructure of market participants. 

These stresses, in turn, caused the 

participants’ back office systems to fail 

to confirm the increased volume of 

trades for a period of time.77 The GAO 

found that the lack of automation in 

trade processing and the purported 

assignment of positions by transferring 

parties to third parties without notice to 

their counterparties were factors 

contributing to this backlog. If 

transactions, whether newly executed or 

recently transferred to another party, are 

left unconfirmed, there is no definitive 

written record of the contract terms. 

Thus, in the event of a dispute, the 

terms of the agreement must be 

reconstructed from other evidence, such 

as email trails or recorded trader 

conversations. This process is 

cumbersome and may not be wholly 

accurate. Moreover, if purported 

transfers of swaps, in whole or in part, 

are made without giving notice to the 

remaining parties and obtaining their 

consent, disputes may arise as to which 

parties are entitled to the benefits and 

subject to the burdens of the transaction. 

As the work of the ODSG 

demonstrates, the industry is capable of 

swift movement to contemporaneous 

execution and confirmation. A large 

back-log of unexecuted confirmations in 

the CDS market created by prolonged 

negotiations and inadequate 

confirmation procedures were the 

subject of the first industry 

commitments made by participating 

dealers to ODSG.78 In October 2005, the 

participating dealers committed to 

reduce by 30 percent the number of 

confirmations outstanding more than 30 

days within four months. In March 

2006, the dealers committed to reduce 

the number of outstanding 

confirmations by 70 percent by June 30, 

2006. By September 2006, the industry 

had reduced the number of all 

outstanding CDS confirmations by 70 

percent, and the number of CDS 

confirmations outstanding more than 30 

days by 85 percent. The industry 

achieved these targets largely by moving 

80 percent of total trade volume in CDS 

to confirmation on electronic platforms, 

eliminating backlogs in new trades. 

By the end of 2011, the largest dealers 

were electronically confirming over 95 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55945 

79See G15 Industry Confirmation Data dated 

April 4, 2012 provided by ISDA, available at 

www.cftc.gov. 

80Chatham argued that the Commission should 

not mandate confirmation through an electronic 

matching platform, because such a mandate could 

preclude end-users from entering into swaps not yet 

available on matching platforms and could increase 

costs for end-users that do not engage in the volume 

of swaps necessary to justify the additional costs of 

connecting to electronic matching platforms. ABC 

& CIEBA also argued that the proposed rule could 

impose processes that require third-party service 

providers or new technology. 

81The Working Group; ISDA; Chatham. 

82CIEBA stated that the rule would impose costly 

increases in operational capacity for pension funds 

and recommended that the Commission provide for 

a ‘‘close of next business day’’ time limit for benefit 

plans, along with a requirement that SDs and MSPs 

provide an acknowledgement at the time of 

execution as well as a draft acknowledgement prior 

to execution. AMG argued that financial entities 

should not be subject to shorter time periods for 

confirmation because many may not have the 

operational resources to meet the deadlines. MFA 

stated that designation as a financial entity does not 

necessarily correlate with a large swap portfolio or 

being highly sophisticated, and thus the short time 

period for confirmation in the proposed rules may 

cause unwarranted economic disadvantages. 

83BGA; MetLife; MFA; GFED; the FHLBs; AMG. 

percent of OTC credit derivative 

transactions, and 90 percent were 

confirmed on the same day as execution 

(T+0). For the same period, the largest 

dealers were electronically confirming 

over 70 percent of OTC interest rate 

derivatives (over 90 percent of trades 

with each other), and over 80 percent 

were confirmed T+0. The rate of 

electronic confirmation of OTC 

commodity derivatives was somewhat 

lower—just over 50 percent, but over 90 

percent for transactions between the 

largest dealers.79 These statistics 

provide some confidence that, over 

time, timely confirmation rates will 

continue to improve. 

The primary benefit of timely and 

accurate confirmation is that the parties 

to a swap know what their deal is. In 

other words, a confirmation definitively 

memorializes all of the terms of the 

swap transaction, which is critical for 

all downstream operational and risk 

management processes. If transactions, 

whether newly executed or recently 

transferred to another party, are left 

unconfirmed, there is no definitive 

written record of the contract terms. 

Risk management processes dependent 

on the trade terms (such as collateral 

management, and payment and 

settlement systems) may be inaccurate, 

and, in the event of a dispute, the terms 

of the agreement must be reconstructed 

from other evidence, such as email trails 

or recorded trader conversations. 

Recognizing the laudable gains in 

electronic confirmation processing by 

the industry and the risk reduction in 

the shortening of time periods between 

execution and confirmation, the 

Commission proposed a confirmation 

rule that would have required SDs and 

MSPs trading with each other to confirm 

their swap transactions within 15 

minutes if the swap transaction was 

executed and processed electronically, 

within 30 minutes if the swap 

transaction was only processed 

electronically, and within the same 

calendar day if the swap transaction 

could not be processed electronically. 

Similarly, the Commission proposed 

that SDs and MSPs have policies and 

procedures for confirming swap 

transactions with financial entities 

within the same calendar day, and with 

counterparties that are not SDs, MSPs, 

or financial entities not later than the 

next business day. 

Several commenters recognized the 

benefits of the Commission’s 

confirmation proposal and wrote in 

support of the approach. Chris Barnard 

wrote that the proposal would increase 

transparency and promote legal 

certainty for swaps. CME stated that it 

supported the goals of improving the 

post-trade processing of swaps and 

ensuring timely and accurate 

confirmation of such data among 

counterparties. CME agreed with the 

overall approach taken by the 

Commission on this subject and with 

the goal of promulgating confirmation 

requirements that are effective, not 

duplicative and cost and time efficient 

to the industry. CME noted the costsavings to market participants of 

confirming their swaps through DCOs, 

which is explicitly permitted under the 

swap confirmation rule. 

On the other hand, multiple 

commenters objected to the 

Commission’s proposal on cost grounds. 

Some read the proposal as detrimentally 

mandating electronic confirmation.80

Other commenters argued that the short 

time periods permitted for confirmation 

would effectively require all terms of a 

swap to be negotiated prior to 

execution, increasing costs for the party 

that is most sensitive to timing of 

market conditions and increasing risk 

by leading to needless disputes and 

operational lapses.81 Still others argued 

that financial entities should not be 

subject to shorter confirmation 

deadlines than non-financial entities.82

Finally, some commenters stated that 

the rule would require changes in 

current market practice and it was 

unclear that the cost of additional 

resources to meet the requirements of 

the rule was outweighed by any 

enhanced transparency or reduction in 

systemic risk.83 No commenter provided 

quantitative data on the comprehensive 

compliance costs of the rule as 

proposed, but ISDA and The Working 

Group enumerated costs related to 

adopting electronic confirmation 

procedures. ISDA stated that each asset 

class uses different electronic 

confirmation platforms, so a trader 

conducting trades in multiple asset 

classes would need to build the 

infrastructure necessary to integrate 

multiple platforms. Such expenditures 

are routine for dealers, says ISDA, but 

for smaller entities, the operational costs 

may impede their ability to hedge risk. 

The Working Group estimated that 

electronic confirmation could cost an 

SD or MSP in excess of $1,000,000 

annually, citing that one third-party 

confirmation service charges $6.00 per 

trade. However, The Working Group 

cited no source for the proposition that 

potential SDs or MSPs currently execute 

the more than 166,000 trades annually 

that would be required to reach a 

$1,000,000 annual confirmation cost at 

$6.00 per trade. 

The Commission carefully considered 

each of these comments in formulating 

the final rule and has responded to the 

cost concerns of commenters where 

doing so was in keeping with the benefit 

of timely and accurate memorialization 

of all the terms of a swap transaction 

between an SD or MSP and its 

counterparties. First, the final rule does 

not apply to swap transactions that are 

executed on a SEF or DCM or that are 

submitted for clearing to a DCO by the 

required confirmation deadline, so 

market participants that mostly transact 

in standardized swaps may not be 

affected by the rule, or will have their 

costs greatly reduced. This fact was 

highlighted by both CME and ICE in 

their comments to the proposed rule. 

Second, the Commission notes that 

the final rule affirmatively does not 

mandate electronic confirmation. 

Instead, the final rule sets an ultimate 

deadline for confirmation of swap 

transactions among SDs and MSPs, 

while also requiring that if 

technologically practicable, such swap 

transactions be confirmed sooner. The 

deadline of ‘‘the end of the first business 

day following the day of execution’’ is 

modified to allow for more time if 

registrants are trading near the end of 

the trading day or if such registrants are 

in different time zones. With respect to 

swap transactions with non-SDs and 

non-MSPs, SDs and MSPs are only 

required to have policies and 

procedures in place that are reasonably 

designed to ensure confirmation by the 

end of the first business day following 

the day of execution (modified for end 

of day trading and time zone 

differences) for financial entities, or by 


sroberts on DSK5SPTVN1PROD with RULES
55946 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

84See ESMA Draft Technical Standards, Article 1 

RM, subsection 2 (stating that uncleared OTC 

derivatives ‘‘shall be confirmed, where available via 

electronic means, as soon as possible and at the 

latest by the end of the same business day.’’), and 

ESMA Draft Technical Standards, Article 1 RM, 

subsection 3 (stating that uncleared OTC derivatives 

‘‘shall be confirmed as soon as possible and at the 

latest by the end of the second business day 

following the date of execution’’). 

85See ISDA Collateral Committee, ‘‘Commentary 

to the Outline of the 2009 ISDA Protocol for 

Resolution of Disputed Collateral Calls,’’ June 2, 

2009 (stating ‘‘Disputed margin calls have increased 

significantly since late 2007, and especially during 

2008 have been the driver of large (sometimes > $1 

billion) un-collateralized exposures between 

professional firms.’’). 

86The Commission also recognizes and 

encourages the industry practice of immediately 

transferring undisputed collateral amounts. 

87See June 2, 2009 summary of industry 

commitments, available at http://www.isda.org/c_

and_a/pdf/060209table.pdf. 

88See ‘‘ISDA 2010 Convention on the 

Investigation of Disputed Margin Calls’’ and ‘‘ISDA 

2010 Formal Market Polling Procedure.’’ 

89See Margin Requirements for Uncleared Swaps 

for Swap Dealers and Major Swap Participants, 76 

FR 23732, 23744 (April 28, 2011). Bank SDs and 

MSPs will also be required to document the process 

by which they will arrive at a valuation for each 

swap for the purpose of collecting margin under the 

the end of the second business day 

following the day of execution for nonfinancial entities, rather than the next 

business day as proposed. The 

Commission would expect an SD’s or 

MSP’s policies and procedures to 

require sufficient pre-trade agreement 

on repetitive terms such that non-SD, 

non-MSP counterparties are able to 

execute in a timely manner without 

protracted pre-trade negotiations that 

may prove costly for market participants 

sensitive to execution timing. The 

requirement for policies and procedures 

(as opposed to hard deadlines) 

recognizes that SDs and MSPs cannot 

force their non-SD, non-MSP 

counterparties to adopt particular 

electronic confirmation processes, but 

must accommodate the needs of their 

counterparties while ensuring, to the 

extent possible, that confirmation is 

achieved within the rule’s time periods. 

In addition, to further reduce the 

burden of the rule on those market 

participants that are least able to quickly 

adapt to the rule’s requirements, the 

Commission notes that compliance with 

the rule is implemented on a staggered 

basis. As discussed above under section 

III.B.2, compliance is required first for 

swaps in the credit and interest rate 

asset class, and, within that asset class, 

first for swaps among SDs, MSPs, and 

financial entities with a longer 

compliance period for swaps between 

SDs or MSPs and non-financial entities. 

Compliance is staggered similarly with 

respect to all other swaps, but with 

longer compliance periods. 

The Commission understands that, for 

certain asset classes, the low number of 

transactions does not seem to justify 

increased expenditure on faster 

confirmations; however, the 

Commission is committed to decreasing 

the length of time between execution 

and confirmation in order to improve 

the efficiency of bilateral markets and 

decrease overall systemic risk resulting 

from outstanding unconfirmed trades 

among many participants. The 

Commission maintains that such 

benefits are significant and important 

regardless of asset class. Thus, the 

Commission has applied the same 

general timeframes to all asset classes, 

but has extended the compliance 

deadlines for commodity, equity, and 

foreign exchange asset classes in order 

to allow participants in those asset 

classes sufficient time to integrate faster 

confirmations without an immediate 

and potentially overwhelming burden. 

Finally, the Commission notes that 

ESMA has proposed confirmation 

requirements that are substantially 

similar to those adopted by the 

Commission in this release.84 By closely 

aligning confirmation requirements 

through consultation with ESMA, the 

Commission believes that SDs and 

MSPs will benefit from a largely unitary 

regulatory regime that does not require 

separate compliance and operational 

policies and procedures. 

C. Portfolio Reconciliation 

Disputes related to confirming the 

terms of a swap, as well as swap 

valuation disputes, have long been 

recognized as a significant problem in 

the OTC derivatives market.85 Portfolio 

reconciliation is considered an effective 

means of identifying and resolving these 

disputes. The Commission recognizes 

that the industry has made significant 

progress in adopting the use of portfolio 

reconciliation to decrease the number of 

swap disputes.86 In December 2008, the 

ODSG’s group of 14 major dealers 

committed to execute daily portfolio 

reconciliations for collateralized 

portfolios in excess of 500 trades 

between participating dealers by June of 

2009.87 As of May 2009, all participating 

dealers were satisfying this 

commitment. In October 2009, the 

ODSG committed to publishing a 

feasibility study on market-wide 

portfolio reconciliation that would set 

forth how regular portfolio 

reconciliation could be extend beyond 

the ODSG dealers to include smaller 

banks, buy-side participants, and 

derivative end users. Consistent with 

this publication, the ODSG dealers 

expanded their portfolio reconciliation 

commitment in March 2010 to include 

monthly reconciliation of collateralized 

portfolios in excess of 1,000 trades with 

any counterparty. Most recently, the 

industry has been preparing a new 

‘‘Convention on the Investigation of 

Disputed Margin Calls’’ and a new 

‘‘Formal Market Polling Procedure’’ that 

are intended to ‘‘create a consistent and 

predictable process * * * that 

eliminates present uncertainties and 

delays.’’ 88

In light of these efforts the 

Commission proposed § 23.502, which 

required SDs and MSPs to reconcile 

their swap portfolios with one another 

and provide counterparties that are not 

registered as SDs or MSPs with regular 

opportunities for portfolio 

reconciliation. Specifically, proposed 

§ 23.502 required SDs and MSPs to 

reconcile swap portfolios with other 

SDs or MSPs with the following 

frequency: daily for portfolios consisting 

of 300 or more swaps, at least weekly for 

portfolios consisting of 50 to 300 swaps, 

and at least quarterly for portfolios 

consisting of fewer than 50 swaps. For 

portfolios with counterparties other 

than SDs or MSPs, the proposed 

regulations required SDs and MSPs to 

establish policies and procedures for 

reconciling swap portfolios: daily for 

swap portfolios consisting of 500 or 

more swaps, weekly for portfolios 

consisting of more than 100 but fewer 

than 500 swaps, and at least quarterly 

for portfolios consisting of fewer than 

100 swaps. In order for the marketplace 

to realize the full risk reduction benefits 

of portfolio reconciliation, the 

Commission also proposed to expand 

portfolio reconciliation to all 

transactions, whether collateralized or 

uncollateralized. For the swap market to 

operate efficiently and to reduce 

systemic risk, the Commission believes 

that portfolio reconciliation should be a 

proactive process that delivers a 

consolidated view of counterparty 

exposure down to the transaction level. 

By identifying and managing 

mismatches in key economic terms and 

valuation for individual transactions 

across an entire portfolio, the 

Commission proposal sought to require 

a process in which overall risk can be 

identified and reduced. 

Agreement between SDs, MSPs, and 

their counterparties on the proper daily 

valuation of the swaps in their swap 

portfolio also is essential for the 

Commission’s margin proposal. Under 

proposed rule § 23.151, non-bank SDs 

and MSPs must document the process 

by which they will arrive at a valuation 

for each swap for the purpose of 

collecting initial and variation margin.89


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55947 

margin rules proposed by the OCC, the Federal 

Reserve Board, and the FDIC. See Margin and 

Capital Requirements for Covered Swap Entities, 76 

FR 27564, 27589 (May 11, 2011). 

90 GFED. 

91MFA; ISDA; The Working Group; MarkitSERV; 

AMG. 

92 Dominion; FHLBs; Chatham. 

93 ISDA; The Working Group; FHLBs; AMG. 

94Chatham; The Working Group; MFA; ISDA. 

95FHLBs. 

96 In December 2008, the ODSG’s group of 14 

major dealers committed to execute daily portfolio 

reconciliations for collateralized portfolios in 

excess of 500 trades between participating dealers 

by June of 2009. See June 2, 2009 summary of 

industry commitments, available at http://www.

isda.org/c_and_a/pdf/060209table.pdf. As of May 

2009, all participating dealers were satisfying this 

commitment. The ODSG dealers expanded their 

portfolio reconciliation commitment in March 2010 

to include monthly reconciliation of collateralized 

portfolios in excess of 1,000 trades with any 

counterparty. 

All non-bank SDs and MSPs must 

collect variation margin from their nonbank SD, MSP, and financial entity 

counterparties for uncleared swaps on a 

daily basis. Variation margin requires a 

daily valuation for each swap. For 

swaps between non-bank SDs and MSPs 

and non-financial entities, no margin is 

required to be exchanged under 

Commission regulation, but the nonbank SDs and MSPs must calculate a 

hypothetical variation margin 

requirement for each uncleared swap for 

risk management purposes under 

proposed § 23.154(b)(6). 

Several commenters articulated the 

benefits of portfolio reconciliation and 

supported the Commission’s proposal. 

TriOptima supported the regular 

reconciliation of all portfolios as a 

process that will identify issues that can 

minimize counterparty credit exposure 

and operational risk. Chris Barnard also 

supported the rule, stating that the rule 

should increase transparency, promote 

market integrity and reduce risk by 

establishing procedures that will 

promote legal certainty concerning swap 

transactions, assist with the early 

resolution of valuation disputes, reduce 

operational risk, and increase 

operational efficiency. 

Conversely, multiple commenters 

objected to proposed § 23.502 on cost 

grounds. Some commenters argued that 

the rule would require significant 

investment in new infrastructure and 

some argued that the rule would have 

few benefits for SDs and MSPs that 

trade in shorter dated swaps.90 Others 

asserted that portfolio reconciliation at 

the transactional level was only 

necessary if there are portfolio level 

discrepancies that result in margin 

disputes, and argued that routine 

reconciliation at the proposed frequency 

was unnecessarily costly.91 Some 

argued that the swap portfolios of nonSDs, non-MSPs do not pose significant 

risk to the financial system and the rule 

may increase the costs of swaps for such 

entities.92 Still others argued that the 

Commission must provide sufficient 

time for all registrants to develop the 

infrastructure required to meet the 

frequency of reconciliation required by 

the rule. 

In relation to the one business day 

valuation dispute resolution 

requirement, many commenters stated 

that parties to a good-faith dispute 

should have a commercially reasonable 

timeframe in which to consult in order 

to find an appropriate resolution of the 

dispute. These commenters supported 

ISDA’s 2011 Convention on Portfolio 

Reconciliation and the Investigation of 

Disputed Margin Calls and the 2011 

Formal Market Polling Procedure, 

developed pursuant to industry 

commitments to the ODSG, which ISDA 

believes will be widely adopted by OTC 

derivatives market participants, and 

believed these industry efforts should 

play a more significant role in shaping 

the proposed reconciliation rules.93

Other commenters argued that SDs and 

MSPs should not have to expend 

resources to resolve valuation disputes 

exceeding the proposed 10 percent 

threshold if they conclude that the 

discrepancy is not material in their 

particular circumstances.94

The Commission carefully considered 

each of the foregoing comments in 

formulating the final rule. 

It should be noted that the 

Confirmation NPRM stated that the 

Commission anticipated that SDs and 

MSPs will be able to efficiently 

reconcile their internal records with 

their counterparties by reference to data 

in SDRs. The Commission received no 

comments disputing this assertion, and 

one commenter noted that SDRs would 

be in the best position to detect and 

manage discrepancies in the material 

terms of a swap transaction both 

efficiently and effectively.95 The 

Commission has thus determined to 

adopt the portion of the rule that 

requires SDs and MSPs to reconcile the 

material terms of each swap in their 

swap portfolios in addition to 

reconciling the valuation of each swap 

but, at the urging of commenters, has 

reduced the required frequency of 

reconciliation to match the frequency of 

reconciliation currently undertaken by 

the largest prospective SDs.96 The final 

rules require SDs and MSPs to reconcile 

portfolios with other SDs and MSPs at 

the following frequencies: daily for 

portfolios comprising 500 or more 

swaps; weekly for portfolios comprising 

51 to 499 swaps; and quarterly for 

portfolios comprising one to 50 swaps. 

The Commission believes that the 

frequency of reconciliation of material 

terms and valuations of each swap 

required by the rule as modified will 

ensure the risk-reducing benefits of 

reconciliation by presenting a 

consolidated view of counterparty 

exposure down to the transaction level, 

and that these benefits are especially 

noteworthy when considered in light of 

the efficiencies possible through use of 

SDR data in the reconciliation process. 

Having considered comments that the 

frequency of reconciliation with nonSD, non-MSP counterparties required by 

the rule was unnecessary to achieve the 

benefits of portfolio reconciliation 

outlined above, the Commission is also 

reducing the frequency of reconciliation 

required for non-registrant 

counterparties and is modifying the 

final rule to require reconciliation with 

such counterparties quarterly for swap 

portfolios of more than 100 swaps, and 

annually for all other swap portfolios. 

This level was recommended by 

commenters, including The Working 

Group. 

With respect to the proposed rule’s 

one business day deadline for valuation 

dispute resolution among SDs and 

MSPs, the Commission observes that 

daily valuation is critical for the 

appropriate operation of the 

Commission’s proposed rules on 

margin, which is itself essential for the 

mitigation of risk posed by swaps. 

Issues related to swap valuations are 

woven through a number of 

Commission rule proposals. For 

instance, § 23.504(e), as adopted in this 

release, requires SDs and MSPs to report 

valuation disputes with SD or MSP 

counterparties in excess of $20,000,000 

and lasting longer than three business 

days to the Commission, while under 

§ 23.504(b)(4) SDs and MSPs are 

required to agree on valuation 

methodologies with their 

counterparties. 

However, the Commission recognizes 

that valuation dispute resolution may be 

labor intensive and therefore costly. For 

this reason, the Commission modified 

the rule to provide for a five-day 

resolution process. In addition to this 

change, the Commission notes that, the 

costs of valuation dispute resolution are 

mitigated by the operation of several 

other parts of the new regulatory regime 

for swaps. First, the reconciliation 

requirements, and thus the valuation 

dispute resolution requirement, does 

not apply to cleared swaps, because 

DCOs establish settlement prices for 

each cleared swap every business day. 

It is likely that a large part of the swap 


sroberts on DSK5SPTVN1PROD with RULES
55948 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

97 ‘‘It is expected that the standardized, plain 

vanilla, high volume swaps contracts—which 

according to the Treasury Department are about 90 

percent of the $600 trillion swaps market—will be 

subject to mandatory clearing.’’ 156 Cong. Rec. 

S5921 (daily ed. Jul. 15, 2010) (statement of Sen. 

Lincoln). The Tabb group estimates that 60–80 

percent of the swaps market measured by notional 

amount will be cleared within five years of the time 

that the Dodd-Frank Act is implemented. See Tabb 

Group, ‘‘Technology and Financial Reform: Data, 

Derivatives and Decision Making.’’ 

98See ESMA Draft Technical Standards, Article 2 

RM, subsection 4, (stating that ‘‘In order to identify 

at an early stage, any discrepancy in a material term 

of the OTC derivative contract, including its 

valuation, the portfolio reconciliation shall be 

performed: * * * each business day when the 

counterparties have 500 or more OTC derivative 

contracts outstanding with each other; * * * once 

per month for a portfolio of fewer than 300 OTC 

derivative contracts outstanding with a 

counterparty; * * * once per week for a portfolio 

between 300 and 499 OTC derivative contracts 

outstanding with a counterparty.’’). 

99Federal Reserve Bank of New York Staff Report 

No. 424: ‘‘Policy Perspectives on OTC Derivatives 

Market Infrastructure,’’ Jan. 2010 (revised Mar. 

2010). 

100 ‘‘Policy Objectives for the OTC Derivatives 

Markets,’’ President’s Working Group on Financial 

Markets (Nov. 14, 2008). 

101Federal Reserve Bank of New York Staff 

Report No. 424: ‘‘Policy Perspectives on OTC 

Derivatives Market Infrastructure,’’ Jan. 2010 

(revised Mar. 2010). 

102 DTCC Press Release, ‘‘DTCC Trade 

Information Warehouse Completes Record Year 

Processing OTC Credit Derivatives’’ (Mar. 11, 2010). 

Notably, beginning in August 2008, ISDA 

encouraged compression exercises for credit default 

swaps by selecting the service provider and 

defining the terms of service. 

103See www.trioptima.com. Between 2007 and 

2008, TriOptima reduced $54.7 trillion gross 

notional of interest rate swaps and $49.1 trillion 

gross notional of credit swaps. In March of 2010, 

the staff of the Federal Reserve Bank of New York 

estimated that since 2008 nearly $50 trillion gross 

notional of credit default swap positions has been 

eliminated through portfolio compression. Federal 

Reserve Bank of New York Staff Report No. 424: 

‘‘Policy Perspectives on OTC Derivatives Market 

Infrastructure,’’ Jan. 2010 (revised Mar. 2010). 

104See www.isdacdsmarketplace.com. 

portfolios of SDs and MSPs will consist 

of cleared swaps 97 to which the 

reconciliation requirements will not 

apply; valuation disputes will therefore 

only arise in bilateral, uncleared 

portfolios. Second, the reconciliation 

requirements of § 23.503 are expected to 

avoid disputes from arising in the first 

instance through the regular comparison 

of material terms and valuations. Third, 

the Commission expects that 

§ 23.504(b)(4), by requiring agreement 

with each counterparty on the methods 

and inputs for valuation of each swap, 

will assist SDs and MSPs to resolve 

valuation disputes within five business 

days. 

SDs and MSPs need not resolve every 

valuation dispute, but only those where 

the difference in valuation is 10 percent 

or more. The Commission believes the 

10 percent threshold is appropriate as it 

provides certainty as to which disputes 

must be resolved. The Commission 

believes the efficiency of a bright line 

rule, as opposed to the formulas and 

discretion in the alternatives suggested 

by commenters, will better serve the 

operational processes of SDs and MSPs 

and the regulatory oversight of the 

Commission. Thus, to maintain the risk 

mitigation benefits of the rule outlined 

above, the Commission has determined 

to retain the requirement that swap 

valuation disputes among SDs and 

MSPs be resolved within five business 

days. 

As a further cost reduction measure, 

the Commission notes that it has 

extended the compliance dates for those 

SDs and MSPs that have not been 

previously regulated by a prudential 

regulator, and thus are least likely to 

have the infrastructure in place to begin 

regular reconciliation with their 

counterparties. As stated in section 

III.B.3 above, SDs and MSPs that have 

been previously regulated need not 

comply with the rule for three months 

after publication of the final rule in the 

Federal Register. SDs and MSPs that 

have not been previously regulated need 

not comply for six months after 

publication. 

Finally, the Commission notes that 

ESMA has proposed portfolio 

reconciliation requirements that are 

substantially similar to those adopted by 

the Commission in this release.98 By 

closely aligning portfolio reconciliation 

requirements through consultation with 

ESMA, the Commission believes that 

SDs and MSPs will benefit from a 

largely unitary regulatory regime that 

does not require separate compliance 

and operational policies and 

procedures. 

D. Portfolio Compression 

Portfolio compression is a mechanism 

whereby substantially similar 

transactions among two or more 

counterparties are terminated and 

replaced with a smaller number of 

transactions of decreased notional value 

in an effort to reduce the risk, cost, and 

inefficiency of maintaining unnecessary 

transactions on the counterparties’ 

books. In many cases, these redundant 

or economically-equivalent positions 

serve no useful business purpose, but 

can create unnecessary risk,99 as well as 

operational and capital inefficiencies. 

The usefulness of portfolio 

compression as a risk management tool 

has been acknowledged widely. In 2008, 

the PWG identified frequent portfolio 

compression of outstanding trades as a 

key policy objective in the effort to 

strengthen the OTC derivatives market 

infrastructure.100 Similarly, the 2010 

staff report outlining policy perspectives 

on OTC derivatives infrastructure issued 

by the FRBNY identified trade 

compression as an element of strong risk 

management and recommended that 

market participants engage in regular, 

market-wide portfolio compression 

exercises.101

The value of portfolio compression 

also is illustrated by existing market 

participation in compression exercises. 

In March 2010, the Depository Trust and 

Clearing Corporation (DTCC) explicitly 

attributed the reduction in the gross 

notional value of the credit derivatives 

in its warehouse to industry supported 

portfolio compression.102 TriOptima, 

which offers the TriReduce portfolio 

compression service, estimates that it 

terminated $106.3 trillion gross notional 

of interest rate swaps and $66.9 trillion 

gross notional of credit swaps between 

2003 and 2010.103 Similarly, Creditex 

and Markit, which offer portfolio 

compression exercises in single name 

credit default swaps, enabled 

participating institutions to eliminate 

$4.5 trillion in notional between late 

2008 through 2009.104

In light of the recognized benefits of 

portfolio compression in reducing the 

risk, cost, and inefficiency of 

maintaining unnecessary transactions, 

the Commission proposed § 23.503, 

which required SDs and MSPs to 

participate in multilateral compression 

exercises that are offered by those DCOs 

or self-regulatory organizations of which 

the SD or MSP is a member, or as 

required by Commission regulation or 

order. The Commission also proposed 

that SDs and MSPs be required to 

terminate bilaterally all fully offsetting 

swaps between them by the close of 

business on the business day following 

the day the parties entered into the 

offsetting swap transaction and to 

engage annually in bilateral portfolio 

compression exercises with 

counterparties that are also SDs and 

MSPs to the extent that they have not 

participated in a multilateral 

compression exercise. Proposed 

§ 23.503 did not require portfolio 

compression exercises for swaps 

outstanding between an SD or MSP and 

counterparties that are neither SDs nor 

MSPs. Instead, SDs and MSPs were 

required to establish written policies 

and procedures for periodically 

terminating all fully offsetting swaps 

and periodically engaging in 

compression exercises with such 

counterparties. 

Several commenters supported the 

Commission’s proposal and outlined the 

benefits of the approach. For instance, 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55949 

105 ISDA; The Working Group; Markit. 

106TriOptima; Markit; ISDA; ABC & CIEBA; 

AMG; Chatham; Dominion; FHLBs; Freddie Mac; 

MetLife; MFA; NAIC; GFED. 

107The Working Group. 

108See ESMA Draft Technical Standards, Article 

3 RM, subsection 2, (stating that ‘‘counterparties 

with 500 or more OTC derivative contracts 

outstanding which are not centrally cleared shall 

have procedures to regularly, and at least twice a 

year, analyse the possibility to conduct a portfolio 

compression exercise in order to reduce their 

counterparty credit risk and engage in such 

portfolio compression exercise.’’). 

109See Financial Stability Board, ‘‘Implementing 

OTC Derivatives Market Reforms: Report of the OTC 

Derivatives Working Group,’’ (Oct. 10, 2010), 

available at http://www.financialstabilityboard.org/ 

publications/r_101025.pdf. 

110The International Swaps and Derivatives 

Association (ISDA) is a trade association for the 

OTC derivatives industry (http://www.isda.org). 

111Enforceable bilateral netting arrangements are 

a common commercial practice and are an 

important part of risk management and 

minimization of capital costs. 

Blackrock wrote in support of the 

Commission’s proposal and encouraged 

the Commission to expand the proposal 

in order to achieve what Blackrock 

believes to be the essential benefits of 

compression. In addition, Eris Exchange 

wrote in support of compression and 

noted that it should lead to greater 

position netting and the ability to more 

freely unwind aged swap trades without 

having to go through a cumbersome 

novation process involving substantial 

operational burden and negotiated upfront payments. 

On the other hand, multiple 

commenters objected to proposed 

§ 23.503 on cost grounds. Some 

commenters argued that resourceintensive compression exercises should 

not be required in asset classes where 

there is not a high degree of transaction 

standardization and a high volume of 

redundant trades because the benefits 

would not outweigh the costs.105

Similarly, many commenters argued 

that non-SD counterparties should not 

be included in any mandatory 

compression because such entities have 

portfolios with a very small number of 

offsetting transactions (i.e., almost all 

swaps are in the same market direction) 

and the cost of the exercise is not 

justified by the small benefit derived.106

Other commenters noted that it is not 

cost effective to establish and run daily 

systems to monitor for fully offsetting 

swaps where there are likely to be 

none.107 On another tack, some 

commenters argued against requiring 

participation in compression exercises 

offered by DCOs and SROs to avoid lack 

of competition and higher costs. 

The Commission carefully reviewed 

the comments received with respect to 

proposed § 23.503 and considered each 

in formulating the final rule. Partly in 

response to the comments received 

regarding the costs imposed by the 

proposed rule, the Commission has 

revised the rule to reduce the cost 

burden on market participants. First, the 

Commission has determined to exclude 

swaps cleared by a DCO from the rule. 

As noted above, each DCO is required 

to establish portfolio compression 

procedures, but participation in such 

compression exercises by clearing 

members is voluntary. Accordingly, the 

revisions to § 23.503 are consistent with 

the revised DCO final rules with respect 

to cleared swaps. Second, the 

Commission was persuaded that the 

benefits of the rule could be maintained 

without requiring SDs and MSPs to 

incur the costs of mandatory 

compression. Thus, as discussed in 

more detail above, the Commission is 

electing to adopt the alternative 

suggested by commenters and is 

modifying the rule to replace the 

mandatory compression requirement 

with a requirement that SDs and MSPs 

establish policies and procedures for 

periodically engaging in portfolio 

compression exercises with 

counterparties that are also SDs or MSPs 

and for engaging in portfolio 

compression with all other 

counterparties upon request. The 

Commission is qualifying the 

requirement that SDs and MSPs 

terminate fully offsetting swaps by 

requiring instead that SDs and MSPs 

establish policies and procedures for 

terminating fully offsetting swaps in a 

timely fashion, but allowing SDs and 

MSPs to determine where it is 

appropriate to do so. The Commission 

believes that these modifications retain 

the benefits of portfolio compression 

while reducing the compliance costs to 

SDs and MSPs and costs that otherwise 

may have been incurred by other market 

participants. 

Finally, the Commission notes that 

ESMA has proposed portfolio 

compression requirements that are 

substantially similar to those adopted by 

the Commission in this release.108 By 

closely aligning portfolio compression 

requirements through consultation with 

ESMA, the Commission believes that 

SDs and MSPs will benefit from a 

largely unitary regulatory regime that 

does not require separate compliance 

and operational policies and 

procedures. 

E. Swap Trading Relationship 

Documentation 

The OTC derivatives markets 

traditionally have been characterized by 

privately negotiated transactions 

entered into by two counterparties, in 

which each party assumes and manages 

the credit risk of the other. While OTC 

derivatives are traded by a diverse set of 

market participants, such as banks, 

hedge funds, pension funds, and other 

institutional investors, as well as 

corporate, governmental, and other endusers, a relatively few number of dealers 

are, by far, the most significantly active 

participants. As such, the default of a 

dealer may result in significant losses 

for the counterparties of that dealer, 

either from the counterparty exposure to 

the defaulting dealer or from the cost of 

replacing the defaulted trades in times 

of market stress.109

OTC derivatives market participants 

typically have relied on the use of 

industry standard legal documentation, 

including master netting agreements, 

definitions, schedules, and 

confirmations, to document their swap 

trading relationships. This industry 

standard documentation, such as the 

widely used ISDA Master Agreement 

and related definitions, schedules, and 

confirmations specific to particular asset 

classes, offers a framework for 

documenting the transactions between 

counterparties for OTC derivatives 

products.110 The standard 

documentation is designed to set forth 

the legal, trading, and credit 

relationship between the parties and to 

facilitate cross-product netting of 

transactions in the event that parties 

have to close-out their position with one 

another. 

One important method of addressing 

the credit risk that arises from OTC 

derivatives transactions is the use of 

bilateral close-out netting. Parties seek 

to achieve enforceable bilateral netting 

by documenting all of their transactions 

under master netting agreements.111

Following the occurrence of a default by 

one of the counterparties (such as 

bankruptcy or insolvency), the 

exposures from individual transactions 

between the two parties are netted and 

consolidated into a single net ‘‘lump 

sum’’ obligation. A party’s overall 

exposure is therefore limited to this net 

sum. That exposure then may be offset 

by the available collateral previously 

provided being applied against the net 

exposure. As such, it is critical that the 

netting provisions between the parties 

are documented and legally enforceable 

and that the collateral may be used to 

meet the net exposure. In recognition of 

the risk-reducing benefits of close-out 

netting, many jurisdictions provide 

favorable treatment of netting 


sroberts on DSK5SPTVN1PROD with RULES
55950 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

112See e.g., 11 U.S.C. 561 (protecting contractual 

right to terminate, liquidate, accelerate, or offset 

under a master netting agreement and across 

contracts). 

113See 12 CFR part 3, Appendix C; 12 CFR part 

208, Appendix F; 12 CFR part 225, Appendix G; 

and 12 CFR part 325, Appendix D (banking 

regulations regarding qualifying master netting 

agreements). 

114Better Markets. 

115 ISDA & SIFMA. 

116The Working Group; ISDA & SIFMA; FSR; 

MFA; FHLBs; The Coalition for Derivative EndUsers. 

117OCC; IECA. 118See letter from CIEBA. 

arrangements in bankruptcy,112 and 

favorable capital and accounting 

treatment to parties that have 

enforceable netting agreements in 

place.113

There is also a risk that inadequate 

documentation of open swap 

transactions could result in collateral 

and legal disputes, thereby exposing 

counterparties to significant 

counterparty credit risk. By way of 

contrast, adequate documentation 

between counterparties offers a 

framework for establishing the trading 

relationship between the parties. 

To ensure the risk-reducing benefits 

of adequate swap trading relationship 

documentation, the Commission 

proposed § 23.504. Proposed § 23.504 

required SDs and MSPs to establish, 

maintain, and enforce written policies 

and procedures reasonably designed to 

ensure that each SD and MSP and its 

counterparties have agreed in writing to 

all of the terms governing their swap 

trading relationship and have executed 

all agreements required by proposed 

§ 23.504. These included agreement on 

terms related to payment obligations, 

netting of payments, events of default or 

other termination events, netting of 

obligations upon termination, transfer of 

rights and obligations, governing law, 

valuation, and dispute resolution 

procedures, as well as credit support 

arrangements, including margin and 

segregation. Agreement on valuation 

methodologies pursuant to 

§ 23.504(b)(4) is discussed separately 

below. In addition, proposed § 23.504 

required each SD and MSP to have an 

independent internal or external auditor 

examine annually at least 5 percent of 

the swap trading relationship 

documentation created during the year 

to ensure compliance with Commission 

regulations and the SD’s or MSP’s 

policies and procedures established 

pursuant to § 23.504. 

Several commenters supported the 

rule. One stated that clear and thorough 

standards for documentation are 

essential to avoid the situation that 

became apparent when AIG and 

Lehman Brothers failed: A hopelessly 

tangled web of poorly documented 

transactions, with the effort to sort it all 

out emerging as a separate threat to the 

financial system.114 Others supported 

the goal of the rule to ensure that the 

parties to a trade have in fact agreed on 

its economic and legal terms prior to or 

contemporaneously with entering into a 

swap, and are communicating and 

maintaining appropriate records 

memorializing that agreement.115

However, many commenters also 

objected to the proposed rule on cost 

grounds. 

Several commenters strongly urged 

the Commission not to make § 23.504 

retroactively applicable to existing 

swaps because the need to make 

amendments to existing documentation 

would be time consuming and costly.116

Having considered these comments, the 

Commission is adopting the alternative 

presented by commenters and is 

modifying § 23.504 to make clear that 

the rule does not apply to swaps 

executed prior to the date on which SDs 

and MSPs are required to be in 

compliance with § 23.504. The 

Commission notes, however, that the 

rule does not prohibit SDs and MSPs 

from agreeing with their counterparties 

to amend existing swap trading 

relationship documentation to bring 

such documentation into compliance 

with § 23.504 (or any other Commission 

regulation) and ensure that netting 

arrangements will apply to swaps 

executed prior to and after promulgation 

of § 23.504. The ability to combine 

netting sets in this manner may reduce 

costs of collateralization for many SDs 

and MSPs. 

Several commenters were concerned 

that proposed § 23.504 may require 

market participants to incur the burden 

and expense of negotiating master 

agreements even if a stand-alone 

agreement or ‘‘long-form’’ confirmation 

that incorporates terms of a standard 

master agreement by reference would 

sufficiently address legal risks.117 The 

Commission notes, however, that 

nothing in the rule prohibits 

incorporation by reference so long as the 

terms so incorporated are in written 

form, and therefore confirms that so 

long as a ‘‘long-form’’ confirmation 

includes all terms of the trading 

relationship and is executed prior to or 

contemporaneously with entering into a 

swap transaction, such would be in 

compliance with § 23.504. 

A number of comments reflected a 

concern regarding the requirement that 

SDs and MSPs audit no less than 5 

percent of their trading relationship 

documentation annually, arguing that 

the requirement is burdensome and 

recommending that the Commission 

adopt an alternative, principles-based 

approach requiring SDs and MSPs to 

conduct audits sufficient to identify 

material weaknesses in their 

documentation policies and procedures. 

The Commission was persuaded that the 

audit requirement need not prescribe 

the percentage of agreements to be 

audited to maintain the benefits of the 

rule, and has modified the rule in 

accordance with the recommendations 

of commenters. 

In addition, several commenters 

recommended that valuation dispute 

reporting under § 23.504(e) should be 

subject to a materiality standard to 

avoid an overly-burdensome reporting 

requirement that will result in 

substantial informational noise. The 

Commission agreed with these 

commenters and reduced the burden of 

the reporting requirement by revising 

the proposed rule to add a $20,000,000 

threshold on the reporting of valuation 

disputes. 

Finally, the Commission recognizes 

that requiring implementation of the 

documentation requirements of § 23.504 

immediately or within a very 

compressed timeframe creates certain 

costs for industry participants. 

Consequently, reducing these costs— 

enumerated below—by extending the 

compliance schedule represents a 

benefit. 

First, to meet timelines some firms 

will need to contract additional staff or 

hire vendors to handle some necessary 

tasks or projects. Additional staff hired 

or vendors contracted in order to meet 

more pressing timelines represent an 

additional cost for market participants. 

Moreover, as pointed out by 

commenters, a tightly compressed 

timeframe raises the likelihood that 

more firms will be competing to procure 

services at the same time; this could put 

firms that conduct fewer swaps at a 

competitive disadvantage in obtaining 

those services, making it more difficult 

for them to meet required timelines.118

In addition, it could enable service 

providers to command a pricing 

premium when compared to times of 

‘‘normal’’ or lesser competition for 

similar services. That premium 

represents an additional cost when 

compared to a longer compliance 

timeline. 

Second, if entities are not able to 

comply with the documentation 

requirements by a certain date, they may 

avoid transacting swaps requiring 

compliance until such a time as they are 

able to comply. In this event, liquidity 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55951 

119See e.g., ACLI letter. 

120OCC data demonstrates that among insured US 

commercial banks, ‘‘the five banks with the most 

derivatives activity hold 96 percent of all 

derivatives, while the largest 25 banks account for 

nearly 100 percent of all contracts.’’ The report is 

limited to insured US commercial banks, and also 

includes derivatives that are not swaps. However, 

swap contracts are included among the derivatives 

in the report, constituting approximately 63 percent 

of the total notional value of all derivatives. These 

statistics suggest that a relatively small number of 

banks hold the majority of swap positions that 

could create or contribute to distress in the 

financial system. Data is insufficient, however, to 

generalize the conclusions to non-banking 

institutions. See ‘‘OCC’s Quarterly Report on Bank 

Trading and Derivatives Activities: Fourth Quarter 

2011’’ p. 11. http://www.occ.treas.gov/topics/ 

capital-markets/financial-markets/trading/ 

derivatives/dq411.pdf. 

121See ISDA Collateral Committee, ‘‘Commentary 

to the Outline of the 2009 ISDA Protocol for 

Resolution of Disputed Collateral Calls,’’ June 2, 

2009 (stating ‘‘Disputed margin calls have increased 

significantly since late 2007, and especially during 

2008 have been the driver of large (sometimes > $1 

billion) un-collateralized exposures between 

professional firms.’’). 

122The failure of the market to set a price for 

mortgage-backed securities led to wide disparities 

in the valuation of CDS referencing mortgagebacked securities (especially collateralized debt 

obligations). Such wide disparities led to large 

collateral calls from dealers on AIG, hastening its 

downfall. See CBS News, ‘‘Calling AIG? Internal 

Docs Reveal Company Silent About Dozens Of 

Collateral Calls,’’ Jun. 23, 2009, available at: 

http://www.cbsnews.com/stories/2009/06/23/

cbsnews_investigates/main5106672.shtml. 

that otherwise would result from those 

foregone swaps would be reduced, 

making the swaps more expensive for 

market participants taking the other 

side. Moreover, firms compelled to 

withdraw from the market pending 

compliance with required 

documentation measures will either 

leave certain positions un-hedged— 

potentially increasing the firm’s own 

default risk, and therefore the risk to 

their counterparties and the public. 

Alternatively, firms compelled to 

withdraw from the market for a period 

of time could attempt to approximate 

their foregone swap hedges using other, 

likely more expensive, instruments. 

Further, to the extent the withdrawing 

entities are market makers, they will 

forsake the revenue potential that 

otherwise would exist for the period of 

their market absence. 

Third, firms may have to implement 

technological solutions, sign contracts, 

and establish new operational 

procedures before industry standards 

have emerged that address new 

problems effectively. To the extent that 

this occurs, it is likely to create costs. 

Firms may have to incur additional 

costs later to modify their technology 

platforms and operational procedures 

further, and to renegotiate contracts— 

direct costs that a more protracted 

implementation schedule would have 

avoided.119 Moreover, costs created by 

the adoption of standards that fail to 

address certain problems, or attributable 

to undesired competitive dynamics 

resulting from such standards, may be 

longstanding. 

The Commission, informed by its 

consideration of comments and 

alternatives, discussed in the sections 

above and below, believes that the 

approach contained in this adopting 

release is reasonable and appropriate in 

light of the tradeoffs described above. 

The compliance dates discussed above 

give the Commission the opportunity to 

provide additional time to entities in 

ways that generally align with: (1) Their 

resources and expertise, and therefore 

their ability to comply more quickly; 

and (2) their level of activity in the swap 

markets, and therefore the possible 

impact of their swap activities on the 

stability of the financial system. Entities 

with the most expertise in, and systems 

capable to transact, swaps also are likely 

to be those whose transactions represent 

a significant portion of all transactions 

in the swap markets. They are more 

likely to be able to comply quickly, and 

the benefits of requiring them to do so 

are greater than would be the case for 

less active entities. On the other hand, 

entities with less system capability and 

in-house swap expertise may need more 

time to comply with documentation 

requirements, but it is also likely that 

their activities represent a smaller 

proportion of the overall market, and 

therefore are less likely to create or 

exacerbate shocks to the financial 

system.120 The Commission believes 

that SDs, security-based swap dealers, 

MSPs, major security-based swap 

participants, and active funds (as 

defined above) are entities likely 

possessing more advanced systems and 

expertise, and whose swap activities 

constitute a significant portion of 

overall swap market transactions. On 

the other hand, other market 

participants may be less likely to have 

highly developed infrastructure and 

likely have swap activities that 

constitute a less significant proportion 

of the market. Therefore, the 

Commission has determined to stagger 

the compliance dates for § 23.504, 

providing 90, 180, or 270 days for SDs 

and MSPs to bring their swap trading 

relationship documentation into 

compliance with the rules, depending 

on the identity of the counterparty as 

discussed more fully in section III.B.1 

above. 

F. Swap Valuation Methodologies 

Swap valuation disputes have long 

been recognized as a significant problem 

in the OTC derivatives market.121 The 

ability to determine definitively the 

value of a swap at any given time lies 

at the center of many of the OTC 

derivatives market reforms contained in 

the Dodd-Frank Act and is a cornerstone 

of risk management. Swap valuation is 

also crucial for determining capital and 

margin requirements applicable to SDs 

and MSPs and therefore plays a primary 

role in risk mitigation for uncleared 

swaps. 

The Commission recognizes that swap 

valuation is not always an easy task. In 

some instances, there is widespread 

agreement on valuation methodologies 

and the source of formula inputs for 

frequently traded swaps. Many of these 

swaps have been accepted for clearing 

for a number of years (i.e., commonly 

traded interest rate swaps and CDS). 

However, parties often dispute 

valuations of thinly traded swaps where 

there is not widespread agreement on 

valuation methodologies or the source 

for formula inputs. Many of these swaps 

are thinly traded either because of their 

limited use as risk management tools or 

because they are simply too customized 

to have comparable counterparts in the 

market. As many of these swaps are 

valued by dealers internally by 

‘‘marking-to-model,’’ their 

counterparties may dispute the inputs 

and methodologies used in the model. 

As uncleared swaps are bilateral, 

privately negotiated contracts, on-going 

swap valuation for purposes of initial 

and variation margin calculation and 

swap terminations or novations, has 

also been largely a process of on-going 

negotiation between the parties. The 

inability to agree on the value of a swap 

became especially acute during the 

2007–2009 financial crisis when there 

was widespread failure of the market 

inputs needed to value many swaps.122

In light of these concerns, the 

Commission proposed § 23.504(b)(4), 

which required SDs and MSPs to 

include in their swap trading 

relationship documentation an 

agreement with their counterparties on 

the methods, procedures, rules, and 

inputs for determining the value of each 

swap at any time from execution to the 

termination, maturity, or expiration of 

such swap. The Commission believes 

that by requiring agreement between 

counterparties on the methods and 

inputs for valuation of each swap, 

§ 23.504(b)(4) will assist SDs and MSPs 

and their counterparties to arrive at 

valuations necessary for margining and 

internal risk management, and to 

resolve valuation disputes in a timely 

manner, thereby reducing risk. 


sroberts on DSK5SPTVN1PROD with RULES
55952 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

123Better Markets; Michael Greenberger; Chris 

Barnard. 

124The Working Group; ISDA & SIFMA; FSR; 

Markit; Freddie Mac; COPE; MFA; FHLBs; CIEBA; 

EEI; Coalition of Derivatives End-Users. Several of 

these commenters stated that such pre-execution 

negotiations could take months to complete, if 

possible at all. 

125OCC; Hess. 

126The Working Group; Morgan Stanley; MFA; 

IECA; FHLBs; CIEBA; MetLife. 

127Markit. 

128Coalition of Derivatives End-Users. 

129See cftc.gov for information regarding staff 

meetings with ISDA pertaining to these final rules. 

Commenters supported the valuation 

proposal in light of the benefits to risk 

management and adequate 

collateralization.123 Indeed, some 

commenters argued that the 

Commission should have been more 

prescriptive in its approach to 

valuation. 

Multiple commenters, however, 

objected to § 23.504(b)(4) on cost 

grounds. Specifically, commenters 

stated that the rule will significantly 

increase the pre-execution swap 

negotiation burden on SDs, MSPs, and 

their counterparties without an 

offsetting benefit.124 Some commenters 

also objected that the rule may 

discourage the development of more 

refined, dynamic swap valuation 

models that are more accurate, and 

therefore more efficient, than less 

sophisticated or vanilla models.125

Other commenters offered alternatives 

to requiring SDs and MSPs to agree on 

valuation methodologies with their 

counterparties. Many recommended that 

the Commission focus its rules on the 

valuation dispute resolution process, 

rather than valuation methodologies.126

One recommended that the rule include 

an explicit authorization for parties to 

use the services of independent third 

parties to provide any or all of the 

elements required to agree upon the 

valuation of swaps, and not include any 

preferable inputs or pricing sources for 

the valuation of swaps.127 Another 

recommended that the rule be deleted 

and replaced with a requirement that 

SDs and MSPs provide information to 

substantiate their valuations upon the 

request of a counterparty.128

As discussed above, the Commission 

is substantially modifying the rule in 

response to concerns raised and 

alternatives suggested by commenters. 

Many of the changes being made in the 

rule adopted by this release address the 

cost concerns and alternatives outlined 

above. First, the rule has been focused 

on the valuation needed to meet the 

margin requirements under section 4s(e) 

of the CEA and the Commission’s 

regulations under part 23, and to meet 

the risk management requirements 

under section 4s(j) of the Act and the 

Commission’s regulations under part 23. 

The Commission believes that this 

change, by focusing the use of the 

agreed-upon valuation methodologies, 

will ease pre-execution negotiation and 

improve internal risk management 

processes. In addition, the Commission 

responded to concerns from market 

participants who feared they would 

have to agree on precise models, by 

clarifying that they had to agree on a 

process, which includes things such as 

methods, procedures, rules and inputs. 

Parties are free to agree on a model, 

agree to use one party’s confidential 

proprietary model, rely on third-party 

vendors, or a host of other possibilities. 

Second, the rule has been modified 

such that SDs and MSPs need not agree 

on swap valuation methodologies with 

counterparties that are not SDs, MSPs, 

or financial entities, unless such 

counterparties request such agreements. 

The Commission believes that this 

change will alleviate the pre-execution 

negotiation burden on SDs, MSPs, and 

their non-financial entity counterparties 

by limiting such negotiations to 

counterparties that are more likely to 

use sophisticated valuation 

methodologies akin to those in use by 

the SD or MSP itself. 

Third, in response to commenters that 

objected that the rule may discourage 

the development of more refined, 

dynamic swap valuation models that are 

more accurate, and therefore more 

efficient, than less sophisticated or 

vanilla models, the Commission is 

modifying the rule to explicitly permit 

parties to agree on changes or 

procedures to modify their valuation 

agreements at any time. This change 

allows counterparties to determine an 

efficient means of changing the 

agreement for each contract to allow for 

evolution of valuation methodologies 

while maintaining the benefits of 

agreed-upon valuation methodologies. 

Fourth, in response to commenters’ 

concerns regarding the protection of 

proprietary information used in 

valuation, the Commission is modifying 

the rules to make explicit that SDs and 

MSPs are not required to disclose to the 

counterparty confidential, proprietary 

information about any model it may use 

to value a swap. The Commission 

believes this clarification will alleviate 

concerns that proprietary information 

would have to be disclosed as a result 

of the valuation agreement process. 

Finally, the rule has been modified to 

allow for use of a valuation dispute 

resolution process in place of the 

proposed requirement that the 

documentation include alternative 

methods for determining the value of a 

swap in the event of the unavailability 

or failure of any input required to value 

the swap. The Commission believes this 

change lessens the negotiation and 

operational burden on SDs and MSPs. 

The Commission believes that the 

changes outlined above substantially 

reduce the burden of the rule on SDs, 

MSPs, and their counterparties without 

sacrificing the benefits of the rule. The 

rule will serve to assist SDs and MSPs 

and their counterparties in arriving at 

valuations necessary for margining and 

internal risk management, and in 

resolving valuation disputes in a timely 

manner, thereby reducing risk. 

G. Summary of Cost and Benefit 

Considerations: Confirmation, Portfolio 

Reconciliation, and Portfolio 

Compression 

In the Confirmation NPRM, the 

Commission specifically requested 

comment on its consideration of costs 

and benefits. The Commission received 

a number of comments in addition to 

those discussed above. 

ISDA commented that registrants will 

incur substantial initial one-time costs 

to develop, test, and implement new 

procedures and technology that are 

required in order to be compliant with 

the proposed rules. With regard to 

confirmation costs, ISDA asserted that 

market participants will have to invest 

in electronic platforms for confirmation 

for each asset class in order to meet the 

expedited timeframes for confirmation, 

which may be prohibitively expensive, 

particularly for non-SDs and non-MSPs. 

However, ISDA did not provide any 

quantitative data in support of this 

assertion despite multiple requests from 

Commission staff.129

ISDA also argued that given the 

marked improvement in post-trade 

processing, as well as continued 

industry efforts and commitments to 

enhance post-trade processing in a 

targeted, efficient and safe manner, it is 

unclear whether the incremental 

benefits of the Commission’s proposed 

standards applicable to all swap 

confirmations will outweigh the 

significant compliance costs that the 

confirmation requirements will entail. 

To comply with the portfolio 

reconciliation requirement promptly, 

ISDA believes firms that do not 

currently use an electronic platform or 

vendor service will need to expend 

significant time and resources, and even 

those firms that do use electronic 

platforms or vendor services to 

reconcile their portfolios will need to 

make significant adjustments to comply 

with the reconciliation requirement. 

ISDA believes that initial compliance 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55953 

130NERA, Cost-Benefit Analysis of the CFTC’s 

Proposed Swap Dealer Definition Prepared for the 

Working Group of Commercial Energy Firms, 

December 20, 2011. In the late-filed comment 

supplement, NERA estimates these costs for entities 

‘‘engaged in production, physical distribution or 

marketing of natural gas, power, or oil that also 

engage in active trading of energy derivatives’’— 

termed ‘‘nonfinancial energy companies’’ in the 

report. The figure cited includes costs to comply 

with the proposed confirmation, portfolio 

reconciliation, and portfolio compression 

requirements and is based on the survey response 

of only one member of The Working Group. 

Elsewhere in the same report, NERA estimates the 

costs of compliance with the confirmation 

requirements alone at $235,000 for initial set-up 

and annual operating costs of $307,000. 

131This alternative was suggested by both ISDA 

and The Working Group, and the Commission has 

adopted it for these final rules. 

with the proposed rules will cost each 

entity approximately $5–10 million and 

annual portfolio reconciliation expenses 

for a party with a large portfolio may 

rival and perhaps even exceed this 

upfront cost. 

The Working Group requested that the 

Commission address any requirement 

for electronic matching of all or certain 

types of swaps in a separate rulemaking 

that includes a careful study of the 

potential costs imposed by such a rule. 

The Working Group estimated, based on 

the $6.00 per trade fee of the ICE 

eConfirm service, that implementation 

of an electronic matching requirement 

would cost each registrant in excess of 

$1,000,000 annually. In addition, The 

Working Group asserted that there 

would be additional opportunity costs 

associated with no longer being able to 

enter into customized transactions. 

The Working Group requested that the 

Commission evaluate the proposed rules 

in light of its various recordkeeping and 

reporting proposals, as such may cause 

firms to incur tremendous 

administrative obligations to record 

changes to their swap portfolios, their 

accounting records, treasury 

arrangements and capital allocations, as 

well as incurring reporting obligations 

to SDRs on a swap-by-swap basis. The 

Working Group also presented a report 

prepared by NERA estimating that 

compliance with the proposed rules for 

some entities in this category would 

entail annual incremental costs of 

$1,400,000.130

The FHLBs cautioned that SD 

compliance with the proposed rules 

could adversely impact end users in a 

number of ways, including (i) SD 

unwillingness to offer swaps important 

to end user risk management if the SD 

cannot comply with the rules in an 

economic manner; (ii) passing on of SD 

compliance costs to end user 

counterparties, discouraging some end 

users from using cost-effective risk 

management tools and raising overall 

system risk; and (iii) introduction of 

legal uncertainty as to the enforceability 

of swaps that fail to meet the 

confirmation deadlines of the proposed 

rules. The FHLBs also argued that 

certain swap documentation requires 

review by legal staff and the short 

deadline for confirmation would require 

pre-execution review by legal staff, even 

for swaps that are discussed but never 

actually executed, entailing costly and 

unnecessary legal expenditures. 

As discussed in the above sections, 

the Commission has modified many 

aspects of the proposed rules in order to 

mitigate the burden placed on market 

participants as identified by 

commenters while still achieving the 

important policy goals outlined above. 

The Commission has: 

• Provided for a phased 

implementation plan, providing longer 

periods for compliance with the rule for 

those entities for which the rules will be 

most burdensome, with particularly 

long phasing of confirmation 

deadlines; 131

• Expanded the definition of 

‘‘multilateral portfolio compression 

exercise’’ which increases flexibility of 

the rule; 

• Removed the 15 and 30 minute 

acknowledgement and confirmation 

deadlines for swap transactions that are 

‘‘processed electronically’’; 

• Required draft trade 

acknowledgements only to be delivered 

upon request of a counterparty prior to 

execution; 

• Adjusted confirmation deadlines for 

time zone differences and end of day 

trading, providing relief from more 

stringent deadlines; 

• Provided a safe harbor from 

confirmation requirements for swaps 

executed on a SEF or DCM, or cleared 

by a DCO; 

• Clarified which swap transactions 

require confirmation; 

• Reduced the frequency of required 

portfolio reconciliation with non-SDs 

and MSPs; 

• Changed the valuation dispute 

resolution requirement from ‘‘one 

business day’’ to ‘‘policies and 

procedures reasonably designed to 

ensure that valuation disputes are 

resolved within five business days;’’ 

• Required portfolio compression 

with non-SDs and non-MSPs only upon 

request of the non-SD or non-MSP 

counterparty; 

• Changed the mandatory portfolio 

compression requirement among SDs 

and MSPs to a requirement for policies 

and procedures for engaging in regular 

portfolio compression, where 

appropriate; 

• Required fully-offsetting swaps to 

be terminated in a timely fashion (rather 

than within one business day) and only 

where appropriate; and 

• Clarified that the compression rule 

does not apply to cleared swaps; 

compression of cleared swaps will be in 

accordance with the rules of the DCO. 

Through these changes, the 

Commission anticipates that many of 

the concerns raised by commenters 

regarding the costs of the rules will be 

mitigated. 

Confirmation. The Commission 

anticipates that there will be a 

significant adjustment for market 

participants to move to the faster 

timeframes required by the confirmation 

rules, particularly in those asset classes 

where the majority of transactions are 

manually confirmed. SDs and MSPs will 

have to design, compose, and 

implement policies and procedures 

reasonably designed to meet the 

confirmation timeframes; SDs and MSPs 

must also compile and maintain any 

applicable records. Participants may 

invest in electronic platforms for 

confirmation for each asset class in 

order to meet the expedited timeframes 

for confirmation. The Commission 

notes, however, that such investment is 

not necessarily required by the rules as 

market participants are able to confirm 

in any manner that meets the rule’s 

deadline of the first business day after 

the day of execution (or two-business 

day timeframe, for swap transactions 

with non-financial non-registrants). 

With regard to confirmation, the 

historical context reveals that market 

participants, including all major swap 

dealers, have been working on achieving 

timely confirmation across all asset 

classes for the past 5–7 years. 

Consequently, additional costs related 

to confirmation technology for these 

entities would be minimal for those SDs 

and MSPs already achieving timely 

confirmation of their swap transactions. 

In addition, costs will be further 

minimized through a significant phasein period. For example, SDs and MSPs 

will have up to two years to achieve 

compliance with the rules. 

Moreover, the Commission has sought 

to gather additional information about 

the costs of confirmation services from 

both ISDA and major third party service 

providers of confirmation services. 

Commission staff meetings with third 

party service providers have revealed 

that per trade or event confirmations 

can cost anywhere from $3 to $10 per 

transaction. It should be noted, 

however, that confirmation fee 

schedules can be complex and 

dependent on a host of idiosyncratic 

factors. 


sroberts on DSK5SPTVN1PROD with RULES
55954 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

132The Commission also notes the estimates 

provided by NERA, but observes that NERA did not 

provide sufficient information for the Commission 

to determine which portion of such estimates 

assumed implementation of an electronic matching 

requirement. Thus the Commission could not 

independently verify the estimates. 133TriOptima letter. 

The Commission notes The Working 

Group’s estimate of approximately 

$1,000,000 per entity to implement an 

electronic matching requirement, but 

observes that the deletion of the phrase 

‘‘processed electronically’’ from the 

rules should make clear to market 

participants that there is no requirement 

to confirm electronically. However, this 

estimate may be useful for individual 

entities to use as a reference figure for 

investment in electronic platforms.132

The Commission is unable to provide 

more specific quantification of the costs 

of confirmation given the unique 

characteristics of the swap portfolios of 

SDs, MSPs, and their counterparties, as 

well as the parties’ discretion in 

choosing how to comply with the 

confirmation timeframe. 

As noted above, the Commission does 

not believe the rules requiring SDs and 

MSPs to have policies and procedures to 

achieve confirmation with their nonregistrant counterparties should pose an 

unreasonable burden on end users. The 

Commission extended the confirmation 

deadline for non-financial, nonregistrant counterparties to two business 

days after execution, lessening the rush 

to review and approve 

acknowledgements and/or 

confirmations while maintaining a 

relatively quick turn-around for these 

market participants. In addition, the 

Commission anticipates that the 

changed provisions regarding draft 

acknowledgements and compression— 

which give the non-SD or MSP 

counterparty the option as opposed to 

obligation—should ensure that such 

entities are protected from unfair 

practices without overburdening the 

operations of these entities. 

The benefits associated with quicker 

confirmation, as noted in sections III.C 

and IV.B of this release, include 

improvement of post-execution 

operational and risk management 

processes, including the correct 

calculation of cash flows and discharge 

of settlement obligations as well as 

accurate measurement of counterparty 

credit exposure. Timely confirmation 

also allows any discrepancies, 

exceptions, and/or rejections of terms to 

be identified and resolved more quickly, 

lessening the risk of a dispute that could 

disrupt orderly market operations. In 

general, the rules regarding expedited 

confirmation should improve the 

efficient and orderly operations of 

bilateral markets through more effective 

risk management and dispute 

resolution. The extended compliance 

timeframes should allow for a smooth 

transition to the new rules as market 

participants prepare not only to meet 

these standards, but others imposed by 

new regulations under the Dodd-Frank 

Act. 

Reconciliation. In response to ISDA’s 

concern that the reconciliation rules 

would require significant investment in 

electronic platforms for reconciliation, 

especially for those entities with large 

portfolios, the Commission reiterates its 

view that the advent of SDRs will 

eventually ease some of those costs by 

providing a central data location for 

most (if not all) the material terms that 

are required to be reconciled. 

Importantly, the Commission has not 

determined which processes for 

reconciliation are the most appropriate, 

which means that each market 

participant can choose the method for 

reconciliation that best fits its own 

internal structure and cost-benefit 

analysis, provided such method 

comports with the Commission’s 

requirements. In addition, the changes 

listed above—including the reduced 

frequency of reconciliation for portfolios 

between SDs or MSPs and their non-SD 

or non-MSP counterparties—should 

ease the burden of reconciling 

portfolios. While the Commission has 

been unable to independently verify the 

$5–10 million estimate for portfolio 

reconciliation provided by ISDA, the 

Commission expects that the changes 

herein as well as the increased use of 

SDRs will lessen the estimated cost 

considerably. 

In the Confirmation NPRM, the 

Commission asserted that the costs of 

the proposed rules would be minimized 

by the fact that most SDs and MSPs 

reconcile their swap portfolios as part of 

a prudent operational processing regime 

that many, if not most, SDs and MSPs 

already undertake as part of their 

ordinary course of business. In response 

to these assertions, at least one 

commenter agreed that a large number 

of SDs and MSPs already regularly 

reconcile their portfolios with each 

other and with other entities and that 

the increased frequency and inclusion 

of smaller portfolios as proposed should 

prove no obstacle to such entities.133

Consequently, additional costs of the 

Commission’s final rule would be 

minimal for those SDs and MSPs 

already engaged in regular portfolio 

reconciliation. In addition, the 

Commission’s decision to extend the 

valuation dispute resolution 

requirement from one day responds to 

concerns from market participants about 

cost. 

Given the widespread benefits of 

portfolio reconciliation, including 

increased risk management and fewer 

disputes to resolve, the Commission 

believes its final rules regarding 

reconciliation are appropriate 

notwithstanding the increased costs for 

some participants. The Commission 

recognizes that certain costs will still 

arise despite the changes the 

Commission has made. Such costs 

include (i) Increased costs to include all 

material terms rather than some subset 

of terms; (ii) the additional resources to 

design, compose, and implement the 

required policies and procedures; (iii) 

the additional resources needed to 

comply with the dispute resolution 

timeframes; and (iv) the compilation 

and maintenance of applicable records. 

These costs, however, are by nature 

specific to each entity’s internal 

operations; absent specific cost 

estimates from commenters (which were 

not provided), the Commission cannot 

accurately provide estimations 

regarding the resources needed to 

comply. As stated above and in the 

NPRM, portfolio reconciliation is 

widely recognized as an effective means 

of identifying and resolving disputes 

regarding terms, valuation, and 

collateral. Reconciliation is beneficial 

not only to the parties involved but also 

to the markets as a whole. By 

identifying and managing disputed key 

economic terms or valuation for each 

transaction across a portfolio, overall 

risk can be diminished. Registrants will 

be able to identify and correct problems 

in their post-execution processes 

(including confirmation) in order to 

reduce the number of disputes and 

improve the integrity and efficiency of 

their internal processes. Expanding the 

universe of participants subject to 

reconciliation, therefore, can help to 

reduce the risk bilateral markets may 

pose to the broader financial system. 

Compression. Finally, the 

Commission believes its final rules 

regarding portfolio compression 

dramatically reduce costs as compared 

to the proposed rule; however, the 

Commission recognizes that costs will 

necessarily increase from the current 

state of the market. Participants will 

necessarily have to design, compose, 

and implement policies and procedures 

to regularly evaluate compression 

opportunities with their counterparties 

as well as those opportunities offered by 

third parties. However, given the large 

risk management benefits available from 

the regular compression of offsetting 

trades—benefits including reduced risk 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55955 

134The Working Group presented a report 

prepared by NERA estimating that compliance with 

the audit requirements in these and other proposed 

rules for some nonfinancial energy companies 

would entail annual incremental costs of $224,000. 

NERA, Cost-Benefit Analysis of the CFTC’s 

Proposed Swap Dealer Definition Prepared for the 

Continued 

and enhanced operational efficiency— 

the Commission believes the final rules 

are appropriate to ensure the fair and 

orderly operation of bilateral derivatives 

markets. 

In terms of quantification of the costs 

of compression, the Commission notes 

that in its Confirmation NPRM, it stated 

that there are a number of third-party 

vendors that provide compression, and 

some of these providers charge fees 

based on results achieved (such as 

number of swaps compressed). No 

commenter refuted this statement or 

provided alternative information 

regarding quantification. 

H. Section 15(a) Considerations: 

Confirmation, Portfolio Reconciliation, 

and Portfolio Compression 

1. Protection of Market Participants and 

the Public 

The final rules relating to 

confirmation, portfolio reconciliation, 

and portfolio compression protect 

market participants by improving 

operational efficiency and mitigating 

legal risk. In turn, the reduction of risk 

in bilateral markets can reduce risk 

across the interconnected financial 

system, protecting the public from 

costly market disruptions. 

Timely confirmation protects market 

participants by providing certainty as to 

obligations between SDs, MSPs, and 

their counterparties while allowing a 

more efficient processing of disputed 

terms that may become apparent during 

the confirmation process. Disputes 

regarding terms and conditions, when 

left unresolved, can expose market 

participants to significant counterparty 

credit risk. By diminishing the number 

of these disputes that occur and by 

decreasing the length of time in which 

they are resolved, the Commission 

believes these rules protect participants 

from such unnecessary risk. 

2. Efficiency, Competitiveness, and 

Financial Integrity of Derivatives 

Markets 

The final rules improve the efficiency 

of the market by decreasing the amount 

of time trades remain outstanding, 

improving the processes by which 

trades are confirmed, and requiring 

participants to eliminate unnecessary 

trades. Trades that remain unconfirmed 

for extended periods of time create 

inefficient backlogs that inhibit the 

orderliness of the market. Proper 

confirmation, compression, and 

reconciliation policies improve 

transparency in the market and increase 

efficiency by promoting the exchange of 

important market information. 

Requirements regarding confirmations 

and draft acknowledgements, as 

discussed above, provide non-financial 

entities with information necessary for 

confirming promptly. In addition, such 

draft acknowledgements may serve 

counterparties insofar as they might 

compare and assess counterparties, 

which should improve competition 

among SDs and MSPs. 

3. Price Discovery 

The timeliness of confirmations, as 

required under these rules, should 

ensure that all terms including prices of 

transactions are agreed upon quickly 

and efficiently. This linking of price 

terms with all other swap terms should 

improve the information provided to the 

public and regulators through SDRs and 

other means, thereby improving the 

overall price discovery process. Periodic 

reconciliation and compression also aid 

in ensuring that unnecessary and/or 

offsetting trades are netted and that, 

should disputes arise, those disputes are 

promptly and effectively resolved. In 

this way, the pricing information 

communicated regarding trades 

conducted under these rules should be 

accurate and timely, improving the 

price discovery function of bilateral 

derivatives markets. 

4. Sound Risk Management 

As described throughout this release, 

the rules promulgated herein are 

designed to mitigate the risk in bilateral 

derivatives markets by ensuring the 

timely and accurate confirmation of 

trades, reconciliation of portfolios, and 

compression of portfolios. The final 

rules require actions, policies, and 

procedures on the part of SDs and MSPs 

to diminish operational risk, legal risk, 

and counterparty credit risk. The 

Commission believes these 

requirements will encourage sound risk 

management on the part of SDs and 

MSPs; given the systemically important 

nature of these entities, sound risk 

management by SDs and MSPs should 

improve the risk management of the 

financial system as a whole, lessening 

the risks associated with a major market 

crisis. 

5. Other Public Interest Considerations 

The Commission has not identified 

other public interest considerations as a 

result of these rules. 

I. Summary of Cost and Benefit 

Considerations: Swap Trading 

Relationship Documentation 

The Commission requested comment 

on its consideration of costs and 

benefits under section 15(a) of the CEA. 

The Commission received a number of 

responsive comments in addition to 

those discussed above. 

The Working Group stated that the 

Commission should articulate the 

public policy benefit of the proposed 

rule and present analysis that 

demonstrates such benefit exceeds the 

cost imposed on market participants 

and the Commission. IECA stated that 

the proposed regulations would impose 

administrative and regulatory costs in 

excess of any benefit gained. The 

Coalition for Derivatives End Users was 

concerned that the valuation provision 

will increase costs without a 

proportionate benefit. Markit stated that 

the proposed rule will make the process 

of transaction documentation very 

expensive and time consuming, and will 

lead to extremely technical and verbose 

swap documentation, noting that the 

need to negotiate such terms may 

impede effective trading. Markit thus 

believes the costs outweigh the benefits, 

and urges the Commission to impose 

more realistic requirements regarding 

valuation methodologies. 

IECA believes the Commission’s costbenefit analysis did not consider the 

legal review and management time 

expense for end users, which could be 

significant for small entities. IECA 

focuses on the Commission’s estimates 

under the Paperwork Reduction Act, 

and challenges the Commission’s use of 

$125 per hour for legal fees. IECA 

believes that $500 an hour is more 

appropriate for legal fees. IECA also 

believes that the Commission’s estimate 

of an average of 10 hours per 

counterparty to negotiate the new 

documentation under § 23.504(b) is low, 

as the time needed must include not 

only negotiation, but also time for 

determining price points and inputs, 

decision-making time, and senior 

management time. 

The Working Group believes the 

Commission’s implementation costs 

substantially underestimate the 

potential impact because: (i) Margin 

requirements have yet to be proposed 

and negotiation of credit support 

arrangements currently can take 

months; (ii) market participants are 

unlikely to agree to standardized 

valuation methodologies; (iii) the 

Commission does not specifically 

discuss the potentially substantial costs 

associated with the audit requirement 

under § 23.504(e); 134 and (iv) the 


sroberts on DSK5SPTVN1PROD with RULES
55956 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

Working Group of Commercial Energy Firms, 

December 20, 2011. In the late-filed comment 

supplement, NERA estimates these costs for entities 

‘‘engaged in production, physical distribution or 

marketing of natural gas, power, or oil that also 

engage in active trading of energy derivatives’’— 

termed ‘‘nonfinancial energy companies’’ in the 

report. The figure cited includes costs to maintain 

a risk management program, quarterly audits of the 

program, and annual audits of swap trading 

relationship documentation, the first two of which 

are required under a separate rulemaking 

previously adopted by the Commission. 

135 ISDA is partnering with Markit to launch a 

technology-based solution enabling counterparties 

to amend their OTC derivatives documentation 

quickly and efficiently to comply with Dodd-Frank 

regulatory requirements. See http://www2.isda.org/ 

dodd-frank-documentation-initiative/. 

136http.www.bls.gov/oes/2099/mayowe23.

1011.htm. 

proposed rules would significantly alter 

the process by which parties enter into 

swaps, and such costs have not been 

considered. 

As discussed in the above sections, 

the Commission has modified many 

provisions of the final rules in response 

to comments received and in order to 

mitigate the burden imposed on market 

participants while accomplishing the 

goals as laid out in the NPRM. The 

Commission has: 

• Provided for a phased 

implementation plan, providing longer 

periods for compliance with the rule for 

those entities for which the rules will be 

most burdensome; 

• Clarified that the rules will be 

applicable only to swaps that are 

entered into after the rules become 

effective, and therefore not requiring 

retroactive application to existing 

swaps; 

• Clarified that the rules do not apply 

to swaps executed on a SEF or DCM and 

cleared by a DCO, subject to certain 

minimum requirements; 

• Imposed no additional 

requirements regarding documentation 

of events of default, termination events, 

or payment obligations; 

• Permitted parties to agree on either 

alternative methods for determining the 

value of a swap or a valuation dispute 

resolution process; 

• Reduced recordkeeping 

requirements under § 23.504(b)(6); 

• Removed the 5 percent annual 

documentation audit requirement in 

favor of a more general audit standard; 

and 

• Modified the swap valuation 

dispute reporting requirement to reduce 

the number of disputes that must be 

reported to the Commission, the SEC, 

and any applicable prudential regulator, 

and replaced the one-day reporting 

requirement with a three-day 

requirement for SDs and MSPs. 

The Commission believes that these 

changes will reduce or eliminate many 

of the burden concerns raised by 

commenters. 

Still, the Commission anticipates that 

significant costs will be incurred as a 

result of these documentation rules. 

Although the rules do not apply 

retroactively—that is, concerns 

regarding the need to re-negotiate 

already agreed-upon contracts are null— 

there will be costs going forward for 

market participants. Registrants will 

have to (i) Negotiate and document all 

terms of each trading relationship; (ii) 

design, compose, and implement 

policies and procedures reasonably 

designed to ensure the execution of 

swap trading relationship 

documentation, including valuation 

documentation; (iii) obtain 

documentation from counterparties who 

are claiming the end user exception to 

clearing; (iv) periodically audit 

documentation; and (v) keep records 

and/or make reports as required under 

§§ 23.504(d)–(e) and 23.505(b). 

In its Documentation NPRM, the 

Commission considered the costs of its 

proposal and noted that memorializing 

the specific terms of the swap trading 

relationship and swap transactions 

between counterparties is prudent 

business practice and, in fact, many 

market participants already use 

standardized documentation. 

Accordingly, it is believed that many, if 

not most, SDs and MSPs currently 

execute and maintain trading 

relationship documentation of the type 

required by proposed § 23.504 in the 

ordinary course of their businesses, 

including documentation that contains 

several of the terms that would be 

required by the proposed rules. Thus, 

the hour and dollar burdens associated 

with the swap trading relationship 

documentation requirements may be 

limited to amending existing 

documentation to expressly include any 

additional terms required by the 

proposed rules. 

The Commission also explained its 

belief that, to the extent any substantial 

amendments or additions to existing 

documentation would be needed, such 

revisions would likely apply to multiple 

counterparties, thereby reducing the per 

counterparty burden imposed upon SDs 

and MSPs. In addition, in its proposal, 

the Commission anticipated that 

standardized swap trading relationship 

documentation will develop quickly 

and progressively within the industry, 

dramatically reducing the cost to 

individual participants. 

Indeed, the Commission is aware of 

industry-led efforts already underway to 

bring trading relationship 

documentation into compliance with 

new Dodd-Frank Act requirements.135

These types of initiatives are likely to 

lower overall costs to market 

participants. 

The Commission further expects the 

per hour and dollar burdens to be 

incurred predominantly in the first year 

or two after the effective date of the final 

regulations. Once an SD or MSP has 

changed its pre-existing documentation 

with each of its counterparties to 

comply with the proposed rules, there 

likely will be little need to further 

modify such documentation on an 

ongoing basis. 

In terms of quantification, the 

Commission recognizes IECA’s 

comments indicating that the primary 

costs of the documentation and 

valuation rules will be legal costs. In 

terms of a per hour fee, the Commission 

has previously cited Bureau of Labor 

Statistics findings that the mean hourly 

wage of an employee under occupation 

code 23–1011, ‘‘Lawyers,’’ that is 

employed by the ‘‘Securities and 

Commodity Contracts Intermediation 

and Brokerage Industry’’ is $82.22.136

The Commission has adjusted this 

amount upward to $100 per hour 

because SDs and MSPs include large 

financial institutions whose employees’ 

salaries may exceed the mean wage 

provided. To account for the possibility 

that the services of outside counsel may 

be required to satisfy the requirements 

associated with negotiating, drafting, 

and maintaining the required trading 

relationship documentation, the 

Commission used an average salary of 

$125 per hour. In response to comments 

that the hourly rate should be increased 

further, the Commission notes that any 

determination to use outside counsel is 

at the discretion of the registrant. 

Accordingly, the per-hour estimate for 

legal costs associated with these rules is 

$125–500 per hour. In terms of the 

number of hours required to amend 

documentation, whether the 

requirement be ten hours or 

substantially more, the Commission 

notes that industry-wide efforts could 

reduce this amount significantly. 

The Commission also notes the NERA 

report regarding the costs of an annual 

audit. Given the alternative audit 

requirement finalized in these rules, the 

Commission expects that the audit costs 

would be reduced, perhaps 

significantly. 

In conclusion, the Commission 

believes the final rules for 

documentation of swap trading 

relationships are appropriate to ensure 

the efficient and orderly operation of 

bilateral derivatives markets and to 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55957 

137 5 U.S.C. 601 et seq. 

138 47 FR 18618 (Apr. 30, 1982). 

reduce the legal, operational, 

counterparty credit, and market risk that 

can arise from undocumented terms. 

The final rules promote an appropriate 

level of standardization; while the 

Commission does not believe the rules 

prohibit customized terms, the manner 

in which they are documented (i.e. 

written, pre-arranged terms that must 

include certain types of agreements as 

applicable) will become standardized. 

SDs, MSPs, and their counterparties 

alike will have certainty regarding what 

their documentation must include, 

though the actual terms are still readily 

negotiable. The Commission agrees with 

the Financial Stability Oversight Board 

OTC Derivatives Working Group that 

increased documentation 

standardization should improve the 

market in a number of ways, including 

(i) Facilitating automated processing of 

transactions; (ii) increasing the 

fungibility of contracts, which enables 

greater market liquidity; (iii) improving 

valuation and risk management; (iv) 

increasing the reliability of price 

information; (v) reducing the number of 

problems in matching trades; and (vi) 

facilitating reporting to SDRs. 

J. Section 15(a) Considerations: Swap 

Trading Relationship Documentation 

1. Protection of Market Participants and 

the Public 

The final documentation rules will 

protect market participants by ensuring 

that every trading relationship and 

every transaction is properly 

documented. Full and transparent 

documentation diminishes the risk of 

unfair practices like valuing a swap to 

advantage one party at the expense of 

the other. As such, documentation 

protects particularly those parties most 

susceptible to being taken advantage of, 

such as non-financial entities. In 

addition, the legal and credit certainty 

provided by proper documentation 

provides protection to both sides of a 

relationship by ensuring a clear 

understanding of options and 

obligations, particularly in case of 

dispute or market crisis. 

The provisions in the final rules 

related to valuation also provide 

protection to market participants from 

costly disputes over the collateralization 

of a swap; such disputes exacerbated the 

financial crisis as proper 

collateralization for risk management 

purposes could not be determined. 

2. Efficiency, Competitiveness, and 

Financial Integrity of Derivatives 

Markets 

As proper documentation encourages 

orderly operations and diminishes risk, 

the Commission believes the final rules 

improve the efficiency of markets. 

Increased standardization should allow 

for increased competition among SDs 

and MSPs, whose counterparties will be 

better able to compare between swap 

trading relationships to determine 

which relationships with which dealers 

best suit their needs. The transparency 

and certainty provided by proper 

documentation, in addition to the 

diminished risk of predatory trading 

practices, should improve the integrity 

of bilateral derivatives markets. Overall, 

then, the Commission considers the 

final rules to have a net positive impact 

on the efficiency, competitiveness, and 

financial integrity of derivatives 

markets. 

3. Price Discovery 

To the extent the final rules improve 

the process of valuing swap transactions 

between counterparties, they should 

also increase the reliability of pricing 

information; this increase in pricing 

reliability should improve the price 

discovery function of bilateral markets. 

4. Sound Risk Management 

Proper documentation of trading 

relationships and transactions is 

essential to sound risk management; 

simply put, if a dealer is unaware or 

unsure of agreed-upon terms and 

policies, it cannot be managing risk as 

efficiently as possible. The final rules, 

because they require full documentation 

of all facets of the relationship between 

counterparties, mitigate (i) The legal risk 

inherent in poorly documented or oral 

contracts; (ii) the counterparty credit 

risk that stems from improper 

documentation of credit terms and the 

counterparty credit risk that could occur 

based on false or misleading 

representations by either counterparty; 

and (iii) the operational risk that arises 

when internal operations personnel and 

systems do not have full or identical 

information regarding a particular 

transaction or counterparty. 

The final valuation rules also provide 

support for sound risk management 

practices because they strive to ensure 

that two counterparties are not 

disputing the value of a transaction 

where margin or other cash flows are 

being exchanged. Limiting the risk that 

unresolved disputes can create in the 

marketplace as a whole—again 

considering the role valuation disputes 

played in the 2008 financial crisis— 

should allow systemic risk management 

as well as improving the risk 

management processes of individual 

market participants. 

5. Other Public Interest Considerations 

The Commission has not identified 

other public interest considerations as a 

result of these rules. 

V. Related Matters 

A. Regulatory Flexibility Act 

The Regulatory Flexibility Act 

(RFA) 137 requires that agencies consider 

whether the rules 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. 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.138 SDs and 

MSPs are new categories of registrant. 

Accordingly, the Commission noted in 

the proposals that it had not previously 

addressed the question of whether such 

persons were, in fact, small entities for 

purposes of the RFA. 

In this regard, the Commission 

explained that it previously had 

determined that FCMs should not be 

considered to be small entities for 

purposes of the RFA, based, in part, 

upon FCMs’ 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. 

Like FCMs, SDs will be subject to 

minimum capital and margin 

requirements, and are expected to 

comprise the largest global financial 

firms—and the Commission is required 

to exempt from designation as an SD 

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 for the proposals and future 

rulemakings, the Commission proposed 

that SDs not be considered ‘‘small 

entities’’ for essentially the same 

reasons that it had previously 

determined FCMs not to be small 

entities. 

The Commission further explained 

that it had also previously determined 

that large traders are not ‘‘small 

entities’’ for RFA purposes, with the 

Commission considering the size of a 

trader’s position to be the only 

appropriate test for the purpose of large 

trader reporting. The Commission then 

noted that MSPs maintain substantial 

positions in swaps, creating substantial 

counterparty exposure that could have 

serious adverse effects on the financial 


sroberts on DSK5SPTVN1PROD with RULES
55958 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

139See, e.g., Registration of Swap Dealers and 

Major Swap Participants, 77 FR 2613 (Jan. 19, 

2012); Swap Dealer and Major Swap Participant 

Recordkeeping, Reporting, and Duties Rules; 

Futures Commission Merchant and Introducing 

Broker Conflicts of Interest Rules; and Chief 

Compliance Officer Rules for Swap Dealers, Major 

Swap Participants, and Futures Commission 

Merchants, 77 FR 20128 (Apr. 3, 2012). 

140 44 U.S.C. 3501 et seq. 

141These collections include certain collections 

required under the Business Conduct Standards 

with Counterparties rulemaking, as stated in that 

rulemaking. See Business Conduct Standards for 

Swap Dealers and Major Swap Participants with 

Counterparties, 77 FR 9734 (Feb. 17, 2012). 

142See 75 FR at 81528; 76 FR at 6713; 76 FR at 

6723. 

143CFTC, President’s Budget and Performance 

Plan Fiscal Year 2010, p. 13–14 (Feb. 2011), 

available at http://www.cftc.gov/ucm/groups/

public/@newsroom/documents/file/cftcbudget

2012.pdf. The estimated 140 SDs includes 

‘‘[a]pproximately 80 global and regional banks 

currently known to offer swaps in the United 

States;’’ ‘‘[a]pproximately 40 non-bank swap dealers 

currently offering commodity and other swaps;’’ 

and ‘‘[a]pproximately 20 new potential market 

makers that wish to become swap dealers.’’ Id. 

144Letter from Thomas W. Sexton, Senior Vice 

President and General Counsel, NFA to Gary 

Barnett, Director, Division of Swap Dealer and 

Intermediary Oversight, CFTC (Oct. 20, 2011) (NFA 

Cost Estimates Letter). 

stability of the United States banking 

system or financial markets. 

Accordingly, for purposes of the RFA 

for the proposals and future 

rulemakings, the Commission proposed 

that MSPs not be considered ‘‘small 

entities’’ for essentially the same 

reasons that it previously had 

determined large traders not to be small 

entities. 

The Commission concluded its RFA 

analysis applicable to SDs and MSPs as 

follows: ‘‘The Commission is carrying 

out Congressional mandates by 

proposing these rules. The Commission 

is incorporating registration of SDs and 

MSPs into the existing registration 

structure applicable to other registrants. 

In so doing, the Commission has 

attempted to accomplish registration of 

SDs and MSPs in the manner that is 

least disruptive to ongoing business and 

most efficient and expeditious, 

consistent with the public interest, and 

accordingly believes that these 

registration rules will not present a 

significant economic burden on any 

entity subject thereto.’’ 

The Commission did not receive any 

comments on its analysis of the 

application of the RFA to SDs and 

MSPs. Moreover, during the time period 

since the rule proposals were published 

in the Federal Register, the Commission 

has issued final rules in which it 

determined that the registration and 

regulation of SDs and MSPs would not 

have a significant economic impact on 

a substantial number of small 

entities.139 Accordingly, pursuant to 

Section 605(b) of the RFA, 5 U.S.C. 

605(b), the Chairman, on behalf of the 

Commission, certifies that these rules 

will not have a significant economic 

impact on a substantial number of small 

entities. 

B. Paperwork Reduction Act 

The Commission may not conduct or 

sponsor, and a registrant is not required 

to respond to, a collection of 

information unless it displays a 

currently valid Office of Management 

and Budget (OMB) control number. The 

Commission’s adoption of §§ 23.500 

through 23.505 (Swap Confirmation, 

Portfolio Reconciliation, Portfolio 

Compression, Swap Trading 

Relationship Documentation, and End 

User Exception Documentation) 

imposes new information collection 

requirements on registrants within the 

meaning of the Paperwork Reduction 

Act.140

Accordingly, the Commission 

requested and OMB assigned control 

numbers for the required collections of 

information. The Commission has 

submitted this notice of final 

rulemaking along with supporting 

documentation for OMB’s review in 

accordance with 44 U.S.C. 3507(d) and 

5 CFR 1320.11. The title for these 

collections of information are ‘‘Swap 

Trading Relationship Documentation 

Requirements for Swap Dealers and 

Major Swap Participants, OMB control 

number 3038–0088,’’ ‘‘Confirmation, 

Portfolio Reconciliation, and Portfolio 

Compression Requirements for Swap 

Dealers and Major Swap Participants, 

OMB control number 3038–0068,’’ and 

‘‘Orderly Liquidation Termination 

Provision in Swap Trading Relationship 

Documentation for Swap Dealers and 

Major Swap Participants, OMB control 

number 3038–0083.’’ 141 Many of the 

responses to this new collection of 

information are mandatory. 

The Commission protects proprietary 

information according to the Freedom of 

Information Act and 17 CFR part 145, 

‘‘Commission Records and 

Information.’’ In addition, Section 

8(a)(1) of the CEA strictly prohibits the 

Commission, unless specifically 

authorized by the Act, from making 

public ‘‘data and information that 

would separately disclose the business 

transactions or market positions of any 

person and trade secrets or names of 

customers.’’ The Commission also is 

required to protect certain information 

contained in a government system of 

records according to the Privacy Act of 

1974, 5 U.S.C. 552a. 

The regulations require each 

respondent to furnish certain 

information to the Commission and to 

maintain certain records. The 

Commission invited the public and 

other Federal agencies to comment on 

any aspect of the information collection 

requirements discussed in the 

Documentation NPRM, the 

Confirmation NPRM, and the Orderly 

Liquidation NPRM. Pursuant to 44 

U.S.C. 3506(c)(2)(B), the Commission 

solicited comments in order to: (i) 

Evaluate whether the proposed 

collections of information were 

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 estimates 

of the burden of the proposed 

collections 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 

collections of information on those who 

are to respond, including through the 

use of automated collection techniques 

or other forms of information 

technology. 

It is not currently known how many 

SDs and MSPs will become subject to 

these rules, and this will not be known 

to the Commission until the registration 

requirements for these entities become 

effective. In its rule proposals, the 

Commission took ‘‘a conservative 

approach’’ to calculating the burden 

hours of this information collection by 

estimating that as many as 300 SDs and 

MSPs would register.142 Since 

publication of the proposals in late 2010 

and early 2011, the Commission has met 

with industry participants and trade 

groups, discussed extensively the 

universe of potential registrants with 

NFA, and reviewed public information 

about SDs active in the market and 

certain trade groups. Over time, and as 

the Commission has gathered more 

information on the swaps market and its 

participants, the estimate of the number 

of SDs and MSPs has decreased. In its 

FY 2012 budget drafted in February 

2011, the Commission estimated that 

140 SDs might register with the 

Commission.143 After recently receiving 

additional specific information from 

NFA on the regulatory program it is 

developing for SDs and MSPs,144

however, the Commission believes that 

approximately 125 SDs and MSPs, 

including only a handful of MSPs, will 

register. While the Commission 

originally estimated there might be 

approximately 300 SDs and MSPs, 

based on new estimates provided by 

NFA, the Commission now estimates 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55959 

145NFA Letter (Oct. 20, 2011) (estimating that 

there will be 125 SDs and MSPs required to register 

with NFA). 

146See http://www.bls.gov/oes/2099/mayowe23.

1011.htm and http://www.bls.gov/oes/current/ 

oes113031.htm. 

147See Swap Dealer and Major Swap Participant 

Recordkeeping, Reporting, and Duties Rules; 

Futures Commission Merchant and Introducing 

Broker Conflicts of Interest Rules; and Chief 

Compliance Officer Rules for Swap Dealers, Major 

Swap Participants, and Futures Commission 

Merchants, 77 FR 20128, 20196 (Apr. 3, 2012). 

148As noted in the Documentation NPRM, the 

Commission has characterized the annual costs as 

initial annual costs, since the Commission 

anticipates that the cost burdens will be reduced 

dramatically over time as the agreements and other 

records required by the proposed regulations 

become increasingly standardized within the 

industry. 76 FR at 6722. 

149See id. (discussing the characterization of the 

annual costs as initial annual costs). The 

Commission notes that the substantive 

requirements under the Orderly Liquidation rule 

have been reduced significantly. While the proposal 

required the parties to negotiate and agree on 

documentation provisions, the final rules requires 

only a simple notice. The Commission has elected 

not to alter its PRA burden estimate, but observes 

that such estimates are likely to overstate the actual 

burden significantly. 

that there will be a combined number of 

125 SDs and MSPs that will be subject 

to new information collection 

requirements under these rules.145

For purposes of the PRA, the term 

‘‘burden’’ means the ‘‘time, effort, or 

financial resources expended by persons 

to generate, maintain, or provide 

information to or for a Federal Agency.’’ 

For most of the provisions set forth in 

the NPRMs, the Commission estimated 

the cost burden of the proposed 

regulations based upon an average 

salary for Financial Managers of $100 

per hour. In addition, for certain 

provisions in the Documentation NPRM, 

the Commission estimated the cost 

burden of the proposed regulations 

based upon an average salary for 

Lawyers of $125 per hour. In response 

to these estimates, The Working Group 

commented that, inclusive of benefit 

costs and allocated overhead, the perhour average salary estimate for 

compliance and risk management 

personnel should be significantly higher 

than $120. FIA and SIFMA stated that 

some of the compliance policies 

required by the proposed regulations 

will be drafted by both in-house lawyers 

and outside counsel, so the blended 

hourly rate should be roughly $400. 

The Commission notes that its wage 

estimates were based on recent Bureau 

of Labor Statistics findings, including 

the mean hourly wage of an employee 

under occupation code 23–1011, 

‘‘Lawyers,’’ that is employed by the 

‘‘Securities and Commodity Contracts 

Intermediation and Brokerage Industry,’’ 

which is $82.22. The mean hourly wage 

of an employee under occupation code 

11–3031, ‘‘Financial Managers,’’ (which 

includes operations managers) in the 

same industry is $74.41.146 Taking these 

data, the Commission then increased its 

hourly wage estimates in recognition of 

the fact that some registrants may be 

large financial institutions whose 

employees’ salaries may exceed the 

mean wage. The Commission also 

observes that SIFMA’s ‘‘Report on 

Management & Professional Earnings in 

the Securities Industry—2010’’ 

estimates the average wage of a 

compliance attorney and a compliance 

staffer in the U.S. at only $46.31 per 

hour. 

The Commission recognizes that some 

registrants may hire outside counsel 

with expertise in the various regulatory 

areas covered by the regulations 

discussed herein. While the 

Commission is uncertain about the 

billing rates that registrants may pay for 

outside counsel, the Commission 

believes that such counsel may bill at a 

rate of several hundred dollars per hour. 

Outside counsel may be able to leverage 

its expertise to reduce substantially the 

number of hours needed to fulfill a 

requested assignment, but a registrant 

that uses outside counsel may incur 

higher costs than a registrant that does 

not use outside counsel. Any 

determination to use outside counsel is 

at the discretion of the registrant. 

Having considered the comments 

received and having reviewed the 

available data, the Commission has 

determined that $100 per hour for 

Financial Managers, and $125 for 

Lawyers, remain reasonable estimates of 

the per-hour average salary for purposes 

of its PRA analysis. The Commission 

also notes that this determination is 

consistent with the Commission’s 

estimate for the hourly wage for CCOs 

under the recently adopted final rules 

establishing certain internal business 

conduct standards for SDs and MSPs.147

The Commission received comments 

related to the PRA in response to its 

notices of proposed rulemaking. 

Notably, none of these commenters 

suggested specific revised calculations 

with regard to the Commission’s burden 

estimate. 

IECA commented that if all 

confirmations must be in writing, the 

additional employee time cost for each 

market participant would be substantial 

and is not included in the annual cost 

analysis. IECA also commented that the 

estimate of 10 hours per counterparty to 

negotiate new documentation is too low. 

Because the rule requires transactionby-transaction valuation methodologies 

that will need to be newly negotiated for 

many transactions, IECA believes the 

Commission should calculate an 

aggregate amount based on the number 

of transactions. Also, the time needed 

must include not only negotiation, but 

also time for determining pricing points 

and inputs, executive decision-maker 

time, and also senior management and 

board time for reviewing forms and 

material modifications. Time will also 

be needed to reevaluate the ISDA 

documentation if the Commission does 

not state that such are acceptable. 

The Working Group requested that the 

Commission evaluate the proposed rules 

in light of its various recordkeeping and 

reporting proposals, as such may cause 

firms to incur tremendous 

administrative obligations to record 

changes to its swap portfolio, its 

accounting records, treasury 

arrangements and capital allocations 

(including loss of cash flow hedging 

treatment under hedge accounting 

rules), as well as incurring reporting 

obligations to swap data repositories on 

a swap-by-swap basis. 

The Commission has considered the 

comments received concerning the PRArelated burden estimates set forth in the 

notices of proposed rulemaking. 

However, because none of the 

commenters suggested specific revised 

calculations on the estimates, the only 

change that the Commission is making 

to its estimation of annual burdens 

associated with the rules is the change 

to reflect the new estimate of the 

number of SDs and MSPs. 

With respect to the rules proposed in 

the Documentation NPRM, the 

Commission now estimates the initial 

burden to be 6,168 hours per year, at an 

initial annual cost of $684,300, for each 

SD and MSP, and the initial aggregate 

burden cost for all registrants is 

$85,537,500.148 With respect to the rules 

proposed in the Confirmation NPRM, 

the Commission now estimates the 

burden to be 1,282.5 hours, at an annual 

cost of $128,250 for each SD and MSP, 

and the aggregate burden cost for all 

registrants is 160,312.5 burden hours 

and $16,031,250. With respect to the 

rules set forth in the Orderly 

Liquidation NPRM, the Commission 

now estimates the initial burden to be 

270 hours per year, at an initial annual 

cost of $27,000 for each SD and MSP, 

and the initial aggregate burden cost for 

all registrants is 33,750 burden hours 

and $3,375,000.149

In total, the Commission estimates 

that the rules set forth in this Adopting 

Release will impose a burden of 7,720.5 

hours per year, at an initial annual cost 

of $839,550, for each SD and MSP, and 


sroberts on DSK5SPTVN1PROD with RULES
55960 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

150The Commission does not anticipate that SDs 

and MSPs will incur any start-up costs in 

connection with the proposed recordkeeping 

obligations in the rules proposed in the Orderly 

Liquidation NPRM, other than those previously 

noted and accounted for in the Documentation 

NPRM and Confirmation NPRM. 

151According to recent Bureau of Labor Statistics 

findings, the mean hourly wages of computer 

programmers under occupation code 15–1021 and 

computer software engineers under program codes 

15–1031 and 1032 are between $34.10 and $44.94. 

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

Because SDs and MSPs generally will be large 

entities that may engage employees with wages 

above the mean, the Commission has conservatively 

chosen to use a mean hourly programming wage of 

$60 per hour. 

the aggregate burden cost for all 

registrants is $104,943,750. 

In addition to the burden hours 

discussed above, the Commission 

anticipates that SDs and MSPs may 

incur certain start-up costs in 

connection with the proposed 

recordkeeping obligations. Such costs 

would include the expenditures related 

to developing and installing new 

technology and systems, or 

reprogramming or updating existing 

recordkeeping technology and systems, 

to enable the SD or MSP to collect, 

capture, process, maintain, and reproduce any newly required records. 

The Commission received no comments 

with respect to the estimated number of 

burden hours for these start-up costs, or 

with respect to the programming wage 

estimate of $60 per hour. Accordingly, 

the Commission estimates that the startup costs would require 40 burden hours 

for the rules proposed in the 

Documentation NPRM and 40 hours for 

the rules proposed in the Confirmation 

NPRM.150 Thus, the estimated start-up 

burden associated with the required 

technological improvements would be 

$4,800 [$60 × 80 hours per affected 

registrant] or $600,000 in the 

aggregate.151

List of Subjects in 17 CFR Part 23 

Antitrust, Commodity futures, 

Conduct standards, Conflict of Interests, 

Major swap participants, Reporting and 

recordkeeping, Swap dealers, Swaps. 

For the reasons stated in this release, 

the Commission amends 17 CFR part 23 

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, 6b-1, 

6c, 6p, 6r, 6s, 6t, 9, 9a, 12, 12a, 13b, 13c, 16a, 

18, 19, 21. 

■ 2. Subpart I (consisting of §§ 23.500, 

23.501, 23.502, 23.503, 23.504, and 

23.505) is added to read as follows: 

Subpart I—Swap Documentation 

Sec. 

23.500 Definitions. 

23.501 Swap confirmation. 

23.502 Portfolio reconciliation. 

23.503 Portfolio compression. 

23.504 Swap trading relationship 

documentation. 

23.505 End user exception documentation. 

Subpart I—Swap Documentation 

§ 23.500 Definitions. 

For purposes of this subpart I, the 

following terms shall be defined as 

provided. 

(a) Acknowledgment means a written 

or electronic record of all of the terms 

of a swap signed and sent by one 

counterparty to the other. 

(b) Bilateral portfolio compression 

exercise means an exercise in which two 

swap counterparties wholly terminate or 

change the notional value of some or all 

of the swaps submitted by the 

counterparties for inclusion in the 

portfolio compression exercise and, 

depending on the methodology 

employed, replace the terminated swaps 

with other swaps whose combined 

notional value (or some other measure 

of risk) is less than the combined 

notional value (or some other measure 

of risk) of the terminated swaps in the 

exercise. 

(c) Confirmation means the 

consummation (electronically or 

otherwise) of legally binding 

documentation (electronic or otherwise) 

that memorializes the agreement of the 

counterparties to all of the terms of a 

swap transaction. A confirmation must 

be in writing (whether electronic or 

otherwise) and must legally supersede 

any previous agreement (electronically 

or otherwise). A confirmation is created 

when an acknowledgment is manually, 

electronically, or by some other legally 

equivalent means, signed by the 

receiving counterparty. 

(d) Execution means, with respect to 

a swap transaction, an agreement by the 

counterparties (whether orally, in 

writing, electronically, or otherwise) to 

the terms of the swap transaction that 

legally binds the counterparties to such 

terms under applicable law. 

(e) Financial entity means a 

counterparty that is not a swap dealer or 

a major swap participant and that is one 

of the following: 

(1) A commodity pool as defined in 

Section 1a(5) of the Act; 

(2) A private fund as defined in 

Section 202(a) of the Investment 

Advisors Act of 1940; 

(3) An employee benefit plan as 

defined in paragraphs (3) and (32) of 

section 3 of the Employee Retirement 

Income and Security Act of 1974; 

(4) A person predominantly engaged 

in activities that are in the business of 

banking, or in activities that are 

financial in nature as defined in Section 

4(k) of the Bank Holding Company Act 

of 1956; and 

(5) A security-based swap dealer or a 

major security-based swap participant. 

(f) Fully offsetting swaps means swaps 

of equivalent terms where no net cash 

flow would be owed to either 

counterparty after the offset of payment 

obligations thereunder. 

(g) Material terms means all terms of 

a swap required to be reported in 

accordance with part 45 of this chapter. 

(h) Multilateral portfolio compression 

exercise means an exercise in which 

multiple swap counterparties wholly 

terminate or change the notional value 

of some or all of the swaps submitted by 

the counterparties for inclusion in the 

portfolio compression exercise and, 

depending on the methodology 

employed, replace the terminated swaps 

with other swaps whose combined 

notional value (or some other measure 

of risk) is less than the combined 

notional value (or some other measure 

of risk) of the terminated swaps in the 

compression exercise. 

(i) Portfolio reconciliation means any 

process by which the two parties to one 

or more swaps: 

(1) Exchange the terms of all swaps in 

the swap portfolio between the 

counterparties; 

(2) Exchange each counterparty’s 

valuation of each swap in the swap 

portfolio between the counterparties as 

of the close of business on the 

immediately preceding business day; 

and 

(3) Resolve any discrepancy in 

material terms and valuations. 

(j) Prudential regulator has the 

meaning given to the term in section 

1a(39) of the Commodity Exchange Act 

and includes the Board of Governors of 

the Federal Reserve System, the Office 

of the Comptroller of the Currency, the 

Federal Deposit Insurance Corporation, 

the Farm Credit Association, and the 

Federal Housing Finance Agency, as 

applicable to the swap dealer or major 

swap participant. 

(k) Swap portfolio means all swaps 

currently in effect between a particular 

swap dealer or major swap participant 

and a particular counterparty. 

(l) Swap transaction means any event 

that results in a new swap or in a change 

to the terms of a swap, including 

execution, termination, assignment, 

novation, exchange, transfer, 

amendment, conveyance, or 

extinguishing of rights or obligations of 

a swap. 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55961 

(m) Valuation means the current 

market value or net present value of a 

swap. 

§ 23.501 Swap confirmation. 

(a) Confirmation. Subject to the 

compliance schedule in paragraph (c) of 

this section: 

(1) Each swap dealer and major swap 

participant entering into a swap 

transaction with a counterparty that is a 

swap dealer or major swap participant 

shall execute a confirmation for the 

swap transaction as soon as 

technologically practicable, but in any 

event by the end of first business day 

following the day of execution. 

(2) Each swap dealer and major swap 

participant entering into a swap 

transaction with a counterparty that is 

not a swap dealer or a major swap 

participant shall send an 

acknowledgment of such swap 

transaction as soon as technologically 

practicable, but in any event by the end 

of the first business day following the 

day of execution. 

(3) (i) Each swap dealer and major 

swap participant shall establish, 

maintain, and follow written policies 

and procedures reasonably designed to 

ensure that it executes a confirmation 

for each swap transaction that it enters 

into with a counterparty that is a 

financial entity as soon as 

technologically practicable, but in any 

event by the end of the first business 

day following the day of execution. 

(ii) Each swap dealer and major swap 

participant shall establish, maintain, 

and follow written policies and 

procedures reasonably designed to 

ensure that it executes a confirmation 

for each swap transaction that it enters 

into with a counterparty that is not a 

swap dealer, major swap participant, or 

a financial entity not later than the end 

of the second business day following the 

day of execution. 

(iii) Such procedures shall include a 

requirement that, upon a request by a 

prospective counterparty prior to 

execution of any such swap, the swap 

dealer or major swap participant furnish 

to the prospective counterparty prior to 

execution a draft acknowledgment 

specifying all terms of the swap 

transaction other than the applicable 

pricing and other relevant terms that are 

to be expressly agreed at execution. 

(4) Swaps executed on a swap 

execution facility, designated contract 

market, or submitted for clearing by a 

derivatives clearing organization. 

(i) Any swap transaction executed on 

a swap execution facility or designated 

contract market shall be deemed to 

satisfy the requirements of this section, 

provided that the rules of the swap 

execution facility or designated contract 

market establish that confirmation of all 

terms of the transaction shall take place 

at the same time as execution. 

(ii) Any swap transaction submitted 

for clearing by a derivatives clearing 

organization shall be deemed to satisfy 

the requirements of this section, 

provided that: 

(A) The swap transaction is submitted 

for clearing as soon as technologically 

practicable, but in any event no later 

than the times established for 

confirmation under paragraphs (a)(1) or 

(3) of this section, and 

(B) Confirmation of all terms of the 

transaction takes place at the same time 

as the swap transaction is accepted for 

clearing pursuant to the rules of the 

derivatives clearing organization. 

(iii) If a swap dealer or major swap 

participant receives notice that a swap 

transaction has not been confirmed by a 

swap execution facility or a designated 

contract market, or accepted for clearing 

by a derivatives clearing organization, 

the swap dealer or major swap 

participant shall execute a confirmation 

for such swap transaction as soon as 

technologically practicable, but in any 

event no later than the times established 

for confirmation under paragraphs (a)(1) 

or (3) of this section as if such swap 

transaction were executed at the time 

the swap dealer or major swap 

participant receives such notice. 

(5) For purposes of this section: 

(i) ‘‘Day of execution’’ means the 

calendar day of the party to the swap 

transaction that ends latest, provided 

that if a swap transaction is— 

(A) Entered into after 4:00 p.m. in the 

place of a party; or 

(B) Entered into on a day that is not 

a business day in the place of a party, 

then such swap transaction shall be 

deemed to have been entered into by 

that party on the immediately 

succeeding business day of that party, 

and the day of execution shall be 

determined with reference to such 

business day; and 

(ii) ‘‘Business day’’ means any day 

other than a Saturday, Sunday, or legal 

holiday. 

(b) Recordkeeping. (1) Each swap 

dealer and major swap participant shall 

make and retain a record of: 

(i) The date and time of transmission 

to, or receipt from, a counterparty of any 

acknowledgment; and 

(ii) The date and time of transmission 

to, or receipt from, a counterparty of any 

confirmation. 

(2) All records required to be 

maintained pursuant to this section 

shall be maintained in accordance with 

§ 23.203 and shall be made available 

promptly upon request to any 

representative of the Commission or any 

applicable prudential regulator, or with 

regard to swaps defined in section 

1a(47)(A)(v), to any representative of the 

Commission, the Securities and 

Exchange Commission, or any 

applicable prudential regulator. 

(c) Compliance schedule. The 

requirements of paragraph (a) of this 

section are subject to the following 

compliance schedule: 

(1) For purposes of paragraph (a)(1) of 

this section, each swap dealer and major 

swap participant entering into a swap 

transaction that is or involves a credit 

swap or interest rate swap with a 

counterparty that is a swap dealer or 

major swap participant shall execute a 

confirmation for the swap transaction as 

soon as technologically practicable, but 

in any event by: 

(i) The end of the second business day 

following the day of execution for the 

period from the effective date of this 

section to February 28, 2014; and 

(ii) The end of the first business day 

following the day of execution from and 

after March 1, 2014. 

(2) For purposes of paragraph (a)(1) of 

this section, each swap dealer and major 

swap participant entering into a swap 

transaction that is or involves an equity 

swap, foreign exchange swap, or other 

commodity swap with a counterparty 

that is a swap dealer or major swap 

participant shall execute a confirmation 

for the swap transaction as soon as 

technologically practicable, but in any 

event by: 

(i) The end of the third business day 

following the day of execution for the 

period from the effective date of this 

section to August 31, 2013; 

(ii) The end of the second business 

day following the day of execution for 

the period from September 1, 2013 to 

August 31, 2014; and 

(iii) The end of the first business day 

following the day of execution from and 

after September 1, 2014. 

(3) For purposes of paragraph (a)(2) of 

this section, each swap dealer and major 

swap participant entering into a swap 

transaction that is or involves a credit 

swap or interest rate swap with a 

counterparty that is not a swap dealer or 

a major swap participant shall send an 

acknowledgment of such swap 

transaction as soon as technologically 

practicable, but in any event by: 

(i) The end of the second business day 

following the day of execution for the 

period from the effective date of this 

section to February 28, 2014; and 

(ii) The end of the first business day 

following the day of execution from and 

after March 1, 2014. 

(4) For purposes of paragraph (a)(2) of 

this section, each swap dealer and major 


sroberts on DSK5SPTVN1PROD with RULES
55962 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

swap participant entering into a swap 

transaction that is or involves an equity 

swap, foreign exchange swap, or other 

commodity swap with a counterparty 

that is not a swap dealer or a major 

swap participant shall send an 

acknowledgment of such swap 

transaction as soon as technologically 

practicable, but in any event by: 

(i) The end of the third business day 

following the day of execution for the 

period from the effective date of this 

section to August 31, 2013; 

(ii) The end of the second business 

day following the day of execution for 

the period from September 1, 2013 to 

August 31, 2014; and 

(iii) The end of the first business day 

following the day of execution from and 

after September 1, 2014. 

(5) For purposes of paragraph (a)(3)(i) 

of this section, each swap dealer and 

major swap participant shall establish, 

maintain, and follow written policies 

and procedures reasonably designed to 

ensure that it executes a confirmation 

for each swap transaction that is or 

involves a credit swap or interest rate 

swap that it enters into with a 

counterparty that is a financial entity as 

soon as technologically practicable, but 

in any event by: 

(i) The end of the second business day 

following the day of execution for the 

period from the effective date of this 

section to February 28, 2014; and 

(ii) The end of the first business day 

following the day of execution from and 

after March 1, 2014. 

(6) For purposes of paragraph (a)(3)(i) 

of this section, each swap dealer and 

major swap participant shall establish, 

maintain, and follow written policies 

and procedures reasonably designed to 

ensure that it executes a confirmation 

for each swap transaction that is or 

involves an equity swap, foreign 

exchange swap, or other commodity 

swap that it enters into with a 

counterparty that is a financial entity as 

soon as technologically practicable, but 

in any event by: 

(i) The end of the third business day 

following the day of execution for the 

period from the effective date of this 

section to August 31, 2013; 

(ii) The end of the second business 

day following the day of execution for 

the period from September 1, 2013 to 

August 31, 2014; and 

(iii) The end of the first business day 

following the day of execution from and 

after September 1, 2014. 

(7) For purposes of paragraph (a)(3)(ii) 

of this section, each swap dealer and 

major swap participant shall establish, 

maintain, and follow written policies 

and procedures reasonably designed to 

ensure that it executes a confirmation 

for each swap transaction that is or 

involves a credit swap or interest rate 

swap that it enters into with a 

counterparty that is not a swap dealer, 

major swap participant, or a financial 

entity not later than: 

(i) The end of the fifth business day 

following the day of execution for the 

period from the effective date of this 

section to August 31, 2013; 

(ii) The end of the third business day 

following the day of execution for the 

period from September 1, 2013 to 

August 31, 2014; and 

(iii) The end of the second business 

day following the day of execution from 

and after September 1, 2014. 

(8) For purposes of paragraph (a)(3)(ii) 

of this section, each swap dealer and 

major swap participant shall establish, 

maintain, and follow written policies 

and procedures reasonably designed to 

ensure that it executes a confirmation 

for each swap transaction that is or 

involves an equity swap, foreign 

exchange swap, or other commodity 

swap that it enters into with a 

counterparty that is not a swap dealer, 

major swap participant, or a financial 

entity not later than: 

(i) The end of the seventh business 

day following the day of execution for 

the period from the effective date of this 

section to August 31, 2013; 

(ii) The end of the fourth business day 

following the day of execution for the 

period from September 1, 2013 to 

August 31, 2014; and 

(iii) The end of the second business 

following the day of execution from and 

after September 1, 2014. 

(9) For purposes of paragraph (c) of 

this section: 

(i) ‘‘Credit swap’’ means any swap 

that is primarily based on instruments 

of indebtedness, including, without 

limitation: Any swap primarily based on 

one or more broad-based indices related 

to instruments of indebtedness; and any 

swap that is an index credit swap or 

total return swap on one or more indices 

of debt instruments; 

(ii) ‘‘Equity swap’’ means any swap 

that is primarily based on equity 

securities, including, without limitation: 

Any swap primarily based on one or 

more broad-based indices of equity 

securities; and any total return swap on 

one or more equity indices; 

(iii) ‘‘Foreign exchange swap’’ has the 

meaning set forth in section 1a(25) of 

the CEA. It does not include swaps 

primarily based on rates of exchange 

between different currencies, changes in 

such rates, or other aspects of such rates 

(sometimes known as ‘‘cross-currency 

swaps’’); 

(iv) ‘‘Interest rate swap’’ means any 

swap which is primarily based on one 

or more interest rates, such as swaps of 

payments determined by fixed and 

floating interest rates; or any swap 

which is primarily based on rates of 

exchange between different currencies, 

changes in such rates, or other aspects 

of such rates (sometimes known as 

‘‘cross-currency swaps’’); and 

(v) ‘‘Other commodity swap’’ means 

any swap not included in the credit, 

equity, foreign exchange, or interest rate 

asset classes, including, without 

limitation, any swap for which the 

primary underlying item is a physical 

commodity or the price or any other 

aspect of a physical commodity. 

§ 23.502 Portfolio reconciliation. 

(a) Swaps with swap dealers or major 

swap participants. Each swap dealer 

and major swap participant shall engage 

in portfolio reconciliation as follows for 

all swaps in which its counterparty is 

also a swap dealer or major swap 

participant. 

(1) Each swap dealer or major swap 

participant shall agree in writing with 

each of its counterparties on the terms 

of the portfolio reconciliation. 

(2) The portfolio reconciliation may 

be performed on a bilateral basis by the 

counterparties or by a qualified third 

party. 

(3) The portfolio reconciliation shall 

be performed no less frequently than: 

(i) Once each business day for each 

swap portfolio that includes 500 or 

more swaps; 

(ii) Once each week for each swap 

portfolio that includes more than 50 but 

fewer than 500 swaps on any business 

day during any week; and 

(iii) Once each calendar quarter for 

each swap portfolio that includes no 

more than 50 swaps at any time during 

the calendar quarter. 

(4) Each swap dealer and major swap 

participant shall resolve immediately 

any discrepancy in a material term of a 

swap identified as part of a portfolio 

reconciliation or otherwise. 

(5) Each swap dealer and major swap 

participant shall establish, maintain, 

and follow written policies and 

procedures reasonably designed to 

resolve any discrepancy in a valuation 

identified as part of a portfolio 

reconciliation or otherwise as soon as 

possible, but in any event within five 

business days, provided that the swap 

dealer and major swap participant 

establishes, maintains, and follows 

written policies and procedures 

reasonably designed to identify how the 

swap dealer or major swap participant 

will comply with any variation margin 

requirements under section 4s(e) of the 

Act and regulations under this part 

pending resolution of the discrepancy in 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55963 

valuation. A difference between the 

lower valuation and the higher 

valuation of less than 10 percent of the 

higher valuation need not be deemed a 

discrepancy. 

(b) Swaps with entities other than 

swap dealers or major swap 

participants. Each swap dealer and 

major swap participant shall establish, 

maintain, and follow written policies 

and procedures reasonably designed to 

ensure that it engages in portfolio 

reconciliation as follows for all swaps in 

which its counterparty is neither a swap 

dealer nor a major swap participant. 

(1) Each swap dealer or major swap 

participant shall agree in writing with 

each of its counterparties on the terms 

of the portfolio reconciliation, including 

agreement on the selection of any thirdparty service provider. 

(2) The portfolio reconciliation may 

be performed on a bilateral basis by the 

counterparties or by one or more third 

parties selected by the counterparties in 

accordance with paragraph (b)(1) of this 

section. 

(3) The required policies and 

procedures shall provide that portfolio 

reconciliation will be performed no less 

frequently than: 

(i) Once each calendar quarter for 

each swap portfolio that includes more 

than 100 swaps at any time during the 

calendar quarter; and 

(ii) Once annually for each swap 

portfolio that includes no more than 100 

swaps at any time during the calendar 

year. 

(4) Each swap dealer or major swap 

participant shall establish, maintain, 

and follow written procedures 

reasonably designed to resolve any 

discrepancies in the material terms or 

valuation of each swap identified as part 

of a portfolio reconciliation or otherwise 

with a counterparty that is neither a 

swap dealer nor major swap participant 

in a timely fashion. A difference 

between the lower valuation and the 

higher valuation of less than 10 percent 

of the higher valuation need not be 

deemed a discrepancy. 

(c) Reporting. Each swap dealer and 

major swap participant shall promptly 

notify the Commission and any 

applicable prudential regulator, or with 

regard to swaps defined in section 

1a(47)(A)(v) of the Act, the Commission, 

the Securities and Exchange 

Commission, and any applicable 

prudential regulator, of any swap 

valuation dispute in excess of 

$20,000,000 (or its equivalent in any 

other currency) if not resolved within: 

(1) Three (3) business days, if the 

dispute is with a counterparty that is a 

swap dealer or major swap participant; 

or 

(2) Five (5) business days, if the 

dispute is with a counterparty that is 

not a swap dealer or major swap 

participant. 

(d) Reconciliation of cleared swaps. 

Nothing in this section shall apply to a 

swap that is cleared by a derivatives 

clearing organization. 

(e) Recordkeeping. A record of each 

swap portfolio reconciliation consistent 

with § 23.202(a)(3)(iii) shall be 

maintained in accordance with § 23.203. 

§ 23.503 Portfolio compression. 

(a) Portfolio compression with swap 

dealers and major swap participants. 

(1) Bilateral offset. Each swap dealer 

and major swap participant shall 

establish, maintain, and follow written 

policies and procedures for terminating 

each fully offsetting swap between a 

swap dealer or major swap participant 

and another swap dealer or major swap 

participant in a timely fashion, when 

appropriate. 

(2) Bilateral compression. Each swap 

dealer and major swap participant shall 

establish, maintain, and follow written 

policies and procedures for periodically 

engaging in bilateral portfolio 

compression exercises, when 

appropriate, with each counterparty that 

is also a swap dealer or major swap 

participant. 

(3) Multilateral compression. Each 

swap dealer and major swap participant 

shall establish, maintain, and follow 

written policies and procedures for 

periodically engaging in multilateral 

portfolio compression exercises, when 

appropriate, with each counterparty that 

is also a swap dealer or major swap 

participant. Such policies and 

procedures shall include: 

(i) Policies and procedures for 

participation in all multilateral portfolio 

compression exercises required by 

Commission regulation or order; and 

(ii) Evaluation of multilateral portfolio 

compression exercises that are initiated, 

offered, or sponsored by any third party. 

(b) Portfolio compression with 

counterparties other than swap dealers 

and major swap participants. Each swap 

dealer and major swap participant shall 

establish, maintain, and follow written 

policies and procedures for periodically 

terminating fully offsetting swaps and 

for engaging in portfolio compression 

exercises with respect to swaps in 

which its counterparty is an entity other 

than a swap dealer or major swap 

participant, to the extent requested by 

any such counterparty. 

(c) Portfolio compression of cleared 

swaps. Nothing in this section shall 

apply to a swap that is cleared by a 

derivatives clearing organization. 

(d) Recordkeeping. (1) Each swap 

dealer and major swap participant shall 

make and maintain a complete and 

accurate record of each bilateral offset 

and each bilateral or multilateral 

portfolio compression exercise in which 

it participates. 

(2) All records required to be 

maintained pursuant to this section 

shall be maintained in accordance with 

§ 23.203 and shall be made available 

promptly upon request to any 

representative of the Commission or any 

applicable prudential regulator, or with 

regard to swaps defined in section 

1a(47)(A)(v) of the Act, to any 

representative of the Commission, the 

Securities and Exchange Commission, 

or any applicable prudential regulator. 

§ 23.504 Swap trading relationship 

documentation. 

(a) (1) Applicability. The requirements 

of this section shall not apply to: 

(i) Swaps executed prior to the date 

on which a swap dealer or major swap 

participant is required to be in 

compliance with this section; 

(ii) Swaps executed on a board of 

trade designated as a contract market 

under section 5 of the Act or to swaps 

executed anonymously on a swap 

execution facility under section 5h of 

the Act, provided that such swaps are 

cleared by a derivatives clearing 

organization and all terms of the swaps 

conform to the rules of the derivatives 

clearing organization and § 39.12(b)(6) 

of this chapter; and 

(iii) Swaps cleared by a derivatives 

clearing organization. 

(2) Policies and procedures. Each 

swap dealer and major swap participant 

shall establish, maintain, and follow 

written policies and procedures 

reasonably designed to ensure that the 

swap dealer or major swap participant 

executes written swap trading 

relationship documentation with its 

counterparty that complies with the 

requirements of this section. The 

policies and procedures shall be 

approved in writing by senior 

management of the swap dealer and 

major swap participant, and a record of 

the approval shall be retained. Other 

than confirmations of swap transactions 

under § 23.501, the swap trading 

relationship documentation shall be 

executed prior to or contemporaneously 

with entering into a swap transaction 

with any counterparty. 

(b) Swap trading relationship 

documentation. (1) The swap trading 

relationship documentation shall be in 

writing and shall include all terms 

governing the trading relationship 

between the swap dealer or major swap 

participant and its counterparty, 


sroberts on DSK5SPTVN1PROD with RULES
55964 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

including, without limitation, terms 

addressing payment obligations, netting 

of payments, events of default or other 

termination events, calculation and 

netting of obligations upon termination, 

transfer of rights and obligations, 

governing law, valuation, and dispute 

resolution. 

(2) The swap trading relationship 

documentation shall include all 

confirmations of swap transactions 

under § 23.501. 

(3) The swap trading relationship 

documentation shall include credit 

support arrangements, which shall 

contain, in accordance with applicable 

requirements under Commission 

regulations or regulations adopted by 

prudential regulators and without 

limitation, the following: 

(i) Initial and variation margin 

requirements, if any; 

(ii) Types of assets that may be used 

as margin and asset valuation haircuts, 

if any; 

(iii) Investment and rehypothecation 

terms for assets used as margin for 

uncleared swaps, if any; and 

(iv) Custodial arrangements for 

margin assets, including whether 

margin assets are to be segregated with 

an independent third party, in 

accordance with § 23.701(e), if any. 

(4) (i) The swap trading relationship 

documentation between swap dealers, 

between major swap participants, 

between a swap dealer and major swap 

participant, between a swap dealer or 

major swap participant and a financial 

entity, and, if requested by any other 

counterparty, between a swap dealer or 

major swap participant and such 

counterparty, shall include written 

documentation in which the parties 

agree on the process, which may 

include any agreed upon methods, 

procedures, rules, and inputs, for 

determining the value of each swap at 

any time from execution to the 

termination, maturity, or expiration of 

such swap for the purposes of 

complying with the margin 

requirements under section 4s(e) of the 

Act and regulations under this part, and 

the risk management requirements 

under section 4s(j) of the Act and 

regulations under this part. To the 

maximum extent practicable, the 

valuation of each swap shall be based 

on recently-executed transactions, 

valuations provided by independent 

third parties, or other objective criteria. 

(ii) Such documentation shall include 

either: 

(A) Alternative methods for 

determining the value of the swap for 

the purposes of complying with this 

paragraph in the event of the 

unavailability or other failure of any 

input required to value the swap for 

such purposes; or 

(B) A valuation dispute resolution 

process by which the value of the swap 

shall be determined for the purposes of 

complying with this paragraph (b)(4). 

(iii) A swap dealer or major swap 

participant is not required to disclose to 

the counterparty confidential, 

proprietary information about any 

model it may use to value a swap. 

(iv) The parties may agree on changes 

or procedures for modifying or 

amending the documentation required 

by this paragraph at any time. 

(5) The swap trading relationship 

documentation of a swap dealer or 

major swap participant shall include the 

following: 

(i) A statement of whether the swap 

dealer or major swap participant is an 

insured depository institution (as 

defined in 12 U.S.C. 1813) or a financial 

company (as defined in section 

201(a)(11) of the Dodd-Frank Act, 12 

U.S.C. 5381(a)(11)); 

(ii) A statement of whether the 

counterparty is an insured depository 

institution or financial company; 

(iii) A statement that in the event 

either the swap dealer or major swap 

participant or its counterparty is a 

covered financial company (as defined 

in section 201(a)(8) of the Dodd-Frank 

Wall Street Reform and Consumer 

Protection Act, 12 U.S.C. 5381(a)(8)) or 

an insured depository institution for 

which the Federal Deposit Insurance 

Corporation (FDIC) has been appointed 

as a receiver (the ‘‘covered party’’), 

certain limitations under Title II of the 

Dodd-Frank Act or the Federal Deposit 

Insurance Act may apply to the right of 

the non-covered party to terminate, 

liquidate, or net any swap by reason of 

the appointment of the FDIC as receiver, 

notwithstanding the agreement of the 

parties in the swap trading relationship 

documentation, and that the FDIC may 

have certain rights to transfer swaps of 

the covered party under section 

210(c)(9)(A) of the Dodd-Frank Wall 

Street Reform and Consumer Protection 

Act, 12 U.S.C. 5390(c)(9)(A), or 12 

U.S.C. 1821(e)(9)(A); and 

(iv) An agreement between the swap 

dealer or major swap participant and its 

counterparty to provide notice if either 

it or its counterparty becomes or ceases 

to be an insured depository institution 

or a financial company. 

(6) The swap trading relationship 

documentation of each swap dealer and 

major swap participant shall contain a 

notice that, upon acceptance of a swap 

by a derivatives clearing organization: 

(i) The original swap is extinguished; 

(ii) The original swap is replaced by 

equal and opposite swaps with the 

derivatives clearing organization; and 

(iii) All terms of the swap shall 

conform to the product specifications of 

the cleared swap established under the 

derivatives clearing organization’s rules. 

(c) Audit of swap trading relationship 

documentation. Each swap dealer and 

major swap participant shall have an 

independent internal or external auditor 

conduct periodic audits sufficient to 

identify any material weakness in its 

documentation policies and procedures 

required by this section and 

Commission regulations. A record of the 

results of each audit shall be retained. 

(d) Recordkeeping. Each swap dealer 

and major swap participant shall 

maintain all documents required to be 

created pursuant to this section in 

accordance with § 23.203 and shall 

make them available promptly upon 

request to any representative of the 

Commission or any applicable 

prudential regulator, or with regard to 

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

the Act, to any representative of the 

Commission, the Securities and 

Exchange Commission, or any 

applicable prudential regulator. 

§ 23.505 End user exception 

documentation. 

(a) For swaps excepted from a 

mandatory clearing requirement. Each 

swap dealer and major swap participant 

shall obtain documentation sufficient to 

provide a reasonable basis on which to 

believe that its counterparty meets the 

statutory conditions required for an 

exception from a mandatory clearing 

requirement, as defined in section 2h(7) 

of the Act and § 39.6 of this chapter. 

Such documentation shall include: 

(1) The identity of the counterparty; 

(2) That the counterparty has elected 

not to clear a particular swap under 

section 2h(7) of the Act and § 39.6 of 

this chapter; 

(3) That the counterparty is a nonfinancial entity, as defined in section 

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

(4) That the counterparty is hedging 

or mitigating a commercial risk; and 

(5) That the counterparty generally 

meets its financial obligations 

associated with non-cleared swaps. 

Provided, that a swap dealer or major 

swap participant need not obtain 

documentation of paragraphs (a)(3), (4), 

or (5) of this section if it obtains 

documentation that its counterparty has 

reported the information listed in 

§ 39.6(b)(3) in accordance with 

§ 39.6(b)(4) of this chapter. 

(b) Recordkeeping. Each swap dealer 

and major swap participant shall 

maintain all documents required to be 


sroberts on DSK5SPTVN1PROD with RULES
Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 55965 

152See infra above. 

153See Testimony Before the Financial Crisis 

Inquiry Commission, including AIG/Goldman 

Sachs Collateral Call Timeline, available at http:// 

fcic-static.law.stanford.edu/cdn_media/fcictestimony/2010-0701-AIG-Goldman-supportingdocs.pdf (timeline documenting valuation disputes 

and collateral calls); Testimony of Joseph Cassano, 

available at http://fcic-static.law.stanford.edu/cdn_

media/fcic-testimony/2010-0630-Cassano.pdf; and 

AIG Statement Summary, available at http://fcicstatic.law.stanford.edu/cdn_media/fcic-testimony/

2010-0630-AIG-Statement-Summary.pdf. 154Financial Crisis Inquiry Commission, ‘‘The 

Financial Crisis Inquiry Report: Final Report of the 

National Commission on the Causes of the 

Financial and Economic Crisis in the United 

States,’’ Jan. 2011, at 353, available at http://www.

gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf 

[hereinafter the FCIC Report. 155Pub. L. 111 (2010). CEA section 4s(i) states 

that each registered swap dealer and major swap 

participant shall conform with such standards as 

may be prescribed by the Commission by rule or 

regulation that relate to timely and accurate 

confirmation, processing, netting, documentation, 

and valuation of all swaps. 

156See, specifically 17 CFR 23.431(a)(3)(i) 

requiring SDs and MSPs to disclose ‘‘the price of 

the swap and the mid-market mark of the swap.’’ 

157CEA section 4s(i). 

obtained pursuant to this section in 

accordance with § 23.203 and shall 

make them available promptly upon 

request to any representative of the 

Commission or any applicable 

prudential regulator, or with regard to 

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

the Act, to any representative of the 

Commission, the Securities and 

Exchange Commission, or any 

applicable prudential regulator. 

Issued in Washington, DC, on August 24, 

2012, by the Commission. 

Sauntia S. Warfield, 

Assistant Secretary of the Commission. 

Appendices to Confirmation, Portfolio 

Reconciliation, Portfolio Compression, 

and Swap Trading Relationship 

Documentation Requirements for Swap 

Dealers and Major Swap Participants— 

Commission Voting Summary and 

Statements of Commissioners 

NOTE: The following appendices will not 

appear in the Code of Federal Regulations. 

Appendix 1—Commission Voting 

Summary 

On this matter, Chairman Gensler and 

Commissioners Sommers, Chilton, O’Malia 

and Wetjen voted in the affirmative; no 

Commissioner voted in the negative. 

Appendix 2—Statement of Chairman 

Gary Gensler 

I support the final rule implementing 

Congress’ direction that the Commission 

adopt rules for ‘‘timely and accurate 

confirmation, processing, netting, 

documentation, and valuation of all swaps.’’ 

This direction was included in the swaps 

market reform provisions of the Dodd-Frank 

Wall Street Reform and Consumer Protection 

Act (Dodd-Frank Act). 

Each of these requirements promotes 

crucial back office standards that will reduce 

risk and increase efficiency in the swaps 

market. These final rules are critical to the 

risk management of swap dealers and major 

swap participants and lowering their risk to 

the public. 

The rules establish procedures to promote 

legal certainty by requiring timely 

confirmation of all swap transactions, setting 

forth documentation requirements for 

bilateral swap transactions, and requiring 

timely resolutions of valuation disputes. In 

addition, the rules enhance understanding of 

one counterparty’s risk exposure to another, 

and promote sound risk management through 

regular reconciliation and compression of 

swap portfolios. 

The 2008 financial crisis brought to light 

how large financial institutions, including 

AIG, had valuation disputes and other 

problems regarding documentation 

standards. These rules will directly address 

many of those issues, highlighting issues for 

senior management and regulators at an 

earlier stage. 

The final rule builds upon extensive work 

by the Federal Reserve Bank of New York 

(FRBNY) to improve standards in the back 

offices of large financial institutions dealing 

in swaps. Beginning in 2005, the FRBNY, 

along with U.S. and global prudential 

authorities, undertook a supervisory effort to 

enhance operational efficiency and lower risk 

in the swaps market by increasing 

automation in swaps processing, improving 

documentation, and promoting the timely 

confirmation of trades. 

CFTC staff also consulted with other U.S. 

and foreign financial regulators, and 

participated in numerous meetings with 

market participants. CFTC staff worked to 

address the more than 60 public comment 

letters responding to the three proposed rules 

comprising this final rule. 

Appendix 3—Statement of 

Commissioner Bart Chilton 

I support this second package of internal 

business conduct standard final rules. These 

rules establish a set of prudent 

documentation standards for registered swap 

dealers (SDs) and major swap participants 

(MSPs) while aiming to minimize the 

burdens on non-SDs and non-MSPs. Vibrant 

and liquid financial markets are necessary for 

economic prosperity. As shown by the 2007– 

2009 financial crisis, that prosperity itself is 

gravely threatened when the rules governing 

financial markets fail to curb the build-up of 

systemic risk. I am pleased that the preamble 

introducing these rules appropriately refers 

to the tremendous cost of the financial crisis; 

it is obvious that not implementing strong 

regulations effectuating the intent of the 

Dodd-Frank Act, including these final rules, 

would result in social costs to the American 

taxpayer and consumer.152 In addition, I note 

that there are enormous and ongoing social 

costs that taxed our economy as a result of 

the reckless practices that became prevalent 

in the years before the financial crisis. 

The documentation and conduct standards 

set forth in this release are designed to, most 

importantly in my opinion, reduce valuation 

disputes: Disputes between parties about the 

value of a swap or portfolio of swaps. 

Valuation disputes can delay the exchange of 

collateral. The failure to exchange collateral 

in a timely manner can have disastrous 

impacts on a firm’s ability to manage its risk 

and allocate capital efficiently. A large, 

interconnected firm’s inability to manage its 

risk and to properly allocate capital can 

contribute to the generation of systemic risk. 

All of these steps were vividly illustrated 

during the recent financial crisis. 

American International Group’s (AIG) 

inability to value its portfolio accurately and 

agree on valuations and collateral exchanges 

with its counterparties posed a serious 

problem for AIG and its counterparties 

during the financial crisis.153 According to 

the Financial Crisis Inquiry Commission 

Report: 

The OTC derivatives market’s lack of 

transparency and of effective price discovery 

exacerbated the collateral disputes of AIG 

and Goldman Sachs and similar disputes 

between other derivatives counterparties.154

It is with the financial crisis in mind that 

I interpret the Commission’s authority 

generally and more specifically here, under 

section 731 of the Dodd-Frank Act which 

added new section 4s(i) to the Commodity 

Exchange Act (CEA).155 The portfolio 

reconciliation rules in section 23.502 will 

ensure that SDs/MSPs have portfolio 

valuations consistent with those of their 

counterparties. The portfolio compression 

rules in section 23.503 will reduce 

operational risks. The swap trading 

relationship documentation requirements 

will 23.504 will ensure that documentation 

practices in the swaps market cover a number 

of key terms. The documentation of these 

terms will give counterparties greater 

certainty as to their legal rights and 

responsibilities. These final rules, taken in 

conjunction with the Commission’s other 

Dodd-Frank Act-related regulations, 

including part 43 regulations on real-time 

reporting and subpart H of part 23 on 

Business Conduct Standards for Swap 

Dealers and Major Swap Participants with 

Counterparties 156 will contribute 

substantially to encouraging early and 

effective dispute resolution and will ensure 

the ‘‘timely and accurate confirmation, 

processing, netting, documentation, and 

valuation of all swaps.’’ 157

While these rules represent considerable 

progress, I believe it should not be viewed in 

a vacuum and that the Commission should 

respond nimbly in responses to changes in 

the market that could frustrate the underlying 

purpose of these final rules (and all other 

Commission rules for that matter). 

Notwithstanding the progress the 

Commission has made, I remain concerned 

that are still a number of areas that this final 

rule touches upon that remain areas of 

potential future concern: 

1. Dispute resolution and the requirement 

to document alternative methods for 

determining the value of a swap or a dispute 

resolution process under regulation 

23.504(b)(4)(iii). 

This provision, combined with the 

provision in regulation 23.503(c) to report 


sroberts on DSK5SPTVN1PROD with RULES
55966 Federal Register / Vol. 77, No. 176 / Tuesday, September 11, 2012 / Rules and Regulations 

158See Better Markets comment letter. 

159 77 FR 9733 (Feb. 17, 2012). 160 ‘‘A swap dealer or major swap participant 

shall be required to notify the counterparty of the 

swap dealer or major swap participant at the 

beginning of a swap transaction that the 

counterparty has the right to require segregation of 

the funds or other property.’’ 

161This is because once the collateral is 

rehypothecated, then the posting party could lose 

their proprietary interest in the collateral and as a 

result in bankruptcy, such a party could fall into the 

category of unsecured creditors. This can delay or 

prevent recovery of collateral from a bankrupt 

counterparty. 

162 IMF researchers recently estimated that offbalance sheet funding for dealers from 

rehypothecation amounted to $4.5 trillion during 

November 2007 and that it contributed substantially 

to the size of the shadow banking system. See, The 

(sizeable) Role of Rehypothecation in the Shadow 

Banking System, Manmohan Singh and James 

Aitken, IMF Working Paper, July 2010, available at 

http://www.imf.org/external/pubs/ft/wp/2010/

wp10172.pdf. 

‘‘any valuation dispute in excess of 

$20,000,000’’ within one business day if the 

dispute is with another SD/MSP or five 

business days for non-SDs/MSPs, should 

encourage the resolution of disputes. These 

regulations are buttressed by efforts being 

made by certain industry organizations. I 

encourage the Commission to remain vigilant 

in this area and to monitor the disputes 

reported to the Commission and to engage 

with the public to determine whether these 

regulations have their intended effect. 

2. The implied cost of credit and the 

requirement to document credit support 

arrangements under regulation 23.504(b)(3). 

I am concerned that these rules do not 

expressly require SDs and MSPs to document 

the cost of credit if such costs are a factor in 

the price a SD or MSP charges a 

counterparty. While this issue has been 

discussed since the earliest days of the 

negotiations and planning surrounding the 

drafting of the Dodd-Frank Act—and many 

market participants acknowledged that added 

costs would be attendant to engaging in noncleared transactions—the Commission could 

provide, in this rulemaking, an additional 

level of transparency to transactions 

involving creditworthiness considerations.158

I believe that requiring the documentation of 

the embedded cost of credit as a transaction 

fee or credit premium would have deter the 

practice of charging customers a price on a 

swap that depends on creditworthiness. My 

concern is mitigated somewhat by regulation 

23.431(d)(2) (a provision finalized in a 

previous rulemaking) which requires that 

SDs and MSPs provide their non-SD/MSP 

counterparties ‘‘with a daily mark, which 

shall be the mid-market mark of the 

swap.’’ 159 Such a provision would assist an 

end-user to infer the embedded cost of credit 

they were charged by their SD or MSP 

counterparty. Armed with this information, I 

encourage market participants to seek 

documentation of the embedded cost of 

credit as a transaction fee or credit premium. 

As the Commission’s regulations become 

effective, I invite the public to alert the 

Commission if the practice of charging a 

credit fee in the price (i.e., an embedded cost 

of credit) for a swap becomes problematic by, 

for example, diminishing the price discovery 

utility of real-time data published to the 

public under part 43 of the Commission’s 

rules. 

3. Rehypothecation of uncleared swaps 

collateral and the requirement to document 

rehypothecation terms for assets used as 

margin for uncleared swaps under regulation 

23.504(b)(3)(iii). 

This requirement is consistent with section 

724(c) of the Dodd-Frank Act (adding section 

4s(l)(1)(A) to the CEA) and is a welcome 

inclusion in these rules.160 Rehypothecation 

occurs when a person uses assets held as 

collateral for one counterparty in transactions 

with another counterparty. This practice 

contributed to the financial crisis in a 

number of ways, including: (1) 

Rehypothecated collateral was particularly 

difficult to recover in bankruptcy 161 and (2) 

rehypothecation increases leverage in the 

financial system.162 While many buy-side 

firms are learning from the financial crisis 

and requesting their collateral to be held in 

segregated accounts, the potential for a dealer 

default that could affect rehypothecated 

collateral still exists. In light of recent events, 

the Commission and the public should keep 

a watchful eye on the risks in this area. 

[FR Doc. 2012–21414 Filed 9–10–12; 8:45 am] 

BILLING CODE 6351–01–P 


sroberts on DSK5SPTVN1PROD with RULES