Confirmation, Portfolio Reconciliation, Portfolio Compression, and Swap Trading Relationship Documentation Requirements for Swap Dealers and Major Swap Participants

Federal RegisterSep 11, 2012

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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

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 bilaterally-traded, 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.

Commission regulations referred to herein are found at 17 CFR Ch. 1.

II. Comments on the Notices of Proposed Rulemaking

The final rules adopted herein were proposed in three separate notices of proposed rulemaking.

Each proposed rulemaking was subject to an initial 60-day public comment period and a re-opened comment period of 30 days.

The Commission received a total of approximately 62 comment letters directed specifically at the proposed rules.

The Commission considered each of these comments in formulating the final regulations.

See

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)).

See

76 FR 25274 (May 4, 2011) (extending or re-opening comment periods for multiple Dodd-Frank proposed rulemakings).

Comment files for each proposed rulemaking can be found on the Commission Web site,

www.cftc.gov.

The 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).

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.

See

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).

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)

commented that many of the specific provisions in the proposed rules are not required by section 731 of the Dodd-Frank 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 Dodd-Frank 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

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 dealer-dominated 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.

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.

The International Swaps and Derivatives Association (ISDA) is a trade association for the OTC derivatives industry (

http://www.isda.org

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,

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

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 End-Users 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

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 End-Users 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 time-sensitive 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 even-handed 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

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.

See

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 mid-market 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)).

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.

See

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).

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

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

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.

To 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.

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 non-bank SDs and MSPs must calculate a hypothetical variation margin requirement for each uncleared swap for risk management purposes under proposed § 23.154(b)(6).

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.

SDs 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).

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.

However, the final rule reflects the recognition that accurate and

reliable valuations are the foundation of margining and risk management.

Under § 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.

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 mid-market mark of a swap provided by an SD or MSP to its counterparty.

The mid-market mark of the swap represents an objective value that provides counterparties with a baseline to assess swap valuations for other purposes.

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.

See

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.

See

§ 23.431(d). SDs and MSPs must provide a daily mark for uncleared swaps that is the mid-market mark of the swap which does not include amounts for profit, credit reserve, hedging, funding, liquidity, or any other costs or adjustments.

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.

This 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.

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.

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).

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.

Compare 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.”)

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 non-covered 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

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 Dodd-Frank 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 Dodd-Frank 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 Dodd-Frank 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 Dodd-Frank 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

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.

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.

See

End-User Exception to the Clearing Requirement for Swaps, 77 FR 42560, 42590 (July 19, 2012).

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 End-Users 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 non-cleared 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 anti-competitive 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.

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.

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.

U.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.

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.

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.

See

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.

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.

See

G15 Industry Confirmation Data dated April 4, 2012 provided by ISDA, available at

www.cftc.gov.

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

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.

In addition, under the Swap Data Recordkeeping and Reporting rules, all terms agreed in a

confirmation must be reported to an SDR.

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.

See

17 CFR 45.1.

See

17 CFR 45.3.

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.

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.”

See e.g.,

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 76 FR 23732, 23744 (Apr. 28, 2011).

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 third-party 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

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;

(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:

• 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 Non-MSPs

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 non-registrant 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

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.

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 non-financial 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 cross-border 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.

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.

Compare 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.”).

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.

See

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).

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 phase-in schedule, policies and procedures reasonably designed to ensure that a confirmation is executed no later than the end of second business day after execution.

The Commission believes this change will afford SDs and MSPs an

extra business day to confirm their swap transactions with non-financial entities and is more consistent with the time periods suggested by commenters.

Compare 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.”).

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.

Compare 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.”)

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.

See

71 CFR 45.1, Swap Data Recordkeeping and Reporting, 77 FR 2136, 2197 (Jan. 13, 2012).

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.

See

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 post-execution 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.”).

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

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 Dodd-Frank 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.”

See

Confirmation NPRM at 81520.

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.

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.

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.

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).

See

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).

See

Core Principles and Other Requirements for Designated Contract Markets, 77 FR 36612, 36705 (June 19, 2012).

See

Core Principles and Other Requirements for Swap Execution Facilities, 76 FR 1214, 1240 (Jan. 7, 2011).

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

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 life-cycle 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 an

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