Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and Duties Rules; Futures Commission Merchant and Introducing Broker Conflicts of Interest Rules; and Chief Compliance Officer Rules for Swap Dealers, Major Swap Participants, and Futures Commission Merchants

Federal RegisterApr 3, 2012

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 3, and 23

RIN 3038-AC96

Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and Duties Rules; Futures Commission Merchant and Introducing Broker Conflicts of Interest Rules; and Chief Compliance Officer Rules for Swap Dealers, Major Swap Participants, and Futures Commission Merchants

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). These regulations set forth reporting and recordkeeping requirements and daily trading records requirements for swap dealers (SDs) and major swap participants (MSPs). These regulations also set forth certain duties imposed upon SDs and MSPs registered with the Commission with regard to: Risk management procedures; monitoring of trading to prevent violations of applicable position limits; diligent supervision; business continuity and disaster recovery; disclosure and the ability of regulators to obtain general information; and antitrust considerations. In addition, these regulations establish conflicts-of-interest requirements for SDs, MSPs, futures commission merchants (FCMs), and introducing brokers (IBs) with regard to firewalls between research and trading and between clearing and trading. Finally, these regulations also require each FCM, SD, and MSP to designate a chief compliance officer, prescribe qualifications and duties of the chief compliance officer, and require that the chief compliance officer prepare, certify, and furnish to the Commission an annual report containing an assessment of the registrant's compliance activities.

DATES:

The rules are effective June 4, 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,

Division of Swap Dealer and Intermediary Oversight, Ward P. Griffin, Counsel, 202-418-5425,

wgriffin@cftc.gov,

Office of the General Counsel, 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. Reporting, Recordkeeping, and Daily Trading Records Requirements for SDs and MSPs

C. General Records Requirement—§ 23.201

D. Daily Trading Records—§ 23.202

E. Records; Retention and Inspection—§ 23.203

F. Duties of Swap Dealers and Major Swap Participants

G. Risk Management Program for SDs and MSPs—§ 23.600

H. Monitoring of Position Limits—§ 23.601

I. Diligent Supervision—§ 23.602

J. Business Continuity and Disaster Recovery—§ 23.603

K. General Information: Availability for Disclosure and Inspection—§ 23.606

L. Antitrust Considerations—§ 23.607

M. Conflicts of Interest Policies and Procedures by SDs, MSPs, FCMs, and IBs—§ 23.605, § 1.71

N. Designation of a Chief Compliance Officer; Required Compliance Policies; and Annual Report of an FCM, SD, or MSP

III. Effective Dates and Compliance Dates

A. Comments Regarding Compliance Dates

B. Compliance Dates

IV. Cost Benefit Considerations

A. Introduction

B. General Considerations

C. Comments Regarding the Scope of the Proposed Rules

D. Recordkeeping, Reporting, and Daily Trading Records Requirements for SDs and MSPs

E. Duties and Risk Management Requirements of SDs and MSPs

F. Conflicts-of-Interest Policies and Procedures for SDs, MSPs, FCMs, and IBs

G. Designation of a Chief Compliance Officer, Required Compliance Policies, and Annual Report of an FCM, SD, or MSP

H. Conclusion

V. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

I. Background

The Commission is hereby adopting § 23.200 through § 23.205

setting forth reporting and recordkeeping requirements and daily trading records requirements for SDs and MSPs, as required under sections 4s(f) and 4s(g) of the Commodity Exchange Act (CEA); § 23.600 through § 23.607 setting forth certain duties imposed upon SDs and MSPs with regard to: (1) Risk management procedures; (2) monitoring of trading to prevent violations of applicable position limits; (3) diligent supervision; (4) business continuity and disaster recovery; (5) conflicts of interest policies and procedures; (6) disclosure and the ability of regulators to obtain general information; and (7) antitrust considerations, as required under section 4s(j) of the CEA; § 3.3 requiring FCMs, SDs, and MSPs to designate a chief compliance officer, prescribing qualifications and duties of the chief compliance officer, and requiring the chief compliance officer to prepare, certify, and furnish to the Commission an annual report containing an assessment of the registrant's compliance activities, as required under sections 4d(d) and 4s(k) of the CEA; and § 1.71 setting forth certain duties imposed on FCMs and IBs with regard to implementing conflicts of interest policies and procedures, as required under section 4d(c) of the CEA; as well as amendments to § 3.1 to add chief compliance officers to the definition of “principal” and to add a new definition of “board of directors.”

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 five 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 114 comment letters directed specifically at the proposed rules.

The Commission considered

each of these comments in formulating the final regulations.

See

75 FR 76666 (Dec. 9, 2010) (Reporting, Recordkeeping, and Daily Trading Records Requirements for Swap Dealers and Major Swap Participants (Recordkeeping NPRM)); 75 FR 71397 (Nov. 23, 2010) (Regulations Establishing and Governing the Duties of Swap Dealers and Major Swap Participants (Duties NPRM)); 75 FR 70152 (Nov. 17, 2010) (Implementation of Conflicts of Interest Policies and Procedures by Futures Commission Merchants and Introducing Brokers (FCM/IB Conflicts NPRM)); 75 FR 71391 (Nov. 23, 2010) (Implementation of Conflicts of Interest Policies and Procedures by Swap Dealers and Major Swap Participants (SD/MSP Conflicts NPRM)); and 75 FR 70881 (Nov. 19, 2010) (Designation of a Chief Compliance Officer; Required Compliance Policies; and Annual Report of a Futures Commission Merchant, Swap Dealer, or Major Swap Participant (CCO 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 business conduct standards for security-based swap dealers and major security-based swap participants.

See

76 FR 42396 (July 18, 2011).

The Chairman and Commissioners, as well as Commission staff, participated in numerous meetings with representatives of potential SDs and MSPs, existing FCMs, 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 intends to work with the Federal Deposit Insurance Corporation (FDIC) to establish appropriate information-sharing arrangements to ensure that the FDIC has the information it needs to exercise authority under Title II of the Dodd-Frank Act or the Federal Deposit Insurance Act with regard to any SD or MSP registered with the Commission.

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.

A. Regulatory Structure

The proposed regulations did not differentiate between SDs and MSPs that may be a division of a larger entity or institution, but not a separate legal entity. The proposed regulations also did not differentiate between SDs and MSPs, but, rather, applied identical rules to both types of entities. The proposals, however, solicited comments on whether certain provisions of the proposed regulations should be modified or adjusted to reflect the differences among SDs or MSPs. In addition, the proposed regulations tracked the scope of the statutory text, and did not, by their terms, apply only to the swap activities of SDs and MSPs.

In its comment letter, Cargill, Incorporated (Cargill) argued that the proposed rules should recognize Congressional intent to permit a business with a swap dealing division to be subject to SD regulation only for the activities of that division. Cargill recommended that the Commission make clear that the Commission's regulations only apply to the swap dealing business of an SD that is a division of a larger company, and not to the other business activities of the company.

MetLife, Inc. (MetLife), the Managed Funds Association (MFA), BlackRock, and the Asset Management Group of the Securities Industry and Financial Markets Association (AMG) each argued that the Dodd-Frank Act does not require that the Commission to apply the same rules to MSPs as those applied to SDs and that MSPs should not be subject to the same regulations as SDs because MSPs do not engage in market-making activities.

The Securities Industry and Financial Markets Association (SIFMA) and the Federal Home Loan Banks (FHLBs) each recommended that the Commission's regulations should allow registrants that are regulated by a prudential regulator to comply with the Commission's regulations on a substituted compliance basis by complying with comparable regulations of their prudential regulator.

In response to Cargill's comment, the Commission is including a new definition of “swaps activities” in the final regulations, as follows: “

Swaps activities

means a registrant's activities related to swaps and any product used to hedge such swaps, including, but not limited to, futures, options, other swaps or security-based swaps, debt or equity securities, foreign currency, physical commodities, and other derivatives.”

The Commission is using this term in the final regulations to (i) limit the scope of the risk management requirements in § 23.600 to only the swap activities of SDs and MSPs; (ii) define the extent of the recordkeeping requirement in § 23.201; and (iii) limit the scope of the duties and responsibilities of the chief compliance officer of an SD or MSP in § 3.3 to the swaps activities of SDs and MSPs.

In addition, the Commission anticipates that under its further definition of “swap dealer,” an SD that has applied for and received a limited purpose designation from the Commission will be subject to these regulations only for the categories or activities for which the limited purpose designation is granted.

The Commission is not modifying the regulations to differentiate between SDs and MSPs. The Commission observes that no provision of sections 4s(f), (g), (j), and (k) of the CEA, as added by the Dodd-Frank Act, differentiates between the duties and requirements of SDs and those of MSPs. The Commission thus has determined that the intent of sections 4s(f), (g), (j), and (k) is to apply the same requirements to MSPs and SDs, and the Commission is taking the same approach in the final regulations. The Commission believes that to the extent the final regulations are not applicable to an MSP's activities, the MSP is not burdened by being subject to the regulations.

The Commission has considered but rejected a substituted compliance regime with respect to the final rule for registrants subject to regulation by a prudential regulator. The Commission notes that section 4s(e) of the CEA grants prudential regulators exclusive authority to prescribe capital and margin requirements for SDs and MSPs that are banks, but does not extend such authority to any other part of section 4s. Because SDs and MSPs will be registrants of the Commission, the Commission has determined that its interest in ensuring that all registrants are subject to consistent regulation outweighs any burden that may be placed on registrants that are subject to regulation by a prudential regulator. However, the Commission observes that many of its final regulations are modeled on prudential regulations and supervision. Thus the two regimes would be broadly consistent.

B. Reporting, Recordkeeping, and Daily Trading Records Requirements for SDs and MSPs

As added by section 731 of the Dodd-Frank Act, sections 4s(f) and 4s(g) of the CEA established reporting and recordkeeping requirements and daily trading records requirements for SDs and MSPs.

Section 4s(f)(1) requires SDs and MSPs to “make such reports as are required by the Commission by rule or regulation regarding the transactions and positions and financial condition of the registered swap dealer or major swap participant.” In the Recordkeeping NPRM, the Commission proposed regulations, pursuant to sections 4s(f)(1)(B)(i) and (ii) of the CEA, prescribing the books and records requirements of “all activities related to the business of swap dealers or major swap participants,” regardless of whether or not the entity has a prudential regulator.

In addition, the Commission proposed regulations in the Recordkeeping NPRM pursuant to section 4s(g)(1) of the CEA, requiring that SDs and MSPs “maintain daily trading records of the swaps of the registered swap dealer and major swap participant and all related records (including related cash and forward transactions) and recorded

communications, including electronic mail, instant messages, and recordings of telephone calls.” The Commission notes that section 4s(g)(3) requires that daily trading records for each swap transaction be identifiable by counterparty, and section 4s(g)(4) specifies that SDs and MSPs maintain a “complete audit trail for conducting comprehensive and accurate trade reconstructions.” The Commission received 14 comment letters in response to the Recordkeeping NPRM and considered each in formulating the final rules.

C. General Records Requirement—§ 23.201

Proposed § 23.201 set forth the records that SDs and MSPs must maintain. The records required under the proposed rule included full and complete swap transaction information, including all documents on which swap information is originally recorded.

1. Additional Types of Records To Be Retained

In the Recordkeeping NPRM, the Commission requested comments regarding whether additional types of records other than those specified in the proposed rules should be required to be kept by SDs and MSPs. The Commission also requested comment regarding whether drafts of documents should be kept.

The Working Group of Commercial Energy Firms (The Working Group) commented that the current proposal is sufficient and any additional record retention requirements would be of little value to the Commission. Chris Barnard, however, recommended that drafts of documents should also be kept, arguing that the decision process leading up to a final document can be very informative. In order to regulate the use of high-frequency and algorithmic trading strategies, Better Markets, Inc. (Better Markets) recommended that the Commission require SDs and MSPs that employ high-frequency and algorithmic trading strategies to maintain records of each strategy employed including a description of the strategy and its objectives and the algorithms employed, and to maintain a record of every order, cancellation, and trade that occurs in the implementation of each strategy, indexed to the electronic record of the strategy description and properly time stamped.

Having considered these comments and the comments discussed below regarding specific recordkeeping requirements, the Commission has determined that the record retention requirements as proposed are sufficient and has not included any additional requirements in the final rules. With respect to Better Markets' comment, the Commission notes that pursuant to § 23.600(d)(9), as adopted in this release and discussed further below, SDs and MSPs are required to ensure that use of trading programs is subject to policies and procedures governing their use, supervision, maintenance, testing, and inspection, and that such policies and procedures are subject to a recordkeeping requirement pursuant to § 23.600(g).

2. Reliance on Records of Swap Data Repositories

The proposed regulations did not address whether an SD or MSP may rely on reporting a swap to a swap data repository (SDR) as a means of meeting their recordkeeping requirements. Proposed § 23.203(b)(2) required records of any swap to be kept for the life of the swap and for a period of five years following the termination, maturity, expiration, transfer, assignment, or novation date of the swap.

The International Swaps and Derivatives Association (ISDA) and SIFMA (together, ISDA & SIFMA) requested that the Commission clarify the extent to which SDs and MSPs may rely upon SDRs to retain records beyond the time periods that registrants currently retain such records. ISDA & SIFMA did not elaborate on the current retention periods for swaps records, nor did they explain how this approach would work in the absence of established SDRs for all types of swaps.

At this time, the Commission has determined not to permit SDs and MSPs to rely solely on SDRs to meet their recordkeeping obligations under the rules. The Commission believes that reliance on SDRs may be a cost-efficient alternative in the future, but such reliance would be premature at the present time. Additionally, the Commission believes that SDs and MSPs must maintain complete records of their swaps for the purposes of risk management. The data that is required to be reported to an SDR may not be sufficient for these purposes.

3. Transaction Records Maintained in a Form and Manner Identifiable and Searchable by Transaction and Counterparty—§§ 23.201(a)(1), 23.202(a), and 23.202(b)

Proposed § 23.201(a)(1) required SDs and MSPs to keep transaction records in a form identifiable and searchable by transaction and by counterparty. Proposed §§ 23.202(a) and 23.202(b) also required SDs and MSPs to keep daily trading records for each swap and any related cash or forward transaction as a separate electronic file identifiable and searchable by transaction and counterparty.

ISDA & SIFMA recommended that the decision whether to maintain each transaction record as a separate electronic file be left to the reporting counterparties. ISDA & SIFMA argued that SDs and MSPs routinely store data across a number of systems, and that aggregating transaction data from all systems into a single electronic file would require enormous investment across market participants and would require a substantial implementation period.

The Working Group argued that tying records of unfilled or cancelled orders, correspondence (e.g., voice records, email, and instant messages), journals, memoranda, and other records required by proposed § 23.201(a)(1) to each individual transaction in a manner that is identifiable and searchable by transaction would create an enormous technical burden, likely requiring the review, sorting, and assignment of such data to each transaction manually by individual employees. The Working Group recommended therefore that the Commission allow SDs and MSPs to maintain records of the required information in the form and manner currently employed by such firms, not in a single comprehensive file, if such records would be readily accessible and could be provided to the Commission within a reasonable amount of time following a request.

The Commission agrees with the comments, in part, and is modifying the proposed rules to remove the provision in § 23.202(a) and § 23.202(b) that requires each transaction record to be maintained as a separate electronic file. The Commission believes that this modification will make the requirement less burdensome for SDs and MSPs because it will allow such registrants to maintain searchable databases of the required records without the added cost and time needed to compile records into individual electronic files. The Commission notes that the rule, as modified, does not require the raw data in such databases to be tagged with transaction and counterparty identifiers so long as the SD or MSP can readily access and identify records pertaining to a transaction or counterparty by running a search on the raw data. In response to The Working Group's comments, the Commission confirms that swap records can be maintained under current market practice so long as the records are readily accessible, are identifiable and searchable by transaction and counterparty, and otherwise meet the

requirements of § 1.31, as required under § 23.203.

However, the Commission observes that section 4s(g)(3) of the CEA requires registrants to “maintain daily trading records for each counterparty in a manner and form that is identifiable with each swap transaction.” In accordance with this statutory provision, the rules clarify that such trading records should be searchable by transaction and by counterparty. Maintaining records in this manner may prove costly for some SDs and MSPs, but this approach is required by statute and necessary for accurate audit trail construction, which is paramount for successful enforcement of trade practice cases.

4. Business Records—§ 23.201(b)

As proposed, § 23.201(b) required SDs and MSPs to keep full, complete, and systematic business records, including records related to corporate governance, financial records, complaints, and marketing and sales materials.

The Working Group acknowledged that market participants presently retain records that would qualify as business records under the proposal, although not in a single comprehensive file. The Working Group recommended that the Commission permit these records to be retained as they currently are in the normal course of business, as long as such records can be readily accessed and provided to the Commission upon request. For example, many entities retain financial records within their accounting departments, while marketing and sales materials would be retained separately within another division. The Working Group also recommended that the Commission clarify that when a subsidiary is determined to be an SD or MSP, but its parent company is not, business records should only be required to be retained for the subsidiary.

In response to The Working Group's comments, the Commission confirms that the rule does not require SDs and MSPs to keep the required business records in a single comprehensive file. So long as SDs and MSPs are keeping full, complete, and systematic business records that are available for inspection or disclosure, the requirements of § 23.201(b) would be met. The Commission also notes that the rule applies only to registered SDs and MSPs, and, therefore, the rules would not apply to the parent company of a registrant unless the parent company is also an SD or MSP.

5. Records of Complaints Received—§ 23.201(b)

Proposed § 23.201(b) required SDs and MSPs to retain a record of complaints received, certain identifying information about the complainant, and a record of the disposition of the complaint.

MFA commented that the requirement to retain a record of complaints is inappropriate for MSPs because, except in the event such entities are registered as commodity trading advisors or commodity pool operators: (a) Entities that may be classified as MSPs would not be members of NFA or similar organizations; and (b) the filing of such complaints against entities that may be classified as MSPs is neither customary nor consistent with such entities' activities in the market.

Having considered MFA's comment, the Commission is adopting the rule as proposed. MSPs are, by definition, market participants that have a substantial position in swaps, that have outstanding swaps that create substantial counterparty exposure that could have serious adverse effects on the financial stability of the U.S. financial markets, or that are highly leveraged. Consequently, the Commission believes it is possible that a record of complaints, or a pattern of complaints, made against an MSP could be of regulatory value to the Commission. The Commission also notes that pursuant to the Commission's MSP registration rule, each MSP registered with the Commission is also required to be a member of at least one registered self-regulatory organization (SRO).

See

17 CFR 170.16 Registration of Swap Dealers and Major Swap Participants, 77 FR 2613 (Jan. 19, 2012) (stating “Each person registered as a swap dealer or a major swap participant must become and remain a member of at least one futures association that is registered under section 17 of the Act and that provides for the membership therein of such swap dealer or major swap participant, as the case may be, unless no such futures association is so registered.”), available at

www.cftc.gov.

6. Records of Marketing and Sales Materials—§ 23.201(b)(4)

Proposed § 23.201(b)(4) required SDs and MSPs to retain copies of all marketing and sales presentations, advertisements, literature, and communications, and a record of the SD's or MSP's compliance with applicable Federal requirements, Commission regulations, and the rules of any SRO related to marketing and sales materials.

MFA commented that because MSPs are not market makers, they do not produce such materials for public dissemination. Therefore, MFA felt that the concerns about SD marketing and sales materials that necessitate the SDs' recordkeeping requirement are inapplicable to MSPs.

The Commission has decided not to remove MSPs from the relevant provisions of the rule because MSPs would need to comply with the recordkeeping requirement only to the extent that they produce such materials. To the extent that an MSP does not produce marketing or sales materials, the requirements of the rule would be inapplicable.

7. Records of Date and Time of Reports To Swap Data Repositories and Data Reported in Real-Time—§ 23.201(c) and § 23.201(d)

Proposed § 23.201(c) required SDs and MSPs to retain a record of the date and time the SD or MSP reported data or information to SDRs under proposed Part 45. Proposed § 23.201(d) required SDs and MSPs to retain a record of the date and time the SD or MSP reported information for purposes of real-time public reporting under proposed Part 43.

With regard to such records, The Working Group requested that the Commission clarify that the record of the date and time of reports to SDRs and for real-time public reporting be to the minute, and not to the second.

The proposed rule did not specify the form of the depiction of time in records of reports made under parts 43 or 45, other than to say that the record must include the “date and time.” The Commission confirms that SDs and MSPs may record time for the purpose of § 23.201 in their discretion, so long as they comply with any independent requirements under Parts 43 and 45.

8. Records of a “Rationale” for Certain Swap Determinations—§ 23.201(d)(2) & (3)

Proposed § 23.201(d)(2) and (3) required SDs and MSPs to retain a record of the rationale for reporting a less specific data field than is required under the proposed real-time public reporting requirements in part 43, and a record of the rationale for determining that a swap is a large notional swap as required under proposed part 43.

The Working Group requested clarification as to what the Commission is seeking with respect to a “rationale” for these scenarios. The Working Group questions what purpose this information would serve, or what benefit the Commission hopes to derive for purposes of carrying out its duties under the CEA.

The Commission has determined that any substantive recordkeeping requirements necessary for compliance with Part 43 will be taken up in that part and thus has deleted the proposed “rationale” requirements from § 23.201.

D. Daily Trading Records—§ 23.202

Section 4s(g)(1) of the CEA requires that SDs and MSPs maintain daily trading records of their swaps and “all related records (including related cash and forward transactions).” Section 4s(g)(1) also requires that SDs and MSPs maintain recorded communications, including electronic mail, instant messages, and recordings of telephone calls. Section 4s(g)(2) provides that the daily trading records shall include such information as the Commission shall require by rule or regulation. Proposed § 23.202 prescribed daily trading record requirements, which would include trade information related to pre-execution, execution, and post-execution data.

1. Records of Pre-Execution Trade Information—§ 23.202(a)(1)

Proposed § 23.202(a)(1) required SDs and MSPs to make and keep records of pre-execution trade information, including records of all oral and written communications concerning quotes, solicitations, bids, offers, instructions, trading, and prices that lead to the execution of a swap, however communicated.

The Air Transport Association of America, Inc. (ATA) commented that the current telephone recording systems in use by SDs and MSPs may not meet all of the proposed rule's requirements, and that implementing telephone recording systems that are compliant with the requirements would impose a significant additional cost. The ATA's members recognized that there may be benefits from the recording requirement, but they are uncertain that those benefits outweigh the costs of purchasing new, or upgrading existing, telephone phone recording and retrieval systems. The ATA is concerned that the cost of complying with all of the various rules proposed by the Commission will erect unnecessarily high barriers to entry for SDs, foreclosing all but the largest firms from acting as SDs.

MFA commented that it would be inappropriate to impose on MSPs the additional burden of maintaining a record of all oral communications made or received because the SDs with which MSPs enter into swaps would record such information. For the same reasons, MFA commented that the Commission should not require MSPs to create records of the date and time of quotations received or the date and time of execution of each swap and each related cash or forward transaction.

The Working Group argued that even if technology exists to record the required data in a format searchable by transaction and counterparty, it would not be possible to identify pre-execution data specified by the Commission as being applicable to a specific trade because traders and other commercial employees typically engage in ongoing dialogue with counterparties over an extended period of time and do not initiate communications specific to a single trade. The Working Group commented that it would be extremely difficult and time consuming to review manually each communication by a specific trader to determine which conversations or documents ultimately led to the execution of a particular swap and then assign that communication to a unified file.

ISDA & SIFMA asserted that where pre-execution records are maintained today they are captured prior to the execution of a swap and as such they are not linked to a trade. ISDA & SIFMA argued that while it may be possible potentially to search by counterparty with some investment in additional technology, it would not be possible to search by transaction because the infrastructure to link to a transaction is not in place today and the procedural and technical feasibility to do so has not been contemplated nor evaluated. ISDA & SIFMA strongly recommended that the Commission limit the rule to a description of data required as part of a trading record without dictating how such data should be stored and, in particular, that the Commission exclude oral communications from the electronic searchability requirement.

Having considered these comments, the Commission is modifying the proposed rule to remove the requirement that each transaction record be maintained as a separate electronic file, which should be less burdensome for SDs and MSPs because it will allow these registrants to maintain searchable databases of the required records without the added cost and time needed to compile the required records into individual electronic files. The Commission notes that section 4s(g)(3) of the CEA requires registrants to “maintain daily trading records for each counterparty in a manner and form that is identifiable with each swap transaction.” The rule as adopted clarifies that such counterparty records must be searchable by transaction and by counterparty. Maintaining records in this form may prove costly for some registrants, but such form is mandated by the CEA.

However, in light of commenters' concerns, the Commission is adopting § 23.206, which delegates to the Director of the Division of Swap Dealer and Intermediary Oversight the authority to establish an alternative compliance schedule for requirements of § 23.202 that are found to be technologically and economically impracticable for an SD or MSP affected by § 23.202. The purpose of § 23.206 is to facilitate the ability of the Commission to provide a technologically practicable compliance schedule for affected SDs or MSPs that seek to comply in good faith with the requirements of § 23.202.

In order to obtain relief under § 23.206, an affected SD or MSP must submit a request for relief to the Director of the Division of Swap Dealer and Intermediary Oversight. SDs and MSPs submitting requests for relief must specify the basis in fact supporting their claims that compliance with § 23.202 would be technologically or economically impracticable. Such a request may include a recitation of the specific costs and technical obstacles particular to the entity seeking relief and the efforts the entity intends to make in order to ensure compliance according to an alternative compliance schedule. Relief granted under § 23.206 shall not cause a registrant to be out of compliance or deemed in violation of any registration requirements.

Such requests for an alternative compliance schedule shall be acted upon by the Director of the Division of Swap Dealer and Intermediary Oversight or designees thereto within 30 days from the time such a request is received. If not acted upon within the 30 day period, such request will be deemed approved.

The Commission notes that some commenters to a proposed Commission rulemaking to amend § 1.35,

which would require voice recording for futures and swap trading by FCMs and other registrants, raised questions about statements made in the preamble of the Recordkeeping NPRM. In that preamble, the Commission stated that proposed § 23.202 “would not establish an affirmative new requirement to create recordings of all telephone conversations if the complete audit trail requirement can be met through other means, such as electronic messaging or trading.”

For avoidance of doubt, the Commission notes that the rule requires

a record of “all oral and written communications provided or received concerning quotes, solicitations, bids, offers, instructions, trading, and prices, that lead to the execution of a swap.” Thus, to the extent this pre-execution trade information does

not

include information communicated by telephone, the Commission confirms that an SD or MSP is under no obligation to create recordings of its telephone conversations. If, however, any of this pre-execution trade information is communicated by telephone, the SD or MSP must record such communications.

See

Comments to Adaptation of Commission Regulations to Accommodate Swaps, 76 FR 33066, 33088-89 (June 7, 2011), available on the Commission's Web site:

www.cftc.gov.

See

Recordkeeping NPRM, 75 FR at 76668.

With respect to MFA's comments, section 4s(g)(4) of the CEA applies to both SDs and MSPs. Consequently, the audit trail requirements of the proposed rules apply equally to both SDs and MSPs because it is necessary that all Commission registrants have complete and accurate daily trading records. Moreover, the Commission notes that MFA did not provide any factual support for its assertion that every swap entered by an MSP would have an SD as the counterparty.

2. Records of Source and Time of Quotations—§ 23.202(a)(1)(ii)

Proposed § 23.202(a)(1)(ii) required SDs and MSPs to make and keep a record of the date and time, using Coordinated Universal Time (UTC), by timestamp or other timing device, for each quotation provided to, or received from, a counterparty prior to execution of a swap.

The Working Group argued that the Commission should not require a timestamp for every quote given or received, as the timestamp is unnecessary, overly burdensome, and would not assist in trade reconstruction. Further, The Working Group argued that most entities do not currently capture or store this information, that it would be difficult to do so, particularly given that quotations may be developed by multiple sources, and retention of the time of quotations will add additional compliance costs on market participants. The Working Group also requested clarification as to the meaning of “reliable timing data for the initiation” of a transaction.

MFA commented that the Commission should not require MSPs to create records of the date and time of quotations received or the date and time of execution of each swap and each related cash or forward transaction. MFA argued that since SDs should keep such records in connection with their market-making activities, to require an MSP customer to maintain the same records would be duplicative and a significant and unnecessary burden on MSPs.

Having considered these comments, the Commission is adopting the rule as proposed. As noted above, the Commission observes that section 4s(g)(4) of the CEA requires both SDs and MSPs to maintain a complete audit trail for conducting comprehensive and accurate trade reconstructions. The Commission therefore believes that the audit trail requirements of the rule should apply to both SDs and MSPs because it is necessary that all Commission registrants have complete and accurate daily trading records. As explained above, no support has been offered for MFA's assertion that an SD will be the counterparty to every swap executed with an MSP. Additionally, a comprehensive and accurate trade reconstruction necessarily entails a reconstruction of the sequence of events leading up to a trade and that this sequence cannot be reconstructed accurately without reliable timing information. It is noteworthy that commenters were unable to provide any alternative to the timestamp requirement. Therefore, the Commission is retaining the timestamp requirement in the final rule.

With respect to The Working Group's concern regarding the “reliable timing data” requirement, the Commission confirms that the form of “reliable timing data” could be a timestamp, but the exact form is left to the discretion of the registrant.

3. Timestamp for Quotations Using Universal Coordinated Time (UTC)—§ 23.202(a)(1)(ii)

The proposed regulation required SDs and MSPs to record the time of each quotation provided to or received from a counterparty prior to execution using Universal Coordinated Time.

ISDA & SIFMA commented that the value derived by moving the industry to UTC appears minimal when compared to the costs involved. ISDA & SIFMA provided the Commission with no quantitative data regarding these purported additional costs.

Having considered ISDA & SIFMA's comment, the Commission is adopting the rule as proposed. The use of UTC in the rule reflects a consistent approach taken by the Commission in this rule and the Commission's final rules for real-time public reporting

and the swap data reporting rule.

By requiring the use of UTC in § 23.202, the Commission is ensuring that the requirements of Part 23, Part 43, and Part 45 remain consistent to the extent possible.

See

Real-Time Public Reporting of Swap Transaction Data, 77 FR 1182, 1251 (Jan. 9, 2012).

See

Swap Data Recordkeeping and Reporting Requirements, 77 FR 2136, 2212 (Jan. 13, 2012).

4. Records of Time of Execution—§ 23.202(a)(2)(iv)

Proposed § 23.202(a)(2)(iv) required SDs and MSPs to record the date and time of execution of each swap to the nearest minute.

The Working Group argued that the proposed rule conflicts with both the proposed real-time reporting rule and proposed swap data recordkeeping and reporting rule, which required that the time of execution be displayed to the second, rather than minute. The Working Group requested that the Commission be consistent in all of the its recordkeeping and reporting rules, and further requested that the Commission adopt a minute requirement, rather than displaying to the second.

The Commission is adopting the rule as proposed. The Commission notes that the “nearest minute” standard is the standard for futures orders under existing § 1.35. The Commission also notes that the final swap data recordkeeping and reporting rule does not require the time of execution be displayed to the second.

While the proposed real-time reporting rule would require a registrant to record the time of execution to the second in some instances, the Commission believes recordkeeping to the nearest minute is sufficient for purposes of maintaining daily trading records and is consistent with § 1.35.

See

Swap Data Recordkeeping and Reporting Requirements, 77 FR 2136, 2212, 2215 (Jan. 13, 2012).

5. Records of Reconciliation Processes—§ 23.202(a)(3)(iii)

Proposed § 23.202(a)(3)(iii) required SDs and MSPs to keep records of portfolio reconciliation results, categorized by transaction and counterparty.

ISDA & SIFMA commented that maintaining records of reconciliation processes by transaction and counterparty may be particularly problematic because this data is not required to be captured in other markets, such as securities or bond markets, and significant additional infrastructure development would thus be required before this data could be captured and stored. ISDA & SIFMA recommended an ongoing dialogue between the Commission and the industry to understand the requirements for systems needed to meet the

requirements of the proposed rule, in particular the degree to which retained data will need to be identifiable and searchable.

The records of portfolio reconciliation results required under the rule are the minimum needed to monitor an SD's or MSP's compliance with the Commission's proposed § 23.502 on portfolio reconciliation.

Thus, the Commission is adopting the rule as proposed.

See

Confirmation, Portfolio Reconciliation, and Portfolio Compression Requirements for Swap Dealers and Major Swap Participants, 75 FR 81519, 81531 (Dec. 28, 2010).

6. Daily Trading Records for Cash and Forward Transactions Related to a Swap—§ 23.202(b)

Proposed § 23.202(b) required SDs and MSPs to keep daily trading records, similar to those SDs and MSPs are required to keep for swaps, for related cash and forward transactions, defined under proposed § 23.200 as “a purchase or sale for immediate or deferred physical shipment or delivery of an asset related to a swap where the swap and the related cash or forward transaction are used to hedge, mitigate the risk of, or offset one another.”

The Working Group urged the Commission to recognize that, although participants in physical energy commodity markets use swaps and futures to hedge underlying physical positions, they do not, as a general matter, execute such transactions specifically for the purpose of hedging a specified underlying physical position. Rather, according to The Working Group, the predominant practice in physical energy markets is to hedge underlying physical positions on a portfolio or aggregate basis. Given the wide use of portfolio hedging in energy markets, The Working Group believes it would be difficult for energy market participants to link physical positions with arguably “related” swap transactions. The Working Group believes that compliance with proposed § 23.202(b) would impose a large number of very expensive and burdensome requirements on millions of physical transactions that are undertaken by commercial energy firms that are also parties to swap transactions.

ISDA & SIFMA commented that hedging and risk mitigation activities referred to in the proposed daily trading records rule are typically not executed with respect to specific trades; rather they are executed against the overall positions of business units such as trading desks and that it would not be possible to link cash and forward transactions to a specific swap. ISDA & SIFMA also commented that the reference to “hedge” also requires clarity to know the extent to which it comports with existing definitions in the CEA.

Having considered these comments, the Commission is adopting the rule as proposed. The Commission notes that section 4s(g)(1) of the CEA requires registrants to “maintain daily trading records of their swaps * * * and related records (including related cash and forward transactions) * * *.” Rule § 23.200 defines “related cash and forward transactions” as “a purchase or sale for immediate or deferred physical shipment or delivery of an asset related to a swap where the swap and the related cash and forward transaction are used to hedge, mitigate the risk of, or offset one another.” The Commission observes that the definition requires that a “related cash and forward transaction” be related to at least one swap, but does not prohibit such transaction from being related to more than one swap, or a swap from being related to more than one related cash or forward transaction. Therefore, the Commission believes the commenters' concerns that compliance with the rule is not possible in the context of portfolio hedging is misplaced. In addition, in response to the comments received, the Commission confirms that this definition is used solely for purposes of SD and MSP recordkeeping and is not intended to define hedging transactions for any other purpose or any other Commission regulation.

E. Records; Retention and Inspection—§ 23.203

1. Swap and Related Cash or Forward Record Retention Period—§ 23.203(b)(2)

Proposed § 23.203(b)(2) required SDs and MSPs to retain records of any swap or related cash or forward transaction until the termination or maturity of the transaction and for a period of five years after such date.

MFA commented that the vast majority of its members do not currently keep records of transactions for five years following the termination, expiration, or maturity of the transactions and compliance with this rule would be burdensome and costly. MFA recommended that the Commission not impose this record retention requirement on MSPs.

The Working Group argued that the long-term electronic storage of significant amounts of pre-execution communications will prove costly over the proposed five-year period. The Working Group recommended that the Commission re-evaluate whether all records subject to the proposed rule's retention requirements require a five year retention period.

ISDA & SIFMA recommended that further analysis and consultation be performed on the costs and benefits of holding records of all oral and written communications that lead to execution of a swap for the life of a swap plus five years. ISDA & SIFMA commented that they would be supportive of a voice recording obligation aligned to the rules of the UK Financial Services Authority, which are to retain recordings for a minimum period of six months.

By contrast, Chris Barnard recommended that records should be required to be kept indefinitely rather than the general five years under the proposal.

Having considered these comments, the Commission notes that proposed revisions to Commission regulation § 1.31 require retention of swap transaction records for a period of five years following the termination, expiration, or maturity of a swap,

and that § 23.203 is consistent with retention requirements under the final swap data reporting rule.

However, in response to commenters' concerns regarding retention of pre-execution trade information, the Commission is revising the rule to require that voice recordings need be kept for only one year. The Commission believes that the one-year retention period for voice recordings will enable the Commission to execute its enforcement responsibilities under the CEA adequately while minimizing the costs imposed on SDs and MSPs.

See

Adaptation of Commission Regulations to Accommodate Swaps, 76 FR 33066, 33088 (June 7, 2011).

See

17 CFR 45.2, Swap Data Recordkeeping and Reporting Requirements, 77 FR 2136, 2198 (Jan. 13, 2012).

2. “Readily Accessible”—§ 23.203(b)(1) and (b)(2)

The proposed regulation required SDs and MSPs to have both general records and swaps and related cash or forward transaction records readily accessible for the first two years of the applicable retention period.

The Working Group recommended that the Commission clarify whether the requirement that retained records be “readily accessible” means readily accessible by the registrant or by the Commission.

In response, the Commission observes that the term “readily accessible” has been the operative standard in § 1.31 of the Commission's regulations for several years. Specifically, § 1.31 requires that

“[a]ll books and records required to be kept by the Act or by these regulations shall be kept for a period of five years from the date thereof and shall be readily accessible during the first 2 years of the 5-year period.” In response to The Working Group's request for clarification, the Commission expects a registrant to be able to access such records promptly, and such records “shall be open to inspection by any representative of the Commission or the United States Department of Justice.”

Regulation 1.31 further provides that “[a]ll such books and records shall be open to inspection by any representative of the Commission or the United States Department of Justice.”

3. Records To Be Retained in Accordance With Commission Regulation 1.31—§ 23.203(b)

Proposed § 23.203(b) required SDs and MSPs to maintain records in accordance with existing § 1.31.

The Working Group commented that § 1.31 appears to apply to written documents, including electronic images of such documents, and does not seem suitable for electronic records such as those in a trading system, that do not originate from a written document. To be made workable for purposes of complying with the Commission's proposed requirements, The Working Group recommended that § 1.31 be revised to reflect current technologies and industry practices relating to digitized data storage.

The Commission has considered The Working Group's comment, but is adopting the rule as proposed. The Commission believes that The Working Group's concerns about § 1.31 have been addressed by a subsequent rule proposal to amend § 1.31 to reflect current technologies and industry practices related to digitized data storage.

If these amendments are finalized, the Commission believes that § 1.31 will be compatible with electronic records in a trading system and other records that do not originate from a written document.

See

Adaptation of Commission Regulations to Accommodate Swaps, 76 FR 33066, 33088 (June 7, 2011).

F. Duties of SDs and MSPs

As part of an overall business conduct regime for SDs and MSPs, section 4s(j) of the CEA, as added by section 731 of the Dodd-Frank Act, sets forth certain duties for SDs and MSPs, including the duty to: (1) Monitor trading to prevent violations of applicable position limits; (2) establish risk management procedures adequate for managing the day-to-day business of the SD or MSP; (3) disclose to the Commission and to applicable prudential regulators

general information relating to swaps trading, practices, and financial integrity; (4) establish and enforce internal systems and procedures to obtain information needed to perform all of the duties prescribed by Commission regulations; (5) implement conflict-of-interest systems and procedures; and (6) refrain from taking any action that would result in an unreasonable restraint of trade or impose a material anticompetitive burden on trading or clearing. In its Duties NPRM, the Commission proposed six regulations to implement section 4s(j), specifically addressing risk management, monitoring of positions limits, diligent supervision, business continuity and disaster recovery, the availability of general information, and antitrust considerations. The Commission's proposed conflicts of interest policies and procedures were the subject of the separate SD/MSP Conflicts NPRM and are discussed below. The Commission received 20 comment letters in response to the Duties NPRM and considered each in formulating the final rules.

This term is defined for the purposes of this rulemaking and has the same meaning as section 1(a)(39) of the CEA, which includes the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Farm Credit Association, and the Federal Housing Finance Agency.

G. Risk Management Program for SDs and MSPs—§ 23.600

The Commission proposed § 23.600, which required SDs and MSPs to establish and maintain a risk management program reasonably designed to monitor and manage the risks associated with their business as an SD or MSP. Proposed § 23.600 specifically required the risk management program established by SDs and MSPs to consist of written policies and procedures; to have its risk management policies and procedures approved by the governing body of the SD or MSP; and to establish a risk management unit independent from the business trading unit to administer the risk management program.

1. Definitions—§ 23.600(a)

The Commission proposed definitions of “affiliate,” “business trading unit,” “clearing unit,” “governing body,” “prudential regulator,” and “senior management.”

The definitions set forth in § 23.600(a) will apply only to provisions contained in § 23.600. The Commission is adopting the definitions largely as proposed, with the exceptions discussed below.

No comments were received on the proposed § 23.600(a) definitions of “affiliate,” “clearing unit,” or “prudential regulator.” With the exception of one change to the definition of “prudential regulator”, the Commission has decided to adopt those definitions as proposed.

a. Business Trading Unit—§ 23.600(a)(2)

SIFMA recommended that (i) the Commission modify the definition of “business trading unit” to delete the phrase “or is involved in” and replace it with “directly engaged in” to avoid inclusion of risk management, legal, credit, and operations personnel, all of whom could be deemed to be “involved in” business trading unit activities; and (ii) the Commission clarify that independent financial control functions that perform price verification for internal purposes (as opposed to providing prices to clients) are excluded from the business trading unit.

The Commission did not intend to include risk management, legal, credit, and operations personnel in the definition and has revised the definition to exclude such personnel. However, the Commission does not believe that only those personnel “directly engaged in” pricing, trading, sales, marketing, advertising, solicitation, structuring, or brokerage activities sufficiently captures those personnel intended to be included by the definition for purposes of the rule. Thus, the Commission is modifying the proposed definition to exclude risk management, legal, credit, and operations personnel, but also to include specifically personnel exercising direct supervisory authority over the performance of business trading unit functions. Per SIFMA's recommendation, the Commission also has modified the definition to exclude price verification for risk management purposes from the list of business trading unit functions. The Commission believes that the definition as revised will be less burdensome for registrants, but retains the original intent of the definition.

b. Governing Body and Senior Management—§ 23.600(a)(3) and (4)

Cargill recommended that the Commission expand the definitions of governing body and senior management to include the governing body or senior management of the division of a larger company. Cargill, SIFMA, and MetLife also recommended that the Commission permit a management committee or board committee to serve the function of a governing body. SIFMA further requested that the Commission confirm that governing body and senior management approvals required under the proposed rules may occur at the holding company level.

SIFMA recommended that the Commission not limit the definition of “senior management” to direct reports of the chief executive officer, but include any other officer having supervisory or management responsibility (including at the consolidated group level) for any organizational unit, department or division. BG Americas & Global LNG (BGA) argued that the requirement that the risk management unit report directly to a senior officer that reports directly to the CEO is too rigid and does not reflect the reality of most energy trading companies.

In response to commenters, the Commission is modifying the proposed definition of “governing body” to allow an SD or MSP to designate as its governing body “(1) a board of directors; (2) a body performing a function similar to a board of directors; (3) any committee of a board or body; or (4) the chief executive officer of a registrant, or any such board, body, committee or officer of a division of a registrant, provided that the registrant's swaps activities for which registration with the Commission is required are wholly contained in a separately identifiable division.” The Commission believes that under this definition the governing body of an SD or MSP could include a board committee or the governing body or senior management of a division, provided that the swaps activities of an SD or MSP are wholly contained in a separately identifiable division.

Likewise, in response to commenters, the Commission is modifying the proposed definition of “senior management” to provide increased flexibility in registrant governance structures. The Commission is revising the proposed definition to require only that senior management consist of officers of the SD or MSP that have been “specifically granted the authority and responsibility by the registrant's governing body to fulfill the requirements of senior management.”

The Commission believes that the increased flexibility permitted by the revised definitions of “governing body” and “senior management” will be less burdensome for SDs and MSPs, but retains the Commission's intent to have accountability at the highest level of management.

2. Scope of Risk Management Program—§ 23.600(b)

The proposed regulations required SDs and MSPs to establish, document, maintain, and enforce a system of risk management policies and procedures designed to monitor and manage the risks associated with the business of the SD or MSP and the Risk Management Program to take into account risks posed by affiliates and take an integrated approach to risk management at the consolidated entity level.

The Working Group, MetLife, and the Office of the Comptroller of the Currency argued that § 23.600 should be limited to the risks associated with swaps activities, and not other business lines in which the SD or MSP may engage. The Working Group also recommended that the rule be revised to require the risk management program to take into account only swaps-related risks posed by affiliates and take an integrated approach to risk management at the consolidated entity level to the extent the SD or MSP deems necessary to enable effective risk and compliance oversight.

Based on these comments, the Commission has determined that the risk management rules will be limited in scope to apply only to the swaps activities of SDs and MSPs and is modifying proposed § 23.600(b)(1) as recommended by The Working Group.

On the other hand, the Commission has rejected The Working Group's recommendation that SDs and MSPs consider only swaps-related risks posed by affiliates. The Commission believes that an SD or MSP should be aware of all risks posed by affiliates, and the rule should require the SD's or MSP's Risk Management Program to be integrated into overall risk management considerations at the consolidated entity level. However, the Commission is modifying proposed § 23.600(c)(1)(ii) to reflect the fact that Risk Management Programs within an SD or MSP may not have the authority to direct other divisions of a larger company.

Further, the Commission recognizes that some SDs and MSPs will be part of a larger holding company structure that may include affiliates that are engaged in a wide array of business activities. The Commission understands with respect to these entities, that in some instances, the top level company in the holding company structure is in the best position to evaluate the risks that an affiliate of an SD or MSP may pose to the enterprise, as it has the benefit of an organization-wide view and because an affiliate's business may be wholly unrelated to swaps activities. Therefore, to the extent an SD or MSP is part of a holding company with an integrated risk management program, the SD or MSP may address affiliate risks and comply with § 23.600(c)(1)(ii) through its participation in a consolidated entity risk management program.

3. Flexibility To Design Risk Management Program—§ 23.600(b)

The proposed regulation required a registrant's risk management program to include certain enumerated elements: identification of risks and risk tolerance limits; periodic risk exposure reports; a new product policy; policies and procedures to monitor and manage market risk, credit risk, liquidity risk, foreign currency risk, legal risk, operational risk, and settlement risk; use of central counterparties; compliance with margin and capital requirements; and monitoring of compliance with risk management program.

The Working Group and the Edison Electric Institute (EEI) commented that proposed § 23.600 requires a level of detail in the Risk Management Program not provided for in the Dodd-Frank Act, and recommended that the final rules be flexible enough to allow firms to adapt their existing compliance and risk management measures, and not cause firms to add entirely new compliance or risk management infrastructure.

Having considered these comments, the Commission is adopting the rule substantially as proposed. The Commission believes that the requirements of the rules represent prudent risk management practices, but do not prescribe rigid organizational structures. The Commission also believes the “policies and procedures” approach provides an adequate amount of flexibility that will allow registrants to rely upon any existing compliance or risk management capabilities to meet the requirements of the proposed rules. The Commission further believes that nothing would prevent firms from relying upon existing compliance and risk management programs to a significant degree.

4. Risk Management Policies and Procedures—§ 23.600(b)(2)

Proposed § 23.600(b)(2) required that a registrant's risk management program be described in written policies and procedures, that such policies and procedures be approved in writing by the registrant's governing body, and that such policies and procedures be provided to the Commission upon registration and following any material change.

SIFMA recommended that the Commission clarify that written risk management policies and procedures need not be documented in a single, consolidated set, so long as such policies and procedures address all of the elements of the risk management program required by the proposed rules. Cargill commented that registrants

should not be required to furnish risk management policies and procedures to the Commission, as such policies and reports can be obtained by the Commission by special call or reviewed during examinations. By way of contrast, Chris Barnard recommended that the Commission expand the reporting requirement to include public disclosure to allow for market participants to assess a registrant's approach to risk management and increase confidence in the swap markets.

In response to SIFMA's and Cargill's comments, the Commission is modifying the proposed rule to provide that an SD's or MSP's written policies and procedures must be provided upon application for registration to the Commission, or to a futures association registered under section 17 of the CEA, if directed by the Commission, but thereafter only upon request of the Commission. Additionally, the Commission confirms that, so long as the required policies and procedures are maintained in a reasonably useable and accessible fashion, the rule is not intended to mandate the form or manner of documentation or retention.

With respect to Mr. Barnard's recommendation, the Commission is not adopting a public disclosure requirement because registrants' risk management policies and procedures may contain sensitive or proprietary information.

5. Risk Management Unit—§ 23.600(b)(5)

Proposed § 23.600(b)(5) required SDs and MSPs to establish a risk management unit that reports directly to senior management, that is independent from the business trading unit, and that has sufficient authority and resources to carry out the risk management program required by the proposed regulations.

SIFMA recommended that the Commission clarify that different risk management processes may be managed by independent control functions, organized by relevant discipline or specialization, and that such functions, so long as they comply with the independence and other requirements applicable to the risk management unit, need not be part of a single risk management unit. To facilitate a functional working relationship, The Working Group recommended that the Commission clarify that separation of the risk management unit and business trading unit requires only separate and independent oversight of business unit and risk management unit personnel, but not actual physical separation of such personnel.

BGA recommends that the Commission allow the risk and trading units to report to a shared senior officer, as long as the senior officer does not participate in directing, organizing, or executing trades. According to BGA, this would be consistent with the Federal Energy Regulatory Commission's requirement for achieving independence between franchised public utilities and their market-regulated power sales affiliates, and would achieve the appropriate level of independence without requiring companies to overhaul their existing management structures.

Better Markets commented that simply requiring Risk Management Unit independence is inadequate and recommends that the Commission ensure independence with rules similar to those proposed to ensure independence of research analysts in proposed § 23.605, while Cargill requested that the Commission provide greater flexibility in how SDs arrange monitoring and compliance of their risk management program, rather than rigidly requiring complete independence from the business trading unit.

Having considered these comments, the Commission is adopting the rule as proposed. While § 23.600(b)(5) does not require a registrant's risk management unit to be a formal division in the registrant's organizational structure, the Commission expects that an SD or MSP will be able to identify all personnel responsible for required risk management activities as its “risk management unit” even if such personnel fulfill other functions in addition to their risk management activities. In addition, § 23.600(b)(5) permits SDs and MSPs to establish dual reporting lines for risk management personnel performing functions in addition to their risk management duties, but the rule would not permit a member of the risk management unit to report to any officer in the business trading unit for any non-risk management activity. The Commission believes that such dual reporting invites conflicts of interest and would violate the rule's risk management unit independence requirement.

As requested by The Working Group, the Commission confirms that independence of the risk management unit from the business trading unit does not require physical separation.

The Commission notes that per the revised definition of “senior management” discussed above, the risk management unit will not be required to report to an officer that reports directly to the CEO, but to ensure the independence of the risk management unit, the rule would not permit the risk management unit and business trading unit to report to a shared senior officer. The Commission also believes, however, that reporting line independence is sufficient to ensure accountability for the independence of the risk management unit, and, therefore, is not requiring firewalls of the type required in § 23.605 to ensure research analysts are free from conflicts of interest, as proposed by the Better Markets comment.

6. Risk Measurement Frequency—§ 23.600(c)(4)

Proposed § 23.600(c)(4) required registrants to measure their market, credit, liquidity, and foreign currency risk daily.

MetLife commented that the daily risk measuring required by the proposed rule may be excessive for some MSPs, may require substantial information technology and human capital investments, and recommended that the frequency of risk measuring should be determined by an MSP's risk management unit and governing body, rather than be mandated by the Commission.

The Commission is adopting the rule as proposed. MSPs are, by definition, market participants that have a substantial position in swaps, and have outstanding swaps that create substantial counterparty exposure that could have serious adverse effects on the financial stability of the U.S. financial markets, or are highly leveraged. Therefore, the Commission believes that it is entirely appropriate to require such market participants to measure their market, credit, liquidity, and foreign currency risk at least daily.

7. Approval of Exceptions to Risk Tolerance Limits—§ 23.600(c)(1)(i)

Proposed § 23.600(c)(1)(i) required that risk tolerance limits be approved by an SD's or MSP's senior management and governing body and that exceptions to such limits be approved, at a minimum, by a supervisor in the risk management unit.

SIFMA recommended that, subject to aggregate risk limits established for the relevant trading supervisor's authority, trading supervisors, rather than risk management personnel, should have the authority to approve risk tolerance limit exceptions. SIFMA argued that the required quarterly risk exposure reports provided to a registrant's senior management and governing body are an adequate check on decision-making by trading supervisors.

In response to SIFMA's comments, the Commission is revising proposed § 23.600(c)(1)(i) to remove the provision that requires risk management personnel to approve exceptions to risk tolerance limits. Instead, the Commission has determined that exceptions, along with the risk tolerance limits, must be subject to written policies and procedures. With this change, SDs and MSPs are free to grant discretion to trading supervisors to approve risk tolerance limit exceptions within the overall risk tolerance limits approved by the registrant's senior management and governing body.

8. New Product Policy—§ 23.600(c)(3)

Proposed § 23.600(c)(3) required SDs and MSPs to include a new product policy in their risk management programs. The proposed regulations required that such policies include an assessment of the risks of any new product prior to engaging in transactions and specifically required an assessment of potential counterparties; the product's economic function; pricing methodologies; legal and regulatory issues; market, credit, liquidity, foreign currency, operational, and settlement risks; product risk characteristics; and whether the product would alter the overall risk profile of the registrant.

The Working Group recommended that the regulations require only that (i) before an SD or MSP offers a new product, it must conduct due diligence that is commensurate with the risks associated with such product, and (ii) the decision to offer the product be approved by appropriate risk management and business unit personnel. In addition, the Working Group suggested that the Commission provide that the determination as to whether a product is “new” should be left to the SD or MSP.

SIFMA recommended that (i) the Commission clarify that a registrant may structure its new product approval framework so as to focus on only those risk elements that are deemed to be relevant to the product at issue, rather than rigidly following the enumerated list in § 23.600(c)(3); (ii) the Commission allow registrants to provide contingent or limited preliminary approval of new products at a risk level that would not be material to the registrant, in order to provide registrants with the opportunity to obtain experience with the product and to facilitate development of appropriate risk management processes for such product; and (iii) the Commission harmonize its new product policy rules with existing regulatory guidance in this area from banking regulators, the SEC, and SROs.

In response to the commenters' suggestions, the Commission confirms that the list of risks in § 23.600(c)(3)(ii) only need be considered if relevant to the new product, and the Commission is modifying the first sentence of the proposed rule to include the phrase “all relevant risks associated with the new product.”

In response to SIFMA's recommendation, the Commission also is revising the proposed rule to permit SDs and MSPs to grant limited preliminary approval of new products (i) at a risk level that would not be material to the registrant, and (ii) solely for the purpose of facilitating development of appropriate operational and risk management processes for such product.

The Commission is not making any other changes to the rule as proposed. The new product policy was adapted from existing banking and SEC guidance in this area, and the Commission believes the rule as proposed provides adequate guidance with respect to the factors to be considered in determining whether a product is “new” and whether the product presents new risks that should be addressed prior to engaging in any transaction involving the new product.

9. Reporting of Risk Exposure Reports to the Commission—§ 23.600(c)(2)(ii)

Proposed § 23.600(c)(2)(ii) required SDs and MSPs to provide their senior management and governing body with quarterly Risk Exposure Reports detailing the registrant's risk exposure and any recommendations for changes to the risk management program, and copies of these reports were required to be furnished to the Commission within five business days of providing them to senior management.

The Working Group recommended that the Commission provide a standard form of report for any report to be required under the proposed rules, and to clarify what the governing body or senior management is expected to do with information delivered under the rules. The Working Group and Cargill also recommended that Risk Exposure Reports should be required to be submitted to the Commission only upon request so as not to drain Commission resources.

The Commission is not modifying the proposed rule to require SDs' and MSPs' periodic Risk Exposure Reports to be submitted to the Commission only upon request. As discussed below, the rule will require SDs and MSPs to provide these reports to their senior management and governing body no less than quarterly, thus the Commission believes that also furnishing the reports to the Commission quarterly will not be an additional burden.

In response to The Working Group, the Commission has determined not to provide a standard, prescriptive form for the report; rather the form of the report is left to the discretion of the registrant.

In response to The Working Group's request for clarification about what management is supposed to do with Risk Exposure Reports, the Commission believes these reports will serve important informational purposes related to the key risks associated with the registrants' swaps activities and help to ensure accountability at the highest levels for those swap activities of registrants.

10. Reporting to Senior Management and/or Governing Body—§ 23.600(c)(2)(ii)

Proposed § 23.600(c)(2)(ii) required SDs and MSPs to provide their senior management and governing body with Risk Exposure Reports detailing the registrant's risk exposure, and any recommendations for changes to the risk management program, quarterly and upon any material change in the risk exposure of the registrant.

The Working Group and Cargill each commented that Risk Exposure Reports should be provided to senior management and governing body annually. The Working Group argued that quarterly reporting would be too costly and burdensome, would take resources away from risk monitoring, and the frequency may force firms to disclose risk exposures before remedial steps can be taken.

The Commission is adopting the rule as proposed. The Commission does not believe that provision of Risk Exposure Reports to senior management and the governing body of a registrant four times a year is overly burdensome, but rather will provide management with the information necessary to monitor and make adjustments to risk levels in a timely manner.

11. Frequency of Review, Testing, and Audit—§ 23.600(e)

Proposed § 23.600(e) required SDs and MSPs to review and test their risk management programs quarterly using internal or external auditors independent of the business trading unit.

The Working Group, Cargill, and MetLife each recommended that both the frequency and the scope of audits of the risk management program be left to the discretion of the registrant, so long

as such audits are effective and are conducted at least annually. The Working Group and Cargill argued that this regime would provide the desired results without the unnecessary cost and administrative burden imposed by the proposed rules. The Working Group also recommended that the Commission define or clarify what “testing” of the Risk Management Program requires.

Having considered these comments, the Commission is modifying proposed § 23.600(e) to require only

annual

testing and audit of an SD's or MSP's Risk Management Program. The Commission has determined not to specify testing procedures at this time, but to leave the design and implementation of testing procedures to the reasonable judgment of each registrant.

12. Risk Categories—§ 23.600(c)(4)

As proposed, § 23.600(c)(4) required SD and MSP risk management programs to include, at a minimum, certain enumerated elements, including policies and procedures to monitor and manage market risk, credit risk, liquidity risk, foreign currency risk, legal risk, and operational risk.

SIFMA recommended that the Commission clarify that so long as the enumerated risks in § 23.600(c)(4) are systematically monitored and managed, the Commission does not intend to require that each enumerated risk be subject to distinct risk management processes.

While the rule requires that each enumerated risk must be the subject of distinct risk management policies and procedures, Commission does not intend to mandate specific risk management processes. The specific methods of monitoring and managing all risks associated with the swaps activities of an SD or MSP are left to the discretion of the registrant.

13. Market Risk—§ 23.600(c)(4)(i)

Proposed § 23.600(c)(4)(i) required SDs and MSPs to measure their market risk daily, including exposure due to unique product characteristics, volatility of prices, basis and correlation risks, leverage, sensitivity of option positions, and position concentration. The proposed rule would require that if valuation data is derived from pricing models, that such models be validated by qualified, independent persons.

The Working Group recommended that metrics for options, particularly the sensitivity for options, be required to be measured on a frequency less than daily, as metrics can require complex calculations, some of which must be done outside the trading or risk management system. The Working Group also recommended that the Commission clarify that models may be verified by independent, but internal, qualified persons.

In response to The Working Group's comments, the Commission clarifies that, to the extent that an input for measurement of market risk has a reasonable degree of accuracy over a period longer than one day, it would be permissible for a registrant's risk management policies to reflect the conclusion that such an input would not need to be calculated daily for purposes of the daily measurement of a registrant's market risk. The Commission also is modifying the proposed rule to clarify that pricing models may be verified by qualified, independent internal persons.

14. General Ledger Reconciliation—§ 23.600(c)(4)(i)(C)

The proposed regulations required SDs and MSPs to reconcile profits and losses resulting from valuations with the general ledger at least once each business day.

The Working Group commented that, to the extent that transaction valuations are tracked daily, they ordinarily would be tracked in the firm's trading or risk management system, not the general ledger system. The Working Group recommended that consolidation to the general ledger only be required monthly.

Having considered these comments, the Commission has determined that the rule need not require daily reconciliation to the general ledger in order to address the need to manage the risk of a failure to account properly for profits and losses. The Commission therefore is revising the proposed rule to require only that SDs and MSPs have policies and procedures to ensure “periodic reconciliation of profits and losses resulting from valuations with the general ledger.”

15. Establishment of Credit Limits Prior to Trading—§ 23.600(d)(2)

Proposed § 23.600(d)(2) required that SDs and MSPs have policies and procedures requiring traders to transact only with counterparties for whom credit limits have been established.

The Working Group recommended that the Commission allow discretion to make exceptions to the requirement that trades only be executed with counterparties for which credit limits have been established for certain limited risk transactions. Arguing that some transactions carry no counterparty credit risk and that some SDs and MSPs may hedge their counterparty credit risk, SIFMA recommended that, instead of requiring establishment of credit limits prior to trading, the Commission require only that a credit risk evaluation be made prior to trading.

The Commission is adopting the rule as proposed. The Commission observes that the rule does not define “credit limit” and thus provides sufficient discretion to SDs and MSPs to implement policies addressing limited counterparty credit risk transactions.

16. Credit Risk Measurement—§ 23.600(c)(4)(ii)(A)

Proposed § 23.600(c)(4)(ii)(A) required SDs and MSPs to have credit risk policies and procedures providing for daily measurement of overall credit exposure to ensure compliance with counterparty credit limits.

Better Markets argued that the Commission's proposal for rules relating to credit risk are inadequate insofar as they do not provide guidance on how credit risk is to be measured. Better Markets recommended that the Commission's rules relating to management of credit risk require measurement of credit risk using the same techniques employed by derivatives clearing organizations (DCOs) registered with the Commission. Better Markets also specifically recommended that the Commission require credit risk policies of SDs and MSPs to address (i) the risk posed by collateral triggers (like credit rating downgrades) that may require immediate funding under stressful circumstances, and (ii) the credit risk of futures commission merchants (FCMs) acting for the SD or MSP as its clearing member.

Having considered Better Market's comments, the Commission is adopting the rule as proposed. The Commission believes it need not specify a credit risk measurement methodology because the adequacy of a registrant's individual credit risk measurement methodology will be assessed upon a review of a registrant's policies and procedures during registration or upon examination. The Commission also believes that credit risk to FCMs would be covered by the required monitoring and risk management of clearing members by DCOs and the Commission.

17. Liquidity Risk—§ 23.600(c)(4)(iii)(B)

The proposed rules required SDs and MSPs to test their procedures for liquidating all non-cash collateral in a timely manner and without significant effect on price.

SIFMA argued that firms assess the types of collateral that they are willing to accept based on the risk, volatility,

liquidity, and other characteristics of the collateral and additionally establish conservative haircuts for the valuation of collateral, not through testing by actual or simulated disposition of collateral. SIFMA therefore recommended that the Commission not require testing of liquidation procedures by simulated disposition, but only require policies and procedures for identifying acceptable collateral and establishing appropriate haircuts, taking into account reasonably anticipatable adverse price movements.

The proposed rule was not intended to impose a requirement that registrants test collateral liquidation procedures by means of actual or simulated disposition. However, to clarify this matter, the Commission is revising the proposed rule to require policies and procedures that “assess” rather than “test” procedures to liquidate all non-cash collateral in a timely manner without significant effect on price.

18. Foreign Currency Risk—§ 23.600(c)(4)(iv)

Proposed § 23.600(c)(4) required SDs and MSPs to measure the amount of capital exposed to fluctuations in the value of foreign currency daily.

The Working Group recommended that the Commission permit the frequency of measurement of capital exposed to fluctuations in the value of foreign currency to be left to the discretion of the firm, rather than mandating daily measurement.

The Commission believes that the foreign exchange markets are fluid and quick moving, and, therefore, the requirement for daily measurement is not excessive. Accordingly, the Commission is adopting the rule as proposed with respect to foreign currency risk.

19. Legal Risk—§ 23.600(c)(4)(v)

Proposed § 23.600(c)(4)(v) required SDs' and MSPs' risk management policies and procedures to address determinations that transactions and netting arrangements entered into by the registrant have a sound legal basis and documentation tracking to ensure completeness of transaction documentation.

SIFMA recommended that the Commission require only policies and procedures to identify and evaluate the legal risks arising in connection with the registrant's business.

The Commission is making no changes to the rule as proposed. The Commission believes that the two enumerated requirements with respect to legal risk are of special importance with respect to trade processing and risk measurement, but are by no means exhaustive of the legal risks arising in connection with a registrant's business, all of which must be identified by the registrant's risk management policies and procedures.

20. Operational Risk—§ 23.600(c)(4)(vi)

Proposed § 23.600(c)(4)(vi) required SDs and MSPs to establish policies and procedures for managing operational risks, including procedures accounting for reconciliation of all operating and information systems.

The Working Group and SIFMA recommended that the Commission clarify what is meant by “reconciliation of operating and information systems,” as information contained in systems may be reconciled, but systems themselves may not be.

Chris Barnard recommended that the proposed rule be expanded and be more specific about the types of operational risk to be monitored and controlled, arguing that operational risk failures effectively allow other types of risk, such as credit risk and market risk to be excessive. Mr. Barnard also recommended that the proposed rule be expanded to require management for the increased risks inherent in using programs or models from external providers or vendors to avoid using “black boxes” without controls and review.

The Commission agrees with commenters that data within operating and information systems should be reconciled, rather than the systems themselves. Consequently, the Commission is modifying the proposed rule to refer to reconciliation of data within operating and information systems. As modified, the Commission believes that the rule is sufficiently specific to enable SDs and MSPs to establish policies and procedures for adequately managing operational risks, and as such, the Commission is making no changes to the rule based on Mr. Barnard's comments. Nonetheless, the Commission notes that Mr. Barnard's concern about black boxes is addressed, in part, by the requirement to have policies and procedures governing the use and supervision of trading programs under proposed § 23.600(d)(9), as discussed further below.

21. Use of Central Counterparties—§ 23.600(c)(5)

Proposed § 23.600(c)(5) required SDs and MSPs to establish policies and procedures related to central clearing of swaps, including policies that require the use of clearing when a swap is subject to a mandatory clearing determination issued by the Commission, policies setting forth conditions for the voluntary use of central clearing as a means of mitigating counterparty credit risk, and policies requiring diligent investigation into the adequacy of financial resources and risk management procedures of any central counterparty through which the registrant clears.

The Working Group argued that the adequacy of resources and risk management at CCPs registered with the Commission should be monitored by the Commission, not individual firms. EEI requested that the Commission clarify that proposed § 23.600(c)(5) is not seeking to require SDs to use central clearing to mitigate risk if clearing is not required under a valid exemption.

The Commission is adopting the rule regarding use of central counterparties as proposed. The Commission's registration of a central counterparty as a DCO is based on a determination that the applicant meets core principles under the Commodity Exchange Act and Commission regulations. It does not, however, serve as a substitute for the due diligence of registrants who must evaluate the use of a central counterparty in light of their own circumstances. In addition, SDs and MSPs may elect to clear swaps that are not required to be cleared on a voluntary basis through central counterparties that are not registered with the Commission. In those instances, an SD or MSP engaging in some manner of due diligence prior to submitting a swap for clearing would be part of a prudent risk management program. In response to EEI's comment, the Commission observes that the rule would require only that registrants evaluate the use of central clearing as a means of mitigating counterparty credit risk and as part of their overall risk management strategy. Moreover, the rule expressly notes the exception from mandatory clearing that is provided for under section 2(h)(7) of the CEA.

22. Business Trading Unit—§ 23.600(d)

As proposed, § 23.600(d) required SDs and MSPs to establish policies and procedures that require all trading policies to be approved by the governing body of the registrant.

The Working Group recommended that the governing body of an SD or MSP be permitted to delegate approval of trading policies to those with expertise.

The revisions to the definition of governing body discussed above, which allows for a governing body to consist of a committee or the CEO, sufficiently address the Working Group's concerns.

The Commission thus has made no changes to the rule.

23. Transaction Entry by Traders—§ 23.600(d)(5)

Proposed § 23.600(d)(5) required SDs and MSPs to establish policies and procedures that require each trader to follow established policies and procedures for executing and confirming all transactions. Further, in a discussion about the independence of the risk management unit in the preamble to the proposal, the Commission stated that “personnel responsible for recording transactions in the books of the swap dealer or major swap participant cannot be the same as those responsible for executing transactions.”

The Working Group requested clarification about requirements for transaction entry based on the statements made in the preamble to the proposal. The Working Group argued that if the reference to recording transactions in the books of a firm is intended to refer to entries into the general ledger system, then the Working Group agreed that this process should be subject to the usual segregation of duties requirements that protect the general ledger system, but that there is no reasonable basis to prohibit individuals who execute transactions from entering the information regarding such transactions into a firm's trading or risk management system.

BGA commented that typical practice is for traders to enter the trade into the deal monitoring system, and then the risk control group performs a daily review of all new and amended trading activity. BGA explained that the mid-office risk control review is followed by a second review of the trade activity performed by the back-office confirmations group, which generates confirmations and performs portfolio reconciliations to match key trade attributes with counterparties. BGA requested clarification that the reference to “recording transactions in the books” in the proposal preamble is not intended to restrict the initial recording of the trade into the deal capture system by the trader, but refers to the daily review and confirmation and portfolio reconciliation processes performed by the mid and back offices.

SIFMA requested that the Commission confirm that compliance with the rule would not preclude trading personnel from entering the trades they execute into a registrant's trade capture system, provided that the registrant has appropriate policies and procedures reasonably designed to identify the entry of fictitious trades or the failure to accurately enter actual trades.

In response to these comments, the Commission confirms that the rule is not intended to restrict the initial recording of trades into a trade capture system by the trader. Rather, the rule requires traders to follow established policies and procedures governing trade execution and confirmation.

24. Monitoring of Trading—§ 23.600(d)(4) & (d)(9)

As proposed, § 23.600(d)(4) required SDs and MSPs to establish policies and procedures designed to monitor each trader throughout the trading day to prevent the trader from exceeding any limit to which the trader is subject, or from otherwise incurring undue risk. The proposed regulations also require registrants to ensure that trade discrepancies are brought to the immediate attention of senior management and are documented.

The Working Group, with respect to internal limits, recommended that daily monitoring should be at the product desk level, not the trader level, as market practice is to set internal limits at the desk level. Also, the Working Group and SIFMA requested that the Commission clarify that “monitor each trader throughout the trading day” does not mean continuous monitoring, and recommended that the Commission remove the requirement that firms monitor traders to prevent traders from “incurring undue risk” because the meaning of the phrase is ambiguous. The Working Group also recommended that the Commission define “trade discrepancies” and add a materiality standard to the escalation requirement.

MetLife commented that intraday monitoring of traders may be excessive for some MSPs, especially MSPs that use swaps only for hedging purposes. MetLife recommended that the Commission allow the type of monitoring and its frequency to be determined by an MSP's risk management unit and governing body.

Having considered these comments, the Commission is revising the proposed rule to require monitoring be performed to prevent the incurrence of “unauthorized risk” rather than “undue risk.” The Commission believes this formulation better reflects the intent of the rule, which is to ensure that SDs and MSPs have instituted safeguards against the risk of losses to the firm due to rogue trading.

In response to The Working Group's comment requesting a definition of “trade discrepancies,” the Commission notes that the term “trade discrepancies” is intended to refer to any discrepancies between the SD or MSP and its counterparties and to any discrepancies in records or systems of the SD or MSP. Also in response to The Working Group's recommendation that the proposed rule be modified to add a materiality standard for reporting of trade discrepancies to management, the Commission is modifying the rule to require that only trade discrepancies that are not immaterial, clerical errors be brought to the immediate attention of management of the business trading unit. The rule continues to require that all trade discrepancies be documented.

The Commission has made no other changes to the rule based on the comments received. The Commission believes that prudent risk management requires intraday monitoring of traders to detect prohibited activity that may be otherwise undetectable. The Commission notes that the rule requires monitoring of traders to prevent traders from “exceeding any limit to which the trader is subject” but does not specify the types of limits to be monitored. Thus, the Commission observes that the setting of limits requiring intraday monitoring is left to the discretion of each SD and MSP.

In addition, the Commission is finalizing the requirement that SDs and MSPs have policies and procedures governing the use and supervision of trading programs under proposed § 23.600(d)(9), but deleting the term “algorithmic” from the rule text. This rule is an important measure for ensuring that SDs and MSPs monitor their trading activities. In addition to the risk management requirements under this rule, the Commission notes that the use of trading programs would be subject to, among other things, any applicable prohibitions on disruptive trading practices under the CEA and Commission regulations. The Commission also anticipates addressing the related issues of testing and supervision of electronic trading systems and mitigation of the risks posed by high frequency trading.

25. Brokers—§ 23.600(d)(8)

Proposed § 23.600(d)(8) required SDs and MSPs to establish policies and procedures to ensure that the risk management unit reviews broker's statements, reconciles brokers' charges to estimates, reviews and monitors broker's commissions, and initiates payment to brokers.

The Working Group, SIFMA, and MetLife each recommended that the risk management unit not be tasked with reviewing brokers' statements, monitoring commissions or initiating broker payments, as these functions are

currently handled by operations or other control units.

The Commission agrees with commenters that review of brokers' statements, monitoring commissions or initiating broker payments need not be performed by risk management personnel. The Commission is revising the proposed rule to replace this requirement with a requirement that risk management policies and procedures include periodic audit of broker's statements and payments by persons independent of the business trading unit. This change provides the relief requested by commenters while maintaining the requirement that risks connected to the use of brokers are adequately monitored and managed.

H. Monitoring of Position Limits—§ 23.601

To implement section 4s(j)(1) of the CEA, the Commission proposed § 23.601 in the Duties NPRM, which required SDs and MSPs to establish policies and procedures to monitor, detect, and prevent violations of applicable position limits established by the Commission, a designated contract market (DCM), or a swap execution facility (SEF), and to monitor for and prevent improper reliance upon any exemptions or exclusions from such position limits. Proposed § 23.601 also required SDs and MSPs to: (i) Convert all swap positions into equivalent futures positions using the methodology set forth in Commission regulations; (ii) provide training to all relevant personnel on applicable position limits on an annual basis and promptly upon any change to applicable position limits; (iii) test its procedure for monitoring and preventing position limit violations for adequacy and effectiveness each month; (iv) audit its position limit procedures annually; (v) implement an early warning system designed to alert senior management when position limits are in danger of being breached; and (vi) report any detected violation of applicable position limits to the registrant's governing body and to the Commission. Only four market participants and trade groups provided comments on the Commission's proposal.

1. Monitoring for Violations of Position Limits—§ 23.601(a)

The Working Group argued that it is not possible to determine whether transactions that individual traders enter into violate position limits without placing the transactions in the context of an entire portfolio and any relevant hedge exemptions. The Working Group requested clarification that the requirement for intraday monitoring of traders under proposed § 23.600(d)(4) does not require monitoring of individual traders for violations of position limits, and that monitoring for violations of position limits is only required in the context of aggregate swaps and futures portfolios.

The Commission believes that The Working Group's request for clarification is outside the scope of these rules. The level at which monitoring for violations of position limits will be required is subject to the final position limit rules,

and the Commission directs SDs and MSPs to review new § 151.7 of the final position limit rules for guidance when establishing the Position Limit Procedures required by this rule.

See

17 CFR 151.7, Position Limits for Futures and Swaps, 76 FR 71626, 71692 (Nov. 18, 2011) (adopting 17 CFR 151.7 pertaining to the aggregation of positions).

BGA expressed concern about the requirement that an SD or MSP “prevent violations” of position limits established by the Commission. BGA argued that despite having a robust compliance program, it is impossible for an SD or MSP to “prevent violations” because a company cannot before-the-fact prevent a trader from entering a deal that causes a position limit violation. Thus, BGA recommended that the Commission clarify that as long as an SD or MSP provides training on the position limits and establishes and enforces policies for monitoring, detecting, and curing violations, they will have met the obligation to “prevent violations.”

The Commission agrees with BGA that SDs and MSPs should be held to a standard of reasonableness in regard to efforts to prevent violations of position limits. The Commission therefore is revising the proposed rule to state that “[e]ach swap dealer and major swap participant shall establish and enforce written policies and procedures that are

reasonably

designed to monitor for and prevent violations of applicable position limits * * *” (modification to rule text in italics).

2. Training on Applicable Position Limits—§ 23.601(c)

SIFMA recommended that the Commission revise § 23.601(c) to provide that a change in position limit levels will not trigger “training,” but only require effective notification. The Commission agrees with SIFMA's view and is revising the proposed rule accordingly.

3. Diligent Monitoring and Diligent Supervision To Ensure Compliance—§ 23.601(d)

SIFMA recommended that the Commission clarify that monitoring for compliance with position limits need not be performed by risk management personnel, but may be performed by independent compliance, operations, or supervisory personnel.

The rule does not require that position limit monitoring be performed by risk management personnel, nor was such a requirement intended. The Commission confirms that monitoring procedures may be conducted at the discretion of the SD or MSP.

4. Reporting Violations to the Governing Body and the Commission—§ 23.601(e)

The Working Group and MetLife doubted the utility of alerting the governing body of nonmaterial violations of position limits as required under proposed § 23.601(e), and recommended that the Commission require alerting the governing body only when a violation is material and allow registrants to define escalation procedures based on materiality in their Position Limit Procedures.

The Commission does not believe that reporting of position limit violations to the governing body of the registrant should be subject to a materiality standard and is adopting the rule as proposed. The Commission intends the reporting rule to ensure accountability for compliance with position limits at the highest levels of management and believes applying a materiality standard to such reporting would undermine the intention of the rule and introduce unnecessary complication for registrants trying to determine how much of a breach would amount to a material breach. However, the Commission observes that a registrant's governing body could take into account the magnitude of the breach and other facts and circumstances in remediating its monitoring program. For instance, a governing body would respond differently to small, inadvertent breaches that are promptly corrected than larger, repeated violations.

With respect to reporting of position limit violations to the Commission, The Working Group argued that the reporting of on-exchange violations of position limits to the Commission is already done by DCMs and will likely be the responsibility of SEFs as well, so SDs and MSPs should not be required to report on-exchange violations to avoid inundating the Commission with redundant information. The Working Group conceded, however, that if

position limit rules require the aggregation of exchange-traded swaps and over-the-counter swaps, then SDs and MSPs should be required to report position limit violations that occur because of over-the-counter swaps, but recommended that such reporting requirement be subject to a materiality standard.

The Commission agrees that on-exchange position limit violations need not be reported to the Commission by registrants, as they will be reported by DCMs or SEFs and has modified the final rule accordingly.

5. Testing and Audit of Position Limit Procedures—§ 23.601(f) and (h)

With respect to monthly testing of Position Limit Procedures required under proposed § 23.601(f) and annual audit required under proposed § 23.601(h), SIFMA recommended that testing and audit of Position Limit Procedures be required only annually and not be required to be done all at the same time, The Working Group recommended that testing only be required on a semi-annual basis (or on a more frequent basis as the firm might determine to be effective), and MetLife requested that the Commission permit the frequency of testing to be determined by an MSP based on the extent of its swap activities. MetLife also recommended that there be a clear exemption from testing requirements for MSPs that do not trade in swaps for which position limits have been established. SIFMA requested that the Commission clarify that testing should consist of testing for accurate capture of all relevant desk positions by position reporting systems and that § 23.601(h) be revised to allow for “agreed upon procedures” for external auditors.

Having considered these comments, the Commission has determined that monthly testing of Position Limit Procedures by registrants may be unduly burdensome, but believes that only annual or semi-annual testing would be inadequate as such could allow violations to remain undetected for long periods. The Commission therefore is modifying the proposed rule to require quarterly testing, and, in response to the comment of MetLife, only if the registrant trades in swaps for which position limits have been established. The annual audit requirement is being adopted as proposed. In response to the request of SIFMA, the Commission confirms that testing of Position Limit Procedures is expected to entail testing of the accuracy of capture of all relevant desk positions by position reporting systems.

6. Quarterly Reporting of Compliance With Position Limits—§ 23.601(g)

With respect to quarterly reporting of compliance with position limits to the chief compliance officer, senior management, and governing body under proposed § 23.601(g), The Working Group recommended that the proposed rule should be revised to require only annual reports to the entity's senior management and governing body.

As stated above, the Commission intends the reporting rule to ensure accountability for compliance with applicable position limits at the highest levels of management. The Commission believes that the burden of quarterly reporting is outweighed by the benefit of timely notification to decision makers within the SD and MSP of the entity's record of compliance with applicable position limits, thus providing a timely opportunity to adjust or revise Position Limit Procedures to prevent future violations, if necessary.

I. Diligent Supervision—§ 23.602

Proposed § 23.602 was intended to implement section 4s(h)(1)(B) of the CEA, which requires each SD and MSP to conform with Commission regulations related to diligent supervision of the business of the SD and MSP. The proposed regulations required SDs and MSPs to establish a system to supervise all activities relating to its business performed by its partners, members, officers, employees, and agents, that such system be reasonably designed to achieve compliance with the CEA and Commission regulations, that such system designate a person with authority to carry out the supervisory responsibilities of the SD or MSP, and that all such supervisors meet qualification standards that the Commission finds necessary or appropriate.

The Working Group recommended that the Commission not require designation of a single individual with responsibility for supervision, but should allow for designation of a reporting line and that designated supervisors should be permitted to delegate supervisory authority. The Working Group also recommended that SDs and MSPs be given discretion to determine supervisor qualifications, rather than meet “qualification standards as the Commission finds necessary or appropriate.”

MFA recommended that the Commission clarify that the rules do not impose any new (a) fiduciary obligations or duties (i.e., duties beyond those to which participants in the futures and derivatives markets would otherwise be subject to by agreement or by operation of common law), or (b) supervisory duties on market participants. MFA argued that proposed § 23.602 (Diligent Supervision) is similar to the NFA's supervision rule for FCMs (Compliance Rule 2-9), and MFA is concerned that § 23.602 may impose fiduciary and supervisory obligations on registrants similar to those that the NFA imposes on FCMs with respect to third parties.

In response to The Working Group's first comment, the Commission is revising the proposed rule to require “at least one person” rather than “a person” be designated with authority to carry out supervisory responsibilities, which should permit SDs and MSPs more flexibility in designing and implementing the required supervisory system. With respect to the remaining comments of The Working Group, the Commission believes that full accountability for compliance with the CEA and Commission regulations is best served by requiring designation of individuals with supervisory responsibility and that reporting line responsibility is not adequate.

With respect to MFA's comments, the Commission observes that the rule relates generally to the supervision necessary to achieve compliance with the CEA and Commission regulations by the registrant. Many of the specific activities to be supervised are subject to the CEA and other Commission rules that are outside the scope of this rulemaking. The Commission does not intend that § 23.602 impose a fiduciary duty on SDs or MSPs beyond that which would otherwise exist.

Other than the foregoing, the Commission has adopted the rule as proposed.

J. Business Continuity and Disaster Recovery—§ 23.603

Proposed § 23.603 required SDs and MSPs to establish a business continuity and disaster recovery plan that includes procedures for and the maintenance of back-up facilities, systems, infrastructure, personnel, and other resources to achieve the timely recovery of data and documentation and to resume operations generally within the next business day. The proposed regulations also required SDs and MSPs to have their business continuity and disaster recovery plan tested annually by qualified, independent internal audit personnel or a qualified third party audit service.

Tellefsen and Company, L.L.C. (Tellefsen) commented that most, if not all, of potential SDs have the technology and network infrastructure in place to

achieve a next day recovery time objective. However, Tellefsen recommended that the Commission carefully evaluate the business continuity management capabilities of MSPs before establishing a hard date by which these metrics must be in place, as the Commission may have greatly underestimated the time and scope of work for firms to develop, implement and test their business continuity management capabilities (Tellefsen estimates 68-200 person days). The Working Group also argued that the Commission should not require next business day recovery for non-systemically important SDs or MSPs, but should only require recovery “reasonably promptly.”

The Working Group argued that the Commission should not require staffing of back-up facilities to avoid the burden of requiring two persons for the same job. The Working Group also recommended that the Commission should not require annual testing of the business continuity and disaster recovery plan by independent auditors because independent audits would be too costly.

SIFMA recommended that the Commission clarify that an SD's or MSP's business continuity and disaster recovery plan may be part of a consolidated plan established for the various entities in a holding company group if they share common personnel, premises, resources, systems, and infrastructure. SIFMA also recommended that the Commission permit SDs and MSPs subject to the business continuity and disaster recovery requirements of a prudential regulator, or other regulator determined to be comparable by the Commission, to comply with § 23.603 on a substituted compliance basis.

The Commission believes that Tellefsen's concerns regarding the ability of MSPs to comply with the required recovery period will be addressed through the phased implementation of the rule, discussed below.

In response to The Working Group's comment regarding staffing of back-up facilities, the Commission is modifying the proposed rule to clarify that, so long as prompt recovery is reasonably ensured, SDs and MSPs may provide for alternative staffing of back-up facilities as required under the circumstances. The Commission also agrees with the Working Group that annual testing may be performed by qualified internal personnel and is modifying the proposed rule accordingly. However, the Commission believes that independent audits are required to ensure that business continuity and disaster recovery plans remain in compliance with the rule, but that annual audits would be unnecessary and unduly burdensome and costly. Therefore, the Commission is revising the proposed rule to require independent audits only every three years.

The Commission believes that all SDs and MSPs may be critically important to the proper functioning of the swaps market. SDs are critical participants in the swap market and MSPs may, by definition, have exposures that could have serious adverse effects on the financial stability of the United States. Therefore, the Commission continues to believe that a one business day recovery period is the necessary objective for SDs' and MSPs' business continuity and disaster recovery plans. Accordingly, the Commission is not modifying the final rule in this respect.

In response to SIFMA's comments, the Commission confirms that so long as a consolidated business continuity and disaster recovery plan established for the various entities in a holding company group that includes an SD or MSP, or any such plan that is required by a prudential regulator of the SD or MSP, meets the requirements of the rule, such SD or MSP would be in compliance with the Commission's rule. The Commission believes that this result is contemplated by the rule as proposed and so is not modifying the rule in this respect.

K. General Information: Availability for Disclosure and Inspection—§ 23.606

Proposed § 23.606 required SDs and MSPs to make available for disclosure and inspection by the Commission and the SD's or MSP's prudential regulator, all information required by, or related to, the CEA and Commission regulations.

The Working Group recommended that the Commission clarify what is meant by “available for disclosure” if such is different from “available for inspection.” The Working Group also argued that SDs and MSPs should not be required to revise information systems to store information specifically required by each Commission rule, because storage would require extensive investigation that is unnecessary to ensure compliance with the rule.

Having considered The Working Group's comments, the Commission is adopting the rule as proposed. The Commission does not believe the rule specifies or requires any particular storage medium or methodology, but rather only requires SDs and MSPs to have information systems capable of producing the required information promptly. The Commission also has determined not to define further “available for disclosure” or “available for inspection” because it believes these terms as employed in the rule have their plain meanings.

L. Antitrust Considerations—§ 23.607

Proposed § 23.607 prohibited SDs and MSPs from adopting any process or taking any action that results in any unreasonable restraint of trade or imposes any material anticompetitive burden on trading or clearing, unless necessary or appropriate to achieve the purposes of the CEA. The proposed rule also required SDs and MSPs to adopt policies and procedures to prevent such actions.

SIFMA agreed with the Commission's proposed policies and procedures approach. SIFMA argued however that § 23.607(a) goes further, by imposing a blanket prohibition on a registrant adopting any process or taking any action that results in any unreasonable restraint of trade, or imposes any material anticompetitive burden on trading or clearing (unless necessary or appropriate to achieve the purposes of the CEA). SIFMA expressed concern that, given the counterparty rescission and private right of action provisions of the CEA, this prohibition could introduce additional private liability that is unnecessary in light of the enforcement authority of the Commission and antitrust authorities and existing private rights of action under the antitrust laws. SIFMA therefore recommended that the Commission delete § 23.607(a) and instead rely upon the policies and procedures requirement included in § 23.607(b).

Having considered SIFMA's comments, the Commission is adopting the rule as proposed. The blanket prohibition in § 23.607(a) is taken directly from the statutory provision and appropriately implements the prohibition in section 4s(j)(6) of the CEA.

M. Conflicts of Interest Policies and Procedures by SDs, MSPs, FCMs, and IBs—§ 23.605, § 1.71

As discussed above, section 4s(j) of the CEA, as added by section 731 of the Dodd-Frank Act, sets forth certain duties for SDs and MSPs, including the duty to implement conflict-of-interest systems and procedures. Specifically, section 4s(j)(5) mandates that SDs and MSPs implement conflict-of-interest systems and procedures that “establish structural and institutional safeguards to ensure that the activities of any person

within the firm relating to research or analysis of the price or market for any commodity or swap or acting in a role of providing clearing activities or making determinations as to accepting clearing customers are separated by appropriate informational partitions within the firm from the review, pressure, or oversight of persons whose involvement in pricing, trading, or clearing activities might potentially bias their judgment or supervision and contravene the core principles of open access and the business conduct standards described in this Act.” Section 4s(j)(5) further requires that such systems and procedures “address such other issues as the Commission determines to be appropriate.” Proposed § 23.605, as set forth in the SD/MSP Conflicts NPRM, addressed the statutory mandate of section 4s(j)(5).

In relevant part, section 732 of the Dodd-Frank Act amended section 4d of the CEA by creating a new subsection (c), which mandates that the Commission “require that futures commission merchants and introducing brokers implement conflict-of-interest systems and procedures.” New section 4d(c) mandates that such systems and procedures “establish structural and institutional safeguards to ensure that the activities of any person within the firm relating to research or analysis of the price or market for any commodity are separated by appropriate informational partitions within the firm from the review, pressure, or oversight of persons whose involvement in trading or clearing activities might potentially bias the judgment or supervision of the persons.” New section 4d(c) further requires that such systems and procedures “address such other issues as the Commission determines to be appropriate.” Proposed § 1.71, as set forth in the FCM/IB Conflicts NPRM, addressed the statutory mandate of section 4d(c).

As proposed, §§ 23.605 and 1.71 were identical in all material respects. The Commission received 29 comment letters to the SD/MSP Conflicts NPRM and 26 comment letters to the FCM/IB Conflicts NPRM. Many commenters provided comments addressing identical provisions or issues in both proposed rules. The discussion below thus addresses comments to both proposed rules unless otherwise indicated.

1. Compliance Oversight by Self-Regulatory Organizations (SROs)

Although proposed §§ 23.605 and 1.71 prescribed the implementation of conflict-of-interest policies and procedures by SDs, MSPs, FCMs, and IBs, the proposal did not address compliance oversight by SROs. Nonetheless, the Commission received comments on whether the conflict-of-interest policies and procedures mandated under sections 4s(j)(5) and 4d(c) of the CEA should be prescribed by the Commission or by an SRO.

The Futures Industry Association (FIA), ISDA, and SIFMA, in a joint comment, argued that an SRO should oversee and enforce the conflict-of-interest requirements on SDs, MSPs, FCMs, and IBs. FIA, ISDA, and SIFMA stated that SROs would be in a better position than the Commission to address the likely need for future amendments to the rule. The comment suggested that the Commission establish a framework governing the implementation of conflict-of-interest policies and procedures, and instruct the appropriate SRO to write detailed compliance requirements within that framework, including the execution of audit and compliance functions, and the issuance of specific guidance that would be subject to the Commission's review and approval. In a separate comment, JP Morgan expressed a general agreement with the points raised in the FIA/ISDA/SIFMA letter.

Michael Greenberger and UNITE HERE commented that the monitoring and enforcement of the implementation of conflict-of-interest policies and procedures for SDs and MSPs should be carried out by the Commission, as opposed to SROs.

Having considered the comments, the Commission is adopting the rule as proposed on this issue. Unlike section 15D of the Securities Exchange Act of 1934, which mandated that conflict-of-interest rules be adopted either by the SEC, or by a registered securities association or national securities exchange, sections 4s(j)(5) and 4d(c) of the CEA as added by sections 731 and 732 of the Dodd-Frank Act, respectively, direct the CFTC to promulgate such rules. The Commission will continue to collaborate with SROs on conflict-of-interest policies and procedures, particularly with respect to their effectiveness.

2. Exemptive Relief

The Commission's proposal in the FCM/IB NPRM did not expressly address issues surrounding the Commission's exemptive authority. Nonetheless, the Committee on Futures and Derivatives Regulation of the New York City Bar Association argued that, due to the unprecedented scope and breadth of the Commission's rulemakings, the Commission will encounter situations it had not previously considered, rules that do not operate in the manner intended, or unintended consequences when the rules are applied in a specific context. In such situations, exemptive relief would be appropriate and the Commission should prepare for such situations by providing Commission staff with the authority to grant exemptive relief in each rule. Having considered the comment, the Commission does not believe it appropriate to address exemptive relief in this rule. Rather, any person may submit a request for an exemptive, no-action or interpretive letter, in accordance with the procedures set forth in Commission Regulation 140.99.

Further, should any person, in the future, believe that an amendment to a Commission regulation is warranted, such person may petition the Commission for an amendment in accordance with the procedures set forth in Commission Regulation 13.2.

17 CFR 140.99.

17 CFR 13.2.

3. Consistent Conflicts-of-Interest Treatment Between FCMs/IBs and SDs/MSPs

Pierpont Securities Holdings LLC expressed agreement with the Commission's proposal to apply § 23.605 and § 1.71 in a manner that is consistent with one another. The consistency is particularly important in situations where a FCM is an affiliate of, or dually registered as, an SD or MSP. The Commission acknowledges the comment and notes its belief that such consistent treatment is reasonable and reflects the statutory directives and policy goals underlying sections 4d(c) and 4s(j)(5) of the CEA, as amended by sections 732 and 731 of the Dodd-Frank Act, respectively.

4. Definitions—§ 23.605(a), § 1.71(a)

a. Business Trading Unit—§ 23.605(a)(2), § 1.71(a)(2)

The proposed rules defined the term “business trading unit” as “any department, division, group, or personnel of a [SD, MSP, FCM, or IB] or any of its affiliates, whether or not identified as such, that performs or is involved in any pricing, trading, sales, marketing, advertising, solicitation, structuring, or brokerage activities on behalf of a [SD, MSP, FCM, or IB].”

The Commission received a comment from the FHLBs, and a joint comment from FIA, ISDA, and SIFMA, arguing that the Commission should clarify that § 23.605(a)(2) and § 1.71(a)(2) apply to traditional “front office” functions and not to those functions that support the

front office, such as legal, compliance, operations, credit, and human resources functions. FIA/ISDA/SIFMA noted that in order to fulfill legal, compliance, and risk management functions, firms are integrated such that the exclusion of such control and/or support functions should be excluded from the definitions of business trading unit and clearing unit. In a separate comment, JP Morgan expressed a general agreement with the points raised in the FIA/ISDA/SIFMA letter.

In the preambles of the SD/MSP and FCM/IB NPRMs, the Commission noted that the proposed rules are not intended to hinder the execution of sound risk management programs by SDs, MSPs, FCMs, IBs, or by any affiliate of an SD, MSP, FCM, or IB. The Commission's proposals largely addressed the issue raised by the commenters in the proposed definitions of “non-research personnel” at § 23.605(a)(5) and § 1.71(a)(5), which carved out legal and compliance personnel from those definitions. In addition, the final rule modified the definition of non-research personnel to those employees who are not directly responsible for, or otherwise not directly involved in, research or analysis intended for inclusion in a research report. The Commission believes its prior statements and these changes should clarify the scope of the definitions.

Nonetheless, upon reviewing the comments, the Commission has determined it appropriate to modify the definitions. The rule language, as originally proposed, is amended in the final rules to: (1) Clarify that the term includes those persons who directly perform or exercise supervisory authority over the performance of the tasks listed in the rule, and not those who merely are “involved in” such activities, such as the legal, compliance, human resources, risk management, operations, and other support functions; and (2) exclude price verification for risk management purposes from the types of pricing activities covered by the definitions. The Commission believes that these changes will address the issues raised by the commenters while ensuring that the rule text properly reflects the intent of the Commission.

b. Clearing Unit—§ 23.605(a)(3), § 1.71(a)(3)

The proposed rules defined the term “clearing unit” as “any department, division, group, or personnel of a [SD, MSP, FCM, or IB] or any of its affiliates, whether or not identified as such, that performs or is involved in any proprietary or customer clearing activities on behalf of a [SD, MSP, FCM, or IB].”

Similar to the concerns raised in comments on the proposed definition of “business trading unit,” FIA, ISDA, and SIFMA, in a joint comment, argued that the Commission should clarify that § 23.605 and § 1.71 applies to traditional “front office” functions and not to functions that support the front office, such as legal, compliance, operations, credit, and human resources functions. In a separate comment, JP Morgan expressed a general agreement with the points raised in the FIA/ISDA/SIFMA letter.

As stated above with respect to the comments received on the proposed definition of “business trading unit,” the Commission noted in the preambles to the SD/MSP and FCM/IB Conflicts NPRMs that the proposed rules are not intended to hinder the execution of sound risk management programs by SDs, MSPs, FCMs, IBs, or by any affiliate of an SD, MSP, FCM, or IB. The NPRMs largely addressed the issue raised by the commenters in the proposed definitions of “non-research personnel” at § 23.605(a)(5) and § 1.71(a)(5), which carved out legal and compliance personnel from that definition. The Commission reiterates its prior statements on this issue, which should make clear the scope of the definitions.

Nonetheless, upon reviewing the comments, the Commission has determined it appropriate to modify the definitions. The rule language, as originally proposed, is amended in the final rules to clarify that the term includes those persons or groups who perform or exercise supervisory authority over the performance of the tasks listed in the rules, and not those who merely are “involved in” such activities. The Commission believes that these changes will address the issues raised by the commenters while ensuring that the rule text properly reflects the intent of the Commission.

c. Non-Research Personnel—§ 23.605(a)(5)

The proposed rule defined the term “non-research personnel” as “any employee of the business trading unit or clearing unit, or any other employee of the [SD] or [MSP] who is not directly responsible for, or otherwise involved with, research concerning a derivative, other than legal or compliance personnel.”

EEI argued that the Commission should limit the definition of non-research personnel to include only those persons involved with trading, pricing, or clearing activities, and not to other areas.

Upon reviewing the comment, the Commission is adopting the language as originally proposed. The Commission believes that changing the language in the manner suggested by the commenter would increase the risk that SDs or MSPs might attempt to evade the restrictions set forth in the rule.

d. Public Appearance—§ 23.605(a)(6), § 1.71(a)(6)

The proposed rules defined the term “public appearance” as “any participation in a conference call, seminar, forum (including an interactive electronic forum) or other public speaking activity before 15 or more persons, or interview or appearance before one or more representatives of the media, radio, television or print media, or the writing of a print media article, in which a research analyst makes a recommendation or offers an opinion concerning a derivatives transaction.

This term does not include a password-protected webcast, conference call, or similar event with 15 or more existing customers, provided that all of the event participants previously received the most current research report or other documentation that contains the required applicable disclosures, and that the research analyst appearing at the event corrects and updates during the public appearance any disclosures in the research report that are inaccurate, misleading, or no longer applicable.”

The Commission notes that SD and MSP communications with counterparties and potential counterparties also are addressed in the Commission's external business conduct standards rules.

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 (Feb. 17, 2012).

FIA, ISDA, and SIFMA, in a joint comment, argued that the definition of public appearance (speaking before 15 or more “persons”) should articulate that the term “person” includes both a customer that is a natural person and one that is an entity. For example, if a single institutional customer sends 16 employees to a forum held by an SD, MSP, FCM, or IB, each of those employees should not be counted as a “person;” rather, employees from a single institutional customer should be deemed to be one “person” at that forum, for purposes of the rule. In a separate comment, JP Morgan expressed a general agreement with the points raised in the FIA/ISDA/SIFMA letter.

Upon reflection, the Commission agrees with the commenters, and is altering the rules to incorporate the

recommendation offered by the commenter. Specifically, the Commission is modifying the rule to clarify that the term “persons” in this context refers to either natural persons or entities. Thus, for example, if a single entity sends multiple natural persons as representatives to a public speaking activity that may be subject to the rule, such natural persons would be counted as a single “person” for purposes of determining whether the public speaking activity meets the definition of “public appearance.”

e. Research Department—§ 23.605(a)(8), § 1.71(a)(8)

The proposed rules defined the term “research department” as “any department or division that is principally responsible for preparing the substance of a research report relating to any derivative on behalf of a [SD, MSP, FCM, or IB], including a department or division contained in an affiliate of a [SD, MSP, FCM, or IB].”

FIA, ISDA, and SIFMA, in a joint comment, argued that the scope of “research department,” and the restrictions imposed by the proposed rules concerning research departments, should not apply to the global affiliates of an SD, MSP, FCM, or IB. FIA/ISDA/SIFMA posited that the imposition of such restrictions on global affiliates would create significant logistical hurdles and expenses for multinational firms, especially in situations where an affiliate has no significant interaction with the SD, MSP, FCM, or IB. Further, FIA/ISDA/SIFMA suggested that local regulations governing non-US affiliates may not permit such non-US affiliates to comply with the rules. As an alternative, FIA/ISDA/SIFMA suggested that the Commission limit the rules to requiring disclosure “on third party research reports,” and focus the Commission's enforcement resources on SDs, MSPs, FCMs, and IBs that attempt to evade the rule by moving research analysts to affiliates. In a separate comment, JP Morgan expressed a general agreement with the points raised in the FIA/ISDA/SIFMA letter.

Upon reviewing the comments, the Commission has determined it appropriate to adopt the rules as originally proposed. The Commission believes that the alternatives suggested by FIA/ISDA/SIFMA would increase the risk of evasion by multinational registrants. Such risk of evasion outweighs any benefit to be derived from the proffered alternative. However, to clarify any ambiguity that may exist in the rules adopted herein, the Commission confirms that a holding company need not examine the research functions of all of its affiliates under these rules; rather, a holding company needs only to look at those research groups doing research on behalf of an SD, MSP, FCM, or IB. In light of its stated intent, the Commission believes that the cost-effectiveness of the rules will be promoted.

f. Research Report—§ 23.605(a)(9), § 1.71(a)(9)

The proposed rules defined the term “research report” as: “[A]ny written communication (including electronic) that includes an analysis of the price or market for any derivative, and that provides information reasonably sufficient upon which to base a decision to enter into a derivatives transaction.” However, the proposals expressly excluded four categories of communications from coverage by the definitions.

FIA, ISDA, and SIFMA, in a joint comment, argued that the exclusions from the definition of “research report” should be expanded to include general market discussions and other communications that are not “research reports” in other regulatory contexts. The definitions should be limited to those research reports analyzing a specific derivative or futures transaction. Exclusions set forth in other regulatory contexts—specifically NASD Rule 2711(a)(9)(A) and SEC Regulation AC—should be included in the Commission's definitions of “research report.” FIA/ISDA/SIFMA further argued that communications produced by a business trading unit labeled as a “trading/sales desk product” and as “non-research” should be excluded from the definitions of research report. In a separate comment, JP Morgan expressed a general agreement with the points raised in the FIA/ISDA/SIFMA letter.

EEI argued that the Commission should exclude from the definition any communication between an SD or MSP, and its regulator, concerning hedging activity. The commenter posited that firms with small trading operations should be permitted to publish occasional research reports to justify trading decisions, without being subject to the rules set forth in the SD/MSP Conflicts NPRM.

The National Futures Association (NFA) argued that the definition in proposed § 1.71(a)(9) was too broad and suggested that the definition be limited to reports containing material information at a level of detail that amounts to “a call to action to the customer,” or that could have a price impact on the market for a particular product. NFA also argued that the definition should include an exception for general market commentary, similar to NASD Rule 2711. Newedge USA LLC (Newedge) also argued that the definition in proposed § 1.71(a)(9) was too broad, because any discussion of a derivative that references the underlying physical commodity or financial instrument could be deemed to provide “information reasonably sufficient upon which to base a decision to enter into a derivatives transaction.” Newedge contended that the definition of research report should be restricted to “any written communication * * * including an analysis of the price/market for any specific derivative contract, and that provides information reasonably sufficient upon which to base a decision to enter into a transaction involving such specific derivative contract.”

ADM Investor Services Inc. commented on the differences between daily research reports and weekly and monthly research reports, arguing that proposed § 1.71(a)(9) unnecessarily threatened existing industry practices, particularly with respect to opening and closing comments or intraday market comments by IBs, which do not consist of detailed research but could be covered by the proposed definition of “research report.”

Having considered the comments, the Commission has determined it appropriate to modify the exclusions to the definitions of “research report,” as that term was proposed in the SD/MSP and FCM/IB Conflicts NPRMs. Specifically, the Commission agrees with FIA/ISDA/SIFMA's recommendation that “commentaries on economic, political, or market conditions” and “statistical summaries of multiple companies' financial data, including listings of current ratings” should be excluded from the definitions of research report. With regard to the exclusion for commentaries on economic or market conditions, the Commission believes that there are distinguishing characteristics between research reports setting forth factual statements about the market for specific derivatives and commentaries that provide opinion on general economic, political, or market conditions. Accordingly, the Commission has modified the rules to incorporate those two exclusions into the definitions of “research report.”

However, the Commission does not believe that other types of communications should be excluded from the definitions, because they could represent the core focus of a research department doing research on behalf of an SD, MSP, FCM, or IB, e.g., asset

classes, economic variables commonly referenced in derivatives, and on-the-run swap rates. Adopting the NASD 2711 exclusion for analysis concerning economic variables (e.g. rates, inflation) that are commonly referenced in derivatives, would create an exception that would swallow the rule. For example, research conducted on trends in the interest rate, gold, or oil markets are inextricably linked to the swap markets that reference those underlying assets or rate.

The Commission believes that the changes adopted herein will increase consistency with NASD Rule 2711, which was promulgated pursuant to section 15D of the Securities Exchange Act. The Commission believes that the rules, in final form, provide SDs, MSPs, FCMs, and IBs with sufficient flexibility concerning solicitation materials generated by the trading unit, given the exclusion from coverage of “[a]ny communication generated by an employee of the business trading unit that is conveyed as a solicitation for entering into a derivatives transaction, and is conspicuously identified as such.”

The Commission notes that SD and MSP communications with counterparties and potential counterparties are addressed in the Commission's external business conduct standards rules.

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 (Feb. 17, 2012).

5. Policies and Procedures—§ 23.605(b)

As proposed, § 23.605(b) required each SD and MSP to “adopt and implement written policies and procedures reasonably designed to ensure that the [SD] or [MSP] and its employees comply with the provisions of this rule.” Chris Barnard commented that the prevention of SDs and MSPs from engaging in activities with actual, perceived, or potential conflicts of interest will improve transparency and confidence in the markets, and will reduce risk. The Commission acknowledges the comment and is adopting § 23.605(b) without revision.

6. Research Analysts and Research Reports—§ 23.605(c), § 1.71(c)

a. Separation of Research Analysts From Business Trading Unit and Clearing Unit—§ 23.605(c)(1)

Proposed §§ 23.605 and 1.71 prescribed certain restrictions on the relationship between the research department and all non-research personnel. Such restrictions included limitations on influencing the content of research reports, the supervision of research analysts, and the review or approval of research reports.

With regard to this proposed rule, MFA suggested that the Commission provide additional clarity on the proposed rule by further describing the bright lines of separation between the research department and non-research personnel. For example, the commenter queried whether an SD may house its research department and trading department in the same building or on the same floor, and whether different key cards for entry into each department are required by the rule. Additionally, BlackRock commented that the Commission “should explicitly exempt entities whose research personnel produce reports for internal use only.”

After reviewing the comments, the Commission believes that the comments raised by the commenters may best be addressed through clarification of the underlying intent of the rule. Accordingly, the Commission has determined it appropriate to adopt the rule as it was originally proposed. First, with respect to MFA's comments, the rule does not expressly require physical separation of the research department and all non-research personnel; however, such separation will be considered by the Commission to be a good practice by registrants in order to minimize the risk of violating the rule. Second, with respect to BlackRock's comments, the Commission believes that the issue of internal research reports is adequately addressed by proposed § 23.605(a)(9)(iv), which excluded from the definition of “research report” any “internal communications that are not given to current or prospective customers.”

This language is being adopted by the Commission as proposed; however, the provision has been renumbered as § 23.605(a)(9)(vi).

b. Conflicts of Interest Adequately Addressed by Existing Commission and NFA Rules

Proposed § 1.71 did not discuss the issue of whether existing Commission and NFA rules adequately address the directives set forth in section 4d(c) of the CEA as amended by section 732 of the Dodd-Frank Act. Nonetheless, the Commission received comments that raised the issue.

NFA commented that certain of its existing rules address issues raised in the Commission's rule proposal, and that the specific requirements related to research reports that may not be directly applicable to derivatives could have unintended consequences. K&L Gates LLP (on behalf of Peregrine Financial Group Inc.), ADM Investor Services Inc., John Stewart & Associates Inc., and Stewart-Peterson Group Inc. each argued that the issues addressed by the proposed rule are already addressed through existing rules.

Swaps and Derivatives Market Association commented that the proposed rules should be adopted as they were originally proposed.

After considering the comments, the Commission has determined it appropriate to adopt the rule, as it was originally proposed, on this issue. Although certain Commission and NFA rules tangentially address the issues set forth in the proposed rule, section 732 of the Dodd-Frank Act directed the Commission to take certain actions beyond the requirements previously promulgated in the rules of the Commission and NFA. Further, given the similarities between section 4d(c) of the CEA as amended by section 732 of the Dodd-Frank Act, and section 15D of the Securities Exchange Act of 1934, the Commission believes that it is important to provide a measure of specificity with respect to the conflict-of-interest policies and procedures mandated under section 4d(c) and § 1.71. Such specificity will promote consistency in the marketplace. Further, by maintaining consistency—to the extent warranted—with NASD Rule 2711, the Commission believes that the proposed rule will minimize disruption to the marketplace, given that such standards are well-established in the financial industry.

c. Treatment of Small IBs

As proposed, § 1.71 did not establish a separate standard for small IBs. However, in the preamble of the proposed rule, the Commission expressly invited comment on how these rules should apply to FCMs and IBs, considering the varying size and scope of the operations of such firms. The preamble noted, as an example of how the rule could be adjusted to account for firms of different sizes, that NASD Rule 2711(k) provides an exception from certain requirements for `small firms,' defined to include those firms that over the past three years have participated in ten or fewer investment banking services transactions and generated $5 million or less in gross investment banking services revenues from those transactions. The Commission solicited comment on whether a similar approach should be adopted for small FCMs and IBs. Moreover, the exceptions to the definition of research report were designed to address issues typically found in smaller firms where individuals in the trading unit perform

their own research to advise their clients or potential clients.

Several commenters suggested that small IBs should be excepted from the proposed rule. NFA argued that the proposed rule effectively could prohibit the business model of a number of firms that provide an important service to the industry, particularly with respect to agriculture. The commenter suggested that, in adopting an exception for small IBs, the Commission could consider the following factors: A firm's gross annual revenue, number of associated persons, number of annual futures transactions, and nature of the customer base. National Introducing Brokers Association, ADM Investor Services Inc., John Stewart & Associates Inc., and Stewart-Peterson Group Inc. each argued that implementing the proposed rules would be prohibitively costly, burdensome, and unnecessary for small IBs, particularly for IBs dealing with agricultural commodities, and would force small IBs out of business. Chris Barnard noted that small IBs lack the capacity to carry the proportionately heavier regulatory burden set forth in the proposed rule, and as such, some regulatory mitigation would be beneficial, based on number of staff or revenues. Multiple commenters also commented on the limited market price impact of research reports created or distributed by small IBs, as well as the potential that the normal duties of associated persons may be deemed to be research activities for purposes of the rule.

The Commission recognizes and agrees with certain concerns raised by the commenters. Thus, upon review of the comments, the Commission is adopting a separate regulatory standard for small IBs, reflecting the alternative set forth in the preamble of the proposed rule. Section 4d(c) of the CEA mandates the establishment of “appropriate informational partitions” within FCMs and IBs, and all such firms are bound by that statutory requirement. However, the Commission recognizes that the size of an IB plays a significant role in determining the appropriateness of such partitions. Accordingly, the rule, in its final form, establishes a separate standard for any IB that has generated, over the preceding 3 years, $5 million or less in aggregate gross revenues from its activities as an IB. This standard is similar to language in NASD Rule 2711 that was raised expressly as a possible alternative in the preamble of the proposed rule.

For any IB meeting those financial requirements, § 1.71(c) of the rule would not apply. Further, § 1.71(b) has been changed to set forth a separate policies and procedures requirement for small IBs. The recommended language of new § 1.71(b)(2) largely mirrors the statutory requirement of section 4d(c). However, the Commission believes that small IBs should be subject to § 1.71(e) (policies and procedures mandating disclosure of material incentives and conflicts of interest) and § 1.71(f) (recordkeeping and reporting).

The Commission believes that these changes to the rule, as originally proposed, will address the concerns raised by the commenters and limit the cost burden imposed on small IBs.

The provisions of § 1.71(d) are applicable only to FCMs.

Finally, the Commission notes that commentaries on market conditions have been excluded from the definition of “research report,” as discussed above.

d. Insider Trading and Futures Markets

Proposed § 1.71 did not address insider trading in the futures markets, or how that issue impacts the implementation of section 732 of the Dodd-Frank Act. Nonetheless, the Commission received comments on the issue. Specifically, K&L Gates LLP (on behalf of Peregrine Financial Group Inc.), John Stewart & Associates Inc., ADM Investor Services Inc., and Stewart-Peterson Group Inc. each argued that the proposed rules inappropriately relied upon established rules in the securities industry, claiming that no ban on insider trading exists in the futures industry. Further, ADM Investor Services Inc. and Stewart-Peterson Group Inc. each contended that only the publication of a U.S. Department of Agriculture market report could have a dramatic effect on the futures market.

Having considered the comments, the Commission has determined not to modify the rule on this issue. Section 732 of the Dodd-Frank Act directed the Commission to take actions concerning conflict-of-interest policies and procedures, and in that provision, Congress included language previously included in section 15D of the Securities Exchange Act of 1934. Section 15D directed that regulatory language be promulgated to implement that statute, and those regulatory standards are now well-established in the financial industry. Given the similarities in statutory language, coupled with the well-established principles set forth in NASD Rule 2711, the Commission believes that it is important to provide a measure of specificity with respect to the conflict-of-interest policies and procedures mandated under section 4d(c) and the proposed rule. Such specificity will promote consistency and certainty in the marketplace. Further, by maintaining consistency—to the extent warranted—the Commission believes that the final rule will minimize disruption to the marketplace.

e. Exception for FCMs If Engaged in Only a

de minimis

Amount of Proprietary Trading

Proposed § 1.71 did not set forth a de minimis exception for FCMs. Nonetheless, the Commission received a comment from Newedge, which argued that FCMs engaging in minimal proprietary trading should not be subject to the provisions relating to research analysts. The commenter stated that the proposed rule would impose unnecessary burdens, and that a firm that engages in only limited proprietary trading does not present a risk of conflicts of interest.

Having considered the comment, the Commission does not believe it appropriate to modify the proposed rule on this issue. The imposition of a de minimus exception to the conflicts rule is inconsistent with the statutory directive that Congress set forth in section 732 of the Dodd-Frank Act, which does not distinguish between proprietary trading and trading for the accounts of customers. Moreover, the limited nature of a firm's proprietary trading does not serve to negate the issues intended to be addressed through the statutory mandate.

f. Lack of Examples of Research-Related Conflicts of Interest in the Futures Industry

Proposed § 1.71 did not cite specific examples of conflicts of interest in the futures industry, nor did it discuss the prevalence of conflicts in the industry. Nonetheless, the Commission received comments relating to those issues. K&L Gates LLP (on behalf of Peregrine Financial Group Inc.) commented that the Commission failed to cite any evidence of conflicts of interest arising from the publication of research reports. NFA commented that it had issued guidance prohibiting a FCM or IB from trading in a security futures product in anticipation of the issuance of a related research report, but that the commenter was unaware of any instances of conflicts of interest in research reports of security futures products. Further, Senator Carl Levin commented that the Commission should encourage compliance by developing examples of potential or actual conflicts of interest that should be disclosed to investors.

After considering the comments, the Commission has decided not to modify

the proposed rule on this issue. Section 732 of the Dodd-Frank Act directed the Commission to take certain actions concerning conflict-of-interest policies and procedures. Specifically, as noted in the preamble of proposed § 1.71, section 732 “requires, in relevant part, that FCMs and IBs implement conflicts of interest systems and procedures that `establish structural and institutional safeguards to ensure that the activities of any person within the firm relating to research or analysis of the price or market for any commodity are separated by appropriate informational partitions within the firm from the review, pressure, or oversight of persons whose involvement in trading or clearing activities might potentially bias the judgment or supervision of the persons.'” This statutory language draws he

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