[Federal Register Volume 78, Number 215 (Wednesday, November 6, 2013)]
[Rules and Regulations]
[Pages 66621-66637]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-26479]



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  Federal Register / Vol. 78, No. 215 / Wednesday, November 6, 2013 / 
Rules and Regulations  

[[Page 66621]]



COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 23 and 190

RIN 3038-AD28


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

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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

DATES: Effective date: This rule is effective January 6, 2014.
    Compliance dates: For uncleared swap transactions that are entered 
into with ``new counterparties,'' \1\ all persons shall be in 
compliance with the requirements set forth in Subpart L of Part 23 not 
later than May 5, 2014. For uncleared swap transactions that are 
entered into with ``existing counterparties,'' \2\ all persons shall be 
in compliance with the requirements set forth in Subpart L of Part 23 
not later than November 3, 2014. All parties must comply with the Part 
190 rules by January 6, 2014.
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    \1\ A ``new counterparty'' is a counterparty with whom, at the 
time of the effective date of this final rule, no agreement exists 
between the SD or MSP and that counterparty concerning uncleared 
swaps.
    \2\ An ``existing counterparty'' is a counterparty with whom, at 
the time of the effective date of this final rule, an agreement 
exists between the SD or MSP and that counterparty concerning 
uncleared swaps.

FOR FURTHER INFORMATION CONTACT: Robert B. Wasserman, Chief Counsel, 
Division of Clearing and Risk (DCR), at 202-418-5092 or 
[email protected]; Laura Astrada, Associate Chief Counsel, DCR, at 
202-418-7622 or [email protected]; Thomas Smith, Deputy Director, 
Division of Swap Dealer and Intermediary Oversight at 202-418-5495 or 
[email protected]; or Martin White, Assistant General Counsel, Office of 
the General Counsel at 202-418-5129 or [email protected]; in each case, 
also at the Commodity Futures Trading Commission, Three Lafayette 
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Centre, 1155 21st Street NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION: 

Table of Contents

I. Background
    A. Statutory Background
    B. Section 4s(l) of the CEA
    C. Section 20(c) of the CEA
II. Margin Segregation for SD or MSP Counterparties With Respect to 
Uncleared Swaps
    A. Regulation 23.700: Definitions
    B. Regulation 23.701: Notification of Right to Segregation
    C. Regulation 23.702: Requirements for Segregated Margin
    D. Regulation 23.703: Investment of Segregated Margin
    E. Regulation 23.704: Requirements for Non-Segregated Margin
    F. Compliance Date
III. Portfolio Margining
IV. Related Matters
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act
    C. Cost-Benefit Considerations

I. Background

A. Statutory Background

    On July 21, 2010, President Obama signed the Dodd-Frank Act.\3\ 
Title VII of the Dodd-Frank Act \4\ amended the Commodity Exchange Act 
(``CEA'') \5\ to establish a comprehensive new regulatory framework for 
swaps and certain security-based swaps. The legislation was enacted to 
reduce risk, increase transparency, and promote market integrity within 
the financial system by, among other things: (i) Providing for the 
registration and comprehensive regulation of SDs and MSPs; (ii) 
imposing mandatory clearing and trade execution requirements on 
clearable swap contracts; (iii) creating recordkeeping and real-time 
reporting regimes; and (iv) enhancing the rulemaking and enforcement 
authorities of the Commission with respect to, among others, all 
registered entities and intermediaries subject to the oversight of the 
Commission.
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    \3\ Public Law 111-203, 124 Stat. 1376 (2010). The text of the 
Dodd-Frank Act may be accessed at http:www.cftc.gov/ucm/groups/public/@swaps/documents/file/hr4173_enrolledbill.pdf.
    \4\ Pursuant to section 701 of the Dodd-Frank Act, Title VII may 
be cited as the ``Wall Street Transparency and Accountability Act of 
2010''.
    \5\ 7 U.S.C. 1 et seq.
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    Section 724(c) of the Dodd-Frank Act amended the CEA to add section 
4s(l), which includes provisions concerning the rights of 
counterparties to SDs and MSPs with respect to the treatment of such 
counterparty's margin for uncleared swaps. As discussed further in Part 
II of this preamble, these changes are implemented in new Subpart L to 
Part 23 of Title 17, Sec. Sec.  23.700 through 23.704.\6\
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    \6\ The Commission notes that these rules were proposed as 
Sec. Sec.  23.600 through 23.604. Because other rulemakings use 
these sections, this final rulemaking will use and reference 
Sec. Sec.  23.700 through 23.704 throughout, notwithstanding the 
numbering in the proposal.
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    Section 713(c) of the Dodd-Frank Act amends the CEA to add, as 
section 20(c) thereof, a provision that requires the Commission to 
exercise its authority to clarify the legal status, in the event of a 
commodity broker bankruptcy, of (i) securities in a portfolio margining 
account held as a futures account, and (ii) an owner of such account.

B. Section 4s(l) of the CEA

    Section 4s(l) of the CEA sets forth certain requirements concerning 
the rights of counterparties of SDs and MSPs with respect to the 
segregation of money, securities, or other property used to margin, 
guarantee, or otherwise secure uncleared swaps. These requirements 
apply only to initial margin. Section 4s(l) requires that:

[[Page 66622]]

     An SD or MSP notify each counterparty at the beginning of 
a swap transaction that the counterparty has the right to require 
segregation of the funds or other property supplied to margin, 
guarantee, or secure the counterparty's obligations; \7\ and
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    \7\ In a separate rulemaking, the Commission proposed ``minimum 
initial and variation margin requirements'' for each SD or MSP for 
which there is no prudential regulator as a way to ``help ensure the 
safety and soundness of the [SD or MSP].'' See Margin Requirements 
for Uncleared Swaps for Swap Dealers and Major Swap Participants, 76 
FR 23732 (Apr. 28, 2011). Among other things, the Commission 
proposed to require SDs and MSPs to segregate margin for uncleared 
swaps that such SD or MSP receives from other SDs and MSPs 
(hereinafter known as the ``SD/MSP Specific Segregation 
Requirements''). See id. at 23748. Thus, under that proposal, even 
if an SD or MSP did not exercise its right to require segregation of 
the funds or other property that it supplies to margin, guarantee, 
or secure its obligation, such funds or other property would 
nonetheless be segregated.
    The U.S. banking regulators have proposed similar segregation 
requirements for those SDs and MSPs that are prudentially regulated 
and that will be subject to their margin rules. See Margin and 
Capital Requirements for Covered Swap Entities, 76 FR 27564 (May 11, 
2011). The Commission is continuing to consider this proposal in 
light of this related work by U.S. banking regulators and related 
efforts by regulators in other countries. The Commission is aware of 
the importance of developing consistent SD/MSP Specific Segregation 
Requirements where possible in order to address systemic risk issues 
and to avoid regulatory arbitrage concerns. See also section 752 of 
the Dodd-Frank Act.
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     at the request of the counterparty, the SD or MSP shall 
segregate such funds or other property with an independent third party 
custodian. The funds or other property of the counterparty must be kept 
in a segregated account with an independent third party, designated for 
and on behalf of that counterparty, separate from the assets and other 
interests of the SD or MSP.

C. Section 20(c) of the CEA

    Section 713(c) of the Dodd-Frank Act, codified as section 20(c) of 
the CEA, directs the Commission to exercise its authority to ensure 
that securities held in a portfolio margining account carried as a 
futures account are customer property and the owners of those accounts 
are customers for the purposes of subchapter IV of chapter 7 of title 
11.

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

    The Commission sought public comment on customer collateral 
protection with respect to money, securities, or other property used to 
margin, guarantee, or otherwise secure uncleared swaps. First, on 
October 22, 2010, the Commission, through its staff, held a roundtable 
to discuss individual customer collateral protection with respect to 
cleared and uncleared swaps.\8\ Following consideration of the comments 
made during the roundtable, on December 3, 2010, the Commission issued 
a Notice of Proposed Rulemaking (``NPRM''),\9\ and sought comment on 
all aspects of the NPRM, including the definition of initial margin, 
counterparty notification, the nature of the custodian, and the 
investment of segregated collateral.\10\ The Commission received 
comments from twenty-two different commenters regarding the proposed 
regulations in the NPRM.\11\ The Commission, through its staff, also 
met extensively with market participants both prior to and following 
issuance of the NPRM.
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    \8\ The transcript from the roundtable is available at: http://www.cftc.gov/ucm/groups/public/@swaps/documents/dfsubmission/dfsubmission6_102210-transcrip.pdf.
    \9\ See Protection of Collateral of Counterparties to Uncleared 
Swaps; Treatment of Securities in a Portfolio Margining Account in a 
Commodity Broker Bankruptcy, 75 FR 75432 (Dec. 3, 2010).
    \10\ The comment period closed on February 1, 2011, and was 
reopened for 30 days on May 4, 2011. See Reopening and Extension of 
Comment Periods for Rulemakings Implementing the Dodd-Frank Wall 
Street Reform and Consumer Protection Act, 76 FR 25274 (May 4, 
2011).
    \11\ Letters were received from Alternative Investment 
Management Association Limited (AIMA), American Gas Association 
(AGA), the Asset Management Group (AMG) of Securities Industry and 
Financial Markets Association (SIFMA), Edison Electric Institute 
(EEI), Federal Home Loan Banks (FHLB), Federated Investors, Inc. 
(Federated), Fidelity Investments (Fidelity), Intercontinental 
Exchange, Inc. (ICE), International Swaps and Derivatives 
Association (ISDA), Investment Company Institute (ICI), Managed 
Funds Association (MFA), MetLife Inc. (MetLife), National Rural 
Electric Cooperative Association (NRECA), New York City Bar 
Association (NYCBA), Norges Bank Investment Management (Norges), 
State Street Corporation (State Street), SIFMA, SIFMA and ISDA 
(SIFMA/ISDA), and the Working Group of Commercial Energy Firms 
(Working Group). NYCBA's letter was a pre-NRPM letter dated November 
29, 2010. SIFMA's letter was a pre-NPRM letter dated October 27, 
2010. Federated submitted two letters, both of which focused on the 
investment of segregated funds. The Commission also received letters 
from the following individuals: Chris Barnard, Leigh Mckeirnan, and 
Bill Granberry.
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A. Regulation 23.700: Definitions

1. ``Segregate''
    In the NPRM, the Commission proposed to define ``segregate'' 
according to its commonly-understood meaning: To keep two or more items 
in separate accounts, and to avoid combining them in the same transfer 
between two accounts.
    One commenter agreed with the Commission's proposed definition of 
``segregate.'' \12\ Another commenter requested clarification regarding 
the definition of the term segregate and whether it requires that 
collateral be held in an individual customer account or whether such 
term permits an SD or MSP to hold segregated customer collateral in an 
omnibus customer account.\13\ The Commission notes that section 
4s(l)(3)(B) requires that a segregated account be ``designated as a 
segregated account for and on behalf of the counterparty.'' \14\ 
Moreover, regulation 23.702(b) of the final rules requires initial 
margin that is segregated pursuant to a counterparty's election to be 
held in an account for and on behalf of the counterparty.\15\ Thus, 
regulation 23.702(b) requires initial margin to be held in an 
individual customer account. As such, the Commission is adopting the 
definition of ``segregate'' as proposed.
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    \12\ See AIMA letter at 2.
    \13\ Working Group letter at 3.
    \14\ 7 U.S.C. 6s(l)(3)(B).
    \15\ See discussion in section C.1 infra.
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2. ``Variation Margin''
    The Commission proposed to define ``variation margin'' (for which a 
counterparty does not have the right to segregation as section 
4s(l)(2)(B)(i) prescribes) as an amount calculated to cover the current 
exposure arising from changes in the market value of the position since 
the trade was executed or the previous time the position was marked to 
market.
    Six commenters discussed the ``variation margin'' definition.\16\ 
SIFMA/ISDA wrote that the concept of variation margin is different in 
the over-the-counter swaps market than it is in the futures market.\17\ 
In particular, SIFMA/ISDA noted that parties to swaps do not ``pay'' 
margin to each other based on mark-to-market prices; rather they post 
and grant a security interest in collateral based on estimated payment 
amounts derived from current market conditions.\18\ SIFMA/ISDA 
recommended replacing the term ``variation margin'' with the term 
``exposure collateral,'' and defining ``exposure collateral'' to mean 
``money, securities or property posted by a party to secure its 
obligations pursuant to the terms of a swap agreement, the amount of 
which is based on an estimate of the net mark-to-market exposure of all 
transactions under the master swap agreement.'' \19\ AIMA wrote that 
the

[[Page 66623]]

proposed definition of ``variation margin'' was appropriate.\20\
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    \16\ SIFMA/ISDA, ISDA, FHLB, NRECA, AIMA, AMG.
    \17\ SIFMA/ISDA letter at 2. See also ISDA letter at 2.
    \18\ SIFMA/ISDA letter at 2. See also ISDA letter at 2.
    \19\ SIFMA/ISDA letter at 3. See also ISDA letter at 3.
    \20\ AIMA letter at 1.
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    The fact that the statute refers to ``variation margin'' indicates 
that Congress was contemplating the use of the term ``variation 
margin'' as opposed to ``exposure collateral.'' For the sake of 
consistency with other regulations, the Commission is amending the 
definition of ``variation margin'' to add the phrase ``or collateral 
posted by'' after the phrase ``a payment made by''. However, the 
Commission agrees with SIFMA/ISDA's comments regarding the fact that in 
the uncleared OTC derivatives markets, parties do not necessarily 
``pay'' variation margin to each other, and instead post 
collateral.\21\ The Commission therefore notes that although the 
definition of variation margin will include payments, where a payment 
is made, there would not be any collateral to be segregated. The 
definition is otherwise being adopted as proposed.
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    \21\ SIFMA/ISDA letter at 2. See also ISDA letter at 2.
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3. ``Initial Margin''
    The Commission proposed to define ``initial margin'' (for which a 
counterparty has the right to segregation pursuant to CEA section 
4s(l)) as an amount calculated based on anticipated exposure to future 
changes in the value of a swap.
    Ten commenters addressed the definition of ``initial margin.'' \22\ 
ICI wrote that the proposed definition of initial margin was too broad, 
and might be interpreted to also include variation margin.\23\ By 
contrast, Fidelity suggested that ``the proposed definition of `initial 
margin' may be too narrow and could exclude `upfront' deliveries of 
collateral that should properly be treated as initial margin.'' \24\ 
FHLB recommended that the term ``independent amount'' be used instead 
of ``initial margin.'' \25\ However, if the Commission elects to use 
the term ``initial margin,'' FHLB argued that the definition of 
``initial margin'' should, at the very least, track and reference 
``independent amount'' as it appears in the ISDA documentation.\26\ 
SIFMA/ISDA also recommended that the term ``independent amount'' be 
used in the place of ``initial margin,'' and suggested that 
``independent amount'' be defined to mean ``money, securities or 
property posted by a party to secure its obligations pursuant to the 
terms of a swap agreement and that is either (i) specified as an 
[`independent amount'] in the relevant agreement of the parties or (ii) 
calculated based upon terms agreed between the parties (in either case, 
in addition to and separately from any [exposure collateral] 
requirement).'' \27\ Chris Barnard suggested that the Commission 
clarify that initial margin is posted at the commencement or outset of 
a swap transaction as a way to distinguish initial margin from 
variation margin.\28\ AIMA and MetLife wrote that the proposed 
definition of initial margin was appropriate.\29\
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    \22\ ICI, Fidelity, FHLB, AMG, ISDA, Chris Barnard, AIMA, NRECA, 
MetLife, SIFMA/ISDA.
    \23\ ICI letter at 2.
    \24\ Fidelity letter at 2.
    \25\ FHLB letter at 6.
    \26\ FHLB letter at 6. See also AMG letter at 5.
    \27\ SIFMA/ISDA letter at 2-3. See also ISDA letter at 2-3.
    \28\ Chris Barnard letter at 1.
    \29\ AIMA letter at 1. See also MetLife letter at 3, stating 
that for purposes of the proposed rule, the definition of initial 
margin was sufficient, although noting it would request more 
specific guidance for calculating initial margin in the event of 
``future use or expanded definition.''
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    The Commission has considered the comments and understands that 
some commenters prefer the traditional practice of using the term 
``independent amount.'' However, the statute uses the term ``variation 
margin'' and the obvious complimentary term to ``variation margin'' 
would be ``initial margin.'' Moreover, a reference to ``independent 
amount,'' by itself, would not be effective, since the definition of 
``independent amount'' in the ISDA ``Credit Support Annex'' directs the 
reader to a form.\30\ A reference to a form would not be desirable as a 
definition both because it is ambiguous and because the substance of 
the form is subject to change. Therefore, the Commission is adopting 
the definition of initial margin as proposed.
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    \30\ See Paragraph 13 of the ISDA Credit Support Annex. See also 
definition of ``Independent Amount'' in the ISDA Credit Support 
Annex.
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B. Regulation 23.701: Notification of Right to Segregation

1. Required Notification
    Proposed regulation 23.601(a) \31\ implemented the statutory 
requirement set forth in section 4s(l)(1)(A) of the CEA. Specifically, 
with respect to an uncleared swap, proposed regulation 23.601(a) would 
have required an SD or MSP to notify each of its counterparties that a 
counterparty has the right to require any initial margin posted by it 
to be segregated in accordance with Commission regulations.\32\ The 
Commission also stated that it interpreted the language of CEA section 
4s(l)(1)(A) as a segregation right that can be elected or renounced by 
the SD's or MSP's counterparty in its discretion.\33\ As stated in the 
NPRM, Congress's description as a ``right'' of what would otherwise be 
a simple matter for commercial negotiation suggests that this decision 
is an important one, with a certain degree of favor given to an 
affirmative election.\34\ As such, in implementing section 4s(l)(1)(A) 
the Commission is requiring SDs and MSPs to offer their counterparties 
segregation that meets the minimum standards set forth in these rules. 
However, SDs, MSPs and counterparties may negotiate alternative 
arrangements for the handling of collateral if all parties agree.
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    \31\ As discussed above, section numbers in the NPRM are 
slightly different from those in this final rulemaking. See supra n. 
6. Proposed regulation 23.601(a) is being finalized herein as 
regulation 23.701(a).
    \32\ 75 FR at 75433 (Dec. 3, 2010).
    \33\ See also CEA section 4s(l)(4) (referring to cases where the 
counterparty ``does not choose to require segregation'' of margin). 
7 U.S.C. 6s(l)(4).
    \34\ 75 FR at 75433 (Dec. 3, 2010).
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    In the NPRM, the Commission did not propose specific disclosure 
requirements with respect to this notification. Instead, the Commission 
requested comment as to whether the SD or MSP should be required to 
disclose the price of segregation, the price of fees to be paid to the 
custodian (if the SD or MSP is aware of the amount of such fees), or 
differences in the terms of the swap that the SD or MSP is willing to 
offer to the counterparty (e.g., differences in the fixed interest rate 
for an interest rate swap) if the counterparty elects or renounces the 
right to segregation.\35\
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    \35\ Id.
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    Thirteen commenters discussed the costs associated with 
segregation,\36\ with most expressing concern about proper price 
disclosures by the SDs and MSPs. Two commenters indicated that price 
disclosure was not particularly important.
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    \36\ AMG, MFA, State Street, AGA, Fidelity, ICI, SIFMA/ISDA, 
ISDA, FHLB, Chris Barnard, AIMA, MetLife, EEI.
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    Several commenters expressed concern that an SD or MSP would not 
make counterparties aware of the price associated with segregation and 
might impose higher prices or offer less attractive terms to 
counterparties electing segregation.\37\ MFA recommended ``that the 
Commission require SDs and MSPs to provide counterparties with robust 
disclosure of all costs that the SD or MSP will charge to the 
counterparty if the counterparty elects to segregate its initial 
margin.'' \38\ State Street suggested that ``the Commission should . . 
. provide that, although the pricing of the same

[[Page 66624]]

transaction with and without a segregated account may differ, the 
pricing difference should be reflective of actual out-of-pocket costs 
expected to be incurred by the [SD/MSP] as a result of use of the 
segregated account, and that the nature and amounts of those costs 
should be fully disclosed.'' \39\ AGA argued that, without proper 
disclosure, counterparties will be forced ``to exercise in a vacuum 
their right to seek segregation of initial margin for an uncleared 
swap'' and suggested that each SD or MSP be required to notify each 
counterparty as to the price of having a third party hold 
collateral.\40\
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    \37\ AMG letter at 8.
    \38\ MFA letter at 4.
    \39\ State Street letter at 3.
    \40\ AGA letter at 4. See also Fidelity letter at 3.
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    ICI sought to distinguish between fees charged by the custodian--
which ICI does not believe need be disclosed by the SD or MSP--and fees 
embedded in the SD's swaps pricing for not having access to the 
customer's collateral.\41\ SIFMA/ISDA do not believe that mandating 
disclosure is necessary or desirable because ``a counterparty can 
always, in accordance with current market practice, request the 
disclosures it considers necessary from its SD/MSP . . . [and] 
mandatory disclosure by the SD/MSP is impractical because much of the 
material costs are within the control of a third party: the 
custodian.'' \42\
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    \41\ ICI letter at 3.
    \42\ SIFMA/ISDA letter at 3, ISDA letter at 3-4.
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    Finally the FHLB wrote that ``it is very important for SDs/MSPs to 
respond to requests for information regarding the additional costs that 
may be imposed on end-user counterparties that elect to have initial 
margin segregated with an independent custodian.'' \43\
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    \43\ FHLB letter at 7.
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    In light of the concerns expressed by commenters, the Commission 
has determined that a limited set of disclosures should be required. 
First, the SD or MSP must inform the counterparty of the price 
associated with segregation, including custodial fees, to the extent 
the SD or MSP has such information. It is the Commission's view that 
the price of segregation is a material term in any segregation package 
offered by the SD or MSP. Further, where the custodian is an affiliate 
of, or a regular custodian for, the SD or MSP, the SD or MSP may be 
better positioned to know the amount of any such custody costs.\44\ In 
addition, in order for counterparties to make an informed decision as 
to whether to exercise the right of segregation, the identity of an 
acceptable custodian(s) is a material aspect of the notification so 
that counterparties may make informed decisions as to the degree of 
independence of such custodian(s).\45\ As described in more detail in 
section C.1, below, this notification must include at least one credit-
worthy non-affiliate as an option for custodian of segregated initial 
margin. The Commission has amended regulation 23.701 accordingly.
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    \44\ However, if the counterparty selects to use an independent 
custodian (e.g., a non-affiliate of the SD or MSP or a custodian 
with which the SD or MSP does not have a pre-existing relationship), 
the SD or MSP may not be required to inform the counterparty of the 
price of custodianship because the SD or MSP may not have that 
information.
    \45\ Several commenters highlighted the importance of have the 
choice of at least one custodian who is not affiliated with the SD 
or MSP. See generally EEI letter at 2, AIMA at 2, MFA letter at 4, 
and Fidelity letter at 5.
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    The Commission notes that certain entities have developed or are in 
the process of developing electronic platforms through which 
counterparties could access account information regarding the status of 
their collateral. The Commission may consider, in a future rulemaking, 
whether the notification required pursuant to regulation 23.701 should 
include information from the SD or MSP regarding such platforms.
2. Limitation of Right--Variation Margin
    Proposed regulation 23.601(b) \46\ incorporated the limitation in 
section 4s(l)(2)(B)(i) of the CEA that the right to segregation does 
not apply to variation margin. Fidelity recommended that the final rule 
require that SDs and MSPs ``segregate variation margin posted by a 
counterparty at the counterparty's request.'' \47\ Fidelity requested 
that, at a minimum, the rule clarify that ``no change will be necessary 
to collateral agreements [not in conflict with the rule] . . . that 
involve segregation of all margin, initial and variation. . . .'' \48\
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    \46\ Proposed regulation 23.601(b) is being finalized herein as 
regulation 23.701(b).
    \47\ Fidelity letter at 4. See also AMG letter at 6.
    \48\ Fidelity letter at 3-4.
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    The statute clearly excludes variation margin from the 4s(l) 
segregation requirements.\49\ Thus, the request for such a requirement 
is not supported by the statute. However, the Commission confirms that 
this rule governs collateral arrangements for swaps entered into on and 
subsequent to the compliance date and does not affect collateral 
arrangements agreed to for swaps that are entered into prior to the 
compliance date. In addition, the Commission notes that this rulemaking 
does not restrict parties from negotiating segregation arrangements for 
variation margin.
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    \49\ See section 4s(l)(2)(B)(i) of the CEA.
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3. Counterparty Notification
    The Commission regards the inclusion of the term ``right to require 
segregation'' in section 4s(l) of the CEA as requiring that the 
segregation decision is made by appropriate decision-makers within the 
counterparty organization. Proposed regulation 23.601(c) \50\ would 
require that the ``right to require segregation'' notification be made 
to certain senior decision-makers, in descending order of preference. 
Notification would be made to the Chief Risk Officer, or the Chief 
Executive Officer, or to the highest level decision-maker for the SD's 
or MSP's counterparty. The Commission sought comment as to whether this 
list of decision-makers would be appropriate.
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    \50\ Proposed regulation 23.601(c) is being finalized herein as 
23.701(c).
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    Eleven commenters opposed the requirement that the Chief Risk 
Officer receive the segregation notification.\51\ EEI wrote that this 
requirement ``fails to take into account existing governance and 
compliance structures and processes developed and implemented by 
entities for the express purpose of meeting compliance and risk 
management objectives.'' \52\ ICI suggested that notices go to ``an 
authorized person to avoid the disruption that would be associated with 
a [Chief Risk Officer] or other `high-level decision-maker' making an 
election to each SD or MSP before a trade can settle.'' \53\ AGA 
recommended that the notification ``be made to the officer in the 
counterparty responsible for the management of collateral.'' \54\ ISDA 
suggested that the counterparty should identify the proper party to 
receive notice from the SD or MSP.\55\ Similarly, Fidelity wrote that 
the ``final rule should allow the counterparty to select the notice 
recipient.'' \56\
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    \51\ SIFMA/ISDA, NRECA, EEI, ICI, AGA, ISDA, AMG, Fidelity, 
Working Group, AIMA, FHLB.
    \52\ EEI letter at 3.
    \53\ ICI letter at 3.
    \54\ AGA letter at 5.
    \55\ ISDA letter at 5 and SIFMA/ISDA letter at 4. See also AMG 
letter at 7, suggesting that notice be made to any party authorized 
by the counterparty.
    \56\ Fidelity letter at 3. See also Working Group letter at 5.
---------------------------------------------------------------------------

    A counterparty's decision to elect its segregation right is a 
financial decision that is heavily dependent on such counterparty's 
risk assessments. It would seem appropriate, therefore, for a 
counterparty employee who is involved in the assessment of risk and/or 
collateral management to receive this notification. However, after 
consideration of the comments, it is clear that such person does not 
necessarily need to be the Chief Risk Officer. The Commission agrees 
with AGA's comment that a notification should be sent to the ``officer 
in the

[[Page 66625]]

counterparty responsible for the management of collateral.'' \57\ If 
such a person is not identified by the counterparty to the SD or MSP, 
then the notification should be sent to the Chief Risk Officer and so 
on, as described in the proposed rule. Regulation 23.701(c) has been 
amended accordingly.
---------------------------------------------------------------------------

    \57\ AGA letter at 5.
---------------------------------------------------------------------------

4. Required Confirmation
    Before the terms of an uncleared swap are confirmed, proposed 
regulation 23.601(d) \58\ would require that the SD or MSP obtain from 
the counterparty (1) confirmation of receipt of the segregation 
notification by a specified decision-maker, and (2) whether the 
counterparty has elected to exercise its section 4s(l) segregation 
rights. The SD or MSP must maintain records of such confirmation and 
election as business records in accordance with regulation 1.31.\59\
---------------------------------------------------------------------------

    \58\ Proposed regulation 23.601(d) is being finalized herein as 
regulation 23.701(d).
    \59\ 17 CFR 1.31.
---------------------------------------------------------------------------

    ICI's comment letter alone addressed this point.\60\ ICI agreed 
with the proposal that ``confirmation of receipt of the notification 
and election to require segregation or not should occur prior to 
confirming the terms of the uncleared swap.'' \61\ The Commission 
believes that requiring the SD or MSP to obtain confirmation of receipt 
of the segregation notification and the counterparty's decision whether 
to elect segregation prior to confirming the terms of the swaps will 
provide greater certainty for both parties regarding the counterparty's 
segregation election. The Commission also agrees that such confirmation 
should be obtained prior to confirming the terms of the uncleared swap. 
Therefore, the Commission is adopting paragraph (d) as proposed.
---------------------------------------------------------------------------

    \60\ ICI letter at 3.
    \61\ ICI letter at 3. See also discussion in section C.1 infra.
---------------------------------------------------------------------------

5. Limitation of Responsibility To Notify
    Section 4s(l)(1)(A) of the CEA states that an SD or MSP must notify 
its counterparty of the right to require segregation of funds or other 
property supplied to margin, guarantee or secure the obligations of the 
counterparty ``at the beginning of a swap transaction.'' While this 
language could be read to require transaction-by-transaction 
notification, where the parties have a preexisting or on-going 
relationship, such repetitive notification could be redundant, costly 
and needlessly burdensome. On the other hand, the importance of the 
segregation decision, as discussed above, suggests that some periodic 
reconsideration might be appropriate. Proposed regulation 23.601(e) 
\62\ sought to balance these considerations by providing that 
notification to a particular counterparty by a particular SD or MSP 
need only be made once in any calendar year.
---------------------------------------------------------------------------

    \62\ Proposed regulation 23.601(e) is being finalized herein as 
regulation 23.701(e).
---------------------------------------------------------------------------

    Twelve commenters discussed issues surrounding the substance and 
timing of segregation notification,\63\ with the primary concern being 
whether the notification of the right to segregation had to be done on 
a transaction-by-transaction basis or merely once per year.
---------------------------------------------------------------------------

    \63\ NRECA, Working Group, FHLB, MetLife, EEI, AGA, SIFMA/ISDA, 
ISDA, AIMA, AMG, Fidelity, ICI.
---------------------------------------------------------------------------

    The Working Group requested that the rule require notification on 
segregation no more often than once a year, rather than a transaction-
by-transaction notification.\64\ Fidelity supported the proposal that 
notification be required at least annually, stating that this could 
``prompt a counterparty to reconsider its elections in light of 
[changes that could occur during the life of a swap transaction].'' 
\65\ FHLB and MetLife characterized transaction-by-transaction 
notification as repetitive and redundant.\66\ AGA believes that once a 
year is an appropriate notification frequency, unless the price of 
segregation has changed in which case another notice should be 
delivered.\67\
---------------------------------------------------------------------------

    \64\ Working Group letter at 4.
    \65\ Fidelity letter at 3. See also ICI letter at 3.
    \66\ FHLB letter at 6, MetLife letter at 2. See also EEI letter 
at 3.
    \67\ AGA letter at 5-6.
---------------------------------------------------------------------------

    Several commenters requested that the Commission loosen the once-
per-year notification in the Commission's proposed rule. NRECA, SIFMA/
ISDA, AIMA and AMG each wrote that an initial notification is all that 
should be required--a counterparty's initial choice should be deemed to 
apply to all future swaps unless the counterparty seeks to change its 
election.\68\ SIFMA/ISDA proposed ``that an [SD or MSP] should only be 
required to deliver a single notification of the right to segregate, 
and the counterparty should be deemed to have elected not to require 
segregation of its [independent amount] until such time as the 
counterparty duly notifies the [SD or MSP] of its election to require 
segregation.'' \69\
---------------------------------------------------------------------------

    \68\ NRECA letter at 13, SIFMA/ISDA letter at 4, ISDA letter at 
4, AIMA letter at 2 and AMG letter at 7.
    \69\ SIFMA/ISDA letter at 4. See also ISDA letter at 4.
---------------------------------------------------------------------------

    After careful consideration of the comments, the Commission agrees 
that requiring notification on a transaction-by-transaction basis may 
be overly costly and burdensome. In addition, the Commission notes the 
difficulty associated with identifying material changes in the cost of 
segregation and the burden that would be created should the Commission 
require that additional notices be delivered upon such event. However, 
the Commission notes that Congress emphasized the importance of the 
ability of a counterparty to elect to have its collateral segregated, 
describing segregation as a ``right.'' Moreover, the statute does not 
merely grant counterparties the legal right to segregation; it 
specifically requires that the existence of this right be communicated 
to them. The Commission therefore believes that this notification 
requirement is met when an SD or MSP provides notification to a 
counterparty, at least once, in each calendar year. Where an SD or MSP 
does not enter into any swap with the counterparty during a calendar 
year, the notification requirement would not apply. The Commission 
believes that such notification requirement would not be overly 
burdensome, particularly when one considers the importance of the 
counterparty's decision to require segregation. Thus, the Commission 
has decided to adopt the final rule language as proposed.
6. Power To Change Election With Regard to Segregation
    In the NPRM, the Commission proposed regulation 23.601(f),\70\ 
which makes clear that a counterparty's election with respect to the 
segregation of initial margin may be changed at the discretion of the 
counterparty upon delivery of written notice, and such decision shall 
be applicable with respect to swaps entered into between the parties 
after such delivery. Rather than grant the counterparty an absolute 
right to change its election, the Working Group recommended that the 
counterparty must expressly reserve such right: ``[if] a party makes an 
election under the Proposed Rule and does not expressly reserve the 
right to change that election in the relevant swap trading relationship 
documentation, then they cannot do so.'' \71\
---------------------------------------------------------------------------

    \70\ Proposed regulation 23.601(f) is being finalized herein as 
regulation 23.701(f).
    \71\ Working Group letter at 5.
---------------------------------------------------------------------------

    The Commission does not believe that the commenter's clarification 
is appropriate. The Commission notes that the rule clearly states that 
any change to the counterparty's segregation election would only apply 
to ``swaps entered into between the parties after . . . delivery'' of 
written notice to the SD or

[[Page 66626]]

MSP. Therefore, if a counterparty sought to change its segregation 
election, such election would not have retroactive effect (unless both 
the counterparty and the SD or MSP so agreed). In other words, the 
proposed rule leaves changes in terms for pre-existing swaps--including 
with respect to segregation of collateral--as matters for negotiation 
between the parties. The counterparty should retain its rights, under 
the statute, to change its election as to swaps entered into after the 
notice is delivered. As such, the Commission is adopting the final rule 
language as proposed.

C. Regulation 23.702: Requirements for Segregated Margin

1. Independent Custodian and Separate Account
    Pursuant to section 4s(l)(3) of the CEA, the Commission proposed 
regulation 23.602(a)(1),\72\ which required that initial margin, 
segregated in accordance with an election under regulation 23.601, be 
held with a custodian that is independent of both the SD or MSP and the 
counterparty. Proposed regulation 23.602(a)(2) \73\ required such 
initial margin to be held in an account designated as a segregated 
account for and on behalf of the counterparty.\74\ While, as noted, the 
right to segregation does not apply to variation margin, the proposed 
regulation provided that the SD or MSP and the counterparty may agree 
that collateral falling within the definition of variation margin may 
also be held in such segregated account. The Commission requested 
comment on, among other things, whether an affiliate of the SD, MSP or 
the counterparty should be considered an independent custodian. In 
addition, the Commission requested comment on whether either party 
could choose a custodian and, if so, what restrictions, if any, should 
be placed on that choice.
---------------------------------------------------------------------------

    \72\ Proposed regulation 23.602(a)(1) is being finalized herein 
as regulation 23.702(a).
    \73\ Proposed regulation 23.602(a)(2) is being finalized herein 
as regulation 23.702(b).
    \74\ See discussion in section A.1 supra.
---------------------------------------------------------------------------

    Fourteen commenters discussed the choice of custodian for 
segregation.\75\ The topics discussed by commenters included the 
freedom of negotiation between the SD or MSP and counterparty, the use 
of a custodian affiliated with an SD or MSP, the right of the 
counterparty to choose the custodian, and qualifying criteria for a 
custodian.
---------------------------------------------------------------------------

    \75\ MFA, SIFMA/ISDA, ISDA, ICI, Working Group, NRECA, AMG, 
MetLife, EEI, Fidelity, AIMA, FHLB, Norges, State Street.
---------------------------------------------------------------------------

    Four commenters argued that the custodian should be determined 
purely by negotiation between the counterparty and SD or MSP. ICI 
opined that ``the choice of custodian should be left to the agreement 
of the parties.'' \76\ AIMA wrote that ``[t]he parties should be free 
to negotiate which custodian is used, and it may be useful for the [SD] 
or MSP to let the customer know which custodians it has relationships 
with and has conducted appropriate due diligence on, including 
affiliates and non-affiliates, and thus its preferred choices of 
custodian.'' \77\ Similarly, the Working Group suggested ``that outside 
the election to segregate collateral, which is the right of a [SD's or 
MSP's] counterparty, all other terms and parameters of a custodial 
relationship should be left to negotiation between counterparties. . . 
.'' \78\ The NRECA wrote that it ``see[s] no benefit to the Commission 
making [the choice of custodian] by regulation, rather than leaving 
them to arm's length negotiations between contract counterparties.'' 
\79\
---------------------------------------------------------------------------

    \76\ ICI letter at 3-4.
    \77\ AIMA letter at 2.
    \78\ Working Group letter at 2.
    \79\ NRECA letter at 14.
---------------------------------------------------------------------------

    However, AMG stated that while both the counterparty and the SD or 
MSP have an interest in the selection of the custodian, the 
counterparty is likely the party with the greatest interest and should 
therefore have the right to select the custodian.\80\
---------------------------------------------------------------------------

    \80\ AMG letter at 3.
---------------------------------------------------------------------------

    Several commenters discussed whether an affiliate of the SD or MSP 
would qualify as an independent custodian. MetLife suggested ``that a 
custodial arrangement with an affiliate of the SD or MSP would satisfy 
the requirements for the use of an Independent Custodian. . . .'' \81\ 
AMG wrote that ``the CFTC should not limit the choice of custodian 
solely to those unaffiliated with the relevant SD/MSPs and Customer 
Counterparties but should provide the flexibility to use a custodian 
who may also be affiliated with any SD/MSP or Customer Counterparty.'' 
\82\ Fidelity expressed concern that an ``unintended and undesirable 
consequence of banning affiliates from acting as third-party custodians 
could be to prevent counterparties from entering into swaps with [SD/
MSPs], where an affiliate of the [SD/MSP] already serves as a 
depository or custodian of the counterparty.'' \83\
---------------------------------------------------------------------------

    \81\ MetLife letter at 2.
    \82\ AMG letter at 2. See also MFA letter at 3-4, EEI letter at 
2.
    \83\ Fidelity letter at 5.
---------------------------------------------------------------------------

    Other commenters were receptive to the idea of an affiliate 
custodian, but advised that the SD or MSP should be required to present 
options to the counterparty on this issue. For example, AIMA 
recommended that the Commission require SDs and MSPs to ``offer a 
choice of . . . five custodians on whom they have conducted [a] due 
diligence examination, including both an affiliate (if applicable) and 
a non-affiliate.'' \84\ Similarly, FHLB urged the Commission to 
condition allowing an affiliate of the SD or MSP to act as custodian 
upon mutual agreement of the counterparty and the SD or MSP, and 
suggested that ``the SD/MSP [should be] required to offer segregation 
with at least one non-affiliated custodian.'' \85\ SIFMA/ISDA wrote 
that an SD or MSP ``should be required, upon counterparty request, to 
propose at least one creditworthy non-affiliated custodian that the SD/
MSP is willing to use, as an option.'' \86\ AMG noted that the 
regulations should be flexible enough to allow the use of a custodian 
affiliated with an SD, MSP, or the counterparty.\87\
---------------------------------------------------------------------------

    \84\ AIMA letter at 2.
    \85\ FHLB letter at 8.
    \86\ SIFMA/ISDA letter at 5. See also ISDA letter at 7.
    \87\ AMG letter at 2.
---------------------------------------------------------------------------

    Three other commenters suggested that counterparties should have 
the right to designate a non-affiliate custodian. State Street 
recommended that the proposed rules be revised to provide that a 
``counterparty has the right to designate the independent custodian, if 
that custodian is a U.S. bank . . . and otherwise serves as a usual 
depository for assets of the counterparty.'' \88\ Fidelity wrote that 
while affiliates of the SD or MSP can be appropriate custodians, ``a 
counterparty should have the right to require that a third-party 
custodian be independent from the [SD or MSP].'' \89\ Norges proposed 
that the final rule should provide the ``non-dealer/MSP counterparties 
the option to require that initial margin . . . be held with a 
custodian that is in fact independent of any affiliate of the swap 
dealer or MSP.'' \90\
---------------------------------------------------------------------------

    \88\ State Street letter at 2.
    \89\ Fidelity letter at 5. See also FHLB letter at 8, 
recommending that if parties cannot agree on a custodian then the 
counterparty should be able to designate the custodian.
    \90\ Norges letter at 2.
---------------------------------------------------------------------------

    Two commenters offered qualifying criteria for a custodian. The MFA 
suggested that a custodian ought to be ``regulated by a federal or 
state bank regulator, be authorized under federal or state laws to 
exercise corporate trust powers, and have equity of at least

[[Page 66627]]

[$200 million].'' \91\ MetLife suggested that an affiliate custodian 
could satisfy the requirements for an independent custodian where it, 
inter alia, ``maintains a minimum asset value [of at least $2 billion] 
under custodial management.'' \92\
---------------------------------------------------------------------------

    \91\ MFA letter at 4.
    \92\ MetLife letter at 2.
---------------------------------------------------------------------------

    The Commission also received one comment regarding the timing of 
the requirement to segregate. SIFMA/ISDA requested that, due to the 
amount of time required to fully negotiate a custodial arrangement, 
parties ``be permitted to enter into new swaps pending completion of 
custodial documentation satisfactory to both parties for so long as the 
parties are negotiating in good faith to complete such custodial 
documentation.'' \93\ SIFMA/ISDA also argued that the requirement to 
segregate the initial margin ``with respect to all swaps entered into 
after delivery of an election to require segregation . . . unless 
otherwise agreed, become effective only upon the completion of 
custodial documentation.'' \94\
---------------------------------------------------------------------------

    \93\ SIFMA/ISDA letter at 5. See also ISDA letter at 5.
    \94\ SIFMA/ISDA letter at 5, ISDA letter at 5.
---------------------------------------------------------------------------

    The language of the statute does not require that affiliates of a 
counterparty be prohibited from serving as the custodian for segregated 
funds. Affiliates are third-parties in that they are separate legal 
entities, and therefore fall within the terms of the statute. However, 
in light of the correlated insolvency risk wherein if an SD or MSP 
becomes insolvent its affiliates will have an elevated risk of also 
becoming insolvent, the Commission has determined that an SD or MSP 
should be required to provide the counterparty with at least one credit 
worthy non-affiliate as an option to serve as the custodian. The final 
rule text has been amended to incorporate the requirement that SDs and 
MSPs must provide their counterparties with at least one credit worthy 
non-affiliate as an option to serve as the custodian.\95\
---------------------------------------------------------------------------

    \95\ See regulation 23.701(a)(2).
---------------------------------------------------------------------------

    Regarding SIFMA/ISDA's question relating to the timing of 
segregation, waiting until the completion of custodial documentation 
for an election to require segregation to become effective would likely 
create difficulties where an insolvency occurs in the time period 
between agreement and documentation. Thus, it is the Commission's 
position that protection of initial margin is best achieved by 
requiring customer segregation to become effective upon election, not 
upon completion of custodial documentation. In addition, the Commission 
notes that compliance with SIFMA/ISDA's suggested ``good faith'' 
requirement would be impracticable to assess and is not amending the 
rule as suggested.
2. Requirements for Custody Agreement
    In the NPRM, the Commission proposed regulation 23.602(b),\96\ 
which imposed certain requirements on agreements for the segregation of 
margin. Regulation 23.602(b) was intended to provide a balance between 
the minimum interests of (i) the counterparty posting the margin, (ii) 
the SD or MSP for whom the margin is posted, and (iii) the custodian, 
while avoiding the necessity for time-consuming and expensive 
interpleader proceedings.\97\ Under the proposal, an agreement for the 
segregation of margin would have to be in writing, and must include the 
custodian as a party. In addition, to ensure that the SD or MSP 
receives the margin promptly in case it is entitled to do so, and that 
the margin is returned to the counterparty in case it is entitled to 
such return, the agreement must also provide that turnover of control 
shall be made promptly upon presentation of a statement in writing, 
signed by an authorized person under penalty of perjury, that one party 
is entitled to such turnover pursuant to an agreement between the 
parties.\98\ Otherwise, withdrawal of collateral may only be made 
pursuant to the agreement of both the counterparty and the SD or MSP, 
with the non-withdrawing party also receiving immediate notice of such 
withdrawal.\99\
---------------------------------------------------------------------------

    \96\ Proposed regulation 23.602(b) is being finalized herein as 
regulation 23.702(c).
    \97\ If the SD or MSP and the counterparty were to make 
competing claims to the collateral, and if the custodian did not 
have a means under the agreement among the parties to decide between 
such claims without risking legal liability, the custodian would 
likely choose to interplead the collateral.
    \98\ See 28 U.S.C. 1746. See also 18 U.S.C. 1621 (Perjury 
Generally).
    \99\ The importance of taking steps to ensure that unauthorized 
withdrawals are not made is enhanced by the findings of the 
Commission's Division of Clearing and Intermediary Oversight in 
Financial and Segregation Interpretation 10-1, 20 FR 24768, 24770 
(May 11, 2005) (``Findings by both Commission audit staff and the 
SROs of actual releases of customer funds [from third-party 
custodial accounts], without the required knowledge or approval of 
the FCMs, further demonstrate that the risks associated with third-
party custodial accounts are real and material, not merely 
theoretical.'').
---------------------------------------------------------------------------

    Nine commenters argued against imposing a perjury standard on any 
written statements by either the counterparty or the SD or MSP 
informing the custodian to turn over of control of margin.\100\ For 
example, ICI wrote that it ``believe[s] that it is unnecessary to 
introduce the specter of criminal prosecution into custodial account 
documentation. . . .'' \101\
---------------------------------------------------------------------------

    \100\ ICI, Working Group, AMG, Fidelity, SIFMA/ISDA, MFA, ISDA, 
FHLB, MetLife.
    \101\ ICI letter at 4. See also Working Group letter at 4, AMG 
letter at 6, Fidelity letter at 4-5, SIFMA/ISDA letter at 6, MFA 
letter at 5, ISDA letter at 7, MetLife letter at 2.
---------------------------------------------------------------------------

    The Commission believes that a perjury standard is appropriate 
because it mitigates the tradeoff between speed and accuracy in stress 
situations. In circumstances where one party to a swap needs expedient 
turnover of segregated margin (for example, in order to meet margin 
calls on positions hedging the swap) and is unable to obtain timely 
approval from the counterparty (e.g., if margin is being taken from the 
account because the counterparty is in financial trouble), it is 
important for a depository to be able to respond to a unilateral 
request for collateral without having to take the time to independently 
investigate the legitimacy of the request.\102\ At the same time, 
circumstances of market stress may also create incentives for parties 
to illegitimately withdraw collateral from a segregated account.\103\ 
The perjury standard acts as a check on the legitimacy of a demand for 
collateral without requiring the time needed for an independent inquiry 
by the depository. At the same time, an SD, MSP or counterparty making 
a demand for collateral can avoid criminal liability if it does not 
engage in purposeful fraud.
---------------------------------------------------------------------------

    \102\ In times of significant market stress, any unnecessary 
impediments or restrictions on a counterparty's ability to obtain 
immediate access to posted margin when such access is legitimate 
could impair the operations of the counterparty, impair the 
liquidity of other market participants and magnify the impact of a 
market disruption.
    \103\ A party facing insolvency or fearing imminent insolvency 
on the part of its counterparty might be tempted to demand transfer 
of margin without fully ensuring they were entitled to it, to take 
the margin without plans to return it, or take the margin for the 
purpose of covering an unrelated debt in the expectation of saving 
their business and returning the margin shortly thereafter.
---------------------------------------------------------------------------

    The Commission has decided to adopt the rule substantively as 
proposed. However, the Commission points out that it has re-organized 
the rule and modified certain language to provide greater clarity. 
Specifically, the Commission combined the language in paragraphs (a) 
and (a)(1) into paragraph (a). The Commission also renumbered paragraph 
(a)(2) as paragraph (b). The Commission then renumbered paragraph (b) 
as paragraph (c) and switched the text in subparagraphs (1) and (2). 
The Commission also added

[[Page 66628]]

clarifying language to paragraphs (a),(b) and (c) to facilitate this 
reorganization.

D. Regulation 23.703: Investment of Segregated Margin

1. Limitations on Investments
    Proposed regulation 22.603(a) \104\ provides that segregated 
initial margin may only be invested consistent with the standards for 
investment of customer funds that the Commission applies to exchange-
traded futures and cleared swaps, regulation 1.25.\105\
---------------------------------------------------------------------------

    \104\ Proposed regulation 23.603(a) is being finalized herein as 
regulation 23.703(a).
    \105\ Section 4s(l)(2)(B)(ii)(I) of the CEA refers to 
``commercial arrangements regarding the investment of segregated 
funds or other property that may only be invested in such 
investments as the Commission may permit by rule or regulation.''
---------------------------------------------------------------------------

    Eight commenters expressed the view that imposing the standards of 
regulation 1.25 on the investment of collateral for uncleared swaps was 
overly restrictive.\106\
---------------------------------------------------------------------------

    \106\ MetLife, Federated, ICI, AMG, Fidelity, SIFMA/ISDA, ISDA, 
FHLB.
---------------------------------------------------------------------------

    Fidelity suggested that ``custodians under tri-party custody 
arrangements may limit the types of collateral that it will permit 
under such arrangements to those investments permitted pursuant to 
[regulation] 1.25.'' \107\ Fidelity further proposed that the 
Commission require not only segregation of initial margin but also 
variation margin, explaining that ``the right to require segregation of 
variation margin . . . would reduce systemic risk for the same reasons 
that segregation of initial margin reduces systemic risk.'' \108\ 
Similarly, AMG argued that the Commission should ``confirm the right of 
Customer Counterparties to require segregation of both initial margin 
and variation margin,'' explaining that the current practice in the OTC 
market is to require all collateral to be segregated and held by a 
third-party custodian.\109\
---------------------------------------------------------------------------

    \107\ Fidelity letter at 5-6.
    \108\ Fidelity letter at 4.
    \109\ AMG letter at 6.
---------------------------------------------------------------------------

    MetLife wrote that such a restriction is ``outside the scope of 
normal market practice'' and that counterparties ``should be able to 
negotiate the terms for investment of Initial Margin consisting of cash 
within [their] own established investment guidelines.'' \110\ FHLB 
added that ``Congress appropriately did not seek to limit how margin 
for uncleared swaps would be invested,'' asserting that Congress had 
assumed that ``both the end-user counterparty and the SD/MSP would 
necessarily be involved in the decision as to how such funds would be 
invested.'' \111\ Federated warned that this proposal will cause a loss 
of investment returns.\112\
---------------------------------------------------------------------------

    \110\ MetLife letter at 3. See also Federated letter at 3-7, ICI 
letter at 4-6, AMG letter at 3-5, Fidelity letter at 5-6, SIFMA/ISDA 
letter at 6, ISDA letter at 8, FHLB letter at 12.
    \111\ FHLB letter at 13.
    \112\ Federated letter at 7, 11.
---------------------------------------------------------------------------

    In contrast, AIMA wrote that ``[t]he requirements of Regulation 
1.25 of the CFTC Regulations . . . likely strike[ ] the right balance 
between flexibility and the protection of the value of the 
collateral.'' \113\
---------------------------------------------------------------------------

    \113\ AIMA letter at 3.
---------------------------------------------------------------------------

    Regulation 1.25 establishes a general prudential standard used in 
the futures and cleared swaps markets that requires all permitted 
investments of customer segregated funds to be consistent with the 
objectives of preserving principal and maintaining liquidity.\114\ As 
stated by the Commission in regulation 1.25's adopting release, ``[i]n 
finalizing amendments to Regulation 1.25, the Commission seeks to 
impose requirements on the investment of customer segregated funds with 
the goal of enhancing the preservation of principal and maintenance of 
liquidity consistent with Section 4d of the Act.''
---------------------------------------------------------------------------

    \114\ See Investment of Customer Funds and Funds Held in an 
Account for Foreign Futures and Foreign Options Transactions, 76 FR 
78776 (Dec. 19, 2011).
---------------------------------------------------------------------------

    Similarly, the Commission believes that applying the requirements 
of regulation 1.25 to uncleared swaps will increase the safety and 
maintain the liquidity of counterparty funds held by the custodian. 
Regulation 1.25 establishes a general prudential standard by requiring 
that all permitted investments be ``consistent with the objectives of 
preserving principal and maintaining liquidity.'' \115\ While such a 
standard may lead to lower investment returns, lower investment returns 
correlate to decreased investment risk and must be viewed in the 
context of the importance of protecting counterparties' collateral and 
mitigating systemic risk that could result from the loss of access to 
such collateral and, in turn, adversely impact the stability of the 
U.S. financial markets. After considering the comments, the Commission 
has decided to adopt the rule as proposed. The Commission believes that 
the rule achieves the appropriate balance between the goals of 
protecting counterparties' collateral and mitigating systemic risk, on 
the one hand, and the goals of retaining an appropriate degree of 
investment flexibility and opportunities for attaining capital 
efficiency for DCOs and FCMs investing customer segregated funds, on 
the other hand.'' \116\
---------------------------------------------------------------------------

    \115\ Id. at 78776.
    \116\ Id. at 78778.
---------------------------------------------------------------------------

    It should be noted that Sec.  23.703(a) only restricts the manner 
in which an SD or MSP may invest margin that is segregated pursuant to 
an election under Sec.  23.701. This rule does not in any way restrict 
the types of collateral that a counterparty may post to an SD or MSP, 
nor does it require an SD or MSP to convert, in any way, posted 
collateral.\117\
---------------------------------------------------------------------------

    \117\ But cf. Margin Requirements for Uncleared Swaps for Swap 
Dealers and Major Swap Participants, 76 FR 23732 (Apr. 28, 2011) 
(proposing to limit the forms of acceptable initial margin to a 
specified list of eligible collateral for transactions between a 
swap dealer or major swap participant for which there is no 
prudential regulator and a counterparty that is a swap dealer, a 
major swap participant or a financial entity).
---------------------------------------------------------------------------

    In addition, as discussed above, the Commission notes that 
requiring the segregation of variation margin would be beyond the scope 
of section 4s(l) of the statute and what Congress prescribed 
therein.\118\ However, the Commission believes that it would be 
consistent with that statute to allow the parties to agree to have 
segregation arrangements for variation margin. Moreover, the Commission 
acknowledges that where a counterparty and its SD or MSP have agreed to 
segregate both initial margin and variation margin, such margin may be 
commingled and held in the same account. But, to the extent that the 
parties agree to commingle segregated initial and variation margin, the 
Commission clarifies that the requirements set forth in Subpart L to 
this Part 23, including the investment restrictions in regulation 
23.703(a), would apply to all margin held (both initial margin and 
variation margin) in such account.
---------------------------------------------------------------------------

    \118\ See discussion in section B.2 supra.
---------------------------------------------------------------------------

2. Commercial Arrangements Regarding Investments and Allocations
    As required by section 4s(l)(2)(B)(ii) of the CEA and subject to 
the limitations set forth in regulation 23.603(a), proposed regulation 
22.603(b) provided that the SD or MSP and the counterparty may enter 
into any written commercial arrangement regarding the terms of the 
investment of segregated margin and the related allocation of gains and 
losses resulting from such investment. The Commission is adopting this 
aspect of the rule as proposed.\119\
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    \119\ Proposed regulation 23.603(b) is being finalized herein as 
regulation 23.703(b).
---------------------------------------------------------------------------

E. Regulation 23.704: Requirements for Non-Segregated Margin

    Section 4s(l)(4) of the CEA mandates that, if the counterparty does 
not choose to require segregation, the SD or MSP shall report to the 
counterparty, on a

[[Page 66629]]

quarterly basis, ``that the back office procedures of the swap dealer 
or major swap participant relating to margin and collateral 
requirements are in compliance with the agreement of the 
counterparties.'' \120\ Proposed regulation 23.604(a) \121\ implemented 
this provision and required that such reports be made no later than the 
fifteenth (15th) business day of each calendar quarter for the 
preceding calendar quarter. Proposed regulation 23.604(a) made the 
Chief Compliance Officer of the SD or MSP responsible for such report. 
In addition, proposed regulation 23.604(b) provided that this 
obligation shall apply no earlier than the 90th calendar day after the 
date on which the first swap is transacted between the counterparties.
---------------------------------------------------------------------------

    \120\ 7 U.S.C. 6s(l)(4).
    \121\ Proposed regulation 23.604 is being finalized herein as 
regulation 23.704.
---------------------------------------------------------------------------

    Four commenters discussed this proposal.\122\ The Working Group 
wrote that quarterly report of back office compliance for swaps with 
non-segregated margin is unnecessarily burdensome.\123\ SIFMA and ISDA 
also argued that the requirement for a Chief Compliance Officer 
statement would be burdensome.\124\
---------------------------------------------------------------------------

    \122\ Working Group, AIMA, ISDA and SIFMA/ISDA.
    \123\ Working Group letter at 5-6. See also SIFMA/ISDA letter at 
7 and ISDA letter at 8.
    \124\ SIFMA/ISDA letter at 7 and ISDA letter at 9.
---------------------------------------------------------------------------

    SIFMA and ISDA went further, suggesting that disclosure should not 
be required especially where the relevant SD/MSP is permitted to freely 
sell, pledge, rehypothecate, assign, invest, use, commingle, or 
otherwise dispose of any independent amount that it holds, since any 
such disclosure would be meaningless.\125\
---------------------------------------------------------------------------

    \125\ SIFMA/ISDA letter at 7 and ISDA letter at 8.
---------------------------------------------------------------------------

    The Working Group argued that an initial representation as to 
compliance should be treated as renewed each quarter unless altered by 
the SD or MSP.\126\ SIFMA and ISDA proposed giving the counterparty 
permission to waive receipt of the quarterly disclosure.\127\
---------------------------------------------------------------------------

    \126\ Working Group letter at 6.
    \127\ SIFMA/ISDA letter at 7 and ISDA letter at 8.
---------------------------------------------------------------------------

    The Working Group also suggested that in addition to forgoing or 
electing segregation under the rule, parties may choose to segregate 
outside of the proposed rule.\128\ For example, the Working Group 
stated that a counterparty may wish to have its collateral held in an 
SD's omnibus customer account, and that such agreements should be 
permitted.\129\
---------------------------------------------------------------------------

    \128\ Working Group letter at 3.
    \129\ Id.
---------------------------------------------------------------------------

    By contrast AIMA agreed with the proposal for reporting on a 
regular basis and suggested that reporting also occur immediately 
following entry of a swap agreement.\130\
---------------------------------------------------------------------------

    \130\ AIMA letter at 3.
---------------------------------------------------------------------------

    While quarterly reporting may impose certain administrative burdens 
on SDs and MSPs, such quarterly reporting, as contemplated by 
regulation 23.704, is expressly required by the statute.\131\ The 
Commission agrees that since a counterparty may choose not to segregate 
at all, it also may elect to segregate in some lesser manner than that 
contemplated by regulation 23.702. However, the Commission notes that, 
for counterparties who do not choose segregation, as contemplated by 
section 4s(l)(1)(B) of the CEA, the purpose of section 4s(l)(4) of the 
CEA is to confirm that the SD or MSP is adhering to the obligations of 
their agreement. Therefore, the requirements of regulation 23.704 will 
apply to all agreements relating to uncleared swaps for which the 
counterparty does not elect to segregate initial margin pursuant to 
regulation 23.702. Moreover, the Commission believes that placing 
responsibility for the report with the chief compliance officer of the 
SD or MSP required by Section 4s(k) of the CEA is appropriate in light 
of the chief compliance officer's role in making sure the SD or MSP 
complies with its statutory and regulatory obligations.\132\ The 
Commission is adopting the rule as proposed.
---------------------------------------------------------------------------

    \131\ The reporting requirement found in section 4s(l)(4) of the 
CEA states that if the counterparty does not choose to require 
segregation of the funds or other property supplied to margin, 
guarantee, or secure the obligations of the counterparty, the swap 
dealer or major swap participant shall report to the counterparty of 
the swap dealer or major swap participant on a quarterly basis that 
the back office procedures of the swap dealer or major swap 
participant relating to margin and collateral requirements are in 
compliance with the agreement of the counterparties.
    \132\ See generally section 4s(k)(2)(E) of the CEA (stating that 
the chief compliance officer shall ``ensure compliance with the 
[CEA] (including regulations) relating to swaps, including each rule 
prescribed by the Commission under [section 4s].'')
---------------------------------------------------------------------------

F. Compliance Date

    In the NPRM, the Commission requested comment on the appropriate 
timing of effectiveness for the final rules for Part 23. SIFMA/ISDA 
recommended a 6 month implementation period for swaps that are entered 
into with new counterparties and a 12 month implementation period for 
swaps that are entered into with existing counterparties.\133\ The 
Working Group recommended a 12 month implementation period.\134\ After 
consideration of the comments, the Commission has decided to adopt 
SIFMA/ISDA's suggestion, which would provide a 6 month implementation 
period for swaps that are entered into with ``new counterparties'' and 
a 12 month implementation period for swaps that are entered into with 
``existing counterparties.''
---------------------------------------------------------------------------

    \133\ SIFMA/ISDA letter at 8. See also ISDA letter at 9.
    \134\ Working Group letter at 7. See also ICI letter at 6.
---------------------------------------------------------------------------

III. Portfolio Margining

    The NRPM proposed changes to the definition of ``customer'' in 
Sec.  190.01(k) \135\ and the definition of ``customer property'' in 
Sec.  190.08(a)(1)(i)(F) \136\ to implement section 713(c) of the Dodd-
Frank Act, which added section 20(c) of the CEA and stated that the 
Commission ``shall exercise its authority to ensure that securities 
held in a portfolio margining account carried as a futures account are 
customer property and the owners of those accounts are customers for 
the purposes of'' subchapter IV of chapter 7 of the U.S. Bankruptcy 
Code.
---------------------------------------------------------------------------

    \135\ The Commission proposed to define ``customer'' as follows: 
``Customer shall have the same meaning as that set forth in section 
761(9) of the Bankruptcy Code. To the extent not otherwise included, 
customer shall include the owner of a portfolio margining account 
carried as a futures account.''
    \136\ The Commission proposed to include ``To the extent not 
otherwise included, securities held in a portfolio margining account 
carried as a futures account'' in the definition of ``customer 
property.'' 75 FR at 75435 (Dec. 10, 2010).
---------------------------------------------------------------------------

    The Commission received three comments on these proposals.\137\ ICE 
agreed with the proposed amendments to the definition of ``customer'' 
and ``customer property'' stating that the proposal was ``a necessary 
step toward realizing the important benefits of portfolio margining for 
market participants.'' \138\ ICE also expressed concern that the 
reference to ``futures account'' while excluding swaps referred to in 
4d(f) of the CEA would ``create artificial and unnecessary distinctions 
between futures and other products regulated by the Commission,'' \139\ 
and would detract from the ``certainty for the treatment in insolvency 
of portfolio margining arrangements that include both swaps and 
securities.'' \140\ As such, ICE requested a technical clarification to 
make clear that the treatment in insolvency of portfolio margining 
arrangements includes arrangements

[[Page 66630]]

involving swaps.\141\ AIMA also indicated its approval of the proposed 
amendments to the definition of ``customer'' and ``customer property,'' 
\142\ and ICI supported the proposed amendment as an implementation of 
section 713(c) of the Dodd-Frank Act.\143\
---------------------------------------------------------------------------

    \137\ ICE, AIMA, ICI.
    \138\ ICE letter at 2.
    \139\ Id. at 3.
    \140\ Id. at 2.
    \141\ Id. at 2.
    \142\ AIMA letter at 3.
    \143\ ICI letter at 6-7.
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    After careful consideration of the comments, the Commission agrees 
that Congress, in directing the Commission to clarify the treatment of 
``securities'' held in a ``futures account,'' did not mean to imply 
that securities held in a Cleared Swaps Customer Account would not be 
treated as customer property. Accordingly, the Commission will adopt a 
technical clarification, as suggested by ICE's comments, to avoid the 
implication that portfolio margining arrangements involving swaps do 
not receive the same bankruptcy protection as portfolio margining 
arrangements involving futures. Thus, where the Commission has referred 
to a ``futures account'' in the definition of ``customer'' in Sec.  
190.01(k) and the definition of ``customer property'' in Sec.  
190.08(a)(1)(i)(F), the Commission is adding a reference to a ``Cleared 
Swaps Customer Account.'' The Commission is otherwise adopting these 
changes as proposed.
    The Commission also proposed certain technical corrections to 
sections 190.02 and 190.06. The Commission notes, however, that 
substantively identical technical corrections were completed in a prior 
rulemaking, and thus no further action is necessary in this regard 
herein.\144\
---------------------------------------------------------------------------

    \144\ See Protection of Cleared Swaps Customer Contracts and 
Collateral; Conforming Amendments to the Commodity Broker Bankruptcy 
Provisions, 77 FR 6336 (Feb. 7, 2012).
---------------------------------------------------------------------------

IV. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') requires Federal agencies 
to consider the impact of its rules on ``small entities.'' \145\ A 
regulatory flexibility analysis or certification typically is required 
for ``any rule for which the agency publishes a general notice of 
proposed rulemaking pursuant to'' the notice-and-comment provisions of 
the Administrative Procedure Act, 5 U.S.C. 553(b).\146\
---------------------------------------------------------------------------

    \145\ 5 U.S.C. 601 et seq.
    \146\ 5 U.S.C. 601(2), 603, 604 and 605.
---------------------------------------------------------------------------

    With respect to the proposed release, while the Commission provided 
an RFA statement that the proposed rule would impose regulatory 
obligations on SDs and MSPs and noted that SDs and MSPs were new 
categories of registrants, the Commission determined that the SDs and 
MSPs were like FCMs and large traders that have been determined not to 
be small entities.\147\ Thus, in the proposal, the Commission certified 
that the rulemaking would not have a significant economic effect on a 
substantial number of small entities. Comments on that certification 
were sought.
---------------------------------------------------------------------------

    \147\ 75 FR 75432, 75435-36 (Dec. 3, 2010).
---------------------------------------------------------------------------

    As indicated in the NPRM, the final rule will impose regulatory 
obligations on SDs and MSPs. The conclusion that the rule will not have 
a significant economic impact on a substantial number of small entities 
within the meaning of the RFA remains valid for the final rule, which 
like the proposed rule, imposes duties only on SDs and MSPs. Subsequent 
to the publication of the NPRM for this rule, the Commission has 
determined in other rulemakings that SDs and MSPs should not be 
considered small entities based on their size and characteristics 
analogous to non-small entities that pre-dated the adoption of the 
Dodd-Frank Act and has certified that these entities are not small 
entities for RFA purposes.\148\ As stated in prior rules, because of 
the SDs and MSPs size and characteristics and the ``de minimis'' 
requirements, SDs and MSPs should not be considered small entities for 
purposes of the RFA and SBA regulations.\149\ Nevertheless, in the 
``entities'' rule that further defined the terms SD and MSP, 
supplementing the statutory definitions of those terms, the Commission 
expected that if any small entity were to engage in the activities 
covered by the definition, most such entities would be eligible for the 
``de minimis'' exception from the definition.\150\ Also, the Commission 
noted that the MSP participant definition applies only to persons with 
very large swap positions, and therefore the definition of MSP is 
incompatible with small entity status.\151\ Thus, the ``entities'' 
final rule concluded that the rule, insofar as it affected SDs and 
MSPs, would not have a significant economic impact on a substantial 
number of small entities.\152\ The same reasoning applies to the 
present rule.
---------------------------------------------------------------------------

    \148\ See 77 FR 48208, 48306 (Aug. 13, 2012); Further Definition 
of ``Swap,'' ``Security-Based Swap,'' and ``Security-Based Swap 
Agreement''; Mixed Swaps; Security-Based Swap Agreement 
Recordkeeping, citing 76 FR 29868-29869 (May 23, 2011). See also, 
Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and 
Duties Rules; Futures Commission Merchant and Introducing Broker 
Conflicts of Interest Rules; and Chief Compliance Officer Rules for 
Swap Dealers, Major Swap Participants, and Futures Commission 
Merchants, 77 FR 20128, 20193 (Apr. 3, 2012); Registration of Swap 
Dealers and Major Swap Participants, 77 FR 2613, 2620 (Jan. 19, 
2012), citing 75 FR 71379, 71385 (Nov. 23, 2010) (Registration of 
Swap Dealers and Major Swap Participants).
    \149\ The Small Business Administration (``SBA'') identifies (by 
North American Industry Classification System codes) a small 
business size standard of $7 million or less in annual receipts for 
Subsector 523--Securities, Commodity Contracts, and Other Financial 
Investments and Related Activities. 13 CFR 121.201 (1-1-11 Edition). 
65 FR 30840 (May 15, 2000).
    \150\ Further Definition of ``Swap Dealer,'' ``Security-Based 
Swap Dealer,'' ``Major Swap Participant'' and ``Eligible Contract 
Participant,'' 77 FR 30596, 30701 (May 23, 2012).
    \151\ See id.
    \152\ 77 FR at 30701 (May 23, 2012). See also ``Registration of 
Swap Dealers and Major Swap Participants,'' 77 FR 2613, 2620 (Jan. 
19, 2012) (``Registration Adopting Release'') (``In terms of 
affecting a substantial number of small entities . . . the 
Commission is statutorily required to exempt from designation as an 
SD those entities that engage in a de minimis quantity of swaps 
dealing.'').
---------------------------------------------------------------------------

    One commenter, representing a number of market participants in the 
energy business, submitted a comment related to the RFA, stating that 
``[e]ach of the complex and interrelated regulations currently being 
proposed by the Commission has both an individual, and a cumulative, 
effect on . . . small entities.'' \153\ Upon consideration of this 
commenter's statements, the CFTC notes that it is not required to 
consider the cumulative economic impact of the entire mosaic of rules 
under the Dodd-Frank Act, since an agency is only required to consider 
the impact of how it exercises its discretion to implement the statute 
through a particular rule. In all rulemakings, the Commission performs 
an RFA analysis for that particular rule. The observations of this 
commenter therefore do not provide a reason to conclude that the rules 
being promulgated in this rulemaking will have a significant economic 
impact on a substantial number of small entities within the legal 
meaning of the RFA. This is so because, as explained above, the rules 
in question impose duties only on SDs and MSPs and not on other 
entities, small or otherwise.
---------------------------------------------------------------------------

    \153\ NRECA letter at 16.
---------------------------------------------------------------------------

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

B. Paperwork Reduction Act

1. Introduction
    Provisions of new regulation Part 23, specifically regulations 
23.701 and 23.704, include information disclosure requirements that 
constitute the collection of information within the meaning of the 
Paperwork Reduction

[[Page 66631]]

Act of 1995 (``PRA'').\154\ The Commission therefore has submitted this 
collection of information to the Office of Management and Budget 
(``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 
1320.11. Under the PRA, an agency may not conduct or sponsor, and a 
person is not required to respond to, a collection of information 
unless it displays a currently valid control number.\155\ The title for 
this collection of information is ``Disclosure and Retention of Certain 
Information Relating to Swaps Customer Collateral,'' OMB Control Number 
3038-0075, which has been submitted to OMB for approval. The collection 
of information will be mandatory. The information in question will be 
held by private entities and, to the extent it involves consumer 
financial information, may be protected under Title V of the Gramm-
Leach-Bliley Act as amended by the Dodd-Frank Act.\156\ An agency may 
not conduct or sponsor, and a person is not required to respond to, a 
collection of information unless it displays a currently valid OMB 
control number.
---------------------------------------------------------------------------

    \154\ 44 U.S.C. 3501 et seq.
    \155\ Id.
    \156\ See generally Notice of Proposed Rulemaking, Privacy of 
Consumer Financial Information; Conforming Amendments Under Dodd-
Frank Act 75 FR 66014 (Oct. 27, 2010).
---------------------------------------------------------------------------

2. Comments Received on Collection of Information Proposed in NPRM
    Estimates of the expected information collection burden related to 
regulations 23.701 and 23.704 were published for comment in the 
NPRM.\157\ General comments on these regulations and the Commission's 
response are discussed in a previous section of this preamble. The 
Commission received two comments specifically addressing the 
Commission's numerical PRA burden estimate for regulation 23.701.\158\ 
A comment from ISDA stated that the annual burden estimate of 0.3 hours 
per counterparty for this requirement appeared insufficient. The 
comment stated:
---------------------------------------------------------------------------

    \157\ In the NPRM these provisions were numbered as regulation 
23.601 and 23.604.
    \158\ The comments referred to regulation 23.601, reflecting the 
numbering in the NPRM.
---------------------------------------------------------------------------

    Specifically, the following documentation-related functions would 
be necessary: Scheduling, drafting, issuing, tracking, receipt, 
validation, classification and storage. As a result, we believe that 
the process contemplated by the Proposed Rules would entail multiple 
hours of staff time per counterparty.\159\
---------------------------------------------------------------------------

    \159\ ISDA letter at 5.
---------------------------------------------------------------------------

    The second comment made substantially the same point.\160\ In 
response to these comments, and certain other considerations, the 
Commission has reevaluated the per-disclosure burden estimate for 
regulation 23.701 and has modified the estimate as discussed below.
---------------------------------------------------------------------------

    \160\ SIFMA/ISDA letter at 4.
---------------------------------------------------------------------------

3. Adjustments to Estimate of Information Collection Burden Based on 
New Estimate of Expected Total Number of Swap Dealers and Major Swap 
Participants
    The Commission has determined to adjust the burden estimate for 
Regulations 23.701 and 23.704 based on a number of considerations. Both 
regulations apply to SDs and MSPs. At the time the NPRM was published, 
it was estimated, for purposes of the PRA burden estimate, that the 
total number of SDs and MSPs would be about 300 entities. Based on 
information developed since that time, the Commission now estimates 
that the total number of SDs and MSPs, and thus the total number of 
entities required to engage in information collection pursuant to these 
rules, will be about 125 entities.\161\
---------------------------------------------------------------------------

    \161\ See discussion in Registration of Swap Dealers and Major 
Swap Participants, 77 FR 2613, 2622 (Jan. 19, 2012).
---------------------------------------------------------------------------

    For the disclosure required by regulation 23.701 the Commission is 
also adjusting its estimate of the per disclosure burden, for a number 
of reasons. First, the final regulation requires that the disclosure 
(a) identify one or more custodians for segregated initial margin 
acceptable to the SD or MSP, at least one of which must be legally 
independent of the parties to the transactions and (b) provide 
information on the price of segregation for each identified custodian 
to the extent that the SD or MSP has such information. As a result of 
these changes, it is expected that part of the disclosure required by 
the regulation will be standardized, with accompanying efficiencies in 
drafting and making disclosure, but that part of the disclosure may be 
specific to particular transactions. Second, as noted above, commenters 
suggested that the burden estimate in the NPRM was insufficient to 
cover all of the tasks necessary to make the required disclosure.
    In the NPRM, the Commission estimated that disclosure required by 
regulation 23.701 would require 0.3 hours of work per disclosure, which 
could be performed by staff with a salary level of approximately $20 
per hour. The Commission has adjusted this time estimate to 2 hours per 
disclosure based on the considerations discussed immediately above. The 
Commission further estimates that the average dollar cost of the 
disclosure per hour will be $50, giving a cost of $100 for 2 hours of 
work.\162\ In addition, for purposes of the NPRM, the Commission 
estimated that each SD and MSP would make the disclosure once per year 
to an average of between 433 and 666 counterparties.\163\ The 
Commission is adjusting the estimate of number of disclosures per SD or 
MSP per year based on the reduction, noted above, in the estimate of 
the total number of SDs and MSPs from about 300 to about 125. Assuming 
a roughly similar total number of counterparties will be doing business 
with SDs and MSPs, this implies that the number of counterparties doing 
business with each individual SD or MSP in a year will probably be 
higher on average than was estimated at the time of the NPRM. To 
account for this likely effect, the Commission now estimates that each 
SD and MSP will, on average, make the disclosure to approximately 1300 
counterparties each year. As at the time of the NPRM, the Commission 
expects that the number of counterparties per SD or MSP per year is 
likely to be considerably higher than this average figure for the 
largest SDs and MSPs, and smaller than this average figure for some 
other SDs and MSPs. Given the absence of experience with this newly 
promulgated rule, these estimates are subject to an inherent degree of 
uncertainty.
---------------------------------------------------------------------------

    \162\ This estimate is based on the assumption that about three 
quarters of the work will be done by junior level staff with a 
salary of approximately $25 per hour and that about one quarter of 
the work will be done by senior level staff with a salary of 
approximately $100 per hour. Compare SIFMA, Report on Management and 
Professional Earnings in the Securities Industry-2011 at 4 (national 
average total compensation for a junior level compliance specialist 
in the survey equaled $50,998 per year, an hourly equivalent of 
approximately $25), 8 (national average total compensation for a 
compliance attorney in the survey equaled $131,304 per year, an 
hourly equivalent of approximately $65).
    \163\ The estimate in the NPRM assumed that the largest SDs and 
MSPs would make the required disclosure to an average of 5,000-
10,000 counterparties per year and that smaller SDs and MSPs would 
make the required disclosure to an average of about 200 
counterparties per year. See 75 FR at 75436 (Dec. 3, 2010) and n. 
29.
---------------------------------------------------------------------------

    The Commission, in the NPRM, estimated that regulation 23.701 would 
require a total of approximately 130,000-200,000 disclosures per year, 
generating an estimated total annual information collection burden of 
approximately 40,000-60,000 hours and $800,000-$1,200,000. Based on the 
adjustments described above the

[[Page 66632]]

Commission estimates that regulation 23.701 will require a total of 
approximately 162,500 disclosures per year, generating an estimated 
total annual information collection burden of approximately 325,000 
hours and cost of $16,250,000.
    The Commission, in the NPRM, estimated that regulation 23.704 would 
require a total of approximately 260,000-400,000 disclosures per year, 
generating an estimated total annual information collection burden of 
approximately 80,000-120,000 hours and $2,400,000-$3,500,000.\164\ The 
Commission is adjusting this estimate based on the reduced estimate of 
the number of affected SDs and MSPs from 300 to 125, and the increased 
estimate of 1300 counterparties per SD or MSP. In the absence of more 
specific information, the Commission continues to assume for purposes 
of this calculation that half of counterparties will elect not to 
segregate, and will receive the required quarterly disclosure. The 
Commission notes that the cost per counterparty can be divided into two 
costs: An initial cost and an on-going, annual cost. In respect of the 
initial cost, the Commission estimates a total of twenty hours of the 
Chief Compliance Officer's time to prepare and design the SD or MSP's 
compliance procedures for its 23.704 disclosure requirements. In 
respect of ongoing costs, the Commission recognizes that, while the 
degree of disclosure to particular counterparties may differ (e.g., 
agreements may require no disclosure, high-level disclosure only or 
more in-depth disclosure), it is likely that the levels of disclosures 
may coalesce around certain intervals such that efficiencies may be 
observed in respect of analysis and preparation of current disclosures 
and ongoing updates to the same. The Commission estimates that the 
Chief Compliance Officer will spend five hours, on an annual basis, 
updating the existing procedures and reviewing compliance with such 
procedures as well as an additional hour, on a non-regular basis in 
perhaps 2% of the cases, addressing non-routine issues that may arise 
in respect of a particular disclosure to a counterparty. The Commission 
further estimates that a junior compliance officer will spend, on 
average, approximately 0.3 hours per counterparty on a quarterly basis, 
analyzing the procedures followed and preparing the disclosure to be 
sent.
---------------------------------------------------------------------------

    \164\ This estimate in the NPRM was based on the requirement of 
regulation 23.704 that SDs and MSPs make the required disclosure 
four times each year to each of their uncleared swaps counterparties 
that does not choose to require segregation of initial margin. It 
was further based on estimates that each disclosure would require, 
on average, approximately 0.3 hours of staff time by staff with a 
salary level of approximately $30 per hour although, per the terms 
of the rule, this would vary depending on the specifics of the 
agreement of the parties with regard to the back-office procedures 
of the SD or MSP and the extent to which such procedures were 
standardized. The estimate further assumed that about half of all 
uncleared swaps counterparties would not choose segregation of 
initial margin and that, as a result, the largest SDs and MSPs would 
make the required disclosure to an average of 2,500-5,000 
counterparties four times per year and that smaller SDs and MSPs 
would make the required disclosure to an average of about 100 
counterparties four times per year. See 75 FR at 75436 (Dec. 3, 
2010) and n. 30; SIFMA, Report on Management and Professional 
Earnings in the Securities Industry-2011 at 4 (national average 
total compensation for a junior level compliance specialist in 
survey equaled $50,998 per year, an hourly equivalent of 
approximately $25).
---------------------------------------------------------------------------

    Based on these adjustments, the Commission now estimates that 
regulation 23.704 will require initial costs of approximately $280,000 
and, on an ongoing basis, a total of approximately 325,000 disclosures 
per year generating an estimated total annual information collection 
burden of approximately $3.7 million, based on the following: An annual 
cost of $29,300 per SD/MSP comprising eighteen hours for the Chief 
Compliance Officer with a salary level of approximately $110.97 per 
hour and the annual cost of 780 hours for junior compliance staff with 
a salary level of approximately $35 per hour, multiplied by an 
estimated 125 SD/MSPs.

C. Cost-Benefit Considerations

1. Background
    Prior to the passage of the Dodd-Frank Act, the decision to 
segregate and the mechanics of such segregation were unregulated and 
left to the negotiation of the parties to the swap. Under new CEA 
section 4s(l)(1)(A), an SD or MSP is required to notify the 
counterparty of its right to segregation. Upon request by the 
counterparty, the SD or MSP must segregate the funds for the benefit of 
the counterparty, among other requirements under section 4s(l)(1)(B). 
Other paragraphs of section 4s(l) outline the applicability of the 
segregation notification, the nature of the custodian and the reporting 
requirement for unsegregated initial margin.
    This legislative act is indicative of Congress's broad intent to 
increase the safety of the swaps market. While many aspects of Title 
VII of the Dodd-Frank Act promote the increased clearing of swaps, 
section 4s(l) indicates Congress' intent to increase the safety in the 
market for uncleared swaps by creating a self-effectuating requirement 
for the segregation of counterparty initial margin in an entity legally 
separate from the SD or MSP.
    In the NPRM, the Commission invited the public ``to submit any data 
or other information that they may have quantifying or qualifying the 
costs and benefits of the proposal with their comment letters.'' \165\ 
The Commission received no such quantitative data or information with 
respect to these rules. While the Commission did not receive comments 
directly on the costs and benefit analysis, it did receive comments 
that alluded to costs, as discussed in more detail in the sections 
below. For example, some commenters believed that the notification of 
counterparties of their right to segregation would create an 
administrative cost (although no commenters attempted to quantify such 
costs). FHLB, MetLife and EEI characterized transaction-by-transaction 
notification as repetitive and redundant.\166\ Some commenters believed 
that even yearly notification was unnecessary.\167\ On the topic of 
investing initial margin only as allowed under regulation 1.25, 
Federated directly stated that this would cause a loss of investment 
returns.\168\ Finally, the Working Group wrote that requiring quarterly 
reporting for non-segregated margin would be unnecessarily burdensome, 
indicating that producing such reports might create a needless 
administrative cost.\169\
---------------------------------------------------------------------------

    \165\ 75 FR at 75437 (Dec. 3, 2010).
    \166\ FHLB letter at 6, MetLife letter at 2, EEI letter at 3.
    \167\ SIFMA/ISDA letter at 4, ISDA letter at 4, AMG letter at 7.
    \168\ Federated letter at 7, 11.
    \169\ Working Group letter at 6.
---------------------------------------------------------------------------

2. Statutory Mandate To Consider Costs and Benefits
    Section 15(a) of the CEA requires the Commission to consider the 
costs and benefits of its action before promulgating a regulation.\170\ 
In particular, costs and benefits must be evaluated in light of five 
broad areas of market and public concern: (1) Protection of market 
participants and the public; (2) efficiency, competitiveness, and 
financial integrity of futures markets; (3) price discovery; (4) sound 
risk management practices; and (5) other public interest 
considerations. Accordingly, the Commission considers the costs and 
benefits resulting from its own discretionary determinations with 
respect to the section 15(a) factors.
---------------------------------------------------------------------------

    \170\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------

    In issuing these final rules, the Commission has considered the 
costs and benefits of each aspect of the rules, as well as alternatives 
to them. In addition, the Commission has evaluated

[[Page 66633]]

comments received regarding costs and benefits in response to its 
proposal. Where quantification has not been reasonably estimable due to 
lack of necessary underlying information, the Commission has considered 
the costs and benefits of the final rules in qualitative terms.
3. Benefits and Costs of the Final Rule
    A discussion of the costs and benefits of this rule and the 
relevant comments is set out immediately below and continues in the 
discussion of the section 15(a) factors. The discussion of costs and 
benefits here should be read in conjunction with the discussion of rule 
provisions and comments in the remainder of the preamble, which was 
also taken into account in the Commission's overall consideration of 
costs and benefits as part of its decision to promulgate the rule.
    The major provisions of this final rule reflect specific 
requirements compelled by the CEA, as amended by the Dodd-Frank Act. 
This discussion of costs and benefits focuses on the areas in which the 
Commission used its discretion to introduce standards or requirements 
beyond those which were required by statute.
a. Benefits
    The final rule, in regulation 23.701(e), requires notification of 
the right to segregation once per each year that a new swap is entered 
into rather than, e.g., at the beginning of a swap transaction or 
notification only when a counterparty first does business with the SD 
or MSP. Annual notification offers the benefit of ensuring that the 
right to segregation is called to the attention of counterparties 
reasonably close in time to the point at which decisions are made with 
respect to the handling of collateral for particular swaps transactions 
without requiring excessive or repetitive notification in cases where a 
counterparty engages in multiple swaps with a particular SD or MSP over 
the course of a year. Annual notification also reduces the likelihood 
that required information regarding custodians and pricing will become 
obsolete, which would be a significant possibility if notification were 
given only at the beginning of a multi-year business relationship 
between a counterparty and the SD or MSP.
    The final rule, in regulation 23.701(a)(2), requires the SD or MSP 
to identify, in the notification, at least one creditworthy non-
affiliate acceptable to the SD or MSP as a custodian. As discussed 
above, there are benefits to requiring that the counterparty have the 
option of using a non-affiliate custodian for collateral because of the 
likely higher correlation of default risk between an affiliate 
custodian and the SD or MSP. There are also benefits to requiring the 
identity of such a custodian acceptable to the SD or MSP to be 
specifically disclosed because the identity of the custodian is a 
material aspect of any segregation package.
    The final rule also requires, in regulation 23.701(a)(3), the SD or 
MSP to provide the counterparty with the price of segregation to the 
extent that the SD or MSP has such information (e.g., where the 
custodian is an affiliate of, or a regular custodian for, the SD or 
MSP). Requiring the SD or MSP to disclose price information that it has 
available is beneficial because knowledge of the price of segregation 
is essential in order for the counterparty to determine the net value 
of choosing segregation. In transactions in which the parties have 
agreed that a withdrawal of segregated margin may be made without the 
written consent of both the counterparty and the SD or MSP, the final 
rule, in regulation 23.702(c)(2), includes a perjury standard for a 
party unilaterally representing to the custodian that it is entitled to 
segregated initial margin. The benefit of a perjury standard for 
unilateral requests for collateral is that it provides a disincentive 
to parties who might otherwise be inclined to fraudulently request 
collateral, particularly in circumstances where financial distress may 
create incentives to cut corners.
    The final rule requires, in regulation 23.703(a), that any 
investments of segregated initial margin given to an SD or MSP conform 
to regulation 1.25. While not required by statute, this aspect of the 
final rule is beneficial because it will serve to safeguard segregated 
initial margin in the same way that regulation 1.25 safeguards futures 
and cleared swaps customer collateral. Without this requirement, there 
exists a possible moral hazard concern that an SD or MSP may engage in 
excessive risk taking with the funds of a counterparty. This moral 
hazard arises out of either (i) lack of customer awareness, (ii) agency 
costs facing the customer that make it difficult to contract around 
issues of collateral use (e.g., monitoring costs of the SD's or MSP's 
activities by the customer), or (iii) existence of a potential 
government backstop, which lessens the incentive of either SDs or MSPs 
or their customers to impose restrictions on collateral investment.
    The final rule, in regulation 23.704(a), also makes the Chief 
Compliance Officer of the SD or MSP required by section 4s(k) of the 
CEA responsible for the report to each counterparty that elects not to 
require segregation whether or not the back office procedures relating 
to margin and collateral requirements of the SD or MSP were out of 
compliance with the agreement between the SD or MSP and the 
counterparty, consistent with the Chief Compliance Officer's 
section4s(k)(2)(D) of the CEA duties. This provision should enhance 
compliance by SDs and MSPs with these aspects of their agreements with 
their counterparties by highlighting breaches and by incentivizing SDs 
and MSPs to avoid breaches that would have to be reported. Compliance 
by SDs and MSPs with provisions concerning margin and collateral 
requirements should lead to better protection of counterparties in the 
event of the insolvency of the SD or MSP.
b. Costs
    As noted previously, the final rule, in regulation 23.701(e), 
requires yearly notification of the right to segregation. This is less 
costly than a requirement that such notification be given with each 
swap transaction, which would result from a more literal reading of the 
statute.\171\
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    \171\ See CEA section 4s(l)(1)(A) (A swap dealer or major swap 
participant shall be required to notify the counterparty of the swap 
dealer or major swap participant at the beginning of a swap 
transaction that the counterparty has the right to require 
segregation.).
---------------------------------------------------------------------------

    An estimate of the cost of the required yearly notification is 
given in the Paperwork Reduction Act section of this preamble, above. 
The Commission believes that the cost of requiring SDs and MSPs to 
deliver one notification per year to each counterparty is not overly 
burdensome, particularly when one considers the importance of the 
counterparty's decision to require segregation and the large dollar 
volume of business that is typically done by SDs and MSPs.\172\ The 
increased cost associated with an annual notification requirement, as 
compared to a requirement that notification only be required at the 
beginning of a swap relationship between the parties as was urged by 
some commenters, is the difference in the administrative costs of 
sending each additional yearly notification as opposed to just one 
initial notification. Commenters who favored less-than-annual 
notification did not provide specific estimates of this cost 
difference. Based on its assessment of the cost of annual notification, 
the Commission does not

[[Page 66634]]

believe that this cost difference would impose an unreasonable 
burden.\173\
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    \172\ See generally Further Definition of ``Swap Dealer,'' 
``Security-Based Swap Dealer,'' ``Major Swap Participant,'' ``Major 
Security-Based Swap Participant'' and ``Eligible Contract 
Participant,'' 77 FR 30596 (May 23, 2012).
    \173\ For the Commission's analysis and estimate of the costs of 
annual notification, please see the discussion in the Paperwork 
Reduction Act section of this preamble, above.
---------------------------------------------------------------------------

    The requirement that SDs or MSPs reveal to counterparties the 
identity of one or more potential custodians (one of which must be 
unaffiliated), and their respective prices of segregation, should 
impose minimal costs. It is likely that both the identities of 
custodians and related pricing information would, in the ordinary 
course, be included in any negotiation between an SD or MSP and a 
counterparty. In any event, the SD's or MSP's own custodial and pricing 
decisions are known (or certainly readily knowable) by the SD or MSP, 
and thus requiring them to be disclosed should introduce minimal cost 
upon the SD or MSP. There may be an administrative cost to the SD or 
MSP in initially selecting an unaffiliated custodian, if the SD or MSP 
did not previously have a relationship with such an entity. This 
administrative expense need only be a one-time cost and should not be 
overly burdensome.
    The perjury standard introduces a heightened punishment for the 
inappropriate seizure of customer collateral based on false 
representations. The primary cost of such a standard is the exercise of 
excessive caution by SDs or MSPs in asserting their right to this 
collateral, even in instances where that right is warranted.
    The requirement that investments of segregated margin given to an 
SD or MSP adhere to regulation 1.25 may impose costs. The primary cost 
would be a loss of investment returns to SDs and MSPs under the rule as 
opposed to investment returns that would have been permitted without 
the regulation's restriction. Regulation 1.25 requires that investments 
of customer collateral by an SD or MSP adhere to a list of enumerated 
investments, concentration limits and other restrictions because 
certain investments may not adequately meet the statute's paramount 
goal of protecting customer funds.\174\ Nonetheless, the Commission 
recognizes that restricting the type and form of permitted investments 
could result in certain SDs and MSPs earning less income from their 
investments of customer funds. The Commission has (conservatively) 
estimated the excess return (or spread) of investing without 
restrictions, as compared to investing according to regulation 1.25 
guidelines, to be between 0% and 4%.\175\ The associated cost of 
imposing regulation 1.25, which needs to also consider the (risk-based) 
preferences of counterparties over the set of foregone investment 
opportunities, exists somewhere within this range. Secondarily, there 
may be administrative costs to SDs and MSPs in ensuring compliance with 
regulation 1.25 limitations. However, the Commission notes that parties 
are free to negotiate arrangements outside of the final rule.
---------------------------------------------------------------------------

    \174\ See generally 7 U.S.C. 6d.
    \175\ This range is based on an average yield on 10-year T-bonds 
between 4% and 6% and a long-run annualized return on equities 
between 6% and 8%.
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    An estimate of the cost of the quarterly reporting required 
pursuant to regulation 23.704 is given in the Paperwork Reduction Act 
section of this preamble, above. As noted above, the Chief Compliance 
Officer and junior compliance officers' time may result in an added 
cost to the implementation of regulation 23.704. The Chief Compliance 
Officer's involvement with design and implementation of these 
procedures, however, is commensurate with its section 4s(k)(2)(D) CEA 
responsibilities for ``administrating each policy and procedure that is 
required to be established pursuant to [section 4s].'' In addition, 
this cost is outweighed by the relative benefit of the design and 
implementation of effective recordkeeping procedures for the large 
number of counterparties served by each SD or MSP.
c. Consideration of Alternatives
    In arriving at the final rules, in areas in which the Commission 
exercised its discretion, the Commission has considered a number of 
alternatives suggested by commenters.
    The Commission asked in the NPRM whether the SD or MSP should be 
required to disclose the price of segregation, the fees to be paid to 
the custodian (if the SD or MSP was aware of such costs) or differences 
in the terms of the swap that the SD or MSP is willing to offer to the 
counterparty if the counterparty elects or renounces the right to 
segregation. SIFMA/ISDA wrote that mandating disclosure is not 
necessary or desirable because ``a counterparty can always, in 
accordance with current market practice, request disclosures it 
considers necessary from its SD/MSP [hellip] [and] mandatory disclosure 
by the SD/MSP is impractical because much of the material costs are 
within the control of a third party: The custodian.'' \176\ ICI sought 
to distinguish between fees charged by the custodian--which ICI does 
not believe need to be disclosed by the SD or MSP--and fees embedded in 
the SD's or MSP's pricing.\177\ State Street suggested that ``the 
Commission should [hellip] provide that, although the pricing of the 
same transaction with and without a segregated account may differ, the 
pricing difference should be reflective of actual out-of-pocket costs 
expected to be incurred by the [SD or MSP] as a result of use of the 
segregated account, and that the nature and amounts of those costs 
should be fully disclosed.'' \178\
---------------------------------------------------------------------------

    \176\ SIFMA/ISDA letter at 3 and ISDA letter at 3-4.
    \177\ ICI letter at 3.
    \178\ State Street letter at 3.
---------------------------------------------------------------------------

    The Commission could have chosen to take the path requested by 
SIFMA/ISDA, in which no disclosures are mandated by the regulation, or 
the path requested by ICI, in which only fees embedded in the SD's or 
MSP's pricing for segregated margin are disclosed. However, as 
discussed by several commenters, what is relevant to the counterparty 
in determining whether to segregate (and with which custodian) is the 
sum of all associated costs; \179\ both those directly associated with 
the custodian, and any additional charges imposed by the SD or MSP.
---------------------------------------------------------------------------

    \179\ See generally MFA Letter at 4 and State Street letter at 
3.
---------------------------------------------------------------------------

    The SD or MSP will typically be in a better position to know the 
fees charged by the custodian than the counterparty. In such instances, 
the alternatives suggested by SIFMA/ISDA and ICI could result in a lack 
of pricing information for the counterparty, or at best, a more 
difficult path for a counterparty to obtain such information. The SD or 
MSP is responsible for segregation and for using an independent third-
party custodian, and providing price information about the total cost 
of segregation to the counterparty is a key component of evaluating a 
custodian's service.
    The Commission notes State Street's argument, but believes that 
mandating that the difference in prices charged by the SD or MSP should 
only reflect the SD's or MSP's out-of-pocket costs would be excessively 
proscriptive. To the extent that this rule promotes price transparency, 
it will foster more competitive pricing.
    In addition, several commenters requested the Commission eliminate 
the once-per-year notification in the Commission's proposed rule. 
SIFMA/ISDA and AMG each wrote that an initial notification is all that 
should be required. The Commission considered requiring only an initial 
notification, however it opted for a yearly notification. Yearly 
notification serves

[[Page 66635]]

as an appropriate means for calling attention to the importance of the 
right to segregate collateral, and offers a number of benefits, 
relative to one-time-only disclosure, as has been discussed above. 
Similarly, the Commission has concluded that any difference in 
administrative costs should not be excessively burdensome.
    The alternative to a perjury standard for unilateral requests to 
withdraw collateral from segregation is not to have one. However, it is 
the Commission's view that heightening the penalty for fraudulently 
requesting funds to which one is not entitled reduces the incidence of 
such claims, and may serve the general intent of section 4s(l) to 
increase the safety and financial integrity of the uncleared swap 
market and to safeguard the initial margin of parties to uncleared 
swaps, once segregated, while still providing the benefits of a 
unilateral ability to withdraw collateral to parties who agree to such 
an approach.\180\
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    \180\ As discussed below, the perjury rule may in certain 
instances lead to excess caution by SDs and MSPs in cases where they 
do have a right to the collateral. In such instances, the perjury 
rule could adversely affect sound risk management.
---------------------------------------------------------------------------

    The alternatives to subjecting the investment of segregated initial 
margin to regulation 1.25 are to subject it to no restrictions at all 
or to subject it to some other collateral investment regime. The 
Commission notes that none of the commenters proposed an alternative 
investment framework or detailed set of restrictions.\181\ It is the 
Commission's view that the purpose of section 4s(l) is to increase the 
safety of the uncleared swaps market and to protect initial margin, 
once segregated. Regulation 1.25 is used by the Commission for both 
futures and cleared swaps as a means by which to protect segregated 
customer funds against risky investment. Having created a legal 
standard for this purpose, it makes sense to apply it to uncleared 
swaps transactions in which counterparties choose to have their 
collateral segregated within a regulatory framework established by the 
Commission under the authority of section 4s(l).
---------------------------------------------------------------------------

    \181\ While Federated provided some general suggestions, such as 
setting concentration limits on investments with a particular fund 
or family of funds, it argued that there ``should be no limits on 
investment of collateral for uncleared or cleared swaps.'' See 
Federated letter at 10-11.
---------------------------------------------------------------------------

    Alternatives to reporting requirements to non-segregated collateral 
would be to require reports less frequently than quarterly and to not 
place responsibility for such reports on the chief compliance officer. 
The Commission notes that while quarterly reporting may impose certain 
administrative burdens on SDs and MSPs, such quarterly reporting, as 
contemplated by regulation 23.704, is expressly required by the 
statute.\182\ In addition, under section 4s(k)(2)(D) of the CEA, the 
chief compliance officer is ``responsible for administering each policy 
and procedure that is required to be established pursuant to [section 
4s].'' Thus, responsibility for compliance with the quarterly reporting 
requirement, a procedure required by section 4s(l)(4) of the CEA, 
properly rests with the chief compliance officer.
---------------------------------------------------------------------------

    \182\ The reporting requirement found in section 4s(l)(4) of the 
CEA states that if the counterparty does not choose to require 
segregation of the funds or other property supplied to margin, 
guarantee, or secure the obligations of the counterparty, the swap 
dealer or major swap participant shall report to the counterparty of 
the swap dealer or major swap participant on a quarterly basis that 
the back office procedures of the swap dealer or major swap 
participant relating to margin and collateral requirements are in 
compliance with the agreement of the counterparties.
---------------------------------------------------------------------------

4. Section 15(a) Factors
    As noted above, in this final rule, the Commission considers the 
costs and benefits that result from the regulations issued herein 
according to the requirements of section 15(a) of the CEA. Previous 
sections identify four main issues for cost-benefit considerations: (1) 
Notification of the right to segregate, (2) requirements to reveal the 
price of segregation, (3) statements affirming the right to seize 
collateral, and (4) adherence to regulation 1.25 in the investment of 
segregated collateral. This section discusses those considerations in 
light of the section 15(a) criteria described above.
a. Annual Notification of the Right to Segregate
    This requirement ensures that the right to segregation is called to 
the attention of counterparties reasonably close in time to the point 
at which they make decisions regarding the handling of collateral for 
particular swaps transactions and therefore increases the likelihood 
that counterparties will make informed decisions on whether to elect 
segregation. It thereby furthers the protection of market participants 
and the public and promotes sound risk management practices.
b. Revealing the Price of Segregation and Identifying a Custodian
    The statute requires the SD or MSP to notify the counterparty of 
its right to segregation. The final regulation goes beyond the 
statutory requirement by also requiring that the SD or MSP provide an 
unaffiliated custodian that it would be willing to use as well as the 
price associated with segregation. The Commission has determined that 
the benefits for this requirements are compelling and do not entail any 
significant costs.
    The requirement also promotes the protection of market participants 
and the public and promotes sound risk management practices. The 
ability of a counterparty to know the custodian and the price 
associated with segregation is important because it facilitates the 
counterparty's decisions regarding whether to segregate initial margin 
and with whom it wishes to transact swaps. In addition to benefitting 
counterparties facilitating decisions regarding protection of 
collateral in uncleared swaps transactions benefits the public. 
Notwithstanding the movement towards clearing, a large number of swaps 
will remain bilateral contracts. Congress has determined that systemic 
risk will be reduced by offering counterparties the right to segregate 
collateral to avoid losses brought about by default of an SD or MSP and 
providing information on custodians and pricing promotes the exercise 
of this right.
    This requirement also promotes market efficiency, competitiveness 
and financial integrity by facilitating counterparty comparison of 
custodians, which may influence its choice of the SD or MSP with which 
it wishes to transact swaps. To the extent that such price transparency 
promotes competition among custodians, one can expect reductions in the 
cost of segregation, which, in turn, may lead to increased use of the 
segregation option, with the resultant positive implications for sound 
risk management practices. Second, requiring that pricing information 
be obtained by the party best positioned to know such information 
eliminates a circumstance where a party at a comparative disadvantage 
for obtaining such information has to do so.
c. Perjury Standard for Statements Affirming the Right to Unilaterally 
Withdraw Collateral From a Custodian
    The baseline for comparison of this requirement is typical market 
practice, which may include civil and criminal actions against a party 
falsely claiming that it is entitled to funds to which it, in fact, is 
not.
    Introducing a perjury standard for unilateral requests for 
collateral will serve as an additional disincentive for parties who 
might otherwise be inclined to fraudulently request collateral. To the 
extent this standard reduces the incidence of such false claims, the 
rule acts to promote the protection of market participants and the 
public. In addition, fraudulent requests for collateral, if

[[Page 66636]]

honored, can shake victimized parties' confidence in the uncleared 
segregation regime and damage public confidence in the safety of the 
uncleared swap market. Heightening disincentives for fraudulent conduct 
will therefore help to safeguard the financial integrity of the 
uncleared swap market place. As previously mentioned, a primary cost of 
this standard is the exercise of excessive caution by SDs or MSPs in 
asserting their right to this collateral, even in instances where the 
SD or MSP believes that the unilateral withdrawal of such collateral is 
authorized, because of the costs and risks of exposure to a potential 
criminal action. To the extent that this potential cost arises, 
therefore, the requirement can negatively impact the practice of sound 
risk management.
d. Adherence to Regulation 1.25
    Absent this requirement, an SD or MSP's investment options for 
collateral would be left up to the negotiation of the counterparties.
    As discussed above, without this requirement, there exists a 
possible moral hazard concern that an SD or MSP may engage in excessive 
risk taking with the funds of a counterparty. The Commission agrees 
with commenters who claim that this requirement may constrain the 
investment returns of SDs and MSPs relative to those returns achievable 
absent the enhanced safety criteria. Recognizing that there may be some 
reduction in returns, applying regulation 1.25 standards to segregated 
initial margin of uncleared swaps will benefit market participants and 
the public by safeguarding such segregated funds.
    This regulation also benefits the financial integrity of the market 
place. A party who invests its customer's segregated funds is required 
to replenish any losses in the customer account with its own funds. 
During a period of market stress, such a party might be experiencing 
losses in other areas, which may increase the difficulty of making the 
customer whole. In that regard, even if there are not losses in the 
customer account, strains on the SD's or MSP's sources of funds may 
cause delays in a counterparty receiving funds to which it is entitled. 
Regulation 1.25 requires that customer fund investments be made in an 
enumerated list of instruments which preserve principal and maintain 
liquidity.
    Finally, requiring that investments of segregated initial margin 
adhere to regulation 1.25 benefits sound risk management practices by 
ensuring that segregated funds are invested in a safe manner. This 
benefits the counterparty, whose initial margin is safeguarded, and the 
market as a whole, because of the decreased likelihood of a market 
shock causing a chain reaction which results in the loss of segregated 
funds. While the Commission realizes that there may be administrative 
costs in ensuring that regulation 1.25 requirements are followed, the 
Commission expects that SDs and MSPs are sophisticated firms that 
should be able to make the necessary adjustments without much delay or 
expense. The overall benefits of safeguarding segregated funds and the 
resultant reductions in risk to portfolios, as compared to those based 
on a regulatory framework without such limitations, exceed those 
costs.\183\
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    \183\ Based on the subject matter of the rule and comments 
received, the Commission does not expect the rule to have a 
significant effect on price discovery or on other public interest 
considerations not already discussed.
---------------------------------------------------------------------------

List of Subjects

17 CFR Part 23

    Consumer protection, Reporting and recordkeeping requirements, 
Swaps.

17 CFR Part 190

    Bankruptcy, Brokers, Commodity futures, Reporting and recordkeeping 
requirements, Swaps.
    For the reasons stated in the preamble, the Commodity Futures 
Trading Commission amends 17 CFR parts 23 and 190 as follows:

PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

0
1. The authority citation for part 23 continues to read as follows:

    Authority:  7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t, 
9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.


0
2. Add and reserve subpart K.

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

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


Sec.  23.700  Definitions.

    As used in this subpart:
    Initial Margin means money, securities, or property posted by a 
party to a swap as performance bond to cover potential future exposures 
arising from changes in the market value of the position.
    Margin means both Initial Margin and Variation Margin.
    Segregate. To segregate two or more items is to keep them in 
separate accounts, and to avoid combining them in the same transfer 
between two accounts.
    Variation Margin means a payment made by or collateral posted by a 
party to a swap to cover the current exposure arising from changes in 
the market value of the position since the trade was executed or the 
previous time the position was marked to market.


Sec.  23.701  Notification of right to segregation.

    (a) Prior to the execution of each swap transaction that is not 
submitted for clearing, a swap dealer or major swap participant shall:
    (1) Notify each counterparty to such transaction that the 
counterparty has the right to require that any Initial Margin the 
counterparty provides in connection with such transaction be segregated 
in accordance with Sec.  23.702 and Sec.  23.703;
    (2) Identify one or more custodians, one of which must be a 
creditworthy non-affiliate and each of which must be a legal entity 
independent of both the swap dealer or major swap participant and the 
counterparty, as an acceptable depository for segregated Initial 
Margin; and
    (3) Provide information regarding the price of segregation for each 
custodian identified in paragraph (a)(2) of this section, to the extent 
that the swap dealer or major swap participant has such information.
    (b) The right referred to in paragraph (a) of this section does not 
extend to Variation Margin.
    (c) The notification referred to in paragraph (a) of this section 
shall be made to an officer of the counterparty responsible for the 
management of collateral. If no such party is identified by the 
counterparty to the swap dealer or major swap participant, then the 
notification shall be made to the Chief Risk Officer of the 
counterparty, or, if there is no such Officer, the Chief Executive 
Officer, or if none, the highest-level decision-maker for the 
counterparty.
    (d) Prior to confirming the terms of any such swap, the swap dealer 
or major swap participant shall obtain from the counterparty 
confirmation of receipt by the person specified in paragraph (c) of 
this section of the notification specified in paragraph (a) of this 
section, and an election to require such segregation or not. The swap 
dealer or major swap participant shall maintain such

[[Page 66637]]

confirmation and such election as business records pursuant to Sec.  
1.31 of this chapter.
    (e) Notification pursuant to paragraph (a) of this section to a 
particular counterparty by a particular swap dealer or major swap 
participant need only be made once in any calendar year.
    (f) A counterparty's election to require segregation of Initial 
Margin, or not to require such segregation, may be changed at the 
discretion of the counterparty upon written notice delivered to the 
swap dealer or major swap participant, which changed election shall be 
applicable to all swaps entered into between the parties after such 
delivery.


Sec.  23.702  Requirements for segregated margin.

    (a) The custodian of Margin, segregated pursuant to an election 
under Sec.  23.701, must be a legal entity independent of both the swap 
dealer or major swap participant and the counterparty.
    (b) Initial Margin that is segregated pursuant to an election under 
Sec.  23.701 must be held in an account segregated for and on behalf of 
the counterparty, and designated as such. Such an account may, if the 
swap dealer or major swap participant and the counterparty agree, also 
hold Variation Margin.
    (c) Any agreement for the segregation of Margin pursuant to this 
section shall be in writing, shall include the custodian as a party, 
and shall provide that:
    (1) Any withdrawal of such Margin, other than pursuant to paragraph 
(c)(2) of this section, shall only be made pursuant to the agreement of 
both the counterparty and the swap dealer or major swap participant, 
and notification of such withdrawal shall be given immediately to the 
non-withdrawing party;
    (2) Turnover of control of such Margin shall be made without the 
written consent of both parties, as appropriate, to the counterparty or 
to the swap dealer or major swap participant, promptly upon 
presentation to the custodian of a statement in writing, made under 
oath or under penalty of perjury as specified in 28 U.S.C. 1746, by an 
authorized representative of either such party, stating that such party 
is entitled to such control pursuant to an agreement between the 
parties. The other party shall be immediately notified of such 
turnover.


Sec.  23.703  Investment of segregated margin.

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


Sec.  23.704  Requirements for non-segregated margin.

    (a) The chief compliance officer of each swap dealer or major swap 
participant shall report to each counterparty that does not choose to 
require segregation of Initial Margin pursuant to Sec.  23.701(a), no 
later than the fifteenth business day of each calendar quarter, on 
whether or not the back office procedures of the swap dealer or major 
swap participant relating to margin and collateral requirements were, 
at any point during the previous calendar quarter, not in compliance 
with the agreement of the counterparties.
    (b) The obligation specified in paragraph (a) of this section shall 
apply with respect to each counterparty no earlier than the 90th 
calendar day after the date on which the first swap is transacted 
between the counterparty and the swap dealer or major swap participant.

PART 190--BANKRUPTCY

0
4. The authority citation for part 190 continues to read as follows:

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

0
5. In Sec.  190.01, revise paragraph (l) to read as follows:


Sec.  190.01  Definitions.

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

0
6. In Sec.  190.08, redesignate paragraph (a)(1)(i)(F) as paragraph 
(a)(1)(i)(G) and add new paragraph (a)(1)(i)(F) to read as follows:


Sec.  190.08  Allocation of property and allowance of claims.

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

    Issued in Washington, DC, on October 31, 2013, by the 
Commission.
Melissa D. Jurgens,
Secretary of the Commission.

Appendices to Protection of Collateral of Counterparties to Uncleared 
Swaps; Treatment of Securities in a Portfolio Margining Account in a 
Commodity Broker Bankruptcy--Commission Voting Summary and Statement of 
Chairman

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

Appendix 1--Commission Voting Summary

    On this matter, Chairman Gensler and Commissioners Chilton, 
O'Malia, and Wetjen voted in the affirmative; no Commissioner voted 
in the negative.

Appendix 2--Statement of Chairman Gary Gensler

    I support the final rule enhancing the protection of customer 
funds when entering into uncleared swap transactions. Today's final 
rule fulfills Congress' mandate that counterparties of swap dealers 
be given a choice regarding whether or not they get the protections 
that come from segregation of monies and collateral they post as 
initial margin. These are important customer protections for 
counterparties as they enter into customized swaps with swap 
dealers.
    Swap dealers will be required to give each of their 
counterparties the choice with regard to segregation. The dealers 
also will have to provide the prices for the various segregation 
choices. Further, the dealers must give the customers at least one 
custodial arrangement choice not affiliated with the swap dealer's 
bank.
    In addition, this rule provides clarifying changes to ensure 
that if a counterparty chooses segregation for its funds, those 
funds will not be tied up in the bankruptcy of its swap dealer.
    These rules are critical to protecting insurance companies, 
pension funds, community banks and municipal governments wishing to 
hedge a risk in using the customized swaps market.

[FR Doc. 2013-26479 Filed 11-5-13; 8:45 am]
BILLING CODE 6351-01-P