[Federal Register Volume 76, Number 14 (Friday, January 21, 2011)]
[Proposed Rules]
[Pages 3859-3874]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-1218]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-63727; File No. S7-03-11]
RIN 3235-AK91
Trade Acknowledgment and Verification of Security-Based Swap
Transactions
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: In accordance with Section 764(a) of Title VII of the Dodd-
Frank Wall Street Reform and Consumer Protection Act of 2010 (``Dodd-
Frank Act''), the Securities and Exchange Commission (``Commission'')
is proposing rule 15Fi-1 under the Securities Exchange Act of 1934
(``Exchange Act''), 15 U.S.C. 78a et seq., which would require
security-based swap dealers and major security-based swap participants
to provide trade acknowledgments and to verify those trade
acknowledgments in security-based swap transactions.
DATES: Comments should be received on or before February 22, 2011.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml);
Send an e-mail to [email protected]. Please include
File
[[Page 3860]]
Number S7-03-11 on the subject line; or
Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number S7-03-11. This file number
should be included on the subject line if e-mail is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments
are also available for website viewing and printing in the Commission's
Public Reference Room, 100 F Street, NE., Washington, DC 20549, on
official business days between the hours of 10 a.m. and 3 p.m. All
comments received will be posted without change; we do not edit
personal identifying information from submissions. You should submit
only information that you wish to make available publicly.
FOR FURTHER INFORMATION CONTACT: Joseph Furey, Assistant Chief Counsel;
Darren Vieira, Special Counsel; or Ignacio Sandoval, Attorney, at (202)
551-5550, Office of Chief Counsel, Division of Trading and Markets,
Securities and Exchange Commission, 100 F Street, NE., Washington, DC
20549-7010.
SUPPLEMENTARY INFORMATION: The Commission is proposing rule 15Fi-1
pursuant to Section 15F of the Exchange Act.\1\
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\1\ 15 U.S.C. 78o-8.
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I. Background
Section 764 of the Dodd-Frank Act,\2\ enacted on July 21, 2010,
added Section 15F to the Exchange Act.\3\ Among other things, Section
15F requires security-based swap (``SBS'') dealers and major SBS
participants (collectively, ``SBS Entities'') to register with the
Commission, and directs the Commission to prescribe rules applicable to
SBS Entities.
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\2\ Public Law 111-203, 124 Stat. 1376 (2010).
\3\ 15 U.S.C. 78o-8.
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Section 15F(i)(1) of the Exchange Act provides that SBS Entities
must ``conform with such standards as may be prescribed by the
Commission, by rule or regulation, that relate to timely and accurate
confirmation, processing, netting, documentation, and valuation of all
security-based swaps.'' Section 15F(i)(2) of the Exchange Act provides
that the Commission must adopt rules governing documentation standards
for SBS Entities. Proposed rule 15Fi-1 would prescribe standards
related to timely and accurate confirmation and documentation of SBS,
as further described below.
Market participants currently issue a ``trade acknowledgment''
(sometimes referred to by industry participants as a ``draft
confirmation'' or an ``alleged trade'') to memorialize the economic and
related terms of an SBS transaction, regardless of the means by which
the transaction was executed. If an SBS transaction is not reduced to
writing, a court may have to supply contract terms upon which there was
no previous agreement. For this reason, prudent practice requires that,
after coming to an agreement on the terms of a transaction, the parties
document the transaction in a complete and definitive written record so
there is legal certainty about the terms of their agreement in case
those terms are later disputed. Therefore, industry best practices
incorporate a process by which the parties verify that the trade
acknowledgment accurately reflects the terms of their trade.\4\ This
process, through which one party acknowledges an SBS transaction and
its counterparty verifies it, is the confirmation process, which
results in the issuance of a confirmation that reflects the terms of
the contract between the parties.\5\ This confirmation includes any
transaction-specific modifications to master agreements between the
parties that might apply to the transaction, such as the International
Swaps and Derivatives Association (``ISDA'') Master Agreement and
Schedule. A confirmation is thus a written or electronic record of an
SBS transaction that has been sent by one party and verified by the
other where that record has been manually, electronically, or by some
other legally equivalent means, signed by the receiving counterparty.
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\4\ See Part II.D, below, for a discussion of verification.
\5\ Confirmations may also be used by SBS Entities to make
certain disclosures, or to disclaim certain obligations, to a
counterparty. Required disclosures by an SBS Entity will be
addressed separately in proposed ``external business conduct'' rules
for SBS Entities.
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In the past few years, market participants and regulators have paid
particular attention to the timely confirmation of SBS transactions.
The Government Accountability Office has found that, since 2002, the
trading volume of SBS such as credit derivatives has expanded rapidly,
causing stresses on the operational infrastructure of market
participants, which in turn caused the participants' back office
systems to fail for a period of time to confirm the increased volume of
trades.\6\ The GAO viewed the lack of automation and the purported
assignment of positions by transferring parties to third parties
without notice to their counterparties as the primary factors
contributing to this backlog.\7\ The GAO found that if new transactions
are left unconfirmed, there is no definitive written record of the
contract terms. Thus, in the event of a dispute, the terms of the
agreement must be reconstructed from other evidence, such as e-mail
trails or recorded trader conversations. The GAO noted that this
process is cumbersome and may not be wholly accurate. Moreover, if
purported transfers of SBS transactions are made without giving notice
to the remaining parties and obtaining their consent, disputes may
arise as to which parties are entitled to the benefits and subject to
the burdens of the transaction. The GAO found that these circumstances
created significant legal and operational risk for market
participants.\8\ These risks, as well as other operational issues
associated with the over-the-counter derivatives market, have been the
focus of reports and recommendations by the President's Working
Group,\9\ and of ongoing efforts led by the Federal Reserve Bank of New
York (``FRBNY'') to enhance operational capacity in the over-the-
counter derivatives market and improve operational performance, by
increasing automation, promoting timely confirmation of trades, and
ending practices such as the purported unilateral transferring of SBS
transactions.\10\
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\6\ U.S. Government Accountability Office (``GAO''), Credit
Derivatives: Confirmation Backlogs Increased Dealers' Operational
Risks, But Were Successfully Addressed After Joint Regulatory
Action, GAO-07-716 (2007) at pages 3-4 (``GAO Confirmation
Report''). As of September 2005, the accumulated backlog of
unconfirmed over-the-counter credit derivatives trades was 150,000.
\7\ Several factors reduced the risk of unconfirmed trades due
to unilateral assignment, including: (1) The tendency for end-users
to assign contracts to dealers who were generally more credit-worthy
than the end-user; (2) dealers refusing to release posted collateral
until the dealer verified the assignment, and; (3) a novation
protocol in the ISDA Master Agreement that required counterparties
to obtain the written consent of their counterparties before
assigning a trade. Id at pages 17-18.
\8\ Id. at pages 12-15.
\9\ See, e.g., Press Release, President's Working Group on
Financial Markets, Progress Summary on OTC Derivatives Operational
Improvements (November 2008).
\10\ See, e.g,. FRBNY, Summary of OTC Derivatives Commitments
(March 1, 2010).
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[[Page 3861]]
To promote the efficient operation of the SBS market, and to
facilitate market participants' management of their SBS-related risk,
the Commission is proposing a confirmation process in rule 15Fi-1. The
proposed rule will govern the delivery of SBS trade acknowledgments and
the verification of those trade acknowledgments, as described more
fully below. In developing this proposed rule, the Commission has
consulted with other financial regulators, including the Commodity
Futures Trading Commission and the Board of Governors of the Federal
Reserve System.
The Commission understands that proposed rule 15Fi-1, as well as
other proposals that the Commission may consider in the coming months
to implement the Dodd-Frank Act, if adopted, could significantly
affect--and be significantly affected by--the nature and scope of the
security-based swaps market in a number of ways. For example, the
Commission recognizes that if the measures it adopts are too onerous
for existing participants or new entrants, they could hinder the
further development of a market for SBS by unduly discouraging
participation by SBS Entities. On the other hand, if the Commission
adopts rules that are too permissive, they may not adequately protect
investor interests or promote the purposes of the Exchange Act. We also
are aware that the further development of the SBS market may require
the Commission to revise its confirmation standards for SBS
transactions. We urge commenters, as they review our proposal, to
consider generally the role that regulation may play in fostering or
limiting the development of the market for SBS (or the role that market
developments may play in changing the nature and implications of
regulation) and specifically to focus on this issue with respect to the
proposed trade acknowledgment and verification rule for SBS Entities.
II. Discussion of the Proposed Rule
Proposed Exchange Act rule 15Fi-1 would require SBS Entities to
provide to their counterparties a trade acknowledgment, to provide
prompt verification of the terms provided in a trade acknowledgment of
transactions from other SBS Entities, and to establish, maintain, and
enforce policies and procedures that are reasonably designed to obtain
prompt verification of the terms provided in a trade acknowledgment. We
are proposing to define several key terms in the rule to have the
meaning that we believe is commonly attributed to those terms by
industry participants. Thus, as discussed above, we propose to define
the term ``trade acknowledgment'' to mean a written or electronic
record of an SBS transaction sent by one party to the other.\11\ As
used in the proposed rule, the term ``verification'' would mean the
process by which a trade acknowledgment has been manually,
electronically, or by some other legally equivalent means, signed by
the receiving counterparty.\12\ Thus, a ``confirmed'' SBS transaction
would mean a transaction in which the parties have produced a trade
acknowledgment that is agreed to by both parties and that has been
verified.\13\
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\11\ See proposed Rule 15Fi-1(a)(10).
\12\ See proposed Rule 15Fi-1(a)(13).
\13\ See proposed Rule 15Fi-1(a)(4).
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Proposed rule 15Fi-1 would require certain SBS Entities that
purchase or sell any SBS to provide an electronic trade acknowledgment
to the applicable counterparty containing certain required
information--discussed in Part II.C, below--within the prescribed
timeframe. By requiring counterparties to provide trade acknowledgments
of and to verify SBS transactions in a timely way, proposed rule 15Fi-1
is intended to promote the principles of Exchange Act Section
15F(i)(1).
Request for Comment
The Commission requests comment on all aspects of the proposed
definitions of trade acknowledgment, verification and confirmation.
A. Trade Acknowledgment Requirement
1. Events Triggering the Trade Acknowledgment Obligation
Proposed rule 15Fi-1(b) would require an SBS Entity that purchases
or sells any security-based swap to provide a trade acknowledgment to
its counterparty. The terms ``purchase'' and ``sale'' are defined in
Section 3(a) of the Exchange Act.\14\ As amended by the Dodd-Frank Act,
those definitions as applied to SBS transactions include any
``execution, termination (prior to its scheduled maturity date),
assignment, exchange, or similar transfer or conveyance of, or
extinguishing of rights or obligations under, a security-based swap.''
\15\ Because the rule would apply solely to an SBS Entity that
``purchases'' or ``sells'' an SBS, the proposed rule would be
effectively limited to ``principal transactions'' in which the SBS
Entity is a counterparty to the transaction and is acting for its own
account.
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\14\ 15 U.S.C. 78c(a)
\15\ Dodd-Frank Act Sections 761(a)(3) and (4), amending
Exchange Act Sections 3(a)(13) and (14), respectively; 15 U.S.C.
78c(a)(13) and (14).
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Request for Comment
The Commission requests comment on all aspects of the proposal as
to the events that would trigger an obligation to provide a trade
acknowledgment.
1. Are there circumstances, other than purchases or sales of SBS,
when SBS Entities should be required to provide SBS trade
acknowledgments to their counterparties?
2. What are the current market practices with respect to confirming
SBS transactions?
3. How would current industry practices for confirming transactions
be affected by the proposed rule?
4. How should policies and procedures to verify trade
acknowledgments differ from current market practices, if at all?
5. What are the advantages or disadvantages of the proposed rule
compared to current market practices? What additional costs would these
differences entail?
6. Do participants currently have operations and/or departments in
place to comply with the proposed requirements?
7. Do the benefits of promptly providing a trade acknowledgment
justify the additional costs, and, if not, why not?
8. Many, if not most, types of securities transactions are complete
upon settlement of the trade (usually shortly following execution), and
the purchaser and seller have no continuing obligations to one another.
In contrast, parties to SBS transactions have ongoing obligations to
each other that could continue for years, depending on the term of the
SBS transaction. The Commission has proposed to require parties to SBS
transactions to report to an SBS data repository certain life-cycle
events, some of which are included in the definition of purchase and
sale and some of which, like corporate actions (e.g., mergers,
dividends, stock splits, or bankruptcy), are not.\16\ The Commission
understands that some parties may agree to notification upon life-cycle
events, and that certain vendors track some of this information with
regard to securities underlying certain credit default swaps. The
Commission also notes that exchanges and other industry utilities
currently publish similar information (e.g., ex-dividend dates,
bankruptcies) with respect to the cash
[[Page 3862]]
and derivatives markets. Should the Commission also require delivery of
a trade acknowledgment and verification of any types of corporate
actions? To what extent is it the industry custom currently to require
notification to be provided about changes or life-cycle events in the
security, loan, or narrow-based index that underlies an SBS? Should the
proposed rule require trade acknowledgments for these changes or
events?
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\16\ See Regulation SBSR--Reporting and Dissemination of
Security-Based Swap Information, Exchange Act Release No. 63346
(Nov. 19, 2010), 75 FR 75207 (Dec. 2, 2010) (``SBSR Proposing
Release'').
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9. Should the proposed rule require different procedures for
terminations than for other purchases and sales? What are the current
practices with respect to sending notices of termination? What
information should be provided in an acknowledgment of a termination?
2. Who provides the trade acknowledgment?
The Commission proposes using Section 13A(a)(3) of the Exchange Act
as a model to determine which counterparty is responsible for providing
the trade acknowledgment in the transaction. Section 13A(a)(1) provides
that each SBS that is not accepted for clearing by a clearing agency or
derivatives clearing organization must be reported to a swap data
repository or to the Commission.\17\ Section 13A(a)(3) specifies which
party is obligated to make such reports--an SBS dealer, a major SBS
participant, or a counterparty to the transaction--and it does not
require both parties to report the same transaction.\18\ Generally,
Section 13A(a)(3) places the reporting burden on the party that is
expected to transact in SBS more frequently. Similarly, the Commission
proposes requiring only a single trade acknowledgment in any
transaction, and requiring that, in a transaction to which an SBS
Entity is a party, the party responsible for providing the trade
acknowledgment would be determined in the same manner as the party
responsible for reporting the transaction to an SBS data repository or
to the Commission. Therefore in a transaction where only one
counterparty is an SBS dealer or major SBS participant, the SBS dealer
or major SBS participant would be responsible for providing the trade
acknowledgment. In a transaction between an SBS dealer and a major SBS
participant, the SBS dealer would be responsible for providing the
trade acknowledgment. In a transaction where both parties are SBS
dealers, or both parties are major SBS participants, the counterparties
would be responsible for selecting which party must provide the trade
acknowledgment.\19\
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\17\ 15 U.S.C. 78m-1(a)(1).
\18\ 15 U.S.C. 78m-1(a)(3).
\19\ The Commission considered requiring all SBS Entities to
provide SBS trade acknowledgments in each transaction to which they
are a party, but preliminarily has determined not to propose this
approach. Under that approach, in a situation where only one party
is an SBS Entity, that party would provide the trade acknowledgment
to its counterparty. In effect, this is similar to how broker-
dealers are required to provide confirmations to their customers
under Exchange Act rule 10b-10. However, the customers are under no
obligation pursuant to rule 10b-10 to confirm their transactions
with broker-dealers. In situations where both parties were SBS
Entities, each party would cross-acknowledge the transaction by
providing a duplicate trade acknowledgment to the other party.
However, requiring cross-acknowledgment could be needlessly
burdensome and may interfere with more efficient means of
acknowledging transactions. Additionally, legal uncertainty could
result if for some reason the trade acknowledgments did not match
and neither party noticed or challenged the discrepancy.
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Although the responsible counterparty would have the obligation to
provide the trade acknowledgment, that counterparty could use a third-
party to fulfill this obligation. The Commission expects that many
transactions will be confirmed by ``matching services'' provided
through a clearing agency.\20\ We use matching service in this release
to refer only to services through which two parties enter a new
transaction.
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\20\ Under the proposed rule, the term ``clearing agency'' would
mean a clearing agency registered pursuant to section 17A of the
Exchange Act, 15 U.S.C. 78q-1. See proposed Rule 15Fi-1(a)(3). A
clearing agency that captures trade information regarding a
securities transaction and performs an independent comparison of
that information which results in the issuance of legally binding
matched terms to the transaction is providing matching services.
See, also, Exchange Act Release No. 39829 (April 6, 1998), 63 FR
17943 (April 13, 1998) (File No. S7-10-98) (``A vendor that provides
a matching service will actively compare trade and allocation
information and will issue the affirmed confirmation that will be
used in settling the transaction.'').
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A clearing agency is providing matching services if it captures
trade information regarding a securities transaction, performs an
independent comparison of that information, and issues a confirmation
\21\ of the transaction. The Commission believes that the use of
clearing agencies' matching services would promote the principles of
Exchange Act Section 15F(i), and the Commission wishes to encourage SBS
Entities to use these matching services. Accordingly, paragraph (b)(2)
of the proposed rule would provide that an SBS Entity will have
satisfied its requirement to provide a trade acknowledgment if a
clearing agency, through its facilities, produces a confirmation of the
SBS transaction.\22\
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\21\ ``Confirmation'' means a trade acknowledgment that has been
subject to verification. See proposed Rule 15Fi-1(a)(4).
\22\ In the course of clearing and settling SBS transactions,
clearing agencies would need much or all of the information that is
required on a trade acknowledgment, and therefore, the clearing
agency would have in place systems to receive and process the
information on a trade acknowledgment. The Commission notes that
clearing agencies must: register with the Commission and submit
their rules for review and approval by the Commission; meet minimum
standards of care; have the capacity to enforce their rules and
discipline their participants; and have chief compliance officers to
oversee compliance with their statutory and regulatory obligations.
The Commission believes that clearing agencies are thus equipped to
manage the operations necessary to provide trade acknowledgments in
the course of their work clearing and settling SBS transactions.
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A clearing agency may also serve as a central clearing counterparty
(``CCP'') in SBS transactions. In a CCP arrangement, if the original
counterparties to a bilateral SBS transaction are clearing members,
they novate their bilateral trade to the clearing agency (acting as a
CCP). In such a novation to a CCP, each counterparty terminates its
contract with the other and enters into a new contract on identical
terms with the CCP. In this way, the CCP becomes buyer to one
counterparty and seller to the other.\23\ The novation would constitute
a purchase from or a sale to the clearing agency. While the purchase or
sale would require a trade acknowledgment under paragraph (b)(1) of the
proposed rule, paragraph (b)(2) of the proposed rule would permit the
CCP to satisfy the SBS Entity's obligation to provide a trade
acknowledgment to its counterparty, both for the initial bilateral
transaction between an SBS Entity and its counterparty that are
clearing members, and for the subsequent purchases or sales that result
from the novation to the CCP.
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\23\ See Exchange Act Release No. 59527 (Mar. 6, 2009).
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Request for Comment
The Commission solicits comment on all aspects of the allocation of
responsibility between the parties for providing the trade
acknowledgment.
10. Does the proposed rule appropriately allocate the
responsibility to provide a trade acknowledgment?
11. Would permitting the parties to agree which party would provide
a trade acknowledgment in all transactions, instead of only in
transactions between two SBS dealers or two major SBS participants, be
preferable?
12. Should the rule require each SBS Entity that is a party to an
SBS transaction to provide a trade acknowledgment to its counterparty?
13. Should the rule allow persons other than clearing agencies,
such as
[[Page 3863]]
SBS execution facilities, to provide trade acknowledgments on behalf of
SBS Entities?
14. Does the description of the use of matching services, above,
accurately describe current market practice, including market practice
in such forums as the inter-dealer market? If not, what current
practices are not encompassed by the description?
15. Should clearing agencies be permitted to provide trade
acknowledgments on behalf of SBS Entities in transactions where the
clearing agency was not responsible for clearing the transaction
through a matching process? If so, under what conditions?
B. Time To Provide a Trade Acknowledgment
The Commission believes that confirming SBS transactions shortly
after execution should help to promote the stability of the SBS market
by preventing documentation backlogs from creating uncertainty over SBS
Entities' exposure to SBS.\24\ There will be a lag between the time
when an SBS is executed (i.e., the point at which both parties become
irrevocably bound to a transaction under applicable law),\25\ and when
the transaction is confirmed (i.e., when a trade acknowledgment of the
transaction is provided and verified). Requiring prompt provision of
trade acknowledgments of electronically executed or processed SBS
transactions should help SBS Entities to submit timely and accurate
reports with respect to those transactions to SBS data repositories.
However, the Commission believes that the goal of promptly providing
trade acknowledgments must be tempered by the difficulty of achieving
that goal, particularly for customized agreements that are not executed
or processed \26\ electronically.
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\24\ The term ``execution'' would mean the point at which the
parties become irrevocably bound to a transaction under applicable
law. See proposed Rule 15Fi-1(a)(6).
\25\ In the SBS context, an oral agreement over the telephone
will create an enforceable contract, and the time of execution will
be when the parties to the telephone call agree to the material
terms.
\26\ The term ``processed electronically,'' with respect to an
SBS transaction, would mean entered into a security-based swap
dealer or major security-based swap participant's computerized
processing systems after execution to facilitate clearance and
settlement. See proposed Rule 15Fi-1(a)(9). A clearing agency may
process electronically its members' SBS transactions, as discussed
further below.
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Promptly providing a trade acknowledgment would assure that the
parties know the terms of their executed agreement.\27\ Accordingly,
the Commission proposes that the maximum times for providing a trade
acknowledgment of SBS transactions would vary depending upon whether
transactions are electronically executed or electronically processed,
but would not exceed 24 hours following execution. The Commission
preliminarily believes that the prescribed times should be sufficient
for SBS Entities to provide trade acknowledgments without permitting
unnecessary delay. Specifically, proposed rule 15Fi-1(c)(1) would
require any SBS transaction to be confirmed promptly, but in any event:
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\27\ Promptly acknowledging a transaction would also enable
parties to comply with the required time within which data must be
reported to an SBS data repository. See SBSR Proposing Release, note
16 supra.
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For any transaction that has been executed and processed
electronically, a trade acknowledgment must be provided within 15
minutes of execution.
For any transaction that is not electronically executed,
but that will be processed electronically, a trade acknowledgment must
be provided within 30 minutes of execution.
For any transaction that the SBS Entity cannot process
electronically, a trade acknowledgment must be provided within 24 hours
following execution.
The Commission encourages SBS Entities to minimize the number of
manual transactions processed, and to process electronically all SBS
transactions if it is reasonably practicable to do so. However, the
Commission understands that an SBS Entity may have the ability to
process electronically only certain SBS transactions. For example, an
SBS Entity may have the ability to process electronically certain
standardized SBS transactions in certain asset classes, or transactions
that it executes on an exchange or SBS execution facility, but may lack
the ability to process electronically SBS transactions in other asset
classes or that are executed by other means.\28\ The Commission also
understands that an SBS Entity's ability to process a transaction
electronically may be limited by its counterparty's abilities. For
example, an SBS Entity may have the ability to clear an SBS transaction
through a matching facility, but if its counterparty lacks access to
the matching facility, it would need to process transactions with that
counterparty through non-computerized means.
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\28\ Transactions in non-standardized SBS that are individually
negotiated and contain unique terms, or transactions effected
telephonically and processed manually might fall into this category.
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Thus, proposed rule 15Fi-1(c)(2) would require an SBS Entity to
process electronically an SBS transaction if the SBS Entity has the
ability to do so. In other words, an SBS Entity could not delay
providing a trade acknowledgment by choosing to process a transaction
by non-electronic means. The Commission preliminarily believes that
requiring SBS Entities to acknowledge trades as promptly as they are
able to do so would promote the purposes of Exchange Act Section 15Fi-
1.
Request for Comment
The Commission solicits comment on all aspects of the proposed time
to provide a trade acknowledgment, and the requirement for SBS Entities
to process electronically all transactions for which they have the
ability.
16. What is the current industry practice with respect to the time
necessary to confirm trades, and does the operational infrastructure of
SBS Entities makes providing a trade acknowledgment within 24 hours of
execution for manual trades feasible?
17. Should the proposed rule require an SBS Entity to provide a
trade acknowledgment more quickly, particularly for transactions that
are executed or processed electronically?
18. Would the proposed rule provide sufficient time for SBS
Entities to provide trade acknowledgments to their counterparties?
19. Is there currently a backlog in confirming trades, and if so,
would the proposed rule encourage confirming trades and reduce the
backlog? Are there other procedures that would reduce any backlog of
unconfirmed trades?
20. Are there circumstances in which certain terms included on a
trade acknowledgment would not be agreed by the parties within 24 hours
of execution? If so, please explain why parties may not be able to
agree on such terms within 24 hours of the execution of the SBS
transaction. How should an inability to obtain agreement on such
contract terms within 24 hours of execution, when it happens, be
handled?
21. How should the proposed rule address terms required to be on
the trade acknowledgment that are not known on the date of execution?
22. How should the proposed rule address transactions between an
SBS Entity and a fund manager or other agent, where the allocation of
the trade to the fund manager's or agent's accounts is not determined
by the fund manager or agent until sometime after execution? Should a
delay in providing a trade acknowledgment be permitted
[[Page 3864]]
under these circumstances? If so, how long a delay should be permitted?
23. Should the proposed rule require SBS Entities that have the
ability to process transactions electronically do so in all situations?
Are there circumstances when an SBS Entity would have the ability to
process a transaction electronically but should not be required to do
so?
24. How often do trade acknowledgments contain inaccurate
information and what are the most common errors? What procedures are
currently in place to correct those errors?
C. Form and Content of Trade Acknowledgments
Paragraph (d) of proposed rule 15Fi-1 would require the trade
acknowledgments to be provided through any electronic means that
provide reasonable assurance of delivery and a record of transmittal.
The Commission believes that electronic delivery of SBS trade
acknowledgments would promote the timely provision of trade
acknowledgments, in accordance with Exchange Act Section 15F(i) of the
Exchange Act. The proposed rule would provide flexibility for SBS
Entities to determine the specific electronic means by which they will
comply.
The Commission anticipates that clearing agencies may be
instrumental in delivering trade acknowledgments and verifying SBS
transactions for their members, but that the roles played by individual
clearing agencies may vary. For example, as discussed in Part II.A
above, clearing agencies may provide matching services in which they
perform independent comparisons of each security-based swap transaction
participant's trade data regarding the terms of settlement of the
transaction that result in the issuance of legally binding matched
terms to the transactions. Paragraph (b)(2) of the proposed rule would
permit clearing agencies to provide trade acknowledgments on behalf of
SBS Entities; however, SBS Entities would not be limited to using
clearing agencies to provide trade acknowledgments electronically. SBS
Entities may also provide trade acknowledgments through a mutually
agreed upon electronic standard, such as a messaging system that uses
Financial products Markup Language (commonly known as FpML). SBS
Entities may also continue to rely on facsimile transmission or e-mail
to provide trade acknowledgments. The Commission understands these
means of providing trade acknowledgments may be particularly necessary
when engaging in SBS transactions with counterparties that rarely buy
or sell SBS and that consequently do not have the means to receive
trade acknowledgments otherwise.
Providing trade acknowledgments exclusively by mail or overnight
courier would not satisfy the requirements of the proposed rule. These
delayed means of communication do not appear to promote the principles
of Exchange Act Section 15F(i). Moreover, as discussed in Part II.E
below, an SBS Entity must establish, maintain, and enforce policies and
procedures to obtain prompt verification of the terms included in each
trade acknowledgment it provides. This requirement does not appear
compatible with processes to provide trade acknowledgments that rely on
delayed means of communication.
Paragraph (d) of proposed rule 15Fi-1 would require trade
acknowledgments to contain a minimum of 22 items of information, all
but one of which is identical to the items that SBS Entities would be
required to report to an SBS data repository pursuant to the rules the
Commission has separately proposed in Regulation SBSR.\29\ We proposed
to require the information in Regulation SBSR, in part, to facilitate
regulatory oversight and monitoring of the SBS market by providing
comprehensive information regarding SBS transactions and trading
activity.\30\ The Commission believes that counterparties to an SBS
transaction would benefit from receiving a trade acknowledgment that is
similarly comprehensive. In addition, by requiring essentially the same
information to be included on a trade acknowledgment as is reported to
an SBS data repository, the proposed rule should allow SBS Entities to
use systems and databases designed to comply with Regulation SBSR to
also comply with rule 15Fi-1 under the Exchange Act, which would reduce
the burden of complying with proposed rule 15Fi-1.
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\29\ See SBSR Proposing Release, note 16 supra.
\30\ Id.
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The specific items that SBS Entities would provide in a trade
acknowledgment under the proposed rule include: (1) The asset class
\31\ of the security-based swap and, if the security-based swap is an
equity derivative, whether it is a total return swap or is otherwise
designed to offer risks and returns proportional to a position in the
equity security or securities on which the security-based swap is
based; (2) information that identifies the security-based swap
instrument and the specific asset(s) or issuer of a security on which
the security-based swap is based; (3) the notional amount(s), and the
currenc(ies) in which the notional amount(s) is expressed; (4) the date
and time, to the second, of execution, expressed using Coordinated
Universal Time (UTC); (5) the effective date; (6) the scheduled
termination date; (7) the price; \32\ (8) the terms of any fixed or
floating rate payments, and the frequency of any payments; (9) whether
the security-based swap will be cleared by a clearing agency; (10) if
both counterparties to a security-based swap are security-based swap
dealers, an indication to that effect; (11) if the transaction involved
an existing security-based swap, an indication that the transaction did
not involve an opportunity to negotiate a material term of the
contract, other than the counterparty; (12) if the security-based swap
is customized to the extent that the information provided in items (1)
through (11) does not provide all of the material information necessary
to identify such customized security-based swap or does not contain the
data elements necessary to calculate the price, an indication to that
effect; (13) the participant ID of each counterparty; (14) as
applicable, the broker ID, desk ID, and trader ID of the reporting
party; \33\ (15) the amount(s) and currenc(ies) of any up-front
payment(s) and a description of the terms and contingencies of the
payment streams of
[[Page 3865]]
each counterparty to the other; (16) the title of any master agreement,
or any other agreement governing the transaction (including the title
of any document governing the satisfaction of margin obligations),
incorporated by reference and the date of any such agreement; (17) the
data elements necessary for a person to determine the market value of
the transaction; (18) if the security-based swap will be cleared, the
name of the clearing agency; (19) if the security-based swap is not
cleared, whether the exception in Section 3C(g) of the Exchange Act was
invoked; \34\ (20) if the security-based swap is not cleared, a
description of the settlement terms, including whether the security-
based swap is cash-settled or physically settled, and the method for
determining the settlement value; (21) the venue where the security-
based swap was executed; and (22) if the transaction is to be cleared,
any additional information that is required for the transaction to be
cleared by a clearing agency.
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\31\ The term ``asset class'' means those security-based swaps
in a particular broad category, including, but not limited to,
credit derivatives, equity derivatives, and loan-based derivatives.
See proposed Rule 15Fi-1(a)(1).
\32\ The term ``price'' means the price of a security-based swap
transaction, expressed in terms of the commercial conventions used
in that asset class. See proposed Rule 15Fi-1(a)(8).
\33\ Proposed Rule 15Fi-1(a) includes definitions for ``unique
identification code,'' ``broker ID,'' ``desk ID,'' ``participant
ID,'' and ``trader ID.'' Proposed Rule 15Fi-1(a)(12) defines
``unique identification code'' or ``UIC'' as the unique
identification code assigned to a person, unit of a person, or
product by or on behalf of an internationally recognized standards-
setting body that imposes fees and usage restrictions that are fair
and reasonable and not unreasonably discriminatory. If no standards-
setting body meets these criteria, a registered security-based swap
data repository shall assign all necessary UICs using its own
methodology. If a standards-setting body meets these criteria but
has not assigned a UIC to a particular person, unit of a person, or
product, a registered security-based swap data repository shall
assign a UIC to that person, unit of a person, or product using its
own methodology. ``Broker ID'' is a UIC assigned to a person acting
as a broker for a participant. Proposed Rule 15Fi-(1)(a)(2). ``Desk
ID'' is a UIC assigned to the trading desk of a participant or of a
broker of a participant. Proposed Rule 15Fi-1(a)(5). ``Participant
ID'' is a UIC assigned to a participant. Proposed Rule 15Fi-1(a)(7).
``Trader ID'' is a UIC assigned to a natural person who executes
security-based swaps. Proposed Rule 15Fi-1(a)(11). The definitions
of UIC, broker ID, desk ID, participant ID, and trader ID are
identical to the definitions of the same terms the Commission has
proposed in Regulation SBSR, and parties would use the same IDs for
purposes of both rules. See SBSR Proposing Release, note 16 supra.
\34\ Section 3C(g) of the Exchange Act provides certain
exceptions from the general requirement of Section 3C(a)(1) of the
Exchange Act that an SBS be submitted to a registered clearing
agency or a clearing agency that is exempt from registration.
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The first 21 items are identical to the items that would be
reported to an SBS data repository under proposed Regulation SBSR. In
addition, if a transaction is to be cleared, proposed rule 15Fi-
1(d)(22) would require SBS Entities to include on a trade
acknowledgment any additional information that a clearing agency
requires to clear the transaction. The Commission has oversight
authority over clearing agencies, including the ability to approve or
disapprove all proposed rules and rule changes.\35\ These proposed
rules and rule changes are also published for public notice and
comment. The Commission preliminarily believes that additional
information that is significant to a clearing agency would also be
significant to a counterparty, and thus should be included in the trade
acknowledgment. An SBS Entity that is a clearing agency participant
would be required to comply with (and therefore to know) the clearing
agency's requirements because it is obligated to comply with the
clearing agency's rules. If a clearing agency participant acting on
behalf of an SBS Entity submits a transaction to a clearing agency, the
participant would have to obtain the necessary information from the SBS
Entity.
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\35\ See Exchange Act Section 19(b). Section 3(a)(26) of the
Exchange Act defines ``self-regulatory organization'' to include a
registered clearing agency.
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Request for Comment
The Commission requests comment on all aspects of the proposal as
to the form and content of the trade acknowledgment.
25. Is it feasible to require trade acknowledgments to be provided
electronically?
26. Would the requirement for electronic trade acknowledgment
unduly restrict the types of SBS transactions that SBS Entities may
enter into or the persons that may be their counterparties?
27. Would permitting non-electronic means of providing trade
acknowledgments further the Commission's objective to promote the
timely and accurate confirmation, processing, netting, documentation,
and valuation of all SBS?
28. What systems are used to provide confirmations today?
29. Should the proposed rule require SBS Entities to use other
systems, such as electronic messaging systems that rely on machine
readable structured data (and therefore lend themselves to automated
trade processing) or some other process, to provide trade
acknowledgments? If so, please describe those systems.
30. Should we consider any enhancements to current market
practices?
31. Would permitting trade acknowledgments to be provided by
facsimile or e-mail create problems or raise issues, and would the
benefits of permitting acknowledgments to be provided by facsimile or
e-mail outweigh those problems or issues?
32. Would the requirement for trade acknowledgments to be provided
through electronic means that provide reasonable assurance of delivery
and a record of transmittal create difficulties for participants, for
example, because some counterparties are unable to receive trade
acknowledgments electronically, or because electronic trade
acknowledgment is not feasible for transactions in certain asset
classes?
33. Can the Commission's objective to promote the timely provision
of trade acknowledgments be achieved if SBS Entities provide trade
acknowledgments by non-electronic means, such as mail or overnight
courier, and if so, how?
34. Should the proposed rule allow clearing agencies to use methods
other than confirmation by matching or comparison to provide trade
acknowledgments on behalf of SBS Entities?
35. Is there additional information that the proposed rule should
require to be included on a trade acknowledgment?
36. Does the proposed rule require any information that is
unnecessary?
37. The Commission has proposed that the trade acknowledgment
contain a minimum of 22 items of information. In light of the purpose
of the rule, should the Commission simply require instead that the
trade acknowledgment must evidence the entire agreement of the parties?
For example, the Commission could require a trade acknowledgment to
include: (a) ``All of the terms an SBS transaction''; (b) ``all of the
material terms of an SBS transaction''; (c) ``all terms that the
parties have agreed to at the time of execution''; (d) ``all terms that
are necessary for the parties to have a complete and definitive
agreement''; or (e) ``all the terms necessary to fully and completely
describe the transaction.'' Which of these alternatives is best, and
why? Would it be clear how to comply with any or all of these possible
alternatives? If not, why not? Would certain terms used in these
alternative requirements require further definition, such as ``complete
and definitive,'' or ``fully and completely''? If so, what terms would
require further definition, and how should they be defined? Would the
alternative requirements encompass transaction terms that would
otherwise not be included on a trade acknowledgment as required by the
proposed rule and the enumerated items specified therein? If so, what
additional transaction terms would be required? What would be the costs
and benefits or disadvantages of such a principles-based requirement?
38. Please propose any alternative standards to those described in
question 38 the Commission should consider, discuss what additional
information would be required under your alternatives, and the costs
and benefits and the advantages and disadvantages of your proposed
standards.
39. Should the Commission require markup/markdown disclosure or
expected profitability/loss on a trade acknowledgment? If so, why, and
if not, why not? How should SBS Entities calculate markup/markdown or
expected profitability/loss? What would be the best evidence of the
prevailing market price for a SBS transaction from which a markup or
markdown could be calculated? Should the prevailing market price be
based on a dealer's contemporaneous cost, its cost to hedge the
transaction, or a dealer's sale to another SBS dealer or major SBS
participant? Should there be any
[[Page 3866]]
distinction between inter-dealer transactions and transactions between
a dealer and a non-dealer? Are SBS dealers and/or major SBS
participants acting as market makers?
40. The Commission understands that some SBS agreements may receive
credit support from a guarantor or other credit support provider who
agrees to satisfy a party's payment or margin obligations in the event
of default. Should the trade acknowledgment include the legal name of
or other information about the guarantor or credit support provider?
41. How does price differ, if at all, from market value?
42. Should the Commission require that a trade acknowledgment
include in all cases the material information necessary to identify the
SBS or the data elements necessary to calculate its price (rather than
the proposal in paragraph (d)(12))?
43. Should the Commission require that a trade acknowledgment
include in all cases the material information necessary to determine
required upfront payments and any future cash flows (rather the
proposal in paragraph (d)(12))?
44. Do parties typically provide the material information necessary
to identify the SBS or the data elements necessary to calculate its
price in a trade acknowledgment or confirmation? Are there any SBS
transactions, such as highly customized SBS transactions, for which it
would be difficult to provide this information? If so, please describe
these transactions and the information that parties would be challenged
to provide.
45. Section 3C(g)(1) of the Exchange Act provides an exception for
certain counterparties from the mandatory clearing requirement in
Exchange Act Section 3C(a)(1). In order to qualify for the exception,
counterparties would need to comply with the Commission's rules and
regulations, which may require that counterparties provide additional
information to the Commission, such as how a counterparty invoking the
clearing exception generally expects to meet its financial obligations
associated with an SBS or the title of any agreements in place between
the SBS Entity and the counterparty that would support such
counterparty's financial obligations. Should the trade acknowledgment
include such additional information that a counterparty may need to
provide to the Commission? Should the trade acknowledgment include such
additional information that a counterparty may need to provide to the
Commission to support that it is not a financial entity and is using
the SBS to hedge or mitigate commercial risk?
46. The Commission also considered proposing a requirement that
parties use master confirmation agreements for complex products when
such agreements are in widespread use.\36\ If the parties have entered
into a master confirmation agreement, the transaction-specific
confirmations may be less detailed because the confirmation would not
repeat the standard terms included in the master confirmation
agreement. The Commission believes that the use of master confirmation
agreements reduces transaction costs, improves liquidity, and speeds
back-office processing in the markets in which they are adopted, and
therefore encourages their use. However, the Commission believes that
it would be difficult for SBS Entities to determine whether a master
confirmation agreement is ``in widespread use'' and therefore required
to be used. The Commission solicits comment on whether to require the
use of master confirmation agreements in markets in which they are
widespread, and how the Commission and SBS Entities could determine
whether master confirmation agreements are in widespread use.
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\36\ Master confirmation agreements are agreements that
incorporate by reference standardized agreements (such as the 1992
or 2002 ISDA Master Agreement) that allow parties to agree on most
standard terms to be incorporated by reference into a complex trade
and then execute individual transactions by agreeing on a small
subset of economic terms.
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D. Trade Verification
As part of the trade verification process, paragraph (e)(1) of
proposed rule 15Fi-1 would require an SBS Entity to establish,
maintain, and enforce reasonable written policies and procedures to
obtain the prompt verification of trade acknowledgments. The Commission
preliminarily believes this requirement will induce SBS Entities to
minimize the number of unverified trade acknowledgments, and thereby
reduce the operational risk and uncertainty associated with unverified
SBS transactions.
Verifying a transaction would require the SBS Entity responsible
for providing the trade acknowledgment to obtain manually,
electronically, or by some other legally equivalent means, the
signature of its counterparty on the trade acknowledgment.\37\
Verifying trades may be done through a process in which the
counterparty affirms the transaction terms after reviewing a trade
acknowledgment sent by the first party. The counterparty may also
dispute the terms of the transaction (often referred to as a ``DK'' of
the transaction, short for ``don't know''). Verifying or disputing the
transaction may be done by fax or electronically, where the first party
transmits a trade acknowledgment to its counterparty, after which the
counterparty--electronically, manually, or by some other legally
equivalent method--either signs and returns the trade acknowledgment to
verify the transaction, or notifies the counterparty that it rejects
the terms. By promoting prompt verification, the proposed rule is
designed to minimize the operational risk and uncertainty associated
with SBS transactions for which trade acknowledgments have not been
verified.
---------------------------------------------------------------------------
\37\ See Proposed Rule 15Fi-1(a)(13).
---------------------------------------------------------------------------
Pursuant to paragraph (e)(2) of the rule, cleared transactions
would be verified in accordance with the process prescribed by the
registered clearing agency through which the transaction will be
cleared. The Commission expects that clearing agencies will adopt rules
to obtain the signature of a counterparty on a trade acknowledgment as
part of their verification procedures. In electronically processed
transactions, the clearing agency could obtain counterparties'
signatures electronically or by other means. As noted above, the
Commission has authority over registered clearing agencies, including
the authority to review and approve or disapprove all proposed rules
and rule changes.\38\ The Commission would, therefore, be able to
review any proposed rules and rule changes concerning verification of
trade acknowledgments to determine whether the rules or rule changes
are consistent with the purposes of proposed rule 15Fi-1.
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\38\ See Exchange Act Sec. 19(b).
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For SBS transactions that are not subject to clearing, paragraph
(e)(1) of the proposed rule would require SBS Entities to establish
their own trade verification processes. For example, an SBS Entity
could establish, maintain, and enforce policies and procedures under
which it will only deal with a counterparty that agrees to timely
review any trade acknowledgment to ensure that it accurately describes
their agreed upon transaction, and sign and return the trade
acknowledgment as evidence of the verification. SBS Entities' policies
and procedures for verification could also include using a third-party
matching service.\39\
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\39\ As described in Part A.2. above, each counterparty could
submit the SBS terms to an agreed-upon matching service operated by
a registered clearing agency. The matching service would then
compare the submitted transaction terms. If the submitted SBS terms
agreed, the transaction would be verified; otherwise, the matching
service would notify the counterparties of the discrepancies, and
the counterparties would have the opportunity to resolve them.
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[[Page 3867]]
Paragraph (e)(2) of the proposed rule would provide that, in any
SBS transaction to be cleared through a clearing agency, an SBS
Entity's compliance with the verification process prescribed by the
clearing agency satisfies the verification requirements of subparagraph
(e)(1) with respect to the transaction. Therefore, an SBS Entity would
not need to separately verify a transaction with another SBS Entity
cleared through a clearing agency. Additionally, an SBS Entity would
not be required to have separate written policies and procedures that
are reasonably designed to obtain prompt verification of the terms of a
trade acknowledgment if the SBS Entity enters a cleared transaction
with a non-SBS Entity, and the SBS Entity complies with the clearing
agency's verification process.
Paragraph (e)(3) of the proposed rule would require SBS Entities to
promptly verify the accuracy of, or dispute with their counterparties,
the terms of trade acknowledgments they receive pursuant to the
proposed rule. This requirement is intended to reduce the incidence of
unverified SBS transactions, thereby reducing the operational risk for
SBS Entities.
Request for Comment
The Commission solicits comment on all aspects of the proposed
requirement that SBS Entities verify trade acknowledgments they
receive, and establish, maintain, and enforce written policies and
procedures to obtain the prompt verification of the terms of executed
SBS transactions.
47. Should the proposed rule set time limits within which trade
acknowledgments must be verified by SBS Entities? For example, should
the proposed rule require SBS Entities to verify or dispute a trade
acknowledgment within 24 or 48 hours of provision of the trade
acknowledgment? Should SBS Entities be required to verify or dispute a
trade acknowledgment more quickly for SBS transactions that are
executed electronically or processed electronically than for other
transactions?
48. What additional steps could the Commission take to promote
verification of SBS transactions?
49. Should the Commission give more guidance in the types of
policies and procedures it expects SBS Entities to adopt that would be
``reasonably designed to obtain prompt verification of the terms of a
trade acknowledgment''?
50. Are there other ways in which SBS participants currently
evidence their agreement to an SBS transaction besides manual or
electronic signature of a trade acknowledgment that we should consider?
51. The proposed rule requires that parties obtain ``verification''
of the trade acknowledgment, which would be defined to mean manual or
electronic signature of the trade acknowledgment by the receiving
party. Is this definition sufficient? Does this definition differ from
current market practice, and if so, how?
52. Are there other processes currently in place that would not fit
within this definition of ``verification'' that we should consider?
53. Although the Commission believes that matching services are an
effective way to verify SBS transactions, and increase the efficiency
of the SBS settlement process, the Commission has not proposed
requiring SBS Entities to submit their trades to a matching service.
The Commission is concerned that the variety of SBS transactions may
make it unlikely that matching services would be able to verify all
transactions, and the Commission questions whether all SBS Entities'
counterparties would be members or participants (or eligible to be
members or participants) in a matching service. Therefore, a
requirement to submit all trades to a matching service could limit both
the types of transactions and the counterparties in the SBS market. We
request comment on the mandatory use of matching services. Would a
requirement to use matching services limit the types of SBS
transactions or counterparties in the market? How could the Commission
mitigate those effects?
E. Exemption From Rule 10b-10
Proposed paragraph (f) of rule 15Fi-1 would provide an exemption
from the requirements of rule 10b-10 under the Exchange Act for SBS
Entities that confirm their SBS transactions in compliance with
proposed rule 15Fi-1.\40\ Rule 10b-10 generally requires that broker-
dealers effecting securities transactions on behalf of customers,
provide to their customers, at or before completion of the securities
transaction, a written notification containing certain basic
transaction terms.\41\
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\40\ 17 CFR 240.10b-10.
\41\ Examples of transaction terms included on a rule 10b-10
confirmation include: The date of the transaction; the identity,
price, and number of shares bought or sold; the capacity of the
broker-dealer; the dollar or yield at which a transaction in a debt
security was effected, and under specified circumstances, the
compensation paid to the broker-dealer by the customer or other
parties. Id.
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The Dodd-Frank Act amended the Exchange Act definition of
``security'' to include any ``security-based swap.'' \42\ Consequently,
SBS, as securities, are fully subject to the Federal securities laws
and regulations, including, rule 10b-10.\43\ The Commission anticipates
that some SBS Entities may also be registered broker-dealers.
Therefore, in the absence of an exemption, an SBS Entity that is also a
broker or dealer would be required to comply with both rule 10b-10 and
proposed rule 15Fi-1. This could be duplicative and overly burdensome.
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\42\ Dodd-Frank Act Sec. 761(a)(2) (codified at Exchange Act
Section 3(a)(10)).
\43\ The Commission will discuss further the implications of
defining ``security'' to include security-based swaps on the
requirement for brokers and dealers to register with its proposed
rules for SBS Entity registration.
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The proposed exemption in paragraph (f) would apply solely to
transactions in SBS in which an SBS Entity is also a broker or a
dealer, and would not apply to a transaction by a broker-dealer that is
not also an SBS Entity. In other words, a broker-dealer that is not an
SBS Entity would continue to comply with rule 10b-10 to the extent that
it effects transactions in SBS with customers.
As noted in Part A.1 above, because the proposed rule would apply
solely to an SBS Entity that ``purchases'' or ``sells'' an SBS, it is
effectively limited to principal transactions in which the SBS Entity
is a counterparty to the transaction and is acting for its own account.
Thus, the proposed exemption in paragraph (f) would also apply solely
to principal transactions. The Commission recognizes that some SBS
Entities may also engage in SBS brokerage or agency transactions.\44\
Any broker acting as an agent in an SBS transaction, regardless of
whether it is also registered as an SBS Entity, would continue to be
required to comply with Rule 10b-10.\45\
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\44\ An SBS Entity's agency activities would be done pursuant to
its broker-dealer registration under Section 15(b) of the Exchange
Act. 15 U.S.C. 78o(b).
\45\ This would include, at a minimum, disclosure of: The date
of the transaction; the identity, price and number of units (or the
principal amount) bought or sold, and the time of the transaction or
the fact that it will be furnished upon written request (17 CFR
240.10b-10(a)(1)); that they are acting in an agent capacity (17 CFR
240.10b-10(a)(2)); and, under specified circumstances, the amount of
remuneration to be received by the broker from the customer, and
whether the broker is receiving any other remuneration in connection
with the transaction (17 CFR 240.10b-10(a)(2)(i)(B) and (D)).
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[[Page 3868]]
Request for Comment
The Commission solicits comment on all aspects of the proposed
exemption from rule 10b-10 for SBS Entities that provide a trade
acknowledgment pursuant to proposed rule 15Fi-1(f).
54. Is the proposed exemption from rule 10b-10 necessary or
appropriate?
55. Is additional interpretive guidance regarding rule 10b-10
necessary?
III. Implementation Timeframes
The Commission proposes that the rule be effective 60 days after
publication of the final rule in the Federal Register.
Request for Comment
The Commission solicits comment on all aspects of the
implementation time frame for proposed rule 15Fi-1.
56. Would the proposed time frame provide sufficient time for SBS
Entities to comply with the rule?
57. Should the implementation time be coordinated with the
implementation timeframes for proposed Regulation SBSR?
IV. Paperwork Reduction Act
Certain provisions of the proposed rule would result in
``collection of information requirements'' within the meaning of the
Paperwork Reduction Act of 1995 (``PRA'').\46\ The Commission is
therefore submitting proposed rule 15Fi-1 to the Office of Management
and Budget (``OMB'') for review in accordance with 44 U.S.C. 3507 and 5
CFR 1320.11. Compliance with the collection of information requirements
would be mandatory. 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.
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\46\ 44 U.S.C. 3501 et seq.
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A. Summary of Collection of Information
As discussed above, Exchange Act Section 15F(i)(1) provides that
SBS Entities ``shall conform with such standards as may be prescribed
by the Commission, by rule or regulation, that relate to timely and
accurate confirmation, processing, netting, documentation, and
valuation of all security-based swaps.'' \47\ Section 15F(i)(2) of the
Exchange Act further provides that the Commission must adopt rules
governing documentation standards for SBS Entities. Accordingly,
proposed rule 15Fi-1 would adopt documentation standards for the timely
and accurate acknowledgment and verification of SBS transactions by SBS
Entities. The proposed rule contains six paragraphs: (a) Definitions of
relevant terms; (b) the trade acknowledgment obligations of specific
SBS Entities; (c) the prescribed time frames under which a trade
acknowledgment must be sent; (d) the form and content requirements of
the trade acknowledgment; (e) an SBS Entities' verification
obligations; and (f) a limited exemption for brokers from the
requirements of Exchange Act Rule 10b-10.\48\
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\47\ 15 U.S.C. 78o-8.
\48\ 17 CFR 240.10b-10.
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Under paragraph (b)(1) of proposed rule 15Fi-1, sending an SBS
trade acknowledgment would be the obligation of a particular SBS Entity
(i.e., an SBS dealer or major-SBS participant) depending on whether the
SBS Entity and its counterparty are SBS dealers or major SBS
participants and/or any agreements between the counterparties that
delineate the trade acknowledgment responsibility. Paragraph (b)(2) of
the proposed rule however, would provide that SBS Entities will satisfy
this requirement to the extent that an SBS transaction is cleared
through the facilities of clearing agency that matches or compares the
terms of the transaction. Regardless of how the trade acknowledgment
obligation is satisfied however, a trade acknowledgment would be
required to be provided within 15 minutes, 30 minutes or 24 hours
following execution, depending on whether the transaction is executed
and/or processed electronically.\49\
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\49\ Under proposed Rule 15Fi-1(c)(1)(i), any transaction that
is executed and processed electronically would have to be
acknowledged within 15 minutes of execution. Transactions that are
not electronically executed but processed electronically would have
to be acknowledged within 30 minutes of execution. See proposed Rule
15Fi-1(c)(1)(ii). Finally, proposed Rule 15Fi-1(c)(1)(ii) would
require that all other transactions be acknowledged within 24 hours
of execution. Proposed paragraph (c)(2) of the rule however, would
require that transactions be processed electronically if the
counterparties have the ability to do so. As the market for
derivatives develops further however, the Commission believes that
most SBS transactions will be processed electronically.
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Paragraph (d) of proposed rule 15Fi-1 would require that trade
acknowledgments be provided through electronic means and lists the 22
data elements that must be included on each confirmation.\50\ Paragraph
(e)(1) of proposed rule 15Fi-1 would require SBS Entities to establish,
maintain, and enforce policies and procedures reasonably designed to
obtain prompt verification of SBS trade acknowledgments. If a
transaction is cleared through a clearing agency, paragraph (e)(2) of
the proposed rule would also require SBS Entities to comply with the
clearing agency's verification procedures. Regardless of the method of
transmittal, when an SBS Entity receives a trade acknowledgment,
pursuant to paragraph (e)(3) of the proposed rule, it must promptly
verify the accuracy of the trade acknowledgment or dispute the terms
with its counterparty. Paragraph (a) of the proposed rule would define
relevant terms and would not be a ``collection of information'' within
the meaning of the PRA. Similarly, paragraph (f) is an exemptive
provision and would not be a collection of information.
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\50\ See proposed Rule 15Fi-1(d) (1) through (22). See also
discussion in Section II.C. supra.
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B. Proposed Use of Information
The trade acknowledgment and verification requirements of proposed
rule 15Fi-1 would apply to both types of SBS Entities depending on
whether the entity and its counterparty are SBS dealers or major SBS
participants and on any agreements between counterparties addressing
the obligation to send a trade acknowledgment. Generally, the
transaction details that would be provided in a proposed rule 15Fi-1
trade acknowledgment would serve as a written record by which the
counterparties to a transaction memorialize the economic and related
terms of a transaction. In effect, the trade acknowledgment would
reflect the contract entered into between the counterparties. In
addition, proposed rule 15Fi-1's verification requirements are intended
to assure that the written record of the transaction (i.e. the trade
acknowledgment) accurately reflects the terms of the transaction as
understood by the respective counterparties. In situations where an SBS
Entity is provided a trade acknowledgment that is not an accurate
reflection of the agreement, proposed rule 15Fi-1 would require the SBS
Entity to dispute the terms of the transaction.
C. Respondents
Proposed rule 15Fi-1 would only apply to SBS Entities, that is to
SBS dealers and major SBS participants, both of which would be
registered with the Commission. Based on the Commission staff's
discussions with industry participants and incorporated in our other
Dodd-Frank Act related rulemaking, we preliminarily believe that
approximately 50 entities may fit within the definition of SBS dealer,
and up to five entities may fit within the definition of major SBS
participant. Thus, approximately 55 entities may be required to
register with the Commission as SBS Entities and thus,
[[Page 3869]]
would be subject to the trade acknowledgment provision and verification
requirements of proposed rule 15Fi-1.\51\
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\51\ We note that many clearing agencies already have facilities
that would permit SBS Entities to acknowledge and verify SBS
transactions in addition to other services provided by the clearing
agency.
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D. Total Initial and Annual Reporting and Recordkeeping
Pursuant to proposed rule 15Fi-1, all SBS transactions would have
to be acknowledged and verified through the methods and by the
timeframes prescribed in the proposed rule. Collectively, paragraphs
(b), (c), (d) and (e) of proposed rule 15Fi-1 identify the information
that is to be included in a trade acknowledgment; the party responsible
for sending the trade acknowledgment; the permissible methods for
sending the trade acknowledgment; and criteria for verifying the terms
of a trade acknowledgment. According to the Depository Trust and
Clearing Corporation (``DTCC''), there are on average 36,000 single-
name credit-default swap (``CDS'') transactions per day,\52\ resulting
in a total number of 13,140,000 CDS transactions per year. The
Commission preliminarily believes that CDSs represent 85% of all SBS
transactions.\53\ Assuming that at least one SBS Entity is a party to
every SBS transaction, the Commission preliminarily estimates that the
total number of SBS transactions that would be subject to proposed
15Fi-1 on an annual basis would be approximately 15,460,000 which is an
average of 281,091 transactions per SBS Entity per year.\54\
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\52\ See, e.g., http://www.dtcc.com/products/derivserv/data_table_iii.php (weekly data as updated by DTCC).
\53\ The Commission's estimate is based on internal analysis of
available SBS market data. The Commission is seeking comment about
the overall size of the SBS market.
\54\ These figures are based on the following: [13,140,000/0.85]
= 15,458,824, or approximately 15,460,000. (15,460,000 estimated SBS
transactions)/(55 SBS Entities) = 281,091 SBS transactions per SBS
Entity per year. The Commission understands that many of these
transactions may arise from previously executed SBS transactions.
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Based on discussions with industry participants, the Commission
estimates that approximately 99 percent, or 15,305,400
transactions,\55\ are processed electronically, meaning that these
transactions are either cleared through the facilities of a clearing
agency,\56\ or processed through an SBS Entity's internal electronic
systems. The Commission believes that the remaining one percent of SBS
transactions, or 154,600 transactions,\57\ are currently not processed
electronically, but are acknowledged and verified through other means,
such as e-mail, facsimile or other similar means.\58\
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\55\ 15,460,000 SBS transactions x .99 = 15,305,400
transactions.
\56\ See discussion in Part II.A.2 supra.
\57\ 15,460,000 SBS transactions x .01 = 154,600 transactions.
\58\ We note that proposed rule 15Fi-1(c)(2) would require that
SBS transactions be processed electronically if the acknowledging
entity has the ability to do so. As noted above, the Commission
believes that as this market develops further, fewer SBS Entities
will lack the ability to process SBS transactions electronically.
See also note 50 supra.
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As discussed above, the Commission believes that most transactions
will be electronically executed and cleared through the facilities of a
clearing agency. The Commission understands that the clearing of SBS
transactions through the facilities of a clearing agency generally
includes the matching and verification of such transactions. The
Commission has taken this process into account in paragraph (b)(2) of
proposed rule 15Fi-1, which provides that SBS Entities will satisfy the
requirement to provide a trade acknowledgment if a clearing agency
produces a confirmation through its facilities. Nevertheless, the
Commission believes that it will be necessary for SBS Entities, if they
have not already done so, to develop computerized systems for inputting
the terms of an SBS transaction and then transmitting that data to the
relevant clearing agency for electronic processing.
The Commission also believes that such computerized systems will
necessarily have to be programmed so that SBS transactions that are not
electronically processed through the facilities of a clearing agency
can be processed internally. Indeed, it is the Commission's
understanding, through publicly available information and discussions
with industry participants, that many SBS Entities may already have
these types of systems in place.
Because this information is anecdotal, for the purposes of the PRA,
the Commission assumes that most SBS Entities do not currently have the
platforms necessary for processing, acknowledging, and verifying SBS
transactions electronically, whether internally or by transmitting the
necessary data packages to the facilities of a clearing agency for
processing. Therefore, the Commission believes that SBS Entities will
have to develop internal order and trade management systems (``OMS'')
that will be connected or linked to the facilities of a clearing agency
and that will also be able to process SBS transactions internally if
necessary.\59\ The Commission believes that those systems will also
have front-office and back-office linkages that will permit the front
office to input SBS transaction details \60\ and to send these updates
in real-time or near real-time to the back-office so that complete
packages of information can be sent to the clearing agency for
electronic processing and timely acknowledgment, or in the alternative,
so that the relevant SBS Entity can itself electronically process the
transaction and send the required trade acknowledgment.
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\59\ The Commission believes that systems for acknowledging and
verifying SBS transactions will likely be an additional
functionality of an OMS that SBS Entities would have to use to
report SBS transactions to an SBS data repository. See SBSR
Proposing Release, note 16 supra.
\60\ The Commission understands that in some instances,
additional transaction details may have to be entered post-execution
but prior to processing. In the industry, this process generally
referred to as ``enrichment.''
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Based on our staff's discussions with industry participants and
incorporated in our other Commission rulemaking related to the Dodd-
Frank Act,\61\ the Commission preliminarily estimates that the
development of an OMS by SBS Entities for electronic processing of SBS
transactions with the capabilities described above would impose a one-
time aggregate burden of approximately 19,525 hours, or 355 burden
hours per SBS Entity.\62\ This estimate assumes that SBS Entities will
not have to develop an entirely new OMS but rather, would leverage
existing trading and processing platforms and adapt those systems to
satisfy the functionalities described above. In addition, the
Commission further preliminarily estimates that proposed rule 15Fi-1
would impose an ongoing annual hour burden of approximately 23,980
hours or 436 hours per SBS Entity.\63\ This estimate would include day-
to-day technical support of the OMS, as well as the
[[Page 3870]]
amortized annual burden associated with system or platform upgrades and
periodic implementation of significant updates based on new technology,
products, or both.
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\61\ See SBSR Proposing Release, note 16 supra, at Section
XIII.B.4.a.
\62\ This estimate is based on Commission staff discussions with
market participants and is calculated as follows: [((Sr. Programmer
at 160 hours) + (Sr. Systems Analyst at 160 hours) + (Compliance
Manager at 10 hours) + (Director of Compliance at 5 hours) +
(Compliance Attorney at 20 hours)) x 55 (SBS Entities)] = 19,525
burden hours at 355 hours per SBS Entity. The Commission understands
that many SBS Entities may already have computerized systems in
place for electronically processing SBS transactions, whether
internally or through a clearing agency. This may result in lesser
burdens for those parties.
\63\ This estimate is based on Commission staff discussions with
market participants and is calculated as follows: [((Sr. Programmer
at 32 hours) + (Sr. Systems Analyst at 32 hours) + (Compliance
Manager at 60 hours) + (Compliance Clerk at 240 hours) + (Director
of Compliance at 24 hours) + (Compliance Attorney at 48 hours)) x
(55 SBS Entities)] = 23.980 burden hours, or 436 hours per SBS
Entity.
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In addition, pursuant to paragraph (e)(1) of proposed rule 15Fi-1,
SBS Entities must establish, maintain, and enforce written policies and
procedures reasonably designed to obtain prompt verification of
transaction terms. While the cost of these policies and procedures will
vary, the Commission estimates that such policies and procedures would
require an average of 80 hours per respondent to initially prepare and
implement, with a total initial burden of 4,400 hours for all
respondents.\64\ Once these policies and procedures are established,
the Commission estimates that it will take an average 40 hours annually
to maintain these policies and procedures per respondent, with a total
estimated average annual burden of 2,200 hours for all respondents.\65\
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\64\ This estimate is based on Commission staff discussions with
market participants and is calculated as follows: [(Compliance
Attorney at 40 hours) (Director of Compliance at 20 hours) + (Deputy
General Counsel at 20 hours) x (55 SBS Entities)] = 4,400 burden
hours, or 80 hours per SBS Entity.
\65\ This estimate is based on Commission staff discussions with
market participants and is calculated as follows: [(Compliance
Attorney at 20 hours) (Director of Compliance at 10 hours) +
(General Counsel at 10 hours) x (55 SBS Entities)] = 2,200 burden
hours, or 40 hours per SBS Entity.
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E. Recordkeeping Requirements
Pursuant to amendments to the Exchange Act from Title VII of the
Dodd-Frank Act, the Commission plans to propose separate rules for SBS
transactions that include, among other things, recordkeeping and
transaction reporting requirements. Because a trade acknowledgment will
serve as a written record of the transaction, the information required
by proposed Rule 15Fi-1 would be required to be maintained by an SBS
Entity subject to those rules. This requirement will be subject to a
separate PRA submission under that rulemaking.
F. Collection of Information Is Mandatory
Each collection of information discussed above would be a mandatory
collection of information.
G. Will responses of collection of information be kept confidential?
By its terms, information collected pursuant to proposed rule 15Fi-
1 will not be available to the public. Under other rules proposed by
the Commission, however, most, if not all, of the information required
to be included in a trade acknowledgment, as described in paragraph (d)
of the proposed rule, will be otherwise publicly available. In
particular, under proposed Regulation SBSR,\66\ SBS Entities would be
required to report SBS transaction details to a SBS data repository
that will in turn, publicly disseminate SBS transaction data. To the
extent however, that the Commission receives confidential information
pursuant to this collection of information that is otherwise not
publicly available, that information will be kept confidential, subject
to the provisions of the Freedom of Information Act.
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\66\ See SBSR Proposing Release, note 16 supra.
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H. Request for Comment
The Commission requests comment on all aspects of its burden
estimates. The Commission also solicits comment as follows:
58. Is the proposed collection of information necessary for the
performance of the functions of the agency? Would the information have
a practical utility?
59. How accurate are the Commission's preliminary estimates of the
burdens of the proposed collection of information associated with
proposed rule 15Fi-1? How many entities would incur collection of
information burdens pursuant to rule 15Fi-1?
60. Would SBS Entities incur any additional burdens associated with
designing, creating and implementing a system for the processing,
acknowledgment and verification of SBS transactions pursuant to
proposed rule 15Fi-1?
61. Would there be different or additional burdens associated with
the collection of information under proposed rule 15Fi-1 that an SBS
Entity would not undertake in the ordinary course of business?
62. Are there additional burdens that the Commission has not
addressed in its preliminary burden estimates?
63. Are there ways to enhance the quality, utility and clarity of
the information to be collected?
64. Are there ways to minimize the burden of collection of
information on those who would be required to respond, including
through the use of automated collection techniques or other forms of
information technology?
65. What entities may be subject to proposed rule 15Fi-1? Would
specific classes of entities be impacted? How many entities would be
impacted? Will any entity or class of entities be impacted differently
than others?
V. Cost-Benefit Analysis
The Dodd-Frank Act was enacted, in part, to promote the financial
stability of the United States by improving accountability and
transparency in the financial system.\67\ Title VII of the Dodd-Frank
Act designates the Commission to oversee the SBS markets and develop
appropriate regulations. In furtherance of this goal, the Dodd-Frank
Act added Section 15F(i) to the Exchange Act, which requires SBS
Entities to ``conform with such standards as may be prescribed by the
Commission, by rule or regulation, that relate to timely and accurate
confirmation, processing, netting, documentation, and valuation of all
security-based swaps,'' and provides that the Commission must adopt
rules governing those documentation standards. Accordingly, proposed
rule 15Fi-1 would provide these documentation standards with respect to
the timely and accurate provision of trade acknowledgments and
verification of SBS transactions by SBS Entities.
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\67\ See Public Law 111-203 Preamble.
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The market for OTC derivatives, which has been described as
opaque,\68\ has grown exponentially in recent years \69\ and is capable
of affecting significant sectors of the U.S. economy. One of the
primary goals of Title VII of the Dodd-Frank Act is to increase the
transparency and efficiency of the OTC derivatives market and to reduce
the potential for counterparty and systemic risk.\70\ With respect to
the confirmation of OTC derivatives transactions, the GAO noted that
the trading volume of credit derivatives, such as SBS, had expanded so
rapidly that the operational infrastructure and confirmation practices
of many SBS Entities had failed to keep pace with the increased
[[Page 3871]]
volume.\71\ In particular, the GAO noted, among other things, that the
lack of automated systems for confirming and verifying the terms of SBS
transactions contributed to a significant backlog of unconfirmed
transactions, which in turn created significant legal and operation
risk for market participants.\72\ As a result, these risks and other
operational issues associated with OTC derivatives have been the focus
of reports and recommendations by the President's Working Group,\73\
and of ongoing efforts to by the FRBNY \74\ to enhance operational
systems in the OTC market, including the reduction of confirmation
backlogs and the timely provision of confirmations and verification of
transactions in OTC derivatives.
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\68\ With respect to CDSs, for example, the GAO found that
``comprehensive and consistent data on the overall market have not
been readily available,'' that ``authoritative information about the
actual size of the CDS market is generally not available,'' and that
regulators currently are unable ``to monitor activities across the
market.'' GAO, ``Systemic Risk: Regulatory Oversight and Recent
Initiatives to Address Risk Posed by Credit Default Swaps,'' GAO-09-
397T (March 2009), at 2, 5, 27.
\69\ The Bank for International Settlements semi-annual reports
on the swap markets summarizes developments in the OTC derivatives
markets. The report breaks down trading volumes and other statistics
for various classes of derivatives, including credit default swaps,
interest rate and foreign exchange derivatives, and equity and
commodity derivatives. The report covers derivatives trading within
the G10 countries. The most recent report, available at http://www.bis.org/statistics/derstats.htm, covers the period through the
last quarter of 2009.
\70\ See ``Financial Regulatory Reform--A New Foundation:
Rebuilding Financial Supervision and Regulation,'' U.S. Department
of the Treasury, at 47-48 (June 17, 2009).
\71\ See GAO Confirmation Report, supra, note 6 and accompanying
text.
\72\ Id. at pages 12-15.
\73\ See, e.g., Press Release, President's Working Group on
Financial Markets, Progress Summary on OTC Derivatives Operational
Improvements (November 2008).
\74\ See, note 10, supra.
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Proposed rule 15Fi-1 would prescribe standards for the
documentation and timely provision of SBS trade acknowledgments and the
verification of such trade acknowledgments. More specifically, proposed
Rule 15Fi-1 would require SBS Entities to provide a trade
acknowledgment of an SBS transaction within 15 minutes, 30 minutes or
24 hours following execution of the transactions, depending on whether
the transaction is executed and/or processed electronically.\75\ In
addition, the proposed rule would require SBS Entities to include
specified information in the trade acknowledgment,\76\ to verify
transactions with other SBS Entities, and to establish, maintain, and
enforce reasonable written policies and procedures for verifying the
transaction terms. The proposed rule would require most SBS
transactions to be processed and acknowledged electronically if the SBS
Entity has the ability to do so, but also would provide that many of
the requirements of the rule can be satisfied through the facilities of
the clearing agency that clears an SBS transaction.
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\75\ See note 49 supra.
\76\ See note 50 supra. See also proposed Rule 15Fi-1(c)(1).
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A. Benefits
The Commission believes that proposed rule 15Fi-1 would yield
substantial benefits to the SBS market and address many of the concerns
noted by the GAO regarding the timely and accurate acknowledgment of
OTC derivatives transactions. In particular, by requiring SBS Entities
to timely provide trade acknowledgments and verify SBS transactions and
to use electronic means when possible, the Commission is addressing the
concern raised by the GAO regarding the legal and operational risks
associated with confirmation backlogs in the OTC derivatives markets.
In particular, the GAO noted in its report that the lack of automation
was a significant contributor to confirmation backlogs.\77\ The
Commission believes that requiring SBS transactions to be processed
electronically would help reduce what the GAO described as the
operational and legal risks accompanying unconfirmed derivatives
transactions. In addition, the Commission believes that permitting SBS
Entities to rely on the facilities of a clearing agency to satisfy
their requirements under the proposed rule will encourage these
entities to use clearing agency facilities, thereby promoting
efficiency and automation in this market.
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\77\ See GAO Confirmation Report, supra note 6.
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B. Costs
Proposed rule 15Fi-1 would impose initial and ongoing costs on SBS
Entities. The Commission believes that these costs will be a function
of number of SBS transactions entered into by SBS Entities, whether SBS
Entities have the ability to electronically process SBS transactions,
and whether SBS Entities will enter into SBS transactions that can be,
and are, cleared by a clearing agency.
The Commission obtained information from publicly available sources
and consulted with industry participants in an effort to quantify the
number of aggregate SBS transactions on an annual basis. According to
the DTCC, there are on average 36,000 single-name CDS transactions per
day,\78\ resulting in a total number of 13,140,000 CDS transactions per
year. The Commission preliminarily believes that CDSs represent 85% of
all SBS transactions.\79\ Therefore, the Commission preliminarily
believes that there will be a total of approximately 15,460,000 SBS
transactions entered into each year. Assuming that at least one SBS
Entity is a party to every SBS transaction, the Commission
preliminarily estimates that the total number of SBS transactions that
would be subject to proposed 15Fi-1 on an annual basis would be
approximately 15,460,000 which is an average of 281,091 transactions
per SBS Entity per year.\80\
To fulfill the proposed rule's requirements, the Commission
believes that SBS Entities would have to develop an OMS with portals to
relevant clearing agencies and real-time or near real-time linkages
between an SBS Entity's front and back-office operations. The
development of an OMS would have to occur regardless of whether an SBS
transaction is, or can be, cleared by a clearing agency.
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\78\ See, e.g., http://www.dtcc.com/products/derivserv/data_table_iii.php (weekly data as updated by DTCC).
\79\ The Commission's estimate is based on internal analysis of
available SBS market data. The Commission is seeking comment about
the overall size of the SBS market.
\80\ These figures are based on the following: [13,140,000/0.85]
= 15,458,424, or approximately 15,460,000. (15,460,000 estimated SBS
transactions)/(55 SBS Entities) = 309,200 SBS transactions per SBS
Entity per year. The Commission understands that many of these
transactions may arise from previously executed SBS transactions.
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The Commission preliminarily estimates that an SBS Entity's
development of an OMS that achieves compliance with proposed rule 15Fi-
1 would impose a one-time aggregate cost of $3,665,750,\81\ or
approximately $66,650 per SBS Entity. This estimate includes the
development of an OMS that leverages off of an SBS Entity's existing
front-office and back-office operational platforms. The Commission
further preliminarily estimates that the requirements of proposed rule
15Fi-1 would impose an ongoing annual aggregate cost of $4,022,920, or
approximately $73,144 per SBS Entity.\82\ This estimate would include
day-to-day technical supports of the OMS, as well as an estimate of the
amortized annual burden associated with system or platform upgrades and
periodic ``re-platforming'' (i.e., implementing significant updates
based on new technology, products or both). In addition, the Commission
estimates that the development and implementation of written policies
and procedures as required under paragraph (e)(1) of the proposed rule
would impose initial costs of $1,754,500, or
[[Page 3872]]
approximately $31,900 per SBS Entity.\83\ Once established, the
Commission estimates that it would cost respondents approximately
$877,250 per year, or $15,950 per respondent,\84\ to update and
maintain these policies and procedures.
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\81\ This estimate is based on the following: [((Sr. Programmer
(160 hours) at $285 per hour) + (Sr. Systems Analyst (160 hours) at
$251 per hour) + (Compliance Manager (10 hours) at $294 per hour) +
(Director of Compliance (5 hours) at $426 per hour) + (Compliance
Attorney (20 hours) at $291 per hour) x (50 SBS Entities)] =
$3,665,750 or $66,650 per SBS Entity. The Commission understands
that many SBS Entities may already have computerized systems in
place for electronically processing SBS transactions, whether
internally or through a clearing agency.
\82\ This estimate is based on Commission staff discussions with
market participants and is calculated as follows: [((Sr. Programmer
(32 hours) at $285 per hour) + (Sr. Systems Analyst (32 hours) at
$251 per hour) + (Compliance Manager (60 hours) at $294 per hour) +
(Compliance Clerk (240 hours) at $59 per hour) + (Director of
Compliance (24 hours) at $426 per hour) + (Compliance Attorney (48
hours) at $291 per hour) x (55 SBS Entities)] = $4,022,920 burden
hours, or $73,144 per SBS Entity.
\83\ This estimate comes from Commission staff experience
regarding the development of policies and procedures and is
calculated as follows: [(Compliance Attorney (40 hours) at $294 per
hour) + (Director of Compliance (20 hours) at $426 per hour) +
(Deputy General Counsel (20 hours) at $581 per hour) x (55 SBS
Entities)] = $1,754,500 total, or $31,900 per SBS Entity.
\84\ This estimate comes from Commission staff experience
regarding the development of policies and procedures and is
calculated as follows: [(Compliance Attorney (20 hours) at $294 per
hour) + (Director of Compliance (10 hours) at $426 per hour) +
(Deputy General Counsel (10 hours) at $581 per hour) x (55 SBS
Entities)] = $877,250 total, or $15,950 per SBS Entity.
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In sum, the Commission estimates that the initial cost of complying
with proposed rule 15Fi-1 will be $5,417,500 for all respondents, or
$98,500 per SBS Entity.\85\ The Commission estimates that total ongoing
costs to respondents would be $4,900,170 for all respondents, or
$89,094 per SBS Entity.\86\
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\85\ ($3,665,750 initial cost for developing OMS) + ($1,754,500
for developing policies and procedures) = $5,417,500 for all
respondents. ($5,417,500/505 Respondents) = $98,500 per SBS Entity.
\86\ ($4,022,920 ongoing cost for maintaining OMS) + ($877,250
for maintaining policies and procedures) = $4,900,170 for all
respondents. ($4,900,170/55 Respondents) = $89,094 per SBS Entity.
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C. Request for Comment
The Commission requests comment on the costs and benefits of
proposed rule 15Fi-1 discussed above, as well as any costs and benefits
not already described that could result. In addition, the Commission
requests comment on the following:
66. How can the Commission accurately estimate the costs and
benefits of the proposed rule?
67. What are the costs currently borne by SBS Entities that would
be subject to proposed rule 15Fi-1 with respect to the acknowledgment
and verification of SBS transactions?
68. How many entities would be subject to the proposed rule? How
transactions would be subject to the proposed rule?
69. Are there additional costs involved in complying with the rule
that have not been identified? What are the types, and amounts, of the
costs?
70. Would the obligations imposed on SBS Entities by proposed rule
15Fi-1 be a significant enough barrier to cause some firms not to enter
the SBS market? If so, how many firms might decline to enter the
market? How could the cost of their not entering the market be
measured? How should the Commission weigh those costs, if any, against
the anticipated benefits from reducing legal and operational risk to
SBS Entities from the proposal, as discussed above?
71. Would there be additional benefits from the proposed rule that
have not been identified?
VI. Consideration of Burden on Competition and Promotion of Efficiency,
Competition, and Capital Formation
Exchange Act Section 3(f) requires the Commission, when engaging in
rulemaking that requires it to consider whether an action is necessary
or appropriate in the public interest, to consider, in addition to the
protection of investors, whether the action would promote efficiency,
competition, and capital formation. In addition, Section 23(a)(2) of
the Exchange Act requires the Commission, when making rules under the
Exchange Act, to consider the impact of those rules on competition.
Section 23(a)(2) also prohibits the Commission from adopting any rule
that would impose a burden on competition not necessary or appropriate
in furtherance of the purposes of the Exchange Act.
The Commission preliminarily believes that the documentation
standards for the provision of trade acknowledgments and verification
of SBS transactions, as required by the Dodd-Frank Act and implemented
by proposed rule 15Fi-1, would promote efficiency, competition, and
capital formation by encouraging SBS Entities to automate their systems
for SBS transactions, providing further incentive for SBS Entities to
clear SBS transactions through clearing agencies' automated facilities,
thus lowering transaction costs, and helping alleviate the legal and
operational risks encountered by SBS Entities when SBS transactions are
otherwise confirmed through manual methods.
The Commission's experience with the acknowledgment and
verification of other types of securities is that the timely resolution
of disputes regarding the terms of a transaction are more efficiently
handled near in time to when the transaction took place. Timely
acknowledgment and verification of SBS transactions will provide
counterparties with the appropriate means by which to evaluate their
own risk exposures in a timely manner, thereby enabling them to more
quickly and efficiently determine whether and how to deploy capital in
other asset classes. In addition, the Commission believes that
competition will be promoted because market participants would be
encouraged to enter into SBS transactions with SBS Entities whose
automated operations reduce the amount of time it takes to confirm the
terms of a trade. In particular, the Commission believes that the need
for speed and efficiency in today's capital markets would encourage
market participants in general, and SBS Entities in particular, to
provide quicker and more efficient process for confirming SBS
transactions because counterparties to an SBS transaction must not only
concern themselves with the SBS transaction, but also the underlying
reference security that itself is subject to rapid market movements.
VII. Consideration of Impact on the Economy
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996 (``SBREFA''), the Commission must advise the OMB whether
the proposed regulation constitutes a ``major'' rule. Under SBREFA, a
rule is considered ``major'' when, if adopted, it results or is likely
to result in: (1) An annual effect on the economy of $100 million or
more (either in the form of an increase or a decrease); (2) a major
increase in costs or prices for consumers or individual industries; or
(3) significant adverse effect on competition, investment or
innovation. If a rule is ``major,'' its effectiveness will generally be
delayed for 60 days pending Congressional review.
The Commission requests comment on the potential impact of proposed
rule 15Fi-1 on the economy on an annual basis, on the costs or prices
for consumers or individual industries, and on competition, investment,
or innovation. Commenters are requested to provide empirical data and
other factual support for their view to the extent possible.
VIII. Regulatory Flexibility Act Certification
The Regulatory Flexibility Act (``RFA'') requires Federal agencies,
in promulgating rules, to consider the impact of those rules on small
entities. Section 603(a) of the Administrative Procedure Act, as
amended by the RFA, generally requires the Commission to undertake a
regulatory flexibility analysis of all proposed rules, or proposed rule
amendments, to determine the impact of such rulemaking on ``small
entities.'' Section 605(b) of the RFA states that this requirement
shall not apply to any proposed rule or proposed rule amendment which,
if adopted, would not have a significant economic impact
[[Page 3873]]
on a substantial number of small entities.
For purposes of Commission rulemaking in connection with the RFA, a
small entity includes: (1) When used with reference to an ``issuer'' or
a ``person,'' other than an investment company, an ``issuer'' or
``person'' that, on the last day of its most recent fiscal year, had
total assets of $5 million or less; or (2) a broker-dealer with total
capital (net worth plus subordinated liabilities) of less than $500,000
on the date in the prior fiscal year as of which its audited financial
statements were prepared pursuant to Rule 17a-5(d) under the Exchange
Act, or, if not required to file such statements, a broker-dealer with
total capital (net worth plus subordinated liabilities) of less than
$500,000 on the last day of the preceding fiscal year (or in the time
that it has been in business, if shorter); and is not affiliated with
any person (other than a natural person) that is not a small business
or small organization.
Based on our staff's discussions with SBS market participants, the
Commission preliminarily believes that the majority of SBS transactions
have at least one counterparty that is either a SBS dealer or major SBS
participant, and that these entities--whether registered broker-dealers
or not--would exceed the thresholds defining ``small entities'' set out
above. Accordingly, neither of these types of entities would likely
qualify as small entities for purposes of the RFA. Moreover, even in
situations in which one of the counterparties to a SBS is not covered
by these definitions, the Commission preliminarily does not believe
that any such entities would be ``small entities'' as defined in
Commission Rule 0-10. Industry participants have indicated to our staff
that only persons or entities with assets significantly in excess of $5
million participate in the SBS market. For example, as stated in a
current survey conducted by Office of the Comptroller of the Currency,
99.9% of CDS positions by U.S. commercial banks and trusts are held by
those with assets over $10 billion.\87\ Given the magnitude of this
figure, and the fact that it so far exceeds $5 million, the Commission
preliminarily believes that the vast majority of, if not all, SBS
transactions do not involve small entities for purposes of the RFA.
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\87\ See Office of the Comptroller of the Currency, ``Quarterly
Report on Bank Trading and Derivatives Activities Second Quarter
2010'' (2010).
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In addition, the Commission preliminarily believes that the
entities likely to register as SBS Entities would not be small
entities. Industry participants have indicated to our staff that most
if not all of the registered SBS Entities would be part of large
business entities, and that all registered SBS Entities would have
assets exceeding $5 million and total capital exceeding $500,000.
Therefore, the Commission preliminarily believes that none of the SBS
Entities would be small entities.
On this basis, the Commission preliminarily believes that the
number of SBS transactions involving a small entity as that term is
defined for purposes of the RFA would be de minimis. Moreover, the
Commission does not believe that any aspect of proposed rule 15Fi-1
would be likely to alter the type of counterparties presently engaging
in SBS transactions. Therefore, the Commission preliminarily does not
believe that proposed rule 15Fi-1 would impact any small entities.
For the foregoing reasons, the Commission certifies that proposed
Rule 15Fi-1 would not have a significant economic impact on a
substantial number of small entities for purposes of the RFA. The
Commission encourages written comments regarding this certification.
The Commission requests that commenters describe the nature of any
impact on small entities, indicate whether they believe that SBS
Entities are unlikely to be small entities, and provide empirical data
to support their responses.
IX. Statutory Basis and Text of Proposed Amendments
The Commission is proposing to adopt Rule 15Fi-1 pursuant to
Section 15F of the Exchange Act, as amended.
List of Subjects in 17 CFR Part 240
Reporting and recordkeeping requirements, Securities, Security-
based swaps, Security-based swap dealers, Major security-based swap
participants.
In accordance with the foregoing, the Securities and Exchange
Commission is proposing to amend Title 17, chapter II of the Code of
Federal Regulations as follows:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
1. The general authority citation for Part 240 is revised to read
as follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i,
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78o-4, 78o-8, 78p, 78q,
78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37,
80b-3, 80b-4, 80b-11, and 7201 et seq.; and 18 U.S.C. 1350, and 12
U.S.C. 5221(e)(3) unless otherwise noted.
* * * * *
2. Add an undesignated center heading following Sec. 240.15Cc1-1
and add Sec. 240.15Fi-1 to read as follows:
Registration and Regulation of Security-Based Swap Dealers and Major
Security-Based Swap Participants
Sec. 240.15Fi-1 Acknowledgment and verification of security-based
swap transactions.
(a) Definitions. For the purposes of this section:
(1) The term asset class means those security-based swaps in a
particular broad category, including, but not limited to, credit
derivatives, equity derivatives, and loan-based derivatives.
(2) The term broker ID means the UIC assigned to a person acting as
a broker for a participant.
(3) The term clearing agency means a clearing agency registered
pursuant to section 17A of the Securities Exchange Act of 1934 (15
U.S.C. 78q-1).
(4) The term confirmation means a trade acknowledgment that has
been subject to verification.
(5) The term desk ID means the UIC assigned to the trading desk of
a participant or of a broker of a participant.
(6) The term execution means the point at which the parties become
irrevocably bound to a transaction under applicable law.
(7) The term participant ID means the UIC assigned to a
participant.
(8) The term price means the price of a security-based swap
transaction, expressed in terms of the commercial conventions used in
that asset class.
(9) The term processed electronically means entered into a
security-based swap dealer or security-based swap participant's
computerized processing systems to facilitate clearance and settlement.
(10) The term trade acknowledgment means a written or electronic
record of a security-based swap transaction sent by one party to the
other.
(11) The term trader ID means the UIC assigned to a natural person
who executes security-based swaps.
(12) The term unique identification code or UIC means the unique
identification code assigned to a person, unit of a person, or product
by or on behalf of an internationally recognized standards-setting body
that imposes fees and usage restrictions that are fair and reasonable
and not unreasonably discriminatory. If no standards-setting body meets
these criteria, a registered security-based swap data repository shall
assign all necessary UICs using its own methodology. If a standards-
setting body meets these criteria but has not
[[Page 3874]]
assigned a UIC to a particular person, unit of a person, or product, a
registered security-based swap data repository shall assign a UIC to
that person, unit of a person, or product using its own methodology.
(13) The term verification means the process by which a trade
acknowledgment has been manually, electronically, or by some other
legally equivalent means, signed by the receiving counterparty.
(b) Trade acknowledgment requirement. (1) In any transaction in
which a security-based swap dealer or major security-based swap
participant purchases from or sells to any counterparty a security-
based swap, a trade acknowledgment must be provided by:
(i) The security-based swap dealer, if the transaction is between a
security-based swap dealer and a major security-based swap participant;
(ii) The security-based swap dealer or major security-based swap
participant, if only one counterparty in the transaction is a security-
based swap dealer or major security-based swap participant; or
(iii) The counterparty that the counterparties have agreed will
provide the trade acknowledgment in any transaction other than one
described in paragraph (b)(1)(i) or (ii) of this section.
(2) A security-based swap dealer or major security-based swap
participant will have satisfied the requirements of paragraph (b)(1) of
this section if a clearing agency through its facilities produces a
confirmation of each security-based swap transaction.
(c) Prescribed time. (1) Any trade acknowledgment required by
paragraph (b) of this section must be provided promptly, but in any
event:
(i) For any transaction that has been executed and processed
electronically, within 15 minutes of execution;
(ii) For any transaction that is not executed electronically, but
that will be processed electronically, within 30 minutes of execution;
or
(iii) For any transaction that cannot be processed electronically
by the security-based swap dealer or security-based swap participant,
within 24 hours following execution.
(2) A transaction must be processed electronically if the security-
based swap dealer or major security-based swap participant has the
ability to do so.
(d) Form and content of trade acknowledgment. Any trade
acknowledgment required in paragraph (b) of this section must be
provided through electronic means that provide reasonable assurance of
delivery and a record of transmittal, and must disclose:
(1) The asset class of the security-based swap and, if the
security-based swap is an equity derivative, whether it is a total
return swap or is otherwise designed to offer risks and returns
proportional to a position in the equity security or securities on
which the security-based swap is based;
(2) Information that identifies the security-based swap instrument
and the specific asset(s) or issuer of a security on which the
security-based swap is based;
(3) The notional amount(s), and the currenc(ies) in which the
notional amount(s) is expressed;
(4) The date and time, to the second, of execution expressed using
Coordinated Universal Time (UTC);
(5) The effective date;
(6) The scheduled termination date;
(7) The price;
(8) The terms of any fixed or floating rate payments, and the
frequency of any payments;
(9) Whether or not the security-based swap will be cleared by a
clearing agency;
(10) If both counterparties to a security-based swap are security-
based swap dealers, an indication to that effect;
(11) If the transaction involved an existing security-based swap,
an indication that the transaction did not involve an opportunity to
negotiate a material term of the contract, other than the counterparty;
(12) If the security-based swap is customized to the extent that
the information provided in paragraphs (d)(1) through (11) of this
section does not provide all of the material information necessary to
identify such customized security-based swap or does not contain the
data elements necessary to calculate the price, an indication to that
effect;
(13) The participant ID of each counterparty;
(14) As applicable, the broker ID, desk ID, and trader ID of the
reporting party;
(15) The amount(s) and currenc(ies) of any up-front payment(s) and
a description of the terms and contingencies of the payment streams of
each counterparty to the other;
(16) The title of any master agreement, or any other agreement
governing the transaction (including the title of any document
governing the satisfaction of margin obligations), incorporated by
reference and the date of any such agreement;
(17) The data elements necessary for a person to determine the
market value of the transaction;
(18) If the security-based swap will be cleared, the name of the
clearing agency;
(19) If the security-based swap is not cleared, whether the
exception in Section 3C(g) of the Exchange Act (15 U.S.C. 78c-3(g)) was
invoked;
(20) If the security-based swap is not cleared, a description of
the settlement terms, including whether the security-based swap is
cash-settled or physically settled, and the method for determining the
settlement value;
(21) The venue where the security-based swap was executed; and
(22) If the transaction is to be cleared, any additional
information that is required for the transaction to be cleared by a
clearing agency.
(e) Trade verification. (1) A security-based swap dealer or major
security-based swap participant must establish, maintain, and enforce
written policies and procedures that are reasonably designed to obtain
prompt verification of the terms of a trade acknowledgment provided
pursuant to paragraph (b) of this section.
(2) In any security-based swap transaction to be cleared through a
clearing agency, a security-based swap dealer or major security-based
swap participant must comply with the verification process prescribed
by the clearing agency. Such compliance shall satisfy the requirements
of paragraph (e)(1) of this section with respect to the transaction.
(3) A security-based swap dealer or major security-based swap
participant must promptly verify the accuracy of, or dispute with its
counterparty, the terms of a trade acknowledgment it receives pursuant
to paragraph (b) of this section.
(f) Exemption from Sec. 240.10b-10. A security-based swap dealer
or major security-based swap participant who is also a broker or dealer
and who complies with paragraph (b) of this section with respect to a
security-based swap transaction is exempt from the requirements of
Sec. 240.10b-10 of this chapter with respect to the security-based
swap transaction.
Dated: January 14, 2011.
By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011-1218 Filed 1-20-11; 8:45 am]
BILLING CODE 8011-01-P