Acknowledgment and Verification Adopting Release, 81 FR at 39831 n.
243.
---------------------------------------------------------------------------

3. Reporting of Certain Valuation Disputes
    Proposed Rule 15Fi-3(c) would require each SBS Entity to promptly
notify the Commission (and any applicable prudential regulator for an
SBS Entity that is also a bank), in a form and manner acceptable to the
Commission, of any security-based swap valuation dispute in excess of
$20,000,000 (or its equivalent in any other currency) if not resolved
within a prescribed time period. As previously noted, we crafted the
rule in this way to provide SBS Entities with flexibility to determine
the most efficient and cost-effective form and manner of making such
submissions, so long as it is deemed to be acceptable by the
Commission.\187\ Accordingly, we preliminarily do not expect there to
be any initial burden of designing a system for submitting these
notices.\188\ We also preliminarily believe that the associated ongoing
hourly burden of preparing and submitting such notices would be
minimal. In addition, until SBS Entities

are registered with the Commission, it is difficult for us to determine
the typical number of valuation disputes meeting the applicable
thresholds that SBS Entities would be required to submit on an annual
basis. As such, and consistent with the estimate the CFTC provided when
it first proposed a similar requirement, we preliminarily estimate that
each SBS Entities will spend on average of 24 hours each year complying
with this requirement, for an estimated average annual burden of 1,320
hours in the aggregate for all 55 respondents.\189\ We also recognize,
however, that there are differences between the markets for swaps and
security-based swaps and welcomes comment from the public on this
estimate.
---------------------------------------------------------------------------

    \187\ See supra note 47.
    \188\ In the request for comments, we asked whether we should
require such notices to be submitted in a particular manner, such as
having them sent to a dedicated email box or using the EDGAR system
(or any successor system thereto, as designated by the Commission).
As SBS Entities will already have access to EDGAR (and a Form ID) by
virtue of having used the system to register with the Commission, we
would not expect there to be any initial burden associated with
either approach.
    \189\ See Swap Trading Relationship Documentation Requirements
for Swap Dealers and Major Swap Participants, 76 FR 6715, 6723 (Feb.
8, 2011).
---------------------------------------------------------------------------

    Combining all of the estimated burdens described above, the
Commission preliminarily estimates that proposed Rule 15Fi-3 would
impose an estimated one-time initial burden of 1,635 hours in the
aggregate for all SBS Entities to prepare new written policies and
procedures or to bring existing ones into compliance. The Commission
also preliminarily estimates that proposed Rule 15Fi-3 would impose an
estimated ongoing burden of 26,482.5 hours each year in the aggregate
for all SBS Entities, which is composed of (1) an estimated annual
burden of 10,450 hours in the aggregate for all SBS Entities to engage
in portfolio reconciliation with SBS Entities; (2) an estimated annual
burden of 12,512.5 hours in the aggregate for all SBS Entities to
engage in portfolio reconciliation with non-SBS Entities; (3) an
estimated annual burden of 2,200 hours in the aggregate for all SBS
Entities to revise and maintain the written policies and procedures
required pursuant to the rule; and (4) 1,320 hours for all SBS Entities
to report certain large valuation disputes to the Commission and any
applicable prudential regulator.\190\ These calculations are summarized
in PRA Tables 3 and 4, below.
---------------------------------------------------------------------------

    \190\ Rule 15Fi-3(a)(1) and 15Fi-3(b)(1) also require an SBS
Entity to agree in writing with each of its counterparties on the
terms of the portfolio reconciliation including, if applicable,
agreement on the selection of any third party service provider who
may be performing the reconciliation. The Commission expects SBS
Entities to undertake this agreement as part of the written trading
relationship documentation each is required to enter into with its
counterparties as a result of proposed Rule 15Fi-5. Thus, the
estimate here does not account for this burden, which is instead
assumed to form part of the burden of complying with Rule 15Fi-5.

   PRA Table 3--Proposed Rule 15Fi-3: Total Estimated Initial Burdens
------------------------------------------------------------------------
                                                          Total one-time
               Requirement                 Hourly burden  burden (hours)
------------------------------------------------------------------------
Preparation of New Written Policies and                1              35
 Procedures (35 dual SEC-CFTC
 registrants)...........................
Preparation of New Written Policies and               80           1,600
 Procedures (20 SEC-only registrants)...
                                         -------------------------------
    Total Aggregate One-Time Burden for   ..............           1,635
     all 55 respondents.................
------------------------------------------------------------------------

                          PRA Table 4--Proposed Rule 15Fi-3: Summary of Annual Burdens
----------------------------------------------------------------------------------------------------------------
                       Requirement                             Aggregate hourly burden (all 55 respondents)
----------------------------------------------------------------------------------------------------------------
Portfolio Reconciliations with Other SBS Entities.......  10,450
Portfolio Reconciliations with Non-SBS Entities.........  12,512.5
Revise and Maintain Written Policies and Procedures.....  2,200
Prepare and Submit Notices of Valuation Disputes >$20     1,320
 million.
                                                         -------------------------------------------------------
    Total Aggregate Annual Burden for all 55 respondents  26,482.5
----------------------------------------------------------------------------------------------------------------

4. Proposed Rule 15Fi-4: Portfolio Compression
    With regard to the written policies and procedures, the Commission
continues to believe that of the estimated 55 persons that may register
with the Commission as SBS Entities, approximately 35 will be dually-
registered with the CFTC as Swap Entities. In addition, and as we
previously noted, the CFTC's adopted final rules requiring Swap
Entities to establish, maintain, and follow written policies and
procedures on bilateral offsets and portfolio compression exercises
are, other than as expressly noted above in Section I.C, substantively
identical to those proposed by Rule 15Fi-4. Accordingly, these 35
entities are already required to establish, maintain, and follow
relevant written policies and procedures related to bilateral offsets
and portfolio compression exercises involving their swap portfolios,
and these policies and procedures would be expected to be largely
consistent with those that would be required with respect to their
security-based swap portfolios. Assuming that these existing policies
and procedures would simply need to be amended to apply to security-
based swap transactions upon adoption of proposed Rule 15Fi-4, we
preliminarily estimate that the initial burden of revising these
policies and procedures would be one hour per respondent, for an
estimated one-time initial burden of 35 hours in the aggregate.
    With respect to the remaining 20 SBS Entities that are not dually-
registered with the CFTC, the Commission preliminarily estimates, based
on prior estimates in earlier Dodd-Frank rulemakings, that these
policies and procedures would require an average of 80 hours per non-
dually-registered respondent to initially prepare and implement, for an
estimated average annual burden of 1,600 hours in the aggregate.\191\
Once these policies and procedures are established, the Commission
estimates that it will take an average of 40 hours annually to revise
and maintain these policies and procedures per respondent (including
both dually-registered and non-dually-registered SBS Entities), for an
estimated average annual burden of 2,200 hours in the aggregate for all
55 respondents.
---------------------------------------------------------------------------

    \191\ See supra note 184.
---------------------------------------------------------------------------

    In addition, the respondents will incur additional hourly burdens
as they undertake bilateral offsets and portfolio compression exercises
consistent with these written policies and procedures. As noted above
the Commission estimates that each of the 55 estimated

SBS Entities will be counterparty to an average of 18 other SBS
Entities and 350 non-SBS Entities, for a total of 368 counterparties.
For purposes of conducting bilateral offsets and portfolio compression
exercises, the Commission preliminarily estimates that (1) each SBS
Entity will have an average of one set of security-based swaps that are
eligible for annual bilateral offset with each of these 368
counterparties, (2) each SBS Entity will conduct an annual bilateral
compression exercise with one-third, or six of its 18 SBS Entity
counterparties, (3) each SBS Entity will conduct an annual bilateral
compression exercise with each of its 350 non-SBS Entity
counterparties, and (4) each SBS Entity will engage in multilateral
compression exercises at an average rate of 12 exercises per year.
    The Commission preliminarily believes that each bilateral offset
and portfolio compression exercise is likely to be conducted through an
automated process. As a result, we preliminarily believe that (1) each
bilateral offset will require on average five minutes of respondent
time to complete with each of the 350 non-SBS Entity counterparties,
(2) each bilateral offset will require on average 2.5 minutes of
respondent time to complete with each of the 18 SBS Entity
counterparties,\192\ (3) each bilateral compression will require an
average of 15 minutes of respondent time to complete with each of the
350 non-SBS Entity counterparties, (4) each bilateral compression will
require an average of 7.5 minutes with each of the six SBS Entity
counterparties,\193\ and (5) each multilateral compression exercise
will require an average of 30 minutes of respondent time to complete 12
times annually. In each of those hourly burdens, the figure used is the
combined estimate for both counterparties. Based on these estimates,
the Commission estimates the average annual hourly burden for these
activities at 124.16 hours per respondent, an estimated average annual
burden of 6,828.8 hours in the aggregate. These calculations are
summarized in PRA Table 5, below.
---------------------------------------------------------------------------

    \192\ Similar to our estimates in the context of the portfolio
reconciliation requirements, because the five minute estimate is for
the entire bilateral offset process, without respect to how that
time is allocated between the two parties, to avoid double-counting
we have divided it by one-half in the context of security-based swap
portfolios between two SBS Entities, resulting in an estimate of 2.5
minutes per bilateral offset for those portfolios.
    \193\ Again, we have divided the 15 minute estimate to complete
the bilateral compression exercise by one-half in the context of
security-based swap portfolios between two SBS Entities, resulting
in an estimate of 7.5 minutes per bilateral compression for those
portfolios.

                              PRA Table 5--Portfolio Compression With All Entities
----------------------------------------------------------------------------------------------------------------
                                                                     Number of     Hourly burden
                Type of exercise                     Number of        annual       per exercise    Total annual
                                                  counterparties     exercises        (hours)     burden (hours)
----------------------------------------------------------------------------------------------------------------
Bilateral Offset (w/non-SBS Entities)...........             350               1           .0833           29.16
Bilateral Offset (w/SBS Entities)...............              18               1           .0417             .75
Bilateral Compression (w/non SBS-Entities)......             350               1             .25            87.5
Bilateral Compression (w/SBS Entities)..........               6               1            .125             .75
Multilateral Compression........................             N/A              12              .5               6
                                                 ---------------------------------------------------------------
    Total per respondent........................  ..............  ..............  ..............          124.16
                                                 ---------------------------------------------------------------
    Total Aggregate Annual Burden for all 55      ..............  ..............  ..............         6,828.8
     respondents................................
----------------------------------------------------------------------------------------------------------------

    Combining all of the estimated burdens described above, the
Commission preliminarily estimates that proposed Rule 15Fi-4 would
impose an estimated one-time initial burden of 1,635 hours in the
aggregate for all SBS Entities to prepare new written policies and
procedures or to bring existing ones into compliance. The Commission
also preliminarily estimates that proposed Rule 15Fi-4 would impose an
estimated ongoing burden of 9,028.8 hours each year in the aggregate
for all SBS Entities, which is composed of (1) an estimated annual
burden of 1,603.8 hours in the aggregate to conduct bilateral offsets
with non-SBS Entities; (2) an estimated annual burden of 41.25 hours in
the aggregate to conduct bilateral offsets with SBS Entities; (3) an
estimated annual burden of 4,812.5 hours in the aggregate to
participate in bilateral compression exercises with non-SBS Entities;
(4) an estimated annual burden of 41.25 hours in the aggregate to
participate in bilateral compression exercises with SBS Entities; (5)
an estimated annual burden of 330 hours in the aggregate to participate
in multilateral compression exercises; and (6) an estimated annual
burden of 2,200 hours in the aggregate for all SBS Entities to revise
and maintain written policies and procedures. These calculations are
summarized in PRA Tables 6 and 7, below.

    PRA Table 6--Proposed Rule 15Fi-4: Total Estimated Initial Burden
------------------------------------------------------------------------
                                           Hourly burden  Total one-time
                Activity                      (hours)     burden (hours)
------------------------------------------------------------------------
Preparation of New Written Policies and                1              35
 Procedures (35 dual SEC-CFTC
 registrants)...........................
Preparation of New Written Policies and               80           1,600
 Procedures (20 SEC-only registrants)...
                                         -------------------------------
    Total Aggregate One-Time Burden for   ..............           1,635
     all 55 respondents.................
------------------------------------------------------------------------

      PRA Table 7--Proposed Rule 15Fi-3: Summary of Annual Burdens
------------------------------------------------------------------------
                                                             Aggregate
                                                           hourly burden
                       Requirement                         (hours) (all
                                                                55
                                                           respondents)
------------------------------------------------------------------------
Bilateral Offsets with non-SBS Entities.................         1,603.8
Bilateral Offsets with SBS Entities.....................           41.25
Bilateral Compression with non-SBS Entities.............         4,812.5
Bilateral Compression with SBS Entities.................           41.25
Multilateral Compression................................             330
Revise and Maintain Written Policies and Procedures.....           2,200
                                                         ---------------
    Total Aggregate Annual Burden for all 55 respondents         9,028.8
------------------------------------------------------------------------

5. Proposed Rule 15Fi-5: Written Trading Relationship Documentation
    As previously noted, the Commission estimates that each SBS Entity
will have 18 SBS Entity counterparties and 350 non-SBS Entity
counterparties, for a total of 368 counterparties per SBS Entity. For
the purposes of the underlying documentation requirements, and based on
staff discussions with market participants, the Commission understands
that many SBS Entities already have in place industry-standard written
trading relationship documentation that is likely to contain many of
the elements required by this proposed rule. With this in mind, the
Commission preliminarily estimates that (1) the initial burden per
respondent to negotiate and draft written trading relationship
documentation with non-SBS Entities that is compliant with proposed
Rule 15Fi-5 will be approximately 30 hours (which is the combined
estimate for both counterparties), and (2) the initial burden per
respondent to negotiate and draft written trading relationship
documentation with SBS Entities that is compliant with proposed Rule
15Fi-5 will be approximately 15 hours.\194\ These estimates are
averages, and both account for the fact that some SBS Entities may lack
appropriate documentation in certain respects and will need to enter
into new documentation with counterparties, while in other cases
existing documentation will need only to be modified to be brought into
compliance. The Commission's estimates are further based on an
assumption that, in each case, the written documentation will always
include the valuation agreements set forth in proposed Rule 15Fi-
5(b)(4), notwithstanding the fact that the rule only requires this
information in certain circumstances.
---------------------------------------------------------------------------

    \194\ As was the case in calculating the PRA estimates for the
portfolio reconciliation and portfolio compression requirements,
because the 30 hours estimate is for the entire process of
negotiating and executing written trading relationship
documentation, without respect to how that time is allocated between
the two parties, to avoid double-counting we have divided it by one-
half in the context of counterparties that are also SBS Entities,
resulting in an estimate of 15 hours to negotiate and execute such
documentation.
---------------------------------------------------------------------------

    Based on these estimates and assumptions, the Commission
preliminarily believes that the requirement to prepare written
relationship documentation in accordance with proposed Rule 15Fi-5 will
result in an estimated one-time initial burden of 9,540 hours for each
of the 55 SBS Entity respondents, for an estimated average one-time
burden of 524,700 hours in the aggregate. The Commission also
preliminarily believes that there will be little need to modify the
written trading relationship documentation on an ongoing basis once it
is in place, and therefore is not estimating any additional annual
hourly burden for ongoing modifications.
    With regard to the written policies and procedures required
pursuant to proposed Rule 15Fi-5, the Commission continues to believe
that of the estimated 55 persons that may register with the Commission
as SBS Entities, approximately 35 will be dually-registered with the
CFTC as Swap Entities. In addition, and as we previously noted, the
CFTC's adopted final rules requiring Swap Entities to establish,
maintain, and follow written policies and procedures requiring the
execution of written trading relationship documentation are, other than
as expressly noted above in Section I.D, substantively identical to
those proposed by Rule 15Fi-5. Accordingly, these 35 entities are
already required to establish, maintain, and follow relevant written
policies as they relate to the execution of written trading
relationship documentation involving their swap portfolios, and these
policies and procedures would be expected to be largely consistent with
those that would be required with respect to their security-based swap
portfolios. Assuming that these existing policies and procedures would
simply need to be amended to apply to security-based swap transactions
upon adoption of proposed Rule 15Fi-5, we preliminarily estimate that
the average initial burden of revising these policies and procedures
would be one hour per respondent, for an estimated one-time burden of
35 hours in the aggregate.
    With respect to the remaining 20 SBS Entities that are not dually-
registered with the CFTC, the Commission preliminarily estimates, based
on prior estimates in earlier Dodd-Frank rulemakings, that these
policies and procedures would require an average of 80 hours per non-
dually-registered respondent to initially prepare and implement, for an
estimated average annual burden of 1,600 hours in the aggregate.\195\
Once these policies and procedures are established, the Commission
estimates that it will take an average of 40 hours annually to revise
and maintain these policies and procedures per respondent (including
both dually-registered and non-dually-registered SBS Entities), for an
estimated average annual burden of 2,200 hours in the aggregate for all
55 respondents.
---------------------------------------------------------------------------

    \195\ See supra note 184.
---------------------------------------------------------------------------

    With regard to having an independent auditor conduct the required
periodic audit of written trading relationship documentation and the
requirement to retain a record of each such audit, the Commission
estimates that it will take an average of 10 hours to audit an SBS
Entity's documentation with each of its 368 counterparties, for a total
of 3,680 hours per SBS Entity, or 202,400 hours for all 55 SBS Entity
respondents.
    Combining all of the estimated burdens described above, the
Commission preliminarily estimates that proposed Rule 15Fi-5 would
impose an estimated one-time initial burden of 593,985 hours in the
aggregate for all SBS Entities, which consists of (1) 1,635 hours in
the aggregate for all SBS Entities to prepare new written policies and
procedures or to bring

existing ones into compliance, (2) 577,500 hours in the aggregate for
SBS Entities to negotiate and execute trading relationship
documentation with 350 non-SBS Entity counterparties, and (3) 14,850
hours in the aggregate for SBS Entities to negotiate and execute
trading relationship documentation with 18 SBS Entity counterparties.
The Commission also preliminarily estimates that proposed Rule 15Fi-5
would impose an estimated ongoing burden of 204,600 hours each year in
the aggregate for all SBS Entities, which is composed of: (1) An
estimated annual burden of 2,200 hours in the aggregate for all SBS
Entities to revise and maintain written policies and procedures and (2)
an estimated annual burden of 202,400 hours in the aggregate for all
SBS Entities to conduct the required periodic audits. These
calculations are summarized in PRA Tables 8 and 9, below.

   PRA Table 8--Proposed Rule 15Fi-5: Total Estimated Initial Burdens
------------------------------------------------------------------------
                                           Hourly burden  Total one-time
                Activity                      (hours)     burden (hours)
------------------------------------------------------------------------
Preparation of New Written Policies and                1              35
 Procedures (35 dual SEC-CFTC
 registrants)...........................
Preparation of New Written Policies and               80           1,600
 Procedures (20 SEC-only registrants)...
Negotiate and Execute Trading                         30         577,500
 Relationship Documentation with 350 non-
 SBS Entities (all 55 respondents)......
Negotiate and Execute Trading                         15          14,850
 Relationship Documentation with 18 SBS
 Entities (all 55 respondents)..........
                                         -------------------------------
    Total Aggregate One-Time Burden for   ..............         593,985
     all 55 respondents.................
------------------------------------------------------------------------

      PRA Table 9--Proposed Rule 15Fi-3: Summary of Annual Burdens
------------------------------------------------------------------------
                                                             Aggregate
                                                           hourly burden
                       Requirement                         (hours) (all
                                                                55
                                                           respondents)
------------------------------------------------------------------------
Audit of Written Trading Relationship Documentation.....         202,400
Revise and Maintain Written Policies and Procedures.....           2,200
                                                         ---------------
    Total Aggregate Annual Burden for all 55 respondents         204,600
------------------------------------------------------------------------

6. Proposed Amendments to Rules 17a-3, 17a-4, 18a-5, and 18a-6: Books
and Records Requirements
    The proposed amendments to Rules 17a-3, 17a-4, 18a-5, and 18a-6
would impose collection of information requirements that result in
initial and annual time burdens for SBS Entities. The proposed
amendments to Rules 17a-3 and 18a-5 would require three additional
types of records to be made and kept current by SBS Entities--records
regarding portfolio reconciliations, valuation disputes, and portfolio
compressions. Because the burden to make these records is accounted for
in the PRA estimates for proposed Rules 15Fi-3 and 15Fi-4, the burden
imposed by these proposed new requirements is the requirement in Rules
17a-4 and 18a-6 to maintain and preserve a written record of these
tasks, as well as the additional requirements in those provisions to
maintain and preserve records of policies and procedures required by
Rules 15Fi-3 through 15Fi-5 and written agreements with counterparties
regarding the terms of portfolio reconciliation. The Commission
estimates that these recordkeeping requirements, as proposed to be
amended, would impose an initial burden of 60 hours per firm for
updating the applicable policies and systems required to account for
capturing the additional records made pursuant to proposed Rule 15Fi-3
through 15Fi-5, and an ongoing annual burden of 75 hours per firm for
maintaining such records as well as to make additional updates to the
applicable recordkeeping policies and systems to account for the
proposed rules. As noted previously, the Commission estimates that
there are 55 SBS Entity respondents, for a total average initial annual
burden for all respondents of 3,300 hours and a total ongoing average
annual burden of 4,125 hours.
7. Proposed Amendment to Rule 3a71-6: Substituted Compliance
    Proposed amended Rule 3a71-6 would require submission of certain
information to the Commission to the extent SBS Entities elect to
request a substituted compliance determination with respect to the
proposed portfolio reconciliation, portfolio compression, and written
trading relationship documentation requirements. The Commission expects
that registered SBS Entities will seek to rely on substituted
compliance upon registration, and that it is likely that the majority
of such requests will be made during the first year following the
effective date. Requests would not be necessary with regard to
applicable rules and regulations of a foreign financial regulatory
system that have previously been the subject of a substituted
compliance determination in connection with the applicable rules.
    The Commission expects that the great majority of substituted
compliance applications will be submitted by foreign authorities, and
that very few substituted compliance requests will come from SBS
Entities. For purposes of this assessment, the Commission estimates
that three such SBS Entities will submit such an application.\196\
---------------------------------------------------------------------------

    \196\ See Business Conduct Standards Adopting Release, 81 FR at
30097 n. 1582.
---------------------------------------------------------------------------

    The Commission has previously estimated that the paperwork burden
associated with making each such substituted compliance request would
be approximately 80 hours of in-house counsel time, plus $80,000 for
the services of outside professionals (based on 200 hours of outside
time x $400 per hour).\197\ The Commission is currently of the belief
that this prior estimate is sufficient to cover a combined substituted
compliance request that also seeks a determination for the portfolio
reconciliation, portfolio compression, and written trading relationship
documentation rules proposed in this release. This estimate results in
an aggregate total of 240 internal hours, plus $240,000 for outside
services. Therefore, the Commission estimates that the total paperwork
burden incurred by such entities associated

with preparing and submitting a request for a substituted compliance
determination in connection with the portfolio reconciliation,
portfolio compression, and written trading relationship documentation
requirements will be approximately 240 hours per applicant, plus
$240,000 for the services of outside professionals for all three
requests.
---------------------------------------------------------------------------

    \197\ See Business Conduct Standards Adopting Release, 81 FR at
30097 n. 1583.
---------------------------------------------------------------------------

E. Collection of Information Is Mandatory

    Each collection of information for proposed Rules 15Fi-3 through
15Fi-5 and for the proposed amendments to Rules 17a-3, 17a-4, 18a-5,
and 18a-6 is a mandatory collection of information. With respect to the
proposed amendment to Rule 3a71-6, the application for substituted
compliance is mandatory for all foreign financial authorities or SBS
Entities that seek a substituted compliance determination.

F. Confidentiality

    Proposed Rule 15Fi-3(c) would require an SBS Entity to promptly
notify the Commission of any security-based swap valuation dispute in
excess of $20,000,000 (or its equivalent in any other currency) if not
resolved within: (1) Three business days, if the dispute is with a
counterparty that is an SBS Entity; or (2) five business days, if the
dispute is with a counterparty that is not an SBS Entity. We have
requested comment as to whether these notices should be submitted to
the Commission on a confidential basis. No other information would be
submitted directly to the Commission under proposed Rules 15Fi-3
through 15Fi-5 or under the proposed amendments to Rules 17a-3, 17a-4,
18a-5, and 18a-6. To the extent that the Commission receives
confidential information pursuant to this collection of information
that is otherwise not publicly available, including in connection with
examinations or investigations, that information will be kept
confidential, subject to applicable law.
    With regard to the proposed amendment to Rule 3a71-6, the
Commission generally will make requests for a substituted compliance
determination public, subject to requests for confidential treatment
being submitted pursuant to any applicable provisions governing
confidentiality under the Exchange Act.

G. Request for Comment

    We request comment on whether our estimates for burden hours and
any external costs as described above are reasonable. Pursuant to 44
U.S.C. 3506(c)(2)(B), the Commission solicits comments in order to: (1)
Evaluate whether the proposed collections of information are necessary
for the proper performance of the functions of the Commission,
including whether the information will have practical utility; (2)
evaluate the accuracy of the Commission's estimate of the burden of the
proposed collections of information; (3) determine whether there are
ways to enhance the quality, utility, and clarity of the information to
be collected; and (4) determine whether there are ways to minimize the
burden of the collections of information on those who are to respond,
including through the use of automated collection techniques or other
forms of information technology.
    In addition, would we would appreciate any comments related to our
Paperwork Reduction Act estimates with respect to the following:
     The number of counterparties with whom an SBS Entity would
maintain a security-based swap portfolio.
     The number and proportion of security-based swap
portfolios that would fall under each of the proposed thresholds for
determining the frequency of the required portfolio reconciliations,
with respect to both SBS Entity and non-SBS Entity counterparties.
     The hourly burden of conducting each portfolio
reconciliation and the use of automated systems to perform this
function, including those offered by third parties.
     The use of third parties to perform portfolio
reconciliation and portfolio compression exercises, any upfront burdens
associated with engaging a third party to perform these services, and
the ongoing burdens associated with each exercise.
     The burdens associated with establishing and routinely
updating all required policies and procedures.
    The agency has submitted the proposed collections of information to
OMB for approval.Persons wishing to submit comments on the collection
of information requirements should direct the comments to the Office of
Management and Budget, Attention: Desk Officer for the Securities and
Exchange Commission, Office of Information and Regulatory Affairs,
Washington, DC 20503, and send a copy to Brent J. Fields, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090, with reference to File No. S7-28-18. OMB is required to
make a decision concerning the collection of information between 30 and
60 days after publication of this release. Consequently, a comment to
OMB is best assured of having its full effect if OMB receives it within
30 days of publication. Requests for materials submitted to OMB by the
Commission with regard to these collections of information should be in
writing, refer to File No. S7-28-18, and be submitted to the Securities
and Exchange Commission, Office of FOIA Services, 100 F Street NE,
Washington, DC 20549-2736.

VI. Economic Analysis

    The Commission is sensitive to the economic effects of its rules,
including the costs and benefits and the effects of its rules on
efficiency, competition, and capital formation. Section 3(f) \198\ of
the Exchange Act requires the Commission, whenever it engages in
rulemaking pursuant to the Exchange Act and is required to consider or
determine whether an action is necessary or appropriate in the public
interest, also 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) \199\ of the Exchange Act
requires the Commission, when promulgating rules under the Exchange
Act, to consider the impact such rules would have on competition.
Section 23(a)(2) also provides that the Commission shall not adopt any
rule which would impose a burden on competition that is not necessary
or appropriate in furtherance of the purposes of the Exchange Act.\200\
---------------------------------------------------------------------------

    \198\ 15 U.S.C. 78c(f).
    \199\ 15 U.S.C. 78w(a)(2).
    \200\ See id.
---------------------------------------------------------------------------

A. Broad Economic Considerations

    Unlike some other types of securities transactions, a security-
based swap typically gives rise to ongoing obligations between
transaction counterparties during the life of the transaction,
including payments contingent on specific events, such as a corporate
default or a change in the price of an underlying reference asset
(e.g., changes in price to the floating leg of a total return swap).
Consequently, certain risk mitigation techniques, such as engaging in
portfolio reconciliation at periodic intervals, exercising
opportunities for portfolio compression, and ensuring that the terms of
a transaction are fully documented, are important practices for
assisting SBS Entities in effectively measuring and managing market and
credit risk.
    Credit risk refers to the probability of a financial loss due to a
counterparty to a transaction failing to fulfill its financial
obligations. In order to manage credit risk in the security-based swap
context properly, a market participant

should know the identity of each of its counterparties, the details of
the obligations of each counterparty in each transaction into which the
two have entered, and the value of those obligations (including for
purposes of calculating margin or measuring outstanding exposure for
risk management). The greater the number of counterparties and
transactions, the complexity of those transactions, and the value of
the outstanding obligations, the more important it becomes for each
counterparty to have well-documented credit risk management policies.
    The risks of the counterparties' failure to manage credit risk
adequately may not become apparent until the onset of a financial
crisis. Such a crisis occurred in the fall of 2008, when certain events
threatened to freeze U.S. and global credit markets. The severity of
that crisis has been partially attributed to poor risk management
practices of financial firms and flawed supervisory oversight for
certain financial institutions.\201\
---------------------------------------------------------------------------

    \201\ See Lessons of the Financial Crisis for Future Regulation
of Financial Institutions, at 3-4, IMF Policy Paper (Feb. 4, 2009),
available at: http://www.imf.org/external/np/pp/eng/2009/020409.pdf;
see also Sewall Chan, Financial Crisis Was Avoidable, Inquiry Finds,
N.Y. Times (Jan. 25, 2011), available at: http://www.nytimes.com/2011/01/26/business/economy/26inquiry.html?_r=1;.
---------------------------------------------------------------------------

    Shortcomings in credit risk management and documentation may be
unobservable to counterparties and other market participants until a
crisis occurs as it did in 2008; thus some benefits of compliance will
accrue to the financial system as a whole while the ongoing direct
costs are borne by the institution. If firms do not fully internalize
the benefits of risk management, then they may underinvest. For
example, shortcomings in documentation were reported to have created
significant problems during the financial crisis that immediately
preceded passage of the Dodd-Frank Act in connection with efforts by
Barclays PLC to take over a portion of Lehman Brothers Holdings Inc.'s
derivatives trades.\202\ Shortcomings in the documentation of portfolio
valuation methods and reconciliation of portfolio values were also
exposed when, during bankruptcy proceedings, counterparties' valuations
differed by hundreds of millions of dollars from the value of those
same positions on the bankrupt entity's books.\203\
---------------------------------------------------------------------------

    \202\ See Linda Sandler, Lehman Derivatives Records a `Mess,'
Barclays Executive Says, Bloomberg (Aug. 30, 2010), available at:
http://www.bloomberg.com/news/articles/2010-08-30/lehman-derivatives-records-a-mess-barclays-executive-says.
    \203\ See Satyajit Das, In the Matter of Lehman Brothers, 59
Wilmott 20-29 (May 2012). Disagreement over CDO valuation between
AIG and its counterparties was also an issue around the same time.
See supra note 15 and accompanying text.
---------------------------------------------------------------------------

    Among other things, effective risk management requires the
existence of sound documentation, periodic reconciliation of
portfolios, rigorously tested valuation methodologies, and sound
collateralization practices.\204\ More broadly, the President's Working
Group on Financial Policy (``PWG'') noted shortcomings in the OTC
derivatives market as a whole during the financial crisis that
immediately preceded passage of the Dodd-Frank Act. The PWG identified
the need for an improved integrated operational structure supporting
OTC derivatives, specifically highlighting the need for an enhanced
ability to manage counterparty risk through ``netting and collateral
agreements by promoting portfolio reconciliation and accurate valuation
of trades.'' \205\
---------------------------------------------------------------------------

    \204\ See PriceWaterhouseCoopers, Lehman Brothers' Bankruptcy:
Lessons learned for the survivors, Informational presentation for
clients, (Aug. 2009), at 12-24, available at: http://www.pwc.com/en_JG/jg/events/Lessons-learned-for-thesurvivors.pdf.2009), at 12-
24, available at http://www.pwc.com/en_JG/jg/events/Lessons-learned-for-thesurvivors.pdf.
    \205\ See The President's Working Group on Financial Markets,
Policy Statements on Financial Market Developments, (Mar. 2008)
(``PWG Report''), available at: http://www.treasury.gov/resource-center/fin-mkts/Documents/pwgpolicystatemktturmoil_03122008.pdf.2008) (``PWG Report''),
available at http://www.treasury.gov/resource-center/fin-mkts/Documents/pwgpolicystatemktturmoil_03122008.pdf.
---------------------------------------------------------------------------

    The rules we are proposing today are designed to ensure that SBS
Entities implement certain risk mitigation techniques by engaging in
periodic portfolio reconciliation, maintaining policies and procedures
for engaging in certain forms of portfolio compression exercises with
each of their counterparties, and maintaining policies and procedures
reasonably designed to ensure that they execute written trading
relationship documentation with each of their counterparties prior to
executing a security-based swap transaction. The proposed rules also
would set minimum standards with respect to identifying the matters
that must be addressed in the security-based swap trading
documentation, and outline certain requirements related to the
resolution of discrepancies, particularly those involving differences
in the valuation of security-based swaps.\206\ In proposing these
rules, the Commission preliminarily believes that they will promote
effective risk management practiced by security-based swap market
participants in a number of important ways, which we discuss in greater
detail below.
---------------------------------------------------------------------------

    \206\ The proposed rules also would (1) address the potential
availability of substituted compliance in connection with those
portfolio reconciliation, portfolio compression, and trading
relationship documentation requirements and (2) add corresponding
requirements to the Commission's recordkeeping rules that would
require SBS Entities to make and keep records demonstrating
compliance with the new risk mitigation requirements.
---------------------------------------------------------------------------

    The Commission notes that, where possible, it has attempted to
quantify the costs, benefits, and effects on efficiency, competition,
and capital formation expected to result from adopting these rules. In
certain cases, however, the Commission is unable to quantify the
economic effects. Crucially, many of the relevant economic effects,
such as improved risk management and the value of Commission
enforcement and oversight, are inherently difficult to quantify. In
other cases, we lack the information necessary to provide reasonable
estimates. For example, we lack data on prices charged by certain
third-party service providers, current trading relationship
documentation practices for entities and transactions not already
subject to similar rules from other regulators, the fraction of
outstanding positions that when reconciled will result in a dispute and
the costs incurred by the participants in resolving the dispute. To the
best of our knowledge, no such data is publicly available. Where the
Commission is unable to quantify the economic effects, the discussion
is qualitative in nature and includes, where possible, descriptions of
the direction of these effects. The Commission requests data from
commenters to help quantify these effects.

B. Economic Baseline

    To assess the economic impact of the proposed risk mitigation
rules, the Commission is using as a baseline the security-based swap
market as it exists today, including applicable rules that have already
been adopted, and excluding rules that have been proposed but not yet
finalized. The analysis includes the statutory and regulatory
provisions that currently govern the security-based swap market
pursuant to the Dodd-Frank Act, as well as rules adopted in, among
others, the Business Conduct Standards Adopting Release \207\ and the
Trade Acknowledgment and Verification Adopting Release.\208\ Moreover,
because participants in the security-based swap market may also operate
in other markets, particularly the swaps market, we have considered
both the direct and indirect impact of

rules that have been adopted by other regulators (e.g., the CFTC as
well as foreign regulatory bodies) in formulating the baseline. Our
understanding of the market is informed by available data on security-
based swap transactions, though we acknowledge the data available to us
limits the extent to which we can quantitatively characterize the
market. Because this data does not cover the entire market, we have
developed an understanding of market activity using a sample that
includes only certain portions of the market.
---------------------------------------------------------------------------

    \207\ See supra note 138.
    \208\ See supra note 6.
---------------------------------------------------------------------------

    Furthermore, the overall Title VII regulatory framework will have
consequences for the ways in which security-based swaps are transacted
which, in turn, will affect the activities addressed by these proposed
rules. For example, the proposed rules generally do not apply to
security-based swaps cleared through a registered clearing agency.
Therefore, the scope of future mandatory clearing requirements may
affect the overall level of security-based swap activity subject to the
final rules ultimately adopted under the proposal, as well as the
overall costs borne by SBS Entities.
1. Security-Based Swap Market Activity and Participants
a. Available Data From the Security-Based Swap Market
    The Commission's understanding of the market is informed, in part,
by available data on security-based swap transactions, though the
Commission acknowledges that limitations in the data limit the extent
to which it is possible to quantitatively characterize the market.
Since this data does not cover the entire market, the Commission has
analyzed market activity using a sample of transactions that includes
only certain segments of the market. The Commission believes, however,
that the data underlying this analysis provides reasonably
comprehensive information regarding single-name CDS transactions and
the composition of the participants in the single-name CDS market.
    Specifically, the analysis of the state of the current security-
based swap market is based on data obtained from the Depository Trust
and Clearing Corporation (``DTCC'') Derivatives Repository Limited
Trade Information Warehouse (``DTCC-TIW''), especially data regarding
the activity of market participants in the single-name CDS market
during the period from 2006 to 2017.\209\ Although the definition of
``security-based swap'' is not limited to single-name CDS,\210\ single-
name CDS contracts make up a majority of security-based swaps, and we
believe that the single-name CDS data is sufficiently representative of
the market to inform our analysis of the current security-based swap
market. According to data published by the Bank for International
Settlements (``BIS''), the global notional amount outstanding in
single-name CDS was approximately $4.6 trillion,\211\ in multi-name
index CDS was approximately $4.4 trillion, and in multi-name, non-index
CDS was approximately $343 billion.\212\ The total gross market value
outstanding in single-name CDS was approximately $130 billion, and in
multi-name CDS instruments was approximately $174 billion.\213\ The
global notional amount outstanding in equity forwards and swaps as of
December 2017 was $3.21 trillion, with total gross market value of $197
billion.\214\
---------------------------------------------------------------------------

    \209\ In prior releases, the Commission has examined data for
other time periods. For example, in the Business Conduct Standards
Adopting Release, the Commission presented an analysis of TIW data
for November 2006 through December 2014. While the exact numbers of
various groups of transacting agents and account holders in that
analysis differ from the figures reported in this section (for a
longer time period), we do not observe significant structural
differences in market participation. Compare 81 FR at 30102 (Tables
1 and 2) with Tables 1 and 2 below.
    \210\ While other repositories may collect data on transactions
in total return swaps on equity and debt, we do not currently have
access to such data for these products (or other products that are
security-based swaps). Additionally, the Commission explains below
that data related to single-name CDS provides reasonably
comprehensive information for the purpose of this analysis.
    \211\ The global notional amount outstanding represents the
total face amount used to calculate payments under outstanding
contracts. The gross market value is the cost of replacing all open
contracts at current market prices.
    \212\ See BIS, Semi-annual OTC derivatives statistics at
December 2017, Table 10.1, available at: https://www.bis.org/statistics/d10_1.pdf (last accessed May 18, 2018).
    \213\ See id.
    \214\ These totals include swaps and security-based swaps, as
well as products that are excluded from the definition of ``swap,''
such as certain equity forwards. See OTC, Equity-Linked Derivatives
Statistics, Table D8, available at: https://www.bis.org/statistics/d8.pdf (last accessed May 18, 2018). For the purposes of this
analysis, the Commission assumes that multi-name index CDS are not
narrow-based index CDS and therefore, do not fall within the
security-based swap definition. See 15 U.S.C. 78c(a)(68)(A). See
also Further Definition of ``Swap,'' ``Security-Based Swap,'' and
``Security-Based Swap Agreement''; Mixed Swaps; Security-Based Swap
Agreement Recordkeeping, 77 FR 48208. The Commission also assumes
that all instruments reported as equity forwards and swaps are
security-based swaps, potentially resulting in underestimation of
the proportion of the security-based swap market represented by
single-name CDS. Therefore, when measured on the basis of gross
notional outstanding single-name CDS contracts appear to constitute
roughly 59% of the security-based swap market. Although the BIS data
reflects the global OTC derivatives market, and not just the U.S.
market, the Commission has no reason to believe that these ratios
differ significantly in the U.S. market.
---------------------------------------------------------------------------

    The Commission further notes that the data available from TIW does
not encompass those CDS transactions that both: (i) Do not involve U.S.
counterparties; \215\ and (ii) are based on non-U.S. reference
entities. Notwithstanding this limitation, the TIW single-name CDS data
should provide sufficient information to permit the Commission to
identify the types of market participants active in the security-based
swap market and the general pattern of dealing within that market.\216\
---------------------------------------------------------------------------

    \215\ Following publication of the Warehouse Trust Guidance on
CDS data access, TIW surveyed market participants, asking for the
physical address associated with each of their accounts (i.e., where
the account is organized as a legal entity). This physical address
is designated the registered office location by TIW. When an account
reports a registered office location, we have assumed that the
registered office location reflects the place of domicile for the
fund or account. When an account does not report a registered office
location, we have assumed that the settlement country reported by
the investment adviser or parent entity to the fund or account is
the place of domicile. Thus, for purposes of this analysis, the
Commission has classified accounts as ``U.S. counterparties'' when
they have reported a registered office location in the United
States. The Commission notes, however, that this classification is
not necessarily identical in all cases to the definition of U.S.
person under Rule 3a71-3(a)(4).
    \216\ The challenges the Commission faces in estimating measures
of current market activity stem, in part, from the absence of
comprehensive reporting requirements for security-based swap market
participants. The Commission has adopted rules regarding trade
reporting, data elements, and public reporting for security-based
swaps that are designed to, when fully implemented, provide the
Commission with additional measures of market activity that will
allow us to better understand and monitor activity in the security-
based swap market. See Regulation SBSR Adopting Release, 81 FR at
53545.
---------------------------------------------------------------------------

b. Affected SBS Entities
    Final SBS Entity registration rules have been adopted, but
compliance is not yet required. Therefore, we do not have data on the
actual number of SBS Entities that will register with the Commission,
or the number of persons associated with registered SBS Entities. The
Commission has elsewhere estimated that up to 50 entities may register
with the Commission as security-based swap dealers, and up to five
additional entities may register as major security-based swap
participants,\217\ and these estimates remain unchanged.
---------------------------------------------------------------------------

    \217\ See, e.g., Registration Adopting Release, 80 FR at 49000.
---------------------------------------------------------------------------

    Firms that act as dealers play a central role in the security-based
swap market. Based on an analysis of 2017 single-name CDS data in TIW,
accounts of those firms that are likely to exceed the

security-based swap dealer de minimis thresholds and trigger
registration requirements for intermediated transactions with a gross
notional amount of approximately $2.9 trillion, approximately 55% of
the gross notional intermediated by the top five dealer accounts.\218\
---------------------------------------------------------------------------

    \218\ The Commission staff analysis of DTCC Derivatives
Repository Limited Trade Information Warehouse transaction records
indicates that approximately 99% of single-name CDS price-forming
transactions in 2017 involved an ISDA-recognized dealer.
---------------------------------------------------------------------------

    These dealers transact with hundreds or thousands of
counterparties. Approximately 21% of accounts of firms expected to
register as security-based dealers and observable in TIW have entered
into security-based swaps with over 1,000 unique counterparty accounts
as of year-end 2017.\219\ Another 25% of these accounts transacted with
500 to 1,000 unique counterparty accounts; 29% transacted with 100 to
500 unique accounts; and 25% of these accounts intermediated security-
based swaps with fewer than 100 unique counterparties in 2017. The
median dealer account transacted with 495 unique accounts (with an
average of approximately 570 unique accounts). Non-dealer
counterparties transacted almost exclusively with these dealers. The
median non-dealer counterparty transacted with two dealer accounts
(with an average of approximately three dealer accounts) in 2017.
---------------------------------------------------------------------------

    \219\ Many dealer entities and financial groups transact through
numerous accounts. Given that individual accounts may transact with
hundreds of counterparties, the Commission may infer that entities
and financial groups may transact with at least as many
counterparties as the largest of their accounts.
---------------------------------------------------------------------------

c. Other Market Participants
    In addition to dealers, thousands of other participants appear as
counterparties to security-based swap contracts in our sample, and
include, but are not limited to, investment companies, pension funds,
private funds, sovereign entities, and industrial companies. We observe
that most non-dealer users of security-based swaps do not engage
directly in the trading of swaps, but trade through banks, investment
advisers, or other types of firms acting as dealers or agents. Based on
an analysis of the counterparties to trades reported to the TIW, there
are 2,110 entities that engaged directly in trading between November
2006 and December 2017.\220\
---------------------------------------------------------------------------

    \220\ These 2,110 entities, which are presented in more detail
in Table 1, infra, include all DTCC-defined ``firms'' shown in TIW
as transaction counterparties that report at least one transaction
to TIW as of December 2017. The staff in the Division of Economic
and Risk Analysis classified these firms, which are shown as
transaction counterparties, by machine matching names to known
third-party databases and by manual classification. See, e.g.,
Dealing Activity Adopting Release, 81 FR 8602, fn.43. Manual
classification was based in part on searches of the EDGAR and
Bloomberg databases, the SEC's Investment Adviser Public Disclosure
database, and a firm's public website or the public website of the
account represented by a firm. The staff also referred to ISDA
protocol adherence letters available on the ISDA website.
---------------------------------------------------------------------------

    As shown in Table 1 below, close to three-quarters of these
entities (DTCC-defined ``firms'' shown in TIW, which we refer to here
as ``transacting agents'') were identified as investment advisers, of
which approximately 40% (about 30% of all transacting agents) were
registered as investment advisers under the Advisers Act.\221\ Although
investment advisers are the vast majority of transacting agents, the
transactions they executed account for only 12.8% of all single-name
CDS trading activity reported to the TIW, measured by number of
transaction-sides (each transaction has two transaction sides, i.e.,
two transaction counterparties). The vast majority of transactions
(83.3%) measured by number of transaction-sides were executed by ISDA-
recognized dealers.
---------------------------------------------------------------------------

    \221\ See 15 U.S.C. 80b1-80b21. Transacting agents participate
directly in the security-based swap market, without relying on an
intermediary, on behalf of principals. For example, a university
endowment may hold a position in a security-based swap that is
established by an investment adviser that transacts on the
endowment's behalf. In this case, the university endowment is a
principal that uses the investment adviser as its transacting agent.

 Table 1--The number of Transacting Agents by Counterparty Type and the Fraction of Total Trading Activity, From
                   November 2006 Through December 2017, Represented by Each Counterparty Type
----------------------------------------------------------------------------------------------------------------
                                                                                Transaction
                       Transacting agents                             Number          Percent          share
                                                                                (percent)
----------------------------------------------------------------------------------------------------------------
Investment Advisers.............................................            1635            77.5            12.8
    - SEC registered............................................             658            31.2             8.6
Banks...........................................................             262            12.4             3.4
Pension Funds...................................................              29             1.4             0.1
Insurance Companies.............................................              42             2.0             0.2
ISDA-Recognized Dealers \222\...................................              17             0.8            83.3
Other...........................................................             125             5.9             0.2
                                                                 -----------------------------------------------
        Total...................................................           2,110           100.0             100
----------------------------------------------------------------------------------------------------------------

    Principal holders of CDS risk exposure are represented by
``accounts'' in the TIW.\223\ The staff's analysis of these accounts in
TIW shows that the 2,110 transacting agents classified in Table 1
represent 13,137 principal risk holders. Table 2, below, classifies
these principal risk holders by their counterparty type and whether
they are represented by a registered or unregistered investment
adviser.\224\ For instance, banks in Table 1 allocated transactions
across 349 accounts, of which 20 were represented by investment
advisers. In the remaining instances, banks traded for their own
accounts. Meanwhile, ISDA-recognized dealers in Table 1 allocated
transactions across 91 accounts. Private funds are the largest type of
account holders that we were able to classify, and although not
verified through a recognized database, most of the funds

we were not able to classify appear to be private funds.\225\
---------------------------------------------------------------------------

    \222\ For the purpose of this analysis, the ISDA-recognized
dealers are those identified by ISDA as belonging to the G14 or G16
dealer group during the period: JP Morgan Chase NA (and Bear
Stearns), Morgan Stanley, Bank of America NA (and Merrill Lynch),
Goldman Sachs, Deutsche Bank AG, Barclays Capital, Citigroup, UBS,
Credit Suisse AG, RBS Group, BNP Paribas, HSBC Bank, Lehman
Brothers, Soci[eacute]t[eacute] G[eacute]n[eacute]rale, Credit
Agricole, Wells Fargo and Nomura. See, e.g., https://www.isda.org/a/5eiDE/isda-operations-survey-2010.pdf.
    \223\ ``Accounts'' as defined in the TIW context are not
equivalent to ``accounts'' in the definition of ``U.S. person''
provided by Exchange Act rule 3a71-3(a)(4)(i)(C). They also do not
necessarily represent separate legal persons. One entity or legal
person may have multiple accounts. For example, a bank may have one
DTCC account for its U.S. headquarters and one DTCC account for one
of its foreign branches.
    \224\ Unregistered investment advisers include all investment
advisers not registered under the Investment Advisers Act and may
include investment advisers registered with a state or a foreign
authority as well as investment advisers that are exempt reporting
advisers under Section 203(l) or 203(m) of the Investment Advisers
Act.
    \225\ For the purposes of this discussion, ``private fund''
encompasses various unregistered pooled investment vehicles,
including hedge funds, private equity funds, and venture capital
funds. There remain over 5,800 DTCC accounts unclassified by type.
Although unclassified, each account was manually reviewed to verify
that it was not likely to be a special entity within the meaning of
the Dodd-Frank Act and instead was likely to be an entity such as a
corporation, an insurance company, or a bank.
    \226\ This column reflects the number of participants who are
also trading for their own accounts.

    Table 2--The Number and Percentage of Account Holders--by Type--Who Participate in the Security-Based Swap Market Through a Registered Investment
                Adviser, an Unregistered Investment Adviser, or Directly as a Transacting Agent, from November 2006 Through December 2017
--------------------------------------------------------------------------------------------------------------------------------------------------------

--------------------------------------------------------------------------------------------------------------------------------------------------------
Account holders by type                                          Number       Represented by a
                                                                           registered investment
                                                                                adviser
                                                                Represented by an
                                                             unregistered investment
                                                                      dviser
                                                                  Participant is
                                                             transacting agent \226\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Private Funds.............................................        3,857        1,973           51%        1,859           48%           25            1%
DFA Special Entities......................................        1,319        1,262           96%           37            3%           20            2%
Registered Investment Companies...........................        1,159        1,082           93%           73            6%            4            0%
Banks (non-ISDA-recognized dealers).......................          349           20            6%            8            2%          321           92%
Insurance Companies.......................................          301          196           65%           34           11%           71           24%
ISDA-Recognized Dealers...................................           91            0            0%            0            0%           91          100%
Foreign Sovereigns........................................           83           63           76%            3            4%           17           20%
Non-Financial Corporations................................           75           52           69%            4            5%           19           25%
Finance Companies.........................................           20           11           55%            0            0%            9           45%
Other/Unclassified........................................        5,883        3,745           64%        1,887           32%          251            4%
                                                           ---------------------------------------------------------------------------------------------
    All...................................................       13,137        8,404           64%        3,905           30%          828            6%
--------------------------------------------------------------------------------------------------------------------------------------------------------

d. Outstanding Positions
    Our analysis here focuses on outstanding positions in single-name
CDS. As we have previously noted, although the definition of a
security-based swap is not limited to single-name CDS, we believe that
the single-name CDS data is sufficiently representative of the market
and therefore can directly inform the analysis of the state of the
current security-based swap market.\227\ In 2017, there were 1,534,753
single-name CDS transactions reported to DTCC-TIW, of which 1,036,155
were transactions with a clearing agency as a counterparty.\228\
Currently, security-based swap transactions are generally negotiated
and executed bilaterally, typically with a dealer as one of the
counterparties. Indeed, based on our analysis of DTCC-TIW data for
2017, more than 99% of single-name CDS transactions have an ISDA-
recognized dealer as a counterparty, and 31% of transactions are
between two ISDA-recognized dealers.\229\
---------------------------------------------------------------------------

    \227\ While other repositories may collect data on transactions
in total return swaps on equity and debt, we do not currently have
access to such data for these products (or other products that are
security-based swaps). In the Cross-Border Proposing Release, we
explained that we believed that data related to single-name CDS was
reasonable for purposes of this analysis; such transactions appear
to constitute roughly 82% of the security-based swap market as
measured on a notional basis. See Cross-Border Proposing Release, 78
FR at 31120 n. 1301. None of the commenters to that release disputed
these assumptions, and we therefore continue to believe that,
although the BIS data reflect the global OTC derivatives market, and
not just the U.S. market, these ratios are an adequate
representation of the U.S. market.
    Also consistent with our approach in that release, with the
exception of the analysis regarding the degree of overlap between
participation in the single-name CDS market and the index CDS market
(cross-market activity), our analysis below does not include data
regarding index CDS (including CDS based on narrow-based security
indices) as we do not currently have sufficient information to
identify the relative volumes of index CDS that are either swaps or
security-based swaps.
    \228\ For the purposes of this analysis, we estimate there were
approximately 1.53 million single-name CDS transactions in 2017, of
which approximately 1.04 million were transactions with a clearing
agency as a counterparty. In addition to CDS, security-based swap
products include equity swaps, such as total return swaps on single
names and swaps based on narrow-based security indices. The
Commission currently lacks comprehensive data on equity swaps,
including data on transaction volumes and notional amounts. While
there were more than 1.53 million security-based swap transactions
in 2017, we do not currently have sufficient information to
precisely identify the number of transactions beyond those that were
single-name CDS. However, while recognizing that average notional
transaction amounts for equity and multi-name CDS may differ from
average notional transaction amounts for CDS, our estimate (using
data from 2015) that single-name CDS constitute roughly 82% of the
security-based swap market implies that there were approximately
337,000 security-based swap transactions in 2017 in addition to the
approximately 1.53 million single-name CDS transactions we identify
in the DTCC-TIW data, or 1.87 million total security-based swap
transactions. Note that our estimate that single-name CDS
constitutes roughly 82% of the security-based swap market is based
on notional transaction amounts rather than transaction counts; in
using this figure to estimate the total number of security-based
swap transactions, we have assumed that the average notional amount
is the same across single-name CDS, multi-name CDS, and equity
swaps.
    \229\ For the purpose of this analysis, the reference to ``ISDA-
recognized dealers'' means those dealers identified by ISDA as
belonging to the G14 or G16 dealer group during the period. This
group includes: JP Morgan Chase NA (and Bear Stearns), Morgan
Stanley, Bank of America NA (and Merrill Lynch), Goldman Sachs,
Deutsche Bank AG, Barclays Capital, Citigroup, UBS, Credit Suisse
AG, RBS Group, BNP Paribas, HSBC Bank, Lehman Brothers,
Soci[eacute]t[eacute] G[eacute]n[eacute]rale, Credit Agricole, Wells
Fargo and Nomura. See, e.g., https://www.isda.org/a/5eiDE/isda-operations-survey-2010.pdf. See also Aldasoro, Inaki, and Torsten
Ehlers, 2018, The Credit Default Swap Market: What a Difference a
Decade Makes, BIS Quarterly Review June 2018, Graph 2, available at:
https://www.bis.org/publ/qtrpdf/r_qt1806b.pdf. https://www.bis.org/publ/qtrpdf/r_qt1806b.pdf. https://www.bis.org/publ/qtrpdf/r_qt1806b.pdf, Graph 2.
---------------------------------------------------------------------------

    As of December 30, 2017 there were 360,473 outstanding positions
(with a gross notional value of $4.196 trillion) in single-name
corporate CDS of which 252,108 positions ($2.095 trillion) did not
include a central counterparty (``CCP'') as one of the counterparties.
Of the 252,108 positions, 158,674 positions ($1.383 trillion) were
between two market participants the Commission expects will register as
SBS Entities, based on an analysis of DTCC-TIW data.\230\ In addition,
90,559 positions ($0.684 trillion) were between an expected SBS Entity
and a market participant not expected to register as an SBS Entity and
2,875 ($0.028 trillion) were between two participants not expected to
register as SBS Entities.
---------------------------------------------------------------------------

    \230\ See supra Section VI.B.1.b for current estimates of the
number of SBS Entities.
---------------------------------------------------------------------------

    If transactions are examined instead, there were 383,212 price-
forming transactions in calendar-year 2017 (with an aggregate gross
trade size of $5.304 trillion) in single-name corporate CDS of which
175,600 transactions ($4.321 trillion) did not include a CCP as one of
the counterparties. Of those 175,660

transactions, 75,119 transactions ($1.695 trillion) were between two
expected SBS Entities, 99,370 transactions ($2.245 trillion) were
between an expected SBS Entity and a participant not expected to
register, and 1,171 transactions ($0.382 trillion) were between two
participants not expected to register as SBS Entities.
    Further analysis of the data reveals that of the 24 expected SBS
Entities with outstanding positions as of December 30, 2017, 10 are not
U.S. persons and may be subject to similar requirements as those being
proposed here by foreign regulators. We note that the data available to
us from DTCC-TIW does not encompass those CDS positions that both: (i)
Do not involve U.S. counterparties; \231\ and (ii) are based on non-
U.S. reference entities. Notwithstanding this limitation, we believe
that the DTCC-TIW data provides sufficient information to identify the
types of market participants active in the security-based swap market
and the general pattern of transactions within that market.\232\ We
find that of the outstanding positions on December 30, 2017, 317,854
positions ($1.661 trillion) include at least one expected SBS Entity,
3,037 ($0.018 trillion) are between non-U.S. domiciled expected SBS
Entities and 60,948 ($0.489 trillion) are between a non-U.S, domiciled
expected SBS Entity and a participant not expected to register as an
SBS Entity.
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    \231\ We note that DTCC-TIW's determinations as to the domicile
of a counterparty or reference entity may not reflect our definition
of ``U.S. person'' in all cases. Our definition of ``U.S. person''
follows the definition used in the Commission's June 2014 release
where it, among other things, adopted rules and guidance regarding
the application of the certain Title VII definitions in the cross-
border context. See Application of ``Security-Based Swap Dealer''
and ``Major-Security-Based Swap Participant'' Definitions to Cross-
Border Security- Based Swap Activities, Exchange Act Release No.
72472 (June 25, 2014), 79 FR 47277, 47303 (Aug. 12, 2014
(republication)) (``Cross-Border Adopting Release'').
    \232\ The challenges we face in estimating measures of current
market activity stems, in part, from the absence of comprehensive
reporting requirements for security-based swap market participants.
The Commission has adopted rules regarding trade reporting, data
elements, and public reporting for security-based swaps that are
designed to, when fully implemented, provide us with appropriate
measures of market activity. See Regulation SBSR Adopting Release,
80 FR at 14699-700.
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2. Current Portfolio Reconciliation Practices
    While the Commission does not have data on current portfolio
reconciliation practices of security-based swap market
participants,\233\ certain market participants we expect will register
as SBS Entities are already subject to similar requirements from other
regulators. In particular, those entities that are also registered with
the CFTC as Swap Entities are subject to CFTC rules on portfolio
reconciliation. These rules require Swap Entities to reconcile their
swap portfolios with one another and to provide counterparties who are
not registered as Swap Entities with regular opportunities for
portfolio reconciliation.\234\ The Commission has reviewed these rules
and preliminarily believes that, other than as expressly noted above in
Section I.B, they are substantively identical to the rules we are
proposing today.\235\
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    \233\ Although the Commission does not have information on the
number of valuation discrepancies between counterparties in SBS
markets, a June 2017 survey on dealer financing noted that two-
fifths of survey respondents reported that the volume of valuation
disputes increased somewhat over the September 2016 to June 2017
period. Small net fractions of dealers responded that the volume,
duration, and persistence of mark and collateral disputes had
increased in OTC derivatives, especially in foreign exchange and
interest rate contracts. Three-fifths of dealers responded that, on
average, it takes more than two days but less than a week to resolve
a mark and collateral dispute on VM. One-third indicated two days or
fewer. See Yesol Huh, Division of Research and Statistics, Federal
Reserve Board, The June 2017 Senior Credit Officer Opinion Survey on
Dealer Financing Terms, available at: https://www.federalreserve.gov/data/scoos/files/scoos_201706.pdf.
    \234\ See 17 CFR 23.502 (Portfolio reconciliation).
    \235\ See, e.g., supra Section I.B.2 for a discussion of
similarities and differences in approach to the definition of
material terms that must be reconciled.
---------------------------------------------------------------------------

    Further, SBS Entities that are domiciled outside of the U.S. may be
subject to similar requirements of regulators from their home
jurisdiction. For example, entities subject to Chapter VII, Article 13
of EU Regulation No 149/2013 already must comply with portfolio
reconciliation requirements similar to those under the proposed rules.
The EU regulations require all counterparties to agree on arrangements
under which portfolios shall be reconciled before entering into an OTC
derivative contract. Furthermore, the frequency of portfolio
reconciliation under those regulations depends on both whether either
counterparty is a ``financial counterparty'' or a ``non-financial
counterparty'' (each as defined in European regulations), and the
number of outstanding contracts between the counterparties.
    In addition to regulations that may apply to certain SBS Entities
that are either dually registered with the CFTC as Swap Entities or
subject to similar portfolio reconciliation rules in other
jurisdictions, portfolio reconciliation forms a part of current market
practices. In particular, ISDA publishes a set of `best practices' for
its members for the OTC derivatives collateral process that addresses,
among other things, portfolio reconciliation of non-cleared OTC
derivatives.\236\ These `best practices' include written agreement
between counterparties as to the terms of the reconciliation and
reconciliation tolerances, and also recognize both the CFTC and EU
rules pertaining to portfolio reconciliation.
---------------------------------------------------------------------------

    \236\ See ISDA, 2013 Interim Updated Best Practices for the OTC
Derivatives Collateral Process, Best Practices 10.1--10.6 (Oct. 23,
2013), available at: https://www2.isda.org/attachment/NjA3NQ==/2013%20ISDA%20Best%20Practices%20for%20the%20OTC%20Derivatives%20Collateral%20Process%20-%20FINAL.pdf (``ISDA Collateral Best
Practices'').
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3. Current Portfolio Compression Practices
    While the Commission does not have data on current portfolio
compression practices of security-based swap market participants,
certain SBS Entities are already subject to similar compression
requirements in other contexts similar to the situation involving
portfolio reconciliation. Specifically, SBS Entities that are also
registered with the CFTC as Swap Entities are subject to CFTC rules on
portfolio compression. As discussed above, the Commission has reviewed
those rules and preliminarily believes that they are, other than as
expressly noted above in Section I.C, substantively identical to the
rules we are proposing today.
    Further, SBS Entities that are domiciled outside of the U.S. may be
subject to similar requirements from regulators in their home
jurisdiction. For example, entities subject to Chapter VII, Article 14
of EU Regulation No 149/2013 already must comply with portfolio
compression requirements. Under these requirements any entity that has
500 or more non-cleared OTC derivative contracts with any one
counterparty must have procedures in place to regularly (at least twice
a year) analyze the possibility of conducting a portfolio compression
exercise in order to reduce their counterparty credit risk and engage
in such a portfolio compression exercise. The EU regulations differ
from these proposed rules in a few important ways, including their
application to all OTC derivative positions, not just security-based
swaps, as well as the minimum frequency of compression exercises.
Moreover, both financial and non-financial counterparties are required
under the EU regulations to ensure that they are able to provide ``a
reasonable and valid explanation to the relevant competent authority
for concluding that a portfolio compression exercise is not
appropriate.''

    In addition to regulations that may apply to certain SBS Entities
that are either dually registered with the CFTC as Swap Entities or
subject to similar portfolio compression rules in other jurisdictions,
portfolio compression forms a part of current market practices. The
ISDA Collateral Best Practices also includes a best practice that
addresses portfolio compression, explaining that trades that are
subject to industry-wide trade-reducing events should be removed from
the portfolio on the day the trade-reducing event occurs and that this
should be in agreement with governing documentation for the applicable
risk reducing process.\237\
---------------------------------------------------------------------------

    \237\ See ISDA Collateral Best Practices, supra note 236, Best
Practice 8.4.
---------------------------------------------------------------------------

    Although we lack data on current portfolio compression practices of
individual SBS market participants, the importance of portfolio
compression is illustrated by the scope of its use among security-based
swap market participants.\238\ In March 2010, DTCC explicitly
attributed the reduction in the gross notional value of the credit
derivatives in its warehouse to industry supported portfolio
compression.\239\ Using data from TriOptima, the BIS reports CDS
portfolio compression rates as high as 25% of notional outstanding in
the first half of 2008.\240\ Compression volumes fell steadily over the
following years due, in part, to falling transaction volumes and the
rise of central clearing.\241\ TriOptima, as well as other firms,
continue to offer compression services, and the Commission
preliminarily believes that the fact that market participants continue
to find it worthwhile to pay for such services lends support to the
argument that market participants view portfolio compression as a
valuable tool.
---------------------------------------------------------------------------

    \238\ The data available to the Commission with respect to
portfolio compression does not allow for enumeration of the actual
participants which participate in such practices; however,
inferences regarding the scope can be drawn from the magnitude of
the reduction in the gross notional value of the credit derivatives.
    \239\ See DTCC Press Release, DTCC Trade Information Warehouse
Completes Record Year Processing OTC Credit Derivatives, (Mar. 11,
2010). Notably, beginning in August 2008, ISDA encouraged
compression exercises for CDS by selecting the service provider and
defining the terms of service.
    \240\ See Aldasoro, Inaki, and Torsten Ehlers, 2018, The Credit
Default Swap Market: What a Difference a Decade Makes, BIS Quarterly
Review June 2018, Graph 1 panel 2 and accompanying text, available
at: https://www.bis.org/publ/qtrpdf/r_qt1806b.pdf. In March of 2010,
the staff of the FRBNY estimated that since 2008 nearly $50 trillion
gross notional of CDS positions has been eliminated through
portfolio compression. See FRBNY OTC Derivatives Report, supra note
62.
    \241\ Id.
---------------------------------------------------------------------------

    The chart below illustrates the opportunities for portfolio
compression between 2010 and 2017 for single-name security-based
swaps.\242\ As the gap between gross and net notional values widens,
the opportunities for portfolio compression increase. Over our
reference period, however, the difference between gross and net
notional values has declined. For instance, in 2010, the percentage,
which captures the ratio of net to gross notional value, was 11.0%, but
this number has been gradually increasing through December 30, 2018
when it was 15.2%. Smaller ratios indicate greater opportunities for
portfolio compression; however, as shown in the chart below, based on
changes in gross and net notional value over time, unexploited
opportunities for compression are diminishing.\243\
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    \242\ The chart below includes only gross and net notional of
single-name security-based swaps. The inclusion of index security-
based swaps could expand potential compression opportunities
available to SBS Entities.
    \243\ The result is likely driven by banks and securities firms.
See Aldasoro, Inaki, and Torsten Ehlers, 2018, supra note 240, Graph
5.

[GRAPHIC] [TIFF OMITTED] TP15FE19.000

    It is possible that market participants may already be taking
advantage of portfolio compression opportunities. However, the
Commission does not infer that the entirety of the reduction in the gap
between gross and net notional values is due to portfolio compression
exercises. Other plausible explanations for the reduction in the gross
notional value of security-based swaps include both fewer and/or
smaller new transactions, expiration of existing positions without
rollover into new positions, and loss or consolidation of market
participants throughout time. Due to limitations of the data available
to the Commission, it is infeasible to distinguish the overall effect
of portfolio compression exercises on the reduction in the gross
notional value of the security-based swap market from the alternative
explanations presented above.
4. Current Trading Relationship Documentation Practices
    Memorializing the specific terms of the security-based swap trading
relationship and security-based swap transactions between
counterparties is prudent business practice and, in fact, many market
participants already use standardized documentation. Examination of the
use of ISDA Master Agreements (the measure of trading relationship
documentation available to the Commission in the data provided by DTCC-
TIW) shows that the percentage of transactions with these agreements
declines from 78.2% in 2008 to 34.1% in 2017, with the peak occurring
in 2010 (96.1%). However, as trading relationship documentation may be
different when the counterparty is a CCP, an analysis of documentation
on aggregate security-based swap transactions (both cleared and
uncleared) may be misleading. With the introduction of ICE Clear Credit
in 2009, the percentage of cleared transactions has increased over
time, thus a seemingly more relevant measure to look at is the
frequency of use of ISDA Master Agreements for uncleared transactions.
Approximately 99% of all uncleared transactions are reported (by DTCC-
TIW) as using trading relationship documentation (in the form of ISDA
Master Agreements) in 2017 compared to 78.2% in 2008. Accordingly, the
Commission generally believes that many, if not most, market
participants currently execute and maintain trading relationship
documentation of the type required by the proposed rules in the
ordinary course of their businesses, including documentation that
contains several of the terms that would be required by the proposed
rules.
    Finally, and similar to the discussion regarding the reconciliation
and compression, SBS Entities that are also registered with the CFTC as
Swap Entities are subject to CFTC rules requiring the use of trading
relationship documentation. As discussed above, the Commission has
reviewed those rules and preliminarily believes that they are, other
than as expressly noted above in Section I.D, substantively identical
to the rules we are proposing today.

C. Economic Costs and Benefits, Including Impact on Efficiency,
Competition, and Capital Formation

    In this section we first discuss the expected effects of the
proposed rules on efficiency, competition, and capital formation,
focusing particularly on the risk-mitigation benefits that stem from
the use of portfolio reconciliation, expanding opportunities for
portfolio compression, and improvements in documentation. We then turn
our discussion to additional costs and benefits, including compliance
costs and alternatives considered of the proposed rules.
1. Effects on Efficiency, Competition, and Capital Formation
    Risk mitigation rules have the potential to affect efficiency,
competition, and capital formation in the security-based swap market,
primarily through a reduction in operational, market, and credit risks
that accompany outstanding security-based swap positions. In addition,
the substituted compliance framework may provide additional effects
that are distinct from the broader market impacts that are described
below. As with the benefits and costs, we believe that several of the
effects described below only occur to the extent that current market
practices do not already conform to our proposed rules.
a. Broad Market Effects
    In the release adopting final rules requiring SBS Entities to
provide trade acknowledgments and to verify those trade acknowledgments
with their counterparties to security-based swap transactions, the
Commission explained the importance of confirming trades in a timely
manner, noting that confirmation of the terms of a transaction is
essential for SBS Entities ``to effectively measure and manage market
and credit risk.'' 244 245 In this regard, portfolio
reconciliation addresses many of these same issues, but unlike the
confirmation process, which occurs at the outset of a transaction,
reconciliation operates throughout the life of the transaction.\246\
---------------------------------------------------------------------------

    \244\ See Trade Acknowledgment and Verification Adopting
Release, 81 FR at 39833.
    \245\ See supra Section I.B.1.
    \246\ See id.
---------------------------------------------------------------------------

    Failure to periodically conduct portfolio reconciliation may cause
errors and disputes over the terms of a transaction that may exist to
go undetected, leading to errors in measurement and management of
market and credit risks associated with particular transactions. More
generally, timely portfolio reconciliation will provide counterparties
with accurate information that will enable them to evaluate their own
risk exposure in a timely manner. Efficient and cost-effective risk
management may conserve resources and free up capital that can be
deployed in other asset classes, promoting risk-sharing and efficient
capital allocation. In addition, cost-effective risk management may
reduce the overall costs of financial intermediation, allowing market
participants to increase lending and other capital formation
activities.
    Similarly, periodic portfolio reconciliation and improved standards
for transaction documentation may contribute to broader market
stability, particularly during periods of distress. Disagreement as to
one or more material terms of a transaction or inadequate documentation
could hinder timely and efficient settlement of security-based swap
transactions, particularly in the case of a credit event on a reference
entity on which many different counterparties have, in the aggregate, a
large notional outstanding exposure. During periods of financial
distress, uncertainty about terms, value, and documentation of
outstanding transactions could contribute to liquidity and cash
shortfalls that threaten the stability of the financial system. Thus,
to the extent that the proposed rules reduce uncertainty about
outstanding transactions, we expect reduced risk of uncertainty about
the credit risk of potential counterparties, particularly during a
financial crisis.
    Finally, to the extent that portfolio reconciliation requirements
differ from current market practices, the proposed rules have the
potential to affect competition across multiple dimensions. If the
costs of portfolio reconciliation, portfolio compression, and complying
with transaction documentation rules for security-based swap
transactions are largely fixed (i.e., the costs come from establishing
infrastructure and systems necessary to

perform portfolio reconciliation and portfolio compression and comply
with documentation requirements) rather than varying with the number of
transactions or positions outstanding, smaller dealers intermediating a
smaller number of trades may have a larger burden placed on them;
larger dealers, on the other hand, may be able to spread the costs over
a greater number of trades or positions, with a lower average cost of
complying with these rules. Similarly, the costs of establishing an
infrastructure to comply with these requirements may create a barrier
to entry for market participants wishing to establish a SBS dealer
business.\247\
---------------------------------------------------------------------------

    \247\ The Commission does not expect that this effect would
extend to major SBS participants, which are by definition the
largest non-dealer participants in the security-based swap market.
As described in the economic baseline, out of more than 4,000
security-based swap market participants, we expect at most five to
register as major SBS participants. These entities maintain
substantial positions in security-based swaps, as defined in the
Intermediary Definitions Adopting Release, and the Commission
expects these entities have sufficient resources and infrastructure
to comply with portfolio reconciliation and documentation
requirements.
---------------------------------------------------------------------------

b. Substituted Compliance
    As discussed above, if the Commission has made a positive
substituted compliance determination with respect to a particular
foreign regulatory regime, SBS Entities operating in that jurisdiction
may be able to satisfy their Title VII risk mitigation requirements by
complying with similar requirements of the foreign financial regulatory
system. Substituted compliance would be available only for SBS Entities
who are not U.S. persons.
    The Commission is proposing to amend its rules to make substituted
compliance potentially available to the portfolio reconciliation,
portfolio compression, and trading relationship documentation
requirements in order to minimize the likelihood that SBS dealers are
subjected to potentially duplicative or conflicting regulation. The
Commission preliminarily believes that duplicative regulations that
achieve comparable regulatory outcomes increase the compliance burdens
on market participants without corresponding increases in benefits. By
decreasing the compliance burden for foreign SBS dealers active in the
U.S. market, the availability of substituted compliance could encourage
foreign firms' participation in the U.S. market, increasing the ability
of U.S. firms to access global liquidity, and reducing the likelihood
that liquidity would fragment along jurisdictional lines. Such
participation and access to liquidity might result in increased
competition between both U.S. and foreign intermediaries without
compromising the regulatory benefits intended by the applicable risk
mitigation rules.
2. Portfolio Reconciliation
    Disputes related to confirming the terms of a swap, as well as swap
valuation disputes, have long been recognized as a significant problem
in the OTC derivatives market. The Commission preliminarily believes
that the ability to determine definitively the value of a security-
based swap at any given time is an important component of many of the
OTC derivatives market reforms contained in the Dodd-Frank Act and is a
component of sound risk management practices.\248\ Security-based swap
valuation is also crucial for determining capital and margin
requirements applicable to SBS Entities and therefore plays a primary
role in risk mitigation for uncleared security-based swaps. Portfolio
reconciliation is considered an effective means of identifying and
resolving these disputes at a time and in a manner that will be least
disruptive to the counterparties and the broader financial system.
---------------------------------------------------------------------------

    \248\ See ISDA Collateral Best Practices, supra note 236,
Section 10.
---------------------------------------------------------------------------

    Parties may dispute valuations of thinly traded security-based
swaps where there is not agreement on valuation methodologies or the
source for formula inputs. Many of these security-based swaps are
thinly traded either because of their limited liquidity or because they
are simply too customized to have comparable counterparts in the
market. As many of these security-based swaps are valued by dealers
internally by ``marking-to-model,'' their counterparties may dispute
the inputs and methodologies used in the model. As uncleared security-
based swaps are bilateral, privately negotiated contracts, on-going
security-based swap valuation for purposes of initial and variation
margin calculation and security-based swap terminations or novations,
also has been largely a process of on-going negotiation between the
parties. The inability to agree on the value of a security-based swap
became especially acute during the financial crisis that immediately
preceded passage of the Dodd-Frank Act when there was widespread
failure of the market inputs needed to value many security-based
swaps.\249\
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    \249\ The lack of liquidity in markets for mortgage-backed
securities led to wide disparities in the valuation of CDS
referencing mortgage-backed securities (especially collateralized
debt obligations). Such wide disparities led to large collateral
calls from dealers on AIG, hastening its downfall. See CBS News,
``Calling AIG? Internal Docs Reveal Company Silent About Dozens of
Collateral Calls,'' June 23, 2009, available at: http://www.cbsnews.com/stories/2009/06/23/cbsnews_investigates/main5106672.shtml; See also Financial Crisis Inquiry Commission, The
Financial Crisis Inquiry Report: Final Report of the National
Commission on the Causes of the Financial and Economic Crisis in the
United States, Chapter 8, available at: https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf.
---------------------------------------------------------------------------

a. Requirements
    The Commission is proposing rules and interpretations that
generally would require each SBS Entity (1) to engage in portfolio
reconciliation with counterparties who are also SBS Entities at
periodic intervals based on the number of outstanding transactions with
the counterparty and (2) to establish, maintain, and follow written
policies and procedures reasonably designed to ensure that it engages
in portfolio reconciliation with counterparties who are not SBS
Entities, also at periodic intervals based on the number of outstanding
transactions with the counterparty.\250\
---------------------------------------------------------------------------

    \250\ Pursuant to proposed Rule 15Fi-3(d), the new requirements
regarding portfolio reconciliation would not apply to a clearing
transaction (i.e., a security-based swap that has a clearing agency
as a direct counterparty). See supra note 58 and accompanying text.
---------------------------------------------------------------------------

    The Commission is proposing to vary the proposed portfolio
reconciliation requirement based on the particular type of counterparty
with which the SBS Entity transacts. For transactions between two SBS
Entities, the proposed rules would require the two sides to engage in
portfolio reconciliation at frequencies that are based on the size of
the security-based swap portfolio between the two parties.\251\ In
addition to the requirements regarding the frequency of the
reconciliation, proposed Rule 15Fi-3(a)(1) would require the two SBS
Entities to agree in writing with each of their counterparties on the
terms of the portfolio reconciliation including, if applicable,
agreement on the selection of any third party service provider who may
be performing the reconciliation.
---------------------------------------------------------------------------

    \251\ See proposed Rule 15Fi-3(a).
---------------------------------------------------------------------------

    To the extent that the two SBS Entities identify a discrepancy, the
proposed rule would require the parties to take certain steps. First,
proposed Rule 15Fi-3(a)(4) would require the two sides to resolve
immediately any discrepancy in a material term, whether identified
directly as part of the portfolio reconciliation or otherwise. Second,
proposed Rule 15Fi-3(a)(5) would require each SBS Entity to establish,
maintain, and follow written policies and procedures reasonably
designed to resolve any discrepancy in a valuation identified as part
of a

portfolio reconciliation or otherwise as soon as possible, but in any
event within five business days after the date on which the discrepancy
is first identified. As a condition to this requirement, however,
proposed Rule 15Fi-3(a)(5) would require each SBS Entity to establish,
maintain, and follow written policies and procedures reasonably
designed to identify how the SBS Entity will comply with any variation
margin requirements under Section 15F(e) of the Exchange Act \252\ and
any related regulations pending resolution of the valuation
discrepancy. Finally, proposed Rule 15Fi-3(a)(5) would clarify that for
purposes of the requirement to resolve valuation discrepancies within
five business days of being identified, a difference between the lower
valuation and the higher valuation of less than 10% of the higher
valuation need not be deemed a discrepancy.\253\
---------------------------------------------------------------------------

    \252\ 15 U.S.C. 78o-10(e).
    \253\ This 10% threshold would apply on a transaction-by-
transaction basis, and not on a portfolio level.
---------------------------------------------------------------------------

    Separately, with respect to transactions between an SBS Entity and
a counterparty that is not an SBS Entity, proposed Rule 15Fi-3(b) would
require each SBS Entity to establish, maintain, and follow written
policies and procedures reasonably designed to ensure that it engages
in portfolio reconciliation as set forth in the rule.\254\ This is in
contrast to proposed Rule 15Fi-3(a), which expressly requires portfolio
reconciliation with respect to transactions where both counterparties
are SBS Entities.
---------------------------------------------------------------------------

    \254\ See proposed Rule 15Fi-3(b).
---------------------------------------------------------------------------

    Proposed Rule 15Fi-3(b) contains a number of requirements regarding
the contents of the policies and procedures required therein, as they
relate to reconciliation with non-SBS Entities, which are largely
consistent with the requirements imposed directly on the parties under
proposed Rule 15Fi-3(a). Specifically, proposed Rule 15Fi-3(b)(3)
provides that such policies and procedures must require that the
portfolio reconciliation be performed no less frequently than: (1) Once
each calendar quarter for each security-based swap portfolio that
includes more than 100 security-based swaps at any time during the
calendar quarter and (2) once annually for each security-based swap
portfolio that includes no more than 100 security-based swaps at any
time during the calendar year.
    In addition, proposed Rule 15Fi-3(b)(4) requires each SBS Entity to
establish, maintain, and follow written procedures reasonably designed
to resolve any discrepancies in the valuation or a material term of
each security-based swap identified as part of a portfolio
reconciliation or otherwise with a counterparty that is not an SBS
Entity within five days.\255\
---------------------------------------------------------------------------

    \255\ Similar to the requirement in paragraph (a) of the
proposed rule for portfolio reconciliation with counterparties that
are either SBS dealers or major SBS participants, proposed Rule
15Fi-3(b)(4) provides that a difference between the lower valuation
and the higher valuation of less than 10% of the higher valuation
need not be deemed a discrepancy for purposes of that paragraph. See
supra note 39 and accompanying text (discussing the 10% threshold in
the context of Rule 15Fi-3(a)(5)).
---------------------------------------------------------------------------

    Finally, proposed Rule 15Fi-3(c) would require each SBS Entity to
promptly notify the Commission of any security-based swap valuation
dispute in excess of $20,000,000 (or its equivalent in any other
currency) if not resolved within:
     three business days, if the dispute is with a counterparty
that is an SBS Entity, or
     five business days, if the dispute is with a counterparty
that is not an SBS Entity.
    Such notification would be required to be in a form and manner
acceptable to the Commission, and would also be required to be sent to
any applicable prudential regulator (i.e., for any SBS Entity that is
also a bank, to its bank regulator).\256\
---------------------------------------------------------------------------

    \256\ See supra Section I.B.6.
---------------------------------------------------------------------------

    For the security-based swap market to operate efficiently and to
reduce credit and operational risk between counterparties, the
Commission preliminarily believes that, although the frequency of
portfolio reconciliation depends on the number of positions with a
counterparty, reconciliation should occur by position because terms may
vary across positions with the same counterparty. By identifying and
managing mismatches in key economic terms and valuation for individual
transactions across an entire portfolio, these rules are intended to
require a process in which risk between counterparties can be
identified and reduced.
b. Benefits
    Reconciliation is beneficial not only to the parties involved but
also to the markets as a whole. By identifying and managing disputed
key economic terms or valuation for each transaction across a
portfolio, an entity's counterparty credit risk and operational risk
can be diminished. By requiring a systematic reconciliation process, as
well as policies and procedures related to portfolio reconciliation
between counterparties, SBS Entities will be able to better identify
and correct problems in a timely manner in their post-execution
processes (including confirmation) in order to reduce the number of
disputes and improve the integrity and efficiency of their internal
processes. Accordingly, expanding the universe of participants subject
to the reconciliation requirements can help to reduce the risk
bilateral markets may pose to the broader financial system.
    As discussed above, because shortcomings in credit risk management
and documentation may only become evident during a crisis, some
benefits of portfolio reconciliation will accrue to the financial
system as a whole while the ongoing direct costs are borne by the
individual market participant. Therefore, in the absence of these
rules, the level and frequency of portfolio reconciliation chosen by
individual market participants may be less than what would be desired
by all market participants in order to properly manage risks to the
financial system.
    In addition, the Commission preliminarily believes that the
proposed tiering of obligations, whereby the frequency of the portfolio
reconciliation would be based on the number of outstanding transactions
with the applicable counterparty, represents a reasonable attempt to
calibrate the costs to the benefits expected from reconciling a
person's security-based swap portfolio at regular intervals. In this
respect, those benefits would be expected to rise for larger--and often
more complex--portfolios that may represent a greater potential for
loss than a smaller, less complex portfolio.
    The Commission preliminarily believes that, given the expected
benefits of making the frequency of portfolio reconciliation a function
of the size of a portfolio with a particular counterparty, setting the
frequency of reconciliation identical to that adopted by the CFTC will
provide additional benefit for SBS Entities that are also registered
with the CFTC as Swap Entities. In particular, harmonizing the
frequency of reconciliation for swaps and SBS should reduce
implementation cost and reduce operational complexity.
    Similarly, the Commission notes that the EC has adopted portfolio
reconciliation requirements for the EU that are similar to those
proposed by the Commission in this release. The Commission
preliminarily believes that aligning its portfolio reconciliation
requirements with those in other major security-based swap markets will
benefit SBS Entities by avoiding the imposition of disparate compliance
and operational policies and procedures.

    Moreover, proposed Rule 15Fi-3(a)(2) provides that portfolio
reconciliation may be performed either on a bilateral basis by the
counterparties or by a third party selected by the counterparties in
accordance with paragraph (a)(1) of the proposed rule. Under this
approach, the process for selecting a third-party service provider--or
the actual identity of the service provider--should be included in the
written agreement between the two sides setting forth the terms of the
portfolio reconciliation process.
    In the absence of periodic portfolio reconciliation, if the
counterparties to a security-based swap transaction are not in
agreement with respect to each of the terms of the transaction that may
affect each party's rights and obligations, any such difference could
lead to complications at various points throughout the trade.\257\
These discrepancies could be exacerbated if they remain undetected
until such times as the parties become obligated to perform on their
requirements under the contract. Such discrepancies could be
particularly problematic if they are discovered during a period of
financial stress for the market participant.\258\ Thus, portfolio
reconciliation may help to mitigate the possibility of a discrepancy
unexpectedly affecting performance by ensuring that the parties are and
remain in agreement with respect to all of the material terms of the
security-based swap transaction.
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    \257\ See supra note 14.
    \258\ See supra note 203.
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    Regular reconciliation of all portfolios is a process to reduce
counterparty credit exposure and operational risk and help prevent
disputes from arising. The rule should promote market integrity and
reduce risk by establishing procedures that will promote legal
certainty concerning security-based swap transactions, assist with the
early resolution of valuation disputes, reduce operational risk, and
increase operational efficiency.
    The proposed rules may have differential benefits for smaller
market participants. Smaller market participants may not have the
bargaining power necessary to compel larger counterparties to
coordinate on portfolio reconciliation. Since SBS Entities, absent a
mandate, are likely to focus risk management resources on larger
counterparties, the ability of smaller counterparties to require the
necessary cooperation from their counterparties who are SBS Entities
will be improved. Reduced uncertainty concerning material terms and
valuation methodologies could reduce the risks to these smaller
participants for using SBS for hedging market risk to which they may be
exposed.
    Portfolio reconciliation is particularly relevant with respect to
terms related to the valuation of the instrument. Unresolved
discrepancies regarding the value of a security-based swap can lead to,
among other things, active disputes between counterparties with respect
to the amount of margin that must be posted or collected, as well as
errors and other complications that may result in significant
uncollateralized exposure in the uncleared security-based swap markets
(or alternately, potentially inefficient overcollateralization).
Accordingly, we preliminarily believe that requiring counterparties to
clearly document the applicable processes and requirements for
calculating and exchanging margin in connection with a security-based
swap transaction is an important step in achieving this broader
regulatory objective.
    The notification requirement of proposed Rule 15Fi-3(c) would
provide the Commission with information about disagreements over
position values between counterparties. Valuation is one of the most
fundamental elements for determining the economic rights and
obligations of each of the counterparties to a security-based swap
transaction. For example, market participants manage credit risks to
their counterparties by exchanging margin with each other in an amount
determined using the value of the underlying security-based swap. If
those valuations are not accurate for any reason, such as human or
system errors, problems with the valuation methodology, or an issue
affecting the timeliness of the calculation, that error could result in
one of the counterparties having an uncollateralized credit exposure
and a potential for loss in the event of a default. We therefore expect
that the notification requirement could assist the Commission in
anticipating potential valuation problems that could ultimately lead to
market disruption, and in identifying potential issues with respect to
an SBS Entity's internal valuation methodology. As noted above, the
CFTC has adopted a nearly identical requirement with the same
$20,000,000 threshold, and the Commission believes that divergence from
that requirement could lead to additional costs for SBS Entities that
are also registered with the CFTC as Swap Entities.\259\ Finally, as
discussed above, the Commission preliminarily believes reconciliation
may provide indirect benefits by improving the accuracy of SDR
data.\260\ As described above in Section I.B.2, the information that
SBS Entities would initially be required to reconcile with their
counterparties would include each term that is required to be reported
to a registered SDR under Rule 901 under the Exchange Act.\261\
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    \259\ See supra Section I.B.6.
    \260\ See SDR Adopting Release, 80 FR at 14528-48, for a
discussion of the expected economic benefits accurate SBS data held
at SDRs.
    \261\ See proposed Rule 15Fi-1(i)(1) (referencing 17 CFR
242.901).
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c. Costs
    The portfolio reconciliation rules the Commission is proposing
today are similar to the corresponding CFTC rules for Swap Entities. As
a result, the one-time costs to develop, test, and implement new
procedures and technology that may be required in order to be compliant
with the proposed rules are mitigated by the fact that many SBS
Entities also are likely to be Swap Entities. These dually registered
entities are likely to be familiar with these general requirements and
have the infrastructure in place to comply with similar rules that
apply to their swap business.
    SBS Entities that are not also CFTC-regulated Swap Entities and
that do not currently use an electronic platform or vendor service to
conduct portfolio reconciliation will need to expend significant time
and resources to modify the necessary systems to comply with proposed
Rule 15Fi-3. Even those SBS Entities that do use electronic platforms
or vendors services may find it necessary to make significant
adjustments to comply with the rules. The Commission estimates a one-
time upfront cost of approximately $5-10 million for an SBS Entity that
is not also a Swap Entity.\262\ Although the Commission does not
currently have cost data for either reconciliation performed in-house
or by third-party service providers, and therefore cannot quantify
these costs, the Commission preliminarily believes that the ongoing
portfolio reconciliation cost would likely be a function of portfolio
size and the availability of third party service providers.
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    \262\ This estimate is based on an estimate supplied by ISDA to
the CFTC in response to their proposed portfolio reconciliation
rule. See CFTC Risk Mitigation Adopting Release 77 FR at 55952-3.
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    In contrast, when commenting on the CFTC's then-proposed portfolio
reconciliation rule, a third party provider of multilateral compression
services stated that a large number of Swap Entities already regularly
reconcile their portfolios with each other and with other entities and
that

the increased frequency and inclusion of smaller portfolios as proposed
should prove no obstacle to such entities.\263\ If SBS Entities have
similar business practices, then this comment suggests start-up and on-
going portfolio reconciliation costs could be small.
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    \263\ See Letter from Per Sj[ouml]berg, Executive Vice TriOptima
AB to the CFTC, dated Feb. 28, 2011 at 2, available at: http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=30562&SearchText.28, 2011 at 2, available at
http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=30562&SearchText.
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    The Commission preliminarily believes that certain costs will arise
despite the fact that an SBS Entity also may be registered with the
CFTC as a Swap Entity, and therefore subject to similar rules already
adopted by the CFTC. Such costs may include (i) increased costs to
account for possible differences between the SEC and CFTC related to
the terms considered to be material for purposes of the reconciliation
requirement; (ii) the additional resources necessary to design,
compose, and implement the required policies and procedures; (iii) the
additional resources needed to comply with the dispute resolution
timeframes; and (iv) the compilation and maintenance of applicable
records. These costs, however, are by nature specific to each entity's
internal operations; absent specific information from commenters, the
Commission cannot provide reasonable estimations regarding the
resources needed to comply.
    The proposed rule also requires SBS Entities to agree in writing
with each of their counterparties on the terms of the portfolio
reconciliation including, if applicable, agreement on the selection of
any third party service provider who may be performing the
reconciliation. Accordingly, each counterparty to a SBS Entity subject
to these rules would incur an upfront cost in implementing this
requirement, particularly since the Commission would expect that such
terms be agreed to in writing prior to, or contemporaneously with, the
two parties executing any new security-based swap transaction. These
costs would be mitigated if, once the parties have agreed in writing on
the terms of the portfolio reconciliation for the first time, the two
sides comply with this requirement for subsequent transactions by
merely agreeing in writing to abide by the existing agreement regarding
the reconciliation process. This practice could help to ensure that
portfolio reconciliation begins without delay after execution of the
transaction and is designed to minimize the number of disagreements
regarding the portfolio reconciliation process itself.
    The Commission estimates that of the 55 market participants we
expect to register as SBS Entities, approximately 35 will be dually-
registered with the CFTC and may already have automated portfolio
reconciliation systems in place. Thus, for these entities, the costs
associated with modifying these existing systems to account for
security-based swap reconciliations is expected to be minimal. For the
remaining 20 SBS Entities which are not expected be dually-registered
with the CFTC, the anticipated personnel costs associated with setting
up an automated portfolio reconciliation system per SBS Entity is
$58,795, or $1,175,900 in aggregate.264 265 The Commission
preliminarily believes that these costs would be a component of the
upfront cost estimate of $5-10 million discussed above.\266\ For each
SBS Entity, we anticipate that approximately 190 hours per year will be
required for reconciliation or a total of 10,450 hours across the 55
SBS Entities.\267\ With respect to reconciliations with non-SBS
counterparties, the Commission estimates that an additional 227.5 hours
per SBS Entity, or 12,512.5 hours in aggregate would be needed for
automated portfolio reconciliation with these counterparties.\268\
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    \264\ This estimate is based on the following: [(Sr. Programmer
(80 hours) x $314 per hour) + (Sr. Systems Analyst (80 hours) x $269
per hour) + (Compliance Manager (10 hours) x $293 per hour) +
(Director of Compliance (5 hours) x $461 per hour) + (Compliance
Attorney (20 hours) x $346 per hour)] = $58,795 per SBS Entity, or
($58,795 x 20 SBS Entities) = $1,175,900 in aggregate.
    \265\ The hourly rates for internal professionals used
throughout Sections VII.C.2.c, VII.C.3.c, and VII.C.4.c of the
release are taken from SIFMA's Management & Professional Earnings in
the Securities Industry 2013, modified to account for an 1800-hour
work-year and inflation, and multiplied by 5.35 to account for
bonuses, firm size, employee benefits, and overhead.
    \266\ See supra note 262 and associated text.
    \267\ Each SBS Entity is anticipated to have counterparty
relationships with approximately one-third of the other SBS market
participants (\1/3\ x 55 = 18.333), which is rounded to 18
participants. Of those counterparty relationships, two are expected
to have portfolios in excess of 500 positions, which would need to
be reconciled daily (252 trading days per year), four would have