between 50 and 500 positions, which would need to be reconciled
weekly (52 weeks per year), and the remaining 12 would have less
than 50 positions, which would need to be reconciled quarterly (four
times per year). The Commission estimates that each portfolio
reconciliation would require 30 minutes, 15 minutes per
counterparty, through an automated system, thus the total
anticipated reconciliation time would be [(2 counterparties x 252
trading days x 0.25 hours) + (4 counterparties x 52 weeks x 0.25
hours) + (12 counterparties x 4 quarters x 0.25 hours)] = 190 hours
per SBS Entity, or (190 x 55 SBS Entities) = 10,450 hours in
aggregate.
    \268\ There are anticipated to be 13,137 total SBS
counterparties, of which 55 are registered SBS Entities, leaving
13,082 non-SBS market participants. See supra note 179. The
Commission estimates that each SBS Entity will transact with
approximately 350 of these non-registered participants. Of those 350
counterparties, 35 are expected to have portfolio positions in
excess of 100 positions, which would require quarterly
reconciliations, while the remaining 315 are expected to have
positions of less than 100 security-based swaps, and therefore,
would require annual reconciliation. The Commission estimates that
each portfolio reconciliation would require 30 minutes through an
automated system, thus the total anticipated reconciliation time
would be [(35 counterparties x 4 quarters x 0.5 hours) + (315
counterparties x 1 time per year x 0.5 hours)] = 227.5 hours per SBS
Entity, or (227.5 x 55 SBS Entities) = 12,512.5 hours in aggregate.
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    The Commission further estimates that the development and
implementation of written policies and procedures as required under
proposed Rule 15Fi-3 would impose an initial cost of $702,232.50. Of
the total 55 SBS Entities that would be subject to Rule 15Fi-3, 35 are
estimated to be dually-registered with the CFTC, and are anticipated to
already have policies and procedures in place with respect to
reconciliation. The expected additional time to revise the existing
policies and procedures for these SBS Entities is expected to be one
hour per SBS Entity, for a cumulative 35 hours, costing $429.50 per SBS
Entity or $15,032.50 in aggregate.\269\ For the remaining 20 SBS
Entities, the Commission estimates that it will take approximately 80
hours per entity to establish the written policies and procedures. The
costs for these SBS Entities will be $687,200, or $34,360 per SBS
Entity.\270\ Once established, the Commission estimates that it would
cost SBS Entities approximately $944,900 or $17,180 per SBS Entity to
revise and maintain these policies and procedures.\271\ Resolution of
valuation discrepancies can be labor intensive. One objective of the
proposed rule is to reduce the incidence of valuation discrepancies
through the periodic reconciliations between security-based swap
counterparties. It is unlikely, however, that the proposed rule will
completely eliminate disputes related to

valuation. The Commission lacks data on the fraction of positions that,
when reconciled, will result in a dispute as well as the costs likely
to be incurred resolving those disputes, and is therefore unable to
quantify these costs. However, the Commission recognizes that the costs
associated with resolution of these disputes is likely to be higher
than costs for reconciliations in which disputes do not arise.
---------------------------------------------------------------------------

    \269\ The estimate is based on the following: [((Compliance
Attorney (30 minutes) at $346 per hour) + ((Director of Compliance
(15 minutes) at $461 per hour) + ((Deputy General Counsel (15
minutes) at $565 per hour)] = $429.50 per hour per SBS Entity or
($429.50 per hour x 35 SBS dually-registered Entities) = $15,032.50.
    \270\ The estimate is based on the following: [((Compliance
Attorney (40 hours) at $346 per hour) + ((Director of Compliance (20
hours) at $461 per hour) + ((Deputy General Counsel (20 hours) at
$565 per hour)] = $34,360 per SBS Entity or ($34,360 x 20 SBS
Entities that are not dually-registered) = $687,200 in aggregate.
    \271\ The estimate is based on the following: [((Compliance
Attorney (20 hours) at $346 per hour) + ((Director of Compliance (10
hours) at $461 per hour) + ((Deputy General Counsel (10 hours) at
$565 per hour)] = $17,180 per SBS Entity or ($17,180 x 55 SBS
Entities) = $944,900 in aggregate.
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    However, the Commission preliminarily believes that these costs may
be mitigated by only requiring counterparties to address differences in
valuation greater than 10%. These costs of reconciliation may be
further mitigated by agreement between the counterparties to use a
third party service provider to assist in resolving valuation
discrepancies. Reconciliation of other terms is likely to be less
costly as the terms of the agreement are unlikely to change over the
life of the contract.
    The 10% threshold was designed to both identify large deviations in
valuations between SBS Entities, while not requiring those entities to
devote significant effort to resolving minor valuation disputes.
Further, this threshold is identical to that already adopted by the
CFTC.\272\ The Commission notes, however, that this 10% threshold is at
the transaction level, rather than the entity level. While
discrepancies could be random in nature, the risk exists that one
counterparty could have systemic issues in valuation across its entire
portfolio, thereby leading to discrepancies in valuation with one or
several counterparties and throughout the portfolio. For example, if an
entity's valuation model consistently undervalued each of its security-
based swap positions by 9%, in aggregate, the overall level of risk
could be substantial, even though it would not trigger a discrepancy
event as currently defined by the 10% transaction level threshold.
Further, since the Commission estimates that approximately 35 of the
expected 55 SBS Entities are likely to be dually-registered with the
CFTC and active in swap and security-based swap markets, these
participants are likely to face higher costs when regulations differ.
---------------------------------------------------------------------------

    \272\ See 17 CFR 23.502 (portfolio reconciliation).
---------------------------------------------------------------------------

    The costs of resolving valuation disputes are expected to be
mitigated, because the reconciliation requirements are expected to
prevent disputes from arising in the first instance through the regular
comparison of material terms and valuations. The Commission
preliminarily believes that by requiring SBS Entities to reach
agreement with certain counterparties on the methods and inputs for
valuation of each security-based swap, as required in connection with
the trading relationship documentation requirements in proposed Rule
15Fi-5, the overall framework of these rules should assist SBS Entities
in resolving valuation disputes within five business days. In addition,
the Commission estimates that SBS Entities will spend an average of 24
hours per year to comply with the notification requirement of proposed
Rule 15Fi-3(c) costing $8,304 per SBS Entity or $456,720 in
aggregate.\273\
---------------------------------------------------------------------------

    \273\ The estimate is based on the following: [Compliance
Attorney (24 hours) at $346 per hour] = $8,304 per entity x 55 SBS
entities = $456,720.
---------------------------------------------------------------------------

    Lastly, portfolio reconciliation costs are also mitigated by virtue
of the fact that cleared security-based swaps are not within the scope
of the requirements of these rules. The Commission preliminarily
believes that CCPs establish settlement prices for each cleared
security-based swap every business day for margining purposes and this
process is more appropriately addressed by rules governing a clearing
agency's risk management practices.\274\ Because a large part of the
security-based swap portfolios of SBS Entities may consist of cleared
security-based swaps to which the reconciliation requirements will not
apply, the sizes of the bilateral, uncleared portfolios (to which the
requirement would apply) may be limited.\275\
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    \274\ See supra Section I.B.7.
    \275\ Currently, there is no regulatory requirement in the
United States to clear security-based swaps. As of December 2015,
approximately 56% of the total volume of new trade activity in
single-name security-based swap products had been cleared through
ICE Clear Credit. Further, approximately 79% of index CDS
transactions were centrally cleared as of December 2015 (see https://www.isda.org/a/kVDDE/swapsinfo-q4-2015-review-final.pdf);
therefore, single-name security-based swaps potentially could be
cleared at a similar rate.
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d. Alternatives
    The proposed rule creates a specific definition of ``material
terms'' for purposes of determining what discrepancies must be resolved
in connection with the portfolio reconciliation which includes each
term required to be reported to an SDR, but then permits SBS Entities
to exclude any term that is not relevant to the ongoing rights and
obligations of the parties and the valuation of the security-based swap
during subsequent reconciliations. The Commission considered not
providing a specific definition of ``material terms'' and allowing SBS
Entities discretion in determining those terms that are relevant to the
ongoing rights or obligations of the parties or affect the valuation of
the security-based swap.
    The Commission has preliminarily concluded that the data required
to be submitted to an SDR in connection with regulatory reporting
requirements is an appropriate measure for determining which terms
should be reconciled pursuant to proposed Rule 15Fi-3. The Commission
also preliminarily believes that tying the definition of ``material
terms'' to reporting requirements to an SDR could reduce the burdens on
some SBS Entities by potentially allowing them to leverage the same
electronic systems used for SDR reporting for purposes of the portfolio
reconciliation requirements.
    The portfolio size breakpoints and frequencies are consistent with
those adopted by the CFTC for Swap Entities and are therefore likely to
be familiar to those entities that are registered as both an SBS Entity
and a Swap Entity. These are also the breakpoints adopted by the EC.
Further, the Commission believes that alternative breakpoints based on
the number of transactions which deviate from those adopted by the CFTC
and the EC would likely impose additional costs on SBS Entities without
any corresponding increases in material benefits to those participants.
    Although the notion of breakpoints based on number of transactions
previously has been accepted by the CFTC and other regulatory agencies,
the Commission notes that breakpoints based on alternative measures
could be considered. In particular, breakpoints for reconciliation
could be categorized by either gross (or net) notional amounts of
positions or the current market value of positions, and identified as
levels or scaled by some measure such as the aggregate notional value
of the market (for gross or net notional values) or the assets of the
SBS Entity (if market values are used instead). Although the number of
security-based swaps between counterparties is easy to capture, it may
actually be misleading with respect to the complexity or magnitude of
the risk between counterparties.
    For instance, say two counterparties have over 500 transactions
between them, but the average value of each transaction is only $5
million notional value. The total exposure between the two
counterparties would only be $2.5 billion, but this portfolio would
need to be reconciled daily due to the number of transactions. If, on
the other hand, two counterparties have only 40 transactions, but the
average value of each transaction is $1 billion notional value, the
overall exposure would be $40 billion (16 times greater exposure

than the 500 transaction counterparties), but this portfolio would only
be reconciled quarterly. Basing breakpoints on some measure other than
the number of transactions may enable SBS Entities to better assess the
overall level of counterparty credit risk as well as operational risk
associated with their security-based swap portfolios. Setting aside
these concerns, the Commission believes that breakpoints based on the
number of transactions is likely to capture the complexity of SBS
Entities' portfolios, and that reconciliations based on this dimension
are likely to identify discrepancies in a timely manner. Further, given
that the Commission estimates that approximately 35 of the expected 55
SBS Entities are likely to be dually-registered with the CFTC and
active in both swap and security-based swap markets, this alternative
could potentially impose additional costs due to differences in
regulatory requirements.
    The Commission has also considered alternatives to the requirement
that valuation discrepancies exceeding 10% must be resolved within five
days. The 10% threshold is consistent with the rule adopted by the CFTC
for Swap Entities and, as a result, is likely to be familiar to those
entities that are registered as both an SBS Entity and a Swap Entity.
The Commission preliminarily believes that the proposed 10% threshold
is high enough to prevent market participants from incurring costs to
resolve small valuation differences that would have only a small effect
on margin or other risk management practices, yet low enough to prevent
difference in valuation from resulting in significant miscalculations
in risk management.
    As noted above, there are potential economic costs that could
accrue to counterparties related to both the 10% threshold and the five
business day resolution window. An alternative (albeit supplementary)
approach would be an additional requirement of a valuation threshold
related to the overall portfolio discrepancies, in aggregate and/or
with individual counterparties. For instance, if the aggregate
portfolio has valuation discrepancies of 5% or 10%, this could trigger
a discrepancy event, even if the individual transaction-level
discrepancies fall below the prescribed threshold as documented
currently in the proposed rule. Relatedly, while the five business day
window is narrow enough to potentially stem valuations from deviating
for extended periods of time while still providing a horizon in which
parties can work through their valuation disputes, entities can face
significant counterparty risk over seemingly short-term horizons. For
relatively stable valuation disputes in which the value does not
continue to deviate further from the agreed-upon level, then a five
business day window is likely to be sufficient; however, a more
compressed alternative horizon could be invoked when the discrepancies
in value continue to widen between counterparties. The Commission
preliminarily believes that the proposed five business day horizon is
sufficient and serves as an upper-bound for which market participants
to address and correct any material discrepancies that arise during
reconciliation. Moreover, this approach is consistent with requirements
from other regulators, and given the Commission's estimates on SBS
Entities that are likely to be dually-registered with the CFTC, any
differences in regulation would likely impose additional costs to those
entities.
    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).\276\
---------------------------------------------------------------------------

    \276\ See supra Section I.B.6.
---------------------------------------------------------------------------

    The Commission has considered as an alternative, requiring SBS
Entities to make and keep records of valuation discrepancies that
exceed $20,000,000 rather than requiring that they be reported to the
Commission. The Commission preliminarily concluded that the benefit of
receiving an early warning of potential problems before they surfaced
though an ordinary course of review of books and records justifies any
additional cost imposed on SBS entities.
    Proposed Rule 15Fi-3(d), the new requirements regarding portfolio
reconciliation would not apply to a ``clearing transaction'' which is
defined as a security-based swap that has a clearing agency as a direct
counterparty.\277\ A clearing agency means a clearing agency that is
registered with the Commission pursuant to Section 17A of the Exchange
Act and that provides central counterparty services for security-based
swap transactions. The Commission considered as an alternative
including transactions cleared at a foreign clearing agency that is not
registered with the Commission within its definition of ``clearing
transaction'' for the purposes of the proposed rule. The Commission
preliminarily concluded that an approach that is similar to that taken
by the Commission in other rules,\278\ as well as the approach taken by
the CFTC,\279\ would reduce implementation and compliance costs.
---------------------------------------------------------------------------

    \277\ See supra Section I.B.7.
    \278\ See, e.g., Trade Acknowledgement and Verification Adopting
Release, 81 FR at 39839.
    \279\ Specifically, CFTC Rule 23.502(c) provides that
``[n]othing in this section shall apply to a swap that is cleared by
a derivatives clearing organization.'' 17 CFR 23.502(c).
---------------------------------------------------------------------------

    The Commission has considered as an alternative, an alternative
compliance mechanism that would allow a SBS Entity to be deemed in
compliance with certain proposed rules regarding portfolio
reconciliation if the SBS Entity is also registered as a swap dealer or
major swap participant with the CFTC and is in compliance with the
corresponding CFTC portfolio reconciliation rules. The Commission
preliminarily concludes that differences between its proposed rules and
rules adopted by the CFTC may provide certain benefits to SBS Entities
and other market participants that would not be available under a rule
that was identical to the corresponding CFTC rule. For example, the
requirement in the proposed rule that each term required to be reported
to a registered SDR under Rule 901 must be reconciled may facilitate
the verification of transaction data by SDRs, which could address
concerns raised by market participants and data repositories. Such
benefits could be unavailable under an alternative compliance mechanism
given that CFTC portfolio reconciliation rules do not require all of
this information to be reconciled.\280\
---------------------------------------------------------------------------

    \280\ See supra Section I.E for a discussion of the proposed
reconciliation rules and the verification of transaction data by
SDRs. See also supra note 32 for a discussion of differences between
CFTC and proposed Commission requirements concerning third party
reconciliation.
---------------------------------------------------------------------------

3. Portfolio Compression
    Portfolio compression is an important post-trade processing
mechanism that can be an effective and efficient tool for the
management of risk by security-based swap market participants.
Portfolio compression is a mechanism whereby directionally opposite

transactions with substantially similar terms among two or more
counterparties are terminated and, if any exposure remains, replaced
with a smaller number of transactions of decreased notional value in an
effort to reduce the risk, cost, and inefficiency of maintaining
offsetting transactions on the counterparties' books. Because portfolio
compression participants are permitted to establish their own credit,
market, and cash payment risk tolerances and to establish their own
mark-to-market values for the transactions to be compressed, the
process does not alter the risk profiles of the individual participants
beyond a level acceptable to the participant. Portfolio compression is
commonly acknowledged as useful risk management tool.\281\
---------------------------------------------------------------------------

    \281\ See http://www2.isda.org/news/isda-publishes-paper-highlighting-achievements-in-portfolio-compression.
---------------------------------------------------------------------------

a. Requirements
    The Commission is proposing rules and interpretations that
generally would require each SBS Entity to establish, maintain, and
follow written policies and procedures for engaging in certain forms of
portfolio compression exercises with each of its counterparties.
Depending on the number of counterparties, the portfolio compression
exercise would be defined as either a ``bilateral portfolio compression
exercise'' or as a ``multilateral portfolio compression exercise.''
    Under proposed Rule 15Fi-4(a), SBS Entities would be required to
establish, maintain, and follow written policies and procedures for
periodically engaging in both bilateral portfolio compression exercises
and multilateral portfolio compression exercises, when appropriate,
with each counterparty that is also an SBS Entity.\282\ For
transactions with non-SBS Entities, the policies and procedures
required under the proposed rule would require only that portfolio
compression exercise would have to occur when appropriate and only if
requested by any such counterparty.\283\
---------------------------------------------------------------------------

    \282\ See proposed Rules 15Fi-4(a)(2) and (3).
    \283\ See proposed Rule 15Fi-4(b). See also supra notes 70 and
71 and associated text.
---------------------------------------------------------------------------

b. Benefits
    As a mechanism for post-trade management of risk in security-based
swaps, portfolio compression provides benefits not only to the
counterparties in each transaction but also to the markets as a whole.
A portfolio compression exercise permits firms to identify instances in
which directionally opposite transactions with similar terms can be
terminated or replaced, with a smaller number of transactions with
decreased notional value, reducing the overall risk, cost, and
inefficiencies associated with maintaining offsetting transactions. As
such, portfolio compression is recognized as an important risk
management tool.\284\ By expanding the universe of participants
required to maintain portfolio compression policies and procedures,
credit risk in the uncleared security-based swaps market can be reduced
and may provide benefits to the entire financial system.
---------------------------------------------------------------------------

    \284\ For example, in 2008, the PWG identified frequent
portfolio compression of outstanding trades as a key policy
objective in the effort to strengthen the OTC derivatives market
infrastructure. See PWG Report, supra note 205. Similarly, the 2010
staff report issued by the FRBNY outlined policy perspectives on OTC
derivatives infrastructure and identified trade compression as an
element of strong risk management and recommended that market
participants engage in regular, market-wide portfolio compression
exercises. See FRBNY OTC Derivatives Report, supra note 62. Since
the years immediately following the 2008 financial crisis,
compression outside of CCPs has been somewhat less common and has
declined substantially from its 2008 peak. See supra note 240.
---------------------------------------------------------------------------

    Further, the termination of redundant security-based swap
transactions through the portfolio compression process is likely to
result in the potential reduction of both counterparty and operational
risk at the SBS Entity level. The use of portfolio compression also
could reduce the overall level of bilateral risk exposures, while
leaving the net positions of market participants unaltered, thereby
improving operational efficiency. Improvements in operational
efficiency may arise due to fewer overall positions for each entity, a
reduction in carried margin and variation margin calculations, and
fewer (and potentially less frequent) portfolio reconciliations. This
would also reduce the number of bilateral positions that would have to
be resolved in the event of insolvency of a market participant. These
reductions in risk and improvements in operational efficiency of SBS
Entities could benefit the financial system as a whole, thereby
potentially increasing the number of market participants as well as
improving liquidity.
    Although the costs of participating in portfolio reconciliation are
fully internalized by each counterparty, the potential benefits,
particularly for multilateral compression exercises, increase with the
number of counterparties that participate. Under proposed Rule 15Fi-
4(a), SBS Entities would be required to establish, maintain, and follow
written policies and procedures for periodically engaging in both
bilateral portfolio compression exercises and multilateral portfolio
compression exercises, in each case when appropriate, with
counterparties that also are an SBS Entities.\285\ To the extent that
an SBS Entity transacts with a counterparties that are not SBS
Entities, the policies and procedures required under the proposed rule
would require only that portfolio compression exercises occur when
appropriate and only if requested by any such counterparty. In the
absence of the proposed rules, some counterparties may not participate
in compression activities reducing the potential benefits available to
other counterparties and the financial system generally.
---------------------------------------------------------------------------

    \285\ See supra Section I.C.
---------------------------------------------------------------------------

    As noted in the economic baseline, the emergence of third-party
vendors has provided portfolio compression services for security-based
swaps. SBS Entities may be able to continue to benefit from the
services of these third-party vendors to provide additional portfolio
compression opportunities for these firms.
    The proposed rule provides flexibility to security-based swap
market participants with respect to portfolio compression. The
Commission preliminarily believes that by not proposing prescriptive
requirements, an SBS Entity would allow the counterparties flexibility
in the manner in which they reduce the size of their security-based
swap portfolios in light of each counterparty's unique risks and
operations. Moreover, the proposed rules regarding bilateral offset
have been designed to reflect the understanding by the Commission that
firms may have legitimate economic and business reasons for maintaining
fully offsetting security-based swap transactions. Certain portfolio
compression exercises could result in adverse credit exposures to
certain counterparties. For example, the results of a particular
multilateral compression exercise may result in a credit exposure to a
particular counterparty that exceeds credit exposure limits for that
counterparty.
    Thus, the Commission preliminarily believes that the policies and
procedures should be flexible enough to allow an SBS Entity to take the
most appropriate course of action with respect to managing its risks,
while at the same time, encouraging SBS Entities to consider the risk
mitigation possibilities of portfolio compression in a non-arbitrary
manner and consistent with the purposes of Section 15F(i) of the
Exchange Act. As such, proposed

Rules 15Fi-4(a)(1) and (b) would require a firm's policies and
procedures to address the termination of fully offsetting security-
based swaps only ``when appropriate.''
    Finally, the Commission notes that both the CFTC and the EC have
adopted portfolio compression requirements that are substantially
similar to those being proposed by the Commission in this release.\286\
By closely aligning portfolio compression requirements through
consultation with the CFTC and with ESMA, the Commission preliminarily
believes that SBS Entities will benefit from a largely unitary
regulatory regime that does not require separate compliance and
operational policies and procedures.
---------------------------------------------------------------------------

    \286\ See supra note 7 and accompanying text.
---------------------------------------------------------------------------

c. Costs
    SBS Entities will necessarily have to design, compose, and
implement policies and procedures to regularly evaluate compression
opportunities with their counterparties as well as those opportunities
offered by third parties. However, the Commission preliminarily
believes that given the large risk management benefits available from
the regular compression of offsetting trades--benefits including
reduced risk and enhanced operational efficiency--SBS Entities already
undertake regular portfolio compression exercises. For this reason and
those discussed below, the Commission preliminarily believes that the
relevant costs will primarily be the creation of policies and
procedures.
    The greater the level of standardization in security-based swaps,
the less costly it becomes to identify compression opportunities. In
April 2009, ISDA announced the implementation of the 2009 ISDA Credit
Derivatives Determinations Committees and Auction Settlement CDS
Protocol, known colloquially in the industry as the ``Big Bang
Protocol,'' which introduced a number of documentation changes to help
standardize single-name CDS contracts.\287\ Among these changes were
the introduction of standard coupon rates and standard effective dates.
Following the standardization of single-name CDS, compression in this
market segment increased.\288\ As that standardization continues, we
would expect that the cost of identifying appropriate compression
opportunities should continue to fall. Using single-name corporate CDS
data from DTCC-TIW discussed above, we find the percentage of new
trades in North American Single-Name Corporate that have standardized
coupons has risen from 95.2% in 2012 to 99.8% in 2017. The reduction in
the number of roll-dates from four to two in order to both improve
liquidity as well as to align with updates to CDS indices \289\ also
may result in increased standardization and therefore may reduce the
costs of identifying compression opportunities.
---------------------------------------------------------------------------

    \287\ See Press Release, ISDA Announces Successful
Implementation of `Big Bang' CDS Protocol; Determinations Committees
and Auction Settlement Changes Take Effect (Apr. 8, 2009), available
at: https://www.isda.org/a/XS6EE/ISDA-Announces-Successful-Implementation-of-%E2%80%98Big-Bang%E2%80%99-CDS-Protocol-Determinations-Committees-and-Auction-Settlement-Changes-Take-Effect.docx.
    \288\ See Nicholas Vause, Counterparty risk and contract volumes
in the credit default swap market, BIS Quarterly Review (Dec. 2010),
available at: http://www.bis.org/publ/qtrpdf/r_qt1012g.pdf
(``TriOptima became the first company to offer CDS portfolio
compression when it extended its TriReduce service from interest
rate swaps to the CDS market in 2005. In the CDS market, TriReduce
has compressed mainly portfolios of CDS indices and index tranches,
but single names have accounted for an increasing share of its
compression volumes since standardisation in 2009.'').
    \289\ See http://www2.isda.org/asset-classes/credit-derivatives/single-name-cds-roll/.
---------------------------------------------------------------------------

    The Commission estimates that the development and implementation of
written policies and procedures as required under proposed Rule 15Fi-4
would impose an initial cost of $702,232.50 in aggregate. Of the 55
market participants the Commission expects will register as SBS
Entities and be subject to Rule 15Fi-4, the Commission estimates that
approximately 35 of these market participants are registered with the
CFTC, and are anticipated to already have policies and procedures in
place with respect to portfolio compression. The expected additional
time to revise the existing policies and procedures for these SBS
Entities is expected to be one hour per SBS Entity, for a cumulative 35
hours, costing $429.50 per SBS Entity or $15,032.50 in aggregate.\290\
For the remaining 20 SBS Entities, the Commission estimates that it
will take approximately 80 hours per entity to establish the written
policies and procedures. The costs for these SBS Entities will be
$687,200, or $34,360 per SBS Entity.\291\ Once established, the
Commission estimates that it would cost SBS Entities approximately
$944,900 or $17,180 per SBS Entity to revise and maintain these
policies and procedures.\292\
---------------------------------------------------------------------------

    \290\ The estimate is based on the following: [((Compliance
Attorney (30 minutes) at $346 per hour) + ((Director of Compliance
(15 minutes) at $461 per hour) + ((Deputy General Counsel (15
minutes) at $565 per hour)] = $429.50 per hour per SBS Entity or
($429.50 per hour x 35 SBS dually-registered Entities) = $15,032.50.
    \291\ The estimate is based on the following: [((Compliance
Attorney (40 hours) at $346 per hour) + ((Director of Compliance (20
hours) at $461 per hour) + ((Deputy General Counsel (20 hours) at
$565 per hour)] = $34,360 per SBS Entity or ($34,360 x 20 SBS
Entities that are not dually-registered) = $687,200 in aggregate.
    \292\ The estimate is based on the following: [((Compliance
Attorney (20 hours) at $346 per hour) + ((Director of Compliance (10
hours) at $461 per hour) + ((Deputy General Counsel (10 hours) at
$565 per hour)] = $17,180 per SBS Entity or ($17,180 x 55 SBS
Entities) = $944,900 in aggregate.
---------------------------------------------------------------------------

    The Commission further estimates that an SBS Entity will devote
approximately 124.17 hours per year for portfolio offsets and
compression exercises (6,829.35 aggregate hours), a substantial portion
of which will be automated, and some of which may be handled by third-
party vendors.\293\ Similar to our discussion for portfolio
reconciliation (Section VIII.C.2.c), the Commission expects that the
costs of implementing portfolio compression exercises through an
automated process will be minimal for those SBS Entities that are
dually-registered with the CFTC, as many of those systems will already
be in place. With respect to the remaining 20 SBS Entities that are not
dually-registered, the Commission anticipates that any cost associated
with implementing the portfolio reconciliation system may also account
for the portfolio compression exercises that may periodically take
place; therefore, the overall costs of portfolio compression systems
should be minimal.
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    \293\ The Commission estimates that each SBS Entity will
transact with approximately 368 counterparties (18 SBS Entities and
350 non-SBS market participants). It is estimated that approximately
one offset per year will take place between counterparties and it is
expected to take five minutes to complete, for a total number of
hours of (2.5/60 x 18 + 5/60*350) or 29.92 hours per year per SBS
Entity. Further, each SBS Entity is expected to conduct six
bilateral compressions with SBS Entities and 350 bilateral
compressions with non-SBS counterparties, each taking 15 minutes for
total hours of [(7.5/60 x 6) + (15/60 x 350)] = 88.25 hours. Lastly,
each SBS Entity is anticipated to complete 12 multilateral
compressions each year, each taking 30 minutes for a total of 6
hours. Total time for each SBS Entity for portfolio compression
exercises is estimated to be (29.92 + 88.25 + 6) = 124.17 hours, or
6829.35 hours (124.17 hours x 55 SBS Entities).
---------------------------------------------------------------------------

    In terms of quantification of the costs of compression, the
Commission also notes that that there are a number of third-party
vendors that provide compression services, and some of these providers
may charge fees based on results achieved (such as number of swaps or
security-based swaps compressed). Assuming that third-party vendors
charge a fee directly related to the outcome of the compression
exercise (as opposed to a fixed fee in whole or some portion thereof
for portfolio compression activities), the direct costs of portfolio
compression by third-party vendors would therefore likely be

directly related to the economic benefits of reduced counterparty and
operational risk realized through the compression exercises. The
Commission does not currently have pricing data for third-party service
providers that offer portfolio compression services and so is unable to
quantify the costs to market participants who make use of these
services.
    Many non-SBS Entities typically trade only in small volumes and on
one side of a particular security-based swap, to create a synthetic
position in the underlying asset or to hedge another position, for
example. Such one-sided market positions reduce the opportunities to
engage in periodic compression cycles. For SBS Entities that do not
currently participate in compression cycles, there could be costs to
modify the participant's risk systems and connectivity enhancements
that would allow for sharing the necessary information required to
identify compression opportunities and for the booking and processing
of a large volume of security-based swaps in a short time period.
Multilateral compression cycles are typically managed with automated
tools to support tear-up and new trade creation that end-users usually
do not possess, and the costs of obtaining such tools cannot be
justified by the benefits. The rule does not require market
participants to engage in mandatory compression cycles, but only to
establish, maintain, and follow written policies and procedures for
engaging in certain forms of portfolio compression exercises.
d. Alternatives
    The proposed rule requires that SBS Entities establish, maintain,
and follow written policies and procedures as they relate to certain
forms of portfolio compression exercises with each of its
counterparties. As such, the Commission is not proposing to mandate the
specific contents of the policies and procedures created to comply with
these rules.\294\ However, a number of more specific requirements for
portfolio compression could be included. For example, the current
proposal only requires policies and procedures that address compression
to the extent requested by the counterparty rather than a more
prescriptive requirement.\295\
---------------------------------------------------------------------------

    \294\ There is one exception to this statement, see supra note
72.
    \295\ See supra Section I.C.3.
---------------------------------------------------------------------------

    Pursuant to the proposed Rule 15Fi-4, SBS Entities are required
``periodically'' to examine the possibility for whether portfolio
compression exercises can take place. While this provides flexibility
to the counterparties in terms of the frequency with which rebalancing
would have to be explored, it leaves open the possibility that market
participants will suboptimally select the frequency with which
portfolio compression exercises can occur, which could impose
externalities on SBS counterparties as well as the financial system as
a whole. As an alternative, the Commission has considered requiring a
minimum frequency of analysis of portfolio compression exercises. For
instance, at least twice a year, SBS Entities could conduct an analysis
of the possibility of a portfolio compression exercise in order to
reduce their counterparty credit risk and engage in such a portfolio
compression exercise, similar to those adopted by the EC.\296\ Given
that portfolio compression has been identified to be a valuable and
important tool for risk management, it is likely that many SBS Entities
already have in place policies and procedures for periodic evaluation
of compression possibilities, thus imposing a minimum standard could be
burdensome and costly for firms to implement.
---------------------------------------------------------------------------

    \296\ See EU Regulation 149/2013, art. 14, 2013 O.J. 11, 22.
---------------------------------------------------------------------------

    Relatedly, the frequency with which SBS Entities evaluate their
prospects for portfolio compression opportunities could be related to
the number of transactions between counterparties (as is required for
portfolio reconciliation in proposed rule 15Fi-3). For instance, if
counterparties have portfolios in excess of 500 transactions, an
analysis of portfolio compression could be conducted quarterly, while
SBS Entities with portfolios between 50 and 500 transactions, portfolio
compression exercises could be explored twice a year. For
counterparties with fewer than 50 transactions between them (or for
portfolios with non-SBS Entities), portfolio compression exercises
could be simply ``periodically.'' This would allow counterparties to
assess the counterparty credit risk at frequencies aligned with the
complexities of their portfolios without incurring substantive
additional costs of this increase in periodic evaluation of portfolio
compression opportunities. The Commission has considered the costs and
benefits to market participants of imposing policies and procedures
related to portfolio compression based on the number of transactions
between counterparties. However, it is likely that market participants
expected to register as SBS Entities already have policies and
procedures in place to evaluate portfolio compression opportunities
with counterparties, and requiring alterations to these policies could
be costly for these entities without corresponding benefits.
    Proposed Rule 15Fi-4(c), the new requirements regarding portfolio
compression, would not apply to a ``clearing transaction'', which is
defined as a security-based swap that has a clearing agency as a direct
counterparty.\297\ A clearing agency means a clearing agency that is
registered with the Commission pursuant to Section 17A of the Exchange
Act and that provides central counterparty services for security-based
swap transactions. The Commission considered as an alternative
including transactions cleared at a foreign clearing agency that is not
registered with the Commission within its definition of ``clearing
transaction'' for the purposes of the proposed rule. The Commission
preliminarily concluded that an approach that is similar to that taken
by the Commission in other rules,\298\ as well as the approach taken by
the CFTC,\299\ would reduce implementation and compliance costs.
---------------------------------------------------------------------------

    \297\ See supra Section I.C.4.
    \298\ See supra note 278.
    \299\ Specifically, CFTC Rule 23.503(c) provides that
``[n]othing in this section shall apply to a swap that is cleared by
a derivatives clearing organization.'' 17 CFR 23.503(c).
---------------------------------------------------------------------------

    The Commission has considered as an alternative, an alternative
compliance mechanism that would allow a SBS Entity to be deemed in
compliance with certain proposed rules regarding portfolio compression
if the SBS Entity is also registered as a swap dealer or major swap
participant with the CFTC and is in compliance with the corresponding
CFTC portfolio compression rules. The Commission preliminarily
concludes that, as a practical matter, the rules are nearly equivalent,
suggesting that any additional compliance cost arising from differences
in these rules for an entity that is registered with both the CFTC and
the Commission should be small. The Commission preliminarily believes
that the differences that do exist (such as the proposed rule providing
that requested compression by an entity that is not a security-based
swap dealer or major security-based swap participant need only be
conducted if appropriate \300\) may provide marginal benefits to SBS
market participants (such as by preventing portfolio compression that
is not appropriate given the particular circumstances of

the trade and the counterparties to that trade).\301\
---------------------------------------------------------------------------

    \300\ See supra note 70 and accompanying text.
    \301\ The corresponding CFTC compression rule applicable to
transactions with counterparties that are not SBS Entities does not
contain the caveat that any form of compression or offset covered by
the applicable policies and procedures would only need to occur
``when appropriate.'' See supra note 70. We solicit comment on this
difference. See supra Section I.C.5.
---------------------------------------------------------------------------

4. Trading Relationship Documentation
    OTC derivatives market participants typically have relied on the
use of industry standard legal documentation, including master netting
agreements, definitions, schedules, and confirmations, to document
their security-based swap trading relationships. This industry standard
documentation offers a framework for documenting the transactions
between counterparties for OTC derivatives products.\302\ The standard
documentation is designed to set forth the legal, trading, and credit
relationship between the parties and to facilitate netting of
transactions in the event that parties have to close-out their position
with one another or determine credit exposure for margin and collateral
management. Notwithstanding the standardization of such documentation,
some or all of the terms of the master agreement and other documents
are subject to negotiation and modification.
---------------------------------------------------------------------------

    \302\ One commonly used form of the industry standard
documentation is the ISDA Master Agreement and related definitions,
schedules, and confirmations specific to particular asset classes.
As noted in Section VI.B.4, over 99% of uncleared security-based
swap transactions use an ISDA Master Agreement as reported in DTCC-
TIW.
---------------------------------------------------------------------------

a. Requirements
    The Commission is proposing rules and interpretations that
generally would require each SBS Entity to establish, maintain, and
follow written policies and procedures reasonably designed to ensure
that it executes written trading relationship documentation with its
counterparties prior to, or contemporaneously with, executing a
security-based swap. The security-based swap trading relationship
documentation is required to be in writing and to include all material
terms governing the trading relationship between counterparties.
    Further, the proposed rule would also require that the security-
based swap trading relationship documentation include credit support
arrangements.\303\ One of the key elements of Title VII reforms was to
ensure that uncleared OTC derivatives were appropriately
collateralized, thus the documentation of processes for calculating and
exchanging margin in connection with security-based swaps helps to
achieve the broader regulatory objective.\304\
---------------------------------------------------------------------------

    \303\ See supra Section I.C.2
    \304\ 15 U.S.C. 78c-5(f).
---------------------------------------------------------------------------

    The proposed rules also would establish 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.
In the event that discrepancies in valuation arise, the proposed rule
requires that counterparties must provide documentation for either an
alternative method for determining value of the security-based swap or
documentation on the resolution process for such disputes.
    The proposed rule also requires that counterparties to the
security-based swap provide information on their legal status,
particularly in the event of liquidation, as well as to disclose
certain information of a security-based swap accepted for clearing by a
clearing agency, in order to reduce any potential confusion regarding
the status of the trade following its acceptance and novation at the
clearing agency. Lastly, proposed Rule 15Fi-5 requires a periodic
independent audit to identify any material deficiencies in the trading
relationship documentation policies and procedures.
b. Benefits
    Inadequate or incomplete documentation of open security-based swap
transactions could, in some cases, result in collateral and legal
disputes between the two counterparties, thereby exposing both sides to
significant counterparty credit risk. By way of contrast, adequate
documentation between counterparties offers a framework for
establishing the trading relationship between the parties from the
outset of the transaction, which should minimize both the number and
magnitude of potential disputes.
    Further, the proposed rule provides particular guidance with
respect to policies and procedures documenting the valuation of
security-based swaps. Although having policies and procedures regarding
trading relationship documentation in place is important for all
aspects of the transaction, the valuation of the transaction and how it
affects margin requirements on an on-going basis is critical for
managing both counterparty credit as well as operational risk. Pursuant
to proposed Rule 15Fi-5, counterparties are required to provide
information on the valuation methods, procedures, rules, and inputs
(within limits so as to not reveal private information regarding
proprietary valuation models), while further stipulating that either
alternative valuation methods or valuation discrepancy resolutions are
detailed in the trading relationship documentation. These benefits are
both complemented by, and accrue to, the portfolio reconciliation
process contemplated by proposed Rule 15Fi-3. That is, comprehensive
and accurate documentation of a transaction may contribute to a
smoother reconciliation process by reducing the possibility of
discrepancies; and any discrepancies that may still arise could
subsequently be identified and resolved through reconciliation.
    As discussed above, because shortcomings in credit risk management
and documentation may only become evident during a crisis, some
benefits of complying with these rules 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, trading relationship documentation practices employed by
individual market participants may be less thorough than would be
desired by all market participants in order to properly manage risks to
the financial system. However, the widespread use of standard
documentation mitigates both the potential benefit and costs of the
proposed rule.
c. Costs
    Market participants will likely incur ongoing costs associated with
the rules concerning trading relationship documentation. Market
participants will have to (1) negotiate and document all terms of each
trading relationship; (2) design, compose, and implement policies and
procedures reasonably designed to ensure the execution of security-
based swap trading relationship documentation, including valuation
documentation; (3) obtain documentation from counterparties who are
claiming the end user exception to clearing; and (4) periodically audit
documentation and keep records and/or make reports as required under
these rules.
    The Commission estimates that the initial burden to negotiate and
draft trading relationship documentation will be $4,741,680 per SBS
Entity, or $260,792,400 in aggregate across the 55

SBS Entities.\305\ The Commission further estimates that the
development and implementation of written policies and procedures as
required under proposed Rule 15Fi-5 would impose an initial cost of
$702,232.50 in aggregate. Of the total 55 SBS Entities as expected by
the Commission that would be subject to Rule 15Fi-5, 35 are anticipated
to be registered concurrently with the CFTC, and are anticipated to
already have policies and procedures in place with respect to portfolio
compression. The expected additional time to revise the existing
policies and procedures for these Entities is expected to be one hour
per Entity, for a cumulative 35 hours, costing $429.50 per Entity or
$15,032.50 in aggregate.\306\ For the remaining 20 SBS Entities, the
Commission estimates that it will take approximately 80 hours per
entity to establish the written policies and procedures. The costs for
these SBS Entities will be $687,200, or $34,360 per SBS Entity.\307\
Once established, the Commission estimates that it would cost SBS
Entities approximately $944,900 or $17,180 per SBS Entity to revise and
maintain these policies and procedures.\308\ Lastly, proposed Rule
15Fi-5 requires periodic independent audits of the trading relationship
documentation. The Commission estimates that the costs associated with
these audits will be $794,880 per SBS Entity, or $43,718,400 in
aggregate.\309\
---------------------------------------------------------------------------

    \305\ Each SBS Entity is anticipated to be counterparty to 18
other SBS Entities and 350 non-SBS market participants, for a total
of 368 counterparties. The initial negotiation and draft in expected
to take 30 hours per counterparty. The estimation is as follows:
[((Compliance Manager (15 hours) x $346) + (Director of Compliance
(7.5 hours) x $461) + (Deputy General Counsel (7.5 hours) x $565)) x
368 counterparties] = $4,741,680 per SBS Entity, or ($4,741,680 x 55
SBS Entities) = $260,792,400 in aggregate.
    \306\ The estimate is based on the following: [((Compliance
Attorney (30 minutes) at $346 per hour) + ((Director of Compliance
(15 minutes) at $461 per hour) + ((Deputy General Counsel (15
minutes) at $565 per hour)] = $429.50 per hour per SBS Entity or
($429.50 per hour x 35 SBS dually-registered Entities) = $15,032.50.
    \307\ The estimate is based on the following: [((Compliance
Attorney (40 hours) at $346 per hour) + ((Director of Compliance (20
hours) at $461 per hour) + ((Deputy General Counsel (20 hours) at
$565 per hour)] = $34,360 per SBS Entity or ($34,360 x 20 SBS
Entities that are not dually-registered) = $687,200 in aggregate.
    \308\ The estimate is based on the following: [((Compliance
Attorney (20 hours) at $346 per hour) + ((Director of Compliance (10
hours) at $461 per hour) + ((Deputy General Counsel (10 hours) at
$565 per hour)] = $17,180 per SBS Entity or ($17,180 x 55 SBS
Entities) = $944,900 in aggregate.
    \309\ The estimate is based on the following: [368
counterparties x 10 hours per Audit x Auditor ($216 per hour)] =
$794,880 per SBS Entity, or ($794,880 x 55 SBS Entities) =
$43,718,400 in aggregate.
---------------------------------------------------------------------------

    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.\310\ Accordingly,
the Commission preliminarily believes that many, if not most, market
participants that are expected to register as SBS Entities 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. Thus, the hour and dollar
burdens associated with the security-based swap trading relationship
documentation requirements may be limited to amending existing
documentation to expressly include any additional terms required by the
proposed rules. In addition the Commission anticipates that
standardized security-based swap trading relationship documentation
will eventually incorporate changes that may be necessary to comply
with many of the requirements of this rule reducing the cost to
individual security-based swap market participants.\311\
---------------------------------------------------------------------------

    \310\ As noted in Section VI.B.4, as of 2015, the DTCC-TIW data
shows that over 99% of SBS Entities use the ISDA Master Agreement.
    \311\ In response to prior Dodd Frank Act related regulatory
requirements, ISDA in partnership with third party providers, has
created technology-based solutions enabling counterparties to modify
OTC derivatives related documentation quickly and efficiently. See
http://www2.isda.org/dodd-frank-documentation-initiative/.
---------------------------------------------------------------------------

    Proposed Rule 15Fi-5 also includes certain exceptions that are
intended to mitigate costs incurred by market participants while
preserving the risk mitigating benefits of thorough trading
relationship documents. First, the proposed rule would provide an
exception for security-based swaps executed prior to the date on which
the SBS Entity is required to be in compliance with the trading
relationship documentation rule, as it may be costly and impractical to
require SBS Entities to bring existing transactions into compliance
with the proposed rules. The Commission notes that this exception may
increase the likelihood of disputes in valuation with respect to such
transactions, which will be subject to the portfolio reconciliation
requirement of proposed Rule 15Fi-3 even though they are not subject to
the documentation requirements of proposed Rule 15Fi-5. Such disputes
could be costly to resolve and may lead to greater uncertainty with
respect to counterparty credit risk.
    The proposed rule further provides exceptions for any ``clearing
transaction'', which, pursuant to existing Rule 15Fi-1(c) under the
Exchange Act, is defined as a security-based swap that has a clearing
agency as a direct counterparty. Once a security is cleared, the
transaction is primarily governed by the terms of the agreement between
clearing member and the clearing agency. Lastly, the proposed rule
would provide an exception for security-based swaps executed
anonymously on a national securities exchange or an SBSEF, provided
that these security-based swaps are intended to be cleared and are
actually submitted for clearing to a clearing agency that provides CCP
services. This exception is intended to recognize that documentation
requirements may be nearly impossible to fulfill within the context of
cleared anonymous transactions.\312\
---------------------------------------------------------------------------

    \312\ The exception with respect to security-based swap
transactions on national exchanges or SBSEF is limited. See Section
I.D.6 for a complete discussion of those limitations.
---------------------------------------------------------------------------

d. Alternatives
    The Commission has evaluated reasonable alternatives to the
proposed rule on trading relationship documentation. One alternative
would be that all SBS Entities are required to adhere to an industry-
accepted standard form of trading documentation, instead of
establishing policies and procedures related to documentation. It is
unlikely that this alternative would materially alter the primary
benefits of the rule, namely that of reducing disputes over
documentation that could lead to increased counterparty risk, but could
increase overall compliance costs without analogous increases in
benefits, due to reduced operational flexibility.
    Further, the proposed rule requires that SBS Entities undertake a
periodic, independent audit to identify material weaknesses in its
documentation policies and procedures. As proposed, there is
flexibility on behalf of the SBS Entity as to how and when those audits
occur. Alternatively, the Commission has considered limiting to only
external auditors and requiring a once per year audit of trading
relationship documentation. Although this alternative would not
materially amend the primary benefits related to the audit of SBS
Entities' policies and procedures related to trading relationship
documentation, the Commission anticipates that this alternative could
increase compliance costs by reducing operational flexibility.

    Proposed Rule 15Fi-5(a)(1)(ii) would provide an exception to the
trading relationship documentations requirements for any ``clearing
transaction'' which is defined as a security-based swap that has a
clearing agency as a direct counterparty.\313\ A clearing agency means
a clearing agency that is registered with the Commission pursuant to
Section 17A of the Exchange Act and that provides central counterparty
services for security-based swap transactions. The Commission
considered as an alternative including transactions cleared at a
foreign clearing agency that is not registered with the Commission
within its definition of ``clearing transaction'' for the purposes of
the proposed rule. The Commission preliminarily concluded that an
approach that is similar to that taken by the Commission in other
rules,\314\ as well as the approach taken by the CFTC,\315\ would
reduce implementation and compliance costs.
---------------------------------------------------------------------------

    \313\ See supra Section I.D.6.
    \314\ See supra note 278.
    \315\ Specifically, CFTC Rule 23.504(a)(1)(iii) excludes from
the written trading relationship documentation requirements ``swaps
cleared by a derivatives clearing organization.'' 17 CFR
23.504(a)(1)(iii).
---------------------------------------------------------------------------

    The Commission has considered as an alternative, an alternative
compliance mechanism that would allow a SBS Entity to be deemed in
compliance with certain proposed rules regarding trading relationship
documentation if the SBS Entity is also registered as a swap dealer or
major swap participant with the CFTC and is in compliance with the
corresponding CFTC trading relationship documentation rules. The
Commission preliminarily concludes that, as a practical matter, the
rules are nearly equivalent, suggesting that any additional compliance
cost arising from differences in these rules for an entity that is
registered with both the CFTC and the Commission should be small. The
Commission preliminarily believes that differences that do exist are
necessary and appropriate. For example, to the extent that a
transaction entered into on an anonymous basis on a national securities
exchange or SBSEF that is then rejected for clearing but continues to
exist, the Commission preliminarily believes that the counterparties to
the ongoing security-based swap should have in place a written
agreement on the terms of that transaction.\316\
---------------------------------------------------------------------------

    \316\ See supra Section I.D.6.
---------------------------------------------------------------------------

5. Recordkeeping Requirements
    The Commission is also proposing rules that would modify existing
Rules 17a-3 and 17a-4, as well as proposed Rules 18a-5 and 18a-6 for
the recordkeeping and reporting requirements applicable to SBS
Entities. The proposed amendments would involve requiring each SBS
Entity to make and keep current information relevant to portfolio
reconciliation and portfolio compression exercises and to retain all
security-based swap trading relationship documentation required to be
created under proposed Rule 15Fi-5, as well as each policy and
procedure created pursuant to proposed Rules 15Fi-3, 15Fi-4, and 15Fi-
5.
a. Requirements
    The Commission is proposing to amend Rule 17a-3 (which applies to
SBS Entities that are also registered with the Commission as broker-
dealers) and proposed Rule 18a-5 (which applies to SBS Entities that
are not registered with the Commission as broker-dealers). Under these
amendments, each SBS Entity would be required to make and keep records
of each security-based swap portfolio reconciliation and portfolio
compression exercise, which is believed to promote compliance with
proposed Rules 15Fi-3 and 15Fi-4 as well as support SBS Entities in the
event that disputes arise in relation to previous reconciliations or
compressions. The proposed amendments would also require that SBS
Entities make and keep records of valuation disputes in excess of $20
million if not resolved within three (for SBS Entities) or five (for
non-SBS counterparties) days.
    The Commission also is proposing to amend Rule 17a-4 (which applies
to SBS Entities that are also registered with the Commission as broker-
dealers) and proposed Rule 18a-6 (which applies to SBS Entities that
are not registered with the Commission as broker-dealers), which
address record retention. All records made and kept under the proposed
amendments to Rule 17a-3 and proposed Rule 18a-5 would need to be
retained for at least three years. Further, all policies and procedures
related to proposed Rules 15Fi-3 through 15Fi-5, all written agreements
between counterparties on terms of portfolio reconciliation, and all
security-based swap trading relationship documentation with
counterparties would need to be retained until at least three years
following the termination of said policies and procedures and/or
documentation.
b. Benefits
    In proposing these requirements, the Commission considered the
potential benefits of improving the oversight, transparency, and
documentation of security-based swap activities. The amendments to
Rules 17a-3 and 17a-4, and proposed Rules 18a-5 and 18a-6 are intended
to facilitate effective oversight of SBS Entities, thus the benefits
associated with the proposed amendments related to recordkeeping are
beneficial not only to the SBS Entities, but also are expected to
facilitate regulatory oversight.
    Requiring retention of records related to portfolio reconciliation,
portfolio compression, and trading relationship documentation for a
minimum of three years provides SBS Entities with a well-established
track record should disputes about terms of the security-based swap
arise. The benefits of these proposed amendments, to the extent that
they enhance existing practice, could reduce both counterparty credit
risk as well as operational risk for the SBS Entities. Further, the
proposed amendments are expected to facilitate examinations by the
Commission of SBS Entities.
c. Costs
    The Commission also recognizes that there will be costs associated
with the new rules and rule amendments. Those costs include the costs
of creating procedures to ensure that records are kept as required by
the proposed rule amendments, and costs associated with ongoing record
maintenance. As the recordkeeping requirements would be amendments to
Rules 17a-3 and 17a-4, and proposed Rules 18a-5 and 18a-6; however, the
incremental costs of compliance with these amendments is likely to be
minimal.
    The proposed Rules 15Fi-3 through 15Fi-5 would require that SBS
Entities would establish and maintain written policies and procedures
related to portfolio reconciliation, portfolio compression exercises,
and trading relationship documentation. Further, SBS Entities are
already required to comply with the retention of written policies and
procedures with respect to Rule 15Fi-2 related to trade acknowledgement
and verification, and should have recordkeeping systems previously
instituted. Therefore, only minor modifications would need to be made
in order to make the systems compliant with the proposed amendments
regarding recordkeeping requirements for portfolio reconciliation,
portfolio compression exercises, and trading relationship
documentation.
    Generally, the Commission does not expect the amendments to Rules
17a-3 and 17a-4, and proposed Rules 18a-5 and 18a-6 to create material
burdens for registrants, although as noted above the Commission does
expect that there will

be incremental costs related to complying with the proposed rule
amendments.\317\
---------------------------------------------------------------------------

    \317\ See supra Section I.F.1.
---------------------------------------------------------------------------

d. Alternatives
    The Commission has considered reasonable alternatives to the
proposed amendments. In particular, the costs and benefits associated
with the required recordkeeping horizon have been evaluated. Shorter
horizons (of less than three years) would lessen the overall
recordkeeping burden by reducing the retention requirements and
corresponding storage of records. However, as it may take time for
disputes, particularly in the event of liquidations to be fully
settled, shorter horizons may lead to the elimination of relevant
records prior to resolution. On the other hand, longer horizons for
maintaining records could be costly with respect to storage and system
requirements. However, longer record preservation would reduce the
likelihood that historical records are unavailable if needed at some
point in the future.
    Proposed Rule 15Fi-5(c) requires each SBS Entity to have an
independent auditor conduct periodic audits sufficient to identify any
material weakness in it documentation policies and procedures required
by the rule. The Commission considered using the same requirement as
that required by the CFTC that the audit be conducted by an independent
internal or external auditor. The Commission chose not to follow this
approach because in its experience overseeing accounting and auditing
standards in the context of certain disclosure requirements under the
federal securities laws, an internal auditor typically reports to the
management of the applicable entity, which by definition would not
satisfy the test for auditor independence under any existing statutory
or regulatory provision that the Commission administers.\318\ However,
because the proposed rule would still encompass any auditor, whether
external or internal, that is in fact independent, the Commission
preliminarily believes that the practical differences between the
Commission's proposed rule and the corresponding CFTC rule are
negligible.
---------------------------------------------------------------------------

    \318\ See supra Section I.D.5.
---------------------------------------------------------------------------

6. Cross-Border Application of Rules 15Fi-3 Through 15Fi-5
    In early 2016, the Commission adopted Rule 3a71-6 under the
Exchange Act, which determined that non-U.S. SBS Entities could satisfy
certain requirements of Section 15F by complying with comparable
regulatory requirements of a foreign financial regulatory system.\319\
At the time of the substituted compliance rule, it applied solely to
business conduct standards; however, Rule 3a71-6 was amended in the
Trade Acknowledgement and Verification Adopting Release to provide
foreign SBS Entities with the potential to rely on substituted
compliance to satisfy Title VII trade confirmation requirements.\320\
---------------------------------------------------------------------------

    \319\ See Business Conduct Standards Adopting Release, 81 FR at
30074.
    \320\ See Trade Acknowledgement and Verification Adopting
Release, 81 FR at 39827-28.
---------------------------------------------------------------------------

a. Requirements
    The Commission is proposing to amend further Rule 3a71-6 to allow
non-U.S. SBS Entities to potentially be able to satisfy through
substituted compliance the Title VII portfolio reconciliation,
portfolio compression, and trading relationship documentation
requirements in proposed Rules 15Fi-3 through 15Fi-5. The Commission
has preliminarily determined that the principles previously set forth
in the Business Conduct Standards Adopting Release and the Trade
Acknowledgement and Verification Adopting Release with respect to
substituted compliance should in large part similarly pertain to the
reconciliation, compression, and documentation requirements proposed
herein.
b. Benefits
    The Commission proposed amendments to Rule 3a71-6 permit
consideration of substituted compliance in order to reduce the
probability that SBS Entities are subject to potentially duplicative or
conflicting regulation. Market participants that face duplicative
regulatory regimes are likely to attain comparable regulatory outcomes,
but at a cost of increased compliance burdens without an analogous
increase in benefits. The availability of substituted compliance could
decrease the compliance burden for non-U.S. SBS Entities, particularly
as it pertains to portfolio reconciliation, portfolio compression, and
trading relationship documentation. Allowing for the possibility of
substituted compliance may help achieve the risk mitigation
requirements set forth in proposed Rules 15Fi-3 through 15Fi-5, in
particular as it reduces legal uncertainty, counterparty credit risk
exposure, and operational risk for market participants.
    Further, the Commission anticipates broader market implications of
substituted compliance, as well, namely an increase in foreign SBS
dealers' activity in the U.S. market, the expansion of access by both
U.S. and foreign SBS Entities to global liquidity, and a reduction in
the possibility of liquidity fragmentation along jurisdictional lines.
The availability of substituted compliance for non-U.S. SBS Entities
also could promote market efficiency, while enhancing competition in
U.S. markets. Increased participation and access to liquidity is likely
to improve efficiencies related to hedging and risk sharing, while
simultaneously increasing competition between domestic and foreign SBS
Entities.
c. Costs
    The Commission preliminarily believes that the availability of
substituted compliance for portfolio reconciliation, portfolio
compression, and trading relationship documentation would not
substantially alter the benefits intended by the proposed Rules 15Fi-3
through 15Fi-5. In particular, it is expected that the availability of
substituted compliance will not detract from the risk mitigation
benefits that stem from periodic portfolio reconciliation, as well as
policies and procedures regarding portfolio compression exercises and
trading relationship documentation.
    To the extent that substituted compliance reduces duplicative
compliance costs, non-U.S. SBS Entities entering into transactions in
which substituted compliance is available may incur lower overall costs
associated with portfolio reconciliation, portfolio compression, and
documentation exercises with their counterparties than they would
otherwise incur without the option of substituted compliance
availability, either because a non-U.S. SBS Entity may have already
implemented foreign regulatory requirements which have been deemed
comparable by the Commission, or because security-based swap
counterparties eligible for substituted compliance do not need to
duplicate compliance with two sets of comparable requirements.
    A substituted compliance request can be made by either a foreign
regulatory jurisdiction on behalf of its market participants, or by the
registered market participant itself.\321\ The decision to request
substituted compliance is voluntary, and therefore, to the extent that
requests are made by individual market participants, such participants
would request substituted compliance

only if compliance with foreign regulatory requirements was less
costly, in their own assessment, than compliance with both the foreign
regulatory regime and the relevant Title VII requirements, including
portfolio reconciliation, portfolio compression, and trading
relationship documentation requirements. Even after a substituted
compliance determination is made, market participants would only choose
substituted compliance for portfolio reconciliation, compression, and
documentation requirements if the benefits that they expect to receive
from transacting in the U.S. markets exceed the costs that they expect
to bear for doing so.
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    \321\ See Cross-Border Adopting Release, 79 FR at 47277.
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D. Request for Comment

    The Commission requests comment on all aspects of this initial
economic analysis, including whether the analysis has: (i) Identified
all benefits and costs, including all effects on efficiency,
competition, and capital formation; (ii) given due consideration to
each benefit and cost, including each effect on efficiency,
competition, and capital formation; and (iii) identified and considered
reasonable alternatives to the proposed regulations. We request and
encourage any interested person to submit comments regarding the
proposed regulations and our analysis of the potential effects of the
proposed regulations. We request that commenters identify sources of
data and information as well as provide data and information to assist
us in analyzing the economic consequences of the proposed rule and
proposed amendments. We also are interested in comments on the
qualitative benefits and costs we have identified and any benefits and
costs we may have overlooked. In addition to our general request for
comment on the economic analysis associated with the proposed rule and
proposed amendments, we request specific comment on certain aspects of
the proposal:
     We request comment on our characterization of current
portfolio reconciliation practices. Do commenters agree that the
proposed portfolio reconciliation rules are similar to current best
practices? If not, how are they different? Are there third party
service providers that offer portfolio reconciliation services? If so,
what are the costs associated with using such services?
     We request comment on our characterization of current
portfolio compression practices. Do commenters agree that the proposed
portfolio compression rules are similar to current best practices? If
not, how are they different? The Commission understands that there are
third party service providers that offer portfolio compression
services. What are the direct and indirect costs of using such service
providers?
     We request comment on our characterization of current
trading relationship documentation practices. Do commenters agree with
our characterization? If not, how are they different?
     We request comment on our characterization of the benefits
of the proposed regulations concerning portfolio reconciliation. The
Commission preliminarily believes that the main benefit of portfolio
reconciliation is improved management of market and credit risks
associated with particular transactions. Do commenters agree with this
characterization of the benefits? Are there other benefits of the
proposed rule that have not been identified in our discussion and that
warrant consideration? Are the assumptions that form the basis of our
analysis of the benefits appropriate? Can commenters provide data that
supports or opposes these assumptions? Can commenters provide data that
would help the Commission quantify the magnitude of the benefits
identified in our discussion or other benefits that we did not identify
in our discussion and that warrant consideration?
     We request comment on our characterization of the costs of
the proposed regulations concerning portfolio reconciliation. The
Commission preliminarily believes that making its rules as similar as
practicable to those of the CFTC will mitigate compliance costs for SBS
entities. The Commission also preliminarily believes that ongoing
portfolio reconciliation costs would likely be a function of portfolio
size and the availability of third party service providers. Do
commenters agree with our characterization of the costs? Are there
other costs of the proposed rule that have not been identified in our
discussion and that warrant consideration? Are the assumptions that
form the basis of our analysis of the costs appropriate? Can commenters
provide data that supports or opposes these assumptions? Can commenters
provide data that would help the Commission quantify the magnitude of
the costs identified in our discussion or other costs that we did not
identify in our discussion and that warrant consideration?
     We request comment on our characterization of the benefits
of the proposed rules concerning portfolio compression. The Commission
preliminarily believes that the main benefit of the proposed portfolio
compression rule is the potential for reducing the overall risk, cost,
and inefficiencies associated with maintaining offsetting transactions.
Do commenters agree with this characterization of the benefits? Are
there other benefits of the proposed rule that have not been identified
in our discussion and that warrant consideration? Are the assumptions
that form the basis of our analysis of the benefits appropriate? Can
commenters provide data that supports or opposes these assumptions? Can
commenters provide data that would help the Commission quantify the
magnitude of the benefits identified in our discussion or other
benefits that we did not identify in our discussion and that warrant
consideration?
     We request comment on our characterization of the costs of
the proposed regulations concerning portfolio compression. The
Commission preliminarily believes the making its rules as similar as
practicable to those of the CFTC will mitigate compliance costs for SBS
entities. Do commenters agree with our characterization of the costs?
Are there other costs of the proposed rule that have not been
identified in our discussion and that warrant consideration? Are the
assumptions that form the basis of our analysis of the costs
appropriate? The Commission preliminarily believes third-party service
providers often facilitate multilateral portfolio compression but lacks
data on the costs to participants of using these services. Can
commenters provide data that supports or opposes these assumptions? Can
commenters provide data that would help the Commission quantify the
magnitude of the costs identified in our discussion or other costs that
we did not identify in our discussion and that warrant consideration?
     We request comment on our characterization of the benefits
of the proposed rules concerning trading relationship documentation.
The Commission preliminarily believes that the main benefit of the
proposed trading relationship documentation rule is the potential for
reducing the likelihood of collateral and legal disputes between
counterparties that might expose each side to significant counterparty
credit risk. Do commenters agree with this characterization of the
benefits? Are there other benefits of the proposed rule that have not
been identified in our discussion and that warrant consideration? Are
the assumptions that form the basis of our analysis of the

benefits appropriate? Can commenters provide data that supports or
opposes these assumptions? Can commenters provide data that would help
the Commission quantify the magnitude of the benefits identified in our
discussion or other benefits that we did not identify in our discussion
and that warrant consideration?
     We request comment on our characterization of the costs of
the proposed regulations concerning trading relationship documentation.
The Commission preliminarily believes the widespread use of standard
documentation mitigates the costs of the proposed rule. Do commenters
agree with our characterization of the costs? Are there other costs of
the proposed rule that have not been identified in our discussion and
that warrant consideration? Are the assumptions that form the basis of
our analysis of the costs appropriate? Can commenters provide data that
would help the Commission quantify the magnitude of the costs
identified in our discussion or other costs that we did not identify in
our discussion and that warrant consideration?
     Are there any effects on efficiency, competition, and
capital formation that are not identified or are misidentified in our
economic analysis? Please be specific and provide data and analysis to
support your views.
     Do commenters believe that the alternatives the Commission
considered are appropriate? Are there other reasonable alternatives
that the Commission should consider? If so, please provide additional
alternatives and how their costs and benefits would compare to the
proposal.
     We request and encourage any interested person to submit
comments regarding any aspect of the economic analysis of the proposed
rule, specific issues discussed in the economic analysis, and other
matters that may have an effect on the costs or benefits of the
proposed rule. With regard to any comments, we note that such comments
are of particular assistance to our rulemaking initiative if
accompanied by supporting data and analysis of the issues addressed in
those comments.

VII. Consideration of Impact on the Economy

    For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996 (``SBREFA'') \322\ the Commission requests comment on the
potential impact of the proposed rules and amendments on the economy on
an annual basis. The Commission also requests comment on any potential
increases in costs or prices for consumers or individual industries,
and any potential effect on competition, investment, or innovation.
Commenters are requested to provide empirical data and other factual
support for their views to the extent possible.
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    \322\ Public Law 104-121, Title II, 110 Stat. 857 (1996)
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note
to 5 U.S.C. 601).
---------------------------------------------------------------------------

VIII. Regulatory Flexibility Act Certification

    The Regulatory Flexibility Act of 1980 (``RFA'') \323\ requires the
Commission, in promulgating rules, to consider the impact of those
rules on small entities. Section 603(a) \324\ of the Administrative
Procedure Act,\325\ as amended by the RFA, generally requires the
Commission to undertake a regulatory flexibility analysis of all
proposed rules to determine the impact of such rulemaking on ``small
entities.'' Section 605(b) of the RFA \326\ provides that this
requirement shall not apply to any proposed rule or proposed rule
amendment which, if adopted, would not have a significant economic
impact on a substantial number of small entities.
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    \323\ 5 U.S.C. 601 et seq.
    \324\ 5 U.S.C. 603(a).
    \325\ 5 U.S.C. 551 et seq.
    \326\ 5 U.S.C. 605(b).
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    For purposes of Commission rulemaking in connection with the
RFA,\327\ a small entity includes: (1) When used with reference to an
``issuer'' or a ``person,'' other than an investment company, an
``issuer'' or ``person'' that, on the last day of its most recent
fiscal year, had total assets of $5 million or less; \328\ or (2) a
broker-dealer with total capital (net worth plus subordinated
liabilities) of less than $500,000 on the date in the prior fiscal year
as of which its audited financial statements were prepared pursuant to
Rule 17a-5(d) under the Exchange Act,\329\ or, if not required to file
such statements, a broker-dealer with total capital (net worth plus
subordinated liabilities) of less than $500,000 on the last day of the
preceding fiscal year (or in the time that it has been in business, if
shorter); and is not affiliated with any person (other than a natural
person) that is not a small business or small organization.\330\ Under
the standards adopted by the Small Business Administration, small
entities in the finance and insurance industry include the following:
(i) For entities engaged in credit intermediation and related
activities, entities with $175 million or less in assets; \331\ (ii)
for entities engaged in non-depository credit intermediation and
certain other activities, entities with $7 million or less in annual
receipts; \332\ (iii) for entities engaged in financial investments and
related activities, entities with $7 million or less in annual
receipts; \333\ (iv) for insurance carriers and entities engaged in
related activities, entities with $7 million or less in annual
receipts; \334\ and (v) for funds, trusts, and other financial
vehicles, entities with $7 million or less in annual receipts.\335\
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    \327\ Although Section 601(b) of the RFA defines the term
``small entity,'' the statute permits agencies to formulate their
own definitions. The Commission has adopted definitions for the term
``small entity'' for the purposes of Commission rulemaking in
accordance with the RFA. Those definitions, as relevant to this
proposed rulemaking, are set forth in Rule 0-10 under the Exchange
Act, 17 CFR 240.0-10. See Exchange Act Release No. 18451 (Jan., 28,
1982), 47 FR 5215 (Feb., 4, 1982) (File No. AS-305).
    \328\ See 17 CFR 240.0-10(a).
    \329\ 17 CFR 240.17a-5(d).
    \330\ See 17 CFR 240.0-10(c).
    \331\ See 13 CFR 121.201 (Subsector 522).
    \332\ See id. at Subsector 522.
    \333\ See id. at Subsector 523.
    \334\ See id. at Subsector 524.
    \335\ See id. at Subsector 525.
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    With respect to SBS Entities, based on feedback from market
participants and our information about the security-based swap markets,
and consistent with our position in prior Dodd-Frank Act rulemakings,
the Commission continues to believe that (1) the types of entities that
would engage in more than a de minimis amount of dealing activity
involving security-based swaps--which generally would be large
financial institutions--would not be ``small entities'' for purposes of
the RFA and (2) the types of entities that may have security-based swap
positions above the level required to be ``major security-based swap
participants'' would not be ``small entities'' for purposes of the
RFA.\336\
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    \336\ See SBS Entity Registration Adopting Release, 80 FR at
49013; SBS Books and Records Proposing Release, 79 FR at 25296-97
and n.1441; Intermediary Definitions Adopting Release, 77 FR at
30743. See also Sections V (Paperwork Reduction Act) and VI
(Economic Analysis) (discussing, among other things, the economic
impact, including the estimated compliance costs and burdens, of the
amendments).
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    For the foregoing reasons, the Commission certifies that neither
proposed Rules 15Fi-3 through 15Fi, nor the proposed amendments to
Rules 3a71-6, 15Fi-1, 17a-3, 17a-4, 18a-5 (proposed) and 18a-6
(proposed) would, if adopted, have a significant economic impact on a
substantial number of small entities. The Commission encourages written
comments regarding this certification. The Commission solicits comment
as to whether the proposed rules could have an effect on small

entities that has not been considered. The Commission requests that
commenters describe the nature of any impact on small entities and
provide empirical data to support the extent of such impact.

IX. Statutory Basis and Text of Proposed Rules

    The Commission is proposing to revise Rules 3a71-6, 15Fi-1, 17a-3,
and 17a-4 under the Exchange Act (17 CFR 240.3a71-6, 17 CFR 240.15Fi-1,
17 CFR 240.17a-3 [as proposed to be amended at 79 FR 25193, May 2,
2014], and 17 CFR 240.17a-4 [as proposed to be amended at 79 FR 25193,
May 2, 2014]), to revise proposed Rules 18a-5 and 18a-6 under the
Exchange Act (17 CFR 240.18a-5 [as proposed to be adopted at 79 FR
25193, May 2, 2014] and 17 CFR 240.18a-6 [as proposed to be adopted at
79 FR 25193, May 2, 2014]) and to add new Rules 15Fi-3, 15Fi-4, and
15Fi-5 under the Exchange Act (17 CFR 240.15Fi-3, 17 CFR 240.15Fi-4,
and 17 CFR 240.15Fi-5) pursuant to the authority conferred by the
Exchange Act, as amended, and particularly sections 3(b), 15F, 17, and
23(a).\337\
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    \337\ 15 U.S.C. 78c(b), 78o-10, 78q, 78w(a), and 78mm.
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List of Subjects in 17 CFR Part 240

    Reporting and recordkeeping requirements, Securities, Security-
based swaps, Security-based swap dealers, Major security-based swap
participants.

Text of the Amendments

    In accordance with the foregoing, the Securities and Exchange
Commission proposes to amend Title 17, chapter II of the Code of
Federal Regulations as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934

0
1. The general authority citation for Part 240 continues to read as
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss,77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f,
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4,
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20,
80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et seq., and
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; and
Pub. L. 111-203, 939A, 124 Stat. 1376 (2010), unless otherwise
noted.

0
2. Section 240.3a71-6 is amended by adding paragraph (d)(4) to read as
follows:

Sec.  240.3a71-6  Substituted compliance for security-based swap
dealers and major security-based swap participants.

* * * * *
    (d) * * *
    (4) Portfolio reconciliation, portfolio compression, and trading
relationship documentation requirements. The portfolio reconciliation,
portfolio compression, and trading relationship documentation
requirements of section 15F(i) of the Act (15 U.S.C. 78o-10(i)) and
Sec. Sec.  240.15Fi-3 through 15Fi-5; provided, however, that prior to
making such a substituted compliance determination the Commission
intends to consider whether the requirements of the foreign financial
regulatory system for engaging in portfolio reconciliation and
portfolio compression and for executing trading relationship
documentation with counterparties, the duties imposed by the foreign
financial regulatory system, and the information that is required to be
provided to counterparties pursuant to the requirements of the foreign
financial regulatory system, are comparable to those required pursuant
to the applicable provisions arising under the Act and its rules and
regulations.
0
3. Revise Sec.  240.15Fi-1 to read as follows:

Sec.  240.15Fi-1   Definitions.

    For the purposes of Sec.  240.15Fi-1 through Sec.  240.15Fi-5:
    (a) The term bilateral portfolio compression exercise means an
exercise by which two security-based swap counterparties wholly
terminate or change the notional value of some or all of the security-
based swaps submitted by the counterparties for inclusion in the
portfolio compression exercise and, depending on the methodology
employed, replace the terminated security-based swaps with other
security-based swaps whose combined notional value (or some other
measure of risk) is less than the combined notional value (or some
other measure of risk) of the terminated security-based swaps in the
exercise.
    (b) The term business day means any day other than a Saturday,
Sunday, or legal holiday.
    (c) The term clearing agency means a clearing agency as defined in
section 3(a)(23) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(23)) that is registered pursuant to section 17A of the
Securities Exchange Act of 1934 (15 U.S.C. 78q-1) and provides central
counterparty services for security-based swap transactions.
    (d) The term clearing transaction means a security-based swap that
has a clearing agency as a direct counterparty.
    (e) The term day of execution means the calendar day of the
counterparty to the security-based swap transaction that ends the
latest, provided that if a security-based swap transaction is
    (1) Entered into after 4:00 p.m. in the place of a counterparty; or
    (2) Entered into on a day that is not a business day in the place
of a counterparty, then such security-based swap transaction shall be
deemed to have been entered into by that counterparty on the
immediately succeeding business day of that counterparty, and the day
of execution shall be determined with reference to such business day.
    (f) The term execution means the point at which the counterparties
become irrevocably bound to a transaction under applicable law.
    (g) The term financial counterparty means a counterparty that is
not a security-based swap dealer or a major security-based swap
participant and that is one of the following:
    (1) A swap dealer;
    (2) A major swap participant;
    (3) A commodity pool as defined in section 1a(10) of the Commodity
Exchange Act (7 U.S.C. 1a(10));
    (4) A private fund as defined in section 202(a)(29) of the
Investment Advisers Act of 1940 (15 U.S.C. 80b-2(a));
    (5) An employee benefit plan as defined in paragraphs (3) and (32)
of section 3 of the Employee Retirement Income Security Act of 1974 (29
U.S.C. 1002); and
    (6) A person predominantly engaged in activities that are in the
business of banking, or in activities that are financial in nature, as
defined in section 4(k) of the Bank Holding Company Act of 1956 (12
U.S.C. 1843k).
    (h) The term fully offsetting security-based swaps means security-
based swaps of equivalent terms where no net cash flow would be owed to
either counterparty after the offset of payment obligations thereunder.
    (i) The term material terms means:
    (1) With respect to any security-based swap that has not yet been
included in a security-based swap portfolio and reconciled pursuant to
Sec.  240.15Fi-3, each term that is required to be reported to a
registered swap data repository or the Commission pursuant to Sec.
242.901 of this chapter; and
    (2) With respect to all other security-based swaps within a
security-based swap portfolio, each term that is required to be
reported to a registered swap data repository or the Commission
pursuant to Sec.  242.901 of this chapter; provided, however, that such
definition does not include any term that is not

relevant to the ongoing rights and obligations of the parties and the
valuation of the security-based swap.
    (j) The term multilateral portfolio compression exercise means an
exercise by which multiple security-based swap counterparties wholly
terminate or change the notional value of some or all of the security-
based swaps submitted by the counterparties for inclusion in the
portfolio compression exercise and, depending on the methodology
employed, replace the terminated security-based swaps with other
security-based swaps whose combined notional value (or some other
measure of risk) is less than the combined notional value (or some
other measure of risk) of the terminated security-based swaps in the
exercise.
    (k) The term national securities exchange means an exchange as
defined in section 3(a)(1) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(1)) that is registered pursuant to section 6 of the
Securities Exchange Act of 1934 (15 U.S.C. 78f).
    (l) The term portfolio reconciliation means any process by which
the counterparties to one or more security-based swaps:
    (1) Exchange the material terms of all security-based swaps in the
security-based swap portfolio between the counterparties;
    (2) Exchange each counterparty's valuation of each security-based
swap in the security-based swap portfolio between the counterparties as
of the close of business on the immediately preceding business day; and
    (3) Resolve any discrepancy in valuations or material terms.
    (m) The term prudential regulator has the meaning given to the term
in section 3(a)(74) of the Act (15 U.S.C. 78c(a)(74)) and includes the
Board of Governors of the Federal Reserve System, the Office of the
Comptroller of the Currency, the Federal Deposit Insurance Corporation,
the Farm Credit Association, and the Federal Housing Finance Agency, as
applicable to the security-based swap dealer or major security-based
swap participant.
    (n) The term security-based swap execution facility means a
security-based swap execution facility as defined in section 3(a)(77)
of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77)) that is
registered pursuant to section 3D of the Securities Exchange Act of
1934 (15 U.S.C. 78c-4).
    (o) The term security-based swap portfolio means all security-based
swaps currently in effect between a particular security-based swap
dealer or major security-based swap participant and a particular
counterparty.
    (p) The term trade acknowledgment means a written or electronic
record of a security-based swap transaction sent by one counterparty of
the security-based swap transaction to the other.
    (q) The term valuation means the current market value or net
present value of a security-based swap.
    (r) The term verification means the process by which a trade
acknowledgment has been manually, electronically, or by some other
legally equivalent means, signed by the receiving counterparty.
0
4. Section 240.15Fi-3 is added to read as follows:

Sec.  240.15Fi-3  Security-based swap portfolio reconciliation.

    (a) Security-based swaps with security-based swap dealers or major
security-based swap participants. Each security-based swap dealer and
major security-based swap participant shall engage in portfolio
reconciliation as follows for all security-based swaps in which its
counterparty is also a security-based swap dealer or major security-
based swap participant.
    (1) Each security-based swap dealer or major security-based swap
participant shall 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 portfolio reconciliation.
    (2) The portfolio reconciliation may be performed on a bilateral
basis by the counterparties or by a third party selected by the
counterparties in accordance with paragraph (a)(1) of this section.
    (3) The portfolio reconciliation shall be performed no less
frequently than:
    (i) Once each business day for each security-based swap portfolio
that includes 500 or more security-based swaps;
    (ii) Once each week for each security-based swap portfolio that
includes more than 50 but fewer than 500 security-based swaps on any
business day during the week; and
    (iii) Once each calendar quarter for each security-based swap
portfolio that includes no more than 50 security-based swaps at any
time during the calendar quarter.
    (4) Each security-based swap dealer and major security-based swap
participant shall resolve immediately any discrepancy in a material
term of a security-based swap identified as part of a portfolio
reconciliation or otherwise.
    (5) Each security-based swap dealer and major security-based swap
participant shall 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, provided that
the security-based swap dealer and major security-based swap
participant establishes, maintains, and follows written policies and
procedures reasonably designed to identify how the security-based swap
dealer or major security-based swap participant will comply with any
variation margin requirements under section 15F(e) of the Act (15
U.S.C. 78o-10(e)) and regulations thereunder pending resolution of the
discrepancy in valuation. For purposes of this paragraph, a difference
between the lower valuation and the higher valuation of less than 10
percent of the higher valuation need not be deemed a discrepancy.
    (b) Security-based swaps with entities other than security-based
swap dealers or major security-based swap participants. Each security-
based swap dealer and major security-based swap participant shall
establish, maintain, and follow written policies and procedures
reasonably designed to ensure that it engages in portfolio
reconciliation for all security-based swaps in which its counterparty
is neither a security-based swap dealer nor a major security-based swap
participant as follows.
    (1) Each security-based swap dealer or major security-based swap
participant shall 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.
    (2) The portfolio reconciliation may be performed on a bilateral
basis by the counterparties or by one or more third parties selected by
the counterparties in accordance with paragraph (b)(1) of this section.
    (3) The portfolio reconciliation will be required to be performed
no less frequently than:
    (i) 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
    (ii) Once annually for each security-based swap portfolio that
includes no more than 100 security-based swaps at any time during the
calendar year.
    (4) Each security-based swap dealer or major security-based swap
participant shall establish, maintain, and follow

written procedures reasonably designed to resolve any discrepancies in
the valuation or material terms of each security-based swap identified
as part of a portfolio reconciliation or otherwise with a counterparty
that is neither a security-based swap dealer nor major security-based
swap participant in a timely fashion. For purposes of this paragraph, a
difference between the lower valuation and the higher valuation of less
than 10 percent of the higher valuation need not be deemed a
discrepancy.
    (c) Reporting of Security-Based Swap Valuation Disputes. Each
security-based swap dealer and major security-based swap participant
shall promptly notify the Commission, in a form and manner acceptable
to the Commission, and any applicable prudential regulator of any
security-based swap valuation dispute in excess of $20,000,000 (or its
equivalent in any other currency), at either the transaction or
portfolio level, if not resolved within:
    (1) Three business days, if the dispute is with a counterparty that
is a security-based swap dealer or major security-based swap
participant; or
    (2) Five business days, if the dispute is with a counterparty that
is not a security-based swap dealer or major security-based swap
participant.
    (d) Reconciliation of cleared security-based swaps. Nothing in this
section shall apply to any clearing transaction.
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5. Section 240.15Fi-4 is added to read as follows:

Sec.  240.15Fi-4  Security-based swap portfolio compression.

    (a) Portfolio compression with security-based swap dealers and
major security-based swap participants--(1) Bilateral offset. Each
security-based swap dealer and major security-based swap participant
shall establish, maintain, and follow written policies and procedures
for terminating each fully offsetting security-based swap between a
security-based swap dealer or major security-based swap participant and
another security-based swap dealer or major security-based swap
participant in a timely fashion, when appropriate.
    (2) Bilateral compression. Each security-based swap dealer and
major security-based swap participant shall establish, maintain, and
follow written policies and procedures for periodically engaging in
bilateral portfolio compression exercises, when appropriate, with each
counterparty that is also a security-based swap dealer or major
security-based swap participant. Such policies and procedures shall
address, among other things, the evaluation of bilateral portfolio
compression exercises that are initiated, offered, or sponsored by any
third party.
    (3) Multilateral compression. Each security-based swap dealer and
major security-based swap participant shall establish, maintain, and
follow written policies and procedures for periodically engaging in
multilateral portfolio compression exercises, when appropriate, with
each counterparty that is also a security-based swap dealer or major
security-based swap participant. Such policies and procedures shall
address, among other things, the evaluation of multilateral portfolio
compression exercises that are initiated, offered, or sponsored by any
third party.
    (b) Portfolio compression with counterparties other than security-
based swap dealers and major security-based swap participants. Each
security-based swap dealer and major security-based swap participant
shall establish, maintain, and follow written policies and procedures
for periodically terminating fully offsetting security-based swaps and
for engaging in bilateral or multilateral portfolio compression
exercises with respect to security-based swaps in which its
counterparty is an entity other than a security-based swap dealer or
major security-based swap participant, when appropriate and to the
extent requested by any such counterparty.
    (c) Portfolio compression of cleared security-based swaps. Nothing
in this section shall apply to any clearing transaction.
0
6. Section 240.15Fi-5 is added to read as follows:

Sec.  240.15Fi-5  Security-based swap trading relationship
documentation.

    (a)(1) Applicability. The requirements of this section shall not
apply to:
    (i) Security-based swaps executed prior to the date on which a
security-based swap dealer or major security-based swap participant is
required to be in compliance with this section;
    (ii) Any clearing transaction; and
    (iii) Security-based swaps executed anonymously on a national
securities exchange or a security-based swap execution facility,
Provided that:
    (A) Such security-based swaps are intended to be cleared and are
actually submitted for clearing to a clearing agency;
    (B) All terms of such security-based swaps conform to the rules of
the clearing agency; and
    (C) Upon acceptance of such security-based swap by the clearing
agency:
    (1) The original security-based swap is extinguished;
    (2) The original security-based swap is replaced by equal and
opposite security-based swaps with the clearing agency; and
    (3) All terms of the security-based swap shall conform to the
product specifications of the cleared security-based swap established
under the clearing agency's rules; and Provided further, That if a
security-based swap dealer or major security-based swap participant
receives notice that a security-based swap transaction has not been
accepted for clearing by a clearing agency, the security-based swap
dealer or major security-based swap participant shall be required to
comply with the requirements of this section in all respects promptly
after receipt of such notice.
    (2) Policies and procedures. Each security-based swap dealer and
major security-based swap participant shall establish, maintain, and
follow written policies and procedures reasonably designed to ensure
that the security-based swap dealer or major security-based swap
participant executes written security-based swap trading relationship
documentation with its counterparty that complies with the requirements
of this section. The policies and procedures shall be approved in
writing by a senior officer of the security-based swap dealer or major
security-based swap participant, and a record of the approval shall be
retained. Other than trade acknowledgements and verifications of
security-based swap transactions under Sec.  240.15Fi-2, the security-
based swap trading relationship documentation shall be executed prior
to, or contemporaneously with, executing a security-based swap with any
counterparty.
    (b) Security-based swap trading relationship documentation. (1) The
security-based swap trading relationship documentation shall be in
writing and shall include all terms governing the trading relationship
between the security-based swap dealer or major security-based swap
participant and its counterparty, including, without limitation, terms
addressing payment obligations, netting of payments, events of default
or other termination events, calculation and netting of obligations
upon termination, transfer of rights and obligations, allocation of any
applicable regulatory reporting obligations (including pursuant to
Sec. Sec.  242.900 to 242.909) of this chapter, governing law,
valuation, and dispute resolution.
    (2) The security-based swap trading relationship documentation
shall include all trade acknowledgements and verifications of security-
based swap transactions under Sec.  240.15Fi-2.
    (3) The security-based swap trading relationship documentation
shall

include credit support arrangements, which shall contain, in accordance
with applicable requirements under Commission regulations or
regulations adopted by prudential regulators and without limitation,
the following:
    (i) Initial and variation margin requirements, if any;
    (ii) Types of assets that may be used as margin and asset valuation
haircuts, if any;
    (iii) Investment and re-hypothecation terms for assets used as
margin for uncleared security-based swaps, if any; and
    (iv) Custodial arrangements for margin assets, including whether
margin assets are to be segregated with an independent third party, in
accordance with section 3E(f) of the Act (15 U.S.C. 78c-5(f)), if any.
    (4)(i) The security-based swap trading relationship documentation
between security-based swap dealers, between major security-based swap
participants, between a security-based swap dealer and major security-
based swap participant, between a security-based swap dealer or major
security-based swap participant and a financial counterparty, and, if
requested by any other counterparty, between a security-based swap
dealer or major security-based swap participant and such counterparty,
shall include written documentation in which the parties agree on the
process, which may include any agreed upon methods, procedures, rules,
and inputs, for determining the value of each security-based swap at
any time from execution to the termination, maturity, or expiration of
such security-based swap for the purposes of complying with the margin
requirements under section 15F(e) of the Act (15 U.S.C. 78o-10(e)) and
regulations thereunder, and the risk management requirements under
section 15F(j) of the Act (15 U.S.C. 78o-10(j)) of the Act and
regulations thereunder. To the maximum extent practicable, the
valuation of each security-based swap shall be based on recently-
executed transactions, valuations provided by independent third
parties, or other objective criteria.
    (ii) Such documentation shall include either:
    (A) Alternative methods for determining the value of the security-
based swap for the purposes of complying with this paragraph in the
event of the unavailability or other failure of any input required to
value the security-based swap for such purposes; or
    (B) A valuation dispute resolution process by which the value of
the security-based swap shall be determined for the purposes of
complying with this paragraph (b)(4).
    (iii) A security-based swap dealer or major security-based swap
participant is not required to disclose to the counterparty
confidential, proprietary information about any model it may use to
value a security-based swap.
    (iv) The parties may agree on changes or procedures for modifying
or amending the documentation at any time.
    (5) The security-based swap trading relationship documentation of a
security-based swap dealer or major security-based swap participant
shall include the following:
    (i) A statement of whether the security-based swap dealer or major
security-based swap participant is an insured depository institution
(as defined in 12 U.S.C. 1813) or a financial company (as defined in
section 201(a)(11) of the Dodd-Frank Act, 12 U.S.C. 5381(a)(11));
    (ii) A statement of whether the counterparty is an insured
depository institution or financial company;
    (iii) A statement that in the event either the security-based swap
dealer or major security-based swap participant or its counterparty
becomes a covered financial company (as defined in section 201(a)(8) of
the Dodd-Frank Wall Street Reform and Consumer Protection Act, 12
U.S.C. 5381(a)(8)) or is an insured depository institution for which
the Federal Deposit Insurance Corporation (FDIC) has been appointed as
a receiver (the ``covered party''), certain limitations under Title II
of the Dodd-Frank Act or the Federal Deposit Insurance Act may apply to
the right of the non-covered party to terminate, liquidate, or net any
security-based swap by reason of the appointment of the FDIC as
receiver, notwithstanding the agreement of the parties in the security-
based swap trading relationship documentation, and that the FDIC may
have certain rights to transfer security-based swaps of the covered
party under section 210(c)(9)(A) of the Dodd-Frank Wall Street Reform
and Consumer Protection Act, 12 U.S.C. 5390(c)(9)(A), or 12 U.S.C.
1821(e)(9)(A); and
    (iv) An agreement between the security-based swap dealer or major
security-based swap participant and its counterparty to provide notice
if either it or its counterparty becomes or ceases to be an insured
depository institution or a financial company.
    (6) The security-based swap trading relationship documentation of
each security-based swap dealer and major security-based swap
participant shall contain a notice that, upon acceptance of a security-
based swap by a clearing agency:
    (i) The original security-based swap is extinguished;
    (ii) The original security-based swap is replaced by equal and
opposite security-based swaps with the clearing agency; and
    (iii) All terms of the security-based swap shall conform to the
product specifications of the cleared security-based swap established
under the clearing agency's rules.
    (c) Audit of security-based swap trading relationship
documentation. Each security-based swap dealer and major security-based
swap participant shall have an independent auditor conduct periodic
audits sufficient to identify any material weakness in its
documentation policies and procedures required by this section. A
record of the results of each audit shall be retained.
0
7. Section 240.17a-3, as proposed to be amended at 79 FR 25193, May 2,
2014 is further amended by adding paragraph (a)(31) to read as follows:

Sec.  240.17a-3   Records to be made by certain brokers and dealers.

* * * * *
    (a) * * *
    (31)(i) A record of each security-based swap portfolio
reconciliation, whether conducted pursuant to Sec.  240.15Fi-3 or
otherwise, including the dates of the security-based swap portfolio
reconciliation, the number of portfolio reconciliation discrepancies,
the number of security-based swap valuation disputes (including the
time-to-resolution of each valuation dispute and the age of outstanding
valuation disputes, categorized by transaction and counterparty), and
the name of the third-party entity performing the security-based swap
portfolio reconciliation, if any.
    (ii) A copy of each notification required to be provided to the
Commission pursuant to Sec.  240.15Fi-3(c).
    (iii) A record of each bilateral offset and each bilateral
portfolio compression exercise or multilateral portfolio compression
exercise in which it participates, whether conducted pursuant to Sec.
240.15Fi-4 or otherwise, including the dates of the offset or
compression, the security-based swaps included in the offset or
compression, the identity of the counterparties participating in the
offset or compression, the results of the compression, and the name of
the third-party entity performing the offset or compression, if any.
* * * * *

0
8. Section 240.17a-4, as proposed to be amended at 79 FR 25193, May 2,
2014 is amended by revising paragraph (b)(1) and adding paragraphs
(e)(10) and (11) to read as follows:

Sec.  240.17a-4   Records to be preserved by certain exchange members,
brokers and dealers.

* * * * *
    (b) * * *
    (1) All records required to be made pursuant to Sec.  240.17a-
3(a)(4), (a)(6), (a)(7), (a)(8), (a)(9), (a)(10), (a)(11), (a)(16),
(a)(18), (a)(19), (a)(20), (a)(24), (a)(25), (a)(26), (a)(27), (a)(28),
(a)(29), (a)(30), and (a)(31), and analogous records created pursuant
to Sec.  240.17a-3(e).
* * * * *
    (e) * * *
    (10) The written policies and procedures required pursuant to
Sec. Sec.  240.15Fi-3, 240.15Fi-4, and 240.15Fi-5 until three years
after termination of the use of the policies and procedures.
    (11) (i) Each written agreement with counterparties on the terms of
portfolio reconciliation with those counterparties as required to be
created under Sec.  240.15Fi-3(a)(1) and (b)(1) until three years after
the termination of the agreement and all transactions governed thereby.
    (ii) Security-based swap trading relationship documentation with
counterparties required to be created under Sec.  240.15Fi-5 until
three years after the termination of such documentation and all
transactions governed thereby.
    (iii) A record of the results of each audit required to be
performed pursuant to Sec.  240.15Fi-5(c) until three years after the
conclusion of the audit.
* * * * *
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9. Section 240.18a-5, as proposed to be added at 79 FR 25193, May 2,
2014, is further amended by adding paragraphs (a)(18) and (b)(14) to
read as follows:

Sec.  240.18a-5   Records to be made by certain security-based swap
dealers and major security-based swap participants.

* * * * *
    (a) * * *
    (18)(i) A record of each security-based swap portfolio
reconciliation, whether conducted pursuant to Sec.  240.15Fi-3 or
otherwise, including the dates of the security-based swap portfolio
reconciliation, the number of portfolio reconciliation discrepancies,
the number of security-based swap valuation disputes (including the
time-to-resolution of each valuation dispute and the age of outstanding
valuation disputes, categorized by transaction and counterparty), and
the name of the third-party entity performing the security-based swap
portfolio reconciliation, if any.
    (ii) A copy of each notification required to be provided to the
Commission pursuant to Sec.  240.15Fi-3(c).
    (iii) A record of each bilateral offset and each bilateral
portfolio compression exercise or multilateral portfolio compression
exercise in which it participates, whether conducted pursuant to Sec.
240.15Fi-4 or otherwise, including the dates of the offset or
compression, the security-based swaps included in the offset or
compression, the identity of the counterparties participating in the
offset or compression, the results of the compression, and the name of
the third-party entity performing the offset or compression, if any.
* * * * *
    (b) * * *
    (14)(i) A record of each security-based swap portfolio
reconciliation, whether conducted pursuant to Sec.  240.15Fi-3 or
otherwise, including the dates of the security-based swap portfolio
reconciliation, the number of portfolio reconciliation discrepancies,
the number of security-based swap valuation disputes (including the
time-to-resolution of each valuation dispute and the age of outstanding
valuation disputes, categorized by transaction and counterparty), and
the name of the third-party entity performing the security-based swap
portfolio reconciliation, if any.
    (ii) A copy of each notification required to be provided to the
Commission pursuant to Sec.  240.15Fi-3(c).
    (iii) A record of each bilateral offset and each bilateral
portfolio compression exercise or multilateral portfolio compression
exercise in which it participates, whether conducted pursuant to Sec.
240.15Fi-4 or otherwise, including the dates of the offset or
compression, the security-based swaps included in the offset or
compression, the identity of the counterparties participating in the
offset or compression, the results of the compression, and the name of
the third-party entity performing the offset or compression, if any.
* * * * *
0
10. Section 240.18a-6, as proposed to be added at 79 FR 25193, May 2,
2014, is further amended by revising paragraphs (b)(1)(i) and (b)(2)(i)
and adding paragraphs (d)(4) and (d)(5) to read as follows:

Sec.  240.18a-6   Records to be preserved by certain security-based