bifurcated approach.\328\
---------------------------------------------------------------------------

    \328\ See id.
---------------------------------------------------------------------------

    The Commission also 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 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 Rule 15Fi-3. The Commission also
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 20 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
business 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 believes that the 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 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
believes that the five business day horizon is sufficient and serves as
an upper-bound by which time market participants should have addressed
and corrected any material discrepancies that arose 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, Rule 15Fi-3(c) will 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 will be required to be in a form and manner
acceptable to the Commission, and will 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). SBS Entities are also required to
promptly notify the Commission, in a form and manner acceptable to the
Commission, and any applicable prudential regulator, if the amount of
any security-based swap valuation dispute that was the subject of a
previous notice increases or decreases by more than $20,000,000 (or its
equivalent in any other currency), at either the transaction or
portfolio level.\329\
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    \329\ See supra Section II.A.5. Each amended notice is required
to be provided to the Commission and any applicable prudential
regulator no later than the last business day of the calendar month
in which the applicable security-based swap valuation dispute
increases or decreases by the applicable dispute amount.
---------------------------------------------------------------------------

    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 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.
    Pursuant to Rule 15Fi-3(d), the new requirements regarding
portfolio reconciliation will not apply to a security-based swap that
is, directly or indirectly, submitted to and cleared by a clearing
agency registered pursuant to Section 17A of the Exchange Act or by a
clearing agency that the Commission has exempted from registration by
rule or order pursuant to Section 17A.\330\ The Commission modified the
proposed exception for cleared security-based swaps so that it now
applies to the initial bilateral transaction between the original
counterparties (in addition to the resulting transactions between those
counterparties and the clearing agency once the original transaction
has been novated) and to permit the exception to be used when the
clearing agency has been exempted from registration pursuant to Section
17A of the Exchange Act.\331\ The Commission modified the exception in
this manner in response to comments received, as well as to be
consistent with the Commission's margin requirements for security-based
swap transactions and the approach taken by the CFTC,\332\

which should reduce implementation and compliance costs.
---------------------------------------------------------------------------

    \330\ See supra Section II.A.6.
    \331\ See id.
    \332\ Specifically, CFTC Rule Sec.  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(d).
---------------------------------------------------------------------------

    The Commission has considered as an alternative, allowing a SBS
Entity to be deemed in compliance with certain 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 concluded that differences between its 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 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 such an approach given that CFTC portfolio
reconciliation rules do not require all of this information to be
reconciled.\333\
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    \333\ See supra Section II.A for a discussion of the proposed
reconciliation rules and the verification of transaction data by
SDRs. See also supra note 57 for a discussion of differences between
CFTC and 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 a useful risk management tool.\334\
---------------------------------------------------------------------------

    \334\ See http://www2.isda.org/news/isda-publishes-paper-highlighting-achievements-in-portfolio-compression.
---------------------------------------------------------------------------

a. Requirements
    The Commission is adopting rules and providing interpretations that
generally will 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 Rule 15Fi-4(a), SBS Entities are 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.\335\ For transactions
with non-SBS Entities, the policies and procedures required under the
rule will require only that portfolio compression exercise would have
to occur when appropriate and only if requested by any such
counterparty.\336\
---------------------------------------------------------------------------

    \335\ See Rules 15Fi-4(a)(2) and (3).
    \336\ See Rule 15Fi-4(b).
---------------------------------------------------------------------------

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.\337\ 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.
---------------------------------------------------------------------------

    \337\ 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 248. 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 18. 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 286.
---------------------------------------------------------------------------

    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 Rule 15Fi-4(a), SBS
Entities are 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.\338\ To the extent that an SBS Entity transacts
with a counterparties that are not SBS Entities, the policies and
procedures required under the rule require only that portfolio
compression exercises occur when appropriate and only if requested by
any such counterparty. In the absence of these rules, some
counterparties may not participate in compression activities reducing
the potential benefits available to other counterparties and the
financial system generally.
---------------------------------------------------------------------------

    \338\ See supra Section II.B.
---------------------------------------------------------------------------

    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.
    These rules provide flexibility to security-based swap market
participants with respect to portfolio compression. The Commission
believes that by not adopting prescriptive requirements, an SBS Entity
can allow its 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 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. For example, certain portfolio compression exercises
could result in adverse credit exposures to certain counterparties. 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 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, Rules 15Fi-4(a)(1) and (b) 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 adopted by the Commission in this release.\339\
By closely aligning portfolio compression requirements through
consultation with the CFTC and European authorities, the Commission
believes that SBS Entities will benefit from a largely unitary
regulatory regime that does not require separate compliance and
operational policies and procedures.
---------------------------------------------------------------------------

    \339\ See supra note 6 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 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 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.\340\ 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.\341\ As that standardization continues, we
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 \342\ also
may result in increased standardization and therefore may reduce the
costs of identifying compression opportunities.
---------------------------------------------------------------------------

    \340\ 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.
    \341\ 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.'').
    \342\ 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 by Rule 15Fi-4 will impose
an initial cost of $1,302,135 in aggregate.\343\ 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
20 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 20 hours,
costing $461.75 per SBS Entity or $9,235 in aggregate.\344\ For the
remaining 35 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 $1,292,900, or
$36,940 per SBS Entity.\345\ Once established, the Commission estimates
that it will cost SBS Entities approximately $1,015,850 or $18,470 per
SBS Entity to revise and maintain these policies and procedures.\346\
---------------------------------------------------------------------------

    \343\ This figure has been updated from that in the Proposing
Release due to the updated estimate of the number of SBS Entities
that will be dually registered with the CFTC and updates to hourly
rates to account for inflation over the period. See supra note 310
and supra note 311.
    \344\ The estimate is based on the following: [((Compliance
Attorney (30 minutes) at $372 per hour) + ((Director of Compliance
(15 minutes) at $496 per hour) + ((Deputy General Counsel (15
minutes) at $607 per hour)] = $461.75 per hour per SBS Entity or
($461.75 per hour x 20 SBS dually-registered Entities) = $9,235.
    \345\ The estimate is based on the following: [((Compliance
Attorney (40 hours) at $372 per hour) + ((Director of Compliance (20
hours) at $496 per hour) + ((Deputy General Counsel (20 hours) at
$607 per hour)] = $36,940 per SBS Entity or ($36,940 x 20 SBS
Entities that are not dually-registered) = $1,292,900.
    \346\ The estimate is based on the following: [((Compliance
Attorney (20 hours) at $372 per hour) + ((Director of Compliance (10
hours) at $496 per hour) + ((Deputy General Counsel (10 hours) at
$607 per hour)] = $18,470 per SBS Entity or ($18,470 x 55 SBS
Entities) = $1,015,850 in aggregate.
---------------------------------------------------------------------------

    The Commission further estimates that an SBS Entity will devote
approximately 124.16 hours per year for portfolio offsets and
compression exercises (6,828.8 aggregate hours), a substantial portion
of which will be automated, and some of which may be handled by third-
party vendors.\347\

Similar to our discussion for portfolio reconciliation (Section
VII.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 35 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.
---------------------------------------------------------------------------

    \347\ 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 29.91 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 (29.91 + 88.25 + 6) = 124.16 hours, or
6828.8 hours (124.16 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 adopted 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 did not mandate the specific
contents of the policies and procedures created to comply with these
rules.\348\ However, a number of more specific requirements for
portfolio compression could be included. For example, the current rule
as adopted only requires policies and procedures that address
compression to the extent requested by the counterparty rather than a
more prescriptive requirement.\349\
---------------------------------------------------------------------------

    \348\ There is one exception to this statement. See supra note
97.
    \349\ See supra Section II.B.
---------------------------------------------------------------------------

    Pursuant to 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 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.\350\ 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 with little if any corresponding benefit.
---------------------------------------------------------------------------

    \350\ 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 by Rule 15Fi-3). For instance, if
counterparties have portfolios in excess of 500 transactions, an
analysis of portfolio compression could be conducted quarterly, while
for 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 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.
    Pursuant to Rule 15Fi-4(c), the new requirements regarding
portfolio compression will not apply to a security-based swap that is,
directly or indirectly, submitted to and cleared by a clearing agency
registered pursuant to Section 17A of the Exchange Act or by a clearing
agency that the Commission has exempted from registration by rule or
order pursuant to Section 17A.\351\ The Commission modified the
proposed exception for cleared security-based swaps so that it now
applies to the initial bilateral transaction between the original
counterparties (in addition to the resulting transactions between those
counterparties and the clearing agency

once the original transaction has been novated) and to permit the
exception to be used when the clearing agency has been exempted from
registration pursuant to Section 17A of the Exchange Act.\352\ The
Commission modified the exception in this manner in response to
comments received, as well as to be consistent with the Commission's
margin requirements for security-based swap transactions and the
approach taken by the CFTC,\353\ which should reduce implementation and
compliance costs.
---------------------------------------------------------------------------

    \351\ See supra Section II.B.3.
    \352\ See id.
    \353\ Specifically, CFTC Rule Sec.  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, allowing an SBS
Entity to be deemed in compliance with certain 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
concluded 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 believes that the
differences that do exist (such as the adopted 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) \354\ 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).\355\
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    \354\ See supra Section II.B.1.
    \355\ The corresponding CFTC compression rule applicable to
transactions with counterparties that are not Swap 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 Section II.B.1.
---------------------------------------------------------------------------

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.\356\ 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.
---------------------------------------------------------------------------

    \356\ 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 adopting rules and interpretations that generally
will 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 rules being adopted will also require that the
security-based swap trading relationship documentation include credit
support arrangements.\357\ 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.\358\
---------------------------------------------------------------------------

    \357\ See supra Section II.C.
    \358\ 15 U.S.C. 78c-5(f).
---------------------------------------------------------------------------

    The rules also will 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 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 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 provide 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, 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, 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 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
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 rules being adopted.
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 $4,666,103 per SBS
Entity, or $256,635,638 in aggregate across the 55 SBS Entities.\359\
The Commission further estimates that the development and
implementation of written policies and procedures as required under
Rule 15Fi-5 will impose an initial cost of $1,302,135 in
aggregate.\360\ Of the total 55 SBS Entities as expected by the
Commission that would be subject to Rule 15Fi-5, 20 are anticipated to
be registered concurrently with the CFTC, and are anticipated to
already have policies and procedures in place with respect to
relationship documentation. 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 20 hours, costing $461.75 per
Entity or $9,235 in aggregate.\361\ For the remaining 35 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 $1,292,900, or $36,940 per SBS Entity.\362\
Once established, the Commission estimates that it will cost SBS
Entities approximately $1,015,850 or $18,470 per SBS Entity to revise
and maintain these policies and procedures.\363\ Lastly, Rule 15Fi-5
requires periodic independent audits of the trading relationship
documentation. The Commission estimates that the costs associated with
these audits will be $853,760 per SBS Entity, or $46,956,800 in
aggregate.\364\
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    \359\ 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 15 hours per counterparty that is a SBS entity and 30 hours
per counterparty for all other counterparties. See Section VI.D.5.
The estimation is as follows: [((Compliance Manager (15 hours) x
$315) + (Director of Compliance (7.5 hours) x $496) + (Deputy
General Counsel (7.5 hours) x $607)) x 350 counterparties] +
[((Compliance Manager (7.5 hours) x $315) + (Director of Compliance
(3.75 hours) x $496) + (Deputy General Counsel (3.75 hours) x $607))
x 18 SBS entity counterparties] = $4,666,102.50 per SBS Entity, or
($4,666,102.50 x 55 SBS Entities) = $256,635,637.50 in aggregate.
    This figure has been updated from that in the Proposing Release
due to the updated estimate of the number of SBS Entities that will
be dually registered with the CFTC and updates to hourly rates to
account for inflation over the period. See supra note 310 and supra
note 311.
    \360\ Id.
    \361\ The estimate is based on the following: [((Compliance
Attorney (30 minutes) at $372 per hour) + ((Director of Compliance
(15 minutes) at $496 per hour) + ((Deputy General Counsel (15
minutes) at $607 per hour)] = $461.75 per hour per SBS Entity or
($461.75 per hour x 20 SBS dually-registered Entities) = $9,235.
    \362\ The estimate is based on the following: [((Compliance
Attorney (40 hours) at $372 per hour) + ((Director of Compliance (20
hours) at $496 per hour) + ((Deputy General Counsel (20 hours) at
$607 per hour)] = $36,940 per SBS Entity or ($36,940 x 35 SBS
Entities that are not dually-registered) = $1,292,900 in aggregate.
    \363\ The estimate is based on the following: [((Compliance
Attorney (20 hours) at $372 per hour) + ((Director of Compliance (10
hours) at $496 per hour) + ((Deputy General Counsel (10 hours) at
$607 per hour)] = $18,470 per SBS Entity or ($18,470 x 55 SBS
Entities) = $1,015,850 in aggregate.
    \364\ The estimate is based on the following: [368
counterparties x 10 hours per Audit x Auditor ($232 per hour)] =
$853,760 per SBS Entity, or ($853,760 x 55 SBS Entities) =
$46,956,800 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.\365\ Accordingly,
the Commission 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
these rules in the ordinary course of their businesses, including
documentation that contains several of the terms that will be required
by these 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 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.\366\
---------------------------------------------------------------------------

    \365\ As noted in Section VII.B.4, as of 2017, the DTCC-TIW data
shows that over 99% of SBS Entities use the ISDA Master Agreement.
    \366\ 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/.
---------------------------------------------------------------------------

    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 rule will 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 these 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 Rule 15Fi-3 even though
they are not subject to the documentation requirements of Rule 15Fi-5.
Such disputes could be costly to resolve and may lead to greater
uncertainty with respect to counterparty credit risk.
    The rule further provides exceptions for any security-based swap
that is, directly or indirectly, submitted to and cleared by a clearing
agency registered pursuant to Section 17A of the Exchange Act or by a
clearing agency that the Commission has exempted from registration by
rule or order pursuant to Section 17A. 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 rule will provide
an exception for security-based swaps executed anonymously on a
national securities exchange or an SB SEF, 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.\367\
---------------------------------------------------------------------------

    \367\ The exception with respect to security-based swap
transactions on national exchanges or SB SEF is limited. See Section
II.C for a complete discussion of those limitations.
---------------------------------------------------------------------------

d. Alternatives
    As proposed, Rule 15Fi-5(b)(1) would have required that the trading
relationship documentation also include terms governing ``applicable
regulatory reporting obligations (including pursuant to Regulation
SBSR).'' ISDA and SIFMA noted that the particular documentation
requirement would have essentially mirrored the reporting requirements
in Regulation SBSR, including the reporting hierarchy established by
that rule, which would be duplicative, burdensome and impose additional
costs on SBS Entities, and that also may not address the underlying SDR
verification issue.\368\ Accordingly, the Commission has carefully
considered these comments and has modified Rule 15Fi-5(b)(1), such that
it no longer requires that the trading relationship documentation
include terms governing applicable regulatory reporting obligations.
---------------------------------------------------------------------------

    \368\ See supra Section II.C.1. See also ISDA/SIFMA Letter.
---------------------------------------------------------------------------

    The Commission has evaluated reasonable alternatives to the rules
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 rule requires that SBS Entities undertake a periodic,
independent audit to identify material weaknesses in its documentation
policies and procedures. As adopted, 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.
    Rule 15Fi-5(a)(1)(ii) provides an exception to the trading
relationship documentation requirements for any security-based swap
that is, directly or indirectly, submitted to and cleared by a clearing
agency registered pursuant to Section 17A of the Exchange Act or by a
clearing agency that the Commission has exempted from registration by
rule or order pursuant to Section 17A.\369\ The Commission modified the
proposed exception for cleared security-based swaps so that it now
applies the initial bilateral transaction between the original
counterparties (in addition to the resulting transactions between those
counterparties and the clearing agency once the original transaction
has been novated) and to permit the exception to be used when the
clearing agency has been exempted from registration pursuant to Section
17A of the Exchange Act.\370\ The Commission modified the exception in
this manner in response to comments received, as well as to be
consistent with the Commission's margin requirements for security-based
swap transactions and the approach taken by the CFTC,\371\ which should
reduce implementation and compliance costs.
---------------------------------------------------------------------------

    \369\ See supra Section II.C.5.
    \370\ See id.
    \371\ Specifically, CFTC Rule Sec.  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, allowing an SBS
Entity to be deemed in compliance with certain 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 concluded 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 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 SB SEF that is then rejected for clearing but continues to
exist, the Commission believes that the counterparties to the ongoing
security-based swap should have in place a written agreement on the
terms of that transaction.\372\
---------------------------------------------------------------------------

    \372\ See supra Section II.C.
---------------------------------------------------------------------------

5. Recordkeeping Requirements
    The Commission is also adopting rules that will modify existing
Rules 17a-3 and 17a-4, as well as recently adopted Rules 18a-5 and 18a-
6 for the recordkeeping and reporting requirements applicable to SBS
Entities. The amendments will 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 Rule
15Fi-5, as well as each policy and procedure created pursuant to Rules
15Fi-3, 15Fi-4, and 15Fi-5.
a. Requirements
    The Commission is amending Rule 17a-3 (which applies to SBS
Entities that are also registered with the Commission as broker-
dealers) and recently adopted Rule 18a-5 (which applies to SBS Entities
that are not registered with the Commission as broker-dealers). Under
these amendments, each SBS Entity will 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 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 amendments will 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 amending Rule 17a-4 (which applies to SBS
Entities that are also registered with the Commission as broker-
dealers) and recently adopted 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
amendments to Rule 17a-3 and recently adopted Rule 18a-5 will need to
be retained for at least three years. Further, all policies and
procedures related to 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 will 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 recently adopted Rules 18a-5 and 18a-6 are
intended to facilitate oversight of SBS Entities, thus the benefits
associated with the 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 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
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. These include the costs of
creating procedures to ensure that records are kept as required and the
costs associated with ongoing record maintenance. As the recordkeeping
requirements are being adopted as amendments to Rules 17a-3 and 17a-4
and recently adopted Rules 18a-5 and 18a-6, the incremental costs of
compliance from these amendments is likely to be minimal.
    Rules 15Fi-3, 15Fi-4, and 15Fi-5 require that SBS Entities
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 will need to be made in
order to make the systems compliant with the 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 recently adopted 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 rule amendments.\373\
---------------------------------------------------------------------------

    \373\ See supra Section II.D.
---------------------------------------------------------------------------

d. Alternatives
    The Commission has considered reasonable alternatives to the
adopted 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.
    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.\374\ However,
because the rule would still encompass any auditor, whether external or
internal, that is in fact independent, the Commission believes that the
practical differences between the Commission's rule and the
corresponding CFTC rule are negligible.
---------------------------------------------------------------------------

    \374\ See supra Section II.C.
---------------------------------------------------------------------------

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.\375\
At the time the substituted compliance rule was initially adopted, 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.\376\
---------------------------------------------------------------------------

    \375\ See Business Conduct Standards Adopting Release, 81 FR at
30074.
    \376\ See Trade Acknowledgement and Verification Adopting
Release, 81 FR at 39827-28.
---------------------------------------------------------------------------

a. Requirements
    The Commission is further amending 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
Rules 15Fi-3 through 15Fi-5. The Commission has 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 in these rules.
b. Benefits
    The Commission is adopting amendments to Rule 3a71-6 to 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 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, 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 believes that the availability of substituted
compliance for portfolio reconciliation, portfolio compression, and
trading relationship documentation will not substantially alter the
benefits intended by 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 either by a foreign
regulatory jurisdiction on behalf of its market participants, or by the
registered market participant itself.\377\ 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.
---------------------------------------------------------------------------

    \377\ See Cross-Border Adopting Release, 79 FR at 47277.
---------------------------------------------------------------------------

VIII. Regulatory Flexibility Act Certification

    The Regulatory Flexibility Act of 1980 (``RFA'') \378\ requires the
Commission, in promulgating rules, to consider the impact of those
rules on small entities. Section 603(a) \379\ of the Administrative
Procedure Act,\380\ as amended by the RFA, the Commission certified in
the Proposing Release that new Rules 15Fi-3 through 15Fi, and the
proposed amendments to Rules 3a71-6, 15Fi-1, 17a-3, 17a-4, 18a-5 and
18a-6 would not have a significant economic impact on any ``small
entity'' \381\ for purposes of the RFA.\382\ The Commission received no
comments on its certification.
---------------------------------------------------------------------------

    \378\ 5 U.S.C. 601 et seq.
    \379\ 5 U.S.C. 603(a).
    \380\ 5 U.S.C. 551 et seq.
    \381\ 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
rulemaking, are set forth in 17 CFR 240.0-10 (``Rule 0-10''). See
Statement of Management on Internal Accounting Control, Exchange Act
Release No. 18451 (Jan. 28, 1982), 47 FR 5215 (Feb. 4, 1982).
    \382\ See Proposing Release, 84 FR at 4670-71.
---------------------------------------------------------------------------

    For purposes of Commission rulemaking in connection with the
RFA,\383\ 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; \384\ 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,\385\ 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.\386\ 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; \387\ (ii)
for entities engaged in non-depository credit intermediation and
certain other activities, entities with $7 million or less in annual
receipts; \388\ (iii) for entities engaged in financial investments and
related activities, entities with $7 million or less in annual
receipts; \389\ (iv) for insurance carriers and entities engaged in
related activities, entities with $7 million or less in annual
receipts; \390\ and (v) for funds, trusts, and other financial
vehicles, entities with $7 million or less in annual receipts.\391\
---------------------------------------------------------------------------

    \383\ 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
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)
    \384\ See 17 CFR 240.0-10(a).
    \385\ 17 CFR 240.17a-5(d).
    \386\ See 17 CFR 240.0-10(c).
    \387\ See 13 CFR 121.201 (Subsector 522).
    \388\ See id. at Subsector 522.
    \389\ See id. at Subsector 523.
    \390\ See id. at Subsector 524.
    \391\ See id. at Subsector 525.
---------------------------------------------------------------------------

    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
will 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.\392\
---------------------------------------------------------------------------

    \392\ See Proposing Release, 84 FR at 4670; 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).
---------------------------------------------------------------------------

    For the foregoing reasons, the Commission certifies that Rules
15Fi-3 through 15Fi, and the amendments to Rules 3a71-6, 15Fi-1, 17a-3,
17a-4, 18a-5 and 18a-6 will not have a significant economic impact on a
substantial number of small entities for the purposes of the RFA.

IX. Other Matters

    Pursuant to the Congressional Review Act,\393\ the Office of
Information and Regulatory Affairs has designated these rules as a
``major rule,'' as defined by 5 U.S.C. 804(2).
---------------------------------------------------------------------------

    \393\ 5 U.S.C. 801 et seq.
---------------------------------------------------------------------------

    If any of the provisions of these final rules, or the application
thereof to any person or circumstance, is held to be invalid, such
invalidity shall not affect other provisions or application of such
provisions to other persons or circumstances that can be given effect
without the invalid provision or application.

Statutory Basis

    Pursuant to the Exchange Act, 15 U.S.C. 78a et seq., as amended,
and particularly sections 3(b), 15F, 17, and 23(a) (15 U.S.C. 78c(b),
78o-10, 78q, 78w(a), and 78mm), the Commission is amending Sec. Sec.
240.3a71-6, 240.15Fi-1, 240.17a-3, 240.17a-4, 240.18a-5, and 240.18a-6
and adopting Sec. Sec.  240.15Fi-3, 240.15Fi-4, and 240.15Fi-5 under
the Exchange Act.

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 is amending 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, 78dd, 78ll, 78mm,
80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, and 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; Pub. L. 111-203, 939A, 124 Stat. 1376 (2010); and Pub. L. 112-
106, sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *

0
2. Section 240.3a71-6 is amended by adding paragraph (d)(7) to read as
follows:

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

* * * * *
    (d) * * *
    (7) 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 240.15Fi-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. Sec.  240.15Fi-1 through 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) Solely for purposes of Sec.  240.15Fi-2, 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 each term that is required to be
reported to a registered security-based 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 Sec.  240.18a-3 (and any subsequent regulations
promulgated pursuant to section 15F(e) of the Act (15 U.S.C. 78o-
10(e))) pending resolution of the discrepancy in valuation. For
purposes of this paragraph (a)(5), 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 (b)(4),
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--(1) Notice
requirement. 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:
    (i) Three business days, if the dispute is with a counterparty that
is a security-based swap dealer or major security-based swap
participant; or
    (ii) Five business days, if the dispute is with a counterparty that
is not a security-based swap dealer or major security-based swap
participant.
    (2) Amendments. Each security-based swap dealer and major security-
based swap participant shall notify the Commission, in a form and
manner acceptable to the Commission, and any applicable prudential
regulator, if the amount of any security-based swap valuation dispute
that was the subject of a previous notice made pursuant to paragraph
(c)(1) of this section increases or decreases by more than $20,000,000
(or its equivalent in any other currency), at either the transaction or
portfolio level. Such amended notice shall be provided to the
Commission and any applicable prudential regulator no later than the
last business day of the calendar month in which the applicable
security-based swap valuation dispute increases or decreases by the
applicable dispute amount.
    (d) Reconciliation of cleared security-based swaps. Nothing in this
section shall apply to any security-based swap that is, directly or
indirectly, submitted to and cleared by a clearing agency registered
pursuant to section 17A of the Act (15 U.S.C. 78q-1) or by a clearing
agency that the Commission has exempted from registration by rule or
order pursuant to section 17A of the Act (15 U.S.C. 78q-1).

0
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 security-based swap that is,
directly or indirectly, submitted to and cleared by a clearing agency
registered pursuant to section 17A of the Act (15 U.S.C. 78q-1) or by a
clearing agency that the Commission has exempted from registration by
rule or order pursuant to section 17A of the Act (15 U.S.C. 78q-1).

0
6. Section 240.15Fi-5 is added to read as follows:

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

    (a) Scope--(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 security-based swap that is, directly or indirectly,
submitted to and cleared by a clearing agency registered pursuant to
section 17A of the Act (15 U.S.C. 78q-1) or by a clearing agency that
the Commission has exempted from registration by rule or order pursuant
to section 17A of the Act (15 U.S.C. 78q-1); 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, 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 the notice requirement in section 3E(f)(1)(A) of the
Act (15 U.S.C. 78c-5(f)(1)(A)) (and either Sec.  240.15c3-3(p)(4)(i) or
Sec.  240.18a-4(d)(1) thereunder, as applicable), 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
Sec.  240.18a-3 (and any subsequent regulations promulgated pursuant to
section 15F(e) of the Act (15 U.S.C. 78o-10(e))), and the risk
management requirements under section 15F(j) of the Act (15 U.S.C. 78o-
10(j)) of the Act and Sec.  240.15Fh-3(h)(2)(iii)(I) (and any
subsequent regulations promulgated pursuant to section 15F(j) of the
Act (15 U.S.C. 78o-10(j))). 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 (b)(4) 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 is amended by adding paragraph (a)(31) to read as
follows:

Sec.  240.17a-3  Records to be made by certain exchange members,
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 is amended by revising paragraph (b)(1) and adding
paragraphs (e)(11) and (12) 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), (6) through (11), (16), (18) through (20), and (25) through
(31), and analogous records created pursuant to Sec.  240.17a-3(e).
* * * * *
    (e) * * *
    (11) 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.
    (12)(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.
* * * * *

0
9. Section 240.18a-5 is 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 is amended by revising paragraphs (b)(1)(i) and
(b)(2)(i) and adding paragraphs (d)(4) and (5) to read as follows:

Sec.  240.18a-6   Records to be preserved by certain security-based
swap dealers and major security-based swap participants.

* * * * *
    (b) * * *
    (1) * * *
    (i) All records required to be made pursuant to Sec.  240.18a-
5(a)(5) through (9) and (12) through (18).
* * * * *
    (2) * * *

    (i) All records required to be made pursuant to Sec.  240.18a-
5(b)(4) through (7) and (9) through (14).
* * * * *
    (d) * * *
    (4) 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.
    (5)(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.
* * * * *

    Dated: December 18, 2019.

    By the Commission.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2019-27762 Filed 2-3-20; 8:45 am]
 BILLING CODE 8011-01-P