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The CFTC approved four final rules (the “Internal Business Conduct Rules”) affecting duties of swap dealers (“SDs”) and major swap participants (“MSPs”) today, with Chairman Gensler and Commissioners Chilton and Wetjen voting in support of the rules over pointed dissents of Commissioners O’Malia and Sommers. The text of the rules has not been released yet, but the following summary draws from fact sheets released by the Commission with the rulemaking.

(1) Reporting, Recordkeeping, and Daily Trading Records Requirements for SDs and MSPs.

Under this final rule, SDs and MSPs must keep records including full and complete transaction and position information for all swap activities, including all documents on which trade information is originally recorded. Transaction records must be maintained in a manner that is identifiable and searchable by transaction and by counterparty. The final rule also requires that SDs and MSPs keep basic business records, including, among other things, minutes from meetings of the entity’s governing body, organizational charts, and audit documentation. Additionally, certain financial records, records of complaints against personnel, and marketing materials must be kept. Finally, swap dealers and major swap participants must maintain records of information required to be submitted to a swap data repository and reported on a real-time public basis.

The final rule prescribes daily trading record requirements. Pre-execution trade data must be kept, including records of all oral and written communications that lead to the execution of a swap. SDs and MSPs must preserve all information necessary to conduct a comprehensive and accurate trade reconstruction for each swap. Execution trade data must be kept, including all terms of each executed swap and date and time of execution. Post-execution data must be kept, including records of all confirmations, reconciliations, and margining of swaps. Finally, records must also be kept for all cash or forward transactions used to hedge, mitigate the risk of, or offset any swap held by the SD or MSP.

(2) Risk Management Duties for SDs and MSPs

Under the final rule implementing new section 4s(j) of the Commodity Exchange Act, SDs and MSPs must establish a risk management program consisting of written policies and procedures designed to monitor and manage the risks associated with their swap activities. Such program must take into account the following risks and any other relevant risk: market, credit, liquidity, foreign currency, legal, operational, and settlement risks. SDs and MSPs must establish polices for monitoring their traders throughout each trading day for compliance with trading limits established by the firm and require traders to follow established procedures for executing and confirming transactions. SDs and MSPs are required to provide diligent supervision of traders and to separate traders from their risk management units.

SDs and MSPs must establish procedures to monitor for and prevent violations of applicable position limits established by the CFTC or regulated exchanges and to:

1) provide annual training for personnel;
2) diligently monitor and supervise trading;
3) implement an early warning system;
4) test their position limit procedures;
5) document compliance with position limits on a quarterly basis; and
6) audit the procedures annually.

In addition, they must establish a business continuity and disaster recovery plan designed to enable them to resume operations on the business day following an emergency and adopt policies and procedures to prohibit antitrust-type violations.

(3) Conflicts of Interest for SDS, MSPs, Futures Commission Merchants (“FCMs”) and Introducing Brokers (“IBs”)

This rule places restrictions on influencing research analysts employed by SDs, MSPs, FCMs, and IBs, calling for separation of such analysts from a registrant’s trading functions, disclosing their financial interests, and prohibiting retaliation against them for reports adversely impacting the registrant’s business activities.

(4) Designation of Chief Compliance Officer (“CCO”) and Preparation of Annual Compliance Report by SDs and MSPs

Under the Dodd-Frank Act, SDs and MSPs must designate a CCO. The related final rule just approved identifies the following duties of a CCO:

• establish compliance policies;
• resolve conflicts of interest;
• take reasonable steps to ensure compliance of the registrant with the compliance policies, CEA requirements, and Commission regulations;
• identify noncompliance issues; and
• establish procedures for the remediation of such noncompliance issues.

The rule requires each CCO to prepare an annual report that would contain, among other things:

• a description of the registrant’s compliance with the CEA, Commission regulations, and the registrant’s own compliance policies;
• an assessment of the effectiveness of the registrant’s policies;
• a discussion of areas for improvement;
• a description of the resources set aside for compliance; and
• a description of any non-compliance issues identified and addressed.

Dissenting Commissioners

Commissioners O’Malia and Sommers provided statements severely criticizing the final rules. Commissioner O’Malia was particularly harsh regarding what he sees as a glaring failure by the Commission to provide an adequate cost-benefit analysis of the rules as required under the Commodity Exchange Act and by Executive Order, stating:

After reviewing the Internal Business Conduct Rules, I have reached a tipping point and can no longer tolerate the application of such weak standards to analyzing the costs and benefits of our rulemakings. Our inability to develop a quantitative analysis, or to develop a reasonable comparative analysis of legitimate options, hurts the credibility of this Commission and undermines the quality of our rules. I believe it is time for professional help, and I will be following up this statement with a letter to the Director of the OMB seeking an independent review of the Internal Business Conduct Rules to determine whether or not this rulemaking fully complies with the President’s Executive Orders. . . .

Commissioner Sommers lamented the duplicative nature of many requirements and concluded:

We consistently reject reasoned comments from industry professionals with little justification in our cost benefit analysis to support those rejections. . . . I do not believe that these rules have a chance of withstanding the test of time, and instead believe that this Commission will be consumed over the next few years using our valuable resources to rewrite rules that we knew or should have known would not work when we issued them.

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