[Federal Register Volume 76, Number 99 (Monday, May 23, 2011)]
[Proposed Rules]
[Pages 29818-29900]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-11008]
[[Page 29817]]
Vol. 76
Monday,
No. 99
May 23, 2011
Part II
Commodity Futures Trading Commission
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17 CFR Part 1
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Securities and Exchange Commission
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17 CFR Part 240
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Further Definition of ``Swap,'' ``Security-Based Swap,'' and
``Security-Based Swap Agreement''; Mixed Swaps; Security-Based Swap
Agreement Recordkeeping; Proposed Rule
Federal Register / Vol. 76 , No. 99 / Monday, May 23, 2011 / Proposed
Rules
[[Page 29818]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
RIN 3038-AD46
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 33-9204; 34-64372; File No. S7-16-11]
RIN 3235-AL14
Further Definition of ``Swap,'' ``Security-Based Swap,'' and
``Security-Based Swap Agreement''; Mixed Swaps; Security-Based Swap
Agreement Recordkeeping
AGENCIES: Commodity Futures Trading Commission; Securities and Exchange
Commission.
ACTION: Joint proposed rules; proposed interpretations.
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SUMMARY: In accordance with section 712(a)(8), section 712(d)(1),
sections 712(d)(2)(B) and (C), sections 721(b) and (c), and section
761(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act
(``Dodd-Frank Act''), the Commodity Futures Trading Commission
(``CFTC'') and the Securities and Exchange Commission (``SEC'')
(collectively, ``Commissions''), in consultation with the Board of
Governors of the Federal Reserve System (``Board''), are jointly
issuing proposed rules and proposed interpretive guidance under the
Commodity Exchange Act (``CEA'') and the Securities Exchange Act of
1934 (``Exchange Act'') to further define the terms ``swap,''
``security-based swap,'' and ``security-based swap agreement''
(collectively, ``Product Definitions''), regarding ``mixed swaps,'' and
governing books and records with respect to ``security-based swap
agreements.''
DATES: Comments should be received on or before July 22, 2011.
ADDRESSES: Comments may be submitted, identified by File No. S7-16-11,
by any of the following methods:
CFTC:
Agency Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments
through the Web site.
Mail: David A. Stawick, Secretary, Commodity Futures
Trading Commission, Three Lafayette Centre, 1155 21st Street, NW.,
Washington, DC 20581.
Hand Delivery/Courier: Same as mail above.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Please submit your comments using only one method. ``Product
Definitions'' must be in the subject field of responses submitted via
e-mail, and clearly indicated on written submissions. All comments must
be submitted in English, or if not, accompanied by an English
translation. Comments will be posted as received to http://www.cftc.gov. You should submit only information that you wish to make
available publicly. If you wish the CFTC to consider information that
you believe is exempt from disclosure under the Freedom of Information
Act, a petition for confidential treatment of the exempt information
may be submitted according to the procedures established in section
145.9 of the CFTC's regulations.\1\
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\1\ 17 CFR 145.9.
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The CFTC reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from www.cftc.gov that it may deem to be inappropriate for
publication, including obscene language. All submissions that have been
redacted or removed that contain comments on the merits of the
rulemaking will be retained in the public comment file and will be
considered as required under the Administrative Procedure Act and other
applicable laws, and may be accessible under the Freedom of Information
Act.
SEC
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml);
Send an e-mail to [email protected]. Please include
File Number S7-16-11 on the subject line; or
Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090. All submissions should refer to File Number
S7-16-11. This file number should be included on the subject line if e-
mail is used. To help us process and review your comments more
efficiently, please use only one method. The SEC will post all comments
on the SEC's Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments are also available for Web site viewing and
printing in the SEC's Public Reference Room, 100 F Street, NE.,
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 p.m. All comments received will be posted without change;
the SEC does not edit personal identifying information from
submissions. You should submit only information that you wish to make
available publicly.
FOR FURTHER INFORMATION CONTACT: CFTC: Julian E. Hammar, Assistant
General Counsel, at 202-418-5118, [email protected], Mark Fajfar,
Assistant General Counsel, at 202-418-6636, [email protected], or David
E. Aron, Counsel, at 202-418-6621, [email protected], Office of General
Counsel, Commodity Futures Trading Commission, Three Lafayette Centre,
1155 21st Street, NW., Washington, DC 20581; SEC: Matthew A. Daigler,
Senior Special Counsel, at 202-551-5578, Cristie L. March, Attorney-
Adviser, at 202-551-5574, or Leah M. Drennan, Attorney-Adviser, at 202-
551-5507, Division of Trading and Markets, or Michael J. Reedich,
Special Counsel, or Tamara Brightwell, Senior Special Counsel to the
Director, at 202-551-3500, Division of Corporation Finance, Securities
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-7010.
SUPPLEMENTARY INFORMATION: The Commissions jointly are proposing new
rules and interpretive guidance under the CEA and the Exchange Act
relating to the Product Definitions, mixed swaps, and security-based
swap agreements.
Table of Contents
I. Background
II. Scope of Definitions of Swap and Security-Based Swap
A. Introduction
B. Proposed Rules and Interpretive Guidance Regarding Certain
Transactions Outside the Scope of the Definitions of the Terms
``Swap'' and ``Security-Based Swap''
1. Insurance Products
(a) Types of Insurance Products
(b) Providers of Insurance Products
2. The Forward Contract Exclusion
(a) Forward Contracts in Nonfinancial Commodities
(b) Commodity Options and Commodity Options Embedded in Forward
Contracts
(c) Security Forwards
3. Consumer and Commercial Agreements, Contracts, and
Transactions
4. Loan Participations
C. Proposed Rules and Interpretive Guidance Regarding Certain
Transactions Within the Scope of the Definitions of the Terms
``Swap'' and ``Security-Based Swap''
1. In General
[[Page 29819]]
2. Foreign Exchange Products
(a) Foreign Exchange Products Subject to the Secretary's Swap
Determination: Foreign Exchange Forwards and Foreign Exchange Swaps
(b) Foreign Exchange Products Not Subject to the Secretary's
Swap Determination
(i) Foreign Currency Options
(ii) Non-Deliverable Forward Contracts Involving Foreign
Exchange
(iii) Currency Swaps and Cross-Currency Swaps
3. Forward Rate Agreements
4. Combinations and Permutations of, or Options on, Swaps and
Security-Based Swaps
5. Contracts for Differences
D. Certain Interpretive Issues
1. Agreements, Contracts, or Transactions That May Be Called, or
Documented Using Form Contracts Typically Used for, Swaps or
Security-Based Swaps
2. Transactions in Regional Transmission Organizations and
Independent System Operators
III. The Relationship Between the Swap Definition and the Security-
Based Swap Definition
A. Introduction
B. Title VII Instruments Based on Interest Rates, Other Monetary
Rates, and Yields
1. Title VII Instruments Based on Interest Rates or Other
Monetary Rates That Are Swaps
2. Title VII Instruments Based on Yields
3. Title VII Instruments Based on Government Debt Obligations
C. Total Return Swaps
D. Security-Based Swaps Based on a Single Security or Loan and
Single-Name Credit Default Swaps
E. Title VII Instruments Based on Futures Contracts
F. Use of Certain Terms and Conditions in Title VII Instruments
G. The Term ``Narrow-Based Security Index'' in the Security-
Based Swap Definition
1. Introduction
2. Applicability of the Statutory Narrow-Based Security Index
Definition and Past Guidance of the Commissions to Title VII
Instruments
3. Narrow-Based Security Index Criteria for Index Credit Default
Swaps
(a) In General
(b) Proposed Rules Regarding the Definitions of ``Issuers of
Securities in a Narrow-Based Security Index'' and ``Narrow-Based
Security Index'' for Index Credit Default Swaps
(i) Number and Concentration Percentages of Reference Entities
or Securities
(ii) Public Information Availability Regarding Reference
Entities and Securities
(iii) Treatment of Indexes Including Reference Entities That Are
Issuers of Exempted Securities or Including Exempted Securities
4. Security Indexes
5. Evaluation of Title VII Instruments on Security Indexes That
Move From Broad-Based to Narrow-Based or Narrow-Based to Broad-Based
(a) In General
(b) Title VII Instruments on Security Indexes Traded on
Designated Contract Markets, Swap Execution Facilities, Foreign
Boards of Trade, Security-Based Swap Execution Facilities, and
National Securities Exchanges
H. Method of Settlement of Index CDS
I. Security-Based Swaps as Securities Under the Exchange Act and
Securities Act
IV. Mixed Swaps
A. Scope of the Category of Mixed Swap
B. Regulation of Mixed Swaps
1. Introduction
2. Bilateral Uncleared Mixed Swaps Entered Into by Dually-
Registered Dealers or Major Participants
3. Regulatory Treatment for Other Mixed Swaps
V. Security-Based Swap Agreements
A. Introduction
B. Swaps That Are Security-Based Swap Agreements
C. Books and Records Requirements for Security-Based Swap
Agreements
VI. Process for Requesting Interpretations of the Characterization
of a Title VII Instrument
VII. Anti-Evasion
A. CFTC Proposed Anti-Evasion Rules
B. SEC Request for Comment Regarding Anti-Evasion
VIII. Administrative Law Matters--CEA Revisions
IX. Administrative Law Matters--Exchange Act Revisions
X. Statutory Basis and Rule Text
I. Background
On July 21, 2010, President Obama signed the Dodd-Frank Act into
law.\2\ Title VII of the Dodd-Frank Act \3\ (``Title VII'') established
a comprehensive new regulatory framework for swaps and security-based
swaps. The legislation was enacted, among other reasons, to reduce
risk, increase transparency, and promote market integrity within the
financial system, including by: (i) Providing for the registration and
comprehensive regulation of swap dealers, security-based swap dealers,
major swap participants, and major security-based swap participants;
(ii) imposing clearing and trade execution requirements on swaps and
security-based swaps, subject to certain exceptions; (iii) creating
rigorous recordkeeping and real-time reporting regimes; and (iv)
enhancing the rulemaking and enforcement authorities of the Commissions
with respect to, among others, all registered entities and
intermediaries subject to the Commissions' oversight.
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\2\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the
Dodd-Frank Act is available at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.
\3\ Pursuant to section 701 of the Dodd-Frank Act, Title VII may
be cited as the ``Wall Street Transparency and Accountability Act of
2010.''
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Section 712(d)(1) of the Dodd-Frank Act provides that the
Commissions, in consultation with the Board, shall jointly further
define the terms ``swap,'' ``security-based swap,'' and ``security-
based swap agreement'' (``SBSA'').\4\ Section 712(a)(8) of the Dodd-
Frank Act provides further that the Commissions shall jointly prescribe
such regulations regarding ``mixed swaps'' as may be necessary to carry
out the purposes of Title VII. In addition, sections 721(b) and 761(b)
of the Dodd-Frank Act provide that the Commissions may adopt rules to
further define terms included in subtitles A and B, respectively, of
Title VII, and sections 721(c) and 761(b) of the Dodd-Frank Act provide
the Commissions with authority to define the terms ``swap'' and
``security-based swap,'' as well as the terms ``swap dealer,'' ``major
swap participant,'' ``security-based swap dealer,'' and ``major
security-based swap participant,'' to include transactions and entities
that have been structured to evade the requirements of subtitles A and
B, respectively, of Title VII.
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\4\ In addition, section 719(d)(1)(A) of the Dodd-Frank Act
requires the Commissions to conduct a joint study, within 15 months
of enactment, to determine whether stable value contracts, as
defined in section 719(d)(2) of the Dodd-Frank Act, are encompassed
by the swap definition. If the Commissions determine that stable
value contracts are encompassed by the swap definition, section
719(d)(1)(B) of the Dodd-Frank Act requires the Commissions jointly
to determine whether an exemption for those contracts from the swap
definition is appropriate and in the public interest. Section
719(d)(1)(B) also requires the Commissions to issue regulations
implementing the determinations made under the required study. Until
the effective date of such regulations, the requirements under Title
VII do not apply to stable value contracts, and stable value
contracts in effect prior to the effective date of such regulations
are not considered swaps. See section 719(d) of the Dodd-Frank Act.
The Commissions currently are conducting the required joint study
and will consider whether to propose any implementing regulations
(including, if appropriate, regulations determining that stable
value contracts: (i) are not encompassed within the swap definition;
or (ii) are encompassed within the definition but are exempt from
the swap definition) at the conclusion of that study.
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Section 712(d)(2)(B) of the Dodd-Frank Act requires the
Commissions, in consultation with the Board, to jointly adopt rules
governing books and records requirements for SBSAs by persons
registered as swap data repositories (``SDRs'') under the CEA,\5\
including uniform rules that specify the data elements that shall be
collected and maintained by each SDR.\6\ Similarly,
[[Page 29820]]
section 712(d)(2)(C) of the Dodd-Frank Act requires the Commissions, in
consultation with the Board, to jointly adopt rules governing books and
records for SBSAs, including daily trading records, for swap dealers,
major swap participants, security-based swap dealers, and security-
based swap participants.\7\
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\5\ 7 U.S.C. 1 et seq.
\6\ The CFTC has issued proposed rules regarding SDRs and,
separately, swap data recordkeeping and reporting. See Regulations
Establishing and Governing the Duties of Swap Dealers and Major Swap
Participants, 75 FR 71397, Nov. 23, 2010; Swap Data Recordkeeping
and Reporting Requirements, 75 FR 76573, Dec. 8, 2010. The SEC has
also issued proposed rules regarding security-based swap data
repositories (``SBSDRs''), including rules specifying data
collection and maintenance standards for SBSDRs, as well as rules
regarding security-based swap data recordkeeping and reporting. See
Security-Based Swap Data Repository Registration, Duties, and Core
Principles, 75 FR 77306, Dec. 10, 2010; Regulation SBSR--Reporting
and Dissemination of Security-Based Swap Information, 75 FR 75208,
Dec. 2, 2010.
\7\ The CFTC has issued proposed rules regarding recordkeeping
requirements for swap dealers and major swap participants. See
Reporting, Recordkeeping, and Daily Trading Records Requirements for
Swap Dealers and Major Swap Participants, 75 FR 76666, Dec. 9, 2010.
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Under the comprehensive framework for regulating swaps and
security-based swaps established in Title VII, the CFTC is given
regulatory authority over swaps,\8\ the SEC is given regulatory
authority over security-based swaps,\9\ and the Commissions shall
jointly prescribe such regulations regarding mixed swaps as may be
necessary to carry out the purposes of Title VII.\10\ In addition, the
SEC is given antifraud authority over, and access to information from,
certain CFTC-regulated entities regarding SBSAs, which are a type of
swap related to securities over which the CFTC is given regulatory
authority.\11\
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\8\ Section 721(a) of the Dodd-Frank Act defines the term
``swap'' by adding section 1a(47) to the CEA, 7 U.S.C. 1a(47). This
new swap definition also is cross-referenced in new section 3(a)(69)
of the Exchange Act, 15 U.S.C. 78c(a)(69). Citations to provisions
of the CEA and the Exchange Act, 15 U.S.C. 78a et seq., in this
release refer to the numbering of those provisions after the
effective date of Title VII, except as indicated.
\9\ Section 761(a) of the Dodd-Frank Act defines the term
``security-based swap'' by adding new section 3(a)(68) to the
Exchange Act, 15 U.S.C. 78c(a)(68). This new security-based swap
definition also is cross-referenced in new CEA section 1a(42), 7
U.S.C. 1a(42). The Dodd-Frank Act also explicitly includes security-
based swaps in the definition of security under the Exchange Act and
the Securities Act of 1933 (``Securities Act''), 15 U.S.C. 77a et
seq.
\10\ Section 721(a) of the Dodd-Frank Act describes the category
of ``mixed swap'' by adding new section 1a(47)(D) to the CEA, 7
U.S.C. 1a(47)(D). Section 761(a) of the Dodd-Frank Act also includes
the category of ``mixed swap'' by adding new section 3(a)(68)(D) to
the Exchange Act, 15 U.S.C. 78c(68)(D). A mixed swap is defined as a
subset of security-based swaps that also are based on the value of 1
or more interest or other rates, currencies, commodities,
instruments of indebtedness, indices, quantitative measures, other
financial or economic interest or property of any kind (other than a
single security or a narrow-based security index), or the
occurrence, non-occurrence, or the extent of the occurrence of an
event or contingency associated with a potential financial,
economic, or commercial consequence (other than the occurrence, non-
occurrence, or extent of the occurrence of an event relating to a
single issuer of a security or the issuers of securities in a
narrow-based security index, provided that such event directly
affects the financial statements, financial condition, or financial
obligations of the issuer).
\11\ Section 761(a) of the Dodd-Frank Act defines the term
``security-based swap agreement'' by adding new section 3(a)(78) to
the Exchange Act, 15 U.S.C. 78c(a)(78). The CEA includes the
definition of ``security-based swap agreement'' in subparagraph
(A)(v) of the swap definition in CEA section 1a(47), 7 U.S.C.
1a(47). The only difference between these definitions is that the
definition of SBSA in the Exchange Act specifically excludes
security-based swaps (see section 3(a)(78)(B) of the Exchange Act,
15 U.S.C. 78c(a)(78)(B)), whereas the definition of SBSA in the CEA
does not contain a similar exclusion. Instead, under the CEA, the
exclusion for security-based swaps is placed in the general
exclusions from the swap definition (see CEA section 1a(47)(B)(x), 7
U.S.C. 1a(47)(B)(x)). Although the statutes are slightly different
structurally, the Commissions interpret them to have consistent
meaning that the category of security-based swap agreements excludes
security-based swaps.
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To assist the Commissions in further defining the Product
Definitions (as well as certain other definitions) and in prescribing
regulations regarding mixed swaps as may be necessary to carry out the
purposes of Title VII, the Commissions published an advance notice of
proposed rulemaking (``ANPR'') in the Federal Register on August 20,
2010.\12\ The comment period for the ANPR closed on September 20,
2010.\13\ The Commissions received comments addressing the Product
Definitions and/or mixed swaps in response to the ANPR, as well as
comments in response to the Commissions' informal solicitations,\14\
from a wide range of commenters.
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\12\ See Definitions Contained in Title VII of Dodd-Frank Wall
Street Reform and Consumer Protection Act, 75 FR 51429, Aug. 20,
2010. The ANPR also solicited comment regarding the definitions of
the terms ``swap dealer,'' ``security-based swap dealer,'' ``major
swap participant,'' ``major security-based swap participant,'' and
``eligible contract participant.'' These definitions are the subject
of a separate joint proposed rulemaking by the Commissions. See
Further Definition of ``Swap Dealer,'' ``Security-Based Swap
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap
Participant'' and ``Eligible Contract Participant,'' 75 FR 80174,
Dec. 21, 2010 (``Entity Definitions''). The Commissions also
provided the public with the ability to present their views more
generally on implementation of the Dodd-Frank Act through their Web
sites, dedicated electronic mailboxes, and meetings with interested
parties. See Public Comments on SEC Regulatory Initiatives Under the
Dodd-Frank Act/Meetings with SEC Officials located at http://www.sec.gov/spotlight/regreformcomments.shtml; Public Submissions,
located at http://comments.cftc.gov/PublicComments/ReleasesWithComments.aspx; External Meetings, located at http://www.cftc.gov/LawRegulation/DoddFrankAct/ExternalMeetings/index.htm.
\13\ Copies of all comments received by the SEC on the ANPR are
available on the SEC's Internet Web site, located at http://www.sec.gov/comments/s7-16-10/s71610.shtml. Comments are also
available for Web site viewing and printing in the SEC's Public
Reference Room, 100 F Street, NE., Washington, DC 20549, on official
business days between the hours of 10 a.m. and 3 p.m. Copies of all
comments received by the CFTC on the ANPR are available on the
CFTC's Internet Web site, located at http://www.cftc.gov/LawRegulation/DoddFrankAct/OTC_2_Definitions.html.
\14\ See supra note 12.
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The Commissions have reviewed the comments received, and the staffs
of the Commissions have met with many market participants and other
interested parties to discuss the definitions.\15\ Moreover, the
Commissions' staffs have consulted extensively with each other as
required by sections 712(a)(1) and (2) of the Dodd-Frank Act and have
consulted with staff of the Board as required by section 712(d) of the
Dodd-Frank Act.
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\15\ Information about meetings that CFTC staff have had with
outside organizations regarding the implementation of the Dodd-Frank
Act is available at http://www.cftc.gov/LawRegulation/DoddFrankAct/ExternalMeetings/index.htm. Information about meetings that SEC
staff have had with outside organizations regarding the product
definitions is available at http://www.sec.gov/comments/s7-16-10/s71610.shtml#meetings. The views expressed in the comments in
response to the ANPR, in response to the Commissions' informal
solicitations, and at such meetings are collectively referred to as
the views of ``commenters.''
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Based on this review and consultation, the Commissions are
proposing interpretive guidance, and in some instances also proposing
rules, regarding, among other things: (i) The regulatory treatment of
insurance products; (ii) the exclusion of forward contracts from the
swap and security-based swap definitions; (iii) the regulatory
treatment of certain consumer and commercial contracts; (iv) the
regulatory treatment of certain foreign-exchange related and other
instruments; (v) swaps and security-based swaps involving interest
rates (or other rates) and yields; (vi) total return swaps (``TRS'');
(vii) the application of the definition of ``narrow-based security
index'' in distinguishing between certain swaps and security-based
swaps, including credit default swaps (``CDS'') and index CDS; and
viii) the specification of certain swaps and security-based swaps that
are, and are not, mixed swaps. In addition, the Commissions are
proposing rules: (i) establishing books and records requirements
applicable to SBSAs; (ii) providing a mechanism for requesting the
Commissions to interpret whether a particular type of agreement,
contract, or transaction (or class of agreements, contracts, or
transactions) is a swap, security-based swap, or both (i.e., a mixed
swap); and (iii) providing a mechanism for evaluating the applicability
of certain regulatory requirements to particular mixed swaps. Finally,
the CFTC is proposing rules to
[[Page 29821]]
implement the anti-evasion authority provided in the Dodd-Frank Act.
The Commissions believe that the proposed rules and interpretive
guidance will further the purposes of Title VII. While the Commissions
believe that these proposals, if adopted, would appropriately effect
the intent of the Dodd-Frank Act, the Commissions are very interested
in commenters' views as to whether those purposes have been achieved,
and, if not, how to improve these proposals.
II. Scope of Definitions of Swap and Security-Based Swap
A. Introduction
Title VII of the Dodd-Frank Act applies to a wide variety of
agreements, contracts, and transactions classified as swaps or
security-based swaps. The statute lists these agreements, contracts,
and transactions in the definition of the term ``swap.'' \16\ The
statutory definition of the term ``swap'' also has various
exclusions,\17\ rules of construction, and other provisions for the
interpretation of the definition.\18\ One of the exclusions to the
definition of the term ``swap'' is for security-based swaps.\19\ The
term ``security-based swap,'' in turn, is defined as an agreement,
contract, or transaction that is a ``swap'' (without regard to the
exclusion from that definition for security-based swaps) and that also
has certain characteristics specified in the statute.\20\ Thus, the
statutory definition of the term ``swap'' also determines the scope of
agreements, contracts, and transactions that could be security-based
swaps.
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\16\ See CEA section 1a(47)(A), 7 U.S.C. 1a(47)(A). This swap
definition is also cross-referenced in new section 3(a)(69) of the
Exchange Act, 15 U.S.C. 78c(a)(69).
\17\ See CEA section 1a(47)(B), 7 U.S.C. 1a(47)(B), clauses (i)-
(x).
\18\ See CEA sections 1a(47)(C)-(F), 7 U.S.C. 1a(47)(C)-(F).
\19\ See CEA section 1a(47)(B)(x), 7 U.S.C. 1a(47)(B)(x).
\20\ See section 3(a)(68) of the Exchange Act, 15 U.S.C.
78c(a)(68).
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The statutory definitions of ``swap'' and ``security-based swap''
are detailed and comprehensive, and the Commissions believe that
extensive ``further definition'' of the terms by rule is not necessary.
Nevertheless, several commenters have stated,\21\ and the Commissions
agree, that the definitions could be read to include certain types of
agreements, contracts, and transactions that previously have not been
considered swaps or security-based swaps and that nothing in the
legislative history of the Dodd-Frank Act appears to suggest that
Congress intended such agreements, contracts, and transactions to be
regulated as swaps or security-based swaps under Title VII. The
Commissions thus believe that it is important to clarify the treatment
under the definitions of certain types of agreements, contracts, and
transactions, such as insurance products and certain consumer and
commercial contracts.
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\21\ See, e.g., Letter from Edward J. Rosen, Cleary Gottlieb
Steen & Hamilton LLP, Sept. 21, 2010 (``Cleary Letter''); Letter
from Robert Pickel, Executive Vice President, International Swaps
and Derivatives Association, Inc., Sept. 20, 2010 (``ISDA Letter'').
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In addition, commenters also raised questions regarding, and the
Commissions believe that it is important to clarify: (i) The exclusion
for forward contracts from the definitions of the terms ``swap'' and
``security-based swap;'' and (ii) the status of certain commodity-
related products (including various foreign exchange products and
forward rate agreements (``FRAs'')) under the definitions of the terms
``swap'' and ``security-based swap.'' Finally, the Commissions are
providing guidance regarding certain interpretive issues related to the
definitions.\22\
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\22\ Some commenters raised concerns regarding the treatment of
inter-affiliate swaps and security-based swaps. See, e.g., Cleary
Letter; Letter from Coalition for Derivatives End Users, Sept. 20,
2010 (``CDEU Letter''); ISDA Letter; Letter from Richard A. Miller,
Vice President and Corporate Counsel, Prudential Financial Inc.,
Sept. 17, 2010; Letter from Richard M. Whiting, The Financial
Services Roundtable, Sept. 20, 2010. A few commenters suggested that
the Commissions should further define the term ``swap'' or
``security-based swap'' to exclude inter-affiliate transactions. See
Cleary Letter; CDEU Letter. The Commissions are considering whether
inter-affiliate swaps or security-based swaps should be treated
differently from other swaps or security-based swaps in the context
of the Commissions' other Title VII rulemakings.
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B. Proposed Rules and Interpretive Guidance Regarding Certain
Transactions Outside the Scope of the Definitions of the Terms ``Swap''
and ``Security-Based Swap''
1. Insurance Products
A number of commenters expressed concern that the definitions of
the terms ``swap'' and ``security-based swap'' potentially could
include certain types of insurance products \23\ because the statutory
definition of the term ``swap'' includes, in part, any agreement,
contract, or transaction ``that provides for any purchase, sale,
payment, or delivery (other than a dividend on an equity security) that
is dependent on the occurrence, nonoccurrence, or the extent of the
occurrence of an event or contingency associated with a potential
financial, economic, or commercial consequence.'' \24\ The Commissions
do not interpret this clause to mean that products historically treated
as insurance products should be included within the swap or security-
based swap definition.\25\
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\23\ See, e.g., Letter from Ernest C. Goodrich, Jr., Managing
Director--Legal Department, and Marcelo Riffaud, Managing Director--
Legal Department, Deutsche Bank AG, Sept. 20, 2010 (``Deutsche Bank
Letter''); Letter from Sean W. McCarthy, Chairman, Association of
Financial Guaranty Insurers, Sept. 20, 2010 (``AFGI Letter'');
Letter from Robert J. Duke, The Surety & Fidelity Association of
America, Sept. 20, 2010 (``SFAA Letter''); Letter from J. Stephen
Zielezienski, Senior Vice President & General Counsel, American
Insurance Association, Sept. 20, 2010; Letter from Franklin W.
Nutter, President, Reinsurance Association of America, Sept. 20,
2010 (``RAA Letter''); Letter from James M. Olsen, Senior Director
Accounting and Investment Policy, Property Casualty Insurers
Association of America, Sept. 17, 2010; Letter from Jane L. Cline,
President, and Therese M. Vaughan, Chief Executive Officer, National
Association of Insurance Commissioners, Sept. 20, 2010; Letter from
Joseph W. Brown, Chief Executive Officer, MBIA Inc., Sept. 20, 2010
(``MBIA Letter''); Cleary Letter; Letter from White & Case LLP
(``White & Case Letter''), Sept. 20, 2010; Letter from Carl B.
Wilkerson, Vice President and Chief Counsel, Securities &
Litigation, American Council of Life Insurers, Nov. 12, 2010 (``ACLI
Letter''); Letter from Stephen E. Roth, James M. Cain, and W. Thomas
Conner, Sutherland Asbill & Brennan LLP, for the Committee of
Annuity Insurers, Dec. 3, 2010.
\24\ CEA section 1a(47)(A)(ii), 7 U.S.C. 1a(47)(A)(ii).
\25\ The Commissions also believe it was not the intent of
Congress through the swap and security-based swap definitions to
preclude the provision of insurance to individual homeowners and
small businesses that purchase property and casualty insurance. See
CEA section 2(e), 7 U.S.C. 2(e) and section 6(l) of the Exchange
Act, 15 U.S.C. 78f(l) (prohibiting individuals and small businesses
that do not meet specified financial thresholds or other conditions
from entering into swaps or security-based swaps other than on or
subject to the rules of regulated futures and securities exchanges).
---------------------------------------------------------------------------
The Commissions are aware of nothing in Title VII to suggest that
Congress intended for insurance products to be regulated as swaps or
security-based swaps. Moreover, that swaps and insurance products are
subject to different regulatory regimes is reflected in section 722(b)
of the Dodd-Frank Act which, in new section 12(h) of the CEA, provides
that a swap ``shall not be considered to be insurance'' and ``may not
be regulated as an insurance contract under the law of any State.''
\26\
[[Page 29822]]
Accordingly, the Commissions believe that state or Federally regulated
insurance products that are provided by state or Federally regulated
insurance companies \27\ that otherwise could fall within the
definitions should not be considered swaps or security-based swaps so
long as they satisfy the proposed rules or comport with the related
proposed interpretive guidance.\28\ At the same time, however, the
Commissions are concerned that agreements, contracts, or transactions
that are swaps or security-based swaps might be characterized as
insurance products to evade the regulatory regime under Title VII of
the Dodd-Frank Act. Accordingly, the Commissions are proposing rules
and interpretive guidance that would clarify that agreements,
contracts, or transactions meeting certain requirements would be
considered insurance and not swaps or security-based swaps.
---------------------------------------------------------------------------
\26\ 7 U.S.C. 16(h). Moreover, other provisions of the Dodd-
Frank Act address the status of insurance more directly, and more
extensively, than Title VII. For example, Title V of the Dodd-Frank
Act requires the newly established Federal Insurance Office to
conduct a study and submit a report to Congress, within 18 months of
enactment of the Dodd-Frank Act, on the regulation of insurance,
including the consideration of Federal insurance regulation.
Notably, the Federal Insurance Office's authority under Title V
extends primarily to monitoring and information gathering; its
ability to promulgate Federal insurance regulation that preempts
state insurance regulation is significantly restricted. See section
502 of the Dodd-Frank Act (codified in various sections of 31
U.S.C.). Title X of the Dodd-Frank Act also specifically excludes
the business of insurance from regulation by the Bureau of Consumer
Financial Protection. See section 1027(m) of the Dodd-Frank Act, 12
U.S.C. 5517(m) (``The [Bureau of Consumer Financial Protection] may
not define as a financial product or service, by regulation or
otherwise, engaging in the business of insurance.''); section
1027(f) of the Dodd-Frank Act, 12 U.S.C. 5517(f) (excluding persons
regulated by a state insurance regulator, except to the extent they
are engaged in the offering or provision of consumer financial
products or services or otherwise subject to certain consumer laws
as set forth in Title X of the Dodd-Frank Act).
\27\ As discussed above, the establishment of the Federal
Insurance Office under Title V of the Dodd-Frank Act suggests that
Federal insurance law could be established in the future. The
Commissions believe that the proposed rules should, therefore,
include a specific reference to Federal insurance law.
\28\ To the extent an insurance product does not fall within the
language of the swap definition by its terms, it would not need to
satisfy the requirements under the proposed rules in order to avoid
being considered a swap or security-based swap.
---------------------------------------------------------------------------
The proposed rules contain two subparts; the first subpart
addresses the agreement, contract, or transaction and the second
subpart addresses the entity providing that agreement, contract, or
transaction. More specifically, with respect to the former, paragraph
(i) of proposed rule 1.3(xxx)(4) under the CEA and paragraph (a) of
proposed rule 3a69-1 under the Exchange Act would clarify, as discussed
in more detail below, that the terms ``swap'' and ``security-based
swap'' would not include an agreement, contract, or transaction that,
by its terms or by law, as a condition of performance:
Requires the beneficiary of the agreement, contract, or
transaction to have an insurable interest that is the subject of the
agreement, contract, or transaction and thereby carry the risk of loss
with respect to that interest continuously throughout the duration of
the agreement, contract, or transaction;
Requires that loss to occur and to be proved, and that any
payment or indemnification therefor be limited to the value of the
insurable interest;
Is not traded, separately from the insured interest, on an
organized market or over-the-counter; and
With respect to financial guaranty insurance only, in the
event of payment default or insolvency of the obligor, any acceleration
of payments under the policy is at the sole discretion of the insurer.
In addition, the second subpart of the proposed rules, in paragraph
(ii) of proposed rule 1.3(xxx)(4) under the CEA and paragraph (b) of
proposed rule 3a69-1 under the Exchange Act, would require that, in
order to be excluded from the swap and security-based swap definitions
as an insurance product, the agreement, contract, or transaction must
be provided:
By a company that is organized as an insurance company
whose primary and predominant business activity is the writing of
insurance or the reinsuring of risks underwritten by insurance
companies and that is subject to supervision by the insurance
commissioner (or similar official or agency) of any state \29\ or by
the United States or an agency or instrumentality thereof, and such
agreement, contract, or transaction is regulated as insurance under the
laws of such state or the United States;
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\29\ The term ``State'' is defined in section 3(a)(16) of the
Exchange Act to mean ``any State of the United States, the District
of Columbia, Puerto Rico, the Virgin Islands, or any other
possession of the United States.'' 15 U.S.C. 78c(a)(16). The CFTC is
proposing to incorporate this definition into proposed rule
1.3(xxx)(4) for purposes of ensuring consistency between the CFTC
and SEC rules further defining the term ``swap.''
---------------------------------------------------------------------------
By the United States or any of its agencies or
instrumentalities, or pursuant to a statutorily authorized program
thereof; or
In the case of reinsurance only, by a person located
outside the United States to an insurance company that is eligible
under the proposed rules, provided that: (i) such person is not
prohibited by any law of any state or of the United States from
offering such agreement, contract, or transaction to such an insurance
company; (ii) the product to be reinsured meets the requirements under
the proposed rules to be an insurance product; and (iii) the total
amount reimbursable by all reinsurers for such insurance product cannot
exceed the claims or losses paid by the cedant.\30\
---------------------------------------------------------------------------
\30\ The ``cedant'' is the insurer writing the risk being ceded
or transferred to such person located outside the United States.
---------------------------------------------------------------------------
In order for an agreement, contract, or transaction to qualify as
an insurance product that would not be a swap or security-based swap:
(i) The agreement, contract, or transaction would have to meet the
criteria in the first subpart of the proposed rules and (ii) the person
or entity providing the agreement, contract, or transaction would have
to meet the criteria in the second subpart of the proposed rules.\31\
The fact that an agreement, contract, or transaction qualifies as an
insurance product does not exclude it from the swap or security-based
swap definitions if it is not provided by a qualifying person or
entity, nor does the fact that a product is regulated by an insurance
regulator exclude it from the swap or security-based swap definitions
if the agreement, contract, or transaction does not satisfy the
criteria for insurance set forth in the proposed rules.\32\
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\31\ The Commissions note that certain variable life insurance
and annuity products are securities and would not be swaps or
security-based swaps regardless of whether they met the requirements
under the proposed rules. See CEA section 1a(47)(B)(v), 7 U.S.C.
1a(47)(B)(v) (excluding from the definition of ``swap'' any
``agreement, contract, or transaction providing for the purchase or
sale of 1 or more securities on a fixed basis that is subject to--
(I) the [Securities Act]; and (II) the [Exchange Act]''). See also
SEC v. United Benefit Life Ins. Co., 387 U.S. 202 (1967) (holding
that a ``flexible fund'' annuity contract was not entitled to
exemption under section 3(a)(8) of the Securities Act, 15 U.S.C.
77c(a)(8), for insurance and annuities); SEC v. Variable Annuity
Life Ins. Co., 359 U.S. 65 (1959) (holding that a variable annuity
was not entitled to exemption under section 3(a)(8) of the
Securities Act, 15 U.S.C. 77c(a)(8), for insurance and annuities).
\32\ The Commissions note that Title VII provides flexibility to
address the facts and circumstances of new products that may be
marketed or sold as insurance, for the purpose of determining
whether they satisfy the requirements of the proposed rules, through
joint interpretations pursuant to section 712(d)(4) of the Dodd-
Frank Act.
---------------------------------------------------------------------------
In addition, the Commissions are proposing interpretive guidance to
clarify that, independent of paragraph (i) of proposed rule 1.3(xxx)(4)
under the CEA and paragraph (a) of proposed rule 3a69-1 under the
Exchange Act, certain insurance products do not fall within the swap or
security-based swap definitions so long as they are provided in
accordance with paragraph (ii) of proposed rule 1.3(xxx)(4) under the
CEA and paragraph (b) of proposed rule 3a69-1 under the Exchange Act.
(a) Types of Insurance Products \33\
---------------------------------------------------------------------------
\33\ See supra note 23, regarding comments received addressing
this criterion.
---------------------------------------------------------------------------
Paragraph (i) of proposed rule 1.3(xxx)(4) under the CEA and
paragraph (a) of proposed rule 3a69-1 under the Exchange Act would set
forth four criteria for an agreement, contract, or transaction to be
considered insurance. First, the proposed rules would require that the
beneficiary have an ``insurable interest'' underlying the
[[Page 29823]]
agreement, contract, or transaction at every point in time during the
term of the agreement, contract, or transaction for that agreement,
contract, or transaction to qualify as insurance. The requirement that
the beneficiary be at risk of loss (which could be an adverse
financial, economic, or commercial consequence) with respect to the
interest that is the subject of the agreement, contract, or transaction
at all times throughout the term of the agreement, contract, or
transaction would ensure that an insurance contract beneficiary has a
stake in the interest on which the agreement, contract, or transaction
is written.\34\ Similarly, the provision of the proposed rules that
would require the beneficiary to have the insurable interest
continuously during the term of the agreement, contract, or transaction
is designed to ensure that payment on the insurance product is
inextricably connected to both the beneficiary and the interest on
which the insurance product is written. In contrast to an insurance
product, a CDS (which may be a swap or a security-based swap) does not
require the purchaser of protection to hold any underlying obligation
issued by the reference entity on which the CDS is written.\35\
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\34\ Requiring that a beneficiary of an insurance policy have a
stake in the interest traditionally has been justified on public
policy grounds. For example, a beneficiary that does not have a
property right in a building might have an incentive to profit from
arson.
\35\ Standard CDS documentation stipulates that the incurrence
or demonstration of a loss may not be made a condition to the
payment on the CDS or the performance of any obligation pursuant to
the CDS. See, e.g., Int'l Swaps and Derivatives Ass'n, ``2003 ISDA
Credit Derivatives Definitions,'' art. 9.1(b)(i) (2003) (``2003
Definitions) (``[T]he parties will be obligated to perform * * *
irrespective of the existence or amount of the parties' credit
exposure to a Reference Entity, and Buyer need not suffer any loss
nor provide evidence of any loss as a result of the occurrence of a
Credit Event.'').
---------------------------------------------------------------------------
Second, the requirement that an actual loss occur and be proved
under the proposed rules similarly would ensure that the beneficiary
has a stake in the insurable interest that is the subject of the
agreement, contract, or transaction. If the beneficiary can demonstrate
actual loss, that loss would ``trigger'' performance by the insurer on
the agreement, contract, or transaction such that, by making payment,
the insurer is indemnifying the beneficiary for such loss. In addition,
limiting any payment or indemnification to the value of the insurable
interest aids in distinguishing swaps and security-based swaps (where
there is no such limit) from insurance.\36\
---------------------------------------------------------------------------
\36\ To the extent an insurance product provides for such items
as, for example, a rental car for use while the car that is the
subject of an automobile insurance policy is being repaired, the
Commissions would consider such items as constituting part of the
value of the insurable interest.
---------------------------------------------------------------------------
Third, the proposed rules would require that the insurance product
not be traded, separately from the insured interest, on an organized
market or over-the-counter. With limited exceptions,\37\ insurance
products traditionally have been neither entered into on or subject to
the rules of an organized exchange nor traded in secondary market
transactions (i.e., they are not traded on an organized market or over-
the-counter). Whereas swaps and security-based swaps also generally
have not been tradable at-will in secondary market transactions (i.e.,
on an organized market or over-the-counter) without counterparty
consent, the Commissions understand that swaps and security-based swaps
are routinely novated or assigned to third parties, usually pursuant to
industry standard terms and documents.\38\ For the foregoing reasons,
the Commissions believe that lack of trading separately from the
insured interest is a feature of insurance that is useful in
distinguishing insurance from swaps and security-based swaps.
---------------------------------------------------------------------------
\37\ See, e.g., ``Life Settlements Task Force, Staff Report to
the United States Securities and Exchange Commission'' (``In an
effort to help make the bidding process more efficient and to
facilitate trading of policies after the initial settlement occurs,
some intermediaries have considered or instituted a trading platform
for life settlements.''), available at http://www.sec.gov/news/studies/2010/lifesettlements-report.pdf (July 22, 2010).
\38\ See, e.g., Int'l Swaps and Derivatives Ass'n, ``2005
Novation Protocol,'' available at http://www.isda.org/2005novationprot/docs/NovationProtocol.pdf (2005); Int'l Swaps and
Derivatives Ass'n, ``ISDA Novation Protocol II,'' available at
http://www.isda.org/isdanovationprotII/docs/NPII.pdf (2005); Int'l
Swaps and Derivatives Ass'n, 2003 Definitions, supra note 35,
Exhibits E (Novation Agreement) and F (Novation Confirmation).
---------------------------------------------------------------------------
Fourth, the proposed rules would address financial guarantee
policies, also known as bond insurance or bond wraps.\39\ Although such
products can be economically similar to products such as CDS, they have
certain key characteristics that distinguish them from swaps and
security-based swaps.\40\ For example, under a financial guarantee
policy, the insurer typically is required to make timely payment of any
shortfalls in the payment of scheduled interest to the holders of the
underlying guaranteed obligation. Also, for particular bonds that are
covered by a financial guarantee policy, the indenture, related
documentation, and/or the financial guarantee policy will provide that
a default in payment of principal or interest on the underlying bond
will not result in acceleration of the obligation of the insurer to
make payment of the full amount of principal on the underlying
guaranteed obligation unless the insurer, in its sole discretion, opts
to make payment of principal prior to the final scheduled maturity date
of the underlying guaranteed obligation. Conversely, under a CDS, a
protection seller frequently is required to make payment of the
relevant settlement amount to the protection buyer upon demand by the
protection buyer after any credit event involving the issuer.\41\
---------------------------------------------------------------------------
\39\ Several commenters expressed concern that the swap and
security-based swap definitions could encompass financial guarantee
policies. See, e.g., AFGI Letter; Letter from James M. Michener,
General Counsel, Assured Guaranty, Dec. 14, 2010 (``Assured Guaranty
Letter''); MBIA Letter; Letter from the Committee on Futures and
Derivatives Regulation of the New York City Bar Association, Sept.
20, 2010. Financial guarantee policies are used by entities such as
municipalities to provide greater assurances to potential purchasers
of their bonds and thus reduce their interest costs. See ``Report by
the United States Securities and Exchange Commission on the
Financial Guarantee Market: The Use of the Exemption in section
3(a)(2) of the Securities Act of 1933 for Securities Guaranteed by
Banks and the Use of Insurance Policies to Guarantee Debt
Securities'' (Aug. 28, 1987).
\40\ See, e.g., AFGI Letter (explaining the differences between
financial guaranty policies and CDS); Letter from James M. Michener,
General Counsel, Assured Guaranty, Sept. 13, 2010 (noting that the
Financial Accounting Standards Board has issued separate guidance on
accounting for financial guaranty insurance and CDS); Deutsche Bank
Letter (noting that financial guaranty policies require the
incurrence of loss for payment, whereas CDS do not).
\41\ While a CDS requires payment in full on the occurrence of a
credit event, the Commissions recognize that there are other
financial instruments, such as corporate guarantees of commercial
loans and letters of credit supporting payments on loans or debt
securities, that allow for acceleration of payment obligations
without such guarantees or letters of credit being swaps or
security-based swaps.
---------------------------------------------------------------------------
The Commissions do not believe that financial guarantee policies,
in general, should be regulated as swaps or security-based swaps.
However, because of the close economic similarity of financial
guarantee insurance policies guaranteeing payment on debt securities to
CDS, the Commissions also are proposing that, in addition to the
criteria noted above with respect to insurance generally, financial
guarantee policies also would have to satisfy the requirement that they
not permit the beneficiary of the policy to accelerate the payment of
any principal due on the debt securities. This requirement would
further distinguish financial guarantee policies from CDS because, as
discussed above, the latter generally requires payment of the relevant
settlement amount on the CDS after demand by the protection buyer.
[[Page 29824]]
The Commissions believe that requiring all of the criteria in
paragraph (i) of proposed rule 1.3(xxx)(4) under the CEA and paragraph
(a) of proposed rule 3a69-1 under the Exchange Act would help limit the
application of the proposed rules to products appropriately regulated
as insurance and provide that products appropriately subject to the
regulatory regime under Title VII of the Dodd-Frank Act are regulated
as swaps or security-based swaps. As a result, the Commissions believe
that these requirements would help prevent the proposed rules from
being used to circumvent the applicability of the swap and security-
based swap regulatory regimes under Title VII.
However, the Commissions are considering an additional criterion as
well. One ANPR commenter suggested that the proposed rules require
that, in order to qualify as insurance that is excluded from the swap
definition, payment on an agreement, contract, or transaction not be
based on the price, rate, or level of a financial instrument, asset, or
interest or any commodity.\42\ Such a requirement could help to prevent
swaps from being executed in the guise of insurance in order to avoid
the regulatory regime established by Title VII. It may ensure that an
agreement, contract, or transaction is not treated as insurance if it
is used for speculative purposes or to influence prices in derivatives
markets. Yet, another ANPR commenter stated that such a requirement for
an agreement, contract, or transaction to qualify as insurance rather
than a swap ``is not consistent with common variable life insurance and
variable annuity products, which deliver insurance guarantees that do
vary with the performance of specified assets.'' \43\
---------------------------------------------------------------------------
\42\ See Cleary Letter.
\43\ See ACLI Letter.
---------------------------------------------------------------------------
The Commissions request comment on whether, in order for an
agreement, contract, or transaction to be considered insurance pursuant
to paragraph (i) of proposed rule 1.3(xxx)(4) under the CEA and
paragraph (a) of proposed rule 3a69-1 under the Exchange Act, the
Commissions should require that payment not be based on the price,
rate, or level of a financial instrument, asset, or interest or any
commodity. If so, the Commissions also request comment on whether
variable annuity contracts (where the income is subject to tax
treatment under section 72 of the Internal Revenue Code) and variable
universal life insurance should be excepted from such a
requirement.\44\
---------------------------------------------------------------------------
\44\ 26 U.S.C. 72. See also supra note 31.
---------------------------------------------------------------------------
Although the proposed criteria should appropriately identify
agreements, contracts, and transactions that should be considered to be
insurance, the Commissions also are proposing interpretive guidance
that certain enumerated types of insurance products are outside the
scope of the statutory definitions of swap and security-based swap
under the Dodd-Frank Act. These products are surety bonds, life
insurance, health insurance, long-term care insurance, title insurance,
property and casualty insurance, and annuity products the income on
which is subject to tax treatment under section 72 of the Internal
Revenue Code.\45\ The Commissions believe that these enumerated
insurance products do not bear the characteristics of the transactions
that Congress subjected to the regulatory regime for swaps and
security-based swaps under the Dodd-Frank Act.\46\ As a result,
excluding these enumerated insurance products should appropriately
place traditional insurance products outside the scope of the swap and
security-based swap definitions. Such insurance products, however,
would need to be provided in accordance with paragraph (ii) of proposed
rule 1.3(xxx)(4) under the CEA and paragraph (b) of proposed rule 3a69-
1 under the Exchange Act, as discussed below, and such insurance
products would need to be regulated as insurance.
---------------------------------------------------------------------------
\45\ Id.
\46\ The list of enumerated insurance products is generally
consistent with the provisions of section 302(c)(2) of the Gramm-
Leach-Bliley Act (``GLBA''), 15 U.S.C. 6712(c)(2), which addresses
insurance underwriting in national banks.
---------------------------------------------------------------------------
(b) Providers of Insurance Products
The second subpart of the proposed rules, in paragraph (ii) of
proposed rule 1.3(xxx)(4) under the CEA and paragraph (b) of proposed
rule 3a69-1 under the Exchange Act, would require that, in addition to
meeting the product requirements discussed above (or being subject to
the interpretive guidance regarding enumerated insurance products
provided above) the agreement, contract, or transaction be provided by
a person or entity that meets certain criteria. Generally, the product
would have to be provided by a company that is organized as an
insurance company whose primary and predominant business activity is
the writing of insurance or the reinsuring of risks underwritten by
companies whose insurance business is subject to supervision by the
insurance commissioner (or similar official or agency) of any state
\47\ or by the United States or an agency or instrumentality thereof,
and such agreement, contract, or transaction is regulated as insurance
under the laws of such state or of the United States.\48\
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\47\ See supra note 29, regarding the definition of ``State''
contained in the proposed rules.
\48\ This paragraph of the proposed rules is substantially
similar to the definition of an insurance company under the Federal
securities laws. See section 2(a)(13) of the Securities Act, 15
U.S.C. 77b(a)(13); section 2(a)(17) of the Investment Company Act of
1940, 15 U.S.C. 80a-2(a)(17). These definitions also include
reinsurance companies. In order to ensure regulatory consistency,
the Commissions believe that it is appropriate to include
substantially the same definition of an insurance company as
currently exists elsewhere in the Federal securities laws, but the
Commissions are requesting comment regarding the role played by a
receiver or similar official or any liquidating agent for such
insurance company, in its capacity as such, rather than proposing
this provision of the insurance company definition.
---------------------------------------------------------------------------
The requirement that the agreement, contract, or transaction be
provided by a state or Federally regulated insurance company would help
ensure that entities that are not regulated under insurance laws are
not able to avoid regulation under Title VII of the Dodd-Frank Act as
well. The Commissions believe that this requirement also should help
prevent regulatory gaps that otherwise might exist between insurance
regulation and the regulation of swaps and security-based swaps.
The proposed rules also would require that the agreement, contract,
or transaction provided by the insurance company be regulated as
insurance under the laws of the state in which it is regulated or the
United States. The purpose of this proposed requirement is that an
agreement, contract, or transaction that satisfies the other conditions
of the proposed rules must be subject to regulatory oversight as an
insurance product. As a result of the requirement that an insurance
regulator must have determined that the agreement, contract, or
transaction being sold is insurance (i.e., because state insurance
regulators are banned from regulating swaps as insurance),\49\ the
Commissions believe that this condition would help prevent products
that are swaps or security-based swaps from being characterized as
insurance products in order to evade the regulatory regime under Title
VII of the Dodd-Frank Act.
---------------------------------------------------------------------------
\49\ See section 722(b) of the Dodd-Frank Act.
---------------------------------------------------------------------------
The Commissions also believe that it is appropriate to exclude
insurance that is issued by the United States or any of its agencies or
instrumentalities, or pursuant to a statutorily authorized program
thereof, from regulation as swaps or security-based swaps. Such
[[Page 29825]]
insurance would include, for example, Federal insurance of savings in
banks, savings associations, and credit unions; catastrophic crop
insurance; flood insurance; Federal insurance of certain pension
obligations; and terrorism risk insurance. Accordingly, the proposed
rules would provide that products meeting the criteria discussed above
that are required for an agreement, contract, or transaction to qualify
as insurance are excluded from the swap and security-based swap
definitions if they are provided by the Federal government or pursuant
to a statutorily authorized program thereof.
Finally, the Commissions believe that where an agreement, contract,
or transaction qualifies as insurance excluded from the swap and
security-based swap definitions, the lawful reinsurance of that
agreement, contract, or transaction similarly should be excluded. Such
reinsurance would be excluded from the definitions even if the
reinsurer is located abroad and is not state or Federally regulated.
Accordingly, the proposed rules would provide that an agreement,
contract, or transaction of reinsurance would be excluded from the swap
and security-based swap definitions if it is provided by a person
located outside the United States, if such person is not prohibited by
any law of any state or the United States from offering such
reinsurance to a state or Federally regulated insurance company, so
long as the product to be reinsured meets the requirements under the
proposed rules to be an insurance product, and the total amount
reimbursable by all reinsurers for such insurance product cannot exceed
the claims or losses paid by the cedant.
The proposed rules would cover only an agreement, contract, or
transaction by an insurance company and would not affect the
characterization of the asset that is being insured. For example, if an
agreement, contract, or transaction insures or guarantees the payment
on a security, the security would remain subject to all applicable
securities laws. The guarantee agreement, contract, or transaction,
however, would not be regulated as a swap or security-based swap if it
meets all of the requirements of the proposed rules.\50\
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\50\ The guarantee agreement, contract, or transaction, however,
could itself be a security that is subject to the Federal securities
laws.'' See, e.g., section 2(a)(1) of the Securities Act, 15 U.S.C.
77b(a)(1) (including in the statutory definition of ``security'' a
guarantee of a security).
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One commenter has stated that monoline insurance companies (also
called financial guarantors) continue to guarantee payments under
interest rate swaps related to municipal debt.\51\ The CFTC believes
that an insurance ``wrap'' of a swap may not be sufficiently different
from the underlying swap to suggest that Congress intended the former
to fall outside the definition of the term ``swap'' in Title VII.
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\51\ See Letter from Bruce E. Stern, Chairman, Association of
Financial Guaranty Insurers Government Affairs Committee, Feb. 18,
2011, at 11-12 (``[F]inancial guarantors have often guaranteed,
through the issuance of a financial guaranty insurance policy, the
obligations of unaffiliated parties under swaps with other
unaffiliated parties. These insurance policies typically cover
obligations of municipalities under interest rate or basis swaps
relating to bonds issued by municipalities or in connection with
asset backed securities.'').
---------------------------------------------------------------------------
The SEC, however, believes that, where an agreement, contract, or
transaction is a security-based swap, the insurance of that security-
based swap should not be regulated pursuant to Title VII, provided that
the insurance meets the proposed requirements discussed above.\52\
---------------------------------------------------------------------------
\52\ See supra note 32.
---------------------------------------------------------------------------
The Commissions request comment on this issue generally, and also
on the particular questions set forth in the Request for Comment
section below.
The Commissions also are considering whether the issuer of such
insurance (or guarantee) in respect of swaps or security-based swaps
entered into by an affiliate or third party could be considered to be a
major swap participant or major security-based swap participant. The
Commissions have requested comment in the proposing release for the
definitions of the terms ``major swap participant'' and ``major
security-based swap participant''.\53\
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\53\ See proposed Entity Definitions, supra note 12.
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Request for Comment
1. The Commissions request comment on all aspects of proposed rule
1.3(xxx)(4) under the CEA and proposed rule 3a69-1 under the Exchange
Act and the interpretive guidance in this section.
2. Do the proposed criteria for identifying an agreement, contract,
or transaction that would not fall within the swap or security-based
swap definitions appropriately encompass insurance and reinsurance
products? If not, what types of insurance or reinsurance products are
not encompassed, and why?
3. Are there certain products that are commonly known as swaps or
security-based swaps, or that more appropriately should be considered
swaps or security-based swaps, that could satisfy the criteria in
proposed rule 1.3(xxx)(4) under the CEA and proposed rule 3a69-1 under
the Exchange Act?
4. Is the proposed requirement that the beneficiary of an
agreement, contract, or transaction have an insurable interest that is
the subject of the agreement, contract, or transaction, and thereby
carry the risk of loss with respect to that interest continuously
throughout the duration of the agreement, contract, or transaction in
order for the agreement, contract, or transaction not to fall within
the swap or security-based swap definition, an effective criterion in
determining whether a product is insurance? Why or why not?
5. Is the proposed requirement that loss occur and be proved, and
that any payment or indemnification therefor be limited to the value of
the insurable interest, in order for an agreement, contract, or
transaction not to fall within the swap or security-based swap
definition, an effective criterion in determining whether a product is
insurance? Why or why not? Is the requirement that any payment or
indemnification for proved loss be limited to the value of the
insurable interest consistent with conventional insurance analysis
across a broad range of products (including traditional property and
casualty products)? Are there particular products where such a
limitation would not be appropriate? If so, please provide a detailed
description of such products and why such a limitation would not be
appropriate.
6. Is the proposed requirement that the agreement, contract, or
transaction is not traded, separately from the insured interest, on an
organized market or over-the-counter, an effective criterion in
determining whether a product is insurance? Why or why not?
7. Should the Commissions add, as a requirement for an insurance
agreement, contract, or transaction to not be characterized as a swap,
that the agreement, contract, or transaction not be based on the price,
rate, or level of a financial instrument, asset, or interest or any
commodity? Would such a requirement be an effective criterion in
distinguishing insurance from swaps and security-based swaps? Why or
why not? If so, should the Commissions add any carve outs from the
requirement, such as, for example, variable universal life insurance,
or annuity contracts where the income is subject to tax treatment under
section 72 of the Internal Revenue Code? Why or why not? Would such a
requirement help preclude the use of the proposed rules for products
that are swaps or security-based swaps? Why or why not? Would such a
requirement preclude the use of the proposed rules for products that
currently are insurance? If so, what
[[Page 29826]]
insurance products would be precluded by such a requirement, and how?
How are insurance payments determined today?
8. Is the proposed requirement that, with respect to financial
guaranty insurance, in the event of payment default or insolvency of
the obligor, any acceleration of payments under the policy be at the
sole discretion of the insurer an effective criterion in determining
whether a financial guaranty policy is insurance that does not fall
within the swap or security-based swap definition? Why or why not?
9. Does the interpretive guidance proposed in this section
appropriately identify certain enumerated insurance products as
traditional insurance products that would not fall within the swap or
security-based swap definition if the provider of the product satisfies
the requirements of the proposed rules? Why or why not? Is the
interpretive guidance proposed in this section sufficient? Why or why
not? Are there additional types of traditional insurance that should be
similarly enumerated? If so, which ones and why? Could the exclusion of
any of the enumerated insurance products serve to exclude products that
should be regulated as swaps or security-based swaps? If so, which ones
and why? Should the enumerated insurance products be required to be
provided in accordance with paragraph (ii) of proposed rule 1.3(xxx)(4)
under the CEA and paragraph (b) of proposed rule 3a69-1 under the
Exchange Act? Why or why not? If not, please provide a detailed
explanation of the insurance products that should not be subject to
these requirements. Are there insurance products currently offered that
do not meet these criteria? If so, please provide details regarding
such products and their providers.
10. The Commissions are proposing guidance that certain enumerated
types of insurance products, including property and casualty insurance,
are outside the scope of the statutory definitions of the terms
``swap'' and ``security-based swap'' under the Dodd-Frank Act. The
Commissions request comment generally as to the proposed guidance
regarding property and casualty insurance. The CFTC also requests
comment on whether the products specified in section 302(c)(2) of the
GLBA, which names certain insurance products, including private
passenger or commercial automobile, homeowners, mortgage, commercial
multiperil, general liability, professional liability, workers'
compensation, fire and allied lines, farm owners multiperil, aircraft,
fidelity, surety, medical malpractice, ocean marine, inland marine, and
boiler and machinery insurance, should be considered traditional
property and casualty insurance. Why or why not? If so, please provide
an explanation of the product and how it differs from transactions that
should be subject to the swap regulatory regime of the Dodd-Frank Act.
The SEC also requests comment on whether the products specified in
section 302(c)(2) of the GLBA should be enumerated in the Commissions'
proposed guidance regarding property and casualty insurance as outside
of the scope of the swap and security-based swap definitions? Are there
other categories of traditional property and casualty insurance that
should be specifically enumerated? If so, please provide a detailed
description of such other categories of property and casualty insurance
that should be specifically identified, and why. If there are certain
types of property and casualty insurance that fall within the swap
definition, will that affect the ability of persons, including
consumers and businesses, to protect their properties against losses?
If so, please provide a detailed explanation.
11. Are there situations in which an insurance product may be
assigned to another party that are not addressed by the criteria in
proposed rule 1.3(xxx)(4) under the CEA and proposed rule 3a69-1 under
the Exchange Act? Is additional clarification necessary to address such
situations? If so, what clarification?
12. Is the proposed requirement that the agreement, contract, or
transaction be provided by a company that is organized as an insurance
company whose primary and predominant business activity is the writing
of insurance or the reinsuring of risks underwritten by insurance
companies and that is subject to supervision by the insurance
commissioner (or similar official or agency) of any state, as defined
in section 3(a)(16) of the Exchange Act, or by the United States or an
agency or instrumentality thereof, and that the agreement, contract, or
transaction be regulated as insurance under the laws of such state or
of the United States, an effective criterion in determining whether an
agreement, contract, or transaction falls within the swap or security-
based swap definition? Does it sufficiently preclude the use of the
proposed rules by unregulated entities? Why or why not? Does it
sufficiently prevent evasion of the requirements of Title VII with
respect to agreements, contracts, or transactions that are swaps or
security-based swaps? Why or why not?
13. Are there circumstances under which a receiver or similar
official or any liquidating agency for a state or Federally regulated
insurance company, acting in its capacity as such, would be providing
insurance rather than administering an insurance product that is
provided by an insurance company? Please provide a detailed explanation
of any such circumstances. If there are such circumstances, should the
proposed rules include a provision that an agreement, contract, or
transaction that satisfies the criteria of insurance but that is
provided by a receiver or similar official or any liquidating agency
for a state or Federally regulated insurance company, in its capacity
as such, qualify as insurance that is excluded from the swap and
security-based swap definition? Why or why not?
14. Do the proposed rules appropriately treat an agreement,
contract, or transaction that satisfies the criteria of insurance but
that is provided by the United States or any of its agencies or
instrumentalities, or pursuant to a statutorily authorized program
thereof, as insurance that is excluded from the swap and security-based
swap definition? Why or why not? Are there other types of government-
issued insurance products that are not covered by paragraph (ii) of
proposed rule 1.3(xxx)(4) under the CEA and paragraph (b) of proposed
rule 3a69-1 under the Exchange Act? Do states or state agencies or
instrumentalities provide insurance products? Should the proposed
requirement also include a provision that the agreement, contract, or
transaction can be provided by any state or any of its agencies or
instrumentalities, or pursuant to a statutorily authorized program
thereof? Why or why not?
15. Do the proposed rules appropriately treat reinsurance by a
person located outside the United States of a product meeting the
requirements for insurance under the proposed rules, so long as the
total amount reimbursable by all of the reinsurers for such insurance
product cannot exceed the claims or losses paid by the cedant, as
insurance excluded from the swap and security-based swap definitions if
such person is not prohibited by any law of any state or of the United
States from offering such reinsurance to a state or Federally regulated
insurance company? Do these provisions of the proposed rules
sufficiently prevent evasion of the requirements of Title VII with
respect to agreements, contracts, or transactions that are swaps or
security-based swaps? Why or why not?
[[Page 29827]]
16. Are there additional criteria for identifying contracts,
agreements, or transactions that are insurance and not swaps or
security-based swaps that the Commissions should consider? Please
provide detailed information and empirical data, to the extent
possible, supporting any suggested criteria.
17. Should the proposed rules relating to insurance include a
provision related to whether a product is recognized at fair value on
an ongoing basis with changes in fair value reflected in earnings under
U.S. generally accepted accounting principles? If so, what specific
challenges may be encountered in light of the proposed Accounting
Standards Update ``Accounting for Financial Instruments and Revisions
to the Accounting for Derivative Instruments and Hedging Activities,''
issued by the Financial Accounting Standards Board (``FASB'') on May
26, 2010? Is recognizing a product at fair value on an ongoing basis
(with changes in fair value reflected in earnings) inconsistent with
treating such a product as insurance rather than a swap or security-
based swap? Why or why not? Please provide examples of specific
products and their correct accounting treatment under U.S. generally
accepted accounting principles.
18. Where an agreement, contract, or transaction falls within the
swap definition, should insurance of that agreement, contract, or
transaction also be included in the swap definition? Why or why not? Is
the insurance wrap of a swap sufficiently different (economically or
otherwise) from the swap that is insured? Why or why not? Would the
regulation of such swap ``wraps'' as swaps impose costs on or otherwise
impact the underlying cash markets (e.g., the ability to issue, and
cost of issuing, municipal debt)? Please quantify to the extent
possible. Would treating such ``wraps'' as insurance falling outside
the swap definition frustrate or undermine Title VII's objectives in
regulating the swap markets in any way? Why or why not? Please provide
empirical data and analysis to the extent possible.
19. Where an agreement, contract, or transaction falls within the
security-based swap definition, should the insurance of that agreement,
contract, or transaction also be included in the security-based swap
definition? Why or why not? Would the regulation of insurance on a
security-based swap as a security-based swap under Title VII impose
costs or otherwise impact the underlying cash markets (e.g., the
ability to issue, and cost of issuing, municipal debt)? Please quantify
to the extent possible. Would regulating such products as insurance
rather than as security-based swaps frustrate or undermine Title VII's
objectives in regulating the security-based swap and swap markets? Why
or why not? Please provide a detailed explanation and empirical data to
the extent possible.
20. Should the proposed rules include a provision similar to
section 302(c)(1) of the GLBA \54\ that would provide that any product
regulated as insurance before July 21, 2010 (the date the Dodd-Frank
Act was signed into law) and provided in accordance with paragraph (ii)
of proposed rule 1.3(xxx)(4) under the CEA and paragraph (b) of
proposed rule 3a69-1 would be considered insurance and not fall within
the swap definition? Why or why not? Should different criteria apply to
products regulated as insurance before July 21, 2010? Why or why not?
If so, please provide a detailed description of what different criteria
should apply.
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\54\ 15 U.S.C. 6712(c)(1).
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21. The Commissions understand that swap guarantees may be offered
by non-insurance companies. Should the Commissions provide guidance as
to whether swap or security-based swap guarantees (that are not
guarantees or insurance policies offered by insurance companies
discussed above) should be considered swaps or security-based swaps?
Why or why not?
2. The Forward Contract Exclusion
The definitions of the terms ``swap'' and ``security-based swap''
do not include forward contracts. They exclude ``any sale of a
nonfinancial commodity or security for deferred shipment or delivery,
so long as the transaction is intended to be physically settled''.\55\
Commenters have requested guidance from the Commissions regarding the
scope of this exclusion. The Commissions believe it is appropriate to
provide guidance to market participants regarding the applicability of
the exclusion from the definitions of swap and security-based swap for
forward contracts with respect to nonfinancial commodities \56\ and
securities.
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\55\ CEA section 1a(47)(B)(ii), 7 U.S.C. 1a(47)(B)(ii).
\56\ The discussion in subsections (a) and (b) of this section
applies solely to the exclusion of nonfinancial commodity forwards
from the swap definition in the Dodd-Frank Act.
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(a) Forward Contracts in Nonfinancial Commodities
The wording of the forward contract exclusion from the swap
definition with respect to nonfinancial commodities is similar, but not
identical, to the forward contract exclusion from the definition of
``future delivery'' in the CEA, which excludes ``any sale of any cash
commodity for deferred shipment or delivery''.\57\ Several ANPR
commenters expressed the view that, with respect to nonfinancial
commodities, the forward contract exclusion from the swap definition
should be interpreted in the same manner as the CFTC has interpreted
the forward contract exclusion from the term ``future delivery'' and,
in particular, that the CFTC's ``Brent Interpretation'' \58\ should
apply to ``book out'' transactions for purposes of the forward
exclusion from the swap definition.\59\ The CFTC believes that
clarification of the scope of the forward contract exclusion from the
swap definition with respect to nonfinancial commodities is
appropriate.\60\
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\57\ CEA section 1a(27), 7 U.S.C. 1a(27). The CEA does not
define the term ``futures contract.'' Rather, the CEA refers to a
futures contract as a ``contract of sale of a commodity for future
delivery.'' See, e.g., CEA section 2(a)(1)(A), 7 U.S.C. 2(a)(1)(A)
(providing the CFTC with exclusive jurisdiction over ``contracts of
sale of a commodity for future delivery'' (other than security
futures) traded or executed on, among other things, a designated
contract market (``DCM'')); CEA section 4(a), 7 U.S.C. 6(a) (a
``contract for the purchase or sale of a commodity for future
delivery'' other than a contract made on an exchange located outside
the United States must be conducted on or subject to the rules of,
among other things, a DCM). Accordingly, by excluding forward
contracts from the CEA's definition of the term ``future delivery,''
the CEA provides that a forward contract is not a contract of sale
of a commodity for future delivery and, hence, not a futures
contract.
\58\ Statutory Interpretation Concerning Forward Transactions,
55 FR 39188, Sept. 25, 1990 (``Brent Interpretation'').
\59\ See Letter from Joanne T. Medero, Managing Director,
BlackRock, Sept. 20, 2010 (``BlackRock Letter''), Letter from Matt
Schatzman, Senior Vice President, Energy Marketing, BG Americas and
Global LNC, Sept. 20, 2010 (``BG Letter''); Cleary Letter; Letter
from Edward W. Gallagher, President, Dairy Risk Management Services,
a division of Dairy Farmers of America, Inc., Sept. 20, 2010 (``DFA
Letter''); Letter from Eric Dennison, Sr. Vice President and General
Counsel, Stephanie Miller, Assistant General Counsel--Commodities,
and Bill Hellinghausen, Director of Regulatory Affairs, EDF Trading
North America, LLC, Sept. 20, 2010 (``EDF Letter''); Richard F.
McMahon, Jr., Executive Director, Edison Electric Institute, Sept.
20, 2010 (``EEI Letter''); Letter from John M. Damgard, President,
Futures Industry Association, Sept. 20, 2010 (``FIA Letter'');
Letter from Richard Ostrander, Managing Director and Counsel, Morgan
Stanley, Sept. 20, 2010 (``Morgan Stanley Letter''); Letter of
Michael Greenberger, JD, Law School Professor, University of
Maryland School of Law, Sept. 20, 2010 (``University of Maryland
Letter''); R. Michael Sweeney, Jr., Mark W. Menezes, and David T.
McIndoe, Hunton & Williams, LLP, on behalf of the Working Group of
Commercial Energy Firms, Sept, 20, 2010 (``WGCEF Letter''); Letter
from Paul H. Stebbins, Chairman and Chief Executive Officer, World
Fuel Services Corporation, Sept. 17, 2010 (``World Fuel Letter'').
\60\ As discussed in part II.D.1 below, the terminology and
documentation used by the parties are not dispositive of whether a
particular agreement, contract, or transaction is a swap or
security-based swap under the CEA or Exchange Act. Thus, if an
agreement, contract, or transaction with respect to a nonfinancial
commodity qualifies for the forward exclusion from the swap
definition, it would not be a swap even if the parties refer to it
as a swap or document it using an industry standard form agreement
that is typically used for swaps. Conversely, such an agreement,
contract, or transaction that does not qualify for the forward
exclusion from the swap definition would not be excluded even if the
parties refer to it as a forward contract.
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[[Page 29828]]
Forward contracts with respect to nonfinancial commodities are
commercial merchandising transactions. The primary purpose of the
contract is to transfer ownership of the commodity and not to transfer
---------------------------------------------------------------------------
solely its price risk. The CFTC has noted:
The underlying postulate of the [forward] exclusion is that the
[CEA's] regulatory scheme for futures trading simply should not
apply to private commercial merchandising transactions which create
enforceable obligations to deliver but in which delivery is deferred
for reasons of commercial convenience or necessity.\61\
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\61\ Brent Interpretation, supra note 58, at 39190. The CFTC has
reiterated this view in more recent adjudicative orders. See, e.g.,
In re Grain Land Coop., [2003-2004 Transfer Binder] Comm. Fut. L.
Rep. (CCH) ] 29,636 (CFTC Nov. 25, 2003); In re Competitive
Strategies for Agric., Ltd., [2003-2004 Transfer Binder] Comm. Fut.
L. Rep. (CCH) ] 29,635 (CFTC Nov. 25, 2003). Courts have expressed
this view as well. See, e.g., Salomon Forex, Inc. v. Tauber, 8 F.3d
966, 971 (4th Cir. 1993) (``[C]ash forwards are generally
individually negotiated sales * * * in which actual delivery of the
commodity is anticipated, but is deferred for reasons of commercial
convenience or necessity.''); CFTC v. Int'l Fin. Serv. (N.Y.), 323
F. Supp. 2d 482, 495 (S.D.N.Y. 2004). See also CFTC v. Co Petro
Mktg. Grp., Inc., 680 F.2d 573, 579-580 (9th Cir. 1982); CFTC v.
Noble Metals Int'l, Inc., 67 F.3d 766, 772-773 (9th Cir. 1995; CFTC
v. Am. Metal Exch. Corp., 693 F. Supp. 168, 192 (D.N.J. 1988); CFTC
v. Morgan, Harris & Scott, Ltd., 484 F. Supp. 669, 675 (S.D.N.Y.
1979) (forward contract exclusion does not apply to speculative
transactions in which delivery obligations can be extinguished under
the terms of the contract or avoided for reasons other than
commercial convenience or necessity).
The CFTC believes that the forward contract exclusion in the Dodd-
Frank Act with respect to nonfinancial commodities should be read
consistently with this established, historical understanding that a
forward contract is a commercial merchandising transaction.
Many commenters discussed the issue of whether the requirement in
the Dodd-Frank Act that a transaction be ``intended to be physically
settled'' in order to qualify for the forward exclusion from the swap
definition with respect to nonfinancial commodities reflects a change
in the standard for determining whether a transaction is a forward
contract.\62\ Because a forward contract is a commercial merchandising
transaction, intent to deliver historically has been an element of the
CFTC's analysis of whether a particular contract is a forward
contract.\63\ In assessing the parties' expectations or intent
regarding delivery, the CFTC consistently has applied a ``facts and
circumstances'' test.\64\ Therefore, the CFTC reads the ``intended to
be physically settled'' language in the swap definition with respect to
nonfinancial commodities to reflect a directive that intent to deliver
a physical commodity be a part of the analysis of whether a given
contract is a forward contract or a swap, just as it is a part of the
CFTC's analysis of whether a given contract is a forward contract or a
futures contract.
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\62\ See, e.g., BG Letter (forward exclusion for swaps should be
consistent with the forward exclusion from futures); BlackRock
Letter (the CFTC should interpret ``intended to be physically
settled'' consistently with existing CFTC principles, including book
outs); DFA Letter (forward exclusion for swaps should be interpreted
consistently with the CFTC's prior forward contract interpretations
and precedent, including forwards requiring delivery but including
embedded options); EDF Letter (forward exclusion from the definition
of swap should be construed in a consistent manner with the forward
exclusion under the CEA); EEI Letter (forward exclusion from swap
definition should be interpreted consistently with the forward
exclusion from futures); FIA Letter (the Commissions should, through
rulemaking or interpretation, provide that the ``intent'' standard
in the forward exclusion with respect to swaps will be interpreted
the same as the existing forward exclusion with respect to futures);
Morgan Stanley Letter (the forward exclusion from the swap
definition should be interpreted consistently with the forward
exclusion from futures); University of Maryland Letter (forward
exclusion from swap definition intended to be consistent with the
forward exclusion from futures); WGCEF Letter (physical delivery
forwards should be distinguished from swaps under standards
identical to those used in forwards vs. futures); World Fuel Letter
(forward exclusion for swaps should be interpreted in a manner
consistent with the forward exclusion from futures).
\63\ As recently as October 25, 2010, the CFTC observed in In re
Wright that ``it is well-established that the intent to make or take
delivery is the critical factor in determining whether a contract
qualifies as a forward.'' In re Wright, CFTC Docket No. 97-02, 2010
WL 4388247 at *3 (CFTC Oct. 25, 2010) (citing In re Stovall, et al.,
[1977-1980 Transfer Binder] Comm. Fut. L. Rep. (CCH) 20,941 (CFTC
Dec. 6, 1979); Brent Interpretation, supra note 58). In Wright, the
CFTC noted that ``[i]n distinguishing futures from forwards, the
[CFTC] and the courts have assessed the transaction as a whole with
a critical eye toward its underlying purpose. Such an assessment
entails a review of the overall effect of the transaction as well as
a determination as to what the parties intended.'' Id. at *3
(quoting Policy Statement Concerning Swap Transactions, 54 FR 30694,
July 21, 1989 (``Swap Policy Statement'') (citations and internal
quotations omitted).
\64\ In its recent decision in In re Wright, the CFTC applied
its facts and circumstances test in an administrative enforcement
action involving hedge-to-arrive contracts for corn, and observed
that ``[o]ur views of the appropriateness of a multi-factor analysis
remain unchanged.'' Wright, supra note 63, n.13. The CFTC let stand
the administrative law judge's conclusion that the hedge-to-arrive
contracts at issue in the case were forward contracts. Id. at **5-6.
See also Grain Land, supra note 61; Competitive Strategies for
Agric., supra note 61.
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Commenters also requested clarification of the treatment of one
type of forward contract--``book-out'' transactions--in the context of
the forward exclusion from the swap definition with respect to
nonfinancial commodities. The issue of book-outs first arose in 1990 in
the Brent Interpretation\65\ because the parties to the crude oil
contracts in that case could individually negotiate cancellation
agreements, or ``book-outs,'' with other parties.\66\ In describing
these transactions, the CFTC stated:
\65\ See Brent Interpretation, supra note 58. The CFTC issued
the Brent Interpretation in response to a Federal court decision
that held that certain 15-day Brent system crude oil contracts were
illegal off-exchange futures contracts. See Transnor (Bermuda) Ltd.
v. BP N. Am. Petroleum, 738 F. Supp. 1472 (S.D.N.Y. 1990). The Brent
Interpretation provided clarification that the 15-day Brent system
crude oil contracts were forward contracts that were excluded from
the CEA definition of ``future delivery,'' and thus were not futures
contracts. See Brent Interpretation, supra note 58.
\66\ The Brent Interpretation described these ``book-outs'' as
follows: ``In the course of entering into 15-day contracts for
delivery of a cargo during a particular month, situations often
arise in which two counterparties have multiple, offsetting
positions with each other. These situations arise as a result of the
effectuation of multiple, independent commercial transactions. In
such circumstances, rather than requiring the effectuation of
redundant deliveries and the assumption of the credit, delivery and
related risks attendant thereto, the parties may, but are not
obligated to and may elect not to, terminate their contracts and
forego such deliveries and instead negotiate payment-of-differences
pursuant to a separate, individually negotiated cancellation
agreement referred to as a `book-out.' Similarly, situations
regularly arise when participants find themselves selling and
purchasing oil more than once in the delivery chain for a particular
cargo. The participants comprising these `circles' or `loops' will
frequently attempt to negotiate separate cancellation agreements
among themselves for the same reasons and with the same effect
described above.'' Brent Interpretation, supra note 58, at 39190.
It is noteworthy that while such [book-out] agreements may
extinguish a party's delivery obligation, they are separate,
individually negotiated, new agreements, there is no obligation or
arrangement to enter into such agreements, they are not provided for
by the terms of the contracts as initially entered into, and any
party that is in a position in a distribution chain that provides
for the opportunity to book-out with another party or parties in the
chain is nevertheless entitled to require delivery of the commodity
to be made through it, as required under the contracts.\67\
---------------------------------------------------------------------------
\67\ Id. at 39192.
Thus, in the scenario at issue in the Brent Interpretation, the
contracts created a binding obligation to make or take delivery without
providing any right to offset, cancel, or settle on a payment-of-
differences basis. The ``parties enter[ed] into such contracts with the
recognition that they may be required to make or take delivery.'' \68\
---------------------------------------------------------------------------
\68\ Id. at 39189.
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On these facts, the Brent Interpretation concluded that the
[[Page 29829]]
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contracts were forward contracts, not futures contracts:
Under these circumstances, the [CFTC] is of the view that
transactions of this type which are entered into between commercial
participants in connection with their business, which create
specific delivery obligations that impose substantial economic risks
of a commercial nature to these participants, but which may involve,
in certain circumstances, string or chain deliveries of the type
described * * * are within the scope of the [forward contract]
exclusion from the [CFTC's] regulatory jurisdiction.\69\
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\69\ Id. at 39192.
Although the CFTC did not expressly discuss intent to deliver, the
Brent Interpretation concluded that transactions retained their
character as commercial merchandising transactions, notwithstanding the
practice of terminating commercial parties' delivery obligations
through ``book-outs'' as described. At any point in the chain, one of
the parties could refuse to enter into a new contract to book-out the
transaction and, instead, insist upon delivery pursuant to the parties'
obligations under their contract.
The CFTC believes that the principles underlying the Brent
Interpretation similarly should apply to the forward exclusion from the
swap definition with respect to nonfinancial commodities. To summarize,
then, the CFTC believes that: (i) The forward contract exclusion from
the swap definition with respect to nonfinancial commodities should be
interpreted in a manner that is consistent with the CFTC's historical
interpretation of the forward contract exclusion from the definition of
the term ``future delivery''; (ii) intent to deliver is an essential
element of a forward contract excluded from both the swap and future
delivery definitions, and such intent in both instances should be
evaluated based on the CFTC's established multi-factor approach; and
(iii) book-out transactions in nonfinancial commodities that meet the
requirements specified in the Brent Interpretation, and that are
effectuated through a subsequent, separately-negotiated agreement,
should qualify for the forward exclusion from the swap definition.\70\
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\70\ This interpretive guidance is consistent with legislative
history. See 156 Cong. Rec. H5247 (June 30, 2010) (colloquy between
U.S. House Committee on Agriculture Chairman Collin Peterson and
Representative Leonard Boswell during the debate on the Conference
Report for the Dodd-Frank Act, in which Chairman Peterson stated:
``Excluding physical forward contracts, including book-outs, is
consistent with the CFTC's longstanding view that physical forward
contracts in which the parties later agree to book-out their
delivery obligations for commercial convenience are excluded from
its jurisdiction. Nothing in this legislation changes that result
with respect to commercial forward contracts.''). See also 156 Cong.
Rec. H5248-49 (June 30, 2010) (introducing into the record a letter
authored by Senator Blanche Lincoln, Chairman of the U.S. Senate
Committee on Agriculture, Nutrition and Forestry, and Christopher
Dodd, Chairman U.S. Senate Committee on Banking, Housing, and Urban
Affairs, stating that the CFTC is encouraged ``to clarify through
rulemaking that the exclusion from the definition of swap for `any
sale of a nonfinancial commodity or security for deferred shipment
or delivery, so long as the transaction is intended to be physically
settled' is intended to be consistent with the forward contract
exclusion that is currently in the [CEA] and the CFTC's established
policy and orders on this subject, including situations where
commercial parties agree to `book-out' their physical delivery
obligations under a forward contract.'').
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As noted above, the Brent Interpretation applies to ``commercial
participants in connection with their business.'' \71\ Market
participants that regularly make or take delivery of the referenced
commodity (in the case of the Brent Interpretation, a tanker full of
Brent oil) in the ordinary course of their business meet that standard.
Such entities qualify for the forward exclusion from both the future
delivery and swap definitions for their forward transactions under the
Brent Interpretation even if they enter a subsequent transaction to
``book out'' the forward contract rather than make or take delivery.
Intent to make or take delivery can be inferred from the binding
delivery obligation for the referenced commodity in the contract and
the fact that the parties to the contract do, in fact, regularly make
or take delivery of the referenced commodity in the contract in the
ordinary course of their business.
---------------------------------------------------------------------------
\71\ See Brent Interpretation, supra note 58, at 39192.
---------------------------------------------------------------------------
Some commenters to the ANPR requested clarification with regard to
the application of the CFTC's 1993 order exempting certain energy
contracts from regulation under the CEA (the ``Energy Exemption'') \72\
after enactment of the Dodd-Frank Act.\73\ The Energy Exemption
extended the Brent Interpretation regarding the forward contract
exclusion from the term ``future delivery'' to energy commodities other
than oil. The CFTC believes that the book-out provisions of the Brent
Interpretation similarly should apply to the forward contract exclusion
from the swap definition for nonfinancial commodities besides oil.
Further, the CFTC also is proposing interpretive guidance herein that
the Brent Interpretation with respect to the application of the forward
contract exclusion from the term ``future delivery'' in the context of
book-out transactions applies not just to oil, but to all nonfinancial
commodities. The CFTC, therefore, is proposing to withdraw the Energy
Exemption, while retaining and extending through this interpretive
guidance the Brent Interpretation regarding book-outs under the forward
contract exclusion with respect to nonfinancial commodities.\74\
---------------------------------------------------------------------------
\72\ Exemption for Certain Contracts Involving Energy Products,
58 FR 21286, Apr. 20, 1993. The Energy Exemption generally applies
to certain energy contracts: (i) Entered into by persons reasonably
believed to be within a specified class of commercial and
governmental entities; (ii) that are bilateral contracts between two
parties acting as principals; (iii) the material economic terms of
which are subject to individual negotiation by the parties; and (iv)
that impose binding obligations on the parties to make and receive
delivery of the underlying commodity, with no right of either party
to effect a cash settlement of their obligations without the consent
of the other party (except pursuant to a bona fide termination right
such as default). Like the Brent Interpretation, the Energy
Exemption provides that the parties can enter into a subsequent
book-out settlement of the obligation in a manner other than by
physical delivery of the commodity specified in the contract. Id. at
21294.
\73\ See, e.g., WGCEF letter. The CFTC issued the Energy
Exemption shortly after Congress had provided the CFTC with
exemptive authority pursuant to CEA section 4(c), 7 U.S.C. 6(c), in
section 502 of the Futures Trading Practices Act of 1992, Public Law
102-546, 106 Stat. 3590 (1993).
\74\ To avoid any uncertainty, the CFTC also notes that the
Dodd-Frank Act supersedes the Swap Policy Statement. The CFTC is
aware that some commenters have suggested that the Commissions
should exercise their authority to further define the term
``eligible contract participant'' to encompass the ``line of
business'' provision of the Swap Policy Statement. See Swap Policy
Statement, supra note 63, at 30696-30697. The Commissions will
address these comments in their joint final rulemaking with respect
to the Entity Definitions. See supra note 12.
---------------------------------------------------------------------------
(b) Commodity Options and Commodity Options Embedded in Forward
Contracts
Some commenters responding to the ANPR requested clarification
regarding the status of commodity options under the swap
definition.\75\ Questions also were raised regarding options embedded
in forward contracts, i.e., whether a forward contract with respect to
a nonfinancial commodity that contains an embedded option can still
qualify for the forward contract exclusion from the swap
definition.\76\
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\75\ See, e.g., World Fuel Letter (exclusion for commercial
options set forth in CFTC Regulation 32.4 should also be an
exclusion from the swap definition).
\76\ See, e.g., Letter from Patrick Kelly, Policy Advisor, API,
Sept. 20, 2010 (``API Letter''), EEI Letter; Letter from Daniel S.M.
Dolan, VP, Policy Research & Communications, Electric Power Supply
Association, Sept. 20, 2010 (``EPSA Letter'') (physically settled
options should be included in the forward exclusion from the swap
definition); DFA Letter; ISDA Letter. One commenter suggested that
the CFTC should apply to each contract with an enforceable delivery
obligation a rebuttable presumption of intent to deliver, even if an
option to cash settle is included in that contract. See WGCEF
Letter.
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The statutory swap definition explicitly provides that commodity
[[Page 29830]]
options are swaps.\77\ Accordingly, the CFTC recently proposed
revisions to its existing options rules in parts 32 and 33 of its
regulations with respect to the treatment of commodity options under
the Dodd-Frank Act, and requested public comment on those proposed
revisions.\78\ The question of the application of the forward exclusion
from the swap definition with respect to nonfinancial commodities,
where commodity options are embedded in forward contracts (including
embedded options to cash settle such contracts), is similar to that
arising under the CEA's existing forward contract exclusion from the
definition of the term ``future delivery.'' The CFTC's Office of
General Counsel addressed forward contracts that contained embedded
options in a 1985 interpretive statement (``1985 Interpretation''),\79\
which the CFTC recently adhered to in its adjudicatory Order in the
Wright case.\80\ While both were issued prior to the effective date of
the Dodd-Frank Act, the CFTC believes that it would be appropriate to
apply this guidance to the treatment of forward contracts in
nonfinancial commodities that contain embedded options under the Dodd-
Frank Act.
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\77\ 7 U.S.C. 1a(47)(A)(i). Options on securities and certain
options on foreign currency are excluded from the swap definition by
CEA sections 1a(47)(B)(iii) and (iv), respectively. 7 U.S.C.
1a(47)(B)(iii) and (iv). These options are not subject to the
Commissions' proposed guidance in this section.
\78\ See Commodity Options and Agricultural Swaps, 76 FR 6095,
Feb. 3, 2011.
\79\ See Characteristics Distinguishing Cash and Forward
Contracts and ``Trade'' Options, 50 FR 39656, Sept. 30, 1985.
\80\ Wright, supra note 63.
---------------------------------------------------------------------------
In Wright, the CFTC described the 1985 Interpretation and stated
that the CFTC traditionally has engaged in a two-step analysis of
``embedded options'' in which the first step focuses on whether the
option operates on the price or the delivery term of the forward
contract and the second step focuses on secondary trading.\81\ The CFTC
believes that these same principles can be applied with respect to the
forward contract exclusion from the swap definition for nonfinancial
commodities in the Dodd-Frank Act, too. That is, a forward contract
that contains an embedded commodity option or options \82\ would be
considered an excluded nonfinancial commodity forward contract (and not
a swap) if the embedded option(s): (i) May be used to adjust the
forward contract price, but do not undermine the overall nature of the
contract as a forward contract; (ii) do not target the delivery term,
so that the predominant feature of the contract is actual delivery; and
(iii) cannot be severed and marketed separately from the overall
forward contract in which they are embedded.\83\ Conversely, where the
embedded commodity option(s) render delivery optional, the predominant
feature of the contract cannot be actual delivery and, therefore, the
embedded option(s) to not deliver preclude treatment of the contract as
a forward contract for a nonfinancial commodity. The CFTC would look to
the specific facts and circumstances of the transaction as a whole to
evaluate whether any embedded optionality operates on the price or
delivery term of the contract, and whether an embedded commodity option
is marketed or traded separately from the underlying contract, to
determine whether that transaction qualifies for the forward contract
exclusion from the swap definition for nonfinancial commodities.\84\
The CFTC believes that such an approach would help prevent commodity
options that should fall within the swap definition from qualifying for
the forward contract exclusion for nonfinancial commodities instead.
---------------------------------------------------------------------------
\81\ Id. at n.5. In Wright, the CFTC affirmed the Administrative
Law Judge's holding that an option embedded in a hedge-to-arrive
contract did not violate CFTC rules regarding the sale of
agricultural trade options. The CFTC first concluded that the puts
at issue operated to adjust the forward price and did not render the
farmer's overall obligation to make delivery optional. Then, turning
to the next step of the analysis, the CFTC explained that ``the put
and [hedge-to-arrive contract] operated as a single contract, and in
most cases were issued simultaneously * * *. We do not find that any
put was severed from its forward or that either of [the put or the
hedge-to-arrive contract] was traded separately from the other. We
hold that in these circumstances, no freestanding option came into
being. * * *'' Id. at *7.
\82\ The CFTC believes that ``options'' in the plural would
include, for example, a situation in which the embedded optionality
involves option combinations, such as costless collars, that operate
on the price term of the agreement, contract, or transaction.
\83\ See Wright, supra note 63, at **6-7.
\84\ This facts and circumstances approach to determining
whether a particular embedded option takes a transaction out of the
forward contract exclusion for nonfinancial commodities is
consistent with the CFTC's historical approach to determining
whether a particular embedded option takes a transaction out of the
forward contract exclusion from the CEA definition of the term
``future delivery.'' See Wright, supra note 63, at *5 (``As we have
held since Stovall, the nature of a contract involves a multi-factor
analysis . * * *'').
---------------------------------------------------------------------------
(c) Security Forwards \85\
---------------------------------------------------------------------------
\85\ The discussion above regarding the exclusion from the swap
definition for forward contracts on nonfinancial commodities does
not apply to the exclusion from the swap and security-based swap
definitions for security forwards or to the distinction between
security forwards and security futures products.
---------------------------------------------------------------------------
No commenters sought clarification of the exclusion from the swap
and security-based swap definitions for the ``sale of a nonfinancial
commodity or security for deferred shipment or delivery, so long as the
transaction is intended to be physically settled,'' in the context of
most sales of securities for deferred shipment or delivery; however,
some commenters sought clarification of this exclusion in the context
of mortgage securitizations.\86\ The Commissions believe it is
appropriate to address how the exclusions from the definitions of swap
and security-based swap apply to security forwards and other purchases
and sales of securities.
---------------------------------------------------------------------------
\86\ Specifically, commenters requested clarification that the
swap and security-based swap definitions do not include buying and
selling mortgages and forward trading of agency (i.e., Federal Home
Loan Mortgage Corporation (``Freddie Mac''), Federal National
Mortgage Association (``Fannie Mae''), and Government National
Mortgage Association (``Ginnie Mae'') mortgage-backed securities
(``MBS'') in the ``To-Be-Announced'' (``TBA'') market in order to
provide the certainty needed to avoid unnecessary disruption of the
securitization market. See Letter from Stephen H. McElhennon, Vice
President & Deputy General Counsel, Fannie Mae, Sept. 20, 2010
(``Fannie Mae Letter''); Letter from Lisa M. Ledbetter, Freddie Mac,
Sept. 20, 2010.
---------------------------------------------------------------------------
The Dodd-Frank Act excludes purchases and sales of securities from
the definitions of swap and security-based swap in a number of
different clauses.\87\ Under these exclusions, purchases and sales of
securities on a fixed or contingent basis \88\ and sales of securities
for deferred shipment or delivery that are intended to be physically
delivered \89\ are explicitly excluded from the definitions of swap and
security-based swap.\90\ The exclusion from the definitions of swap and
security-based swap of a sale of a security for deferred shipment or
delivery involves an agreement to purchase securities, or groups or
indexes of securities, at a future date at a certain price.
---------------------------------------------------------------------------
\87\ See CEA sections 1a(47)(B)(ii), (v), and (vi), 7 U.S.C.
1a(47)(B)(ii), (v), and (vi).
\88\ See CEA section 1a(47)(B)(v), 7 U.S.C. 1a(47)(B)(v)
(excluding from the swap and security-based swap definitions ``any
agreement, contract, or transaction providing for the purchase or
sale of 1 or more securities on a fixed basis that is subject to
[the Securities Act and Exchange Act]''); CEA section 1a(47)(B)(vi),
7 U.S.C. 1a(47)(B)(vi) (excluding from the swap and security-based
swap definitions ``any agreement, contract, or transaction providing
for the purchase or sale of 1 or more securities on a contingent
basis that is subject to [the Securities Act and Exchange Act],
unless the agreement, contract, or transaction predicates the
purchase or sale on the occurrence of a bona fide contingency that
might reasonably be expected to affect or be affected by the
creditworthiness of a party other than a party to the agreement,
contract, or transaction'').
\89\ See CEA section 1a(47)(B)(ii), 7 U.S.C. 1a(47)(B)(ii).
\90\ The Commissions note that calling an agreement, contract,
or transaction a swap or security-based swap does not determine its
status. See discussion supra part II.D.1.
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[[Page 29831]]
As with other purchases and sales of securities, security forwards
are excluded from the definitions of swap and security-based swap. The
sale of the security in this case occurs at the time the forward
contract is entered into with the performance of the contract deferred
or delayed. If such agreement, contract, or transaction is intended to
be physically settled, the Commissions believe it would be within the
security forward exclusion and therefore outside the swap and security-
based swap definitions.\91\ Moreover, as a purchase or sale of a
security, the Commissions believe it also would be within the
exclusions for the purchase or sale of one or more securities on a
fixed basis (or, depending on its terms, a contingent basis) and,
therefore, outside the swap and security-based swap definitions.\92\
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\91\ See CEA section 1a(47)(B)(ii), 7 U.S.C. 1a(47)(B)(ii).
\92\ See CEA sections 1a(47)(B)(v) and (vi), 7 U.S.C.
1a(47)(B)(v) and (vi).
---------------------------------------------------------------------------
As noted above, commenters requested specific guidance in the
context of forward sales of MBS that are guaranteed or sold by Fannie
Mae, Freddie Mac, and Ginnie Mae and the mortgages underlying such MBS.
MBS guaranteed or sold by Fannie Mae, Freddie Mac and Ginnie Mae
are eligible to be sold in the TBA market, which is essentially a
forward or delayed delivery market.\93\ The TBA market has been
described as one that ``allows mortgage lenders essentially to sell the
loans they intend to fund even before the loans are closed.'' \94\ In
the TBA market, the lender enters into a forward contract to sell MBS
and agrees to deliver MBS on the settlement date in the future. The
specific MBS that will be delivered in the future may not yet be
created at the time the forward contract is entered into.\95\ The
Commissions believe that such forward sales of MBS in the TBA market
would fall within the exclusion for sales of securities on a deferred
settlement or delivery basis even though the precise MBS are not in
existence at the time the forward MBS sale is entered into.\96\
Moreover, as the purchase or sale of a security, the Commissions
believe such forward sales of MBS in the TBA market would fall within
the exclusions for the purchase or sale of one or more securities on a
fixed basis (or, depending on its terms, a contingent basis) and
therefore outside the swap and security-based swap definitions.\97\
---------------------------------------------------------------------------
\93\ Task Force on Mortgage-Backed Securities Disclosure,
``Staff Report: Enhancing Disclosure in the Mortgage-Backed
Securities Markets,'' part II.E.2 (Jan. 2003).
\94\ Id.
\95\ Id.
\96\ See CEA section 1a(47)(B)(ii), 7 U.S.C. 1a(47)(B)(ii).
\97\ See CEA sections 1a(47)(B)(v) and (vi), 7 U.S.C.
1a(47)(B)(v) and (vi).
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Request for Comment
22. The Commissions request comment on all aspects of the proposed
interpretive guidance set forth in this section regarding the forward
contract exclusion from the swap and security-based swap definitions
with respect to nonfinancial commodities and securities.
23. Is the proposed interpretive guidance set forth in this section
sufficient with respect to the application of the forward contract
exclusion from the swap definition with respect to nonfinancial
commodities? If not, what changes should be made? Commenters also are
invited to comment on whether the application of the Brent
Interpretation generally, and its conclusions regarding book-outs in
particular, is appropriate to the forward exclusion from the swap
definition with respect to nonfinancial commodities. Would it permit
transactions that should be subject to the swap regulatory regime to
fall outside of the Dodd-Frank Act?
24. Is it appropriate, in light of the Dodd-Frank Act, for the CFTC
to withdraw the Energy Exemption while concurrently retaining the Brent
Interpretation, and extending it to the forward contract exclusion from
the definition of ``future delivery'' and the swap definition, for
book-out transactions in all nonfinancial commodities? Why or why not?
Is the conclusion that the Dodd-Frank Act supersedes the Swap Policy
Statement appropriate? Why or why not?
25. Are there any provisions of the Energy Exemption or Swap Policy
Statement that the Commissions should consider incorporating into the
definitions rulemakings (other than the request already submitted by
some commenters in response to the proposed Entity Definitions that the
``line of business'' provision of the Swap Policy Statement be
incorporated into the definition of the term ``eligible contract
participant'' (``ECP''))? If so, please explain in detail how such
provisions are consistent with the requirements of the Dodd-Frank Act
and would not permit transactions that should be subject to the swap
regulatory regime to fall outside of the Dodd-Frank Act.
26. How frequently do book-out transactions of the type described
in the Brent Interpretation occur with respect to nonfinancial
commodities? Please provide descriptions of any such transactions, and
data with respect to their frequency. Are there any nonfinancial
commodities or transactions to which the Brent Interpretation should
not apply, either with respect to the forward contract exclusion from
the definition of ``future delivery'' or the forward contract exclusion
from the swap definition, or both? Why or why not?
27. Should a minimum contract size for a transaction in a
nonfinancial commodity (e.g., a tanker full of Brent oil) be required
in order for the transaction to qualify as a forward contract under the
Brent Interpretation with respect to the future delivery and swap
definitions? Why or why not? If so, what standards should apply to
determine such a minimum contract size? Should the Brent Interpretation
for nonfinancial commodities with respect to the future delivery and
swap definitions be limited to market participants that meet certain
requirements? Why or why not? If so, does the ``eligible commercial
entity'' definition in CEA section 1a(17) \98\ provide an appropriate
requirement? Why or why not? What other requirements, if any, should be
imposed?
---------------------------------------------------------------------------
\98\ 7 U.S.C. 1a(17).
---------------------------------------------------------------------------
28. How often, and to what extent, do entities that do not
regularly make or take delivery of the commodity in the ordinary course
of their business engage in transactions that should qualify as forward
contracts? Should such contracts qualify for the safe harbor provided
by the Brent Interpretation? Why or why not? If so, how can it be
demonstrated that the primary purpose of such transaction is to acquire
or sell the physical commodity? Would including these transactions in
the scope of the Brent Interpretation permit transactions that should
be subject to the swap regulatory regime to fall outside of the Dodd-
Frank Act? If so, could this concern be addressed by imposing
conditions in order to qualify for the forward exclusion? What
conditions, if any, would be appropriate?
29. Are ``ring'' or ``daisy chain'' markets for forward contracts,
such as the 15-day Brent market, primarily used for commercial
merchandising, or do they serve other purposes such as price discovery
or risk management? Please explain in detail.
30. Should contracts in nonfinancial commodities that may qualify
as forward contracts be permitted to trade on registered trading
platforms such as DCMs or swap execution facilities (``SEFs'')? If so,
are additional guidance
[[Page 29832]]
or rules necessary to determine whether contracts traded on such
platforms are excluded from the CEA definition of ``future delivery''
and/or the swap definition? If so, please describe in detail such
markets and explain what further guidance or rules would be
appropriate? Should conditions be imposed with respect to the nature of
the market participants or the percentage of transactions that must
result in delivery over a specified measurement period, or both? If so,
what conditions would be appropriate?
31. Should the Commissions provide guidance regarding the scope of
the term ``nonfinancial commodity'' in the forward contract exclusion
from the swap definition? If so, how and where should the Commissions
draw the line between financial and nonfinancial commodities?
32. Should the forward contract exclusion from the swap definition
apply to environmental commodities such as emissions allowances, carbon
offsets/credits, or renewable energy certificates? If so, please
describe these commodities, and explain how transactions can be
physically settled where the commodity lacks a physical existence (or
lacks a physical existence other than on paper)? Would application of
the forward contract exclusion to such environmental commodities permit
transactions that should be subject to the swap regulatory regime to
fall outside the Dodd-Frank Act?
33. Are there other factors that should be considered in
determining how to characterize forward contracts with embedded options
with respect to nonfinancial commodities? If so, what factors should be
considered? Do provisions in forward contracts with respect to
nonfinancial commodities other than delivery and price contain embedded
optionality? How do such provisions operate? Please provide a detailed
analysis regarding how such provisions should be analyzed under the
Dodd-Frank Act.
34. Is the analysis of forward contracts with embedded options in
the 1985 Interpretation and the CFTC's Wright decision appropriately
applied to transactions entered into after the effective date of the
Dodd-Frank Act? Why or why not? If not, how should the analysis be
modified?
35. How would the proposed interpretive guidance set forth in this
section affect full requirements contracts, capacity contracts, reserve
sharing agreements, tolling agreements, energy management agreements,
and ancillary services? Do these agreements, contracts, or transactions
have optionality as to delivery? If so, should they--or any other
agreement, contract, or transaction in a nonfinancial commodity that
has optionality as to delivery--be excluded from the swap definition?
If so, please provide a detailed analysis of such agreements,
contracts, or transactions and how they can be distinguished from
options that are to be regulated as swaps pursuant to the Dodd-Frank
Act. To what extent are any such agreements, contracts, or transactions
in the electric industry regulated by the Federal Energy Regulatory
Commission (``FERC''), State regulatory authorities, regional
transmission organizations (``RTOs''), independent system operators
(``ISOs'') or market monitoring units associated with RTOs or ISOs?
36. Is there any issue with respect to the treatment of commodity
options that the Commissions have not addressed and that should be
addressed as a definitional matter in this rulemaking?
37. Should the Commissions provide more detailed guidance regarding
what constitutes a security forward? For instance, should the
Commissions provide more guidance on what it means for a security
forward to be ``intended to be physically settled''? If so, what
further guidance would be appropriate?
38. Should the Commissions provide more guidance regarding when
forward sales of MBS in the TBA market would fall within the exclusion
for sales of securities on a deferred settlement or delivery basis? Is
there any more guidance the Commissions should provide regarding types
of transactions that occur in the TBA market?
3. Consumer and Commercial Agreements, Contracts, and Transactions
Commenters on the ANPR pointed out a number of areas in which a
broad reading of the swap and security-based swap definitions could
cover certain consumer and commercial arrangements that historically
have not been considered swaps or security-based swaps. Examples of
such instruments cited by commenters include evidences of indebtedness
with a variable rate of interest; \99\ commercial contracts containing
acceleration, escalation, or indexation clauses; \100\ agreements to
acquire personal property or real property, or to obtain mortgages;
\101\ employment, lease, and service agreements, including those that
contain contingent payment arrangements; \102\ and consumer mortgage
and utility rate caps.\103\
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\99\ See Cleary Letter; Letter from Kenneth E. Auer, President
and CEO, The Farm Credit Council, Sept. 20, 2010 (``Farm Credit
Council Letter'').
\100\ See Cleary Letter; White & Case Letter.
\101\ See White & Case Letter; Fannie Mae Letter.
\102\ See BlackRock Letter.
\103\ See White & Case Letter; Deutsche Bank Letter.
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Consumers enter into various types of agreements, contracts, and
transactions as part of their household and personal lives that may
have attributes that could be viewed as falling within the swap or
security-based swap definition. Similarly, businesses and other
entities, whether or not for profit, also enter into agreements,
contracts, and transactions as part of their operations relating to,
among other things, acquisitions or sales of property (tangible and
intangible), provisions of services, employment of individuals, and
other matters that could be viewed as falling within the definitions.
The Commissions do not believe that Congress intended to include
these types of customary consumer and commercial agreements, contracts,
or transactions in the swap or security-based swap definition, to limit
the types of persons that can enter into or engage in them, or to
otherwise to subject these agreements, contracts, or transactions to
the regulatory scheme for swaps and security-based swaps. The
Commissions, therefore, are proposing the following interpretive
guidance to assist consumers and businesses in understanding whether
certain agreements, contracts, or transactions that they enter into
would be regulated as swaps or security-based swaps.
With respect to consumers, the Commissions believe that the types
of agreements, contracts, or transactions that should not be considered
swaps or security-based swaps when entered into by consumers (natural
persons or their agents) as principals primarily for personal, family,
or household purposes, include:
Agreements, contracts, or transactions to acquire or lease
real or personal property, to obtain a mortgage, to provide personal
services, or to sell or assign rights owned by such consumer (such as
intellectual property rights);
Agreements, contracts, or transactions to purchase
products or services at a fixed price or a capped or collared price, at
a future date or over a certain time period (such as agreements to
purchase home heating fuel);\104\
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\104\ These agreements, contracts, or transactions involve
physical delivery which is deferred for convenience or necessity and
thus can be viewed as being akin to forward purchase agreements
(sometimes with embedded options, in the case of those with price
caps), which were discussed above in the context of the exclusion
from the swap definition for forward contracts in nonfinancial
commodities. While the CFTC traditionally has viewed forward
contracts in nonfinancial commodities as limited to commercial
merchandising transactions, the Commissions view consumer
agreements, contracts, and transactions involving periodic or future
purchases of consumer products and services, such as agreements to
purchase energy commodities to heat or cool consumers' homes, as
transactions that are not swaps.
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[[Page 29833]]
Agreements, contracts, or transactions that provide for an
interest rate cap or lock on a consumer loan or mortgage, where the
benefit of the rate cap or lock is realized only if the loan or
mortgage is made to the consumer; and
Consumer loans or mortgages with variable rates of
interest or embedded interest rate options, including such loans with
provisions for the rates to change upon certain events related to the
consumer, such as a higher rate of interest following a default.
The types of commercial agreements, contracts, or transactions that
involve customary business arrangements (whether or not involving a
for-profit entity) and would not be considered swaps or security-based
swaps under this proposed interpretive guidance include:
Employment contracts and retirement benefit arrangements;
Sales, servicing, or distribution arrangements;
Agreements, contracts, or transactions for the purpose of
effecting a business combination transaction; \105\
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\105\ These business combination transactions include, for
example, a reclassification, merger, consolidation, or transfer of
assets as defined under the Federal securities laws or any tender
offer subject to section 13(e) and/or section 14(d) or (e) of the
Exchange Act, 15 U.S.C. 78m(e) and/or 78n(d) or (e). These business
combination agreements, contracts, or transactions can be contingent
on the continued validity of representations and warranties and can
contain earn-out provisions and contingent value rights.
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The purchase, sale, lease, or transfer of real property,
intellectual property, equipment, or inventory;
Warehouse lending arrangements in connection with building
an inventory of assets in anticipation of a securitization of such
assets (such as in a securitization of mortgages, student loans, or
receivables); \106\
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\106\ The Commissions believe that such lending arrangements
included in this category are traditional borrower/lender
arrangements documented using, for example, a loan agreement or
indenture, as opposed to a synthetic lending arrangement documented
in the form of, for example, a TRS. The Commissions also note that
securitization transaction agreements also may contain contingent
obligations if the representations and warranties about the
underlying assets are not satisfied.
---------------------------------------------------------------------------
Mortgage or mortgage purchase commitments, or sales of
installment loan agreements or contracts or receivables;
Fixed or variable interest rate commercial loans entered
into by non-banks \107\; and
---------------------------------------------------------------------------
\107\ See infra note 115 regarding identified banking products.
---------------------------------------------------------------------------
Commercial agreements, contracts, and transactions
(including, but not limited to, leases, service contracts, and
employment agreements) containing escalation clauses linked to an
underlying commodity such as an interest rate or consumer price index.
The Commissions intend this proposed interpretive guidance to allow
consumers to engage in customary transactions relating to their
households and personal or family activities without concern that such
arrangements would be considered swaps or security-based swaps.
Similarly, applying this guidance to customary commercial arrangements
should allow commercial and non-profit entities to continue to operate
their businesses and operations without significant disruption and
ensure that the swap and security-based swap definitions are not read
to include commercial and non-profit operations that historically have
not been considered to involve swaps or security-based swaps.
The types of agreements, contracts, and transactions discussed
above are not intended to be exhaustive of the customary consumer or
commercial arrangements that should not be considered to be swaps or
security-based swaps. There may be other, similar types of agreements,
contracts, and transactions that also should not be considered to be
swaps or security-based swaps. In determining whether similar types of
agreements, contracts, and transactions entered into by consumers or
commercial entities are swaps or security-based swaps, the Commissions
intend to consider the characteristics and factors that are common to
the consumer and commercial transactions listed above:
They do not contain payment obligations, whether or not
contingent, that are severable from the agreement, contract, or
transaction;
They are not traded on an organized market or over-the-
counter; and
In the case of consumer arrangements, they:
--Involve an asset of which the consumer is the owner or beneficiary,
or that the consumer is purchasing, or they involve a service provided,
or to be provided, by or to the consumer, or
In the case of commercial arrangements, they are entered
into:
--By commercial or non-profit entities as principals (or by their
agents) to serve an independent commercial, business, or non-profit
purpose, and
--Other than for speculative, hedging, or investment purposes.
Two of the key components reflected in these characteristics that
distinguish these agreements, contracts, and transactions from swaps
and security-based swaps are that: (i) The payment provisions of the
arrangements are not severable; and (ii) the agreement, contract, or
transaction is not traded on an organized market or over-the-counter--
so that such arrangements would not involve risk-shifting arrangements
with financial entities, as would be the case for swaps and security-
based swaps.\108\
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\108\ There also are alternative regulatory regimes that have
been enacted as part of the Dodd-Frank Act specifically to provide
enhanced protections to consumers relating to various consumer
transactions. See, e.g., the Consumer Financial Protection Act of
2010, Public Law 111-203, title X, 124 Stat. 1376 (July 21, 2010)
(establishing the Bureau of Consumer Financial Protection to
regulate a broad category of consumer products and amending certain
laws under the jurisdiction of the Federal Trade Commission); the
Mortgage Reform and Anti-Predatory Lending Act, Public Law 111-203,
title XIV, 124 Stat. 1376 (July 21, 2010) (amending existing laws,
and adding new provisions, related to certain mortgages). Some of
these agreements, contracts, or transactions are subject to
regulation by the Federal Trade Commission and other Federal
financial regulators and state regulators.
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This proposed interpretive guidance is not intended to be the
exclusive means for consumers and commercial or non-profit entities to
determine whether their agreements, contracts, or transactions fall
within the swap or security-based swap definition. If there is a type
of agreement, contract, or transaction that is not enumerated above, or
does not have all the characteristics and factors that are listed above
(including new types of arrangements that may be developed in the
future), but that a party to the agreement, contract, or transaction
believes is not a swap or security-based swap, the Commissions invite
such party to seek an interpretation from the Commissions as to whether
the agreement, contract, or transaction is a swap or security-based
swap.
Request for Comment
39. Is interpretive guidance of the type proposed in this section
necessary with respect to the application of the swap and security-
based swap definitions to certain consumer and commercial agreements,
contracts, or transactions?
40. Is the interpretive guidance proposed in this section useful,
[[Page 29834]]
appropriate, and sufficient for persons to consider when evaluating
whether agreements, contracts, or transactions of the types described
in this section fall within the swap or security-based swap definition?
41. In particular, are the listed characteristics and factors for
consumer transactions and for commercial transactions appropriate for
purposes of evaluating whether agreements, contracts, or transactions
fall within the swap or security-based swap definition? If not, what
characteristics or factors should be included or excluded, and why? Are
any of the characteristics or factors too narrow or too broad? If so,
how should the listed characteristics and factors be modified, and why?
42. Is a joint interpretation as provided for in section 712(d)(4)
of the Dodd-Frank Act, pursuant to the proposed process discussed in
part VI below, an appropriate means of addressing any further
interpretive questions?
43. Does the interpretive guidance proposed in this section
sufficiently enumerate the types of consumer and commercial agreements,
contracts, or transactions that should not be considered swaps or
security-based swaps? If not, please provide details of other types of
such agreements, contracts, or transactions and an explanation of the
reasons why the definitions should not apply to them.
44. Is the treatment of consumer or commercial contracts containing
payment arrangements sufficiently clear? For example, should the
interpretive guidance expressly address any other specific types of
contracts, such as installment sales contracts, financings used in
normal business operations (such as receivables financings), pensions
and other post-retirement benefits, contracts relating to the
performance of a service, standby liquidity agreements, indemnification
agreements, reimbursement agreements, or affiliate guarantees? Why or
why not?
45. Is the treatment of purchases, sales, leases, or transfers of
equipment and inventory sufficiently flexible to not interfere with
ordinary business operations? As an alternative, should the guidance
expressly cover the purchase, sale, lease, or transfer of assets
(excluding financial assets) that are anticipated to be owned, leased,
licensed, produced, manufactured, processed, or merchandized by one of
the parties or an affiliate? Why or why not?
4. Loan Participations
Two commenters inquired whether loan participations fall within the
scope of the swap and security-based swap definitions.\109\ According
to these commenters, loan participations arise when a lender transfers
the economic risks and benefits of all or a portion of a loan it has
entered into with a borrower to another party as an alternative or
precursor to assigning to such person the loan or an interest in the
loan.\110\ Two types of loan participations are offered in the market
today according to these commenters: LSTA-style participations and LMA-
style participations.\111\ An LSTA-style participation ``specifically
provides that the participation is intended by the parties to be
treated as a sale by the grantor and a purchase by the participant''
and ``is intended to effect a `true sale' of the loan from the grantor
to the participant and put the participant's beneficial ownership
interest in the loan beyond the reach of the grantor's bankruptcy
estate.'' \112\ By contrast, an LMA-style participation, while not
effecting a sale, ``creates a current debtor-creditor relationship
between the grantor and the participant under which a future ownership
interest is conveyed.'' \113\ Neither type of loan participation is a
``synthetic'' transaction according to the March LSTA letter because
``they are merely transfers of cash loan positions'' and ``[t]he ratio
of underlying loan to participation is always one-to-one.''
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\109\ See Letter from R. Bram Smith, Executive Director, The
Loan Syndications and Trading Association, Jan. 25, 2011 (``January
LSTA Letter'') and letter from Elliot Ganz, General Counsel, The
Loan Syndications and Trading Association, Mar. 1, 2011 (``March
LSTA Letter, and collectively with the January LSTA Letter, ``LSTA
Letters''); Letter from Clare Dawson, Managing Director, Loan Market
Association, Feb. 23, 2011.
\110\ See Loan Market Association, ``Guide to Syndicated
Loans,'' section 6.2.5 (``Risk participation may be provided by a
new lender as an interim measure before it takes full transfer of a
loan.''), available at http://www.lma.eu.com/uploads/files/Introductory_Guides/Guide_to_Par_Syndicated_Loans.pdf.
\111\ The LSTA is The Loan Syndications and Trading Association.
The LMA is the Loan Market Association.
\112\ See January LSTA Letter (citation omitted).
\113\ See LSTA Letters. But see Jon Kibbe, Julia Lu and Carl
Winkworth, Richards Kibbe & Orbe, LLP, ``Dodd-Frank Crosses the
Pond: Unintended Consequences for LMA-Style Loan Participations?,''
3 (Nov. 12, 2010) (``The grantor of an LMA-style participation does
not grant an ownership interest in the loan to the participant.'')
(``LMA-Style LP Memo''), available at http://www.rkollp.com/assets/attachments/Dodd-Frank%20Crosses%20the%20Pond%20-%20Unintended%20Consequences%20for%20LMA-Style%20Loan%20Participations.pdf.
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Depending on the facts and circumstances, a loan participation may
be a security under the Federal securities laws and, as such, the loan
participation would be excluded from the definition of swap as the
purchase and sale of a security on a fixed or contingent basis.\114\ In
addition, depending on the facts and circumstances, a loan
participation may be an identified banking product and, as such, would
be excluded from CFTC jurisdiction and from the ``security-based swap''
and ``security-based swap agreement'' definitions.\115\
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\114\ See CEA sections 1a(47)(B)(v) and (vi), 7 U.S.C.
1a(47)(b)(v) and (vi), as amended by section 721(a)(21) of the Dodd-
Frank Act (excluding purchases and sales of a security on a fixed or
contingent basis, respectively from the swap definition).
\115\ See section 403(a) of the Legal Certainty for Bank
Products Act of 2000, 7 U.S.C. 27a(a), as amended by section
725(g)(2) of the Dodd-Frank Act (providing that, under certain
circumstances, the CEA shall not apply to, and the CFTC shall not
exercise regulatory authority over, identified banking products, and
the definitions of the terms ``security-based swap'' and ``security-
based swap agreement'' shall not include identified banking
products).
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The Commissions do not interpret the swap and security-based swap
definitions to include loan participations in which the purchaser is
acquiring a current or future direct or indirect ownership interest in
the related loan and the loan participations are ``true
participations'' (the participant acquires a beneficial ownership
interest in the underlying loans).\116\
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\116\ See generally Richard M. Gray and Suhrud Mehta, Milbank
Tweed Hadley & McCloy LLP, ``US and UK compared Fundamental
differences remain between the markets. But is it worth considering
using a New York participation agreement in an English deal?,''
International Financial Law Review (Oct. 1, 2009) (discussing
differences between New York and English participation markets and
features distinguishing true participations from financings),
available at http://www.milbank.com/NR/rdonlyres/B95C06AD-C3CA-44C9-8433-B6021C4455C9/0/102009_IFLR_USandUKcompared_RGray_SMehta.pdf; Cleary, Gottlieb, Steen & Hamilton, Memorandum for the
Financial Accounting Standards Board, Re: Participations (June 14,
2004) (discussing, among other things, what a ``good'' or ``true''
participation is under the Uniform Commercial Code, the Bankruptcy
Code, case law, and other authority), available at http://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175817895286&blobheader=application%2Fpdf.
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Request for Comment
46. Should any of the enumerated agreements, contracts, or
transactions be considered swaps or security-based swaps whether in
general or in certain narrow circumstances? If so, which ones and why?
In particular, how are loan participations similar to and different
from loan TRS? Does the proposed guidance adequately distinguish
between loan participations similar to and different from loan TRS?
47. Does the Commissions' proposed interpretive guidance regarding
loan participations exclude from the swap or security-based swap
definitions agreements, contracts, or transactions
[[Page 29835]]
that are swaps or security-based swaps? If so, please describe such
agreements, contracts, or transactions and suggested adjustments to the
proposed guidance to capture such agreements, contracts, or
transactions as swaps or security-based swaps.
48. Is the Commissions' proposed interpretive guidance regarding
loan participations as not falling within the swap and security-based
swap definitions appropriate? Why or why not? Should the Commissions
provide further guidance on what constitutes an ``ownership interest''
in the loan underlying a loan participation? If so, what should such
guidance provide?
49. Do all loan participations convey a current or future direct or
indirect ownership interest from the grantor to the participant or sub-
participant? If so, what indicia of ownership are conveyed and when,
particularly in LMA-style loan participations? Do loan participations
use leverage? If so, how?
50. Are any swaps or security-based swaps partly or fully defeased?
51. Should the Commissions provide further guidance regarding the
scope of ``true participation?'' If so, how should the Commissions
delineate the scope thereof?
C. Proposed Rules and Interpretive Guidance Regarding Certain
Transactions Within the Scope of the Definitions of the Terms ``Swap''
and ``Security-Based Swap''
1. In General
In light of provisions in the Dodd-Frank Act that specifically
address certain foreign exchange products, the Commissions are
proposing rules to clarify the status of products such as foreign
exchange forwards, foreign exchange swaps, foreign exchange options,
non-deliverable forwards involving foreign exchange (``NDFs''), and
cross-currency swaps. The Commissions also are proposing a rule to
clarify the status of FRAs and providing interpretive guidance
regarding: (i) Combinations and permutations of, or options on, swaps
or security-based swaps; and (ii) contracts for differences (``CFDs'').
Proposed rule 1.3(xxx)(2) under the CEA and proposed rule 3a69-2
under the Exchange Act would explicitly define the term ``swap'' to
include certain foreign exchange-related products and FRAs unless such
products would be excluded by the list of exclusions in subparagraph
(B) of the swap definition.\117\ In proposing these rules, the
Commissions do not mean to suggest that any other agreement, contract,
or transaction not mentioned in the proposed rules or specifically
enumerated in the statutory definition would not be covered by the swap
or security-based swap definitions in the Dodd-Frank Act.
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\117\ See CEA section 1a(47)(B), 7 U.S.C. 1a(47)(B).
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2. Foreign Exchange Products
(a) Foreign Exchange Products Subject to the Secretary's Swap
Determination: Foreign Exchange Forwards and Foreign Exchange Swaps
The Dodd-Frank Act provides that ``foreign exchange forwards'' and
``foreign exchange swaps'' shall be considered swaps under the swap
definition unless the Secretary of the Treasury (``Secretary'') issues
a written determination that either foreign exchange swaps, foreign
exchange forwards, or both: (i) Should not be regulated as swaps; and
(ii) are not structured to evade the Dodd-Frank Act in violation of any
rule promulgated by the CFTC pursuant to section 721(c) of the Dodd-
Frank Act.\118\ A foreign exchange forward is defined as ``a
transaction that solely involves the exchange of 2 different currencies
on a specific future date at a fixed rate agreed upon on the inception
of the contract covering the exchange.'' \119\ A foreign exchange swap,
in turn, is defined as ``a transaction that solely involves--(A) An
exchange of 2 different currencies on a specific date at a fixed rate
that is agreed upon on the inception of the contract covering the
exchange; and (B) a reverse exchange of the 2 currencies described in
subparagraph (A) at a later date and at a fixed rate that is agreed
upon on the inception of the contract covering the exchange.'' \120\
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\118\ See CEA section 1a(47)(E)(i), 7 U.S.C. 1a(47)(E)(i). The
Secretary has issued a request for comment about whether an
exclusion from the swap definition for foreign exchange swaps,
foreign exchange forwards, or both, is warranted, and on the
application of the statutory factors that the Secretary must
consider in making a determination regarding whether to exclude
these products. See Determinations of Foreign Exchange Swaps and
Forwards, 75 FR 66829, Oct. 29, 2010.
\119\ See CEA section 1a(24), 7 U.S.C. 1a(24).
\120\ See CEA section 1a(25), 7 U.S.C. 1a(25).
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Under the Dodd-Frank Act, if foreign exchange forwards or foreign
exchange swaps are no longer considered swaps due to a determination by
the Secretary, nevertheless, certain provisions of the CEA added by the
Dodd-Frank Act would continue to apply to such transactions.
Specifically, those transactions still would be subject to certain
requirements for reporting swaps, and swap dealers and major swap
participants engaging in such transactions still would be subject to
certain business conduct standards.\121\
---------------------------------------------------------------------------
\121\ See, e.g., CEA sections 1a(47)(E)(iii) and (iv), 7 U.S.C.
1a(47)(E)(iii) and (iv) (reporting and business conduct standards,
respectively).
---------------------------------------------------------------------------
The Commissions are proposing to provide greater clarity by
explicitly defining by rule the term ``swap'' to include foreign
exchange forwards and foreign exchange swaps (as those terms are
defined in the CEA).\122\ The proposed rules would incorporate the
provision of the Dodd-Frank Act that, if the Secretary issues the
written determination described above, foreign exchange forwards and
foreign exchange swaps would no longer be considered swaps. The
proposed rules also would reflect the continuing applicability of
certain reporting requirements and business conduct standards in the
event that the Secretary makes such a determination.\123\
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\122\ As noted above, the proposed rules provide that foreign
exchange forwards and forward exchange swaps would not be swaps if
they fall within one of the exclusions set forth in subparagraph (B)
of the swap definition.
\123\ The exclusion of foreign exchange forwards and foreign
exchange swaps would become effective upon the Secretary's
submission of the determination to the appropriate Congressional
Committees. See CEA section 1a(47)(E)(ii), 7 U.S.C. 1a(46)(E)(ii).
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(b) Foreign Exchange Products Not Subject to the Secretary's Swap
Determination
The Commissions also are proposing rules to provide clarity that a
determination by the Secretary that foreign exchange forwards or
foreign exchange swaps, or both, should not be regulated as swaps would
not affect other products involving foreign currency, such as foreign
currency options, NDFs, and cross-currency swaps. The Commissions are
proposing rules to explicitly define the term ``swap'' to include such
products, irrespective of whether the Secretary makes a determination
to exempt foreign exchange forwards or foreign exchange swaps.\124\
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\124\ As discussed above, however, the proposed rules provide
that none of the products discussed in this section (b) would be
swaps if they fall within one of the exclusions set forth in
subparagraph (B) of the swap definition.
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(i) Foreign Currency Options \125\
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\125\ This discussion is not intended to address, and has no
bearing on, the CFTC's jurisdiction over foreign currency options in
other contexts. See, e.g., CEA sections 2(c)(2)(A)(iii) and
2(c)(2)(B)-(C), 7 U.S.C. 2(c)(2)(A)(iii) and 2(c)(2)(B)-(C) (off-
exchange options in foreign currency offered or entered into with
retail customers).
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As discussed above, the statutory swap definition includes options,
and it expressly enumerates foreign currency options. It encompasses
any agreement, contract, or transaction: '' (i) that is a
[[Page 29836]]
put, call, cap, floor, collar, or similar option of any kind that is
for the purchase or sale, or based on the value, of 1 or more interest
or other rates, currencies, commodities, securities, instruments of
indebtedness, indices, quantitative measures, or other financial or
economic interests or property of any kind.'' \126\
---------------------------------------------------------------------------
\126\ See CEA section 1a(47)(A)(i), 7 U.S.C. 1a(47)(A)(i)
(emphasis added).
---------------------------------------------------------------------------
Foreign exchange options traded on a national securities exchange
(``NSE''), however, are securities under the Federal securities laws
and not swaps or security-based swaps.\127\
---------------------------------------------------------------------------
\127\ See CEA section 1a(47)(B)(iv), 7 U.S.C. 1a(47)(B)(iv).
---------------------------------------------------------------------------
Any determination by the Secretary, discussed above, that foreign
exchange forwards or foreign exchange swaps should not be regulated as
swaps would not impact foreign currency options because a foreign
currency option is neither a foreign exchange swap nor a foreign
exchange forward, as those terms are defined in the CEA. Consequently,
the Commissions are proposing rules to provide clarity by explicitly
defining the term ``swap'' to include foreign currency options (other
than foreign currency options traded on an NSE).\128\ The proposed
rules also would clarify that foreign currency options are not foreign
exchange forwards or foreign exchange swaps under the CEA.
---------------------------------------------------------------------------
\128\ The proposed rules would treat the terms foreign currency
options, currency options, foreign exchange options, and foreign
exchange rate options as synonymous. Moreover, for purposes of the
proposed rules, foreign currency options include options to enter
into or terminate, or that otherwise operate on, a foreign exchange
swap or foreign exchange forward or on the terms thereof. As
discussed above, foreign exchange options traded on an NSE are
securities and therefore not addressed in the proposed rules.
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(ii) Non-Deliverable Forward Contracts Involving Foreign Exchange
An NDF generally is similar to a forward foreign exchange
contract,\129\ except that at maturity, the NDF does not require
physical delivery of currencies and is typically settled in U.S.
dollars. The other currency, usually an emerging market currency
subject to capital controls, is therefore said to be
``nondeliverable.'' \130\ If the spot market exchange rate on the
settlement date is greater (in foreign currency per dollar terms) than
the previously agreed forward exchange rate, the party to the contract
that is long the emerging market currency must pay its counterparty the
difference between the contracted forward price and the spot market
rate, multiplied by the notional amount.\131\
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\129\ A deliverable forward foreign exchange contract is an
obligation to buy or sell a specific currency on a future settlement
date at a fixed price set on the trade date. See Laura Lipscomb,
``Federal Reserve Bank of New York, An Overview of Non-Deliverable
Foreign Exchange Forward Markets,'' 1 (May 2005) (citation omitted)
(``Fed NDF Overview'').
\130\ See id. at 1-2 (citation omitted).
\131\ See id. at 2. Being long the emerging market currency
means that the holder of the NDF contract is the ``buyer'' of the
emerging market currency and the ``seller'' of dollars. Conversely,
if the emerging market currency appreciates relative to the
previously agreed forward rate, the holder of the contract that is
short the emerging market currency must pay its counterparty the
difference between the spot market rate and the contracted forward
price, multiplied by the notional amount. See id. at 2, n.4.
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NDFs are not expressly enumerated in the swap definition, but they
satisfy clause (A)(iii) of the definition because they provide for a
future (executory) payment based on an exchange rate, which is an
``interest or other rate[]'' within the meaning of clause (A)(iii) of
the swap definition.\132\ Each party to an NDF transfers to its
counterparty the risk of the exchange rate moving against the
counterparty, thus satisfying the requirement that there be a transfer
of financial risk associated with a future change in rate. This
financial risk transfer in the context of an NDF is not accompanied by
a transfer of an ownership interest in any asset or liability. Thus, an
NDF is a swap under clause (A)(iii) of the swap definition.\133\
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\132\ See CEA section 1a(47)(A)(iii), 7 U.S.C. 1a(47)(A)(iii)
(providing that a swap is an agreement, contract, or transaction
``that provides on an executory basis for the exchange, on a fixed
or contingent basis, of 1 or more payments based on the value or
level of 1 or more interest or other rates, currencies, commodities,
securities, instruments of indebtedness, indices, quantitative
measures, or other financial or economic interests or property of
any kind, or any interest therein or based on the value thereof, and
that transfers, as between the parties to the transaction, in whole
or in part, the financial risk associated with a future change in
any such value or level without also conveying a current or future
direct or indirect ownership interest in an asset (including any
enterprise or investment pool) or liability that incorporates the
financial risk so transferred * * *.'').
\133\ It appears that at least some market participants view
NDFs as swaps today. See, e.g., Credit Suisse, ``Non-Deliverable
Forwards,'' at 1 (characterizing NDFs as ``a derivative instrument
for hedging * * * exchange-rate risk'' in the absence of a forwards
market), available at https://www.credit-suisse.com/ch/unternehmen/kmugrossunternehmen/doc/nondeliverable_forward_en.pdf; Association
of Corporate Treasurers, ``Glossary of Terms'' (defining an NDF as
``[a] foreign currency financial derivative contract''), available
at http://www.treasurers.org/glossary/N#Non-deliverableforward.
Thus, NDFs also may fall within clause (A)(iv) of the swap
definition as ``an agreement, contract, or transaction that is, or
in the future becomes, commonly known to the trade as a swap.'' See
CEA section 1a(47)(A)(iv), 7 U.S.C. 1a(47)(A)(iv). Cf. CFTC rule
35.1(b)(1)(i), 17 CFR 35.1(b)(1)(i) (providing that the definition
of ``swap agreement'' includes a ``forward foreign exchange
agreement,'' without reference to convertibility or delivery).
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As discussed above, the Secretary may determine that foreign
exchange swaps or foreign exchange forwards should not be regulated as
swaps. The outcome of the Secretary's determination would not impact
NDFs, however, because NDFs (like foreign currency options) do not meet
the definitions of the terms foreign exchange forward or foreign
exchange swap set forth in the CEA. NDFs do not involve an ``exchange''
of two different currencies (an element of the definition of both a
foreign exchange forward and a foreign exchange swap); instead, they
are settled by payment in one currency (usually U.S. dollars).
Notwithstanding their ``forward'' label, NDFs do not fall within
the forward contract exclusion of the swap definition. Currency is
outside the scope of the forward contract exclusion for nonfinancial
commodities. Nor have NDFs traditionally been considered commercial
merchandising transactions. Rather, the NDF markets appear to be driven
in large part by speculation \134\ and hedging,\135\ which features are
more characteristic of swap markets than forward markets.
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\134\ See ``Fed NDF Overview,'' supra note 129, at 5
(``[E]stimates vary but many major market participants estimate as
much as 60 to 80 percent of NDF volume is generated by speculative
interest, noting growing participation from international hedge
funds.'') and 4 (``[D]ealers note that much of the volume in Chinese
yuan NDFs is generated by speculative positioning based on
expectations for an alteration in China's current, basically fixed
exchange rate.'') (italics in original).
\135\ See id. at 4 (noting that ``[much of the] Korean won NDF
volume[,] * * * estimated to be the largest of any currency, * * *
is estimated to originate with international investment portfolio
managers hedging the currency risk associated with their onshore
investments'').
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Based on the foregoing considerations, the Commissions are
proposing to provide greater clarity by explicitly defining the term
``swap'' to include NDFs. The proposed rules also would clarify that
NDFs are not foreign exchange forwards or foreign exchange swaps as
those terms are defined in the CEA.
(iii) Currency Swaps and Cross-Currency Swaps
A currency swap \136\ and a cross-currency swap \137\ each
generally can be
[[Page 29837]]
described as a swap in which the fixed legs or floating legs based on
various interest rates are exchanged in different currencies. Such
swaps can be used to reduce borrowing costs, to hedge currency
exposure, and to create synthetic assets \138\ and are viewed as an
important tool, given that they can be used to hedge currency and
interest rate risk in a single transaction.
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\136\ A swap that exchanges a fixed rate against a fixed rate is
known as a currency swap. See Federal Reserve System, ``Trading and
Capital-Markets Activities Manual,'' section 4335.1 (Jan. 2009).
\137\ Cross-currency swaps with a fixed leg based on one rate
and a floating leg based on another rate, where the two rates are
denominated in different currencies, are generally referred to as
cross-currency coupon swaps, while those with a floating leg based
on one rate and another floating leg based on a different rate are
known as cross-currency basis swaps. Id. Cross-currency swaps also
include annuity swaps and amortizing swaps. In cross-currency
annuity swaps, level cash flows in different currencies are
exchanged with no exchange of principal; annuity swaps are priced
such that the level payment cash flows in each currency have the
same net present value at the inception of the transaction. An
amortizing cross-currency swap is structured with a declining
principal schedule, usually designed to match that of an amortizing
asset or liability. Id. See also Derivatives ONE, ``Cross Currency
Swap Valuation'' (``A cross currency swap is swap of an interest
rate in one currency for an interest rate payment in another
currency. * * * This could be considered an interest rate swap with
a currency component.''), available at http://www.derivativesone.com/cross-currency-swap-valuation/; Financial
Accounting Standards Board, ``Examples Illustrating Application of
FASB Statement No. 138,'' Accounting for Certain Derivative
Instruments and Certain Hedging Activities, section 2, Example 1, at
3 (``The company designates the cross-currency swap as a fair value
hedge of the changes in the fair value of the loan due to both
interest and exchange rates.''), available at http://www.fasb.org/derivatives/examples.pdf.
\138\ BMO Capital Markets, ``Cross Currency Swaps,'' available
at http://www.bmocm.com/products/marketrisk/intrderiv/cross/default.aspx.
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Currency swaps and cross-currency swaps are not foreign exchange
swaps as defined in the CEA because, although they may involve an
exchange of foreign currencies, they also require contingent or
variable payments in different currencies. Because the CEA defines a
foreign exchange swap as a swap that ``solely'' involves an initial
exchange of currencies and a reversal thereof at a later date, subject
to certain parameters, currency swaps and cross-currency swaps would
not be foreign exchange swaps. Similarly, currency swaps and cross-
currency swaps are not foreign exchange forwards because foreign
exchange forwards ``solely'' involve an initial exchange of currencies,
subject to certain parameters, while currency swaps and cross-currency
swaps contain additional elements, as discussed above.
Currency swaps are expressly enumerated in the statutory definition
of the term ``swap.'' \139\ Cross-currency swaps, however, are
not.\140\ Accordingly, based on the foregoing considerations, the
Commissions are proposing rules to provide greater clarity by
explicitly defining the term ``swap'' to include cross-currency swaps.
The proposed rules also would clarify that neither currency swaps nor
cross-currency swaps are foreign exchange forwards or foreign exchange
swaps as those terms are defined in the CEA.
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\139\ See CEA section 1a(47)(A)(iii)(VII), 7 U.S.C.
1a(47)(A)(iii)(VII).
\140\ Clause (A)(iii) of the swap definition expressly refers to
a cross-currency rate swap. See CEA section 1a(47)(A)(iii)(V), 7
U.S.C. 1a(47)(A)(iii)(V). Although the swap industry appears to use
the term ``cross-currency swap,'' rather than ``cross-currency rate
swap'' (the term used in CEA section 1a(47)(A)(iii)(V)), the
Commissions interpret these terms as synonymous.
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Request for Comment
52. Should the proposed rules explicitly define the term ``swap''
to include foreign exchange forwards and foreign exchange swaps, unless
the Secretary determines to exempt them? Should the proposed rules
clarify that, if the Secretary determines to exempt foreign exchange
swaps or foreign exchange forwards, those transactions remain subject
to certain reporting requirements, and swap dealers and major swap
participants entering into such transactions remain subject to certain
business conduct standards, imposed by Title VII and CFTC regulations
promulgated thereunder? Why or why not?
53. Should the proposed rules explicitly define the term ``swap''
to include foreign currency options and clarify that foreign currency
options are not foreign exchange forwards or foreign exchange swaps?
Why or why not? Should the terms foreign currency options, currency
options, foreign exchange options, and foreign exchange rate options be
interpreted as synonymous? Why or why not?
54. Should the proposed rules explicitly define the term ``swap''
to include NDFs and clarify that NDFs are not foreign exchange forwards
or foreign exchange swaps? Why or why not?
55. Should the proposed rules explicitly define the term ``swap''
to include cross-currency swaps as swaps and clarify that currency
swaps and cross-currency swaps are not foreign exchange forwards or
foreign exchange swaps? Why or why not? Should the terms cross-currency
swap and cross-currency rate swap be interpreted as synonymous? Why or
why not?
56. Is additional detail needed within the proposed rules regarding
foreign exchange-related products to provide greater clarity regarding
the specific products listed in the proposed rules? If so, what
additional detail would be necessary?
3. Forward Rate Agreements
In general, the Commissions understand an FRA to be an over-the-
counter contract for a single cash payment, due on the settlement date
of a trade, based on a spot rate (determined pursuant to a method
agreed upon by the parties) and a prespecified forward rate. The single
cash payment is equal to the product of the present value (discounted
from a specified future date to the settlement date of the trade) of
the difference between the forward rate and the spot rate on the
settlement date multiplied by the notional amount. The notional amount
itself is not exchanged.\141\
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\141\ See generally ``Trading and Capital-Markets Activities
Manual,'' supra note 136, section 4315.1 (``For example, in a six-
against-nine-month (6x9) FRA, the parties agree to a three-month
rate that is to be netted in six months' time against the prevailing
three-month reference rate, typically LIBOR. At settlement (after
six months), the present value of the net interest rate (the
difference between the spot and the contracted rate) is multiplied
by the notional principal amount to determine the amount of the cash
exchanged between the parties * * *. If the spot rate is higher than
the contracted rate, the seller agrees to pay the buyer the
differences between the prespecified forward rate and the spot rate
prevailing at maturity, multiplied by a notional principal amount.
If the spot rate is lower than the forward rate, the buyer pays the
seller.'').
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An FRA provides for the future (executory) payment based on the
transfer of interest rate risk between the parties as opposed to
transferring an ownership interest in any asset or liability.\142\
Thus, the Commissions believe that an FRA satisfies clause (A)(iii) of
the swap definition.\143\
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\142\ It appears that at least some in the trade view FRAs as
swaps today. See, e.g., The Globecon Group, Ltd., ``Derivatives
Engineering: A Guide to Structuring, Pricing and Marketing
Derivatives,'' 45 (McGraw-Hill 1995) (``An FRA is simply a one-
period interest-rate swap.''); DerivActiv, Glossary of Financial
Derivatives Terms (``A swap is * * * a strip of FRAs.''), available
at http://www.derivactiv.com/definitions.aspx?search=forward+rate+agreements. Cf. Don M. Chance,
et. al, ``Derivatives in Portfolio Management,'' 29 (AIMR 1998)
(``[An FRA] involves one specific payment and is basically a one-
date swap (in the sense that a swap is a combination of FRAs[,] with
some variations).''). Thus, FRAs also may fall within clause (A)(iv)
of the swap definition, as ``an agreement, contract, or transaction
that is, or in the future becomes, commonly known to the trade as a
swap.'' See CEA section 1a(47)(a)(iv), 7 U.S.C. 1a(47)(a)(iv).
\143\ See CEA section 1a(47)(A)(iii); 7 U.S.C. 1a(47)(A)(iii).
CFTC regulations have defined FRAs as swap agreements. See CFTC rule
35.1(b)(1)(i), 17 CFR 35.1(b)(1)(i); Exemption for Certain Swap
Agreements, 58 FR 5587, Jan. 22, 1993. The CFTC recently has
proposed to repeal that rule in light of the enactment of Title VII
of the Dodd-Frank Act. See Commodity Options and Agricultural Swaps,
supra note 78.
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Notwithstanding their ``forward'' label, FRAs do not fall within
the forward contract exclusion from the swap definition. FRAs do not
involve nonfinancial commodities and thus are outside the scope of the
forward contract exclusion. Nor is an FRA a commercial merchandising
transaction, as there is no physical product to be delivered in an
FRA.\144\ Accordingly,
[[Page 29838]]
the Commissions believe that the forward contract exclusion from the
swap definition for nonfinancial commodities does not apply to
FRAs.\145\
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\144\ See Regulation of Hybrid and Related Instruments, 52 FR
47022, 47028, Dec. 11, 1987 (stating ``[FRAs] do not possess all of
the characteristics of forward contracts heretofore delineated by
the [CFTC]'').
\145\ Current European Union law includes FRAs in the definition
of ``financial instruments.'' See Markets in Financial Instruments
Directive (MiFID), ``Directive 2004/39/EC of the European Parliament
and of the Council,'' Annex I(C), 4, 5, 10 (Apr. 21, 2004),
available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CONSLEG:2004L0039:20070921:EN:PDF. A European
Commission legislative proposal on derivatives, central clearing,
and trade repositories applies to FRAs that are traded over-the-
counter and, thus, would subject such transactions to mandatory
clearing, reporting and other regulatory requirements. See Proposal
for a Regulation of the European Parliament and of the Council on
OTC derivatives, central counterparties and trade repositories,
title I, art. 1(1), COM(2010) 484/5 (Sept. 15, 2010), available at
http://ec.europa.eu/internal_market/financial-markets/docs/derivatives/20100915_proposal_en.pdf.
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Based on the foregoing considerations, the Commissions are
proposing rules to provide greater clarity by explicitly defining the
term ``swap'' to include FRAs. As with the foreign exchange-related
products discussed above, the proposed rules provide that FRAs would
not be swaps if they fall within one of the exclusions set forth in
subparagraph (B) of the swap definition.
Request for Comment
57. Is the description of FRAs accurate? If not, please provide a
detailed description of FRAs. Are there various types of FRAs? If so,
please provide an explanation of their characteristics and how they
differ.
58. What types of market participants use FRAs, and for what
purposes? What market (spot) and fixed rates are used in FRAs, and how
are those rates determined, or on what are those rates based?
59. Should the proposed rules explicitly define the term ``swap''
to include FRAs? Why or why not?
60. Should the proposed rules provide a more detailed description
of what FRAs are? Why or why not? If so, please explain what additional
language regarding FRAs should be included in the proposed rules.
4. Combinations and Permutations of, or Options on, Swaps and Security-
Based Swaps
Clause (A)(vi) of the swap definition provides that ``any
combination or permutation of, or option on, any agreement, contract,
or transaction described in any of clauses (i) through (v)'' of the
definition is a swap or security-based swap.\146\ As a result, clause
(A)(vi) means, for example, that an option on a swap or security-based
swap (commonly known as a ``swaption'') would itself be a swap or
security-based swap, respectively. The Commissions also interpret
clause (A)(vi) to mean that a ``forward swap'' would itself be a swap
or security-based swap, respectively.\147\
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\146\ See CEA section 1a(47)(vi), 7 U.S.C. 1a(47)(vi).
\147\ Forward swaps are also commonly known as forward start
swaps, or deferred or delayed start swaps. A forward swap can
involve two offsetting swaps that both start immediately, but one of
which ends on the deferred start date of the forward swap itself.
For example, if a counterparty wants to hedge its risk for four
years, starting one year from today, it could enter into a one-year
swap and a five-year swap, which would partially offset to create a
four-year swap, starting one year forward. A forward swap also can
involve a contract to enter into a swap or security-based swap at a
future date or with a deferred start date. A forward swap is not a
nonfinancial commodity forward contract or security forward, both of
which are excluded from the swap definition and discussed elsewhere
in this release.
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Request for Comment
61. Is additional guidance regarding swaptions, necessary? Why or
why not? If so, please provide a detailed explanation of what
additional guidance would be necessary.
62. Is the Commissions' description of forward swaps accurate? Why
or why not? If not, please provide a detailed explanation of why the
description is inaccurate. Is additional guidance regarding forward
swaps necessary? Why or why not? If so, please provide a detailed
explanation of what additional guidance would be necessary.
63. Is additional guidance regarding other combinations or
permutations of swaps or security-based swaps necessary? Why or why
not? If so, please provide a detailed description of any particular
agreement, contract, or transaction, including the purposes for which
it is used and the market participants that use it, and what additional
guidance would be necessary.
5. Contracts for Differences
The Commissions have received inquiries over the years regarding
the treatment of CFDs under the CEA and the Federal securities laws. A
CFD generally is an agreement to exchange the difference in value of an
underlying asset between the time at which a CFD position is
established and the time at which it is terminated.\148\ If the value
increases, the seller pays the buyer the difference; if the value
decreases, the buyer pays the seller the difference. CFDs can be traded
on a number of products, including treasuries, foreign exchange rates,
commodities, equities, and stock indexes. Equity CFDs closely mimic the
purchase of actual shares. The buyer of an equity CFD receives cash
dividends and participates in stock splits.\149\ In the case of a long
position, a dividend adjustment is credited to the client's account. In
the case of a short position, a dividend adjustment is debited from the
client's account. CFDs generally are traded over-the-counter (though
they also are traded on the Australian Securities Exchange) in a number
of countries outside the United States.
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\148\ See Ontario Securities Commission, Staff Notice 91-702,
``Offerings of Contracts for Difference and Foreign Exchange
Contracts to Investors in Ontario,'' at part IV.1 (defining a CFD as
``a derivative product that allows an investor to obtain economic
exposure (for speculative, investment or hedging purposes) to an
underlying asset * * * such as a share, index, market sector,
currency or commodity, without acquiring ownership of the underlying
asset''), available at http://www.osc.gov.on.ca/documents/en/Securities-Category9/sn_20091030_91-702_cdf.pdf (Oct. 30, 2009);
Financial Services Authority, Consultation Paper 7/20, ``Disclosure
of Contracts for Difference--Consultation and draft Handbook text,''
at part 2.2 (defining a CFD on a share as ``a derivative product
that gives the holder an economic exposure, which can be long or
short, to the change in price of a specific share over the life of
the contract''), available at http://www.fsa.gov.uk/pubs/cp/cp07_20.pdf (Nov. 2007).
\149\ See, e.g., Int'l Swaps and Derivatives Ass'n, ``2002 ISDA
Equity Derivatives Definitions,'' art. 10 (Dividends) and 11
(Adjustments and Modifications Affecting Indices, Shares and
Transactions).
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CFDs, unless otherwise excluded, may fall within the scope of the
swap and security-based swap definitions.\150\ Whether a CFD is a swap
or security-based swap will depend on the underlying product of that
particular CFD transaction. Because CFDs are highly variable and a CFD
can contain a variety of elements that would affect its
characterization, the Commissions believe that market participants will
need to analyze the characteristics of any particular CFD in order to
determine whether it is a swap or a security-based swap. Therefore, the
Commissions are not proposing rules or additional interpretive guidance
at this time regarding CFDs.
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\150\ In some cases, depending on the facts and circumstances,
the SEC may determine that a particular CFD on an equity security,
for example, should be characterized as constituting a purchase or
sale of the underlying equity security and, therefore, be subject to
the requirements of the Federal securities laws applicable to such
purchases or sales.
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Request for Comment
64. Should the Commissions provide additional guidance regarding
CFDs? Why or why not? If so, please provide a detailed description of
any particular CFD and what additional guidance would be necessary.
[[Page 29839]]
D. Certain Interpretive Issues
1. Agreements, Contracts, or Transactions That May Be Called, or
Documented Using Form Contracts Typically Used for, Swaps or Security-
Based Swaps
The Commissions are aware that individuals and companies may
generally use the term ``swap'' to refer to certain of their
agreements, contracts, or transactions. For example, the term ``swap''
may be used to refer to an agreement to exchange real or personal
property between the parties. Or, two companies that produce fungible
products may use the term ``swap'' to refer to an agreement to perform
each other's delivery obligations--for example, if one company must
deliver the product in California and the other must deliver the same
product in New York, they may use the term ``swap'' to refer to an
agreement that each company will perform the other's delivery
obligation.
The name or label that the parties use to refer to a particular
agreement, contract, or transaction is not determinative of whether it
is a swap or security-based swap.\151\ Also, it may not be relevant
whether the agreement, contract, or transaction is documented using an
industry standard form agreement that is typically used for swaps and
security-based swaps.\152\ Instead, the relevant question is whether
the agreement, contract, or transaction falls within the definition of
the terms ``swap'' or ``security-based swap'' (as further interpreted
pursuant to the guidance proposed herein) based on its terms and other
characteristics. Even if one effect of an agreement is to reduce the
risk faced by the parties (e.g., the ``swap'' of physical delivery
obligations described above may reduce the risk of non-delivery), the
agreement is not a swap or security-based swap unless it otherwise
meets one of the statutory definitions, as further defined by the
Commissions. Similarly, the fact that the parties use another name to
refer to a swap or security-based swap would not be relevant in
determining whether the agreement, contract, or transaction is a swap
or security-based swap as those terms are defined in the CEA and the
Exchange Act and the rules and regulations thereunder.
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\151\ See, e.g., Haekel v. Refco, 2000 WL 1460078, at * 4 (CFTC
Sept. 29, 2000) (``[T]he labels that parties apply to their
transactions are not necessarily controlling''); Reves v. Ernst &
Young, 494 U.S. 56, 61 (1990) (stating that the purpose of the
securities laws is ``to regulate investments, in whatever form they
are made and by whatever name they are called'') (emphasis in
original).
\152\ The CFTC consistently has found that the form of a
transaction is not dispositive in determining its nature. See, e.g.,
Grain Land, supra note 61, at *16 (CFTC Nov. 25, 2003) (holding that
contract substance is entitled to at least as much weight as form);
In the Matter of First Nat'l Monetary Corp., [1984-1986 Transfer
Binder] Comm. Fut. L. Rep. (CCH) ] 22,698 at 30,974 (CFTC Aug. 7,
1985) (``When instruments have been determined to constitute the
functional equivalent of futures contracts neither we nor the courts
have hesitated to look behind whatever self-serving labels the
instruments might bear.''); Stovall, supra note 63 (holding that the
CFTC ``will not hesitate to look behind whatever label the parties
may give to the instrument''). Likewise, the form of a transaction
is not dispositive in determining whether an agreement, contract, or
transaction falls within the regulatory regime for securities. See
SEC v. Merch. Capital, LLC, 483 F.3d 747, 755 (11th Cir. 2007)
(``The Supreme Court has repeatedly emphasized that economic reality
is to govern over form and that the definitions of the various types
of securities should not hinge on exact and literal tests.'')
(quoting Williamson v. Tucker, 645 F.2d 404, 418 (5th Cir. 1981));
Robinson v. Glynn, 349 F.3d 166, 170 (4th Cir. 2003) (``What matters
more than the form of an investment scheme is the `economic reality'
that it represents * * * .'') (internal citation omitted); Caiola v.
Citibank, N.A., New York, 295 F.3d 312, 325 (2d Cir. 2002) (quoting
United Housing Foundation v. Foreman, 421 U.S. 837, 848 (1975) (``In
searching for the meaning and scope of the word `security' * * * the
emphasis should be on economic reality'')).
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Request for Comment
65. What agreements, contracts, or transactions that are not swaps
or security-based swaps are documented using industry standard form
agreements that are typically used for swaps and security-based swaps?
Please provide examples of such agreements, contracts, or transactions
and details regarding their documentation, including why industry
standard form agreements typically used for swaps and security-based
swaps are used.
2. Transactions in Regional Transmission Organizations and Independent
System Operators
The Commissions received a comment letter in response to the ANPR
requesting clarification regarding the status of transactions in RTOs
and ISOs, including financial transmission rights (``FTRs''), under the
swap and security-based swap definitions.\153\ Section 722 of the Dodd-
Frank Act, though, specifically addresses how the CFTC should approach
products regulated by FERC that also may be subject to CFTC
jurisdiction. Section 722 of the Dodd-Frank Act amended CEA section
4(c) \154\ to provide that, if the CFTC determines that an exemption
for FERC-regulated instruments or other specified electricity
transactions would be in accordance with the public interest, then it
shall exempt such instruments or transactions from the requirements of
the CEA. Given this specific provision regarding these FERC-related
products, the CFTC believes the treatment of these products should be
considered under the standards and procedures specified in section 722
of the Dodd-Frank Act for a public interest waiver, rather than through
this joint rulemaking to further define the terms ``swap'' and
``security-based swap.''
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\153\ See WGCEF Letter.
\154\ 7 U.S.C. 6(c).
---------------------------------------------------------------------------
Consequently, the Commissions are not addressing FTRs or other
transactions in RTOs or ISOs within this joint definitional rulemaking.
Instead, persons with concerns about whether FERC-regulated products
may be considered swaps (or futures) should request an exemption
pursuant to section 722 of the Dodd Frank Act.\155\
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\155\ This approach, however, should not be taken to suggest any
findings by the Commissions as to whether or not FTRs or any other
FERC-regulated products are swaps (or futures contracts).
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III. The Relationship Between the Swap Definition and the Security-
Based Swap Definition
A. Introduction
Title VII of the Dodd-Frank Act defines the term ``swap'' under the
CEA,\156\ and also defines the term ``security-based swap'' under the
Exchange Act.\157\ Pursuant to the regulatory framework established in
Title VII, the CFTC has regulatory authority over swaps and the SEC has
regulatory authority over security-based swaps. The Commissions are
proposing to further define the terms ``swap'' and ``security-based
swap'' to clarify whether particular agreements, contracts, or
transactions are swaps or security-based swaps based on characteristics
including the specific terms and conditions of the instrument and the
nature of, among other things, the prices, rates, securities, indexes,
or commodities upon which the instrument is based.
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\156\ See CEA section 1a(47), 7 U.S.C. 1a(47).
\157\ See section 3(a)(68) of the Exchange Act, 15 U.S.C.
78c(a)(68).
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Because the discussion below is focused on whether particular
agreements, contracts, or transactions are swaps or security-based
swaps, the Commissions use the term ``Title VII instrument'' in this
release to refer to any agreement, contract, or transaction that is
included in either the definition of the term ``swap'' or the
definition of the term ``security-based swap.'' Thus, the term ``Title
VII instrument'' is synonymous with ``swap or security-based swap.''
\158\
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\158\ In some cases, the Title VII instrument may be a mixed
swap. Mixed swaps are discussed further in part IV below.
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The determination of whether a Title VII instrument is a swap or
security-
[[Page 29840]]
based swap should be made based on the facts and circumstances relating
to the Title VII instrument at the time that the parties enter into it.
If the Title VII instrument itself is not amended, modified, or
otherwise adjusted during its term by the parties, its characterization
as a swap or security-based swap should not change during its duration
because of any changes that may occur to the factors affecting its
character as a swap or security-based swap.\159\
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\159\ See discussion infra part III.G.3(a) regarding Title VII
instruments based on indexes.
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Classifying a Title VII instrument as a swap or security-based swap
is straightforward for most instruments. The Commissions, however, are
proposing guidance to clarify the classification of swaps and security-
based swaps in certain areas and to provide guidance regarding the use
of certain terms and conditions in Title VII instruments.
B. Title VII Instruments Based on Interest Rates, Other Monetary Rates,
and Yields
Parties frequently use Title VII instruments to manage risks
related to, or to speculate on, changes in interest rates, other
monetary rates or amounts, or the return on various types of assets.
Broadly speaking, Title VII instruments based on interest or other
monetary rates would be swaps, whereas Title VII instruments based on
the yield or value of a single security, loan, or narrow-based security
index would be security-based swaps. However, market participants and
financial professionals sometimes use the terms ``rate'' and ``yield''
in different ways. The Commissions are proposing guidance regarding
whether Title VII instruments that are based on interest rates, other
monetary rates, or yields would be swaps or security-based swaps and
requesting comment as to whether additional clarification in this area
would be appropriate.\160\
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\160\ Commenters did not address these instruments specifically.
A number of commenters urged clarification that various transactions
or obligations, such as commercial loans, are not Title VII
instruments solely because they reference an interest rate. See
BlackRock Letter; Cleary Letter; Farm Credit Council Letter; White &
Case Letter. The Commissions have proposed guidance to address such
customary commercial transactions in part II.B.3 above.
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1. Title VII Instruments Based on Interest Rates or Other Monetary
Rates That Are Swaps
The Commissions believe that when payments exchanged under a Title
VII instrument are based solely on the levels of certain interest rates
or other monetary rates that are not themselves based on one or more
securities, the instrument would be a swap and not a security-based
swap.\161\ Often swaps on interest rates or other monetary rates
require the parties to make payments based on the comparison of a
specified floating rate (such as the London Interbank Offered Rate
(``LIBOR'')) to a fixed rate of interest agreed upon by the parties. A
rate swap also may require payments based on the differences between
two floating rates, or it may require that the parties make such
payments when any agreed-upon events with respect to interest rates or
other monetary rates occur (such as when a specified interest rate
crosses a threshold, or when the spread between two such rates reaches
a certain point). The rates referenced for the parties' obligations are
varied, and examples of such rates include the following:
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\161\ See discussion supra part III.F regarding the use of
certain terms and conditions.
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Interbank Offered Rates: An average of rates charged by a
group of banks for lending money to each other or other banks over
various periods of time, and other similar interbank rates,\162\
including, but not limited to, LIBOR (regardless of currency); \163\
the Euro Interbank Offered Rate (``Euribor''); the Canadian Dealer
Offered Rate (``CDOR''); and the Tokyo Interbank Offered Rate
(``TIBOR''); \164\
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\162\ Interbank lending rates are measured by surveys of the
loan rates that banks offer other banks, or by other mechanisms. The
periods of time for such loans may range from overnight to 12 months
or longer.
The interbank offered rates listed here are frequently called
either a ``reference rate,'' the rate of ``reference banks,'' or by
a designation that is specific to the service that quotes the rate.
For some of the interbank offered rates listed here, there is a
similar rate that is stated as an interbank bid rate, which is the
average rate at which a group of banks bid to borrow money from
other banks. For example, the bid rate similar to LIBOR is called
LIBID.
\163\ Today, LIBOR is used as a rate of reference for the
following currencies: Australian Dollar, Canadian Dollar, Danish
Krone, Euro, Japanese Yen, New Zealand Dollar, Pound Sterling,
Swedish Krona, Swiss Franc, and U.S. Dollar.
\164\ Other interbank offered rates include the following (with
the country or city component of the acronym listed in parentheses):
AIDIBOR (Abu Dhabi); BAIBOR (Buenos Aires); BKIBOR (Bangkok);
BRAZIBOR (Brazil); BRIBOR/BRIBID (Bratislava); BUBOR (Budapest);
CHIBOR (China); CHILIBOR (Chile); CIBOR (Copenhagen); COLIBOR
(Colombia); HIBOR (Hong Kong); JIBAR (Johannesburg); JIBOR
(Jakarta); KAIBOR (Kazakhstan); KIBOR (Karachi); KLIBOR (Kuala
Lumpur); KORIBOR ((South) Korea); MEXIBOR (Mexico); MIBOR (Mumbai);
MOSIBOR (Moscow); NIBOR (Norway); PHIBOR (Philippines); PRIBOR
(Prague); REIBOR/REIBID (Reykjavik); RIGIBOR/RIGIBID (Riga); SHIBOR
(Shanghai); SIBOR (Singapore); SOFIBOR (Sofia); STIBOR (Stockholm);
TAIBOR (Taiwan); TELBOR (Tel Aviv); TRLIBOR and TURKIBOR (Turkey);
VILIBOR (Vilnius); VNIBOR (Vietnam); and WIBOR (Warsaw).
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Money Market Rates: A rate established or determined based
on actual lending or money market transactions, including, but not
limited to, the Federal Funds Effective Rate; the Euro Overnight Index
Average (``EONIA'' or ``EURONIA'') (which is the weighted average of
overnight unsecured lending transactions in the Euro-area interbank
market); the EONIA Swap Index; the Australian dollar RBA 30 Interbank
Overnight Cash Rate; the Canadian Overnight Repo Rate Average
(``CORRA''); the Mexican interbank equilibrium interest rate
(``TIIE''); the NZD Official Cash Rate; the Sterling Overnight
Interbank Average Rate (``SONIA'') (which is the weighted average of
unsecured overnight cash transactions brokered in London by the
Wholesale Markets Brokers' Association); the Swiss Average Rate
Overnight (``SARON''); and the Tokyo Overnight Average Rate (``TONAR'')
(which is based on uncollateralized overnight average call rates for
interbank lending);
Government Target Rates: A rate established or determined
based on guidance established by a central bank including, but not
limited to, the Federal Reserve discount rate, the Bank of England base
rate and policy rate, the Canada Bank rate, and the Bank of Japan
policy rate (also known as the Mutan rate);
General Lending Rates: A general rate used for lending
money, including, but not limited to, a prime rate, rate in the
commercial paper market, or any similar rate provided that it is not
based on any security, loan, or group or index of securities;
Indexes: A rate derived from an index of any of the
foregoing or following rates, averages, or indexes, including but not
limited to a constant maturity rate (U.S. Treasury and certain other
rates),\165\ the interest rate swap rates published by the Federal
Reserve in its ``H.15 Selected Interest Rates'' publication, the
ISDAFIX rates, the ICAP Fixings, a constant maturity swap, or a rate
generated as an average (geometric, arithmetic, or otherwise) of any of
the foregoing, such as overnight index swaps (``OIS'')--provided that
such rates are not based on a specific
[[Page 29841]]
security, loan, or narrow-based group or index of securities;
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\165\ A Title VII instrument based solely on the level of a
constant maturity U.S. Treasury rate would be a swap because U.S.
Treasuries are exempted securities that are excluded from the
security-based swap definition. Conversely, a Title VII instrument
based solely on the level of a constant maturity rate on a narrow-
based index of non-exempted securities under the security-based swap
definition would be a security-based swap.
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Other Monetary Rates: A monetary rate including, but not
limited to, the Consumer Price Index (``CPI''), the rate of change in
the money supply, or an economic rate such as a payroll index; and
Other: The volatility, variance, rate of change of (or the
spread, correlation or difference between), or index based on any of
the foregoing rates or averages of such rates, such as forward spread
agreements, references used to calculate the variable payments in index
amortizing swaps (whereby the notional principal amount of the
agreement is amortized according to the movement of an underlying
rate), or correlation swaps and basis swaps, including but not limited
to, the ``TED spread'' \166\ and the spread or correlation between
LIBOR and an OIS.
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\166\ The TED spread is the difference between the interest
rates on interbank loans and short-term U.S. government debt
(Treasury bills or ``T-bills''). The latter are exempted securities
that are excluded from the statutory definition of the term
``security-based swap.'' Thus, neither any aspect of U.S. Treasuries
nor interest rates on interbank loans, can form the basis of a
security-based swap. For this reason, a Title VII instrument on a
spread between interbank loan rates and T-bill rates also would not
be a security-based swap.
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As discussed above, the Commissions believe that when payments
under a Title VII instrument are based solely on any of the foregoing,
such Title VII instrument would be a swap.
Request for Comment
66. The Commissions request comment generally on the foregoing
proposed guidance regarding Title VII instruments where the underlying
reference is an interest rate or other monetary rate.
67. Does the proposed guidance in this section accurately describe
the types of interest rates and other monetary rates that are used as
an underlying reference of a Title VII instrument, and that should
cause the instrument to be considered a swap? Are any of the rates
identified in this list not used in this manner? Are there any
significant interest or monetary rates that should be added to this
list in order to provide additional guidance?
68. As discussed above, a Title VII instrument would be considered
a security-based swap if the instrument is based on constant maturity
rates that are derived from the market prices and yields of a non-
exempted debt security or a narrow-based security index of debt
securities (depending on the other terms of the Title VII instrument,
such instrument may be a mixed swap). The Commissions request comment
on this guidance. Are there certain constant maturity rates that should
not be considered to be security-based, such that a Title VII
instrument based on those rates would instead be a swap and not a
security-based swap or mixed swap? If so, are there objective criteria
to distinguish between different types of constant maturity rates in
the determination of whether a Title VII instrument is a swap or
security-based swap? If so, please describe any such criteria in
detail.
2. Title VII Instruments Based on Yields
The Commissions also propose guidance to clarify the status of
Title VII instruments in which one of the underlying references of the
instrument is a ``yield.'' In cases when a ``yield'' is calculated
based on the price or changes in price of a debt security, loan, or
narrow-based security index, it is another way of expressing the price
or value of a debt security, loan, or narrow-based security index. For
example, debt securities often are quoted and traded on a yield basis
rather than on a dollar price, where the yield relates to a specific
date, such as the date of maturity of the debt security (i.e., yield to
maturity) or the date upon which the debt security may be redeemed or
called by the issuer (e.g., yield to first whole issue call).\167\
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\167\ See, e.g., Securities Confirmations, 47 FR 37920, Aug. 27,
1982.
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Except in the case of certain exempted securities, when one of the
underlying references of the Title VII instrument is the ``yield'' of a
debt security, loan, or narrow-based security index in the sense where
the term ``yield'' is used as a proxy for the price or value of the
debt security loan, or narrow-based security index, the Title VII
instrument would be a security-based swap. And, as a result, in cases
where the underlying reference is a point on a ``yield curve''
generated from the different ``yields'' on debt securities in a narrow-
based security index (e.g., a constant maturity yield or rate), the
Title VII instrument would be a security-based swap. In either case,
however, where certain exempted securities, such as U.S. Treasury
securities, are the only underlying reference of a Title VII instrument
involving securities, the Title VII instrument would be a swap. Title
VII instruments based on exempted securities are discussed further
below.
The above interpretation would not apply in cases where the
``yield'' referenced in a Title VII instrument is not based on a debt
security, loan, or narrow-based security index of debt securities but
rather is being used to reference an interest rate or monetary rate as
outlined above in subsection one of this section. In these cases, this
``yield'' reference would be considered equivalent to a reference to an
interest rate or monetary rate and the Title VII instrument would be,
under the guidance in this section, a swap (or mixed swap depending on
other references in the instrument).
Request for Comment
69. The Commissions request comment generally on the foregoing
proposed guidance regarding Title VII instruments where the underlying
reference is a ``yield.'' Please provide a detailed explanation of any
uncertainty regarding the Commissions' proposed use of the terms
``yield'' and ``yield curve'' and what additional guidance would be
necessary.
70. Does the proposed guidance in this section appropriately
describe instruments based on the ``yield'' of a debt security that
should be considered security-based swaps? Is additional guidance
necessary regarding when the term ``yield'' is used as a proxy for
price or value? If so, please provide a detailed explanation of any
uncertainty regarding how the term ``yield'' is used and what
additional guidance would be necessary.
71. Are there instruments where the underlying reference is a
``yield'' of a debt security that should be considered a swap as
opposed to a security-based swap? If so, what are they, and how often
are they traded? How are such instruments distinguished from
instruments based on ``yield'' that should be considered security-based
swaps?
3. Title VII Instruments Based on Government Debt Obligations
The Commissions also are providing guidance regarding instances in
which the underlying reference of the Title VII instrument is a
government debt obligation. The security-based swap definition
specifically excludes any agreement, contract, or transaction that
meets the definition of a security-based swap only because it
``references, is based upon, or settles through the transfer, delivery,
or receipt of an exempted security under [section 3(a)(12) of the
Exchange Act], as in effect on the date of enactment of the Futures
Trading Act of 1982 (other than any municipal security as defined in
[section 3(a)(29) of the Exchange Act] * * *), unless such agreement,
contract, or transaction is of the character of, or
[[Page 29842]]
is commonly known in the trade as, a put, call, or other option.''
\168\
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\168\ Section 3(a)(68)(C) of the Exchange Act, 15 U.S.C.
76c(a)(68)(C).
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As a result of this exclusion in the security-based swap definition
for ``exempted securities,'' \169\ if the only underlying reference of
a Title VII instrument involving securities is, for example, the price
of a U.S. Treasury security and does not have any other underlying
reference involving securities, then the instrument would be a swap.
Similarly, if the Title VII instrument is based on the ``yield'' of a
U.S. Treasury security and does not have any other underlying reference
involving securities, then the instrument also would be a swap,
regardless of whether the term ``yield'' is a proxy for the price of
the security.
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\169\ As of January 11, 1983, the date of enactment of the
Futures Trading Act of 1982, Public Law 97-444, 96 Stat. 2294,
section 3(a)(12) of the Exchange Act, 15 U.S.C. 78c(a)(12), provided
that, among other securities, ``exempted securities'' include: (i)
``securities which are direct obligations of, or obligations
guaranteed as to principal or interest by, the United States;'' (ii)
certain securities issued or guaranteed by corporations in which the
United States has a direct or indirect interest as designated by the
Secretary of the Treasury; and (iii) certain other securities as
designated by the SEC in rules and regulations.
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Foreign government securities, by contrast, were not ``exempted
securities'' as of the date of enactment of the Futures Trading Act of
1982 \170\ and thus do not explicitly fall within this exclusion from
the security-based swap definition. Therefore, if the underlying
reference of the Title VII instrument is the price, value, or ``yield''
(where ``yield'' is a proxy for price or value) of a foreign government
security, or a point on a yield curve derived from a narrow-based
security index composed of foreign government securities, then the
instrument would be a security-based swap.
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\170\ Public Law 97-444, 96 Stat. 2294 (1983).
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Request for Comment
72. The Commissions request comment generally on the foregoing
proposed guidance regarding the treatment of Title VII instruments in
which the underlying reference is a government debt obligation.
General Request for Comment: In addition to the particular requests
for comment set forth on the issues discussed above, the Commissions
also request comment generally on the following:
73. Does the proposed guidance in this part III.B accurately
describe market practices and terminology? Will the proposed guidance
be useful in determining whether Title VII instruments are swaps or
security-based swaps?
C. Total Return Swaps
A TRS is a Title VII instrument in which one counterparty, the
seller of the TRS, makes a payment that is based on the price
appreciation and income from an underlying security or security
index.\171\ The other counterparty, the buyer of the TRS, makes a
financing payment that is often based on a variable interest rate, such
as LIBOR (or other interbank offered rate or money market rate, as
described above), as well as a payment based on the price depreciation
of the underlying reference. The ``total return'' consists of the price
appreciation or depreciation, plus any interest or income
payments.\172\ Accordingly, where a TRS is based on a single security
or loan, or a narrow-based security index, the TRS would be a security-
based swap.\173\
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\171\ Where the underlying security is an equity, a TRS is also
known as an ``equity swap.''
\172\ If the total return is negative, the seller receives this
amount from the buyer. TRS can be used to synthetically reproduce
the payoffs of a position. For example, two counterparties may enter
into a 3-year TRS where the buyer of the TRS receives the positive
total return on XYZ security, if any, and the seller of the TRS
receives LIBOR plus 30 basis points and the absolute value of the
negative total return on XYZ security, if any.
\173\ If the underlying reference of the TRS is a broad-based
equity security index, however, the Commissions believe that it
would be a swap (and an SBSA) and not a security-based swap. In
addition, a TRS on an exempted security, such as a U.S. Treasury,
under section 3(a)(12) of the Exchange Act, 15 U.S.C. 78c(a)(12), as
in effect on the date of enactment of the Futures Trading Act of
1982 (other than any municipal security as defined in section
3(a)(29) of the Exchange Act, 15 U.S.C. 78c(a)(29), as in effect on
the date of enactment of the Futures Trading Act of 1982) would be a
swap (and an SBSA) and not a security-based swap.
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Generally, the use of a variable interest rate in the TRS buyer's
payment obligations to the seller is incidental to the purpose of, and
the risk that the counterparties assume in, entering into the TRS.
These payments are a form of financing that reflects the security-based
swap dealer's cost of financing the position or a related hedge,
allowing the TRS buyer to receive payments based on the price
appreciation and income of a security or security index without
purchasing the security or security index. The Commissions believe that
when such interest rate payments act merely as a financing component in
a TRS, or in any other security-based swap, the inclusion of such
interest rate terms would not cause the security-based swap to be
characterized as a mixed swap.\174\ Financing terms may also involve
adding or subtracting a spread to or from the financing rate,\175\ or
calculating the financing rate in a currency other than that of the
underlying reference security or security index.\176\ However, the
Commissions note that where such payments incorporate additional
elements that create additional interest rate or currency exposures
that are unrelated to the financing of the security-based swap, or
otherwise shift or limit risks that are related to the financing of the
security-based swap, those additional elements may cause the security-
based swap to be a mixed swap.
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\174\ Several commenters noted that such instruments should not
be characterized as mixed swaps. See Cleary Letter (expressing the
view that such Title VII instruments should not be characterized as
mixed swaps because ``the floating rate payment obligation is not
the principal driver of the security-based swap and, in that sense,
the security-based swap is not `based on' the level of an interest
rate within the meaning of [the Dodd-Frank Act]''); Deutsche Bank
Letter (explaining that such Title VII instruments in which the
party that is ``synthetically short'' the underlying security makes
payments based on the value of the underlying security to the party
that is ``synthetically long,'' and the synthetically long party
pays the synthetically short party an amount that may be based on
LIBOR or another interest rate, should not be treated as mixed swaps
because the payments to the synthetically short party are generally
intended only for financing costs incurred in establishing or
maintaining the transaction or its hedge); ISDA Letter (noting that
variable interest rate-based payments in connection with a typical
Title VII instrument of this type are ``incidental to what is
essentially a security-based transaction and should not yield mixed
swap status''); Morgan Stanley Letter (noting that the interest
rate-based payments in such Title VII instruments ``reflect
compensation for the financing costs associated'' with the
instrument and ``are not at the core of what is being `swapped'
under the contract''); Letter from Timothy W. Cameron, Esq.,
Managing Director, Asset Management Group, Securities Industry and
Financial Markets Association, Sept. 20, 2010 (expressing the view
that such a financing component is incidental to the Title VII
instrument and should not cause it to be viewed as a mixed swap).
\175\ See, e.g., Moorad Chowdry, ``Total Return Swaps: Credit
Derivatives and Synthetic Funding Instruments,'' at 3-4 (noting that
the spread to the TRS financing rate is a function of: the credit
rating of the counterparty paying the financing rate; the amount,
value, and credit quality of the reference asset; the dealer's
funding costs; a profit margin; and the capital charge associated
with the TRS), available at http://www.yieldcurve.com/Mktresearch/LearningCurve/TRS.pdf.
\176\ For example, a security-based swap on an equity security
priced in U.S. dollars in which payments are made in Euros based on
the U.S. dollar/Euro spot rate at the time the payment is made would
not be a mixed swap. Under these circumstances, the currency is
merely referenced in connection with the method of payment, and the
counterparties are not hedging the risk of changes in currency
exchange rates during the term of the security-based swap.
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For example, where the counterparties embed interest-rate
optionality (e.g., a cap, collar, call, or put) into the terms of a
security-based swap in a manner designed to shift or limit interest
rate exposure, the inclusion of these terms would cause
[[Page 29843]]
the TRS to be both be a swap and a security-based swap (i.e., a mixed
swap). Similarly, if a TRS is also based on non-security-based
components (such as the price of oil, or a currency), the security-
based swap would also be a swap.\177\
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\177\ See Mixed Swaps, infra part IV.
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Request for Comment
74. Is the proposed guidance regarding TRS and other security-based
swaps for which the use of a variable interest rate in a counterparty's
payment obligations is incidental to the risk that counterparties
assume in entering into a TRS or other security-based swap appropriate?
Why or why not? If not, please provide a detailed explanation of what
guidance would be appropriate.
75. How often do market participants use rates, other than
interbank offered rates or money market rates, in TRS to recoup their
financing costs? If so, which rates and what portion of the market
(broken down by product, country, counterparty type, and/or whatever
data are available to commenters), in percentage and/or dollar terms do
TRS with such financing rates constitute? What factors influence the
financing rates that market participants incorporate into their
security-based swaps?
76. Do market participants embed optionality, such a cap, collar,
put, or call, into the payment component of a TRS? If so, how
frequently and for what purpose?
77. Do market participants embed nonfinancial commodity components
into the payment component that directly affect the payments on a TRS
rather than operating as a mere financing component? If so, how
frequently and for what purpose?
78. Do market participants embed foreign currency swaps into a
foreign currency payment component of a TRS? If so, how frequently and
for what purpose?
79. Are there other circumstances under which a TRS should be
treated as a mixed swap rather than a security-based swap or swap? If
so, please provide a detailed description of such circumstances and
explain why.
D. Security-Based Swaps Based on a Single Security or Loan and Single-
Name Credit Default Swaps
The second prong of the security-based swap definition includes a
swap that is based on ``a single security or loan, including any
interest therein or on the value thereof.'' \178\ The Commissions
believe that, under this prong of the definition of security-based
swap, a single-name CDS that is based on a single reference obligation
would be a security-based swap because it would be based on a single
security or loan (or any interest therein or on the value thereof).
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\178\ Section 3(a)(68)(A)(ii)(II) of the Exchange Act, 15 U.S.C.
78c(a)(68)(A)(ii)(II). The first prong of the security-based swap
definition is discussed below.
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In addition, the third prong of the security-based swap definition
includes a swap that is based on the occurrence of an event relating to
a ``single issuer of a security,'' provided that such event ``directly
affects the financial statements, financial condition, or financial
obligations of the issuer.'' \179\ This provision applies generally to
event-triggered swap contracts. With respect to a CDS, such events
could include the bankruptcy of an issuer, a default on one of an
issuer's debt securities, or the default on a non-security loan of an
issuer.\180\ Therefore, the Commissions believe that if the payout on a
CDS on a single issuer of a security is triggered by the occurrence of
an event relating to that issuer, the CDS would be a security-based
swap under the third prong.\181\
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\179\ Section 3(a)(68)(A)(ii)(III) of the Exchange Act, 15
U.S.C. 78c(a)(68)(A)(ii)(III).
\180\ The Commissions understand that in the context of credit
derivatives on asset-backed securities or MBS, the events include
principal writedowns, failure to pay principal and interest
shortfalls.
\181\ The Commissions understand that some single-name CDS now
trade with fixed coupon payments expressed as a percentage of the
notional amount of the transaction and payable on a periodic basis
during the term of the transaction. See Markit, ``The CDS Big Bang:
Understanding the Changes to the Global CDS Contract and North
American Conventions,'' 3, available at http://www.markit.com/cds/announcements/resource/cds_big_bang.pdf. The Commissions believe
the existence of such single-name CDS does not change their
interpretation.
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In this regard, the Commissions note that each transaction under an
ISDA Master Agreement would need to be analyzed to determine whether it
is a swap or security-based swap. For example, the Commissions believe
that a number of single-name CDS that are executed at the same time and
that are documented under one ISDA Master Agreement, but in which a
separate confirmation is sent for each CDS, should be treated as an
aggregation of security-based swaps. As a practical and economic
matter, the Commissions believe that each such CDS would be a separate
and independent transaction. Thus, such an aggregation of single-name
CDS would not constitute a ``group or index'' under the security-based
swap definition but instead would constitute multiple single-name CDS.
E. Title VII Instruments Based on Futures Contracts
A Title VII instrument that is based on a futures contract will
either be a swap or a security-based swap, or both (i.e., a mixed
swap), depending on the nature of the futures contract, including the
underlying reference of the futures contract. The Commissions believe
that a Title VII instrument where the underlying reference is a
security future would be a security-based swap.\182\ The Commissions
believe that, except with respect to certain futures on foreign
government debt securities discussed below, a Title VII instrument
where the underlying reference is a futures contract that is not a
security future would be a swap.\183\
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\182\ A security future is specifically defined in both the CEA
and the Exchange Act as a futures contract on a single security or a
narrow-based security index, including any interest therein or based
on the value thereof, except an exempted security under section
3(a)(12) of the Exchange Act, 15 U.S.C. 78c(a)(12), as in effect on
the date of enactment of the Futures Trading Act of 1982 (other than
any municipal security as defined in section 3(a)(29) of the
Exchange Act, 15 U.S.C. 78c(a)(29), as in effect on the date of
enactment of the Futures Trading Act of 1982).
The term security future does not include any agreement,
contract, or transaction excluded from the CEA under CEA sections
2(c), 2(d), 2(f), or 2(g), 7 U.S.C. 2(c), 2(d), 2(f), or 2(g), (as
in effect on the date of enactment of the Commodity Futures
Modernization Act of 2000 (``CFMA'') or Title IV of the CFMA). See
CEA section 1a(44), 7 U.S.C. 1a(44); section 3(a)(55) of the
Exchange Act, 15 U.S.C. 78c(a)(55).
\183\ Depending on the underlying reference of the futures
contract, though, such swaps could be security-based swap
agreements. For example, a swap on a future on the S&P 500 index
would be a security-based swap agreement.
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Title VII instruments involving futures contracts on foreign
government debt securities present a unique circumstance. Rule 3a12-8
under the Exchange Act exempts certain foreign government debt
securities, for purposes only of the offer, sale, or confirmation of
sale of futures contracts on such foreign government debt securities,
from all provisions of the Exchange Act which by their terms do not
apply to an ``exempted security,'' subject to certain conditions.\184\
To date, the SEC has
[[Page 29844]]
enumerated within rule 3a12-8 debt securities of 21 identified foreign
governments solely for purposes of futures trading.\185\
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\184\ Specifically, rule 3a12-8 under the Exchange Act requires
as a condition to the exemption that the foreign government debt
securities not be registered under the Securities Act (or the
subject of any American depositary receipt registered under the
Securities Act) and that futures contracts on such foreign
government debt securities ``require delivery outside the United
States, [and] any of its possessions or territories, and are traded
on or through a board of trade, as defined in [CEA section 2, 7
U.S.C. 2].'' See rules 3a12-8(b), 3a12-8(a)(2) under the Exchange
Act, 17 CFR 240.3a12-8(b) and 240.3a12-8(a)(2).These conditions were
``designed to minimize the impact of the exemption on securities
distribution and trading in the United States . . . .'' See
Exemption for Certain Foreign Government Securities for Purposes of
Futures Trading, 49 FR 8595, 8596-97, Mar. 8, 1984 (citing Futures
Trading Act of 1982).
\185\ See rule 3a12-8(a)(1) under the Exchange Act (designating
the debt securities of the governments of the United Kingdom,
Canada, Japan, Australia, France, New Zealand, Austria, Denmark,
Finland, the Netherlands, Switzerland, Germany, Ireland, Italy,
Spain, Mexico, Brazil, Argentina, Venezuela, Belgium, and Sweden).
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The Commissions are evaluating the appropriate characterization of
Title VII instruments based on futures on such foreign government debt
securities that are traded in reliance on rule 3a12-8. The Commissions
recognize that as a result of the rule 3a12-8 exemption, futures on
foreign government debt securities of 21 foreign countries trade
pursuant to the CFTC's exclusive jurisdiction and without the futures
being considered security futures. Because futures contracts on the 21
foreign government debt securities designated in rule 3a12-8 are not
security futures, applying the above interpretive guidance to a Title
VII instrument on a futures contract on these foreign government debt
securities would mean that such Title VII instrument would be a
swap.\186\ The Commissions note, however, that the conditions in the
rule 3a12-8 exemption were established specifically for trading futures
contracts on these foreign sovereign debt obligations, not Title VII
instruments based on futures contracts on foreign government debt
securities. Furthermore, the Commissions note that the Dodd-Frank Act
did not exclude debt securities of foreign governments from the
definition of security-based swap. Therefore, a Title VII instrument
based on such debt securities would be a security-based swap. Relying
on rule 3a12-8 for the treatment of Title VII instruments on such
futures would therefore result in different treatments depending on
whether the Title VII instrument is based on a foreign government debt
security or on a future that is in turn based on a foreign government
debt security.\187\ On the other hand, to do otherwise would create
different regulators for a future and Title VII instruments based on
that future.
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\186\ The Commissions note, by contrast, that a Title VII
instrument that is based on the price or value of, or settlement
into, a futures contract on one of the 21 foreign government debt
securities designated in rule 3a12-8 and that is also based on the
price or value of, or had the potential to settle directly into, the
foreign debt security, would be a security-based swap and, depending
on other features of the Title VII instrument, possibly a mixed
swap.
\187\ This is the case today (i.e., different treatments) with
respect to, for example, options on broad-based security indexes and
options on futures on broad-based security indexes.
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The SEC believes that the characterization of a Title VII
instrument involving a foreign government debt security may affect
Federal securities law provisions relating to the distribution of the
underlying foreign debt security. Specifically, the Dodd-Frank Act
included provisions that would not permit issuers, affiliates of
issuers, or underwriters to use security-based swaps to offer or sell
the issuers' securities underlying a security-based swap without
complying with the requirements of the Securities Act.\188\ In
addition, the Dodd-Frank Act provided that any offer and sale of
security-based swaps to non-ECPs would have to be registered under the
Securities Act.\189\ Thus, for example, if a Title VII instrument on a
future on foreign government debt security is characterized as a swap,
and not a security-based swap, then the provisions of the Dodd-Frank
Act enacted to ensure that there could not be offers and sales of
securities made without compliance with the Securities Act, either by
issuers, their affiliates, or underwriters or to non-ECPs, would not
apply to such swap transactions.
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\188\ See section 2(a)(3) of the Securities Act as amended by
the Dodd-Frank Act, 15 U.S.C. 77b(a)(3). This provision applies
regardless of whether the Title VII instrument allows the parties to
physically settle any such security-based swap.
\189\ See section 5 of the Securities Act as amended by the
Dodd-Frank Act. 15 U.S.C. 77e.
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On the other hand, the CFTC believes that characterizing Title VII
instruments based on a future on a foreign government debt security
designated in rule 3a12-8 as security-based swaps could undermine the
regulatory scheme that Congress established in the CEA. As noted above,
the Commissions generally would treat Title VII instruments based on
futures that are not security futures as swaps. Many of the futures on
the 21 foreign government debt securities designated in rule 3a12-8
trade with substantial volume. Section 753 of the Dodd-Frank Act
provided the CFTC with additional antifraud and anti-manipulation
authorities patterned on those provided to the SEC in the Federal
securities laws. The CFTC believes that treating Title VII instruments
based on these futures as security-based swaps, while the underlying
futures come under the CEA, may undermine those authorities.
In sum, depending on how a Title VII instrument on such a future on
a foreign government debt security is characterized, there is potential
for such an instrument: (i) to be used to avoid the application of the
Federal securities laws, including the Dodd-Frank Act provisions, that
otherwise would apply if the Title VII instrument was instead based on
the foreign government debt security directly; or (ii) to be used to
avoid the application of the CEA, including the Dodd-Frank Act
provisions, that otherwise would apply if the Title VII instrument was
instead based on any other futures contract that is not a security
future. Accordingly, the Commissions also are evaluating whether a
Title VII instrument on such a futures contract on a foreign government
debt security should be characterized as a mixed swap.
Request for Comment
80. The Commissions request comment generally on the foregoing
discussion regarding Title VII instruments based on futures contracts
and security futures.
81. What types of such products are traded in the market today? How
often, and where are such products traded?
82. The Commissions are requesting comment on how to characterize a
Title VII instrument where the underlying reference is a futures
contract on one of the 21 foreign government debt securities that have
been designated as ``exempted securities'' under rule 3a12-8 only for
the offer, sale, or confirmation of sale of futures contracts on such
securities and only where the conditions of such exemption are
satisfied. When should a Title VII instrument on a futures contract on
a foreign government debt security being traded in reliance on the
exemption under rule 3a12-8 be treated as a swap, a security-based swap
or a mixed swap? Is there any economic reason why the treatment of a
Title VII instrument on a future on a foreign government debt security
should be different than the treatment of a Title VII instrument on the
foreign government debt security directly? Is there any economic reason
why the treatment of a Title VII instrument on a future on a designated
foreign government debt security should be different than the treatment
of a Title VII instrument on any other futures contract that is not a
security future? If the answer to either of the two preceding questions
is yes, please explain and provide empirical analysis. If the Title VII
instrument is able to be entered into by the issuer, affiliate of the
issuer, or an underwriter, or if the Title VII instrument is being
offered and sold to non-ECPs, should the Title VII instrument be viewed
as a security-based swap or a mixed swap so that market participants
cannot chose
[[Page 29845]]
whether to comply with the registration requirements of the Securities
Act with respect to the foreign government debt securities? Should such
an instrument be viewed as a swap or a mixed swap so that market
participants cannot choose whether to comply with the requirements of
the Dodd-Frank Act concerning clearing, trade execution, reporting, and
standards applicable to dealers and major participants that apply to
Title VII instruments on futures contracts that are not security
futures? Are there other suggested approaches to the treatment of Title
VII instruments on futures on foreign government debt securities that
would preserve the application of the Securities Act as contemplated by
the Dodd-Frank Act to Title VII instruments involving foreign
government debt securities? Are there other suggested approaches to the
treatment of Title VII instruments on futures on foreign government
debt securities that would preserve the application of the CEA as
contemplated by the Dodd-Frank Act to Title VII instruments involving
futures contracts that are not security futures? If the answer to
either of the two preceding questions is yes, please provide detail and
analysis.
F. Use of Certain Terms and Conditions in Title VII Instruments
The Commissions are aware that market participants' setting of
certain fixed terms or conditions of Title VII instruments may be
informed by the value or level of a security, rate, or other commodity
at the time of the execution of the instrument. The Commissions believe
that, in evaluating whether such a Title VII instrument is a swap or
security-based swap, the nature of the security, rate, or other
commodity that informed the setting of such fixed term or condition
should not itself impact the determination of whether the Title VII
instrument is a swap or a security-based swap, provided that the fixed
term or condition is set at the time of execution of the Title VII
instrument and the value or level of that fixed term or condition may
not vary over the life of the Title VII instrument.
For example, a Title VII instrument, such as an interest rate swap,
in which floating payments based on 3-month LIBOR are exchanged for
fixed rate payments of 5% would be a swap, and not a security-based
swap, even if the 5% fixed rate was informed by, or quoted based on,
the yield of a security, provided that the 5% fixed rate was set at the
time of execution and may not vary over the life of the Title VII
instrument.\190\ Another example would be where a private sector or
government borrower that issues a 5-year, amortizing $100 million debt
security with a semi-annual coupon of LIBOR plus 250 basis points also,
at the same time, chooses to enter into a 5-year interest rate swap on
$100 million notional in which this same borrower, using the same
amortization schedule as the debt security, receives semi-annual
payments of LIBOR plus 250 basis points in exchange for 5% fixed rate
payments. The fact that the specific terms of the interest rate swap
(e.g., 5-year, LIBOR plus 250 basis point, $100 million notional, fixed
amortization schedule) were set at the time of execution to match
related terms of a debt security does not cause the interest rate swap
to become a security-based swap. However, if the interest rate swap
contained additional terms that were in fact contingent on a
characteristic of the debt security that may change in the future, such
as an adjustment to future interest rate swap payments based on the
future price or yield of the debt security, then this Title VII
instrument would be a security-based swap that would be a mixed swap.
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\190\ However, to the extent the fixed term or condition is set
at a future date or at a future value or level of a security, rate,
or other commodity rather than the value or level of such security,
rate, or other commodity at the time of execution of the Title VII
instrument, the discussion above would not apply, and the nature of
the security, rate, or other commodity used in determining the terms
or conditions would be considered in evaluating whether the Title
VII instrument is a swap or security-based swap.
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Request for Comment
83. Is the guidance provided by the Commissions regarding the
relevance of the nature of a security, rate, or other commodity that
informs the determination of a fixed term or condition of a Title VII
instrument appropriate? Why or why not? If not, what guidance would be
appropriate?
84. The Commissions are aware that quoting conventions are used in
the context of setting the fixed terms of certain Title VII
instruments, such as interest rate swaps that exchange LIBOR for a
fixed rate that is set at the time of execution by reference to U.S.
Treasury securities.\191\ Are there other Title VII instruments that
use such quoting conventions? If so, please provide a detailed
explanation of such Title VII instruments and the references they use.
---------------------------------------------------------------------------
\191\ The Commissions note that such Title VII instruments would
be swaps in any event because U.S. Treasury securities are exempted
securities that are excluded from the security-based swap definition
in Title VII but understand that such swaps use the reference or
quoting convention described above in setting the terms or
conditions of the Title VII instrument at the time of execution.
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G. The Term ``Narrow-Based Security Index'' in the Security-Based Swap
Definition
1. Introduction\192\
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\192\ Four commenters referred to the definition of the term
``narrow-based security index,'' each in the context of CDS. See
infra notes 209 and 211.
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As noted above, a Title VII instrument in which the underlying
reference of the instrument is a ``narrow-based security index'' is
considered a security-based swap subject to regulation by the SEC,
whereas a Title VII instrument in which the underlying reference of the
instrument is a security index that is not a narrow-based security
index (i.e., the index is broad-based), the instrument is considered a
swap subject to regulation by the CFTC. In this section, the
Commissions propose rules and guidance regarding several issues
regarding the term ``narrow-based security index'' in the security-
based swap definition, including: (i) The existing criteria for
determining whether a security index is a narrow-based security index
and the applicability of past guidance of the Commissions regarding
those criteria to Title VII instruments; (ii) new criteria for
determining whether a CDS where the underlying reference is a group or
index of entities or obligations of entities (typically referred to as
an ``index CDS'') is based on an index that is a narrow-based security
index; (iii) the meaning of the term ``index''; (iv) a rule governing
the tolerance period for Title VII instruments on security indexes
traded on DCMs, SEFs, foreign boards of trade (``FBOTs''), security-
based SEFs, or NSEs, where the security index temporarily moves from
broad-based to narrow-based or from narrow-based to broad-based; and
(v) a rule governing the grace period for Title VII instruments on
security indexes traded on DCMs, SEFs, FBOTs, security-based SEFs, or
NSEs, where the security index moves from broad-based to narrow-based
or from narrow-based to broad-based and the move is not temporary.
2. Applicability of the Statutory Narrow-Based Security Index
Definition and Past Guidance of the Commissions to Title VII
Instruments
As defined in the CEA and Exchange Act,\193\ an index is a
``narrow-based
[[Page 29846]]
security index'' if, among other things, it meets any one of the
following four criteria:
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\193\ Sections 3(a)(55)(B) and (C) of the Exchange Act, 15
U.S.C. 78c(a)(55)(B) and (C), include a definition of ``narrow-based
security index'' in the same paragraph as the definition of security
future. See also CEA sections 1a(35)(A) and (B), 7 U.S.C. 1a(35)(A)
and (B). A security future is a contract for future delivery on a
single security or narrow-based security index (including any
interest therein or based on the value thereof). See section
3(a)(55) of the Exchange Act, 15 U.S.C. 78c(a)(55), and CEA section
1a(44), 7 U.S.C. 1a(44).
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It has nine or fewer component securities;
A component security comprises more than 30% of the
index's weighting;
The five highest weighted component securities in the
aggregate comprise more than 60% of the index's weighting; or
The lowest weighted component securities comprising, in
aggregate, 25% of the index's weighting have an aggregate dollar value
of average daily trading volume of less than $50,000,000 (or in the
case of an index with more than 15 component securities, $30,000,000),
except that if there are two or more securities with equal weighting
that could be included in the calculation of the lowest weighted
component securities comprising, in the aggregate, 25 percent of the
index's weighting, such securities shall be ranked from lowest to
highest dollar value of average daily trading volume and shall be
included in the calculation based on their ranking starting with the
lowest ranked security.\194\
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\194\ See section 3(a)(55)(B) of the Exchange Act, 15 U.S.C.
78c(a)(55)(B). See also CEA sections 1a(35)(A) and (B), 7 U.S.C.
1a(35)(A) and (B).
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The first three criteria apply to the number and concentration of
the ``component securities'' in the index; the fourth criterion applies
to the average daily trading volume of an index's ``component
securities.'' \195\
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\195\ The narrow-based security index definition in the CEA and
Exchange Act also excludes from its scope security indexes that
satisfy certain specified criteria. See sections 3(a)(55)(C)(i)--
(vi) of the Exchange Act, 15 U.S.C. 78c(a)(55)(C)(i)--(vi), and CEA
sections 1a(35)(B)(i)--(vi), 7 U.S.C. 1a(35)(B)(i)--(vi).
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This statutory narrow-based security index definition focuses on
indexes composed of equity securities and certain aspects of the
definition, in particular the evaluation of average daily trading
volume, are designed to take into account the trading patterns of
individual stocks.\196\ However, the Commissions, pursuant to authority
granted in the CEA and the Exchange Act, previously have extended the
definition to other categories of indexes but modified the definition
to take into account the characteristics of those other
categories.\197\ Specifically, the Commissions have provided guidance
regarding the application of the narrow-based security index definition
to futures contracts on volatility indexes \198\ and debt security
indexes.\199\ Today, then, there exists additional guidance for
determining what constitutes a narrow-based security index.
---------------------------------------------------------------------------
\196\ See Joint Order Excluding Indexes Comprised of Certain
Index Options From the Definition of Narrow-Based Security Index, 69
FR 16900, Mar. 31, 2004 (``March 2004 Joint Order'').
\197\ See CEA section 1a(35)(B)(vi), 7 U.S.C. 1a(35)(B)(vi), and
section 3(a)(55)(C)(vi) of the Exchange Act, 15 U.S.C.
78c(a)(55)(C)(vi).
\198\ See March 2004 Joint Order, supra note 196.
\199\ See Joint Final Rules: Application of the Definition of
Narrow-Based Security Index to Debt Securities Indexes and Security
Futures on Debt Securities, 71 FR 39434, July 13, 2006 (``July 2006
Rules'').
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Volatility indexes are indexes composed of index options. The
Commissions issued a joint order in 2004 to define when a volatility
index is not a narrow-based security index. Under this joint order, a
volatility index is not a narrow-based security index if the index
meets all of the following criteria:
The index measures the magnitude of changes (as calculated
in accordance with the order) in the level of an underlying index that
is not a narrow-based security index pursuant to the statutory criteria
for equity indexes discussed above;
The index has more than nine component securities, all of
which are options on the underlying index;
No component security of the index comprises more than 30
percent of the index's weighting;
The five highest weighted component securities of the
index in the aggregate do not comprise more than 60 percent of the
index's weighting;
The average daily trading volume of the lowest weighted
component securities in the underlying index (those comprising, in the
aggregate, 25 percent of the underlying index's weighting) have a
dollar value of more than $50,000,000 (or $30,000,000 in the case of an
underlying index with 15 or more component securities), except if there
are 2 or more securities with equal weighting that could be included in
the calculation of the lowest weighted component securities comprising,
in the aggregate, 25 percent of the underlying index's weighting, such
securities shall be ranked from lowest to highest dollar value of
average daily trading volume and shall be included in the calculation
based on their ranking starting with the lowest ranked security;
Options on the underlying index are listed and traded on
an NSE registered under section 6(a) of the Exchange Act; \200\ and
---------------------------------------------------------------------------
\200\ 15 U.S.C. 78f(a).
---------------------------------------------------------------------------
The aggregate average daily trading volume in options on
the underlying index is at least 10,000 contracts calculated as of the
preceding 6 full calendar months.\201\
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\201\ See March 2004 Joint Order, supra note 196. In 2009, the
Commissions issued a joint order that provided that, instead of the
index options having to be listed on an NSE, the index options must
be listed on an exchange and pricing information for the index
options, and the underlying index, must be computed and disseminated
in real time through major market data vendors. See Joint Order To
Exclude Indexes Composed of Certain Index Options From the
Definition of Narrow-Based Security Index, 74 FR 61116, Nov. 23,
2009 (expanding the criteria necessary for exclusion under the March
2004 Joint Order to apply to volatility indexes for which pricing
information for the underlying broad-based security index, and the
options that compose such index, is current, accurate, and publicly
available).
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With regard to debt security indexes, the Commissions issued joint
rules in 2006 (``July 2006 Rules'') to define when an index of debt
securities \202\ is not a narrow-based security index. The first three
criteria of that definition were similar to the statutory definition
for equities and the order regarding volatility indexes in that a debt
security index would not be narrow based if: (i) It had more than 9
debt securities issued by more than 9 non-affiliated issuers; (ii) the
securities of any issuer included in the index did not comprise more
than 30 percent of the index's weighting; and (iii) the securities of
any five non-affiliated issuers in the index did not comprise more than
60 percent of the index's weighting.
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\202\ Under the rules, debt securities include notes, bonds,
debentures or evidence of indebtedness. See CFTC rule
41.15(a)(1)(i), 17 CFR 41.15(a)(1)(i) and rule 3a55-4(a)(1)(i) under
the Exchange Act, 17 CFR 240.3a55-4(a)(1)(i).
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In the July 2006 Rules, instead of the statutory average daily
trading volume test, however, the Commissions adopted a public
information availability requirement. Under this requirement, assuming
the aforementioned number and concentration limits were satisfied, a
debt security index would not be a narrow-based security index if the
debt securities or the issuers of debt securities in the index met any
one of the following criteria:
The issuer of the debt security is required to file
reports pursuant to section 13 or section 15(d) of the Securities
Exchange Act of 1934; \203\
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\203\ 15 U.S.C. 78m or 78o(d).
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The issuer of the debt security has a worldwide market
value of its outstanding common equity held by non-affiliates of $700
million or more;
The issuer of the debt security has outstanding securities
that are notes, bonds, debentures, or evidence of indebtedness having a
total remaining principal amount of at least $1 billion;
[[Page 29847]]
The security is an exempted security as defined in section
3(a)(12) of the Securities Exchange Act of 1934 \204\ and the rules
promulgated thereunder; or
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\204\ 15 U.S.C. 78c(a)(12).
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The issuer of the security is a government of a foreign
country or a political subdivision of a foreign country.\205\
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\205\ The July 2006 Rules also provided that debt securities in
the index must satisfy certain minimum outstanding principal balance
criteria, established certain exceptions to these criteria and the
public information availability requirement, and provided for the
treatment of indexes that include exempted securities (other than
municipal securities).
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The statutory definition of the term ``narrow-based security
index'' for equities, and the Commissions' subsequent guidance as to
what constitutes a narrow-based security index with respect to
volatility and debt indexes, is applicable in the context of
distinguishing between futures contracts and security futures products.
In the Dodd-Frank Act, Congress included the term ``narrow-based
security index'' in the security-based swap definition, and thus the
statutory definition of the term ``narrow-based security index'' also
applies in distinguishing swaps (on security indexes that are not
narrow-based, also known as ``broad-based'') and security-based swaps
(on narrow-based security indexes). Further, the Commissions believe
that their prior guidance with respect to what constitutes a narrow-
based security index in the context of volatility and debt security
indexes should apply in determining whether a Title VII instrument is a
swap or a security-based swap.
To clarify that the Commissions are applying the prior guidance and
rules to Title VII instruments, the Commissions are proposing rules to
further define the term ``narrow-based security index'' in the
security-based swap definition. Under paragraph (1) of proposed rule
1.3(yyy) under the CEA and paragraph (a) of proposed rule 3a68-3 under
the Exchange Act, for purposes of the security-based swap definition,
the term ``narrow-based security index'' would have the same meaning as
the statutory definition set forth in section 1a(35) of the CEA and
section 3(a)(55) of the Exchange Act,\206\ and the rules, regulations,
and orders issued by the Commissions relating to such definition. As a
result, except as the new rules the Commissions are proposing provide
for other treatment, market participants generally will be able to use
the Commissions' past guidance in determining whether certain Title VII
instruments based on a security index are swaps or security-based
swaps.
---------------------------------------------------------------------------
\206\ 7 U.S.C. 1a(35) and 15 U.S.C. 78c(a)(55).
---------------------------------------------------------------------------
However, the Commissions are proposing interpretive guidance and
additional rules regarding Title VII instruments based on a security
index. The additional rules and interpretive guidance set forth new
narrow-based security index criteria with respect to indexes composed
of securities, loans, or issuers of securities referenced by an index
CDS. The proposed interpretive guidance and rules also address the
definition of an ``index'' and the treatment of broad-based security
indexes that become narrow-based and narrow-based indexes that become
broad-based, including rule provisions regarding tolerance and grace
periods for swaps on security indexes that are traded on CFTC-regulated
trading platforms and security-based swaps on security indexes that are
traded on SEC-regulated trading platforms. These rules and interpretive
guidance are discussed in turn below.
3. Narrow-Based Security Index Criteria for Index Credit Default Swaps
(a) In General
A CDS is a Title VII instrument in which the ``protection buyer''
makes a series of payments to the ``protection seller'' and, in return,
the ``protection seller'' is obligated to make a payment to the
``protection buyer'' if an obligation or obligations (typically bonds,
but in some cases loans) of an entity or entities referenced in the
contract, or the entity or entities themselves, experience a ``credit
event.'' \207\ While the Commissions understand that the underlying
reference for most cleared CDS is a single entity or an index of
entities rather than a single security or an index of securities, the
underlying reference for CDS also could be a single security or an
index of securities.\208\ A CDS where the underlying reference is a
single entity (i.e., a single-name CDS), a single obligation of a
single entity (e.g., a CDS on a specific bond, loan, or asset-backed
security, or any tranche or series of any bond, loan, or asset-backed
security), or an index CDS where the underlying reference is a narrow-
based security index or the issuers of securities in a narrow-based
security index would be a security-based swap.\209\ An index CDS where
the underlying reference is not a narrow-based security index or the
issuers of securities in a narrow-based security index (i.e., a broad-
based index) would be a swap.\210\
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\207\ See supra note 180 and accompanying text.
\208\ See, e.g., Markit, ``Markit CDX'' (describing the Markit
CDX indexes and the number of ``names'' included in each index),
available at http://www.markit.com/en/products/data/indices/credit-and-loan-indices/cdx/cdx.page?; Markit, ``Markit iTraxx Indices,''
(stating that the ``Markit iTraxx indices are comprised of the most
liquid names in the European and Asian markets'') (emphasis added),
available at http://www.markit.com/en/products/data/indices/credit-and-loan-indices/itraxx/itraxx.page?]. Examples of indexes based on
securities include the Markit ABX.HE and CMBX indexes. See Markit,
``Markit ABX.HE,'' (describing the Markit ABX.HE index as ``a
synthetic tradeable index referencing a basket of 20 subprime
mortgage-backed securities''), available at http://www.markit.com/en/products/data/indices/structured-finance-indices/abx/abx.page;
Markit, ``Markit CMBX,'' (describing the Markit CMBX index as ``a
synthetic tradeable index referencing a basket of 25 commercial
mortgage-backed securities''), available at http://www.markit.com/en/products/data/indices/structured-finance-indices/cmbx/cmbx.page.
\209\ Two commenters made suggestions relating to the effect of
the jurisdictional consequences of the definition of the term
``narrow-based security index,'' but neither commented on the
meaning of the term itself. One of the two commenters, recognizing
that a jurisdictional line would exist for CDS, stressed the need
for ``substantially identical'' regulations applicable to CDS. See
Deutsche Bank Letter. The other commenter also noted that a line for
CDS would exist and urged the Commissions to adopt a regulation
stating that a derivatives clearing organization (``DCO'') may be a
clearing agency and a clearing agency may be a DCO, in order to
facilitate portfolio margining and cross-margining. See White & Case
Letter. The Commissions are sensitive to the requirement in section
712(a)(7) of the Dodd-Frank Act to treat functionally or
economically similar products or entities in a similar manner.
\210\ Similarly, an option to enter into a single-name CDS or a
CDS referencing a narrow-based security index as described above
would be a security-based swap, while an option to enter into a CDS
on a broad-based security index or the issuers of securities in a
broad-based security index would be a swap. Index CDS where the
underlying reference is a broad-based security index would be SBSAs.
The SEC has enforcement authority with respect to swaps that are
SBSAs, as discussed further in part V below.
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The statutory definition of the term ``narrow-based security
index,'' as explained above, was designed with the U.S. equity markets
in mind. Thus, the statutory definition is not appropriate for
determining whether an index underlying an index CDS is broad or
narrow-based. Nor is the further guidance that the Commissions have
previously issued with respect to the narrow-based security index
definition discussed above necessarily appropriate, because that
guidance was designed to address and was uniquely tailored to the
characteristics of volatility indexes and debt security indexes in the
context of futures. Accordingly, the Commissions are proposing rules
that would adopt criteria for determining whether an index is a narrow-
based security index within the context of index CDS.\211\
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\211\ Two commenters urged clarification of the definition of
the term ``narrow-based security index'' in the context of CDS to
ensure that it reflects ``the letter and the spirit'' of the
existing definition. See Letter from Thomas W. Jasper, Chief
Executive Officer, Primus Guaranty Ltd., and Gene Park, Chief
Executive Officer, Quadrant Structured Investment Advisers, LLC,
Sept. 20, 2010 (``Primus and Quadrant Letter'').
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[[Page 29848]]
The Commissions are further defining the term ``security-based
swap,'' and the use of the term ``narrow-based security index'' within
that definition to modify the criteria applied in the context of index
CDS in assessing whether the index is a narrow-based security index.
The third prong of the security-based swap definition includes a Title
VII instrument based on the occurrence of an event relating to the
``issuers of securities in a narrow-based security index,'' provided
that such event directly affects the ``financial statements, financial
condition, or financial obligations of the issuer.'' \212\ The first
prong of the security-based swap definition includes a Title VII
instrument that is based on a ``narrow-based security-index.'' \213\
Because the third prong of the security-based swap definition relates
to issuers of securities, while the first prong of such definition
relates to securities, the Commissions are proposing to further define
both the term ``narrow-based security index'' and the term ``issuers of
securities in a narrow-based security index'' in the context of the
definition of security-based swap as applied to index CDS. The
Commissions believe it is important to further define both terms in
order to ensure consistent analysis of index CDS.\214\ While the
wording of the two proposed definitions differs slightly, the
Commissions expect that they would yield the same substantive results
in distinguishing narrow-based and broad-based index CDS.
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\212\ Section 3(a)(68)(A)(ii)(III) of the Exchange Act, 15
U.S.C. 78c(a)(68)(A)(ii)(III).
\213\ Section 3(a)(68)(A)(ii)(I) of the Exchange Act, 15 U.S.C.
78c(a)(68)(A)(ii)(I).
\214\ Because it applies only with respect to index CDS, the
proposed definitions of ``issuers of securities in a narrow-based
security index'' and ``narrow-based security index'' would not apply
with respect to other types of event contracts, whether analyzed
under the first or third prong.
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(b) Proposed Rules Regarding the Definitions of ``Issuers of Securities
in a Narrow-Based Security Index'' and ``Narrow-Based Security Index''
for Index Credit Default Swaps
The Commissions are considering how to further define the terms
``issuers of securities in a narrow-based security index'' and
``narrow-based security index'' in order to provide for appropriate
criteria for determining whether an index composed of issuers of
securities referenced by an index CDS and an index composed of
securities referenced by an index CDS are narrow-based security
indexes. In formulating these criteria, and consistent with the
guidance and rules the Commissions have previously issued and adopted
regarding narrow-based security indexes in the context of security
futures, the Commissions believe that there should be public
information available about a predominant percentage of the reference
entities underlying the index, or, in the case of an index CDS, on an
index of securities, about the issuers of the securities or the
securities underlying the index, in order to reduce the likelihood that
non-narrow-based indexes referenced in index CDS or the component
securities or issuers of securities in that index would be readily
susceptible to manipulation, as well as to help prevent the misuse of
material non-public information through the use of CDS based on such
indexes.
To satisfy these objectives, the Commissions intend to use the
criteria developed for debt indexes discussed above \215\ but tailor
the criteria specifically to address index CDS.\216\ These criteria
would be used solely for the purpose of defining the terms ``narrow-
based security index'' and ``issuers of securities in a narrow-based
security index'' in the first and third prongs of the security-based
swap definition with respect to index CDS and would not be interpreted
to affect any other interpretation or use of the term ``narrow-based
security index'' or any other provision of the Dodd-Frank Act, CEA, or
Exchange Act.
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\215\ See discussion of July 2006 Rules, supra note 199.
\216\ The Commissions note that the language of the proposed
rules is intended, in general, to track the criteria developed for
debt indexes discussed above. Certain changes from the criteria
developed for debt indexes are necessary to address differences
between futures on debt indexes and index CDS. Certain other changes
are necessary because the rules for debt indexes define under what
conditions an index is not a narrow-based security index, whereas
the proposed rules define what is a narrow-based security index. For
example, an index is not a narrow-based security index under the
rule for debt indexes if it is not a narrow-based security index
under either subparagraph (a)(1) or paragraph (a)(2) of the rule.
Under the proposed rules for index CDS, however, an index is a
narrow-based security index if it meets the requirements of both of
the counterpart paragraphs in the proposed rules regarding index CDS
(paragraphs (1)(i) and (1)(ii) of proposed rules 1.3(xxx) and
1.3(aaaa) under the CEA and paragraphs (a)(1) and paragraph (a)(2)
of proposed rules 3a68-1a and 3a68-1b under the Exchange Act), even
though the criteria in the debt index rules and the proposed rules
for index CDS include generally the same criteria and structure.
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(i) Number and Concentration Percentages of Reference Entities or
Securities
The Commissions believe that the first three criteria of the debt
security index test discussed above (i.e., the number and concentration
weighting requirements) are appropriate to apply to index CDS, whether
CDS on indexes of securities or indexes of issuers of securities.
Accordingly, proposed rules 1.3(zzz) under the CEA and proposed
rule 3a68-1a under the Exchange Act would provide that, for purposes of
determining whether an index CDS is a security-based swap under section
3(a)(68)(A)(ii)(III) of the Exchange Act,\217\ the term ``issuers of
securities in a narrow-based security index'' would include issuers of
securities identified in an index in which:
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\217\ 15 U.S.C. 78c(a)(68)(A)(ii)(III).
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Number: There are 9 or fewer non-affiliated issuers of
securities that are reference entities \218\ in the index, provided
that an issuer of securities shall not be deemed a reference entity in
the index unless (i) a credit event with respect to such reference
entity would result in a payment by the credit protection seller to the
credit protection buyer under the CDS based on the related notional
amount allocated to such reference entity, or (ii) the fact of such
credit event or the calculation in accordance with clause (i) above of
the amount owed with respect to such credit event is taken into account
in determining whether to make any future payments under the CDS with
respect to any future credit events;
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\218\ For purposes of proposed rules 1.3(zzz) and 3a68-1a: (i) A
reference entity would be affiliated with another entity if it
controls, is controlled by, or is under common control with, that
entity; (ii) control would mean ownership of 20 percent or more of
an entity's equity, or the ability to direct the voting of 20
percent or more of the entity's voting equity; and (iii) the term
``reference entity'' would include an issuer of securities, an
issuing entity of asset-backed securities, and a single reference
entity or group of affiliated entities; provided that an issuing
entity of an asset-backed security shall not be affiliated with any
other issuing entity or issuer under this proposed definition.
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Single Component Concentration: The effective notional
amount allocated to any reference entity included in the index
comprises more than 30 percent of the index's weighting; or
Largest Five Component Concentration: The effective
notional amount allocated to any 5 non-affiliated reference entities
included in the index comprises more than 60 percent of the index's
weighting.\219\
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\219\ These proposed rules refer to the ``effective notional
amount'' allocated to reference entities or securities in order to
address potential situations in which the means of calculating
payout across the reference entities or securities is not uniform.
Thus, if one or more payouts is leveraged or enhanced by the
structure of the transaction (i.e., 2x recovery rate), that amount
would be the ``effective notional amount'' for purposes of the 30%
and 60% tests in paragraphs (1)(i)(B) and (1)(i)(C) of proposed
rules 1.3(zzz) and 1.3(aaaa) and paragraphs (a)(1)(ii) and
(a)(1)(iii) of proposed rules 3a68-1a and 3a68-1b. Similarly, if the
aggregate notional amount under a CDS is not uniformly allocated to
each reference entity or security, then the portion of the notional
amount allocated to each reference entity or security (which may be
by reference to the product of the aggregate notional amount and an
applicable percentage) would be the ``effective notional amount.''
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[[Page 29849]]
Similarly, proposed rules 1.3(aaaa) under the CEA and proposed rule
3a68-1b under the Exchange Act would provide that, for purposes of
determining whether an index CDS is a security-based swap under section
3(a)(68)(A)(ii)(I) of the Exchange Act,\220\ the term ``narrow-based
security index'' would include an index in which essentially the same
criteria apply, substituting securities for issuers. Under these
proposed criteria, the term ``narrow-based security index'' would mean
an index in which:
---------------------------------------------------------------------------
\220\ 15 U.S.C. 78c(a)(68)(A)(ii)(I).
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Number: There are 9 or fewer securities, or securities
that are issued by 9 or fewer non-affiliated issuers,\221\ in the
index, provided that a security shall not be deemed a component of the
index unless (i) a credit event with respect to the issuer of such
security or a credit event with respect to such security would result
in a payment by the credit protection seller to the credit protection
buyer under the CDS based on the related notional amount allocated to
such security, or (ii) the fact of such credit event or the calculation
in accordance with clause (i) above of the amount owed with respect to
such credit event is taken into account in determining whether to make
any future payments under the CDS with respect to any future credit
events;
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\221\ This language is intended to be consistent with the
language in the rule for debt indexes but the specific language is
different to deal with the differences in structure between the rule
for debt indexes and proposed rules 1.3(aaaa) and 3a68-1b. See
discussion supra note 216.
For purposes of proposed rules 1.3(aaaa) and 3a68-1b: (i) An
issuer would be affiliated with another issuer if it controls, is
controlled by, or is under common control with, that issuer; (ii)
control would mean ownership of 20 percent or more of an issuer's
equity, or the ability to direct the voting of 20 percent or more of
the issuer's voting equity; and (iii) the term ``issuer'' would
include an issuer of securities, an issuing entity of asset-backed
securities, and a single issuer or group of affiliated issuers;
provided that an issuing entity of an asset-backed security shall
not be deemed affiliated with any other issuing entity or issuer
under this proposed definition.
---------------------------------------------------------------------------
Single Component Concentration: The effective notional
amount allocated to the securities of any issuer included in the index
comprises more than 30 percent of the index's weighting; or
Largest Five Component Concentration: The effective
notional amount allocated to the securities of any 5 non-affiliated
issuers included in the index comprises more than 60 percent of the
index's weighting.
Thus, the applicability of the proposed rules would depend on
conditions relating to the number of non-affiliated reference entities,
issuers of securities, or securities, as applicable, included in an
index and the weighting of notional amounts allocated to the reference
entities or securities in the index, as applicable. These first three
criteria of the proposed rules would evaluate the number and
concentration of the issuers or securities in the index, as applicable,
and ensure that an index with a small number of issuers or securities
or concentrated in only a few issuers or securities would be narrow-
based, and thus where such index is the underlying reference of an
index CDS, the index CDS would be a security-based swap.
Specifically, the proposed rules would provide that an index
meeting any one of certain identified conditions would be a narrow-
based security index. The first condition in paragraph (1)(i)(A) of
proposed rule 1.3(zzz) under the CEA and paragraph (a)(1)(i) of
proposed rule 3a68-1a under the Exchange Act is that there are 9 or
fewer non-affiliated issuers of securities that are reference entities
in the index. An issuer of securities would count toward this total
only if a credit event with respect to such entity would result in a
payment by the credit protection seller to the credit protection buyer
under the CDS based on the notional amount allocated to such entity, or
if the fact of such a credit event or the calculation of the payment
with respect to such credit event is taken into account when
determining whether to make any future payments under the CDS with
respect to any future credit events.
Similarly, the first condition in paragraph (1)(i)(A) of proposed
rules 1.3(aaaa) under the CEA and paragraph (a)(1)(i) of proposed rule
3a68-1b under the Exchange Act would provide that a security would
count toward the total number of securities in the index only if a
credit event with respect to such security, or the issuer of such
security, would result in a payment by the credit protection seller to
the credit protection buyer under the CDS based on the notional amount
allocated to such security, or if the fact of such a credit event or
the calculation of the payment with respect to such credit event is
taken into account when determining whether to make any future payments
under the CDS with respect to any future credit events. These
provisions are intended to ensure that an index concentrated in a few
reference entities or securities, or a few reference entities that are
affiliated or a few securities issued by a few issuers that are
affiliated, are within the ``narrow-based'' definition and that an
entity is not counted as a reference entity in the index, and a
security is not counted as a security in the index, unless a credit
event with respect to the entity, issuer, or security affects payout
under a CDS on the index.\222\
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\222\ This requirement is generally consistent with the
definition of ``narrow-based security index'' in CEA section
1a(35)(A), 7 U.S.C. 1a(35)(A), and section 3(a)(55)(B) of the
Exchange Act, 15 U.S.C. 78c(a)(55)(B), and the July 2006 Rules,
supra note 199.
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In addition, the proposed rules would provide that a reference
entity or issuer of a security in an index and any of that reference
entity's or issuer's affiliated entities are deemed to be a single
reference entity or issuer in the index.\223\ For purposes of the
narrow-based security index definition for index CDS under the third
prong and first prong, a reference entity or issuer would be affiliated
with another entity if it controls, is controlled by, or is under
common control with, that other entity or issuer. The proposed rules
would define control, solely for purposes of this provision, to mean
ownership of 20% or more of an entity's or issuer's equity or the
ability to direct the voting of 20% or more of an entity's or issuer's
voting equity.\224\ This definition of control is designed to provide a
clear standard for determining affiliation for purposes of the narrow-
based security index criteria with respect to index CDS. Determining
whether a reference entity or issuer is affiliated with another entity
or issuer is important in assessing whether an index meets the criteria
in the proposed rules because the notional amounts allocated to all
affiliated reference entities, or all securities issued by affiliated
issuers, included in an index must be aggregated in order to prevent a
concentration of the index in reference entities or securities issued
by issuers that are affiliated and because a reference entity's and
issuer's affiliates must be considered when determining whether the
reference entity or security meets the public information availability
test discussed below. In addition, in order to ensure application of
the criteria regarding index CDS to indexes of
[[Page 29850]]
reference entities that have issued asset-backed securities as defined
in section 3(a)(77) of the Exchange Act,\225\ as well as indexes of
such asset-backed securities, the term reference entity and the term
issuer under the proposed rules includes issuing entities of asset-
backed securities. The proposed rules also would provide that each
issuing entity of an asset-backed security is considered a separate
reference entity or issuer, as applicable.
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\223\ See proposed rule 1.3(zzz)(4) under the CEA and proposed
rule 3a68-1a(d) under the Exchange Act.
\224\ The affiliate issue under the Federal securities laws is
generally a facts and circumstances determination based on the
definition of the term ``affiliate'' contained in such laws. See,
e.g., rule 405 under the Securities Act, 17 CFR 230.405; rule 12b-2
under the Exchange Act, 17 CFR 240.12b-2.
\225\ 15 U.S.C. 78c(a)(77). The Commissions note that section
941 of the Dodd-Frank Act added the definition of the term ``asset-
backed security'' as section 3(a)(77) of the Exchange Act, 15 U.S.C.
78c(a)(77). However, section 761(a)(6) of the Dodd-Frank Act also
added the definition of the term ``security-based swap execution
facility'' as section 3(a)(77) of the Exchange Act, 15 U.S.C.
78c(a)(77). References to the definition of the term ``asset-backed
security'' in this release are to the definition added by section
941 of the Dodd-Frank Act.
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The second condition, in paragraphs (1)(i)(B) of proposed rules
1.3(zzz) and 1.3(aaaa) under the CEA and paragraphs (a)(1)(ii) of
proposed rules 3a68-1a and 3a68-1b under the Exchange Act, is that the
effective notional amount allocated to any reference entity or security
included in the index comprises more than 30 percent of the index's
weighting.
The third condition, in paragraphs (1)(i)(C) of proposed rules
1.3(zzz) and 1.3(aaaa) under the CEA and paragraphs (a)(1)(iii) of
proposed rules 3a68-1a and 3a68-1b under the Exchange Act, is that the
effective notional amount allocated to any 5 non-affiliated reference
entities, or to the securities of any 5 non-affiliated issuers,
included in the index that are the underlying reference entities or
securities, respectively, comprises more than 60 percent of the index's
weighting.
Given that Congress determined that these concentration percentages
are appropriate to characterize an index as a narrow-based security
index, and the Commissions have determined they are appropriate for
debt security indexes in the security futures context, the Commissions
believe that these concentration percentages are appropriate to apply
to the notional amount allocated to reference entities and securities
in order to apply similar standards to indexes that are the underlying
references of index CDS. Moreover, with respect to both the numerical
and concentration percentage criteria, the markets have had experience
with these criteria with respect to futures on equity indexes,
volatility indexes, and debt security indexes.
(ii) Public Information Availability Regarding Reference Entities and
Securities
In addition to the numerical and concentration percentage criteria,
the debt security index test also included, as discussed above, a
public information availability test. This test was designed to reduce
the likelihood that broad-based debt security indexes or the component
securities or issuers of securities in that index would be readily
susceptible to manipulation. The fourth condition in the proposed rules
includes a similar public information availability test that is
intended solely for purposes of determining whether an index underlying
a CDS is narrow-based. Except as discussed below, under the proposed
rules, an index CDS would be considered narrow-based if a reference
entity or security included in the index does not meet any one of the
following criteria:
The reference entity or the issuer of the security is
required to file reports pursuant to the Exchange Act or the
regulations thereunder;
The reference entity or the issuer of the security is
eligible to rely on the exemption provided in rule 12g3-2(b) under the
Exchange Act; \226\
---------------------------------------------------------------------------
\226\ 17 CFR 240.12g3-2(b).
---------------------------------------------------------------------------
The reference entity or the issuer of the security has a
worldwide market value of its outstanding common equity held by non-
affiliates of $700 million or more; \227\
---------------------------------------------------------------------------
\227\ See July 2006 Rules, supra note 199, at 39537 (noting that
issuers having worldwide equity market capitalization of $700
million are likely to have public information available about them).
---------------------------------------------------------------------------
The reference entity or the issuer of the security (other
than an issuing entity of an asset-backed security as defined in
section 3(a)(77) of the Exchange Act \228\) has outstanding securities
that are notes, bonds, debentures, or evidences of indebtedness having
a total remaining principal amount of at least $1 billion;
---------------------------------------------------------------------------
\228\ 15 U.S.C. 78c(a)(77).
---------------------------------------------------------------------------
The reference entity is an issuer of an exempted security,
or the security is an exempted security, each as defined in section
3(a)(12) of the Exchange Act \229\ and the rules promulgated thereunder
(except a municipal security);
---------------------------------------------------------------------------
\229\ 15 U.S.C. 78c(a)12.
---------------------------------------------------------------------------
The reference entity or the issuer of the security is a
government of a foreign country or a political subdivision of a foreign
country; or
If the reference entity or the issuer of the security is
an issuing entity of asset-backed securities as defined in section
3(a)(77) of the Exchange Act,\230\ such asset-backed securities were
issued in a transaction registered under the Securities Act and have
publicly available distribution reports.
---------------------------------------------------------------------------
\230\ 15 U.S.C. 78c(a)(77).
---------------------------------------------------------------------------
However, so long as the effective notional amounts allocated to
reference entities or securities that satisfy the public information
availability test comprise at least 80 percent of the index's
weighting, failure by a reference entity or security included in the
index to satisfy the public information availability test would be
disregarded if the effective notional amounts allocated to that
reference entity or security comprise less than 5 percent of the
index's weighting.
These issuer eligibility criteria are intended to condition the
characterization of an index as ``narrow-based'' on the likelihood that
information about a predominant percentage of the reference entities or
securities included in the index is publicly available.\231\ For
example, a reference entity or issuer of securities that is required to
file reports pursuant to the Exchange Act or the regulations thereunder
makes regular and public disclosure through those filings. Moreover,
reference entities and issuers of securities that do not file reports
with the SEC but that are eligible to rely on the exemption in rule
12g3-2(b) under the Exchange Act (i.e., foreign private issuers) are
required to make certain types of financial information publicly
available in English on their Web sites or through an electronic
information delivery system generally available to the public in their
primary trading markets.\232\ The Commissions believe that other
reference entities or issuers of securities that do not file reports
with the SEC, but that have worldwide equity market capitalization of
$700 million, have $1 billion in outstanding debt (other than in the
case of issuing entities of asset-backed securities), issue exempted
securities (other than municipal securities), or are foreign
[[Page 29851]]
sovereign entities either are required to or are otherwise sufficiently
likely, solely for purposes of the proposed ``narrow-based security-
index'' and ``issuers of securities in a narrow-based security index''
definitions, to have public information available about them.\233\
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\231\ See discussion supra part III.G.3(b). Most of the
thresholds in the public information availability test are similar
to those the Commissions adopted in their joint rules regarding the
application of the definition of the term ``narrow-based security
index'' to debt security indexes and security futures on debt
securities. See July 2006 Rules, supra note 199. The July 2006 Rules
also included an additional requirement regarding the minimum
principal amount outstanding for each security in the index. The
Commissions have not included this requirement in proposed rule
1.3(zzz) under the CEA and proposed rule 3a68-1a under the Exchange
Act. The numerical thresholds also are similar to those the SEC
adopted in its securities offering reform rules, which were based on
data analysis conducted by the SEC's Office of Economic Analysis.
See Securities Offering Reform, 70 FR 44722, Aug. 3, 2005.
\232\ 17 CFR 240.12g3-2(b).
\233\ It is important to note that the public information
availability test is designed solely for purposes of distinguishing
between index CDS that are swaps and index CDS that are security-
based swaps. The proposed criteria are not intended to provide any
assurance that there is any particular level of information actually
available regarding a particular reference entity or issuer of
securities. Meeting one or more of the proposed criteria for the
limited purpose here--defining the terms ``narrow-based security
index'' and ``issuers of securities in a narrow-based security
index'' in the first and third prongs of the security-based swap
definition with respect to index CDS--would not substitute for or
satisfy any other requirement for public disclosure of information
or public availability of information for purposes of the Federal
securities laws.
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In the case of indexes including asset-backed securities, or
reference entities that are issuing entities of asset-backed
securities, information about the reference entity or issuing entity of
the asset-backed security would not alone be sufficient and,
consequently, the proposed rules provide that the public information
availability test would be satisfied only if certain information also
is available about the asset-backed securities. An issuing entity
(whether or not a reference entity) of asset-backed securities may meet
the public information availability test if such asset-backed
securities were issued in a transaction registered under the Securities
Act and distribution reports about such asset-backed securities are
publicly available. In addition, because of the lack of public
information regarding many asset-backed securities, despite the size of
the outstanding amount of securities,\234\ the proposed rules would not
permit such reference entities and issuers to satisfy the public
information availability test by having $1 billion in outstanding debt.
Characterizing an index with reference entities or securities for which
public information is not likely to be available as ``narrow-based,''
and thus index CDS where the underlying references or securities are
such indexes as security-based swaps, should help to ensure the
transparency of the index components.
---------------------------------------------------------------------------
\234\ See generally Asset-Backed Securities, 75 FR 23328, May 3,
2010.
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In sum, an index that is not narrow-based under the number and
weighting requirements would be characterized as broad-based (and thus
an index CDS, where the underlying reference is that index, would be
characterized as a swap and not a security-based swap) unless one of
the reference entities or securities in the index fails to meet one of
the criteria in the public information availability test set forth in
the proposed rules. Yet, even if one or more of the reference entities
or securities included in the index fail the public information
availability test, the proposed rules would provide that the terms
``issuers of securities in a narrow-based security index'' and
``narrow-based security index'' would not include such an index, so
long as the applicable reference entity or security that failed the
test represents less than 5 percent of the index's weighting, and so
long as reference entities or securities comprising at least 80 percent
of the index's weighting do satisfy the public information availability
test.
An index that includes a very small proportion of reference
entities or securities that do not satisfy this public information
availability test should nevertheless be treated as a broad-based
security index. This would be achieved where the index satisfies both
of the requirements at the time the parties enter into the index CDS.
The 5-percent weighting threshold is designed to provide that reference
entities or securities not satisfying the public information
availability test comprise only a very small portion of the index, and
the 80-percent weighting threshold is designed to provide that a
predominant percentage of the reference entities or securities in the
index satisfy the public information availability test. As a result,
these thresholds would provide market participants with flexibility in
constructing an index. The Commissions believe that this provision is
appropriate and that providing such flexibility is not likely to
increase the likelihood that an index that satisfies these provisions
would be readily susceptible to manipulation or the likelihood that the
component securities or issuers of securities in that index also would
be subject to manipulation or that there would be misuse of material
non-public information about them through the use of CDS based on such
indexes.
The Commissions also are proposing that, for index CDS entered into
solely between ECPs, the public information availability test may
instead be satisfied other than in the manner discussed above.
Accordingly, solely for index CDS entered into between ECPs, an index
would be considered narrow-based if a reference entity or security
included in the index does not meet any one of the criteria enumerated
above or any one of the following criteria:
The reference entity or the issuer of the security (other
than issuing entities of asset-backed securities) provides to the
public or to such eligible contract participant information about such
reference entity or issuer pursuant to rule 144A(d)(4) under the
Securities Act; \235\
---------------------------------------------------------------------------
\235\ 17 CFR 230.144A(d)(4).
---------------------------------------------------------------------------
Financial information about the reference entity (other
than an issuing entity of asset-backed securities) is otherwise
publicly available; or
In the case of an asset-backed security, or a reference
entity that is an issuing entity of asset-backed securities,
information of the type and level included in public distribution
reports for similar asset-backed securities is publicly available about
both the reference entity or issuing entity as well as such asset-
backed securities.
Reference entities or reference securities that meet alternative
public information criteria currently may underlie CDS that are entered
into by ECPs and that are cleared by central counterparties operating
pursuant to exemptive orders granted by the SEC.\236\ In addition,
solely with respect to index CDS entered into by ECPs, so long as the
effective notional amounts allocated to reference entities or
securities that satisfy this expanded public information availability
test comprise at least 80 percent of the index's weighting, a reference
entity or security included in the index that fails to satisfy this
expanded public information availability test would be disregarded if
the effective notional amounts allocated to that reference entity or
security comprise less than 5 percent of the index's weighting.
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\236\ See, e.g., Order Granting Temporary Exemptions Under the
Securities Exchange Act of 1934 in Connection With Request of
Chicago Mercantile Exchange Inc. and Citadel Investment Group,
L.L.C. Related to Central Clearing of Credit Default Swaps, and
Request for Comments, Exchange Act Release No. 34-59578 (Mar. 13,
2009). This order has been extended a number of times, most recently
on November 29, 2010. See Order Extending Temporary Conditional
Exemptions Under the Securities Exchange Act of 1934 in Connection
With Request of Chicago Mercantile Exchange Inc. Related to Central
Clearing of Credit Default Swaps and Request for Comment, Exchange
Act Release No. 34-63388 (Nov. 29, 2010).
---------------------------------------------------------------------------
The Commissions are also seeking comment as to whether the public
information availability test should apply to the extent that an index
is compiled by an index provider that is not a party to an index CDS
(``third-party index provider'') and makes publicly available general
information about the construction of the index, index rules, identity
of components, and predetermined adjustments, and which index is
referenced by an index CDS that is offered on or subject to the rules
of a DCM or SEF, or by direct access in
[[Page 29852]]
the U.S. from an FBOT that is registered with the CFTC.
The CFTC believes that the requirement that the index be compiled
by a third-party index provider may help to ensure that information is
publicly available because such index providers generally employ a
variety of selection criteria for inclusion of reference entities or
securities in the indexes for index CDS, including liquidity
thresholds. The CFTC believes that requiring that such index providers
make publicly available general information about the construction of
the index, index rules, components, and predetermined adjustments may
help ensure transparency regarding the index and its components. In
addition, the CFTC believes that the requirement that the index be the
underlying reference of an index CDS that is offered for trading on or
subject to the rules of a DCM or SEF, or by direct access in the U.S.
from a registered FBOT, helps to ensure that information about the
index is publicly available and that the index is not readily
susceptible to manipulation. The CEA prohibits DCMs and SEFs from
offering for trading contracts that are readily susceptible to
manipulation.\237\ Similarly, under rules recently proposed by the
CFTC, FBOTs only may offer contracts by direct access from the U.S.
that are not readily susceptible to manipulation.\238\ The CFTC
believes that CFTC oversight of DCMs, SEFs and registered FBOTs for
compliance with these requirements \239\ will help ensure that
information about an index that is the underlying reference of an index
CDS traded on these platforms is publicly available and is not readily
susceptible to manipulation.\240\
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\237\ See CEA sections 5(d)(3), 7 U.S.C. 7(d)(3) (a DCM ``shall
list on the contract market only contracts that are not readily
susceptible to manipulation.''); 5h(f)(3), 7 U.S.C. 7b-3(f)(3) (same
requirement for SEFs).
\238\ See Registration of Foreign Boards of Trade, 75 FR 70973,
Nov. 19, 2010.
\239\ CFTC oversight in evaluating compliance with the
requirement that a swap not be readily susceptible to manipulation
for cash settled contracts includes consideration of whether cash
settlement is at a price reflecting the underlying cash market, will
not be subject to manipulation or distortion, and is based on a cash
price series that is reliable, acceptable, publicly available, and
timely. See 17 CFR Part 40, Appendix A--Guideline No. 1.
\240\ Such indexes also would be SBSAs, providing the SEC with
antifraud and anti-manipulation authority.
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The SEC believes that a third-party index provider that simply
provides general information about the construction of an index, index
rules, components, and predetermined adjustments is not a substitute
for the public availability of information about the issuers of the
securities or the securities in the index; nor does such a third-party
index provider indicate a likelihood that such public information is
available, which the SEC believes, for purposes of index CDS, is
important to market integrity and to investors in engaging in
transactions based on such indexes. If a third-party index provider
does not require, as a condition of inclusion in an index it compiles,
that information likely is publicly available regarding the component
issuers or securities in the index, the SEC does not believe investors
will have adequate information regarding such component issuers or
securities. In addition, the SEC notes that, absent specified standards
regarding what persons constitute a third-party index provider for
purposes of the proposed rules, any person that compiles an index at
the behest of another person could constitute a ``third-party index
provider.'' Moreover, the SEC does not believe that requiring an index
CDS to be offered on or subject to the rules of a DCM or SEF, or by an
FBOT, addresses whether public information likely is available about
the issuers of securities or securities in an index compiled by a
third-party index provider. As a result, the SEC does not believe that
an index compiled by a third-party index provider that makes publicly
available general information about the construction of the index,
index rules, components, and index adjustments, and that is referenced
by an index CDS that is offered for trading on or subject to the rules
of a DCM or SEF, or by direct access in the U.S. from a registered
FBOT, should substitute for the public information availability test
under the proposed rules for index CDS.
Accordingly, the Commissions seek comment as to whether the public
information availability test should apply to indexes compiled by a
third-party index provider that makes publicly available general
information about the construction of the index, index rules, identity
of components, and predetermined adjustments, and which index is
referenced by an index CDS that is offered on or subject to the rules
of a DCM or SEF, or by direct access in the U.S. from an FBOT that is
registered with the CFTC.
(iii) Treatment of Indexes Including Reference Entities That Are
Issuers of Exempted Securities or Including Exempted Securities
In addition, the proposed rules provide for alternative treatment
of indexes that include exempted securities or reference entities that
are issuers of exempted securities.\241\ The Commissions believe such
treatment is consistent with the objective and intent of the definition
of the term ``security-based swap,'' as well as the approach taken in
the context of security futures.\242\ Accordingly, paragraph (1)(ii) of
proposed rules 1.3(zzz) and 1.3(aaaa) under the CEA and paragraph
(a)(2) of proposed rules 3a68-1a and 3a68-1b under the Exchange Act
would provide that, in the case of an index that includes exempted
securities, or reference entities that are issuers of exempted
securities, in each case as defined as of the date of enactment of the
Futures Trading Act of 1982 (other than municipal securities), such
securities or reference entities are excluded from the index when
determining whether the securities or reference entities in the index
constitute a ``narrow-based security index'' or ``issuers of securities
in a narrow-based security index'' under the proposed rules.
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\241\ See proposed rules 1.3(zzz)(1)(i) and 1.3(aaaa)(1)(i)
under the CEA and proposed rules 3a68-1a(a)(2) and 3a68-1b(a)(2)
under the Exchange Act; July 2006 Rules, supra note 199.
\242\ See section 3(a)(68)(C) of the Exchange Act, 15 U.S.C.
78c(a)(68)(C) (providing that ``[t]he term `security-based swap'
does not include any agreement, contract, or transaction that meets
the definition of a security-based swap only because such agreement,
contract, or transaction references, is based upon, or settles
through the transfer, delivery, or receipt of an exempted security
under paragraph (12) [of the Exchange Act], as in effect on the date
of enactment of the Futures Trading Act of 1982 (other than any
municipal security as defined in paragraph (29) [of the Exchange
Act] as in effect on the date of enactment of the Futures Trading
Act of 1982), unless such agreement, contract, or transaction is of
the character of, or is commonly known in the trade as, a put, call,
or other option'').
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Under paragraph (1)(ii) of proposed rules 1.3(zzz) and 1.3(aaaa)
under the CEA and paragraph (a)(2) of proposed rules 3a68-1a and 3a68-
1b under the Exchange Act, an index composed solely of securities that
are, or reference entities that are issuers of, exempted securities
(other than municipal securities) would not be a ``narrow-based
security index'' or an index composed of ``issuers of securities in a
narrow-based security index.'' In the case of an index where some, but
not all, of the securities or reference entities are exempted
securities (other than municipal securities) or issuers of exempted
securities (other than municipal securities), the index would be a
``narrow-based security index'' or an index composed of ``issuers of
securities in a narrow-based security index'' only if the index is
narrow-based when the securities that are, or reference entities that
are issuers of, exempted securities (other than municipal securities)
are
[[Page 29853]]
disregarded. The Commissions believe this approach would result in
consistent treatment for indexes regardless of whether they include
securities that are, or issuers of securities that are, exempted
securities (other than municipal securities) while ensuring that
exempted securities (other than municipal securities) and issuers of
exempted securities (other than municipal securities) are not included
in an index merely to make the index either broad-based or narrow-based
under the proposed rules.
Request for Comment
The Commissions request comment on all aspects of proposed rules
1.3(zzz) and 1.3(aaaa) under the CEA and proposed rules 3a68-1a and
3a68-1b under the Exchange Act, as applied to CDS, including the
following:
85. Do the proposed criteria for identifying when an index of
reference entities constitutes ``issuers of securities in a narrow-
based security index'' and when an index of securities constitutes a
``narrow-based security index'' effectively encompass the key elements
of a narrow-based security index as it pertains to paragraph
(A)(ii)(III) (i.e., the third prong) and paragraph (A)(ii)(I) (i.e.,
the first prong) of the security-based swap definition? Why or why not?
86. Should an index with 9 or fewer non-affiliated issuers of
securities or 9 or fewer securities be ``narrow-based?'' Why or why
not?
87. Should an index in which the effective notional amounts
allocated to any reference entity or security included in the index
comprise more than 30 percent of the index's weighting be ``narrow-
based''? Why or why not?
88. Should an index in which the effective notional amounts
allocated to any 5 non-affiliated reference entities or securities
included in the index comprise more than 60 percent of the index's
weighting be ``narrow-based''? Why or why not?
89. Should an index in which publicly available information is not
available for a predominant percentage of reference entities or
securities included in the index be ``narrow-based'' for purposes of
index CDS? Why or why not? The Commissions note that the criteria for
the public information availability test do not necessarily ensure that
there is in fact public information available regarding the relevant
entities or securities, or that the criteria act in any way as a
substitute for the actual availability of public information; instead,
the criteria, taken as a whole, are intended to capture, for purposes
of the definition of the term ``narrow-based security index'' for index
CDS, those entities or securities, that on average, are likely to have
public information available, and that the relevant index would
therefore not be treated as ``narrow-based.'' Do the proposed criteria
appropriately achieve this objective? Are the criteria for the public
information availability test under the proposed rules appropriate to
result in a sufficient likelihood that public information about the
component securities or issuers of securities in an index CDS would be
available to properly address the regulatory interests of the Federal
securities laws? Are the $700 million and $1 billion thresholds
discussed above appropriate tests for the likelihood of publicly
available information in this context? These thresholds are similar to
those in the SEC securities offering reform rules used to determine, in
part, whether a particular issuer was a ``well-known seasoned issuer,''
in order to streamline registration requirements under the Securities
Act.\243\ Are there companies that have less than $700 million in
worldwide equity capitalization, or less than $1 billion in outstanding
debt (other than asset-backed securities), and that do not otherwise
satisfy the public information availability test, that have public
information available about them for purposes of determining whether an
index CDS that includes such a company as a reference entity or such a
security is broad or narrow-based? The Commissions request comment on
the appropriate thresholds for determining whether there likely is
public information available for purposes of the proposed definition of
narrow-based security index and issuers of securities in a narrow-based
security index for purposes of index CDS, in particular whether these
thresholds should be modified higher or lower, and request empirical
data to support the response.
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\243\ See supra note 231.
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90. Is it appropriate to treat an issuer eligible to rely on rule
12g3-2(b) under the Exchange Act as meeting the public information
availability test under the proposed rules? Why or why not? Would such
a provision include issuers that otherwise would not satisfy the
information condition in the proposed rules? Why or why not? Please
provide a detailed explanation and include empirical data to support
any suggested modification.
91. With respect to asset-backed securities, is the proposed
criterion for meeting the public information availability test, that
the asset-backed securities were issued in a transaction registered
under the Securities Act and have publicly available distribution
reports, the correct approach? Why or why not? Should such a provision
explicitly also apply to include asset-backed securities issued by
Fannie Mae and Freddie Mac? Why or why not? Please provide a detailed
explanation of whether and why such a condition is necessary and
include empirical data to support any suggested modification.
92. Should the proposed rules exclude a reference entity or
security in the index from the public information availability test, so
long as the reference entity or security included in the index
represents less than five percent of the index's weighting? Why or why
not?
93. Should the proposed rules exclude a reference entity or
security in the index from the public information availability test, so
long as the reference entities or securities comprising at least 80
percent of the index's weighting satisfy the provisions of those
paragraphs? Why or why not?
94. The Commissions are considering whether the public information
availability test in proposed rules 1.3(zzz) and 1.3(aaaa) under the
CEA and proposed rules 3a68-1a and 3a68-1b under the Exchange Act
should apply to an index of issuers of securities or securities that is
created and published by a third-party index provider that is not a
party to an index CDS and makes publicly available general information
about the construction of the index, index rules, components, and
predetermined adjustments, and which index is referenced by an index
CDS that is offered on or subject to the rules of a DCM or SEF, or by
direct access in the U.S. from an FBOT that is registered with the
CFTC. How are indexes created by such a third-party index provider and
what type of compensation do they receive? What role do parties to a
swap or security-based swap play in determining the constituents or
index criteria? What type of information does a third-party index
provider ensure is publicly available on an ongoing basis about each of
the constituent issuers of securities or securities identified in the
index and what actions does the third-party index provider take to
ensure the accuracy of information about the issuers of securities or
securities in any index compiled by such third-party index provider?
How would a third-party index provider take steps to ensure that the
indexes it creates are composed of issuers of securities or securities
for which there likely is public information available? Please provide
detailed examples.
95. If the Commissions determine to use, as an alternative to the
public
[[Page 29854]]
information availability test in the proposed rules relating to index
CDS, the existence of a third-party index provider that is not a party
to an index CDS and makes publicly available general information about
the construction of the index, index rules, components, and
predetermined adjustments, and which index is referenced by an index
CDS that is offered on or subject to the rules of a DCM or SEF, or by
direct access in the U.S. from an FBOT that is registered with the
CFTC, what requirements, if any, should the Commissions impose on the
DCM, SEF, or FBOT to ensure that public information likely will be
available in this context regarding the issuers of securities or
securities in the index? What specified standards, if any, should the
Commissions require the DCM, SEF, or FBOT to meet for purposes of the
proposed rules?
96. Should index CDS based on an index compiled by a third-party
index provider as described in this section be considered a ``mixed
swap'' rather than a swap in order to ensure that the protections of
the Federal securities laws apply with respect to index constituents
about which public information about the constituent issuers of
securities or securities in the index (subject to the de minimis
provisions of the proposed rules) may not be available?
97. Are there other criteria that the Commissions should adopt as
alternative means of satisfying the public information availability
test in the proposed rules? If so, please explain what they are and
what requirements the Commissions should impose to ensure the public
availability of information regarding issuers of securities or
securities in index CDS.
98. Should the proposed rules provide, solely with respect to CDS
that may be entered into only between eligible contract participants,
that the information availability test could be satisfied if the
reference entity or the issuer of the security (i) except in the case
of issuing entities of asset-backed securities, provides information to
the public or to such eligible contract participant pursuant to rule
144A(d)(4) of the Securities Act; (ii) except in the case of issuing
entities of asset-backed securities, financial information is otherwise
publicly available about the reference entity or the issuer of the
security; or (iii) in the case of asset-backed securities and issuing
entities of asset-backed securities, financial information of the type
and level included in public distribution reports for similar asset-
backed securities about both the issuing entity and such asset-backed
securities is publicly available? Why or why not? Please provide a
detailed explanation and empirical data, to the extent feasible.
99. Should the proposed rules include additional or other criteria
to determine whether an index is ``narrow-based'' with respect to index
CDS? If so, what criteria should be included, and why?
100. Does the proposed treatment of index CDS whereby a payment is
contemplated based on the default of a particular entity in the index
rather than solely on the value of the index adequately address the
Federal regulatory interests under the Federal securities laws and the
Commodity Exchange Act?
101. Does the definition of ``control'' for purposes of identifying
whether a reference entity or issuer is affiliated with another entity
(ownership of 20 percent or more of an entity's or issuer's equity, or
the ability to direct the voting of 20 percent or more of the entity's
or issuer's voting equity) appropriately identify when affiliates are
in a control relationship for these purposes? Why or why not? Should
these thresholds be higher or lower? Please provide supporting data
and/or analysis. Should issuing entities of asset-backed securities be
considered separate reference entities or issuers for purposes of the
proposed criteria? If not, why not? Are there circumstances under which
issuing entities of asset-backed securities should not be considered
separate reference entities or issuers for purposes of the proposed
criteria? Why or why not?
102. Are there other categories or types of CDS that proposed rules
1.3(zzz) and (aaaa) and proposed rules 3a68-1a and 3a68-1b do not
address or that require additional clarification regarding their
treatment under the Dodd-Frank Act? If so, please provide a detailed
description of any such categories or types of CDS, as well as any
analysis, supported by empirical data to the extent feasible, of what
clarification is necessary.
103. Are there other categories of event-type contracts relating to
issuers of securities that require additional clarification regarding
their treatment under the Dodd-Frank Act? If so, please provide a
detailed explanation of the types of contracts and why the proposed
rules should apply to such other event-type contracts.
4. Security Indexes
The Dodd-Frank Act defines the term ``index'' as ``an index or
group of securities, including any interest therein or based on the
value thereof.'' \244\ The Commissions are proposing guidance as to how
to determine when a portfolio of securities is a narrow-based or broad-
based security index and the circumstances in which changes to the
composition of a security index (including a portfolio of securities)
\245\ underlying a Title VII instrument would affect the
characterization of such Title VII instrument.\246\
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\244\ See section 3(a)(68)(E) of the Exchange Act, 15 U.S.C.
78c(a)(68)(E).
\245\ A ``portfolio'' of securities could be a group of
securities and therefore an ``index'' for purposes of the Dodd-Frank
Act. To the extent that changes are made to the securities
underlying the Title VII instrument and each such change is
individually confirmed, then those substituted securities would not
be part of a security index as defined in the Dodd-Frank Act, and
therefore a Title VII instrument on each of those substituted
securities would be a security-based swap.
\246\ Solely for purposes of the discussion in this section, the
terms ``security index'' and ``security portfolio'' are intended to
include either securities or the issuers of securities.
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In most cases, a security index is designed to reflect the
performance of a market or sector by reference to representative
securities or interests in securities. There are a number of well-known
security indexes established and maintained by recognized index
providers currently in the market.\247\ The Commissions understand,
however, that instead of using these established indexes, market
participants may enter into a Title VII instrument where the underlying
reference of the Title VII instrument is a portfolio of securities
selected by the counterparties or created by a third-party index
provider at the behest of one or both counterparties. In some cases,
the Title VII instrument may give one or both of the counterparties,
either directly or indirectly (e.g., through an investment adviser or
through the third-party index provider), discretionary authority to
change the composition of the security portfolio, including, for
example, by adding or removing securities in the security portfolio on
an ``at-will'' basis during the term of the Title VII instrument.\248\
The Commissions believe that where the counterparties, either directly
or indirectly (e.g., through an investment adviser or through the
third-party index provider), have this discretionary authority to
change the
[[Page 29855]]
composition or weighting of securities in a security portfolio, that
security portfolio should be treated as a narrow-based security index,
and that therefore a Title VII instrument on that security portfolio
would be a security-based swap.\249\
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\247\ For instance, the S&P 500[reg] is an index that gauges the
large cap U.S. equities market.
\248\ Alternatively, counterparties may enter into Title VII
instruments where a third-party investment manager selects an
initial portfolio of securities and has discretionary authority to
change the composition of the security portfolio in accordance with
guidelines agreed upon with the counterparties. Such security
portfolios would be treated as narrow-based security indexes with
Title VII instruments on those security portfolios being security-
based swaps.
\249\ The Commissions understand that a security portfolio could
be labeled as such or could just be an aggregate of individual Title
VII instruments documented, for example, under a master agreement or
by amending an annex of securities attached to a master trade
confirmation. If the security portfolio were created by aggregating
individual Title VII instruments, each Title VII instrument would
need to be evaluated in accordance with the proposed guidance to
determine whether it is a swap or a security-based swap. For the
avoidance of doubt, if the counterparties to a Title VII instrument
exchanged payments under that Title VII instrument based on a
security index that was itself created by aggregating individual
security-based swaps, such Title VII instrument would be a security-
based swap. See discussion supra part III.D.
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The Commissions believe, however, that not all changes that occur
to the composition or weighting of a security index underlying a Title
VII instrument will always result in that security index being treated
as a narrow-based security index. Many security indexes are constructed
and maintained by an index provider pursuant to a published
methodology.\250\ For instance, the various Standard & Poor's security
indexes are reconstituted and rebalanced as needed and on a periodic
basis pursuant to published index criteria.\251\
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\250\ See, e.g., NASDAQ, ``NASDAQ-100 Index'' (``The NASDAQ-100
Index is calculated under a modified capitalization-weighted
methodology. The methodology is expected to retain in general the
economic attributes of capitalization-weighting while providing
enhanced diversification. To accomplish this, NASDAQ will review the
composition of the NASDAQ-100 Index on a quarterly basis and adjust
the weightings of Index components using a proprietary algorithm, if
certain pre-established weight distribution requirements are not
met.''), available at http://dynamic.nasdaq.com/dynamic/nasdaq100_activity.stm
\251\ Information regarding security indexes and their related
methodologies may be widely available to the general public or
restricted to licensees in the case of proprietary or ``private
label'' security indexes. Both public and private label security
indexes are frequently subject to intellectual property protection.
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In addition, counterparties to a Title VII instrument frequently
agree to use as the underlying reference of a Title VII instrument a
security index based on predetermined criteria where the security index
composition or weighting may change as a result of the occurrence of
certain events specified in the Title VII instrument at execution, such
as ``succession events.'' Counterparties to a Title VII instrument also
may use a predetermined self-executing formula to make other changes to
the composition or weighting of a security index underlying a Title VII
instrument. In either of these situations, the composition of a
security index may change pursuant to predetermined criteria or
predetermined self-executing formulas without the Title VII instrument
counterparties, their agents, or third-party index providers having any
direct or indirect discretionary authority to change the security
index.
In general, and by contrast to Title VII instruments in which the
counterparties, either directly or indirectly (e.g., through an
investment adviser or through the third-party index provider), have the
discretion to change the composition or weighting of the referenced
security index, where there is an underlying security index for which
there are predetermined criteria or a predetermined self-executing
formula for adjusting the security index that are not subject to change
or modification through the life of the Title VII instrument and that
are set forth in the Title VII instrument at execution (regardless of
who establishes the criteria or formula), a Title VII instrument on
such underlying security index would be on a broad-based or narrow-
based security index, depending on the composition and weighting of the
underlying security index. Subject to the interpretation discussed
below regarding security indexes that may shift from being a narrow-
based security index or broad-based security index during the life of
an existing Title VII instrument,\252\ the characterization of a Title
VII instrument based on a security index as either a swap or a
security-based swap would depend on the characterization of the
security index using the above interpretation.\253\
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\252\ As discussed further below, the Commissions are concerned
about the potential use of security indexes to game the narrow-based
security index definition.
\253\ See supra note 249 regarding the aggregation of separate
trades.
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Request for Comment
104. The Commissions request comment on whether there are
additional or other criteria that would be appropriate in determining
whether a security index or security portfolio would constitute a
narrow-based security index for purposes of the definitions of the
terms ``swap'' and ``security-based swap.'' Please discuss any criteria
in detail and provide any supporting data where relevant.
105. What are the ways in which Title VII instruments involving
security portfolios are structured, including changes in security
portfolio composition?
106. Should ``discretionary authority to change'' by the
counterparties, either directly or indirectly (e.g., through an
investment adviser or through the third-party index provider), be a
determinative factor for whether a security portfolio should be treated
as a narrow-based security index? Why or why not? Are there Title VII
instruments where the underlying reference is a security portfolio
where counterparties may directly or indirectly (e.g., through an
investment manager or the third-party provider) exercise discretionary
authority to change the composition of the security portfolio that
should not be considered security-based swaps? Why or why not? Please
provide a detailed explanation of such Title VII instruments, the means
by which, and why, the composition of the underlying security portfolio
are established and subsequently changed, and for what purpose such
Title VII instruments are used.
107. Should a security index, where changes to the composition are
not subject to discretionary authority but instead may be made pursuant
to predetermined criteria or a predetermined self-executing formula set
forth in the Title VII instrument at execution, be considered either a
broad-based security index or a narrow-based security index, depending
on its constitution? Why or why not? Are changes pursuant to such
predetermined criteria or formulas common? How frequently do such
changes occur? What sorts of events trigger such changes? Please
provide a detailed explanation and empirical data, to the extent
feasible.
108. Are the terms ``predetermined criteria'' and ``predetermined
self-executing formula'' clear? Why or why not? If not, what
alternative or additional guidance should be provided to clarify under
what circumstances changes to the composition of a security index
underlying a Title VII instrument may be made without being considered
``at will'' or discretionary changes by the counterparties, either
directly or indirectly (e.g., through an investment adviser or through
the third-party index provider), that would result in the security
index being treated as a narrow-based security index and the Title VII
instrument being a security-based swap? Are there specific additional
criteria, restrictions, or parameters that should be considered? If so,
please provide a detailed explanation regarding such criteria,
restrictions, or parameters, including the types of changes that should
or should not be permitted.
109. Are there specific methodologies or criteria, agreed to at or
prior to the
[[Page 29856]]
execution of a Title VII instrument, for changing the composition of an
underlying security index, that should be explicitly addressed by the
Commissions in providing the proposed guidance regarding security
indexes? If so, please provide a detailed explanation of those
methodologies or criteria and what additional guidance is necessary.
110. Would restrictions on the frequency of changes to the
composition of a security index underlying a Title VII instrument be
useful in determining whether the underlying security index should be
treated as a narrow-based security index? If so, please provide a
detailed explanation of what restrictions should apply and why, as well
as empirical data to the extent feasible.
5. Evaluation of Title VII Instruments on Security Indexes That Move
From Broad-Based to Narrow-Based or Narrow-Based to Broad-Based
(a) In General
As discussed above, the determination of whether a Title VII
instrument is a swap, a security-based swap, or both (i.e., a mixed
swap), is made at the execution of the Title VII instrument.\254\ If
the security index underlying a Title VII instrument migrates from
being broad-based to being narrow-based, or vice versa, during the life
of a Title VII instrument, the characterization of that Title VII
instrument would not change from its initial characterization
regardless of whether the Title VII instrument was entered into
bilaterally or was executed through a trade on or subject to the rules
of a DCM, SEF, FBOT, security-based SEF, or NSE. For example, if two
counterparties enter into a swap based on a broad-based security index,
and three months into the life of the swap the security index
underlying that Title VII instrument migrates from being broad-based to
being narrow-based, the Title VII instrument would remain a swap for
the duration of its life and would not be recharacterized as a
security-based swap.
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\254\ See discussion supra part III.A.
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If the material terms of a Title VII instrument are amended or
modified during its life, the Commissions would view the amended or
modified Title VII instrument as a new Title VII instrument.\255\ As a
result, the characteristics of the underlying security index must be
reassessed at the time of such an amendment or modification to
determine whether the security index has migrated from broad-based to
narrow-based or vice versa. If the security index has migrated, then
the characterization of the amended or modified Title VII instrument
would be determined by evaluating the characterization of the
underlying security index at the time the Title VII instrument is
amended or modified. Similarly, if a security index has migrated from
broad-based to narrow-based or vice versa, any new Title VII instrument
based on that security index would be characterized pursuant to an
evaluation of the underlying security index at the execution of that
new Title VII instrument.
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\255\ For example, if, on its effective date, a Title VII
instrument tracks the performance of an index of 12 securities but
is amended during its term to track the performance of only 8 of
those 12 securities, the Commissions would view the amended or
modified Title VII instrument as a new Title VII instrument.
Conversely, if, on its effective date, a Title VII instrument tracks
the performance of an index of 12 securities but is amended during
its term to reflect the replacement of a departing ``key person'' of
a hedge fund that is a counterparty to the Title VII instrument with
a new ``key person,'' the Commissions would not view the amended or
modified Title VII instrument as a new Title VII instrument because
the amendment or modification is not to a material term of the Title
VII instrument. Because it would be a new Title VII instrument, any
regulatory requirements regarding new Title VII instruments would
apply.
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The Commissions are proposing guidance regarding circumstances in
which the character of a security index on which a Title VII instrument
is based changes according to predetermined criteria or a predetermined
self-executing formula set forth in the Title VII instrument (or in a
related or other agreement entered into by the counterparties or a
third-party index provider to the Title VII instrument) at execution.
Where at the time of execution such criteria or such formula would
cause the underlying broad-based security index to become or assume the
characteristics of a narrow-based security index or vice versa during
the duration of the instrument,\256\ then the characterization of the
Title VII instrument based on such security index would be a mixed swap
during the entire life of the Title VII instrument.\257\ Although at
certain points during the life of the Title VII instrument the
underlying security index would be broad-based and at other points the
underlying security index would be narrow-based, the Commissions
believe that regulating such a Title VII instrument as a mixed swap
from the execution of the Title VII instrument and throughout its life
reflects the appropriate characterization of a Title VII instrument
based on a security index that migrates pursuant to predetermined
criteria or a predetermined self-executing formula.
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\256\ Thus, for example, if a predetermined self-executing
formula agreed to by the counterparties of a Title VII instrument at
or prior to the execution of the Title VII instrument provided that
the security index underlying the Title VII instrument would
decrease from 20 to 5 securities after six months, such that the
security index would become narrow-based as a result of the reduced
number of securities, then the Title VII instrument would be a mixed
swap at its execution. The characterization of the Title VII
instrument as a mixed swap would not change during the life of the
Title VII instrument.
\257\ As discussed above in part III.G.4, to the extent a Title
VII instrument permits ``at will'' substitution of an underlying
security index, however, as opposed to the use of predetermined
criteria or a predetermined self-executing formula, the Title VII
instrument would be a security-based swap at its execution and
throughout its life regardless of whether the underlying security
index was narrow-based at the execution of the Title VII instrument.
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The Commissions believe that this guidance regarding the use of
predetermined criteria or a predetermined self-executing formula would
prevent potential gaming of the Commissions' guidance regarding
security indexes and prevent potential regulatory arbitrage based on
the migration of a security index from broad-based to narrow-based or
vice versa. In particular, the Commissions note that predetermined
criteria and predetermined self-executing formulas can be constructed
in ways that take into account the characteristics of a narrow-based
security index and prevent a narrow-based security index from becoming
broad-based and vice versa.
(b) Title VII Instruments on Security Indexes Traded on Designated
Contract Markets, Swap Execution Facilities, Foreign Boards of Trade,
Security-Based Swap Execution Facilities, and National Securities
Exchanges
The Commissions recognize that security indexes underlying Title
VII instruments that are traded on DCMs, SEFs, FBOTs, security-based
SEFs, or NSEs raise particular issues if an underlying security index
migrates from broad-based to narrow-based or vice versa. The
characterization of an exchange-traded Title VII instrument at its
execution, as explained above, would not change through the life of the
Title VII instrument, regardless of whether the underlying security
index migrates from broad-based to narrow-based or vice versa.
Accordingly, a market participant who enters into a swap on a broad-
based security index traded on or subject to the rules of a DCM, SEF or
FBOT that migrates from broad-based to narrow-based may hold that
position until the swap's expiration without any change in regulatory
responsibilities, requirements, or obligations, and
[[Page 29857]]
similarly a market participant who enters into a security-based swap on
a narrow-based security index traded on a security-based SEF or NSE may
hold that position until the security-based swap's expiration without
any change in regulatory responsibilities, requirements, or
obligations.
However, in the absence of any action by the Commissions, if the
market participant wants to offset the swap or enter into a new swap on
the DCM, SEF or FBOT where the underlying security index has migrated
from broad-based to narrow-based, or to offset the security-based swap
or enter into a new security-based swap on a security-based SEF or NSE
where the underlying security index has migrated from narrow-based to
broad-based, the participant would be prohibited from doing so. That is
because swaps may trade only on DCMs, SEFs, and FBOTs, and security-
based swaps may trade only on registered NSEs and security-based
SEFs.\258\ The Commissions believe it is important to address how to
treat Title VII instruments traded on trading platforms where the
underlying security index migrates from broad-based to narrow-based or
narrow-based to broad-based so that market participants will know where
such Title VII instruments may be traded and can avoid potential
disruption of their ability to offset or enter into new Title VII
instruments on trading platforms when such migration occurs. The
Commissions are proposing rules accordingly.\259\
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\258\ If a swap were based on a security index that migrated
from broad-based to narrow-based, a DCM, SEF, or FBOT could no
longer offer the Title VII instrument because it would be a
security-based swap. Similarly, if a security-based swap were based
on a security index that migrated from narrow-based to broad-based,
a security-based SEF or NSE could no longer offer the Title VII
instrument because it would be a swap.
\259\ The proposed rules apply only to the particular Title VII
instrument that is traded on or subject to the rules of a DCM, SEF,
FBOT, security-based SEF, or NSE. To the extent that a particular
Title VII instrument is not traded on such a trading platform (even
if another Title VII instrument of the same class or type is traded
on such a trading platform) the proposed rules would not apply to
that particular Title VII instrument.
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Congress and the Commissions addressed a similar issue in the
context of security futures, where the security index on which a future
is based may migrate from broad-based to narrow-based or vice versa.
Congress provided in the definition of ``narrow-based security index''
in both the CEA and the Exchange Act \260\ for a tolerance period
ensuring that, under certain conditions, a futures contract on a broad-
based security index traded on a DCM may continue to trade, even when
the index temporarily assumes characteristics that would render it a
narrow-based security index under the statutory definition.\261\ In
general, an index is subject to this tolerance period, and therefore is
not a narrow-based security index, if: (i) a futures contract on the
index traded on a DCM for at least 30 days as a futures contract on a
broad-based security index before the index assumed the characteristics
of a narrow-based security index and (ii) the index does not retain the
characteristics of a narrow-based security index for more than 45
business days over 3 consecutive calendar months. Pursuant to these
statutory provisions, if the index becomes narrow-based for more than
45 business days over 3 consecutive calendar months, the index is
excluded from the definition of the term ``narrow-based security
index'' for the following 3 calendar months as a grace period.
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\260\ CEA section 1a(35)(B)(iii), 7 U.S.C. 1a(35)(B)(iii);
section 3(a)(55)(C)(iii) of the Exchange Act, 15 U.S.C.
78c(a)(55)(C)(iii).
\261\ By joint rules, the Commissions have provided that
``[w]hen a contract of sale for future delivery on a security index
is traded on or subject to the rules of a foreign board of trade,
such index shall not be a narrow-based security index if it would
not be a narrow-based security index if a futures contract on such
index were traded on a designated contract market * * * .'' See CFTC
rule 41.13, 17 CFR 41.13, and rule 3a55-3 under the Exchange Act, 17
CFR 240.3a55-3. Accordingly, the statutory tolerance period rules
applicable to futures on security indexes traded on DCMs apply to
futures traded on FBOTs as well.
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The Commissions believe a similar tolerance period should apply to
swaps traded on DCMs, SEFs, and FBOTs and security-based swaps traded
on security-based SEFs and NSEs. Accordingly, the Commissions are
proposing rules providing for tolerance periods for swaps that are
traded on DCMs, SEFs, or FBOTs and for security-based swaps traded on
security-based SEFs and NSEs.
Under paragraph (2)(i)(A) of proposed rule 1.3(yyy) under the CEA
and paragraph (b)(1)(i) of proposed rule 3a68-3 under the Exchange Act,
to be subject to the tolerance period, a security index underlying a
swap executed on or subject to the rules of a DCM, SEF, or FBOT must
not have been a narrow-based security index \262\ during the first 30
days of trading.\263\ If the index becomes narrow-based during the
first 30 days of trading, paragraph (2)(i)(B) of proposed rule 1.3(yyy)
under the CEA and paragraph (b)(1)(ii) of proposed rule 3a68-3 under
the Exchange Act provide that the index must not have been a narrow-
based security index during every trading day of the 6 full calendar
months preceding a date no earlier than 30 days prior to the
commencement of trading of a swap on such index.\264\ If either of
these alternatives are met, paragraph (2)(ii) of proposed rule 1.3(yyy)
under the CEA and paragraph (b)(2) of proposed rule 3a68-3 under the
Exchange Act provide that the index will not be a narrow-based security
index if it has been a narrow-based security index for no more than 45
business days over 3 consecutive calendar months. Paragraph (2) of
proposed rule 1.3(yyy) under the CEA and paragraph (b) of proposed rule
3a68-3 under the Exchange Act apply solely for purposes of swaps traded
on or subject to the rules of a DCM, SEF, or FBOT.
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\262\ For purposes of the proposed rules, the term ``narrow-
based security index'' shall also mean ``issuers of securities in a
narrow-based security index.'' See supra part III.G.3(b) (discussing
the proposed rules defining ``issuers of securities in a narrow-
based security index'').
\263\ This provision is consistent with the provisions of the
CEA and the Exchange Act applicable to futures contracts on security
indexes. CEA section 1a(35)(B)(iii)(I), 7 U.S.C. 1a(35)(B)(iii)(I);
section 3(a)(55)(C)(iii)(I) of the Exchange Act, 15 U.S.C.
78c(a)(55)(C)(iii)(I).
\264\ This alternative test is the same as the alternative test
applicable to futures contracts in CEA rule 41.12, 17 CFR 41.12 and
rule 3a55-2 under the Exchange Act, 17 CFR 240.3a55-2.
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Similarly, paragraph (3) of proposed rule 1.3(yyy) under the CEA
and paragraph (c) of proposed rule 3a68-3 under the Exchange Act
provide a tolerance period for security-based swaps traded on security-
based SEFs or NSEs. Under paragraph (3)(i)(A) of proposed rule 1.3(yyy)
under the CEA and paragraph (c)(1)(i) of proposed rule 3a68-3 under the
Exchange Act, to be subject to the tolerance period, a security index
underlying a security-based swap executed on a security-based SEF or
NSE must have been a narrow-based security index during the first 30
days of trading. If the index becomes broad-based during the first 30
days of trading, paragraph (3)(i)(B) of proposed rule 1.3(yyy) under
the CEA and paragraph (c)(1)(ii) of proposed rule 3a68-3 under the
Exchange Act provide that the index must have been a non-narrow-based
security index during every trading day of the 6 full calendar months
preceding a date no earlier than 30 days prior to the commencement of
trading of a security-based swap on such index. If either of these
alternatives are met, paragraph (3)(ii) of proposed rule 1.3(yyy) under
the CEA and paragraph (c)(2) of proposed rule 3a68-3 under the Exchange
Act provide that the index will be a narrow-based security index if it
has been a security index that is not narrow-based for no more than 45
business days over 3 consecutive
[[Page 29858]]
calendar months.\265\ Paragraph (3) of proposed rule 1.3(yyy) under the
CEA and paragraph (c) of proposed rule 3a68-3 under the Exchange Act
apply solely for purposes of security-based swaps traded on security-
based SEFs or NSEs.
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\265\ These provisions are consistent with the parallel
provisions in the CEA and the Exchange Act applicable to futures
contracts on security indexes traded on DCMs. CEA section
1a(35)(B)(iii)(II), 7 U.S.C. 1a(35)(B)(iii)(II); section
3(a)(55)(C)(iii)(II) of the Exchange Act, 15 U.S.C.
78c(a)(55)(C)(iii)(II).
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The Commissions are proposing that, once the tolerance period under
the proposed rules has ended, there would be a grace period during
which a Title VII instrument based on a security index that has
migrated from broad-based to narrow-based or vice versa would be able
to trade on the platform on which Title VII instruments based on such
security index were trading before the security index migrated and can
also, during such period, be cleared. Paragraph (4)(i) of proposed rule
1.3(yyy) under the CEA and paragraph (d)(1) of proposed rule3a68-3
under the Exchange Act would provide for an additional 3-month grace
period applicable to a security index that becomes narrow-based for
more than 45 business days over 3 consecutive calendar months, solely
with respect to swaps that are traded on or subject to the rules of
DCMs, SEFs, or FBOTs. During the grace period, such an index would not
be considered a narrow-based security index. Paragraph (4)(ii) of
proposed rule 1.3(yyy) under the CEA and paragraph (d)(2) of proposed
rule3a68-3 under the Exchange Act would apply the same grace period to
a security-based swap on a security index that becomes broad-based for
more than 45 business days over 3 consecutive calendar months, solely
with respect to security-based swaps that are traded on a security-
based SEF or NSE. During the grace period, such an index would not be
considered a broad-based security index.\266\ As a result, this
proposed rule would provide sufficient time for the migrated Title VII
instrument to satisfy listing and clearing requirements applicable to
swaps or security-based swaps, as appropriate.
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\266\ These provisions are consistent with the parallel
provisions in the CEA and the Exchange Act applicable to futures
contracts on security indexes traded on DCMs. See CEA section
1a(35)(D), 7 U.S.C. 1a(35)(D); section 3(a)(55)(E) of the Exchange
Act, 15 U.S.C. 78c(a)(55)(E).
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There would be no overlap between the tolerance and the grace
periods under the proposed rules and no ``re-triggering'' of the
tolerance period. For example, if a security index becomes narrow-based
for more than 45 business days over 3 consecutive calendar months,
solely with respect to swaps that are traded on or subject to the rules
of DCMs, SEFs, or FBOTs, but as a result of the proposed rules is not
considered a narrow-based security index during the grace period, the
tolerance period provisions would not apply, even if the security-index
migrated temporarily during the grace period. After the grace period
has ended, a security index would need to satisfy anew the requirements
under the proposed rules regarding the tolerance period in order to
trigger a new tolerance period.
The Commissions note that the proposed rules would not result in
the recharacterization of any outstanding Title VII instruments. In
addition, the proposed tolerance and grace periods would apply only to
Title VII instruments that are traded on or subject to the rules of
DCMs, SEFs, FBOTs, security-based SEFs, and NSEs.
Request for Comment
The Commissions request comment on all aspects of proposed rules
1.3(yyy) under the CEA and proposed rule 3a68-3 under the Exchange Act,
including the following:
111. The Commissions request comment regarding whether the term
``narrow-based security index'' as defined in the CEA and the Exchange
Act \267\ requires further definition solely in the context of Title
VII instruments.
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\267\ CEA sections 1a(35)(A) and (B), 7 U.S.C. 1a(35)(A) and
(B); section 3(a)(55)(B) and (C) of the Exchange Act, 15 U.S.C.
78c(a)(55)(B) and (C).
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112. Are there particular types of Title VII instruments that
require additional guidance as to how the narrow-based security index
definition applies? If so, which types of Title VII instruments? How
should the definition apply to them? Please provide a detailed
explanation of such Title VII instruments and the additional guidance
that would be appropriate.
113. Does the proposed guidance effectively address security
indexes that migrate from broad-based to narrow-based and vice versa?
Why or why not? If not, what additional or alternative requirements
would be appropriate, and why?
114. Will the proposed limitations regarding the use of
predetermined criteria or predetermined self-executing formulas for
Title VII instruments effectively prevent gaming of the proposed rules
and potential regulatory arbitrage based on the migration of a security
index or security portfolio from broad-based to narrow-based or vice
versa? Why or why not? If not, please provide a detailed explanation of
why not, and what additional or alternative limitations would do so.
115. Should the standard pursuant to which a Title VII instrument
would be a mixed swap during the entire life of the Title VII
instrument require instead that the predetermined criteria or
predetermined self-executing formula be constructed in such a manner
that a broad-based security index or security portfolio would be
reasonably likely to become or assume the characteristics of a narrow-
based security index or security portfolio, or vice versa? Why or why
not? Are there additional or alternative standards that should be used
in determining when a Title VII instrument would be a mixed swap during
the entire life of the Title VII instrument? If so, please provide a
detailed explanation of such standards and why they would be effective.
116. Do the proposed tolerance period rules appropriately address
security indexes that temporarily change from broad-based to narrow-
based, and from narrow-based to broad-based, in the context of Title
VII instruments that are executed on or subject to the rules of a DCM,
SEF, FBOT, security-based SEF, or NSE? Why or why not? If not, how
should the proposed tolerance period rules be modified?
117. Should the ``grace period'' applicable to Title VII
instruments executed on or subject to the rules of a DCM, SEF, FBOT,
security-based SEF, or NSE regarding a security index that becomes
narrow-based or broad-based, respectively, for more than 45 business
days over 3 consecutive calendar months be modified? Why or why not? If
so, what modifications should be made?
118. What would be the impact of the proposed rules on market
participants with open swap or security-based swap positions if the
security index underlying a swap were to become narrow-based or if the
security index underlying a security-based swap were to become broad-
based? Should market participants be allowed to liquidate their swaps
or security-based swaps prior to expiration but after the grace period?
If so, how would the listing market restrict trading for liquidation
only?
H. Method of Settlement of Index CDS
The method that the parties have chosen or use to settle an index
CDS following the occurrence of a credit event under such index CDS
also can affect whether such index CDS would be a swap, a security-
based swap, or both (i.e., a mixed swap). The Commissions believe that
if an index CDS that is not based on a narrow-based
[[Page 29859]]
security index under the Commissions' proposed rules includes a
mandatory physical settlement provision that would require the delivery
of, and therefore the purchase and sale of, a non-exempted security
\268\ or a loan in the event of a credit event, such an index CDS would
be a mixed swap.\269\ Conversely, the Commissions believe that if an
index CDS that is not based on a narrow-based security index under the
Commissions' proposed rules includes a mandatory cash settlement \270\
provision, such index CDS would be a swap, and not a security-based
swap or a mixed swap, even if the cash settlement were based on the
value of a non-exempted security or a loan.
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\268\ The Commissions note that section 3(a)(68)(C) of the
Exchange Act, 15 U.S.C. 78c(a)(68)(C), provides that ``[t]he term
``security-based swap'' does not include any agreement, contract, or
transaction that meets the definition of a security-based swap only
because such agreement, contract, or transaction references, is
based upon, or settles through the transfer, delivery, or receipt of
an exempted security under paragraph (12) [of the Exchange Act], as
in effect on the date of enactment of the Futures Trading Act of
1982 (other than any municipal security as defined in paragraph (29)
[of the Exchange Act] as in effect on the date of enactment of the
Futures Trading Act of 1982), unless such agreement, contract, or
transaction is of the character of, or is commonly known in the
trade as, a put, call, or other option.''
\269\ The Commissions' views as to the legal basis for such a
conclusion differ. The SEC also notes that there must either be an
effective registration statement covering the transaction or an
exemption under the Securities Act would need to be available for
such physical delivery of securities and compliance issues under the
Exchange Act would also need to be considered.
\270\ The Commissions are aware that the 2003 Definitions supra
note 35, include ``Cash Settlement'' as a defined term and that such
``Settlement Method'' (also a defined term in the 2003 Definitions)
works differently than auction settlement pursuant to the ``Big Bang
Protocol'' or ``Auction Supplement'' (each as defined below). The
Commissions' use of the term ``cash settlement'' in this section
includes ``Cash Settlement,'' as defined in the 2003 Definitions,
and auction settlement, as described in the ``Big Bang Protocol'' or
``Auction Supplement.''
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The Commissions believe that an index CDS that is not based on a
narrow-based security index under the Commissions' proposed rules and
that provides for cash settlement in accordance with the 2009 ISDA
Credit Derivatives Determinations Committees and Auction Settlement
Supplement to the 2003 Definitions (the ``Auction Supplement'') or with
the 2009 ISDA Credit Derivatives Determinations Committees and Auction
Settlement CDS Protocol (``Big Bang Protocol'') \271\ would be a swap,
and would not be considered a security-based swap or a mixed swap
solely because the determination of the cash price to be paid is
established through a securities or loan auction.\272\ In 2009, auction
settlement, rather than physical settlement, became the default method
of settlement for, among other types of CDS, index CDS on corporate
issuers of securities.\273\ The amount of the cash settlement is
determined through an auction triggered by the occurrence of a credit
event.\274\ The Auction Supplement ``hard wired'' the mechanics of
credit event auctions into the 2003 Definitions.\275\ The Commissions
understand that the credit event auction process that is part of the
ISDA terms works as follows:
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\271\ See Int'l Swaps and Derivatives Ass'n, Inc., ``2009 ISDA
Credit Derivatives Determinations Committees and Auction Settlement
CDS Protocol,'' available at http://www.isda.org/bigbangprot/docs/Big-Bang-Protocol.pdf.
\272\ The possibility that such index CDS may, in fact, be
physically settled if an auction is not held or if the auction fails
would not affect the characterization of the index CDS.
\273\ The Commissions understand that the Big Bang Protocol is
followed for index CDS involving corporate debt obligations but is
not followed for index CDS based on asset-backed securities, loan-
only CDS, and certain other types of CDS contracts. To the extent
that such other index CDS contain auction procedures similar to the
auction procedures for corporate debt to establish the cash price to
be paid, the Commissions also would not consider such other index
CDS that are not based on narrow-based security indexes under the
Commissions' proposed rules to be mixed swaps.
\274\ The Commissions understand that other conditions may need
to be satisfied as well for an auction to be held.
\275\ See supra note 35.
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Following the occurrence of a credit event under a CDS, a
determinations committee (``DC'') established by ISDA, following a
request by any party to a credit derivatives transaction that is
subject to the Big Bang Protocol or Auction Supplement, will determine,
among other matters: (i) Whether and when a credit event occurred; (ii)
whether or not to hold an auction to enable market participants to
settle those of their credit derivatives transactions covered by the
auction; (iii) the list of deliverable obligations of the relevant
reference entity; and (iv) the necessary auction specific terms. The
credit event auction takes place in two parts. In the first part of the
auction, dealers submit physical settlement requests, which are
requests to buy or sell any of the deliverable obligations (based on
the dealer's needs and those of its counterparties), and an initial
market midpoint price is created based on dealers' initial bids and
offers. Following the establishment of the initial market midpoint, the
physical settlement requests are then calculated to determine the
amount of open interest.
The aggregate amount of open interest is the basis for the second
part of the auction. In the second part of the auction, dealers and
investors can determine whether to submit limit orders and the levels
of such limit orders. The limit orders, which are irrevocable, have a
firm price in addition to size and whether it is a buy or sell order.
The auction is conducted as a ``dutch'' auction, in which the open buy
interests and open sell interests are matched.\276\ The final price of
the auction is the last limit order used to match against the open
interest. The final price in the auction is the cash price used for
purposes of calculating the settlement payments in respect of the
orders to buy and sell the deliverable obligations and it is also used
to determine the cash settlement payment under the CDS.
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\276\ The second part of the credit event auction process
involves offers and sales of securities that must be made in
compliance with the provisions of the Securities Act and the
Exchange Act. First, the submission of a physical settlement request
constitutes an offer by the counterparty to either buy or sell any
one of the deliverable obligations in the auction. Second, the
submission of the irrevocable limit orders by dealers or investors
are sales or purchases by such persons at the time of submission of
the irrevocable limit order. Through the auction mechanism, where
the open interest (which represents physical settlement requests) is
matched with limit orders, buyers and sellers are matched. Finally,
following the auction and determination of the final price, the
counterparty who has submitted the physical delivery request decides
which of the deliverable obligations will be delivered to satisfy
the limit order in exchange for the final price. The sale of the
securities in the auction occurs at the time the limit order is
submitted, even though the identification of the specific
deliverable obligation does not occur until the auction is
completed.
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I. Security-Based Swaps as Securities Under the Exchange Act and
Securities Act
Pursuant to the Dodd-Frank Act, a security-based swap is defined as
a ``security'' under the Exchange Act \277\ and Securities Act.\278\ As
a result, security-based swaps are subject to the Exchange Act and the
Securities Act and the rules and regulations promulgated
thereunder.\279\ To the
[[Page 29860]]
extent that security-based swaps differ from more traditional
securities products, however, the SEC is soliciting comment on whether
additional guidance may be necessary regarding the application of
certain provisions of the Exchange Act and the Securities Act, and the
rules and regulations promulgated thereunder, to security-based swaps.
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\277\ See section 761(a)(2) of the Dodd-Frank Act (inserting the
term ``security-based swap'' into the definition of ``security'' in
section 3a(10) of the Exchange Act, 15 U.S.C. 78c(a)(10)).
\278\ See section 768(a)(1) of the Dodd-Frank Act (inserting the
term ``security-based swap'' into the definition of ``security'' in
section 2(a)(1) of the Securities Act, 15 U.S.C. 77b(a)(1)).
\279\ Sections 761(a)(3) and (4) of the Dodd-Frank Act amend
sections 3(a)(13) and (14) of the Exchange Act, 15 U.S.C. 78c(a)(13)
and (14), and section 768(a)(3) of the Dodd-Frank Act adds section
2(a)(18) to the Securities Act, 15 U.S.C. 77b(a)(18), to provide
that the terms ``purchase'' and ``sale'' of a security-based swap
shall mean the ``the execution, termination (prior to its scheduled
maturity date), assignment, exchange, or similar transfer or
conveyance of, or extinguishing of rights or obligations under, a
security-based swap, as the context may require.''
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Request for Comment
119. Are there Exchange Act or Securities Act provisions, or rules
and regulations promulgated thereunder, that contemplate application to
cash market securities products or other securities products for which
additional guidance may be necessary when applied to security-based
swaps? If so, which provisions, and why? Please provide detailed
analysis and empirical data, to the extent feasible.
120. What additional guidance or modifications would be necessary
to any such provisions in order to address the application of these
provisions to security-based swaps while still achieving the regulatory
purposes of those provisions?
IV. Mixed Swaps
A. Scope of the Category of Mixed Swap
The category of mixed swap is described, in both the definition of
the term ``security-based swap'' in the Exchange Act and the definition
of the term ``swap'' in the CEA, as a security-based swap that is also:
based on the value of 1 or more interest or other rates, currencies,
commodities, instruments of indebtedness, indices, quantitative
measures, other financial or economic interest or property of any kind
(other than a single security or a narrow-based security index), or the
occurrence, non-occurrence, or the extent of the occurrence of an event
or contingency associated with a potential financial, economic, or
commercial consequence (other than an event described in subparagraph
(A)(ii)(III) [of section 3(a)(68) of the Exchange Act]).\280\
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\280\ Section 3(a)(68)(D) of the Exchange Act, 15 U.S.C.
78c(a)(68)(D); CEA section 1a(47)(D), 7 U.S.C. 1a(47)(D).
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A mixed swap, therefore, is both a security-based swap and a
swap.\281\
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\281\ Id. The exclusion from the definition of the term ``swap''
for security-based swaps does not include security-based swaps that
are mixed swaps. See CEA section 1a(47)(B)(x), 7 U.S.C.
1a(47)(B)(x).
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The Commissions believe that the scope of mixed swaps is, and is
intended to be, narrow. Title VII establishes robust and largely
parallel regulatory regimes for both swaps and security-based swaps and
directs the Commissions to jointly prescribe such regulations regarding
mixed swaps as may be necessary to carry out the purposes of the Dodd-
Frank Act.\282\ More generally, the Commissions believe the category of
mixed swap was designed so that there would be no gaps in the
regulation of swaps and security-based swaps. Therefore, in light of
the statutory scheme created by the Dodd-Frank Act for swaps and
security-based swaps, the Commissions believe the category of mixed
swap covers only a small subset of Title VII instruments.\283\
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\282\ See section 712(a)(8) of the Dodd-Frank Act.
\283\ See Morgan Stanley Letter (expressing the view that ``the
universe of mixed swaps should be relatively small''); Letter from
Timothy W. Cameron, Esq., Managing Director, Asset Management Group,
Securities Industry and Financial Markets Association (``SIFMA
Letter'') (suggesting that the scope of products included in the
mixed swap category should be limited to ``avoid unnecessary and
duplicative regulation'').
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For example, a Title VII instrument in which the underlying
references are the value of an oil corporation stock and the price of
oil would be a mixed swap. Similarly, a Title VII instrument in which
the underlying reference is a portfolio of both securities (assuming
the portfolio is not an index or, if it is an index, that the index is
narrow-based) and commodities would be a mixed swap. Mixed swaps also
would include certain Title VII instruments called ``best of'' or ``out
performance'' swaps that require a payment based on the higher of the
performance of a security and a commodity (other than a security).\284\
As discussed elsewhere in this release, the Commissions also believe
that certain Title VII instruments may be mixed swaps if they meet
specified conditions.
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\284\ See Cleary Letter (providing as examples of mixed swaps,
``a swap based on the out-performance of gold, oil or another
commodity relative to a security or narrow-based security index,''
``a security-based swap with knock-out/knock-in events tied to the
value of gold, oil or another commodity,'' and ``[s]waps on indices
or baskets that include narrow-based security index and physical
commodity components''); Deutsche Bank Letter (indicating that
``best-of'' swaps should be treated as mixed swaps); Morgan Stanley
Letter (``An example of a mixed swap might be a contract under which
one party takes long exposure to the common stock of a U.S.
corporation while simultaneously taking short exposure to the price
of gold.'').
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The Commissions also believe that the use of certain market
standard agreements in the documentation of Title VII instruments
should not in and of itself transform a Title VII instrument into a
mixed swap. For example, many instruments are documented by
incorporating by reference market standard agreements. Such agreements
typically set out the basis of establishing a trading relationship with
another party but are not, taken separately, a swap or security-based
swap. These agreements also include termination and default events
relating to one or both of the counterparties; such counterparties may
or may not be entities that issue securities.\285\ The Commissions
believe that the term ``any agreement * * * based on * * * the
occurrence of an event relating to a single issuer of a security,'' as
provided in the definition of the term ``security-based swap,'' was not
intended to include such termination and default events relating to
counterparties included in standard agreements that are incorporated by
reference into a Title VII instrument.\286\ Therefore, an instrument
would not be simultaneously a swap and a security-based swap (and thus
not a mixed swap) simply by virtue of having incorporated by reference
a standard agreement, including default and termination events relating
to counterparties to the Title VII instrument.
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\285\ Those standard events include inter alia bankruptcy,
breach of agreement, cross default to other indebtedness, and
misrepresentations.
\286\ See section 3(a)(68)(A)(ii)(III) of the Exchange Act, 15
U.S.C. 78c(a)(68)(A)(ii)(III).
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Request for Comment
The Commissions request comment on the following:
121. Are there other examples of Title VII instruments that should,
or should not, be included within the mixed swap category?
122. How frequently, and for what purposes, do market participants
use mixed swaps?
123. Can, and should, the economic goals of mixed swaps be
accomplished using a combination of separate Title VII instruments,
none of which would need to constitute a mixed swap? What problems, if
any, would arise from the ``disaggregation'' of mixed swaps?
B. Regulation of Mixed Swaps
1. Introduction
Paragraph (a) of proposed rule 1.9 under the CEA and proposed rule
3a68-4 under the Exchange Act would define a ``mixed swap'' in the same
manner as the term is defined in both the CEA and the Exchange Act. The
Commissions are proposing two rules to address the regulation of mixed
swaps. First, paragraph (b) of proposed rule 1.9 under the CEA and
proposed rule 3a68-4 under the Exchange Act would provide a regulatory
framework with which parties to bilateral uncleared mixed swaps (i.e.,
mixed swaps that are neither executed on or subject to the rules of a
DCM, NSE, SEF, security-based SEF, or FBOT nor cleared through a DCO or
clearing agency), as to which at least
[[Page 29861]]
one of the parties is dually registered with both Commissions, would
need to comply. Second, paragraph (c) of the proposed rules would
establish a process for persons to request that the Commissions issue a
joint order permitting such persons (and any other person or persons
that subsequently lists, trades, or clears that class of mixed swap)
\287\ to comply, as to parallel provisions \288\ only, with specified
parallel provisions of either the CEA or the Exchange Act, and related
rules and regulations (collectively ``specified parallel provisions''),
instead of being required to comply with parallel provisions of both
the CEA and the Exchange Act.
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\287\ All references to Title VII instruments in this part IV
and in part VI shall include a class of such Title VII instruments
as well. For example, a ``class'' of Title VII instrument would
include instruments that are of similar character and provide
substantially similar rights and privileges.
\288\ For purposes of paragraph (c) of proposed rule 1.9 under
the CEA and rule 3a68-4 under the Exchange Act, ``parallel
provisions'' means comparable provisions of the CEA and the Exchange
Act that were added or amended by Title VII with respect to
security-based swaps and swaps, and the rules and regulations
thereunder.
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2. Bilateral Uncleared Mixed Swaps Entered Into by Dually-Registered
Dealers or Major Participants
Swap dealers and major swap participants will be comprehensively
regulated by the CFTC and security-based swap dealers and major
security-based swap participants will be comprehensively regulated by
the SEC.\289\ The Commissions recognize that there may be differences
in the requirements applicable to swap dealers and security-based swap
dealers, or major swap participants and major security-based swap
participants, such that dually-registered market participants may be
subject to potentially conflicting or duplicative regulatory
requirements when they engage in mixed swap transactions. In order to
assist market participants in addressing such potentially conflicting
or duplicative requirements, the Commissions are proposing rules that
would permit dually-registered swap dealers and security-based swap
dealers and dually-registered major swap participants and major
security-based swap participants to comply with an alternative
regulatory regime when they enter into certain mixed swaps under
specified circumstances.
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\289\ Section 712(a)(7)(A) of the Dodd-Frank Act requires the
Commissions to treat functionally or economically similar entities
in a similar manner.
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Accordingly, paragraph (b) of proposed rule 1.9 under the CEA and
rule 3a68-4 under the Exchange Act would provide that a bilateral
uncleared mixed swap,\290\ where at least one party is dually-
registered with the CFTC as a swap dealer or major swap participant and
with the SEC as a security-based swap dealer or major security-based
swap participant, would be subject to all applicable provisions of the
Federal securities laws (and SEC rules and regulations promulgated
thereunder). The proposed rules also would provide that such mixed
swaps would be subject to only the following provisions of the CEA (and
CFTC rules and regulations promulgated thereunder):
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\290\ For purposes of the proposed rules, a ``bilateral
uncleared mixed swap'' would be a mixed swap that: (i) Is neither
executed on nor subject to the rules of a DCM, NSE, SEF, security-
based SEF, or FBOT; and (ii) will not be submitted to a DCO or
registered or exempt clearing agency to be cleared. To the extent
that a mixed swap is subject to the mandatory clearing requirement
(see CEA section 2(h)(1)(A), 7 U.S.C. 2(h)(1)(A), and section
3C(a)(1) of the Exchange Act) (and where a counterparty is not
eligible to rely on the end-user exclusion from mandatory clearing
requirement (see CEA section 2(h)(7), 7 U.S.C. 2(h)(7), and section
3C(g) of the Exchange Act)), this alternative regulatory treatment
would not be available.
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Examinations and information sharing: CEA sections 4s(f)
and 8; \291\
---------------------------------------------------------------------------
\291\ 7 U.S.C. 6s(f) and 12, respectively.
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Enforcement: CEA sections 2(a)(1)(B), 4(b), 4b, 4c, 6(c),
6(d), 6c, 6d, 9, 13(a), 13(b) and 23; \292\
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\292\ 7 U.S.C. 2(a)(1)(B), 6(b), 6b, 6c, 9 and 15, 13b, 13a-1,
13a-2, 13, 13c(a), 13c(b), and 26, respectively.
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Reporting to an SDR: CEA section 4r; \293\
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\293\ 7 U.S.C. 6r.
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Real-time reporting: CEA section 2(a)(13); \294\
---------------------------------------------------------------------------
\294\ 7 U.S.C. 2(a)(13).
---------------------------------------------------------------------------
Capital: CEA section 4s(e); \295\ and
---------------------------------------------------------------------------
\295\ 7 U.S.C. 6s(e).
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Position Limits: CEA section 4a.\296\
\296\ 7 U.S.C. 6a.
The Commissions believe that paragraph (b) of the proposed rules would
address potentially conflicting or duplicative regulatory requirements
for dually-registered dealers and major participants that are subject
to regulation by both the CFTC and the SEC, while requiring dual
registrants to comply with the regulatory requirements the Commissions
believe are necessary to provide sufficient regulatory oversight for
mixed swaps transactions entered into by such dual registrants. The
CFTC also believes that paragraph (b) of the proposed rules would
provide clarity to dually-registered dealers and major participants,
who are subject to regulation by both the CFTC and the SEC, as to the
requirements of each Commission that will apply to their bilateral
uncleared mixed swaps.
Request for Comment
124. The Commissions request comment generally on the foregoing
proposed rules regarding the regulation of mixed swaps entered into by
dually-registered swap or security-based swap dealers and major swap or
security-based swap participants.
125. Does paragraph (b) of proposed rule 1.9 under the CEA and
proposed rule 3a68-4 under the Exchange Act provide effective
regulatory treatment for bilateral uncleared mixed swaps entered into
by persons that are dually registered both as swap dealers or major
swap participants with the CFTC and security-based swap dealers or
major security-based swap participants with the SEC? If not, how should
the proposed regulatory treatment be modified?
126. Are the enumerated sections of the CEA (and the regulations
promulgated thereunder) that are reserved in paragraph (b) appropriate?
Are there sections that should be withdrawn? Why or why not? Are there
sections that should be added? Why or why not?
3. Regulatory Treatment for Other Mixed Swaps
Because mixed swaps are both security-based swaps and swaps,\297\
absent a joint rule or order by the Commissions permitting an
alternative regulatory approach, persons who desire or intend to list,
trade, or clear a mixed swap (or class thereof) would be required to
comply with all the statutory provisions in the CEA and the Exchange
Act (including all the rules and regulations thereunder) that were
added or amended by Title VII with respect to swaps or security-based
swaps.\298\ Such dual regulation may not be appropriate in every
instance and may result in potentially conflicting or duplicative
regulatory requirements. However, before the Commissions can determine
the appropriate regulatory treatment for mixed swaps (other than the
treatment discussed above), the Commissions would need to understand
better the nature of the mixed swaps that parties want to trade.
Paragraph (c) of proposed rule 1.9 under the CEA and proposed
[[Page 29862]]
rule 3a68-4 under the Exchange Act would establish a process pursuant
to which any person who desires or intends to list, trade, or clear a
mixed swap (or class thereof) that is not subject to the provisions of
paragraph (b) (i.e., bilateral uncleared mixed swaps entered into by at
least one dual registrant) may request the Commissions to publicly
issue a joint order permitting such person (and any other person or
persons that subsequently lists, trades, or clears that class of mixed
swap) to comply, as to parallel provisions only, with the specified
parallel provisions, instead of being required to comply with parallel
provisions of both the CEA and the Exchange Act.\299\
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\297\ See supra note 10.
\298\ Because security-based swaps are also securities,
compliance with the Federal securities laws and rules and
regulations thereunder (in addition to the provisions of the Dodd-
Frank Act and the rules and regulations thereunder) would also be
required. To the extent one of the Commissions has exemptive
authority with respect to other provisions of the CEA or the Federal
securities laws and the rules and regulations thereunder, persons
may submit separate exemptive requests or rulemaking petitions
regarding those provisions to the relevant Commission.
\299\ Other than with respect to the specified parallel
provisions with which such persons may be permitted to comply
instead of complying with parallel provisions of both the CEA and
the Exchange Act, any other provision of either the CEA or the
Federal securities laws that applies to swaps or security-based
swaps will continue to apply.
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Paragraph (c) of the proposed rules would further provide that a
person submitting such a request to the Commissions must provide the
Commissions with:
(i) All material information regarding the terms of the specified,
or specified class of, mixed swap;
(ii) the economic characteristics and purpose of the specified, or
specified class of, mixed swap;
(iii) the specified parallel provisions, and the reasons the person
believes such specified parallel provisions would be appropriate for
the mixed swap (or class thereof);
(iv) an analysis of (1) the nature and purposes of the parallel
provisions that are the subject of the request; (2) the comparability
of such parallel provisions; and (3) the extent of any conflicts or
differences between such parallel provisions; and
(v) such other information as may be requested by either of the
Commissions.
This provision is intended to provide the Commissions with
sufficient information regarding the mixed swap (or class thereof) and
the proposed regulatory approach to make an informed determination
regarding the appropriate regulatory treatment of the mixed swap (or
class thereof).
Paragraph (c) of the proposed rules also would allow a person to
withdraw a request regarding the regulation of a mixed swap at any time
prior to the issuance of a joint order by the Commissions. This
provision is intended to permit persons to withdraw requests that they
no longer need. This, in turn, would save the Commissions time and
staff resources.
Paragraph (c) would further provide that in response to a request
pursuant to the proposed rules, the Commissions may jointly issue an
order, after public notice and opportunity for comment, permitting the
requesting person (and any other person or persons that subsequently
lists, trades, or clears that class of mixed swap) to comply, as to
parallel provisions only, with the specified parallel provisions (or
another subset of the parallel provisions that are the subject of the
request, as the Commissions determine is appropriate), instead of being
required to comply with parallel provisions of both the CEA and the
Exchange Act. In determining the contents of such a joint order, the
Commissions could consider, among other things, (i) the nature and
purposes of the parallel provisions that are the subject of the
request; (ii) the comparability of such parallel provisions; and (iii)
the extent of any conflicts or differences between such parallel
provisions.
Finally, paragraph (c) of the proposed rules would require the
Commissions, if they determine to issue a joint order pursuant to these
rules, to do so within 120 days of receipt of a complete request (with
such 120-day period being tolled during the pendency of a request for
public comment on the proposed interpretation). If the Commissions do
not issue a joint order within the prescribed time period, the proposed
rules require that each Commission publicly provide the reasons for not
having done so. Paragraph (c) makes clear that nothing in the proposed
rules requires either Commission to issue a requested joint order
regarding the regulation of a particular mixed swap (or class thereof).
These provisions are intended to provide market participants with a
prompt review of requests for a joint order regarding the regulation of
a particular mixed swap (or class thereof). The proposed rules also
would provide transparency and accountability by requiring that at the
end of the review period, the Commissions issue the requested order or
publicly state the reasons for not doing so.
Request for Comment
127. Is the proposed procedure set forth in paragraph (c)
appropriate? Should paragraph (c) of the proposed rules include a more
detailed process for persons to request that the Commissions issue a
joint order permitting such persons to comply, as to parallel
provisions only, with specified parallel provisions, instead of being
required to comply with parallel provisions of both the CEA and the
Exchange Act? If so, please provide a detailed explanation of what that
process should include.
128. Is the information required by paragraph (c) in support of a
request for a joint order appropriate? Are there specific economic
characteristics that should be required? In particular, should
requesting persons be required to provide the specified parallel
provisions, and the reasons the person believes it would be appropriate
to request that regulatory treatment, as well as an analysis of (i) the
nature and purposes of the parallel provisions that are the subject of
the request; (ii) the comparability of such parallel provisions; and
(iii) the extent of any conflicts or differences between such parallel
provisions? Why or why not? If not, please provide a detailed
explanation, including what information requesting persons should be
required to provide.
129. Is there additional or alternative information that the
Commissions should require persons to submit in connection with a
request regarding the regulation of particular mixed swaps (or class
thereof)? If so, what additional or alternative information should be
required?
130. Should persons be able to withdraw a request for a joint order
regarding the regulation of a particular mixed swap (or class thereof)?
Why or why not? Should there be additional requirements regarding such
withdrawals? If so, what should they be?
131. Is the 120-day timeframe for issuance of a requested joint
order provided for in paragraph (c) of proposed rule 1.9 under the CEA
and proposed rule 3a68-4 under the Exchange Act appropriate? Is it too
short or too long? Are the provisions for tolling this timeframe during
a public comment period appropriate? Why or why not? Where the
Commissions do not issue a joint order, is it appropriate that they
each publicly provide the reasons for not doing so within the
applicable timeframe? Why or why not?
V. Security-Based Swap Agreements
A. Introduction
SBSAs are swaps over which the CFTC has regulatory and enforcement
authority but for which the SEC also has antifraud and certain other
authority.\300\
[[Page 29863]]
The term ``security-based swap agreement'' is defined as a ``swap
agreement'' (as defined in section 206A of the GLBA \301\) of which ``a
material term is based on the price, yield, value, or volatility of any
security or any group or index of securities, including any interest
therein'' but does not include a security-based swap.\302\ The Dodd-
Frank Act amended the definition of ``swap agreement'' in section 206A
of the GLBA \303\ to eliminate the requirements that a swap agreement
be between ECPs, as defined in 1a(12)(C) of the CEA,\304\ and subject
to individual negotiation.\305\
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\300\ See section 3(a)(78) of the Exchange Act, 15 U.S.C.
78c(a)(78); CEA section 1a(47)(A)(v), 7 U.S.C. 1a(47)(A)(v). The
Dodd-Frank Act provides that certain CFTC registrants, such as DCOs
and SEFs, will keep records regarding SBSAs open to inspection and
examination by the SEC upon request. See, e.g., sections 725(e) and
733 of the Dodd-Frank Act. The Commissions are committed to working
cooperatively together regarding their dual enforcement authority
over SBSAs.
\301\ 15 U.S.C. 78c note.
\302\ See section 3(a)(78) of the Exchange Act, 15 U.S.C.
78c(a)(78). The CFMA amended the Exchange Act and the Securities Act
to exclude swap agreements from the definitions of security in those
Acts but subjected ``security-based swap agreements,'' as defined in
section 206B of the GLBA, 15 U.S.C. 78c note, to the antifraud,
anti-manipulation, and anti-insider trading provisions of the
Exchange Act and Securities Act. See CFMA, supra note 182, title
III.
The CEA does not contain a stand-alone definition of
``security-based swap agreement'' but includes the definition
instead in subparagraph (A)(v) of the swap definition in CEA section
1a(47), 7 U.S.C. 1a(47). The only difference between these
definitions is that the definition of SBSA in the Exchange Act
specifically excludes security-based swaps (see section 3(a)(78)(B)
of the Exchange Act, 15 U.S.C. 78c(a)(78)(B)), while the definition
of SBSA in the CEA does not contain a similar exclusion. Instead,
the exclusion for security-based swaps is placed in the general
exclusions from the definition of swap in the CEA (see CEA section
1a(47)(B)(x), 7 U.S.C. 1a(47)(B)(x)).
\303\ 15 U.S.C. 78c note.
\304\ 7 U.S.C. 1a(12)(C).
\305\ See section 762(b) of the Dodd-Frank Act. Sections 762(c)
and (d) of the Dodd-Frank Act also made conforming amendments to the
Exchange Act and the Securities Act to reflect the changes to the
regulation of ``swap agreements'' that are either ``security-based
swaps'' or ``security-based swap agreements'' under the Dodd-Frank
Act.
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B. Swaps That Are Security-Based Swap Agreements
Although the Commissions believe it is not possible to provide a
bright line test to define an SBSA, the Commissions believe that it is
possible to clarify that certain types of swaps clearly fall within the
definition of SBSA. For example, a swap based on an index of securities
that is not a narrow-based security index (i.e., a broad-based security
index) would fall within the definition of an SBSA under the Dodd-Frank
Act.\306\ Similarly, an index CDS that is not based on a narrow-based
security index or on the ``issuers of securities in a narrow-based
security index,'' as defined in proposed rule 1.3(zzz) under the CEA
and proposed rule 3a68-1a under the Exchange Act, would be an SBSA. In
addition, a swap based on a U.S. Treasury security or on certain other
exempted securities other than municipal securities would fall within
the definition of an SBSA under the Dodd-Frank Act.\307\ The
Commissions have received no comments regarding the definition of SBSA
in the Dodd-Frank Act in response to the ANPR, and have not been made
aware of any significant market confusion regarding what constitutes an
SBSA since the definition of SBSA was enacted as part of the CFMA in
2000. Accordingly, the Commissions are not proposing to further define
SBSA at this time beyond providing the examples above.\308\
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\306\ Swaps based on indexes that are not narrow-based security
indexes are not included within the definition of the term security-
based swap under the Dodd-Frank Act. See section 3(a)(68)(A)(ii)(I)
of the Exchange Act, 15 U.S.C. 78c(a)(68)(A)(ii)(I), and discussion
supra part III.G. However, such swaps have a material term that is
``based on the price, yield, value, or volatility of any security or
any group or index of securities, or any interest therein,'' and
therefore such swaps fall within the SBSA definition.
\307\ Swaps on U.S. Treasury securities that do not have any
other underlying references involving securities are expressly
excluded from the definition of the term ``security-based swap''
under the Dodd-Frank Act. See section 3(a)(68)(C) of the Exchange
Act, 15 U.S.C. 78c(a)(68)(C) (providing that an agreement, contract,
or transaction that would be a security-based swap solely because it
references, is based on, or settles through the delivery of one or
more U.S. Treasury securities (or certain other exempted securities)
is excluded from the security-based swap definition). However, swaps
on U.S. Treasury securities or on other exempted securities covered
by subparagraph (C) of the security-based swap definition have a
material term that is ``based on the price, yield, value, or
volatility of any security or any group or index of securities, or
any interest therein,'' and therefore they fall within the SBSA
definition.
\308\ The Commissions note that certain transactions that were
not ``security-based swap agreements'' under the CFMA are
nevertheless included in the definition of security-based swap under
the Dodd-Frank Act--including, for example, a CDS on a single loan.
Accordingly, although such transactions were not subject to insider
trading restrictions under the CFMA, under the Dodd-Frank Act they
are subject to the Federal securities laws, including insider
trading restrictions.
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Request for Comment
132. The Commissions request comment on whether further
clarification of the definition of SBSA is necessary or appropriate.
Commenters should provide a detailed analysis regarding what further
guidance should be provided and how that guidance would affect what
constitutes an SBSA.
133. The Commissions also request comment on whether there are
other examples of swap transactions that the Commissions should clarify
meet the definition of SBSA.
C. Books and Records Requirements for Security-Based Swap Agreements
The Dodd-Frank Act requires the Commissions to adopt rules
regarding the books and records required to be kept for SBSAs.
Specifically, section 712(d)(2)(B) of the Dodd-Frank Act requires the
Commissions, in consultation with the Board, to jointly adopt rules
governing books and records requirements for SBSAs by persons
registered as SDRs under the CEA, including uniform rules that specify
the data elements that shall be collected and maintained by each SDR.
Similarly, section 712(d)(2)(C) of the Dodd-Frank Act requires the
Commissions, in consultation with the Board, to jointly adopt rules
governing books and records for SBSAs, including daily trading records,
for swap dealers, major swap participants, security-based swap dealers,
and major security-based swap participants.
As discussed above, SBSAs are swaps over which the CFTC has primary
regulatory authority, but for which the SEC has antifraud, anti-
manipulation, and certain other authority. The CFTC has proposed rules
governing books and records for swaps, which would apply to swaps that
also are SBSAs.\309\ The Commissions believe that the proposed rules
would provide sufficient books and records regarding SBSAs and do not
believe that additional books and records requirements are necessary
for SBSAs. The Commissions therefore are proposing rules to clarify
that there would not be additional books and records requirements
regarding SBSAs other than those proposed for swaps. Specifically,
proposed rule 1.7 under the CEA and proposed rule 3a69-3 under the
Exchange Act would not require persons registered as SDRs under the CEA
and the rules and regulations thereunder to (i) keep and maintain
additional books and records regarding SBSAs other than the books and
records regarding swaps that SDRs would be required to keep and
maintain pursuant to the CEA and rules and regulations thereunder; and
(ii) collect and maintain additional data regarding SBSAs other than
the data regarding swaps that SDRs would be required to collect and
maintain pursuant to the CEA and rules and regulations thereunder.
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\309\ See Swap Data Recordkeeping and Reporting Requirements,
supra note 6 (proposed rules regarding swap data recordkeeping and
reporting requirements for SDRs, DCOs, DCMs, SEFs, swap dealers,
major swap participants, and swap counterparties who are neither
swap dealers nor major swap participants); Reporting, Recordkeeping,
and Daily Trading Records Requirements for Swap Dealers and Major
Swap Participants, supra note 7 (proposed rules regarding reporting
and recordkeeping requirements and daily trading records
requirements for swap dealers and major swap participants).
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[[Page 29864]]
In addition, the proposed rules would not require persons
registered as swap dealers or major swap participants under the CEA and
rules and regulations thereunder, or registered as security-based swap
dealers or major security-based swap participants under the Exchange
Act and rules and regulations thereunder, to keep and maintain
additional books and records, including daily trading records,
regarding SBSAs other than the books and records regarding swaps those
persons would be required to keep and maintain pursuant to the CEA and
the rules and regulations thereunder.\310\
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\310\ Proposed rule 1.7 under the CEA and proposed rule 3a69-3
under the Exchange Act would provide that the term ``security-based
swap agreement'' has the meaning set forth in CEA section
1a(47)(A)(v), 7 U.S.C. 1a(47)(A)(v), and section 3(a)(78) of the
Exchange Act, 15 U.S.C. 78c(a)(78), respectively.
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Request for Comment
134. The Commissions request comment on the proposed rules
regarding books and records requirements for SBSAs. Will requiring the
same recordkeeping information for SBSAs that will be required for
swaps under the CFTC's recordkeeping rules be sufficient? Should the
Commissions impose additional recordkeeping requirements for SBSAs? If
so, why, and what additional recordkeeping should be required?
VI. Process for Requesting Interpretations of the Characterization of a
Title VII Instrument
As discussed above, there may be Title VII instruments (or classes
of Title VII instruments) that may be difficult to categorize
definitively as swaps or security-based swaps. Further, because mixed
swaps are both swaps and security-based swaps, identifying a mixed swap
may not always be straightforward.
Section 712(d)(4) of the Dodd-Frank Act provides that any
interpretation of, or guidance by, either the CFTC or SEC regarding a
provision of Title VII shall be effective only if issued jointly by the
Commissions (after consultation with the Board) on issues where Title
VII requires the CFTC and SEC to issue joint regulations to implement
the provision. The Commissions believe that any interpretation or
guidance regarding whether a Title VII instrument is a swap, a
security-based swap, or both (i.e., a mixed swap), must be issued
jointly pursuant to this requirement. Consequently, the Commissions are
proposing a process for interested persons to request a joint
interpretation by the Commissions regarding whether a particular Title
VII instrument (or class of Title VII instruments) is a swap, a
security-based swap, or both (i.e., a mixed swap).
Section 718 of the Dodd-Frank Act establishes a process for
determining the status of ``novel derivative products'' that may have
elements of both securities and futures contracts. Section 718 of the
Dodd-Frank Act provides a useful model for a joint Commission review
process to appropriately categorize Title VII instruments. As a result,
the Commissions' proposed process rules regarding swaps, security-based
swaps, and mixed swaps include various attributes of the process
established in section 718 of the Dodd-Frank Act. In particular, to
permit an appropriate review period that provides sufficient time to
ensure Federal regulatory interests are satisfied that also does not
unduly delay the introduction of new financial products, the proposed
process, like the process established in section 718, would include a
deadline for responding to a request for a joint interpretation.\311\
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\311\ The Commissions note that section 718 of the Dodd-Frank
Act is a separate process from the process the Commissions are
proposing, and that any future interpretation involving the process
under section 718 would not affect the process being proposed here,
nor would any future interpretation involving the process proposed
here affect the process under section 718.
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Proposed rule 1.8 under the CEA and proposed rule 3a68-2 under the
Exchange Act would establish a process for parties to request a joint
interpretation regarding the characterization of a particular Title VII
instrument (or class thereof). Specifically, paragraph (a) of the
proposed rules would provide that any person may submit a request to
the Commissions to provide a public joint interpretation of whether a
particular Title VII instrument is a swap, a security-based swap, or
both (i.e., a mixed swap).
Paragraph (a) of the proposed rules is intended to afford market
participants with the opportunity to obtain greater certainty from the
Commissions regarding the regulatory status of particular Title VII
instruments under the Dodd-Frank Act. This provision should decrease
the possibility that market participants inadvertently might violate
the regulatory requirements applicable to a particular Title VII
instrument.
Paragraph (b) of proposed rules 1.8 under the CEA and proposed rule
3a68-2 under the Exchange Act would provide that a person requesting an
interpretation as to the characterization of a Title VII instrument as
a swap, a security-based swap, or both (i.e., a mixed swap), must
provide the Commissions with the person's determination of the
characterization of the instrument and supporting analysis, along with
certain other documentation. Specifically, the person must provide the
Commissions with the following information:
All material information regarding the terms of the Title
VII instrument;
A statement of the economic characteristics and purpose of
the Title VII instrument;
The requesting person's determination as to whether the
Title VII instrument should be characterized as a swap, a security-
based swap, or both (i.e., a mixed swap), including the basis for such
determination; and
Such other information as may be requested by either
Commission.
This provision is intended to provide the Commissions with
sufficient information regarding the Title VII instrument at issue so
that the Commissions can appropriately evaluate whether it is a swap, a
security-based swap, or both (i.e., a mixed swap). By requiring that
requesting persons furnish a determination regarding whether they
believe the Title VII instrument is a swap, a security-based swap, or
both (i.e., a mixed swap), including the basis for such determination,
this provision also would assist the Commissions in more quickly
identifying and addressing the relevant issues involved in arriving at
a joint interpretation of the characterization of the instrument.
Paragraph (c) of proposed rule 1.8 under the CEA and proposed rule
3a68-2 under the Exchange Act would provide that a person may withdraw
a request made pursuant to paragraph (a) at any time prior to the
issuance of a joint interpretation or joint notice of proposed
rulemaking by the Commissions. Notwithstanding any such withdrawal, the
Commissions may provide an interpretation regarding the
characterization of the Title VII instrument that was the subject of a
withdrawn request.
This provision is intended to permit parties to withdraw requests
for which the party no longer needs an interpretation. This, in turn,
would save the Commissions time and staff resources. If the Commissions
believe such an interpretation is necessary regardless of a particular
request for interpretation, however, the Commissions may provide such a
joint interpretation of their own accord.
Paragraph (d) of proposed rule 1.8 under the CEA and proposed rule
3a68-2 under the Exchange Act would
[[Page 29865]]
provide that if either Commission receives a proposal to list, trade,
or clear an agreement, contract, or transaction (or class thereof) that
raises questions as to the appropriate characterization of such
agreement, contract, or transaction (or class thereof) as a swap,
security-based swap, or both (i.e., a mixed swap), the receiving
Commission promptly shall notify the other. This provision of the
proposed rules would further provide that either Commission, or their
Chairmen jointly, may submit a request for a joint interpretation as to
the characterization of the Title VII instrument where no external
request has been received.
This provision is intended to ensure that Title VII instruments do
not fall into regulatory gaps and will help the Commissions to fulfill
their responsibility to oversee the regulatory regime established by
Title VII of the Dodd-Frank Act by making sure that Title VII
instruments are appropriately characterized, and thus appropriately
regulated. An agency, or their Chairmen jointly, submitting a request
for an interpretation as to the characterization of a Title VII
instrument under this paragraph would be required to submit the same
information as, and could withdraw a request in the same manner as, a
person submitting a request to the Commissions. The bases for these
provisions are set forth above with respect to paragraphs (b) and (c)
of these proposed rules.
Paragraph (e) of proposed rule 1.8 under the CEA and proposed rule
3a68-2 under the Exchange Act would require the Commissions, if they
determine to issue a joint interpretation as to the characterization of
a Title VII instrument, to do so within 120 days of receipt of the
complete external or agency submission (unless such 120-day period is
tolled during the pendency of a request for public comment on the
proposed interpretation).\312\ If the Commissions do not issue a joint
interpretation within the prescribed time period, the proposed rules
require that each Commission publicly provide the reasons for not
having done so. This provision of the proposed rules also incorporates
the mandate of the Dodd-Frank Act that any joint interpretation by the
Commissions be issued only after consultation with the Board of
Governors of the Federal Reserve System.\313\ Finally, paragraph (e)
makes clear that nothing in the proposed rules requires either
Commission to issue a requested joint interpretation regarding the
characterization of a particular instrument.
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\312\ This 120-day period is based on the timeframe set forth in
section 718(a)(3) of the Dodd-Frank Act.
\313\ See section 712(d)(4) of the Dodd-Frank Act.
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These provisions are intended to guarantee market participants a
prompt review of submissions requesting a joint interpretation of
whether a Title VII instrument is a swap, a security-based swap, or
both (i.e., a mixed swap). The proposed rules also would provide
transparency and accountability by requiring that at the end of the
review period, the Commissions issue the requested interpretation or
publicly state the reasons for not doing so.
Paragraph (f) of proposed rule 1.8 under the CEA and proposed rule
3a68-2 under the Exchange Act would permit the Commissions, in lieu of
issuing a requested interpretation, to issue (within the timeframe for
issuing a joint interpretation) a joint notice of proposed rulemaking
to further define one or more of the terms ``swap,'' ``security-based
swap,'' or ``mixed swap.'' Such a rulemaking, as required by Title VII,
would be required to be done in consultation with the Board of
Governors of the Federal Reserve System. This paragraph is intended to
provide the Commissions with needed flexibility to address issues that
may be of broader applicability than the particular Title VII
instrument that is the subject of a request for a joint interpretation.
Request for Comment
135. The Commissions request comment generally on all aspects of
proposed rule 1.8 under the CEA and proposed rule 3a68-2 under the
Exchange Act.
136. Should proposed rule 1.8(a) under the CEA and proposed rule
3a68-2(a) under the Exchange Act include a more specific process for
persons to request a joint interpretation of whether a Title VII
instrument is a swap, a security-based swap, or both (i.e., a mixed
swap)? If so, what additional specificity would be appropriate?
137. Would the information required by paragraph (b) of the
proposed rules be sufficient for the Commissions to consider a request?
Should requesting persons have to provide a statement regarding the
economic characteristics and purpose of the Title VII instrument?
Should requesting persons have to provide a determination regarding
whether such instrument should be characterized as a swap, a security-
based swap, or both (i.e., a mixed swap), along with reasons therefor?
138. Is there additional or alternative information that the
Commissions should require persons to submit in connection with a
request for an interpretation regarding whether a Title VII instrument
is a swap, a security-based swap, or both (i.e., a mixed swap)? If so,
what additional or alternative information should be required?
139. Should persons be able to withdraw a request for an
interpretation pursuant to paragraph (c) of proposed rule 1.8 under the
CEA and proposed rule 3a68-2 under the Exchange Act? Why or why not?
Should there be additional parameters around or requirements regarding
such withdrawals? If so, what should they be?
140. Is the 120-day timeframe for issuance of a requested joint
interpretation provided for in paragraph (e) of proposed rule 1.8 under
the CEA and proposed rule 3a68-2 under the Exchange Act appropriate? Is
it too short or too long? Are the provisions for tolling this timeframe
during a public comment period, and for permitting the Commissions to
proceed with a joint notice of proposed rulemaking instead of issuing a
joint interpretation, appropriate? Why or why not? Where the
Commissions do not issue a joint interpretation, is it helpful that
they each publicly provide the reasons for not doing so within the
applicable timeframe? Why or why not?
141. Title VII requires that certain persons that are registered
with the CFTC keep books and records relating to SBSAs open to
inspection and examination by the SEC. As discussed in part V above,
the Commissions are not proposing additional recordkeeping or other
regulatory requirements for SBSAs that would require pre-transaction
identification of a swap as an SBSA by market participants. Under these
circumstances, is it appropriate to include SBSAs in the interpretation
process set forth in proposed rule 1.8 under the CEA and proposed rule
3a68-2 under the Exchange Act? Why or why not?
142. Would it be appropriate to include SBSAs in the interpretation
process, if their inclusion required the Commissions to extend the 120-
day timeframe for issuance of a requested joint interpretation to, for
example, 180 days for all products in order to address a potential
increase in requests? Why or why not?
VII. Anti-Evasion
A. CFTC Proposed Anti-Evasion Rules
Section 721(c) of the Dodd-Frank Act requires the CFTC to adopt a
rule to further define the terms ``swap,'' ``swap dealer,'' ``major
swap participant,'' and ``eligible contract participant,'' in order
``[t]o include transactions and entities
[[Page 29866]]
that have been structured to evade'' subtitle A of Title VII (or an
amendment made by subtitle A). Section 761(b)(3) of the Dodd-Frank Act,
in turn, grants discretionary authority to the SEC to define the terms
``security-based swap,'' ``security-based swap dealer,'' ``security-
based major swap participant,'' and ``eligible contract participant,''
with regard to security-based swaps, ``for the purpose of including
transactions and entities that have been structured to evade subtitle B
of Title VII (or amendments made by subtitle B). The CFTC notes that
several provisions of Title VII reference the promulgation of anti-
evasion rules:
Subparagraph (E) of the definition of ``swap'' provides
that foreign exchange swaps and foreign exchange forwards shall be
considered swaps unless the Secretary of the Treasury makes a written
determination that either foreign exchange swaps or foreign exchange
forwards, or both, among other things, ``are not structured to evade
the [Dodd-Frank Act] in violation of any rule promulgated by the [CFTC]
pursuant to section 721(c) of that Act;'' \314\
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\314\ CEA section 1a(47)(E), 7 U.S.C. 1a(47)(E).
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Section 722(d) of the Dodd-Frank Act provides that the
provisions of the CEA relating to swaps shall not apply to activities
outside the United States unless those activities, among other things,
``contravene such rules or regulations as the [CFTC] may prescribe or
promulgate as are necessary or appropriate to prevent the evasion of
any provision of [the CEA] that was enacted by the [Title VII];'' \315\
and
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\315\ CEA section 2(i), 7 U.S.C. 2(i). New CEA section 2(i), as
added by section 722(d) of the Dodd-Frank Act, also provides that
the provisions of Title VII relating to swaps shall not apply to
activities outside the United State unless those activities ``have a
direct and significant connection with activities in, or effect on,
commerce of the United States.''
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Section 725(g) of the Dodd-Frank Act amends the Legal
Certainty for Bank Products Act of 2000 to provide that, although
identified banking products generally are excluded from the CEA, that
exclusion shall not apply to an identified banking product that is a
product of a bank that is not under the regulatory jurisdiction of an
appropriate Federal banking agency,\316\ meets the definition of
``swap'' or ``security-based swap,'' and ``has been structured as an
identified banking product for the purpose of evading the provisions of
the [CEA], the [Securities Act], or the [Exchange Act].'' \317\
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\316\ The term ``identified banking product'' is defined in
section 402 of the Legal Certainty for Bank Products Act of 2000, 7
U.S.C. 27. The term ``appropriate Federal banking agency'' is
defined in CEA section 1a(2), 7 U.S.C. 1a(2), and section 3(a)(72)
of the Exchange Act, 15 U.S.C. 78c(a)(72), which were added by
sections 721(a) and 761(a) of the Dodd-Frank Act, respectively.
\317\ Section 741(b) of the Dodd-Frank Act amends section 6(e)
of the CEA, 7 U.S.C. 9a, to provide that any DCO, swap dealer, or
major swap participant ``that knowingly or recklessly evades or
participates in or facilitates an evasion of the requirements of
section 2(h) [of the CEA] shall be liable for a civil monetary
penalty in twice the amount otherwise available for a violation of
section 2(h) [of the CEA].'' This anti-evasion provision is not
dependent upon the promulgation of a rule under section 721(c) of
the Dodd-Frank Act, and hence this release does not apply to the
anti-evasion authority regarding CEA section 2(h), 7 U.S.C. 2(h).
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The CFTC has determined to exercise its anti-evasion rulemaking
authority under the Dodd-Frank Act.\318\
---------------------------------------------------------------------------
\318\ No comments were received in response to the ANPR that
specifically addressed anti-evasion authority. One commenter,
however, noted that evasion is a concern. See Letter from David A.
Berg, Esq., Vice President & General Counsel, Air Transport
Association (Sept. 20, 1010).
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Structuring transactions and entities to evade the requirements of
the Dodd-Frank Act could take any number of forms. As with the law of
manipulation, the ``methods and techniques'' of evasion are ``limited
only by the ingenuity of man.'' \319\ In light of the myriad methods of
potential evasion, any attempt to comprehensively determine what
constitutes evasion, or to provide a bright-line test of evasion by
rule, would likely not be effective as would-be evaders could simply
restructure their transactions or entities to fall outside any rigid
boundary. Accordingly, proposed rule 1.3(xxx)(6) under the CEA
generally would define as swaps those transactions that are willfully
structured to evade the provisions of Title VII governing the
regulation of swaps. Specific provisions would apply in similar fashion
to currency and interest rate swaps that are willfully structured as
foreign exchange forwards or foreign exchange swaps, and to
transactions of a bank that is not under the regulatory jurisdiction of
an appropriate Federal banking agency where the transactions are
willfully structured as identified banking products to evade the new
regulatory regime for swaps that was enacted in Title VII. These
proposed rules would not apply to any agreement, contract, or
transaction structured as a security (including a security-based swap)
under the securities laws (as defined in section 3(a)(47) of the
Exchange Act).
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\319\ Cargill v. Hardin, 452 F.2d 1154, 1163 (8th Cir. 1971).
---------------------------------------------------------------------------
The Dodd-Frank Act also gives the CFTC general authority to prevent
evasion of Title VII that occurs outside of the United States.
Specifically, as noted above, section 722(d) of the Dodd-Frank Act
states that the provisions of the CEA relating to swaps that were
enacted by Title VII (including any rule prescribed or regulation
promulgated thereunder) shall not apply to activities outside the
United States unless, among other things, those activities ``contravene
such rules or regulations as the [CFTC] may prescribe or promulgate as
are necessary or appropriate to prevent the evasion of any provision of
[the CEA] that was enacted by [Title VII].'' The CFTC is proposing
rules to address potential evasion of Title VII under this provision of
the Dodd-Frank Act.
Proposed rule 1.6 under the CEA would prohibit activities conducted
outside the United States, including entering into transactions and
structuring entities, to willfully evade or attempt to evade any
provision of the CEA as enacted under Title VII or the rules and
regulations promulgated thereunder. No activity, however, conducted
outside of the United States with respect to a security (including a
security-based swap) under the securities laws (as defined in section
3(a)(47) of the Exchange Act) and that is subject to the jurisdiction
of the SEC would be prohibited pursuant to proposed rule 1.6.
The CFTC's proposed rule 1.3(xxx)(6) further defining the term
``swap'' would further provide that transactions, other than
transactions structured as securities, willfully structured to evade
shall be considered in determining whether a person is a swap dealer or
major swap participant. Proposed rule 1.6 would further provide that an
activity conducted outside the United States, other than an activity
with respect to a security (including a security-based swap), to
willfully evade or attempt to evade, shall be subject to the swap
provisions of the CEA enacted under Title VII of the Dodd-Frank Act.
The CFTC believes that these provisions are necessary to fully prevent
those who seek to willfully evade the regulatory requirements
established by Congress in Title VII relating to swaps from enjoying
any benefits from their efforts to evade.
Finally, the CFTC's proposed rules would provide that in
determining whether a transaction has been willfully structured to
evade, neither the form, label, nor written documentation of the
transaction shall be dispositive. The CFTC believes that looking beyond
the form of the transaction to examine its actual substance is
necessary to prevent evasion through clever draftsmanship. Such an
approach is consistent with the CFTC's case law in the context of
determining whether a contract is a futures contract.\320\
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\320\ See, e.g., Grain Land, supra note 61, at 55748 (holding
that contract substance is entitled to at least as much weight as
form); First Nat'l Monetary Corp., supra note 152, at 30974;
Stovall, supra note 152, at 23779 (holding that the CFTC ``will not
hesitate to look behind whatever label the parties may give to the
instrument'').
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[[Page 29867]]
In order to provide clarity concerning the anti-evasion rules, the
CFTC also proposes to provide interpretive guidance as to certain types
of circumstances that may constitute an evasion of the requirements of
Title VII, while at the same time preserving the CFTC's ability to
determine, on a case-by-case basis, that particular or other types of
transactions or actions constitute an evasion of the requirements of
the statute or the regulations promulgate thereunder. In developing
this guidance, the CFTC has considered legislative, administrative, and
judicial precedent with respect to the anti-evasion provisions in other
Federal statutes. For example, the CFTC has examined the anti-evasion
provisions in the Truth in Lending Act,\321\ the Bank Secrecy Act,\322\
and the Internal Revenue Code.\323\ Based on these other statutory
anti-evasion provisions, as well as the CFTC's authority under the
Dodd-Frank Act to define terms and promulgate rules and regulations to
prevent evasion, the CFTC is proposing this interpretive guidance as to
what may constitute evasion of the requirements of the Dodd-Frank Act
with respect to swaps. The CFTC emphasizes, however, that it would
examine each individual case on a case-by-case basis, and additional
practices or circumstances may warrant a finding that particular
conduct or transactions constitute an evasion of the requirements of
the Dodd-Frank Act with respect to swaps.
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\321\ 15 U.S.C. 1604(a) provides, in relevant part, that the
Federal Reserve Board:
Shall prescribe regulations to carry out the purposes of this
subchapter * * *. [T]hese regulations may contain such
classifications, differentiations, or other provisions, and may
provide for such adjustments and exceptions for any class of
transactions, as in the judgment of the Board are necessary or
proper to effectuate the purposes of this subchapter, to prevent
circumvention or evasion thereof, or to facilitate compliance
therewith.
In affirming the Board's promulgation of Regulation Z, the
Supreme Court noted that anti-evasion provisions such as section
1604(a) evince Congress's intent to ``stress[] the agency's power to
counteract attempts to evade the purposes of a statute.'' Mourning
v. Family Publ'ns Serv., Inc., 411 U.S. 356, 370 (1973) (citing
Gemsco v. Walling, 324 U.S. 244 (1945) (giving great deference to a
regulation promulgated under similar prevention-of-evasion
rulemaking authority in the Fair Labor Standards Act)).
\322\ 31 U.S.C. 5324 (stating, in pertinent part, that ``[n]o
person shall, for the purpose of evading the reporting requirements
of [the Bank Secrecy Act (BSA) or any regulation prescribed
thereunder].* * * structure or assist in structuring, or attempt to
structure or assist in structuring, any transaction with one or more
domestic financial institutions''). The Federal Deposit Insurance
Corporation regulations implementing the BSA require banks to report
transactions that ``''the bank knows, suspects, or has reason to
suspect'' are ``designed to evade any regulations promulgated under
the Bank Secrecy Act.'' 12 CFR 353.3 (2010).
\323\ The Internal Revenue Code makes it unlawful for any person
willfully to attempt ``in any manner to evade or defeat any tax * *
*.'' 26 U.S.C. 7201. While a considerable body of case law has
developed under the tax evasion provision, the statute itself does
not define the term, but generally prohibits willful attempts to
evade tax.
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Business Purpose. The CFTC recognizes that transactions may be
structured, and entities may be formed, in particular ways for
legitimate business purposes, without any intention of circumventing
the requirements of the Dodd-Frank Act with respect to swaps. In
evaluating whether a person is evading or attempting to evade the
requirements with respect to a particular instrument, entity, or
transaction, the CFTC would consider the extent to which a person has a
legitimate business purpose for structuring the instrument or entity or
entering into the transaction in that particular manner. Although
different means of structuring a transaction or entity may have
differing regulatory implications and attendant requirements, absent
other indicia of evasion, the CFTC would not consider transactions,
entities, or instruments structured in a manner solely motivated by a
legitimate business purpose to constitute evasion. However, to the
extent a purpose in structuring an entity or instrument or entering
into a transaction is to evade the requirements of Title VII with
respect to swaps, the structuring of such instrument, entity, or
transaction may be found to constitute evasion.\324\
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\324\ A similar concept applies with respect to tax evasion. A
transaction that is structured to avoid the payment of taxes but
that lacks a valid business purpose may be found to constitute tax
evasion. See, e.g., Gregory v. Helvering, 293 U.S. 465, 469 (1935)
(favorable tax treatment disallowed because transaction lacked any
business or corporate purpose). Under the ``sham-transaction''
doctrine, ``a transaction is not entitled to tax respect if it lacks
economic effects or substance other than the generation of tax
benefits, or if the transaction serves no business purpose.'' Winn-
Dixie Stores, Inc. v. Comm'r, 254 F.3d 1313, 1316 (11th Cir. 2001)
(citing Knetsch v. United States, 364 U.S. 361 (1960)). ``The
doctrine has few bright lines, but `it is clear that transactions
whose sole function is to produce tax deductions are substantive
shams.''' Id. (quoting United Parcel Serv. of Am., Inc. v. Comm'r,
254 F.3d 1014, 1018 (11th Cir 2001)).
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Fraud, deceit, or unlawful activity. The CFTC believes that the
Internal Revenue Service's delineation of what constitutes tax evasion,
as elaborated upon by the courts, provides a useful guidepost for
determining which types of activities should be considered to
constitute an evasion of the Dodd-Frank Act. The Internal Revenue
Service distinguished between tax evasion and legitimate means for
citizens to minimize, reduce, avoid or alleviate the tax that they pay
under the Internal Revenue Code. Whereas permissible means of reducing
tax (or ``tax avoidance,'' as the Internal Revenue Service refers to
the practice) is associated with full disclosure and explanation of why
the tax should be reduced under law, tax evasion consists of the
willful attempt to evade tax liability, and generally involves
``deceit, subterfuge, camouflage, concealment, or some attempt to color
or obscure events or to make things seem other than they are.'' \325\
Similarly, persons that craft derivative transactions, structure
entities, or conduct themselves in a deceptive or other illegitimate
manner in order to avoid regulatory requirements should not be
permitted to enjoy the fruits of their deceptive or illegitimate
conduct. In determining whether particular conduct is an evasion of the
Dodd-Frank Act, the CFTC will consider the extent to which the conduct
involves deceit, deception, or other unlawful or illegitimate
activity.\326\
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\325\ The Internal Revenue Service explains:
Avoidance of taxes is not a criminal offense. Any attempt to
reduce, avoid, minimize, or alleviate taxes by legitimate means is
permissible. The distinction between avoidance and evasion is fine,
yet definite. One who avoids tax does not conceal or misrepresent.
He/she shapes events to reduce or eliminate tax liability and, upon
the happening of the events, makes a complete disclosure. Evasion,
on the other hand, involves deceit, subterfuge, camouflage,
concealment, some attempt to color or obscure events or to make
things seem other than they are. For example, the creation of a bona
fide partnership to reduce the tax liability of a business by
dividing the income among several individual partners is tax
avoidance. However, the facts of a particular investigation may show
that an alleged partnership was not, in fact, established and that
one or more of the alleged partners secretly returned his/her share
of the profits to the real owner of the business, who, in turn, did
not report this income. This would be an instance of attempted
evasion.
Internal Revenue Service, Internal Revenue Manual, part
9.1.3.3.2.1, available at http://www.irs.gov/irm/part9/irm_09-001-003.html#d0e169.
\326\ Although deceitful, deceptive, or illegitimate conduct may
be sufficient to find that evasion has occurred, such conduct is not
a prerequisite for a finding of evasion, particularly when other
indicia of evasion are present, such as, for example, when the
transaction lacks any business purpose.
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Request for Comment
The CFTC requests comment on all aspects of the proposed anti-
evasion rules, including the following:
143. Are the CFTC's proposed rules and interpretive guidance set
forth in this section sufficient to address the evasion concerns in
Title VII? Is further guidance necessary? If so, what further guidance
would be appropriate?
[[Page 29868]]
144. Is further definition of the term ``swap'' necessary to
address transactions that have been structured to evade subtitle A of
Title VII? If so, what further definition is appropriate, and why?
Please provide specific examples or scenarios, and a detailed analysis
of any such transactions and the guidance that would be appropriate.
145. In addition to defining the term ``swap'' to address evasion
generally, and with respect to certain foreign exchange products and
identified banking products in particular, are CFTC rules prohibiting
transactions from being willfully structured to evade or attempt to
evade (similar to the proposed rules regarding activities conducted
outside the United States) subtitle A of Title VII appropriate?
B. SEC Request for Comment Regarding Anti-Evasion
Section 761(b)(3) of the Dodd-Frank Act grants discretionary
authority to the SEC to define the terms ``security-based swap,''
``security-based swap dealer,'' ``security-based major swap
participant,'' and ``eligible contract participant,'' with regard to
security-based swaps, ``for the purpose of including transactions and
entities that have been structured to evade subtitle B of Title VII (or
amendments made by subtitle B). Section 772(b) of the Dodd-Frank Act
states that the provisions of the Exchange Act that were added by Title
VII (including any rule or regulation thereunder) shall not apply to
any person insofar as that person transacts a business in security-
based swaps outside the jurisdiction of the United States, unless such
person transacts such business ``in contravention of such rules and
regulations as the [SEC] may prescribe as necessary or appropriate to
prevent evasion of any provision of [the Exchange Act] that was added
by [Title VII].'' \327\
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\327\ See section 30(c) of the Exchange Act, 15 U.S.C. 78dd(c).
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The SEC is not proposing specific rules regarding anti-evasion at
this time. The SEC may consider whether to propose anti-evasion rules
based on comments received or after having experience with the new
regulatory regime under subtitle B of Title VII.
Request for Comment
146. The SEC requests comment on whether SEC rules or interpretive
guidance addressing anti-evasion regarding security-based swaps,
security-based swap dealers, major security-based swap participants, or
ECPs are necessary. Why or why not? Should the SEC adopt rules and
interpretive guidance modeled on the CFTC's proposals? If other rules
or interpretive guidance are necessary, please provide a detailed
description of what rules or interpretative guidance would be
necessary.
147. Are SEC rules or interpretive guidance addressing evasion in
the context of activities conducted outside the United States
necessary? Why or why not? Should the SEC adopt rules and interpretive
guidance modeled on the CFTC's proposals? If other rules or
interpretive guidance are necessary, please provide a detailed
description of what rules or interpretative guidance would be
necessary.
VIII. Administrative Law Matters--CEA Revisions
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires that agencies
consider whether the rules they propose will have a significant
economic impact on a substantial number of small entities and, if so,
provide a regulatory flexibility analysis respecting the impact.\328\
Most of the entities that will be impacted by this proposed rulemaking
have previously been determined to not be small entities. In addition,
this proposed rulemaking, which provides interpretive guidance, general
rules of construction and definitions that will largely be used in
other rulemakings will, by itself, not impose a significant economic
impact on market participants or entities.
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\328\ 5 U.S.C. 601 et seq.
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1. Effect of the Proposed Rulemaking
The proposed rulemaking in this release further defines, and
clarifies, the statutory terms ``swap,'' ``security-based swap,''
``security-based swap agreement,'' and ``mixed swap.'' It also provides
a process for requesting joint interpretations from the Commissions as
to whether agreements, contracts, and transactions are swaps, security-
based swaps, or mixed swaps, as well as a process for requesting
alternative regulatory treatment for certain mixed swaps. This proposed
rulemaking also includes books and records, and data, requirements for
SDRs, swap dealers, and major swap participants with respect to SBSAs,
and implements the anti-evasion rulemaking authority granted to the
CFTC under several provisions of the Dodd-Frank Act.
Additionally, this release proposes interpretive guidance that the
forward contract exclusion from the swap definition in the Dodd-Frank
Act with respect to nonfinancial commodities should be read
consistently with the forward contract exclusion from the CEA
definition of the term ``future delivery.'' In that regard, the CFTC is
proposing to retain the Brent Interpretation and extend it to apply to
all nonfinancial commodities, and as a result, to withdraw the Energy
Exemption,\329\ which had extended the Brent Interpretation regarding
the forward contract exclusion from the term ``future delivery'' to
energy commodities other than oil. The Energy Exemption listed certain
``appropriate persons'' that could rely on the exemption.
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\329\ Energy Exemption, supra note 72.
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The CFTC anticipates that this proposed rulemaking will affect
primarily the following entities: DCMs, DCOs, ECPs, swap dealers, major
swap participants, SEFs, SDRs, FBOTs, and those ``appropriate persons''
who previously relied on the Energy Exemption.
2. Specific Entities That Are Not Small Entities
The vast majority of entities impacted by this proposed rulemaking
previously have been determined to not be small entities by the CFTC.
Prior to the enactment of the Dodd-Frank Act, the following entities
had been determined by the CFTC to not be small entities for purposes
of the RFA: DCMs, DCOs, and ECPs. Other entities that will be affected
by this rulemaking, including swap dealers, major swap participants,
SEFs, SDRs, and FBOTs, have been certified by the CFTC not to be small
entities in other proposed recent CFTC rulemaking implementing
requirements of the Dodd-Frank Act. Specifically:
i. Swap Dealers, Major Swap Participants, SEFs, SDRs, and FBOTs.
The CFTC previously has certified that swap dealers, major swap
participants, SEFs, SDRs, and FBOTs are not small entities for purposes
of the RFA.\330\ Nevertheless, because these are new categories of
registrants under the Dodd-Frank Act, the CFTC is, again, hereby
determining that these entities are not small entities.
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\330\ See respectively, Registration of Swap Dealers and Major
Swap Participants, 75 FR 71379, 71385, Nov. 23, 2010 (swap dealers
and major swap participants); Requirements for Derivatives Clearing
Organizations, Designated Contract Markets, and Swap Execution
Facilities Regarding the Mitigation of Conflicts of Interest, 75 FR
63732, 63745, Oct. 18, 2010 (SEFs); Swap Data Repositories, 75 FR
80898, 80926, Dec. 23, 2010 (SDRs); Registration of Foreign Boards
of Trade, 75 FR 70974, 70987, Nov. 19, 2010 (FBOTs).
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a. Swap Dealers: As noted above, the CFTC previously has determined
that FCMs are not small entities for the purpose of the RFA based upon,
among
[[Page 29869]]
other things, the requirements that FCMs must meet, including certain
minimum financial requirements that enhance the protection of
customers' segregated funds and protect the financial condition of FCMs
generally. Swap dealers similarly will be subject to minimum capital
and margin requirements, and are expected to comprise the largest
global financial firms. Entities that engage in a de minimis quantity
of swap dealing in connection with transactions with or on behalf of
customers will be exempt from designation as a swap dealer. For
purposes of the RFA, the CFTC is hereby determining that swap dealers
not be considered to be ``small entities'' for essentially the same
reasons that FCMs previously have been determined not to be small
entities.
b. Major Swap Participants: The CFTC also previously has determined
that large traders are not small entities for the purpose of the RFA.
Major swap participants, among other things, maintain substantial
positions in swaps, creating substantial counterparty exposure that
could have serious adverse effects on the financial stability of the
U.S. banking system or financial markets. For purposes of the RFA, the
CFTC is hereby determining that major swap participants not be
considered to be ``small entities'' for essentially the same reasons
that large traders previously have been determined not to be small
entities.
c. SEFs: The Dodd-Frank Act defines a SEF to mean a trading system
or platform in which multiple participants have the ability to accept
bids and offers made by multiple participants in the facility or
system, through any means of interstate commerce, including any trading
facility that facilitates the execution of swaps between persons and is
not a DCM. The CFTC previously has determined that DCMs are not small
entities because, among other things, they may be designated only when
they meet specific criteria, including expenditure of sufficient
resources to establish and maintain adequate self-regulatory programs.
Likewise, the CFTC will register an entity as a SEF only after it has
met specific criteria, including the expenditure of sufficient
resources to establish and maintain an adequate self-regulatory
program. For purposes of the RFA, the CFTC is hereby determining that
SEFs not be considered to be ``small entities'' for essentially the
same reasons that DCMs previously have been determined to be small
entities.
d. SDRs: The CFTC previously has determined that DCMs and DCOs are
not small entities because, among other things, of ``the central role''
they play in ``the regulatory scheme concerning futures trading.''
\331\ Because of the ``importance of futures trading in the national
economy,'' to be designated as a contract market or registered as a
DCO, the respective entity must meet stringent requirements set forth
in the CEA. Similarly, swap positions that are recorded, reported and
disseminated by SDRs will be an important part of the national economy.
SDRs will receive data from market participants and will be obligated
to facilitate swap execution by reporting real-time data. Similar to
DCMs and DCOs, SDRs will play a central role both in the regulatory
scheme concerning swap trading. Additionally, the Dodd-Frank Act
permits DCOs to register as SDRs. For purposes of the RFA, the CFTC is
hereby determining that SDRs not be considered to be ``small entities''
for essentially the same reasons that DCMs and DCOs previously have
been determined not to be small entities.
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\331\ Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618, Apr. 30, 1982.
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e. FBOTs. The term ``foreign board of trade'' has been used in the
CEA and in the CFTC's Regulations to refer to a board of trade
``located outside the U.S.'' \332\ The term ``board of trade'' is
defined in the CEA as ``any organized exchange or trading facility.''
\333\ An ``organized exchange,'' in turn, includes designated or
registered exchanges, such as DCMs.\334\ The CFTC previously has
determined that DCMs are not ``small entities.'' As noted above,
because of DCMs' importance to the economy, they must meet stringent
requirements set forth in the CEA. Similarly, the CFTC will register an
FBOT only after it has met criteria similar to those required of a DCM.
Critically, an FBOT will be registered only after demonstrating, among
other things, that it possesses the attributes of an organized
exchange, adheres to appropriate rules prohibiting abusive trading
practices, and enforces appropriate rules to maintain market and
financial integrity. Because FBOTs and DCMs are functionally equivalent
entities, for purposes of the RFA, the CFTC hereby is determining that
FBOTs not be considered to be small entities for essentially the same
reasons that DCMs previously have been determined not to be small
entities.
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\332\ See CEA section 4(a), 7 U.S.C. 6(a); CFTC rule 1.33(ss),
17 C.F.R. 1.33(ss).
\333\ CEA section 1a(2), 7 U.S.C. 1a(2).
\334\ CEA section 1a(27), 7 U.S.C. 1a(27).
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ii. DCMs, DCOs, and ECPs. The CFTC previously has determined that
DCMs, DCOs, and ECPs, are not small entities for purposes of the
Regulatory Flexibility Act.\335\ The Dodd-Frank Act requires that
counterparties to swaps that are traded on a bilateral basis not on or
subject to the rules of a DCM be ECPs. Prior to the enactment of the
Dodd-Frank Act, ECPs trading swaps were generally outside the scope of
CFTC oversight under the CEA. The CFTC cannot estimate with precision
the number of non-ECPs that will, as permitted by the Dodd-Frank Act,
trade swaps on DCMs. Nevertheless, this proposed rulemaking by the CFTC
provides proposed further definitions of the terms ``swap,''
``security-based swap,'' ``mixed swap'' and ``security-based swap
agreement,'' and proposes rules of construction and interpretive
guidance (including guidance as to agreements, contracts, and
transactions that are not included within the scope of the swap
definition), that will largely be used in other rulemakings and which,
by themselves, do not impose significant new regulatory requirements on
market participants.
---------------------------------------------------------------------------
\335\ See respectively, Policy Statement and Establishment of
Definitions of ``Small Entities'' for Purposes of the Regulatory
Flexibility Act, supra note 331, at 18619 (DCMs); A New Regulatory
Framework for Clearing Organizations, 66 FR 45604, 45609, Aug. 29,
2001 (DCOs); Opting Out of Segregation. 66 FR 20740, 20743, Apr. 25,
2001 (ECPs).
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iii. ``Appropriate Persons'' who relied on the Energy Exemption.
The Energy Exemption listed certain ``appropriate persons'' that could
rely on the exemption and also required that, to be eligible for this
exemption, an ``appropriate person'' must have a demonstrable capacity
or ability to make or take delivery. The Energy Exemption stated: ``in
light of the general nature of the current participants in the market,
the CFTC believes that smaller commercial firms, which cannot meet
[certain] financial criteria, should not be included.'' \336\
Therefore, the CFTC does not believe that the ``appropriate persons''
eligible for the Energy Exemption, and who may be affected by its
withdrawal, are ``small entities'' for purposes of RFA.
---------------------------------------------------------------------------
\336\ Energy Exemption, supra note 72.
---------------------------------------------------------------------------
Accordingly, the Chairman, on behalf of the CFTC, hereby certifies
pursuant to 5 U.S.C. 605(b) that the proposed rules will not have a
significant impact on a substantial number of small entities.
Nonetheless, the CFTC specifically requests comment on the impact that
this proposed rulemaking may have on small entities.
[[Page 29870]]
B. Paperwork Reduction Act
1. Introduction
Proposed CFTC rules 1.8 and 1.9 would result in new ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act of 1995 (``PRA''). An agency may not conduct or sponsor,
and a person is not required to respond to, a collection of information
unless it displays a currently valid Office of Management and Budget
(OMB) control number.
2. Summary of the Proposed Requirements
Proposed rule 1.8 of the CEA would allow persons to submit a
request for a joint interpretation from the Commissions regarding
whether an agreement, contract or transaction (or a class thereof) is a
swap, security-based swap, or mixed swap. Proposed rule 1.8 provides
that a person requesting an interpretation as to the nature of an
agreement, contract, or transaction as a swap, security-based swap, or
mixed swap must provide the Commissions with the person's determination
of the nature of the instrument and supporting analysis, along with
certain other documentation, including a statement of the economic
purpose for, and a copy of all material information regarding the terms
of, each relevant agreement, contract, or transaction (or class
thereof). The Commissions also may request the submitting person to
provide additional information. In response to the submission, the
Commissions may issue a joint interpretation regarding the status of
that agreement, contract, or transaction (or class of agreements,
contracts, or transactions) as a swap, security-based swap, or mixed
swap.
Proposed rule 1.9 enables persons to submit requests to the
Commissions for joint orders providing an alternative regulatory
treatment for particular mixed swaps. Under proposed rule 1.9, a person
would provide to the Commissions a statement of the economic purpose
for, and a copy of all material information regarding, the relevant
mixed swap. In addition, the person would provide the specific
alternative provisions that the person believes should apply to the
mixed swap, the reasons the person believes it would be appropriate to
request an alternative regulatory treatment, and an analysis of: (i)
The nature and purposes of the specified provisions; (ii) the
comparability of the specified provisions to other statutory provisions
of Title VII of the Dodd-Frank Act and the rules and regulations
thereunder; and (iii) the extent of any conflicting or incompatible
requirements of the specified provisions and other statutory provisions
of Title VII and the rules and regulations thereunder. The Commissions
also may request the submitting person to provide additional
information.
3. Information Provided by Reporting Entities
The burdens imposed by proposed CFTC rules 1.8 and 1.9 are the same
as the burdens imposed by the SEC's proposed rules 3a68-2 and 3a68-4.
Therefore, the burdens that would be imposed on market participants
under CFTC rules 1.8 and 1.9 already have been accounted for within the
SEC's calculations regarding the impact of this collection of
information under the PRA and the request for a control number that
will be submitted by the SEC to OMB.\337\
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\337\ 44 U.S.C. 3501-3521. See also 44 U.S.C. 3509 and 3510.
---------------------------------------------------------------------------
4. Information Collection Comments
The CFTC invites public comment on any aspect of the reporting and
recordkeeping burdens discussed above. Pursuant to 44 U.S.C.
3506(c)(2)(B), the CFTC solicits comments in order to: (i) Evaluate
whether the proposed collections of information are necessary for the
proper performance of the functions of the CFTC, including whether the
information will have practical utility; (ii) evaluate the accuracy of
the CFTC's estimate of the burden of the proposed collections of
information; (iii) determine whether there are ways to enhance the
quality, utility, and clarity of the information to be collected; and
(iv) minimize the burden of the collections of information on those who
are to respond, including through the use of automated collection
techniques or other forms of information technology.
Comments may be submitted directly to the OMB's Office of
Information and Regulatory Affairs, by fax at (202) 395-6566 or by e-
mail at [email protected]. Please provide the CFTC with a
copy of submitted comments so that all comments can be summarized and
addressed in the preamble to the final rulemaking. Please refer to the
Addresses section of this notice of proposed rulemaking for comment
submission instructions to the CFTC. A copy of the supporting
statements for the collections of information discussed above may be
obtained by visiting RegInfo.gov. OMB is required to make a decision
concerning the collections of information between 30 and 60 days after
publication of this release in the Federal Register. Consequently, a
comment to OMB is most ensured of being fully effective if received by
OMB (and the CFTC) within 30 days after publication of this release.
Nothing in the foregoing affects the deadline enumerated above for
public comment to the CFTC on the rules and interpretive guidance
proposed herein.
C. Cost-Benefit Analysis
CEA section 15(a) \338\ requires the CFTC to consider the costs and
benefits of its actions before issuing a rulemaking under the CEA. By
its terms, section 15(a) does not require the CFTC to quantify the
costs and benefits of a rule or to determine whether the benefits of
the rulemaking outweigh its costs; rather, it requires that the CFTC
``consider'' the costs and benefits of its actions. Section 15(a)
further specifies that the costs and benefits shall be evaluated in
light of five broad areas of market and public concern: (i) Protection
of market participants and the public; (ii) efficiency,
competitiveness, and financial integrity of futures markets; (iii)
price discovery; (iv) sound risk management practices; and (v) other
public interest considerations. The CFTC may in its discretion give
greater weight to any one of the five enumerated areas and could in its
discretion determine that, notwithstanding its costs, a particular rule
is necessary or appropriate to protect the public interest or to
effectuate any of the provisions or accomplish any of the purposes of
the CEA.
---------------------------------------------------------------------------
\338\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
1. Costs and Benefits of the Proposed Definitions
The proposed rulemaking and interpretive guidance would further
define the terms ``swap,'' ``security-based swap,'' ``security-based
swap agreement,'' and ``mixed swap.'' The scope of the definitions of
the terms ``swap,'' ``security-based swap,'' ``security-based swap
agreement,'' and ``mixed swap'' will be an important factor in
determining the scope of activities and entities that will be subject
to various requirements set forth in the Dodd-Frank Act, such as
reporting, registration, business conduct, and capital requirements.
Those requirements, which will be implemented in rules proposed or to
be proposed by the CFTC, will likely lead to compliance costs, capital
holding costs, and other costs, which have been or will be addressed in
the CFTC's proposals to implement those requirements.
[[Page 29871]]
Yet, the CFTC believes that the proposal to further define the
terms ``swap,'' ``security-based swap,'' ``security-based swap
agreement,'' and ``mixed swap'' is, for the most part, in line with the
expectations of market participants and does not depart significantly
from how market participants would interpret the statutory definitions
of these terms set forth in Title VII of the Dodd-Frank Act. Thus, the
CFTC does not believe that the proposed rules and interpretive guidance
further defining these terms impose any significant incremental costs
beyond the costs associated with the statutory definitions.
The CFTC also believes that the proposed rules and guidance
regarding the definitions will lead to benefits in the form of
increased market transparency, reduced systemic risk, and a lower
incidence of market-wide crises and other market failures. Further, the
proposed rules and guidance can be consistently applied by
substantially all market participants to determine which agreements,
contracts, or transactions are, and which are not, swaps, security-
based swaps, security-based swap agreements, or mixed swaps. Thus, the
proposed rules and interpretive guidance will help to create a level
playing field. Market participants will be able to use Title VII
instruments more efficiently and the swap markets will operate more
effectively because all market participants will be relying on
consistent and clear definitions. The clarity provided by the proposed
rules and interpretive guidance relating to the definitions is in the
public interest because this clarity will permit the public to better
evaluate information about Title VII instruments made available under
the Dodd-Frank Act. In particular, they will allow market participants
to better understand publicly-available price data. The clarity of the
definitions also has the potential to ease the negotiation of Title VII
instruments and reduce other transaction costs. These factors are
expected to permit the public to make a more extensive use of Title VII
instruments for risk management and other purposes.
The CFTC requests comment as to the costs and benefits of the
proposed rules and interpretive guidance regarding the definitions for
market participants, markets, and the public. In particular, comment is
requested as to whether there are any aspects of the proposed rules and
interpretive guidance regarding the definitions that are both
burdensome to apply and not helpful to achieving clarity as to the
scope of the defined terms. In addition, are there less burdensome
means of providing clarity as to the scope of the defined terms?
2. Costs and Benefits of Proposed Rules and Interpretive Guidance
Regarding Insurance
Proposed CFTC rule 1.3(xxx)(4) under the CEA would clarify that
insurance products that meet certain requirements, that are provided by
state or Federally regulated insurance companies, and that are
regulated as insurance products, would not be swaps. Specifically,
proposed rule 1.3(xxx)(4) would define the term ``swap'' so that it
would not include an agreement, contract, or transaction that, by its
terms or by law, as a condition of performance on the agreement,
contract, or transaction: (i) Requires the beneficiary to have an
insurable interest that is the subject of the agreement, contract, or
transaction and thereby carry the risk of loss with respect to that
interest continuously throughout the duration of the agreement,
contract, or transaction; (ii) requires that loss to occur and to be
proved, and that any payment or indemnification therefore be limited to
the value of the insurable interest, separately from the insured
interest; (iii) is not traded, separately from the insured interest, on
an organized market or over-the-counter; and (iv) with respect to
financial guarantee insurance only, in the event of payment default or
insolvency of the obligor, any acceleration of payments under the
policy is at the sole discretion of the insurer.
Proposed rule 1.3(xxx)(4) also would require that the agreement,
contract, or transaction: (i) Be provided by a person or entity that is
organized as an insurance company whose primary and predominant
business activity is the writing of insurance or the reinsuring of
risks underwritten by insurance companies and that is subject to
supervision by the insurance commissioner, or similar official or
agency, of a state (as defined under section 3(a)(16) of the Exchange
Act \339\) or by the United States or an agency or instrumentality
thereof, and be regulated as insurance under the laws of such state or
the United States; (ii) be provided by the United States or any of its
agents or instrumentalities, or pursuant to a statutorily authorized
program thereof; or (iii) in the case of reinsurance only, be provided
by a person located outside the United States to an insurance company
that meets the above requirements, provided that such person is not
prohibited by the law of any state or the United States from offering
such agreement, contract, or transaction to such insurance company, the
product to be reinsured meets the requirements above for insurance
products, and the total amount reimbursable by all reinsurers for such
insurance product cannot exceed the claims or losses paid by the
cedant.
---------------------------------------------------------------------------
\339\ 15 U.S.C. 78c(a)(16).
---------------------------------------------------------------------------
An agreement, contract, or transaction would have to meet all of
these criteria in order to qualify as an insurance product that falls
outside of the swap and security-based swap definitions pursuant to the
proposed rules. The Commissions also are proposing interpretative
guidance to clarify that certain enumerated types of traditional
insurance products, such as life insurance, health insurance, and
property and casualty insurance, are outside the scope of the statutory
swap and security-based swap definitions.
(a) Costs
In complying with proposed rule 1.3(xxx)(4), a market participant
will need to ascertain whether an agreement, contract, or transaction
is an insurance product according to the criteria set forth in the
definition. This analysis will have to be performed upon entering into
the agreement, contract, or transaction to ensure compliance with the
proposed rule. Absent this analysis, however, the cost associated with
the uncertainty cited by commenters as to whether an agreement,
contract, or transaction that the participants consider to be insurance
could instead be regulated as a swap is expected to be greater than the
cost of the analysis proposed herein.
To the extent that the criteria under proposed rule 1.3(xxx)(4)
inadvertently fail to exclude certain types of insurance products from
the proposed definitions, these failures could lead to costs for market
participants entering into agreements, contracts, or transactions that
might be improperly regulated as swaps and not as insurance products.
Similarly, to the extent that the criteria under the proposed rule lead
to the inadvertent treatment of certain types of swaps as insurance,
costs for market participants entering into agreements, contracts, or
transactions that are improperly regulated as insurance products and
not as swaps may increase.
(b) Benefits
The proposed rule and interpretative guidance regarding insurance
will help to assure that traditional insurance products remain subject
to the current regulatory scheme for insurance and not to the
regulatory regime established by the Dodd-Frank Act for swaps. Market
[[Page 29872]]
participants, therefore, will be able to continue to rely on their
previous understanding of insurance regulations without any additional
burden that may have resulted if they had to instead comply with
regulations under the Dodd-Frank Act.
Without the proposed rule and interpretative guidance herein,
market participants may be uncertain about whether an agreement,
contract, or transaction is an insurance product that is subject to
regulation as a swap. Proposed rule 1.3(xxx)(4) is intended to
eliminate the potential uncertainty of what constitutes an insurance
product by setting forth clear and objective criteria for determining
that an agreement, contract, or transaction is an insurance product
that is not subject to regulation as a swap. Providing such an
objective rule and guidance alleviates additional costs of inquiring
with the Commissions, or obtaining an opinion of counsel, about whether
an agreement, contract, or transaction is an insurance product or a
swap. The added clarity provided by the rule and guidance proposed
herein will enhance the efficiency of the swaps market and also allow
market participants to engage in sound risk management practices
because they will be readily able to consider whether a particular
agreement, contract, or transaction is insurance or a swap at the
outset.
The CFTC requests comment as to the costs and benefits of proposed
rule 1.3(xxx)(4) and interpretive guidance contained herein to
distinguish between insurance products and swaps for market
participants, markets, and the public.
3. Costs and Benefits of Proposed Rule Regarding Foreign Exchange
Products and Forward Rate Agreements
Proposed CFTC rule 1.3(xxx)(2) under the CEA would explicitly
define the term ``swap'' to include an agreement, contract, or
transaction that is a cross-currency swap, currency option, foreign
currency option, foreign exchange option, foreign exchange rate option,
foreign exchange forward, foreign exchange swap, forward rate
agreement, and non-deliverable forward involving foreign exchange,
unless such agreement, contract, or transaction is otherwise excluded
by section 1a(47)(B) of the CEA. Proposed rule 1.3(xxx)(2) also
provides that: (i) A foreign exchange forward or a foreign exchange
swap shall not be considered a swap if the Secretary of the Treasury
makes the determination described in CEA section 1a(47)(E)(i); and (ii)
notwithstanding any such determination, certain provisions of the CEA
will apply to such foreign exchange forward or foreign exchange swap
(specifically, the reporting requirements in section 4r of the CEA and
regulations thereunder and, in the case of a swap dealer or major swap
participant that is a party to a foreign exchange swap or foreign
exchange forward, the business conduct standards in section 4s of the
CEA and regulations thereunder). Proposed rule 1.3(xxx)(2) further
clarifies that a currency swap, cross-currency swap, currency option,
foreign currency option, foreign exchange option, foreign exchange rate
option, or non-deliverable forward involving foreign exchange is not a
foreign exchange forward or foreign exchange swap subject to a
determination by the Secretary of the Treasury as described above.
(a) Costs
In complying with proposed rule 1.3(xxx)(2), a market participant
will need to ascertain whether an agreement, contract, or transaction
is a swap under the definition. This analysis will have to be performed
upon entering into the agreement, contract, or transaction to ensure
compliance with the proposed rule. However, any costs associated with
this analysis are expected to be less than the costs of doing the same
analysis absent the proposed rule, particularly given potential
confusion in the event of a determination by the Secretary of the
Treasury that foreign exchange forwards and/or foreign exchange swaps
not be considered swaps. To the extent that proposed rule 1.3(xxx)(2)
leads to the improper inclusion of certain types of agreements,
contracts, and transactions in the swap definition, and therefore the
imposition of additional requirements and obligations, these
requirements and obligations could lead to costs for market
participants entering into such agreements, contracts, or transactions.
(b) Benefits
Because the statutory definition of the term ``swap'' includes a
process by which the Secretary of the Treasury may determine that
certain agreements, contracts, and transactions that meet the statutory
definition of a ``foreign exchange forward'' or ``foreign exchange
swap,'' respectively,\340\ shall not be considered a swap, the CFTC is
concerned that application of the definition, without further
clarification, may cause uncertainty about whether, if the Secretary of
the Treasury makes such a determination, certain agreements, contracts,
or transactions would be swaps. Proposed rule 1.3(xxx)(2) would clarify
that a currency swap, cross-currency swap, currency option, foreign
currency option, foreign exchange option, foreign exchange rate option,
or non-deliverable forward involving foreign exchange is a swap (unless
it is otherwise excluded by the statutory definition of the term
``swap''). The proposed rule also would clarify that reporting
requirements, and business conduct requirements for swap dealers and
major swap participants, are applicable to foreign exchange forwards
and foreign exchange swaps even if the Secretary of the Treasury
determines that they should not be considered swaps. The CFTC also is
concerned that confusion could be generated by the ``forward'' label of
non-deliverable forwards involving foreign exchange, and forward rate
agreements. Proposed rule 1.3(xxx)(2) would clarify that these types of
agreements, contracts, and transactions are swaps.
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\340\ CEA section 1a(24), 7 U.S.C. 1a(24)(definition of a
``foreign exchange forward''); CEA section 1a(25), 7 U.S.C.
1a(25)(definition of a ``foreign exchange swap'').
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Providing a clarifying rule to market participants to determine
whether certain types of agreements, contracts, or transactions are
swaps alleviates additional costs to persons of inquiring with the
Commissions, or obtaining an opinion of counsel, about whether such
agreements, contracts, or transactions are swaps. In addition, a
clarifying rule regarding the requirements that apply to foreign
exchange forwards and foreign exchange swaps that are subject to a
determination by the Secretary of the Treasury similarly alleviates
additional costs to persons of inquiring with the Commissions, or
obtaining an opinion of counsel, to determine the requirements that are
applicable to such foreign exchange forwards and foreign exchange
swaps. As with the other rules related to product definitions, added
clarity will increase the efficiency of the swaps market and also will
enable market participants to engage in sound risk management
practices, which will benefit both market participants and the public.
The CFTC requests comment as to the costs and benefits of proposed
rule 1.3(xxx)(2) for market participants, markets, and the public.
4. Costs and Benefits of Proposed Rules and Interpretive Guidance
Regarding Title VII Instruments Where the Underlying Reference Is a
Security Index
Proposed CFTC rule 1.3(yyy)(1) provides that, for purposes of the
security-based swap definition, the term ``narrow-based security
index'' would have the same meaning as the statutory definition set
forth in CEA section
[[Page 29873]]
1a(35), and the rules, regulations, and orders issued by the
Commissions relating to such definition. As a result, except as the new
rules the Commissions are proposing provide for other treatment, market
participants generally will be able to use the Commissions' past
guidance in determining whether certain Title VII instruments based on
a security index are swaps or security-based swaps.
The Commissions also are proposing interpretive guidance and
additional rules regarding Title VII instruments based on a security
index. The interpretive guidance and additional rules set forth new
narrow-based security index criteria with respect to indexes composed
of securities, loans, or issuers of securities referenced by an index
CDS. The proposed interpretive guidance and rules also address the
definition of an ``index'' and the treatment of broad-based security
indexes that become narrow-based and narrow-based indexes that become
broad-based, including rule provisions regarding tolerance and grace
periods for swaps on security indexes that are traded on CFTC-regulated
trading platforms.
(a) Costs
In complying with the proposed rules, a market participant will
need to ascertain whether an index CDS is a swap or a security-based
swap according to the criteria set forth in the definitions of the
terms ``issuers of securities in a narrow-based security index'' and
``narrow-based security index'' as used in the security-based swap
definition. This analysis will have to be performed upon entering into
an index CDS, and when the material terms of an index CDS are amended
or modified, to ensure compliance with proposed rules 1.3(zzz) or
1.3(aaaa). However, any such costs are expected to be less than the
costs of doing the same analysis absent the proposed rules, which the
CFTC believes would be more difficult and lead to greater uncertainty.
Proposed rules 1.3(zzz) and 1.3(aaaa) allow market participants to
minimize the costs of determining whether an index CDS is a swap or a
security-based swap by providing a test with objective criteria that is
similar to a test with which they already are familiar in the security
futures context, yet tailored to index CDS in particular.
Additionally, absent proposed rule 1.3(yyy), which applies the
tolerance period rules, if a security index underlying a Title VII
instrument traded on a trading platform migrated from being broad-based
to being narrow-based, market participants may suffer disruption of
their ability to offset or enter into new Title VII instruments, and
incur additional costs as a result.
(b) Benefits
Proposed rules 1.3(zzz) and 1.3(aaaa) would clarify the treatment
of an index CDS as either a swap or a security-based swap by setting
forth objective criteria for meeting the definition of the terms
``issuers of securities in a narrow-based security index'' and
``narrow-based security index,'' respectively. These objective rules
will alleviate additional costs to persons trading index CDS of
inquiring with the Commissions, or obtaining an opinion of counsel, to
make complex determinations regarding whether an index is broad- or
narrow-based, and whether an index CDS based on such an underlying
index is a swap or security-based swap.
Also, proposed rules 1.3(zzz) and 1.3(aaaa) should reduce the
potential for market participants to use an index CDS to evade
regulations, because they set objective requirements relating to the
concentration of the notional amount allocated to each reference entity
or security included in the index, as well as the eligibility
conditions for reference entities and securities. Finally, these
proposed rules benefit the public by requiring that the providers of
index CDS make publicly available sufficient information regarding the
reference entities in an index underlying the index CDS. By requiring
that such information be made publicly available, proposed rules
1.3(zzz) and 1.3(aaaa) seek to assure the transparency of the index
components that will be beneficial to market participants who trade
such instruments and to the public.
Separately, proposed rule 1.3(yyy) addresses exchange-traded swaps
based on security indexes where the underlying index migrates from
broad-based to narrow-based. The proposed rule includes provisions that
many market participants are familiar with from security futures
trading. The CFTC believes that by using a familiar regulatory scheme,
market participants will be able to more readily understand the
proposed rule as compared to a wholly new regulatory scheme. Also, the
proposal of a ``tolerance period'' for swaps on security indexes that
migrate from broad-based to narrow-based also creates greater clarity
by establishing a 45-day timeframe (and subsequent grace period) on
which market participants may rely. This tolerance period results in
cost savings when compared to the alternative scenario where no
tolerance period is provided and a migration of an index from broad-
based to narrow-based would result in potential impediments to the
ability of market participants to offset their swap positions.
Finally, the Commissions are proposing interpretive guidance that
the determination of whether a Title VII instrument is a swap, a
security-based swap, or both (i.e., a mixed swap), is made at the
execution of the Title VII instrument. If the security index underlying
a Title VII instrument migrates from being broad-based to being narrow-
based, or vice versa, during the life of a Title VII instrument, the
characterization of that Title VII instrument would not change from its
initial characterization regardless of whether the Title VII instrument
was entered into bilaterally or was executed through a trade on or
subject to the rules of a DCM, SEF, FBOT, security-based SEF, or NSE.
Absent this guidance, market participants may need to expend additional
resources to continually monitor their swaps to see if the indexes on
which they are based have migrated from broad-based to narrow-based.
Since the proposal provides that the initial determination prevails
regardless of whether the underlying index migrates from broad-based to
narrow-based, market participants do not need to expend these
monitoring costs.
The CFTC requests comment as to the costs and benefits of proposed
rules 1.3(yyy), 1.3(zzz), and 1.3(aaaa), and the proposed guidance
contained herein, regarding Title VII instruments where the underlying
reference is a security index, and regarding index CDS, for market
participants, markets, and the public.
5. Costs and Benefits of Processes To Determine Whether a Title VII
Instrument Is a Swap, Security-Based Swap, or Mixed Swap, and To
Determine Regulatory Treatment for Mixed Swaps
(a) Costs
Proposed rule 1.8 under the CEA would allow persons to submit a
request for a joint interpretation from the Commissions regarding
whether an agreement, contract or transaction (or a class of
agreements, contracts, or transactions) is a swap, security-based swap,
or mixed swap. The CFTC estimates the cost of submitting a request for
a joint interpretation pursuant to rule 1.8 would be approximately 20
hours of internal company or individual time and a cost of $9,480 for
the services of outside professionals. Once such a joint interpretation
is made, however, other market participants that seek to transact in
the same agreement, contract, or
[[Page 29874]]
transaction (or class thereof) would have regulatory clarity about
whether it is a swap, security-based swap, or mixed swap.
Separately, proposed CFTC rule 1.9 under the CEA allows persons to
submit a request for a joint order from the Commissions regarding an
alternative regulatory treatment for particular mixed swaps. This
process applies except with respect to bilateral, uncleared mixed swaps
where one of the parties to the mixed swap is dually registered with
the CFTC as a swap dealer or major swap participant and with the SEC as
a security-based swap dealer or major security-based swap participant.
With respect to bilateral uncleared mixed swaps where one of the
parties is a dual registrant, the proposed rule provides that such
mixed swaps would be subject to a regulatory scheme set forth in rule
1.9 in order to provide clarity as to the regulatory treatment of such
mixed swaps.
The CFTC estimates that the cost of submitting a request for a
joint order seeking an alternative regulatory treatment for a
particular mixed swap would be approximately 30 hours of internal
company or individual time and a cost of approximately $15,800 for the
services of outside professionals. Absent such a process, though,
market participants that desire or intend to enter into such a mixed
swap (or class thereof) would be required pursuant to Title VII of the
Dodd-Frank Act to comply with all regulatory requirements applicable to
both swaps and security-based swaps. The CFTC believes that the cost of
such dual regulation would likely be at least as great, if not greater,
than the costs of the process set forth in proposed rule 1.9 to request
an alternative regulatory treatment for such the mixed swap. The
proposed rule regarding bilateral uncleared mixed swaps where at least
one party is a dual registrant does not entail any additional costs,
and may reduce costs for dual registrants that enter into such mixed
swaps by eliminating potentially duplicative or inconsistent
regulation.
(b) Benefits
The CFTC believes that the proposed rules that enable market
participants to submit requests for joint interpretations regarding the
nature of various agreements, contracts, or transactions, and requests
for joint orders regarding the regulatory treatment of mixed swaps,
will help to create a level playing field (since the joint
interpretations and joint orders will be available to all market
participants) regarding which agreements, contracts, or transactions
constitute swaps, security-based swaps, or mixed swaps, and the
regulatory treatment applicable to particular mixed swaps. The
availability of such joint interpretations and joint orders regarding
the scope of the definitions and the regulatory treatment of mixed
swaps will reduce transaction costs and thereby promote the use of
Title VII instruments and the efficient operation of the swap markets.
This, in turn, is expected to encourage the use of Title VII
instruments for risk management and other purposes. The separate
proposed rule for bilateral uncleared mixed swaps where at least one
party is dually registered should eliminate potentially duplicative and
inconsistent regulation.
The CFTC requests comment as to the costs and benefits of the
processes for seeking joint interpretations and joint orders in
proposed rules 1.8 and 1.9, respectively, for market participants,
markets, and the public.
6. Costs and Benefits of SBSA Books and Records, and Data, Requirements
Proposed CFTC rule 1.7 under the CEA would clarify that there would
not be books and records, or data, requirements regarding SBSAs other
than those that would exist for swaps. The proposed rule alleviates any
additional books and records or information costs to persons who are
required to keep and maintain books and records regarding, or collect
and maintain data regarding, SBSAs because the proposed rule does not
require such persons to keep or maintain any books and records, or
collect and maintain any data, regarding, SBSAs that differs from the
books, records, and data required regarding swaps.
Specifically, proposed rule 1.7 would require persons registered as
SDRs to: (i) keep and maintain books and records regarding SBSAs only
to the extent that SDRs are required to keep and maintain books and
records regarding swaps; and (ii) collect and maintain data regarding
SBSAs only to the extent that SDRs are required to collect and maintain
data regarding swaps. In addition, proposed rule 1.7 would require
persons registered as swap dealers or major swap participants to keep
and maintain books and records, including daily trading records,
regarding SBSAs only to the extent that those persons would be required
to keep and maintain books and records regarding swaps.
Because proposed rule 1.7 imposes no requirements with respect to
SBSAs other than those that exist for swaps, proposed rule 1.7 would
impose no costs other than those that are required with respect to
swaps in the absence of proposed rule 1.7. Proposed rule 1.7 provides
clarity by establishing uniform requirements regarding books and
records, and data collection, requirements for swaps and for SBSAs.
The CFTC requests comment as to the costs and benefits of proposed
rule 1.7 for market participants, markets, and the public.
7. Costs and Benefits of the Proposed Interpretive Guidance Regarding
the Forward Contract Exclusion From the Swap Definition
The CFTC is proposing interpretive guidance that the forward
contract exclusion from the swap definition for nonfinancial
commodities should be read consistently with the forward contract
exclusion from the CEA definition of the term ``future delivery.'' In
that regard, the CFTC is proposing to retain the Brent Interpretation
and extend it to apply to all nonfinancial commodities, and to withdraw
the Energy Exemption which had extended the Brent Interpretation
regarding the forward contract exclusion from the term ``future
delivery'' to energy commodities other than oil. The CFTC also is
proposing that its prior guidance regarding commodity options embedded
in forward contracts should be applied as well to the treatment of
forward contracts in nonfinancial commodities that contain embedded
options under the Dodd-Frank Act.
The CFTC anticipates that its proposed interpretive guidance
construing the forward contract exclusion consistently with respect to
the definitions of the terms ``swap'' and ``future delivery'' in this
manner will not impose any material costs on market participants. It
also will establish a uniform interpretation of the forward contract
exclusion for the definitions of both statutory terms, which will avoid
the significant costs that some commenters stated would result if the
forward contract exclusion were construed differently in these two
contexts.\341\
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\341\ See EEI Letter (``Without legal certainty as to the
regulatory treatment of their forward contracts, EEI's members and
other end users who rely on the forward contract exclusion likely
will face higher transaction costs due to greater uncertainty. These
increased transaction costs may include: (i) More volatile or higher
commodity prices; and (ii) increased credit costs, in each case
caused by changes in market liquidity as end users change the way
they transact in the commodity markets. A single regulatory approach
that uses the same criteria to confirm that a forward contract is
excluded from the Commission's jurisdiction over swaps and futures
will reduce this uncertainty and the associated costs to end
users.'' (footnote omitted)).
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The CFTC requests comment as to the costs and benefits of the
proposed interpretative guidance regarding the
[[Page 29875]]
forward contract exclusion from the swap definition, including the
retention of the Brent Interpretation and its extension to all
nonfinancial commodities and the withdrawal of the Energy Exemption,
for market participant, markets, and the public.
8. Costs and Benefits of the Proposed Anti-Evasion Rules and
Interpretive Guidance
The CFTC is proposing to exercise the anti-evasion rulemaking
authority granted to it by the Dodd-Frank Act. Generally, proposed CFTC
rule 1.3(xxx)(6) under the CEA would define as a swap any agreement,
contract, or transaction that is willfully structured to evade (or as
an attempt to evade) the provisions of Title VII governing the
regulation of swaps. Further, proposed CFTC rule 1.6 under the CEA
would prohibit activities conducted outside the United States,
including entering into agreements, contracts, and transactions and
structuring entities, to willfully evade any provision of the CEA as
enacted by Title VII or the rules and regulations promulgated
thereunder.
As opposed to providing a bright-line test, proposed rule
1.3(xxx)(6) would apply to agreements, contracts, and transactions, and
proposed rule 1.6 would apply to agreements, contracts, transactions
and entities, that are willfully structured to evade (or as an attempt
to evade) the provisions of Title VII governing the regulation of
swaps. Although this test does not provide a bright line, it helps
ensure that would-be evaders cannot intentionally structure their
transactions or entities for the sole purpose of evading the
requirements of Title VII. The CFTC also is proposing interpretive
guidance as to certain types of circumstances that may constitute an
evasion of the requirements of Title VII, while at the same time
preserving the CFTC's ability to determine, on a case-by-case basis,
that other types of transactions or actions constitute an evasion of
the requirements of the statute or the regulations promulgated
thereunder. This will promote the enforcement of the anti-evasion rules
in a manner that does not inappropriately interfere with activities
undertaken for legitimate business purposes.
Absent the proposed anti-evasion rules and interpretive guidance,
price discovery would be impaired because markets would not be informed
about those transactions. Additionally, systemic risk could increase in
a manner that the CFTC would not be able to measure accurately. The
proposed anti-evasion rules and interpretive guidance will bring the
appropriate scope of transactions and entities within the regulatory
framework established by the Dodd-Frank Act, which will better allow
the CFTC to assure transparency and address systemic risk.
Request for Comment
148. After considering the costs and benefits of the proposed rules
and interpretive guidance as discussed in this section, the CFTC has
determined to issue the proposal. The CFTC invites public comment on
all of its cost-benefit considerations. Commenters are requested to
submit empirical data or other factual information quantifying or
qualifying the costs and benefits of the proposed rules and
interpretive guidance with their comments, to the extent possible.
D. Consideration of Impact on the Economy
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996 (``SBREFA'') \342\ the CFTC must advise the Office of
Management and Budget as to whether the proposed rules constitute a
``major'' rule. Under SBREFA, a rule is considered ``major'' where, if
adopted, it results or is likely to result in: (i) An annual effect on
the economy of $100 million or more (either in the form of an increase
or a decrease); (ii) a major increase in costs or prices for consumers
or individual industries; or (iii) significant adverse effect on
competition, investment or innovation. If a rule is ``major,'' its
effectiveness will generally be delayed for 60 days pending
Congressional review. The CFTC does not believe that any of the
proposed rules in this release, in their current form, would constitute
a major rule.
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\342\ Public Law 104-121, Title II, 110 Stat. 857 (1996)
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note
to 5 U.S.C. 601).
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The CFTC requests comment on the potential impact of the proposed
rules on the economy on an annual basis, on the costs or prices for
consumers or individual industries, and on competition, investment or
innovation. Commenters are requested to provide empirical data and
other factual support for their views to the extent possible.
IX. Administrative Law Matters--Exchange Act Revisions
A. Paperwork Reduction Act
1. Background
Proposed rules 3a68-2 and 3a68-4(c) would contain new ``collection
of information'' requirements within the meaning of the Paperwork
Reduction Act of 1995.\343\ The SEC is submitting them to the Office of
Management and Budget (``OMB'') for review in accordance with the
PRA.\344\ An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it displays
a currently valid OMB control number. OMB has not yet assigned a
control number to the new collection of information.
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\343\ 44 U.S.C. 3501 et seq.
\344\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
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These proposed rules contain collections and are being proposed
pursuant to the Exchange Act. The proposed rules would establish a
process through which a person could submit a request to the
Commissions that the Commissions provide a joint interpretation of
whether an agreement, contract, or transaction (or class thereof) is a
swap, security-based swap, or both (i.e., a mixed swap). The rules also
would establish a process with respect to mixed swaps through which a
person could submit a request to the Commissions that the Commissions
issue a joint order permitting the requesting person (and any other
person or persons that subsequently lists, trades, or clears that class
of mixed swap) to comply, as to parallel provisions only, with the
specified parallel provisions, instead of being required to comply with
parallel provisions of both the CEA and the Exchange Act. The hours and
costs associated with preparing and sending these requests would
constitute reporting and cost burdens imposed by each collection of
information.
2. Summary of Collection of Information Under Proposed Rules 3a68-2 and
3a68-4(c)
The SEC is proposing new rules that would allow persons to submit
requests to the Commissions for joint interpretations regarding whether
a particular agreement, contract, or transaction (or class thereof) is
a swap, security-based swap, or both (i.e., a mixed swap), and for
joint orders permitting alternative regulatory treatment for particular
mixed swaps.
First, the SEC is proposing new rule 3a68-2, which would allow
persons to submit a request for a joint interpretation from the
Commissions regarding whether an agreement, contract, or transaction
(or a class thereof) is a swap, security-based swap, or both (i.e., a
mixed swap). Under proposed rule 3a68-2, a person would provide to the
Commissions a copy of all material information regarding the terms of,
and a statement of the economic characteristics and purpose of, each
relevant agreement, contract, or
[[Page 29876]]
transaction (or class thereof), along with that person's determination
as to whether each such agreement, contract, or transaction (or class
thereof) should be characterized as a swap, security-based swap, or
both (i.e., a mixed swap). The Commissions also may request the
submitting person to provide additional information.
The Commissions may issue in response a joint interpretation or
joint notice of proposed rulemaking regarding the status of that
agreement, contract, or transaction (or class thereof) as a swap,
security-based swap, or both (i.e., a mixed swap). Any joint
interpretation, like any joint notice of proposed rulemaking, will be
public and may discuss the material information regarding the terms of
the relevant agreement, contract, or transaction (or class thereof), as
well as any other information the Commissions deem material to the
interpretation.
Requesting persons also would be permitted to withdraw a request
made pursuant to proposed rule 3a68-2 at any time before the
Commissions have issued a joint interpretation or joint notice of
proposed rulemaking in response to the request. Regardless of a
particular request for interpretation, however, the Commissions could
provide such a joint interpretation or joint notice of proposed
rulemaking of their own accord.
Persons would submit requests pursuant to proposed rule 3a68-2 on a
voluntary basis. However, if a person submits a request, all of the
information required under the proposed rule, including any additional
information requested by the Commissions, must be submitted to the
Commission, except to the extent a person withdraws the request
pursuant to the proposed rule.
For purposes of the PRA, the SEC estimates that the total annual
paperwork burden resulting from proposed rule 3a68-2 would be
approximately 20 hours of internal company or individual time and a
cost of approximately $9,480 for the services of outside professionals
that the SEC believes would consist of services provided by
attorneys.\345\ As discussed further below, these total costs include
all collection burdens associated with the proposed rules, including
burdens related to the initial determination requirements.
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\345\ For convenience, the estimated PRA hour burdens have been
rounded to the nearest whole dollar. Data from SIFMA's ``Management
& Professional Earnings in the Securities Industry 2009,'' modified
by SEC staff to account for an 1800-hour work-year and multiplied by
5.35 to account for bonuses, firm size, employee benefits, and
overhead, suggest that that the cost of an attorney is $316 per
hour.
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Second, the SEC is proposing new rule 3a68-4(c), which would allow
persons to submit requests to the Commissions for joint orders
regarding the regulation of a particular mixed swap (or class thereof).
Under proposed rule 3a68-4(c), a person would provide to the
Commissions a copy of all material information regarding the terms of,
and the economic characteristics and purpose of, the specified (or
specified class of) mixed swap. In addition, a person would provide the
specified parallel provisions, and the reasons the person believes such
specified parallel provisions would be appropriate for relevant mixed
swap (or class thereof), and an analysis of: (i) The nature and
purposes of the parallel provisions that are the subject of the
request; (ii) the comparability of such parallel provision; and (iii)
the extent of any conflicts or differences between such parallel
provisions. The Commissions also may request the submitting person to
provide additional information.
The Commissions may issue in response a joint order, after public
notice and opportunity for comment, providing that the requesting
person (and any other person or persons that subsequently lists,
trades, or clears that mixed swap (or class thereof)) is permitted to
comply, as to parallel provisions only, with the specified parallel
provisions (or another subset of the parallel provisions that are the
subject of the request, as the Commissions determine is appropriate),
instead of being required to comply with parallel provisions of both
the CEA and the Exchange Act. Any joint order will be public and may
discuss the material information regarding the terms of the mixed swap
(or class thereof), as well as any other information the Commissions
deem material to the order. Requesting persons also would be permitted
to withdraw a request made pursuant to proposed rule 3a68-4(c) at any
time before the Commissions have issued a joint order in response to
the request.
Persons would submit requests pursuant to proposed rule 3a68-4(c)
on a voluntary basis. However, if a person submits a request, all of
the information required under the proposed rule, including any
additional information requested by the Commissions, must be submitted
to the Commission, except to the extent a person withdraws the request
pursuant to the proposed rule.
For purposes of the PRA, the SEC estimates that the total annual
incremental paperwork burden resulting from proposed rule 3a68-4(c)
would be approximately 30 hours of internal company or individual time
and a cost of approximately $15,800 for the services of outside
professionals, which the SEC believes would consist of services
provided by attorneys.\346\ As discussed further below, these total
costs include all collection burdens associated with the proposed
rules, including burdens related to the initial determination
requirements.
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\346\ See supra note 345.
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3. Proposed Use of Information
The SEC would use the information collected pursuant to proposed
rule 3a68-2 to evaluate an agreement, contract, or transaction (or
class thereof) in order to provide joint interpretations or joint
notices of proposed rulemaking with the CFTC regarding whether these
agreements, contracts, or transactions (or classes thereof) are swaps,
security-based swaps, or both (i.e., mixed swaps) as defined in the
Dodd-Frank Act. The SEC would use the information collected pursuant to
proposed rule 3a68-4(c) to evaluate a specified, or a specified class
of, mixed swaps in order to provide joint orders or joint notices of
proposed rulemaking with the CFTC regarding the regulation of that
particular mixed swap or class of mixed swap. The information provided
to the SEC pursuant to proposed rules 3a68-2 and 3a68-4(c) also would
allow the SEC to monitor the development of new OTC derivatives
products in the marketplace and determine whether additional rulemaking
or interpretive guidance is necessary or appropriate.
4. Respondents
It is difficult to calculate the precise number of requests that
would be submitted to the Commissions under proposed rules 3a68-2 and
3a68-4(c), given the historical unregulated state of the OTC
derivatives market. Although any person could submit a request under
proposed rule 3a68-2, the SEC believes as a practical matter that the
relevant categories of such persons would be swap dealers and security-
based swap dealers, major swap participants and major security-based
swap participants, SEFs, security-based SEFs, DCOs clearing swaps, DCMs
trading swaps, SDRs, SBSDRs, and clearing agencies clearing security-
based swaps, and the total number of persons could be 475.\347\
Similarly, although any
[[Page 29877]]
person could submit a request under proposed rule 3a68-4(c), the SEC
believes as a practical matter that the relevant categories of such
persons would be SEFs, security-based SEFs, and DCMs trading swaps, and
the total number of persons could be 72.\348\
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\347\ This total number includes an estimated 250 swap dealers,
50 major swap participants, 50 security-based swap dealers, 10 major
security-based swap participants, 35 SEFs, 20 security-based SEFs,
12 DCOs, 17 DCMs, 15 SDRs, 10 SBSDRs, and 6 clearing agencies, as
set forth by the CFTC and SEC, respectively, in their other Dodd-
Frank Act rulemaking proposals. See Entity Definitions, supra note
12 (regarding security-based swap dealers and major security-based
swap participants); Registration of Swap Dealers and Major Swap
Participants, supra note 330 (regarding swap dealers and major
security-based swap participants); Security-Based Swap Data
Repository Registration, Duties, and Core Principles, supra note 6
(regarding SBSDRs); Swap Data Repositories, supra note 330
(regarding SDRs); Core Principles and Other Requirements for Swap
Execution Facilities, 76 FR 1214, Jan. 7, 2011 (regarding SEFs);
Registration and Regulation of Security-Based Swap Execution
Facilities, 76 FR 10948, Feb. 28, 2011 (regarding security-based
SEFs); Financial Resources Requirements for Derivatives Clearing
Organizations, 75 FR 63113, Oct. 14, 2010 (regarding DCOs);
Information Management Requirements for Derivatives Clearing
Organizations, 75 FR 78185, Dec. 15, 2010 (regarding DCOs); Risk
Management Requirements for Derivatives Clearing Organizations, 76
FR 3698, Jan. 20, 2011 (regarding DCOs); Core Principles and Other
Requirements for Designated Contract Markets, 75 FR 80572, Dec. 22,
2010 (regarding DCMs); Clearing Agency Standards for Operation and
Governance, 76 FR 14472, Mar. 16, 2011 (regarding clearing
agencies).
\348\ Id.
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However, based on the SEC's experience and information received
from commenters to the ANPR \349\ and during meetings with the public
to discuss the Product Definitions generally, including the
interpretation of whether a transaction is a swap, security-based swap,
or both (i.e., a mixed swap), and taking into consideration the
certainty provided by the proposed rules and interpretive guidance in
this release, the SEC believes that the number of requests that would
be submitted by such persons to the Commissions to provide joint
interpretations as to whether a given agreement, contract, or
transaction is a swap, security-based swap, or both (i.e., a mixed
swap), would be small, and therefore expects that only a small number
of requests would be submitted pursuant to proposed rule 3a68-2. With
respect to proposed rule 3a68-4(c), the SEC also estimates the number
of requests for joint orders would be small.\350\ Pursuant to the
Commissions' proposed rules and interpretive guidance, a number of
persons that engage in agreements, contracts, or transactions that are
swaps, security-based swaps, or both (i.e., a mixed swap) would be
certain that their transactions are, indeed, swaps, security-based
swaps, or both, (i.e., a mixed swap) and would not request an
interpretation pursuant to proposed rule 3a68-2. Also, as the
Commissions provide joint interpretations regarding whether agreements,
contracts, or transactions (or classes thereof) are or are not swaps,
security-based swaps, or both (i.e., mixed swaps), the SEC expects that
the number of requests for interpretation will decrease over time. The
SEC believes that the rules and interpretive regarding swaps, security-
based swaps, and mixed swaps the Commissions are proposing, as well as
the additional guidance issues pursuant to joint interpretations and
orders under proposed rules 3a68-2 and 3a68-4 will result in a narrow
pool of potential respondents, approximately 50,\351\ to the collection
of information requirements of proposed rule 3a68-2.
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\349\ See supra note 283 and accompanying text.
\350\ See discussion supra part IV.A.
\351\ The SEC believes that there would be approximately 50
requests in the first year. See discussion infra part IX.A.5. The
SEC recognizes that one person might submit more than one request,
but for purposes of the PRA is considering each such request as one
person in order to provide a more conservative estimate of the
number of persons that would be subject to paperwork burdens.
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Similarly, because the SEC believes that both the category of mixed
swap transactions and the number of market participants that engage in
mixed swap transactions are small, the SEC believes that the pool of
potential persons requesting a joint order regarding the regulation of
a specified, or specified class of, mixed swap pursuant to proposed
rule 3a68-4(c) would be small (approximately 10 \352\). Also, those
requests submitted pursuant to proposed rule 3a68-2 that result in an
interpretation that the agreement, contract, or transaction (or class
thereof) is not a mixed swap would reduce the pool of possible persons
submitting a request regarding the regulation of particular mixed swaps
(or class thereof) pursuant to proposed rule 3a68-4(c). In addition,
not only the requesting party, but also any other person or persons
that subsequently lists, trades, or clears that mixed swap, would be
subject to, and must comply with, the joint order regarding the
regulation of the specified, or specified class of, mixed swap, as
issued by the Commissions. Therefore, the SEC believes that the number
of requests for a joint order regarding the regulation of mixed swaps,
particularly involving specified classes of mixed would decrease over
time.
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\352\ See id.
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The SEC seeks comment on the number of persons that potentially
would submit requests pursuant to rules 3a68-2 and 3a68-4(c).
5. Paperwork Reduction Act Burden Estimates
Proposed rules 3a68-2 and 3a68-4(c) would, if adopted, require
submission of certain information to the Commissions to the extent
persons elect to request an interpretation and/or alternative
regulatory treatment. Proposed rules 3a68-2 and 3a68-4(c) each require
the information that a requesting party must include in its request to
the Commissions in order to receive a joint interpretation or order, as
applicable.
(a) Proposed Rule 3a68-2
Proposed rule 3a68-2 would require any party requesting a joint
interpretation under the rule to include disclosures about the
agreement, contract, or transaction (or class thereof) in question as
well as a statement of economic purpose and the requesting party's
initial determination regarding whether the agreement, contract, or
transaction (or class thereof) is a swap, security-based swap, or both
(i.e., a mixed swap). The proposed rule would apply only to requests
made by persons that desire an interpretation from the Commissions. For
each agreement, contract, or transaction (or class thereof) for which a
person requests the Commissions' joint interpretation, the requesting
person would be required to provide a copy of all material information
regarding the applicable terms; a statement of the economic
characteristics and purpose; and the requesting person's determination
as to whether such agreement, contract, or transaction (or class
thereof) is a swap, security-based swap, or both (i.e., a mixed swap),
including the basis for the requesting person's determination. The
requesting person also would be required to provide such other
information as the Commissions may request.
As discussed above, the SEC believes the number of persons that
would submit requests pursuant to proposed rule 3a68-2 is quite small
given the proposed rules and interpretive guidance regarding swaps,
security-based swaps, and mixed swaps the Commissions are
providing.\353\ Although the SEC does not have precise figures for the
number of requests that persons would submit, the SEC believes it is
reasonable to estimate that it likely
[[Page 29878]]
would be fewer than 50 requests in the first year. For purposes of the
PRA, the SEC estimates the total paperwork burden associated with
preparing and submitting a person's request to the Commissions pursuant
to proposed rule 3a68-2 would be 20 hours per request and associated
costs of $9,480.\354\ Assuming 50 requests in the first year, the SEC
estimates that this would result in an aggregate burden for the first
year of 1000 hours of company time (50 requests x 20 hours/request) and
$474,000 for the services of outside professionals (e.g., attorneys)
(50 requests x 30 hours/request x $316).
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\353\ This estimate is based on comments from and discussions
with market participants regarding uncertainty concerning whether
certain contracts might be considered swaps, security-based swaps,
or both, i.e., mixed swaps, and the size of the mixed swaps
category, although the SEC has not received data regarding the
specific number of potential transaction types for which there is
uncertainty or that are mixed swaps.
\354\ This estimate is based on information indicating that the
average burden associated with preparing and submitting a no-action
request to the SEC staff in connection with the identification of
whether certain products were securities, which the SEC believes is
a process similar to the process under proposed rule 3a68-2, was
approximately 20 hours and associated costs of $9,480. Assuming
these costs correspond to legal fees, which we estimate at an hourly
cost of $316, we estimate that this cost is equivalent to
approximately 30 hours ($9,480/$316).
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As discussed above, the SEC believes that as the Commissions
provide joint interpretations or joint notices of proposed rulemaking,
the number of requests received will decrease over time. Although the
SEC does not have precise figures for the number of requests that
persons would submit after the first year, the SEC believes it is
reasonable to estimate that it likely would be fewer than 10 requests
on average in ensuing years. Assuming 10 requests in ensuing years, the
SEC estimates that this would result in an aggregate burden in each
ensuing year of 200 hours of company time (10 requests x 20 hours/
request) and $94,800 for the services of outside professionals (e.g.,
attorneys) (10 requests x 30 hours/request x $316).
(b) Proposed Rule 3a68-4(c)
Proposed rule 3a68-4(c) would require any party requesting a joint
order regarding the regulation of a specified, or specified class of,
mixed swap under the rule to include disclosure about the agreement,
contract, or transaction (or class thereof) that is a mixed swap as
well as a statement of economic purpose for the mixed swap (class
thereof). In addition, a person would provide the specified parallel
provisions that the person believes should apply to the mixed swap (or
class thereof), the reasons the person believes the specified parallel
provisions would be appropriate for the mixed swap, and an analysis of:
(i) The nature and purposes of the parallel provisions that are the
subject of the request; (ii) the comparability of such parallel
provisions; and (iii) the extent of any conflicts or differences
between such parallel provisions. The requesting person also would be
required to provide such other information as the Commissions may
request.
As discussed above, the SEC believes the number of requests that
persons would submit pursuant to proposed rule 3a68-4(c) is quite small
given the limited types of agreements, contracts, or transactions (or
class thereof) the Commissions believe would constitute mixed
swaps.\355\ In addition, depending on the characteristics of a mixed
swap (or class thereof), a person may choose not to submit a request
pursuant to proposed rule 3a68-4(c). The SEC also notes that any joint
order issued by the Commissions would apply to any person that
subsequently lists, trades, or clears that specified, or specified
class of, mixed swap, so that requests for joint orders could diminish
over time. Also, persons may submit requests for an interpretation
under proposed rule 3a68-4(c) that do not result in an interpretation
that the agreement, contract, or transaction (or class thereof) is a
mixed swap. Therefore, although the SEC does not have precise figures
for the number of requests that persons would submit, the SEC believes
it is reasonable to estimate that it likely would be fewer than 20
requests in the first year. For purposes of the PRA, the SEC estimates
the total paperwork burden associated with preparing and submitting a
party's request to the Commissions pursuant to proposed rule 3a68-4(c)
would be 30 hours and associated costs of $15,800 per request for mixed
swaps for which a request for a joint interpretation pursuant to
proposed rule 3a68-4(c) was not previously made.\356\ Assuming 20
requests in the first year, the SEC estimates that this would result in
an aggregate burden for the first year of 600 hours of company time (20
requests x 30 hours/request) and $316,000 for the services of outside
professionals (20 requests x 50 hours/request x $316).
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\355\ See supra note 283 and accompanying text.
\356\ This estimate is based on information indicating that the
average burden associated with preparing and submitting a no-action
request to the SEC staff in connection with the regulatory treatment
of certain securities products which the SEC believes is a process
similar to the process under proposed rule 3a68-4(c), was
approximately 30 hours and associated costs of $15,800. Assuming
these costs correspond to legal fees, which we estimate at an hourly
cost of $316, we estimate that this cost is equivalent to
approximately 50 hours ($15,800/$316).
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For mixed swaps for which a request for a joint interpretation
pursuant to proposed rule 3a68-2 was previously made, the SEC estimates
the total paperwork burden under the PRA associated with preparing and
submitting a party's request to the Commissions pursuant to proposed
rule 3a68-4(c) would be 10 hours fewer and $4,740 less per request than
for mixed swaps for which a request for a joint interpretation pursuant
to proposed rule 3a68-2 was not previously made because certain,
although not all, of the information required to be submitted and
necessary to prepare pursuant to proposed rule 3a68-4(c) would have
been required to be submitted and necessary to prepare pursuant to
proposed rule 3a68-2.\357\ Although certain requests made pursuant to
proposed rule 3a68-4(c) may be made without a previous request for a
joint interpretation pursuant to proposed rule 3a68-2, the SEC believes
that most requests under proposed rule 3a68-2 that result in the
interpretation that an agreement, contract, or transaction (or class
thereof) is a mixed swap will result in a subsequent request for
alternative regulatory treatment pursuant to proposed rule 3a68-4(c).
Assuming, therefore, that 90 percent, or 18 of the estimated 20
requests pursuant to proposed rule 3a68-4(c) in the first year, as
discussed above, would be such ``follow-on'' requests, the SEC
estimates that this would result in an aggregate burden in the first
year of 360 hours of company time (18 requests x 20 hours/request) and
$199,080 for the services of outside professionals (18 requests x 35
hours/request x $316).
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\357\ This estimate takes into account that certain information
regarding the mixed swap (or class thereof), namely the material
terms and the economic purpose, will have already been gathered and
prepared as part of the request submitted pursuant to proposed rule
3a68-2. The SEC estimates that these items constitute approximately
10 hours fewer and a reduction in associated costs of $4,740.
Assuming these costs correspond to legal fees, which we estimate at
an hourly cost of $316, we estimate that this cost is equivalent to
approximately 15 hours ($4,740/$316).
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As discussed above, the SEC believes that as the Commissions
provide joint orders regarding alternative regulatory treatment, the
number of requests received will decrease over time. The SEC believes
it is reasonable to estimate that it likely would be fewer than 5
requests on average in ensuing years. Assuming 5 requests in ensuing
years, the SEC estimates that this would result in an aggregate burden
in each ensuing year of 150 hours of company time (5 requests x 30
hours/request) and $79,000 for the services of outside professionals (5
requests x 50 hours/request x $316). As discussed above, assuming that
approximately 90 percent, or 4 of the estimated 5 requests pursuant to
proposed rule 3a68-4(c) in
[[Page 29879]]
ensuing years would be ``follow-on'' requests to requests for joint
interpretation from the Commissions under proposed rule 3a68-4(c), the
SEC estimates that this would result in an aggregate burden in each
ensuing year of 80 hours of company time (4 requests x 20 hours/
request) and $44,240 for the services of outside professionals (4
requests x 35 hours/request x $316).
Request for Comment
Pursuant to 44 U.S.C. 3506(c)(2)(B), the SEC solicits comments to:
(i) Evaluate whether the proposed collection of information is
necessary for the proper performance of the functions of the agency,
including whether the information will have practical utility; (ii)
evaluate the accuracy of the SEC's estimate of burden of the proposed
collection of information; (iii) determine whether there are ways to
enhance the quality, utility, and clarity of the information to be
collected; and (iv) evaluate whether there are ways to minimize the
burden of the collection of information on those that are to respond,
including through the use of automated collection techniques or other
forms of information technology. In addition, the SEC requests comment
on the accuracy of the estimates regarding the total paperwork burden.
In particular, the SEC requests comment for purposes of the PRA on
the following:
149. How many requests for a joint interpretation from the
Commissions would be submitted pursuant to rule 3a68-2?
150. How many requests for a joint order from the Commissions would
be submitted pursuant to rule 3a68-4(c)?
151. How many requests for a joint order from the Commissions would
be submitted pursuant to rule 3a68-4(c) regarding the same agreement,
contract, or transaction (or class thereof) that was the subject of a
request for a joint interpretation from the Commissions submitted
pursuant to rule 3a68-2?
152. Are the paperwork burden estimates, for both company time and
outside services, as discussed above accurate? Do these estimates
reflect the paperwork burdens and costs associated with requests made
pursuant to proposed rules 3a68-2 and 3a68-4(c)?
Commenters should, when possible, provide empirical data to support
their views.
Any member of the public may direct to us or to OMB any comments
concerning the accuracy of these burden estimates and any suggestions
for reducing these burdens. Persons submitting comments on the
collection of information requirements should direct the comments to
the Office of Management and Budget, Attention Desk Officer for the
Securities and Exchange Commission, Office of Information and
Regulatory Affairs, Washington, DC 20503, and should send a copy to
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090, with reference to File No. S7-16-11.
Requests for materials submitted to OMB by the SEC with regard to these
collections of information should be in writing, refer to File No. S7-
16-11, and be submitted to the Securities and Exchange Commission,
Office of Investor Education and Advocacy, 100 F Street NE.,
Washington, DC 20549-0213. OMB is required to make a decision
concerning the collection of information between 30 and 60 days after
publication of this release. Consequently, a comment to OMB is best
ensured of having its full effect if OMB receives it within 30 days of
publication.
B. Cost-Benefit Analysis
1. Background
Title VII establishes a regulatory framework for OTC derivatives.
As part of that framework, Title VII amends the CEA and the Exchange
Act to broadly categorize covered derivative products as swaps,
security-based swaps, SBSAs, and/or mixed swaps. In particular, section
712(d)(1) of the Dodd-Frank Act provides that the Commissions, in
consultation with the Board, shall jointly further define, among other
things, the terms ``swap,'' ``security-based swap,'' and ``security-
based swap agreement.'' Section 712(a)(8) of the Dodd-Frank Act
provides further that the Commissions shall jointly prescribe such
regulations regarding ``mixed swaps'' as may be necessary to carry out
the purposes of Title VII. In addition, sections 712(d)(2)(B) and (C)
of the Dodd-Frank Act require the Commissions, in consultation with the
Board, to jointly adopt rules governing books and records for SBSAs for
SDRs that are registered under the CEA, swap dealers, major swap
participants, security-based swap dealers, and major security-based
swap participants.
The Product Definitions and the regulation of mixed swaps are part
of the Dodd-Frank Act's comprehensive framework for regulating the
swaps markets whereby the CFTC is given regulatory authority over
``swaps,'' \358\ the SEC is given regulatory authority over ``security-
based swaps,'' \359\ and the Commissions shall jointly prescribe such
regulations regarding mixed swaps as may be necessary to carry out the
purposes of Title VII.\360\ In addition, the SEC is given antifraud
authority over, and access to information from certain CFTC-regulated
entities (e.g., DCOs, SEFs, and swap dealers) regarding, SBSAs.\361\
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\358\ See CEA section 1a(47), 7 U.S.C. 1a(47) (cross-referenced
in section 3(a)(69) of the Exchange Act, 15 U.S.C. 78c(a)(69)).
\359\ See section 3(a)(68) of the Exchange Act, 15 U.S.C.
78c(a)(68) (cross-referenced in CEA section 1a(42), 7 U.S.C.
1a(42)).
\360\ See CEA section 1a(47)(D), 7 U.S.C. 1a(47)(D); section
3(a)(68)(D) of the Exchange Act, 15 U.S.C. 78c(68)(D).
\361\ See section 3(a)(78) of the Exchange Act, 15 U.S.C.
78c(a)(78); CEA section 1a(47)(A)(v), 7 U.S.C. 1a(47)(A)(v).
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In most instances, the Commissions' proposed rules and guidance
merely clarify the application of the Product Definitions to specific
products as is required by the relevant provisions of the CEA and
Exchange Act, as modified by the Dodd-Frank Act and the regulation of
mixed swaps. However, for some of the rules the Commissions are
proposing, the Commissions are exercising their discretion to further
define the Product Definitions and to regulate mixed swaps, which would
generate costs and benefits to market participants. The Commissions
also are fulfilling the requirement in Dodd-Frank that they establish
requirements regarding books and records with respect to SBSAs, which
also would generate costs and benefits to market participants. The
costs and benefits regarding these rules are discussed below.
2. Proposed Rule 3a68-1a
(a) Benefits
A security-based swap includes a swap that is based on the
``occurrence, nonoccurrence, or extent of the occurrence of an event
relating to a single issuer of a security or the issuers of securities
in a narrow-based security index, provided that such event directly
affects the financial statements, financial condition, or financial
obligations of the issuer'' (the ``Event Provision'').\362\ Proposed
rule 3a68-1a would provide that, solely for purposes of determining
whether a CDS is a security-based swap under the Event Provision, the
term ``issuers of securities in a narrow-based security index'' would
have the meaning as set forth in proposed rule 3a68-1a.
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\362\ Section 3(a)(68)(A)(ii)(III) of the Exchange Act, 15
U.S.C. 78c(a)(68)(A)(ii)(III).
---------------------------------------------------------------------------
Because index CDS typically are written on indexes of entity names,
not on indexes of the specific securities of those entities, the
Commissions are
[[Page 29880]]
concerned that the application of the Event Provision, without further
clarification, may cause uncertainty about whether certain index CDS
would be security-based swaps or swaps. Therefore, proposed rule 3a68-
1a would eliminate the potential uncertainty of the treatment of index
CDS as either security-based swaps or swaps by setting forth clear and
objective criteria for meeting the definition of ``issuers of
securities in a narrow-based security index'' and therefore being a
security-based swap.
The SEC requests comments, data, and estimates regarding the
benefits associated with proposed rule 3a68-1a. The SEC also requests
comments, data, and estimates regarding any additional benefits that
could be realized with proposed rule 3a68-1a.
(b) Costs
In complying with proposed rule 3a68-1a, a market participant will
need to ascertain whether an index CDS is a security-based swap or swap
according to the criteria set forth for meeting the definition of
``issuers of securities in a narrow-based security index.'' This
analysis will have to be performed by market participants upon entering
into an index CDS to determine whether the index CDS is subject to the
SEC's regulatory regime for security-based swaps or the CFTC's
regulatory regime for swaps. The SEC notes, however, that any such
costs would be in lieu of the costs of doing the same analysis under
the statutory security-based swap definition. Because the statutory
security-based swap definition lacks the specificity provided by
proposed rule 3a68-1a, the SEC believes analysis of an index CDS would
under proposed rule 3a68-1a would lead to less uncertainty than would
the same analysis under the statutory security-based swap definition.
Providing a clear rule to persons to determine whether an index CDS is
a security-based swap under section 3(a)(68)(A)(ii)(III) of the
Exchange Act \363\ could alleviate additional costs to persons of
inquiring with the Commissions about whether an index CDS is a swap or
security-based swap under that provision, as well as costs of obtaining
an opinion of counsel regarding the applicability of that provision to
a particular index CDS.
---------------------------------------------------------------------------
\363\ 15 U.S.C. 78c(a)(68)(A)(ii)(III).
---------------------------------------------------------------------------
In addition, proposed rule 3a68-1a is generally consistent with the
definition of ``narrow-based security index'' that exists in section
3(a)(55)(B) of the Exchange Act, as modified to address debt securities
in the context of security futures.\364\ Because some market
participants are familiar with this definition, as well as with
performing analyses of products in the security futures context based
on this definition, the SEC believes that the proposed definition of
``issuers of securities in a narrow-based security index'' will
mitigate uncertainty for those market participants regarding the
treatment of index CDS. In addition, because such market participants
would be familiar with many of the criteria in proposed rule 3a68-1a,
such market participants would require less time and effort, and thus
incur less cost, in determining the scope and applicability of such
criteria to the determination of whether an index CDS is a swap or
security-based swap.
---------------------------------------------------------------------------
\364\ See July 2006 Rules, supra note 199.
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The SEC requests comment as to the costs that determinations under
proposed rule 3a68-1a would impose on market participants, as well as
estimates and empirical data to support these costs. In addition, the
SEC requests comment on any other costs associated with proposed rule
3a68-1a that have not been considered and what the extent of those
costs would be.
3. Proposed Rule 3a68-1b
(a) Benefits
A security-based swap includes a swap that is based on ``an index
that is a narrow-based security index, including any interest therein
or on the value thereof.'' \365\ Proposed rule 3a68-1b would provide
that, solely for purposes of determining whether a CDS is a security-
based swap under section 3(a)(68)(A)(ii)(I) of the Exchange Act,\366\
the term ``narrow-based security index'' would have the meaning as set
forth in proposed rule 3a68-1b.
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\365\ Section 3(a)(68)(A)(ii)(I) of the Exchange Act, 15 U.S.C.
78c(a)(68)(A)(ii)(I).
\366\ 15 U.S.C. 78c(a)(68)(A)(ii)(I).
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Because index CDS may be written in indexes of the specific
securities of entities as well as on indexes of entity names, the
Commissions are concerned that the application of section
3(a)(68)(A)(ii)(I) of the Exchange Act,\367\ without further
clarification, may cause uncertainty about whether certain index CDS
would be security-based swaps or swaps. Therefore, proposed rule 3a68-
1b would eliminate the potential uncertainty of the treatment of index
CDS as either security-based swaps or swaps by setting forth clear and
objective criteria for meeting the definition of ``narrow-based
security index'' and therefore being a security-based swap.
---------------------------------------------------------------------------
\367\ 15 U.S.C. 78c(a)(68)(A)(ii)(I).
---------------------------------------------------------------------------
The SEC requests comments, data, and estimates regarding the
benefits associated with proposed rule 3a68-1b. The SEC also requests
comments, data, and estimates regarding any additional benefits that
could be realized with proposed rule 3a68-1b.
(b) Costs
In complying with proposed rule 3a68-1b, a market participant will
need to ascertain whether an index CDS is a security-based swap or swap
according to the criteria set forth for meeting the definition of
``narrow-based security index.'' This analysis will have to be
performed by market participants upon entering into an index CDS to
determine whether the index CDS is subject to the SEC's regulatory
regime for security-based swaps or the CFTC's regulatory regime for
swaps. The SEC notes, however, that any such costs would be in lieu of
the costs of doing the same analysis under the statutory security-based
swap definition. Because the statutory security-based swap definition
lacks the specificity provided by proposed rule 3a68-1b, the SEC
believes analysis of an index CDS would under proposed rule 3a68-1b
lead to less uncertainty than would the same analysis under the
statutory security-based swap definition. Providing a clear rule to
persons to determine whether an index CDS is a security-based swap
under section 3(a)(68)(A)(ii)(I) of the Exchange Act \368\ could
alleviate additional costs to persons of inquiring with the Commissions
about whether an index CDS is a swap or security-based swap under that
provision, as well as costs of obtaining an opinion of counsel
regarding the applicability of that provision to a particular index
CDS.
---------------------------------------------------------------------------
\368\ 15 U.S.C. 78c(a)(68)(A)(ii)(I).
---------------------------------------------------------------------------
In addition, proposed rule 3a68-1b is generally consistent with the
definition of ``narrow-based security index'' that exists in section
3(a)(55)(B) of the Exchange Act, as modified to address debt securities
in the context of security futures.\369\ Because some market
participants are familiar with this definition, as well as with
performing analyses of products in the security futures context based
on this definition, the SEC believes that the proposed definition of
``narrow-based security index'' will mitigate uncertainty for those
market participants regarding the treatment of index CDS. In addition,
because such market participants would be familiar with many of the
criteria in proposed rule 3a68-1b, such market
[[Page 29881]]
participants would require less time and effort, and thus incur less
cost, in determining the scope and applicability of such criteria to
the determination of whether an index CDS is a swap or security-based
swap.
---------------------------------------------------------------------------
\369\ See July 2006 Rules, supra note 199.
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The SEC requests comment as to the costs that determinations under
proposed rule 3a68-1a would impose on market participants, as well as
estimates and empirical data to support these costs. In addition, the
SEC requests comment on any other costs associated with proposed rule
3a68-1a that have not been considered and what the extent of those
costs would be.
4. Proposed Rule 3a68-2
(a) Benefits
Proposed rule 3a68-2 would establish a process for persons to
request an interpretation of whether an agreement, contract, or
transaction (or class of agreements, contracts, or transactions) is a
swap, security-based swap, or both (i.e., a mixed swap).
Proposed rule 3a68-2 would afford persons with the opportunity to
obtain greater certainty from the Commissions regarding whether certain
products are swaps, security-based swaps, or both, i.e., mixed swaps.
The SEC believes that this provision would decrease the possibility
that market participants inadvertently might violate regulatory
requirements regarding products that may constitute swaps, security-
based swaps, or mixed swaps, which could lead to enforcement action. It
also would decrease the likelihood that products might fall into
regulatory gaps by providing a method for market participants to seek
interpretations regarding the status of products for which the
applicable regulatory regime might otherwise remain uncertain. In
addition, the SEC believes the proposed rule will provide the
opportunity for financial innovation by providing a flexible structure
that will allow for the development of new products that otherwise
might be hindered by the lack of regulatory certainty.
(b) Costs
Under proposed rule 3a68-2, a person could request the Commissions
to provide an interpretation of whether an agreement, contract, or
transaction (or class thereof) is a swap, security-based swap, or mixed
swap. The SEC estimates that the cost of requesting this interpretation
for a particular agreement, contract, or transaction (or class thereof)
would be approximately 20 hours of internal company or individual time
and a cost of approximately $9,480 for the services of outside
professionals.\370\ The SEC notes, however, that any such costs are in
lieu of the costs of doing the same analysis without requesting the
Commissions to provide an interpretation. In addition, as noted above,
if the Commissions provide an interpretation pursuant to a request
under proposed rule 3a68-2, a market participant, and other market
participants that desire to transact in the same (or same class of)
agreement, contract, or transaction, would have regulatory certainty
about whether that agreement, contract, or transaction (or class
thereof) is a swap, security-based swap, or both (i.e., a mixed swap).
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\370\ See discussion supra part VIII.
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Also, the SEC believes that as persons make requests for
interpretations about whether agreements, contracts, or transactions
(or classes thereof agreements) are swaps, security-based swaps, or
both, i.e., mixed swaps, pursuant to proposed rule 3a68-2, the
subsequent costs for persons transacting in those products for which
the Commissions have provided interpretations should be reduced.
The SEC requests comment as to the costs that proposed rule 3a68-2
would impose on market participants, as well as estimates and empirical
data to support these costs. In addition, the SEC requests comment on
any other costs associated with proposed rule 3a68-2 that have not been
considered herein and what the extent of those costs would be.
5. Proposed Rule 3a68-3
(a) Benefits
Proposed rule 3a68-3 would provide that, except as otherwise
provided in proposed rule 3a68-3, for purposes of section 3(a)(68) of
the Exchange Act,\371\ the term ``narrow-based security index'' has the
meaning set forth in section 3(a)(55) of the Exchange Act,\372\ and the
rules, regulations, and orders of the SEC thereunder. This definition
would eliminate potential uncertainty regarding the treatment of a
narrow-based security index to which section 3(a)(55) of the Exchange
Act also applies.\373\
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\371\ 15 U.S.C. 78c(a)(68).
\372\ 15 U.S.C. 78c(a)(55).
\373\ 15 U.S.C. 78c(a)(55).
---------------------------------------------------------------------------
Proposed rule 3a68-3 also would provide a tolerance period for the
definition of ``narrow-based security index'' to ensure that, under
certain conditions, a security index underlying a swap will not be
considered a narrow-based security index and a security index
underlying a security-based swap will be considered a narrow-based
security index, even when the security index underlying the swap or
security-based swap temporarily assumes characteristics that would
render it a narrow-based security index or not a narrow-based security
index, respectively. In addition, proposed rule 3a68-3 would provide
for an additional 3-month grace period applicable to a security index
that becomes narrow-based, or broad-based, as applicable, for more than
45 business days over 3 consecutive calendar months.
Because security indexes underlying Title VII instruments may
migrate from narrow-based to broad-based, or vice versa, the
Commissions are concerned that application of the narrow-based security
index definition, without further clarification, may cause uncertainty
regarding treatment of Title VII instruments traded on trading
platforms when such migration has occurred. Therefore, proposed rule
3a68-3 would eliminate the potential uncertainty of the treatment of
such Title VII instruments by setting forth clear and objective
criteria regarding the application of the narrow-based security index
definition to security indexes that have migrated from narrow-based to
broad-based or from broad-based to narrow-based.
The SEC requests comments, data, and estimates regarding the
benefits associated with proposed rule 3a68-3. The SEC also requests
comments, data, and estimates regarding any additional benefits that
could be realized with proposed rule 3a68-3.
(b) Costs
In complying with proposed rule 3a68-3, a market participant will
need to ascertain whether a security index underlying a Title VII
instrument is narrow-based or broad-based according to the criteria set
forth for the tolerance periods and grace periods in the proposed rule.
This analysis would be performed upon entering into Title VII
instrument on a security index to ensure compliance with proposed rule
3a68-3. The SEC notes, however, that any such costs would be in lieu of
the costs of doing the same analysis under the narrow-based security
index definition, which the SEC believes would be more difficult and
lead to greater uncertainty, rather than the clarity provided under
proposed rule 3a68-3. Providing a clear rule to market participants to
determine whether a Title VII instrument traded on a trading platform
where the underlying security index has so migrated could alleviate
additional costs to persons of inquiring with the Commissions about
whether a Title VII instrument is a swap or a security-based swap, as
well as costs of obtaining an opinion of counsel
[[Page 29882]]
regarding a particular Title VII instrument.
In addition, proposed rule 3a68-3 is generally consistent with the
tolerance period and grace period that exist in section 3(a)(55) of the
Exchange Act for futures contracts.\374\ Because market participants
are familiar with such tolerance period and grace period as well as
with performing analyses of products in the futures context based on
these provisions, the SEC believes that the proposed tolerance period
and grace period in proposed rule 3a68-3 will mitigate uncertainty for
market participants regarding the treatment of these Title VII
instruments. Proposed rule 3a68-3 also would allow market participants
to minimize the costs of determining whether a security index
underlying a Title VII instrument is considered narrow-based or not by
providing a test that is substantially similar to a test with which
they are familiar in the futures context. In addition, the tolerance
period under proposed rule 3a68-3 mitigates uncertainty for market
participants trading Title VII instruments on trading platforms by
allowing temporary migration of an underlying security index within
certain specifications without disrupting the status of Title VII
instruments based on that security index. Similarly, the grace period
under proposed rule 3a68-3 mitigates uncertainty for market
participants trading Title VII instruments on trading platforms by
allowing time for any necessary actions to be made to accommodate the
non-temporary migration of a security index underlying Title VII
instruments.
---------------------------------------------------------------------------
\374\ See supra note 261 and accompanying text.
---------------------------------------------------------------------------
The SEC requests comment as to the costs that determinations under
proposed rule 3a68-3 would impose on market participants, as well as
estimates and empirical data to support these costs. In addition, the
SEC requests comment on any other costs associated with proposed rule
3a68-3 that have not been considered, and what the extent of those
costs would be.
6. Proposed Rule 3a68-4
(a) Benefits
A mixed swap is both a security-based swap and a swap, subject to
dual regulation by the Commissions, and proposed rule 3a68-4 would
define the term ``mixed swap'' in the same manner as the term is
defined in both the Exchange Act.\375\ Proposed rule 3a68-4 would also
provide that a mixed swap that is not executed on or subject to the
rules of a DCM, SEF, FBOT, NSE, or security-based SEF and that will not
be submitted to a DCO or registered or exempt clearing agency to be
cleared (``bilateral uncleared mixed swap''), and where at least one
party to the mixed swap is registered with the SEC as a security-based
swap dealer or major security-based swap participant and also with the
CFTC as a swap dealer or major swap participant, shall be subject to
the provisions of the Securities Act and the rules and regulations
promulgated thereunder and only to certain provisions of the CEA and
the rules and regulations promulgated thereunder. In addition, proposed
rule 3a68-4 would establish a process for persons to request that such
persons be permitted to comply, as to parallel provisions only, with
the specified parallel provisions, instead of being required to comply
with parallel provisions of both the CEA and the Exchange Act.
---------------------------------------------------------------------------
\375\ Section 3(a)(68)(D) of the Exchange Act, 15 U.S.C.
78c(a)(68)(D); CEA section 1(a)(47)(D), 7 U.S.C. 1(a)(47)(D).
---------------------------------------------------------------------------
Because, as noted above, mixed swaps are both swaps and security-
based swaps, and thus are subject to regulation as both swaps and
security-based swaps, the Commissions are concerned that, without
further clarification, there may be uncertainty as to the scope of, and
the requirements applicable to, transactions that fall within the
definition of the term ``mixed swap.''
Proposed rule 3a68-4(a) would define the term ``mixed swap'' in the
same manner as the term is defined in the Exchange Act. This rule,
coupled with guidance regarding mixed swaps provided by the
Commissions, further clarifies whether a security-based swap is a mixed
swap and could eliminate the need to obtain an opinion of counsel
regarding a particular security-based swap.
The Commissions are proposing rule 3a68-4(b) to eliminate
potentially duplicative and conflicting regulation in the context of
mixed swaps by providing that a bilateral uncleared mixed swap, where
at least one party to the mixed swap is dually-registered with the SEC
as a security-based swap dealer or major security-based swap
participant and also with the CFTC as a swap dealer or major swap
participant, would be subject to all applicable provisions of the
securities laws (and SEC rules and regulations promulgated thereunder)
but would be subject only to certain CEA provisions (and CFTC rules and
regulations promulgated thereunder). Therefore, proposed rule 3a68-4(a)
would reduce both the number of and potential uncertainty regarding
which requirements of each Commission will apply to bilateral uncleared
mixed swaps entered into by dually-registered dealers and major
participants.
Proposed rule 3a68-4(c) also would afford persons with an
opportunity to seek alternative regulatory treatment of a specified, or
specified class of, mixed swap. Absent such alternative regulatory
treatment, a person that desires or intends to list, trade, or clear a
mixed swap would be required to comply with all the statutory
provisions of Title VII, including all the rules and regulations
thereunder, that are applicable to both security-based swaps and swaps.
The SEC believes that such a requirement could pose practical
difficulties for mixed swap transactions \376\ and that permitting
persons to request alternative regulatory treatment of a specified, or
specified class of, mixed swaps would allow the Commissions to address
the potential for duplicative or contradictory regulatory requirements
regarding a particular mixed swap.
---------------------------------------------------------------------------
\376\ See discussion supra part IV.
---------------------------------------------------------------------------
The information submitted by persons pursuant to proposed rule
3a68-4(c) would assist the Commissions in more quickly identifying and
addressing the relevant issues involved in providing alternative
regulatory treatment.
The SEC requests comments, data, and estimates regarding the
benefits associated with proposed rule 3a68-4. The SEC also requests
comments, data, and estimates regarding any additional benefits that
could be realized with proposed rule 3a68-4.
(b) Costs
Providing a clear rule for persons who engage in bilateral
uncleared mixed swaps would reduce the potential for duplicative or
contradictory regulatory requirements that apply to such bilateral
uncleared mixed swaps.
Under proposed rule 3a68-4(c), a person also could request the
Commissions to provide alternative regulatory treatment of a specified,
or specified class of, mixed swap. The SEC estimates that the cost of
requesting alternative regulatory treatment for a particular mixed swap
(or class thereof) would be approximately 30 hours of internal company
or individual time and a cost of approximately $15,800 for the services
of outside professionals.\377\ The SEC notes, however, that any such
costs are in lieu of the costs of complying with all the statutory
provisions in Title VII, including all the rules and regulations
thereunder, that are applicable to both security-based swaps and swaps,
which the SEC
[[Page 29883]]
believes would be more costly than requesting alternative regulatory
treatment, and which potentially could pose practical
difficulties.\378\
---------------------------------------------------------------------------
\377\ See discussion supra part VIII.
\378\ See discussion supra part IV.B.
---------------------------------------------------------------------------
Also, the SEC believes that as persons make requests for
alternative regulatory treatment of specified, or specified classes of,
mixed swaps pursuant to proposed rule 3a68-4, the subsequent costs for
persons transacting in those products for which the Commissions have
provided for alternative regulatory treatment should be reduced.
The SEC requests comment as to the costs that proposed rule 3a68-4
would impose on market participants, as well as estimates and empirical
data to support these costs. In addition, the SEC requests comment on
any other costs associated with proposed rule 3a68-4 that have not been
considered herein, and what the extent of those costs would be.
7. Proposed Rule 3a69-1
(a) Benefits
Proposed rule 3a69-1 would clarify that state or Federally
regulated insurance products provided by state or Federally regulated
insurance companies, or by certain reinsurers, provided such insurance
products meet certain other requirements, would not be swaps.
Specifically, proposed rule 3a69-1 would define the term ``swap'' so
that it would not include an agreement, contract, or transaction that,
by its terms or by law, as a condition of performance on the agreement,
contract, or transaction: (i) Requires the beneficiary of the
agreement, contract, or transaction to have an insurable interest that
is the subject of the agreement, contract, or transaction and thereby
carry the risk of loss with respect to that interest continuously
throughout the duration of the agreement, contract, or transaction;
(ii) requires that loss to occur and to be proved, and that any payment
or indemnification therefor be limited to the value of the insurable
interest; (iii) is not traded, separately from the insured interest, on
an organized market or over-the-counter; and (iv) with respect to
financial guarantee insurance only, in the event of payment default or
insolvency of the obligor, any acceleration of payments under the
policy is at the sole discretion of the insurer. Proposed rule 3a69-1
also would require that the agreement, contract, or transaction: (i) Be
provided by a company that is organized as an insurance company whose
primary and predominant business activity is the writing of insurance
or the reinsuring of risks underwritten by insurance companies and that
is subject to supervision by the insurance commissioner, or similar
official or agency, of a state, as defined under section 3(a)(16) of
the Exchange Act,\379\ or by the United States or an agency or
instrumentality thereof, and be regulated as insurance under the laws
of such state or the United States; (ii) be provided by the United
States or any of its agents or instrumentalities, or pursuant to a
statutorily authorized program thereof; or (iii) in the case of
reinsurance only, be provided by a person located outside the United
States to an insurance company that meets the above requirements,
provided that such person is not prohibited by the law of any state or
the United States from offering such agreement, contract, or
transaction to such insurance company, the product to be reinsured
meets the requirements above for insurance products, and the total
amount reimbursable by all reinsurers for such insurance product cannot
exceed the claims or losses paid by the cedant. An agreement, contract,
or transaction would have to meet all of these criteria in order to
qualify as an insurance product that falls outside of the swap and
security-based swap definitions pursuant to the proposed rules.
---------------------------------------------------------------------------
\379\ 15 U.S.C. 78c(a)(16).
---------------------------------------------------------------------------
The SEC is concerned that, without further clarification, market
participants may be uncertain about whether an agreement, contract, or
transaction is an insurance product that is not subject to regulation
as a swap or security-based swap. Therefore, proposed rule 3a69-1 would
eliminate the potential uncertainty of what constitutes an insurance
product by setting forth clear and objective criteria for meeting the
definition of an insurance product that is not subject to regulation as
a swap or security-based swap.
The SEC requests comments, data, and estimates regarding the
benefits associated with proposed rule 3a69-1. The SEC also requests
comments, data, and estimates regarding any additional benefits that
could be realized with proposed rule 3a69-1.
(b) Costs
In complying with proposed rule 3a69-1, a market participant will
need to analyze its agreements, contracts, and transactions that are
insurance products under the provisions of the proposed rule to
determine whether such insurance products fall outside the definitions
of the terms ``swaps'' and ``security-based swap.'' This analysis will
have to be performed upon entering into the agreement, contract, or
transaction to ensure compliance with proposed rule 3a69-1. The SEC
notes, however, that any such costs would be in lieu of the costs of
doing the same analysis absent proposed rule 3a69-1, which the SEC
believes would be more difficult and lead to greater uncertainty than
if the analysis were done under proposed rule 3a69-1. Providing an
objective rule to determine whether an agreement, contract, or
transaction is an insurance product could alleviate additional costs of
inquiring with the Commissions about whether an agreement, contract, or
transaction is an insurance product or a swap, or costs of obtaining an
opinion of counsel regarding a particular agreement, contract, or
transaction.
To the extent that the criteria under proposed rule 3a69-1 lead to
the inadvertent omission of certain types of insurance products, these
omissions could lead to costs for market participants entering into
agreements, contracts, or transactions that might be omitted because
these agreements, contracts, or transactions would be regulated as
swaps and not as insurance products. Similarly, to the extent that the
criteria under proposed rule 3a69-1 lead to the inadvertent inclusion
of certain types of swaps or security-based swaps, these inclusions
could lead to costs for market participants entering into agreements,
contracts, or transactions that are regulated as insurance products and
not as swaps or security-based swaps. The SEC has requested comment on
whether the criteria under proposed rule 3a69-1 inadvertently omits
certain types of insurance products or includes certain types of swaps
in order to minimize these potential costs. The SEC believes that,
pursuant to comments on the proposed criteria, any subsequent
modifications the Commissions make to proposed rule 3a69-1 would
significantly curtail the potential for inadvertent omissions or
inclusions.
The SEC requests comment as to the costs that determinations under
proposed rule 3a69-1 would impose on market participants, as well as
estimates and empirical data to support these costs. In addition, the
SEC requests comment on any other costs associated with proposed rule
3a69-1 that have not been considered, and what the extent of those
costs would be.
8. Proposed Rule 3a69-2
(a) Benefits
Proposed rule 3a69-2 provides that the term ``swap'' has the
meaning set forth in section 3(a)(69) of the Exchange
[[Page 29884]]
Act and that, without limiting the definition of ``swap'' in section
3(a)(69) of the Exchange Act, an agreement, contract, or transaction
that is a cross-currency swap, currency option, foreign currency
option, foreign exchange option, foreign exchange rate option, foreign
exchange forward, foreign exchange swap, FRA, or NDF would fall within
the meaning of the term ``swap'', unless such agreement, contract, or
transaction is otherwise excluded by section 1a(47)(B) of the CEA.\380\
Proposed rule 3a69-2 also provides that a foreign exchange forward or a
foreign exchange swap shall not be considered a swap if the Secretary
of the Treasury makes a determination described in section 1a(47)(E)(i)
of the CEA\381\ and that, notwithstanding such provision, certain
provisions of the CEA will apply to such foreign exchange forward or
foreign exchange swap, namely the reporting requirements in section 4r
of the CEA,\382\ and regulations thereunder, and, in the case of a swap
dealer or major swap participant that is a party to a foreign exchange
swap or foreign exchange forward, the business conduct standards in
section 4s of the CEA,\383\ and regulations thereunder. In addition,
proposed rule 3a69-2 provides that the terms ``foreign exchange
forward'' and ``foreign exchange swap'' have the meanings set forth in
the CEA and that a currency swap, cross-currency swap, currency option,
foreign currency option, foreign exchange option, foreign exchange rate
option, and NDF is not a foreign exchange forward or foreign exchange
swap for purposes of sections 1a(24) and 1a(25) of the CEA.\384\
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\380\ 15 U.S.C. 78c(a)(69); 7 U.S.C. 1a(47)(B).
\381\ 7 U.S.C. 1a(47)(E)(i).
\382\ 7 U.S.C. 6r.
\383\ 7 U.S.C. 6s.
\384\ 7 U.S.C. 1a(24) and 1a(25).
---------------------------------------------------------------------------
Proposed rule 3a69-2 would restate portions of the statutory
definition of ``swap'' and enumerate certain types of agreements,
contracts, and transactions that are swaps in order to consolidate
parts of the definition and related interpretations for ease of
reference. Proposed rule 3a69-2 would also specify certain reporting
and business conduct requirements that are applicable to foreign
exchange forwards and foreign exchange swaps, and provide definitions
for such terms.
Because the statutory definition of the term ``swap,'' though
broadly worded and specific regarding the status of certain agreements,
contracts, and transactions, does not explicitly mention every
agreement, contract, or transaction that would fall within the
definition, the Commissions are concerned that application of the
definition, without further clarification, may cause uncertainty about
whether certain agreements, contracts, or transactions would be swaps.
Proposed rule 3a69-2 would eliminate the potential uncertainty of the
treatment of such agreements, contracts, and transactions as swaps by
setting forth clear and objective criteria for certain agreements,
contracts, and transactions without limiting the scope of the statutory
definition of the term ``swap.'' Proposed rule 3a69-2 also would
eliminate the potential uncertainty regarding the reporting and
business conduct requirements applicable to foreign exchange forwards
and foreign exchange swaps by specifying the provisions for which
compliance is required.
(b) Costs
In complying with proposed rule 3a69-2, a market participant will
need to analyze its agreements, contracts, and transactions under the
provisions of the proposed rule to determine whether such agreements,
contracts, and transactions are swaps according to the criteria set
forth in the proposed rule. This analysis will have to be performed
upon entering into the agreement, contract, or transaction to ensure
compliance with proposed rule 3a69-2. The SEC notes, however, that any
such costs would be in lieu of the costs of doing the same analysis
absent proposed rule 3a69-2, which the SEC believes would be more
difficult and lead to greater uncertainty than if the analysis were
done under proposed rule 3a69-2.
Providing an objective rule to market participants to determine
whether certain types of agreements, contracts, or transactions are
swaps could alleviate additional costs to persons of inquiring with the
Commissions about whether such agreements, contracts, or transactions
are swaps, as well as costs of obtaining an opinion of counsel
regarding a particular agreement, contract, or transaction. In
addition, an objective rule regarding reporting and business conduct
requirements could alleviate additional costs to persons of inquiring
with the Commissions about which reporting and business conduct
requirements are applicable to foreign exchange forwards and foreign
exchange swaps, and could reduce the costs of obtaining an opinion of
counsel regarding a particular foreign exchange forward or foreign
exchange swap.
To the extent that the criteria under proposed rule 3a69-2 lead to
the inadvertent inclusion of certain types of agreements, contracts,
and transactions or additional reporting or business conduct
obligations for certain swaps, these inclusions and additional
requirements could lead to costs for market participants entering into
agreements, contracts, or transactions to which proposed rule 3a69-2
applies. The SEC has requested comment on whether the criteria under
proposed rule 3a69-2 provide sufficient clarity regarding the specific
products included in the rule and whether the criteria should clarify
the applicability of reporting and business conduct requirements in
order to minimize these potential costs. The SEC believes that,
pursuant to comments on the proposed criteria, any subsequent
modifications the Commissions make to proposed rule 3a69-2 would
significantly curtail the potential for inadvertent inclusions or
additional reporting or business conduct requirements.
The SEC requests comment as to the costs that determinations under
and compliance with proposed rule 3a69-2 would impose on market
participants, as well as estimates and empirical data to support these
costs. In addition, the SEC requests comment on any other costs
associated with proposed rule 3a69-2 that have not been considered, and
what the extent of those costs would be.
9. Proposed Rule 3a69-3
(a) Benefits
Proposed rule 3a69-3 would provide that the term ``security-based
swap agreement'' has the meaning set forth in section 3(a)(78) of the
Exchange Act.\385\ Proposed rule 3a69-3 also would provide that
registered SDRs, swap dealers, major swap participants, security-based
swap dealers, and major security-based swap participants are not
required to maintain additional books and records, or, in the case of
registered SDRs, collect and maintain additional information regarding,
SBSAs other than the books and records (and, in the case of registered
SDRs, information) required to be kept (or collected) and maintained
regarding swaps pursuant to the CEA and the CFTC rules and regulations
promulgated thereunder.
---------------------------------------------------------------------------
\385\ 15 U.S.C. 78c(a)(78).
---------------------------------------------------------------------------
Because, as noted above, security-based swap agreements are subject
the CFTC's regulatory and enforcement authority and the SEC's antifraud
and certain other authority, the Commissions are concerned that,
without further clarification, there may be uncertainty as to the scope
of transactions that fall within the definition of the term ``security-
based
[[Page 29885]]
swap agreement.'' Proposed rule 3a69-3(c) would define the term
``security-based swap agreement'' in the same manner as the term is
defined in the Exchange Act. This rule, coupled with guidance regarding
security-based swap agreements provided by the Commissions, further
clarifies whether a swap is a security-based swap agreement and could
eliminate the need to obtain an opinion of counsel regarding a
particular security-based swap agreement.
Section 712(d)(2)(B) and (C) of the Dodd-Frank Act requires the
Commissions to engage in joint rulemaking regarding books and records
requirements for SBSAs. Providing that persons required to keep and
maintain books and records regarding, or collect and maintain data
regarding, swaps are not required to keep or maintain additional books
and records regarding, or collect and maintain additional data
regarding, SBSAs alleviates any additional books and records or
information costs to such persons.
(b) Costs
The SEC believes that, because proposed rule 3a69-3 includes within
the definition of SBSA no agreements, contracts, or transactions that
would not be an SBSA in the absence of the proposed rule, proposed rule
3a69-3 would impose no costs other than those that are required with
respect to swaps in the absence of proposed rule 3a69-3. In addition,
the SEC believes that, because proposed rule 3a69-3 imposes no
requirements with respect to SBSAs other than those that exist for
swaps, proposed rule 3a69-3 would impose no costs other than those that
are required with respect to swaps in the absence of proposed rule
3a69-3.
To the extent that the criteria under proposed rule 3a69-3
inadvertently lead to additional requirements with respect to SBSAs,
these additional requirements could lead to costs for market
participants entering into the SBSAs to which proposed rule 3a69-3
applies. The SEC has requested comment regarding whether the
requirements under proposed rule 3a69-3 are sufficient. The SEC
believes that, pursuant to comments on the proposed rule, any
subsequent modifications the Commissions make to proposed rule 3a69-3
would significantly curtail the potential for inadvertent additional
requirements.
The SEC requests comment as to the costs that compliance with
proposed rule 3a69-3 would impose on market participants, as well as
estimates and empirical data to support these costs. In addition, the
SEC requests comment on any other costs associated with proposed rule
3a69-3 that have not been considered, and what the extent of those
costs would be.
Request for Comment
153. The SEC has considered the costs and benefits of the proposed
rules and clarifications regarding the Product Definitions, the
regulation of mixed swaps, and the books and records requirements for
SBSAs. The SEC is sensitive to these costs and benefits, and encourages
commenters to discuss any additional costs or benefits beyond those
discussed here, as well as any reductions in costs. In particular, the
SEC requests comment on the potential costs, as well as any potential
benefits, resulting from the proposed rules and clarifications
regarding the Product Definitions, the regulation of mixed swaps, and
the books and records requirements for SBSAs for issuers, investors,
broker-dealers, security-based swap dealers, major security-based swap
participants, persons associated with a security-based swap dealer or a
major security-based swap participant, other security-based swap
industry professionals, regulators, and other market participants. The
SEC also seeks comment on the accuracy of any of the benefits
identified and also welcomes comment on any of the costs identified
here. In addition, the SEC encourages commenters to identify, discuss,
analyze, and supply relevant data, information, or statistics regarding
any such costs or benefits, including estimates and views regarding
these costs and benefits for particular types of market participants,
as well as any other costs or benefits that may result from the
adoption of the proposed rules, as well as the clarifications provided.
C. Consideration of Burden on Competition, and Promotion of Efficiency,
Competition, and Capital Formation
Section 3(f) of the Exchange Act \386\ requires the SEC, whenever
it engages in rulemaking and is required to consider or determine
whether an action is necessary or appropriate in the public interest,
to consider whether the action would promote efficiency, competition,
and capital formation. In addition, section 23(a)(2) of the Exchange
Act \387\ requires the SEC, when adopting rules under the Exchange Act,
to consider the impact such rules would have on competition. Section
23(a)(2) of the Exchange Act also prohibits the SEC from adopting any
rule that would impose a burden on competition not necessary or
appropriate in furtherance of the purposes of the Exchange Act.\388\
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\386\ 15 U.S.C. 78c(f).
\387\ 15 U.S.C. 78w(a)(2).
\388\ Id.
---------------------------------------------------------------------------
1. Proposed Rule 3a68-1a
The SEC believes that proposed rule 3a68-1a would create an
efficient process for a market participant to determine whether an
index CDS is a swap or a security-based swap by setting forth clear
methods and guidelines, thereby reducing potential uncertainty. Because
swaps and security-based swaps both are regulated pursuant to the Dodd-
Frank Act by either the CFTC or the SEC, and an index CDS would be
either a swap or a security-based swap, regardless of whether the SEC
proposed rule 3a68-1a, the SEC believes that the proposed rule would
not have an adverse effect on capital formation.
Similarly, the SEC believes that proposed rule 3a68-1a would not
impose any significant burdens on competition because an index CDS
would be regulated as a swap or security-based swap regardless of
whether the SEC proposed rule 3a68-1a. The proposed rule is a means of
providing greater clarity for market participants on whether a specific
index CDS is a swap or a security-based swap.
2. Proposed Rule 3a68-1b
The SEC believes that proposed rule 3a68-1b would create an
efficient process for a market participant to determine whether an
index CDS is a swap or a security-based swap by setting forth clear
methods and guidelines, thereby reducing potential uncertainty. Because
swaps and security-based swaps both are regulated pursuant to the Dodd-
Frank Act by either the CFTC or the SEC, and an index CDS would be
either a swap or a security-based swap, regardless of whether the SEC
proposed rule 3a68-1b, the SEC believes that the proposed rule would
not have an adverse effect on capital formation.
Similarly, the SEC believes that proposed rule 3a68-1b would not
impose any significant burdens on competition because an index CDS
would be regulated as a swap or security-based swap regardless of
whether the SEC proposed rule 3a68-1b. The proposed rule is a means of
providing greater clarity for market participants on whether a specific
index CDS is a swap or a security-based swap.
3. Proposed Rule 3a68-2
The SEC believes that proposed rule 3a68-2 would create an
efficient process for a market participant to request the Commissions
to determine whether an
[[Page 29886]]
agreement, contract, or transaction (or class thereof) is a swap,
security-based swap, or both (i.e., a mixed swap) by setting forth
clear methods and guidelines, thereby reducing potential uncertainty.
Because swaps, security-based swaps, and mixed swaps all are regulated
pursuant to the Dodd-Frank Act by either the CFTC, the SEC, or both the
CFTC and SEC, and because market participants still would need to
determine whether an agreement, contract, or transaction (or class
thereof) is a swap, security-based swap, or mixed swap regardless of
whether the SEC proposed rule 3a68-2, the SEC believes that the
proposed rule would not have an adverse effect on capital formation.
In addition, the SEC believes the proposed rule will provide the
opportunity for financial innovation by providing a flexible structure
that will allow for the development of new products, which may promote
capital formation.
Similarly, the SEC believes that proposed rule 3a68-2 would not
impose any significant burdens on competition because, to the extent an
agreement, contract, or transaction (or class thereof) is a swap,
security-based swap, or both (i.e., a mixed swap), that agreement,
contract, or transaction (or class thereof) would be regulated as a
swap, security-based swap, or mixed swap regardless of whether the SEC
proposed rule 3a68-2. The proposed rule is a means of providing a
process for market participants to request clarity regarding whether a
specific agreement, contract, or transaction (or class thereof) is a
swap, security-based swap, or mixed swap.
4. Proposed Rule 3a68-3
The SEC believes that proposed rule 3a68-3 would create an
efficient process for a market participant to determine whether a
security index underlying a Title VII instrument is narrow-based or
broad-based, and therefore whether the Title VII instrument is a swap
or a security-based swap, by setting forth clear methods and
guidelines, thereby reducing potential uncertainty. Because swaps and
security-based swaps both are regulated pursuant to the Dodd-Frank Act
by either the CFTC or the SEC, and a Title VII instrument on a security
index would be either a swap or a security-based swap regardless of
whether the SEC proposed rule 3a68-3, the SEC believes that the
proposed rule would not have an adverse effect on capital formation.
Similarly, the SEC believes that proposed rule 3a68-3 would not
impose any significant burdens on competition because a Title VII
instrument on a security index would be regulated as a swap or
security-based swap regardless of whether the SEC proposed rule 3a68-3.
The proposed rule is a means of providing greater clarity for market
participants regarding whether a specific Title VII instrument on a
security index is a swap or a security-based swap.
5. Proposed Rule 3a68-4
The SEC believes that proposed rule 3a68-4 would create an
efficient process for a market participant to request alternative
regulatory treatment regarding a specified, or specified class of,
mixed swap by setting forth clear methods and guidelines, thereby
reducing potential uncertainty and dual regulatory requirements.
Because a mixed swap is regulated pursuant to the Dodd-Frank Act, and,
absent proposed rule 3a68-4, persons that desire or intend to list,
trade, or clear a mixed swap would be required to comply with all the
statutory provisions in Title VII, including all the rules and
regulations thereunder, that are applicable to both swaps and security-
based swaps, the SEC believes that the proposed rule would not have an
adverse effect on capital formation. Proposed rule 3a68-4 would permit
such persons to request a joint order permitting themto comply with an
alternative regulatory regime that would address the potential dual
regulatory requirements applicable to transactions in mixed swaps under
Title VII.
Similarly, the SEC believes that proposed rule 3a68-4 would not
impose any significant burdens on competition because to the extent an
agreement, contract, or transaction (or class thereof) is a mixed swap,
transactions in that mixed swap would be subject to all of the
statutory provisions of Title VII, including all the rules and
regulations thereunder, that are applicable to both swaps and security-
based swaps, if the Commissions were not to provide alternative
regulatory treatment pursuant to proposed rule 3a68-4.
6. Proposed Rule 3a69-1
The SEC believes that proposed rule 3a69-1 would create an
efficient process for a market participant to determine whether an
agreement, contract, or transaction is an insurance product and is not
a swap by setting forth clear methods and guidelines, thereby reducing
potential uncertainty. Because insurance products and insurance
companies currently are regulated pursuant to state insurance law, and
would continue to be so regardless of whether the SEC proposed rule
3a69-1, the SEC believes that the proposed rule would not have an
adverse effect on capital formation.
Similarly, the SEC believes that proposed rule 3a69-1 would not
impose any significant burdens on competition because insurance
products and insurance companies currently are regulated pursuant to
state insurance law and would continue to be so regardless of whether
the SEC proposed rule 3a69-1. The proposed rule is a means of providing
greater clarity for market participants on whether a specific
agreement, contract, or transaction is an insurance product and is not
a swap.
7. Proposed Rule 3a69-2
The SEC believes that proposed rule 3a69-2 would create an
efficient process for a market participant to determine whether an
agreement, contract, or transaction is a swap, a foreign exchange
forward, or a foreign exchange swap or is subject to certain reporting
and business conduct requirements, by setting forth clear methods and
guidelines, thereby reducing potential uncertainty. Because agreements,
contracts, and transactions that are swaps, foreign exchange forwards,
or foreign exchange swaps under proposed rule 3a69-2 would be swaps,
foreign exchange forwards, or foreign exchange swaps and, in the case
of foreign exchange forwards and foreign exchange swaps, would be
subject to reporting and business conduct requirements under the CEA,
in the absence of proposed rule 3a69-2, the SEC believes that the
proposed rule would not have an adverse effect on capital formation.
Similarly, the SEC believes that proposed rule 3a69-2 would not
impose any significant burdens on competition because swaps, foreign
exchange swaps, and foreign exchange forwards continue to be regulated
as such regardless of whether the SEC proposed rule 3a69-2. The
proposed rule is a means of providing greater clarity for market
participants on whether a specific agreement, contract, or transaction
is a swap, foreign exchange forward, or foreign exchange swap and
whether certain reporting and business conduct requirements apply in
the case of foreign exchange forwards and foreign exchange swaps.
8. Proposed Rule 3a69-3
The SEC believes that proposed rule 3a69-3 would create an
efficient process for registered SDRs, SDs, MSPs, security-based swap
dealers, and major security-based swap participants to determine the
books and records requirements for SBSAs by setting forth
[[Page 29887]]
clear guidelines, thereby reducing potential uncertainty. Proposed rule
3a69-3(c) also would define the term ``security-based swap agreement''
in the same manner as the term is defined in the Exchange Act. Because
SBSAs are swaps, they are subject to certain books and records
requirements under the CEA (and CFTC rules and regulations promulgated
thereunder) that are applicable to swaps and would continue to be so
regardless of whether the SEC proposed rule 3a69-3. The SEC believes
that the proposed rule would thus not have an adverse effect on capital
formation.
Similarly, the SEC believes that proposed rule 3a69-3 would not
impose any significant burdens on competition because SBSAs would be
regulated as swaps regardless of whether the SEC proposed rule 3a69-3.
The proposed rule is a means of providing greater clarity for market
participants regarding SBSAs, including the books and records
requirements for SBSAs.
Request for Comment
154. The SEC requests comment on the possible effects of the
proposed rules under the Exchange Act regarding efficiency,
competition, and capital formation. The SEC requests that commenters
provide views and supporting information regarding any such effects.
The SEC notes that such effects are difficult to quantify. The SEC
seeks comment on possible anti-competitive effects of the proposed
rules under the Exchange Act not already identified. The SEC also
requests comment regarding the competitive effects of pursuing
alternative regulatory approaches that are consistent with section
712(a) and 712(d) of the Dodd-Frank Act. In addition, the SEC requests
comment on how the other provisions of the Dodd-Frank Act for which SEC
rulemaking is required will interact with and influence the competitive
effects of the proposed rules and clarifications under the Exchange
Act.
D. Consideration of Impact on the Economy
For purposes of SBREFA the SEC must advise the OMB as to whether
the proposed rules and interpretive guidance under the Exchange Act
constitute ``major'' rules. Under SBREFA, a rule is considered
``major'' where, if adopted, it results or is likely to result in: (1)
An annual effect on the economy of $100 million or more (either in the
form of an increase or a decrease); (2) a major increase in costs or
prices for consumers or individual industries; or (3) significant
adverse effect on competition, investment or innovation. If a rule is
``major,'' its effectiveness will generally be delayed for 60 days
pending Congressional review.
The SEC requests comment on the potential impact of the proposed
rules and interpretive guidance under the Exchange Act on the economy
on an annual basis, on the costs or prices for consumers or individual
industries, and on competition, investment, or innovation. Commenters
are requested to provide empirical data and other factual support for
their view to the extent possible.
E. Initial Regulatory Flexibility Act Certification
The RFA requires Federal agencies, in promulgating rules, to
consider the impact of those rules on small entities. Section 603(a)
\389\ of the Administrative Procedure Act,\390\ as amended by the RFA,
generally requires the SEC to undertake a regulatory flexibility
analysis of all proposed rules, or proposed rule amendments, to
determine the impact of such rulemaking on ``small entities.'' \391\
Section 605(b) of the RFA states that this requirement shall not apply
to any proposed rule or proposed rule amendment, that, if adopted,
would not have a significant economic impact on a substantial number of
small entities.\392\
---------------------------------------------------------------------------
\389\ 5 U.S.C. 603(a).
\390\ 5 U.S.C. 551 et seq.
\391\ Although section 601(b) of the RFA defines the term
``small entity,'' the statute permits agencies to formulate their
own definitions. The SEC has adopted definitions for the term small
entity for the purposes of SEC rulemaking in accordance with the
RFA. Those definitions, as relevant to this proposed rulemaking, are
set forth in rule 0-10, 17 CFR 240.0-10. See Statement of Management
on Internal Accounting Control, 47 FR 5215, Feb. 4, 1982.
\392\ See 5 U.S.C. 605(b).
---------------------------------------------------------------------------
For purposes of SEC rulemaking in connection with the RFA, a small
entity includes: (i) 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,\393\ or (ii) 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,\394\ 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.\395\ Under the
standards adopted by the Small Business Administration, small entities
in the finance and insurance industry include the following: (i) For
entities in credit intermediation and related activities, entities with
$175 million or less in assets or, for non-depository credit
intermediation and certain other activities, $7 million or less in
annual receipts; (ii) for entities in financial investments and related
activities, entities with $7 million or less in annual receipts; (iii)
for insurance carriers and entities in related activities, entities
with $7 million or less in annual receipts; and (iv) for funds, trusts,
and other financial vehicles, entities with $7 million or less in
annual receipts.\396\
---------------------------------------------------------------------------
\393\ See 17 CFR 240.0-10(a).
\394\ See 17 CFR 240.17a-5(d).
\395\ See 17 CFR 240.0-10(c).
\396\ See 13 CFR 121.201.
---------------------------------------------------------------------------
Based on the SEC's existing information about the swap markets, the
SEC believes that the swap markets, while broad in scope, are largely
dominated by entities such as those that would be covered by the ``swap
dealer,'' ``security-based swap dealer,'' ``major swap participant,''
and ``major security-based swap participant'' definitions.\397\ The SEC
believes that such entities exceed the thresholds defining ``small
entities'' set out above. Moreover, although it is possible that other
persons may engage in swap and security-based swap transactions, the
SEC does not believe that any of these entities would be ``small
entities'' as defined in rule 0-10 under the Exchange Act.\398\
Feedback from industry participants about the swap markets indicates
that only persons or entities with assets significantly in excess of $5
million (or with annual receipts significantly in excess of $7 million)
participate in the swap markets.
---------------------------------------------------------------------------
\397\ See, e.g., CEA section 1a(49), 7 U.S.C. 1a(49) (defining
``swap dealer''); section 3(a)(71)(A) of the Exchange Act, 15 U.S.C.
78c(a)(71)(A) (defining ``security-based swap dealer''); CEA section
1a(33), 7 U.S.C. 1a(33) (defining ``major swap participant'');
section 3(a)(67)(A) of the Exchange Act, 15 U.S.C. 78c(a)(67)(A)
(defining ``major security-based swap participant''). Such entities
also would include commercial entities that may use swaps to hedge
or mitigate commercial risk.
\398\ See 17 CFR 240.0-10(a).
---------------------------------------------------------------------------
To the extent that a small number of transactions did have a
counterparty that was defined as a ``small entity'' under SEC rule 0-
10, the SEC believes it is unlikely that the proposed rules and
clarifications regarding the Product Definitions, the regulation of
mixed swaps, and the books and records requirements for SBSAs would
have a significant economic impact on that
[[Page 29888]]
entity. The proposed rules and clarifications simply would address
whether certain products fall within the swap definition, address
whether certain products are swaps, security-based swaps, SBSAs, or
mixed swaps, provide a process for requesting interpretations of
whether agreements, contracts, and transactions are swaps, security-
based swaps, and mixed swaps, provide a process for requesting
alternative regulatory treatment for mixed swaps, and establish books
and records requirements for SBSAs, which are applicable to all
entities.
For the foregoing reasons, the SEC certifies that the proposed
rules and clarifications regarding the Product Definitions, the
regulation of mixed swaps, and the books and records requirements for
SBSAs would not have a significant economic impact on a substantial
number of small entities for purposes of the RFA. The SEC encourages
written comments regarding this certification. The SEC requests that
commenters describe the nature of any impact on small entities and
provide empirical data to support the extent of the impact.
X. Statutory Basis and Rule Text
List of Subjects
17 CFR Part 1
Definitions, General swap provisions.
17 CFR Part 240
Reporting and recordkeeping requirements, Securities.
Commodity Futures Trading Commission
Pursuant to the Commodity Exchange Act, 7 U.S.C. 1 et seq., as
amended by Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act, Public Law 111-203, 124 Stat. 1376 (2010) (``Dodd-Frank
Act''), and sections 712(a)(8), 712(d), 721(a), 721(b), 721(c), 722(d),
and 725(g) of the Dodd-Frank Act, the CFTC is proposing to adopt rules
1.3(xxx) through 1.3(aaaa) and 1.6 through 1.9 under the Commodity
Exchange Act.
Text of Proposed Rules
For the reasons stated in the preamble, the CFTC is proposing to
further amend Title 17, Chapter I, of the Code of Federal Regulations,
as amended at 75 FR 63732, October 18, 2010, 75 FR 65586, Oct. 26,
2010, 75 FR 77576, Dec. 13, 2010, 75 FR 80174, Dec. 21, 2010, and 76 FR
722, Jan. 6, 2011, as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
1. The authority citation for part 1 is revised to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6c, 6e, 6f, 6g, 6h,
6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 7, 7a, 7b, 8, 9, 10, 12, 12a,
12c, 13a, 13a-1, 16, 16a, 21, 23, and 24.
2. Amend Sec. 1.3 by adding paragraphs (xxx), (yyy), (zzz), and
(aaaa) to read as follows:
Sec. 1.3 Definitions.
* * * * *
(xxx) Swap. (1) In general. The term swap has the meaning set forth
in section 1a(47) of the Commodity Exchange Act.
(2) Inclusion of particular products. (i) The term swap includes,
without limiting the meaning set forth in section 1a(47) of the
Commodity Exchange Act, the following agreements, contracts, and
transactions:
(A) A cross-currency swap;
(B) A currency option, foreign currency option, foreign exchange
option and foreign exchange rate option;
(C) A foreign exchange forward;
(D) A foreign exchange swap;
(E) A forward rate agreement; and
(F) A non-deliverable forward involving foreign exchange.
(ii) The term swap does not include an agreement, contract, or
transaction described in paragraph (xxx)(2)(i) of this section that is
otherwise excluded by section 1a(47)(B) of the Commodity Exchange Act.
(3) Foreign exchange forwards and foreign exchange swaps.
Notwithstanding paragraph (xxx)(2) of this section:
(i) A foreign exchange forward or a foreign exchange swap shall not
be considered a swap if the Secretary of the Treasury makes a
determination described in section 1a(47)(E)(i) of the Commodity
Exchange Act.
(ii) Notwithstanding paragraph (xxx)(3)(i) of this section:
(A) The reporting requirements set forth in section 4r of the
Commodity Exchange Act and regulations promulgated thereunder shall
apply to a foreign exchange forward or foreign exchange swap; and
(B) The business conduct standards set forth in section 4s of the
Commodity Exchange Act and regulations promulgated thereunder shall
apply to a swap dealer or major swap participant that is a party to a
foreign exchange forward or foreign exchange swap.
(iii) For purposes of section 1a(47)(E) of the Commodity Exchange
Act and this Sec. 1.3(xxx), the term foreign exchange forward has the
meaning set forth in section 1a(24) of the Commodity Exchange Act.
(iv) For purposes of section 1a(47)(E) of the Commodity Exchange
Act and this Sec. 1.3(xxx), the term foreign exchange swap has the
meaning set forth in section 1a(25) of the Commodity Exchange Act.
(v) For purposes of sections 1a(24) and 1a(25) of the Commodity
Exchange Act and this Sec. 1.3(xxx), the following transactions are
not foreign exchange forwards or foreign exchange swaps:
(A) A currency swap or a cross-currency swap;
(B) A currency option, foreign currency option, foreign exchange
option, or foreign exchange rate option; and
(C) A non-deliverable forward involving foreign exchange.
(4) Insurance. The term swap as used in section 1a(47) of the
Commodity Exchange Act does not include an agreement, contract, or
transaction that:
(i) By its terms or by law, as a condition of performance on the
agreement, contract, or transaction:
(A) Requires the beneficiary of the agreement, contract, or
transaction to have an insurable interest that is the subject of the
agreement, contract, or transaction and thereby carry the risk of loss
with respect to that interest continuously throughout the duration of
the agreement, contract, or transaction;
(B) Requires that loss to occur and to be proved, and that any
payment or indemnification therefor be limited to the value of the
insurable interest;
(C) Is not traded, separately from the insured interest, on an
organized market or over-the-counter; and
(D) With respect to financial guaranty insurance only, in the event
of payment default or insolvency of the obligor, any acceleration of
payments under the policy is at the sole discretion of the insurer; and
(ii) Is provided:
(A) By a company that is organized as an insurance company whose
primary and predominant business activity is the writing of insurance
or the reinsuring of risks underwritten by insurance companies and that
is subject to supervision by the insurance commissioner (or similar
official or agency) of any State or by the United States or an agency
or instrumentality thereof, and such agreement, contract, or
transaction is regulated as insurance under the laws of such State or
of the United States;
(B) By the United States or any of its agencies or
instrumentalities, or pursuant to a statutorily authorized program
thereof; or
[[Page 29889]]
(C) In the case of reinsurance only, by a person located outside
the United States to an insurance company that is eligible under
paragraph (xxx)(4)(ii) of this section, provided that:
(1) Such person is not prohibited by any law of any State or of the
United States from offering such agreement, contract, or transaction to
such an insurance company;
(2) The product to be reinsured meets the requirements under
paragraph (xxx)(4)(i) of this section to be insurance; and
(3) The total amount reimbursable by all reinsurers for such
insurance product cannot exceed the claims or losses paid by the
cedant.
(5) State. For purposes of paragraph (xxx)(4) of this section, the
term State means any state of the United States, the District of
Columbia, Puerto Rico, the U.S. Virgin Islands, or any other possession
of the United States.
(6) Anti-evasion. (i) An agreement, contract, or transaction that
is willfully structured to evade any provision of Subtitle A of the
Wall Street Transparency and Accountability Act of 2010, including any
amendments made to the Commodity Exchange Act thereby (Subtitle A),
shall be deemed a swap for purposes of Subtitle A and the rules,
regulations, and orders of the Commission promulgated thereunder.
(ii) An interest rate swap or currency swap, including but not
limited to a transaction identified in paragraph (xxx)(3)(v) of this
section, that is willfully structured as a foreign exchange forward or
foreign exchange swap to evade any provision of Subtitle A shall be
deemed a swap for purposes of Subtitle A and the rules, regulations,
and orders of the Commission promulgated thereunder.
(iii) An agreement, contract, or transaction of a bank that is not
under the regulatory jurisdiction of an appropriate Federal banking
agency (as defined in section 1a(2) of the Commodity Exchange Act),
where the agreement, contract, or transaction is willfully structured
as an identified banking product (as defined in section 402 of the
Legal Certainty for Bank Products Act of 2000) to evade the provisions
of the Commodity Exchange Act, shall be deemed a swap for purposes of
the Commodity Exchange Act and the rules, regulations, and orders of
the Commission promulgated thereunder.
(iv) The form, label, and written documentation of an agreement,
contract, or transaction shall not be dispositive in determining
whether the agreement, contract, or transaction has been willfully
structured to evade as provided in paragraphs (xxx)(6)(i) through
(xxx)(6)(iii) of this section.
(v) An agreement, contract, or transaction that has been willfully
structured to evade as provided in paragraphs (xxx)(6)(i) through
(xxx)(6)(iii) of this section shall be considered in determining
whether a person is a swap dealer or major swap participant.
(vi) Notwithstanding the foregoing, no agreement, contract, or
transaction structured as a security (including a security-based swap)
under the securities laws (as defined in section 3(a)(47) of the
Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(47))) shall be deemed
a swap pursuant to this Sec. 1.3(xxx)(6) or shall be considered for
purposes of paragraph (xxx)(6)(v) of this section.
(yyy) Narrow-based security index as used in the definition of
``security-based swap.''
(1) In general. Except as otherwise provided in paragraphs (zzz)
and (aaaa) of this section, for purposes of section 1a(42) of the
Commodity Exchange Act, the term narrow-based security index has the
meaning set forth in section 1a(35) of the Commodity Exchange Act, and
the rules, regulations and orders of the Commission thereunder.
(2) Tolerance period for swaps traded on designated contract
markets, swap execution facilities, and foreign boards of trade.
Notwithstanding paragraph (yyy)(1) of this section, solely for purposes
of swaps traded on or subject to the rules of a designated contract
market, swap execution facility, or foreign board of trade, a security
index underlying such swaps shall not be considered a narrow-based
security index if:
(i)(A) A swap on the index is traded on or subject to the rules of
a designated contract market, swap execution facility, or foreign board
of trade for at least 30 days as a swap on an index that was not a
narrow-based security index; or
(B) Such index was not a narrow-based security index during every
trading day of the six full calendar months preceding a date no earlier
than 30 days prior to the commencement of trading of a swap on such
index on a market described in paragraph (yyy)(2)(i)(A) of this
section; and
(ii) The index has been a narrow-based security index for no more
than 45 business days over three consecutive calendar months.
(3) Tolerance period for security-based swaps traded on national
securities exchanges or security-based swap execution facilities.
Notwithstanding paragraph (yyy)(1) of this section, solely for purposes
of security-based swaps traded on a national securities exchange or
security-based swap execution facility, a security index underlying
such security-based swaps shall be considered a narrow-based security
index if:
(i)(A) A security-based swap on the index is traded on a national
securities exchange or security-based swap execution facility for at
least 30 days as a security-based swap on a narrow-based security
index; or
(B) Such index was a narrow-based security index during every
trading day of the six full calendar months preceding a date no earlier
than 30 days prior to the commencement of trading of a security-based
swap on such index on a market described in paragraph (yyy)(3)(i)(A) of
this section; and
(ii) The index has been a security index that is not a narrow-based
security index for no more than 45 business days over three consecutive
calendar months.
(4) Grace period. (i) Solely with respect to a swap that is traded
on or subject to the rules of a designated contract market, swap
execution facility, or foreign board of trade, an index that becomes a
narrow-based security index under paragraph (yyy)(2) of this section
solely because it was a narrow-based security index for more than 45
business days over three consecutive calendar months shall not be a
narrow-based security index for the following three calendar months.
(ii) Solely with respect to a security-based swap that is traded on
a national securities exchange or security-based swap execution
facility, an index that becomes a security index that is not a narrow-
based security index under paragraph (yyy)(3) of this section solely
because it was not a narrow-based security index for more than 45
business days over three consecutive calendar months shall be a narrow-
based security index for the following three calendar months.
(zzz) Meaning of ``issuers of securities in a narrow-based security
index'' as used in the definition of ``security-based swap'' as applied
to index credit default swaps.
(1) Notwithstanding paragraph (yyy)(1) of this section, and solely
for purposes of determining whether a credit default swap is a
security-based swap under the definition of ``security-based swap'' in
section 3(a)(68)(A)(ii)(III) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(68)(A)(ii)(III), as incorporated in section 1a(42) of the
Commodity Exchange Act, the term issuers of securities in a narrow-
based security index means issuers of
[[Page 29890]]
securities identified in an index in which:
(i)(A) There are 9 or fewer non-affiliated issuers of securities
that are reference entities in the index, provided that an issuer of
securities shall not be deemed a reference entity for purposes of this
section unless:
(1) A credit event with respect to such reference entity would
result in a payment by the credit protection seller to the credit
protection buyer under the credit default swap based on the related
notional amount allocated to such reference entity; or
(2) The fact of such credit event or the calculation in accordance
with paragraph (zzz)(1)(i)(A)(1) of this section of the amount owed
with respect to such credit event is taken into account in determining
whether to make any future payments under the credit default swap with
respect to any future credit events;
(B) The effective notional amount allocated to any reference entity
included in the index comprises more than 30 percent of the index's
weighting;
(C) The effective notional amount allocated to any five non-
affiliated reference entities included in the index comprises more than
60 percent of the index's weighting; or
(D) Except as provided in paragraph (zzz)(2) of this section, for
each reference entity included in the index, none of the following
criteria is satisfied:
(1) The reference entity is required to file reports pursuant to
section 13 or section 15(d) of the Securities Exchange Act of 1934 (15
U.S.C. 78m or 78o(d));
(2) The reference entity is eligible to rely on the exemption
provided in rule 12g3-2(b) under the Securities Exchange Act of 1934
(17 CFR 240.12g3-2(b));
(3) The reference entity has a worldwide market value of its
outstanding common equity held by non-affiliates of $700 million or
more;
(4) The reference entity (other than an issuing entity of an asset-
backed security as defined in section 3(a)(77) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a)(77)) has outstanding securities
that are notes, bonds, debentures, or evidences of indebtedness having
a total remaining principal amount of at least $1 billion;
(5) The reference entity is the issuer of an exempted security as
defined in section 3(a)(12) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(12)) (other than any municipal security as defined in
section 3(a)(29) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(29)));
(6) The reference entity is a government of a foreign country or a
political subdivision of a foreign country;
(7) If the reference entity is an issuer of asset-backed securities
as defined in section 3(a)(77) of the Securities Exchange Act of 1934
(15 U.S.C. 78c(a)(77)), such asset-based securities were issued in a
transaction registered under the Securities Act of 1933 (15 U.S.C. 77a
et seq.) and have publicly available distribution reports; and
(8) For a credit default swap entered into solely between eligible
contract participants as defined in section 1a(18) of the Commodity
Exchange Act:
(i) The reference entity (other than a reference entity that is an
issuing entity of an asset-backed security as defined in section
3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77)))
provides to the public or to such eligible contract participant
information about the reference entity pursuant to rule 144A(d)(4)
under the Securities Act of 1933 (17 CFR 230.144A(d)(4));
(ii) Financial information about the reference entity (other than a
reference entity that is an issuing entity of an asset-backed security
as defined in section 3(a)(77) of the Securities Exchange Act of 1934
(15 U.S.C. 78c(a)(77))) is otherwise publicly available; or
(iii) In the case of a reference entity that is an issuing entity
of asset-backed securities as defined in section 3(a)(77) of the
Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77)), information of
the type and level included in public distribution reports for similar
asset-backed securities is publicly available about both the reference
entity and such asset-backed securities; and
(ii)(A) The index is not composed solely of reference entities that
are issuers of exempted securities as defined in section 3(a)(12) of
the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(12)), as in
effect on the date of enactment of the Futures Trading Act of 1982
(other than any municipal security as defined in section 3(a)(29) of
the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(29))), as in
effect on the date of enactment of the Futures Trading Act of 1982);
and
(B) Without taking into account any portion of the index composed
of reference entities that are issuers of exempted securities as
defined in section 3(a)(12) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(12)), as in effect on the date of enactment of the
Futures Trading Act of 1982 (other than any municipal security as
defined in section 3(a)(29) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(29))), the remaining portion of the index would be a
narrow-based security index under paragraph (zzz)(1)(i) of this
section.
(2) Paragraph (zzz)(1)(i)(D) of this section will not apply with
respect to a reference entity included in the index if:
(i) The effective notional amounts allocated to such reference
entity comprise less than five percent of the index's weighting; and
(ii) The effective notional amounts allocated to reference entities
that satisfy paragraph (zzz)(1)(i)(D) of this section comprise at least
80 percent of the index's weighting.
(3) For purposes of this paragraph (zzz):
(i) A reference entity is affiliated with another entity if it
controls, is controlled by, or is under common control with, that
entity; provided that each reference entity that is an issuing entity
of an asset-backed security as defined in section 3(a)(77) of the
Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77)) will not be
considered affiliated with any other issuing entity of an asset-backed
security.
(ii) Control means ownership of 20 percent or more of an entity's
equity, or the ability to direct the voting of 20 percent or more of
the entity's voting equity.
(iii) The term reference entity includes:
(A) An issuer of securities;
(B) An issuing entity of an asset-based security as defined in
section 3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(77)); and
(C) A single reference entity or a group of affiliated entities;
provided that each issuing entity of an asset-backed security as
defined in section 3(a)(77) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(77)) is a separate reference entity.
(aaaa) Meaning of ``narrow-based security index'' as used in the
definition of ``security-based swap'' as applied to index credit
default swaps.
(1) Notwithstanding paragraph (yyy)(1) of this section, and solely
for purposes of determining whether a credit default swap is a
security-based swap under the definition of ``security-based swap'' in
section 3(a)(68)(A)(ii)(I) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(68)(A)(ii)(I), as incorporated in section 1a(42) of the
Commodity Exchange Act, the term narrow-based security index means an
index in which:
(i)(A) The index is composed of 9 or fewer securities or securities
that are issued by 9 or fewer non-affiliated issuers, provided that a
security shall
[[Page 29891]]
not be deemed a component of the index for purposes of this section
unless:
(1) A credit event with respect to the issuer of such security or a
credit event with respect to such security would result in a payment by
the credit protection seller to the credit protection buyer under the
credit default swap based on the related notional amount allocated to
such security; or
(2) The fact of such credit event or the calculation in accordance
with paragraph (aaaa)(1)(i)(A)(1) of this section of the amount owed
with respect to such credit event is taken into account in determining
whether to make any future payments under the credit default swap with
respect to any future credit events;
(B) The effective notional amount allocated to the securities of
any issuer included in the index comprises more than 30 percent of the
index's weighting;
(C) The effective notional amount allocated to the securities of
any five non-affiliated issuers included in the index comprises more
than 60 percent of the index's weighting; or
(D) Except as provided in paragraph (aaaa)(2) of this section, for
each security included in the index, none of the following criteria is
satisfied:
(1) The issuer of the security is required to file reports pursuant
to section 13 or section 15(d) of the Securities Exchange Act of 1934
(15 U.S.C. 78m or 78o(d));
(2) The issuer of the security is eligible to rely on the exemption
provided in rule 12g3-2(b) under the Securities Exchange Act of 1934
(17 CFR 240.12g3-2(b));
(3) The issuer of the security has a worldwide market value of its
outstanding common equity held by non-affiliates of $700 million or
more;
(4) The issuer of the security (other than an issuing entity of an
asset-backed security as defined in section 3(a)(77) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a)(77))) has outstanding securities
that are notes, bonds, debentures, or evidences of indebtedness having
a total remaining principal amount of at least $1 billion;
(5) The security is an exempted security as defined in section
3(a)(12) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(12))
(other than any municipal security as defined in section 3(a)(29) of
the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(29)));
(6) The issuer of the security is a government of a foreign country
or a political subdivision of a foreign country;
(7) If the security is an asset-backed security as defined in
section 3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(77)), the security was issued in a transaction registered under
the Securities Act of 1933 (15 U.S.C. 77a et seq.) and has publicly
available distribution reports; and
(8) For a credit default swap entered into solely between eligible
contract participants as defined in section 1a(18) of the Commodity
Exchange Act:
(i) The issuer of the security (other than an issuing entity of an
asset-backed security as defined in section 3(a)(77) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a)(77))) provides to the public or
to such eligible contract participant information about such issuer
pursuant to rule 144A(d)(4) of the Securities Act of 1933 (17 CFR
230.144A(d)(4));
(ii) Financial information about the issuer of the security (other
than an asset-backed security as defined in section 3(a)(77) of the
Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77))) is otherwise
publicly available; or
(iii) In the case of an asset-backed security as defined in section
3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77)),
information of the type and level included in public distribution
reports for similar asset-backed securities is publicly available about
both the issuing entity and such asset-backed security; and
(ii)(A) The index is not composed solely of exempted securities as
defined in section 3(a)(12) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(12)), as in effect on the date of enactment of the
Futures Trading Act of 1982 (other than any municipal security as
defined in section 3(a)(29) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(29))), as in effect on the date of enactment of the
Futures Trading Act of 1982); and
(B) Without taking into account any portion of the index composed
of exempted securities as defined in section 3(a)(12) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a)(12)), as in effect on the date
of enactment of the Futures Trading Act of 1982 (other than any
municipal security as defined in section 3(a)(29) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a)(29))), the remaining portion of
the index would be a narrow-based security index under paragraph
(aaaa)(1)(i) of this section.
(2) Paragraph (aaaa)(1)(i)(D) of this section will not apply with
respect to securities of an issuer included in the index if:
(i) The effective notional amounts allocated to all securities of
such issuer included in the index comprise less than five percent of
the index's weighting; and
(ii) The securities that satisfy paragraph (aaaa)(1)(i)(D) of this
section comprise at least 80 percent of the index's weighting.
(3) For purposes of this paragraph (aaaa):
(i) An issuer is affiliated with another issuer if it controls, is
controlled by, or is under common control with, that issuer; provided
that each issuing entity of an asset-backed security as defined in
section 3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(77)) will not be considered affiliated with any other issuing
entity of an asset-backed security.
(ii) Control means ownership of 20 percent or more of an issuer's
equity, or the ability to direct the voting of 20 percent or more of
the issuer's voting equity.
(iii) The term issuer includes:
(A) An issuer of securities;
(B) An issuing entity of an asset-based security as defined in
section 3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(77)); and
(C) A single issuer or a group of affiliated issuers; provided that
each issuing entity of an asset-backed security as defined in section
3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77))
is a separate issuer.
3. Add Sec. Sec. 1.6 through 1.9 to read as follows:
Sec.
1.6 Anti-evasion.
1.7 Books and records requirements for security-based swap
agreements.
1.8 Interpretation of swaps, security-based swaps, and mixed swaps.
1.9 Regulation of mixed swaps.
* * * * *
Sec. 1.6 Anti-evasion.
(a) It shall be unlawful to conduct activities outside the United
States, including entering into agreements, contracts, and transactions
and structuring entities, to willfully evade or attempt to evade any
provision of the Commodity Exchange Act as enacted by Subtitle A of the
Wall Street Transparency and Accountability Act of 2010 or the rules,
regulations, and orders of the Commission promulgated thereunder
(Subtitle A).
(b) The form, label, and written documentation of an agreement,
contract, or transaction, or an entity, shall not be dispositive in
determining whether the agreement, contract, or transaction, or entity,
has been entered into or structured to willfully evade as
[[Page 29892]]
provided in paragraph (a) of this section.
(c) An activity conducted outside the United States to evade as
provided in paragraph (a) of this section shall be subject to the
provisions of Subtitle A.
(d) Notwithstanding the foregoing, no agreement, contract, or
transaction structured as a security (including a security-based swap)
under the securities laws (as defined in section 3(a)(47) of the
Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(47))) shall be deemed
a swap pursuant to this Sec. 1.6.
5. Add Sec. 1.7 to read as follows:
Sec. 1.7 Books and records requirements for security-based swap
agreements.
(a) A person registered as a swap data repository under section 21
of the Commodity Exchange Act and the rules and regulations thereunder:
(1) Shall not be required to keep and maintain additional books and
records regarding security-based swap agreements other than the books
and records regarding swaps required to be kept and maintained pursuant
to section 21 of the Commodity Exchange Act and the rules and
regulations thereunder; and
(2) Shall not be required to collect and maintain additional data
regarding security-based swap agreements other than the data regarding
swaps required to be collected and maintained by such persons pursuant
to section 21 of the Commodity Exchange Act and the rules and
regulations thereunder.
(b) A person shall not be required to keep and maintain additional
books and records, including daily trading records, regarding security-
based swap agreements other than the books and records regarding swaps
required to be kept and maintained by such persons pursuant to section
4s of the Commodity Exchange Act and the rules and regulations
thereunder if such person is registered as:
(1) A swap dealer under section 4s(a)(1) of the Commodity Exchange
Act and the rules and regulations thereunder;
(2) A major swap participant under section 4s(a)(2) of the
Commodity Exchange Act and the rules and regulations thereunder;
(3) A security-based swap dealer under section 15F(a)(1) of the
Securities Exchange Act of 1934 (15 U.S.C. 78o-10(a)(1)) and the rules
and regulations thereunder; or
(4) A major security-based swap participant under section 15F(a)(2)
of the Securities Exchange Act of 1934 (15 U.S.C. 78o-10(a)(2)) and the
rules and regulations thereunder.
(c) The term security-based swap agreement has the meaning set
forth in section 1a(47)(A)(v) of the Commodity Exchange Act.
6. Add Sec. 1.8 to read as follows:
Sec. 1.8 Interpretation of swaps, security-based swaps, and mixed
swaps.
(a) In general. Any person may submit a request to the Commission
and the Securities and Exchange Commission to provide a joint
interpretation of whether a particular agreement, contract, or
transaction (or class thereof) is:
(1) A swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act and the rules and regulations promulgated
thereunder;
(2) A security-based swap, as that term is defined in section
1a(42) of the Commodity Exchange Act and the rules and regulations
promulgated thereunder; or
(3) A mixed swap, as that term is defined in section 1a(47)(D) of
the Commodity Exchange Act and the rules and regulations promulgated
thereunder.
(b) Request process. In making a request pursuant to paragraph (a)
of this section, the requesting person must provide the Commission and
the Securities and Exchange Commission with the following:
(1) All material information regarding the terms of the agreement,
contract, or transaction (or class thereof);
(2) A statement of the economic characteristics and purpose of the
agreement, contract, or transaction (or class thereof);
(3) The requesting person's determination as to whether the
agreement, contract, or transaction (or class thereof) should be
characterized as a swap, a security-based swap, or both, (i.e., a mixed
swap), including the basis for such determination; and
(4) Such other information as may be requested by the Commission or
the Securities and Exchange Commission.
(c) Request withdrawal. A person may withdraw a request made
pursuant to paragraph (a) of this section at any time prior to the
issuance of a joint interpretation or joint notice of proposed
rulemaking by the Commission and the Securities and Exchange Commission
in response to the request; provided, however, that notwithstanding
such withdrawal, the Commission and the Securities and Exchange
Commission may provide a joint interpretation of whether the agreement,
contract, or transaction (or class thereof) is a swap, a security-based
swap, or both (i.e., a mixed swap).
(d) Request by the Commission or the Securities and Exchange
Commission. In the absence of a request for a joint interpretation
under paragraph (a) of this section:
(1) If the Commission or the Securities and Exchange Commission
receives a proposal to list, trade, or clear an agreement, contract, or
transaction (or class thereof) that raises questions as to the
appropriate characterization of such agreement, contract, or
transaction (or class thereof) as a swap, a security-based swap, or
both (i.e., a mixed swap), the Commission or the Securities and
Exchange Commission, as applicable, promptly shall notify the other of
the agreement, contract, or transaction (or class thereof); and
(2) The Commission or the Securities and Exchange Commission, or
their Chairmen jointly, may submit a request for a joint interpretation
as described in paragraph (a) of this section; such submission shall be
made pursuant to paragraph (b) of this section, and may be withdrawn
pursuant to paragraph (c) of this section.
(e) Timeframe for joint interpretation. (1) If the Commission and
the Securities and Exchange Commission determine to issue a joint
interpretation as described in paragraph (a) of this section, such
joint interpretation shall be issued within 120 days after receipt of a
complete submission requesting a joint interpretation under paragraph
(a) or (d) of this section.
(2) The Commission and the Securities and Exchange Commission shall
consult with the Board of Governors of the Federal Reserve System prior
to issuing any joint interpretation as described in paragraph (a) of
this section.
(3) If the Commission and the Securities and Exchange Commission
seek public comment with respect to a joint interpretation regarding an
agreement, contract, or transaction (or class thereof), the 120-day
period described in paragraph (e)(1) of this section shall be stayed
during the pendency of the comment period, but shall recommence with
the business day after the public comment period ends.
(4) Nothing in this section shall require the Commission and the
Securities and Exchange Commission to issue any joint interpretation.
(5) If the Commission and the Securities and Exchange Commission do
not issue a joint interpretation within the time period described in
paragraph (e)(1) or (e)(3) of this section, each of the Commission and
the Securities and Exchange Commission shall publicly provide the
reasons for not issuing such a joint interpretation within the
applicable timeframes.
(f) Joint notice of proposed rulemaking. (1) Rather than issue a
joint interpretation pursuant to paragraph (a) of this section, the
Commission and the
[[Page 29893]]
Securities and Exchange Commission may issue a joint notice of proposed
rulemaking, in consultation with the Board of Governors of the Federal
Reserve System, to further define one or more of the terms swap,
security-based swap, or mixed swap.
(2) A joint notice of proposed rulemaking described in paragraph
(f)(1) of this section shall be issued within the timeframe for issuing
a joint interpretation set forth in paragraph (e) of this section.
7. Add Sec. 1.9 to read as follows:
Sec. 1.9 Regulation of mixed swaps.
(a) In general. The term mixed swap has the meaning set forth in
section 1a(47)(D) of the Commodity Exchange Act.
(b) Regulation of bilateral uncleared mixed swaps entered into by
dually-registered dealers or major participants. A mixed swap:
(1) That is neither executed on nor subject to the rules of a
designated contract market, national securities exchange, swap
execution facility, security-based swap execution facility, or foreign
board of trade;
(2) That will not be submitted to a derivatives clearing
organization or registered or exempt clearing agency to be cleared; and
(3) Where at least one party is registered with the Commission as a
swap dealer or major swap participant and also with the Securities and
Exchange Commission as a security-based swap dealer or major security-
based swap participant, shall be subject to:
(i) The following provisions of the Commodity Exchange Act, and the
rules and regulations promulgated thereunder:
(A) Examinations and information sharing: sections 4s(f) and 8 of
the Commodity Exchange Act;
(B) Enforcement: sections 2(a)(1)(B), 4(b), 4b, 4c, 6(c), 6(d), 6c,
6d, 9, 13(a), 13(b), and 23 of the Commodity Exchange Act;
(C) Reporting to a swap data repository: section 4r of the
Commodity Exchange Act;
(D) Real-time reporting: section 2(a)(13) of the Commodity Exchange
Act;
(E) Capital: section 4s(e) of the Commodity Exchange Act; and
(F) Position Limits: section 4a of the Commodity Exchange Act; and
(ii) The provisions of the Federal securities laws, as defined in
section 3(a)(47) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(47)), and the rules and regulations promulgated thereunder.
(c) Process for determining regulatory treatment for other mixed
swaps--(1) In general. Any person who desires or intends to list,
trade, or clear a mixed swap (or class thereof) that is not subject to
paragraph (b) of this section may request the Commission and the
Securities and Exchange Commission to issue a joint order permitting
the requesting person (and any other person or persons that
subsequently lists, trades, or clears that mixed swap) to comply, as to
parallel provisions only, with specified parallel provisions of either
the Commodity Exchange Act or the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.), and the rules and regulations thereunder
(collectively, specified parallel provisions), instead of being
required to comply with parallel provisions of both the Commodity
Exchange Act and the Securities Exchange Act of 1934. For purposes of
this paragraph (c), parallel provisions means comparable provisions of
the Commodity Exchange Act and the Securities Exchange Act of 1934 that
were added or amended by the Wall Street Transparency and
Accountability Act of 2010 with respect to swaps and security-based
swaps, and the rules and regulations thereunder.
(2) Request process. A person submitting a request pursuant to
paragraph (c)(1) of this section must provide the Commission and the
Securities and Exchange Commission with the following:
(i) All material information regarding the terms of the specified,
or specified class of, mixed swap;
(ii) The economic characteristics and purpose of the specified, or
specified class of, mixed swap;
(iii) The specified parallel provisions, and the reasons the person
believes such specified parallel provisions would be appropriate for
the mixed swap (or class thereof); and
(iv) An analysis of:
(A) The nature and purposes of the parallel provisions that are the
subject of the request;
(B) The comparability of such parallel provisions;
(C) The extent of any conflicts or differences between such
parallel provisions; and
(D) Such other information as may be requested by the Commission or
the Securities and Exchange Commission.
(3) Request withdrawal. A person may withdraw a request made
pursuant to paragraph (c)(1) of this section at any time prior to the
issuance of a joint order under paragraph (c)(4) of this section by the
Commission and the Securities and Exchange Commission in response to
the request.
(4) Issuance of orders. In response to a request under paragraph
(c)(1) of this section, the Commission and the Securities and Exchange
Commission, as necessary to carry out the purposes of the Wall Street
Transparency and Accountability Act of 2010, may issue a joint order,
after notice and opportunity for comment, permitting the requesting
person (and any other person or persons that subsequently lists,
trades, or clears that mixed swap) to comply, as to parallel provisions
only, with the specified parallel provisions (or another subset of the
parallel provisions that are the subject of the request, as the
Commissions determine is appropriate), instead of being required to
comply with parallel provisions of both the Commodity Exchange Act and
the Securities Exchange Act of 1934. In determining the contents of
such joint order, the Commission and the Securities and Exchange
Commission may consider, among other things:
(i) The nature and purposes of the parallel provisions that are the
subject of the request;
(ii) The comparability of such parallel provisions; and
(iii) The extent of any conflicts or differences between such
parallel provisions.
(5) Timeframe. (i) If the Commission and the Securities and
Exchange Commission determine to issue a joint order as described in
paragraph (c)(4) of this section, such joint order shall be issued
within 120 days after receipt of a complete request for a joint order
under paragraph (c)(1) of this section, which time period shall be
stayed during the pendency of the public comment period provided for in
paragraph (c)(4) of this section and shall recommence with the business
day after the public comment period ends.
(ii) Nothing in this section shall require the Commission and the
Securities and Exchange Commission to issue any joint order.
(iii) If the Commission and the Securities and Exchange Commission
do not issue a joint order within the time period described in
paragraph (c)(5)(i) of this section, each of the Commission and the
Securities and Exchange Commission shall publicly provide the reasons
for not issuing such a joint order within that timeframe.
Securities and Exchange Commission
Pursuant to the Exchange Act, 15 U.S.C. 78a et seq., and
particularly, sections 3 and 23 thereof, and sections 712(a)(8),
712(d), 721(a), 761(a) of the Dodd-Frank Act, the SEC is proposing to
adopt rules 3a68-1a through 3a68-4 and
[[Page 29894]]
3a69-1 through 3a69-3 under the Exchange Act.
Text of Proposed Rules
For the reasons stated in the preamble, the SEC is proposing to
amend Title 17, Chapter II of the Code of the Federal Regulations as
follows:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
1. The general authority citation for Part 240 is revised to read
as follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i,
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4, 78o-8,
78p, 78q, 78s, 78u-5, 78w, 78x, 78dd(b), 78dd(c), 78ll, 78mm, 80a-
20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, and 7201 et seq.;
18 U.S.C. 1350; and 12 U.S.C. 5221(e)(3), unless otherwise noted.
* * * * *
2. Add Sec. Sec. 240.3a68-1a through 240.3a68-4 and Sec. Sec.
240.3a69-1 through 240.3a69-3 to read as follows:
240.3a68-1a Meaning of ``issuers of securities in a narrow-based
security index'' as used in section 3(a)(68)(A)(ii)(III) of the Act.
240.3a68-1b Meaning of ``narrow-based security index'' as used in
section 3(a)(68)(A)(ii)(I) of the Act.
240.3a68-2 Interpretation of swaps, security-based swaps, and mixed
swaps.
240.3a68-3 Meaning of ``narrow-based security index'' as used in the
definition of ``security-based swap''.
240.3a68-4 Regulation of mixed swaps.
240.3a69-1 Definition of ``swap'' as used in section 3(a)(69) of the
Act--insurance.
240.3a69-2 Definition of ``swap'' as used in section 3(a)(69) of the
Act--additional products.
240.3a69-3 Books and records requirements for security-based swap
agreements.
* * * * *
Sec. 240.3a68-1a Meaning of ``issuers of securities in a narrow-based
security index'' as used in section 3(a)(68)(A)(ii)(III) of the Act.
(a) Notwithstanding Sec. 240.3a68-3(a) of this chapter, and solely
for purposes of determining whether a credit default swap is a
security-based swap under section 3(a)(68)(A)(ii)(III) of the Act (15
U.S.C. 78c(a)(68)(A)(ii)(III)), the term issuers of securities in a
narrow-based security index as used in section 3(a)(68)(A)(ii)(III) of
the Act means issuers of securities identified in an index in which:
(1)(i) There are 9 or fewer non-affiliated issuers of securities
that are reference entities in the index, provided that an issuer of
securities shall not be deemed a reference entity for purposes of this
section unless:
(A) A credit event with respect to such reference entity would
result in a payment by the credit protection seller to the credit
protection buyer under the credit default swap based on the related
notional amount allocated to such reference entity; or
(B) The fact of such credit event or the calculation in accordance
with paragraph (a)(1)(i)(A) of this section of the amount owed with
respect to such credit event is taken into account in determining
whether to make any future payments under the credit default swap with
respect to any future credit events;
(ii) The effective notional amount allocated to any reference
entity included in the index comprises more than 30 percent of the
index's weighting;
(iii) The effective notional amount allocated to any five non-
affiliated reference entities included in the index comprises more than
60 percent of the index's weighting; or
(iv) Except as provided in paragraph (b) of this section, for each
reference entity included in the index, none of the following criteria
is satisfied:
(A) The reference entity is required to file reports pursuant to
section 13 or section 15(d) of the Act (15 U.S.C. 78m or 78o(d));
(B) The reference entity is eligible to rely on the exemption
provided in Sec. 240.12g3-2(b) of this chapter;
(C) The reference entity has a worldwide market value of its
outstanding common equity held by non-affiliates of $700 million or
more;
(D) The reference entity (other than an issuing entity of an asset-
backed security as defined in section 3(a)(77) of the Act (15 U.S.C.
78c(a)(77))) has outstanding securities that are notes, bonds,
debentures, or evidences of indebtedness having a total remaining
principal amount of at least $1 billion;
(E) The reference entity is the issuer of an exempted security as
defined in section 3(a)(12) of the Act (15 U.S.C. 78c(a)(12)) (other
than any municipal security as defined in section 3(a)(29) of the Act
(15 U.S.C. 78c(a)(29)));
(F) The reference entity is a government of a foreign country or a
political subdivision of a foreign country;
(G) If the reference entity is an issuer of asset-backed securities
as defined in section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)), such
asset-based securities were issued in a transaction registered under
the Securities Act of 1933 (15 U.S.C. 77a et seq.) and have publicly
available distribution reports; and
(H) For a credit default swap entered into solely between eligible
contract participants as defined in section 3(a)(65) of the Act (15
U.S.C. 78c(a)(65)):
(1) The reference entity (other than a reference entity that is an
issuing entity of an asset-backed security as defined in section
3(a)(77) of the Act (15 U.S.C. 78c(a)(77))) provides to the public or
to such eligible contract participant information about the reference
entity pursuant to Sec. 230.144A(d)(4)) of this chapter;
(2) Financial information about the reference entity (other than a
reference entity that is an issuing entity of an asset-backed security
as defined in section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77))) is
otherwise publicly available; or
(3) In the case of a reference entity that is an issuing entity of
asset-backed securities as defined in section 3(a)(77) of the Act (15
U.S.C. 78c(a)(77)), information of the type and level included in
public distribution reports for similar asset-backed securities is
publicly available about both the reference entity and such asset-
backed securities; and
(2)(i) The index is not composed solely of reference entities that
are issuers of exempted securities as defined in section 3(a)(12) of
the Act (15 U.S.C. 78c(a)(12)), as in effect on the date of enactment
of the Futures Trading Act of 1982 (other than any municipal security
as defined in section 3(a)(29) of the Act (15 U.S.C. 78c(a)(29))), as
in effect on the date of enactment of the Futures Trading Act of 1982);
and
(ii) Without taking into account any portion of the index composed
of reference entities that are issuers of exempted securities as
defined in section 3(a)(12) of the Act (15 U.S.C. 78c(a)(12)), as in
effect on the date of enactment of the Futures Trading Act of 1982
(other than any municipal security as defined in section 3(a)(29) of
the Act (15 U.S.C. 78c(a)(29))), the remaining portion of the index
would be a narrow-based security index under paragraph (a)(1) of this
section.
(b) Paragraph (a)(1)(iv) of this section will not apply with
respect to a reference entity included in the index if:
(1) The effective notional amounts allocated to such reference
entity comprise less than five percent of the index's weighting; and
(2) The effective notional amounts allocated to reference entities
that satisfy paragraph (a)(1)(iv) of this section comprise at least 80
percent of the index's weighting.
(c) For purposes of this Sec. 3a68-1a:
(1) A reference entity is affiliated with another entity if it
controls, is controlled by, or is under common control with,
[[Page 29895]]
that entity; provided that each reference entity that is an issuing
entity of an asset-backed security as defined in section 3(a)(77) of
the Act (15 U.S.C. 78c(a)(77)) will not be considered affiliated with
any other issuing entity of an asset-backed security.
(2) Control means ownership of 20 percent or more of an entity's
equity, or the ability to direct the voting of 20 percent or more of
the entity's voting equity.
(3) The term reference entity includes:
(i) An issuer of securities;
(ii) An issuing entity of an asset-based security as defined in
section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)); and
(iii) A single reference entity or a group of affiliated entities;
provided that each issuing entity of an asset-backed security as
defined in section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)) is a
separate reference entity.
Sec. 240.3a68-1b Meaning of ``narrow-based security index'' as used
in section 3(a)(68)(A)(ii)(I) of the Act.
(a) Notwithstanding Sec. 240.3a68-3(a) of this chapter, and solely
for purposes of determining whether a credit default swap is a
security-based swap under section 3(a)(68)(A)(ii)(I) of the Act (15
U.S.C. 78c(a)(68)(A)(ii)(I)), the term narrow-based security index as
used in section 3(a)(68)(A)(ii)(I) of the Act means an index in which:
(1)(i) The index is composed of 9 or fewer securities or securities
that are issued by 9 or fewer non-affiliated issuers, provided that a
security shall not be deemed a component of the index for purposes of
this section unless:
(A) A credit event with respect to the issuer of such security or a
credit event with respect to such security would result in a payment by
the credit protection seller to the credit protection buyer under the
credit default swap based on the related notional amount allocated to
such security; or
(B) The fact of such credit event or the calculation in accordance
with paragraph (a)(1)(i)(A) of this section of the amount owed with
respect to such credit event is taken into account in determining
whether to make any future payments under the credit default swap with
respect to any future credit events;
(ii) The effective notional amount allocated to the securities of
any issuer included in the index comprises more than 30 percent of the
index's weighting;
(iii) The effective notional amount allocated to the securities of
any five non-affiliated issuers included in the index comprises more
than 60 percent of the index's weighting; or
(iv) Except as provided in paragraph (b) of this section, for each
security included in the index none of the following criteria is
satisfied:
(A) The issuer of the security is required to file reports pursuant
to section 13 or section 15(d) of the Act (15 U.S.C. 78m or 78o(d));
(B) The issuer of the security is eligible to rely on the exemption
provided in Sec. 40.12g3-2(b) of this chapter;
(C) The issuer of the security has a worldwide market value of its
outstanding common equity held by non-affiliates of $700 million or
more;
(D) The issuer of the security (other than an issuing entity of an
asset-backed security as defined in section 3(a)(77) of the Act (15
U.S.C. 78c(a)(77))) has outstanding securities that are notes, bonds,
debentures, or evidences of indebtedness having a total remaining
principal amount of at least $1 billion;
(E) The security is an exempted security as defined in section
3(a)(12) of the Act (15 U.S.C. 78c(a)(12)) (other than any municipal
security as defined in section 3(a)(29) of the Act (15 U.S.C.
78c(a)(29)));
(F) The issuer of the security is a government of a foreign country
or a political subdivision of a foreign country;
(G) If the security is an asset-backed security as defined in
section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)), the security was
issued in a transaction registered under the Securities Act of 1933 (15
U.S.C. 77a et seq.) and has publicly available distribution reports;
and
(H) For a credit default swap entered into solely between eligible
contract participants as defined in section 3(a)(65) of the Act (15
U.S.C. 78c(a)(65)):
(1) The issuer of the security (other than an issuing entity of an
asset-backed security as defined in section 3(a)(77) of the Act (15
U.S.C. 78c(a)(77))) provides to the public or to such eligible contract
participant information about such issuer pursuant to Sec.
230.144A(d)(4)) of this chapter;
(2) Financial information about the issuer of the security (other
than an asset-backed security as defined in section 3(a)(77) of the Act
(15 U.S.C. 78c(a)(77))) is otherwise publicly available; or
(3) In the case of an asset-backed security as defined in section
3(a)(77) of the Act (15 U.S.C. 78c(a)(77)), information of the type and
level included in public distribution reports for similar asset-backed
securities is publicly available about both the issuing entity and such
asset-backed security; and
(2)(i) The index is not composed solely of exempted securities as
defined in section 3(a)(12) of the Act (15 U.S.C. 78c(a)(12)), as in
effect on the date of enactment of the Futures Trading Act of 1982
(other than any municipal security as defined in section 3(a)(29) of
the Act (15 U.S.C. 78c(a)(29))), as in effect on the date of enactment
of the Futures Trading Act of 1982); and
(ii) Without taking into account any portion of the index composed
of exempted securities as defined in section 3(a)(12) of the Act (15
U.S.C. 78c(a)(12)), as in effect on the date of enactment of the
Futures Trading Act of 1982 (other than any municipal security as
defined in section 3(a)(29) of the Act (15 U.S.C. 78c(a)(29))), the
remaining portion of the index would be a narrow-based security index
under paragraph (a)(1) of this section.
(b) Paragraph (a)(1)(iv) of this section will not apply with
respect to securities of an issuer included in the index if:
(1) The effective notional amounts allocated to all securities of
such issuer included in the index comprise less than five percent of
the index's weighting; and
(2) The securities that satisfy paragraph (a)(1)(iv) of this
section comprise at least 80 percent of the index's weighting.
(c) For purposes of this Sec. 240.3a68-1b:
(1) An issuer is affiliated with another issuer if it controls, is
controlled by, or is under common control with, that issuer; provided
that each issuing entity of an asset-backed security as defined in
section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)) will not be
considered affiliated with any other issuing entity of an asset-backed
security.
(2) Control means ownership of 20 percent or more of an issuer's
equity, or the ability to direct the voting of 20 percent or more of
the issuer's voting equity.
(3) The term issuer includes:
(i) An issuer of securities;
(ii) An issuing entity of an asset-based security as defined in
section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)); and
(iii) A single issuer or a group of affiliated issuers; provided
that each issuing entity of an asset-backed security as defined in
section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)) is a separate
issuer.
Sec. 240.3a68-2 Interpretation of swaps, security-based swaps, and
mixed swaps.
(a) In general. Any person may submit a request to the Commission
and the Commodity Futures Trading Commission to provide a joint
interpretation of whether a particular agreement, contract, or
transaction (or
[[Page 29896]]
class thereof) is a swap, as that term is defined in section 3(a)(69)
of the Act (15 U.S.C. 78c(a)(69)) and the rules and regulations
promulgated thereunder, a security-based swap, as that term is defined
in section 3(a)(68) of the Act (15 U.S.C. 78c(a)(68)) and the rules and
regulations promulgated thereunder, or a mixed swap, as that term is
defined in section 3(a)(68)(D) of the Act and the rules and regulations
promulgated thereunder.
(b) Request process. In making a request pursuant to paragraph (a)
of this section, the requesting person must provide the Commission and
the Commodity Futures Trading Commission with the following:
(1) All material information regarding the terms of the agreement,
contract, or transaction (or class thereof);
(2) A statement of the economic characteristics and purpose of the
agreement, contract, or transaction (or class thereof);
(3) The requesting person's determination as to whether the
agreement, contract, or transaction (or class thereof) should be
characterized as a swap, a security-based swap, or both (i.e., a mixed
swap), including the basis for such determination; and
(4) Such other information as may be requested by the Commission or
the Commodity Futures Trading Commission.
(c) Request withdrawal. A person may withdraw a request made
pursuant to paragraph (a) of this section at any time prior to the
issuance of a joint interpretation or joint notice of proposed
rulemaking by the Commission and the Commodity Futures Trading
Commission in response to the request; provided, however, that
notwithstanding such withdrawal, the Commission and the Commodity
Futures Trading Commission may provide a joint interpretation of
whether the agreement, contract, or transaction (or class thereof) is a
swap, a security-based swap, or both (i.e., a mixed swap).
(d) Request by the Commission or the Commodity Futures Trading
Commission. In the absence of a request for a joint interpretation
under paragraph (a) of this section:
(1) If the Commission or the Commodity Futures Trading Commission
receives a proposal to list, trade, or clear an agreement, contract, or
transaction (or class thereof) that raises questions as to the
appropriate characterization of such agreement, contract, or
transaction (or class thereof) as a swap, a security-based swap, or
both (i.e., a mixed swap), the Commission or the Commodity Futures
Trading Commission, as applicable, promptly shall notify the other of
the agreement, contract, or transaction (or class thereof); and
(2) The Commission or the Commodity Futures Trading Commission, or
their Chairmen jointly, may submit a request for a joint interpretation
as described in paragraph (a) of this section; such submission shall be
made pursuant to paragraph (b) of this section, and may be withdrawn
pursuant to paragraph (c) of this section.
(e) Timeframe for joint interpretation.
(1) If the Commission and the Commodity Futures Trading Commission
determine to issue a joint interpretation as described in paragraph (a)
of this section, such joint interpretation shall be issued within 120
days after receipt of a complete submission requesting a joint
interpretation under paragraph (a) or (d) of this section.
(2) The Commission and the Commodity Futures Trading Commission
shall consult with the Board of Governors of the Federal Reserve System
prior to issuing any joint interpretation as described in paragraph (a)
of this section.
(3) If the Commission and the Commodity Futures Trading Commission
seek public comment with respect to a joint interpretation regarding an
agreement, contract, or transaction (or class thereof), the 120-day
period described in paragraph (e)(1) of this section shall be stayed
during the pendency of the comment period, but shall recommence with
the business day after the public comment period ends.
(4) Nothing in this section shall require the Commission and the
Commodity Futures Trading Commission to issue any joint interpretation.
(5) If the Commission and the Commodity Futures Trading Commission
do not issue a joint interpretation within the time period described in
paragraph (e)(1) or (e)(3) of this section, each of the Commission and
the Commodity Futures Trading Commission shall publicly provide the
reasons for not issuing such a joint interpretation within the
applicable timeframes.
(f) Joint notice of proposed rulemaking.
(1) Rather than issue a joint interpretation pursuant to paragraph
(a) of this section, the Commission and the Commodity Futures Trading
Commission may issue a joint notice of proposed rulemaking, in
consultation with the Board of Governors of the Federal Reserve System,
to further define one or more of the terms swap, security-based swap,
or mixed swap.
(2) A joint notice of proposed rulemaking described in paragraph
(f)(1) of this section shall be issued within the timeframe for issuing
a joint interpretation set forth in paragraph (e) of this section.
Sec. 240.3a68-3 Meaning of ``narrow-based security index'' as used in
the definition of ``security-based swap.''
(a) In general. Except as otherwise provided in Sec. 240.3a68-1a
and Sec. 240.3a68-1b of this chapter, for purposes of section 3(a)(68)
of the Act (15 U.S.C. 78c(a)(68)), the term narrow-based security index
has the meaning set forth in section 3(a)(55) of the Act (15 U.S.C.
78c(a)(55)), and the rules, regulations, and orders of the Commission
thereunder.
(b) Tolerance period for swaps traded on designated contract
markets, swap execution facilities and foreign boards of trade.
Notwithstanding paragraph (a) of this section, solely for purposes of
swaps traded on or subject to the rules of a designated contract
market, swap execution facility, or foreign board of trade pursuant to
the Commodity Exchange Act (7 U.S.C. 1 et seq.), a security index
underlying such swaps shall not be considered a narrow-based security
index if:
(1)(i) A swap on the index is traded on or subject to the rules of
a designated contract market, swap execution facility, or foreign board
of trade pursuant to the Commodity Exchange Act (7 U.S.C. 1 et seq.)
for at least 30 days as a swap on an index that was not a narrow-based
security index; or
(ii) Such index was not a narrow-based security index during every
trading day of the six full calendar months preceding a date no earlier
than 30 days prior to the commencement of trading of a swap on such
index on a market described in paragraph (b)(1)(i) of this section; and
(2) The index has been a narrow-based security index for no more
than 45 business days over three consecutive calendar months.
(c) Tolerance period for security-based swaps traded on national
securities exchanges or security-based swap execution facilities.
Notwithstanding paragraph (a) of this section, solely for purposes of
security-based swaps traded on a national securities exchange or
security-based swap execution facility, a security index underlying
such security-based swaps shall be considered a narrow-based security
index if:
(1)(i) A security-based swap on the index is traded on a national
securities
[[Page 29897]]
exchange or security-based swap execution facility for at least 30 days
as a security-based swap on a narrow-based security index; or
(ii) Such index was a narrow-based security index during every
trading day of the six full calendar months preceding a date no earlier
than 30 days prior to the commencement of trading of a security-based
swap on such index on a market described in paragraph (c)(1)(i) of this
section; and
(2) The index has been a security index that is not a narrow-based
security index for no more than 45 business days over three consecutive
calendar months.
(d) Grace period.
(1) Solely with respect to a swap that is traded on or subject to
the rules of a designated contract market, swap execution facility or
foreign board of trade pursuant to the Commodity Exchange Act (7 U.S.C.
1 et seq.), an index that becomes a narrow-based security index under
paragraph (b) of this section solely because it was a narrow-based
security index for more than 45 business days over three consecutive
calendar months shall not be a narrow-based security index for the
following three calendar months.
(2) Solely with respect to a security-based swap that is traded on
a national securities exchange or security-based swap execution
facility, an index that becomes a security index that is not a narrow-
based security index under paragraph (c) of this section solely because
it was not a narrow-based security index for more than 45 business days
over three consecutive calendar months shall be a narrow-based security
index for the following three calendar months.
Sec. 240.3a68-4 Regulation of mixed swaps.
(a) In general. The term mixed swap has the meaning set forth in
section 3(a)(68)(D) of the Act (15 U.S.C. 78c(a)(68)(D)).
(b) Regulation of mixed swaps entered into by dually-registered
dealers or major participants. A mixed swap:
(1) That is neither executed on nor subject to the rules of a
designated contract market, national securities exchange, swap
execution facility, security-based swap execution facility, or foreign
board of trade;
(2) That will not be submitted to a derivatives clearing
organization or registered or exempt clearing agency to be cleared; and
(3) Where at least one party is registered with the Commission as a
security-based swap dealer or major security-based swap participant and
also with the Commodity Futures Trading Commission as a swap dealer or
major swap participant, shall be subject to:
(i) The following provisions of the Commodity Exchange Act (7
U.S.C. 1 et seq.), and the rules and regulations promulgated
thereunder, set forth in the rules and regulations of the Commodity
Futures Trading Commission:
(A) Examinations and information sharing: 7 U.S.C. 6s(f) and 12;
(B) Enforcement: 7 U.S.C. 2(a)(1)(B), 6(b), 6b, 6c, 9, 13b, 13a-1,
13a-2, 13, 13c(a), 13c(b), 15 and 26;
(C) Reporting to a swap data repository: 7 U.S.C. 6r;
(D) Real-time reporting: 7 U.S.C. 2(a)(13);
(E) Capital: 7 U.S.C. 6s(e); and
(F) Position Limits: 7 U.S.C. 6a; and
(ii) The provisions of the Federal securities laws, as defined in
section 3(a)(47) of the Act (15 U.S.C. 78c(a)(47)), and the rules and
regulations promulgated thereunder.
(c) Process for determining regulatory treatment for mixed swaps.
(1) In general. Any person who desires or intends to list, trade,
or clear a mixed swap (or class thereof) that is not subject to
paragraph (b) of this section may request the Commission and the
Commodity Futures Trading Commission to issue a joint order permitting
the requesting person (and any other person or persons that
subsequently lists, trades, or clears that mixed swap) to comply, as to
parallel provisions only, with specified parallel provisions of either
the Act (15 U.S.C. 78a et seq.) or the Commodity Exchange Act (7 U.S.C.
1 et seq.), and the rules and regulations thereunder (collectively,
specified parallel provisions), instead of being required to comply
with parallel provisions of both the Act and the Commodity Exchange
Act. For purposes of this paragraph (c), parallel provisions means
comparable provisions of the Act and the Commodity Exchange Act that
were added or amended by the Wall Street Transparency and
Accountability Act of 2010 with respect to security-based swaps and
swaps, and the rules and regulations thereunder.
(2) Request process. A person submitting a request pursuant to
paragraph (c)(1) of this section must provide the Commission and the
Commodity Futures Trading Commission with the following:
(i) All material information regarding the terms of the specified,
or specified class of, mixed swap;
(ii) The economic characteristics and purpose of the specified, or
specified class of, mixed swap;
(iii) The specified parallel provisions, and the reasons the person
believes such specified parallel provisions would be appropriate for
the mixed swap (or class thereof); and
(iv) An analysis of:
(A) The nature and purposes of the parallel provisions that are the
subject of the request;
(B) The comparability of such parallel provisions;
(C) The extent of any conflicts or differences between such
parallel provisions; and
(D) Such other information as may be requested by the Commission or
the Commodity Futures Trading Commission.
(3) Request withdrawal. A person may withdraw a request made
pursuant to paragraph (c)(1) of this section at any time prior to the
issuance of a joint order under paragraph (c)(4) of this section by the
Commission and the Commodity Futures Trading Commission in response to
the request.
(4) Issuance of orders. In response to a request under paragraph
(c)(1) of this section, the Commission and the Commodity Futures
Trading Commission, as necessary to carry out the purposes of the Wall
Street Transparency and Accountability Act of 2010, may issue a joint
order, after notice and opportunity for comment, permitting the
requesting person (and any other person or persons that subsequently
lists, trades, or clears that mixed swap) to comply, as to parallel
provisions only, with the specified parallel provisions (or another
subset of the parallel provisions that are the subject of the request,
as the Commissions determine is appropriate), instead of being required
to comply with parallel provisions of both the Act (15 U.S.C. 78a et
seq.) and the Commodity Exchange Act (7 U.S.C. 1 et seq.). In
determining the contents of such joint order, the Commission and the
Commodity Futures Trading Commission may consider, among other things:
(i) The nature and purposes of the parallel provisions that are the
subject of the request;
(ii) The comparability of such parallel provisions; and
(iii) The extent of any conflicts or differences between such
parallel provisions.
(5) Timeframe.
(i) If the Commission and the Commodity Futures Trading Commission
determine to issue a joint order as described in paragraph (c)(4) of
this section, such joint order shall be issued within 120 days after
receipt of a complete request for a joint order under paragraph (c)(1)
of this section, which time period shall be stayed
[[Page 29898]]
during the pendency of the public comment period provided for in
paragraph (c)(4) of this section and shall recommence with the business
day after the public comment period ends.
(ii) Nothing in this section shall require the Commission and the
Commodity Futures Trading Commission to issue any joint order.
(iii) If the Commission and the Commodity Futures Trading
Commission do not issue a joint order within the time period described
in paragraph (c)(5)(i) of this section, each of the Commission and the
Commodity Futures Trading Commission shall publicly provide the reasons
for not issuing such a joint order within that timeframe.
Sec. 240.3a69-1 Definition of ``swap'' as used in section 3(a)(69) of
the Act--Insurance
The term swap as used in section 3(a)(69) of the Act (15 U.S.C.
78c(a)(69)) does not include an agreement, contract, or transaction
that:
(a) By its terms or by law, as a condition of performance on the
agreement, contract, or transaction:
(1) Requires the beneficiary of the agreement, contract, or
transaction to have an insurable interest that is the subject of the
agreement, contract, or transaction and thereby carry the risk of loss
with respect to that interest continuously throughout the duration of
the agreement, contract, or transaction;
(2) Requires that loss to occur and to be proved, and that any
payment or indemnification therefor be limited to the value of the
insurable interest;
(3) Is not traded, separately from the insured interest, on an
organized market or over-the-counter; and
(4) With respect to financial guaranty insurance only, in the event
of payment default or insolvency of the obligor, any acceleration of
payments under the policy is at the sole discretion of the insurer; and
(b) Is provided:
(1) By a company that is organized as an insurance company whose
primary and predominant business activity is the writing of insurance
or the reinsuring of risks underwritten by insurance companies and that
is subject to supervision by the insurance commissioner (or similar
official or agency) of any State, as defined in section 3(a)(16) of the
Act (15 U.S.C. 78c(a)(16)), or by the United States or an agency or
instrumentality thereof, and such agreement, contract, or transaction
is regulated as insurance under the laws of such State or of the United
States;
(2) By the United States or any of its agencies or
instrumentalities, or pursuant to a statutorily authorized program
thereof; or
(3) In the case of reinsurance only, by a person located outside
the United States to an insurance company that is eligible under
paragraph (b) of this section, provided that:
(i) Such person is not prohibited by any law of any State or of the
United States from offering such agreement, contract, or transaction to
such an insurance company;
(ii) The product to be reinsured meets the requirements under
paragraph (a) of this section to be insurance; and
(iii) The total amount reimbursable by all reinsurers for such
insurance product cannot exceed the claims or losses paid by the
cedant.
Sec. 240.3a69-2 Definition of ``swap'' as used in section 3(a)(69) of
the Act--Additional Products.
(a) In general. The term swap has the meaning set forth in section
3(a)(69) of the Act (15 U.S.C. 78c(a)(69)).
(b) Inclusion of particular products. (1) The term swap includes,
without limiting the meaning set forth in section 3(a)(69) of the Act
(15 U.S.C. 78c(a)(69), the following agreements, contracts, and
transactions:
(i) A cross-currency swap;
(ii) A currency option, foreign currency option, foreign exchange
option and foreign exchange rate option;
(iii) A foreign exchange forward;
(iv) A foreign exchange swap;
(v) A forward rate agreement; and
(vi) A non-deliverable forward involving foreign exchange.
(2) The term swap does not include an agreement, contract, or
transaction described in paragraph (b)(1) of this section that is
otherwise excluded by section 1a(47)(B) of the Commodity Exchange Act
(7 U.S.C. 1a(47)(B)).
(c) Foreign exchange forwards and foreign exchange swaps.
Notwithstanding paragraph (b)(2) of this section:
(1) A foreign exchange forward or a foreign exchange swap shall not
be considered a swap if the Secretary of the Treasury makes a
determination described in section 1a(47)(E)(i) of the Commodity
Exchange Act (7 U.S.C. 1a(47)(E)(i)).
(2) Notwithstanding paragraph (c)(1) of this section:
(i) The reporting requirements set forth in section 4r of the
Commodity Exchange Act (7 U.S.C. 6r) and regulations promulgated
thereunder shall apply to a foreign exchange forward or foreign
exchange swap; and
(ii) The business conduct standards set forth in section 4s of the
Commodity Exchange Act (7 U.S.C. 6s) and regulations promulgated
thereunder shall apply to a swap dealer or major swap participant that
is a party to a foreign exchange forward or foreign exchange swap.
(3) For purposes of section 1a(47)(E) of the Commodity Exchange Act
(7 U.S.C. 1a(47)(E)) and this Sec. 240.3a69-2, the term foreign
exchange forward has the meaning set forth in section 1a(24) of the
Commodity Exchange Act (7 U.S.C. 1a(24)).
(4) For purposes of section 1a(47)(E) of the Commodity Exchange Act
(7 U.S.C. 1a(47)(E)) and this Sec. 240.3a69-2, the term foreign
exchange swap has the meaning set forth in section 1a(25) of the
Commodity Exchange Act (7 U.S.C. 1a(25)).
(5) For purposes of sections 1a(24) and 1a(25) of the Commodity
Exchange Act (7 U.S.C. 1a(24) and (25)) and this Sec. 240.3a69-2, the
following transactions are not foreign exchange forwards or foreign
exchange swaps:
(i) A currency swap or a cross-currency swap;
(ii) A currency option, foreign currency option, foreign exchange
option, or foreign exchange rate option; and
(iii) A non-deliverable forward involving foreign exchange.
Sec. 240.3a69-3 Books and records requirements for security-based
swap agreements.
(a) A person registered as a swap data repository under section 21
of the Commodity Exchange Act (7 U.S.C. 24a) and the rules and
regulations thereunder:
(1) Shall not be required to keep and maintain additional books and
records regarding security-based swap agreements other than the books
and records regarding swaps required to be kept and maintained pursuant
to section 21 of the Commodity Exchange Act (7 U.S.C. 24a) and the
rules and regulations thereunder; and
(2) Shall not be required to collect and maintain additional data
regarding security-based swap agreements other than the data regarding
swaps required to be collected and maintained by such persons pursuant
to section 21 of the Commodity Exchange Act (7 U.S.C. 24a) and the
rules and regulations thereunder.
(b) A person shall not be required to keep and maintain additional
books and records, including daily trading records, regarding security-
based swap agreements other than the books and records regarding swaps
required to be kept and maintained by such persons pursuant to section
4s of the Commodity Exchange Act (7 U.S.C. 6s) and the rules
[[Page 29899]]
and regulations thereunder if such person is registered as:
(1) A swap dealer under section 4s(a)(1) of the Commodity Exchange
Act (7 U.S.C. 6s(a)(1)) and the rules and regulations thereunder;
(2) A major swap participant under section 4s(a)(2) of the
Commodity Exchange Act (7 U.S.C. 6s(a)(2)) and the rules and
regulations thereunder;
(3) A security-based swap dealer under section 15F(a)(1) of the Act
(15 U.S.C. 78o-10(a)(1)) and the rules and regulations thereunder; or
(4) A major security-based swap participant under section 15F(a)(2)
of the Act (15 U.S.C. 78o-10(a)(2)) and the rules and regulations
thereunder.
(c) The term security-based swap agreement has the meaning set
forth in section 3(a)(78) of the Act (15 U.S.C. 78c(a)(78)).
Dated: April 29, 2011.
By the Commodity Futures Trading Commission.
David A. Stawick,
Secretary.
Dated: April 29, 2011.
By the Securities and Exchange Commission.
Cathy H. Ahn,
Deputy Secretary.
Product Definitions Contained in Title VII of the Dodd-Frank Wall
Street Reform and Consumer Protection Act--CFTC Voting Summary and
Statements of CFTC Commissioners
Note: The following will not appear in the Code of Federal
Regulations.
CFTC Voting Summary
On this matter, Chairman Gensler and Commissioners Dunn, Chilton
and O'Malia voted in the affirmative; Commissioner Sommers voted in the
negative.
Statement of CFTC Chairman Gary Gensler
I support the proposed rulemaking to implement the Dodd-Frank Act's
requirement to further define derivatives products that come under
Title VII of the Act.
The CFTC worked closely with the SEC, in consultation with the
Federal Reserve, on this proposed rule to further define swaps,
security-based swaps, mixed swaps and security-based swap agreements.
The statutory definition of swap is very detailed. This rule is
consistent with that detailed definition and Congressional intent. For
example, interest rate swaps, currency swaps, commodity swaps,
including energy, metals and agricultural swaps, and broad-based index
swaps, such as index credit default swaps, are all swaps. Consistent
with Congress's definition of swaps, the rule also defines options as
swaps.
In preparing the proposed rule, staff worked to address the more
than 80 comments that were submitted by the public in response to the
joint advance notice of proposed rulemaking on product definitions.
Many of the commenters asked that the Commissions specifically provide
guidance on what is not a swap or security-based swap.
For example, under the Commodity Exchange Act, the CFTC does not
regulate forward contracts. Over the decades, there has been a series
of orders, interpretations and cases that market participants have come
to rely upon regarding the exception from futures regulation for
forwards and forwards with embedded options. Consistent with that
history, the Dodd-Frank Act excluded from the definition of swaps ``any
sale of a nonfinancial commodity or security for deferred shipment or
delivery, so long as the transaction is intended to be physically
settled.'' The proposed rule interprets that exclusion in a manner that
is consistent with the Commission's previous history of the forward
exclusion from futures regulation.
Further, consistent with the Dodd-Frank Act, the proposed rule
clarifies that state or Federally regulated insurance products that are
provided by regulated insurance companies will not be regulated under
Title VII of the Act. Similarly, the proposal clarifies that certain
consumer and commercial arrangements that historically have not been
considered swaps, such as consumer mortgage rate locks, contracts to
lock in the price of home heating oil and contracts relating to
inventory or equipment, also will not be regulated under Title VII of
the Act.
Statement of CFTC Commissioner Jill Sommers
I respectfully dissent from the action taken today by the
Commission to issue proposed regulations relating to ``Product
Definitions Contained in Title VII of the Dodd-Frank Wall Street Reform
and Consumer Protection Act.''
I disagree with the approach taken by the Commission with regard to
the proposed ``Anti-Evasion'' provisions. I agree that Dodd-Frank
Section 721(c) directs the Commission to further define certain terms
to include transactions or entities that have been structured to evade
Dodd-Frank. I do not agree that Congress directed the Commission to
promulgate broad ``Anti-Evasion'' provisions, and I point out that the
Securities and Exchange Commission today has declined to promulgate
such provisions in this joint rulemaking.
By promulgating a broad regulation today that essentially says that
any transaction that does not fall within the definition of ``swap''
because it has been structured to evade Dodd-Frank nonetheless is a
swap, the Commission is over-reading its Congressional mandate. The
statutory definition of ``swap'' includes a laundry-list of
transactions that Congress intended to include within the definition.
If Congress intended the definition of ``swap'' also to include a broad
statement that any transaction structured to evade Dodd-Frank is a
``swap,'' Congress would have incorporated such a provision within the
statutory definition. By directing the Commission to ``further define''
the term ``swap'' by rule, Congress is directing the Commission not to
make the broad statement it declined to make, but to think through
whether the definition of ``swap'' needs to be modified by rule to
include specific transactions within the definition.
In addition to my concern about the ``Anti-Evasion'' provisions
included within this proposal, I am concerned about an important issue
that is not raised within this proposal. Multinational organizations
whose statutory mission is to combat poverty and foster economic
development have raised concerns about the application of Dodd-Frank to
their activities. This proposal omits any discussion of their issues.
In my view the following language should be included within the
proposal, and I urge the public to comment upon the issues raised:
Transactions Involving Certain Foreign or Multinational Entities
The swap definition expressly excludes ``any agreement, contract,
or transaction a counterparty of which is a Federal Reserve bank, the
Federal Government, or a Federal agency that is expressly backed by the
full faith and credit of the United States.'' \399\ Some commenters
have suggested that the Commissions should exercise their authority to
further define the terms ``swap'' and ``security-based swap'' to
similarly exclude transactions in which a counterparty is an
international public organization, a foreign central bank, a foreign
sovereign, or a multi-or supra-national organization.\400\ Commenters
[[Page 29900]]
have advanced international comity, national treatment, limited
regulatory resources, limits on the Commissions' respective
extraterritorial jurisdiction, and international harmonization as
rationales for such an approach.\401\
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\399\ 7 U.S.C. 1a(47)(B)(ix).
\400\ See, e.g., letter from Gunter Pleines, Head of Banking
Department, and Diego Devos, General Counsel, Bank for International
Settlements (``BIS Letter''); Cleary Letter. The Commissions note
that various other terms may be used to refer to organizations that
generally: (i) Limit their membership to sovereign nations; (ii) are
established by treaty; (iii) have a separate legal identity from
their members; and (iv) ``are usually specialized and of
international or regional scope'' and ``formed between three or more
nations to work on issues that relate to all of the countries in the
organization. See, e.g., http://portal.unesco.org/en/ev.php-URL_ID=32408&URL_DO=DO_TOPIC&URL_SECCTION=201.html; http://www.geni.org/globalenergy/library/organizations/index.shtml. For
convenience, the Commissions use the term ``supranational
organization'' herein to refer to organizations having such
characteristics.
\401\ See, e.g., BIS Letter (citing Article 1, paragraph 4, of
the proposed EU Regulation on Central Clearing of OTC Derivatives,
available at http://register.consilium.europa.eu/pdf/en/11/st05/st05059.en11.pdf, which excludes from its coverage the BIS,
multilateral development banks, European central banks and similarly
situated ``other national bodies performing similar functions and
other public bodies charged with or intervening in the management of
the public debt'').
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Request for Comment
The Commissions request comment generally on the
appropriate application of the Dodd-Frank Act to international public
organizations, foreign central banks, foreign sovereigns (or foreign
sovereign wealth funds), supranational organizations, and any other
foreign or multinational entity that may be analogous to the entities
excluded from the swap definition in CEA Section 1a(47)(B)(ix).
Should the Commissions further define the terms ``swap''
and ``security-based swap'' to exclude transactions in which a
counterparty is an international public organization, foreign central
bank, foreign sovereign (or foreign sovereign wealth fund),
supranational organization, or any other foreign or multinational
entity that may be analogous to an entity excluded from the swap
definition in CEA Section 1a(47)(B)(ix)? Why or why not? If so, how
should the Commissions delineate the scope of entities whose
transactions would be excluded? Please describe in detail the nature of
the entity whose transactions would be excluded and explain the reasons
for such an exclusion. Would such an exclusion inappropriately cause
transactions that should be regulated as swaps or security-based swaps
to fall outside of the regulatory regime established by the Dodd-Frank
Act? Why or why not?
If the Commissions further define the terms ``swap'' and
``security-based swap'' to exclude any such entity, should the
exclusion be subject to any conditions, or should the exclusion be
limited to particular requirements of Title VII? Why or why not? If so,
what conditions would be appropriate, and/or what requirements of Title
VII should the exclusion apply to, and why?
If the Commissions further define the terms ``swap'' and
``security-based swap'' to exclude any such entity, to what extent
should counterparties to such transactions be subject to the
requirements of Title VII? What would be the appropriate regulatory
treatment of such counterparties in these circumstances?
[FR Doc. 2011-11008 Filed 5-20-11; 8:45 am]
BILLING CODE 6351-01-P; 8011-01-P